Although some form of banking, mainly of the money-lending type, has been in existence in India since ancient times, it was only over a century ago that proper banking began. The earliest institutions which undertook banking business under the British regime were agency houses which carried on banking business, in addition to their trading activities. Most of these agency houses were closed down between 1929-32. Following serious financial troubles, three presidency banks were later amalgamated into Imperial Bank of India in 1919.

The modern banking system started in India in the beginning of the 19th century. Bank of Hindustan (1770) was the first bank to be established (Alexander and Co.) at Calcutta under European management. Other bank set up were Bank of Bengal (1806). Bank of Bombay (1840) and the Bank of Madras (1843) were called Presidency Banks. The first purely Indian bank was the Punjab National Bank (1894) but in 1881 the first bank with limited liability to be managed by an Indian board, namely, the Oudh Commercial Bank founded. Subsequently, the Punjab National Bank was established in 1894. Swadeshi movement, which began in 1906, encouraged the formation of a number of commercial banks. Banking crisis during 1913- 1917 and failure of 588 banks in various states during the decade ending in 1949 underlined the need for regulating and controlling commercial banks. The Banking Companies (Inspection Ordinance) was passed in January 1946 and the Banking Companies (Restriction of Branches) Act in February 1946.

Post Independence period 1947-1991

The Banking Companies Act was passed in February 1949, which was subsequently amended to read Banking Regulation Act.

Nationlisation of Banks

With a view to bring commercial banks into the mainstream of economic development with definite social obligations and objectives, the Government issued ordinance on 19 July 1969 acquiring ownership and control of 14 major banks in the country, with deposits exceeding Rs 50 crore each. Six more commercial banks were nationalized from 15 April 1980. The objectives of public sector banking system were outlined on 21 July 1969.

Nationalization was done to check the concentration of economic power in few hands. In the private sector banking, a small number of shareholders could determine the patterns of allocation suitable for their own needs. Secondly, Nationalization was essential for bringing about sectoral and regional balances, and to correct the urban bias. Finally, banks were considered to be an instrument of social transformation and not only a means of profit maximization.

Credit extension policy of banks

Priority sectorslending

Priority sector refers to those sectors of the economy which may not get timely and adequate credit in the absence of this special dispensation. Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections.

Extension of credit to small borrowers in the hitherto neglected sectors of the economy has been one of the key tasks assigned to the public sector banks in the post-nationalisation period.

Priority Sector includes the following categories:

• Agriculture
•  Micro and Small Enterprises
• Education
• Housing
• Export Credit
• Renewable Energy
• Social infrastructure
• others

To achieve this objective, banks have drawn up schemes to extend credit to small borrowers in sectors such as agriculture, small-scale industry, road and water transport, retail trade and small business which traditionally had very little share in the credit extended by banks. Taking into account the need to provide financial resources through bank credit to weaker sections for specific needs, consumption credit (with certain limits) has been included in priority sectors. Presently 40% of the credit extension should go towards priority sector lending.

Credit to weaker sections

With a view to augment credit flow to small and poor farmers, commercial banks were advised by the Reserve Bank of India to provide at least 10 per cent of their net bank credit or 25 per cent of their priority-sector advances to weaker sections comprising small and marginal farmers, landless labourers, tenant farmers and share-croppers, artisans, village and cottage industries, beneficiaries of Scheme of Urban Micro Enterprises (SUME), the Integrated Rural Development Programme, and Scheme for Liberation and Rehabilitation of Scavengers, scheduled castes and scheduled tribes and beneficiaries of Differential Rate of Interest (DRI) Scheme.

Credit flow to agriculture

Banks were initially given a target of extending 15 per cent of the total advances as direct finance to the agriculture sector to be achieved by March 1985. This target was subsequently raised to 18 per cent to be achieved by March 1990. In terms of the guidelines issued by the Reserve Bank of India in October 1993, both direct and indirect advances for agriculture are taken together for assessing the target of 18 per cent with the condition that lending for indirect agriculture does not exceed one fourth of the total agriculture lending target of 18 per cent of the net bank credit.

