FINANCIAL SECTOR

REFORMS:

What is financial sector reforms?

The financial sector reforms is the process of reforms in the financial sector
started as for back as in 1991, as a part of the integration of the Indian Financial
Market with the Global Market . For better understanding the country was facing
political uncertainty on account of the decreasing association government at the
centre. In this the foreign exchange reserve was $3 billion and sufficient to import
bill for one month and the country was slowly down in debt. The overseas investor
were easily away from investing in this country. In the domestic industrial growth
was sluggish and agricultural production did not contribute to the economy as
expected. In this situation the foreign exchange market is high and rupee is down .
Thus the credit rating agencies were not attractive at all.
Why need financial reforms?
Change in rule of thumbs
Financial institutions and markets were in bad shape
Banking sectors suffered from lack of competitions
Low capital base, low productivity
High intermediation costs
Note proper risk management system

High transaction cost

Control over pricing of financial
Banks were running at a loss or very low profit
Weakling of management and control functions
Imposition of high CRR, SLR and Directed credit programs for profit sectors

1.

First Generation Reforms:

The reforms in the financial sector can be classified into the first generation which
establish in 1991. While the Rajah Chellaiah Committee came out and
Narasimham Committee appointed in 1991.

Reduction in the Statutory Liquidity Ratio (SLR) and Cash Reserve

Ratio (CRR): The Narasimham Committee had recommended bringing down the
statutory pre-emotions such as SLR and CRR. It recommended that SLR was 35%
and reduced to 25% over the period of time and CRR was 15% and reduced to
10% over the period of time. When reduced these rations, bank would have more
funds in their hands to deploy them in remunerative loan assets. The committee
also recommended that banks should get some interest on the CRR balanced.

Redefining the priority sector: The Narasimham Committee redefined the

priority sector to include the marginal farmers, tiny sector, small business and
transport sector, village and cottage industries etc. The committee also
recommended that there should be a target of 10% of the aggregate credit fixed for
the Priority Sector at least.

Market related interest rate of government securities:

In this an active debt management policy influence the composition, maturity
structure and yield of government securities. There debt were auction of 91 days
treasury bills and 364 day treasury bills . The introduction of auction system the
interest rate on government borrowing instrument were closely market related. The
coupon rate on the 10 year state government securities was hiked 13% to 13.5% .
This is called Zero Coupon Bond.
Introduction of prudential norms:
In this in order to fall in line with international practices Capital To Risk Weighted
Asset Ratio(CRAR) were introduced in the banking sector. The CRAR was initially
fixed 8% which was brought up to 9%. Banks are required to reach 10% by march
10%.

2. Strengthening Of Recovery Mechanism:

One of the major problems faced by the commercial banks were the mounting non
performing assets. The NPA in public sector banks constituted as high as 15% as at the
end of march 1999. The weak and time consuming legal framework in the country
delayed the recovery substantially. Thus the mechanism so as to make available the
funds locked up in NPAs for recycling.

Capital Restructuring:
In the capital restructuring the large amount of non performance assets in the banks
poor them of the income from a major portion of advances. And there profitability is
came under serve and some of the banks moving to red zone. Consequently many banks
entered the capital market with public issue and came out successful while some
remained divorced from the capital market on account of their adverse financial position.

Deregulation of interest rate:

The committee observed that the prevailing structure of administered rate was highly
complex and rigid and called for deregulating it so that it reflects the emerging market
condition.
However banks were given freedom fix the prime lending rate(PLR). The PLR could
be varied periodically. The banks were given freedom to quote interest rate for loans
amounting to RS. 200000 and above. And another important movement was deregulation
the interest rate for deposit. Banks were given the permission to interest rate based on
Asset Liability Management(ALM).

 Entry of new generation banks:

In this the healthy competition among the banks , permission was granted to open
new banks in the private sector with paid up capital RS. 100 crore. New generation
banks like the IndusInd Bank, Centurion Bank were started with modern facilities.
And new generation banks are collaboration for foreign banks for short time.

