CHAPTER-III

REVIEW OF BANKING SECTOR REFORMS

3.1 Banking Sector Reforms under the NEP of 1991 - Historical Background

3.2 Need of Banking Sector Reforms

3.3 Objectives of Banking Sector Reforms

3.4 Problems faced by Indian banks

3.5 Banking Sector Reforms Narasimham Committee - I, Recommendations

3.6 Banking Sector Reforms Narasimham Committee - II, Recommendations

3.7 Banking Sector Reforms, Vision 2020

36 CHAPTER - III

REVIEW OF BANKING SECTOR REFORMS

3.1 BANKING SECTOR REFORMS UNDER THE NEP OF 1991 - HISTORICAL BACKGROUND :- Banking Sector is one of the most important sectors of the economy. A 'bank' is a financial institute. Bank brings together two sets of the people. Those who have excess funds today and those who are in need of funds today. In absence of the banking institutions it will be very difficult to have 'double co-incidence of wants', in between the above mentioned two sectors - 'lenders' and 'bonowers'. In such a situation channelisation of savings for the productive purpose would be difficult. In turn, it will severely obstruct the economy. Therefore, in the modem world, baking is a must. Banking is a service industry. Banks deal in funds. On the one hand they collect funds by way of various types of deposits. On the other hand, they lend money to the needy persons or borrowers for the different reasons. Thus, bankers deal in money. But they use funds of others and for the use of others! Bankers thus are intermediaries. For the purpose of the 'intermediation', which is one of the most important functions of banks, they raise capital, own land and buildings, maintain the staff and the machines. Thus, there involves cost for this type of business activity. Therefore, bankers must earn at least reasonable 'profit'. "'Profit' is any excess of revenue over all sorts of costs including those of capital". They must earn revenue and they must incur costs. This is possible mainly because of charging of price for the capital-use. It is called 'interest'. 'Interest' earned on the loans and advances must be more than the 'Interest' paid on the deposits. This is in its real sense a banking-business! Afterall, banking institutions are the 'business-institutions' and not the 'charity-institutions'. They must earn "profit" in this sense!

In other words, banks are the 'commercial banks'. As the name suggests, bankers must earn profit. Banks are 'commercial', in one more sense. Traditionally, in the European countries, bankers used to give loans

37 only for the 'trade and commerce'. They were focused mainly on these activities and not on number of other activities such as provision of Safe Deposit Vaults, dealing in share market, mutual funds, insurance, etc. Thus "commercial" is a generic term here to indicate 'trade & commerce'. After a passage of time, the fiinctions of banks went on increasing. They started giving loans for the purposes other than the trading purposes. For example, housing loans, educational loan, loan for the purchase of consumer durable items, etc. Bankers' Functions changed. Their scope widened. They are no more just a 'commercial bankers', but beyond that. Still their name remained as 'commercial bankers'.

All these 'non-banking' businesses and activities of banks are also to earn more business and more profit! Thus, bankers must earn profit!

In India, because of the dominant presence of the public-sector banks, including nationalised banks, number of responsibilities were given to these banks. Many activities like 'priority sector lending', though important for the nation, were of less use or no use to the bankers from the view point of their profit earning. Many bankers were losing an opportunity to make profits. Many a times they used to earn losses! The Government was (and is) financing the losses. It implies that, banks were very weak to earn profits. This was not possible for the banks to pull on with losses on continuous basis. Some corrective mechanism was needed.

Secondly, there was also a question of'hidden losses' or 'pseudo profits', because of the methods of calculations and accounting. Many 'pending loans' (Non-Perfomiing loans in the modem language) were considered for future earnings & the profits were calculated on the basis of such future earnings, assuming the realization. In absence of the realization, there was a loss of interest earning and the principal amount! 'Profits' shown on the basis of such unrealized and expected (or 'Ex-ante') earnings, were showing the misleading picture of the given bank.

38 It was also necessary to avoid such wrong calculations in the banking- industry. Therefore, once again there was a need of altogether different approach to see to the Banking Sector. Reforms were invited to give true picture of the banks.

Though a continuous need and the continuous process, here it is necessary to concentrate on the Banking Sector Reforms, with reference to the NEP of 1991.

Following the Narasimham Committee Report, it was necessary for the Government of India to go for the financial sector reforms. The Report of the Committee on the Financial System came in November 1991. The Committee after studying and analyzing the progress with respect to the financial system, identified some problems. In case of Banking System, which is a sub-set of the financial system, the Committee found that there was a need to consider the efficiency and profitability of the Banks. Both the issues were of importance. Firstly, the counting or quantification of the efficiency. Secondly, to mould Banking System in such a manner that the calculations of profits and accounting related to it, is not misleading! In other words. If Profit is there, it must be real or genuine profit, after the deducfion of all sorts of costs. One can interpret the recommendations of the Committee in such a manner that, the Committee was of the opinion that, the 'Pseudo Profit' are dangerous than the situation where there is a loss!

The Narasimham Committee has itself explained the need and objectives of Banking (and Financial) Sector Reforms.

3.2 NEED OF BANKING SECTOR REFORMS :-

1. 'The competitive spirit and efficiency of the real economy' was to be increased while launching the Policy of Liberalisafion, with respect to the trade and industry.

39 2. The strength of the financial sector can be improved by improving financial health and efficiency.

3. A greater market orientation is needed for financialinstitution s through new 'products' and 'innovative services'.

4. Physical or geographical expansion is required to be matched by qualitative improvement.

5. Challenges of globalization need a thorough reforms of the financial sector.

6. Money Market and Capital Market development requires Banking Sector Reforms.

3.3 OBJECTIVES OF BANKING REFORMS :-

1. To improve efficiency and effectiveness of the system with particular reference to the economy of operations, accountability and profitability of banking and financial institutions.

2. To improve and modernise the organisational systems, procedures and managerial policies.

3. To infiise greater compefitive vitality into the financialsystem , so as to enable it respond more effecdvely to the emerging credit needs of the economy.

4. To have a balanced-growth of various types of financial institutions in the Money Market and the Capital Market of the country.

5. To introduce and basically evolve an appropriate supervision system with full efficiency.

The Narasimham Committee has considered the Banking System prevalent in the economy at that time (1991). There were following important segments of banks in the economy showing simultaneous presence :-

40 1. Public Sector Banks

- State Bank of India (and Subsidiary Companies)

- Subsidiary Banks of State Bank of India - Nationalised Banks (and Subsidiary Companies) 2. Private Sector Banks - Indian Private Sector Banks - Old - New - Local Area Banks - Foreign Banks These came under 'Commercial Banks' 3. Regional Rural Banks (RRBs) 4. Co-operative Banks Co-operative Banks have spread which can be shown with the help of the Pyramid like structure.

State Co-operative Banks (at the top in the respective States)

41 The pyramid like structure shown above refers mainly to the rural banking sector. Very importantly, there is a segment under Co-operative Banking in the urban sector and that is of Urban Co-operative Banks (UCBs).

Moreover, there are following apex institutions working in the financial- sector of the economy.

