Financial Sector Reforms

October, 2021

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Introduction

Chapter discusses the context, need, objectives, approach, content

and appraisal of financial sector reforms in India during 1991-97.
New Economic policy (NEP) of structural adjustments and stabilisation
programme was introduced in June 1991.
Financial system reforms received special attention as part of this
policy.
After announcing NEP govenment announed a high level committee on
financial system ”to examine all aspects related to structure,
organisation, functions and procedures of the financial system.”

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Pre-Reform Period (Before 1990s)
A classic example of “financial repression”, with monetary policy
subservient to the fiscal
fixed exchange rate system
poor financial infrastructure
lack of competition, low capital base, low productivity, and high
intermediation cost in banking sector
extensive regulations such as administered interest rates
lack of proper risk management systems and prudential norms resulting
in poor asset quality
control over pricing of financial assets, barriers to entry and high
transaction costs
imposition of high CRR, SLR and directed credit programmes for the
priority sectors
banks had to continue to finance non-viable sick units compromising
their own viability
Financial reforms were needed as the financial health, integrity,
autonomy, flexibility and vibrancy in the financial sector had
deteriorated.
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Need for Reforms

The economic reforms that took place in 1991 were amidst two major
crises involving the financial sector
BOP crisis throwing India on the brink of the default
Threat of insolvency in the banking system

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Reform Process

Financial sector reforms took place in a calibrated fashion after

excessive consultations with the experts, committees and various
market participants.
The reform measures were planned in such a way so as to reinforce
each other.
Attempts were made to strengthen market forces in a competitive
environment.
Proper incentives and operational flexibility were provided to achieve
the desire goals through interplay of market forces.
Starting with a dire situation, the transformation has taken place in a
gradual fashion, with a well sequenced and coordinated policy
measures which has improved the stability and the resilience of the
financial sector.
The aim of the reform process has been to achieve the best
international practices.

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Main Objectives of Financial Sector Reforms
To create autonomous, transparent, competitive, market oriented,
world integrated financial system.
Increase the allocative efficiency of available savings, and promote
accelerated growth of real sector.
Increase effectiveness. accountability, profitability, viability,
professionalism and depolitisation of financial sector.
Increase rate of return on real investment.
Promote competition by creating level playing fields and facilitating
free entry and exit for institutions and market players.
Dismantle administered system of interest rates.
Reduce level of resource pre-emptions and to improve effectiveness of
directed credit programmes.
Build a financial infrastructre relating to supervision, audit technology
and legal matters.
Modernise instruments of monetary control so as to make them more
suitable for the conduct of monetary policy in market environment.
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Systemic Policy Reforms
Most interest rate in economy deregulated; the system of
administered interest rates largely dismantled and the structure of
interest rates greatly simplified.
Preemption of banks’ resources through SLR in favor of government
was brought down and the rate of return on SLR securities is
maintained by and large at market rates.
Capital adequacy norms for banks and financial institutions
introduced. Basel Committee framework for capital adequacy
adopted.
Recovery of debts due to banks and financial institutions Act, 1993
passed to set up special recovery tribunals to facilitate quicker
recovery of loans.
System of ad-hoc trasury bills abolished and replaced by ways and
means advance effective from April 1, 1997.
SEBI made a statutory body in February 1992 and armed with
necessary authority and powers for regulation and reform of the
capital market.
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Systemic Policy Reforms...

Private sector allowed to set up banks, mutual funds, money market

mutual funds, insurance companies etc.
Public sector bank permitted diversified ownership subject to 51
percent holding of government/RBI.
SBI, IFCI and IRBI converted into public limited companies.
Policy of permitting foreign banks to open branches liberalised.
Convertibility clause is no longer obligatory in the case of assistance
sanctioned by term lending institutions.
Floating interest rate on financial assistance (linked to 364-day TBs)
introduced by all-India development banks.
Interlinkages between various linkages of the financial market
including money, government securities and forex market instruments
have increased.
Auction of government securities have been introduced.
A separate financial market department within RBI created.
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Banking Reforms
State bank of India and other nationalised banks enabled to access
the capital market for debt and equity.
Prudential norms for income recognition, classification of assets and
provisioning of debts for commercial banks, including regional rural
banks and financial institutions developed.
Banks required to make the balance sheet fully transparent and make
full disclosures in keeping with International Accounting Standards
Committee.
Banks are given greater freedom to open, shift, and swap branches as
also to open extension counters.
Operational autonomy has been granted to public sector banks.
Transparent norms have been introduced for entry of Indian private
sector, foreign and joint-venture banks and insurance companies,
permission of foreign investment in the financial sector in the form of
FDI as well as portfolio investment, permission to banks to diversify
product portfolio and business activities.
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Banking Reforms...

Roadmap has been developed for presence of foreign banks and

guidelines are issued for mergers and amalgamation of private sector
banks and NBFCs.
Sharp reduction in pre-emption through reserve requirements , market
determined prices for government securities and disbanding of
administered interest rates.
Setting up of Credit Information Bureau of India Limited (CIBIL) for
information sharing on defaulters as also other borrowers.
Establishment of the board for financial supervision as the apex
supervisory authority for commercial banks, financial institutions and
non-banking financial companies.
Strengthening corporate governance, enhanced due diligence on
important shareholders, fit and proper tests for directors.

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References

1 L.M .Bhole and J.Mahakud (2011). Financial Institutions and

Markets, Tata McGraw Hill, 5th Edition.

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