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Financial Sector Reforms
As the economy grows and becomes more sophisticated, the banking sector has to develop pari pasu in a manner that it supports and stimulates such growth. With increasing global integration, the Indian banking system and financial system has as a whole had to be strengthened so as to be able to compete. India has had more than a decade of financial sector reforms during which there has been substantial transformation and liberalisation of the whole financial system. It is, therefore, an appropriate time to take stock and assess the efficacy of our approach. It is useful to evaluate how the financial system has performed in an objective quantitative manner. This is important because India’s path of reforms has been different from most other emerging market economies: it has been a measured, gradual, cautious, and steady process, devoid of many flourishes that could be observed in other countries.
Until the beginning of the 1990s, the state of the financial sector in India could be described as a classic example of “financial repression” a la MacKinnon and Shaw. The sector was characterised, inter alia, by administered interest rates, large pre-emption of resources by the authorities and extensive micro-regulations directing the major portion of the flow of funds to and from financial intermediaries. While the true health of financial intermediaries, most of them public sector entities, was masked by relatively opaque accounting norms and limited disclosure, there were general concerns about their viability. Insurance companies – both life and non-life - were all publicly owned and offered very little product choice. In the securities market, new equity issues were governed by a plethora of complex regulations and extensive restrictions. There was very little transparency and depth in the secondary market trading of such securities. Interest rates on government securities, the predominant segment of fixed-income securities, were decided through administered fiat. The market for such securities was a captive one where the players were mainly financial intermediaries, who had to invest in government securities to fulfill high statutory reserve requirements. There was little depth in the foreign exchange market as most such transactions were governed by inflexible and low limits and also prior approval requirements. Compartmentalisation of activities of different types of financial intermediaries eliminated the scope for competition among existing financial intermediaries. In addition, strong entry barriers thwarted competition from new entrants.
The end result was low levels of competition, efficiency and productivity in the financial sector, on the one hand, and severe credit constraints for the productive entities, on the other, especially for those in the private sector. The other major drawback of this regime was the scant attention that was placed on the financial health of the intermediaries. Their capitalisation levels were low. The lack of commercial considerations in credit planning and weak recovery culture resulted in large accumulation of non-performing loans. This had no impact on the confidence of depositors, however, because of government ownership of banks and financial intermediaries. The predominance of Government securities in the fixed-income securities market of India mainly reflects the captive nature of this market as most financial intermediaries need to invest a sizeable portion of funds mobilised by them in such securities. While such norms were originally devised as a prudential measure, during certain periods, such statutory norms pre-empted increasing proportions of financial resources from intermediaries to finance high Government borrowings.
Financial sector refers to the part of the economy which consists of firms and institutions that have the responsibility to provide financial services to the customers of the commercial and retail segment. The financial sector can include commercial banks, non banking financial companies, investment funds, money market, insurance and pension companies, and real estate etc. The financial sector is considered as the base of the economy which is essential for the mobilization and distribution of financial resources.
The financial sector reforms refer to steps taken to reform the banking system, capital market, government debt market, foreign exchange market etc. An efficient financial sector is necessary for the mobilization of households savings and to ensure their proper utilisation in productive sectors. Before 1991, the Indian financial sector was suffering from several lacunae and deficiencies which had reduced their quality and efficiency of operations. Therefore, financial sector reforms had become essential at that time.
The main objectives, therefore, of the financial sector reform process in India initiated in the early 1990s have been to :
Financial sector reforms refer to the reforms in the banking system and capital market.
An efficient banking system and a well-functioning capital market are essential to mobilize savings of the households and channel them to productive uses. The high rate of saving and productive investment are essential for economic growth. Prior to 1991 while the banking system and the capital market had shown impressive growth in the volume of operations, they suffered from many deficiencies with regard to their efficiency and the quality of their operations.
The weaknesses of the banking system was extensively analyzed by the committee (1991) on financial sector reforms, headed by Narasimham. The committee found that banking system was both over-regulated and under-regulated. Prior to 1991 system of multiple regulated interest rates prevailed. Besides, a large proportion of bank funds was preempted by Government through high Statutory Liquidity Ratio (SLR) and a high Cash Reserve Ratio (CRR). As a result, there was a decrease in resources of the banks to provide loans to the private sector for investment.
This preemption of bank funds by Government weakened the financial health of the banking system and forced banks to charge high interest rates on their advances to the private sector to meet their needs of credit for investment purposes. Further, the lack of transparency in the accounting practice of the banks and non-application of international norms by the banks meant that their balance sheets did not reflect their underlying financial position.
This was prominently revealed by 1992 scarcity scam triggered by Harshad Mehta. In this situation the quality of investment portfolio of the banks deteriorated and culture of’ non-recovery’ developed in the public sector banks which led to a severe problem of non-performing assets (NPA) and low profitability of banks. Financial sector reforms aim at removing all these weaknesses of the financial system.
Under these reforms, attempts have been made to make the Indian financial system more viable, operationally efficient, more responsive and improve their allocative efficiency. Financial reforms have been undertaken in all the three segments of the financial system, namely banking, capital market and Government securities market.
We explain below various reforms in these three segments in financial sector initiated since 1991:
An important financial reform has been the reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) so that more bank credit is made available to the industry, trade and agriculture. The statutory liquidity ratio (SLR) which was as high as 39 per cent of deposits with the banks has been reduced in a phased manner to 25 per cent.
It may be noted that under statutory liquidity ratio banks are required to maintain a minimum amount of liquid assets such as government securities and gold reserves of not less than 25 per cent of their total liabilities. In 2008, statutory liquidity ratio was reduced to 24 per cent by RBI.
Similarly, cash reserve ratio (CRR) which was 15 per cent was reduced over phases to 4.5 per cent in June 2003. It may be noted that reduction in CRR has been possible with reduction of monetized budget deficit of the government and doing away with the automatic system of financing government’s budget deficit through the practice of issuing ad hoc treasury bills to the Central Government.
On the other hand, reduction in Statutory Liquidity Ratio (SLR) has been possible because efforts have been made by government to reduce fiscal deficit and therefore its borrowing requirements. Besides, reduction in SLR has become possible because of a shift to payment of market-related rates of interest on government securities.
Since the government securities are free from any risk and now bear market-related interest rates, the banks may themselves feel inclined to invest their surplus funds in these securities, especially when demand for credit by the industry and trade is not adequate.
The reduction in CRR and SLR has made available more lendable resources for industry, trade and agriculture. Reductions in CRR and SLR also made possible for Reserve Bank of India to use open market operations and changes in bank rate as tools of monetary policy to achieve the objectives of economic growth, price stability and exchange rate stability.
