Reforms in Indian Banking Sector



A 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


Reforms in Indian Banking Sector
operational environment of the Indian banking sector.


forces due to the deregulated interest rates. These have significantly affected the

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.


Reforms in Indian Banking Sector


The Narasimham Committee has presented a detailed analysis of various problems and challenges facing the Indian banking system and made wide-ranging recommendations for improving and strengthening its functions.




01 04

1.2 Reduction of SLR and CRR 1.3 Minimum Capital Adequacy Ratio 07 1.4 1.5 1.6 Prudential Norms Disclosure Norms 19

11 17

Rationalisation of Foreign Operations in India


Reforms in Indian Banking Sector


Special Tribunals and Asset Reconstruction 23

Fund 26 1.9 1.10 1.11 39

1.8 Restructuring of Weak Banks Asset Liability Management System 29 Reduction of Government Stake in PSBs 32 Deregulation of Interest Rate

List of Illustrations and Visual Aids Illustration No. Title Page no.


Reforms in Indian Banking Sector 1 2 3 4 5 6 Classification of Loan Assets of SCBs Indian Banks: Trend in ROE Capital Contributed by Government Income and Expenses Profile of banks Trends in CRR and SLR Growth In Investments In Government Securities by Banks 14 20 27 39 61 67 2011 5 .

Reforms in Indian Banking Sector 2011 Chapter No 01 introduction 6 .

iv. The main recommendations of the Committee were: i. the RBI had proposed to from the committee chaired by M. on the banking sector reforms highlighted the weaknesses in the Indian banking system and suggested reform measures based on the Basle norms. Manmohan Singh. Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years Progressive reduction in Cash Reserve Ratio (CRR) Phasing out of directed credit programmes and redefinition of the priority sector Deregulation of interest rates so as to reflect emerging market conditions 7 . The reform measures necessitated the deregulation of the financial sector. Narasimham. ii. aspects relating to the Structure. The initiation of the financial sector reforms brought about a paradigm shift in the banking industry. former RBI Governor in order to review the Financial System viz. The Narasimham Committee report. In 1991. the need was felt to restructure the Indian banking industry. particularly the banking sector. iii. submitted to the then finance minister. The guidelines that were issued subsequently laid the foundation for the reformation of Indian banking sector.1 Introduction 2011 As the real sector reforms began in 1992. Organisations and Functioning of the financial system.Reforms in Indian Banking Sector 1.

xiv. Rural banks. viii. asset classification and provisioning against bad and doubtful debts vii. 8 per cent by March 1996. which could become international in character. xvi. xv. so as to have 3 or 4 large banks. 2011 Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993. Imparting transparency to bank balance sheets and making more disclosures 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. Abolition of branch licensing Liberalising the policy with regard to allowing foreign banks to open offices in India 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 8 .Reforms in Indian Banking Sector v. and 8 per cent by those banks having international operations by March 1994 vi. Adoption of uniform accounting practices in regard to income recognition. x. xiii. including RRBs. ix. xii. 8 to 10 national banks and local banks confined to specific regions. confined to rural areas xi.

Among these are the reductions in SLR/CRR. mutual funds. etc. Several recommendations have been accepted and are being implemented in a phased manner. xx. leasing companies etc. introduction of capital adequacy norms. A separate authority for supervision of banks and financial 2011 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 Obtaining resources from the market on competitive terms by DFIs Speedy liberalisation of capital market Supervision of merchant banks. This committee’s terms of reference included review of progress in reforms in the banking sector over the past six years. etc. adoption of prudential norms for asset classification and provisions. xxi.. xviii. allowing entry to new entrants in private sector banking sector. and deregulation of most of the interest rates. xix.Reforms in Indian Banking Sector xvii. 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. charting of a programme of banking sector reforms required to make the Indian banking system more robust and internationally competitive and framing of detailed 9 . Keeping in view the need of further liberalisation the Narasimham Committee II on Banking Sector reform was set up in 1997.

The major recommendations are : i. 9% by 2000 and 10% by 2002 v. There should be no further re-capitalization by the Govt. This committee constituted submitted its report in April 1998. guaranteed accounts must also be categorized as NPAs under the usual norms 10 . Risk weight for a Govt. 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. International practice of income recognition by introduction of the 90-day norm instead of the present 180 days. viii. xi.Banks having high NPA should transfer their doubtful and loss categories to ARCs which would issue Govt. Govt.CAR to be raised to 10% from the present 8%.Banks should avoid ever greening of their advances vii. guaranteed account must be 100 percent iv. Capital adequacy requirements should take into account market risks also ii. securities should be marked to market iii. In the next three years.Reforms in Indian Banking Sector 2011 recommendations in regard to make the Indian banking system more robust and internationally competitive. NPA level should be brought down to 5% by 2000 and 3% by 2002. entire portfolio of Govt. bonds representing the realisable value of the assets.A provision of 1% on standard assets is required. x. ix. xii.

To rationalize staff strengths. 2000 and laid down rules for provisioning. it has assigned a 2. 2001). an appropriate VRS must be introduced. 2000. To start with. xvi. called for 0. 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.25 per cent provisioning on standard assets (from fiscal 2000). Only a few of these mainly constitute to the reforms in the banking sector. xiv. shortened the life of sub-standard assets from 24 months to 18 months (by March 31. 1999) and a minimum capital adequacy ratio of 9 per cent as on March 31.Reforms in Indian Banking Sector 2011 xiii. Recruitment of skilled manpower directly from the market be given urgent consideration xv.5 per cent risk-weightage on gilts by March 31. REFORMS 11 . 100 per cent risk weightage on foreign exchange (March 31. There is need to institute an independent loan review mechanism especially for large borrowal accounts to identify potential NPAs.

Reforms in Indian Banking Sector 2011 Chapter No 02 Reduction Of slr and crr 12 .

and also help in monetary regulation.8 per cent. The monetary policy perspective essentially looks at SLR and CRR requirements (especially CRR) in the light of several other roles they play in the economy. The markets fell precipitously because banks and corporates did not accurately measure the risk spread that should have been reflected in their lending activities.2 Reduction of SLR and CRR 2011 The South East Asian countries introduced banking reforms wherein bank CRR and SLR was reduced. With an effective return of a mere 2. Nor did they manage such risks or provide for them in their balance sheets. allocate bank credit between the government and the private sectors. The Narasimham Committee had argued for reductions in SLR on the grounds that the stated government objective of reducing the fiscal deficits will obviate the need for a large portion of the current SLR. The 13 . The CRR is considered an effective instrument for monetary regulation and inflation control. And followed the South East Asian Crisis.Reforms in Indian Banking Sector 1. provide protection to deposit-holders. CRR is a major drag on banks' profitability. However bankers strongly feel that these along with high non-performing assets (on which banks do not earn any return) 10 percent CRR and 25 percent SLR (most banks have SLR investments way above the stipulation) are affecting banks' bottomlines. this increased the lending capacity of banks. the need for the use of CRR to control secondary expansion of credit would be lesser in a regime of smaller fiscal deficits. The SLR is used to impose financial discipline on the banks. Similarly.

5 per cent. This argument is sometimes carried further to state that RBI makes profits on impounded money. Ultimately. with the Statutory Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-97 in a period of 5 years. the banks' control over resource deployment.Reforms in Indian Banking Sector 2011 committee offered the route of Open Market Operations (OMO) to the Reserve Bank of India for further monetary control beyond that provided by the (lowered) SLR and CRR reserves. at the cost of bank profitability. and Germany) towards drastic lowering of reserve requirements is often used to support the argument for reduced reserve levels in India. It is also claimed that the low returns from the forced investments in government securities adversely affect the bank profitability . To some extent. Australia. was much greater than the (earlier) returns on the government securities. and the other which favours the bank reserves as a monetary policy instrument. the rule was Reduction in the reserve requirements of banks. which averages at 15-16 per cent. The arguments for higher or lower SLR and CRR ratios stem from two different perspectives one which favours the banks. Canada. and returns to the banks from the "preempted" funds. Some problems with the stated aim of reducing SLR and CRR are: 14 .the cost of deposits for banks. Switzerland. this argument has been weakened by the increase in interest on government securities to 13. The bank perspective seeks to maximise "lendable" resources. The recent trend in several developed countries (US.

