Indian Economy, 5th edition (59 page)

The three decades after nationalisation had seen a phenomenal expansion in the geographical coverage and financial spread of the banking system in the country. As certain weaknesses
were found to have developed in the system during the late eighties, it was felt that these had to be addressed to enable the financial system to play its role ushering in a more efficient and competitive economy.
20
Accordingly, a
high level
c
ommittee on Financial System (CFS) was set up on August 14, 1991 to examine all aspects relating to
structure, organisation, function
and
procedures
of the financial system—based on its recommedations, a comprehensive reform of the banking system was introduced in the fiscal 1992–93.
21

The CFS based its recommendations on certain
assumptions
22
which are basic to the banking industry. And the suggestions of the committee became logical in light of this assumption, there is no second opinion about it. The assumption says that
“the resources of the banks come from the general public and are held by the banks in trust that they are to be deployed for maximum benefit of the depositors”.
This assumption automatically implied:

(i)
That even the Government had no business to endanger the solvency, health and efficiency of the nationalised banks under the pretext of using banks, resources for
economic planning, social banking, poverty alleviation,
etc.

(ii)
Besides, the Government had no right to get hold of the funds of the banks at low interest rates and use them for financing its consumption expenditure (i.e revenue and fiscal deficits) and thus defraud the depositors.

The recommendations of the CFS (
Narasimham Committee I
) were
aimed
at:

(i)
Ensuring a degree of operational
flexibility;

(ii)
internal autonomy
for public sector banks (PSBs) in their decision making process; and

(iii)
greater degree of
professionalism
in banking operation.

Recommendation of CFS

The CFS recommondation
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could be summed up under five sub-titles:

1. On Directed Investment:

The RBI was advised not to use the CRR as a principal instrument of monetary and credit control, in place it should rely on open market operations (OMOs) increasingly. Two proposals advised regarding the CRR:

(i)
CRR should be progressively reduced from the present high level of 15 per cent to 3 to 5 per cent; and

(ii)
RBI should pay interest on the CRR of banks above the basic minimum at a rate of interest equal to the level of banks, one year deposit.

Concerning the SLR it was advised to cut it to the minimum level (i.e. 25 per cent) from the present high level of 38.5 per cent in the next 5 years (it was cut down to 25 per cent in October 1997). The Government was also suggested to progressively move towards market-based borrowing programme so that banks get economic benefits on their SLR investments.

These suggestions were directed to the goal of making more funds available to the banks, converting idle cash for use, and cutting down the interest rates banks charge on their loans.

2. On Directed Credit Programme:

Under this sub-title the suggestions revolved around the compulsion of priority sector lending (PSL) by the banks:

(i)
Directed credit programme should be phased out gradually. As per the committee, agriculture and small scale industries (SSIs) had already grown to a mature stage and they did not require any special support; two decades of interest subsidy were enough. Therefore, concessional rates of interest could be dispensed with.

(ii)
Directed credit should not be a regular programme—it should be a case of extraordinary support to certain weak sections—besides, it should be temporary, not a permanent one.

(iii)
Concept of PSL should be redefined to include only the weakest sections of the rural community such as marginal farmers, rural artisans, village and cottage industries, tiny sector, etc.

(iv)
The “redefined PSL” should have 10 per cent fixed of the aggregate bank credit.

(v)
The composition of the PSL should be reviewed after every 3 years.

3. On the Structure of Interest Rates:

The major recommendations on the structure of interest rates are:

(i)
Interest rates to be broadly determined by market forces;

(ii)
All controls of interest rates on deposits and lending to be withdrawn;

(iii)
Concessional rates of interest for PSL of small sizes to be phased out and subsidies on the IRDP loans to be withdrawn;

(iv)
Bank rate to be the anchor rate and all other interest rates to be closely linked to it; and

(v)
The RBI to be the sole authority to simplify the structure of interest rates.

4. On Structural Reorganisation of the Bank:

For the structural reorganisation of banks some major suggestions were given:

(i)
Substantial reduction in the number of the PSBs through mergers and acquisitions—to bring about greater efficiency in banking operations;

(ii)
Dual control of RBI and Banking Division (of the Ministry of Finance) should go immediately and RBI to be made the primary agency for the regulation of the banking system;

(iii)
The PSBs to be made free and autonomous;

(iv)
The RBI to examine all the guidelines and directions issued to the banking system in the context of the independence and autonomy of the banks;

(v)
Every PSB to go for a radical change in work technology and culture, so as to become competitive internally and to be at par with the wide range of innovations taking place abroad; and

(vi)
Finally, the appointment of the Chief Executive of Bank (CMD) was suggested not to be on political considerations but on professionalism and integrity. An independent panel of experts was suggested which should recommend and finalise the suitable candidates for this post.

5. Asset Reconstruction Companies/Fund:

To tackle the menace of the higher non-performing assets (NPAs) of the banks and the financial institutions, the committee suggested setting up of the asset reconstruction companies/funds (taking clue from the US experience).

The committee directly blamed the Government of India (GoI) and the Ministry of Finance for the sad state of affairs of the PSBs. These banks were used and abused by the GoI, the officials, the bank employees and the trade unions, the report adds. The recommendations were revolutionary in many respects and were opposed by the bank unions and the leftist political parties.

