DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY, LUCKNOW
2020-2021

BANKING LAW
[FINAL DRAFT]
ON
“Study on NARSIMHAN COMMITTEES- 1991 & 1998”

UNDER THE GUIDANCE OF: SUBMITTED BY:

Dr. APARNA SINGH AVIRAL CHANDRAA
Dr. R.M.L.N.L.U. ENROLL NO. – 180101-035
VI SEMESTER

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 ACKNOWLEDGEMENT
Apart from the efforts of me, the success of this project depends largely on the
encouragement and guidelines of many others. I take this opportunity to express my gratitude
to the people who have been instrumental in the successful completion of this project. I
would like to show my greatest appreciation to Dr. Aparna Singh. I can't say thank you
enough for your tremendous support and help. I feel motivated and encouraged every time I
attend your class. Your willingness to motivate me contributed tremendously to my project. I
also would like to thank you for showing me some example that related to the topic of my
project. Without your encouragement and guidance this project would not have materialized.
Besides, I would like to thank the authority of Dr. Ram Manohar Lohiya National Law
University for providing us with a good environment and facilities to complete this project.
Finally, an honourable mention goes to my family and friends for their understandings and
supports on me in completing this project. Without helps of the particular that mentioned
above, I would face many difficulties in completing this project.

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 Table of contents Page No.

1. Introduction 4
2. A Brief Review of Banking Sector in India 5
3. Narsimham Committee- I, 1991
• BASIC APPROACH OF THE COMMITTEE 6
• PROBLEMS AND CONSTRAINTS OF BANKING SYSTEM
(a). Directed Investment 7
(b). Directed Credit Programme 8
(c). Political and Administrative Interference 9
(d). Subsidizing of Credit: Low rate of Interest 10
(e). Mounting Expenditure of Banks 10
• RECOMMENDATIONS
(a). On Directed Investment 11
(b). On Directed Credit Programme 12
(c). On the Structure of Interest Rates 12
(d). On the Structural Reorganisation of Banking Sector 13
(e). Other Recommendations 13
• REFORM IN BANKING SECTOR 14
4. Narsimham Committee- II, 1998
• RECOMMENDATIONS
(a). Need for stronger Banking System 17
(b). Experiment with the Concept of Narrow Banking 17
(c). Small Local Banks 18
(d). Capital Adequacy Ratio 18
(e). Public Ownership and Real Autonomy 18
(f). Review and Update Banking Laws 19
• EVALUATION 19
5. Impact of Reforms 19
6. Conclusion 21
7. References 23

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 1. INTRODUCTION:
After the set back of early nineties when the Government of India had to pledge the gold to
acquire foreign currency to meet the severe problem of balance of payment temporarily, the
Government planned to liberalize the Indian economy and open its door to the foreigners to
speed up the development process as a long-term solution for the ailing economy. The
economic liberalization move, which was initiated in 1991 when the new government
assumed office, has touched all the spheres of national activity. Perhaps one area where the
deregulatory policies had the maximum impact was the banking sector. The seed of the
reforms in Indian banking were sown by the Narasimham Committee appointed by the RBI
under the chairmanship of M. Narasimham, the former Governor of RBI, to examine the
aspects relating to the structure, organization, functions and procedures of the financial
system and suggest remedial measures. The Committee submitted its report in November
1991 and thus, began a new chapter in Indian banking. Norms for income recognition,
classification and provisioning of assets besides capital adequacy were introduced in Indian
banking in a phased manner with other measures.
The financial system reforms were based on twin principles of operational flexibility and
functional autonomy so as to enhance the efficiency, productivity and profitability of the
financial institutions continuously. It aimed at providing a diversified, efficient and
competitive financial system with ultimate objective of improving the efficiency of available
resources, increasing the return on investments in promoting an accelerated growth of the real
sector of the economy. The specific goals of the reforms were the development of transparent
and efficient capital and money markets, promotion of competition through free entry/exit in
financial sector, improvement in access of financial savings, improvement of financial health
of banks by recapitalizing, restructuring etc. of weaker banks, improvement in the level of
managerial competence and quality of human resources, and building up financial institutions
and infrastructure relating to supervision, audit, technology and legal framework.
Face of Global Banking is undergoing a transition. Banking is now a global issue. Reforms in
the financial sector, covering banking, insurance, financial markets, trade, taxation etc. have
been a major catalyst in strengthening the fundamentals of the Indian economy. The reform
measures have brought about sweeping changes in this critical sector of the Indian's
economy. Banking in India is generally fairly mature in terms of supply, product range, and
reach-even though reach in rural India still remains a challenge for the private sector and
foreign banks in the year 2015.

