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September 08, 2014

The Committee on Banking Sector Reforms (CBSR) - 1998


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The Government of India set up this committee on 'Banking Sector Reforms' under the chairmanship of M. Narasimham in the year 1998. The Committee submitted its report in April 1998 to the Government of India. 

The following are the major recommendations of the Narasimham Committee (1998) on Banking Sector Reforms.
  1. Stronger Banking System : Narasimham Committee has made out a strong case for a stronger banking system in the country. This can be especially in the context of capital account convertibility (CAC) which would involve large inflows and out flows of capital and consequent complications for exchange rate management and domestic liquidity. For this purpose, the Committee has recommended the merger of strong banks, which will have a multifier effect on industry. The Committee has however cautioned the merger of strong and weak banks, as this may have a negative impact on the asset quality of the stronger bank. Foreign exchange open credit limit risks should be integrated into calculation of risk weighted assets and carry 100% risk weight. Public sector banks in a position to access the capital market at home or abroad be encouraged, as subscription to bank capital funds cannot be regarded as a priority claim on budgetary resources. 
  2. Capital Adequacy Norms : The Committee opined that the earlier norms on capital adequacy norms have to be reviewed. The minimum capital to risk assets ratio (CRAR) is increased from the 8 percent to 10 percent in a phased manner. RBI should be empowered to raise this further for individual banks if the risk profile warrants such an increase. Industrial banks shortfalls in the CRAR are treated on the same line as adopted for reserve requirement viz. uniformity across weak and strong banks. There should be panel provisions for banks that do not maintain CRAR. 
  3. Non-Performing Assets (NPA) : An asset be classified as doubtful if it is in the substandard category for 18 months in first instance and eventually for 12 months and loss if it has been identified but not written off. The Committee opined that these norms should be regarded as the minimum and brought into force in a phased manner. For evaluating the quality of assets portfolio, advances covered by government guarantees, which have turned sticky, should be treated as NPAs. Such advances should be separately shown to facilitate fuller disclosure and greater transparency of operations. As per the committee for banks with a high NPA portfolio two alternative approaches could be adopted. One Approach can be that all loan assets in the doubtful and loss categories should be identified and their reliable value determined, these assets could be transferred to an Asset Reconstruction Company (ARC) which would issue NPA swap bonds, provided stamp duties are not excessive. 
  4. Direct Lending : The Committee noted the reasons as to why the government could not recognize the need to reduce the scope of direct credit under priority sector from 40 percent to 10 percent. Special needs of the weaker and employment oriented sectors like food processing, poultry, dairy etc need to be covered under priority sectors. A high incidence of NPAs could also be treated to policies of direct credit to correct this distortion; banks should extend credit to the important segment, of the economies, i.e., agriculture and small sector on commercial considerations and credit worthiness. 
  5. Small Local Banks : The Committee has proposed that while two or three banks with an international orientation and 8 to 10 large national banks should take care of the needs of large and medium corporate sector and larger of the small enterprises, there will still be a need for a large number of local banks. The Committee has suggested the setting up of small, local banks, which should be combined, to states or cluster of districts in order to serve local trade, small industry and agriculture. At the same time these banks should have strong correspondent relationships with the larger national and international banks. 
  6. System and Methods : The Committee recommended that there should be an independent loan review mechanism especially for large borrower accounts and systems to identify potential NPAs. Banks may evolve a filtering mechanism by stipulating in house prudential limits beyond which exposures on single / group borrowers are taken keeping in view their risk profile as revealed through credit rating and other relevant factors, banks and financial institutions should have  a system of recruiting skilled manpower from the open market. Public sector banks should be given flexibility to determine managerial remuneration levels taking into account market trends. The Committee also opined that there is a need to induct information technology in several areas like tracking of spreads, costs and NPA for higher profitability, accurate and timely information for strategic decision to identify and promote profitable products and customers, risk and asset liability management and efficient treasury management. 
  7. Structural Issues : The Narasimham Committee has proposed the following structural issues on banking system :
    1. Minimum shareholdings by government / RBI in the equity of the nationalized banks and the SBI should be brought down to 33 percent. 
    2. There should be no recourse to any scheme of debt waiver in view of its serious and deterious impact on the culture of credit. 
    3. The debt securitization concept within the priority sector, be considered to enable banks, which are not able to reach the priority sector target to purchase the debt from institutions, which are able to lend beyond their mandated percentage. 
    4. RRBs and cooperative banks should reach a minimum of 8 percent capital to risk weighted assets over a period of 5 years. 
    5. All cooperative banking institutions should come under the Banking Regulation Act, under agencies of RBI / NABARD.
  8. Transparency and Credibility : More transparency and credibility to be ensured so that market can form its judgement about the soundness of an institution. Wrong reporting can be subject to penalty. Banks should be required to publish half-yearly disclosure requirements in two parts. The first should be a) A general disclosure providing a summary of performance over a period of time, say 3 years b) A brief summary aimed at the depositor / investor should provide brief information of matters such as capital adequacy ratio, NPA and profitability. Since functions of regulation and supervision are originally linked so working be renamed as the Board for Finance Regulation and Supervision (BFRS), which should be given statutory powers and be comprised of professionals. The Committee is opined that the dedicated and effective machinery for debt recovery for banks and financial institutions be established. 
  9. Amendments of Banking Laws : The Committee has suggested the urgent need to review and amend the provisions of RBI Act, Banking Regulation Act, State Bank of India, Banking Nationalization Act etc. So as to bring them in live with the current needs of the banking industry in the competitive global environment. 
That's all for now friends. In our next post we shall discuss about the Impact of Banking Sector Reforms. Happy Reading :)
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