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The banking sector plays a vital role through promoting business in urban as well as in rural areas in recent years. Without a sound and effective banking system, India cannot be considered as a healthy economy. For the past three decades India's banking system has several outstanding achievements to its credit. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process. With total deposits of over Rs. 22 lakh crores in 2007-08, the Indian commercial banking sector is one of the largest in the world. Over the decades, the Indian banking sector has grown steadily in size, measured in terms of total deposits, at a fairly uniform average annual growth rate of about 22%. The retrospect of the events clearly indicates that the Indian banking sector has come far away from the days of nationalization. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector. As the international standards became prevalent, banks had to unlearn their traditional operational methods of directed credit, directed investments and fixed interest rates, all of which led to deterioration in the quality of loan portfolios, inadequacy of capital and the erosion of profitability. The recent international consensus on preserving the soundness of the banking system has veered around certain core themes. These are: effective risk management systems, adequate capital provision, sound practices of supervision and regulation, transparency of operation, conducive public policy intervention and maintenance of macroeconomic stability in the economy. Until recently, the lack of competitiveness vis-à-vis global standards, low technological level in operations, over staffing, high NPAs and low levels of motivation had shackled the performance of the banking industry.
However, the banking sector reforms have provided the necessary platform for the Indian banks to operate on the basis of operational flexibility and functional autonomy, thereby enhancing efficiency, productivity and profitability. The reforms also brought about structural changes in the financial sector and succeeded in easing external constraints on its operation, i.e. reduction in CRR and SLR reserves, capital adequacy norms, restructuring and recapitulating banks and enhancing the competitive element in the market through the entry of new banks.
The reforms also include increase in the number of banks due to the entry of new private and foreign banks, increase in the transparency of the banks balance sheets through the introduction of prudential norms and increase in the role of the market forces due to the deregulated interest rates. These have significantly affected the operational environment of the Indian banking sector.
To encourage speedy recovery of Non-performing assets, the Narasimham committee laid directions to introduce Special Tribunals and also lead to the creation of an Asset Reconstruction Fund. For revival of weak banks, the Verma Committee recommendations have laid the foundation. Lastly, to maintain macroeconomic stability, RBI has introduced the Asset Liability Management System. The East-Asian crisis has demonstrated the vital importance of financial institutions in sustaining the momentum of growth and development. It is no longer possible for developing countries like India to delay the introduction of these reforms of strong prudential and supervisory norms, in order to make the financial system more competitive, more transparent and more accountable.
The competitive environment created by financial sector reforms has nonetheless compelled the banks to gradually adopt modern technology to maintain their
market share. Thus, the declaration of the Voluntary Retirement Scheme accounts for a positive development reducing the administrative costs of Public Sector banks. The developments, in general, have an emphasis on service and technology; for the first time that Indian public sector banks are being challenged by the foreign banks and private sector banks. Branch size has been reduced considerably by using technology thus saving manpower. The deregulation process has resulted in delivery of innovative financial products at competitive rates; this has been proved by the increasing divergence of banks in retail banking for their development and survival. In order to survive and maintain strong presence, mergers and acquisitions has been the most common development all around the world. In order to ensure healthy competition, giving customer the best of the services, the banking sector reforms have lead to the development of a diversifying portfolio in retail banking, and insurance, trend of mergers for better stability and also the concept of virtual banking.
SCENARIO OF BANKING SECTOR IN PRE-REFORM PERIOD:
Banking is an ancient business in India. Initially, the growth of Indian banks was very slow and also experienced periodic failures between 1913 and 1948. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act, 1949 as per amending Act of 1965 (Act No. 23 of 1965). During those days, public had lesser confidence in the banks. As an aftermath deposit mobilization was slow. Government took major steps in Indian banking sector reform after independence. On 19th July 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. Fourteen major commercial banks were nationalized.
Second phase of nationalization of Indian banking sector reform was carried out in 1980 with seven more banks having deposits over 200 crore. This step brought 80 percent of the banking segment in India under Government ownership. After the nationalization, the branches of the public sector bank in India rose to approximately 800 percent and deposits and advances took a huge jump by 11,000 percent. Thus, the Indian banking system became predominantly government owned by the early 1990s. Banking sector in pre reform period was facing very poor performance due to excessive loans in comparison to total deposits having a ratio more than 50 percent consisting of about 90 percent of all commercial banking and continuous escalation in non-performing assets (NPAs) in the portfolio of banks also posed a significant threat to the very stability of the financial system.
WAVE OF BANKING SECTOR REFORMS IN 1991
In 1991, the country was caught into a deep crisis. The government at this juncture decided to introduce comprehensive economic reforms. The banking sector reforms were part of this package. The main objective of banking sector reforms was to promote a diversified, efficient and competitive financial system with the ultimate goal of improving the allocative efficiency of resources through operational flexibility, improved financial viability and institutional strengthening. Many of the regulatory and supervisory norms were initiated first for the commercial banks and were later extended to other types of financial intermediaries. While nudging the Indian banking system to better health through the introduction of international best practices in prudential regulation and supervision early in the reform process, the main idea was to increase competition in the system gradually. The reforms have focused on removing financial repression through reductions in statutory preemptions, while stepping up prudential regulations at the same time. Furthermore, interest rates on both deposits and lending of banks had been progressively deregulated.
