Narasimham Committee on Banking Sector Reforms (1998)
Encyclopedia
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 to 1980s, 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.
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.Radical prescriptions
| url = http://www.hinduonnet.com/fline/fl1510/15101090.htm
| work = SUDHA MAHALINGAM, Frontline Vol. 15 :: No. 10
| date = 09-22 May 1998
| accessdate = 21 February 2011
}} 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 first Narasimhan Committee (Committee on the Financial System - CFS) was appointed by Manmohan 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). This article is about the recommendations of the Second Narasimham Committee, the Committee on Banking Sector Reforms.
The purpose of the Narasimham-I Committee was to study all aspects relating to the structure, organization, 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. M. Narasimham, Chairman, submitted the report of the Committee on Banking Sector Reforms (Committee-II) to the Finance Minister Yashwant Sinha
in April 1998.
of these banks. The committee further added that given that the government nominees to the board
of banks are often members of parliament
, politicians, bureaucrats, etc., they often interfere in the day-to-day operations of the bank in the form of the behest-lending. As such the committee recommended a review of functions of banks boards with a view to make them responsible for enhancing shareholder value through formulation of corporate strategy and reduction of government equity.
To implement this, criteria for autonomous status was identified by March 1999 (among other implementation measures) and 17 banks were considered eligible for autonomy. But some recommendations like reduction in Government's equity to 33%, the issue of greater professionalism and independence of the board of directors of public sector banks is still awaiting Government follow-through and implementation.
Pursuant to the recommendations, the RBI introduced a Liquidity Adjustment Facility
(LAF) operated through repo and reverse repos in order to set a corridor for money market interest rates. To begin with, in April 1999, an Interim Liquidity Adjustment Facility (ILAF) was introduced pending further upgradation in technology and legal/procedural changes to facilitate electronic transfer. As for the second recommendation, the RBI decided to transfer its respective shareholdings of public banks like State Bank of India
(SBI), National Housing Bank
(NHB) and National Bank for Agriculture and Rural Development
(NABARD) to GOI. Subsequently, in 2007-08, GOI decided to acquire entire stake of RBI in SBI, NHB and NABARD. Of these, the terms of sale for SBI were finalised in 2007-08 itself.
. The Committee recommended the use of mergers to build the size and strength of operations for each bank. However, it cautioned that large banks should merge only with banks of equivalent size and not with weaker banks, which should be closed down if unable to revitalize themselves. Given the large percentage of non-performing asset
s for weaker banks, some as high as 20% of their total assets, the concept of "narrow banking" was proposed to assist in their rehabilitation.
There were a string of mergers in banks of India during the late 90s and early 2000s, encouraged strongly by the Government of India|GOI in line with the Committee's recommendations. However, the recommended degree of consolidation is still awaiting sufficient government impetus.
The committee's recommendations let to introduction of a new legislation which was subsequently implemented as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and came into force with effect from 21 June 2002.
norms. This would also improve their risk taking ability. The committee targeted raising the capital adequacy ratio
to 9% by 2000 and 10% by 2002 and have penal provisions for banks that fail to meet these requirements. For asset classification, the Committee recommended a mandatory 1% in case of standard assets and for the accrual of interest income to be done every 90 days instead of 180 days.
To implement these recommendations, the RBI in Oct 1998, initiated the second phase of financial sector reforms by raising the banks' capital adequacy ratio by 1% and tightening the prudential norms for provisioning and asset classification in a phased manner on the lines of the Narasimham Committee-II report. The RBI targeted to bring the capital adequacy ratio to 9% by March 2001. The mid-term Review of the Monetary and Credit Policy of RBI announced another series of reforms, in line with the recommendations with the Committee, in October 1999.
informed the banks that the RBI had a three to four year perspective on the implementation of the Committee's recommendations.
Based on the other recommendations of the committee, the concept of a universal bank
was discussed by the RBI and finally ICICI bank became the first universal bank of India. The RBI published an "Actions Taken on the Recommendations" report on 31 October 2001 on its own website. Most of the recommendations of the Committee have been acted upon (as discussed above) although some major recommendations are still awaiting action from the Government of India.
leading to successful implementation of most of its recommendations. Then it turned out that during the 2008 economic crisis of major economies worldwide, performance of Indian banking sector was far better than their international counterparts. This was also credited to the successful implementation of the recommendations of the Narasimham Committee-II with particular reference to the capital adequacy norms and the recapitalization of the public sector banks. The impact of the two committees has been so significant that elite politicians and financial sectors professionals have been discussing these reports for more than a decade since their first submission applauding their positive contribution over the years.
