Economic Reforms of the Banking Sector In India Indian banking sector has undergone major changes and reforms

during economic reforms. Though it was a part of overall economic reforms, it has changed the very functioning of Indian banks. This reform have not only influenced the productivity and efficiency of many of the Indian Banks, but has left everlasting footprints on the working of the banking sector in India. Let us get acquainted with some of the important reforms in the banking sector in India. 1.Reduced CRR and SLR : The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are gradually reduced during the economic reforms period in India. By Law in India the CRR remains between 3-15% of the Net Demand and Time Liabilities. It is reduced from the earlier high level of 15% plus incremental CRR of 10% to current 4% level. Similarly, the SLR Is also reduced from early 38.5% to current minimum of 25% level. This has left more loanable funds with commercial banks, solving the liquidity problem. 2.Deregulation of Interest Rate : During the economics reforms period, interest rates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit of interest on deposits. Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs. Interest rates on the bank loans above Rs.2 laths are full decontrolled. These measures have resulted in more freedom to commercial banks in interest rate regime 3.Fixing prudential Norms : In order to induce professionalism in its operations, the RBI fixed prudential norms for commercial banks. It includes recognition of income sources. Classification of assets, provisions for bad debts, maintaining international standards in accounting practices, etc. It helped banks in reducing and restructuring Non-performing assets (NPAs). 4.Introduction of CRAR : Capital to Risk Weighted Asset Ratio (CRAR) was introduced in 1992. It resulted in an improvement in the capital position of commercial banks, all most all the banks in India has reached the Capital Adequacy Ratio (CAR) above the 1

statutory level of 9%. 5.Operational Autonomy : During the reforms period commercial banks enjoyed the operational freedom. If a bank satisfies the CAR then it gets freedom in opening new branches, upgrading the extension counters, closing down existing branches and they get liberal lending norms. 6.Banking Diversification : The Indian banking sector was well diversified, during the economic reforms period. Many of the banks have stared new services and new products. Some of them have established subsidiaries in merchant banking, mutual funds, insurance, venture capital, etc which has led to diversified sources of income of them.

7.New Generation Banks : During the reforms period many new generation banks have successfully emerged on the financial horizon. Banks such as ICICI Bank, HDFC Bank, UTI Bank have given a big challenge to the public sector banks leading to a greater degree of competition. 8.Improved Profitability and Efficiency : During the reform period, the productivity and efficiency of many commercial banks has improved. It has happened due to the reduced Non-performing loans, increased use of technology, more computerization and some other relevant measures adopted by the government. These are some of the import reforms regarding the banking sector in India. With these reforms, Indian banks especially the public sector banks have proved that they are no longer inefficient compared with their foreign counterparts as far as productivity is concerned.

Banking Sector Reforms 1999-2000 In line with the recommendations of the second Narasimham Committee, the Mid-Term Review of the Monetary and Credit Policy of October 1999 announced a gamut of measures to strengthen the banking system. Important measures on strengthening the health of banks included: (i) assigning of risk weight of 2.5 per cent to cover market risk in respect of investments in securities outside the SLR by March 31, 2001 (over and above the existing 100 per cent risk weight) in addition to a similar prescription for Government and other approved securities by March 31, 2000, and (ii) lowering of the exposure ceiling in respect of an individual borrower from 25 per cent of the bank's capital fund to 20 per cent, effective April 1, 2000. Capital Adequacy and Recapitalisation of Banks Out of the 27 public sector banks (PSBs), 26 PSBs achieved the minimum capital to risk assets ratio (CRAR) of 9 per cent by March 2000. Of this, 22 PSBs had CRAR exceeding 10 per cent. To enable the PSBs to operate in a more competitive manner, the Government adopted a policy of providing autonomous status to these banks, subject to certain benchmarks. As at end-March 1999, 17 PSBs became eligible for autonomous status. Prudential Accounting Norms for Banks The Reserve Bank persevered with the on-going process of strengthening prudential accounting norms with the objective of improving the financial soundness of banks and to bring them at par with international standards. The Reserve Bank advised PSBs to set

up Settlement Advisory Committees (SACs) for timely and speedier settlement of NPAs in the small scale sector, viz., small scale industries, small business including trading and personal segment and the agricultural sector. The guidelines on SACs were aimed at reducing the stock of NPAs by encouraging the banks to go in for compromise settlements in a transparent manner. Since the progress in the recovery of NPAs has not been encouraging, a review of the scheme was undertaken and revised guidelines were issued to PSBs in July 2000 to provide a simplified, non-discriminatory and nondiscretionary mechanism for the recovery of the stock of NPAs in all sectors.

Asset Liability Management (ALM) System The Reserve Bank advised banks in February 1999 to put in place an ALM system, effective April 1, 1999 and set up internal asset liability management committees (ALCOs) at the top management level to oversee its implementation. Banks were expected to cover at least 60 per cent of their liabilities and assets in the interim and 100 per cent of their business by April 1, 2000. The Reserve Bank also released ALM system guidelines in January 2000 for all-India term-lending and refinancing institutions, effective April 1, 2000. As per the guidelines, banks and such institutions were required to prepare statements on liquidity gaps and interest rate sensitivity at specified periodic intervals. Risk Management Guidelines The Reserve Bank issued detailed guidelines for risk management systems in banks in October 1999, encompassing credit, market and operational risks. Banks would put in place loan policies, approved by their boards of directors, covering the methodologies for measurement, monitoring and control of credit risk. The guidelines also require banks to evaluate their portfolios on an on-going basis, rather than at a time close to the balance sheet date. As regards off-balance sheet exposures, the current and potential credit exposures may be measured on a daily basis. Banks were also asked to fix a definite time-frame for moving over to the Value-at-Risk (VaR) and duration approaches for the measurement of interest rate risk. The banks were also advised to evolve detailed policy and operative framework for operational risk management. These guidelines

together with ALM guidelines would serve as a benchmark for banks which are yet to establish an integrated risk management system.

CHAP.2 DEVELOPMENT OF BANKING IN INDIA Technological Developments in Banking

In India, banks as well as other financial entities have entered the domain of information technology and computer networking. A satellite-based Wide Area Network (WAN) would provide a reliable communication framework for the financial sector. The Indian Financial Network (INFINET) was inaugurated in June 1999. It is based on satellite communication using VSAT technology and would enable faster connectivity within the financial sector. The INFINET would serve as the communication backbone of the proposed Integrated Payment and Settlement System (IPSS). The Reserve Bank constituted a National Payments Council (Chairman: Shri S. P. Talwar) in 1999-2000 to focus on the policy parameters for developing an IPSS with a real time gross settlement (RTGS) system as the core. Revival of Weak Bank The Reserve Bank had set up a Working Group (Chairman: Shri M. S. Verma) to suggest measures for the revival of weak PSBs in February 1999. The Working Group, in its report submitted in October 1999, suggested that an analysis of the performance based on a combination of seven parameters covering three major areas of i) solvency

(capital adequacy ratio and coverage ratio), ii) earnings capacity (return on assets and net interest margin) and iii) profitability (operating profit to average working funds, cost to income and staff cost to net interest income plus all other income) could serve as the framework for identifying the weakness of banks. PSBs were, accordingly, classified into three categories depending on whether none, all or some of the seven parameters were met. The Group primarily focused on restructuring of three banks, viz., Indian Bank, UCO Bank and United Bank of India, identified as weak as they did not satisfy any (or most) of the seven parameters. The Group also suggested a two-stage restructuring process, whereby focus would be on restoring competitive efficiency in stage one, with the options of privatization and/or merger assuming relevance only in stage two. Deposit Insurance Reforms Reforming the deposit insurance system, as observed by the Narasimham Committee (1998), is a crucial component of the present phase of financial sector reforms in India. The Reserve Bank constituted a Working Group (Chairman: Shri Jadish Captor) to examine the issue of deposit insurance which submitted its report in October 1999. Some of the major recommendations of the Group are : (i) fixing the capital of the Deposit Insurance and Credit Guarantee Corporation (DICGC) at Rs.500 core, contributed fully by the Reserve Bank, (ii) withdrawing the function of credit guarantee on loans from DICGC and (iii) risk-based pricing of the deposit insurance premium in lieu of the present flat rate system. A new law, in supersession of the existing enactment, is required to be passed in order to implement the recommendations. The task of preparing the new draft law has been taken up. The relevant proposals in this respect would be forwarded to the Government for consideration. Non-Banking Financial Companies (NBFCs) Reforms The process of registration of NBFCs is a continuous one. The Reserve Bank (Amendment) Act 1997 had allowed a period of three years to NBFCs which did not have the statutory minimum net owned funds (No) of Rs.25 laky at the commencement of the Act to attain the minimum No and thus become eligible for registration. The three-year time period expired on January 9, 2000. Out of 26,938 NBFCs whose No was less than Rs.25 laky as on January 9, 2000, as many as 8,070 NBFCs have reported to