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 2. A BREIF REVIEW OF BANKING SECTOR IN INDIA:
The reform measures have brought about sweeping changes in this critical sector of the
Indian's economy. For the past three decades that is 1970 to 2000, India's banking system has
several outstanding achievements to its credit. It is no longer restricted to only metropolitans
or cosmopolitans in India.1 In India, prior to nationalization, banking was restricted mainly to
the urban areas and neglected in the rural and semi-urban areas.
By 1991, India's financial system was loaded with an inefficient and financially unsound
banking sector. Some of the reasons for this were viz. high reserve requirements,
administered interest rates, directed credit, lack of competition, political interference and
corruption. The Narasimham Committee Report (1991) recommended several reform
measures such as reduction of reserve requirements, de-regulation of interest rates,
introduction of prudential norms, strengthening of bank supervision and improving the
competitiveness of the system. The second Narasimham Committee Report (1998) too
focused on issues like strengthening of the banking system, upgrading of technology and
human resource development.2
Banking in India is generally fairly mature in terms of supply, product range, and reach-even
though reach in rural India still remains a challenge for the private sector and foreign banks in
the year 2007.India has 88 scheduled commercial banks, 28 public sector banks that is with
the Government of India holding a stake, 29 private banks do not having Government stake;
they may be publicly listed and traded on stock exchanges, and 31 foreign banks. They have a
combined network of over 53,000 branches and 17,000 ATMs. According to a report by
ICRA Limited, a rating agency, the public sector banks hold over 75 per cent of total assets
of the banking industry, with the private and foreign banks holding 18.2 per cent and 6.5 per
cent respectively3

3. NARSIMHAM COMMITTEE I, 1991:

India had witnessed a phenomenal expansion in the geographical coverage and functional
spread of our banking and financial system since nationalisation in 1969. Despite impressive
quantitative achievements in resource mobilisation and in extending the credit reach, several
distortions had, over the years crept into banking and financial system. As a result,

[1] www.finance.Indiamart.com
[2] A.S. Ramasastri and Samuel Achamma, 2006.
[3] www.rbi.org.in

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productivity and efficiency of the system had suffered; its portfolio quality had badly
deteriorated and profitability had been eroded. Several public sector banks and financial
institutions had become weak and some public sector banks had been incurring losses year
after year. Their customer service was poor, their work technology outmoded and they were
unable to meet the challenges of a competitive environment. It was under these circumstances
that the Government of India set up High Level Committee with Mr. M. Narasimham, a
former Governor of the Reserve Bank of India as Chairman to examine all aspects relating to
structure, organisation, functions and procedures of the financial system. This Committee on
the Financial System submitted its report in November 1991.
Basic Approach of the Committee:
The Narsimham Committee (1991) was primarily interested in improving the financial health
of public sector banks and development financial institutions (DFIs), so as to make them
viable and efficient and meet fully the emerging needs of real economy. The basic approach
of the Committee was that greater market orientation would strengthen the financial system
and thus improve its efficiency: “The solvency, health and efficiency of the institutions
should be central to effective financial reform”. The major recommendations of the
Narsimham Committee centred round the banking system, the development financial
institutions (DFIs) and the money and capital markets.
At the outset, the Narsimham Committee (1991) acknowledged the spectacular success of the
public sector banks since their nationalisation in July 1969.
(a) massive branch expansion, particularly in rural areas;
(b) expansion in the volume of deposits- bank deposits now constituted two-fifths of financial
assets of the household sector in 1991;
(c) rural penetration of the banking system- rural deposits as a proportion of total deposits as
a proportion of total deposits had increased from 3 percent to 15 percent;
(d) diversion of an increasing portion of the bank credit to priority sectors, viz., agriculture,
small industry, transport, etc.- the priority sector credit had gone up from 14 percent to 41
percent between 1969 and 1991;
(e) increase in deposit and borrowal accounts- over 300 million deposit accounts in the
country and over 35 million borrowal accounts (there were barely 4,00,000 borrowal
accounts in 1969); and

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(f) more involvement in the relatively underbanked states- the expansion of priority sector
lending and the emphasis on area approach has almost evened out regional disparities and
concentration of banking business was relatively less in 1991.
While the banking system in India had thus recorded spectacular progress since
nationalisation, it had also suffered serious decline in productivity and efficiency and
consequent erosion in profitability. Narsimham Committee (1991) pointed out Government
directed investment and Government directed credit programmes were two major causes for
this state of affairs.
Problems and Constraints of Banking System:
A. DIRECTED INVESTMENT-
Maintenance of adequate liquid assets is a basis principle of sound banking. Hence
commercial banks in India were required by the Banking Regulation Act, 1949 under Section
24 to maintain liquid assets in the form of gold, cash and unencumbered approved securities-
that is, government securities and government guaranteed securities- equal to not less than 25
percent of their total demand and time deposit liabilities. This requirement was known as
statutory liquidity ratio (SLR) and the RBI was given the power to change this ratio.
Accordingly, RBI raised SLR from 25 percent to 30 percent (in November 1972) and further
gradually to 38.5 percent by 1991. RBI had stepped up the SLR for two reasons:
(a) A higher SLR forced commercial banks to maintain a larger proportion of their funds in
government securities and government guaranteed securities (of public sector financial
institutions) and thus reduced the capacity of commercial banks to grant loans and advances
to business and industry.
(b) A higher SLR diverted bank funds away from loans and advances to industry and trade, to
investment in Government securities (G-sec); this was said to have an anti-inflationary effect.
The Narsimham Committee (1991) argued that the high SLR adversely affected profitability
of the banks because the rate of interest received by banks on government securities was less
than the market related rates of interest. Besides, with higher SLR, the amount of funds left
with banks for allocation to productive economic sectors like agriculture, industry and trade
was reduced. The Narsimham Committee characterised the high SLR as tax on the banking
system and also on savings routed through banks.
The Narsimham Committee (1991) accepted the view, though indirectly, that the high SLR
was a fraud perpetrated by the Finance Ministry of the Government of India on the captive
banking system. By using Section 24 of the Banking Regulation Act, the Finance Ministry