1991 India economic crisis
By 1985, India had started having balance of payments problems. By the end of 1990, it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to such a point that India could barely finance three...
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
Banking in India
Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the...
. During this period, recognizing the evolving needs of the sector, the Finance Ministry of Government of India
Government of India
The Government of India, officially known as the Union Government, and also known as the Central Government, was established by the Constitution of India, and is the governing authority of the union of 28 states and seven union territories, collectively called the Republic 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
M. Narasimham
M. Narasimham was the thirteenth Governor of the Reserve Bank of India from 2 May 1977 to 30 November 1977RBI follows a policy of in house promotions, where all staff persons are promoted internally. The only two jobs where this is not done is for the Governor and one Deputy Governor. In...
. 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
Social democracy
Social democracy is a political ideology of the center-left on the political spectrum. Social democracy is officially a form of evolutionary reformist socialism. It supports class collaboration as the course to achieve socialism...
era of the 1960s to 1980s, 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.
Background
During the decades of the 60s and the 70s, India nationalisated most of its banks. This culminated with the balance of payments crisis1991 India economic crisis
By 1985, India had started having balance of payments problems. By the end of 1990, it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to such a point that India could barely finance three...
of the Indian economy
Economy of India
The Economy of India is the ninth largest in the world by nominal GDP and the fourth largest by purchasing power parity . The country is a part of the G-20 major economies and the BRICS, in addition to being partners of the ASEAN. India has a per capita GDP of $3,608 as per 2010 figures, making it...
where India had to airlift gold to International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
(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
Government of India
The Government of India, officially known as the Union Government, and also known as the Central Government, was established by the Constitution of India, and is the governing authority of the union of 28 states and seven union territories, collectively called the Republic 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
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
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.Radical prescriptions
| url = http://www.hinduonnet.com/fline/fl1510/15101090.htm
| work = SUDHA MAHALINGAM, Frontline Vol. 15 :: No. 10
| date = 09-22 May 1998
| accessdate = 21 February 2011
}} In the light of these requirements, two expert Committees were set up in 1990s under the chairmanship of M. Narasimham
M. Narasimham
M. Narasimham was the thirteenth Governor of the Reserve Bank of India from 2 May 1977 to 30 November 1977RBI follows a policy of in house promotions, where all staff persons are promoted internally. The only two jobs where this is not done is for the Governor and one Deputy Governor. In...
(an ex-RBI (Reserve Bank of India
Reserve Bank of India
The Reserve Bank of India is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of...
) governor) which are widely credited for spearheading the financial sector reform in India. The first Narasimhan Committee (Committee on the Financial System - CFS) was appointed by Manmohan Singh
Manmohan Singh
Manmohan Singh is the 13th and current Prime Minister of India. He is the only Prime Minister since Jawaharlal Nehru to return to power after completing a full five-year term. A Sikh, he is the first non-Hindu to occupy the office. Singh is also the 7th Prime Minister belonging to the Indian...
as India's Finance Minister
Finance minister
The finance minister is a cabinet position in a government.A minister of finance has many different jobs in a government. He or she helps form the government budget, stimulate the economy, and control finances...
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). This article is about the recommendations of the Second Narasimham Committee, the Committee on Banking Sector Reforms.
The purpose of the Narasimham-I Committee was to study all aspects relating to the structure, organization, 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
Capital adequacy ratio
Capital adequacy ratio , also called Capital to Risk Assets Ratio , is a ratio of a bank's capital to its risk...
among other things. M. Narasimham, Chairman, submitted the report of the Committee on Banking Sector Reforms (Committee-II) to the Finance Minister Yashwant Sinha
Yashwant Sinha
Yashwant Sinha is an Indian politician and a former finance minister of India and foreign minister in Atal Bihari Vajpayee's cabinet...
in April 1998.
Recommendations of the Committee
The 1998 report of the Committee to the GOI made the following major recommendations:Autonomy in Banking
Greater autonomy was proposed for the public sector banks in order for them to function with equivalent professionalism as their international counterparts. For this the panel recommended that recruitment procedures, training and remuneration policies of public sector banks be brought in line with the best-market-practices of professional bank management. Secondly, the committee recommended GOI equity in nationalized banks be reduced to 33% for increased autonomy. It also recommended the RBI relinquish its seats on the board of directorsBoard of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
of these banks. The committee further added that given that the government nominees to the board
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
of banks are often members of parliament
Parliament of India
The Parliament of India is the supreme legislative body in India. Founded in 1919, the Parliament alone possesses legislative supremacy and thereby ultimate power over all political bodies in India. The Parliament of India comprises the President and the two Houses, Lok Sabha and Rajya Sabha...