A commitment to a unidirectional movement of these vital controls irrespective of the effects on. not likely to stabilize in the near future. if the economic indicators become unfavourable. Open market operations have not been used to any significant extent in India for monetary control. 15 . This scenario thus indicates that despite the stated aim of reductions in SLR and CRR. The RBI had announced an increase in interest rate on CRR balance to 6% from the present 4%. therefore. and the response of. The time required for gaining experience with the use of such operations would be much more than 5-6 years. and RBI has already indicated as much. RBI may be forced to revert to higher reserve levels. as they have to maintain a minimum balance of 8% with the RBI. Bank investment are.Reforms in Indian Banking Sector 2011 1. would be unwise. The supporting condition of smaller fiscal deficits is not happening in reality 2. other economic factors (such as inflation). This will certainly boost the profits of banks. 3.

Nov.May.Nov.May93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 SLR CRR Illustration 1 16 .May.May.May.Nov.Reforms in Indian Banking Sector Trends in CRR and SLR 1993 – 2001 2011 40 35 30 Percentage of DTL 25 20 15 10 5 0 May.Nov.Nov.Nov.May.May.Nov.Nov.May.

Reforms in Indian Banking Sector 2011 17 .

Reforms in Indian Banking Sector 2011 Chapter No 03 Minimum Capital Adequacy ratio 18 .

Capital Adequacy The growing concern of commercial banks regarding international competitiveness and capital ratios led to the Basle Capital Accord 1988. to be achieved by year-end 1992. 1996. • Tier-I Capital. Later. all banks required attaining the capital adequacy norm of 8 per cent. by March 31.Reforms in Indian Banking Sector Minimum Capital Adequacy Ratio committee recommended a Stipulation of minimum capital 1. and 8 per cent by those banks having international operations by March 1994. the banks will have to identify their Tier-I and Tier-II capital and assign risk weights to the assets.3 2011 The adequacy ratio of 4 per cent to risk weighted assets by March 1993. The minimum CAR that the Indian banks are required to meet is set at 9 percent. 8 per cent by March 1996. Having done this they will have to assess the Capital to Risk Weighted Assets Ratio (CRAR). The accord sets down the agreement to apply common minimum capital standards to their banking industries. the RBI also issued similar capital adequacy norms for the Indian banks. as per the Basle Committee Recommendations. comprising of Paid-up capital Statutory Reserves Disclosed free reserves Capital reserves representing surplus arising out of sale proceeds of assets 19 . Based on the Basle norms. According to these guidelines.

the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. costly money to refurbish the capital base. 20 . comprising of 2011 Undisclosed Reserves and Cumulative Perpetual Preference Shares Revaluation Reserves General Provisions and Loss Reserves The Narasimham Committee had recommended that the capital adequacy norms set by the Bank of International Settlements (BIS) be followed by the Indian banks also. Inadequacy? The structural inadequacy that is said to be responsible for the stock scam was the compartmentalisation of the capital and money markets. Where time and legal efforts might have forced them to pay more. In this situation. or some alternative arrangement. The need to make massive provisions obviously results in a depletion of capital. The BIS norm for capital adequacy is 8 per cent of risk-weighted assets. the need for ARF is now paramount. Such interconnections between various parts of the financial system will continue to develop as the demands made by the rest of the economy on the financial system increase in the next two decades. errant loanees are now getting away with token payments which the funds starved banks are only too willing to accept. a short-term danger of the new provisioning and capital adequacy norms arises from the inefficiency of the Asset Reconstruction Fund (ARF).Reforms in Indian Banking Sector • Tier-II Capital. Also. and the availability of "illegal" arbitrage opportunities. Thus. But the capital adequacy norm means the banks have to find additional.

the Indian public sector banks may attract more "punishments" in the form of politically motivated "loan waivers". but the recent stock scam showed that the banks are perhaps being forced to take excessive risks to improve the profitability. such as banks.the source of capital would not make much difference in the Indian scenario.banking or government . "loan melas".  Capital increases the disincentive for the bank management to take excessive risk: If significant amount of their own funds are at stake.Reforms in Indian Banking Sector 2011 The banking sector specialists have traditionally claimed that capital plays several roles in all "depository institutions".  Capital acts as a buffer between the bank and the deposit guarantee corporation (funded by the tax-payer): while this is true 21 . the government's ability to play such a role effectively is suspect. Since management control will remain with bureaucrats . and non-performing assets. At the same time. However. However. these roles can vary significantly between the public sector banks and those in the private sector. the equity-owners have a powerful incentive to control the amount of risk the bank incurs. The justification for capital adequacy norms for banks is brought out by the following arguments:  Capital lowers the probability of bank failure more capital means added ability to withstand unexpected losses. and more time for the bank to work through potentially fatal problems. This may remain true for the public sector banks only if the government acts as a vigilant shareholder. The Indian banks have traditionally shown risk-aversion.

 Capital helps avoid "credit crunches": a well-capitalized bank can continue to lend in the face of losses.Reforms in Indian Banking Sector 2011 for the private banks. which would otherwise have to be called in. the government-owned capital in the public sector banks is itself taxpayer money. because of the size of 22 . increase in capital owned directly by the government has several attendant problems' The situation is complicated by the fact that " private management" does not provide an answer in India. New opportunities can be quickly made use of by lending appropriately.  Capital increases the long-term competitiveness: more capital allows a bank to build long-term customer relationships. and respond to positive as well as negative changes in the economic environment. In an economic downturn. If the bank is not constrained by capital. It can thereby recover more from the loans. well-capitalized banks may provide a vital source of continuing credit. especially in view of the large quantities of non-performing assets. Similar losses might force a poorly capitalized bank to restrict credit (to increase capital ratios). and (b) however. The Dilemma The foregoing discussion clearly brings out two conclusions: (a) increasing the capital base of the nationalised banks is necessary. it can give valuable time to customers with temporary repayment problems.

8 per cent. One short-term fallout of the capital adequacy norms has been the massive increases in investments by the banks in government securities. In the first ten months of 1993-94. The problem with this practice of the banks is that it can upset the balance of maturity patterns between deposits (many of ' which are short-term) and investments (which have 10 year maturities). investments in them do not add to the capital requirements.65 per cent. especially when interest rates are deregulated. the investments in government securities shot up by 18. for example. Now. while investments surged by 18. banks would have to develop much better investment management skills. Despite a strong growth in aggregate deposits of 13. 23 . talent and expertise in bank management is available mainly in the existing nationalised banks. credit grew by only 6. and significant open market operations are started.Reforms in Indian Banking Sector 2011 the institutions involved. Also.8 per cent while bank credit grew at only 6. The banks are therefore choosing to deploy funds mobilised through deposits in these long-term gilts.6 per cent. Since the risk-weight of government securities is zero.8 per cent.

8 %] [8.6 %] 26390 1992-93 [Up to Jan 93] 32364 [14. suggested further revision i.June]. 9% by 2000 and 10% by 2002 Illustration 2 24 .Reforms in Indian Banking Sector 2011 1991.6 %] 19857 [18.7 %] 11042 [12. Jan 1993.Report on Trends and Progress of Banking in India 1991-92 [July .0 %] [21.0 %] 15131 15460 Source: Reserve Bank of India Bulletin [1994] Supplement .0 %] 20966 [16.2 %] 1993-94 [Up to Jan 94] 37187 [13. 1998.e.1992-93 92 Aggregate deposits growth Bank credit growth Investments 9291 36441 [19.8 %] 9999 [6. CAR to be raised to 10% from the present 8%(1998). Growth In Investments In Government Securities by Banks The Narasimham Committee II.

Reforms in Indian Banking Sector 2011 Chapter No 04 Prudential norms 25 .

