Narasimham Committee on Banking Sector Reforms From the 1991 India economic crisis to its status of fourth largest

economy in the world by 2010, India has grown significantly in terms of economic development. So has its banking sector. During this period, recognizing the evolving needs of the sector, the Finance Ministry of Government of India (GOI) set up various committees with the task of analyzing India's banking sector and recommending legislation and regulations to make it more effective, competitive and efficient.[1] Two such expert Committees were set up under the chairmanship of M. Narasimham. They submitted their recommendations in the 1990s in reports widely known as the Narasimham Committee-I (1991) report and the Narasimham Committee-II (1998) Report. These recommendations not only helped unleash the potential of banking in India, they are also recognized as a factor towards minimizing the impact of global financial crisis starting in 2007. Unlike the socialist-democratic era of the 1960s to 1980s, India is no longer insulated from the global economy and yet its banks survived the 2008 financial crisis relatively unscathed, a feat due in part to these Narasimham Committees.

Background During the decades of the 60s and the 70s, India nationalisated most of its banks. This culminated with the balance of payments crisis of the Indian economy where India had to airlift gold to International Monetary Fund (IMF) to loan money to meet its financial obligations. This event called into question the previous banking policies of India and triggered the era of economic liberalisation in India in 1991. Given that rigidities and weaknesses had made serious inroads into the Indian banking system by the late 1980s, the Government of India (GOI), post-crisis, took several steps to remodel the country's financial system. (Some claim that these reforms were influenced by the IMF and the World Bank as part of their loan conditionality to India in 1991).[3] The banking sector, handling 80% of the flow of money in the economy, needed serious reforms to make it internationally reputable, accelerate the pace of reforms and develop it into a constructive usher of an efficient, vibrant and competitive economy by adequately supporting the country's financial needs.[4] In the light of these requirements, two expert Committees were set up in 1990s under the chairmanship of M. Narasimham (an ex-RBI (Reserve Bank of India) governor) which are widely credited for spearheading the financial sector reform in India.[3] The first Narasimhan Committee (Committee on the Financial System - CFS) was appointed by Manmohan Singh as India's Finance Minister on 14th August 1991,[5] [1] and the second one (Committee on Banking Sector Reforms)[6] was appointed by P.Chidambaram[7] as Finance Minister in December 1997.[8] Subsequently, the first one widely came to be known as the Narasimham Committee-I (1991) and the second one as Narasimham-II Committee(1998).[9][10] This article is about the

[4][6] Secondly.recommendations of the Second Narasimham Committee. organization. the Committee on Banking Sector Reforms. The Committee submitted its report to the Finance Minister in November 1991 which was tabled in Parliament on 17th December 1991. submitted the report of the Committee on Banking Sector Reforms (Committee-II) to the Finance Minister Yashwant Sinha in April 1998. training and remuneration policies of public sector banks be brought in line with the bestmarket-practices of professional bank management.[4][12][13] It also recommended the RBI relinquish its seats on the board of directors of these banks.[4] As such the committee recommended a review of functions of banks boards with a view to make them responsible for enhancing shareholder value through formulation of corporate strategy and reduction of government equity. Chairman. The purpose of the Narasimham-I Committee was to study all aspects relating to the structure.[6] The Narasimham-II Committee was tasked with the progress review of the implementation of the banking reforms since 1992 with the aim of further strengthening the financial institutions of India.[4] It focussed on issues like size of banks and capital adequacy ratio among other things. The committee further added that given that the government nominees to the board of banks are often members of parliament. they often interfere in the day-to-day operations of the bank in the form of the behest-lending. functions and procedures of the financial systems and to recommend improvements in their efficiency and productivity. Recommendations of the Committee The 1998 report of the Committee to the GOI made the following major recommendations: [edit]Autonomy in Banking Greater autonomy was proposed for the public sector banks in order for them to function with equivalent professionalism as their international counterparts.[11] For this the panel recommended that recruitment procedures. etc. bureaucrats. politicians. Narasimham.[11] . the committee recommended GOI equity in nationalized banks be reduced to 33% for increased autonomy.[9] M.