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could manage to get as much as 38.5 percent of the aggregate deposits of banks for (a)
financing its own expenditure and at the same time, (b) pay a rate of interest lower than what
the banks were paying to their depositors. The Finance Ministry could at least be justified if it
used these funds for development purposes. But the government was using bank funds even
for paying salaries of government employees in certain years.
Cash Reserve Ratio (CRR): Under the Reserve Bank of India Act, 1934, every scheduled
bank had to keep certain minimum reserves with the RBI- initially it was 5 percent against
demand deposits and 2 percent against time deposits. By an amendment of 1962, RBI was
empowered to vary the cash reserve between 3 percent-15 percent of the total demand and
time deposits. Generally, CRR is changed only occasionally by Central Banks in other
countries but this was not so in India. The CRR had been changed many times, as part of the
overall strategy of demand management. By 1991, the CRR was raised to the statutory
maximum of 15 percent on the average.
Now, taking SLR and CRR together, banks had to keep as much as 53.5 percent of their
aggregate deposits as cash balance with RBI or in government securities and securities of
public sector financial institutions. The RBI paid interest at the rate of 3.5 percent on the cash
reserves kept by scheduled banks with it under CRR and at 5 percent on incremental cash
balances. Narsimham Committee (1991) found that the rates of interest received by the
scheduled banks from RBI for their eligible cash balances were below the rate which
scheduled banks had to pay to their depositors for one year deposits. Likewise, the rate of
interest the banks received on government securities was much lower than market rate. Thus
the reserve requirements imposed on the scheduled banks were like taxes and had led to
continuous loss in potential income of banks, which, in turn, had adversely affected their
profitability.
B. DIRECTED CREDIT PROGRAMME-
A major objective of bank nationalisation in July 1969 was to extend the reach of bank credit
both geographically to unbanked regions and functionally to agriculture and hitherto
neglected sectors, designated as “priority sectors”. In course of time, the Government added
more categories of sectors like the export sector, food procurement operations, etc. for the
special attention of scheduled banks. Banks were asked to make a success of these directed
credit programmes. They were also told to shift from security-oriented credit to purpose-
oriented credit.

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This system of directed credit programme was hailed by the Indian government as a great
success but this was achieved at the cost of:
(a) deterioration in the quality of the loans, inadequate attention to the qualitative aspects of
lending, growth of overdues and consequent erosin of profitability; and
(b) shift from security oriented credit to purpose oriented credit- the banks were asked to
make this shift so as to establish a link between technological upgradation in agriculture and
small industry and the availability of finance. Over the years, this aspect was ignored and, as
a result there was no proper loan appraisal of credit applications, no collateral requirements
and no post credit supervision and monitoring.
C. POLITICAL AND ADMINISTRATIVE INTERFERENCE-
According to the Narsimham Committee (1991), the most serious damage to the public sector
banks was the political and administrative interference in credit decision-making. For
instance, loan-melas organised by Congress party leaders in the 1970s and 1980s to direct
bank credit to their supporters in rural and urban areas were contrary to the principle of sound
banking. Commenting on the loan melas, the Narsimham Committee 1991 stated: “The
intended socially oriented credit in the process, degenerated into irresponsible lending”. 4 This
was also the case in distribution of IRDP loans among the poor and the economically weak in
our rural areas. “In many cases of IRDP lending, banks have virtually abdicated their
responsibilities in undertaking need-based credit assessment and appraisal of potential
viability and instead have tended to rely on lists of identified borrowers prepared by
Government authorities.”5 According to Narsimham Committee (1991), as much as 20
percent of agricultural and small industrial credit is of this “infected” or “contaminated”
portfolio.
Political interference in banking functions was found in other areas also. For instance, the
Centre and the States directed banks to continue to extend credit to sick industrial units, often
against their better commercial judgement. Likewise, “advice” from BIFR and “directions”
from judicial courts had forced banks to extend credit to sick industrial units. As a result of
all these “instructions”, “advice” and “directions”, public sector banks had suffered badly:
lower income, inadequate provisioning for bad debt, locking of credit from more productive
uses and erosion of profitability.
D. SUBSIDIZING OF CREDIT: LOW RATE OF INTEREST-