Close to 16 per cent of loans made by Indian banks were NPAs . The net NPAs (gross NPAs minus provisioning) stands at Rs 21. asset classification and provisioning against bad and doubtful debts has been laid down by the Central Bank. the NPAs have come down over the last 5-6 years.563 crore which is about 16 per cent of the total loan assets of the banks. a code stating adoption of uniform accounting practices in regard to income recognition. it actually makes the problems worse.very high compared to say 5 per cent in banking systems in advanced countries. in absolute terms they have grown. banks give another loan to the company with the help of which it can pay the due interest on the original loan. gross NPAs in the banking sector stands at Rs 45. While this allows the bank to project a healthy image. to avoid classifying problem assets as NPAs. RBI discourages such practices.232 crore which is about 7 per cent of loans advanced by the banking sector. Though in percentage terms. signifying that while new NPAs are being added to banks' operations every year. 26 . recovery of older dues is also taking too long. Magnitude of the problem According to the latest RBI figures.Reforms in Indian Banking Sector 1. What is ever greening or rescheduling of loans? Sometimes. and creates more NPAs in the long run.4 2011 Prudential Norms To get a true picture of the profitability and efficiency of the Indian Banks.

If the assets of the bank go bad it is the capital that comes to its rescue. the one major move in this direction was brought about by the Basle Committee. Considering the implications of the NPAs and also for imparting greater transparency and accountability in banks operations and restoring the credibility of confidence in the Indian financial system. Implies that the bank should have adequate capital to face the likely losses that may arise from its risky assets. the lower will be the asset quality and vice versa.Increased Transparency 2011 Apart from the interest rate structure. This became imperative. Courtesy the nationalization agenda and the directed credit.Reforms in Indian Banking Sector Asset Quality . they help in arresting its deterioration. The asset quality of the bank and its capital are closely associated. In the changed business environment. they bring out the true position of a Bank’s loan portfolio. the net interest income is also affected by the asset quality of the bank. the problem still remains. NPAs expose the banks to not just credit risk but also to liquidity risk. and secondly. the RBI introduced prudential norms and regulations. The prudential norms which relate to income recognition. most of the public sector banks were burdened with huge NPAs. As stated earlier. where banks are exposed to greater and different types of risk. asset classification and provisioning for bad and doubtful debts serve two primary purposes – firstly. Asset quality is reflected by the quantum of non-performing assets (NPAs) – the higher the level of NPAs. which can help it sustain unforeseen losses. it becomes essential to have a good capital base. as banks 27 . While the government did contribute to write-off these bad loans. which laid the capital standards that banks have to maintain.

Reforms in Indian Banking Sector


began to cross over their national boundaries and begin to operate in international markets. Following the Basle Committee measures, RBI also issued the Capital Adequacy Norms for the Indian banks also.

 The regulation for income recognition states that the Income on NPAs cannot be booked. Interest income should not be recognized until it is realized. An NPA is one where interest is overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on accrual basis, but is to be treated as income only when actually received. Income in respect of accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic system for income recognition based on the prospect of realisability of the security. On non-performing accounts the banks should not charge or take into account the interest.


Reforms in Indian Banking Sector


Income-recognition norms have been tightened for consortium banking too. Member banks have to intimate the lead-bank to arrange for their share of recovery. They will no more have the privilege of stating that the borrower has parked funds with the lead-bank or with a member-bank and that their share is due for receipt. The new notifications emanated after deliberations held between the RBI and a cross-section of banks after a working group headed by chartered accountant, PR Khanna, submitted its report. The working group was set after the RBI’s Board for Financial Supervision (BFS) wanted divergences in NPA accounting norms by banks from central bank guidelines to be addressed. The working group had identified three areas of divergence: non-compliance with RBI norms; subjectivity arising out of the flexibility in norms; and differences in the valuation of securities by banks, auditors and RBI.

As of now, for income recognition norms, the RBI has suggested that the international norm of 90 days be implemented in a phased manner by 2002. The current norm is 180 days.

ASSET CLASSIFICATION While new private banks are careful about their asset quality and consequently have low non-performing assets (NPAs), public sector banks have large NPAs due to wrong lending policies followed earlier and also


Reforms in Indian Banking Sector


due to government regulations that require them to lend to sectors where potential of default is high. Allaying the fears that bulk of the NonPerforming Assets (NPAs) was from priority sector, NPA from priority sector constituted was lower at 46 per cent than that of the corporate sector at 48 per cent. Loans and advances account for around 40 per cent of the assets of SCBs. However, delay/default in payment of interest and/or repayment of principal has rendered a significant proportion of the loan assets nonperforming. As per RBI’s prudential norms, a Non-Performing Asset (NPA) is a credit facility in respect of which interest/installment has remained unpaid for more than two quarters after it has become past due. “Past due” denotes grace period of one month after it has become due for payment by the borrower. The Mid-Term Review of Monetary and Credit Policy for 2000-01 has proposed to discontinue this concept with effect from March 31, 2001. Regulations for asset classification Assets should be classified into four classes - Standard, Sub-standard, Doubtful, and Loss assets. NPAs are loans on which the dues are not received for two quarters. NPAs consist of assets under three categories: sub-standard, doubtful and loss. RBI for these classes of assets should evolve clear, uniform, and consistent definitions. The health code system earlier in use would have to be replaced. The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories:


Reforms in Indian Banking Sector


Standard Assets: It carries not more than the normal risk attached to the business and is not an NPA. Sub-standard Asset: An asset which remains as NPA for a period exceeding 24 months, where the current net worth of the borrower, guarantor or the current market value of the security charged to the bank is not enough to ensure recovery of the debt due to the bank in full. Doubtful Assets: An NPA which continued to be so for a period exceeding two years (18 months, with effect from March, 2001, as recommended by Narasimham Committee II, 1998). Loss Assets: An asset identified by the bank or internal/ external auditors or RBI inspection as loss asset, but the amount has not yet been written off wholly or partly. The banking industry has significant market inefficiencies caused by the large amounts of Non Performing Assets (NPAs) in bank portfolios, accumulated over several years. Discussions on non-performing assets have been going on for several years now. One of the earliest writings on NPAs defined them as "assets which cannot be recycled or disposed off immediately, and which do not yield returns to the bank, examples of which are: Overdue and stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and bank balances with other banks, and amounts locked up in frauds". The following Table shows the distribution of total loan assets of banks in the public private sectors and foreign banks for 1997-98 through 1999-


It is worth noting that the ratio of incremental standard assets of SCBs to their total loan assets increased from 83.9 1.8 1.2 3.0 1.1 86.8 1.0 2.3 87.0 1.0 85.0 1.3 91.9 0.4 93. Loss 1997-98 1998-99 1999-2000 1.8 6. In other words.9 0.6 92.9 1. the ratio of incremental NPAs of SCBs to their total loan assets declined significantly from 16.0 86.7 0. Classification of Loan Assets of SCBs (Percentage distribution of total loan assets) Assets A.7 0.6 85.6 5.6 9.9 4.9 1.1 4.7 2. Standard 1997-98 1998-99 1999-2000 B.9 per cent in 1998-99 to 2.0 5.Reforms in Indian Banking Sector 2011 2000.8 percent in 1999-2000.9 4.9 0.0 4. Doubtful 1997-98 1998-99 1999-2000 D.8 1.9 2.3 5. Sub-standard 1997-98 1998-99 1999-2000 C.7 3.9 5.9 1.2 percent in 1999-2000.9 4.9 0.2 Public Private Foreign SCBs 32 .1 per cent in 1998-99 to 97.0 1.0 91.2 2.8 1.1 84.2 91.5 93.

the banks will have to tighten their credit evaluation process to prevent this scale of sub-standard and loss assets. sometimes involving up to 18 different officials. doubtful. and loss assets. Of these. 1994). the sub-standard assets account for Rs 12.Reforms in Indian Banking Sector E. ( assets (A) 3 ) The asset classification norms have resulted in a huge quantity of assets being classified into the sub-standard. For the future.106 crores. Crore) 1997-98 1998-99 1999-2000 284971 325328 380077 36753 43049 58249 30972 31059 37432 352696 399436 475758 2011 Note: Addition of percentages for B to D may not add up to 100 minus Note: Addition of percentages for B to D may not add up to 100 minus the the percentage share of standard assets (A) due to rounding. most of whom do not add any value (information or judgment) to the evaluation. The present evaluation process in several banks is burdened with a bureaucratic exercise. doubtful assets Rs 20. As at 31 March 1993. percentage share of standardIllustration due to rounding.930 crores (RBI Bulletin. and loss assets Rs 3.588 crores. the total of Non-Performing Assets (NPAs) for the public sector banks (SBI. Total Assets (Rs. PROVISIONING NORMS 33 . its seven associates.552 crores. and 20 nationalised banks) stood at Rs 36.