Advances to SC/ST borrowers

People belonging to the scheduled castes and scheduled tribes are recognised as the most vulnerable sections of the society. Banks have been asked to make special efforts to assist them with adequate credit to enable them to undertake self-employment ventures to acquire income generating capital assets so as to improve their standard of living.

Recently Micro-Finanace has become important part of credit extension policy of banks for weaker sections. The aim is Financial Inclusion.

Targets And Sub-Targets For Banks Under Priority Sector

Categories	Domestic scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) and Foreign banks with 20 branches and above	Foreign banks with less than 20 branches
Total Priority Sector	40 per cent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.	40 per cent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, to be achieved in a phased manner by 2020.
Agriculture #	18 per cent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher. Within the 18 percent target for agriculture, a target of 8 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher is prescribed for Small and Marginal Farmers.	Not applicable
Micro Enterprises	7.5 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.	Not applicable
Advances to Weaker Sections	10 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher	Not applicable

Joint-stock banks having Rs.5 lakh or more as capital and reserves are called scheduled banks by Reserve Bank of India. Included in the Second Scheduled on the RBI Act, these banks are registered as a limited liability, joint stock company under the Indian Companies Act.

Banking structure

1.         Apex – Reserve bank of India

2.         Public Sector Banks

• State Bank of India and its associate banks called the State Bank group
• 19 nationalised banks
• Regional Rural Banks mainly sponsored by Public Sector Banks

3.         Private Sector Banks

• Indian private banks
• Foreign private banks
• Non-scheduled Banks

4.         Co-operative sector

The co-operative banking sector has been developed in the country to the suppliment the village money lender. The co-operatiev banking sector in India is divided into 4 components

• State Co-operative Banks
• Central Co-operative Banks
• Primary Agriculture Credit Societies
• Land Development Banks or Agricultural Development Banks
• Urban Co-operative Banks

5.         Development banks[1]

• Industrial Finance Corporation of India (IFCI)
• Industrial Development Bank of India (IDBI)
• Industrial Credit and Investment Corporation of India (ICICI)
• Industrial Investment Bank of India (IIBI)
• Small Industries Development Bank of India (SIDBI)
• SCICI Ltd.
• National Bank for Agriculture and Rural Development (NABARD)
• Export Import Bank of India
• National Housing Bank

Reserve Bank of India

The Reserve Bank of India (RBI) was established under the Reserve Bank of India Act, 1934 on 1 April 1935 and nationalised on 1 January 1949. The Bank is the sole authority for issue of currency in India other than one rupee coins and subsidiary coins and notes. As the agent of the Central government, the Reserve Bank undertakes distribution of one-rupee notes and coins, as well as small coins issued by the Government. The Bank acts as banker to the Central government, State governments, commercial banks, state co-operative banks and some of the financial institutions. It formulates and administers monetary policy with a view to ensuring stability in prices while promoting higher production in the real sector through proper deployment of credit. RBI plays an important role in maintaining the stability of exchange value of the rupee and acts as an agent of the Government in respect of India’s membership of International Monetary Fund. The Reserve Bank also performs a variety of developmental and promotional functions. Apart from these, RBI also handles the borrowing programme of the Government of India.

REGIONAL RURAL BANKS (RRBS)

RRB’s began to be set up in 1975, after the Narasimhan Committee Report. Initially 5 RRBs were established at Moradabad and Gorakhpur (UP), Bhiwani (Haryana), Jaipur (Rajasthan) and Malda (West Bengal) on October 2, 1975.  RRBs are working in all states of the country except in Sikkim and Goa.

The equity / shareholding pattern of RRBs is

CentralGovernemt – 50%

State governments – 15 %

Sponsor banks (EgSBI, PNB etc.) – 35%

While Centre and sponsor banks have been infusing capital, state governments have been found wanting in providing their share.

RRBs are scheduled banks, its area of operation is limited to one or more districts of a state. They usually pay 1% or 2% higher rate of interest in comparison to commercial banks. RBI is the regulatory authority of RRBs and their inspection is undertaken by NABARD. 

Since April 1987, no new RRB has been opened keeping in view the recommendations of Kelkar Committee. After the ongoing process of merger and acquisitions, number of RRBs has come down continuously – as on March-end, 2011, the total number of RRBs stood at 82; this fell to 64 in March 2013 and 57 in March 2014. As for now, the process of further amalgamation of RRBs has been put on hold by Ministry of Finance.