1. Industrial Development Bank of India (IDBI)

2. Small Industries Development Bank of India (SIDBI)

3. National Bank for Agricultural And Rural Development (NAB ARD)

4. Export-Import Bank of India (EXIM Bank)

5. Industrial Investment Bank of India (IIBI)

6. National Housing Bank (NHB)

7. Other Development Banks (Institutions)

at the national level, such as Industrial Credit And Investment Corporation of India (now called ICICI)

All these financial insfitutions cover Banking Financial Institutions ('Banks' as mentioned earlier) and Non-Banking Financial Institutions -NBFIs (as mentioned above here). The Narasimham Committee has taken a note of overall structure prevailing in India and also tried to understand the problems faced by the Nationalised Banks. This is because, nationalized banking segment or sector is most important banking sector in the Indian economy.

After studying the problems of nafionalised banks (and other banks also) the Committee came to the conclusion about the Reforms.

After Nationalisation of 14 big banks in 1969 and 6 big banks in 1980 (currently the number is 19, because of the merger of New Bank of India in Punjab National Bank in 1990s), the banking system could expand remarkably- region-wise and economic sector-wise, throughout the country. Deposits and Advances increased tremendously. (Deposits - From Rs.5906 Cr. in the year

42 1970-71 to Rs.31,96,940 Cr. in the year 2008-2009 and Bank credit increased from Rs.4684 Cr. in 1970-71 to Rs.23,61,914 Cr. in the year 2008-2009. Source :- RBI Bulletins of the respective years)

However, these years of progress and expansion witnessed a serious decline in the productivity and efficiency of the banking-system in general and of the public sector banks in particular. Therefore, the Narasimham Committee went into a detailed investigation into the causes of these problems and identified the specific problems and practices, as the causes eating into the productive efficiency and profitability of the Indian Commercial Banks.

3.4 PROBLEMS FACED BY INDIAN BANKS :-

3.4.1 Neglect of Sound Banking principles while lending.

Banking is a business where each and every bank has to take care that its Liquidity and Profitability is properly reconciled. In other words, while making investment (say, in Loans, advances, etc.) limits of risks are to be considered and maintained. Higher profitability is expected if more loans are sanctioned by compromising Liquidity. This is not expected, as higher investments (and less liquidity-maintenance) may lead to higher profitability but in that case heavy risks are there of getting funds locked and of course, of non-recovery of locked funds (Principal amount). Therefore, it is necessary to have proper Portfolio Management of banks. As per the rules regarding liquidity, on their own banks are expected to keep a portion of their total assets in the form of liquid and semi-liquid assets. However, it is observed that, banks sometimes neglect the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) requirements.

But at the same time, the Committee also observed that if the Statutory requirements are kept high, it becomes very difficult for the bankers to go for profitable investments with limited availability of fiinds. In a way it is a kind of

43 'Directed Investment'. 'Directed' by the Reserve Bank of India (RBI), limiting the freedom of banks, unnecessarily !

3.4.2 'Directed Investment' - SLR case

The Central Bank of the country, the Reserve Bank of India prescribes minimum reserve requirements and it is given legislative powers to alter these requirements as and when necessary. The Banking Regulation Act (BR Act) 1949 requires that the commercial banks must keep their liquid assets in the form of cash, gold and the Government securities, under Section 24 of the Act. This requirement is called Statutory Liquidity Ratio (SLR). Initially it was 25% of the total demand and time deposits (liabilities) of the banks. The RBI was empowered to change this minimum SLR as and when necessary. By the year 1991, the SLR was increased gradually to 38.5%.

The RBI normally uses changes in the SLR as a tool for different purposes.

(i) To control inflation,

(ii) A higher SLR channelises bank funds into long-term investments in the Government securities, due to which, firstly, the inflation control is possible and secondly, the Government gets funds for the purpose of its developmental activities.

The point considered by the Narasimham Committee was of profitability of banks. Due to higher SLR banks funds get locked in the Governmental securities earning relatively low returns to banks (as normally, the rates of interest on the Government-securities are low), upto that extent the banks loose an opportunity to invest in more profitable lines of returns. The Committee, therefore, branded the higher SLR as "a tax on banking and also on saving"!

44 The Committee was very upset due to the Government's (the Ministry of Finance) attitude to collect funds at relatively very lower rate of interest, than the market rate of interest, through SLR, and utilizing such low-cost funds for non-developmental purposes like payment of salaries to the Government-employees and for other administrative spendings.

3.4.3 Direct Investment - CRR cause

It was obligatory for the banks (even prior to BR Act 1949) to keep Cash Reserve Ratio (CRR) as 5% of the demand liabilities and 2% of the time liabilities of the banks in the form of cash with the RBI, under the RBI Act of 1934. As per the amendment in the RBI Act in 1962, the RBI was empowered to vary the CRR in between 3 to 15% of the total demand and time liabilities.

As per 1991 reality, therefore, the SLR and CRR taken together was 53.5% ! Because of this, the freedom of banking business was really getting hampered. According to the Committee, whatever investments were possible for the banks, the majority of that was in the form of 'Directed Investment', forced on the banks, Obviously, this was not suitable in the new era of Liberalisation.

3.4.4 Directed Credit

Because of the peculiar nature of the Indian economy, where inequalities of income and dualism related to that prevails, the system of'Priority Sector Lending' was designed. For example, farmers, small-scale industrialists (especially tiny industries and cottage industries) small transport operators, artisans, education, socially weaker sections of the society came under this. From the view point of the society as a whole the 'priority sector lending' was introduced. But the list of 'priority-sectors' went an increasing. The priority sector lending was 'purpose oriented' and not the 'security oriented'. For the bankers, therefore, risks were very high, and they had to assess their anticipated income of a loan proposal. The resuh was adverse.

45 (i) The quantitative credit expansion was achieved at the cost of quahty, resulting into mounting overdues and bad debts;

(ii) 'The anticipated income principle' was proved to be counterproductive in the sense that, most of the credit went to undeserving proposals, resulting into less returns with high anticipations!

Many such problems were posed by the Priority Sector Lending.

(a) Indiscriminate lending

The banks were willing to comply with the percentages prescribed for the Priority Sector Lending. The needy borrowers were either illiterate or they did not have the knowledge of the facility and therefore were used to approach under the care and guidance of local leaders. This led to the politicization of the whole issue.

(b) Higli Costs and Low Profits

The Priority Sector Lending borrowal accounts were very small and therefore to achieve the targets it was necessary to increase the total number of accounts. In such a situation, monitoring the utilization of the funds became difficult, time consuming. The situation led to higher costs of service and lower rates of returns / profitability!

(c) Tied Banks

In absence of the freedom of utilizing and deploying the funds to make profit, the situation resulted into the creation of different pressures on the bankers.

RBI prescribed high CRR & SLR percentages leaving hardly 40-45% of the total funds available for discretionary deployment and above all, these loans carried concessional interest rates with very poor assurance of recovery!

46 (d) Geographical Imbalance and lopsided lending

In the States like Bihar, Madhya Pradesh and Uttar Pradesh the demand for the loans was limited and therefore the banks, to achieve the target of 40% of the total lendings as priority sector lending started concentrating on those states or regions where easy-demand was there. Such states were relatively developed. But due to this act, for the branches in the developed regions burden of priority-sector lending increased bringing down the availability of those funds which could be otherwise utilized for making better profits.

In order to address the points mentioned above the Narasimham Committee on Financial System (1991) was of the opinion to suggest Reforms in the Banking System in India, and recommended number ofthings.

Some additional problems identified were as follows.