390 crores pertaining to 1992-93.Reforms in Indian Banking Sector 2011 Banks will be required to make provisions for bad and doubtful debts on a uniform and consistent basis so that the balance sheets reflect a true picture of the financial status of the bank.Rs 10. The encouraging profits recently declared by several banks have to be seen in the light of provisions made by them . (ii) 100 per cent of security shortfall for doubtful assets and 20 per cent to 50 per cent of the secured portion. 34 . and (iii) 10 per cent of the total out standings for substandard assets. Banks need to have better credit appraisal systems so as to prevent NPAs from occurring. The Narasimham Committee has recommended the following provisioning norms (i) 100 per cent of loss assets or 100 per cent of out standings for loss assets. and the additional provisions for 1993-94. The most important relaxation is that the banks have been allowed to make provisions for only 30 per cent of the "provisioning requirements" as calculated using the Narasimham Committee recommendations on provisioning (but with the diluted asset classification). A provision of 1% on standard assets is required as suggested by Narasimham Committee II 1998. The nationalised banks have been asked to provide for the remaining 70 per cent of the "provisioning requirements" by 31 March 1994.

05 35 .Reforms in Indian Banking Sector 2011 To the extent that provisions have not been made. Chapter No. the profits would be fictitious.

Reforms in Indian Banking Sector 2011 Disclosure norms 36 .

Perhaps even the loan waivers and loan "melas" which are often decried by bankers form only a small portion of the total NPAs. This should be done to ensure that the taxpayer’s money given to the banks as capital is not used to write off private loans without adequate efforts and punishment of defaulters. the banks will have to tighten their credit evaluation process to prevent this scale of sub-standard and loss assets.Reforms in Indian Banking Sector 1. deposits. These disclosures were to be made for the year ending March 2000 In fact. A lot therefore depends upon the seriousness with which a new regime of 37 . the banks must be forced to make public the nature of NPAs being written off.5 Disclosure Norms 2011 Banks should disclose in balance sheets maturity pattern of advances. As mentioned above. investments and borrowings. most of whom do not add any value (information or judgment) to the evaluation. sometimes involving up to 18 different officials. much more stringent disclosure norms are the only way to increase the accountability of bank management to the taxpayers. Apart from this. The present evaluation process in several banks is burdened with a bureaucratic exercise. But whether this government and its successors will continue to play with bank funds remains to be seen. # A Close look: For the future. banks are also required to give details of their exposure to foreign currency assets and liabilities and movement of bad loans.

As per the proposed new policy guidelines. The move is aimed at providing the investor with a better insight into viewing a bank's performance in totality. but at the same time it was assumed that the problems will be dealt with by the parent. including all its branches and subsidiaries. RBI has set up a working group recently under its Department of Banking Operations and Development to come out with necessary guidelines on consolidated accounts for banks.Reforms in Indian Banking Sector 2011 regulation is pursued by RBI and the newly formed Board for Financial Supervision. the banks will be required to consolidate their accounts including all its subsidiaries and other holding companies for better transparency. # Result: This will require the banks to have a stricter monitoring system of not only their own bank. This will be a path-breaking change to the existing norms wherein each bank conducts its accounts without taking into consideration the disclosures of its subsidiaries and other divisions for disclosure. According to a banker. and not as isolated entities. but also the other subsidiaries in other sectors 38 . Towards this end. RBI norms for consolidated PSU bank accounts The Reserve Bank of India (RBI) has moved to get public sector banks to consolidate their accounts with those of their subsidiaries and other outfits where they hold substantial stakes. earlier subsidiaries were floated as external independent entities wherein the accounting details were not incorporated in the parent bank's balance sheet.

merchant banking. The Investors Advantage Getting all these accounts consolidated with that of the parent bank will provide the investor a better understanding of the banks' performances while deciding on their exposures. Now. this will very much form an integral part of the parent's balance sheet. These new norms will necessitate not only that the problems are handled by the parent. point out bankers. this will no longer be an external disclosure to the parent banks' books of accounts. More so. The working group was set up following the need to bring about transparency on the lines of international norms through better disclosures. Some public sector banks are even preparing their accounts in line with US GAAP norms in anticipation of a US listing. but investors are also aware of what exactly the problems are and how they affect the bottomlines of the parent banks. 39 . This is all the more important in the context of the recent announcements made by some major public sector banks where they have said they would hive off or close down some of their under performing subsidiaries. Rather.Reforms in Indian Banking Sector 2011 like mutual funds. since a number of public sector banks are now listed entities whose stocks are traded on the stock exchanges. under the new guidelines. These norms will therefore be in line with the future plans of these banks as well. housing finance and others.

Reforms in Indian Banking Sector 2011 For instance. 40 . if a subsidiary is not performing well or making losses. this will reflect in the parent's balance sheet.

Reforms in Indian Banking Sector 2011 Chapter No.6 Rationalisation of Foreign Operations in India 41 in .06 Rationalization Of foreign Operation indian 1.

Entry of New Banks in the Private Sector As per the guidelines for licensing of new banks in the private sector issued in January 1993. 300 crore within three years of commencement of business. 42 . • Promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time. • promoters need to bring in at least 40 percent of the fresh capital. Based on a review of experience gained on the functioning of new private sector banks. their contribution of 40 per cent shall be locked in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one year of bank’s operations. 300 crore within three years. revised guidelines were issued in January 2001. • Initial capital other than promoters’ contribution could be raised While augmenting capital to Rs.Reforms in Indian Banking Sector 2011 Liberalising the policy with regard to allowing foreign banks to open offices in India or rather Deregulation of the entry norms for private sector banks and foreign sector. through public issue or private placement. The main provisions/requirements are listed below : • Initial minimum paid-up capital shall be Rs. 200 crore. RBI had granted licenses to 10 banks. this will be raised to Rs.

however. • No large industrial house can promote a new bank. • NBFCs with good track record can become banks. Bhakey. it is also necessary to open 25 per cent of the branches in rural/semi-urban areas. Shortfall in NRI contribution to foreign equity can be met through contribution by designated multilateral institutions. No credit facilities shall be extended to them. • NRI participation in the primary equity of the new bank shall be to the maximum extent of 40 per cent. G. The remaining portion of fresh capital could be raised through public issue or private placement. Individual companies connected with large industrial houses can. • the case of other domestic banks. president of the State Bank of India Officers Association. which will maintain an arms length relationship with companies in the promoter group and the individual company/ies investing in equity.Reforms in Indian Banking Sector 2011 which will also be locked in for 5 years. equity participation shall be limited to 20 per cent within the 40 per cent ceiling. "Our industry did not oppose the entry of private bankers because we knew they will not be able to reach out to the rural markets” states. "Even 43 .M. contribute up to 10 per cent of the equity of a new bank. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter. as in criteria • on a continuous basis from commencement of operations. subject to specified A minimum capital adequacy ratio of 10 per cent shall be maintained Priority sector lending target is 40 per cent of net bank credit.

