Transformation of banking sector in India

The financial sector in India is predominantly a banking sector with commercial banks including the public sector, private sector, cooperatives, and foreign banks accounting for more than 64% of the total assets held by the financial system. The banking regulator further permitted new private banks and entities like payment banks, and small finance banks operating in the banking sector.

Earlier to reforms initiated by the government during the 1990s, banking operations both on the assets and liabilities side were governed by the guidelines set out by the regulator. The regulator’s guidelines ensured banks’ margins on a cost-plus basis, and therefore competition was virtually absent with no incentive to cut costs, raise efficiency, or upgrade credit assessment skills. The pricing of financial resources whether it is bank lending to corporates or borrowings by the Government or the foreign exchange, each of these was determined broadly on the directions of the banking regulator rather than its opportunity cost. Thus, reforms in the financial sector focused on the removal of multiple structural bottlenecks, the introduction of new players/instruments, free pricing of financial assets, relaxation of quantitative restrictions improvement in trading, clearing and settlement practices, more transparency, etc.

The broad approach of reforms was to bring more competition along with higher flexibility and operational autonomy to the banks, stability of the players at the same time was intended to be ensured by emphasizing the building up of risk management capabilities and introduction of prudential regulation and supervision in line with best international practices. The reforms included interest rate decontrols, cuts in reserve and liquidity requirements, an overhaul of priority sector lending, deregulation of entry barriers, strengthening of prudential regulations and supervision, restructuring, and partial privatization of public sector banks through stock exchanges. Moreover, the widening of ownership due to stock market listing and associated disclosure requirements brought greater market discipline and transparency in the bank management. These measures transformed the banking sector which could be discerned in measures of efficiency and soundness.

Before reforms, the major problems faced by the banking system were on account of statutory pre-emption of banks’ resources. The effective CRR reduced from 15% in 1991 to 4.50%,   SLR reduced from 38.5% in 1992 to 18% at present to ensure that banks have sufficient funds to meet the demands of their customers. Removal of these constraints meant a planned reduction in statutory pre-emption. The guidelines for licensing of new banks in the private sector were issued by RBI in January 1993 and granted licences to 10 banks in the private sector from 1993 to 2000. This involved reducing government control, allowing private and foreign banks to enter the sector, and promoting competition.

Basle Accord capital standards were adopted in April 1992. Accordingly, Income Recognition & Asset Classification norms of 90 days were introduced as per international standards. To reflect a bank’s actual financial health in its balance sheet and as per the recommendations made by the Committee on Financial System (Chairman Shri M. Narasimham), the Reserve Bank has introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the banks. Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for. In case of doubtful assets, regarding the secured portion, provision may be made at rates ranging from 25 percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful. These are assets where there is a defined weakness or default in repayment. Also, the provisioning should be made based on the classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realisable value thereof. Income from non-performing assets (NPA) is not recognised on an accrual basis but is booked as income only when it is received. Banks are required to maintain a minimum provision of a general provision of 15 percent on the total outstanding should be made without making any allowance for ECGC guarantee cover and securities available on sub-standard assets. The ‘unsecured exposures’ which are identified as ‘substandard’ would attract an additional provision of 10 per cent, i.e., a total of 25 per cent on the outstanding balance. However, given certain safeguards such as escrow accounts available in respect of infrastructure lending, infrastructure loan accounts that are classified as sub-standard will attract provisioning of 20 per cent instead of the aforesaid prescription of 25 per cent. The provisioning requirements for all types of standard assets vary between 0.25% to 1.00% and for restructured advances 5%. Banks should make general provisions for standard assets at the following rates for the funded outstanding on a global loan portfolio basis The provisions towards Standard Assets need not be netted from gross advances but shown separately as ‘Contingent Provisions against Standard Assets’ under ‘Other Liabilities and Provisions Others’ in Schedule 5 of the balance sheet. These measures created a helpful environment for banks and other credit institutions to provide adequate and timely finance to different sectors of the economy by appropriately pricing their loan products based on the risk profile of the borrowers.

The transformations of the following financial markets have created a robust ecosystem for financial transformation in India.

Read:

Transformation of the banking sector in India

Transformation of the Money market in India

Transformation of Government securities market

Transformation of the Foreign exchange market in India

Transformation of the Capital market in India

Transformation of the Credit market in India

Transformation of Payment Systems in India