Thus, Dr. C. Rangarajan, the former Governor of Reserve Bank of India, says, “As we move away from automatic monetisation of deficits, monetary policy will come into own. The regulation of money and credit will be determined by the overall perception of the Central monetary authority on what appropriate level of expansion of money and credit should be depending on how the real factors in the economy are evolving”.
A basic weakness of the Indian financial system was that interest rates were administered by the Reserve Bank/Government. In the case of commercial banks, both deposit rates and lending rates were regulated by Reserve Bank of India. Before 1993, rate of interest on Government Securities could be maintained at low levels through the means of high Statutory Liquidity Ratio (SLR).
Under SLR regulation commercial banks and certain other financial institutions were required by law to invest a large proportion of their liabilities in Government securities. The purpose behind the administered interest-rate structure was to enable certain priority sectors to get funds at concessional rates of interest. Thus the system of administered interest rates involved cross subsidization; concessional rates charged from primary sectors were compensated by higher rates charged from other non-concessional borrowers.
The structure of administered rates has been almost totally done away with in a phased manner. RBI no longer prescribes interest rates on fixed or time deposits paid by their banks to their depositors. Banks have also been freed from any prescribed conditions of premature withdrawal by depositors. Individual banks are free to determine their conditions for premature withdrawal. Currently, there is prescribed rate of 3.5 per cent for Savings Bank Accounts.
Note that Savings Bank Account are actually used by the individuals as current account even with cheque-book facility. Since the banks’ cost of servicing these accounts is high, rate of interest on them is bound to be low. Besides, there is lower interest rate ceilings prescribed for foreign currency denominated deposits from non-resident Indians (NRI). Such a lower prescribed ceiling is required for managing external capital flows, especially short-term capital flows, till we switch over to liberalisation of capital account.
Lending rates of interest for different categories which were earlier regulated have been gradually deregulated. However, RBI insists upon transparency in this regard. Each bank is required to announce prime lending rates (PLRs) and the maximum spread it charges. Maximum spread refers to the difference between the lending rate and bank’s cost of funds.
Interest on smaller loans up to Rs. 2,00,000 are regulated at concessional rates of interest. At present, the interest rate on these smaller loans should not exceed the prime lending rates. Besides, lending interest rates for exports are also prescribed and are linked to the period of availment. Changes in prescribed interest rates for exports have been often used as an instrument to influence repatriation of export proceeds.
Thus, except prescribed lending rates for exports and small loans up to Rs. 2, 00,000, the lending rates have been freed from control. Banks can now fix their lending rates as per their risk reward perception of borrowers and purposes for which bank loans are sought.
In order to ensure that financial system operates on sound and competitive basis, prudential norms, especially with regard to capital-adequacy ratio, have been gradually introduced to meet the international standards. Capital adequacy norm refers to the ratio of paid-up capital and reserves to deposits of banks. The capital base of Indian banks has been very much lower by international standards and in fact declined over time.
As a part of financial sector reforms, capital adequacy norm of 8 per cent based on risk-weighted asset ratio system has been introduced in India. Indian banks which have branches abroad were required to achieve this capital-adequacy norm by March 31, 1994. Foreign banks operating in India had to achieve this norm by March 31, 1993.
Other Indian banks had to achieve this capital adequacy norm of 8 per cent latest by March 31, 1996. Banks were advised by RBI to review their existing level of capital funds as compared to the prescribed capital adequacy norm and take steps to increase their capital base in a phased manner to achieve the prescribed norm by the stipulated date.
It may be noted that Global Trust Bank (GTB), a private sector bank, whose operations had to be stopped by RBI on July 24, 2004 had a capital adequacy ratio much below the prescribed prudent capital adequacy ratio norm. In this regard, link between capital adequacy and provisioning is worth noting. Capital adequacy norm can be met by the banks after ensuring that adequate capital provisions have been made.
To achieve this capital adequacy norm, Government had come in to provide capital funds to some nationalized banks. Some stronger public sector banks raised funds from the capital market by selling their equity. Law was passed to enable the public sector banks to go to the capital markets for raising funds to enhance their capital base. Banks can also use a part of their annual profits to enhance their capital base (that is, ploughing back of retained earnings into investment).
After nationalization of 14 large banks in 1969, no bank had been allowed to be set up in the private sector. While the importance and role of public sector banks in Indian financial system continued to be emphasised, it was however recognized that there was urgent need for introducing greater competition in the Indian money market which could lead to higher efficiency of the financial system.
Accordingly, private sector banks such as HDFC, Corporation Bank, ICICI Bank, UTI Bank, IDBI Bank and some others have been set up. Establishment of these banks has made substantial contribution to housing finance, car loans and retail credit through credit card system. They have made possible the wider use of what is often called plastic money, namely, ITM cards, Debit Cards, and Credit Cards.
In addition to the setting up of private sector Indian banks, competition has also sought to be promoted by permitting liberal entry of branches of foreign banks, therefore, CITI Bank, Standard Chartered Bank, Bank of America, American Express, HSBC Bank have opened more branches in India, especially in the metropolitan cities
An important recent step is the liberalisation of foreign direct investment in banks. In the budget for 2003-04, the limit of foreign direct investment in banking companies was raised from 49 per cent to the maximum 74 per cent of the paid up capital of the banks. However, this did not apply to the wholly owned subsidiaries of foreign banks.
A foreign bank may operate in India through any one of three channels, namely:
(1) As branches of foreign banks,
(2) A wholly owned subsidiary of a foreign bank,
(3) A subsidiary with aggregate foreign investment up to the maximum of 74 per cent of the paid-up capital.
The above measures are expected to facilitate setting up of subsidiaries by foreign banks. Besides fostering competition among banks they have also increased transparency and disclosure standards to reach the international standards. Banks have to submit to RBI and SEBI, the maturity pattern of their assets and liabilities, movements in the provision account and about non-performing assets (NPA).
RBI’s annual publication ‘Trends and Progress of Banking in India’ provides detailed information on individual bank’s financial position, that is, their losses, assets, liabilities, NPA etc. which enable public assessment of the working of the banks.
Non-performing assets of banks have been a big problem of commercial banks. Non-performing assets mean bad loans, that is, loans which are difficult to recover. A large quantity of non-performing assets also lowers the profitability of bank. In this regard, a norm of income recognition introduced by RBI is worth mentioning. According to this, income on assets of a bank is not recognized if it is not received within two quarters after the last date.
In order to improve the performance of commercial banks recovery management has been greatly strengthened in recent years. Measures taken to reduce non-performing assets include restructuring at the bank level, recovery of bad debt through Lok Adalats, Civil Courts, setting up of Recovery Tribunals and compromise settlements. The recovery of bad debt got a great boost with the enactment of ‘Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest’ (SARFAESI). Under this Act, Debt Recovery Tribunals have been set up which will facilitate the recovery of bad debts by the banks.