3.4.5 Misdirected Efforts

Poverty eradication programme needs number ofthings to be done to have proper utility and returns of the credit facilities, in absence of such factors like awareness creation among the people, skills development, encouragement to the work culture, giving credit facilities is of no use. Secondly, in such a situation banks enter into a serious situation of non-return of the principal amount and no income of interest!

Thus, poverty eradication only through the bank-credit to the poor people, say through the 'Priority Sector Lending schemes; or any other Scheme for that matter is an effort in the vain.

3.4.6 Unethical Divergence of Funds

Hard-earned savings of the small and medium people are normally kept in the Banks. Utility and productive channelisation of such savings is a matter of utmost care to be taken by the banks. If it is not taking place due to

47 the several reasons as indicated earlier, it is nothing but the unethical siphoning- off the savings. It was happening in Indian Banking System , as per the Committee's observations.

3.4.7 Faulty implementation

Appropriate implementation of different schemes for the poor people, farmers class, etc. needs (1) Clear-cut definitions of the concepts like 'poverty-line' (2) Proper scrutiny from the view point of banking principles, that too, by the financial experts. In absence of the fulfillment of all such requirements, which was the situation prevailing in India, as the Committee observed; implementation was very faulty.

3.4.8 Misappropriation of funds

It is observed by the Committee that the "unholy alliance" between the borrowers, the middlemen, corrupt and inefficient bank staff or the staff of the concerned Government Department, resulted into misappropriation of funds, meaning that, the deserving end-users, say poor families did not get the benefit of such schemes. At the same time the truth remained that the deserving poor, if at all could get the credit assistance, they were not in a position to make timely repayment. Thus, in both the cases, banks were at loss, of course unwillingly.

3.4.9 Wealteningofthe Banking Fibre

As the Committee puts it, there are multifold bad effects.

1. Thousands of crores of rupees were wasted,

2. Indian financial system became shaky due to the losses or non-return of the funds.

3. The financial discipline and accountability of the banks to the people went down.

4. The principle of sound-banking was threatened.

48 The Narasimham Committee therefore expressed its discomfort over the issue of'social banking', which was practiced.

In such an atmosphere the very survival of the banking institutions could be questioned and it was on the stakes. There was no alternative but to suggest Reforms and insist for the implementation.

3.5 BANKING SECTOR REFORMS NARASIMHAM COMMITTEE -1, RECOMMENDATIONS :-

First Generation Reforms

The Government of India appointed a High Level Committee, in 1991 to study and give recommendations on the Financial System, under the Chairmanship of Shri M.Narasimham, former Governor of the RBI. The Committee was expected to consider all the aspects relating to the structure of Indian Banking, organisational issues, functions, procedures, etc. The other members of the Committee included - The Deputy Governor of the RBI (Banking Operations Department), The Chairperson of the SBI Shri. Manu Shroff, the Chairperson of the IDBI, Shri Y.H. Melegan, the Chairperson of the ICICI Shri M.D. Chaudhari and also the Additional Secretary (Banking).

Alongwith the problems faced by the Banking Sector in India, which are mentioned earlier, the Committee also observed following things for the consideration,

(i) ' Directed Investments' in SLR & CRR have restricted the operational flexibility of banks and have brought down their incomes. Therefore, the Committee recommended-

A progressive reduction in SLR and CRR

(ii) 'Directed Credit Programmes' - served the nation with respect to draw the attention of banks to the 'neglected sectors'. But the

49 Committee has put a note on the observation that in order to empower the neglected sectors, say 'Priority Sector', it is better to use 'fiscal measures' (related to the Govt, taxation and expenditure), rather than the 'monetary measures' (like credit measures)

The Committee recommended that the broader guidelines can be issued by the Credit-controlling authority (the Central Bank, that is the RBI) but the Authority should avoid close-micro level monitoring. As the result, the Recommendation is that to have gradual phasing-out of 'directed credit programmes'. In other words, it was recommended by the Committee the gradual withdrawal of the Directed Credit programmes.

The Committee suggested - redefinition of the 'Priority Sector', to include only the small and marginal farmers, tiny-industrial sector (as per the Govt, definition, with effect fi-omOc t 2,2006, Tiny Enterprises are those with investment in plant and machinery of less than Rs. 25 lakhs - Source - 'Economic Survey (2007-08)' and 'Annual Report of 2010-11 of the Ministry of Micro, Small & Medium Enterprises'), small business operators, small transport operators, village and cottage industries (Village industries are those SSIs which are in villages and Cottage industries are those SSIs having capital investment less than Rs.3 crores and operating in a 'cottage' or a 'house', with some special characteristics. Source - 'Economic Survey' (2007-08) and Micro, Small & Medium Enterprises') rural artisans and weaker sections of the society. The credit target for this sector was fixed at 10% of aggregate bank credit and after 3 years a review should be taken to find out whether policy should be continued. The concessional interest rates should also be reviewed.

Very important Recommendation of the Committee was for the agricultural credit and small-scale-industries (SSI) credit, that the

50 "supervision and techno-economic appraisal of proposals without any political, administrative or other interference should be made".

(iii) Interest rates structure

The Committee noted the fact that in the era of Globalisation and Privatisation slowly the 'administered interest rates' regime should be abolished. "Banks should be free to take the decisions with respect to the interest rates and interest rate structures". This is because of the fact, that the 'interest rates' is a price of scarcely available 'loanable funds' and has number of alternative uses. As the result, the banks should be in a position to take the 'business-decisions' considering the allocation of the loanable funds, depending upon the market conditions. This was a step towards 'market-determined interest rates'.

(iv) Avoidance of tax concessions by the Govt.

According to the Committee "the Government should avoid giving tax concessions to various saving instruments (for instance. National Saving Certificates) on ad hoc basis. The RBI should make simplification of the interest rate structure and issue guidelines, so that, "the direction and level of interest rates gets monitored automatically, on the basis of the Bank Rate. The Bank Rate should act as an 'anchor-rate'.

(v) Capital Adequacy Ratio

The observation of the Committee was that generally the Indian banks were undercapitalised. The lower Capital Ratios were showing the inadequacies of the capital. Sound banking is dependent on the sufficiency of the capital and accordingly at the international level there are norms for Capital Adequacy, framed by the Bank of International Settlements (BIS). The Committee therefore, recommended the Capital Adequacy Ratios to be maintained as per the international norms, of course, slowly and step by step.

51 (vi) Changes in the Indian Banking Structure

The Committee observed that in India the baking structure is such that there are number of banks under different types of ownership patterns. But almost all the banks, including those in the public sector are relatively very small in size, if compared with the International Banks or Multinational Banks.

In the new era of Globalisation and therefore heavy competition, it is necessary that Indian banks must grow size-wise also. For that matter, structural changes were required and suggested by the Committee. Obviously, the small banks from the co-operative banking field had number of limitations. Private Sector banks had to take their decisions at their level. Hence, indirectly the recommendations were applicable to the public sector banks.

The recommendations were -

(i) Let us have only 3 to 4 large scale banks. Thus, the mergers of different nationalised banks and State Bank of India (SBI) and State Bank of India Group Banks were recommended. In other words 19+1+7 banks were to be merged in the group of 6-7 banks each, such that there would be only 3-4 large scale banks in India. The structure could be such that, there are big banks in East, West, South, North regions of India. These banks were to be made of international repute or the Indian Multinational Banks.

(ii) There would be 8 to 10 National Level banks with a nation­ wide branch-network engaged in general banking.

