BANKING & INSURANCE I NSURANCE LAW LAW PROJECT RE R E COMME COMME NDATI ONS OF THE SE COND COND NARSI NARSI MHAN
“
COMMI COMMI TTE TTE E RE PORT PORT ON ON BANKI NG SE SE CTOR CTOR RE F ORMS ”
SUBMITTED TO: Dr. APARNA SINGH
(ASSISTANT PROFESSOR OF LAW)
PROJECT SUBMITTED BY: ISHI SEHGAL R ISHI
Semester VI, Section B
E NROLL. NO. 150101112 R OLL OLL NO. 115
AM MANOHAR LOHIYA NATIONAL LAW DR . R AM
U NIVERSITY. LUCKNOW, UTTAR PRADESH
ACKNOWLEDGMENT
First , the Researcher extends his profound gratitude and thankfulness to Dr. Aparna Singh Faculty for Banking& Insurance Law, who gave an opportunity to the researcher to work on the given topic and limit himself as per his comfort. She also steered the researcher in getting through this robust job of completing this assignment. Secondly, the Researcher lengthens his thanks to Faculty of Library and all the students of the seventh semester who provided useful inputs during the classroom discussion of the topic and for the shore up and co-operation they provided with. I also take this opportunity to thank all those people who contribute in their own small ways but fail to get a mention.
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INTRODUCTION ................................................................................................ 3 RECOMMENDATIONS OF THE SECOND NARSIMHAM COMMITTEE REPORT ON BANKING SECTOR REFORMS ................................................. 6 Capital Adequacy .................................................................................................. 6 Assets quality and Directed Credit ....................................................................... 7 Prudential Norms and Disclosure Requirements .................................................. 8 Systems and Methods in Banks ............................................................................ 9 Rural and Small Industrial Credit ....................................................................... 10 CONCLUSION TO THE REPORT, ITS RECOMMENDATIONS AND CURRENT STATUS .......................................................................................... 10 Capital Adequacy ................................................................................................ 10 Assets quality and Directed Credit ..................................................................... 11 Prudential Norms and Disclosure Requirements ................................................ 11 Systems and Methods in Banks .......................................................................... 12 Rural and Small Industrial Credit ....................................................................... 13 BIBLIOGRAPHY ............................................................................................... 14 Articles (including e-Articles) ............................................................................ 14 websites ............................................................................................................... 14
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INTRODUCTION Globalization is a complex phenomenon and a process that is, perhaps, best managed by public policies. Globalization has several dimensions arising out of what may be called the consequential enhanced connectivity among people across borders. While such enhanced connectivity is determined by three fundamental factors, viz., technology, taste and public policy, cross-border integration can have several aspects: cultural, social, political and economic. There has been a significant progress towards globalization in the recent past and policy-wise, there have been impressive initiatives, the extent to which India is globalized is considerably at the lower end of the emerging economies. 1 Flexibility in product and factor markets play a part not only in capturing the gains from financial sector reform but also more generally from globalization. Face of Global Banking is undergoing a transition. Banking is now a global issue. Since the early 1980s, bankers working together with national policymakers and officials at such international financial institutions (IFIs) as the World Bank and the International Monetary Fund (IMF) have largely succeeded in deregulating the global banking system. Banking is now a global issue. 2 Reforms in the financial sector, covering banking, insurance, financial markets, trade, ta xation etc. have been a major catalyst in strengthening the fundamentals of the Indian economy. The reform measures have brought about sweeping changes in this critical sector of the Indian's economy.3 In order to understand present make up of banking sector in India and its past progress, it will be fitness of things to look at its development in a somewhat longer historical perspective. The past four decades and particularly the last two decades witnessed cataclysmic change in the face of commercial banking all over the world. Indian banking system has also followed the same trend. 4 The reform measures have brought about sweeping changes in this critical sector of the Indian's economy. For the past three decades that is 1970 to 2000, India's banking system has several outstanding achievements to its credit. It is no longer restricted to only metropolitans or cosmopolitans in
1
http://www.smsvaranasi.com/insight/banking_sector_reforms_in_india_some_reflections.pdf