have stepped up their No to Rs.25 laky or more, thus becoming eligible for registration. In addition, the Reserve Bank received 2,211 applications for extension of time. As per the provisions in the Act and NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 1998, NBFCs with No less than Rs.25 laky are not entitled to accept fresh public deposits. In the case of new NBFCs, which commence the business of a non-bank financial institution as on or after April 21, 1999, and which seek registration with the Reserve Bank, the requirement of minimum No was raised to Rs.2 core. As on June 30, 2000, the Reserve Bank has granted certificates of registration to 679 companies permitting them to accept public deposits and to 8,451 companies without authorisation for acceptance of public deposits. Financial Institutions Reforms The traditional division between banks (as providers of working capital) and FIs (as providers of project finance) is increasingly getting blurred with the deepening of financial reforms and integration of financial markets. There is a need to gradually put in place a regulatory framework which will facilitate eventually the transition to universal banking. The Reserve Bank undertook a number of policy measures during 1999-2000, relating to the prudential regulation and supervision of all India term-lending and refinancing institutions. Effective March 31, 2000, a risk weight of 2.5 per cent was assigned to all securities to cover the market risk over and above the existing 20-100 per cent credit risk weight assigned to different types of securities Indian Financial Reforms with Reference to Banking Sector Analysis of Indian Financial Sector reveals that it is at present going through a phase of stable growth rate which is experiencing a upward swing. The rise can be maintained over a long period by keeping the inflation down. The financial sector in India has experienced a growth rate of 8.5% per annum. The rise in the growth rate suggests the growth of the economy. The financial policies and the monetary policies are able to sustain a stable growth rate. The reforms pertaining to the monetary policies and the macro economic policies over the last few years have influenced the Indian economy to the core. The major step towards opening up of the financial market further was the

nullification of the regulations restricting the growth in the financial sector. To maintain such a growth for a long term the inflation has to come down further. The analysis of Indian financial sector shows the growth of the sector was the result of the individual development Analysis The cater Analysis spite of removal to of the of of of the the the the pliable various of the Indian by but divisions Indian ill-used under Capital forward in trading the sector. market mechanism locations market set up

The ratio of the transaction was increased with the share ratio and deposit system The introduction of InfoTech systems in the National Stock Exchange (NSE) in order to investors stock Venture the different exchanges Capital external Privatization

The venture capital sector in India is one of the most active in the financial sector in hindrances Presently in India there are around 34 national and 2 international SEBI registered venture capital funds Analysis banking transformed banking Position operations limit more subject of sector in the India Indian is nearly completely. users to friendly RBI and easy. Banking US$ 270 sector billion. The banking system in India is the most extensive. The total asset value of the entire The total deposit is nearly US$ 220 billion. Banking sector in India has been Presently the latest inclusions such as Internet banking and Core banking have made approval

Guidelines issued to banks to ensure qualitative improvement in their customer service. Loan system introduced for delivery of bank credit. Banks required to bifurcate the maximum permissible bank finance of Rs. 200 million and above into loan component of 40% (short term working capital loan) and cash credit component of 60%. The last decade witnessed the maturity of India's financial markets. Since 1991, every governments of India took major steps in reforming the financial sector of the country. Banking Sector is the backbone of any financial system and economy. Commercial

banks play an important role in the development of underdeveloped/developing economies by mobilization of resources and their better allocation. Indian Banking System is regulated by the central bank of the country i.e. Reserve Bank of India (RBI), which was nationalized in 1949. RBI is the primary regulator for the banking sector and the government exercises direct and indirect control over banks through RBI to protect the depositors and to stabilize the banking system . The Indian banking system has changed a lot over the last five decades especially in the last 15 years with India taking to the path of free market economy and globalization with clear commitments under WTO (World Trade Organization) regime. A journey from private ownership and control of commercial banks to government ownership and control by way of nationalization, has come in full circle in the wake of liberalization and introduction of new players in the shape of Private Sector Banks and Foreign Banks. Currently there are twenty eight public sector banks which account for 87% of the total bank branches (and 74% of deposits), twenty four private sector banks which account for 12% of the total bank branches (and 20% of deposits) and twenty nine foreign banks accounting for 0.45% of the branches (and 5.5% of deposits) (Indian Banks' Association, 2007). The entry of foreign/private banks and various financial sector reforms like deregulation of interest rates, new norms on asset classification and provisioning, adoption of Basle Accord on capital adequacy coupled with other policy measures aimed at adopting best global practices has revolutionized the banking industry in India. The Public Sector Banks, which still account for the major part of the Indian Banking Industry in terms of size and reach are facing stiff competition from Private and Foreign Banks as also from the Non-Banking Financial Institutions. The Foreign Banks which form only 0.26 % of the total number of branches in India still manage to gather 5% of the total deposits.

CHAP. 3 PHASES OF NATIONALISATION Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle

free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades Indias banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of Indias growth process.In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in india as the Central Banking Authority.During those day as public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders. PhaseII Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised.Second phase of nationalisation Indian Banking Sector Reform was 11

carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership.The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949 : Enactment of Banking Regulation Act. 1955 : Nationalisation of State Bank of India. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks. 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. Nationalisation of seven banks with deposits over 200 core. After the nationalisation of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%.Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions. PhaseIII This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices.The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure I. Banking in the Pre-reform Period It is useful to briefly recall the nature of the Indian banking sector at the time of initiation of financial sector reform in India in the early 1990s. This would facilitate a

greater clarity of the rationale and basis of reforms. The Indian financial system in the pre-reform period, i.e., upto the end of 1980s, essentially catered to the needs of planned development in a mixed economy framework where the government sector had a domineering role in economic activity. The strategy of planned economic development required huge development expenditures, which was met thorough the dominance of government ownership of banks, automatic monetization of fiscal deficit and subjecting the banking sector to large pre-emptions both in terms of the statutory holding of Government securities (statutory liquidity ratio, or SLR) and administrative direction of credit to preferred sectors. II. Contours of reforms Financial sector reforms encompassed broadly institutions especially banking, development of financial markets, monetary fiscal and external sector management and legal and institutional infrastructure.Reform measures in India were sequenced to create an enabling environment for banks to overcome the external constraints and operate with greater flexibility. Such measures related to dismantling of administered structure of interest rates, removal of several preemptions in the form of reserve requirements and credit allocation to certain sectors. Interest rate deregulation was in stages and allowed build up of sufficient resilience in the system. This is an important component of the reform process which has imparted greater efficiency in resource allocation. Parallel strengthening of prudential regulation, improved market behaviour, gradual financial opening and, above all, the underlying improvements in macroeconomic management helped the liberalisation process to run smooth. The share of the public sector banks in total banking assets has come down from 90 per cent in 1991 to around 75 per cent in 2006: a decline of about one percentage point every year over a fifteen-year period. Diversification of ownership, while retaining public sector character of these banks has led to greater market accountability and improved efficiency without loss of public confidence and safety. It is significant that the infusion of funds by government since the initiation of reforms into the public sector banks amounted to less than 1 per cent of Indias GDP, a figure much lower than that for many other countries. Another major objective of banking sector reforms has been to enhance efficiency and productivity through increased competition. Establishment of new banks was allowed in the private

