Reform of the Banking sector (1992-2008), Present Status of Banking System

The introduction of reforms in the banking sector was based on the commendations of different committees such as the First Narasimham Committee- 1991, the Verma Committee – 1996, the Khan Committee – 1997, the Second Narasimham Committee – 1998, etc. The government of India and RBI have navigated the banking crises in India using both fire-fighting measures to resolve immediate issues and long-term measures for reforming the system in line with the recommendations of these expert committees.

Reductions of key policy rates:

RBI gradually reduced SLR from 38.5% to 24% in 1992 which is now 18 per cent. CRR reduced from 10% to 9% in 1999 and 5.5 percent in 2008 which is now 4.5 per cent. Bank rate which was 12% in 1992 gradually reduced to 6.75% at present. The bank rate was activated to enable it to tackle the market situation. This was in line with the Narashimam committee report submitted in 1991 which recommended reducing the high proportion of SLR and other key policy rates, to increase the bank’s productivity rates.

Re-organization of the existing Indian banking system:

As advocated by the Narashimam Committee recommendation, effective action has been undertaken by the Government to consolidate Public Sector banks by the amalgamation of five Associate banks of State Bank of India (SBI) and Bharatiya Mahila Bank (BMB) into the SBI in 2016. Further, the mega consolidation, which took effect from April 1, 2020, saw 10 PSBs consolidate into four — Oriental Bank of Commerce and United Bank of India merged with Punjab National Bank; Syndicate Bank merged with Canara Bank; Andhra Bank and Corporation Bank merged with Union Bank of India; and Allahabad Bank with Indian Bank. Before this mega consolidation, Vijaya Bank and Dena Bank had merged with Bank of Baroda with effect from April 1, 2019. The merger of banks was expected to facilitate the creation of strong and competitive banks in the Public Sector space to meet the credit needs of a growing economy, absorb shocks and can raise resources without depending unduly on the State exchequer. It is in keeping with the Indradhanush Action Plan of the Government and will improve the efficiency and profitability of the Banking sector. There were other remarkable changes seen during this phase. The Indian government approved foreign investment, paving the way for international banks to open their branches in India. Opening of Foreign banks branches/offices are allowed. Small finance banks received permission to open branches throughout the country, and payment banks also came into existence. With these changes, important developments in technology have emerged and continue to evolve in the banking industry.

Competition from New Private Sector Banks:

New private sector banks have already started functioning. These new private sector banks are allowed to raise capital contributions from foreign institutional investors to 20% and from NRIs up to 40%. This has led to increased competition. After liberalisation, the RBI approved 10 such private banks. In 1996, RBI issued guidelines for setting up Local Area Banks, and it approved the setting up of 7 LABs in the private sector. LABs will help in mobilizing rural savings and channeling them into investment in local areas. Scheduled Commercial Banks are given freedom to open new branches and upgrade extension counters, after attaining capital adequacy ratio and prudential accounting norms. The banks are also permitted to close non-viable branches other than in rural areas.

Review of Supervisory Arrangement and formation of a separate quasi-autonomous body under RBI for supervising banks and financial institutions:

The RBI has set up a Board of Financial Supervision with an advisory Council to strengthen the supervision of banks and financial institutions. In 1993, RBI established a new department known as the Department of Supervision as an independent unit for the supervision of commercial banks. Further, the Board for Financial Supervision (BFS) was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India under the Reserve Bank of India (Board for Financial Supervision) Regulations, 1994. It is an autonomous body and directs the policies and operations relating to the supervision of banks, DFIs, and NBFCs. The Governor of the Reserve Bank is the Chairman of the BFS while the Deputy Governor in charge of supervision is the Vice-chairman. The other two Deputy Governors of the Bank, together with four non-official directors from the Central Board of the Bank, are the members of the BFS. Since its formation in November 1994, the BFS, which meets every month, has positioned a new strategy for on-site supervision of banks and a system of off-site monitoring, based on a quarterly reporting system.

Reaching of 8% capital adequacy ratio:

The CAR or the CRAR is computed by dividing the capital of the bank with aggregated risk-weighted assets for credit risk, operational risk, and market risk. Currently, the minimum ratio of capital to risk-weighted assets is 8% under Basel II and 10.5% (which includes a 2.5% conservation buffer) under Basel III. In India, the Reserve Bank of India (RBI) mandates the CAR for scheduled commercial banks to be 9%, and for public sector banks, the CAR to be maintained is 12%.High capital adequacy ratios are those that are higher than the minimum requirements under Basel II and Basel III. Currently, all the commercial banks and public sector banks achieved the target set by RBI.

Raising capital through public issues:

The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to enable the banks to raise capital through public issues. This is subject to the provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI has already raised a substantial amount of funds through equity and bonds. Banks have been allowed to enter capital market and 12 banks have started this. In addition, Banks have also been authorised to issue bonds to raise their TIER-II capital. There won’t be any guarantee from the government for such bonds to improve capital adequacy ratio.

