At the outset the Government had recognised that financial sector reform was an integral part of the new economic policy. A high level committee headed by Mr. M.N. Narasimham was appointed to consider all relevant aspects of the structure, organisation, functions and procedures of the financial system. Following the committee’s report in November 1991, the Government embarked on a far–reaching processes of reform covering both the banking system and the capital market. The need for a thorough –going reform of the financial system was further underscored by the now famous securities scam (or irregularities of the banks) news of which broke out in April 1992.
A large part of the agenda for reform of the financial system relates to the problems facing the public sector commercial banks, which have dominated banking in India since nationalization in July 1969. The goal of nationalization was to extend the reach of banking and financial services to all parts of the country and to all sections of society. It also aimed at widening the net of resources mobilization.
While there are significant achievements, they have been accompanied by serious shortcomings as well. For instance, the quality of customer service has not kept pace with modern standards and changing expectations. The time taken for processing and completing banking transactions is too long. The banks have also not kept pace with the revolutionary changes in computer and communication technologies. This affected the speed, accuracy and of efficiency of services and the basic integrity of banking processes such as internal controls and inter-branch reconciliation of accounts. It also militated against prompt decision–making and against improved productivity and profitability. All these were greatly reflected in the poor financial condition of the banks and the adverse impact it had on the economy.
The Narasimham Committee recognised the fact that the quantitative success of the public sector banks in India was achieved at the expenses of deterioration in qualitative factors such as profitability, efficiency and the most important the quality of the loan portfolio which now needed to take the centre stage. The elements of the recovery programme reiterated by the committee are as follows:
- Reduce presumption of lending capacity through staged reductions in SLR and CRR, while moving the yield on government debt to market–related levels.
- Stress availability rather than subsidy in provision of credit to the priority sector, and restrict cross-subsidy only to the smaller borrowers. The goal should be to establish incentives that induce adequate flows of credit to priority uses, especially agriculture, without compromising on prudential and commercial consideration.
- Move to objective, internationally recognised accounting standards, with suitable transitional provisions to give banks time to adjust. These accounting norms will clarify and strengthen the incentives for bank managements to exercise greater care in credit assessment and recov
- Make additional capital available from the government and the capital markets to strengthen banks’ financial position and provide a basis for future growth. Provision of capital by the government will be conditional on monitorable improvements in the management and recovery performance of each bank. Access to the markets will impose the additional discipline of prospectus registration or assessment by credit rating agencies and accountability to non-governmental sharehold
- Improve prospects for recovery by setting up special recovery tribunals in major metropolitan areas
- Set up a credit information database for exchange of information on the credit history of large borrowers subject to confidentialit
- Upgrade the caliber of appointees to board level posts, stressing longevity and security of tenu
- Enhance managerial accountability and stress performance–related promot
- Encourage technological modernization in banks through computerization and greater labour flexibi
- Encourage greater competition for public sector banks through the controlled entry of modern, professional private sector banks including foreign
- Create a new board for financial supervision to devote exclusive attention to issues of compliance and supervision and review the Banking Regulatio
- Act. Ensure viable mechanisms for supply of credit to the rural sector, smallscale industry and weaker sections.
The steadfast pursuit of this agenda promised to transform Indian banking and the public sector banks in particular (By June 1996 the following targets had to be attained).
a) all public sector banks achieving 8 percent capital to risk–assets ratio
b) half the public sector banks (weighted by deposits) should be quoted on the stock market with appropriate representation of shareholders on bank boards.
c) significant entry of new private sector banks
d) SLR and CRR appreciably reduced
e) interest rates deregulated
f) at least 500 branches of public sector banks would be fully computerized.
Reforms in Development Banking Sector
The Narasimham Committee recognized that the development financial institutions’ operation in India was marked by the total absence of competition in the matter of provision of loans and medium-term finances. The system had evolved into a segmentation of business between DFIs and the banks, the latter concentrating on working capital finance and the former on investment finance. Borrowers as a consequence had no choice in selecting an institution to finance their projects. The committee suggested delinking of these institutions from the state governments for better efficiency. The operations of the DFIs in respect of loan sanctions should be the sole responsibility of the institutions themselves based on a professional appraisal of projects. The Government also embarked on a process of disinvestments in some of the bigger institutions like IDBI etc.
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