4
Report of the Committee on the Financial System, 1991, p. 30.
5
Ibid, p. 30.

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The Government of India managed to appropriate bank funds under the SLR scheme at low
rates of interest for its own use. At the same time the Government of India stipulated that
bank lending would also be at concessional rate of interest, which really amounted to subsidy
on such loans- to make up this loss, bans were forced to charge very high rates of interest on
borrowers from industry and trade. The Narsimham Committee (1991) pointed out that this
was clearly based on the misconception that socially-oriented credit should also be low cost
credit. The committee emphasized that adequate and timely access to credit was far more
important than its cost. The policy makers in this country had clearly ignored the fact that
institutional finance was much cheaper than the alternative of informal sector finance (from
money lenders and indigenous bankers). According to Narsimham Committee (1991), there
was actually no need for interest subsidy which only reduced the ability of the banking
system to build its strength and to extend the coverage of bank credit even wider. Besides,
there was the question of basic morality or logic in forcing banks to make available their
funds to Government at low rates of interest or for the Finance Ministry of the Government of
India to use bank funds for IRDP at concessional rates of interest. The public who keep their
hard earned savings with the banks for safe custody have a right to expect a decent rate of
interest on their savings. The Finance Ministry has no moral right to use or rather waste the
funds of the public sector banks.
E. MOUNTING EXPENDITURE OF BANKS-
I have explained above the squeeze on profitability of banks from the side of revenue. From
the expenditure side, public sector banks were saddled with mounting expenditure. The
Narmsimham Committee (1991), mentioned the following points:
(i) Phenomenal increase in branch banking without any relation to demonstrated need and
potential viability.
(ii) The lines of command and control tended to weaken central office supervision, internal
inspection and audit, and increased unreconciled inter-branch and inter-bank entries.
(iii) Rapid growth in staff in number and in accelerated promotions: this has led to
deterioration in the quality of manpower, over-manning at all levels.
(iv) Role of Trade Unions: they have contributed increasingly to the restrictive practices
regarding promotions, transfers, discipline and work culture, mechanisation and
computerisation, etc. Remunerations and their upward revisions were not related to
productivity of either individual banks or to the system. Inefficient customer service and
declining labour productivity were the consequences.

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(v) Extension of the coverage of bank credit to agriculture and small industry where the unit
cost of administering the loans was high; besides this type of credit was at low rates of
interest, as mentioned earlier.
Thus, despite impressive quantitative achievements in resource mobilisation and in
expanding the credit reach, several distortions had, over the years, crept into the banking
system. Several public sector banks had become weak financially and were unable to meet
the challenges of a competitive environment.
Recommendations:
The Narsimham Committee’s recommendations were based on fundamental assumption that
the resources of the banks come from the general public and were held by the banks in trust
and they were to be deployed for the maximum benefit of the depositors. This assumption
automatically implies that even the government had no business to endanger the solvency,
health and efficiency of the nationalised banks under the pretext of using banks’ resources for
economic planning, social banking, poverty eradication, etc. Besides, the Government had no
right to get hold of the funds of the banks at low rates of interest and use them for financing
its consumption expenditure – paying the salaries of employees, for example- and thus
defraud the depositors. The Narsimham Committee recommendations were aimed at:
(i) ensuring a degree of operational flexibility;
(ii) internal autonomy for public sector banks in their decision making process; and
(iii) greater degree of professionalism in banking operations.
A. ON DIRECTED INVESTMENT-
The Narsimham Committee (1991) gave two important recommendations as regards SLR and
CRR.
(a) Statutory Liquidity Ratio (SLR)- The Government should give up immediately the
practice of using SLR as a major instrument of mobilising funds for the government and the
public sector financial institutions. The Narsimham Committee (1991) recommended that the
government should reduce the SLR from present 38.5 percent of the net demand and time
liabilities to 25 percent over next five years. A reduction in SLR would leave more funds
with banks for allocation to agriculture, industry, trade, etc.
(b) Cash Reserve Ratio (CRR)- The Narsimham Committee (1991) recommended that RBI
should rely on open market operations increasingly and reduce its dependence on CRR. The
committee proposed that-

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(i) CRR should progressively reduced from present high level of 15 percent to 3 to 5 percent;
and
(ii) RBI should pay interest on impounded deposits of banks above the basic minimum at a
rate of interest equal to the level of banks’ one year deposits.
These recommendations would reduce the amount of idle cash kept by the banks with the
RBI under CRR and release the amount for more productive and remunerative purposes.
Besides, banks would also earn more income from the cash balances they kept with RBI.
B. ON DIRECTED CREDIT PROGRAMMES-
The Narsimham Committee (1991) recommended that the system of directed credit
programmes should be gradually phased out. For one thing, agriculture and small industry
had already grown to a mature stage and they did not require any special support. For
another, two decades of assistance with interest subsidy were enough and, therefore,
occasional interest rates could be dispensed with. The Committee had argued that the system
of directed credit should not be a regular programme but should be case of extraordinary
support to certain weak sections of the economy.6 Besides, it should be temporary, not a
permanent one.
The Committee also proposed that the concept of priority sector should be refined to include
only the weakest sections of the rural community such as marginal farmers, rural artisans,
village and cottage industries, tiny sector, etc. The directed credit programme for this
“redefined” priority sector should be fixed at 10 percent of the aggregate bank credit. The
system should be reviewed after a period of three years or so to assess the need to continue or
terminate the programme as also the stipulation of the concessional rate of interest. The social
purpose of the bank credit should be to enhance small industry. The Narsimham Committee
(1991) emphasized in this connection: “The postulates of social banking need not clash with
sound banking.”
C. ON THE STRUCTURE OF INTEREST RATES-
The Narsimham Committee, (1991) recommended that the level and structure of interest rates
in the country should be broadly determined by market forces. All controls and regulations on
interest rates on lending and deposit rates of banks and financial institutions on debentures
and company deposits, etc. should be removed. Concessional rates of interest for priority
sector loans of small sizes should be phased out; and subsidies in IRDP loans should be
withdrawn.
6
Hans Binswanger and S.R. Khandker, “The Impact of Formal Finance on the Rural Economy of India,” World
Bank Policy Research Working Paper No. 949 (Washington DC, 1992).