(iii) Local banks would be of the operations confined to the specific region only.

(iv) There would be Rural Banks, including the Regional Rural Banks (RRBs) - These banks would be confined to the rural

52 areas only and their business would be predominantly financing of agriculture and allied activities.

(v) Setting-up of New Local Banks - These banks would be different than the earUer established banks and will try to bridge the credit-gap. Very important recommendation in case of these banks is to discontinue 'branch-banking' structure and to have number of independent small Local Banks in different regions. These banks were to be set up as 'rural subsidiaries' of 'national banks'. These could have compact area of operation and would be similar to the RRBs. It was recommended that these banks would get support from National Bank for Agricultural And Rural Development (N ABARD).

Thus, all the above mentioned points are related to theNarasimham Committee-I First Generation Refomis and the historical background related to such Reforms.

The main focus was that the banking system should be vibrant and competitive in nature. It must have operational flexibility alongwith the functional autonomy. Banks should earn profits, their efficiency must be of high degree, their performance should be 'productive' one. A series of measures was recommended by the Committee aimed at greater flexibility to bank operations, improved asset quality, greater disclosures, structure of prudential norms, better housekeeping interms of accounting practices.

Ex-Govemor of the RBI Dr.Bimal Jalan, therefore, has stated that,"the Central Bank has a set of prudential norms that are aimed at importing strength to the financial institutions, and inducing greater accountability and market- discipline. The "norms" include not only Capital Adequacy, Assets Classification and Provisioning, but also accounting standards, exposure and disclosure norms and guidelines for investment, risk-management and asset-liability management".

53 Thus, these recommendations are a landmark in the evolution of banking system. But it cares for the purpose of banks and simultaneously tries to change the system from highly regulated to more market-oriented.

The RBI has grouped the first phase of Reforms into 3 main areas :-

(i) Enabling measures

(ii) Strengthening measures

(iii) histitutional measures

There is one more way to classify the Measures.

3.5.1 Liberalisation Measures

It encompasses the SLR and CRR measures. The recommendations with respect to essential changes in SLR and CRR structure are already explained in this chapter earlier. The explanation shows that the Banks get liberalised due to the implementation of SLR-CRR Measures.

3.5.2 Prudential Norms

As the name suggests, these are the norms to enhance 'Prudence' in banking. Introduced by the RBI in April 1992, it was expected to have phased implementation, for the purpose of ensuring safety of banks. Prudential Nomas impart more transparency in the business. Overall financial stability is also expected to go up because of the implementation of Prudential Norms.

Prudential Norms cover Capital Adequacy Norms (under BASEL Committee Norms), suggesting minimum 4% capital adequacy ratio (CAR) in relation to Risk-weighted Assets. The Tier I capital should not be less than 2%. The BLS standard should be achieved over a period of 3 years (from March 1993 onwards) and that is 8%. Moreover, the Norm suggests that assets of banks should be evaluated on the basis of their 'realizable value'.

The Income Recognition norm suggests that the interest income on advances must come to the bank regularly. Traditionally the time period

54 considered by banks was of 2 quarters. The Committee recommended International norm of 90 days (1 quarter). This was to be achieved in phased manner by 2002.

For this purpose the Assets Classification is to be done by banks now on the basis of the 'performance' of the specific asset/s.

1. Standard Asset

2. Sub-Standard Asset

3. Doubtful Asset

4. Loss Asset

Adequate Provisioning is also recommended for the Doubtful and Loss (or bad) Assets. Detailed instructions for the provisioning are laid down. The advice to the banks is given to make and keep their balance-sheet clean, transparent.

Thus, for the above mentioned Non-Performing Assets (NPAs) or Non-performing Loans the Committee has recommended the Provisioning norms.

L Outstanding Sub-Standard Assets - 10%

ii. On Loss Assets - 100% provision

iii. On secured portion of Doubtful Assets - 20 to 50% provision

3.5.3 Competition Directed Measures

For years together no new bank was opened in India. To suit the policy of Liberalisation and Privatisation and of course, to allow and increase the competition in the banking field (Presumption is 'more genuine competition leads to better product / service') it was necessary to start issuing new licences to the banks. These banks were to be opened by the private sector establishments and in the form of 'public limited (listed) banking companies'. Many private sector financial companies / groups were ready to enter into banking business.

55 As the result, the RBI announced the new guidelines to open new private sector banks. (January 1,1993).

These guidelines in the form of criteria were :-

(i) Minimum capital to be invested in the beginning must be Rs. lOOcrores.

(ii) Banks must use the Modem-computerised technologies

(iii) Head-Office to be established at Non-Metropolitan city centre.

A change in the initial capital-requirement for the new private sector banks was made in January 2001.

The paid-up capital requirement was raised to Rs.200 crores and this capital base was to be increased by every such newly established private sector bank to Rs. 300 crores within a period of time of 3 years after the commencement of business of the bank.

(iv) The "promoters share" in a bank must not be less than 40% of the total capital requirement.

After the issue of new guidelines or criteria. 9 new private sectors banks were established.

(v) Permission to the Foreign Banks

Few foreign-banks were already operating in India. As per the new guidelines the Foreign Banks have also been pennitted to set-up their subsidiaries; Joint-ventures or branches are also allowed.

The immediate impact is seen. The number of foreign banks working in India increased from 24 in 1991 to 42 in the year 2000. The branch-expansion of foreign banks also took place during the same time period is from 140 branches to 185 branches.

56 (vi) Rationalization of branches-permitted.

Over a period of time, since 1969, that is after Nationahsation phase-I, number of public sector banks and other banks were facing the problem related to specific already opened branches. Such branches were to be rationalized as these were making continuous losses or were earning less profit and had poor business. Now, as per the recommendations the flexibility is introduced in the system. Banks are now allowed to open Specialized branches, to convert existing non-urban rural branches into satellite-office, close down some branches (other than those in the rural area)

(vii) Licensing-liberalised

Without the prior approval from the RBI banks can their new branches. This is a kind of abolishment of licerising This was allowed to the banks if the bank attains Capital Adequacy nonns and Prudential Accounting standards.

3.5.4 Supportive Measures

From the accounting year 1991-92 the changes are made in the institutional framework. The RBI evolved the Risk-Based Supervision Methodology with the international standards or best practices.

The Board of Financial Supervision was established in the year 1994, with the operational support of the RBI Department of Banking Supervision.

A Three-tier supervisory model was introduced to cover

1. Outside inspection

2. Off-site monitoring

3. Periodical external auditing

- all based on CAMELS; meaning -

57 Capital Adequacy

Assets Quality

Management Earnings

Liquidity and System Controls

Setting-up of Special Recovery Tribunals.

These are additional precautionary measures.

SARFAAESI Act 2002 was passed. It implies the 'Securitization And Reconstruction of Financial Assets And Enforcement of Security Interests". The name suggests the meaning ! The Act makes it possible to the Banks to dispose-off the securities of defaulting-borrowers and to recover the debt from such disposals.

On the basis of all these observations and the Narasimham Committee-I recommendations, we can have following summary.

Recommendations of the Narasimham Committee-I (Phase-1,1991 ):-

"(a) Recommendations of the Committee Pertaining to CRR and SLR:

(i) Cash Reserve Ratio (CRR) which is maintained as a Percentage of net demand and time liabilities by the banks with the RBI should be brought down.