it cautioned that large banks should merge only with banks of equivalent size and not with weaker banks. To begin with.To implement this. Subsequently. Of these. . the terms of sale for SBI were finalised in 2007-08 itself.[16] [edit]Reform in the role of RBI First.[4][9][11] This proposal had been severely criticized by the RBI employees union. GOI decided to acquire entire stake of RBI in SBI.[18] As for the second recommendation. eight to ten national banks and a large number of regional and local banks.[11] It recommended a three tier banking structure in India through establishment of three large banks with international presence. the committee recommended that the RBI withdraw from the 91-day treasury bills market and that interbank call money and term money markets be restricted to banks and primary dealers. the RBI decided to transfer its respective shareholdings of public banks like State Bank of India (SBI). Stronger banking system The Committee recommended for merger of large Indian banks to make them strong enough for supporting international trade. criteria for autonomous status was identified by March 1999 (among other implementation measures) and 17 banks were considered eligible for autonomy. in April 1999. NHB and NABARD.[20] The Committee recommended the use of mergers to build the size and strength of operations for each bank. Pursuant to the recommendations. As such.[14] But some recommendations like reduction in Government's equity to 33%. National Housing Bank (NHB) and National Bank for Agriculture and Rural Development (NABARD) to GOI.[17] It observed that "The Reserve Bank as a regulator of the monetary system should not be the owner of a bank in view of a possible conflict of interest". it highlighted that RBI's role of effective supervision was not adequate and wanted it to divest its holdings in banks and financial institutions. the Committee proposed a segregation of the roles of RBI as a regulator of banks and owner of bank. in 2007-08. an Interim Liquidity Adjustment Facility (ILAF) was introduced pending further upgradation in technology and legal/procedural changes to facilitate electronic transfer.[13][15] the issue of greater professionalism and independence of the board of directors of public sector banks is still awaiting Government follow-through and implementation.[14][6] Second.[12] However. the RBI introduced a Liquidity Adjustment Facility (LAF) operated through repo and reverse repos in order to set a corridor for money market interest rates.

Overall the committee wanted a proper system to identify and classify NPAs. the Narasimham Committee-II also highlighted the need for 'zero' non-performing assets for all Indian banks with International presence.which should be closed down if unable to revitalize themselves. the concept of "narrow banking" was proposed to assist in their rehabilitation. some as high as 20% of their total assets.[6] NPAs to be brought down to 3% by 2002[4] and for an independent loan review meachnism for improved management of loan portfolios. The Committee recommended creation of Asset Reconstruction Funds or Asset Reconstruction Companies to take over the bad debts of banks.[6] Given the large percentage of non-performing assets for weaker banks.[21] However. 2002 and came into force with effect from 21 June 2002.[10] The 1998 report further blamed poor credit decisions. [6] The committee's recommendations let to introduction of a new legislation which was subsequently implemented as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. the recommended degree of consolidation is still awaiting sufficient government impetus.[4] . encouraged strongly by the Government of India|GOI in line with the Committee's recommendations.[11] The committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002 and have penal provisions for banks that fail to meet these requirements.[10] Subsequently. behest-lending and cyclical economic factors among other reasons for the build up of the non-performing assets of these banks to uncomfortably high levels.[4][22][23] The option of recapitalization through budgetary provisions was ruled out.[9] This would also improve their risk taking ability.[4] Earlier the Narasimham Committee-I had broadly concluded that the main reason for the reduced profitability of the commercial banks in India was the priority sector lending.[11] There were a string of mergers in banks of India during the late 90s and early 2000s.[16] [edit]Non-performing assets Non-performing assets had been the single largest cause of irritation of the banking sector of India.[24][25][26] [edit]Capital adequacy and tightening of provisioning norms In order to improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms. allowing them to start on a clean-slate. The committee had highlighted that 'priority sector lending' was leading to the build up of non-performing assets of the banks and thus it recommended it to be phased out.

