M naraSIMHAM COMMITEE ON FINANCIAL AND BANKING SECTOR REFORM pdf

1. M.NARASIMHAM COMMITTEE








COURSE NO. 322
SHWETANSHU GUPTA (49 -MBA-2013)
DIVYA GUPTA (13-MBA-2013)

2. M.NARASIMHAM COMMITTEE

Introduction:
From the 1991 India economic crisis to its status of fourth largest economy in the world by 2010,
India has grown significantly in terms of economic development. So has its banking sector.
During this period, recognizing the evolving needs of the sector, the Finance Ministry
of Government of India (GOI) set up various committees with the task of analyzing India's
banking sector and recommending legislation and regulations to make it more effective,
competitive and efficient. Two such expert Committees were set up under the chairmanship of M.
Narasimham. They submitted their recommendations in the 1990s in reports widely known as the Narasimham
Committee-I (1991) report and the Narasimham Committee-II (1998) Report. These
recommendations not only helped unleash the potential of banking in India, they are also
recognized as a factor towards minimizing the impact of global financial crisis starting in 2007.
Unlike the socialist-democratic era of the 1960s to1980s, India is no longer insulated from the
global economy and yet its banks survived the 2008 financial crisis relatively unscathed, a feat due in part to
these Narasimham Committees

REASONS FOR THE ESTABLISHMENT OF COMMITTEE:
During the decades of the 60s and the 70s, India nationalised most of its banks. This culminated
with the balance of payments crisis of the Indian economy where India had to airlift gold
to International Monetary Fund (IMF) to loan money to meet its financial obligations. This event
called into question the previous banking policies of India and triggered the era of economic
liberalisation in India in 1991. Given that rigidities and weaknesses had made serious inroads
into the Indian banking system by the late 1980s, the Government of India (GOI), post-crisis,
took several steps to remodel the country's financial system. (Some claim that these reforms were
influenced by the IMF and the World Bank as part of their loan conditionality to India in 1991).
The banking sector, handling 80% of the flow of money in the economy, needed serious reforms
to make it internationally reputable, accelerate the pace of reforms and develop it into a
constructive usher of an efficient, vibrant and competitive economy by adequately supporting the
country's financial needs. In the light of these requirements, two expert Committees were set up
in 1990s under the chairmanship of M. Narasimham (an ex-RBI (Reserve Bank of India)
governor) which are widely credited for spearheading the financial sector reform in India. The

3. M.NARASIMHAM COMMITTEE

first Narasimham Committee (Committee on the Financial System – CFS) was appointed
byManmohan Singh as India's Finance Minister on 14 August 1991, and the second one
(Committee on Banking Sector Reforms) was appointed by P.Chidambaram

as Finance Minister
in December 1997. Subsequently, the first one widely came to be known as the Narasimham
Committee-I (1991) and the second one as Narasimham-II Committee (1998).
The purpose of the Narasimham-I Committee was to study all aspects relating to the structure,
organisation, functions and procedures of the financial systems and to recommend improvements
in their efficiency and productivity. The Committee submitted its report to the Finance Minister
in November 1991 which was tabled in Parliament on 17 December 1991.
The Narasimham-II Committee was tasked with the progress review of the implementation of the
banking reforms since 1992 with the aim of further strengthening the financial institutions of
India. It focussed on issues like size of banks and capital adequacy ratio among other things.
[9]
M.
Narasimham, Chairman, submitted the report of the Committee on Banking Sector Reforms
(Committee-II) to the Finance Minister Yashwant Sinha in April 1998.

PROBLEMS IDENTIFIED BY THE NARASIMHAM COMMITTEE
1. Directed Investment Programme: The committee objected to the system of maintaining high
liquid assets by commercial banks in the form of cash, gold and unencumbered government
securities. It is also known as the statutory liquidity Ratio (SLR). In those days, in India, the
SLR was as high as 38.5 percent. According to the M. Narasimham's Committee it was one of
the reasons for the poor profitability of banks. Similarly, the Cash Reserve Ratio- (CRR) was
as high as 15 percent. Taken together, banks needed to maintain 53.5 percent of their resources
idle with the RBI.
2. Directed Credit Programme: Since nationalization the government has encouraged the
lending to agriculture and small-scale industries at a confessional rate of interest. It is known
as the directed credit programme. The committee opined that these sectors have matured and
thus do not need such financial support. This directed credit programme was successful from
the government's point of view but it affected commercial banks in a bad manner. Basically it
deteriorated the quality of loan, resulted in a shift from the security oriented loan to purpose

4. M.NARASIMHAM COMMITTEE

oriented. Banks were given a huge target of priority sector lending, etc. ultimately leading to
profit erosion of banks.
3. Interest Rate Structure: The committee found that the interest rate structure and rate of
interest in India are highly regulated and controlled by the government. They also found that
government used bank funds at a cheap rate under the SLR. At the same time the government
advocated the philosophy of subsidized lending to certain sectors. The committee felt that
there was no need for interest subsidy. It made banks handicapped in terms of building main
strength and expanding credit supply.
4. Additional Suggestions: Committee also suggested that the determination of interest rate
should be on grounds of market forces. It further suggested minimizing the slabs of interest.