, politicians, bureaucrats, etc., they often interfere in the day-to-day operations of the bank in the form of the behest-lending. As such the committee recommended a review of functions of banks boards with a view to make them responsible for enhancing shareholder value through formulation of corporate strategy and reduction of government equity.
To implement this, criteria for autonomous status was identified by March 1999 (among other implementation measures) and 17 banks were considered eligible for autonomy. But some recommendations like reduction in Government's equity to 33%, the issue of greater professionalism and independence of the board of directors of public sector banks is still awaiting Government follow-through and implementation.
Reform in the role of RBI
First, the committee recommended that the RBI withdraw from the 91-day treasury bills market and that interbank call money and term money markets be restricted to banks and primary dealers. Second, the Committee proposed a segregation of the roles of RBI as a regulator of banks and owner of bank. It observed that "The Reserve Bank as a regulator of the monetary system should not be the owner of a bank in view of a possible conflict of interest". As such, it highlighted that RBI's role of effective supervision was not adequate and wanted it to divest its holdings in banks and financial institutions.Pursuant to the recommendations, the RBI introduced a Liquidity Adjustment Facility
Liquidity adjustment facility
Liquidity adjustment facility is a monetary policy tool which allows banks to borrow money through repurchase agreements....
(LAF) operated through repo and reverse repos in order to set a corridor for money market interest rates. To begin with, in April 1999, an Interim Liquidity Adjustment Facility (ILAF) was introduced pending further upgradation in technology and legal/procedural changes to facilitate electronic transfer. As for the second recommendation, the RBI decided to transfer its respective shareholdings of public banks like State Bank of India
State Bank of India
The State Bank of India is the largest Indian banking and financial services company with its headquarters in Mumbai, India. It is state-owned. The bank traces its ancestry to British India, through the Imperial Bank of India, to the founding in 1806 of the Bank of Calcutta, making it the oldest...
(SBI), National Housing Bank
National Housing Bank
The National Housing Bank is a state owned bank and regulation authority in India, created on July 8, 1988 under section 6 of the National Housing Bank Act . The headquarters is in New Delhi and i's total staff June 30, 2008 was 80....
(NHB) and National Bank for Agriculture and Rural Development
National Bank for Agriculture and Rural Development
National Bank for Agriculture and Rural Development is an apex development bank in India having headquarters based in Mumbai and other branches are all over the country...
(NABARD) to GOI. Subsequently, in 2007-08, GOI decided to acquire entire stake of RBI in SBI, NHB and NABARD. Of these, the terms of sale for SBI were finalised in 2007-08 itself.
Stronger banking system
The Committee recommended for merger of large Indian banks to make them strong enough for supporting international trade. It recommended a three tier banking structure in India through establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. This proposal had been severely criticized by the RBI employees unionTrade union
A trade union, trades union or labor union is an organization of workers that have banded together to achieve common goals such as better working conditions. The trade union, through its leadership, bargains with the employer on behalf of union members and negotiates labour contracts with...
. The Committee recommended the use of mergers to build the size and strength of operations for each bank. However, it cautioned that large banks should merge only with banks of equivalent size and not with weaker banks, which should be closed down if unable to revitalize themselves. Given the large percentage of non-performing asset
Non-performing asset
A Non-performing asset is defined as a credit facility in respect of which the interest and/or instalment of principal has remained ‘past due’ for a specified period of time.-Identification:...
s for weaker banks, some as high as 20% of their total assets, the concept of "narrow banking" was proposed to assist in their rehabilitation.
There were a string of mergers in banks of India during the late 90s and early 2000s, encouraged strongly by the Government of India|GOI in line with the Committee's recommendations. However, the recommended degree of consolidation is still awaiting sufficient government impetus.