As a result of the above measures gross NPA declined from Rs. 70,861 crores in 2001-02 to Rs. 68, 715 crores in 2002-03. But there are substantial amounts of non-performing assets whose recovery is still to be made. Besides, as a result of introduction of risk-based supervision by RBI, the ratio of gross NPA to gross advances of scheduled commercial banks declined from 12.7 per cent in 1999-2000 to 8.8 per cent in 2002-03.
Another significant financial sector reform is the elimination of direct or selective credit controls. Selective credit controls have been done way with. Under selective credit controls RBI used to control through the system of changes in margin for provision of bank credit to traders against stocks of sensitive commodities and to stock brokers against shares. As a result, there is now greater freedom to both the banks and borrowers in respect of credit.
But it is worth mentioning that banks are required to observe the guidelines issued by RBI regarding lending to priority sectors such as small scale industries and agriculture. The advances eligible for priority sectors lending have been increased at deregulated interest rates.
This is in accordance with the recognition that the main problem is more of availability of credit than the cost of credit. In June 2004 UPA Government announced that credit to farmers for agriculture will be available at 2 per cent below PLR of banks. Further, credit for agriculture will be doubled in three years time.
To promote financial inclusion the government has started the scheme of micro finance. RBI provides guidelines to banks for mainstreaming micro-credit providers and enhancing the outreach of micro-credit providers inter alia stipulated that micro-credit extended by banks to individual borrowers directly or through any intermediary would henceforth be reckoned as part of their priority-sector lending. However, no particular model was prescribed for micro-finance and banks have been extended freedom to formulate their own model(s) or choose any conduit/intermediary for extending micro-credit.
Though there are different models for pursuing micro-finance, the Self-Help Group (SHG)-Bank Linkage Programme has emerged as the major micro-finance programme in the country. It is being implemented by commercial banks, regional rural banks (RRBs), and cooperative banks.
Under the SHG-Bank Linkage Programme, as on 31 March 2012, 79.60 lakh SHG-held savings bank accounts with total savings of? 6,551 crore were in operation. By November 2012 another 2.14 lakh SHGs had come under the ambit of the programme, taking the cumulative number of savings-linked groups to 81.74. As on 31 March 2012, 43.54 lakh SGHs had outstanding bank loans of Rs. 36,340 crore (Table 35.1). During 2012-13 (up to November 2012), 3.67 lakh SHGs were financed with an amount Rs. 6, 664.15 crore.
Extension of Swabhimaan Scheme:
Under the Swabhimaan financial inclusion campaign, over 74,000 habitations with population in excess of 2,000 had been provided banking facilities by March 2012, using various models and technologies including branchless banking through business correspondents (BCs).
The Finance Minister in his Budget Speech of 2012-13 had announced that Swabhimaan would be extended to habitations with population more than 1,000 in the north-eastern and hilly states and population more than 1,600 in the plains areas as per Census 2001.
Accordingly, about 45,000 such habitations had been identified for coverage under the extended Swabhimaan campaign. As per the progress received through the conveners of State Level Bankers’ Committee (SLBC), out of the identified habitations, 10,450 have been provided banking facilities by end of December, 2012. This will extend the reach of banks to all habitations above a threshold population.
The Government of India set up the RIDF in 1995 through contribution from commercial banks to the extent of their shortfall in priority sector lending by banks with the objective of giving low cost fund support to states and state-owned corporations for quick completion of ongoing projects relating to medium and minor irrigation, soil conservation, watershed management, and other forms of rural infrastructure.
The Fund has continued, with its corpus being announced every year in the Budget. Over the years, coverage under the RIDF has been made more broad-based in each tranche and, at present, a wide range of 31 activities under various sectors is being financed.
The annual allocation of funds for the RIDF announced in the Union Budget has gradually increased from Rs. 2000 crore in 1995- 96 (RIDF 1) to Rs. 20,000 crore in 2012-13. Further, a separate window was introduced in 2006-07 for funding the rural roads component of the Bharat Nirman Programme with a cumulative allocation of Rs. 18,500 crore till 2009-10.
From inception of the RIDF in 1995-6 to March 2012, 462,229 projects have been sanctioned with a sanctioned amount of Rs. 1, 43,230 crore. Of the cumulative RIDF loans sanctioned to state governments, 42 per cent have gone to the agriculture and allied sector, including irrigation and power; 15 per cent to health, education, and rural drinking water supply; while the share of rural roads and bridges has been 31 per cent and 12 per cent, respectively. The annual allocation of funds under the RIDF has gradually increased from Rs. 2,000 crore in 1995-6 (RIDF I) to Rs. 20,000 crore in 2012-13 (RIDF XVIII).
As against the total allocation of Rs. 1, 72,500 crore, encompassing RIDFI to XVIII, sanctions aggregating Rs. 1, 51,154 crore have been accorded to various state governments and an amount of Rs. 1, 00,051 crore disbursed up to the end of November 2012. Nearly 55 per cent of allocation has been made to southern and northern regions. The National Rural Roads Development Agency (NRRDA) has disbursed the entire amount of Rs. 18,500 crore sanctioned for it (under RIDF XII-XV) by March 2010. During 2012-13 (up to end November 2012), Rs. 5,829 crore was disbursed to the states under the RIDF .
The Government of India has decided to introduce a Direct Benefit Transfer (DBT) scheme with effect from 1 January 2013. To begin with, benefits under 26 schemes will directly be transferred into the bank accounts of beneficiaries in 43 identified districts across respective states and union territories (UT).
Banks will ensure that all beneficiaries in these districts have a bank account. All PSBs and RRBs have made provision so that the data collected by the Departments/Ministries/Implementing agency concerned can be used for seeding the bank account details in the core banking system (CBS) of banks with Aadhaar. All PSBs have also joined the Adhaar Payment Bridge of the National Payment Corporation of India for smooth transfer of benefits.
This is significant reforms measure to put a check on the growing fiscal deficit of the Central Government. Before 1997 whenever there was a deficit in Central Government budget this was financed by borrowing from RBI through issuing of ad hoc treasury bills. RBI issued new notes against these treasury bills and delivered them to the Central Government.
Since Government incurred deficits year after year, the question of retiring these ad hoc treasury bills did not arise. In this way there was automatic monetisation of Central Government’s budget deficit resulting in the increase in reserve money in the economy. With the operation of money multiplier, the increase in reserve money led to a manifold increase in money supply in the economy which contributed to inflationary tendencies in the Indian economy. Dr. C. Rangarajan in an important contribution to financial management highlighted the adverse effects of automatic monetisation of Government’s budget deficits through ad hoc treasury bills.
