Financial and Banking sector reforms

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The Banking System at the time of independence was largely urban oriented and remained out of reach of rural population. Commercial Banks mostly confined their lending to trade, commerce and industry and treated agriculture as a non priority. Security- oriented lending was the order of the day. Banks did not pay any attention to the farming community, the Agriculturist was forced to borrow from money lenders, who charged exorbitant rates of interest and imposed onerous conditions.To overcome these issues, ‘Social Control measures’ were initiated by then Prime Minister Smt. Indira Gandhi in 1968 to help the Indian masses in poverty alleviation.

The main objective of the financial sector reforms in India initiated in the early 1990s was to create an efficient, competitive and stable financial sector that could then contribute in greater measure to stimulate growth.

  • Situation before reforms
    • Financial markets were marked by administered interest rates, quantitative ceilings, statutory pre-emptions, captive market for government securities, excessive reliance on central bank financing of fiscal deficit, pegged exchange rate and current and capital account restrictions.
  • Reforms
    • Phased reductions in statutory pre-emption like CRR and SLR
    • Deregulation of interest rates on deposits and lending, except for a select segment.
    • Diversification of ownership of banking institutions: private shareholding in public sector banks
    • Financial Markets: removal of structural bottlenecks, introduction/diversification of new players/instruments, free pricing of financial assets, relaxation of quantitative restrictions, better regulatory systems, introduction of new technology, improvement in trading infrastructure, clearing and settlement practices and greater transparency.
  • Effects
    • The banking sector reform combines a comprehensive reorientation of competition, regulation and ownership in a non-disruptive and cost-effective manner.
    • FDI in the private sector banks is now allowed upto 74 pc
    • 100 pc FDI is allowed under the automatic route in NBFCs
    • Urban Cooperative Banks suffer from various problems. Several structural, legislative and regulatory measures have been initiated in recent years for UCBs with a view to evolving a policy framework oriented towards revival and healthy growth of the sector.
    • Fin mkt: the price discovery in the primary market is more credible than before and secondary markets have acquired greater depth and liquidity.
    • Number of steps (like RTGS) for making the payment systems safe, secure and efficient.

At present, financial regulation in India is oriented towards product regulation, i.e. each product is separately regulated. For example, fixed deposits and other banking products are regulated by the Reserve Bank of India (RBI), small savings products by the Government of India (GoI), mutual funds and equity markets by the Securities and Exchange Board of India (SEBI), insurance by the Insurance Regulatory Development Authority of India (IRDA) and the New Pension Scheme (NPS) by the Pension Fund Regulatory and Development Authority (PFRDA).

The nationalisation of 14 major Banks on 19th July 1969 by then Prime Minister Mrs. Indira Gandhi was done with the following objectives and reasons :-

  • To serve a large social purpose and to sub-serve national priorities
  • Rapid growth of agriculture, small industries, exports,
  • raising employment levels, e
  • ncouragement of new entrepreneurs and development of backward areas.

‘The Committee on Financial System’ was constituted by the Government of India, under the Chairmanship of Mr M Narasimham, former Governor of RBI. The aim of the said committee was to recommend measures to restore the financial health of Commercial Banks and make them function efficiently and profitably.

Recommendations of the Narasimham Committee

  • Autonomy in Banking
  • Reform in the role of RBI
  • Stronger banking system
  • Non-performing assets
  • Capital adequacy and tightening of provisioning norms
  • Entry of foreign banks
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