M.NARASIMHAN COMMITTEE REPORT -I ON FINANCIAL SECTOR REFORMS,
1991
The Narsimham Committee was set up in order to study the problems of the Indian financial
system and to suggest some recommendations for improvement in the efficiency and
productivity of the financial institution.
The committee has given the following major recommendations:-
1. Reduction in the SLR and CRR: The committee recommended the reduction of the higher
proportion of the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio 'CRR'. Both of
these ratios were very high at that time. The SLR then was 38.5% and CRR was 15%. This
high amount of SLR and CRR meant locking the bank resources for government uses. It was
hindrance in the productivity of the bank thus the committee recommended their gradual
reduction. SLR was recommended to reduce from 38.5% to 25% and CRR from 15% to 3 to
5%.
2. Phasing out Directed Credit Programme: In India, since nationalization, directed credit
programmes were adopted by the government. The committee recommended phasing out of
this programme. It also called for a re-defining of the priority sector. This programme
compelled banks to earmark then financial resources for the needy and poor sectors at

5. M.NARASIMHAM COMMITTEE

confessional rates of interest. It was reducing the profitability of banks and thus the committee
recommended the stopping of this programme.
3. Interest Rate Determination: The committee felt that the interest rates in India are regulated
and controlled by the authorities. The determination of the interest rate should be on the
grounds of market forces such as the demand for and the supply of fund. Hence the committee
recommended eliminating government controls on interest rate and phasing out the
concessional interest rates for the priority sector.
4. Structural Reorganizations of the Banking sector: The committee recommended that the
actual numbers of public sector banks need to be reduced. Three to four big banks including
SBI should be developed as international banks. Eight to Ten Banks having nationwide
presence should concentrate on the national and universal banking services. Local banks
should concentrate on region specific banking. Regarding the RRBs (Regional Rural Banks), it
recommended that they should focus on agriculture and rural financing. They recommended
that the government should assure that henceforth there won't be any nationalization and
private and foreign banks should be allowed liberal entry in India. It also proposed that there
be no bar to start new banks in the private sector being set up provided they conform to the
start-up capital and other requirements.
5. Establishment of the ARF Tribunal: The proportion of bad debts and Non-performing asset
(NPA) of the public sector Banks and Development Financial Institute was very alarming in
those days. The committee recommended the establishment of an Asset Reconstruction Fund
(ARF). This fund will take over the proportion of the bad and doubtful debts from the banks
and financial institutes. It would help banks to get rid of bad debts. The Committee
recommended that the assets of bank should be classified into 4 categories: (a) standard (b)
sub-standard (c) doubtful, and (d) loss assets. It also called for full and transparent disclosures
to be made in the Balance Sheet as recommended by the International Accounting Standards
Committee.
6. Removal of Dual control: Those days’ banks were under the dual control of the Reserve
Bank of India (RBI) and the Banking Division of the Ministry of Finance (Government of
India). The committee recommended the stepping of this system. It considered and
recommended that the RBI should be the only main agency to regulate banking in India. The
Committee believed that the internal organization should be the prerogative of the

6. M.NARASIMHAM COMMITTEE

management of the Individual Banks. For the medium and large national banks the Committee
proposed a three-tier structure in terms of head office, a zonal office and branches. For very
large banks, a four tier-structure was proposed, with the addition of a regional office along
with the three mentioned above
7. Banking Autonomy: The committee recommended that the public sector banks should be free
and autonomous. In order to pursue competitiveness and efficiency, banks must enjoy
autonomy so that they can reform the work culture and banking technology upgradation will
thus be easy.
8. Capital markets: The Committee suggested that there should be no need to obtain any prior
permission to issue capital. It also called for the office of the “Controller of capital issues” to
be abolished. The Committee also recommended that the Capital markets should be opened for
Foreign Portfolio Investments
Some of these recommendations were later accepted by the Government of India and became
banking reforms.
M. NARASIMHAM COMMITTEE REPORT II ON BANKING SECTOR REFORMS –
1999
In 1998 the government appointed yet another committee under the chairmanship of Mr.
Narsimham. It is better known as the Banking Sector Committee. It was told to review the
banking reform progress and design a programme for further strengthening the financial system
of India. The committee focused on various areas such as capital adequacy, bank mergers, bank
legislation, etc.
It submitted its report to the Government in April 1998 with the following recommendations.
1. Strengthening Banks in India: The committee considered the stronger banking system in the
context of the Current Account Convertibility 'CAC'. It thought that Indian banks must be
capable of handling problems regarding domestic liquidity and exchange rate management in
the light of CAC. Thus, it recommended the merger of strong banks which will have
'multiplier effect' on the industry.