2 ibid. 3 http://www.smsvaranasi.com/insight/banking_sector_reforms_in_india_some_reflections.pdf 4 http://shodhganga.inflibnet.ac.in/bitstream/10603/3712/11/11_chapter%204.pdf 3
India. In India, prior to nationalization, banking was restricted mainly to the urban areas and neglected in the rural and semi-urban areas. In over five decades since dependence, banking system in India has passed through five distinct phase, viz. (1) Evolutionary Phase (prior to 1950) (2) Foundation phase (1950-1968) (3) Expansion phase (1968-1984) (4) Consolidation phase (1984-1990) (5) Reformatory phase (since 1990) By 1991, India's financial system was loaded with an inefficient and financially unsound banking sector. Some of the reasons for this were viz. high reserve requirements, administered interest rates, directed credit, lack of competition, political interference and corruption. The Narasimham Committee Report (1991) recommended several reform measures such as reduction of reserve requirements, de-regulation of interest rates, introduction of prudential norms, strengthening of bank supervision and improving the competitiveness of the system. The second Narasimham Committee Report (1998) too focused on issues l ike strengthening of the banking system, upgrading of technology and human resource development. 5 The first committee report was major breakthrough in the field of banking reforms. The Narasimham Committee-I identified the following factors as responsible for decline in income earnings: i. Directed investment in terms of minimum Statutory Liquidity Ratios which together with variable Cash Reserve Ratio, pre-empting well 64 over half of the total r esources mobilized by banks. ii. Directed credit programme of deploying 40 per cent of bank credit to the priority sectors at low interest rates. iii. Low capital base. iv. Low technology.
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http://www.allbankingsolutions.com/Banking-Tutor/early-bank-reforms1.shtml 4
v. Phenomenal branch expansion. vi. Political interference in loan disbursal and poverty eradication programmes. The above factors led to the depression in the interest income available to banks on the one hand and the deterioration in the quality of loan portfolio both of the priority sector and traditional sectors resulting in accumulation of non-performing assets on the other. This has been responsible for erosion of earnings and profitability of banks.6 However, later, the Government appointed a seco nd high-level Committee on Banking Sector Reforms under the chairmanship' of Mr. Narasimham to "review the progress of banking sector reforms to date and chart a programme of financial sector reforms necessary to strengthen the Indian Financial System and make it internationally competitive. 7 The Committee in its report (April 1998) made wide-ranging recommendations covering entire gamut of issues ranging from capital adequacy, asset quality, NPAs, prudential norms, asset-liability management, earnings and profits, mergers and acquisitions, reduction in government shareholdings to 33 per cent in public sector banks, the creation of gIobal-sized banks, recasting banks boards to revamping banking legislation. 8 The project shall look as to what the second committee had recommended on the banking reforms and how much relevance it holds currently.
6
http://www.iimahd.ernet.in/~jrvarma/papers/WP1009.pdf http://pezzottaitejournals.net/index.php/IJAFMP/article/download/954/pdf 8 Ibid. 7
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RECOMMENDATIONS OF THE SECOND NARSIMHAM COMMITTEE REPORT ON BANKING SECTOR REFORMS The second generation reforms could be conveniently looked at in terms of three broad interrelated issues: (i)
measures that need to be taken to strengthen the foundations of the banking system,
(ii)
related to this, streamlining procedures, upgrading" technology and human resource development, and
(iii)
structural changes in the system.
These would cover aspects of banking policy, institutional, supervisory, and legislative dimensions. The some of the important recommendations of the Committee may be stated as under:
Capital Adequacy 1. The Committee suggests that that pending the emergence of markets in India where market risks can be covered, it would be desirable that capital adequacy requirements take into account market risks in addition to the credit risks. 2. In Chapter III para 3.11, the committee suggests that the entire portfolio of Government securities should be marked to market and this schedule of adjustment should be announced at the earliest. It would be appropriate that there should be a 5% weight for market risk for Govt. and approved securities. 3. The risk weight for a Government guaranteed advance should be the same as for other advances. To ensure that banks do not suddenly face difficulties in meeting the capital adequacy requirement, the new prescription on risk weight for Government guaranteed advances should be made prospective from the time the new prescriptio n is put in place. (Chapter III para 3.12) 4. There is an additional capital requirement of 5% of the foreign exchange open position limit. Such risks should be integrated into the calculation of risk weighted assets. The 6
Committee recommends that the foreign exchange open position limits should carry a 100% risk weight. (Chapter III para 3.13) 9 5.