(ii) There should be less emphasis on variations in CRR as a measure of controlling the secondary expansion of credit.

(iii) The Statutory Liquidity Ratio (SLR) should be reversed back to 25% over a period of next five years.

(iv) Statutory Liquidity Ratio should not be used as a means of financing the public sector.

58 (b) Recommendations of the Committee Pertaining to Interest Rate Structure:

(i) Concessional rates of interest for priority sector loans of small size should be phased out.

Interest rates should be deregulated with efforts to reduce fiscal deficit.

(ii) There should be deregulation of interest rates, i.e., the interest rates should be determined by the forces of demand and supply

(iii) As the SLR is progressively reduced, - the Government may bring a gradual increase in the borrowing rates to bring them in line with market determined rates.

(vi) The interest rate should be related with the bank rate.

(c) Recommendations of the Committee Pertaining to Directed Credit Programme:

(i) Directed Credit Programmes should be phased out.

(ii) The meaning of priority sector should be redefined and it should include the small and marginal farmers, tiny industry, small business and transport operators, village and cottage industry, rural artisans and other weaker sections of the society.

(iii) The credit target for the priority sector should be fixed at 10% (instead of 40%) of aggregate credit.

(d) Recommendations of the Committee Pertaining to Income Recognition and Asset Classification and Provisioning.

(i) Banks and financial institutions should adopt uniform accounting practices especially with respect to Income Recognition and provisioning against doubtful debts.

59 (ii) Interest on NPAs should not be recognized in the accounts as income.

(iii) An asset would be classified as non-performing if interest on that asset remains due for a period exceeding 180 days at the balance sheet date.

(iv) The assets should be classified into four categories for the purpose of provisioning against bad and doubtftil debts.

Standard, Substandard, Doubtful and Loss.

Basis of Provisioning:

Standard Assets : No Provision is required.

Sub-Standard Assets:

10% on adjusted outstanding after excluding INC account/interest suspense account and unrealised interest of the previous year.

Doubtful Assets :

The portion of outstanding covered by DICGC/ECGC amount receivable need not be provided for. The provisions can be calculated on the totals of adjusted security-wise classification of outstanding at the prescribed percentages for different categories of NPA. The provisioning percentages on adjusted outstanding are as under:

Secured Portion:

(a) Doubtfiil for one year/NPA upto and including 3 years - 20%.

(b) Doubtful for more than one year to three years/NPA. 3 to 5 years - 30%.

(c) Doubtful for more than three years/NPA for more than 5 years - 50%.

(d) Unsecured portion -100%,

60 Loss Assets : 100% of adjusted outstanding. This is worked out by Head Offices.

(e) Recommendations of the Committee Pertaining to Capital Adequacy Norms:

(i) All the banks in India should adopt the capital adequacy norms suggested by the 'Basel Committee' on Banking Regulations and Supervisory Practices.

(ii) All banks should achieve capital adequacy of 8% of the risk weighted assets in a phased manner.

(f) Recommendations of tlie Committee Pertaining to Management of Non-Performing Assets (NPAs):

(i) NPA figures should include advances covered by Government guarantee and which have turned sticky and these should be shown separately in the balance sheets of banks to facilitate fuller disclosure.

(ii) Regular monitoring of the performance of each loan asset.

(iii) Easy identification of problem assets for the speedy remedial action.

(iv) Effective follow-up for recovery of NPAs.

(g) Recommendations of tlie Committee Pertaining to Debt Recovery Tribunals :

(i) Special debt recovery tribunals should be set in order to realize the dues to the credit institutions without delay.

(ii) There should be speedy recovery of all the outstanding dues.

61 3.6 BANKING SECTOR REFORMS NARASIMHAM COMMITTEE - II, RECOMMENDATIONS :-

(Second Generation Reforms)

(a) Recommendations of the Committee Pertaining to Consolidation of Banking System: The committee recommended that in order to achieve greater efficiency in banking operation, there should be substantial reduction in the number of public sector banks through mergers and acquisitions.

(i) There should be 3 to 4 large banks which should be international in character

(ii) 8 to 10 national banks with countrywide network of branches.

(iii) Local banks whose operations are confirmed to specific regions.

(iv) Rural banks including the RRB', who will operate in the rural areas concentrating mainly on the agricultural sector. That the present system of branch licensing should be discontinued and banks should have the freedom to open branches purely on profitability considerations. The Narasimhan Committee did not favour 'further nationalization' of banks. Foreign banks should be allowed to open branches in India.

(b) Recommendations of the Committee Pertaining to Directed Credit Programme:

(i) The share of priority sector in the total bank credit has to be reduced from the existing level of 40% to 10%.

(ii) There is a need for redefining the concept of priority sector advances.

62 (iii) The interest subsidiary element in credit for priority sector should be totally eliminated and interest rate on loans under Rs. 2 lakhs should be deregularised for scheduled commercial banks.

(c) Recommendations of the Committee Pertaining to Redefining of the NPAs:

(i) NPA figures should include the advances covered by Government Guarantee and which have turned sticky.

(ii) NPA level has to be reduced to the level 3% by 2002.

(iii) Banks with high NPA level have two alternatives, viz; either to create asset reconstruction company and all loans in doubtful and loss categories should be identified and their releasable value should be determined and these assets should be transferred to such Asset Reconstruction Company or to issue bonds, backed by Government Guarantee, to make them eligible for SLR investment by banks and the approved instrument by LIC, GIC and Provident Funds.

(d) Recommendations of the Committee Pertaining to Revision in the Capital Adequacy.

(i) For detennining and assessing the capital adequacy ratio, the market risks should be taken into considerafion.

(ii) The risk weight to advances under the govemment guarantees should also be the same as that for other advances.

(iii) Capital adequacy ratio has to be increased from the existing level of 8% to 10% in a phased manner, viz; 9% by 2000 and 10% by 2002."

Source of the summary : Summary is taken from the book by Dr.Mukund Mahajan, Indian Banking System, Nirali Prakashan, June 2009. pages 8.1 to 8.13, in between.

63 These Recommendations are given by the Narasimham Committee 1998, a second high level Committee on Banking Sector Reforms under the Chairmanship of Mr.M.Narasimham to review the progress of banking sector reforms.

The important objective was to chalk out a programme of financial sector reforms required to strengthen the Indian Financial System in general and to suggest those things to empower the Indian Financial System competitive at the International level. The Committee gave the Report in April 1998 with the number of Recommendations with respect to capital adequacy norms, quality of assets, prudential norms, portfolio (asset-liability) management of banks, profitability of banks, mergers, reducing the Government shareholdings to 33% level in the public-sector banks, creation of global banks, etc.

The logic and propriety of these Banking Sector Refonns can be traced as follows :-

A. Measures to Strengthen the Banking System

(i) Capital Adequacy Ratios.

The Committee suggested Higher Norms of Capital Adequacy. "Minimum Capital to Risk Assets Ratio (CRAR) be increased to 10% from its earlier level of 8%. This was to be done in the phased manner. By the end of year 2000,9% target was to be achieved. And by the end of 2002 the target was to achieve 10% CRAR. The Committee suggested that the RBI should have the power to change this requirement upwards in respect of individual bank cases.