7. M.NARASIMHAM COMMITTEE

2. Narrow Banking: Those days many public sector banks were facing a problem of the Non-
performing assets (NPAs). Some of them had NPAs were as high as 20 percent of their assets.
Thus for successful rehabilitation of these banks it recommended 'Narrow Banking Concept'
where weak banks will be allowed to place their funds only in short term and risk free assets.
3. Capital Adequacy Ratio: In order to improve the inherent strength of the Indian banking
system the committee recommended that the Government should raise the prescribed capital
adequacy norms. This will further improve their absorption capacity also. Currently the capital
adequacy ration for Indian banks is at 9 percent.
4. Bank ownership: As it had earlier mentioned the freedom for banks in its working and bank
autonomy, it felt that the government control over the banks in the form of management and
ownership and bank autonomy does not go hand in hand and thus it recommended a review of
functions of boards and enabled them to adopt professional corporate strategy.
5. Review of banking laws: The committee considered that there was an urgent need for
reviewing and amending main laws governing Indian Banking Industry like RBI Act, Banking
Regulation Act, State Bank of India Act, Bank Nationalisation Act, etc. This upgradation will
bring them in line with the present needs of the banking sector in India.
Apart from these major recommendations, the committee has also recommended faster
computerization, technology upgradation, training of staff, depoliticizing of banks,
professionalism in banking, reviewing bank recruitment, etc.
IMPACTS OF REFORMS ON THE BANKING INDUSTRY:
1. Branch Expansion: The Indian banking industry had made sufficient progress during the
reforms period.
The progress of the industry can be judged in terms of branch expansion and growth of credit
anddeposits. However, the branch expansion of the SCBs has slowed down during the post
1991 era but population per bank branch has not changed much and the figure is
hovering around 15,000 per branch. Therefore, banking sector has maintained the gains in
terms of branch network in the phase of social banking during the reform period.

8. M.NARASIMHAM COMMITTEE

2. Interest Rate Deregulation: The main aim of the interest rate reforms was to simplify the
complex and the tiered interest rate structure that India had during pre-1990. Different interest
rates, based upon size, purpose, maturity of loan, group, sector, region, etc., were rationalized
to converge at a single lending rate called as prime lending rate over a period of five years.
The aim was to provide more options and flexibility to banks for their asset liability
management operations and shift towards indirect monetary control (Kohli, 2005). The motive
behind the liberalization of interest rates in the banking system was to allow the banks more
flexibility and encourage competition.

3. Directed Credit Directed credit policies have been an important part of India’s financial sector
reforms. Under the directed credit policy commercial banks are required to provide 40 percent
of their commercial loans to the priority sectors which include agriculture, small-scale
industry, small transport operators, artisans, etc. Within the aggregate ceiling, there are
various sub-ceilings for agriculture and also for loans to poverty related target groups. The
Narasimham committee had recommended reduction of the directed credit to 10 percent from
40 percent. The committee had also suggested narrowing down the definition of priority
sector to focus on small farmers and low-income target groups. The performance of the
private sector banks in the area of priority sector lending remain less satisfactory with 12 out
of 30 private sector banks failing to achieve the overall priority sector targets. Only one
private sector bank, ICICI Bank, could achieve the sub-targets within the priority sector.
Private sector banks credit to weaker sections at 1.2 percent of net bank credit is much lower
than the stipulated target of 10 percent for the sector. Foreign banks have achieved the overall
priority sector targets and sub-targets for export credit and nearly achieve the sub-target with
respect to SSI as well. The priority sector lending witnessed a growth of 18 percent in2010-
2011 over the previous year. However the growth of agriculture advances decelerated to9,1
percent in 2010-2011 as compared with growth of 23 percent in the previous year.(Report on
trend and progress of Banking in India).

