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Volume-7; Issue-1; Jan.-June-2017; pp.

39-49; ISSN: 2350-0115

Banking Sector Reforms and NPA: Impact on Indian

Commercial Banks

Navneet Kaur (Research Scholar)

Priyanka Majumdar (Research Scholar)
Prof. Ram Milan
Department Of Commerce, University Of Lucknow.


The banking system in India functions as a nerve center of the entire economic system
of the country. Non-performing assets had been the single largest cause of irritation of the banking
sector of India. The management of non-performing asset is crucial aspect for any banking institution.
Balance sheets of the Indian banks have been weighing down with high levels of impaired loans due
to the banking sector reforms initiated since 1992.Earlier, the Narasimham Committee-I had broadly
concluded that the main reason for the reduction in the profit of the commercial banks in India was
the priority sector lending. The committee had highlighted that 'priority sector lending' was
preeminenting to ramp up of non-performing assets of the banks and thus it recommended it to be lay
down. Subsequently, the Narasimham Committee-II also highlighted the need for 'zero' non-
performing assets for all Indian banks. In the changing sides, the banks are under tremendous
pressure to redefine their priorities in order to manage effectively the challenges for their survival
and growth. With limited resources and time the main goal of the banks can be achieved by proper
prioritization of priorities. It is therefore, very important to maintain and manage such assets in order
to facilitate the cash rotation and drive profit out of the investment. This paper focuses on Indias
banking sector, developments that have taken place and its impact on Indian commercial banks as a
result of process of banking reforms initiated in 1992.This paper also examines the trends of NPAs in
India from various dimensions.

Keywords: NPA, Priority sector lending, banking sector, economic system.


Commercial banks in India form the most important part of the Indian financial system in terms of
their role in channeling credit to the commercial sector and facilitating the process of financial
inclusion. Commercial banks have undergone a number of changes in terms of size, efficiency of
operation and financial soundness and are predominantly responsible accelerating trade and
Volume-7; Issue-1; Jan.-June-2017; pp. 39-49; ISSN: 2350-0115

developmental activities in India. A strong banking sector is important for growing economy. The
failure of the banking sector may have an adverse impact on other sectors. India faced a macro-
economic crisis in 1991. The country becoming a defaulter in payments seemed as reasonable
possibility. The economy was growing at a very low rate. This asserts the Government of India on a
path of liberalization and globalization of Indian economy. The process of reforms understandably had
to start from financial sector reforms. From 1947 to 1990, there was impressive enlargement of the
banking system, which is the most important factor of financial sector. However, at the end of 1990,
there was a general consensus that the banking system has not become sound enough as it should have
been. There was consideration for serious concern on account of poor financial conditions of
commercial banks, most of which were in public sector. Non-performing asset (NPA) is one of the
major involvements for banks in India. NPAs reflect the performance of banks. A high level of NPAs
suggests high probability of a large number of credit defaults that affect the profitability and net-worth
of banks and also disintegrate the value of the asset. The NPA growth involves the necessity of
provisions, which reduces the overall profits and shareholders value. The banks were nowhere near
the international level norms regarding capital adequacy, accounting practices etc. In a globalised
economy, it threatened to become a major disadvantage.

Reforms in banking sector are viewed as intervention of Government in the banking industry to
provide a solution for prevailing anomalies in the practice of banking business. Predominantly,
banking reforms are resulted towards financial development in all consequences and will pave the way
for boosting economic performance. Out of such concerns, Government of India appointed a high level
committee headed by Shri. M. Narasimham, a former Governor of the Reserve Bank of India to
address the problems and suggest the remedial measures. The recommendations of the committee
became the basis of financial sector and banking sector reforms.

Since it reflect on the asset quality, credit risk and efficiency in the allocation of resources to
productive sectors. The committee on banking sector reforms rightly pointed out that the funds locked
up in NPAs are not available for productive use or reprocess. The major objective of Indian banking
sector reforms was to promote operational independence, compliance and competition in the system
and to augment the banking standards in India to the global standards of banking.

Narasimham Committee Recommendations (1991 and 1997)

Indian banking system has undergone widespread structural reforms since 1991. The banks faced a
decline in productivity, efficiency and erosion of the profitability by 1990 despite commendable
growth. The reforms introduced since 1992-93 breathed a fresh air in the banking sector. Some of the
major recommendations were:

Reduction of Statutory Liquidity Ratio (SLR) from 38.5 per cent to 25 per cent over a period of
five years along with progressive reduction in Cash Reserve Ratio (CRR).

