Explain the measures taken for bringing out the Banking Sector reforms in India?

Explain the measures taken for bringing out the Banking Sector reforms in India

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BANKING SECTOR REFORMS IN INDIA:

*INTRODUCTION:

~ India had an extremely regulated system of banking.

~ This system suffered from various draw backs.

~ To overcome these draw backs, various reforms were undertaken in two phases.

~ As a result, India achieved stability and efficiency in the banking system.

*CAUSES OF REFORMS:

~ A highly regulated banking system had various drawbacks like lack of competition, low capital base, ineffeciency and high intermediation costs.

~ Thus, the depositors and borrowers were highly dissatisfied.

~ More over, after the nationalisation of banks in 1969, the pre-dominance of the public sector increased leading financial repression.

~ Also modern technology had no place in the banking system and the quality of service was inadequate.

~ Improper risk management systems and weak prudential standards gave rise to poor asset quality and low profitability.

~ In order to improve the adverse condition of the then existing banking system, various reforms were introduced since 1991.

~ These reforms were carried out in two distinct phase.

*FIRST PHASE OF BANKING SECTOR REFORMS:

~ These reforms were carried out on the recommendations of the NARSHIMAM COMMITTEE (1991:Part 1)

~ These reforms can be categorised as:

1)Strengthening Measures.

2)Operational Flexibility Measures.

3)Competitive Efficiency Measures.

4)Legal Environment Measures.

5)Customer Services and Priority Sector Lending Measures.

1)STRENGTHENING MEASURES:

~ These measures help the bank to strengthen itself to face the fluctuation in the economic environment.

~ These measures comprise the following reforms:-

#Capital adequcy:

~ The ratio of minimum capital to risk assets is called the CAPITAL ADEQUACY RATIO.( CAR)

~ The CAR has been increased to 9%. At present almost 78% banks have a CAR above 10%.

~ This improves the trust and confidence of the banks in the eyes of the depositors.

#Prudential Norms:

~ These norms were initiated by the RBI to bring professionalism in commercial banks.

~ They include asset classification, income recognition and provision for bad debts.

~ These norms ensure the presentation of accurate financial position of banks as per international accounting practices.

#Valuation Norms:

~ These norms were more helpful to nationalised banks.

~ It made it possible for nationalised banks to raise funds through public issues.

#Transparency and Disclosures:

~ These norms ushered in more transparency and disclosure in published account.

2)OPERATIONAL FLEXIBILITY MEASURES:

~ These norms provided flexibility to banks in their functioning. They include the following measures

#Reduction of SLR and CRR:

~ The CRR ratio was reduced considerably from 15% (1991) to 6% (2010).

~ Similarly the SLR ratio was also reduced from 38.5% to 25%.

~ These reduced ratios enable the bank to release more funds for commercial lending (Loans & Advance)

#Deregulation of Interest Rates:

~ This norm gave banks the freedom to fix their:

^ Prime lending rates (excluding export credit).

^ Variable interest rates on all deposits (except savings deposits)

#Setting-up Subsidiaries:

~ Banks are encouraged to set-up their subsidiaries.

~ This helps to diversify activities like mutual funds, venture capital, merchant banking, housing finance etc.

~ This increases the profit margin and consolidates the bank's position in the financial market.

#Freedom of Operation:

~ Banks were allowed to open new branches and upgrade extension counters.

~ They are also permitted to close down non-viable branches (except in rural area).

3)COMPETITIVE EFFECIENCY MEASURES:

~ These measures improve the competitive efficiency of banks.

~ These measures paved way for private sectors and foreign banks to enter the banking business.

~ The government's share holding in the nationalised banks was considerably brought down to 51%.

4)LEGAL ENVIRONMENT MEASURES:

~ These measures provided legal assistance to the banking system for quick recovery of dues.

~ The RBI set up Debt Recovery Tribunals to provide a mechanism to recover loans.

~ Also, a High Power Committee was form to suggest appropriate foreclosure laws.

5)CONSUMER SERVICES AND PRIORITY SECTOR LENDING:

~ Banks are suggested to provide at least 40% of lending to priority sector.

~ However, priority sectors have been redefined and subsidy has been reduced.