(ii) Asset Quality, NPAs

The Committee recommended that Assets to be classified as 'doubtfiil' if these are in the 'substandard category' continuously for 18 months in the first instance and eventually 12 months, and the loss of it therefore is to be identified, but need not be written-off

64 Advances guaranteed by the Government should also be treated as NPAs, as the Committee recommends. Banks are strictly warned against "Ever greening" mechanism suggesting that banks need not sanction fresh advances to the defaulting parties with a view to settle interest dues and trying to avoid such loans showing under NPAs!

The Committee suggested that the average level of NPAs should be brought down for all the banks to below 5% level, by the year 2000 and to 3% level by 2012. For those banks, showing international presence the Committee recommended to bring down to Gross NPAs to 5% by the end of the year 2000, and to 3% by the end of the year 2012. The Net NPA should be brought down to 3% by the end of the year 2000 and to 0% only, by the end of the year 2012.

To consider the matters of the banks with high NPA portfolio, the Committee suggested the establishment of an Asset Reconstruction Company. This Company should take-over all the bad-debts.

(iii) Prudential Norma and Disclosure Requirements

The Recommendation is given that the '90 days norni' should be made applicable to the Indian banks in phased manner by the end of 2002. This is internationally accepted norni and practice and therefore should be adopted.

'Income Recognition, Assets Classification and Provisioning' must apply even to the government guaranteed advances, in the near fiiture', as it is suggested. Asset-Liability Management should be given more attention by the Indian banks.

B. Systems and Methods in Banks

The Committee noted the importance of proper standard banking systems in the banks. In an era of globalization the systems of all the banks must go to the standardization. As the result number of suggestions are given

65 with reference to internal inspection and audit, concurrent audit-report submission, appropriate returns to be submitted by the banks, risk- management system, etc. All these things depend upon the expertise available. And therefore Committee recommended the inclusion of an additional whole time Director on the Board of the banks. Recruitment of skilled man-power, revision of remunerations to the management-personnel are also the recommendations.

C. Structural Set-Ups

(i) Mergers

The Committee suggested that there should be only two fornis of financial institutions - Banking Financial Institutions and Non-Banking Financial Institutions (NBFIs). Mergers of different institutions of this type should be based on the location and some other related advantages. Mergers need not be there to dodge the responsibilities of the weak banks. Mergers between strong banks are welcomed by the Committee.

(ii) What to do with the Weak Banks?

A case-by-case examination of the Weak Banks to be undertaken for the purpose 'restructuring'. Potential viability to be judged and accordingly a step for the purpose of financial and operational restructuring to be taken. Such banks for the purpose of their survival should go for the efforts for the recovery, control on expenses, that is, cutting down the operational costs and encouraging the sound branches further.

A Weak Bank should be defined as the "one whose accumulated losses and Net NPAs exceed its net-worth" or "one whose operating profits less its income on recapitalization bonds is negative for 3 consecutive years".

66 (iii) Narrow Banks Narrow Banks are defined as, "those banks, which have becpme weak because of high proportion of NPAs (20% of the total assets in some cases)". Such banks are to be considered as "Narrow Banks". Narrow Banking implies that the weak banks should place their funds in the short-term risk-free assets only.

(iv) New Banks

The Committee recommended the policy to give permission to the New Private Sector Banks, with different norms applicable at the time of establishment. (It is akeady explained earlier in this work).

The Foreign Banks are also allowed to enter in India by having their subsidiaries established or the joint-ventures in India. These banks for number of policy and practical purposes should be treated at par with the New Private Sector Banks.

(v) Need for stronger Banks

The Committee stressed the need for the Stronger Banks in India.

The main reason was of the introduction of the 'full capital account convertibility of Rupee.' (It is not introduced yet in the country). If such a convertibility is introduced it requires expertise in Forex Market alongwith the Technology, fiinds availability and the stability of the bank.

As the result, the Committee felt that India needs Stronger Banks. The only way which was found suitable to the Committee at that time was to have mergers of stronger and weaker banks. At the same time the winding-up of weaker banks was suggested.

(vi) Banking Structure

The Committee has advocated the creation of 3 to 4 banks of international standard and 8 to 10 banks at the national level. The setting-up of small local banks should come alongwith that to cater to

67 the needs of local traders, small industrialists, farmers, etc. All these banks, local, national and international will be inter-connected in the sense that these will have trade and business relations with each other. The whole structure, thus, will be oriented towards better service, catering to the requirements of the economy and also the cohesiveness and complementarily.

(vii) Local Area Banks

Channelisation of savings on the basis of basic tapping of savings is required in India. For this purpose, the Government of India had taken the decision to establish Local Area Banks (LABs). The jurisdiction of each LAB was of 3 districts each. The RBI issued the guidelines for the establishment of LABs in 1996 and 7 such LABs in the private sector were approved. Actual licenses were issued to 5 LABs in Andhra Pradesh, Kamataka, Rajasthan, Gujarat and Punjab. This was quite a good initiative on the part of the RBI, in the light of the Recommendations of the Narasimham Committee, to promote private sector and secondly, to issue new licenses for banking to meet the requirements of the society at large.

(viii) Autonomy and the Public Ownership

The public ownership of the Nationalised banks had less autonomy, due to the dominance of the Government. The Governmental interference was to be eliminated and the administrative and functional autonomy was to be imparted to the pubUc sector banks, in the changing scenario of banking and economy.

Accordingly, the Committee recommended a review of functions of the Boards of Directors of the public-sector banks. The objective of the review was to make the Boards more responsible to the share holders of these banks.

68 Thus, slowly but surely the paradigm shift in case of efficiency and service-provision was expected in case of public-sector banks.

(ix) Review of Banking Laws

Number of Acts related to the Banking and Finance Sector were to be reviewed, and required amendments were to be made, so that the banking sector gets moulded as per the pressing demand of an hour. The Narasimham Committee for that matter suggested the need to review provisions of the Banking Regulation Act, Nationalisation Act, the RBI Act and the SBI Act. This recommendation was of high importance to overcome the hindrances in the path of the 'changes' in the banking sector or the Banking Sector Reforms

V y *, 3.7 BANKING SECTOR REFORMS, VISION 2020 X£^

Banking Sector Reforms recommended by the Narasimham Committee-I (1991) and the Narasimham Committee-Il (1998) have given a new direction to the Indian Banking System. Of course, it is not a one-time affair or an instance. It is a process. As the result, we will have to see the Banking Sector Refonns, their implementation and the impact over a period of time. While doing so, on the other hand the economy as such keeps on changing . It is not a static one. There is dynamism. Therefore, it becomes inevitable to revisit the Banking Sector Reforms and their impact. If required, it will be necessary to have number of amendments, adjustments, etc. The time-span to know the impact of the earlier Reforms and Recommendations was small, considering the velocity of changes in the economy. Of course, it must be noted here that the work done and the depth of the understanding of the problems and the scope considered by the Committee is excellent and far-reaching.

69 In the meanwhile, we find that in the light of the Committee reports, we will have to foresee what will happen in the coming years, say by 2020.

Honourable Ex-President of India Dr.APJ Abdul Kalam has given us a vision, 'Vision of India for 2020'. Accordingly, number of walks of life have tried to foresee their future. The Planning Commission of India, Government of India has also produced a document "India Vision 2020". This Document has taken into consideration, the economic profile of India as 'Vision 2020' and tried to visualize the future of Banking Industry. We can have a glimpses ofthat.