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Stipulation of minimum capital adequacy ratio of 8 per cent to risk weighted assets by March
Adoption of uniform accounting practices in regard to income recognition, asset classification and
provisioning against bad and doubtful debts.
Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad
and doubtful advances at a discount.
Liberalizing the policy with regard to allowing foreign banks to open offices in India.
Rationalization of foreign proceedings of Indian banks.
Giving freedom to individual banks to recruit officers.
Ending dissimulation of control over banking system by Banking Division and RBI
Revised procedure for selection of Chief Executives and Directors of Boards of public sector

The Narasimham Committee II was set up in 1997 to review the progress of the implementation of the
banking reforms since 1992 with the aim of further strengthening the financial institutions of India.
Some of the recommendations were:

Raise the capital adequacy ratio to 9 per cent by 2000 and 10 per cent by 2002 along with
significant reduction in NPA that improved their Risk absorption capacity.
Greater autonomy to PSB in order for them to function with equivalent professionalism as their
international counterparts.
The Government of India equity in nationalized banks should be reduced to 33 per cent for
increased autonomy.
No further re-capitalisation by government. Transfer of bad loans to Asset Reconstruction
Recruitment of skilled manpower directly from the market is given urgent consideration.

2. NPA (Non-Performing Asset)

When loan given by a bank or financial institution and the borrower delays in payment of interest or
principle amount beyond 90 days, is known as Non-performing assets. Banks are not allowed to book
any income from Non-performing assets. They have to make provision for the Non performing assets
or keep money aside. If any advance or credit facilities granted by bank to a borrower become non-
performing, then the bank will have to examine all the advances/credit facilities granted to that
borrower as non-performing without having any regard to certain advances/credit facilities which still
have performing status. Non-performing Asset is called so because it is an Asset which does not
bring substantial income to its owner and is just dormant. Basically, it has something that should work
but which does not.

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Volume-7; Issue-1; Jan.-June-2017; pp. 39-49; ISSN: 2350-0115


Uppal, R.K. and Kaur, R. (2007), studied Indian Banking Industry: Comparative Performance
Evaluation in the Liberalized and Globalized Era, and concluded that the efficiency of all the bank
groups has increased in the second post banking sector reforms period but these banking sector
reforms are more beneficial for new private sector banks and foreign banks.

Ravindra N. Sontakke and Chandan Tiwari (2013) studied Trend Analysis of Non Performing Asset
in Scheduled Commercial Banks in India, and concluded that NPA cause serious strain on the
profitability as, on the one hand banks cannot book income on such accounts and on the other hand
they are required to charge the funding cost and provision requirements to their profits. If NPAs are
not properly managed, it can cause financial and economic degradation which in turns hampers the
investment climate which is crucial source looking to the present state of our economy.

Nagaraju, R. C. (2014) studied Impact of banking sector reforms on Indian banking system: Some
developments and challenges ahead. It concludes that the financial reforms have had a moderately
positive impact on reducing the concentration of the banking sector and improving performance.
Moreover, allowing banks to engage in non-traditional activities has contributed to improved
profitability and cost and earnings efficiency of the whole banking sector including public sector
banks. By contrast, investment in government securities has lowered the profitability and cost
efficiency of the whole banking sector, including public sector banks.

Jayashree R Kotnal, Dr. Meena R Chandawarkar (2015) studied Banking sector reforms and non-
performing assets: A study of Vijayapur district Co-operative banks, and concluded that the Co-
operative bank is much consistent in management of Non-Performing Assets as it shows coefficient of
variation. It is found that the bank shows tremendous growth in its banking transactions. There is a
decreasing tendency in Non-performing assets over the years, which is a good sign for the bank.

Devika Rani and Usha K N (2016) studied A Study on Non-Performing Assets & Performance of
New Generation Private Banks in India and concluded that the health of the economy is closely
related to the soundness of its banking system. Non-Performing Assets may not turn banks into Non-
Performing Banks; instead steps should be taken to convert Non-Performing Assets into Now-
Performing Assets. It is better to avoid NPAs at the budding stage of credit consideration by putting in
place of rigorous and appropriate credit appraisal mechanisms.

Mohammed Arif Pasha & T. Srivenkataramana (2014) studied Non-Performing Assets of Indian
Commercial Banks: A Critical Evaluation and concluded that the survival of an organisation depends
upon the satisfaction level of the customers which is very important for service industries. In fierce
competitive world, a customer has many options today. Hence, a committed customer is very
important for a service organization.

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To discuss various issues of NPA management in the light of reforms.