There were some other major suggestions of the committee which made it possible to get the following
24
things done by the Government:

(i)
opening of new private sector banks permitted in 1993;

(ii)
prudential norms relating to income recognition, asset classification and provisioning by banks on the basis of objective criteria laid down by the RBI;

(iii)
the introduction of the capital adequacy norms (i.e. CAR provisions) with international standard started;

(iv)
simplification in the banking regulation (i.e. via board for financial supervision in 1994); etc.

Banking Sector Reform

The government commenced a comprehensive reform process in the financial system in 1992–93 after the recommendations of the CFS in 1991. In December 1997 the Government did set up another committtee on the banking sector reform under the chairmanship of M. Narasimham.
25
The objective of the committee is objectively clear by the
terms of reference
it was given while setting up—

“To review the progress of banking sector reforms to date and chart a programme of financial sector reforms necessary to strengthen India’s financial system and make it internationally competitive”

The
Narasimham Committee-II
(Popularly called by the Government of India) handed over its reports in April 1998 which included the following major suggestions
26
:

(i)
Need for a stronger banking system for which mergers of the PSBs and the financial Institutions (AIFIs) were suggested—stronger banks and the DFIs (development financial institutions i.e. AIFIs) to be merged while weaker and unviable ones to be closed.

(ii)
A 3-tier banking structure was suggested after mergers:

•
Tier-1
to have 2 to 3 banks of international orientation;

•
Tier-2
to have 8 to 10 banks of national orientation; and

•
Tier-3
to have a large number of local banks.

The first and second tiers were to take care of the banking needs of the corporate sector in the economy.

(iii)
Higher norms of Capital-to-Risk—Weighted Adequacy Ratio (CRAR) suggested—increased to 10 per cent.

(iv)
Budgetary recapitalisation of the PSBs is not viable and should be abandoned.

(v)
Legal framework of loan recovery should be strengthened (the government passed the
SARFAESI (Act, 2002
).

(vi)
Net NPAs for all banks suggested to be cut down to below 5 per cent by 2000 and 3 per cent by 2002.

(vii)
Rationalisation of branches and staffs of the PSBs suggested.

(viii)
Licencing to new private banks (domestic as well as foreign) was suggested to continue with.

(ix)
Banks’ boards should be depoliticised under RBI supervision.

(x)
Board for financial Regulation and Supervisions (BFRS) should be set up for the whole banking, financial and the NBFCs in India
27
.

New Rules for Opening Banks

The Reserve Bank of India announced the much-awaited new eligibility criteria for opening new banks in India by the private entities, in September 2011 and finalised in February 2013, after cousidering advices and suggestions formthe business and industry.

The issue of giving licences to a few private parties to start commercial banks has always been a sensitive one. More so, at this juncture, when it is believed that the new policy relaxation is primarily for the benefit of large industrial houses and business groups. Before 1969, many leading banks, including Bank of India, Bank of Baroda and United Commercial Bank, were owned or controlled by leading business groups. In a two-stage process that began in 1969, the government nationalised these banks in a decision that had as much to do with domestic politics as economics. The case for the takeover was built on the ground that these banks were serving their private promoters’ interests and that in any case there was a need to reorient the banking system towards national interests (a period of social control of banks preceded their takeover). The bias against large industrial houses has continued in the reform era. Following the guidelines of 1993 and 2001, some private banks came into being but none of them was sponsored by large business houses. However, this time it is likely that a few industrial houses will make the grade. The rules are as given beow:

Eligible promoters:
Entities/groups in the private sector, owned and controlled by residents, with diversified ownership, sound credentials and integrity and having successful track record of at least ten years will be eligible to promote banks. In a significant move, the RBI has barred groups having even an exposure of 10 per cent (by way of assets or income or both) in real estate and/or broking activities over the past three years. Evidently, these sectors are ‘speculative’ in nature and the business model adopted in such businesses will be ‘misaligned’ with that required by a bank.

Corporate structure:
New banks will be set only through a wholly-owned non-operative holding company (NOHC), which will be registered with the RBI as a non-banking finance company. All financial activities of the promoter group will come under the NOHC. The idea is to ring fence the financial interests of the group from its other business activities and give a measure of protection to the bank’s depositors.

Capital Requirement:
It will be Rs.500 crore. The NOHC will hold a minimum 40 per cent of the capital for five years from the date of licensing and aggregate non-resident shareholding will not exceed 49 per cent for the first five years.

Corporate governance:
50 per cent of the directors of the NOHC should be independent directors.

Business Model:
should be realistic and viable and should address how the bank proposes to achieve financial inclusion, bank should have a fourth of its branches in unbanked rural areas. The RBI will have the powers to vet the business plan and pull up the promoters for any deviations.

Amendment:
to the Banking Regulation Act, 1949, will be carried out to give the central bank extensive powers in a wide range of matters necessary for effective supervision.

Listing on Stock Exchanges:
The bank shall get its shares listed on the stock exchanges within two years of licensing.

DRI

The differential rate of interest (DRI) is a lending programme launched by the government in April 1972 which makes it obligatory upon all the public sector banks in India to lend 1 per cent of the total lending of the preceding year to
‘the poorest among the poor’
at an interest rate of 4 per cent per annum. The total lending in 2005–06 was
`
351 crores.