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sector and foreign banks were also permitted more liberal entry. Nine new private banks are in operation at present, accounting for around 10-12 per cent of commercial banking assets. Security Reforms The legal environment for conducting banking business has also been strengthened. Debt recovery tribunals were part of the early reforms process for adjudication of delinquent loans. More recently, the Securitisation Act was enacted in 2003 to enhance protection of creditor rights. To combat the abuse of financial system for crime-related activities, the Prevention of Money Laundering Act was enacted in 2003 to provide the enabling legal framework. The Negotiable Instruments (Amendments and Miscellaneous Provisions) Act 2002 expands the erstwhile definition of 'cheque' by introducing the concept of 'electronic money' and 'cheque truncation'. The Credit Information Companies (Regulation) Bill 2004 has been enacted by the Parliament which is expected to enhance the quality of credit decisions and facilitate faster credit delivery.. Central Government securities Reforms in the Government securities market were aimed at imparting liquidity and depth by broadening the investor base and ensuring market-related interest rate mechanism. The important initiatives introduced included a market-related government borrowing and consequently, a phased elimination of automatic monetisation of Central Government budget deficits. This, in turn, provided a fillip to switch from direct to indirect tools of monetary regulation, activating open market operations and enabled the development of an active secondary market. The gamut of changes in market development included introduction of newer instruments, establishment of new institutions and technological developments, along with concomitant improvements in transparency and the legal framework. Processes of Reform What are the unique features of our reform process? First, financial sector reform was undertaken early in the reform cycle in India. Second, the banking sector reforms were not driven by any immediate crisis as has often been the case in several emerging

economies. Third, the design and detail of the reform were evolved by domestic expertise, while taking on board the international experience in this regard. Fourth, enough space was created for the growth and healthy competition among public and private sectors as well as foreign and domestic sectors. How useful has been the financial liberalization process in India towards improving the functioning of institutions and markets? Prudential regulation and supervision has improved; the combination of regulation, supervision and safety nets has limited the impact of unforeseen shocks on the financial system. Financial entities have become increasingly conscious about risk management practices and have instituted risk management models based on their product profiles, business philosophy and customer orientation. Additionally, access to credit has improved, through newly established domestic banks, foreign banks and banklike intermediaries. Government debt markets have developed, enabling greater operational independence in monetary policy making. The growth of government debt markets has also provided a benchmark for private debt markets to develop. There have also been significant improvements in the information infrastructure. . The Report of Narasimhan Committee II Sometime in early 1997, the then finance minister Mr.P.Chidambaram requested Mr.Narasimham to chair another committee to review what had been accomplished and to suggest a new vision for our banking industry. In April, 1998 Mr.Narasimhan submitted are under process of implementation. Excerpts from the views expressed by a former Finance Minister Mr.P.Chidambaramn recently on the subject in a lecture delivered by him at the Administrative Staff College, Hyderabad are reproduced here under: 1. Government should divest its Equity in PSBs "Government should reduce its equity holding to below 51% in all banks. We can debate whether the reduction should be to 33% or 26%. But it must go below 51%. I might add that when I say government holding I mean government's plus the RBI's holding. Banks must become Board managed companies subject, of course, to effective supervision, regulation and monitoring by a single agency. This is the central issue in banking reform

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and, as long as we skip around it, we are not addressing the core of the problem. Needless to say, what we require is a political decision, and it will be my endeavour to convince my colleagues of the imperative of reducing government's holding in banks to below 51% immediately." 2. Net NPA to be pegged down to the level of 5% by 2000 and 3% soon thereafter "The Narasimham Committee has made many other useful suggestions with which I am in complete agreement. In particular, the goal of having a NNPA for all banks at around 5% by the year 2000 and 3% soon thereafter must inform our policies and strategies for reforms. This will call for sustained measures to tackle the problem of backlog NPAs on a one-time basis". 3. The capital adequacy norm of 8% must be increased to 10% but the additional capital requirements should in my view, not come from the Budget but must be raised in the capital market.(CAR already increased to 9% from March,2001.) 4. The problem of high interest rates "We must remove policy-induced pressures on the real interest rate. The effective rates of return offered by government's small savings schemes, relief bonds and provident funds are too high and they put a competitive pressures on the real interest rate on bank deposits. They have other consequences too, such as the stretching of the fiscal deficit. When inflation rises, as a result of other policy driven measures, there is further upward pressure on the interest rates. When inflation falls, the interest rate does not fall because it is "anchored" by the SSI rate and thus real interest rate rises. This is not the place to dwell on the disastrous consequences of a high interest rate economy. Most projects flounder - and many new entrepreneurs have gone broke - in a regime of high interest rates. Moreover, government's expenditure on debt-servicing goes up uncontrollably, leaving little for investment or development. In recent years, the central government's expenditure on interest payments has risen from Rs.27,000 core in 1991-92 to Rs.75,000 core in 1998-99. We must make a three-pronged attack on interest rates. Reduction of the fiscal deficit must be the first goal of budget making. Government promoted savings instruments must offer lower rates of interest. The new theology - or rather the new-found love for the old theology - of buying a little more growth through inflation must be given a final burial, and inflation

control must regain primacy in economic management. Through these and other measures, we must lower real interest rates and pave the way for a truly competitive banking sector." 5. Debt recovery " The Narasimham Committee has reiterated its suggestion on the creation of a separate bad debts recovery institution. Many of us remain unconvinced. The moral hazard argument is too familiar to be dismissed summarily. Besides, the idea sends the wrong signals. We have to make our legal machinery more business-like and allow banks to settle bad accounts on what they consider commercially sensible terms. During my tenure, I encouraged banks to set up Settlement Advisory Boards headed by a judge. While there were some encouraging results, the process was halting and slow.. I have a suggestion: we may combine the objectives of the existing Debt Recovery Tribunals and the Settlement Advisory Boards and create a single authority for each group of banks, composed of a banker and a judge. This authority could be tasked to promote settlements as well as decree suits and direct recoveries. The alternative idea of an Asset Recovery Corporation, which will be another government body, and manned by officers who will also live in fear of investigative agencies, cannot do better". 6. The Rural Credit System is in a shambles "The second item on the agenda for financial sector reforms should be a revamp of rural credit system. As I have indicated earlier, NABARD's resources base has been augmented substantially. Successive Budgets have also provided about Rs.400 core for the revitalisation of 50 Regional Rural Banks. I continued with the scheme of Rural Infrastructure Development Fund (RIDF) under the aegis of NABARD. Sanctions under the RIDF have amounted to Rs.5800 core in the last three years. Institutional credit to agriculture has increased from Rs.15,000 core in 1992-93 to Rs.34,000 core in 1997-98. " "But structural problems in the rural financial system remain. There still exists a substantial gap between the demand (leave alone the "need") and the supply of agricultural credit. The increasing credit needs of the fast growing rural non-farm sector have also to be factored in. The planning Commission in its Ninth Plan document estimates that the growth rate in agricultural credit flow, broadly defined, has to be maintained at about 16% per year, while the growth rate has been around 10% per year over the past decade. Moreover 50% of the

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credit demand will be from small and marginal farmers which our present day institutions are ill-equipped to serve. It is farmers holding more than 5 acres of land who dominate cooperative membership; consequently, they also corner the bulk of agriculture credit from commercial banks. Small and marginal farmers are denied access to credit. It has been estimated that over half their credit needs are met by non-institutional sources. Inevitably, they pay usurious interest rates. This could well be one of the factors contributing to the distress of ryots manifested most tragically in suicides in states like Andhra Pradesh, Karnataka and Maharashtra. 7. Other problems concerning rural credit " I wish to briefly dwell upon an irony in our credit delivery system. A large number of people have very small savings - you may call them micro-savers. No effort is made to mobilise these micro savings, thanks to the transactional costs of our banks and other institutions. On the other side, there are a large number of people whose credit requirements are also very small - you may call them micro-borrowers. They are the most neglected segment. Small and marginal farmers, village artisans and craftsmen and service providers in villages like the dhobi, tailors and hairdressers fall in this segment. They cannot buy fertilizer or new tools; they cannot upgrade their skills. They remain entrenched in poverty. For some time now, I have reflected on the need to build an institutional bridge between micro-servers and micro-lenders. The most notable example in this region is the Grameen Bank of Bangladesh. In a small way, SEWA of Ahmedabad caters to the credit needs of working women. I suggest that loans to successful self-help groups like SWEA should be treated as priority sector lending and as an alternative to IRDP and similar schemes. I also suggest that we should encourage new forms of local institutions which can take up this task. The idea of Local Area Banks which I mooted two years ago was a step in that direction. The opposition to the proposed LABs was led by the existing inefficiently run banks, including the Regional Rural Banks. I regret to say that it is an idea whose time has sadly not yet come." "Commercial banks account for about 34% of short term credit and about 55% of term credit disbursements to agriculture. In many ways, the growth of commercial bank activities is a reflection of the complete failure of the Regional Rural Banks and the precarious financial condition of the cooperative credit structure. The build - up of overdues