the private banks. with their level of contingent liabilities being much higher then their other counterparts viz. All those who beat their drums for the privatisation parade. The new private banks have been consistently gaining market shares from the public sector banks. to denationalise our public sector banks. These banks have targeted non-fund based income as major source of revenue. The bad debt figures even in the two to three year old new private sector banks have crossed over 6% to the total advances. They are there in the country to fill the private pockets with their typical selectivity of business and costly operations. which is much on the move after globalisation.Reforms in Indian Banking Sector 2011 after privatisation not more than 10 per cent of the Indian population can afford to open accounts in private banks. ICICI bank. Their technological edge and product innovation has seen them gaining market share from the slower. GTB. cannot be the alternative to our well-developed public sector banks. 44 . while the trends in the old private banks are still higher. BOP and UTI Bank have come out with IPOs as per licensing requirement. IndusInd. HDFC bank. despite the fact that they have no social commitment lendings in their portfolios. In any case. The major beneficiary of this has been corporate clients who are most sought after now." Can the keenly supported private and foreign banks cater to the banking needs of the people in India fairly? Takeover and merger dramas are in progress in the world of private sector banks now and time only can tell how many will live to render safe banking services in the days to come. PSU and old private sector banks. less efficient older banks. do so with vested interests. in the Indian context.

their efficiency ratios (employee’s productivity and profitability ratios) have also improved significantly. While. the two leading banks in this sector had set a new trend in the Indian banking sector. During the year. Large number of unprofitable branches B.Reforms in Indian Banking Sector 2011 The new generation private sector banks have made a strong presence in the most lucrative business areas in the country because of technology upgradation. their operating expenses have been falling as compared to the PSU banks. Excess staffing of serious magnitude C. As a result. most of these banks had a foreign capital infusion and some of the other banks have already initiated talks about a strategic alliance with a foreign partner. HDFC Bank. Non Performing Assets on account of politically directed lending and industrial recession in last few years 45 . ICICI Bank became the first bank in the country to list its shares on NYSE. The new private sector banks have performed very well in the FY2000. Most of these banks have registered an increase in net profits of over 50%. The Reserve Bank of India had advised the promoters of these banks to bring their stake to 40% over a time period. They have been able to make significant inroads in the retail market of the public sector and the old private sector banks. as a part of its expansion plans had taken over Times Bank. The main problems concerning the nationalized / state sector banks are as follows: A.

nonreconciliation of accounts. are more profitable and  have cleaner loans. misuse and fraud etc E.The new banks are growing faster.Reforms in Indian Banking Sector 2011 D. Declining interest rates. PSU Banks by and large take relatively longterm deposits at fixed rates to lend for working capital purposes at variable rates. 46 . inability to the present scenario of declining  interest rates. It therefore is negatively affected when interest rates decline as it takes time to reduce interest rates on deposits when lending has to be done at lower interest rates due to competitive pressures. as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money. The quality implementation of new technology has been going on at very rapid pace in the private sector. NPAs. ATMs etc The private’ edge  Technology. some of the new private banks are better able to manage the maturity mix. Inability to introduce profitable new consumer oriented products like credit cards. while PSU banks are lagging behind in the race.The private banks have used technology to provide service through lower cost delivery mechanisms. Reforms among public sector banks are slow. Lack of computerization leading to low service delivery levels.

The new private banks are able to provide a range of financial services under one roof. thus increasing their fee based revenues. List of Banks operating in India.Reforms in Indian Banking Sector  2011 Convergence. 47 .

Reforms in Indian Banking Sector 2011 48 .

Reforms in Indian Banking Sector 2011 Chapter No 07 Special tribunals And asset reconstruction fund 49 .

Reforms in Indian Banking Sector 2011 1. To expedite adjudication and recovery of debts due to banks and financial institutions (FIs) at the instance of the Tiwari Committee (1984). In the interim. Accordingly. the only recourse available to banks/FIs to cover their dues from recalcitrant borrowers. DRTs. 1993 (DRT). when all else failed. It was quite common for cases to drag on interminably. appointed by the Reserve Bank of India (RBI).7 Special Tribunals and Asset Reconstruction Fund Setting up of special tribunals to speed up the process of recovery of loans and setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount was one of the crucial recommendations of the Narasimham Committee. there was nothing left of the security that had been 50 . The act was amended in January 2000 to tackle some problems with the old act. was to file a suit in a civil court. banks had a huge portfolio of accounts where cases were pending in civil courts. the government enacted the Debt Recovery Tribunal Act. Prior to the passage of the DRT Act. more often than not. a compulsion! One of the main factors responsible for mounting non-performing assets (NPAs) in the financial sector has been the inability of banks/FIs to enforce the security held by them on loans gone sour. DRTs and Appellate DRTs have been established at different places in the country. The result was that by the late ’80s. stripped their premises of all assets so that that by the time the final verdict came. borrowers.

would do away with the costly. DRTs failed to make a significant dent. it was felt. DRTs soon ran into rough weather. The functioning of debt recovery tribunals has been 51 .Reforms in Indian Banking Sector pledge to the bank The Advantage 2011 DRTs. Bangalore. Following the passage of the Act in August 1993. time-consuming civil court procedures that stymied recovery procedures since they follow a summary procedure that expedites disposal of suits filed by banks/FIs. However. Guwahati and Patna. the tribunals did not have powers of attachment before judgment. for appointment of receivers or for ordering preservation of property Thus. Delhi. The truth undiscovered. many more DRTs and ADRTs have been set up. as a consequence of the numerous lacunae in the act and the huge backlog of past cases where suits had been filed. legal infrastructure for the recovery of non-performing loans still does not exist. CURRENT STATUS AND BANKERS COMPLAINS ! Unfortunately. DRTs were set up at Calcutta. The constitutional validity of the Act itself was questioned. that the Supreme court modified its earlier order — staying the operation of the Delhi High Court order quashing the constitution of the DRT for Delhi — to allow the setting up of three more DRTs in Chennai. For instance. Jaipur and Ahmedabad along with an Appellate Tribunal at Mumbai. Subsequently. It was only in March 1996.

60. Warns K. over Rs 12. Even that is an under estimate as it does not include advances covered by government guarantees." And so too will provisions. Complains Bank of Baroda's Kannan: "Of the Rs 45.R. It also empowers the presiding officer to execute the decree of the official receiver based on the certificate issued by the DRT.000 crore is locked up in the courts.000-crore worth of gross NPAs.000 crore. the only solution to the problem of high NPAs is ruthless provisioning. which have turned sticky.000 crore. Maheshwari. More recently.Reforms in Indian Banking Sector 2011 hampered considerably by litigation in various high courts. Recent Developments The recent amendment (Jan 2000) to the DRT Act addresses many of the lacunae in the original act. Transfer of cases from one DRT to another has also been made easier. thus enabling the asset to escape the non-performing loan tag. Nor does it include allowances for "ever greening"--the practice of extending fresh advances to defaulting corporates so that the prospective defaulter can make interest payments. the Supreme Court has ruled that the DRT Act will take precedence over the Companies Act in the recovery of debt. 52 ." So. It empowers DRTs to attach the property on the borrower filing a complaint of default. IndusInd Bank: "NPA levels are going to go up for all the banks. putting to rest all doubts on that score. which means it is still stuck with net NPAs worth Rs 25. the banking system has provided for about Rs 20. Till date. Managing Director.