In August 1991, the Government appointed a committee under the chairmanship of M. Narasimham, which worked for the liberalization of banking practices. The aim of this Committee was to bring about operational flexibility and functional autonomy so as to enhance efficiency, productivity and profitability of banks. The Narasimham Committee has presented a detailed analysis of various problems and challenges facing the Indian banking system and made wideranging recommendations for improving and strengthening its functions. The Committee submitted its report in November, 1991 and recommended i. Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years ii. iii. Progressive reduction in Cash Reserve Ratio (CRR) Phasing out of directed credit programmes and redefinition of the priority sector iv. v. Deregulation of interest rates so as to reflect emerging market conditions Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994 vi. Adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts vii. Imparting transparency to bank balance sheets and making more disclosures viii. ix. Setting up of special tribunals to speed up the process of recovery of loans Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount
Restructuring of the banking system, so as to have 3 or 4 large banks, which could become international in character, 8 to 10 national banks and local banks confined to specific regions. Rural banks, including RRBs, confined to rural areas
Abolition of branch licensing Liberalising the policy with regard to allowing foreign banks to open offices in India
xiii. xiv. xv.
Rationalisation of foreign operations of Indian banks Giving freedom to individual banks to recruit officers Inspection by supervisory authorities based essentially on the internal audit and inspection reports
Ending duality of control over banking system by Banking Division and RBI A separate authority for supervision of banks and financial institutions which would be a semi-autonomous body under RBI
Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks
xix. xx. xxi.
Obtaining resources from the market on competitive terms by DFIs Speedy liberalisation of capital market Supervision of merchant banks, mutual funds, leasing companies etc., by a separate agency to be set up by RBI and enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc.
Several recommendations have been accepted and are being implemented in a phased manner. Among these are the reductions in SLR/CRR, adoption of prudential norms for asset classification and provisions, introduction of capital
adequacy norms, and deregulation of most of the interest rates, allowing entry to new entrants in private sector banking sector, etc. Keeping in view the need of further liberalization the Narasimham Committee II on Banking Sector reform was set up in 1997. This committee s terms of reference included review of progress in reforms in the banking sector over the past six years, charting of a programme of banking sector reforms required to make the Indian banking system more robust and internationally competitive and framing of detailed recommendations in regard to make the Indian banking system more robust and internationally competitive. This committee constituted submitted its report in April 1998. The major recommendations were: i. Capital adequacy requirements should take into account market risks also ii. In the next three years, entire portfolio of Govt. securities should be marked to market iii. Risk weight for a Govt. guaranteed account must be 100 percent iv. CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by 2002 v. An asset should be classified as doubtful if it is in the sub-standard category for 18 months instead of the present 24 months vi. Banks should avoid ever greening of their advances vii. There should be no further re-capitalization by the Govt. viii. NPA level should be brought down to 5% by 2000 and 3% by 2002. ix. Banks having high NPA should transfer their doubtful and loss categories to ARCs which would issue Govt. bonds representing the realisable value of the assets. x. International practice of income recognition by introduction of the 90-day norm instead of the present 180 days.
xi. A provision of 1% on standard assets is required. xii. Govt. guaranteed accounts must also be categorized as NPAs under the usual norms xiii. There is need to institute an independent loan review mechanism especially for large borrowable accounts to identify potential NPAs. xiv. Recruitment of skilled manpower directly from the market be given urgent consideration xv. To rationalize staff strengths, an appropriate VRS must be introduced. xvi. A weak bank should be one whose accumulated losses and net NPAs exceed its net worth or one whose operating profits less its income on recap bonds is negative for 3 consecutive years. To start with, it has assigned a 2.5 per cent risk-weightage on gilts by March 31, 2000 and laid down rules for provisioning; shortened the life of sub-standard assets from 24 months to 18 months (by March 31, 2001); called for 0.25 per cent provisioning on standard assets (from fiscal 2000); 100 per cent risk weightage on foreign exchange (March 31, 1999) and a minimum capital adequacy ratio of 9 per cent as on March 31, 2000.