the RBI in Oct 1998. the concept of a universal bank was discussed by the RBI and finally ICICI bank became the first universal bank of India. [27] Based on the other recommendations of the committee. It said that foreign banks can be allowed to set up subsidiaries and joint ventures that should be treated on a par with private banks. [14] [edit]Entry of Foreign Banks The committee suggested that the foreign banks seeking to set up business in India should have a minimum start-up capital of $25 million as against the existing requirement of $10 million.[27] The RBI targeted to bring the capital adequacy ratio to 9% by March 2001.[28] The mid-term Review of the Monetary and Credit Policy of RBI announced another series of reforms.[6] For asset classification. in line with the recommendations with the Committee. in October 1999. initiated the second phase of financial sector reforms by raising the banks' capital adequacy ratio by 1% and tightening the prudential norms for provisioning and asset classification in a phased manner on the lines of the Narasimham Committee-II report. RBI Governor Bimal Jalan informed the banks that the RBI had a three to four year perspective on the implementation of the Committee's recommendations.[14] To implement these recommendations. the Committee recommended a mandatory 1% in case of standard assets and for the accrual of interest income to be done every 90 days instead of 180 days. [4] [edit]Implementation of recommendations In 1998. Most of the recommendations of the Committee have been acted upon (as discussed above) although some major recommendations are still awaiting action from the Government of India.[31] [edit]Criticism .[18][29][30] The RBI published an "Actions Taken on the Recommendations" report on 31 October 2001 on its own website.

[3] This caused some suffering to small borrowers (both individuals and businesses in tiny. to meet in Delhi and to work out a plan of action in the wake of the Narasimham Committee report on banking reforms. the Cash Reserve Ratio. Directed Credit Programme : Since nationalization the government has encouraged the lending to agriculture and small-scale industries at a confessional rate of interest. representing about 1. Taken together. According to some.There were protests by employee unions of banks in India against the report. the committees failed to recommend measures for faster alleviation of poverty in India by generating new employment. This was also credited to the successful implementation of the recommendations of the Narasimham Committee-II with particular reference to the capital adequacy norms and the recapitalization of the public sector banks. performance of Indian banking sector was far better than their international counterparts. The Union of RBI employees made a strong protest against the Narasimham II Report. Problems Identified By The Narasimham Committee Directed Investment Programme : The committee objected to the system of maintaining high liquid assets by commercial banks in the form of cash. Narasimham's Committee it was one of the reasons for the poor profitability of banks. in India. Similarly. the SLR was as high as 38. It is also known as the statutory liquidity Ratio (SLR). Reception Initially. In those days. the recommendations were well received in all quarters.3 million bank employees in India. It is known as the directed credit programme. banks needed to maintain 53. This . micro and small sectors).[2] The impact of the two committees has been so significant that elite politicians and financial sectors professionals have been discussing these reports for more than a decade since their first submission applauding their positive contribution over the years.5 percent of their resources idle with the RBI. The committee opined that these sectors have matured and thus do not need such financial support. According to the M.5 percent.(CRR) was as high as 15 percent. The committee was also criticized in some quarters as "anti-poor". including the Planning Commission of India leading to successful implementation of most of its recommendations.[32] Then it turned out that during the 2008 economic crisis of major economies worldwide. [20] There were other plans by the United Forum of Bank Unions (UFBU). gold and unencumbered government securities.

This high amount of SLR and CRR meant locking the bank resources for government uses. The SLR then was 38. directed credit programmes were adopted by the government.directed credit programme was successful from the government's point of view but it affected commercial banks in a bad manner. The committee felt that there was no need for interest subsidy. The committee has given the following major recommendations:Reduction in the SLR and CRR : The committee recommended the reduction of the higher proportion of the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio 'CRR'.5% and CRR was 15%. It further suggested minimizing the slabs of interest. ultimately leading to profit erosion of banks.5% to 25% and CRR from 15% to 3 to 5%. At the same time the government advocated the philosophy of subsidized lending to certain sectors. since nationalization. Phasing out Directed Credit Programme : In India. Narasimham's Committee also found various inconsistencies regarding the banking system in India. Additional Suggestions : Committee also suggested that the determination of interest rate should be on grounds of market forces. It made banks handicapped in terms of building main strength and expanding credit supply. Both of these ratios were very high at that time. The committee . Basically it deteriorated the quality of loan. resulted in a shift from the security oriented loan to purpose oriented. Narasimham Committee Report I . Banks were given a huge target of priority sector lending. Interest Rate Structure : The committee found that the interest rate structure and rate of interest in India are highly regulated and controlled by the government.1991 The Narsimham Committee was set up in order to study the problems of the Indian financial system and to suggest some recommendations for improvement in the efficiency and productivity of the financial institution. etc. They also found that government used bank funds at a cheap rate under the SLR. Along with these major problem areas M. In order to remove them and make it more vibrant and efficient. SLR was recommended to reduce from 38. it has given the following recommendations. It was hindrance in the productivity of the bank thus the committee recommended their gradual reduction.

