• From the 1991 India economic crisis to its status of third largest economy in the world by 2011, India has grown significantly in terms of economic development. So has its banking sector.
• During this period, recognising the evolving needs of the sector, the Finance Ministry of Government of India (GOI) set up various committees with the task of analysing India's banking sector and recommending legislation and regulations to make it more effective, competitive and efficient.
• Two such expert Committees were set up under the chairmanship of M. Narasimham.
• They submitted their recommendations in the 1990s in reports widely known as the Narasimham Committee-I ...view middle of the document...
The committee further added that given that the government nominees to the board of banks are often members of parliament, politicians, bureaucrats, etc., they often interfere in the day-to-day operations of the bank in the form of the behest-lending. As such the committee recommended a review of functions of banks boards with a view to make them responsible for enhancing shareholder value through formulation of corporate strategy and reduction of government equity.
To implement this, criteria for autonomous status was identified by March 1999 (among other implementation measures) and 17 banks were considered eligible for autonomy. But some recommendations like reduction in Government's equity to 33%, the issue of greater professionalism and independence of the board of directors of public sector banks is still awaiting Government follow-through and implementation.
Reform in the role of RBI
First, the committee recommended that the RBI withdraw from the 91-day treasury bills market and that interbank call money and term money markets be restricted to banks and primary dealers. Second, the Committee proposed a segregation of the roles of RBI as a regulator of banks and owner of bank. It observed that "The Reserve Bank as a regulator of the monetary system should not be the owner of a bank in view of a possible conflict of interest". As such, it highlighted that RBI's role of effective supervision was not adequate and wanted it to divest its holdings in banks and financial institutions.
Pursuant to the recommendations, the RBI introduced a Liquidity Adjustment Facility (LAF) operated through repo and reverse repos to set a corridor for money market interest rates. To begin with, in April 1999, an Interim Liquidity Adjustment Facility (ILAF) was introduced pending further upgradation in technology and legal/procedural changes to facilitate electronic transfer. As for the second recommendation, the RBI decided to transfer its respective shareholdings of public banks like State Bank of India (SBI), National Housing Bank (NHB) and National Bank for Agriculture and Rural Development (NABARD) to GOI. Subsequently, in 2007–08, GOI decided to acquire entire stake of RBI in SBI, NHB and NABARD. Of these, the terms of sale for SBI were finalised in 2007–08 itself.
Stronger banking system
The Committee recommended for merger of large Indian banks to make them strong enough for supporting international trade. It recommended a three tier banking structure in India through establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. This proposal had been severely criticized by the RBI employees union. The Committee recommended the use of mergers to build the size and strength of operations for each bank. However, it cautioned that large banks should merge only with banks of equivalent size and not with weaker...