Banking and Financial Reforms in India | SBI PO Prelims & Mains Preparation - Bank Exams PDF Download

Introduction

• Financial Sector
• Monetory and Fiscal Policy
• Capital Market
• Foreign Exchange Market
• Money & Government securities market
• Banking Reforms

In Early 1990 s

• Extensive Regulation
• Administered Interest rates
• Directed Credit Programmes
• Weak Banking structure
• Lack of proper accounting & Risk management system
• Lack of transparency in operations
• Pre-exemption of resources from the banking system by the government to finance its fiscal deficts
• Excessive structural and micro regulation that inhibit financial innovations and increased transactions costs
• Poorly developed debt and money market
• Outdated technologies and institutional structures that made the capital market and the rest of the financial system highly inefficient .
• Government regulated th price at which firms could issues equity , the rate of interest which they could offer on their bonds , and the debt equity ration that was permissible in different Industries
• Working capital management was even more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to their customers
• Working capital was financed almost entirely by banks at interest rates laid down by central banks
• Working capital was related more to the credit needs of the borrower than creditworthiness.

Major Contours of Reforms

• Removal of existing financial repression
• Creation of an efficient , productivity and profitability sector
• Enabling the process of price discovery by the market determination of interest rates that improves allocative efficient of resources
• Providing operational and functional autonomy to institutions
• Preparing the financial system for increasing international competition
• Opening the external sector in a calibrated manner
• Promoting financial stability in the wake of domestic and external shocks

Major Sector of Reforms

• Banking Sector
• Monetory Sector
• Financial Sector
• Forex Market

Growth Phases in Banking Sector

.

• Evolutionary Phase (Prior to 1950)
• Foundation Phase (1950 - 1968)
• Expansion Phase (1968 – 1984)
• Consolidation Phase ( 1984 – 1990)Reformatory Phase ( Since 1990)

Banking Reforms in India

• The Indian banking sectors is an important constituent of the Indian financial system .
• The banking sectors plays a vital role of promoting business in urban as well as in rural areas in recent years .
• Without in India can not be considered as a healthy economy.
• For the past three decades India’s banking system has several outstanding achievements to its credit .
• NPA’s Have increased since 2011 after a steady decline in 2000’s

Non Performing Assets (NPA)

• NPA is any asset of a bank which is not producing any income 
• A lone or lease that is not meeting its stated principle and interest payments.
• Bank Usually classify as nonperforming assets any commercial loans which are more than 90 days overdue and any consumer loans which are more than 180 days overdue .
• For agricultural loans , if the interest and/or the instalment or principle remains overdue for two harvest seasons , it is declared as NPA’s
• But , this period should not exceed two years . After two years any unpaid loan/instalment will be classified as NPA.

Types of NPA

• SUB-STANDARD - NPA Less than 12 Months
• DOUGHTFUL – NPA more than 12 months
• LOSS ASSETS – When Bank or its auditor have identified the loss , but it has not been written off.

Reasons for Such a Situation

• EXTERNAL REASON – Global Economic Slowdown.
• INTERNAL REASON – Indiscriminate lending and poor recovery.

External Reasons

• Reasons related to the corporate sector
• The global economy has also slowed down
• Continuing uncertainty in the global markets has lead to lower exports of various products like textiles , engineering goods , leather , gems , etc .
• A hurt Corporate sector is finding it difficult to pay loans .

Other Factors

• The ban in mining projects , delay in environment related permits affecting power , iron and steel sector , volatility in prices of raw material and the shortage in availability of power .
• Bank in india are highly regulated . Priority sector lending (PSL) is one of these regulations which require the bank to give a certain % of their loans to certain sectors of society
• The sluggish legal system (Judiciary in India) and lack of systematic and constant efforts by the banks make it difficult to recover these loans from corporate and non-corporate .

Internal Factors

• Indiscriminate lending by some state owned banks during the high growth period (2004-2008) is one of the main reasons for the deterioration in assets quality .
• Bankers say there is a lack of rig our in loan appraisal systems and monitoring of warning signals at state run banks.
• Poor recovery and use of coercive technique by banks in recovering loans.