9. M.NARASIMHAM COMMITTEE

REGULATORY REFORMS:
Since the beginning of the financial sector reforms, an important task of the policy makers was
to bring in an appropriate regulatory framework. The design of an appropriate regulatoryframe
work, which encourages competition and efficiency in banking services and at the same time,
ensures a safe banking sector may be very difficult and complex component of the banking.
Based on the status of the asset, an asset is classified on to four categories- standard, sub-
standard, doubtful and loss asset. In India, standard assets are defined as credit facilities of which
interest or principal or both are paid by due date. Generally, Sub-standard assets are
called NPAs. A sub-
standard asset is called doubtful asset if it remains NPA for two years 2000(reduced to 18
months in 2001and further reduced to 12 months over a four-year period starting from March
2005). An asset is called as loss, without any waiting period, where the dues are considered
uncollectible or marginally collectible. The concept of past due in the identification of NPA was
dispensed with from March 2001 and the 90 days delinquency norm was adopted for the
classification of NPAs with effect from March 2004. While gross NPAs in % terms have
declined steadily from 15.70% at end march1997 to 2.25% at end march 2011.The matter of
concern is that the share of priority sector NPAs in gross NPAs of domestic banks witnessed an
increase in 2010-2011 over previous year. Agriculture sector contributed 44% of total
incremental NPAs of domestic banks. Similarly, weaker sections NPAs to weaker sections
advances also witnessed an increase in PSBs and private sector banks.

Supervision and Privatization of Banks
The gradual privatization of public sector banks has been an important component of banking
sector reforms in India. This has been prompted more by the need to raise capital to meet there
vise capital adequacy norms, rather than a conscious policy decision on the part of the govt. to
withdraw from banking operations (Kohli, 2006). In 1994, the committee on Banking Sector
Reforms (CBSR) suggested to dilute the govt. shareholding in public sector banks to
51 percent. Still the govt. has to recapitalize public sector
banks to large extent through budgetary support. In 2001, govt. ownership in banks was further

10. M.NARASIMHAM COMMITTEE

reduced to 33 percent with the condition that no individual shareholder can hold more than1
percent of the shares. However, the privatization of public sector banks in India is not yielding
the expected result. By 1998, only 9 public banks (out of 20) had gone for public equity to
strengthen their capital base. The dismal performance of these banks in raising capital from the
market could be gauged from the fact that in 1998-99 the minimum shareholding of govt. was 66
percent. By March 2001,
11 public sector banks were listed at the National Stock Exchange, but the share of top 5 banksac
counted for 95 percent of the total traded shares of them. Majority ownership of public
sector banks by govt. has been a symbol of faith in India and it is an important point in
the process of privatization.

FUTURE CONCERN AND PROSPECTS:
It has been observed that the banking sector in India has provided a mixed response to these
forms initiated by the RBI and the Government of India since the 1991. The sector has responded
very positively in the field of enhancing the role of market forces, regarding measures of
prudential regulations of accounting, income recognition, provisioning and exposure, reduction
of NPAs and regarding the up gradation of technology. But at the same time the reform has
failed to bring up a banking system which is at par with the international level and still the Indian
banking sector is mainly controlled by the govt. as public sector banks being the leader in all the
spheres of the banking network in the country. Thus, there are certain concerns, which need to be
discussed for improving the overall efficiency of the banking sector:

1. Need for Banks to Conform to the Priority Sector-Lending Target: At the aggregate level, bank
groups adhere to the targets prescribed by the RBI, however at bank level, there are a
number of banks, which were not able to meet the targets set for priority sector as a
whole and for agriculture credit.
2. Need to Improve the Quality of Banking Services: It is another area, which requires
continuous improvement to attract more customers of the formal banking channels. There
is need to promote transparency by way of informing customers about different charges
levied by them.

11. M.NARASIMHAM COMMITTEE

3. Need to further improve the Efficiency: Maintaining profitability is a challenge especially in
a highly competitive environment. Thus there is a need to reduce operating expenses in
the interest of efficiency and profitability.
4. Need to Closely Monitor the Quality of Assets: A challenging task in the midst of regular
policy rates hike was the management of the quality of assets. Though the GNPA ratio
witnessed improvement in recent years, certain concerns with regard to asset quality of
the banking sector continued to loom large. Further it is a concern that a substantial
portion of the total incremental NPAs of domestic banks in2010-11 was contributed by
agricultural NPA. There is a need to improve credit flow to rural areas. The matter of
concern is the concentration of banking business in a few metropolitan centers. Thus,
efforts need to be taken to improve credit flow to the rural areas as also to the north
eastern, eastern and central regions. To conclude, focused attention on the issues that are
being confronted by the banking sector may be imperative in the largest interest of
securing economic growth with equity. Once these issues are addressed, the Indian
banking sector has the potential to become further deeper and stronger. Greater attention
to these issues would facilitate better finance structure of the economy and in the medium
to long-term lead to broad based economic growth.