Objectives

• The RRBs are sponsored by public sector banks to meet credit and other financial facilities in rural areas. They provide cheap credit facility to small and marginal farmers, agriculture labourers, artisans and small entrepreneurs.
• They were established to take the banking services to the door steps of rural masses, especially in remote rural areas with no access to banking services. 
• These banks were also intended to mobilise rural savings and channelise for supporting the productive activities in the rural area. 

RRB Amendment Act 2015

The parliament in an efort to revamp the RRBs passed the RRB Amendment Act to amend the RRB Act, 1976.

Main provisions of the act are-

• Total Authorized Capital of RRBs is to be raised to Rs. 2000 crores in place of 5 crores earlier.
• The Total Authorized Capital of Rs. 2000 crores is to be divided into 200 crore shares of Rs. 10 each.
• RRBs have been allowed to raise capital from private investors by issuing shares. But on condition that combined shareholding of Union+ State+ Sponsor bank should not fall below 51%.
• States can buy more shares, to increase their shareholding above 15%.
• RRB can appoint Board of directors from outside union-state and sponsor bank nominated people. One person cannot become director in maximum 2 RRBs.
• Director’s tenure limit: 3 years. Maximum two terms allowed.

Advantages over the previous Act of 1976-

The Act aims at expanding the Total Authorized Capital of the RRBs thereby increasing their operational capabilities.

The Act also divides the total capital into smaller shares to increase their tradability in the shares market. Now due to cheap cost of shares more people will buy them thereby infusing capital in the RRBs.

By allowing independent directors the Act tries to bring in efficient management and accountability into the functioning of the RRBs.

The Act allows states to raise their share in the RRBs thereby having more say in decision making of these banks.

COOPERATIVE BANKS

Co-operative banks in India also perform fundamental banking activities but they are different form commercial banks.  Commercial banks have been constituted by an Act passed by parliament while co-operative banks have been constituted by different State under various Acts related to co-operative societies of various states. 

Co-operative bank organisation in India has three tier set up. 

Three Tier Structure

1.         State Co-operative bank is the apex cooperative credit institution in the state.

2.         Central or District Co -operative bank works as district level.

3.         At the lowest level co-operative setup in Primary Credit societies which works at village level.

Primary Credit Societies

These societies provide short term credit facilities to agriculture sector.  Minimum 10 persons of a village (or are) can form a primary credit society.  These PCSs are also called Primary Agriculture Credit Societies(PACS).  These societies grant short-term loans (generally one year period) for productive activities but this period can be extended upto 3 years under special circumstances.

Central (or district) co-operative bank

The working area of these banks is limited to one district only.  Central Co-operative Bank can be divided in two parts:

• Co-operative Banking Union
• Mixed Central Co-operative Bank

The membership of Co-operative Banking Union is given to co-operative societies only, while the membership of mixed central co-operative bank can be granted to both co-operative societies and individuals.  Generally all states in India are having central co-operative banks with mixed membership and are providing sufficient financial assistance to both PSCs and individuals.

Central Co-operative Banks get loans from State Co-operative bank and give loans to Primary Credit Societies.  The duration of such loans vary from one year to three years.  In this way Central Co-operative Bank plays a bridge and Primary Credit Societies. 

State Co-operative Bank (SCB)

It is the apex co-operative bank of the state.  It grants loans to central co-operative bank and regulates their activities.  State co-operative bank gets loans form RBI.  Hence, SCB acts as a link between RBI and Central co-operative banks.  State Co-operative Bank raises its current capital by shares and loans.  RBI generally provides loans to SCB on interest rate, one or two per cent lower than bank rate. At present 28 State Co-operative Banks are working in the country.

Difference between Commercial bank and Co-operative Bank

• Commercial bank can establish its branches in any district/state of the country while, contrary to it, co-operative bank can operate its activities only within limited area. For example, District Co-operative Bank can perform banking activities within the boundaries of the concerned district.
• Similarly, Primary Credit Societies can perform banking services within concerned villages.  Co-operative banks can not open their branches in foreign countries while commercial banks can do that.
• Banking Regulation Act 1949 is fully applicable to all commercial banks while it is partially applicable to co-operative banks.  In other words, RBI has partial control over cooperative banks.
• Co-operative banks work on principles of co-operation while commercial banks adopt pure commercial principles in their operation.  That is the reason why co-operative banks succeed in getting financial assistance from RBI on concessional rate.