Deregulation of Interest rates:

The Narasimham Committee advocated that interest rates should be allowed to be determined by market forces. Since 1992, interest rates have become much simpler and freer. Scheduled Commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates.

Full discloser banks’ accounts and proper classification of assets:

As per RBI direction, the balance sheet and P&L statements of banks are mandatorily changed to new format from 1992. The new format is given in vertical format in which all information in attached schedules to bring transferency in the bank balance sheets.

Prudential norms for income recognition, asset classification and provisioning:

The objective of prudential regulation is to protect the stability of the financial system and protect deposits so its main focus is on the safety and soundness of the banking system and on nonbanking financial companies (NBFCs) that take deposits from the public. The Reserve Bank of India decided in April 1992 to introduce a risk-asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee. With the introduction of prudential norms in 1992, the Health Code-based system for the classification of advances has ceased to be a subject of supervisory interest.

Banks are required to make provisions on their assets, based on the period, for which the asset remained nonperforming and the realisability of the dues. Please find an explanation of some of the aspects relating to NPA asset classification by clicking ‘DEFINITION OF NPA AND ASSET CLASSIFICATIONS’

Based on the asset classification, banks, and financial institutions have to make adequate provisions as per RBI guidelines. Click ‘LOAN PROVISIONING UNDER PRUDENTIAL NORMS’ to know if the quantum of provisioning is required as per prudential norms. Banks are not supposed to charge/ debit interest in any NPA account and for taking to income account (i.e. income recognition), including accounts guaranteed by the Government.

Reduction of NPA in commercial banks:

Once the recognition of income, classification of assets, and provisioning of bad debts were done among other things, efforts were made to reduce the NPA leading to a sharp fall in the level of bad assets from 1994 to 2008. It was found that the gross NPA assets ratio of all the PSU banks was as high as 25 per cent as of 31, March 1994. The gross non-performing assets (GNPAs) of scheduled commercial banks (SCBs) and NBFCs are below 3 per cent of total advances as of the end of March 2024. RBI highlighted several key factors contributing to this positive trend, including enhanced provisioning for bad loans, sustained capital adequacy, and increased profitability.

The recovery process of bad loans:

Banks are striving hard to reduce NPAS by various methods such as the rehabilitation of viable units, rephasing loan installments wherever necessary, applying for settlement of the claim from CGTMSE/ECGC, Compromise settlements like OneTime Settlement (OTS), out f Court Settlement (OCS), writing off non-recoverable assets are parts of the process involved in reducing NPAs. Recovery through Lok Adalat, recovery through DRT, recovery through SARFAESI proceedings, and filing a civil suit for recovery of dues, are the other methods of reducing NPAs. The introduction of the Insolvency and Bankruptcy Code (IBC) shall give greater relief to lenders in India as secured and unsecured creditors. In terms of the RBI circular dated February 12, 2018, the ‘Resolution Plans’ (RP) under IBC are required to be implemented within the timeline given below in respect of large accounts where the exposures of the lender are at Rs.20 billion and above. If the account is in default as on the reference date (on or after March 1, 2018), then 180 days from the reference date, or if the account is in default after the reference date, then 180 days from the date of first such default. Once the problem areas were detected, efforts were made to reduce the NPA leading to a sharp fall in the level of bad assets from 1996 to 2009.

Setting up Asset Reconstruction Fund:

In the Union Budget 2021-22, Finance Minister Nirmala Sitharaman announced the setting up of Asset Reconstruction Companies in India to take care of Non-Performing Assets (NPAs) of stressed banks. ARCs in India have been set up by state-owned and private-sector banks. 2024. ARCs help banks clean up their balance sheets by acquiring financial assets from banks and financial institutions through auctions or bilateral negotiations. They securitize and reconstruct the assets to bring liquidity into the system. ARCs are mandated to maintain a capital adequacy ratio of a minimum of 15% of their total risk-weighted assets.   These directions aim to streamline and regulate the functioning of Asset Reconstruction Companies in India, ensuring transparency, accountability, and integrity in the financial system.

Present Status of Banking System

Core banking can be seen as a stepping stone to modern technological developments in banking. Thanks to these developments, customers no longer need to visit their home branches for basic banking tasks. They can transact core banking facilities from the nearest bank branch instead. With the emergence of internet technology, things have now gone online, allowing customers to access banks 24/7, at their convenience, and from almost anywhere. Digital and mobile banking support this concept by letting customers access various banking products, services, and facilities from mobile devices. For banks, it means having to provide minimal human intervention, and for customers, it means staying on top of their finances from anywhere. The rapid developments in Payment Systems and technology have led to the implementation of major reforms of payment systems to expedite the processing of payments, reduce the risk and uncertainty associated with noncash payments, facilitate the adoption of indirect monetary policy instruments, and foster financial market development. Now there are over 45 varieties of digital payment systems, digital enablers, and payment options available to consumers in India. To know about them (Read: 45 TYPES OF DIGITAL PAYMENT OPTIONS AVAILABLE TO CONSUMERS IN INDIA)

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