is severely restricting the capability of rural credit institutions to expand their activities by availing of refinance. 50% of the primary agriculture credit societies that have reported their working results have incurred losses. Overdues of primary land development banks is now close to 40% and of State land development banks close to 46%. That is the price we have paid for allowing political parties and politicians to take virtual control of cooperative institutions 8. "There is another sensitive issue, namely, priority sector lending. Today, Commercial banks are mandated to lend 18% to agriculture. This target was fixed at a time when the reserve requirements of CRR and SLR combined were as high as 63%. Today, these reserve requirements are at 36%. The lending base has, in fact, doubled in the last five years. Two questions arise. First, does it make sense to continue to insist on 18% ? Second, if larger sums are available for lending why do most banks fall short of the 18% target? There are no simple answers. I suspect it has something to do with the way our banks have evolved looking more towards the cities and towns, trade and industry and large borrowers, and to a distaste of bank officers to rub shoulders with farmers. We treat the priority sector as a sacred cow, and we starve it. It is not enough to make lending to agriculture mandatory; it must be made profitable. Refinance at lower rates will help, but such lending will be truly profitable only when the transaction costs of banks are sharply reduced". 9. Reform of the Insurance Sector "Financial sector reforms are more than banking sector reforms. I turn now to the third item on the agenda. The insurance industry in India has been a public sector monopoly. The Malhotra Committee gave us a blueprint for its liberalisation. I tried to implement that blueprint. My approach was a three-stage one. First the establishment of a statutory Insurance Regulatory Authority. Second the opening of the heath insurance business and the pensions business on the ground that just about 20 million Indians have organised pension cover and 2 million Indians have health insurance. Third the opening of the life insurance business itself. I saw this as a three to five year exercise." " Since the debaters have now exhausted themselves, I would now advocate an immediate and simultaneous opening of all segments of the insurance business. I am glad that the Finance Minister sees the need for this now which, sadly, his party did not see a year ago. I

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would also say that foreign participation is necessary for the technology and product expertise that they will bring, and we should allow foreign equity up to 49% in insurance joint ventures. Currently, LIC and GIC provide about Rs.6000-7000 core annually for various infrastructure projects in water supply, power, sanitation and housing. If we open the insurance business, each new company would be able to generate at least another Rs.5000 core annually from the tenth year onwards for investment in infrastructure sectors. The opening of the insurance and pensions industry is the only way we will be able to mobilise increasing amounts of resources for long-gestation infrastructure projects. Over time, government must also reduce its stake in LIC and GIC. What is true of banks is also true of insurance companies - government ownership is a strong deterrent to professionalism, behaviour." managerial freedom, customer-friendliness and entrepreneurial

10. Infrastructure financing "The fourth item is the need for innovation in relation to infrastructure financing. Government guarantees may have been needed in the initial stages of attracting private investment but they have run their course. I have already spoken of the need to open the insurance and pensions businesses. We have much to learn from countries like Chile and Singapore. Singapore is a state-based system, while in Chile the system is being increasingly privatized. There is need for new financial instruments like asset-backed securitisation and municipal bonds. Innovative and diverse financing techniques must allocate risks optimally in private infrastructure projects. The Ahmedabad Municipal Corporation recently raised, successfully, large resources through a bond issue. For smaller cities and towns that may not be in a position to do likewise, there is need for an urban infrastructure financing agency that will float 20-30 year securities and on-lend to the municipal bodies. Along with much needed resources, it will also bring much needed financial discipline into these bodies. Both the elected bodies and the electorate may in due course realise that user charges - which are now too low - would have to be raised to service the long-term bonds. Following an announcement made in my 1996 Budget speech, the Infrastructure Development Finance Company with an authorised capital base of

Rs.5000 core established in January 1997. Foreign investors have taken a keen interest in the IDFC and the Company has made a promising beginning. The development of a longterm debt market will also underpin the growth of private infrastructure." 11. Regulatory Authorities "My fifth item on the reform agenda is the special need for regulation and supervision in a world of capital mobility. The East Asian crisis has reminded us forcefully once again that liberalization and globalisation of financial markets must be accompanied by strong financial systems capable of handling large flows and assessing the potential risks involved in foreign exchange exposure both by the banks and their clients. There is no simple way of ensuring that banks are strong. Effective regulation and supervision must be based on a transparent set of rules, as close as possible to international standards, combined with free and timely availability of information, and strong, proactive action again those breaking the rules. Such regulation is different from controls or bureaucratic interventions which come naturally to us. There is a case for continuing with controls over the inflow of short-term capital. There may also be a case for hastening slowly on the road to capital account convertibility. But there is no case at all for going slow on liberalisation. In most areas, we must move from old approach of controls that impede markets to regulations that do not interfere with markets but discipline the transgressors. Our regulatory agencies must be made more professional and specialised. Economic, financial and market research must inform their decisions and actions. And information technology can make a greater difference to organisational efficiency in the financial sector."

Monetary and Financial Sector Reforms in India: Reserve Bank of India The objectives of this paper are to review the monetary and financial sector reforms in India, identify the emerging issues and explore the prospects for further reform. The first part is devoted to a brief background on the need for reforms taken up in 1991-92. The second part is devoted to the institutional aspects of the reform. Issues relating to ownership, competition and regulation in the financial sector as a whole, but primarily in the banking sector are analysed. The third part relating to policy framework focuses on

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monetary policy and credit delivery. The fiscal policy insofar as it impacts on the financial sector is also analysed. The fourth part focuses on managing process of reform in its various dimensions and perspective is that of the Reserve Bank of India (RBI). The concluding part identifies the critical elements that would possibly determine the progress of reform. Need for Reforms The Indian financial system of the pre-reform period essentially catered to the needs of planned development in a mixed-economy framework where theGovernment sector had a predominant role in economic activity. As part of planned development, the macroeconomic policy in India moved from fiscal neutrality to fiscal activism (Reddy 2000). Such activism meant large developmental expenditures, much of it to finance longgestation projects requiring long-term finance. The sovereign was also expected to raise funds at fine rates, and understandably at below the market rates for private sector. In order to facilitate the large borrowing requirements of the Government, interest rates on Government securities were artificially pegged at low levels, which were unrelated to market conditions. The government securities market, as a result, lost its depth as the concessional rates of interest and maturity period of securities essentially reflected the needs of the issuer (Government) rather than the perception of the market. The provision of fiscal accommodation through ad hoc treasury bills (issued on tap at 4.6 per cent) led to high levels of monetisation of fiscal deficit during the major part of the eighties. In order to check the monetary effects of such large-scale monetisation, the cash reserve ratio (CRR) was increased frequently to control liquidity. The environment in the financial sector in these years was thus characterised by segmented and underdeveloped financial markets coupled with paucity of instruments. The existence of a complex structure of interest rates arising from economic and social concerns of providing concessional credit to certain sectors resulted in cross subsidisation which implied that higher rateswere charged from non-concessional borrowers. The regulation of lending rates, led to regulation of deposit rates to keep cost of funds to banks at reasonable levels, so that the spread between cost of funds and return on funds is maintained. The system of administered interest rates was

characterised by detailed prescription on the lending and the deposit side leading to multiplicity and complexity of interest rates. By the end of the eighties, the financial system was considerably stretched. The directed and concessional availability of bank credit with respect to certain sectors resulted not only in distorting the interest rate mechanism, but also adversely affected the viability and profitability of banks. The lack of recognition of the importance of transparency, accountability and prudential norms in the operations of the banking system led also to a rising burden of non-performing assets. In sum, there was a de facto joint family balance sheet of Government, RBI and commercial banks, with transactions between the three segments being governed by plan priorities rather than sound principles of financing inter-institutional transactions (Reddy, November 2000). There was a widespread feeling that this joint family approach, which sought to enhance efficiency through co-ordinated approach, actually led to loss of transparency, of accountability and of incentive to measure or seek efficiency.