Since in the eighties and nineties Government borrowed heavily due to large fiscal deficits, expansionary impact of these deficits had to be countered by RBI by raising CRR and SLR from time to time. Besides, in the context of heavy borrowing by the Central Government the need to counter the impact on the money supply by raising CRR to mop up excess liquidity increased so as to control inflation.
In this environment RBI could not use the instrument of open market operations to regulate the money supply and rate of interest. At a time when Government borrowed heavily in the market to meet its large deficit, the use of open market operations (i.e. selling Government securities in the open market from its own reserves by RBI) would have resulted in sharp rise in interest rate.
Dr. Rangarajan succeeded in getting abolished the system of automatic monetisation of ever-rising budget deficits through the issue of ad hoc treasury bills by the Government. In its place the system of Ways and Means Advances (WMA) were introduced from April 1,1997. Under this new system of Ways and Means Advance (WMA) financial limits are fixed to accommodate temporary mismatches in Government receipts and payments and further that market related interest rate is charged on these advances.
The limit for WMA and rate of interest charged on them are mutually agreed between RBI and Government from time to time. Further, after 1999 no overdrafts by the Government are permitted for a period beyond 10 consecutive days. Thus, ways and means advances are in fact loans to the Government given by RBI for a short period of time.
It is important to note that with the abolition of ad hoc treasury bills, the system of 91 days tap treasury Bills has also been discontinued with effect from April 1, 1997. Accordingly, with the introduction of the system of Ways and Means Advances (WMA), the conventional concept of budget deficit and deficit financing have also lost their relevance.
Therefore, the earlier practice of showing budgetary deficit in Government’s budget and the extent of deficit financing has been abandoned. Instead, at present the magnitudes of fiscal deficit, revenue deficit and primary deficits are provided in the budget and become key indicators of Government’s fiscal position.
It is clear from above that the new system of Ways and Means Advances (WMA) has given more autonomy to RBI for conducting its monetary policy. Another related important financial reform is the enactment of’ Fiscal Responsibility and Budget Management (FRBM)’ Act, which provides a relationship between Government’s fiscal stance and RBI’s monetary management.
According to FRBM, Central Government will take appropriate measures to reduce fiscal deficit to 2 per cent and to eliminate entirely revenue deficit in a time-bound manner by March 31, 2008. It has been provided in the law that revenue deficit and fiscal deficit may exceed targets specified in the rules only on grounds of national security or natural calamity or such other exceptional circumstances as specified by Central Government.
An important provision of the Act is that the Central Government shall not borrow from RBI except by Ways and Means Advances. Further, an important feature of FRBM Act is that RBI will not subscribe to the primary issues of Central Government securities from the year 2006-07.
Since October 2003, a New Pension Scheme (NPS) was introduced by the Central Government for its employees. Later many States have also joined the scheme for their employees. The New Pension Scheme is a contributory retirement scheme.
All employees joining Central Government after January 1, 2004 have to join the scheme and contribute to it to obtain pension after their retirement. Later many states have also joined the scheme for their employees. It is now also open to private individuals and eight fund managers manage the scheme.
The pension authority was named as Pension Fund Regulatory and Development (PFRDA). Till September 2013, this pension authority has been functioning under executive authority since October 2003. Now in September 2013, the Indian Parliament passed the Pension Fund Regulatory Development Authority Bill, eight years after it was introduced in March 2005. This bill seeks to empower PFRDA to regulate the pension scheme (NPS).
The corpus of PFRDA has Rs. 34,965 crore. NPS has been there with us for nine years and to manage such a large amount of Rs. 35,000 crore was not good to be managed by a non-statutory authority. It should be managed by a statutory authority. All that this new legislation does is to make the non-statutory authority a statutory authority.
The legislation regarding Pension Fund Regulatory and Development Authority passed by the Parliament is an important financial reform that will pave the way for foreign investment in the sector. At present the new pension scheme has about 5.3 million subscribers and the scheme has a corpus of around Rs. 35,000 crore.
The Finance Minister has clarified that foreign investment in the pension sector will be 26% and linked to that in the insurance sector. The government has already approved 49% foreign investment in the insurance sector.
“I am confident that the Pension Bill will be passed in Rajya Sabha,” Chidambaram said adding that the government had accepted all but one suggestion of the Standing Committee on Finance that gave its recommendations on the Bill in August 2011. The PFRDA will notify New Pension System schemes that provide minimum assured returns, incorporated after the standing committee suggested some sort of guaranteed returns.
The NPS will also provide for withdrawal for some limited purposes, which was not the case earlier. The reform will go a long way in increasing the coverage of formal pension and social security plans in India, where only about 12% of the active workforce has any formal pension or social security plan.
The opening of the pension sector, even at 26%, will encourage foreign investors to put their money, as India has a huge population that needs social security cover. We do not have much pension products now but once there are more players, there will be more products which will help to channelize this pension money into the economy. The Bill will further empower the PFRDA to regulate the NPS and other pension schemes that are not covered under any Act.
POLICY REFORMS IN THE FINANCIAL SECTOR BANKING REFORMS
Commercial banking constitutes the largest segment of the Indian financial system. Despite the general approach of the financial sector reform process to establish regulatory convergence among institutions involved in broadly similar activities, given the large systemic implications of the commercial banks, many of the regulatory and supervisory norms were initiated first for commercial banks and were later extended to other types of financial intermediaries. After the nationalisation of major banks in two waves, starting in 1969, the Indian banking system became predominantly government owned by the early 1990s. Banking sector reform essentially consisted of a two pronged approach. While nudging the Indian banking system to better health through the introduction of international best practices in prudential regulation and supervision early in the reform cycle, the idea was to increase competition in the system gradually. The implementation periods for such norms were, however, chosen to suit the Indian situation. Special emphasis was placed on building up the risk management capabilities of the Indian banks. Measures were also initiated to ensure flexibility, operational autonomy and competition in the banking sector. Active steps have been taken to improve the institutional arrangements including the legal framework and technological system within which the financial institutions and markets operate. Keeping in view the crucial role of effective supervision in the creation of an efficient and stable banking system, the supervisory system has been revamped.
Unlike in other emerging market countries, many of which had the presence of government owned banks and financial institutions, banking reform has not involved large scale privatisation of such banks. The approach, instead, first involved recapitalisation of banks from government resources to bring them up to appropriate capitalisation standards. In the second phase, instead of privatisation, increase in capitalisation has been done through diversification of ownership to private investors up to a limit of 49 per cent, thereby keeping majority ownership and control with the government. With such widening of ownership most of these banks have been publicly listed; this was designed to introduce greater market discipline in bank management, and greater transparency through enhanced disclosure norms. The phased introduction of new private sector banks, and expansion in the number of foreign bank branches, provided for new competition. Meanwhile, increasingly tight capital adequacy, prudential and supervision norms were applied equally to all banks, regardless of ownership.
