Banking Sector Reforms
Some recommendations were made by the Chakravarthy Committee in 1985 for improving the performance of the banking sector. However, the government lacking initiative did not carry out reform measures earnestly. In 1991, the situation was different. The country was caught in a deep economic crisis. The government at this juncture decided to introduce comprehensive economic reforms. The banking sector reforms were part of this package. The government appointed a Committee on the Financial System under the chairmanship M.Narasimham in August 1991 which delivered its report within three months. The government also appointed the Committee on Banking Sector Reforms under the Chairmanship of M. Narasimham which submitted its report in April 1998. These reports are landmark documents and have influenced greatly the banking sector reforms during the past few years.
Prudential Regulation and Supervision:
Financial markets need supervision to prevent criminal fraud as well as financial panic. However, it is now generally agreed that controls on interest rates and credit allocation and micro-monitoring of bank decisions are not very desirable. But this may not be enough particularly in a nationalised banking system because bank managers do not act in the interest of the shareholder, that is, the government. The supervisory system must also be strengthened in the absence of which financial scandals will cause serious crises. An important example of such a scandal is the stock market scam of 1992. In this case, illegal bank advances were made to stockbrokers and the losses arising from these irregularities were as large as Rs. 5,000 crores. Such scandals can be prevented by proper supervision and enforcement of regulations. The Board of Financial Supervision has been constituted as a supervisory authority. It is presently functioning within the RBI. India has yet to devise appropriate regulatory structures. It is now recognised that early warning systems are as much necessary as ex-post monitoring. Earlier, the RBI’s emphasis was on an on-site inspection of banks. The off-site backup was very much lacking in the past an account of date information system. It is now planned to streamline the information system so that off-site analysis can be made to support on-site monitoring.
Rehabilitation of Public Sector Banks:
By 1991 the banking system had become extremely fragile due to the large proportion of non-performing assets. Overall non-performing assets were as large as 24.8 per cent of the total loan portfolio in 1994. A cleanup operation was thus urgently required. The government decided to follow the recapitalization route for the restoration of net worth. The recapitalisation requires a direct infusion of capital to the banks from the budget and the non-performing assets are left on their books. The case for an Asset Reconstruction Fund is that transferring non-performing assets from the bank’s books enables the bankers to work for the future while the task of recovery is delegated to the specialists. As a result o the various measures undertaken in recent years, there has been a distinct improvement in the performance of banks.
Reduction in the SLR and the CRR:
For a long time, the government intervention in India’s hanking sector was in the form of high SLR and CRR. In this manner, the government pre-empted bank resources at below-market rates. This policy benefited the government as it reduced the cost of borrowing. But it was directly responsible for eroding the profits of the banks. The Narasimhami Committee, therefore, recommended a reduction in the SLR to 25 per cent by 1996 and an unspecified reduction in the CRR. The government has accepted these recommendations and has acted decisively as regards reducing both the reserve ratios. SLR has now been reduced to the total net demand and time liabilities.
Some price in terms of efficiency has to be paid for ensuring effective monetary control. These considerations notwithstanding, the CRR was reduced to 13 per cent by May 1996. Thereafter in just eight months, it was brought down to 10 per cent. As of June 2003, it has been 4.5 per cent. However, to check the liquidity overhang in the system, the RBI raised the CRR to 5.0 per cent effective from September 11, 2004. The CRR was further hiked in 2006 and 2007. In April 2010 it stood at 6.0 per cent. Thereafter it was reduced in stages. CRR was brought down to 4 per cent in 2013 (Feb).
Deregulation of Interest Rates:
The administered interest rate system in India had over the years become unduly complex and had acquired features that reduced its ability to promote effective use of credit. This was not realised in the official circles until its deficiencies were highlighted by the Chakravarthy Committee of the RBI. On account of social concerns, a system of concessional interest rates was developed in this country. The Chakravarthy Committee was in favour of providing credit at concessional rates to target groups under the priority sector lending. However, even this committee observed that the system of concessional interest rates had become too complex and needed some kind of rationalisation. , The policy of providing too many bank loans to different favoured groups at multiple concessional interest rates not only contributed to the deterioration in the profitability of banks, but also led to inefficient use of credit reflected in uneconomic creation of additional capacity and its underutilisation, heavy accumulation of inventories, and poor quality of project preparation and its inefficient implementation. The Chakravarthy Committee had recommended that the controlled competition among banks should be allowed implying that banks should have some freedom to vary their lending rates of interest, subject to some minimum rate fixed by the RBI and not the maximum. This was considered to be necessary for better allocation of credit.
The Narasimham Committee has forcefully argued that interest rates should increasingly be allowed to perform their main function of allocating scarce loanable funds among alternative users. For them to do so, rates will have to be allowed broadly to be determined by market forces. · The government accepted this approach for the role of interest rates in the Indian economy and adopted the necessary measures to deregulate them. However, before 1990-91, progress in this direction was very low. Starting in April 1992, the structure of interest rates has become much freer and simpler. Now banks are allowed to set interest rates on all term deposits of maturity of over 30 days and are free to determine the prime lending rate for term loans of three years and above.
Directed Credit:
After the nationalisation of commercial banks, a strong case was made out in favour of directed credit on the grounds of both efficiency and equity. In practice, however, the directed credit not only undermined the profitability of the banks but also failed to promote efficiency and equity. The Narasimham Committee which noted that the case for directed credit under existing conditions is quite weak recommended phasing out of the directed credit programme. As it. would need some time, some credit support was recommended in the medium term to the priority sector which has been redefined.
Competition:
Until 1991 there was little competition in the banking sector. The public sector banks dominating the banking industry in terms of size of assets acted as a monolith. The government has now recognised the need to make the banking industry more competitive. It has thus made certain policy changes such as deregulation of interest rates and dilution of consortium lending requirements. Moreover, banking has been opened up to the private sector. The Reserve Bank has been granting new banking licenses periodically.
Here are the notes for Foreign Trade, Introduction And Composition.