INTRODUCTION

Since 1991, structural reforms have been implemented in India, in several sectors including
trade, industry, foreign investment, exchange rate, financial sector and monetary and fiscal
policy. The approach guiding this process has been, to introduce reform at a gradual pace
combined with effective and appropriate regulations and intervention policies. Introduction of
a broad consensus for reform have been pursued aggressively. Today, these all are getting
reflected in the renewed confidence in the economy, as represented by the sustained growth in
agriculture, revival of industrial output, substantial reduction in the inflation rate and stability
in the external sector, characterised by a high export performance and increased foreign capital
inflows. Reform of the domestic financial sector did not form part of the initial set of reforms,
but events quickly moved it to forefront. Today, financial sector restructuring, liberalisation
and deregulation have become more prominent on the reform agenda. The 'Financial Sector'
covers the banking system and nonbanking financial system. In India, the Banking sector
accounts for two-thirds of the assets of the formal financial sector. The Non-Bank financial
sector comprises the capital market, development finance institutions, insurance and mutual
funds. "Banks" are at the heart of the financial system and reform of the banking system is the
most pressing elements in financial reforms. But an efficient financial sector, also needs, other
financial institutions which offers various services to ultimate borrowers and lenders in an
efficient manner.
This was prominently revealed by 1992 scarcity scam triggered by Harshad Mehta. In this
situation the quality of investment portfolio of the banks deteriorated and culture of’ non-
recovery’ developed in the public sector banks which led to a severe problem of non-
performing assets (NPA) and low profitability of banks. Financial sector reforms aim at
removing all these weaknesses of the financial system.
Under these reforms, attempts have been made to make the Indian financial system more
viable, operationally efficient, more responsive and improve their allocative efficiency.
Financial reforms have been undertaken in all the three segments of the financial system,
namely banking, capital market and Government securities market.

ROLE OF THE FINANCIAL SECTOR

The financial sector reform in India, is an integral part of the overall programme of economic
reforms, aimed at improving productivity and efficiency. Until recently, the financial sector-
economic growth relationship had not received adequate attention in the economic literature.
In classical economics, analysis of the nature of equilibrium between planned savings and
investment is made, linking it to the process of financial intermediation, which facilitates the
transfer of savings from surplus units to deficit units. Even the neo-classical approach to
economic growth had ignored the financial component. Similarly, the theory of finance largely
along micro considerations, with little explicit analysis of the larger implications for the real
economic growth. The early literature in economics concerned itself with only the question
whether money alone really mattered. As J. S. Mill, had remarked that, there can be nothing in
the economy less important than Money
The financial intermediaries, essentially provides three 'Transformation' services.
1. Liability-asset and size transformation i.e. mobilisation of funds and their allocation,
provision of large loans on the basis of numerous small deposits.
2. Maturity transformation i.e. mobilisation of funds and providing borrowers long
term loans which are better matched to the cash flows generated by their investments, and
finally,
3. Risk transformation, i.e. transforming and distributing risk through diversification, so
that associated with investors are reduced for savers.
4.Functional efficrency, is measured, by the extent to which transaction cost of borrowers
and lenders is reduced. More generally, analysts talk of 'operational efficiency and
allocational efficiency'. While the former, relates to the transaction costs, the later, deals with
the distribution of mobilised funds, among competing demands. Functional efficiency, must
therefore, relate to: -
• The soundness of the appraisals, as measured by the level of overdues.
• The resource cost of specific operations, and
• The quality and speed of delivery of services.