SCENARIO OF BANKING SECTOR IN POST REFORM PERIOD: As the Indian banking system had become predominantly government owned by the early 1990s, banking sector reforms essentially took a two pronged approach. First, the level of competition was gradually increased within the banking system while simultaneously introducing international best practices in prudential regulation and supervision tailored to Indian requirements. In particular, special emphasis was placed on building up the risk management capabilities of Indian banks while measures were initiated to ensure flexibility, operational autonomy and competition in the banking sector. Second, active steps were taken to improve the institutional arrangements including the legal framework and
technological system. The supervisory system was revamped in view of the crucial role of supervision in the creation of an efficient banking system. . Measures to improve the health of the banking system had included (i) restoration of public sector banks' net worth through recapitalization where needed; (ii) streamlining of the supervision process with combination of on-site and off-site surveillance along with external auditing; (iii) introduction of risk based supervision; (iv) introduction of the process of structured and discretionary intervention for problem banks through a prompt corrective action (PCA) mechanism; (v) institutionalization of a mechanism facilitating greater coordination for regulation and supervision of financial conglomerates; (vi) strengthening creditor rights (still in process); and (vii) increased emphasis on corporate governance. During the 90 s quite a few new private sector banks made their appearance, predominantly floated by public sector or quasi-public sector financial institutions. Several foreign banks also made their entry into the Indian banking scenario while the existing foreign banks expanded their operations. Meanwhile, the performance of public sector banks continued to be saddled with operational and lending inefficiencies. The Verma Committee in 2000 identified Indian Bank, UCO Bank and United Bank of India as the weakest of the twenty-seven public sector banks, in terms of NPAs and accumulated losses. In March 2002, the gross NPAs of scheduled commercial banks amounted to Rs. 71,000 crores out of which Rs. 57,000 crores or roughly 80 percent came from the public sector banks. Financial liberalization has, however, had a predictable effect in the distribution of scheduled commercial banking in India. Between 1969 and 1991 for instance, the share of the rural branches increased from about 22 percent to over 58 percent. The number of rural bank branches actually declined from the 1991 figure of over 35,000 branches by about 3000 branches. Between 1969 and 1991 the share of urban and metro branches fell from over 37 percent to less than 23 percent. In the years since it has crawled back up to over 31 percent.
EFFECT OF REFORMS
These reform measures have had major impact on the overall efficiency and stability of the banking system in India. The present capital adequacy of Indian banks is comparable to those at international level. There has been a marked improvement in the asset quality with the percentage of gross non-performing assets (NPAs) to gross advances for the banking system reduced from 14.4 per cent in 1998 to 7.2 per cent in 2004. The reform measures have also resulted in an improvement in the profitability of banks. The Return on Assets (RoA) of the banks rose from 0.4 per cent in the year 1991-92 to 1.2 per cent in 2003-04. Considering that, globally, the RoA has been in the range 0.9 to 1.5 per cent for 2004, Indian banks are well placed. The banking sector reforms also emphasized the need to review the manpower resources and rationalize the requirements by drawing a realistic plan so as to reduce the operating cost and improve the profitability. During the last five years, the business per employee for public sector banks more than doubled to around Rs.25 million in 2004.
Closed economy Self-reliance State-led economic growth Import substitution License-dominated regime
Open economy Integration with world markets Market-determined economic growth Export orientation Delicensing, deregulations & debureaucatisation Selective and effective state interventions Market-determined prices at large Contain all kinds of deficits Deflationary monetary & fiscal policies Private investments as growth engine Withdrawal from the areas of private interest
Frequent state interventions Politically administered prices Not much concern for deficits Development by inflationary process PSUs as engines of growth Dominance of PSUs
Philosophy of natural monopoly
Minimize the gap between public and private sectors Inducement to FDI & MNCs Liberalisation of restrictions Deregulation of interest rates Credit policy reforms Reforms in capital market Minimize public sector budgetary resources Tax reforms
Restrictions on FDI & MNCs Restrictions on currency movements State-controlled interest rates State-controlled credit Underdeveloped capital market Huge public sector budgetary resources High tax rates
CONCLUSION Since the process of liberalization and reform of the financial sector were introduced in 1991, banking sector has undergone major transformation. The underlying objectives of the reform were to make the banking system more competitive, productive and profitable. Indian banks especially the public sector banks and the old private sector banks are lagging far behind their competitors in terms of both productivity and profitability so the public sector banks and old private sector banks need to go for the major transformation program for increase their productivity and profitability. No doubt, the banking sector has been successful in improving the health and efficiency of banking sector in India but they have failed in achieving growth with equity. Privatization and globalization have also introduced excessive competition (domestic as well as foreign) before Indian public sector banks which has created an unstable banking environment. After studying banking reform process it can be suggested that the public sector banks must create strategic alliance with the rural regional banks to open up rural branches and increased use of technology for improved products and services for the same. Banks must reinvent themselves so that they can make a viable market out of the middle and low corporate. Government should be strong enough to ensure accountability of professionally managed firms causing the subprime crisis
in well known financial institutions. Branch and ATM licensing should be abolished in order to reduce competition. Prevailing conditions in current scenario are not opportunistic in terms of fee income. Although liberalization of financial services and competition has improved customer services but experience shows that customers' interests are not always accorded priority. The banks need to focus at ensuring greater financial stability to tackle lots of challenges successfully to keep growing and strengthen the Indian banking sector.