PROBLEMS of THE BANKS

The three decades after nationalization saw a phenomenal expansion in the geographical coverage and financial spread of the banking system in the country. As certain rigidities and weaknesses were found to have developed in the system, during the late eighties the Government of India felt that these had to be addressed to enable the financial system to play its role in ushering in a more efficient and competitive economy.

1.         Profitability and efficiency levels have been very low especially in the case of public sector banks not to speak of the quality of service. The government policy like high reserve requirements (CRR, SLR) and high priority sector lending has has also affected the profitability of the banks in India.

2.         The banking system was burdened with NPAs (Non-performing assets) of around 17 per cent (in actual terms it could have been more considering the loose asset classification frame work which existed then).

3.         Regulation had a strangle hold on all aspects of the banking sector including entry of players, interest rates and credit allocation to name a few.

4.         The loan meals, priority sector lending and a host of such schemes contributed to the low profitability of the banking sector.

5.         Absence of professionalism, poor customer services, lack of prudential accounting norms are some of the major problems.

The banking sector in India though in a relatively healthy state compared to the banking sector in several economies, has some issues that are preventing it from functioning with full efficiency. These problems can be classified as-

• Financial problems
• Problems related with Governance
• Structural Problems

Financial problems

As per the economic survey 2014-15 the banking sector in India is reeling under Double Financial Repressioni.e. repression on the asset side as well as liability side.

Financial Repression on the Asset side

Financial Repression on the asset side is due to NPAs (Non-performing assets), SLR requirements and Priority sector lending.

SLR (Statutory Liquidity Ratio) requirements- The Statutory Liquidity Ratio is a requirement on banks to hold a certain share of their resources in liquid assets such as cash, government securities (G-secs) and gold. In principle, the SLR can perform a prudential role because any unexpected demand from depositors can be quickly met by liquidating these assets.

In practice, the SLR has become a means of financing (at less than market rates presumably) a bulk of the government’s fiscal deficit, suggesting that SLR cuts are related to the government’s fiscal position.

The SLR is a form of financial repression where the government pre-empts domestic savings at the expense of the private sector. Real interest rates are lower than they would be otherwise.

The Economic survey presents the case for gradually reducing this requirement- both to free up capital for the banks and to make the market for government bonds more liquid.

Also, SLR reductions could allow banks to offload G-secs and reap the capital gains which could help recapitalise them, reducing the need for government resources, and helping them raise private resources at better returns compared to G-secs.

PSL (priority sector lending) requirements – According to several studies the PSL has failed to achieve the intended benefits of financial inclusion and is instead being misused thereby leading to asset side repression on banks. Findings of these studies are-

The PSL is being utilized by rich farmers more compared to the poor ones (the number of high value loans (Rs.10 lakh and above) are on a constant rise).

There is no mechanism to monitor the end use of the loan and hence several of such loans are being used for non-productive consumption.

Most of the agricultural loans are in March instead of the sowing times of Rabi and Kharif. This is so because the banks do not readily forward loans to farmers until the yearly deadline.

Most of the PSL are in relatively rich states like Haryana Punjab etc. and not in more needy states like Odisha, Arunachal etc.

These facts suggest that PSL needs to be restructured.

NPAs-The Non-Performing Assets of banks at 5.1% are well within the Basel norms. But their recent increase is an alarming trend that needs to be curtailed.

Most of the NPAs are on account of default by big borrowers.

Also, the inadequate bankruptcy laws, overburdened Debt Recovery Tribunals, ineffective implementation of the SARFAESI act add to the problems.

Solutions

Deregulate: As the banking sector exits the financial repression on the liability side, aided by the fall in inflation, this is a perfect opportunity to relax asset-side repression.

First, SLR requirements can be gradually relaxed. This will provide liquidity to the banks, depth to the government bond market, and encourage the development of the corporate bond market. The right sequence would be to gradually reduce SLR and then provide incentives for a deeper bond market.