MAJOR ISSUES IN FINANCIAL SECTOR REFORM

Financial reforms, which were induced in 1991-92 based on the recommendations of the
Narasimham Committee, came as a breath of fresh air, as banks were given a chance to recover
lost ground. The path and direction are clear, it is therefore, necessary to analyse and conjecture
the future of banking, which will by typified by intense competition, as it would act as the
fulcrum of all banking activity. The major issues in the financial sector are: -
1. Role of banks in the new environment of LPG Package,
2. Problem of profitability and efficiency,
3. Solution towards Non-Performing Assets,
4. Recapitalisation of banks,
5. Deployment of credit in the Priority Sector,

The reforms in the financial system are linked to the question of refoms in the real i.e. non-
financial sectors. In the planned system, where factors of production are owned by the State,
no need for elaborate financial system was felt. Planning authorities vwjuld directly take bulk
of decisions. In a decentralised market economy, on the other hand, markets perform a co-
ordinating role. Financial system is particularly important in mobilisation of societal savings
and its efficient deployment in different investible avenues. It also provides a payment
mechanism, which is critically important for growth in production and trade. As long as,
money and financial system function smoothly, their importance is not realised, but defective
financial system would adversely affect almost all other sectors.
CURRENT STATUS OF BANKING SECTOR REFORMS IN INDIA
This section, of Banking Sector Reforms, basically refers to the period till 1999.
REDUCTION OF PRE-EMPTIONS: -
1. Cash Reserve Ratio (CRR): -
• CRR is at 11 percent on NDTL (excluding zero CRR liabilities).
• 10 percent incremental CRR on FCNR (B) deposits, over the level as on April
11, 1997.
• In view of exemption of CRR for certain categories of foreign currency liabilities and net
inter-banks liabilities, effective CRR is 9.75 percent.
• Interest on cash balances, maintained with RBI is paid to 'Scheduled Commercial Banks
(SCBs) at 4 percent per annum on eligible cash balances over the minimum 3 percent of CRR.
2. Statutory Liquidity Ratio (SLR): -
• SLR is 25 percent on NDTL, which is the minimum prescribed, under the Banking Regulation
Act.

DEVELOPMENT IN INDIAN FINANCIAL SYSTEM

While economic theory may have taken a long time to recognise the importance of financial
sector in real world, the governments in the third world recognised the importance of
developing financial institutions and markets. This was true of India, as well where the RBI
took upon itself to set up an array of specialised institutions to meet the financing needs of
different segments in the economy. Capital markets were not developed and not considered to
be sophisticated enough to mobilise funds on the required scale. Commercial banks too were
concentrated in cities and were financing, mainly domestic and foreign trade transactions.
Hence, creation of a proper institutional structure became government's priority, initially, the
government gave priority to setting up new institutions; later the focus shifted to taking over
existing private institutions in its fold. The financial system grew with the national economy,
and became diversed.

REFORMING THE FINANCIAL SECTOR:

The 'Financial Sector Reforms' in India is, an integral part of the overall programme of
economic reforms, aimed at improving productivity and efficiency. In India, reform of the
domestic financial sector did not form part of the initial set of reforms, but events quickly
moved it to forefront. Today, financial sector restructuring, liberalisation and deregulation have
become more prominent on the reform agenda. In any financial sector reform, the institutions
immediately affected are the 'Banks', since they typically dominate the financial systems, in
the early stages of financial development. Banks are central to providing short-term financing
to the various economic entities. Banks are also distinguishable from other financial institutions
by a unique characteristic, which gives them power to provide means of payment in non-cash
transactions. As the reform of the financial system takes its root, it is the banking system which
comes to face increasing competition from non-banks and the capital markets. A major lesson
to be learnt from the experiences of the other countries which have gone through a programme
of financial sector reform, is that, reforms are successful, only if they are accompanied by fiscal
consolidation, moderate inflation and no sharp appreciation's in the real effective interest rate.
The problem which the financial sector reforms, ran into in the Southern cone countries were,
because of uncontrolled inflation and sharp appreciation in real exchange rate.
The 3 major building blocks of the financial sector reform in India have been; -
1. Removing or relaxing the external constraints;
2. Introduction of prudential norms; and
3. Institutional strengthening.
The chief merit of reform process, has been the cautions sequencing of reforms and the
consistent and the mutually reinforcing character of the various measures taken. Even as the
new prudential norms are being introduced, the capital base of the banks has been strengthened
and organisational improvements are being put in place. Through these reform measures,
foundation for an efficient and a well-functioning banking system is laid down. A renewed and
a reinvigorated banking system can play an important role in accelerating economic growth.
Banking system is on the threshold of a second revolution. It has, however miles to go. But the
steps that are being taken, are in right direction.
NARASIMHAM COMMITTEE'S REPORT ON BANKING SECTOR REFORMS
(1998)
The Committee on the 'Banking Sector Reform' with Chairman Shri. M. Narasimham, was
constituted on December 26, 1997 to review the progress of implementation of financial sector
reforms recommended by the Committee on Financial Systems (CFS) (1991), and to suggest
remedial measures for strengthening the banking system, covering areas of banking policy,
institutional structure, supervisory system, legislative and technological changes. These
recommendations of the Committee, submitted in April 1998, were considered in consultation
with the Government of India and some of the decisions were announced on October 30, 1998
as part of 'Mid-Term Review of Monetary and Credit Policy for 1998-99'.

