The GlobalANALYST, November 2014: Banking Reforms: M G Warrier

The Global Analyst, November 2014


Banking Sector Reforms*
                  Quest for a Holistic Approach

 M G Warrier

 The Global ANALYST has in different contexts looked at the financial sector reforms from various perspectives. The change of guard in Reserve Bank of India in September 2013 and installation of Modi government in New Delhi after 2014 Lok Sabha Elections have given an opportunity to India to take stock of the progress made so far in the entire reform process, make appropriate corrective measures and proceed further, keeping in view the sole objective of taking the India Growth Story forward without compromising the interests of 1.25 billion people who represent India.

Certain observations made in the recent past by RBI Governor Dr Raghuram Rajan infuses some confidence even in the minds of analysts and economists, who, for valid reasons, fear that the  cobweb of bureaucratic interference and political maneuvering will delay or stop midway any meaningful efforts at reforms. According to media reports, addressing a select gathering of prominent and influential Indian-American businessmen from the finance and investment banking sector at an event organised by the Consulate General in collaboration with the India-America Chamber of Commerce during the second week of October 2014,. underscoring the need for financial sector reforms, Dr Raghuram Rajan stressed that “The time to deliver begins now. We need to focus on deliverables” adding that there is political will to undertake reforms and improve India’s economic growth.

Perhaps, the Indian financial sector was fortunate during the pre-reform days to get adequate attention from government. From the setting up of Reserve bank of India in 1935 to establishment of Regional Rural Banks during 1980’s, institution-building and regulatory reforms to support savings and meeting credit needs has been an ongoing process. During the second half of last century, GOI and RBI had a holistic approach to development of institutions in the financial sector.

As regards the reform-focus on commercial banks, bank nationalisation was a major measure which brought back the social responsibility aspect of banking which is a business dependent entirely on public deposits. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports, in1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector. The opening up of the economy has brought to surface, the lack of competitiveness vis-à-vis global standards, low technological level in operations, over staffing, high NPAs and low levels of motivation  in domestic commercial banks in general and public sector banks in particular. The recent initiatives in banking sector reforms aim at providing the necessary platform for the Indian banks to operate on the basis of operational flexibility and functional autonomy, thereby enhancing efficiency, productivity and profitability.

 The reforms also include increase in the number of banks due to the entry of new private and foreign banks, increase in the transparency of the banks’ balance sheets through the introduction of prudential norms and increase in the role of the market forces due to the deregulated interest rates. These have significantly affected the operational environment of the Indian banking sector.

But, the fact that India has been a country of lost opportunities makes one add a word of  caution, even in the best of circumstances. The pressure on ministries to show quick results, the problems faced by incumbents in various positions who are new to their present assignments due to various constraints make application of mind difficult. In the process, softer options like ‘rebottling’ of old ‘solutions’ or retaining status quo resurface. The mindset that retained AADHAAR, the hurry in implementing FSLRC(Financial Sector Legislative Reforms Commission) recommendations, the hurried financial inclusion drive forcing public sector banks to shut their eyes to normal precautions they would have taken while opening new accounts or promising credit limits and so on could be traced back to this phenomenon.

Indian financial sector needs an inclusive approach to reforms. In July 2013, present RBI Deputy Governor(then Executive Director) R Gandhi, in a speech recalled the objective ‘supporting financial inclusion’ which was included as one of the objectives for allowing new banks when the discussion paper on the subject was released almost three years earlier. He observed that ‘Financial inclusion has to be a precondition for such banks…’ Gandhi also said in the same context that ‘Post independence, we had a resolution to give attention to poverty alleviation. Our economic planning had poverty alleviation as a key plank…Still, these forty-odd years (sic), efforts have not made serious dent. This indicates the enormous challenges that lie ahead for us in achieving financial inclusion…’

A recent CRISIL study conducted on the basis of three parameters -- branch, deposit and credit penetration -- across the 632 districts in India showed the bottom 50 districts had just three banks per 100,000 of population, just half of the 7.6 bank branches on an all-India level. These districts had just two per cent of the total bank branches in the country. Besides, they also had just 4,068 loan accounts per 100,000 of population as compared to an all-India level of 11,680 accounts. 
Lack of awareness, low incomes, poverty and illiteracy were among the key factors identified which lead to a low demand for financial services and, consequently, to exclusion.

Recent years have seen RBI, after a gap of almost two decades, taking aggressive interest in improving banking outreach by propagating the slogan of ‘Financial Inclusion’. But, the branch expansion had lost priority in the anxiety to reduce costs and save on regular staff by allowing Banking Correspondents etc.

At this stage, RBI, through the existing mechanism of State Level and District Level Bankers
Committees, revisit the process of identifying potential centres for opening ‘brick and mortar’ bank branches in semi-urban and rural areas and publish the list to give an opportunity to existing banks to open branches. The prospective new banks should also be asked to select centres from the list simultaneously with their plan to open urban branches.


On September 30, 2014, Finance Ministry has appointed some Task Forces for working out the modalities for implementation of certain recommendations of the Financial Sector Legislative Reforms Commission including the controversial ones like setting up of Public Debt Management Agency (transfer of public debt management responsibility from RBI) and setting up of Financial Sector Appellate Tribunal(Super Regulator above RBI) on which RBI Governor Dr Rajan had expressed dissent.

The expectation of the babus could be that the one year term and possible further extensions that may be given to the Task Forces may see Dr Rajan at the fag end of his present term and his voice may become feeble by that time. One is aware that a High Level Committee on which RBI Governor is member has asked the concerned division of the Finance Ministry to examine the FSLRC recommendations. But by any yardstick, appointment of these Task Forces to come back with appropriate architecture to implement the recommendations is a conscious leap, similar to implementation of NPS during the first half of last decade.

But the speed should not blind vision or overtake priorities. The pressure being put on banks and the banking regulator makes one think on these lines. During his recent visit  to US, in one of the speeches, prime Minister Narendra Modi had mentioned that India has no ‘home-grown’ terrorism. Meaning, terrorism has migrated to India from outside. Remembered this in the context of reform strategies applied across sectors in India since early 1990’s. We will not stray away from financial sector. We do not need organ transplantations of sorts in India’s financial sector which include banks. What we need is not surgical approach, but the preserving and curing physician’s approach to the existing institutional structure. From Reserve Bank of India to the village level primary agricultural credit society, India has a  live and working institutional structure. In the name of reforms, attempts are being made to destroy existing structures and rebuilding new ones borrowing ‘models’ from geographical areas which have nothing much in common with India in terms of development needs, history or resources.



*Submitted version of the article. The published version include some data charts and the contents have been slightly edited.


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