Banking Sector Reforms During Nationalization in India

The financial sector reforms are one of the most important policy agenda of the authorities around the world. There are several reasons for the same.

  • Firstly, the reforms are needed to increase the efficiency of financial resource mobilizations and generate higher levels of growth.
  • Secondly, financial sector reforms are utmost necessary for the macro-economic stability. India saw its worst economic crisis in the decade of 1980s.

In 1991, India embarked into an era of Economic Reforms which led to liberalization, privatization and globalization of the Indian Economy. The financial sector reforms were an integral part to these reforms. The financial sector reforms got momentum with the recommendations of various committees such as Chakravarty Committee (1985), Vaghul Committee (1987) and most notably by Narasimham Committee (1991), which is also known as first Narasimham Committee.

Importance of year 1991

Prior to 1991, India was more or less an isolated economy, loosely integrated with the economy of rest of the world. The public sector was born out of a planned economy model, which was underpinned by a Nehruvian-Fabian socialist philosophy. In 1991, India embarked on the path of liberalization, privatization and globalization. This injected new energy into the slow growing Indian Economy. With reference to Banking sector, it was in this year that the first Narasimham Committee gave a blueprint of banking sector reforms. On the basis of these recommendations, the government launched a comprehensive financial sector liberalization programme which included interest rates liberalization, reduction of reserved rations, reduced government control in banking operations and establishment of a market regulatory framework. Another outcome of liberalization was the dismantling of prohibitions against foreign direct investment. Some  more outcomes of reforms that impacted the banking sector were:-

  • Steps were taken to move to a market determined exchange rate system, and a unified exchange rate was achieved in the 1990s itself
  • The government also released a slew of norms pertaining to asset classification, income recognitions, capital adequacy etc which the banks had to comply with
  • Current account convertibility was allowed for the Rupee in accordance with IMF conditions
  • Nationalized banks were allowed to raise funds from the capital markets to strengthen their capital base
  • The lending rates for commercial banks was deregulated, thereby freeing them to lend more or as they saw fit
  • Also, banks were allowed to fix their own interest rates on domestic term deposits that matures within two years
  • Customers were encouraged to move away from physical cash, as RBI issued guidelines to the banks pertaining to the issuance of debit cards and smart cards
  • The process of introducing computerization in all branches of banks began in 1993 in line with the Committee on Computerization in Banks’ recommendations, which had been submitted in 1989
  • FII (Foreign Institutional Investors) were allowed to invest in dated Government Securities
  • The Foreign Exchange Management Act (FEMA) was enacted in 1999 and effectively repudiated the Foreign Exchange Regulation Act (FERA) of 1973. FEMA enabled the development and maintenance of the Indian foreign exchange markets and facilitated external trade and payments
  • The NSE (National Stock Exchange) began its operations in 1994
  • RBI began the practice of auctioning Treasury Bills spanning 14 days and 28 days

Capital index bonds were introduced in India for the first time. The newly adopted policy of liberalization led the RBI to provide licenses to conduct banking operations to some private banks such as ICICI Bank, HDFC Bank etc. The growth of industries and expansion of economic operations also revitalized banking operations, which had to keep up with the demand for various banking operations by the flourishing and even nascent enterprises. Bankers also responded to the renewed demand from the industrial sector and regular customers. New technology and customer-friendly measures were adopted by bankers to attract and retain customers. The Banking Ombudsman was established, so that consumers could have a forum to address their grievances against banks and the services they provided.

We note here that the banking / financial sector reforms are an ongoing process and few recent events as part of banking sector reforms include deregulation of interest rates, payment banks, increased autonomy to banks, Basel III compatibility of banks, Regulation of Non-banking Finance Companies etc.

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