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The Committee further proposed that RBI should be the sole authority to simplify the
structure of interest rates. The Bank rate should be the anchor rate and all other interest rates
should be closely linked to it.
D. ON THE STRUCTURAL REORGANISATION OF THE BANKING STRUCTURE-
To bring about greater efficiency in banking operations, the Narsimham Committee (1991)
proposed a substantial reduction in the number of public sector banks through mergers and
acquisitions. According to the Committee, the broad pattern should consist of:
(a) 3 or 4 large banks (including State Bank of India) which could become international in
character;
(b) 8 to 10 national banks with a network of branches throughout the country engaged in
general or universal banking;
(c) Local Banks whose operations would be generally confined to a specific region; and
(d) Rural banks including RRBs whose operations would be confined to the rural areas and
whose business would be predominantly engaged in financing of agriculture and allied
activities.
Since the country already had a network of rural and semi-urban branches, the Narsimham
Committee proposed that the present system of licensing of branches with the objective of
spreading the banking habit should be discontinued. Banks should have the freedom to open
branches purely on profitability considerations.
E. OTHER RECOMMENDATIONS-
The setting up of Assets Reconstruction Fund (ARF) - Nationalised banks and Development
Finance Institutions (DFIs) were burdened with sub-standard, doubtful and loss assets known
as non-performing assets (NPAs). Narsimham Committee recommended the setting up of
Assets Reconstruction Fund (ARF), to take over from nationalised banks and financial
institutions, a portion of their bad and doubtful debts of banks and financial institutions were
to be transferred in a phased manner to ensure smooth and effective functioning of the ARF.
This arrangement would help the banks and the financial institutions to take off their bad and
doubtful debts from their balance sheets and recycle the funds realised through this process
into more productive uses.
Remove the Duality of Control - The Narsimham Committee (1991) recommended that the
present system of dual control over the banking system between RBI and the Banking
Division of Ministry of Finance should end immediately and that RBI should be the primary
agency for the regulation of banking system.

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Free and Autonomous Banks-The Narsimham Committee recommended that the public
sector banks should be free and autonomous. Every bank should go for a radical change in
work technology and culture, so as to become competitive internally and to be in step with
wide ranging innovations taking place abroad. RBI should examine all the guidelines and
directions issued to the banking system in the context of the independence and autonomy of
banks. Finally, the appointment of the Chief Executive of a bank (Chairman-cum-managing
Director) should not be based on political considerations but on professionalism and integrity
and should be made by an independent panel of experts and not by Government as at present.
The Narsimham Committee 1991 directly blamed the Government of India and the Finance
Ministry for the sad state of affairs of the public sector banks. These banks were used and
abused by the Finance Ministry of the Government of India, the bank officials and the bank
employees and the bank unions.
The recommendations of the Narsimham Committee, 1991 were revolutionary in many
respects and were naturally opposed by the bank unions and the leftist political parties.
Reform in Banking Sector (1992-2006):
Despite stiff opposition from bank unions and political parties in the country, the Government
of India accepted all major recommendations of Narsimham Committee (1991) and started
implementing them straight away:
(1) Statutory Liquidity Ratio (SLR): On incremental net demand and time liabilities (DTL)
has been reduced from 38.5 percent to 25 percent and SLR outstanding net domestic demand
and time liabilities were reduced gradually from 38.5 percent to 25 percent in October 1997;
this was minimum stipulated under Section 24 of Banking Regulation Act, 1949.
(2) Cash Reserve Ratio (CRR): The incremental cash reserve ratio (ICRR) of 10 percent was
abolished. But RBI could not reduce CRR immediately. When conditions eased and money
growth started slowing down since 1995-96, RBI reduced CRR gradually from 15 percent to
5.5 percent in December 2001. The purpose of reducing CRR was to release funds for
lending to the industrial and other sectors which were starved of bank credit.
(3) Interest rate slabs: were gradually reduced from 20 to 2 by 1994-95. The important
changes in interest rates since 1991-92 are as follows:
(a) Interest rate on domestic term deposits has been decontrolled;
(b) The prime lending rate of SBI and most other banks on general advances of over 2 lakhs
has been reduced;
(c) Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled; and

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(d) The interest rates on deposits and on advances of all cooperative banks (except urban
cooperative banks) have been deregulated.
The purpose of deregulation on interest rate on high slab of bank advances was to stimulate
healthy competition among the banks and encourage their operational efficiency. It would
also help banks better adjust their lending rates to the track record and risk perception with
regard to their customers.
Scheduled Commercial Banks have now the freedom to set interest rates on their deposits
subject to minimum floor rates and maximum ceiling rates.
(4) Prudential Norms: have been started by RBI as part of the reformative process. The
purpose of prudential system of recognition of income, classification of assets and provision
of bad debts is to ensure that the books of commercial banks reflect their financial position
more accurately and in accordance with internationally accepted accounting practices. These
help in more effective supervision of banks.
Prudential norms required banks to make 100 percent provision for all non-performing assets
(NPAs). As funding for this purpose was placed at Rs. 10,000 crores, it was phased over two
years. Banks had to make at least 30 percent provision against doubtful and bad debts during
1992-93 and the balance 70 percent in 1993-94.
(5) Capital Adequacy Norms: were fixed at 8 percent by RBI in April 1992 and the banks
had to comply with them over a three year period. By end March 1996, all public sector bans
had attained capital to risk weighted assets ratio of 8 percent. The full norm of 8 percent was
also attained by foreign banks in India and by some Indian banks.
The prudential guidelines and the new capital adequacy norms expect scheduled commercial
banks to make large provisions amounting to over Rs. 14,000 crores for bad and doubtful
advances in their portfolio. As the resulting losses would erode the already inadequate capital
of the banks, the viability and financial health of banking system was sought to be protected
by a capital contribution of Rs. 5,700 crores by the Union Government in the budget for
1993-94 and another Rs, 5,600 crores in the budget for 1994-95 for recapitalisation of the less
profitable nationalised banks. The recipient banks were required to draw up plans to become
viable over a period of two to three years.
A new capital framework was introduced for Indian scheduled commercial banks based on
the Basel Committee recommendations presenting two tiers of capital for the banks:

