Narasimham Committee Report on Financial Reforms

Group 15Ajinkya Pati l – 11020241002

Gautam Siddharth – 11020241017Vivek Choksi - 11020241049

Introduction:• Headed by Mr. M. Narasimham, who was the

13th Governor of RBI

• First Committee, known as Narasimham Committee I, was appointed in August 1991, against the backdrop of the Balance of Payment Crisis

• Set up to analyze all factors related to financial system and give recommendation to improve its efficiency and productivity

• The Second Committee, Known as Narasimham Committee II, was appointed in 1998

• It was given the task to review the implementation of the Banking Sector Reforms

Narasimham Committee

Report I (1991)

• Narasimham Committee I was a nine-member committee set up by the Government of India on 14 August 1991

• It was set up to examine all aspects relating to the structure, organisation, functions and procedures of the financial system

• The Committee submitted its report to the Government on November 16, 1991

• The report was tabled in the Parliament on December 17, 1991

Key Suggestions:• Reduction in CRR and SLR• Phasing out Directed Credit Programmes• Interest Rate Deregulation• Structural Reorganization of Banks• Change in the Control Structure of Banks• Establishment of ARF tribunal• Change in Classification of Assets• Allowing Banks to raise Capital• Liberalization of Capital Markets

Reduction in the SLR and CRR:

• One of the most important recommendations made by the committee was a drastic reduction in CRR and SLR

• Committee noted that the high amount of CRR and SLR was hindering the productivity of Banks considerably

• SLR was recommended to reduce from 38.5 % to 25% and CRR was recommended to be reduced to 15% to a range of 3-5% by 1996-97

Directed Credit Programs:• The committee acknowledged the role of these

programs in extending the reach of Banking system to the neglected sectors of the economy

• However, it also called for re-examination of the present relevance of these programs, especially for those sectors which had become self-sufficient

• Accordingly, the committee proposed that the directed credit committees should be phased out

• It also called for a re-defining of the priority sector

Interest Rate Deregulation:

• The Committee observed that the prevailing structure of administered rates was highly complex and rigid and called for deregulating it so that it reflects the emerging market conditions

• However, it warned against instant deregulation and suggested that the rates be brought in line with the market rates gradually over a period of time

• The Committee also recommended phasing out Concessional Interest rates

Structural Reorganization of Banks:In regard to the structure of the Banking System, The Committee believed that the structure should consist of:

• 3-4 Banks (Including SBI) becoming International Banks• 8 to 10 national banks with a network of branches

throughout the country engaged in 'universal' banking• Local banks whose operations would be generally

confined to a specific region• Rural banks (including RRBs) whose operations would be

confined to the rural areas and whose business would be predominantly engaged in financing of agriculture and allied activities

• The move towards this revised system should be market driven and based on profitability considerations and brought about through a process of mergers and acquisitions

• The Committee also called on the Government to stop further nationalization of Banks

• 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

• It also called for liberalizing the process of foreign banks entering the country

Control of Banks:• The committee recommended that RBI should be the

sole authority in-charge of controlling the Banks• It also called for greater autonomy to be given to Public

sector banks.• The Committee believed that the internal organization

should be the prerogative of the 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

Establishment of ARF tribunal:• Those days, the proportion of bad debts and non-

performing assets of the public sector banks and Development financial institutes was very high.

• The committee recommended the establishment of an Asset Reconstruction Fund (ARF)

• The suggestion was that the ARF would take over the proportion of the bad and doubtful debts from the banks and financial institutes.

• All bad and doubtful debts of the banks were to be transferred in a phased manner to ensure smooth and effective functioning of the ARF

• The committed also suggested the formation of special tribunals to recover loans granted by the bank

Classification of Assets:

• 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

Raising Capital through Markets:

• The Committee recommended that profitable banks and banks with good reputation should be permitted to raise capital from the public through the capital market

• Regarding other banks, the government should subscribe to their capital or give a loan, which should be treated as a subordinate debt, to meet their capital requirements

Liberalisation of 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

Narasimham Committee Report II (1998)

Banking Sector Reforms Committee• Setup by the Finance Ministry of the Government of

India under the chairmanship of Mr M. Narasimham in 1998.

• Committee submitted the report in April 1998

• Aim was to review the progress of the implementation of the banking reforms since 1992 with the aim of further strengthening the financial institutions of India

• Report focused on issues like size of banks and capital adequacy ratio

Recommendations:Need for a Stronger Banking System:

• The Narasimham Committee has made out a strong case for a stronger banking system in the country

• Recommended the merger of strong banks which will have a “multiplier effect” on industry

• Recommended the use of mergers to build the size and strength of operations for each bank

• Committee has also supported that two or three large strong banks be given international or global character

Narrow Banking:

• 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

• For successful rehabilitation of these banks, the committee recommended 'Narrow Banking Concept'

• Weak banks will be allowed to place their funds only in short term and risk free assets.

Capital Adequacy Ratio:

• To improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms

• This would improve their Risk absorption capacity

• The committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002

• Recommended penal provisions for banks that fail to meet these requirements

Autonomy to Banks:• Greater autonomy was proposed for the public sector

banks in order for them to function with equivalent professionalism as their international counterparts

• Committee recommended GOI equity in nationalized banks be reduced to 33% for increased autonomy

• RBI should relinquish its seats on the board of directors of these banks

• 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

Review of banking laws:

• Committee considered that there was an urgent need for reviewing and amending main laws governing Indian Banking Industry

• RBI Act, Banking Regulation Act, State Bank of India Act, Bank Nationalization Act, etc.

• This upgradation will bring them in line with the present needs of the banking sector in India

Non-performing assets:• Narasimham Committee-II also highlighted the

need for 'zero' non-performing assets for all Indian banks with International presence

• 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

• Committee recommended a proper system to identify and classify NPAs and for an independent loan review mechanism for improved management of loan portfolio

• To implement these recommendations, the RBI in Oct 1998, initiated the second phase of financial sector reforms on the lines of Narasimham Committee-II report

• RBI raised Capital Adequacy Ratio by 1%

• Tightened the prudential norms for provisioning and asset classification in a phased manner

• RBI targeted to bring the capital adequacy ratio to 9% by March 2001

Implementation:

• 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

• Criteria for “autonomous status” was identified by March 1999 and 17 banks were considered eligible for autonomy

• Committee's recommendations let to introduction of a new legislation in 2002, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

• 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

Impact:• Recommendations were far-fetched and far-ahead of their times

• Recommendations were well received, leading to successful implementation of most of its recommendations

• During the 2008 economic crisis, performance of Indian banking sector was far better than their international counterparts

• This was 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

• Impact of the two committees has been so significant that the financial-economic sector professionals have been applauding there positive contribution

Bibliography:• “Banking” – by N. T. Somashekar• www.rbi.org.in• www.nabard.org/fileupload/DataBank/

Newsletters/March1992.pdf• http://www.expressindia.com/fe/daily/19971230/3

6455263.html

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