Stylised features of the banking sector reforms have been given in below:
Banking Reforms:
A. Prudential Measures
B. Competition Enhancing Measures
C. Measures Enhancing Role of Market Forces
D. Institutional and Legal Measures
E. Supervisory Measures
Technology Related Measures
Setting up of INFINET as the communication backbone for the financial sector, introduction of Negotiated Dealing System (NDS) for screen-based trading in government securities and Real Time Gross Settlement (RTGS) System.
DEBT MARKET REFORMS
Major reforms have been carried out in the government securities (G-Sec) debt market. In fact, it is probably correct to say that a functioning G-Sec debt market was really initiated in the 1990s. The system had to essentially move from a strategy of pre-emption of resources from banks at administered interest rates and through monetisation to a more market oriented system. Prescription of a “statutory liquidity ratio” (SLR), i.e., the ratio at which banks are required to invest in approved securities, though originally devised as a prudential measure, was used as the main instrument of pre-emption of bank resources in the pre-reform period. The high SLR requirement created a captive market for government securities, which were issued at low administered interest rates. After the initiation of reforms, this ratio has been reduced in phases to the statutory minimum level of 25 per cent. Over the past few years numerous steps have been taken to broaden and deepen the Government securities market and to raise the levels of transparency. Automatic monetisation of the Government’s deficit has been phased out and the market borrowings of the Central Government are presently undertaken through a system of auctions at market-related rates.
Major facets of the reforms in the government securities are provided below:
Reforms in the Government Securities Market
Institutional Measures
Increase in Instruments in the Government Securities Market
Enabling Measures
FOREIGN EXCHANGE MARKET REFORMS
The Indian forex exchange market had been heavily controlled since the 1950s, along with increasing trade controls designed to foster import substitution. Consequently, both the current and capital accounts were closed and foreign exchange was made available by the Reserve Bank of India through a complex licensing system. The task facing India in the early 1990s was therefore to gradually move from total control to a functioning foreign exchange market. The move towards a market-based exchange rate regime in 1993 and the subsequent adoption of current account convertibility were the key measures in reforming the Indian foreign exchange market. Reforms in the foreign exchange market focused on market development with prudential safeguards without destabilising the market (Reddy, 2002 a). Authorised Dealers of foreign exchange have been allowed to carry on a large range of activities. Banks have been given large autonomy to undertake foreign exchange operations. In order to deepen the foreign exchange market, a large number of products have been introduced and entry of newer players has been allowed in the market.
Since 1950s, India had a highly controlled foreign exchange market and foreign exchange was made available to the Reserve Bank of India in a very complex manner. The steps taken for the reform of the foreign exchange market were:
Highlights of reforms in the foreign exchange market have been given below.
Exchange Rate Regime
Institutional Framework
Increase in Instruments in the Foreign Exchange Market.
Liberalisation Measures
The Indian approach to opening the external sector and developing the foreign exchange market in a phased manner from current account convertibility to the ongoing process of capital account opening is perhaps the most striking success relative to other emerging market economies. There have been no accidents in this process, the exchange rate has been market determined and flexible and the process has been carefullycalibrated. The capital account is effectively convertible for non-residents, but has some way to go for residents. The Indian approach has perhaps gained greater international respectability after the enthusiasm for rapid capital account opening has been dimmed since the Asian crisis.
REFORMS IN OTHER SEGMENTS OF THE FINANCIAL SECTOR
Measures aimed at establishing prudential regulation and supervision and also competition and efficiency enhancing measures have also been introduced for nonbank financial intermediaries as well. Towards this end, non-banking financial companies (NBFCs), especially those involved in public deposit taking activities, have been brought under the regulation of RBI. Development Finance Institutions (DFIs), specialised term-lending institutions, NBFCs, Urban Cooperative Banks and Primary Dealers have all been brought under the supervision of the Board for Financial Supervision (BFS). With the aim of regulatory convergence for entities involved in similar activities, prudential regulation and supervision norms were also introduced in phases for DFIs, NBFCs and cooperative banks. The insurance business remained within the confines of public ownership until the late 1990s. Subsequent to the passage of the Insurance Regulation and Development Act in 1999, several changes were initiated, including allowing newer players/joint ventures to undertake insurance business on risk-sharing/commission basis.
The Insurance Regulatory and Development Agency (IRDA) has been established to regulate and supervise the insurance sector. With the objective of improving market efficiency, increasing transparency, integration of national markets and prevention of unfair practices regarding trading, a package of reforms comprising measures to liberalise, regulate and develop capital market was introduced. An important step has been the establishment of the Securities and Exchange Board of India (SEBI) as the regulator for equity markets. Since 1992, reform measures in the equity market have focused mainly on regulatory effectiveness, enhancing competitive conditions, reducing information asymmetries, developing modern technological infrastructure, mitigating transaction costs and controlling of speculation in the securities market. Another important development under the reform process has been the opening up of mutual funds to the private sector in 1992, which ended the monopoly of Unit Trust of India (UTI), a public sector entity. These steps have been buttressed by measures to promote market integrity. The Indian capital market was opened up for foreign institutional investors (FIIs) in 1992.
The Indian corporate sector has been allowed to tap international capital markets through American Depository Receipts (ADRs), Global Depository Receipts (GDRs), Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings (ECBs). Similarly, Overseas Corporate Bodies (OCBs) and non-resident Indians (NRIs) have been allowed to invest in Indian companies. FIIs have been permitted in all types of securities including Government securities and they enjoy full capital convertibility. Mutual funds have been allowed to open offshore funds to invest in equities abroad.
REFORM IN THE MONETARY POLICY FRAMEWORK
What has been the change in monetary policy in the wake of these changes in different market segments as well as sectors.
The transition of economic policies in general, and financial sector policies in particular, from a control oriented regime to a liberalised but regulated regime has also been reflected in changes in the nature of monetary management. While the basic objectives of monetary policy, namely price stability and ensuring adequate credit flow to support growth, have remained unchanged, the underlying operating environment for monetary policy has undergone a significant transformation. An increasing concern is the maintenance of financial stability. The basic emphasis of monetary policy since the initiation of reforms has been to reduce market segmentation in the financial sector through increase in the linkage between various segments of the financial market including money, government securities and forex market.
Major features of the reforms in the monetary policy framework have been provided below:
Reforms in the Monetary Policy Framework Objectives
Twin objectives of “maintaining price stability” and “ensuring availability of adequate credit to productive sectors of the economy to support growth” continue to govern the stance of monetary policy, though the relative emphasis on these objectives has varied depending on the importance of maintaining an appropriate balance.