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(a) Tier I or core capital, considered the most permanent and readily available support
against unexpected losses, included paid-up capital, statutory reserves, share premium and
capital reserve; and
(b) Tier II capital consisting of undisclosed reserves, fully paid-up cumulative perpetual
preference shares, revaluation reserves, general provisions and loss reserves, etc.
It was also prescribed that Tier II capital should not be more than 100 percent of the Tier I
capital.
(6) Access to Capital Market: The Government of India has amended the Banking
Companies (Acquisition and Transfer of Undertakings) Act to enable the nationalised banks
to access the market for capital funds through public issue, subject to the provision that
holding of Central Government would not fall below 51 percent of the paid-up capital.
SBI was the first to raise through public issue over Rs. 1,400 crores as equity, and Rs. 1,000
cores as bonds. RBI shareholding of SBI is now 67 percent as against 99 percent earlier. SBI
Act also has been amended to allow 10 percent voting rights to the shareholders. The Oriental
Bank of Commerce raised Rs. 360 crores during 1994-95 through a public issue. Other
nationalised banks have also approached the capital market subsequently.
(7) Freedom of Operation: Scheduled commercial banks have now been given freedom to
open new branches and upgrade extension counters, after obtaining capital adequacy norms
and prudential accounting standards. They are also permitted to close non-viable branches
other than in rural areas. Bank lending norms have been liberalised and banks have been
given freedom to decide levels of holdings of individual items of inventories and receivables.
(8) New Private Sector banks: Ten private sector banks have already started functioning.
These new private sector banks are allowed to raise capital contribution from foreign
institutional investors’ upto 20 percent and from non-resident Indians upto 40 percent.
(9) Local Area Banks: In the 1996-97 budget, the Government of India announcd the setting
up of new private local area banks (LABs) with jurisdiction over three contiguous districts.
These banks would help to mobilise rural savings and to channelize them into investment in
local areas. The RBI has issued guidelines for setting up of such banks in 1996 and gave its
approval “in principle” to the setting up of seven LABs in the private sector.
(10) Supervision of Commercial Banks: Supervision of commercial banks is being tightened
by RBI, specially after the securities scam of 1992. RBI has set up a Board of Financial
Supervision with an Advisory Council under the chairmanship of the Governer to strengthen
the supervisory and survellience system of the banks and financial institutions. RBI has also

16
established in December 1993 a new department known as Department of Supervision as an
independent unit for supervision of commercial banks and to assist the Board of Financial
Supervision.
(11) Recovery of Debts: The government of India passed “Recovery of Debts due to banks
and Financial Institutions Act, 1993” in order to facilitate and speed up the recovery of debts
due to banks and financial institutions. Six Special Recovery Tribunals have been set up at
Kolkata, New Delhi, Jaipur, Ahemdabad, Bangalore and Chennai to facilitate quicker
recoveries of loan arrears within six months and an Appellate Tribunal has also been set up in
Mumbai.

4. NARSIMHAM COMMITTEE II, 1998:

The Finance Ministry of the Government of India appointed Mr. Narsimham as chairman of
one more Committee; this time it was called the Committee on Banking Sector Reforms. This
Committee was asked to “review the banking sector reforms to date and chart a programme
on financial sector reforms necessary to strengthen India’s financial system and make it
internationally competitive.” The Narsimham Committee on Banking Sector reforms
submitted its report to the government in April, 1998.This report covers the entire gamit of
issues, ranging from capital adequacy, bank mergers, the creation of global-sized banks,
recasting bank boards and revamping bank legislation.
Recommendations:
A. NEED FOR STRONGER BANKING SYSTEM-
The Narsimham Committee on Banking Sector Reforms (1998) made out a strong case for a
stronger banking system in the country, especially in the context of capital account
convertibility (CAC) which would involve large inflows and outflows of capital and
consequent complications for exchange rate management and domestic liquidity. To handle
such problems, India needed a strong and resilient banking and financial system. For this
purpose, the Narsimham Committee (1998) recommended the merger of strong banks which
would have a ‘multiplier effect’ on industry. The Committee, however, cautioned the merger
of strong and weak banks, as this might have a negative impact on the asset quality of the
stronger bank. During 2004-05, Finance Minister P. Chidambaram had vigorously advocated
merger of PSBs to get benefits of economies.
The Committee also recommended that two or three large Indian Banks be given
international or global character.