To review the recent banking sector reforms in relation to management of bank assets.
To assess the impact of reforms on the efficiency of Indian Banks.
To evaluate the performance of the banks in relation to NPA.
To impart necessary suggestions for the improvement of the efficiency and profitability of Indian


The research study is mainly based on secondary sources, which is compiled from Reserve Bank of
India (RBI) website, report on trend and progress of banking in India, RBI annual reports and Indian
Banking association Bulletin and from review of Literature. The data is also collected from other
sources like books, journals etc.


For years, Indian lenders, especially state-run banks, were engaged in volume game to balloon their
balance sheets and appease their promoter (the government). That has been so ever since
nationalization of these banks happened in two stages (beginning 1969). Governments often treated
these banks as their extended arms and used them for populist measures.

NPA picture of Indias government-owned banks evolved so far:

From Rs 53,917 crore, Indian banks gross non-performing assets (GNPAs) in September 2008; the
bad loans have now grown to Rs 3, 41,641 crore in September 2015. In other words, the total GNPAs
of banks, as a percentage of the total loans, has grown from 2.11 per cent to 5.08

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Volume-7; Issue-1; Jan.-June-2017; pp. 39-49; ISSN: 2350-0115


Surprisingly, in the pre-crisis period, private banks topped the list of banks with highest NPAs. A
quick look at the top ten NPA scorers in September 2008 shows ICICI Bank at the top. This was
followed by small and medium-sized private sector banks such as Karnataka Bank, Lakshmi Vilas
Bank, Kotak Mahindra and IndusInd Bank. Among the few public banks that figure in the list are
Central Bank, UCO Bank and Syndicate Bank.

By March 2009, the scene began changing gradually. More state-run banks began appearing in the
picture. The countrys largest lender by assets, State Bank of India (SBI) and Indian Overseas Bank
found place in the list of top NPA scorers. Still private sector lenders figured prominently in the list
with ICICI and DCB Bank leading the pack.

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Things had worsened to a great extent by March 2014, the bad loan troubles of government banks
began to hit hard despite the best efforts by banks to cover up possible NPA stock to restructured loan
category. The list now is dominated mostly by public sector banks, with eight out of ten banks being
government owned.

It wouldnt be an exaggeration to say that state-run banks are on the verge of a crisis due to their high
NPAs, which constitute over 90 percent of the total bad loans of the industry. Many of them have
reported losses on account of huge NPAs in the December quarter. Investors are dumping shares of
these banks while there is a sense of uncertainty prevailing on the extent of troubles in the banking

Nine out of 10 most stressed banks in the sector are government banks. The RBI has given a deadline
of March 2017 for all banks to clean up their balance sheets, which also require these lenders to set
aside huge chunk of capital in the form of provisions. But, there is also huge capital implication on

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these banks on account of high NPAs too. Banks need to set aside money (known as provisions) to
cover their bad loans. The onus to keep government banks stay afloat lies with the government, which
is the owner of these banks that control 70 per cent of the banking industry assets.

Factors Contributing to NPAs

Investing in high risk assets to earn high income.

Willful default by the borrowers, siphoning off funds, fraud and misappropriation by promoters
and directors dispute.

Fraudulent practices like advancing loans to ineligible persons, advances without security or
references etc.

Most of the funds are diverted unnecessary expansion and diversion of business.

Many internal reasons like inefficient management, inappropriate technology, labour problems,
marketing failure, etc. resulting in poor performance of the companies.

External reasons like a recession in the economy, infrastructural problems, price rise, delay in
release of sanctioned limits by banks, delay in settlement of payments by government, natural
calamities, etc.

The absence of portfolio concentration limits, poor industry analysis, cursory financial analysis of

Excessive reliance on collateral, absence of follow up action by banks, poor control on loan
documentation. Inadequate customers contract.



The visible impact of first generation reforms may be summarized as follows:

a) The banking system is well diversified with the establishment of new private banks and about 20
new foreign banks after 1993. The entry of modern, professional private sector banks and foreign
banks has enhanced competition. With the deregulation of interest rates both for advances as well
as deposits, competition between different bank groups and between banks in the same group has
become intense.
b) Finance regulation through statutory preemptions has been lowered while stepping up of the
prudential regulations.
c) Steps have been taken to strengthen PSBs through increasing their autonomy, recapitalization, etc.
d) A set of micro-prudential measures have been stipulated with regard to capital adequacy, asset
classification, provisioning, accounting rules, valuation norms, etc.