Second, PSL norms can be re-assessed to slowly make priority sector more targeted, smaller, and need-drivenas proposed by the NachiketMor committee.

Independent Renegotiation committee-Appointment of an Independent Renegotiation Commission with political authority and reputational integrity to resolve some of the big and difficult cases. When the next boom and bust comes around, India needs to be better prepared to distribute pain between promoters, creditors, consumers, and taxpayers. Being prepared for the cleanup is as important as the being prudent in the run-up.

Financial Repression on the Liability Side- High inflation and limited return on banks’ assets has ensured that the rates maintained by banks fetched households a negative real rate of return on deposits. Hence banks are receiving fewer deposits as people move towards physical assets.

Recently due to falling Inflation, the repression on liability side has eased somewhat.

Structural problems

In India the share of banks towards total credit advanced in economy stands at 95%. This exposes them to high risks due to defaults.

Also, Public Sector Banks account for over 80% of these credits thereby increasing the risk factor for them further.

The Capital Markets and Private Banks have failed to give any competition to the Public Sector Banks in credit market.

Solution- More banks and more kinds of banks must be encouraged. Healthy competition from capital markets is essential too which will require policy support from the government. For ex- making mandatory a share of credit from capital markets for big borrowers.

Governance related problems

See PJ Nayak committee on governance reforms.

PJ Nayak Committee on reforms in governance of Bank Boards

In Public Sector Banks (PSBs) government owns a minimum of 50% shares thereby having majority voting power. This means that government has major say in matters of appointments and decision making in PSBs. Such government influence often leads to lack of autonomy on part of banks and is often responsible for poor performance of PSBs.

Therefore the PJ Nayak Committee recommends reforms in governance of Bank Boards of PSBs. Main recommendations of the committee are-

Repeal following laws-

• Bank Nationalization Act 1970, 1980.
• State Bank of India Act 1955.
• SBI Subsidiaries Act 1959.

Because above acts require Government to keep shareholding >50%, and appoints MDs and board directors.

Once those acts are repealed Government should setup a Bank Investment Company (BIC), under Companies act, 2013 as a “Core investment company”. Government should transfer its shares of PSBs, to BIC.  Consequently al the PSBs to be registered as subsidiaries of BIC and they are to become “Ltd.” Companies.

The government should sign an agreement of autonomy with the BIC and allow it to vote on important appointments and decisions by involving all the shareholders. (In UK, Government has setup UKFI (UK Financial investment ltd.) for the same purpose.)

Until BIC is constituted, a Bank Boards Bureau involving senior bankers to be setup for appointments and other functions of BIC.

Implications of these reforms-

The appointments will be based on performance and talent thereby ensuring better performance and management of PSBs.

Presently, the PSBs are open to scrutiny by not just RBI but also by CVC, CAG, RTI etc. This excessive oversight affects decision making as the managers are afraid to take bold business oriented decisions. Falling of government share below 50% will ensure that banks are free from oversight of multiple agencies.

Due to government ownership PSBs also suffer from ‘fiscal repression’ i.e. they are directed to invest in Government Securities which though safe yield very low returns thereby affecting their profitability.

Also they suffer fiscal repression due to loan waivers, advancing cheap loans to government agencies etc.

Governance reforms will free banks of these fiscal repressions.

DOMESTIC SYSTEMATICALLY IMPORTANT BANKS

In 2009 Financial Stability Board (FSB) was setup. It is an international body affiliated with the G-20 that monitors global financial health. FSB highlighted that each country has certain banks which are big and important in terms of huge client base, large size of assets and liabilities, cross border and cross-sector functioning (like insurance, mutual funds etc.)

These banks are so big and important that economy cannot afford their failure and hence in case of poor performance the government is forced to offer them a bailout package. Consequently, these banks become confident they’re “too big to fail” so they will always be rescued by market-forces or the government and will continue to indulge in grey-areas and reckless practices.

Hence, we need to identify such systematically important banks (SIB) at Domestic and global level. We must force them to have additional capital/backup against financial emergency, so that taxpayer money not wasted in rescuing them during crisis.