Constitution of a banking supervisory board:

A John Crow former governor of bank of Canada , de regulation does not mean de
supervision, the process of reforms in the financial sector warranted closer
supervision. This felt need was addressed by carving out a department of banking
supervision out of the department of banking operation and development in RBI.
The banks were rated based on the CAMEL system of rating.

Constitution of rural infrastructure development fund:

With a view to provide funds for rural development a rural infrastructure
development fund(RIDF) was constituted under the supervision on NABARD. Such
investment attracted interest at the rate of 10% p.a.

Capital market reforms:

In this SEBI took control over the capital market. In 1996 the National Securities
Depositaries Limited(NSDL) was started to enable paperless trading. The
dematerialization process introduce by the NSDL helped investor to convert
physical certificates into electronic balances maintain their account.

Regulations relating to NBFCs:

The non banking finance sector also went through the process of reforms. The new
regulation introduced necessitating the NBFCs to register with Reserve Bank Of
India. These measure regulated the operation of NBFCs in the country and many of
those companies which followed unethical practices had to be close down.

Insurance sector reforms:

The Malhotra Committee appointed for the restructuring of the Insurance sector
suggested the privatization of insurance business as well as formation of an
Insurance Regulatory and Development Authority(IRDA).The Insurance bill has
been passed in parliament and IRDA has started. The insurance bill permits private
companies that have net worth RS. 500 crore to start insurance business in the
country in collaboration with foreign participants. Foreign equity participation is
restricted to 26%.

3. SECOND GENERATION REFORM

Introduction of structural reforms in the banking and financial market to

overcome systematic shock. The second Narasimham Committee Report
suggested various measures in this report. Some of these measures are:

1.

A phased enhancement of minimum capital adequacy requirement from

8% to 10% to be made over the next 4 years. The new norms require
banks to maintain CRR at 10% instead of achieving the ratio as on the
balance sheet date.

2.

Present income and provisioning standards need to be upgraded to

conform to international standards. As per the new norms, provision has
to be made on the standard assets also, with effect from March 2000.

3.

Gross NPA has to be brought down to 5%% and the net NPA has to be
brought down to 2.5% within 3 to 5 years.

4. DFIs are to be permitted to undertake the banking business, thus

bringing both the wholesale and retail banking sector under one
umbrella. The system envisages that there should be only one class of
banks.
5. Accepting that NBFCs forms a part and parcel of the financial system,
the regulatory framework has been initiated to provide incentives to
merge and to convert themselves into banks.
6.

Banking supervision strengthened by adopting the Basel Committee's

Core Principles for Effective Bank Supervision in September 1997.

7.

Adequate accounting and disclosure standards, and reporting system

were to be introduced to avoid delay in the recognition of the banking
problem. Accordingly banks are now required to publish quarterly
working results, including provisioning.

8.

Recognition of bank-wise as against industry-wise uniform approach to

HRD, technology, industrial relations, and customer service of the
economy, is the other item on the agenda.

9. Directed credit and targets for sector-wise priority sector lending to be reviewed in the
light of the R. V. Gupta committee recommendations on agriculture credit and
restricting its scope to very specific target groups to smaller borrowers of Rs. 2 Lakh
and below.
10. Country-wide debate to be generated to build consensus on structural reforms and
institutional issues involving political economy questions like Govt. ownership of banks,
weak banks and narrow banking concepts, merger of banks, universal banking concept
etc.

Narrow banking, which means restricting the balance size of weak banks by curtailing
asset growth. Narrow banking are only permitted to perform investment operations and
are not permitted to expand their credit portfolio.
The main criticism is that the opening up of the economy to the internationals would
ultimately eat away the profitability of domestic industries. Secondly the multinationals
would use our country as a dumping ground.
Uncontrolled external borrowing would ultimately lead the country to a debt trap and
the countrys fiscal deficit would increase on account higher interest expenditure. The
immediate task now before the Govt. is to arrest the inflation and facilitate southward
movement of interest rate.