Reflecting development of financial market and liberalisation, use of broad money as an intermediate target has been de-emphasised and a multiple indicator approach has been adopted.
Emphasis has been put on development of multiple instruments to transmit liquidity and interest rate signals in the short-term in a flexible and bi-directional manner. l Increase of the linkage between various segments of the financial market including money, government security and forex markets.
Instruments
Move from direct instruments (such as, administered interest rates, reserve requirements, selective credit control) to indirect instruments (such as, open market operations, purchase and repurchase of government securities) for the conduct of monetary policy.
Introduction of Liquidity Adjustment Facility (LAF), which operates through repo and reverse repo auctions to set up a corridor for short-term interest rate. LAF has emerged as the tool for both liquidity management and also as a signalling devise for interest rate in the overnight market.
Use of open market operations to deal with overall market liquidity situation especially those emanating from capital flows. l Introduction of Market Stabilisation Scheme (MSS) as an additional instrument to deal with capital inflows without affecting short-term liquidity management role of LAF.
Developmental Measures
Discontinuation of automatic monetisation through an agreement between the Government and the Central Bank. Rationalisation of Treasury Bill market. Introduction of delivery versus payment system and deepening of inter-bank repo market.
Introduction of Primary Dealers in the government securities market to play the role of market maker.
Amendment of Securities Contracts Regulation Act to create the regulatory framework.
Deepening of government securities market by making the interest rates on such securities market related. Introduction of auction of government securities. Development of a risk-free credible yield curve in the government securities market as a benchmark for related markets.
Development of pure inter-bank call money market. Non-bank participants to participate in other money market instruments.
Introduction of automated screen-based trading in government securities through Negotiated Dealing System (NDS). Setting up of risk-free payments and system in government securities through Clearing Corporation of India Limited (CCIL). Phased introduction of Real Time Gross Settlement (RTGS) System.
Deepening of forex market and increased autonomy of Authorised Dealers.
The key policy development that has enabled a more independent monetary policy environment was the discontinuation of automatic monetisation of the government’s fiscal deficit through an agreement between the Government and the Reserve Bank of India in 1997. The enactment of the Fiscal Responsibility and Budget Management Act has strengthened this further :from 2006, the Reserve Bank will no longer be permitted to subscribe to government securities in the primary market. The development of the monetary policy framework has also involved a great deal of institutional initiatives to enable efficient functioning of the money market: development of appropriate trading, payments and settlement systems along with technological infrastructure. Against this discussion of what has been done, let me now turn to what the process has led to in the Indian financial sector.
PERFORMANCE OF THE FINANCIAL SECTOR UNDER THE REFORM PROCESS
BANKING SECTOR
Banking sector reform has established a competitive system driven by market forces. The process, however, has not resulted in disregard of social objectives such as maintenance of the wide reach of the banking system or channelisation of credit towards disadvantaged but socially important sectors. At the same time, the reform period experienced strong balance sheet growth of the banks in an environment of operational flexibility. A key achievement of the banking sector reform has been the sharp improvement in the financial health of banks, reflected in significant improvement in capital adequacy and improved asset quality. This has been achieved despite convergence of the prudential norms with the international best practices.
There have also been substantial improvements in the competitiveness of the Indian banking sector reflected in the changing composition of assets and liabilities of the banking sector across bank groups. In line with increased competitiveness, there has been improvement in efficiency of the banking system reflected inter alia in the reduction in interest spread, operating expenditure and cost of intermediation in general. Contemporaneously there have been improvements in other areas as well including technological deepening and flexible human resource management.
The expansion of branch network peaked in the phase of social banking during the 1970s and 1980s. Despite the slowdown in branch expansion since the 1990s, the population per bank branch, however, has not changed much since the 1980s, and has remained at around 15,000. It is often asserted that the Indian banking sector is saddled with too many branches, adding to its high intermediation costs. In fact, at about 8-10,000, the population per branch in developed countries is lower than that in India. Therefore, the reform process has maintained the gains in terms of the outreach of bank branches achieved in the phase of social banking. Despite a decline, direct lending to disadvantaged segments of the economy under the priority sector advances remained high during the reform period. The decline in priority sector lending since the initiation of reforms in fact reflects greater flexibility provided to banks to meet such targets. Currently, in the event a bank fails to meet the priority sector lending target through direct lending, the bank can invest the shortfall amount with the apex organisations dealing with flow of funds towards agriculture and small-scale industries. While adherence of banks to the norms on direct lending towards the priority sector still remains desirable, the current arrangement reflects how the reform process has provided operational flexibility to banks even while meeting social objectives. The discernible increase in the proportion of bank deposits to national income is reflective of the enhanced deepening of the Indian financial system during the period. Simultaneously, there have been considerable increases in per capita deposits and credit.
This also implies an increase in the average business per bank branch, which is likely to have improved the viability of individual bank branches including those in the rural and semi-urban centres. In the post-reform period, banks have consistently maintained high rates of growth in their assets and liabilities. This is particularly credible given the low inflationary situation that prevailed in this period compared to the earlier periods, most notably in the 1980s.
On the liability side, there has not been much compositional change since the initiation of reforms whereby deposits continue to account for about 80 per cent of the total liabilities. On the asset side, however, there is a definite increase in the share of investments. While the share of loans and advances did decline in the 1990s, it has recovered in recent years. Despite the large decline in SLR in the 1990s,3 the sharp increase in investments by banks is reflective of their attempt to evolve treasury operations into profit centres. The reduction in cash reserve ratio and improved inter-office adjustments in a substantially computerised and networked environment, inter alia, did free up substantial amounts of bank resources, which enabled banks to concentrate on investment operations with greater vigour. Interestingly, despite the reduced regulatory requirement to invest in government and other securities approved for SLR investment, the major increase in investment operations by Indian banks since the mid 1990s has been on account of their investment in government securities. This reflects the sustenance of high fiscal deficits of both central and state governments, particularly after the Pay Commission award leading to increase in the government salary bill in 1997. Furthermore, subdued industrial growth since 1997 also led to lower credit demand, providing banks further incentive to place their resources in riskfree government securities.
It is also possible that, in a declining interest rate scenario in the presence of a developing debt market, this was a rational profit maximising strategy. Banks’ investment in non-SLR securities as a proportion of total assets has in fact declined since 1999-2000. While in the 1990s, greater orientation towards investment activities and aversion to credit risk exposure may have deterred banks from undertaking their ‘core function’ of providing loans and advances, banks seem to have struck a greater balance between investment and loans and advances in recent years. Improved atmosphere for recovery created in the recent years coupled with greater awareness about market risks associated with large holding of securities portfolio seem to have induced banks to put greater efforts in extending loans.