They also reflect the ability of borrowers to dodge the lenders. there is nothing a DRT can do till such time as the case is disposed of by the BIFR.Reforms in Indian Banking Sector 2011 SOME MORE ISSUES As things stand. Once the fact of their sickness has prima facie been accepted by the Board for Industrial and Financial Reconstruction (BIFR). iron out delays at the DRT end. The main culprit for all this is the law. Existing recovery processes in the country are aimed at recovering lenders' dues after a company has gone sick and not nipping sickness in the bud. the DRT Act supersedes all acts other than The Sick Industrial Companies Act (SICA). as well as ensure that promoters do not have the time and opportunity to bleed their companies before they go into winding up. Yet the number of cases pending before DRTs and courts make a telling commentary on the inability of lenders to make good their threat. This lacuna too must be addressed if DRTs are to live up to their promise. This means that recovery procedures can still be stalled by companies declaring themselves sick under SICA. Since sickness is defined in law as the erosion of capital of a company for three consecutive years. there is little to recover from a sick company after it has been referred to the Board of Industrial and Financial Revival (BIFR). The amendments would ensure speedy recovery of dues. 53 .

together.000 crore. The solution could lie in better risk management 54 . or writing off these debts altogether (which may not find favour with shareholders). tot up to a staggering Rs 60.Reforms in Indian Banking Sector 2011 What's hurting banks now is the fact that these new issues have cropped up even as they have been (unsuccessfully) wrestling with their NPAs which. The stratagem of using Debt Recovery Tribunals has failed. Now these banks have to explore the option of liquidating the assets of defaulting companies (a litigitinous route).

Reforms in Indian Banking Sector 2011 Chpter No 08 Restructuring Of weak banks 55 .

industrialists and financial experts Independent Financial Restructuring Authority to monitor implementation of revival package        56 . and the weak Banks are.8 Restructuring of Weak Banks 2011 How to deal with the weak Public Sector Banks is a major problem for the next stage of banking sector reforms. not responsible for their current predicament. This perception often leads to an expectation that all weak Banks must be helped to restructure after which they would be able to survive in the new environment. either through VRSs or through wage-cuts Branch rationalisation. the Reserve Bank of India set up a Working Group in February.25% increase negotiated by the IBA A 25% reduction in staff-strength. including the closure of loss-making foreign branches Transfer of non-performing assets to an Asset Reconstruction Fund Reconstitution of bank boards to include professionals. therefore. including the 12. Verma to suggest measures for the revival of weak public sector banks in India. which Identification of weak banks by using benchmarks for 7 critical ratios Recapitalisation of 3 weak banks conditional on their achieving specified milestones Five-year freeze on all wage-increases. The major  recommendations/points of the brief THE VERMA PRESCRIPTION…a Working Group.S.Reforms in Indian Banking Sector 1. It is particularly difficult because the poor financial position of many of these banks is often blamed on the fact that the regulatory regime in earlier years did not place sufficient emphasis on sound banking. 1999 under the Chairmanship of Shri M. Keeping in view the urgent need to revive the weak banks.

(ii) Earning Capacity (return on assets and net interest margin) and (iii) Profitability (ratio of operating profit to average working funds. stage two covers options of privatisation and/or merger. stage one involves operational.Reforms in Indian Banking Sector 2011  Seven parameters covering three areas have been identified. these are (i) Solvency (capital adequacy ratio and coverage ratio). 57 . organisational and financial restructuring aimed at restoring competitive efficiency.  Restructuring of weak banks should be a two-stage operation. ratio of cost to income and ratio of staff cost to net interest + income all other income).

ARF may restrict itself to the NPAs of the three identified weak banks. and pull out from the subsidiaries (Indian Bank).  A 30-35 percent reduction in staff cost required in the three identified weak banks to enable them to reach the median level of ratio of staff cost to operating income. sell foreign branches (Indian Bank and UCO Bank) to prospective buyers including other public sector banks.Reforms in Indian Banking Sector  Operational restructuring essentially involves 2011 up building capabilities to launch new products.  To begin with. attract new customers. the three identified weak banks should adopt a VRS covering at least 25 percent of the staff 58 . better use of compromises for reduction of NPAs based on recommendations transfer of NPAs of to the ARF Settlement Advisory Committees. establish a common networking and processing facility in the field of technology.  In order to control staff cost. ARF should focus on relatively larger NPAs (Rs.  The action programme for handling of NPAs should cover honouring of Government guarantees. etc.etc. managed by an independent AMC. 50 lakh and above). secure higher fee-based earnings. the fund needed for ARF is to be provided by the Government. improve credit culture.

for the three banks taken together. UCO bank had been posting losses for the past eleven years. 59 . In August 2001. rationalisation of branch network.Reforms in Indian Banking Sector 2011 strength. where only strong and efficient banks will be allowed to give commercial loans. The three identified banks on committee recommendations were UCO bank.  Experts have also suggested the concept of narrow banking.  The organisational restructuring includes delayering of the decision making process relating to credit. United Bank of India and Indian Bank. 1200 crore. Three more PSBs declared sick are Dena Bank. 1100 to Rs. the government of India directed UCO Bank to shut down 800 branches and also 4 international operations in line with the Verma committee recommendation on sick banks. Allahabad Bank and Punjab and Sindh Bank. etc. while the weak banks will take positions in less risky assets such as government securities and inter-bank lending. the estimated cost of VRS ranges from Rs.

09 Asset liability Management System 1.9 Asset Liability Management System 60 .Reforms in Indian Banking Sector 2011 Chapter No.

The uncertainty of interest rate movements gave rise to interest rate risk thereby causing banks to look for processes to manage their risk. With the freedom obtained through reform process. The necessity The asset-liability management in the Indian banks is still in its nascent stage. gamut of new products and greater use of information technology. the Reserve Bank has recently issued comprehensive guidelines to banks for putting in place an asset-liability management system. This complacent behavior of banks forced the Reserve Bank to use regulatory tactics to ensure the implementation of the ALM. In India. The government ownership of most banks resulted in a carefree attitude towards risk management. the Indian banks have reached greater horizons by exploring new avenues. The emergence of this concept can be traced to the mid 1970s in the US when deregulation of the interest rates compelled the banks to undertake active planning for the structure of the balance sheet. Nor did they manage such risks or provide for them in their balance sheets. To cope with these pressures banks 61 . The recognition of these risks brought Asset Liability Management to the centre-stage of financial intermediation. where markets fell precipitously because banks and corporates did not accurately measure the risk spread that should have been reflected in their lending activities. the post-reform banking scenario is marked by interest rate deregulation. In the wake of interest rate risk came liquidity risk and credit risk as inherent components of risk for banks.Reforms in Indian Banking Sector 2011 The critical role of managing risks has now come into the open. entry of new private banks. especially against the experience of the recent East Asian crisis. Also.

currency and liquidity risks. The banks are expected to cover fully their assets and liabilities by April 2000. interest rate risk. driven by corporate strategy. foreign exchange risk.Reforms in Indian Banking Sector 2011 were required to evolve strategies rather than ad hoc fire fighting solutions. Imprudent liquidity management can put banks' earnings and reputation at great risk. It is. This will provide information on bank’s position as to whether the bank is long or short. therefore. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process. These pressures call for structured and comprehensive measures and not just ad hoc action. ALM framework rests on three pillars ALM Organisation: 62 . Implementation of asset liability management (ALM) system RBI has issued guidelines regarding ALM by which the banks have to ensure coverage of at least 60% of their assets and liabilities by Apr ’99. equity / commodity price risk. important that banks introduce effective risk management systems that address the issues related to interest rate. liquidity risk and operational risk. Banks are exposed to several major risks in the course of their business credit risk.

Information is the key to the ALM process. Bank will not like to lend to D rated client even at a higher rate of interest. For example. Consider the procedure for sanctioning a loan. While somebody with BBB rating will be charged PLR + 2. financial efficiency. The borrower who approaches the bank. adequately and expeditiously. say. Naturally. The guidelines for the loan sanctioning procedure are decided in the ALCO meetings with targets set and goals established ALM Information System ALM Information System for the collection of information accurately. On the basis of this appraisal the borrower is charged certain rate of interest to cover the credit risk. ALM Process 63 . ALCO is a decisionmaking unit responsible for balance sheet planning from a risk return perspective including strategic management of interest and liquidity risk.g. there will be certain cut-off for credit appraisal.Reforms in Indian Banking Sector 2011 The ALCO consisting of the banks senior management including CEO should be responsible for adhering to the limits set by the board as well as for deciding the business strategy of the bank in line with the banks budget and decided risk management objectives. A good information system gives the bank management a complete picture of the bank's balance sheet. a client with credit appraisal AAA will be charged PLR.5 %. operational efficiency. below which the bank will not lend e. is appraised by the credit department on various parameters like industry prospects. management evaluation and others which influence the working of the client company.