Institutional Aspects of Reforms

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Institutions At present, the institutional structure of the financial system is characterised by (a) banks, either owned by the Government, RBI or private sector (domestic or foreign) and regulated by the RBI; (b) development financial institutions and refinancing institutions, set up either by a separate statute or under Companies Act, either owned by Government, RBI, private or other development financial institutions and regulated by the RBI and (c) non-bank financial companies (NBFCs), owned privately and regulated by the RBI. Since the onset of reforms, there has been a change in the ownership pattern of banks. The legislative framework governing public sector banks (PSBs) was amended in 1994 to enable them to raise capital funds from the market by way of public issue of shares. Many public sector banks have accessed the markets since then to meet the increasing capital requirements, and until 2001-02, Government made capital injections out of the Budget to public sector banks, totalling about 2 per cent of GDP. The Government has initiated legislative process to reduce the minimum Government ownership in nationalized banks from 51 to 33 per cent, without altering their public sector

character. The underlying rationale of the proposal appears to be that the salutary features of public sector banking is not lost in the transformation process. Reforms have altered the organizational forms, ownership pattern and domain of operations of financial institutions (FIs) on both the asset and liability fronts. Drying up of low cost funds has led to an intensification of the competition for resources for both banks and FIs. At the same time, with banks entering the domain of term lending and FIs making a foray into disbursing short-term loans, the competition for supply of funds has also increased. Besides, FIs have also entered into various fee-based services like stockbroking, merchant banking, advisory services and the like. Currently, while Industrial Credit and Investment Corporation of India Ltd. (ICICI) is in the process of finalising its merger with ICICI Bank, Industrial Development Bank of India (IDBI) is also expected to be corporatised soon.

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Steps have also been initiated to infuse competition into the financial system. The RBI issued guidelines in 1993 is respect of establishment of new banks in the private sector. Likewise, foreign banks have been given more liberal entry. Recently, the norms for entry of new private banks were rationalised. Two new private sector banks have been given in-principle approval under these revised guidelines. The Union Budget 2002-03 has also provided a fillip to the foreign banking segment, permitted these banks, depending on their size, strategies and objectives, to choose to operate either as branches of their overseas parent, or, corporatize as domestic companies. This is expected to impart greater flexibility in their operations and provide them with a level-playing field vis--vis their domestic counterparts. As a group, however, the performance of PSBs in terms of profitability, spreads, non-performing assets and standard assets position seems to have been lower than that of the new private sector and foreign banks. Regulation and Supervision A second major element of financial sector reforms in India has been a set of prudential measures aimed at imparting strength to the banking system as well as ensuring safety and soundness through greater transparency, accountability and public credibility. Capital adequacy norms for banks are in line with the Basel Committee standards and from the end of March 2000, the prescribed ratio has been raised to 9 per cent. 2 While the objective has been to meet the international standards, in certain cases, fine-tuning has occurred keeping in view the unique country-specific circumstances. For instance, risk weights have been prescribed for investment in Central Government securities on considerations of interest rate risk. Also, while there is a degree of gradualism, there is an intensification beyond the 'best practices' in several instances in recent period, an example being exposure norms stipulated for the banking sector in respect of investmentin equity. Investments are valued and classified into appropriate categories, as per international best practices.. The supervisory strategy of the Board for Financial Supervision (BFS) constituted as part of reform consists of a four-pronged approach, including restructuring system of inspection, setting up of off-site surveillance, enhancing the role of external auditors, and strengthening corporate governance, internal controls and audit procedures. The BFS, in effect, integrates within the Reserve Bank

the supervision of banks, NBFCs and financial institutions.

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Changing Monetary Policy Framework Since the onset of the reforms process, monetary management in terms of framework and instruments has undergone significant changes, reflecting broadly the transition of the economy from a regulated to liberalized and deregulated regime. 3 While the twin objectives of monetary policy of maintaining price stability and ensuring availability of adequate credit to productive sectors of the economy to support growth have remained unchanged; the relative emphasis on either of these objectives has varied over the year depending on the circumstances. Reflecting the development of financial markets and the opening up of the economy, the use of broad money as an intermediate target has been de-emphasised, but the growth in broad money (M 3) continues to be used as an important indicator of monetary policy. The composition of reserve money has also changed with net foreign exchange assets currently accounting for nearly one-half. A multiple indicator approach was adopted in 1998-99, wherein interest rates or rates of return in different markets (money, capital and government securities markets) along with such data as on currency, credit extended by banks and financial institutions, fiscal position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions in foreign exchange available on high frequency basis were juxtaposed with output data for drawing policy

The thrust of monetary policy in recent years has been to develop an array of instruments to transmit liquidity and interest rate signals in the short-term in a more flexible and bi-directional manner. A Liquidity Adjustment Facility (LAF) has been introduced since June 2000 to precisely modulate short-term liquidity and signal shortterm interest rates. The LAF, in essence, operates through repo and reverse repo auctions thereby setting a corridor for the short-term interest rate consistent with policy objectives. There is now greater reliance on indirect instruments of monetary policy. The RBI is able to modulate the large market borrowing programme by combining strategic debt management with active open market operations. Bank Rate has emerged as a reasonable signally rate while the LAF rate has emerged as both a tool for liquidity management and signaling of interest rates in the overnight market. The RBI has also been able to use open market operations effectively to manage the impact of capital flows in view of the stock of marketable Government securities at its disposal and development of financial markets brought about as part of reform. The responsibility of the RBI in undertaking reform in the financial markets has been driven mainly by the need to improve the effectiveness of the transmission channel of monetary policy. The developments of financial markets have therefore, encompassed regulatory and legal changes, building up of institutional infrastructure, constant finetuning in market microstructure and massive upgradation of technological infrastructure.

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Since the onset of reforms, a major focus of architectural policy efforts has been on the principal components of the organised financial market spectrum: the money market, which is central to monetary policy, the credit market, which is essential for flow of resources to the productive sectors of the economy, the capital market, or the market for long-term capital funds, the Government securities market which is significant from the point of view of developing a risk-free credible yield curve and the foreign exchange market, which is integral to external sector management. Along with the steps taken to improve the functioning of these markets, there has been a concomitant strengthening of the regulatory framework. The medium-term objective at present is to make the call and term money market purely inter-bank market for banks, while non-bank participants, who are not subject to reserve requirements, can have free access to other money market instruments and operate through repos in a variety of instruments. The Clearing Corporation of India Ltd is expected to facilitate the development of a repo market in a risk free environment for settlement. A phased programme for moving out of the call money market has already been announced and the final phase-out will coincide with the implementation of the Real Time Gross Settlement (RTGS) system.

11 With the switchover to borrowings by Government at market related interest rates through auction system in 1992, and more recently, abolition of system of automatic monetisation, it was possible to progress towards greater market orientation in Government securities. Further reforms in the Government Securities market have resulted in the rationalization of T-Bills market, increase in instruments and participants, elongated the maturity profile, created greater fungibility in the secondary market, instituted a system of delivery versus payment, strengthened the institutional framework through Primary Dealers and more recently Clearing Corporation, and enhanced the transparency in market operations. With the switchover to borrowings by Government at market related interest rates through auction system in 1992, and more recently, abolition of system of automatic monetisation, it was possible to progress towards greater market orientation in Government securities. Further reforms in the Government Securities market have resulted in the rationalization of T-Bills market, increase in instruments and participants, elongated the maturity profile, created greater fungibility in the secondary market, instituted a system of delivery versus payment, strengthened the institutional framework through Primary Dealers and more recently Clearing Corporation, and enhanced the transparency in market operations. Clarity in the regulatory framework has also been established with the amendment to the Securities Contracts Regulation Act. A Negotiated Dealing System for trading in Government Securities is in operation. Further developments in the Government Securities market hinges on legislative changes consistent with modern technology and market practices; introduction of a RTGS system, integrating the payments and settlement systems for Government securities and standardisation of practices with regard to manner of quotes, conclusion of deals and code of best practices for repo transactions. The movement to a market-based exchange rate regime took place in 1993. Reforms in the foreign exchange market have focused on market development with prudential safeguards without destabilizing the market. Thus, authorized dealers have been given the freedom to initiate trading position in the overseas markets; borrow or invest funds in the overseas markets (up to 15 per cent of tier I capital, unless otherwise approved); determine the interest rates

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12 (subject to a ceiling) and maturity period of Foreign Currency Non-Resident (FCNR) deposits (not exceeding three years); and use derivative products for asset-liability management. These activities are subject to net overnight position limit and gap limits, to be fixed by them. Other measures such as permitting forward cover for some participants, and the development of the rupee-forex swap markets also have provided additional instruments to hedge risks and help reduce exchange rate volatility. Alongside the introduction of new instruments (cross-currency options, interest rates and currency swaps, caps/collars and forward rate agreements), efforts were made to develop the forward market and ensure orderly conditions. Foreign institutional investors were allowed entry into forward markets and exporters have been permitted to retain a progressively increasing proportion of their earnings in foreign currency accounts. The RBI conducts purchase and sale operations in the forex market to even out excess volatility. In respect of the financial markets, linkage between the money, Government Securities and forex markets has been established and is growing. The price discovery in the primary market is more credible than before and secondary markets have acquired greater depth and liquidity. The number of instruments and participants in the markets has increased in all markets, the most impressive being the Government Securities market. The institutional and technological infrastructures that have been created by the RBI to enable transparency in operations and secured settlement systems. foreign institutional investors has strengthened the integration between the domestic and international capital markets.

