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30 December, 1997

Financial sector reforms - an assessment 

Sudha Sharma  
Finance minister P Chidambaram has taken the right step by announcing the setting up of a committee under the chairmanship of M Narasimham, former RBI governor, to review progress of financial sector reforms. The panel is also required to chalk out a new agenda for further financial sector reforms that may be adopted by the new government in March 1998 for strengthening the financial sector and making it internationally competitive. This indicates Chidambaram's concern for removing the weaknesses in banking system which he had voiced on several occasions.

The continued Asian currency crisis, in spite of IMF financial support, has brought to fore the need to strengthen the Indian financial sector for enabling it to withstand volatility of currency flows in the face of growing globalisation and India's progressive march towards capital account convertability, and for ensuing high growth with economic stability.

Moreover, it has also revealed that strong fundamentals of an economy is no substitute for a strong financial sector.

Narasimham had earlier headed the first committee on reforms of the banking system in India after the initiation of economic reforms in the country and submitted the report in November 1991, examining all aspects relating to the structure, organisation, procedures and operations of banks. The second panel is required to deliberate, inter alia, on three prime aspects relating to privatisation through disinvestment, revamping of rural credit and infrastructure financing. It is, therefore, appropriate to capture the current overall banking scenario and the tasks ahead.

Recognising the spectacular growth registered by public sector banks since nationalisation in July 1969, the first Narasimham committee report acknowledged the massive branch expansion and its rural spread, large deposit and credit growth and a phenomenal rise in priority sector lending from 14 per cent to 41 per cent. It also took note of decline in the quality of customer service, efficiency and productivity, and its adverse impact on profitability. It attributed the public sector banks' malaise to political and administrative interference in decision making, holding of loan melas, disbursement of IRDP loans based on lists of borrowers identified by government authorities, extension of bank credit to sick units under government directions, subsidisation of socially oriented credit, etc. This had led to the creation of contaminated portfolio in the banks with mounting expenditure due to expansion irrespective of viability and over-staffing, unprincipled trade unionism, directed credit programmes and directed investments in government securities, etc.

The Narasimham committee recommended substantial reduction in the number of public sector banks through mergers and acquisitions in order to strengthen the banking structure, with 3 to 4 large banks having international operations, 8 to 10 banks having national operations, local banks with regional presence and rural banks having operations in rural areas. It also recommended the setting up new banks in the private sector and allowing more foreign banks to open branches in India to spur competition.

Regarding directed credit programmes, the committee recommended phasing out this system as more than two decades of assistance at subsidised rates should have resulted in maturing of agriculture and small scale industry.

The priority sector should be redefined to include only the weakest sections of the society such as marginal farmers, rural artisans, village and cottage industries, etc., and should have 10 per cent of aggregate bank credit earmarked for it.

Concessional rates of interest on all types of loans including small loans should be phased out and subsidies on IRDP loans should be withdrawn.

The Narasimham committee recommended that banks and FIs should have freedom to determine interest rates on deposits and loans and that the bank rate should emerge as anchor rate for determination of all other interest rates.

The SLR should be reduced from 38.5 per cent to 25 per cent of the net demand and time liabilities by 1996-97 and CRR should be cut to release banks' cash balances for more productive purposes.

The financial sector reforms carried out so far have implemented some of the recommendations of the Narasimham committee relating to bank rate, SLR, CRR, freeing of deposit and lending rates, opening of new private sector and foreign banks, etc. But there are several other areas relating to rationalisation of directed credit flows, charging normal rate of interest on small loans, subsidisation of interest, banks' reorganisation and restructuring, closing down of unviable bank branches and reduction & redeployment of staff, reduction of unreconciled inter-branch and inter-bank entries running into several thousand crore, cutting down overdues especially in rural banks as well as huge NPAs of public sector banks, mechanisation and computerisation of bank branches, improvement in customer service, raising efficiency and productivity, inducting disciplined trade unionism, etc., which need to be tackled expeditiously to strengthen the Indian banking system.

Lastly, the capital base of banks needs to be enhanced by privatisation, a few weak banks need to be merged with their stronger counterparts and greater transparency in balance sheets introduced and the treasury operations of the banks need to be considerably strengthened, apart from evolving an effective system of regulation of NBFCs which have emerged as an important segment of the financial sector. The financial reforms have thus to graduate from quantitative to qualitative parameters.

The author is a freelance journalist

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.

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