D.

The initial wave of banking reforms

In order to tackle the problem of NPAs there exists consensus among the reformers, as per them
this requires two policy reforms. The first set of reform should focus on targeting od the
currently existing NPAs, while the other one should focus on ensuring that minimum number of
new NPAs are created. This section focuses on progress in India in order to find a viable
solution for the existing NPAs by transferring the risk attached to those investors who are willing
in the capital markets. In order to achieve this goal efficiently an appropriate institutional and
legal environment is required.1 Obviously, before beginning on such sort of reforms,
acknowledgement of persisting problem is necessary. As economic reform were prioritized most
during the decade of 1990s, the policy maker of India realized very soon that redressing the
problem of NPAs was very crucial. Further, in order to make the banks able to compete
effectively it was one of the steps perceived as the beginning marker.2

It was in the year 1991, when the first initiative towards addressing the same was taken by RBI
by commissioning Narasimhan committee.3 The committee highlighted that it was due to the
laxity in the prudential norms related to asset classification, provisioning and income
recognition, which had intensified the problem of NPAs.4 Thus, the committee made it open,
what was till now kept as a secret in the circles of national and international banking. It pointed
that the banks had large folios of NPAs in their sheet. The committee suggested that banks must
maintain capital adequacy ratio of eight percent that is risk weighted,5 make norms for bad loans
along with identifying problem loans existing on their balance sheets.6 It further acknowledged

1
See Mukherjee, supra note 80, at 65.
2
See generally Mistry, supra note 83; see also Bhaumik & Piesse, supra
note 78, at 10.
3
GovT. OF INDIA, REPORT OF THE COMMITTEE ON FINANCIAL SYSTEM (1991)
[hereinafter NARASIMHAM COMMITTEE 1991 REPORT].
4
See Bhaumik & Piesse, supra note 78, at 10. See also infra note 99 for a
system of classification of bank advances used by the RBI.
5
Patel, supra note 93, at 2657.
6
See NARASIMHAM COMMITTEE 1991 REPORT, supra note 91; see also
Mukherjee, supra note 80, at 72.
that scope for delay in recognizing bad loans is reduced via stricter asset classification norms and
practice of provisioning. The committee hence, exhorted to define NPAs in a proper manner
along with setting up tribunals for Debt recovery (DRTs) in order to work out the bad loans
made in the past.7

On its part the RBI acted swiftly while responding to the prescriptions rolled out by the
committee and indicated the Public Sector Banks of the various measures that required to be
adopted.8 For instance, for classification of bank advances new norms were issued. Other steps
taken in the pursuance of the recommendation were reducing the cash reserve ratio, freezing up
the interest rates on advances and deposits.9 Moreover, the dependence of PSBs on the
government of India was reduced via allowing them to access capital market in order to raise
equity capital10. By the end of the fiscal year 1998 these reforms were completed thereby,
making the sector ready for the another rounds of reforms.11 Hence, the government of India in
the year 1998 constituted another committee basically referred as the second Narasimhan
Committee with the aim of constructing a strong base for the system of banking along with
reviving the mundane of issue of technology upgradation.12

This was the time that was interesting for the policy makers of India. The economies of south
were left devastated while the future of the financial reforms was eft hazy after the Asian
financial crisis. Further, another committee setup by the Reserve Bank of India, named Tarapore
committee submitted its direction on laying down the roadmap for convertibility of capital
accounts.13 The committee specifically highlighted that before making the rupee fully convertible
the banking system of the nation must be strengthened.14 Hence, it was in this context the second
committee setup in 1989 started drawing its suggestions targeting the norms of asset

7
See Mukherjee, supra note 80, at 72.
8
9
10
11
GoVT. OF INDIA, REPORT OF THE COMMITFEE ON FINANCIAL SYSTEM (1998)
[hereinafter NARAS]MHAM COMMITTEE 1998 REPORT].
12
See Bhaumik & Piesse, supra note 78, at 11.
13
See Recommendations of Tarapore Committee on Capital Account
Convertibility, available at http://iic.nic.in/iic3j.htm (1997).
14
See id.; see also Bhaumik & Piesse, supra note 78, at 11.

2
classification and capital adequacy.15 An attempt was made by the committee in resolving the
issue of NPAs via securitization of the assets. The committee laid the proposal for setting up an
Asset Reconstruction Company (ARC),16 which would in essence assess the realizable value of
NPAs and issue the bonds guaranteed by the government that would make the tier two capital or
issue the swap binds relate to the NPAs. Moreover, new criteria for the income recognition and
asset classification were laid down by the committee. Despite of the committee pointing out at
the bad condition of few of the banks, it stopped short of proposing any drastic changes.17

15
See NARASImHAM COMMITTEE 1998 REPORT, supra note 103;
16
See NARASIMHAM COMMITTEE 1998 REPORT, supra note 103; see also
Mukherjee, supra note 80, at 72-73.
17
Bhaumik & Piesse, supra note 78, at 13.