Non-performing assets
Non-performing assets had been the single largest cause of irritation of the banking sector of India. Earlier the Narasimham Committee-I had broadly concluded that the main reason for the reduced profitability of the commercial banks in India was the priority sector lending. The committee had highlighted that 'priority sector lending' was leading to the build up of non-performing assets of the banks and thus it recommended it to be phased out. Subsequently, the Narasimham Committee-II also highlighted the need for 'zero' non-performing assets for all Indian banks with International presence. The 1998 report further blamed poor credit decisions, behest-lending and cyclical economic factors among other reasons for the build up of the non-performing assets of these banks to uncomfortably high levels. The Committee recommended creation of Asset Reconstruction Funds or Asset Reconstruction Companies to take over the bad debts of banks, allowing them to start on a clean-slate. The option of recapitalization through budgetary provisions was ruled out. Overall the committee wanted a proper system to identify and classify NPAs, NPAs to be brought down to 3% by 2002 and for an independent loan review meachnism for improved management of loan portfolios.The committee's recommendations let to introduction of a new legislation which was subsequently implemented as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and came into force with effect from 21 June 2002.
Capital adequacy and tightening of provisioning norms
In order to improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacyCapital adequacy ratio
Capital adequacy ratio , also called Capital to Risk Assets Ratio , is a ratio of a bank's capital to its risk...
norms. This would also improve their risk taking ability. The committee targeted raising the capital adequacy ratio
Capital adequacy ratio
Capital adequacy ratio , also called Capital to Risk Assets Ratio , is a ratio of a bank's capital to its risk...
to 9% by 2000 and 10% by 2002 and have penal provisions for banks that fail to meet these requirements. For asset classification, the Committee recommended a mandatory 1% in case of standard assets and for the accrual of interest income to be done every 90 days instead of 180 days.
To implement these recommendations, the RBI in Oct 1998, initiated the second phase of financial sector reforms by raising the banks' capital adequacy ratio by 1% and tightening the prudential norms for provisioning and asset classification in a phased manner on the lines of the Narasimham Committee-II report. The RBI targeted to bring the capital adequacy ratio to 9% by March 2001. The mid-term Review of the Monetary and Credit Policy of RBI announced another series of reforms, in line with the recommendations with the Committee, in October 1999.
Entry of Foreign Banks
The committee suggested that the foreign banks seeking to set up business in India should have a minimum start-up capital of $25 million as against the existing requirement of $10 million. It said that foreign banks can be allowed to set up subsidiaries and joint ventures that should be treated on a par with private banks.Implementation of recommendations
In 1998, RBI Governor Bimal JalanBimal Jalan
Bimal Jalan is a former Governor of India's Reserve Bank anda nominated member of the Upper House of India's Parliament, the Rajya Sabha during 2003-2009.- Education and career :...
informed the banks that the RBI had a three to four year perspective on the implementation of the Committee's recommendations.
Based on the other recommendations of the committee, the concept of a universal bank
Universal bank
A universal bank participates in many kinds of banking activities and is both a commercial bank and an investment bank.The concept is most relevant in the United Kingdom and the United States, where historically there was a distinction drawn between pure investment banks and commercial banks. In...
was discussed by the RBI and finally ICICI bank became the first universal bank of India. The RBI published an "Actions Taken on the Recommendations" report on 31 October 2001 on its own website. Most of the recommendations of the Committee have been acted upon (as discussed above) although some major recommendations are still awaiting action from the Government of India.
Criticism
There were protests by employee unions of banks in India against the report. The Union of RBI employees made a strong protest against the Narasimham II Report. There were other plans by the United Forum of Bank Unions (UFBU), representing about 1.3 million bank employees in India, to meet in Delhi and to work out a plan of action in the wake of the Narasimham Committee report on banking reforms. The committee was also criticized in some quarters as "anti-poor". According to some, the committees failed to recommend measures for faster alleviation of poverty in India by generating new employment. This caused some suffering to small borrowers (both individuals and businesses in tiny, micro and small sectors).Reception
Initially, the recommendations were well received in all quarters, including the Planning Commission of IndiaPlanning commission of India
The Planning Commission is an institution in the Government of India, which formulates India's Five-Year Plans, among other functions.-History:...
leading to successful implementation of most of its recommendations. Then it turned out that during the 2008 economic crisis of major economies worldwide, performance of Indian banking sector was far better than their international counterparts. This was also credited to the successful implementation of the recommendations of the Narasimham Committee-II with particular reference to the capital adequacy norms and the recapitalization of the public sector banks. The impact of the two committees has been so significant that elite politicians and financial sectors professionals have been discussing these reports for more than a decade since their first submission applauding their positive contribution over the years.