Credit Delivery The reforms have accorded greater flexibility to banks to determine both the volume and terms of lending. The RBI has moved away from microregulation of credit to macro management. External constraints to the banking system in terms of the statutory premptions have been lowered. All this has meant greater lendable resources at the disposal of banks. The movement towards competitive and deregulated interest rate regime on the lending side has been completed with linking of all lending rates to PLR of the concerned bank and the PLR itself has been transformed into a benchmark rate. As a result of reforms, borrowers are able to the get credit at lower interest rates. The lending rate between 1991-92 and 2001-02 has declined from about 19.0 per cent to current levels of 10.5-11.0 per cent. The actual lending rates for top rated borrowers could even be lower since banks are permitted to lend at below Prime Lending Rate (PLR). Further, since banks invest in Commercial Paper (CP), which is more directly related to money market rates, many top rated borrowers are able to tap bank funds at rates below the prime lending rates. These developments have been possible to banks because the overall flexibility now available in the interest rate structure has enabled them to reduce their deposit rates and still improve their spreads. In terms of priority sector credit also, the element of subsidisation has been removed although some sort of directed lending to Agriculture, Small Scale Entry of New Banks in the Private Sector As per the guidelines for licensing of new banks in the private sector issued in January 1993, RBI had granted licenses to 10 banks. Based on a review of experience gained on the functioning of new private sector banks, revised guidelines were issued in January 2001. The main provisions/requirements are listed below:Initial minimum paid-up capital shall be Rs. 200 core; this will be raised to Rs. 300 core within three years of commencement of business.

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 Promoters contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time; their contribution of 40 per cent shall be locked in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one year of banks operations. Initial capital other than promoters contribution could be raised through public issue or private placement. While augmenting capital to Rs. 300 core within three years, promoters need to bring in at least 40 percent of the fresh capital, which will also be locked in for 5 years. The remaining portion of fresh capital could be raised through public issue or private placement. NRI participation in the primary equity of the new bank shall be to the maximum extent of 40 per cent. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter, equity participation shall be limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI contribution to foreign equity can be met through contribution by designated multilateral institutions. No large industrial house can promote a new bank. Individual companies connected with large industrial houses can, however, contribute up to 10 per cent of the equity of a new bank, which will maintain an arms length relationship with companies in the promoter group and the individual company/ies investing in equity. No credit facilities shall be extended to them. NBFCs with good track record can become banks, subject to specified criteria A minimum capital adequacy ratio of 10 per cent shall be maintained on a continuous basis from commencement of operations. Priority sector lending target is 40 per cent of net bank credit, as in the case of other domestic banks; it is also necessary to open 25 per cent of the branches in rural/semiurban areas.

Our industry did not oppose the entry of private bankers because we knew they will not be able to reach out to the rural markets states, G.M. Bhakey, president of the State Bank of India Officers Association. Even after privatization not more than 10 per cent of the Indian population can afford to open accounts in private banks.The new generation private sector banks have made a strong presence in the most lucrative business areas in the country because of technology upgradation. While, their operating expenses have been falling as compared to the PSU banks, their efficiency ratios (employees productivity and profitability ratios) have also improved significantly. The new private sector banks have performed very well in the FY2000. Most of these banks have registered an increase in net profits of over 50%. They have been able to make significant inroads in the retail market of the public sector and the old private sector banks. During the year, the two leading banks in this sector had set a new trend in the Indian banking sector. HDFC Bank, as a part of its expansion plans had taken over Times Bank. ICICI Bank became the first bank in the country to list its shares on NYSE. The Reserve Bank of India had advised the promoters of these banks to bring their stake to 40% over a time period. As a result, most of these banks had a foreign capital infusion and some of the other banks have already initiated talks about a strategic alliance with a foreign partner. The main problems concerning the nationalized / state sector banks are as follows: 1. Large number of unprofitable branches 2. Excess staffing of serious magnitude 3. Non Performing Assets on account of politically directed lending and industrial recession in last few years 4. Lack of computerization leading to low service delivery levels, nonreconciliation of accounts, inability to control, misuse and fraud etc 5. Inability to introduce profitable new consumer oriented products like credit cards, ATMs etc

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The privates edge Technology- The private banks have used technology to provide quality service through lowercost delivery mechanisms. The implementation of new technology has been going on at very rapid pace in the private sector, while PSU banks are lagging behind in the race.Declining interest rates- in the present scenario of declining interest rates, some of the new private banks are better able to manage the maturity mix. PSU Banks by and large take relatively long-term deposits at fixed rates to lend for working capital purposes at variable rates. It therefore is negatively affected when interest rates decline as it takes time to reduce interest rates on deposits when lending has to be done at lower interest rates due to competitive pressures.NPAs- The new banks are growing faster, are more profitable and have cleaner loans. Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money.Convergence- The new private banks are able to provide a range of financial services under one roof, thus increasing their fee based revenues. ANALYSIS OF INDIAN FINANCIAL REFORMS WITH REFERENCE TO BANKING SECTOR Analysis of Indian Financial Sector reveals that it is at present going through a phase of stable growth rate which is experiencing a upward swing. The rise can be maintained over a long period by keeping the inflation down. The financial sector in India has experienced a growth rate of 8.5% per annum. The rise in the growth rate suggests the growth of the economy. The financial policies and the monetary policies are able to sustain a stable growth rate. The reforms pertaining to the monetary policies and the macro economic policies over the last few years have influenced the Indian economy to the core. The major step towards opening up of the financial market further was the nullification of the regulations restricting the growth in the financial sector. To maintain such a growth for a long term the inflation has to come down further. Analysis of the Indian Banking sector

Banking in India Reforms and Reorganization The banking industry in India is undergoing a transformation since the beginning of liberalization. Interest rates have declined considerably but there is evidence of underlending by the banks. The social objectives of banking measured in terms of rural credit are, expectedly, taking a back seat. The performance of the banks has improved slightly over time with the public sector banks doing the worst among all banks. The banking sector as a whole and particularly the public sector banks still suffer from considerable NPAs, but the situation has improved over time. New legal developments like the SARFAESI Act provide new options to banks in their struggle against NPAs. The adoption of Basel-II norms however imply new challenges for Indian banks as well as regulators. Over time, the Indian banking industry has become more competitive and less concentrated. The new private sector banks have been the most efficient though the recent collapse of Global Trust bank has raised issues about efficiency and regulatory effectiveness. ancient business in India with some of oldest references in the writings of Manu. Bankers played an important role during the Mogul period. During the early part of the East India Company era, agency houses were involved in banking. Modern banking (i.e.