17
B. EXPERIMENT WITH THE CONCEPT OF NARROW BANKING-
The Narsimham Committee (1998) was seriously concerned with the rehabilitation of weak
PSBs which have accumulated a high percentage of non-paying assets (NPAs, which, in
some cases was as high as 20 percent of total assets. The Committee (1998) suggested the
concept of narrow banking to rehabilitate such weak banks. Narrow Banking implies that
weak banks place their funds only in short-term in risk free assets- these banks attempt to
match their demand deposits by safe liquid assets. In case the concept of narrow banking was
found to be non-applicable to rehabilitate weak banks, the issue of closure should be
examined, according to the Committee.
C. SMALL LOCAL BANKS-
The Narsimham Committee (1998) argued: “While two or three banks with an international
orientation and 8-10 large national banks should take care of the needs of the large and
medium corporate sector and the larger of smaller enterprises, there will still be a need for a
large number of local banks.” The Committee has, therefore, suggested the setting up of
small, local banks which would be confined to States or cluster of districts in order to serve
local trade, small industry and agriculture. At the same time, these banks should have strong
corresponding relationship with larger national and international banks.
D. CAPITAL ADEQUACY RATIO-
The Narsimham Committee (1998) also suggested that Government should consider raising
the prescribed capital adequacy ratio to improve the inherent strength of the banks and to
improve their risk absorption capacity. The Committee suggested higher capital adequacy
requirements for banks and setting up of an Asset Reconstruction Fund (ARF) to take over
the bad debts of the banks.
E. PUBLIC OWNERSHIP AND REAL AUTONOMY-
The Narsimham Committee (1998) argued that Government ownership and management of
banks did not enhance autonomy and flexibility in the working of public sector banks. In this
connection, the Committee recommended a review of the functions of boards so that they
remain responsible for formulation of corporate strategy.
The Narsimham Committee (1998) considered the issue of ‘autonomous status’ for the Board
for Financial Supervision of RBI and the need to segregate regulatory and supervisory
functions of RBI. The Committee expressed the need for RBI to maintain an arms length
from those being regulated and hinted at the need for withdrawing RBI nominee from the
Bank boards. The Committee stated: “Regulation should be concerned with laying down

18
procedural and disclosure norms and sound procedures and ensure adherence to these and not
get into day-to-day management of banks.”
F. REVIEW AND UPDATE BANKING LAWS-
The Narsimham Committee (1998) suggested the urgent need to review and amend the
provisions of RBI Act, Banking Regulation Act, State Bank of India Act, Bank
Nationalisation Act, etc. so as to bring them in line with the current needs of the banking
industry.
Evaluation:
Really speaking, there was no purpose in setting up the second Narsimham Committee on
Banking Sector Reforms even before a decade had elapsed for full implementation of the
First Committee Report (submitted in 1991). As one critic commented: “Banking, that is, a
stray recommendation here or there are like the categorical rejection of the merger of weak
with strong banks and the suggestion to try out narrow banking, as far as all other issues are
concerned, whether it is organisation, restructuring, freeing bank boards from day-to-day
management and interference or segregating the regulatory and supervisory role of the
Reserve Bank of India (RBI), it is like watching an action replay of the earlier report.” We
can compare some of the major recommendations of the 1991 and 1998 reports of the
Committees; both presided over by Mr. Narsimham.
1998 RECOMMENDATIONS 1991 RECOMMENDATIONS
More strong banks Merge banks to reduce numbers
Free bank boards from Government Free bank boards from Government
interference interference
Move to three tier structure Move to three tier structure
Review capital adequacy norms Fix capital adequacy at 8 percent
Consider whether autonomy is consistent Ensure autonomy of banks: wind-up banking
with public ownership division of the finance ministry

5. IMPACT OF REFORMS:
The impact of reforms in the banking sector has been positive. In a recent study, T.T. Ram
Mohan has shown that there has been an improvement in the performance of Public Sector

19
Banks (PSBs) on several indicators of efficiency and stability as the following facts clearly
bring out:7
1. PROFITABILITY: As measured by net return on assets, profitability in PSBs rose from -
0.4 percent in 1992-95 to 0.8 percent in 2005-06, with a peak of 1.12 percent being achieved
in 2003-04. According to Ram Mohan, “It is not just that Indian Banks have achieved a
turnaround. They have gone on to become the most profitable in the world. Internationally a
return of 1 percent on assets is considered a benchmark of excellence... In 2004, among the
industrialised economies, only the US banking system did better than the Indian on a pre-tax
basis. Among the Asian Economies, only Indonesia did better in 2003.”8
2. INTERMEDIATION COSTS: These costs as a proportion of assets have declined from a
high of 2.99 percent in 1995-96 to 2.06 percent in 2005-06. It is often said that the
intermediation costs in Indian banking are on higher side. However, this is not just entirely
true. According to Ram Mohan, intermediation costs in Indian banking system are lower than
those of highly profitable banking systems such as those in the USA and Australia and higher
than those in the U.K., Japan and Germany, whose systems are not as profitable.
3. NET INTEREST MARGIN (SPREAD): The spread for PSBs has risen from 2.72
percent in 1992-95 to 2.85 percent in 2005-06. Generally in a regime of deregulation, one
expects to see a reduction in spreads. But this has not happened in India. While this has been
bad for borrowers, it has been a blessing for banks.
4. COST/INCOME RATIO: The cost to income ratio has fallen steeply from 73.7 percent
in 1992-93 to 45.1 percent in 2003-04. Internationally, a cost to income ratio of less than
50 percent is considered commendable.
5. NON-PERFORMING ASSETS: In the area of non-performing assets again, the PSBs
have shown an improvement. The net NPA/ total assets has declined from 36.5 percent in
1996-97 to 0.72 percent in 2005-06.
6. CAPITAL ADEQUACY: At the onset of reforms, the PSBs were struggling to meet the
capital adequacy norm of 8 percent. The capital adequacy has since risen to 12.4 percent in
2006.
All these facts go to show that there has been a remarkable improvement in the
performance of PSBs on several indicators of efficiency and stability. While the study of

