Banking Sector Reforms in India: an Analysis

Citation: Kumar, Manoj, G. D. Krishna, and S. Bhardwaj. "Banking

Sector Reforms in India." International Research Journal of
Commerce Arts and Science"
Semester: 5
Year: 2022-23

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 CONTENTS

1. Abstract 3

2. Introduction 3

3. Motivation of the Author 3

4. Major Findings 3

5. Analysis 5

6. Data and Methodology 6

7. Criticism 6

8. Conclusion & Future Prospects 7

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Abstract:

Independent India enacted numerous reforms in the agricultural, industrial, and banking sectors.
The Research Paper under study throws light on the banking sector reforms introduced by the
Independent Government of India and the Reserve Bank of India. It first points to the status of the
sector in the post-independence era and then scrutinizes the impact of these reforms to give us
useful insight into where it stands today.

Introduction:

Indian Economy after gaining independence was left baffled when colonizers set sail back home. The
challenges for Independent India were many and prevailed at every stage of economic development
over the years. Crippled India, however, was learning to stand back on its feet with the help of
significant growth and development in the agricultural and industrial sectors. The Banking Sector,
even so, struggled.
Banking Sector is an indispensable element of the financial system of any country. It plays a major
role in a country’s economic growth and development. The Banking system in India was under the
umbrella of the Government and the Reserve Bank of India. So several reforms were enacted as a
part of the New Economic Policy of 1991 to enhance the efficiency, productivity, and profitability of
the sector and revive it.
The impact of these reforms was of many folds, sectors, and dimensions.
This study is therefore an attempt to first learn about the major reforms enacted, to make a critical
analysis and understanding of the significance of the reforms, to arrive at a conclusion, and to
identify prospects.

The motivation of the Author:

The author conducted the study and analysis to make a simplified and concise assessment of the
reforms in the banking sector as it is an integral part of the financial system of India. He first enlists
the reforms and then reveals the impact of the reforms concerning the factors of credit delivery,
market share of banks, profitability, and prudential regulations. Since the sector essentially acts as
the Backbone of the economy, the author also made attempts to figure out its prospects.

Major Findings:

In this section of the study, the focus is on the summary of the timeline of the banking system since
independence, the reforms enacted by the government of India, and the recommendations
prescribed for sound financial development by the committees established for the successful
execution of the reforms.

The Banking system in India has been the core of the financial system since the year 1969. When the
colonizers sailed back home, Independent India had plenty of issues to take care of. The
Independent Banking sector was almost crippled and in shambles. Though the foreigners set up the
Reserve Bank of India under their rule yet much was left to be organized. So the Government of

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Independent India made attempts to widen the banking sector's services in several rounds to boost
the financial development of the nation.

In the first round, fourteen of the major scheduled banks were brought under the umbrella of the
Government of India and the Reserve Bank of India. In the year 1980, six more commercial banks
were nationalized and brought under the Government's control. By the year 1990, the government
set a plethora of social goals for the banking sector to achieve. This resulted in the nationalized
public sector bank becoming unprofitable. Hence, culminated the financial repression in the nation.

The financial repression was mainly characterized by a shocking decline in productivity, low
efficiency, and extremely low profitability. The need of the hour then was to develop a sound and
intricate financial banking system. Consequently, Committees were formed, namely Narsimham I
(1991) and Narsimham II (1998), to evaluate the sector and propose reforms for sound
development.

The Narsimham Committee I and II submitted their reports and findings and accordingly prescribed
changes and recommendations and proposed a healthy way of executing reforms in the sector.
Comprehensive economic reforms were initiated, banking sector reforms being a part of them.

The reforms were initiated with the following objectives:

Primary objectives:

 to increase competition utilizing supervision and via the introduction of prudential

regulations
 to remove financial repression

Secondary objectives:

 to improve the efficiency of the process of financial intermediation

 to improve the conduct of monetary policy and
 to create a conducive environment for the integration of the domestic financial sector and
the global system

However, in the words of the author, the main objective of the banking sector reforms was to
promote a diversified, efficient, competitive financial system with the ultimate goal of improving
financial viability and institutional strengthening.

The reforms were then initiated forth for the commercial banks and later extended to other financial
intermediaries. The committees suggested the role of the central bank be separated from being the
monetary authority to the regulator of the banking sector. Additionally, they also gave forth
recommendations, a few of which being:

 The merger of strong public-sector banks

 Allow narrow banks to facilitate their rehabilitation
 Close weaker banks if rehabilitation is not possible
 Set up an asset reconstruction fund for increasing non-performing assets

Due to increasing competition between the public and private banks, the government established
the Board of Financial Supervision and the Indian Financial Network. Negotiated dealing systems for
screen-based trading and Real-time gross settlement system were introduced for sturdy
development.

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Analysis- Impact of Reforms:

Analysis can be drawn from the author's perspective and the impacts of the reforms can be studied
under the following dimensions:

1. Branch expansion
2. Interest Rate Deregulation
3. Directed Credit Policy
4. Regulatory Reforms
a) Market Structure
b) Capital Adequacy Norms
c) Accounting and Provisioning of Non-Performing Assets(NPAs)
d) Supervision and Privatisation of Banks

Branch Expansion, according to the author, made quite some progress during the reform execution
period. However, not much changed. Though the number of branches increased the population per
branch remained the same as before the reform period. The scale of progress was limited to branch
expansion, growth of credit, and deposits. The sector thereby maintained gains in terms of branch
network during the reform period.