Following the guidelines of FSB, RBI has to identify Domestic Systematically Important Banks every year. These banks have to maintain additional capital and are also open to additional regulatory oversight by RBI. This will ensure that these banks do not enter into any grey areas and shoddy practices (like the one exposed by Cobrapost Sting operation) and do not need bailout packages that consume taxpayers’ money.

The banks depending on their size have to maintain an additional capital ranging from 0.2% to 1% of their Risk Weighted Assets.

At the beginning of the 1990s many public sector banks became unprofitable and undercapitalized. The root cause of this was the excess emphasis given to social banking goals like widening the reach of banking services. The crucial elements like capital adequacy, profitability and low NPAs which are sine qua non for sound and efficient banking were given a back seat. About all, governmental protection acted as a disincentive leading to lethargy in the bank managements.

Opined the committee “the deterioration in the financial health of the system has reached a point where unless remedial measures are taken soon, it could further corrode the real value of and return on the savings entrusted to them and even have an adverse impact on depositor and investor confidence”.

Important committees on Banking sector reforms

Narasimham Committee Recommendations

Against this backdrop, the committee on the financial system headed by Mr. M. Narsimhan was constituted on 14 August 1991 to examine all aspects of the financial sector and suggest reforms so as to transform the sector from a highly regulated one to market oriented one. It submitted a report to the Finance Ministry and it was laid on the table of the Parliament on December 17, 1991. Its suggestions included:

• Deregulation of entry reducing the reserve preemption levels,
• Interest rate deregulation,
• Review of priority sector lending,
• Institution of capital adequacy and prudential norms,
• Improving accounting practices,
• Allowing public sector banks to access the capital market,
• Setting up of ARF (Asset Reconstruction Fund),
• Relaxing the branch licensing policies,
• Granting autonomy in the recruitment of staff,
• Curbing excessive regulation and regulation of NBFCs et al.

Second report of the Narasimham committee

A high-level Committee, under the Chairmanship of Shri M. Narasimham, was constituted by the Government of India in December 1997 to review the record of implementation of financial system reforms recommended by the CFS in 1991

The Committee has submitted its report to the Government in April 1998.

The second report of the Narasimham committee has reiterated many of its previous recommendations. It has also suggested some new ones in the light of seven years of post-reform experience.

1.   Significant among these is the one relating to reduction of government of India’s stake to 33 per cent in public sector banks.

2.   This the appointment of chairmen and managing directors shall be left to the boards of banks.

3.   Stock options to the employees of banks going public have also been suggested.

5.   As regards weak banks (banks whose accumulated losses and net NPAs exceed capital funds or in the case of public sector banks whose operating results less income from recapitalization bounds reveal losses for three consecutive years) their transformation into narrow banks has been suggested as a short-term measure. These banks would deploy 100 per cent of their money in low or no risk investments. This approach it is argued would lead to rehabilitation of weak yet potential banks.

6.   Gradual increase in capital adequacy ratio has been proposed so as to make it 9 per cent by the year 2000 and 10 per cent by the year 2002.

7.   As regards the norms of income recognition from accrual of interest 90 days cycle has been recommended against the present 180 days. A provision of one per cent for standard assets is made applicable. Extension of tax-deductibility has been recommended for the provisions made since these provisions affect the balance sheets of banks.

8.   The committee has also mooted the concept of NPA swap bonds. The assets identified as doubtful or loss making can be transferred to an asset reconstruction company (ARC), which in turn issues NPA swap bonds to the banks. The ARC shall be entitled to file suits in debt recovery tribunals for recovery.

9.   Depoliticisation of appointments of chairmen is one of the significant recommendations aimed at improving the flexibility and autonomy of banks. This would encourage professionalism in the bank management and board appointments. The review of the functions of the boards and the management has also been suggested. Greater emphasis shall be accorded to the concept of enhancement of shareholder value avers the committee.

10. Considering the bloated work force and its concomitant cost implications the committee recommends that the present system of industrywise wage settlements shall be given way to bank-wise settlements. To reduce the surplus staff the committee has mooted the implementation of golden handshake.