Capital Position and Asset Quality
A set of micro-prudential measures have been stipulated since the onset of reforms aimed at imparting strength to the banking system as well as ensuring safety and soundness in order to fix ‘the true position of bank’s balance sheet and…to arrest its deterioration’ (Rangarajan, 1998). With regard to prudential requirements, norms for income recognition and asset classification (IRAC), introduced in 1992, have been strengthened over the years in line with international best practices. A strategy to attain CRAR of 8 per cent in a phased manner was put in place and subsequently the level was raised to 9 per cent with effect from 1999-2000. The overall capital position of commercial sector banks has witnessed a marked improvement during the reform period .
Illustratively, as at end-March 2003, 91 out of the 93 commercial banks operating in India maintained CRAR at or above 9 per cent. The corresponding figure for 1995-96 was 54 out of 92 banks.4 Improved capitalisation of public sector banks was initially brought through substantial infusion of funds by government to recapitalise these banks. On a cumulative basis, infusion of funds by government into the public sector banks since the initiation of reforms for the purpose of recapitalisation amounted to less than 1 per cent of India’s GDP, a figure much lower than that for some other countries. Subsequently, in order to reduce pressure on the budget and to introduce market discipline, public sector banks have been allowed to raise funds through issue of equity in the market subject to the maintenance of 51 per cent public ownership. 20 out of the 27 public sector banks have raised capital from the market. In order to improve their price-earning ratios, many public sector banks have also returned part of government’s equity subscription. Another important factor in the improvement in capital position of banks operating in India stemmed from deployment of retained earnings out of increased profits. The reform period also witnessed considerable improvements in the asset quality of banks. Nonperforming loans (NPLs) as ratios of both total advances and assets declined substantially and consistently since the mid-1990s. Moreover, for the first time since the initiation of reforms, in 2002-03, the absolute amount of NPLs in both gross and net terms witnessed declines (Table 5).
This improved recovery performance raises a few interesting issues. First, from the pattern of NPLs over the years, it can be argued that to a large extent the NPL problems faced by Indian banks are legacy problems emanating from credit decisions taken before the full implementation of the banking sector reforms. Second, there has been a distinct improvement in the credit appraisal process in the Indian banking system under the reform process whereby incremental NPLs have been low despite the fact that Indian industry has gone through a relatively low-growth phase since the mid-1990s. Finally, in recent years, the recovery performance of public sector banks has been better than private sector banks – both old and new – in terms of net NPL (i.e. net of provisioning).
Foreign banks, however, exhibited the best recovery performance and lowest NPL levels among the all bank-groups. This raises a question mark on the applicability of the argument that links performance of banks with ownership pattern in the context of Indian banking. Another interesting point that merits mention is that despite India’s transition to a 90-day NPL recognition norm (from 180-day norm) since 2004, both gross and net NPLs as a percentage of total advances declined between end-March 2003 and end-March 2004. This reflects the success of new initiatives for resolution of NPLs including promulgation of the SARFAESI5 Act in containing NPLs. Greater provisioning and write-off of NPLs in the face of greater profitability also helped keeping the NPLs low during 2003-04. Competition and Efficiency One of the major objectives of banking sector reforms has been to enhance efficiency and productivity through enhanced competition. Such policies have led to considerable and consistent reduction in the shares of public sector banks in the total income, expenditure and assets of the commercial banking system.
Shares of Indian private sector banks, especially new private sector banks established in the 1990s, in the total income and assets of the banking system have improved considerably since the mid-1990s. A number of new private sector banks have emerged as dynamic components of the Indian banking system, reducing not only the market share of public sector banks but also those of foreign banks. The reduction in the asset share of foreign banks, however, is partially due to their increased focus on off-balance sheet non-fund based business. Notwithstanding such transformation, the position of public sector banks in the Indian banking system continues to be predominant as these banks account for nearly three-fourths of assets and income. It is important to note that public sector banks have responded to the new challenges of competition, which is reflected in the increase in share of these banks in the overall profit of the banking sector.
From the position of net loss in the mid-1990s, in recent years the share of public sector banks in the profit of the commercial banking system has become broadly commensurate with their share of assets, indicating a broad convergence of profitability across various bank groups. This is yet another example that, with operational flexibility, public sector banks are competing effectively with private sector and foreign banks. The market discipline imposed by the listing of most public sector banks has also probably contributed to this improved performance. Public sector bank managements are now probably more attuned to the market consequences of their activities. Since the mid-1990s, profitability levels of commercial banks have hovered in the range of 0.7- 0.8 per cent, except during certain exceptional years.
Clearly this is an improvement over the profitability prior to the initiation of the reform process. Moreover, there is a general improvement in the profitability situation in the recent years across bank groups. Since the mid-1990s, consistent with soft interest rate policies, both interest income and interest expenditure of banks as proportions of total assets have declined. However, interest expenditure declined faster than interest income, resulting in an increase in net interest income. Reflecting the greater emphasis on income and expenditure management, there has been a general reduction in the operating expenditure as a proportion of total assets.
This is also reflective of efficiency gain of the Indian banking under the reform process. This has been achieved in spite of large expenditures incurred by Indian banks in installation and upgradation of information technology. Moreover, in order to address manpower redundancies, public sector banks also incurred large expenditures under voluntary pre-mature retirement of nearly 12 per cent of their total staff strength. The process, however, resulted in reduced operating expenditure in the medium-term. Another reflection of greater competition and efficiency of the Indian banking system can be captured from the considerable reduction in interest spread over the reform period.
Once again, this reduction has been across the bank-groups. In fact, the spread is the highest for foreign banks and lowest for new private sector banks.
A major impact of the reform process on the Indian banking has been in terms of change in business strategy of the banks. When banking sector reforms were introduced, over 90 per cent of the income of commercial banks in India was in the form of interest income, this proportion has gone down substantially to about 80 per cent in recent years. This reflects greater diversification of banks into non-fund based business and also emergence of treasury and foreign exchange business as profit centres for Indian banks.
FOREIGN EXCHANGE MARKET
The reforms measures in the foreign exchange market have resulted in significant deepening of the market in terms of both instruments and variety of players. Despite certain fluctuations, daily average turnover in the Indian foreign exchange market has shown a general increase. A survey by the Bank for International Settlements on the foreign exchange market turnover during 2001 in which 43 countries including India participated reveals that while foreign exchange market turnover declined the world over considerably as compared to 1998, it increased in India.
