Impact of Reforms on the Soundness of Indian Banking and Need of Third Generation Reforms

Abstract

After the set back of early nineties when the Government of India had to pledge the gold to acquire foreign currency to meet the severe problem of balance of payment temporarily, the Government planned to liberalize the Indian economy and open its door to the foreigners to speed up the development process as a long-term solution for the ailing economy. The economic liberalization move, which was initiated in 1991 when the new government assumed office, has touched all the spheres of national activity. Perhaps the one area where the deregulatory policies had the maximum impact was the banking sector. Efforts were made to bring reforms in the financial system of the country. The seed of the reforms in India were sown by the Narasimham Committee appointed by the RBI under the chairmanship of M. Narasimham, the former Governor of RBI, to examine the aspects relating to the structure, organization, functions and procedures of the financial system and suggest remedial measures. The Committee submitted its reports in November 1991 and thus, began a new chapter in Indian banking. Norms for income recognition, classification and provisioning of assets besides capital adequacy were introduced in Indian banking in a phased manner with other measures. Banking reforms have indeed transformed Indian Banks into strong, stable, profitable and prosperous entities. Indian banking system can now claim that their NPA levels are of international standards, with prudential provisioning, classification and an adequate capital base. But effective cost management, recovery management, technological intensity of banking, governance and risk management, financial inclusion are the areas, which will have a key bearing on the ability of Indian banks to remain competitive and enhance soundness. In this paradigm, improvement in policy framework, regulatory regime, market-perceptions, and indeed, popular sentiments relating to governance in banks need to be on the top of the agenda to serve the society’s needs and realities while being in harmony with the global perspective. Indian banks are not likely to be impacted much by the new capital rules (Basel III), the aggregate capital to risk weighted assets ratio of Indian banking system stood as 13.6 per cent (Basel I) and 14.0 (Basel II) of which Tier-I capital constituted about 9.3 per cent as on March 201'3 Therefore, Indian banking system need not to be significantly stretched in meeting the proposed new capital rules, both in terms of capital requirement and the quantity of capital. But there may be negative impact arising from shifting of some deductions from Tier-I and Tier-II capital to common equity. Indian banking system cannot afford to continue to operate with such thin minimum regulatory capital and liquidity requirements as the system does not have the capacity for another round of bail outs, nor does the public have the tolerance for it. However, the increasing NPAs in public sector banks means higher capital requirements, hence more capital from markets. Given that Indian banks are better managed than their counterparts in other countries, it would be of little concern, but still a worry to raise capital cheap. However, Government has earmarked Rs.150 billion for recapitalization of state-owned banks in 201'211 to shore up their Tier-I capital to at least 8 per cent.