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e) CRAR (Per cent to the risk weighted assets) of banks stood at 8 per cent. The percentage of Net
NPAS to net advances of PSBs has declined from 14.4 per cent in 1993-94 to 8.5 per cent by
f) As per RBI Report on Currency and Finance consequent upon prudential norms, the most visible
structural change has been improvement in asset quality.
g) The Government of India, in a major policy announcement, decided to reduce its stake in PSBs
from 100 per cent to 51 per cent retaining, however, the policy parameters of PSBs. The
Government proposes to reduce further its stake to 33 per cent. Moreover, there is a provision for
foreign investments to the extent of 20 per cent. The net result of the dilution in ownership of
PSBs is that these banks are becoming slowly joint sector banks.
h) A number of PSBs like State Bank of India, Andhra Bank, Bank of Baroda, Canara Bank, Punjab
National Bank have gone up for public issue since 1994.
i) Mergers and acquisitions have been taking place in the banking sector. In the past, due to the
existence of a large number of small non-viable banks, the RBI encouraged larger of small banks
with big banks. Now, market driven mergers between private banks have been taking place.


a) After liberalisation bank are free from unnecessary restriction. The private bank and foreign banks
entered. Due to it the level of competition was gradually increased. The technology took place in
banking sector.
b) The reform measures have resulted in the improvement in the profitability of banks.
c) The Narsimham Committee seeks to consolidate the gains made in the Indian financial sectors while
improving the quality of portfolio, providing greater operational flexibility, autonomy in the internal
operations of the banks and FIs so to nurture in, a healthy competitive and vibrant financial sector.
d) As intense competition becomes a way of doing, banks have to pay attention to customer service.
Product innovations and process engineering are the order of the day. Since interest income has
fallen with lowering of interest rates on advances, banks have to look for enhancing fee-based
income, to fill the gap in interest income. Banks have therefore been mooring towards providing
value added services to customers.


NPA management means managing of loan assets of a bank, financial institution in such a manner
that the quantum of NPAs are contained at the bare minimum or at least at the international prescribed
level. The suggestions are related to the improvement in the management of NPA.

1. As concern to future feasibility of the banks provision is necessary. It is advisable for the bank to
classify the assets according to the prudential norms of Reserve bank of India and keep aside
prescribed amount of provision as a reserve to future likelihood of bank concern.

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2. The bank has to maintain strong relationship with the client and conduct recovery camps for the
effective recovery of loans.
3. The bank should provide training and awareness programme regarding the repayment of loans.
Effective use of funds, repercussions of non-payments etc., for effective utilization of available
funds and smooth recovery.
4. The objectives of NPA management should be
a. To make more assets performing.
b. To reduce quantum of NPAs.
c. To minimize the amount of provision requirements.

The said objectives can be achieved firstly by preventing slippage of performing assets; secondly by
upgrading nonperforming assets and thirdly by liquidating non-performing assets.


The health of the economy is closely related to the soundness of its banking system. As far as old
NPAs are concerned, a bank can remove it on its own or sell the assets to Asset Management
Companies (AMCs) to clean up its balance sheet. For preventing fresh NPAs, the bank itself should
adopt proper policies. Recently, RBI has released framework for revitalizing distressed assets in the
economy. The Framework outlines a corrective action plan that will incentivize early identification of
problem cases, timely restructuring of accounts which are considered to be viable, and taking prompt
steps by banks for recovery or sale of unusable accounts. The main features of the Framework are:
Early formation of a lenders committee with timelines to agree to a plan for settlement. Incentives for
lenders to agree collectively and quickly to a plan: better regulatory treatment of stressed assets if a
resolution plan is underway, accelerated provisioning if no agreement can be reached. Since the
financial reforms of 1991 there have been significant favorable changes in Indias highly regulated
banking sector. It wrap up that the financial reforms have had a moderately positive impact on
reducing the concentration of the banking sector and improving performance. The current policy of
reestablishing the banking sector through encouraging the entry of new banks has so produced some
positive results. However, the fact that competition has occurred only at the lower end suggests that
bank regulators should conduct a more thorough reconstitution of public sector banks. Given that
public sector banks have scale advantages, the current approach of improving their performance
without rationalizing them may not yield further benefits for Indias banking sector. As two decades
have passed since the reforms were initiated and public sector banks have been uncovered to the new
regulatory environment, it may be time for the Government to take a further step by stimulating
mergers and acquisitions and closing unviable banks.

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1. Government of India, 'Report of the Committee on Banking Sector Reforms', (Chairman: M.

Narasimham), New Delhi, April 1998, Retrieved from
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