The Committee accordingly recommends that the minimum capital to risk assets ratio be increased to 10% from its present level of 8%. It would be appropriate to phase the increase as was done on the previous occasion. Accordingly, the Committee recommends that an intermediate minimum target of 9% be achieved by the year 2000 and the ratio of 10% by 2002. The RBI should also have the authority to raise this further in respect of individual banks if in its judgement the situation with respect to their risk profile warrants such an increase. The issue of individual banks' shortfalls in the CRAR needs to be addressed in much the same way that the discipline of reserve requirements is now applied, viz., of uniformity across weak and strong banks. (Chapter III, para 3.15 – 3.16) 10
6. In respect of PSBs, the additional capital requirement will have to come from either the Govt. or the market. hose banks which are in a position to access the capital market at home or abroad should, therefore, be encouraged to do so.
Assets quality and Directed Credit 1. The Committee recommends that an asset be classified as doubtful if it is in the substandard category for 18 months in the first instance and eventually for 12 months and loss if it has been so identified but not written off. These norms, which should be regarded as the minimum, may be brought into force in a phased manner.(Chapter III, para 3.18) Introduction of the norm of 90 days for income recognition in a phased manner.11 2. The Committee is of the view that for the purposes of evaluating the quality of asset portfolio such advances should be treated as NPAs. If , however, for reason of the sovereign guarantee argument such advances are excluded from computation, the Committee would recommend that Government guaranteed advances which otherwise
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https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251 Ibid. 11 Ibid. 10
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would have been classified as NPAs should be separately shown as an aspect of fuller disclosure and greater transparency of operations. (Chapter III, para 3.21)12 3. The Committee notes that the regulatory and supervisory authorities are paying particular attention to such breaches in the adherence to the spirit of the NPA definitions and are taking appropriate corrective action. At the same time, it is necessary to resist the suggestions made from time to time for a relaxation of the definition of NPAs and the norms in this regard (Chapter III, para 3.22) 13 4. he Committee believes that the objective should be to reduce the average level of net NPAs for all banks to below 5% by the year 2000 and to 3% by 2002. 5. The Committee is of the firm view that in any effort at financial restructuring in the form of hiving off the NPA portfolio from the books of the banks or measures to mitigate the impact of a high level of NPAs must go hand in hand with operational restructuring. 6. Directed credit has a proportionately higher share in NPA portfolio of banks and has been one of the factors in erosion in the quality of bank assets. There is continuing need for banks to extend credit to agriculture and small scale sector which are important segments of the national economy, on commercial considerations and on the basis of creditworthiness. In this process, there is scope for correcting the distortions arising out of directed cr edit and its impact on banks’ assets quality. (Chapter III, para 3.31) 14
Prudential Norms and Disclosure Requirements 1. With regard to income recognition, in India, income stops accruing when interest or installment of principal is not paid within 180 days. The Committee believes that we should move towards international practices in this regard and recommends the introduction of the norm of 90 days in a phased manner by the year 2002.(Chapter III, para 3.35)15
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http://www.isec.ac.in/WP%20252%20-%20Meenakshi%20Rajeev%20and%20H%20P%20Mahesh.pdf 13 https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251 14 http://shodhganga.inflibnet.ac.in/bitstream/10603/3712/11/11_chapter%204.pdf 15 Ibid. 8
2. At present, there is no requirement in India for a general provision on standard assets. In the Committee’s view a general provision, say, of 1% would be appropriate and RBI should consider its introduction in a phased manner. (Chapter III, para 3.36) 16 3. The RBI should direct banks to publish, in addition to financial statements of independent entities, a consolidated balance sheet to reveal the strength of the group. Full disclosure would also be required of connected lending and lending to sensitive sectors. Furthermore, it should also ask banks to disclose loans given to related companies in the bank's balance sheets. Full disclosure of information should not be only a regulatory requirement. It would be necessary to enable a bank’s creditors, investors and rating agencies to get a true picture of its functioning – an important requirement in a market driven financial sector. 4.