11. While the economic reform has been making considerable progress the legal system has maintained status quo. The committee felt that banking sector is in need of an appropriate legal framework to help enforce the contracts and protect the interests of secured creditors especially in bankruptcy proceedings. The experience with the debt recovery tribunals has not been encouraging. These apart the relevance of continued existence of different laws e.g. RBI Act. Banking regulation Act, Sick Industrial Companies Act and SBI Act etc. is proposed for review.

NachiketMor committee

The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI in September 2013, was mandated with the task of framing a clear and detailed vision for financial inclusion and financial deepening in India.

In its final report, the Committee has outlined six vision statements for full financial inclusion and financial deepening in India:

The Committee further lays down a set of four design principles namely;

• Stability,
• Transparency,
• Neutrality, and
• Responsibility.

PJ Nayak Committee

The P J Nayak Committee or officially the Committee to Review Governance of Boards of Banks in India, was set up by the Reserve Bank of India (RBI) to review the governance of the board of banks in India. The Committee was set up in January 2014. The Committee was chaired by P J Nayak, the former CEO and Chairman of Axis Bank.

Recommendations

• Repeal the Bank Nationalisation Act (1970, 1980), the SBI Act and the SBI Subsidiaries Act. This is because these acts require the government to have above 50% share in the banks.
• After the above acts are repealed, the government should set up a Bank Investment Company (BIC) as a holding company or a core investment company.
• The government to transfer its share in the banks to this BIC. Thus, the BIC would become the parent holding company of all these national banks, which would become subsidiaries. As a result of this, all the PSBs (public sector banks) would become ‘limited’ banks. BIC will be autonomous and have the power to appoint the Board of Directors and make other policy decisions.
• Until the BIC is formed, a temporary body called the Bank Boards Bureau (BBB) will be formed to do the functions of the BIC. Once BIC is formed, the BBB will be dissolved.
• The BBB will advice on appointments to the board, banks’ chairman and other executive directors.

Arguments in favour of the recommendations

• The chairman’s pay will be linked to the profits. So, he/she will focus on marketing, improving customer base and advertisements.
• The banks will be under only RBI supervision and not the CVC, RTI and CAG. This will make the banks more amenable to taking calculated risks. In nationalised banks, because they are subject to supervision from CAG, RTI, etc. bold decisions are not taken by the management.
• Generally, national banks invest their profits in government securities only. Hence, they do not make huge profits because government securities are considered safe bets. This is also because government owns majority shares in them which indirectly controls where they invest in. This is also called ‘fiscal repression’. This can be avoided because private banks invest in securities that give higher returns than G-secs.
• Nationalised banks could be forced to bailout loss-making entities (like the case with UTI and IDBI).
• Nationalised banks were also forced to give cheap loans to FCI and also waive off farmers’ debts.

Arguments against the recommendations

• Some people argue that lowering the government share to below 51% will make the banks only ‘profit-motive’. In India, financial inclusion in rural areas is less and if banks run only for profits, no branches will be set up in villages.
• When the oversight of the CAG and CVC are gone, there is a possibility of fraud.

Universal banking- Khan Committee

Around the same time of second phase of reforms, Khan Committee headed by S.H. Khan of IDBI also came up with recommendations for universal banking. If the players in the financial system need to become globally competitive the boundaries between commercial banks and DFIs(Development Financial Institutions) shall be demolished. A regulatory framework to enable such harmonization needs to be evolved.

The committee proposed mergers between banks and DFIs as also between banks inter se. The rationale for this stems from the fact that in the post liberalization era DFIs are increasingly operating on commercial lines as opposed to developmental considerations.

To facilitate free competition the committee has recommended the institution of a super regulator who shall supervise various regulating agencies to ensure institution-neutral regulatory treatment - a thorough revamp of the multiple legislative framework governing DFIs, banks and recovery process. Off-site supervision as opposed to on-site supervision shall deserve the attention of supervisors reckons the committee. As regards the reserve pre-emptions like the Narasimham committee it also suggested for slashing the requirement to international levels. As far as the priority sector lending is concerned, the committee opines that subjecting the whole banking sector to directed lending is undesirable. On the contrary, it has also observed that priority sector lending is expected to continue and suggested inclusion of infrastructure lending into priority sectors.