~ Banking Ombudsman Scheme was introduced for quick settlement of customer disputes.

*SECOND PHASE OF BANKING SECTOR REFORMS:

~ These reforms are being carried out on the recommendations of NARSHIMAM COMMITEE II

(yr 1998).

~ The following reforms have been undertaken:

1)NEW AREAS FOR BANK FINANCING: These include

- Insurance

- Credit cards asset management

- Leasing investment banking

- Infrastructure financing factoring etc.

2)INSTRUMENTS FOR ENHANCED FLEXIBILITY AND BETTER RISK MANAGEMENT:

- forward rate agreements cross currency forward contracts

- interest rate swaps liquidity adjustment facility

-forward cover to hedge sinflows (FDIs)

3)UPGRADED TECHNOLOGY INFRASTRUCTURE FOR PAYMENTS AND SETTLEMENTS:

~ Electronic fund Transfer.

~ Centralized fund management system.

~ Negotiated dealing system.

~ Structured Financial messaging solution, etc.

~ Real Time Gross Settlement system (RTGS).

4)ADOPTION OF GLOBAL STANDAARDS:

~ Introduction of risk based supervision of banks.

~ basel II Norms.

5)CREDIT DELIVERY MECHANISMS:

~ Increase flow of credit to priority sectors.

~ Definition of priority sector widened.

6)RISK MANAGEMENT SYSTEM IN BANKS:

~ Setting up of Risk Management Committees.

~ Specialised committes monitor various risk like credit risk, operational risks, market risks, etc.

7)FOREIGN DIRECT INVESTMENT:

~ The limit for foreign direct investment in private banks has been increased to 74%.

~ 10% capital on voting rights has been removed.

UNIVERSAL BANKING:

~ Universal banking refers to the combination of commercial banking and investment banking.

~ It includes a vast range of other financial services beyond commercial banking.

~ They include insurance, leasing, investment advisory etc.

9)MANAGEMENT OF NPAs:

~ The enactment of securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 is an important step in the banking sector.

~ It led to setting up of asset management compains and enhancing of creditor rights.

~ An asset management company is authorised to acquire the NPAs of the banks.

~ In case of NPAs, a secured creditor can serve a notice to the borrower to discharge the liabilities within 60 days, failing which, he is entitled to take over the possession/management of secured assets.

~ Several institutional measures have been initiated to contain the level of NPAs, like:

^ Corporate Debt Restructuring (CDR)

^ Debt Recovery Tribunals (DTRs)

^ Lok Adalats.

10)MERGERS AND AMALGAMATION OF BANKS:

~ RBI has issued guidelines for mergers and amalgamations of private sector banks.

~ These guidelines cover details regarding:

^ Process of merger proposal

^ Determination of swap ratios.

^ Disclosures and norms buying / selling shares by the promoters before / during the process of merger.

11)MANAGERIAL AUTONOMY FOR PUBLIC SECTOR BANKS:

~ The Government of India has issued a managerial autonomy for public sector banks. (Feb 2005)

~ This enables them to compete with private sector banks.

~ Public sector banks are allowed to:

^ Explore new lines of business.

^ Make suitable acquisitions.

^ Close or merge unviable branches.

^ Open branches abroad.

^ Set up subsidiaries.

^ Exit from an existing line of business.

^ Decide human resource issues.

12)ANTI-MONEY LAUNDERING GUIDELINES:

~ In recent years, prevention of money laundering has assured greater importance.

~ In Nov 2004, RBI revised Know Your Customer (KYC) guidelines.

~ Banks have to frame their policies within the network of KYC guideline. They relate to customer acceptance, customer identification, risk management and monitoring transaction.

13)APPLICATION OF INFORMATION TECHNOLOGY: (IT)

~ There is increased use of IT in banking.

~ Banks have introduced various facilities like:

^ Online Banking

^ E-Banking

^ Internet Banking

^ Telephone Banking, etc.

14)CUSTOMER SERVICES:

~ These measures improve customer service of commercial banks.

~ They include:

^ Banking Ombudsman.

^ Customer Service Committee of the Board.

^ Credit Card Facilities.

^ Settlement of claims of deceased Depositor.

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