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in the form of joint-stock companies) may be said to have had its beginnings in India as far back as in 1786, with the establishment of the General Bank of India. Three Presidency Banks were established in Bengal, Bombay and Madras in the early 19th century. These banks functioned independently for about a century before they were merged into the newly formed Imperial Bank of India in 1921. The Imperial Bank was the forerunner of the present State Bank of India. The latter was established under the State Bank of India Act of 1955 and took over the Imperial Bank. The Swadeshi movement witnessed the birth of several indigenous banks including the Punjab National Bank, Bank of Baroda and Canara Bank. In 1935, the Reserve Bank of India was established under the Reserve Bank of India Act as the central bank of India. In spite of all these developments, independent India inherited a rather weak banking and financial system marked by a multitude of small and unstable private banks whose failures frequently robbed their middle-class depositors of their lifes savings. After independence, the Reserve Bank of India was nationalized in 1949 and given wide powers in the area of bank supervision through the Banking Companies Act (later renamed Banking Regulations Act). The nationalization of the Imperial bank through the formation of the State Bank of India and the subsequent acquisition of the state owned banks in eight princely states by the State Bank of India in 1959 made the government the dominant player in the banking industry

Banking Sector Reforms Has To Be Liberalized: Economic Survey 2008-09 The Economic Survey 2008-09 which was presented by the Union Finance Minister, Pranab Mukherjee, has called for the liberalization of the reforms related to banking and financial markets. The reforms related to enhancing foreign investments in the banks in a step by step fashion as well as lifting up of the bans on certain commodities have also been put forward by the survey. The survey also has demanded for an accelerated passage of the Banking Regulations (Amendment) Bill. It also has added that individuals who have a very high net worth has to be given permission for direct investment in capital markets. According to the survey report, this bill will help in the better management of liquidity requirements and will help in the liberalization of the

regulations related to investment banking. The ban on the commodity futures contracts has been sought to be removed to restore price discovery and price-risk management. Futures trading in rice, urad and toovar has been suspended indefinitely, and that of sugar till Dec 31. The survey has also recommended that the government must liberalise spot and futures currency markets of India. The survey suggested that the financial market regulations must be under the power of Securities and Exchanges Board of India (SEBI). Additionally, it has favoured liberalising of the investment norms of insurance and pension funds and tax incentives for the development of the long-term debt markets. In a move which will have important impact on the Indian corporate debt market, the Economic Survey has advised the government to allow the repurchase of the corporate bonds, thus providing an exit route for the investors.

Banking sector in India - need for reforms

After liberalisation of the economy in 1991, the Indian banking sector witnessed tremendous growth and it now enjoys a global footprint. Apart from the growth the sector in the last decade and a half, the regulatory bodies like Reserve Bank of India also established a vibrant regulatory framework which is at par with the best economies in the world.

However, the recent economic crisis has exposed the vulnerability of the financial systems across the globe. It has at the same time established the importance of the banking sector in fuelling sustainable growth of the country. Though the Indian banks have performed well on the parameters of asset quality and profitability, there are several notable limitations which hamper the growth of the sector. The first and foremost is the low penetration of the Indian banking system. Other than that, outdated labour laws, 39

restriction on capital availability, weak corporate governance and fragmented nature of the banking industry are the other major impediments.

There are several other challenges and issues that the banking industry face in the changing global scenario. Apart from their traditional banking functions, Indian banks have now started offering several value added product and services both in the wholesale as well as retail banking segments. Hence there is an increased demand for quality manpower for marketing and sales operations.

Though, at present, the interest rates are low due to the efforts of the government to tame the current economic crisis, in normal circumstances Indian banks face stiff competition from global banks. The levels of services rendered by the Indian banks still leave a lot more to be desired. Only those banks which are able to meet the enhanced expectations of the costumers will be able to survive in the churning that the sector is undergoing currently. The banking institutions on their parts should find out new ways and means in terms of mergers & acquisitions and developing new business models to tap new markets. To meet these challenges and sustain the growth in the banking sector, several measures will have to be undertaken by policy makers - The Reserve Bank of India, the Finance Ministry and other regulatory bodies. The government and other regulatory bodies will have to constantly keep a tab on the banking sector scenario and ensure constant policy and regulatory interventions. The government should ensure that a better industry structure evolves with greater consolidation of the banking industry. It should not only provide regulatory coverage to the banks but also give them more freedom to deploy their resources in a profitable manner. The labour laws too need to be evolved in sync with the changing times. While promoting the sector, the government should also maintain a focus on its social sector obligations and give proper guarantees and market subsidies to the banking organisations in this regard. Banks should be encouraged to use technology and other innovative measures to tap the lower income and rural markets.

CHAP. OTHER REFORMS RELATED TO INDIAN ECONOMY Stock market reforms in India India currently has two major stock exchanges, namely the Bombay Stock Exchange and the National Stock Exchange. The provision for liquidity is a major function of a stock exchange. There have been important structural changes in the Indian financial sector. One of them is the stock market reform. The Bombay Stock Exchange (BSE) used to be the premier exchange in India until 1994. The National Stock Exchange (NSE) began its operations in 1994 and has dramatically transformed the Indian stock markets. From the inception NSE started stealing a march over BSE both in terms of trading performance and in establishing itself as the foremost stock exchange in the country. Despite a seemingly high rate, India faced a severe shortage of investible resources. By early 1990s it was recognized that it is crucial to raise funds from abroad to fill the gap. Financial sector reforms were needed to remedy the structural weakness and inefficiencies in the stock markets, primary markets, banking and insurance sectors. Reforms were required in order to boost investor confidence and broaden the investor base. The Indian corporate sector demanded these reforms in order to reduce the cos

Financial Sector Reforms in Indian bank Institutional Measures 41

 Administered interest rates on government securities were replaced byan auction system for price discovery. Automatic monetisation of fiscaldeficit through the issue of ad hoc Treasury Bills was phased out. Primary Dealers (PD) were introducedas market makers in the government securities market. For ensuring transparency in the trading of government securities.Delivery versus Pay (DvP) settlement system was introduced. Repurchase agreements (repo) was introduced as a tool of shortterm liquidity adjustment. Subsequently, the Liquidity Adjustment Facility (LAF) was introduced. LAF operates through repo and reverse auctions to set up a corridor for short-term interest rate. LAF has emerged as the tool for both liquidity management and also signaling device for interest rates in the overnight market. Market Stabilisation Scheme (MSS) has been introduced, which has expanded the instruments available to the Reserve Bank formanaging the surplus liquidity in the system. Increase in Instruments in Government Securities Market Debt Market Reforms Major reforms have been carried out in the government securities (G-Sec) debt market. In fact, it is probably correct to say that a functioning G-Sec debt market was really initiated in the 1990s. The system had to essentially move from a strategy of preemption of recourse from banks at administered interest rates and through monetisation to a more market oriented system. Prescription of a statutory liquidity ratio (SLR), i.e. the ratio at which banks are required to invest in approved securities, though originally devised as a prudential measure, was used as the main instrument of pre-emption of bank resources in the pre-reform period. The high SLR requirement created a captive market for government securities, which were issued at low administered interest rates. After the initiation of reforms, this ratio has been reduced in phases to the statutory minimum

level of 25%. Over the past few years numerous steps have been taken to broaden and deepen the Government securities market and to raise the levels of transparency. Automatic monetisation of the Governments deficit has been phased out and the market borrowings of the Central Government are presently undertaken through a system of auctions at marketrelated rates. The key lesson learned through this debt market reform process is that setting up such a market is not easy and needs a great deal of proactive work by the relevant authorities. An appropriate institutional framework has to be created for such a market to be built and operated in sustained manner. Legislative provisions, technology development, market infrastructure such as settlementE Forex Market Reforms The Indian forex exchange market had been heavily controlled since the 1950s, along with increasing trade controls designed to foster import substitution. Consequently, both the current and capital accounts were closed and foreign exchange was made available by the RBI through a complex licensing system. The task facing Indian in the early 1990s was therefore to gradually move from total control to a functioning forex market. The move towards a market-based exchange rate regime in 1993 and the subsequent adoption of current account convertibility were the key measures in reforming the Indian foreign exchange market. Reforms in the foreign exchange market focused on market development with prudential safeguards without destabilizing the market (Reddy, 2002 a). Authorised Dealers of foreign exchange have been allowed to carry on a large range of activities. Banks have been given large autonomy to undertake foreign exchange market a large number of products have been introduced and entry of newer players has been allowed in the market. The Indian approach to opening the external sector and developing the foreign exchange market in a phased manner from current account convertibility to the ongoing process of capital account opening is perhaps the most striking success relative to other emerging market economies. There have been no accidents in this process, the exchange rate has been market determined and flexible and the process has been carefully calibrated. The capital account is effectively convertible for non-residence.