"(1) Liberalisation and deregulation process started in 1991 -1992 has made a sea change in the banking system. From regulated environment, Banking sector gradually moved into a market driven competitive system. Our move towards global benchmark has been, by and large, calibrated and regulator - driven. The pace of changes gained momentum in the last few years. Globalisation would gain greater speed in the coming years particularly on account of expected opening of financial services under WTO. This will further gather momentum bringing Non-financial institution also into integrated financial system.

(2) The conventional definition of banking might undergo changes. The advent of new technologies could see the emergence of new financial players doing fmancial interaiediation.

(3) Keeping in view the GDP growth forecast, Indian exports is expected to grow at sustainable rate of 15% per annum. This will offer enormous scope to banks in India to increase their forex business and international presence .Banks in India wanting to increase their intemational presence could naturally be expected to follow these corporates and other trade flows in and out.

(4) While some customers might value relationship banking, others might prefer convenience banking.

70 (5) Large scale efforts are needed to upgrade skills in credit risk measuring, controlling and monitoring as also revamp operating procedures. Credit evaluation may have to shift from cash flow based analysis to borrower account behaviour, so that the state of readiness of Indian banks for Basel II regime improves. The emphasis in the future would be towards more fee based services rather that lending operations.

(6) There will be change in the ownership pattern. Presence of international players in the fmancial system would be felt. Some Indian Bank will become global. As a first step Govt, has started reducing its holding in PSBs. Shortly holding is likely to be reduced to 33%. Mergers and acquisitions would gather momentum as managements will strive to meet the expectations of stake holders(FDls)

(7) Corporate governance in banks and financialinstitution s would assume greater importance in the coming years and this will be reflected in the composition of Boards of the banks.

(8) Concept of social banking will undergo a change. Changes could be expected in the delivery channels used for lending to small borrowers and agriculturist and unorganised sector. Use of intermediaries or franchise agents could emerge as means to reduce transaction cost.

(9) Most of the changes in the landscape of fmancial sector would be technology driven

3.7.1 Changes in the structure of the banks

(1) The financial sector reforms ushered in the year 1991 have been well calibrated and timed to ensure a smooth transition of the system from highly regulated regime to a market economy. The fmancial reforms, in mid 90s, have made the balance sheets of the banks look healthier and helped them to move towards achieving global benchmarks in terms of prudential norms and best practices.

71 (2) Under Basel Capital Accord more stress will be given to risk based approach relying on external rating as well as internal rating of each asset and capital charge accordingly. Internal risk based approach would need substantial investment in technology and development of MIS tools. Another aspect which is included in Basel II accord is provision for capital allocation for operational risk. This is new parameter and even internationally evaluation tools are not yet developed. This would be another area where banking system will have to reckon additional capital needs and functioning of its processes.

(3) Financial reforms have brought in much needed competition in the market place. The competition to the existing banks came mainly from the techno-savvy private sector banks. In the coming years, we expect to see greater flow of foreign capital to come into Indian banking sector. Opening of banking sector to global players would see banks facing global competition. Technology is expected to be the main facilitator of change in the financial sector Implementation of technology solutions involves huge capacity outlay. Besides the heavy investment cost, technology applications also have a high degree of obsolescence. Bank will need to look for ways to optimize resources for technology applications. In this regard, global partnerships on technology skill sharing may help.

(4) Next inevitable stage is of consolidation. Mergers and acquisitions between PSBs or between public sector bank and private sector bank would gain momentum as pressure on capital structure mounts

(5) Consolidation could take place through strategic aUiances/partnerships. That will help banks to achieve economy in scale or operations and augment capital base. The advantage could be in achieving segmentation in the market. Transaction cost would be reduced through outsourcing, leverage synergies in operations. This will avoid problems related to cultural integration.

(6) Opening up of the financial sector from 2005 under WTO, would see a number of global players taking large stakes and control over banking entities

72 in the country. Govt, policy to reduce its holding and allowing greater FDI in banking sector and also the remove the existing 10% cap on voting rights of share holders are pointers to these developments.

(7) The process of improvement in capital base, without support from the Government will also come on the financialinstitution s in co-operative sector.

(8) Very large network of branches, which at present has rendered the system cost ineffective and deficient in services will be rationalized. The concept of branch banking will go. These functions would be outsourced and banks can concentrate on developing new products and earning fee based income.

(9) The composition of bank staff will change. Total computerization will render major part of the staff surplus. Rightsizing exercise will take place with introduction of another VRS. Only specialized persons will find jobs in the banks

3.7.2 Product Innovation and Re-engineering

(1) With increased competition in the banking industry, the net interest margin of the banks has come down over the last one decade. Liberalisation with globalisation will see the spread narrowing fiirther to 1-1.5% as in the case of banks operating in developed countries. The changes will be motivated by the desire to meet the customer requirements and to reduce the cost and improve the efficiency of service.

(2) As we move towards greater globalisation, what is the evolving scenario of bank branches? First, branches are our main channel of Delivering banking services. Their positioning has a direct and substantial impact on quantum and quality of our business. Second, they account for a significant share in non-interest expenditure. This has a far reaching implication for our cost structure, which, in the context of emerging globalisation, has to be minimized.

73 3.7.3 The issue is to be considered under seven sub questions

(1) Huge construction cost, maintenance cost, connection between branches and controlling offices is only through telephones. Their prominence will surely decline. Several forms of deliver/ channels based on communication technology will take their place (AIM). These will be more economical in very respect. They need hardly any space. The requirement of human resource to ensure their functioning is much less. Delivery cannels based on technology communication would provide interface between the customer and the machine, latter providing services required by the former. Present telebanking involving interaction between customer and human at the branch will be replaced by Voice Recognising machine.

(2) Electronic media will emerge as the most used method. The hub will be linked to all channels of distribution criss-crossing the country. Banking services will be available on all days and at all times. In the process, time and space will cease to have any relevance.

(3) To the customer, front office interface will cease to be a human face. He will be dealing with machines. The processing of his needs will be done by machines which may be physically located at the place of interaction but mostly, at far off places - in a centralised hub. It is also possible that the maintenance of the hub and other related aspects may be outsourced. Hence, there will be substantial reduction in banking personnel proper.

(4) Normal (traditional) banking functions will be taken care of by the computers through hub. Investment consultancy, merger and acquisition portfolio management services etc. which are now considered in the realm of investment banking will be new areas for concentration. Since such activities are mainly electronic media based, the human resource at such branches may be more of electronic and communication engineers as also hardware and software specialist. A traditional banker will be noted by his absence.

74 (5) This will require huge upfront cost to set up the new machines, hardware and software as also net working. (Updating the technology also has a very high cost.) This cost is an investment. The returns are spread over a short period. Breakeven will therefore, depend upon large scale use of delivery channels and charging them accordingly. The maintenance cost also is too high. Since the structure will be based on highly sensitive chips, certain basic infrastructure like uninterrupted power supply, and optimal temperature are needed at the hub. Dependable telephone lines or lease lines, cable lines are needed. Against these, one will have to consider the relative cost of human resources used in the traditional banking.

(6) While there could be a decline in physical security requirement, the demand for intellectual security will be high. Electronic media is extremely vulnerable to cyber crime, hacking and general failure. These will need arrangement for disaster recovery, extremely sound security features and the like. Incidentally, these will add to total cost.

(7) In an increasingly competitive world, which is the hall mark of globalisation improved efficiency is necessary. We now have a growing share of young customers, who are impatient and relatively less committed to relationship banking.