Banks should be encouraged to adopt statistical risk management techniques like Value-at-Risk in respect of balance sheet items, which are susceptible to market price fluctuations, forex rate volatility and interest rate changes.
Systems and Methods in Banks 1. Banks should bring out revised Operational Manuals and update them regularly, keeping in view the emerging needs and ensure adherence to the instructions so that these operations are conducted in the best interest of a bank and with a view to promoting good customer service. 17 2. An area requiring close scrutiny in the coming years would be computer audit, in view of large scale usage and reliance on information technology (Chapter IV, para 4.7)18 3. There is enough international experience to show the dangers to an institution arising out of inadequate reporting to and checking by the back offices of trading transactions and positions taken. Banks should pay special attention to this aspect (Chapter IV, para 4.8). 4. The Committee would strongly urge the managements of public sector banks to take steps to reverse this trend.
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https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251 http://www.vikalpa.com/pdf/articles/1992/1992_july_sep_3_9.pdf 18 Ibid. 17
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5. The Committee would urge the managements of Indian banks to review the changing training needs in individual banks keeping in mind their own business environment and to address these urgently. (Chapter IV, para 4.32) 19
Rural and Small Industrial Credit 1. The Committee also recommends that a distinction be made between NPAs arising out of client specific and institution specific reasons and general (agro-climatic and environmental issues) factors 2. As a measure of improving the efficiency and imparting a measure of flexibility the committee recommends consideration of the debt securitisation concept within the priority sector.20 3. Third-tier banks should be promoted and strengthened to be autonomous, vibrant, effective and competitive in their operations.(Chapter VI, para 6.16). 21
CONCLUSION TO THE REPORT, ITS RECOMMENDATIONS AND CURRENT STATUS The current status of the Second Narsimham Committee report can be jotted down in a few points:
Capital Adequacy
1. Banks are now required to assign capital for market risk. A risk weight of 2.5% for market risk has been introduced on investments in Govt. and other approved securities with effect from the year ending 31 st March, 2000. For investments in
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https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251 http://www.iimahd.ernet.in/~jrvarma/papers/WP1009.pdf 21 http://pezzottaitejournals.net/index.php/IJAFMP/article/download/954/pdf 20
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securities outside SLR, a risk weight of 2.5% for market risk has been introduced with effect from the year ending 31 st March, 2001. 2. The percentage of banks’ portfolio of Govt. and approved securities which is required to be marked to market has progressively been increased. For the year ending 31 st March, 2000, banks were required to mark to market 75% of their investments. In order to align the Indian accounting standards with the international best practices
and taking into consideration the evolving international
developments, the norms for classification and valuation of investments have been modified with effect from September 30, 2000. 3. The minimum capital to risk asset ratio (CRAR) for banks has been enhanced to 9% with effect from the year ending March 31,2000.
Assets quality and Directed Credit 1. In the Monetary and Credit Policy announced in April 2001, the banks have been advised to chalk out an appropriate tranisition path for smoothly moving over to 90 days norm. As a facilitating measure, banks should move over to charging of interest at monthly rests by April 1, 2002. Banks should commence making additional provisions for such loans , starting from the year ending March 31, 2002, which would strengthen their balance sheets and ensure smooth transition to the 90 days norm by March 31, 2004. 2. The RBI has reiterated that banks and financial institutions should adhere to the prudential norms on asset classification, provisioning, etc. and avoid the practice of 'evergreening'.22 3. Banks have been advised to take effective steps for reduction of NPAs and also put in place risk management systems and practices to prevent re-emergence of fresh NPAs.
Prudential Norms and Disclosure Requirements 1. The recommendation of the Committee that we should move towards international practices in regard to income recognition is accepted in principle. However, tightening of the prudential norms should be made keeping in view the existing legal framework,
22
Ibid. 11
production and payment cycles, business practices, the predominant share of agriculture in the country’s economy, etc. The production and repayment cycles in the industry in the country generally involve a period of not less than from 4 to 6 months. 2. Banks have been advised to disclose the following information, in addition to the existing disclosures, in the ‘Notes on Accounts’ to the balance sheet from the accounting year ended March 31, 2000.