Liberalization of Interest rates took place. The pre-1990s structure of the interest rate system was
complex. So liberalization was an attempt to simplify the complex structure, provide flexibility to
banks for asset liability management operations, and encourage competition. Different Interest rates
converged to a single "prime lending rate". Consequently, a shift towards indirect monetary control
was seen.

One of the many recommendations proposed by the Narsimham Committee was to narrow down
the definition of the priority sector to targeted groups so that the needy would reap the benefits of
the reforms. The focus was on small farmers and low-income target groups. Private banks'
performance was unsatisfactory. Twelve out of thirty private banks failed to achieve the targets of
the priority sectors. Ceilings existed to target the groups so commercial banks, however, provided
40% of commercial loans to the priority sectors. On the other hand, foreign banks achieved the
targets. Notably, priority sector lending achieved growth of 18% in the year 2010-11.

The regulatory reforms were enacted to encourage competition, and efficiency and to promote a
safe banking sector. The Narsimham committee guided the framework and thereafter the regulatory
framework was designed to address issues of market structure, capital adequacy norms, accounting
and provision of Non-performing assets, and supervision and privatization of banks.

The Reserve Bank of India issued policy guidelines regarding the entry of private sector banks into
the banking industry. These provided the banks with a complete map, helping them navigate how to
get themselves registered and licensed, and listed under the Bombay stock exchange and/or
National stock exchange. Priority sector lending requirements were set up and guidelines for existing
banks were drafted. New ATMs were set up in rural and semi-urban areas. This led to the
transformation of the market structure.

The Bank of International Settlements was set up by the government which recommended the
adoption of common capital adequacy standards. Several capital ratios were formulated to assess

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the capital structure. Committees such as Basel Committee I were established to look after the
adoption of the ratios. A new classification of capital was done into Tier 1 and Tier 2.

The Reserve Bank of India introduced regulations relating to the accounting and provisioning of non-
performing assets. These regulations brought about changes such as the quantification of non-
performing assets, objectivity of assessment of non-performing assets, and provisioning credit
problems. These increased the degree of freedom and uniformity in the banking sector. It promoted
transparency. The assets were also classified into standard, sub-standard, doubtful, and loss assets
for better assessment of the non-performing assets.

To meet the new capital adequacy norms and to raise capital, the gradual privatization of banks took
place. The government’s shareholding was initially diluted to 51% in the public sector units and later
reduced to just 33%. The regulation was made to ensure that no individual shareholder can hold
more than 1% of shares.

Data and Methodology:

With a mix of mostly qualitative and a bit of quantitative data as provided by the author, the study is
based on the research paper “Banking Sector Reforms in India” from the International Research
Journal of Commerce Arts and Science.
To gain insight into the historical transformation of the banking sector from shackles to where it
stands today, this paper was chosen. The study of this Research Paper is an attempt to understand
the reforms that were introduced in the Banking sector as a part of the NEP of 1991.

Criticisms:

The paper was found to be well-researched and well-structured. Mr. Manoj Kumar did an impressive
job of giving the reader an exhaustive insight into the happenings in the Banking Sector since the
post-independence period. The impact of the reforms discussed was however sector-specific and did
not give a clear picture of the effects of the reforms on other sectors of the economy.

I believe the paper was more focused on listing out the reforms than explaining the after-effects of
their introduction into the economy. The author also states the immediate positive and negative
outcomes of the reforms and affirms that the Indian banking system is far away from reaching the
international level of banking. Even so, the author fails to define and mention the international level
and its structures and elements. Though the different needs of prospects are noted, the methods
and how to do so are not stated.

Regardless, a proper conclusion is drawn and future concerns are reflected upon.

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Conclusion & Future Prospects:

The author states that the result of the reforms enacted in the sector yielded a mixed response. The
reforms turned out to be forward-looking in the role of markets, measures of prudential regulation,
reduction of Non-Performing Assets(NPA), and upgradation of technology. Reforms were, however,
gloomy on the part of the control and reach as public banks were leading the system in all spheres,
making the sector dominated by government control and not at par with the international level of
the banking system.

The following future concerns were discussed in the paper:

 Priority sector lending:

The need for banks to conform to the “priority sector lending” targets is mentioned. It is
noted that as a result of the reforms, at the aggregate level the priority and agriculture
sector targets set by the Reserve Bank of India are well met and good but on an individual
bank level, it is far from true.

 Quality of Banking services:

The need to improve the quality of banking services is highlighted. The author suggests
continuous improvement in the sector. He recommends that banks be more transparent by
informing the public about the various kinds of charges levied and services offered.

 The efficiency of the Banking sector:

The efficiency of the banking sector lacks advancement. The article proposes that banks
reduce their operating expenses. This would help them to maintain profitability in the
competitive environment.

 Quality of Assets:
According to the author, the management of the quality of assets can play a significant role
in the banking sector. So he points to the need to closely monitor the quality of assets. This
would also promote an improved flow of credit to the rural areas, northeast, east and
central regions of India which need them the most.

Greater attention to the above concerns would be beneficial for the banking sector as per the
author. It will help the Indian Banking System to become more broad and robust. It would help the
sector secure a better rate of economic growth rate alongside equity. This can also help promote a
better financial structure for the economy.

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