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 financial institutions 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 financial system, 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.