Narsimham. The committee recommended the establishment of an Asset Reconstruction Fund (ARF). Regarding the RRBs (Regional Rural Banks).recommended phasing out of this programme. Removal of Dual control : Those days banks were under the dual control of the Reserve Bank of India (RBI) and the Banking Division of the Ministry of Finance (Government of India). Eight to Ten Banks having nationwide presence should concentrate on the national and universal banking services. It considered and recommended that the RBI should be the only main agency to regulate banking in India. In order to pursue competitiveness and efficiency. it recommended that they should focus on agriculture and rural financing. Structural Reorganizations of the Banking sector : The committee recommended that the actual numbers of public sector banks need to be reduced. Narasimham Committee Report II . It would help banks to get rid of bad debts. The determination of the interest rate should be on the grounds of market forces such as the demand for and the supply of fund. The committee recommended the stepping of this system. They recommended that the government should assure that henceforth there won't be any nationalization and private and foreign banks should be allowed liberal entry in India. It is better known as the Banking Sector Committee. Hence the committee recommended eliminating government controls on interest rate and phasing out the concessional interest rates for the priority sector. Banking Autonomy : The committee recommended that the public sector banks should be free and autonomous. Three to four big banks including SBI should be developed as international banks. This fund will take over the proportion of the bad and doubtful debts from the banks and financial institutes. It was told to review the banking reform progress and design a programme for further . Establishment of the ARF Tribunal : The proportion of bad debts and Non-performing asset (NPA) of the public sector Banks and Development Financial Institute was very alarming in those days.1998 In 1998 the government appointed yet another committee under the chairmanship of Mr. This programme compelled banks to earmark then financial resources for the needy and poor sectors at confessional rates of interest. Local banks should concentrate on region specific banking. Interest Rate Determination : The committee felt that the interest rates in India are regulated and controlled by the authorities. It was reducing the profitability of banks and thus the committee recommended the stopping of this programme. banks must enjoy autonomy so that they can reform the work culture and banking technology upgradation will thus be easy.

technology upgradation. Bank ownership : As it had earlier mentioned the freedom for banks in its working and bank autonomy. reviewing bank recruitment. bank mergers. This will further improve their absorption capacity also. training of staff. depoliticizing of banks. Thus for successful rehabilitation of these banks it recommended 'Narrow Banking Concept' where weak banks will be allowed to place their funds only in short term and risk free assets. Some of them had NPAs were as high as 20 percent of their assets.strengthening the financial system of India. This upgradation will bring them in line with the present needs of the banking sector in India. bank legislation. Banking Regulation Act. Currently the capital adequacy ration for Indian banks is at 9 percent. Strengthening Banks in India : The committee considered the stronger banking system in the context of the Current Account Convertibility 'CAC'. Thus. it recommended the merger of strong banks which will have 'multiplier effect' on the industry. Review of banking laws : The committee considered that there was an urgent need for reviewing and amending main laws governing Indian Banking Industry like RBI Act. the committee has also recommended faster computerization. Bank Nationalisation Act. State Bank of India Act. The committee focused on various areas such as capital adequacy. Narrow Banking : Those days many public sector banks were facing a problem of the Non-performing assets (NPAs). it felt that the government control over the banks in the form of management and ownership and bank autonomy does not go hand in hand and thus it recommended a review of functions of boards and enabled them to adopt professional corporate strategy. It thought that Indian banks must be capable of handling problems regarding domestic liquidity and exchange rate management in the light of CAC. etc. etc. etc. Apart from these major recommendations. Evaluation of Narsimham Committee Reports . It submitted its report to the Government in April 1998 with the following recommendations. Capital Adequacy Ratio : In order to improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms. professionalism in banking.

the RBI has to play a major role. Narasimham who was 13th governor of RBI. M. Only a few of its recommendations became banking reforms of India and others were not at all considered. As far as recommendations regarding bank restructuring.The Committee was first set up in 1991 under the chairmanship of Mr. Because of this a second committee was again set up in 1998. strengthening the regulation are concerned. . management freedom. it will prove to be fruitful in making Indian banks more profitable and efficient. If the major recommendations of this committee are accepted.

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