The RBI in its guidelines has asked Indian banks to use traditional techniques like Gap Analysis for monitoring interest rate and liquidity risk. Its 64 . ultimately risk management is a culture that has to develop from within the internal management systems of the banks. The final guidelines have been formulated to serve as a benchmark for those banks which lack a formal ALM System. In the normal course. Banks that have already adopted more sophisticated systems may continue their existing systems but they should ensure to fine-tune their current information and reporting system so as to be in line with the ALM System suggested in the Guidelines. Other banks should examine their existing MIS and arrange to have an information system to meet the prescriptions of the new ALM System. However RBI is expecting Indian banks to move towards sophisticated techniques like Duration. VaR in the future. adoption of a uniform ALM System for all banks may not be feasible. Simulation.Reforms in Indian Banking Sector The basic ALM process involves identification. Banks need to address these risks in a structured manner by upgrading their risk management and adopting more comprehensive Asset-Liability Management (ALM) practices than has been done hitherto But. 2011 and measurement management of risk parameters. banks are exposed to credit and market risks in view of the asset-liability transformation. Is it possible ? Keeping in view the level of computerisation and the current MIS in banks.

65 .Reforms in Indian Banking Sector 2011 critical importance will come into sharp focus once current restrictions on banks’ portfolios are further liberalised and are subjected to the pressure of macro economic fluctuations.

Reforms in Indian Banking Sector 2011 Chapter no 10 Reduction of Government stake in psb s 66 .

This will be done without changing the public-sector character of banks and while ensuring that fresh issue of shares is widely held by the public." Banking is a business and not an extension of government. 67 . lean and competitive. public-sector banks will need more capital.10 Reduction of Government Stake in PSBs 2011 This is what the finance minister said in his budget speech on February 29. To meet the minimum capital adequacy norms set by the RBI and to enable the banks to expand their operations. RBI has been prescribing prudential norms for banks broadly consistent with international practice. the Government has decided to accept the recommendations of the Narasimham Committee on Banking Sector Reforms for reducing the requirement of minimum shareholding by government in nationalised banks to 33 per cent. If "privatisation" is a still a dirty word.Reforms in Indian Banking Sector 1. The best way to achieve this is to privatise the banks and make the managements accountable to real shareholders. such capital has to be raised from the public which will result in reduction in government shareholding. 2000. "In recent years. a good starting point for us is to restrict government stake to 33 per cent. To facilitate this process. Banks must be self-reliant. With the Government budget under severe strain.

to pave the way for the reduction in its stake. irrespective of the equity holdings. However.Reforms in Indian Banking Sector 2011 During the winter session of the Parliament. There has been considerable delay in the past in filling up the posts of the chairman and executive director of some banks. 68 . on 16 November 2000. is a clear indication of Government of India’s determination to amend the concerned Acts. which have far reaching consequences for the future of the Indian banking sector cleared amendment of the Banking Companies (Acquisitions and Transfer of Undertakings) Act 1970/1980 for facilitating the dilution of government’s equity to 33 percent Government’s action programme has expressed clearly its programme for the dilution of its stake in bank equity. As a result public sector banks may find it very difficult to attract strategic investors. it is not willing to give away the management control in the nationalised banks.  The government would continue to have the prerogative of the appointment of the chief executives and the directors of the nationalised banks. with adequate safeguards for ensuring its control on the operations of the banks. The Cabinet had taken this decision. SALIENT FEATURES of the proposed amendments Government would retain its control over the banks by stipulating  that the voting rights of any investor would be restricted to one per cent. The proposal had been to reduce the minimum shareholding from 51 per cent to 33 per cent. the Union Cabinet has taken certain decisions. immediately on the next day after the bank employees went on strike.

Paid-up capital of nationalised banks can now fall below 25 per cent of the authorised capital. This decision is in tune with the recommendation of Narasimham committee. adopt and approve the annual accounts and adopt the same at the annual general meetings. While conceptually it is desirable to decentralise power. operationally it may be difficult to share power at peer level. the government would retain the right to nominate its representative in the boards and strangely a nominee of the government can be in more than one bank after the amendment. It is said that the proposed amendment to the Act would also give the board of banks greater autonomy and flexibility.  Amendment will also enable the setting up of bank-specific Financial Restructuring Authority (FRA). It has to be seen as to how the four full time directors would function in unison.  It is proposed to amend the provisions in the Banking Companies (Acquisition and Transfer of Undertakings) Act to enable the bank shareholders to discuss.  The number of whole time directors would be raised to four as against the present position of two. Members of FRA will 69 . Authority will be empowered to take over the management of the weak banks. it was observed that inter personal relations were not cordial among the two at the top. the chairman and managing director and the executive director.Reforms in Indian Banking Sector 2011 It is not clear as to how this aspect would be taken care of in future. In quite a few cases. However.  It has been decided to discontinue the mandatory practice of nominating the representatives of the government of India and the Reserve Bank in the boards of nationalised banks.

This implies proposed that they would continue to be subject to parliamentary and other scrutiny despite relaxations.Reforms in Indian Banking Sector comprise of experts from various fields & will be appointed by the government. This is the reason why the banks would continue to be statutory bodies even after the reduction in government equity below 51 per cent and the banks would not become companies. which leads to a reduction in 70 . apart from granting banks the freedom to restructure their equity. on the advice of Reserve Bank of India. Reserve Bank’s perception. The measures seen in totality are clearly aimed at enabling banks to access the capital markets and raise funds for their operations. the Reserve Bank has been emphatic in its views on lowering the stake of the government in the equity of nationalized banks: The panel wants government stake to be diluted to less than 50 per cent in order to make banks' decision-making more autonomous. the capital has to be raised from the public. “in view of the severe budgetary strain of the government. It has said. 2011 The government has been maintaining that the nationalised banks would continue to retain public sector character even after the reduction in equity. The Government seems to have no plans to reduce its control over these banks. The Act will also permit it to transfer its stake if the need arises.

the government is arming itself with powers to sell its stake if it so desires at a later date. In the domestic context. 71 . the banks in the joint sector are expected to control the commanding heights of the banking business in the years to come.Reforms in Indian Banking Sector 2011 government shareholding. • Official sources explained that this has been done to enable banks to clean up their balance sheets so that they can access the capital market easily. the idea behind a reduction in government stake is to free bank employees from being treated as "public servants. by directly reducing the government stake below 50 per cent.” The process of the transition from public sector to the joint sector has already been initiated with 7 of the public sector banks accessing the capital market for expanding their capital base. the banks will be free from the shackles of the central vigilance commission." Instead. Since total privatization is not contemplated. In terms of transferring equity.

Reforms in Indian Banking Sector 2011 A LOOK AT PAST The Indira Gandhi government had nationalised 14 commercial banks through the Banking Companies (Acquisitions and Transfer of Undertakings) Ordinance in 1969. banks could reduce equity only up to 25 per cent of the paid up capital on the date of nationalisation. but that has been within the prescribed 25 per cent cap. The Nationalisation Act provides that the PSU banks cannot sell a single share. to help induction of public as 72 . This is the reason why banks have been tapping the market to fund their expansion plans. Till now. The 20 nationalised banks became 19 subsequently after New Bank of India merged with Punjab National Bank. Some banks like the Bank of Baroda have returned equity to the government in the past. The 1970 and 1980 Acts brought about after the nationalisation of 14 and 6 banks respectively were first amended in 1994 to allow government to reduce its equity in them to up to 49 per cent. The government holds majority or entire equity of 19 nationalised banks currently. The 1994 amendments brought it down to 51 per cent. Only six of these 19 banks have so far accessed the market and to gone for public issues meet its additional capital needs. Also the Act originally provided that the government must mandatorily hold 100 per cent stake in banks.

