FINANCIAL SECTOR REFORMS

Deficiencies in the System2

� Decline in productivity and effeciency

� Erosion of profitability

� Directed lending – depleting profits

� SLR and CRR hindered income earning capability� SLR and CRR hindered income earning capability

� Political and administrative interference

� Technological backwardness

� Low capital adequacy ratio

� Delinked from sound international banking

Objectives 3

� Policy framework – rate of interest, directed credit

� Prudential norms – recapitalisation and restructuring of weaker banks

� Financial structure relating to supervision, audit, technology and legal frameworktechnology and legal framework

� Upgrading level of managerial competence and quality of human resources

Financial Sector Reforms (1st Phase)1st Narasimham Committee (Nov 1991)

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� Reduction of SLR (25%) and CRR (10%)

� Interest rate on CRR Balances – at Bank rate

� Phasing out of priority lending – 10% (However Govthas not reduced it from 40%)

� Interest rate deregulation – Market driven

� Capital adequacy norms – minimum 9%

� Asset Classification

FSR (Contd)5

� Transparency – Balance sheet and profit and loss account

� Loan recovery – Debt Recovery Tribunal 1993 (29 tribunals and 5 appellate tribunal)

Tackling Doubtful debts – Asset Reconstruction � Tackling Doubtful debts – Asset Reconstruction Fund

� Restructuring of Banks – 3-4 large banks which would become international; 8-10 national banks ( no progress here – New bank of India has been merged with Punjab National Bank)

FSR (2nd Phase) Focus of Banks6

� Specialisation – retail, agriculture, export, SSI, corporate sector

� Non-fund business – advisory, consultancy services, guarantees, custody services

� Overlap in product coverage of commercial banks and non-bank financial intermediariesnon-bank financial intermediaries

� Financial intermediation in large companies� Management of credit risk and NPAs� Work in deregulated interest rate system� Mergers and consolidation� Collaboration with other banks – remittance, foreign exchange, cash management

2nd Narasimham Committee ( April 23, 1998)

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� Capital adequacy requirements to take into account market risks besides credit risk

� 5% risk weight for portfolio of govt securities (2.5% implemented)

� Capital to risk assets ratio raised to 10%� Capital to risk assets ratio raised to 10%

� Doubtful asset if the asset is NPA for 18 months

� Even govt guaranteed assets must be treated as NPA if so

� Banks to reduce Net NPA level to below 5% by 2000 and 3% by 2002

� Asset Reconstruction company (ARC)

2nd FSR (contd)8

� Introduction of the 90 day norm

� 0.25% provision for standard assets

� Asset liability management – to cover liquidity and interest rate risks

� Statistical risk management techniques like value-at-� Statistical risk management techniques like value-at-risk ; forex rate volatility and interest rate changes

� Independent loan review mechanism especially for large borrowal accounts and systems to identify potential NPAs

� Voluntary Retirement System

2nd FSR (Contd)9

� DFIs to convert themselves into banks (initiated)

� Minimum shareholding by govt/RBI in nationalisedbanks to 33% (Govt introduced a bill in 2000, no progress so far)

� Minimum net worth of NBFCs to be enhanced to Rs. 200 LakhsMinimum net worth of NBFCs to be enhanced to Rs. 200 Lakhs

� Inter-bank call and notice money market and inter-bank term money market should be restricted strictly to banks and primary dealers

� The RRBs and Co-operative Banks should reach a minimum of 8% capital to risk weighted assets over 5 years