In recent years, the turnover in the foreign exchange market has been nearly 6 times higher than the aggregate size of India’s balance of payments. While inter-bank transactions accounted for about 80 per cent of the turnover in the foreign exchange market, merchant transactions registered high growth rates in recent years. The increased turnover can be taken as an indicator of the extent of liberalisation of the Indian foreign exchange market and the consequent deepening of the foreign exchange market. Full convertibility on the current account and extensive liberalisation of the capital account transactions have facilitated not only transactions in foreign currency, these have enabled the corporates to hedge various types of risks associated with foreign currency transactions. Authorised Dealers (ADs) are the leading agencies in the transmission of the liberalisation measures in the context of foreign exchange market as well as widening and deepening of such markets.
With the deepening of foreign exchange market and increased turnover, income of commercial banks through such transactions increased considerably. In recent years, profit from foreign exchange transactions accounted for 20-30 per cent of the total profit of the public sector banks. Despite liberalisation of the capital account and introduction of a market determined exchange rate, the foreign exchange market in India remained stable barring a few episodes of mild volatility .
Therefore, India’s current exchange rate policy of managing volatility without fixed target levels has yielded satisfactory results. It is, however, important to point out that RBI intervention in the foreign exchange market has been relatively small in terms of volume. During 2002-03, a year considered to be characterised by considerable intervention by the Reserve Bank, gross intervention by the Reserve Bank of India accounted for less than 3 per cent of the turnover in the foreign exchange market. This shows the predominant role of market forces in determination of the external value of the rupee. Reflecting the resilience of the Indian economy, in particular the financial sector, there has been a large inflow of funds towards the country in recent years. This has reflected in large accumulation of foreign exchange reserves. An analysis of the sources of reserve accretion indicates that buoyancy in services exports, large unilateral private transfers reflecting mainly remittance from Diaspora, and various types of non-debt creating capital inflows have been the major source for the accumulation of foreign exchange reserves.
It is interesting to note that while financial sector reforms started at the backdrop of external sector crisis, India’s foreign exchange reserves reached historical peaks when the country has substantially liberalised norms governing flows of foreign exchange. Accumulation of foreign exchange reserves also reflects monetary policy response in face of large capital inflows. The process has been successful in maintaining price stability. Available indicators of reserve adequacy suggest that India’s current level of foreign exchange reserves can be considered adequate as a cushion against potential disruptions to trade and current transactions as well as external debt servicing obligations. In the absence of an international lender of last resort, the reserves also provide the country a level of self-insurance against destabilising and costly financial crisis.
OTHER FINANCIAL INTERMEDIARIES
In line with banks, there has been an almost acrossthe-board improvement in the financial health of other financial intermediaries as well in terms of improvements in capital position and reduction in NPLs. Among the cooperative banks, there have been improvements in capital position, reduction in spread and operating expenses. Despite the decline in NPLs as a proportion of total assets for a majority of the cooperative banks, the ratio for some of the large cooperative banks increased significantly, mainly on account of inappropriate riskmanagement and corporate governance practices. Measures have been put in place to guard against repetition of such episodes, but this remains a burden. Capital adequacy levels of most of the major DFIs have improved while NPL levels declined since the mid1990s. Moreover, reflecting the adaptability of DFIs to changed business environment under the reform process, the share of para-banking activities such as underwriting, direct subscription and guarantees has increased from 10 per cent in the early-1990s to over 30 per cent in recent years.
Some of the DFIs, however, have not been able to adjust as well as the others in the new environment mainly because of their past investment behaviours. Moreover, a few of the large DFIs felt that they could perform better as banks under the new environment. ICICI has already transformed itself into a bank and similar moves are underway for the Industrial Development Bank of India (IDBI). There has also been a large transformation in the NBFC sector, whereby a large number of NBFCs have discontinued their public deposit taking activities. Under the strategy of sequenced reform, such measures in the insurance sector were introduced later than the banking sector. Despite this relatively late start, the insurance sector has witnessed considerable changes over the past few years. A large number of private insurance companies, generally with foreign capital participation, have entered the sector. The current profile of the Indian insurance industry reflects that, notwithstanding the entry of private sector players, in terms of both assets and liabilities, insurance companies from the public sector continue to dominate the industry.
Despite this, given the fast pace of growth in the insurance industry, private players have been able to market their products (IRDA, 2002). Perhaps more importantly, liberalisation of entry norms in insurance segment has brought about a sea change in product composition. While in the past, tax incentives were the major driving force of the insurance industry, particularly life insurance industry, in the emerging situation the normal driving force of an insurance industry is taking important roles (IRDA, 2002). Driven by competitive forces and also the emerging socioeconomic changes including increased wealth, education and awareness about insurance products have resulted in introduction of various novel products in the Indian market. Along with the changing product profile, there have also been salutary improvements in consumer service in recent years, driven largely by the impact of new technology usage, better technical know-how consequent upon foreign collaboration and focused product targeting, dovetailed to specific segments of the populace as well as cross-selling of products through bancassurance. Insurance companies are also taking active steps to venture into innovative distribution channels for their products over and above creating strong agency network. EQUITY MARKET The 1990s have been good for the Indian equity market. The market has grown exponentially in terms of resource mobilisation, number of stock exchanges, number of listed stocks, market capitalisation, trading volumes, turnover and investors’ base . Along with this growth, the profile of the investors, issuers and intermediaries has changed significantly. The market has witnessed a fundamental institutional change resulting in drastic reduction in transaction costs and significant improvement in efficiency, transparency and safety (NSE, 2003).
In the 1990s, reform measures initiated by SEBI such as, market determined allocation of resources, rolling settlement, sophisticated risk management and derivatives trading have greatly improved the framework and efficiency of trading and settlement. Almost all equity settlements take place at the depository. As a result, the Indian capital market has become qualitatively comparable to many developed and emerging markets. The liberalisation and consequent reform measures have drawn the attention of foreign investors leading to a rise in portfolio investment in the Indian capital market. During the first half of the 1990s, India accounted for a larger volume of international equity issues than any other emerging market (IMF, 1995). Over the recent years, India has emerged as a major recipient of portfolio investment among the emerging market economies. Apart from such large inflows, reflecting the confidence of cross-border investors on the prospects of Indian securities market, since 1993, when entry of FII was permitted for the first time, except for one year, India received positive portfolio inflows in each year. The stability of portfolio flows towards India is in contrast with large volatility of portfolio flows in most emerging market economies.
The overall impact of the financial sector reforms has been positive. However consistent reforms are needed to maintain the economic growth and make it inclusive of all the sections of society. The recent measures taken by government includes the bankruptcy and insolvency code for resolution of non performing assets, the indradhanush strategy for strengthening the banking sector, the goods and services tax for making India a unified market, single window clearance to remove red tapism and bring transparency, startup India scheme and standup India scheme to boost economic growth in the country etc. India has reached among the top 100 in the ease of doing business of World Bank. But continued efforts are required to sustain and improve the economic growth rate.
By: Gurjeet Kaur ProfileResourcesReport error
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