Ans: Banking in India in the
modern sense originated in the last decades of the 18th century. Banking can be defined as the business activity of accepting and safeguarding money owned
by other individuals and entities, and then lending out this money in order to
earn a profit. However, with the passage of time, the
activities covered by banking business have
widened and now various other services are also offered by banks. The
banking services these days include issuance of debit and credit
cards, providing safe custody of valuable items, lockers, ATM services
and online transfer of funds across the country / world.
Structure of Indian Banking System :
Banks can be divided into two
parts:
Banking Reforms by
Narsimham Committee:
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 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.
Along with these major problem areas M. Narasimham's
Committee also found various inconsistencies regarding the banking system in
India. In order to remove them and make it more vibrant and efficient, it has
given the following recommendations.
Narasimham Committee Report
I - 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. This programme compelled banks to
earmark then financial resources for the needy and poor sectors at 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.
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.
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.
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 up
gradation will thus be easy.
Some
of these recommendations were later accepted by the Government of India and
became banking reforms.
Narasimham Committee
Report II - 1998
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.
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 up
gradation 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 up gradation, training of staff, depoliticizing of
banks, professionalism in banking, reviewing bank recruitment, etc.
Evaluation of Narsimham
Committee Reports
The
Committee was first set up in 1991 under the chairmanship of Mr. M. Narasimham
who was 13th governor of RBI. Only a few of its recommendations became banking
reforms of India and others were not at all considered. Because of this a
second committee was again set up in 1998.
As
far as recommendations regarding bank restructuring, management freedom,
strengthening the regulation are concerned, the RBI has to play a major role.
If the major recommendations of this committee are accepted, it will prove to
be fruitful in making Indian banks more profitable and efficient.
Banking Challenges
The
banking challenges that are facing by Indian banking are as follows:
1.
Increase
penetration of banking in India- tackle demand supply mismatch
Primarily supply side
constraints are responsible for the high levels of financial exclusion in the
country, as they have a causal effect in keeping demand low from certain
factions of the population. The demand supply mismatch, which is reflected in
measures of financial exclusion, shows the limitations on the banks’ ability to
supply products and services.
A large proportion of the population in India, largely
concentrated in rural areas is believed to be financially excluded from
formalized credit markets (implies having access to bank credit) and payments
systems (implies not having access to bank accounts). Inaccessible
institutional credit drives these people to use the services of unorganized
credit markets which charge interest at rates in the range of 35-60%. According
to the Report of the Committee on Financial Inclusion (NABARD, 2008) and NSSO,
45.9 million farmer households in India do not have access to credit, even from
non institutional sources. Only 27% of farmer households have loans from
institutionalized sources, two-thirds of which also borrow from the unorganized
sector. Among the urban poor class, financial exclusion level is not determined
with certainty, since this population group is highly migratory. But, clearly,
north eastern, eastern and central regions suffer more from financial exclusion
than other regions of the country.
Many initiatives are being taken by the RBI and other
banks in the country, notably public sector banks, to increase supply of
financial services to the unbanked areas. Introduction of ‘no frills’ account
(2005) and utilizing services of NGOs and other civil organizations for
providing financial services (2006) are some steps in that direction. The
ability of banks to supply products and services is clearly reflected in the
population being served by them per branch, or their physical presence
geographically.
Foreign banks committed to making a play in India will
need to adopt alternative approaches to win the “race for the customer” and
build a value-creating customer franchise in advance of regulations potentially
opening up post 2009. At the same time, they should stay in the game for
potential acquisition opportunities as and when they appear in the near term.
Maintaining a fundamentally long-term value-creation mindset will be their
greatest challenge.
2.
Credit disbursement
to the priority sector:
One of the major challenges faced by the banking
system in India is to provide timely and cost effective credit to the priority
sectors especially the agriculture and Small scale industries, which are
critical in generating employment and support the growth momentum of the
economy. After witnessing robust growth between FY05-FY07, the growth in
agriculture credit witnessed some moderation in FY08. Thus banks are required
to ensure availability of credit to the agriculture sector, which forms the
backbone of the Indian economy. With significant slowdown in economic activity
and exports during the latter part of FY09, the credit growth to the micro and
small experienced some moderation. While it is important for the banks to
maintain the asset quality, they also need to direct the credit flow towards
small and medium enterprises which play a critical role in India’s economic
development.
3.
Maintain asset
quality:
The secured advances made by banks have shown a mild
decline in FY09. The unsecured advances of banks particularly of credit card
receivables have increased substantially. In FY09, the quality of assets of
banks has come under scrutiny, as the rising interest rates started putting
pressure on the repayment by borrowers in the H1 FY09. While the interest rates
began to soften in the latter part of the fiscal, the risk of default persisted
mainly due to slowdown in economic activity. Thus a major challenge in the
current economic scenario for the Indian banks is to maintain the gains made
with respect to asset quality over the past few years.
In such situations, unsecured advances possess greater
risk to business. The sensitive sector advances is an important indicator
towards the quality of assets held by banks. Though this does not in itself
indicate a high risk, the higher exposure signals a greater need for monitoring
by the banks as the susceptibility increases. This is of even greater
importance in the current scenario when capital markets and real estate are
extremely risky sectors. The exposures of SCBs to sensitive sectors have
increased inexplicably from less than 3.5% to over 20% within a span of two
years. New private sector banks have the highest exposure to sensitive sectors,
largely due to the exposure in real estate.
4.
Improve risk
management mechanism:
Strategies to combat the problem of high risk
perception must be taken up by banks on priority basis. Increased usage of
rating services must be employed to reduce risk. Besides, SME specific risk
management procedures must be setup to make the business more viable, as the
risk perception associated with lending to small enterprises is generally very
high. Further, the banks would also be required to acquire skill for managing
emerging risks resulting from innovations in financial products as well as
technological advancements.
The availability and ease access to reliable
data/information to both banks and regulators/supervisors of the banking system
is a key for prudent risk management. Hence, strengthen the existing system
would be another challenge for the banking industry. More over the recent
global financial market turmoil has accentuated the need for further
improvement in the transparency and disclosure standards.
5.
Technology
adoption:
The problem of resistance from workforce has largely
been neutralized over the years, but the primary issue involved with the
adoption and rapid integration of technological processes within banks still
related to human resources- the availability of technically skilled resources
is scarce. Technology is not among the core competencies of financial
institutions, which necessitates outsourcing. Banks in India are different from
banks in many other countries, in ways that they have a very large branch
network and varied needs specific to regions and customers. Most off the shelf
solutions are not exactly in conformity to the needs of the banks, which makes
room for large customizations.
Besides, a serious concern in implementing complex
technologies is protection against frauds and hackings. Security concern slows
down technology adoption significantly for the banking industry. A fast pace of
development of security systems is imperative to the adoption of large scale
innovations in the industry.
Another issue is that of business process
reengineering, which is required after computerization. Failure to successfully
carry out BPR neutralizes the benefits that an institution wishes to accomplish
via adoption of a technological process.
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