3.7.4 Views on Banking Sector Reforms

The reform process in the Banking Industry has started in 1991. A High Level Committee was appointed on 14.08.1991. Report was to be submitted by 15.11.1991 .It is on record that International Monetary Fund and World Bank imposed conditions for granting loans to meet foreign exchange requirements of the country. It is feared that some of the conditions which relate to Banking Industry might have indirectly formed a part of recommendations through the Committee.

The two major issues confronting the people of this country are I. growing unemployment, 2.rising prices. The financial institutions in general

75 and banking industry' in particular are the veins of economic activity and channels of credit. As such, they must be charged with fulfillment of these objectives viz. full employment and price stability.

Full Employment:- Full employment does not imply creation of more physical jobs. The ultimate goal in this direction must be to ensure employment of full resources of each individual. Bank credit must become a means to supplement human resources which in turn, individually and collectively, would competently augment the resource and further generate the funds needed for subsequent growth. Banks must be entrusted with this task of full employment through productive deployment of credit.

Price Stability:- Since the banks are dealing in money and money is the standard of prices, it is but natural that the banks must be entrusted with and held responsible for the money supply and through it the price stability. Tliis can be done by maintaining the ratio of total currency and credit at constant overall level to the Gross National Product. The Government will remain the supreme fiscal authority but should respect the monetary authority. A constant subservience of monetary authority to the fiscal authority cannot bring about and maintain price stability.

3.7.5 The Issues In The Banking Industry

The Reform exercise is being conducted after three decades of Nationalisation of Commercial Banks, preceded by what was termed as Social Control. The avowed purpose of both, Social Control and Nationalisation was to snap the traditional links between the commercial banks and industrial and business houses and to channelise the bank credit to weaker sectors which were accorded the planned priorities by the Government of the day. With reforms the concept of social banking/lending would undergo a change. Rather than being seen as directed lending such lending would be business driven. The changes could be expected in the delivery channels used for lending to small and medium borrowers and agriculturists and unorganised sectors

76 (micro credit). Use of intermediaries or franchise agents could emerge as means to reduce transaction cost. The emphasis in future would be towards more on fee based services rather than lending operations. More focus will be on convenience banking rather than on relationship banking. Banks have traveled from class banking to mass banking in 1969 and to class banking under globalisation and libaralisation.

The most urgent and immediate need is to increase credit provision to the rural areas for both agriculture and non agricultural activities .If the flows of bank credit to agriculture, small scale industries and other informal sectors have to be expanded, some comprehensive and enduring strategy for credit delivery has to be put in place and loss of momentum spawned by the neglect of developmental goals by banks now for over a decade has to be regained.

3.7.6 Requirement of Capital, Owned Fund for meeting cost of teclinology upgradation, Capital Adequacy norm under be sal. II and provisioning.

Liberalisation and de-regulation process started in 1991 -92 has made a sea change in the banking system. Our move towards global benchmark has been by and large calibrated and regulator driven. Globalisation would gain more momentum in coming few years particularly on account of opening up of financialservice s under WTO. Four trends change the banking industry viz. consolidation of players through mergers and acquisitions, globalisation of operations, development of new technology and universalisation of banking. The conventional definition of banking may undergo a change. Most of the changes in the landscape of financial sector would be technology driven. Technology is expected to be the main facilitator of change in the financial sector. Implementation of technology solutions involves huge capital outlay. Besides the heavy investment cost, technology applications also have a high degree of obsolescence. This will lead to global partnership on technology and skill sharing.

77 Under the existing Basel Capital Accord, allocation of capital follows a one-size-fit-all approach. This would be replaced by risk based approach to capital allocation. Under Basel II. the emphasis is on risk based approach relying on external rating as well as internal rating of each asset and capital charge accordingly. The internal risk based approach would need substantial investment in technology and development of MIS tools.

Public sector banks had relied on Government support for capital augmentation. However, with the Government making a conscious decision to reduce its holding in banks, most of the banks have approached the capital market for raising resources. It is expected that pressure of market forces would be the determining factor for the consolidation in structure of these banks. There could be some large banks at national level, some local level banks and few large Indian banks with international character .Opening of the financial sector from 2005 under WTO, would see a number of global banks taking large stake and control over banking entities in country. They would bring with them capital, technology and management skills. Govemment policy to allow Foreign Direct Investment in banking and move to amend BANKING Regulation Act to remove the existing 10% cap on voting rights of share holders is pointer to these developments.

Non Performing Asset is not new to banking industry. Banks are under constant pressure to show a lowest percentage of NPA at the end of it financial year and percentage is kept to minimum by making provisions for willful defaulters also. This also brings pressure on earnings of the banks.

The new factor mentioned earlier would force the banks to go in for strategic alliance and collaborative approach, as an alternative to mergers and acquisitions to reduce the transaction cost.

While the gains from consolidation are expected along greater economies of scale and scope available to bigger banks, the evidence doesn't support an automatic association between large size and profitability. On the

78 other hand, bigger banks tend to rely much more on arm's length transactions and standardised balance sheets and loan account, on fee based income that seek to avert credit interest risk and on trading risks at the security market. These tendencies give rise to the phenomenon of financial exclusion at the same time that it engenders financial fi^gility via a greater exposure to financial markets. To advocate bank mergers as a general policy move and not as a carefully thought-out measure to consolidate the gains of two banks, would lend legitimacy to the above outcomes.

Consolidation also amplifies the financial fragility resulting from liberalisation in the form of increased exposure of banks to the sensitive sector commodities, real estate and capital market, where speculation is rife and returns volatile. Once the domestic financial sector is liberalised and then linked to external capital flows through capital account convertibility, the probability of banking crisis, currency crisis and financial crisis increases manifold. Dealing with these problems requires not merely restraining and even reversing the change in banking policy regime, but a restoration of an important role for a accountable central bank as regulatory authority. The shift in regime is accompanied by a combination of regulatory forbearance and emphasis on improved accounting practices, better disclosure and new capital adequacy norms. While these do not always deliver on their regulatory objectives, the capital adequacy norms often result in a contraction of banking lending. The essential problem in seeking a greater role of FDI in the domestic banking sector, springs from the attendant loss of autonomy and control on domestic policy making and outcomes. It is to be noted that these expression of the loss of economic sovereignty.

3.7.7 Human Resource Development

Rationalisation of a very large net work of branches, which at present, as mentioned in the report, rendered the system cost ineffective and deficient in service, would take place. As we move along, the concept of branch

79 banking will undergo changes. Banks will find that many of its could be outsourced more profitably without compromising on the quality of service. With greater use of technology, outsourcing of services in different areas, and total computerization major part of the existing employees will be rendered surplus. Banks will go for rightsizing exercise. Another round of VRS to shed excess flabwil l be resorted to. It is a compromise on policy of full employment."

(Source - "Indian Banking 2010" - Indian Banks Association (IB A), January 2004)

By observing all the views expressed above, it is very clear that for Indian banks there is a series of emerging challenges in the years to come. These challenges could be the Threats or Opportunities. The past-experience, since 1991 shows that the Indian banks definitely keep the potential and have shown the "vision, vigour and values" to overcome the challenged and convert them into opportunities for healthy sustenance, growth and development. In the next Chapter we have taken an account of such endeavours of Indian banks in general and the Strategic Response of Urban Co-operative Banks in particular.

80