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a. Maturity pattern of loans and advances, b. Maturity pattern of investment securities, c. Foreign currency assets and liabilities d. Movement in NPAs, e. Maturity pattern of deposits f.
Maturity pattern of borrowings
g. Lending to sensitive sectors as defined from time to time 3. Comprehensive guidelines have been issued to enable banks to put in place appropriate risk management systems. Banks have also been advised to adopt statistical risk management techniques like Value-at-Risk ( which is a statistical method of assessing the potential maximum loss from a credit or investment exposure, over a definite holding period at a given confidence level) or other models appropriate to their level of business operation. (Circular. DBOD. No. BP.BC 98/21.04.103/99 dated 7.10.99) 24
Systems and Methods in Banks 1. Banks have been advised to bring out revised Operative Manuals and update them regularly. Banks have confirmed having brought out revised Manuals. (Circular. DBOD. No.BP.BC.29/21.01.023/98-99 dt.16.4.99 ) 25
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http://www.allbankingsolutions.com/Banking-Tutor/early-bank-reforms1.shtml http://www.allbankingsolutions.com/Banking-Tutor/early-bank-reforms1.shtml 25 http://www.smsvaranasi.com/insight/banking_sector_reforms_in_india_some_reflections.pdf 24
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2. Banks have been advised to put in place an independent Loan Review Mechanism, as recommended by the Committee. (Cir. DBOD.No.BP.BC.103/21.01.002/98 dated 31.10.98)26 3. The public sector banks have been permitted to rec ruit from the open market or by way of campus recruitment, skilled personnel in areas like information technology, risk management, treasury operations, etc.
Rural and Small Industrial Credit 1. The recommendation of the Committee, which basically aims at ensuring that the target for priority sector lending is achieved by each of the banks, has been re-examined. As of March 2000, all public sector banks with the exception of UCO Bank have achieved the priority sector lending target individually and the public sector banks as a Group has exceeded the target at the macro-level. The UCO Bank is short of achievement only marginally.
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2. In principle approval has been granted for setting up of 10 Local Area Banks (LABs). Out of these, on account of non- compliance with the terms and conditions, the ‘in principle’ approvals given to 4 banks were withdrawn. Of the remaining, 4 LABs have already started functioning after obtaining licences under Section 22 of Banking Regulation Act, 1949. The process of reforms has all along been pre-designed with a longterm vision. The two Committees on financial sector reforms (Narasimham Committee-I and II) have outlined a clear long-term vision for the banking segment particularly in terms of ownership of PSBs, level of competition, etc.28 Reform measures have been all pervasive in terms of coverage of almost all problem areas. In fact, it can be said that, it is difficult to find an area of concern in the banking sector on which there has not been a Committee or a group.
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https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251 http://www.smsvaranasi.com/insight/banking_sector_reforms_in_india_some_reflections.pdf 28 Ibid. 27
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BIBLIOGRAPHY Articles (including e-Articles)
http://www.isec.ac.in/WP%20252%20%20Meenakshi%20Rajeev%20and%20H%20P%20Mahesh.pdf
http://www.smsvaranasi.com/insight/banking_sector_reforms_in_india_some_reflecti ons.pdf
http://shodhganga.inflibnet.ac.in/bitstream/10603/3712/11/11_chapter%204.pdf
http://www.allbankingsolutions.com/Banking-Tutor/early-bank-reforms1.shtml
http://www.iimahd.ernet.in/~jrvarma/papers/WP1009.pdf
https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=251
http://zenithresearch.org.in/images/stories/pdf/2012/Jan/ZIJMR/2%20Sultan%20singh %20Asset%20Qaulit1y.pdf
http://www.iica.in/images/sarfaesi_papers.pdf
http://finmin.nic.in/fslrc/fslrc_report_vol1.pdf
http://www1.worldbank.org/finance/assets/images/IndiaFinancialSystem.pdf
http://www.garph.co.uk/IJARMSS/Dec2013/4.pdf
websites
http://www.jstor.org/
http://manupatra.com/
http://www.legallyindia.com/
http://www.scconline.com/
http://www.worldbank.org
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