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Liberalisation Measures Authorised dealers permitted to initiate trading positions, borrow and invest in overseas Authorised dealers permitted to initiate tradingpositions, borrow and invest in overseas market subject to certain specifications and ratification by respective Banks Boards. Banks are also permitted to fix interest rates on non-resident deposits, subject to certain specification, use derivative products for asset-liability management and fix overnight open position limits and gap limits in the foreign exchange market, subject to ratification by RBI. Permission to various participants in the foreign exchange market, including exporters, Indian investing abroad, FIIs, to avail forward cover and enter into swap transactions without any limit subject to genuine underlying exposure. FIIs and NRIs permitted to trade in exchangetraded derivative contracts subject to certain conditions. Foreign exchange earners permitted to maintain foreign currency accounts. Residents are permitted to open such accounts within the general limit arket subject to certain pecifications and atification by respective Banks Boards.banks are also permitted to fix interest rates non-resident deposits, subject to certain pecification, use derivative position limits and gap limits products for sset-liability management and fix overnight in the foreign echange market, subject to ratification by RBI. Permission to various participants n the foreign xchange market, including exporters,Indian investing abroad, FIIs, to avail forward over and enter into swaptransactionswithout any limit subject to genuine underlying exposure. FIIs and NRIs permitted to trade in exchangetradedderivative contracts subject to certainconditions. Foreign exchange earners permitted to maintainforeign currency accounts. Residents arepermitted to open such accounts within thegeneral limitfixed-exchange rate system to fixingthe value of rupee against a basket of currenciesand further to market-determined

floatingexchange rate regime. Adoption of convertibility of rupee for currentaccount transactions with acceptance of ArticleVIII of the Articles of Agreement of the IMF. Defacto full capital account convertibility for nonresidentsand calibrated liberalisation of transactionsundertaken forcapital account purposes inthe case of residents. Institutional Framework Replacement of the earlier Foreign ExchangeRegulation Act (FERA), 1973 by the market iendly Foreign Exchange Management Act,1999. Delegation of considerable powers by RBIto Authorised Dealers to release foreignexchange for a variety of purposes.

Increase in Instruments in forex market Development of rupee-foreign currency swap market. Introduction of additional hedging instruments,such as, foreign currency-rupee options. Authoriseddealers permitted to use innovative productslike cross-currency options, interest rate and currencyswaps, cap/collars and forward rate agreements(FRSs) in the international forex market Liberalisation Measures Authorised dealers permitted to initiate tradingpositions, borrow and invest in overseasmarket subject to certain specifications andratification by respective Banks Boards. Banks are also permitted to fix interest rateson non-resident deposits, subject to certain specification, ratification by RBI. Permission to various participants in the foreigexchange market, including exporters,Indian investing abroad, FIIs, to avail forwardcover and enter into swap transactionswithout any limit subject to genuine underlying use derivative products forasset-liability management and fix overnightopen position limits and gap limits in the foreignexchange market, subject to

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exposure. FIIs and NRIs permitted to trade in exchangetradedderivative contracts subject to certain conditions. Foreign exchange earners permitted to maintainforeign currency accounts. Residents arepermitted to open such accounts within thegeneral limit of US$25,000 per Reforms in other segments Measures aimed at establishingprudential regulation andsupervision and also competition and efficiency enhancing measureshave also been introduced for nonbankfinancial intermediaries aswell. Towards this end, non-bankingfinancial companies (NBFCs),especially those involved in publicdeposit taking activities, have been brought under the regulation ofRBI. Development Finance Institutions (DFIs), specialized term-lendinginstitutions, NBFCs, UrbanCooperative Bank and PrimaryDealers have all been broughtunder the supervision of the Boardfor Financial Supervision (BFS).With the aim of regulatory convergencefor entities involved insimilaractivities, prudential regulationand supervision norms were alsointroduced in phases for DFIs,NBFCs and cooperative banks.The insurance business remained within the confined of publicownership until the late 1990s.Subsequent to the passage of theInsurance Regulation and DevelopmentAct in 1999, several changeswere initiated, including allowingnewer players/joint ventures toundertake insurance business onrisksharing/commission basis.With the objective of improvingmarket efficiency, increasingtransparency, integration ofnational markets and prevention ofunfair practices regarding trading,apackage of reforms comprisingmeasures to liberalise, regulate anddevelop capital market was introduced.An important step has beenthe establishment of the Securitiesand Exchange Board of India(SEBI) as the regulator for equity markets. Since 1992, reform measuresin the equity market havefocused mainly on regulatoryeffectiveness, enhancing competitiveconditions, reducing informationasymmetries, developingmodern technological infrastructure,mitigating transactioncosts and controlling of speculationin the securities market.Another important

developmentunder the reform process has beenthe opening up of mutual funds totheprivate sector in 1992, whichended the monopoly of Unit Trustof India (UTI), a public sectorentity. These steps have been buttressedby measures to promote market integrity.The Indian capital market wasopened up for foreign institutionalinvestors (FIIs) in 1992. The Indiancorporate sector has been allowedto tap international capital marketsthrough American Depository Receipts(ADRS), Global DepositoryReceipts (GDRS), Foreign CurrencyConvertible Bonds (FCCBs)and External Commercial Borrowing(ECBs). Similarly, OverseasCorporate Bodies (OCBs) and nonresidentIndian(NRIs) have beenallowed to invest in Indian companies.FIIs have been permitted in alltypes of securities including Governmentsecurities and they enjoy full capital convertibility. Mutualfunds have been allowed toopen offshore funds to invest inequities abroad. Reform in Monetary Policy Framework The transition of economicpolicies in general, and financialsector policies in particular, from acontrol oriented regime to a liberalizedbut regulated regime has alsobeen reflectedin changes in thenature of monetary management. While the basic objectives of monetarypolicy, namely price stability and ensuring adequate credit flow to support growth, have remained unchanged, the underlying operating environment for monetary policy ahs under gone a significant transformation. An increasing concern is the maintenance of financial stability. The basic emphasis of monetary policy since the initiation of reforms has been to reduce market segmentation in the financial sector through increase in the linkage between various segments of the financial market including money, government securities and forex market. The key policy development that has enable a more independent monetary policy environment was the discontinuation of automatic monetization of the governments fiscal deficit through an agreement between the Government and RBI in 1997. The enactment of the Fiscal Responsibility and Budget management Act has strengthened this further. (Based on lectures by the author, including in Washing D.C on September 2, 2004) I

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K.V.PENDHARKAR COLLEGE OF ARTS, SCIENCE & COMMERCE. BANKING & INSURANCE DEPT.

T.Y.B.COM.(B&I) SEMESTER 5 PROJECT ON : REFORMS IN INDIAN BANKING SECTOR

NAME:DARSHANA NAMDEV AMKAR. ROLL NO.116301

GUIDENCE BY: PROF. OMKAR DATAR.

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SR.NO.

PARTICULARS

1 MEANING & ORIGIN OF BANK 2 3 4 5 6 7 8 9 HISTORY OF BANKING IN INDIA INDIAN FINANCIAL SECTOR REFORMS WITH REF.TO BANKING SECTOR POSITION LIMIT SUBJECT TO RBI APPROVAL SECOND PHASE OF FINANCIAL FINANCIAL & BANKING SECTOR REFORM 1997 BANKING SECTOR REFORM 1999-2000 BANKING IN INDIA REFORMS & REORGANISATION ENTRY OF NEW BANKS IN PRIVATE SECTOR INVESTMENT IN INDIA PRIVATE BANKING REFORM & PUBLIC BANKING REFORMS 10 11 12 13 14 15 16 17 18 19 20 21 NEED FOR RFORM BANKING IN INDIA CUISTOMER EXPECTATION & PERCEPTION ACROSS THE INDIAN BANKING SECTOR BANKING SECTOR IN INDIA HAQS TO BE LIBERLISED ECONOMICN REFORMS OF THE BANKING SECTOR INSTITUTIONAL ASPECTS OF REFORM POLICY ENVIORNMENT CHANGING POLICY FRAMEWORK NON-BANKING FINANCIAL COMPANIES REFORM MONETARY & FINANCIAL SECTYOR REFORM IN INDIA REFORMS IN MONETARY POILICY FRAMEWORK ANALYSIS OF FINANACIAL REFORMS STOCK MARKET REFORMS IN INDIA INCREASE IN GOVT. SECURITIES, FOREX MARKET & REFORMS IN OTHER SEGMENTS 22 IMPACT OF GLOBALISATION ON BANKING SECTOR IN INDIA