Sagar Chander

Some Background.
One of the first Indian Bank - Bank of Hindustan,

set up in 1870. Era of change in banking started with the establishment of three presidency banks under Presidency Banks Act 1876 - Bank of Calcutta, Bank of Bombay and Bank of Madras. In 1921, all presidency banks were amalgamated to form the Imperial Bank of India. Reserve Bank of India Act was passed in 1934 & Reserve Bank of India (RBI) was constituted as an apex bank without major government ownership.

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Banking Regulations Act was passed in 1949 which brought Reserve Bank of India under government control In 1955, RBI acquired control of the Imperial Bank of India, which was renamed as State Bank of India. In 1959, SBI took over control of eight private banks floated in the erstwhile princely states, making them as its 100% subsidiaries. RBI was empowered in 1960, to force compulsory merger of weak banks with the strong ones. The total number of banks was thus reduced from 566 in 1951 to 85 in 1969.

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In July 1969, government nationalised 14 banks having deposits of Rs.50 crores & above. The Narasimham Committee report suggested wide ranging reforms for the banking sector in 1992 to introduce internationally accepted banking practices The amendment of Banking Regulation Act in 1993 saw the entry of new private sector banks.

Need for Reforms?

Sector was highly regulated. High reserve requirement (SLR was stupendously high

at 38.5%). Administered interest rates. Large allocation to priority sector. Lack of internal risk management. Lack of Competition. Poor loan recovery. Weak capital position. Technology deficiency.

Banking Reforms
The first wave of financial liberalization took place in the second half of the 1980s, mainly taking the form of
Introduction of Treasury Bills Development of money markets Partial Interest Rate Deregulation In 1988, the Discount and Financial House of India was established In 1989, both commercial paper and certificates of deposit were introduced

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Based on the 1985 report of the Chakravarty Committee,

coupon rates on government bonds were gradually increased to reflect demand and supply conditions In 1988, the maximum (or ceiling) lending rate and ranges in minimum rates were unified and switched to a minimum-lending rate (MLR) in 1988. As a result, banks were able to set interest rates more flexibly. In 1989, the maximum interest rates on call money were liberalized

Banking Reforms
Second wave of Liberalisation started with Narsimham Committee Recommendations Reduction of the CRR and SLR The CRR has declined gradually from 15% in 1991 to 5.75% in November 2001 and to 5.5% in December 2001. The SLR was reduced gradually from 38.5% in 1991 to 25% in October 1997. The SLR has remained at this rate until today, while the legal upper limit has stayed at 40% throughout the period

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Interest Rate Deregulation

The Government started interest rate deregulation in 1992. This led to a complete liberalization of all term deposit rates and lending rates on advances in excess of Rs200,000. The remaining interest rate controls are savings deposit rates and lending rates up to Rs200,000.

Priority Sector Lending

Advances to the priority sectors should be reduced from 40% to 10%. While the targets of 40% imposed on domestic banks and 32% on foreign banks have not changed during the reform period, the burden of this directed lending practice has been gradually reduced by :- expanding the definition of priority sector lending, and - liberalizing lending rates on advances in excess of Rs200,000,

Entry Deregulation
The RBI

issued guidelines in 1993 governing the establishment of new private sector banks. The guidelines stated that a new bank needed to :

maintain minimum paid-up capital of Rs. 1 billion; list its shares on stock exchanges; fulfill the priority sector lending requirement with modification allowed in the composition of such lending for an initial period of three years;

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set a ceiling of 1% of total voting rights held by an individual shareholder as stipulated by the Banking Regulation Act of 1949; postpone setting up a subsidiary or mutual fund until at least three years after its establishment, and use modern infrastructural facilities to provide good customer service

Deregulation of Branch Restriction

The RBI changed its licensing policy in 1992 in

order to provide banks with operational autonomy to rationalize their branch networks. Banks were allowed to shift their existing branches within the same locality, open certain types of specialized branches, convert existing nonviable rural branches into satellite offices, spin off business of a branch, and open extension counters and administrative units without prior approval of the RBI.

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The RBI allowed banks to open branches freely, provided

that a bank met the capital adequacy ratio of 8%; earned a net profit for three consecutive years, and had NPAs not exceeding 15% of total outstanding loans. In 1998/99, old and new foreign banks were permitted to open up to 12 branches a year, as against the earlier stipulation of eight branches.

Reforms post 1999-2000

By 1999-2000 a lot of reform had already been

undertaken. Considerable relaxation of rules on the entry of new private banks. Most interest rate decontrols lifted by 1994 Banks were now allowed to charge differential interest rates for firms based on risk perceptions. Rules and norms regarding capital adequacy and recognition and disclosure of non performing loans in place.

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The Board for Financial Supervision was set up within

the RBI to attend exclusively to supervisory functions. In the post 2000 period an extremely significant trend that emerged especially after2004 was the significant rise in the bank credit to GDP ratio. It rose from 0.29 in 2004 to 0.54 in 2008. Loans made to individuals rose from 9.4% of outstanding bank credit in 2000 to 23.8% in 2007.

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The ratio of loans to total assets/liabilities for

scheduled commercial banks rose from about 0.40 in 2000 to 0.57 in 2007. Rapid expansion of personal loans (including housing loans) from 11.2% (4%) of outstanding bank loans in 2000 to 22.3 (11.7) in 2007. Share of agriculture was more or less constant at 9% to 10% in this period. Share of industry declined from 46.5 in 2000 to 38.1 in 2007.

Reasons for this credit expansion??

Over this period the CRR was reduced in stages

though it started rising especially since 2007. This was period of relatively low inflation and high growth. This was a period of moderate interest rates compared to the mid and late nineties. The priority sector lending norms have been substantially eased in the period after 2000.

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As things stand the priority sector lending norms are

40% of net bank credit for domestic banks (this target was set way back in 1985) and 32% (this target was set in 1993) of net bank credit for foreign banks operating in India. What has changed dramatically over the years is the identity of sectors to be counted under priority sector

Priority Sectors
Agriculture
Small scale industries (including setting up of

industrial estates) Small road and water transport operators(owning up to 10 vehicles). Small business (Original cost of equipment used for business not to exceed Rs 20 lacs) Retail trade (advances to private retail traders up to Rs.10 lacs)

 Professional and self-employed persons.

State

sponsored organizations for Scheduled Castes/Scheduled Tribes Education (educational loans granted to individuals by banks) Consumption loans (under the consumption credit scheme for weaker sections)