7
T.T. Ram Mohan, “Banking Reforms in India: Charting a Unique Course” Economic and Political Weekly,
March 31, 2007, p. 1110-1.
8
Ibid., p. 1111.

20
T.T. Ram Mohan is limited to public sector banks, the conclusions apply to the Indian
banking sector as a whole.

6. CONCLUSION:
The banking sector reforms, which were implemented as a part of overall economic reforms,
witnessed the most effective and impressive changes, resulting in significant improvements
within a short span. The distinctive features of the reform process may be stated thus:
(i) The process of reforms has all along been pre-designed with a long term vision. The two
Committees on financial sector reforms (Narasimham Committee-I and II) have outlined a
clear long-term vision for the banking segment particularly in terms of ownership of PSBs,
level of competition, etc.
(ii) Reform measures have been all pervasive in terms of coverage of almost all problem
areas. In fact, it can be said that, it is difficult to find an area of concern in the banking sector
on which there has not been a Committee or a group.
(iii) Most of the reform measures before finalization or implementation were passed through
a process of extensive consultation and discussion with the concerned parties.
(iv) Most of the reform measures have targeted and achieved international best practices and
standards in a systematic and phased manner. .
(v) All the reform measures and changes have been systematically recorded and are found in
the annual reports as well as in the annual publications of RBI on "Trend and Progress of
Banking in India".
The banking system, which was over-regulated and over administered, was freed from all
restrictions and entered into an era of competition since 1992. The entry of modern private
banks and foreign banks enhanced competition. Deregulation of interest rates had also
intensified competition. Prudential norms relating to income recognition, asset classification,
provisioning and capital adequacy have led to the improvement of financial health of banks.
Consequent upon prudential norms the most visible structural change has been improvement
in the quality of assets. Further, there has been considerable improvement in the profitability
of banking system. The net profits of SCBs, which were negative in 1992-93, become
positive in 1994-95 and stood at Rs. 17,077.07 Crore by March 2003. The profitability of the
Indian Banking System was reasonably in line with International experience.
It may be pointed out that the banking sector reform is certainly not a one-time affair. It has
evolutionary elements and follows a progression of being and becoming. Form this point,

21
Indian experience of restructuring banking sector has been reasonably a successful one. There
was no major banking crisis and the reform measures were implemented successfully since
1992. Some expressed the fear that the reforms will sound a blow to social banking. The
Government did not accept the Narasimham Committee-I recommendation that advances to
priority sector should be brought down from 40 per cent to 10 per cent. The Banks continued
to be directed to lend a minimum of 18 per cent of total banks credit to agriculture sector.

7. REFERENCES:
1. Ministry of Finance (1991), Report of the Committee on the Financial System
(Narasimham Committee), New Delhi, Government of India.
2. Eswar S. Prasad and Raghuram G. Rajan, Next Generation Financial Reforms for India,
Finance & Development, A Quarterly Publication of the International Monetary Fund, Vol
45, No. 3, September 2008.
3. Sameer Kochhar, Growth & Finance Essays in Honour of C. Rangarajan, Academic
Foundation, Daryaganj, New Delhi--‐110002, RBI 2011
4. RBI, Report on Trend and Progress of Banking in India, Reserve Bank of India, Retrieved
from http://www.rbi.org.in/scripts/Publications.aspx 2010-11, pp 59.
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Chamber of Commerce & Industry, 23rd June 2011 at Chennai
6. Swamy, Vighneswara, Bank--‐Based Financial Intermediation for Financial Inclusion and
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8. R. Bajaj, Chairman, (1997) Draft code on corporate governance, Confederation of Indian
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9. S.K. Barua, V. Raghunathan, J. R. Varma and N. Venkiteswaran (1994), “Analysis of the
Indian Security Industry: Market for Debt.
10. International Monetary Fund (1993), International Capital Markets Part II: Systemic
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11. McKinnon, R. I. (1973), Money and Capital in Economic Development, Washington, the
Brookings Institution.

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12. Ministry of Finance (1993a), Economic Reforms: Two Years After and the Tasks Ahead,
New Delhi, Government of India.
13. Ministry of Finance (1993b), Public Sector Commercial Banks and Financial Sector
Reforms: Rebuilding for a Better Future, New Delhi, Government of India.
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17. Standard and Poor (1997), “Financial System Stress and Sovereign Credit Risk”,
Standard and Poor’s Credit Week, December 10, 1997.
18. Sunderarajan, V. and Tomas J. T. Balino (1991), Banking Crises: Cases and Issues,
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