POST REFORM STATUS IN INDIAN BANKING SYSTEM

The recommendations of the Narasimham Committee, constitute a 'landmark' in the evolution
of the banking policy being centred around, transforming Indian banking from a highly
regulated to a more market-oriented economy, albeit in a phased manner. In spite of difficulties,
commercial banks have gone into the 'new" areas of the banking business. They have very
positively responded to the clarion call, not only as 'catalysts' of developmental changes but as
'Torch bearers' ushering in an egalitarian society. This section, of 'Post-reform Status' refers to
the status, after the period from 1992 onwards, i.e. after the implementation of
recommendations of Narasimham Committee by the GDI. Reform measures, undertaken on a
year-wise basis is presented.
Cash Reserve Ratio: - (CRR) • In 1992-93, the incremental CRR of 10 percent on NDTL was
withdrawn. • From 1993-November. 1997, average CRR reduced in phases from 15 percent to
9.5 percent. • In 1994, CRR was increased temporarily for monetary policy reasons. • In 1997,
Inter-bank liabilities were exempted from CRR. During the period, average CRR of 15 percent
was imposed gradually on Non-Resident deposits and subsequently removed. In April 1997,
10 percent incremental CRR was From December, 1997 to January 1998 CRR was increased
in phases by 1 percent temporarily for stabilising forex markets and then reduced to 10 percent.
• In 1998, CRR hiked to 11 percent for stabilising the forex markets.
Statutory Liquidity Ratio (SLR): - • From 1992-94, SLR was reduced in phased manner,
through a stepper reduction SLR on incremental deposits and by bringing forward the base date
every time. • SLR on increase in NDTL over the level as on September 30, 1994 was reduced
to 25 percent. The base SLR level was reduced to 33.75 percent. • In April, 1997, Inter-Bank
liabilities were exempted from SLR. • In October, 1997, SLR reduced to 25 percent on entire
NDTL, which is the minimum stipulated under Section 24, of Banking Regulation Act. Banks
are maintaining on average above 30 percent.

CONCLUSION
The paper argues that the present financial regulatory system poses challenges for the growth
of a competitive and dynamic financial system. While some reforms were introduced in the
nineties, bigger challenges persist. Sectoral orientation of financial regulation, missing
markets, limited focus on consumer protection, lack of competition and financial repression
are some of the problems with the present financial system. Present approach to financial
regulatory reform has been piecemeal with a focus on addressing one narrow problem at a time.
As an outcome, the financial regulatory system is inconsistent with the general direction of
financial market growth. Drawing on the fundamental premise that any form of state
intervention must be guided by an understanding of market failures and recommendations of
expert committees, the FSLRC came up with a modern, coherent, non-sectoral law (IFC) with
nine areas of state intervention. Consumer protection, micro-prudential regulation, resolution,
systemic risk regulation, capital controls, monetary policy, public debt management,
development and redistribution and contracts, trading and market abuse are the nine areas
requiring state intervention.