Capital Account Convertibility and banks

CAC would open the Indian banks to greater competition from international players. Worldwide the accent of the banking sector is on consolidation with a view to creating global finance powerhouses, which provide a complete range of, financial services under one umbrella. But the most important requirement for this would be the size of the balance sheet and a substantial capital base to cushion the wide gamut of on and off balance sheet risks. The proposal put forth by the Narasimham Committee is in tune with this global trend.

PADmaNABHAN COMMITEE

This committee was set up to review the system of supervision of the banks. This committee recommended a new rating methodology popularly called CAMEL

C	Capital adequacy
A	Asset quality
M	Management
E	Earnings
L	Liquidity.

Foreign banks

Foreign banks[1] to either operate as branches of their parent banks or to set up subsidiaries. Subsidiaries will have to adhere to all banking regulations, including priority sector lending norms, applicable to other domestic banks.

RBI has allowed total foreign direct investment in private banks to touch 49%. Other highlights include:

• Foreign banks with branch operations in India have been permitted by the regulator to acquire equity stakes in local private banks.
• It has retained the government control on public sector banks, including the country’s largest bank State Bank of India, where the combined FDI and portfolio investment cap still remains unchanged at 20 per cent.
• The maximum voting rights per shareholder will be 10 per cent of the total voting rights of the bank. For public sector banks, it is restricted to one per cent of the total voting rights, while for SBI; it is 10 per cent for all other shareholders, except RBI, which has a 59 per cent shareholding in the bank.

The birth of the Basel banking norms is attributed to the incorporation of the Basel Committee on Banking Supervision (BCBS), established by the central bank of the G-10 countries in 1974. This came into being under the patronage of Bank for International Settlements (BIS), Basel, Switzerland. The Committee formulates guidelines and provides recommendations on banking regulation based on capital risk, market risk and operational risk. The Committee was formed in response to the chaotic liquidation of Herstatt Bank, based in Cologne, Germany in 1974. The incident illustrated the presence of settlement risk in international finance. Historically, in 1973, the sudden failure of the Bretton Woods System resulted in the occurrence of casualties in 1974 such as withdrawal of banking license of BankhausHerstatt in Germany, and shut down of Franklin National Bank in New York. In 1975, three months after the closing of Franklin National Bank and other similar disruptions, the central bank governors of the G-10 countries took the initiative to establish a committee on Banking Regulations and Supervisory Practices in order to address such issues. This committee was later renamed as Basel Committee on Banking Supervision. The Committee acts as a forum where regular cooperation between the member countries takes place regarding banking regulations and supervisory practices. The Committee aims at improving supervisory knowhow and the quality of banking supervision quality worldwide. Currently there are 27 member countries in the Committee since 2009. These member countries are being represented in the Committee by the central bank and the authority for the prudential supervision of banking business. Apart from banking regulations and supervisory practices, the Committee also focuses on closing the gaps in international supervisory coverage.

The first set of Basel Accords, known as Basel I, was issued in 1988 with the primary focus on credit risk. It proposed creation of a banking asset classification system on the basis of the inherent risk of the asset. Basel II, the second set of Basel Accords, was published in June 2004 – in order to control misuse of the Basel I norms, most notably through regulatory arbitrage. The Basel II norms were intended to create a uniform international standard on the amount of capital that banks need to guard themselves against financial and operational risks. This again would be achieved through maintaining adequate capital proportional to the risk the bank exposes itself to (through its lending and investment practices). It also laid increased focus on disclosure requirements. The third installment of the Basel Accords (Basel III) was introduced in response to the global financial crisis, and is scheduled to be implemented by 2020

It calls for greater strengthening of capital requirements, bank liquidity and bank leverage. However, critics argue that these norms may further hamper the stability of the financial system by providing higher incentive to circumvent the regulations. The Indian banking system has remained largely unscathed in the global financial crisis. This is mainly amongst others, on account of the relatively robust capitalization of Indian banks. The Reserve Bank of India (RBI) had scheduled the start date for implementation of Basel III norms over a 6-year period starting April 2013. The recent requirement of infusion of additional equity in view of the low economic growth and increasing non-performing assets of Indian banks paint a gloomy picture and may cause a delay in the implementation of Basel III norms.