Impact of NPA's

• The higher is the amount of NPA , the weaker will be the bank revenue stream
• NPA assets act as dead weight on the balance sheet
• As the NPA of the bank will rise , it will bring a scarcity of funds in the Indian Security Market.
• Few banks will be willing to lend if they ane not sure of the recovery of their money
• The shareholder of the banks will lose of money as banks themselves will find it tough to survive in the market
• This will lead to a crisis of confidence in the market .
• The price of loan , i.e the interest rates will shoot up
• Shooting of interest rates will directly impact the investors who wish to take loans for setting up infrastructure , industrial projects , etc .
• This will hurt the overall demand in the indian economy
• Finally it will lead to lower growth rates and higher inflation because of the higher cost of capital
• This trend may continue in a vicious circle and deepen the crisis .

Prevention

• Conservatism
• Bank needs to be more conservative in granting loans to sector that have traditionally found to be contributors in NPA
• The infrastructure sector , instead of getting loan from the banks can be funded from Infrastructure Debt Funds (IDFs) or other specialized funds for infrastructural development in the country .

Improving Processes

• The credit sanctioning process of bank needs to go much more beyond the traditional analysis statement and analysing the history of promoters
• For example , banks rely more on the information given by credit bureaus . However , it is often noticed that several defaults by some corporate are not registered in their credit history .

Reformatory Phase (1991 Onwards)

• Continued financial profilacy of the Government coupled with close monitoring and control
• Decline in productivity and profitability
• Economic crisis of 1991
• Economic suffered from serious inflationary pressures , emerging scarcities of essential commodities and breakdown of fiscal discipline .

First Phase of Reforms (1991)

• The Narsimhan committee I appointed to restore the financial health of commercial banks and to make their functioning efficient and profitability
• Recommendation aimed at changes according to greater flexibility to bank operations .
• The committee submitted its report in November 1991 with 23 recommendations.

Implemented Recommendations

• Lowering SLR & CRR
• Prudential Norms
• Capital Adequacy Norms
• Recovery of Debts
• Deregulation of Interest Rates
• Competition from New Private Sector Banks .
• Phasing out of Directed Credit
• Access to Capital Market
• Local area banks
• Supervision from commercial banks

Second Phase of Reforms (1998)

• The committee of placed greater importance on structural measures and improvement in standards of disclosers and levels of transparency
• Recommendations of NARASHIMHA COMMITTEE II

Implemented Recommendations

• New areas
• New instruments
• Risk managements
• Customers service
• Universal banking
• Information technology
• Increase in FDI limit

Impact on Indian Banking Sector

• Intense competition
• Lowered pre-emptions
• Broadening the ownership base of PSB’s
• Value Added Services.

Technology Related Measures

• INFINIT a the communication backbone for the Financial Sector / Banking sector
• Negotiated Dealing System (NDS) for screen based trading in Government securities
• Real Time Gross Settlement (RTGS) System

“True test of the success of the banking reforms would be the extents of NPS’s ’’

Monitory Policy Reforms

• Twin objectives of Maintaining price stability & Ensuring availability of adequate credit to productivity sectors
• Use of broad money (M2) as an intermediates target has been deemphasized and a multiple indicator approach has been adopted
• Development of multiple instruments to transmit liquidity and interest rate signals in the short terms in a flexible and bi-directional manner
• Increase of the inter-linkage between various segments of the financial market including money , government security and forex markets
• Open market operations (OMO) to deal with overall market liquidity situation especially those emanating from capital flows
• Introduction of Market stabilization Scheme (MSS) as an additional instruments to deal with enduring capital inflows without affecting short-term liquidity management role of LAF
• Introduction of Liquidity Adjustment Facility (LAF) , which operates through repo and reserve repo auctions Liquidity Adjustment Facility (LAF)
• To nudge overnight interest rates within a specific corridor
• To de-emphasize targeting of banks and focus increasingly on interest rates
• Reducing the cash reserve ration (CRR) without loss of monetary control

Capital Market Reforms

• Capital adequacy and prudential regulation were introduced for brokers , and other intermediaries.
• Dematerilization of Scrips was initiated with the creation of legislative framework and the setting up of the first depository
• Settelment period was reduced to one weak
• Carry forward trading was banned
• Tentative move were made towards a rolling settlement system.