What did they have to say ? Union parliamentary affairs minister Pramod Mahajan said: “The amendment is an enabling provision.. It was as usual. called for 100 per cent divestment of the government stake. the government provided that all shares. The amendments shareholding.. either from the domestic or international capital markets.” strategic alliances with of privatisation? Why should the taxpayers’ money be used repeatedly for improving the capital base of the public sector banks? The Indian Banks' Association had. “Banks should be allowed to access 100 per cent capital from public. in its memo to the committee. We are only making it easier for banks to access funds from the market. This will increase the accountability of banks to shareholders”. protesting against the government’s policy of privatisation of public sector banks.It is not the intention of the government to privatise these banks or enter into remove restrictions on the transfer of government Who is afraid private sector.Reforms in Indian Banking Sector shareholders. Employees of the public sector banks went on a token strike on 15 November. 2011 At this stage. excluding government shares could be transferred. reported that the strike was total and 73 . This was necessary to permit the transfer of shares when public shareholders sold their stake in banks.

74 . This is an expedient decision contributing to the process of liberalisation of the economy. though one or two TV channels interviewed a couple of people. The inconveniences caused to millions of 2011 customers. unconnected with the issues involved. Union bank will issue an IPO next year. went unnoticed.Reforms in Indian Banking Sector successful. As for current status. who could not articulate their views properly. in order to reduce the 100 percent government stake to 70 percent and then gradually to 33 percent.

Reforms in Indian Banking Sector 2011 From 1992-93 to 1998-99. have received Rs. Indian Bank and United Bank of India. the government has injected into the 19 public sector banks. Illustration 5 THE STATE BANK STORY 75 . three banks-UCO Bank.446 crore as additional capital.20. an amount of Rs. Of this.5729 crore Capital Contributed by Government Capital Added [Rs in Crores] 90 150 400 635 150 365 490 45 130 220 705 50 415 160 680 535 200 215 65 5700 Bank Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab National Bank Punjab & Sind Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank Total Source: Reserve Bank of India Bulletin [1994].

Though there is no special significance attached to the 33 per cent threshold in the Company Law — which recognised only 26 per cent and 74 per cent as two major thresholds for management and ownership 76 . The immediate beneficiary of this move would be Corporation Bank where government equity is down to 66 per cent. they have no option but to go to the market to meet their fund requirements. Since a decision on the new threshold has been taken in the case of the nationalised banks. the government is expected to follow suit by moving an ordinance to reduce the RBI stake in the SBI to 33 % The issue of reducing government stake in the nationalised banks has come about on account of demand from the SBI which had demanded that either RBI as the stakeholder pump in funds for the SBI’s massive expansion plans or permit it to issue shares to the public to raise the necessary funds. Both the Banking Regulation Act and the SBI Act provide that government shares cannot be divested and since the government has decided that it would no longer support banks through budgetary support. The bank would be able to access funds from the market without being hampered by the 51 per cent minimum government holding threshold. which currently limits the ability of banks to expand beyond a certain level.Reforms in Indian Banking Sector 2011 The demand for funds by the SBI is even more acute than even the Corporation Bank since the SBI Act provides for a minimum 55 per cent RBI holding in SBI. and the bank is already close to breaching this threshold.

1972. United Insurance and New India Assurance 77 .National Insurance Corp. and demerge its four subsidiaries . The law ministry has already cleared both proposals of the finance ministry. The banks. like insurance companies. The State would continue to be the single largest shareholder in banks even after its stake had been brought down to 33 per cent. the ordinance would amend the GIC Act. have strong unions and. In the case of GIC. The government is also proposing to move an ordinance for demerger of four subsidiaries of GIC.Reforms in Indian Banking Sector 2011 control — the government has opted for 33 per cent on the basis of the recommendations of the Narasimham Committee. The committee had felt that this threshold would provide comfort to the employees. hence. Oriental Insurance. a phased reduction in government equity was recommended.

Reforms in Indian Banking Sector 2011 78 .

Reforms in Indian Banking Sector 2011 CHAPTER NO 11 Deregulation On Interest rates 79 .

Only the rate on savings deposits remains controlled by RBI. including 15-day deposits. For long. Initially lending rates came down. The 1998 Narasimham Reforms suggested deregulation of interest rates on term deposits beyond a period of 15 days.000. Banks are free to determine the interest rate on deposits and lending rates on all lendings above Rs. The rationale for liberalising interest rates in the banking system was to allow banks greater flexibility and encourage competition. when the Reserve Bank of India controlled the rates payable on deposits of different maturities. At present. an administered structure of interest rate has been in vogue in India. leading to a decline in yields on advances and investments. have been freed. Lending rates were similarly freed in a series of 80 . With effect from October 97 interest rates on all time deposits. Interest rates in the banking system have been liberalised very substantially compared to the situation prevailing before 1991.11 Deregulation on Interest Rates 2011 The interest rate regime has also undergone a significant change. the Reserve Bank prescribes only two lending rates for small borrowers.Reforms in Indian Banking Sector . 1. Banks were able to vary rates charged to borrowers according to their cost of funds and also to reflect the credit worthiness of different borrowers. 200. In the last couple of years there has been a clear downward trend in interest rates.

Interest rates on loans upto Rs 2. but is now aligned with the Prime Lending Rate (PLR) which is determined by the boards of individual Banks.000.00. Earlier interest rates on loans below Rs 2. The Reserve Bank now directly controls only the interest rate charged for export credit.00. which accounts for about 10% of commercial advances. RBI also considers removal of existing controls on lending rates in other Commercial Banks as the Indian economy gets used to higher interest rate regime on shorter loan duration. The line to control is the cost of funds. since the markets determine asset yields. With the deregulation of the interest rates banks are given the freedom to price their assets and liabilities 81 . Banks’ income will depend on the interest rate structure and the pricing policy for the deposits and the credit. which account for 25% of total advances. Interest rates on time deposits were decontrolled in a sequence of steps beginning with longer-term deposits and the liberalisation was progressively extended to deposits of shorter maturity. which reduces the degree of concessionality but does not eliminate it. is not fixed at a level set by the RBI.000 were fixed at a highly concessional level. Cooperative Banks were freed from all controls on lending rates in 1996 and this freedom was extended to Regional Rural Banks and private local area banks in 1997. The new arrangement sets a ceiling on these rates at the PLR.Reforms in Indian Banking Sector 2011 steps. The opportunity to improve yields on the corporate side tends to be limited if banks don’t want to increase the risk profile of the portfolio.

In this regard. As far as the interest costs are concerned. Nevertheless. competition for the funds and the other banking services rose. the prevailing interest rate structure will be a major deciding factor for the rates. But what influence both the interest costs and the intermediation costs is the time factor as it is directly related to costs. have a better edge over the nationalized banks. which are yet to be automated at the branch level. with the increase in the number of players. Income and Expenses Profile of Banks Interest Income • Interest/discount on advances/bills • Interest on investments • Interest on balances with RBI and other interbank funds • Others Interest Expenses • Interest on deposits • Interest on Refinance/interbank borrowings • Others 82 . The solution for these two influencing factors lies predominantly on technology. The consequential impact is being felt on the income profile of the banks especially due to the fact that the interest income component of the total income is significantly larger than the non-interest income component.Reforms in Indian Banking Sector 2011 effectively and also plan for a proper maturity pattern to avoid assetliability mismatches. which are equipped with the latest technology. the new private banks and the foreign banks.

Reforms in Indian Banking Sector Other Income • Commission.  Insurance. Postage. • Miscellaneous Operating Expenses  Payments 2011 to and provisions for employees • Rent. taxes and lighting • Printing and stationery • Advertisement and publicity • Depreciation on Bank’s property • Director’/Auditor’s fees and expenses • Law charges. etc. • Other expenses 83 . Exchange and Brokerage • Profit on sale of investments • Profit on revaluation of investments • Profit on sale of land. • Repairs and Maintenance. etc. building and other assets • Profit on exchange transactions • Income earned by way of dividends.

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