First Narasimham Committee

The First Narasimham Committee, officially known as the Committee on the Financial System (CFS), was established by the Government of India in August 1991 under the chairmanship of M. Narasimham, former Governor of the Reserve Bank of India (RBI). The committee was constituted in the backdrop of India’s 1991 economic crisis to examine the structure, functioning, and efficiency of the Indian financial system and to suggest reforms to make it more robust, competitive, and responsive to the changing economic environment.
The recommendations of the First Narasimham Committee laid the foundation for India’s banking and financial sector reforms in the 1990s and played a pivotal role in liberalising the Indian economy.

Background and Context

By 1991, the Indian economy was facing a severe balance of payments crisis, high fiscal deficit, and inefficient financial institutions. The banking sector was largely government-controlled, burdened by poor profitability, low capital adequacy, directed lending, and operational inefficiencies.
To revitalise the financial system in alignment with the broader economic liberalisation process initiated in 1991, the government appointed the Narasimham Committee to review the existing framework and recommend comprehensive reforms.

Objectives of the Committee

The main objectives of the First Narasimham Committee were:

1. To review the structure and functioning of the financial system.
2. To identify weaknesses in the banking and financial institutions.
3. To recommend measures to improve efficiency, competitiveness, and profitability.
4. To suggest policies to strengthen the banking sector’s role in economic development.
5. To integrate the Indian financial system with global best practices.

Key Recommendations of the First Narasimham Committee (1991)

The Committee’s recommendations covered a wide range of reforms aimed at improving the health, efficiency, and competitiveness of India’s financial system.

1. Reduction in Statutory Pre-emptions

• The committee noted that high levels of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) reduced banks’ ability to lend productively.
• Recommendation:
  • Reduce SLR gradually from 38.5% to 25%.
  • Reduce CRR from around 15% to 3–5% over time.
  • This would free more resources for productive lending and enhance profitability.

2. Capital Adequacy Norms

• Indian banks had weak capital bases and poor financial health.
• Recommendation:
  • Introduce capital adequacy norms in line with Basel I standards.
  • Fix a Capital-to-Risk Weighted Assets Ratio (CRAR) of 8% for banks.
  • Ensure adequate provisioning for bad loans.

3. Prudential Norms for Asset Classification

• Prior to the reforms, banks did not follow uniform accounting and income recognition standards.
• Recommendation:
  • Introduce prudential norms for income recognition, asset classification, and provisioning.
  • Classify assets as standard, sub-standard, doubtful, and loss assets.
  • Recognise income on loans only when it is actually received (not merely accrued).

4. Reduction in Directed Credit Programmes

• The committee found that mandatory lending under Priority Sector Lending (PSL) affected bank profitability and efficiency.
• Recommendation:
  • Reduce priority sector lending target from 40% to 10% of total advances.
  • Focus credit to truly priority segments such as small and marginal farmers, rural artisans, and weaker sections.

5. Interest Rate Deregulation

• The committee observed that administered interest rates led to distortions in the allocation of credit.
• Recommendation:
  • Move towards market-determined interest rates.
  • Allow banks to fix their own lending and deposit rates based on market conditions.

6. Restructuring and Consolidation of Banks

• The committee recommended a four-tier banking structure:
  1. Large international banks (to compete globally).
  2. National banks (operating across the country).
  3. Regional banks (serving specific states or regions).
  4. Local rural banks and cooperative banks (serving rural areas).
• It suggested merging weaker banks with stronger ones to build financially viable institutions.

7. Autonomy of Banks

• Public sector banks (PSBs) were overburdened by government interference.
• Recommendation:
  • Provide greater operational freedom and autonomy to PSBs.
  • Reduce government equity in PSBs to 33%.
  • Allow professional management and independent boards.

8. Establishment of Asset Reconstruction Mechanism

• To deal with non-performing assets (NPAs), the committee recommended creating institutions to acquire and resolve bad loans.
• This led to the eventual formation of Asset Reconstruction Companies (ARCs) and other mechanisms for NPA management.

9. Reform in Banking Supervision and Regulation

• Strengthen the role of the Reserve Bank of India (RBI) as the regulator.
• Establish an independent Banking Supervision Board under the RBI for effective supervision.
• Improve audit and transparency standards.

10. Development of Money and Capital Markets

• The committee recognised that a well-functioning financial market was essential for efficient credit allocation.
• Recommendation:
  • Develop money, government securities, and capital markets.
  • Promote financial instruments like certificates of deposit, commercial papers, and treasury bills.
  • Strengthen financial institutions like SEBI, IDBI, and UTI.

11. Entry of Private and Foreign Banks

• To foster competition and improve efficiency, the committee recommended:
  • Allowing entry of new private sector banks.
  • Liberalising norms for foreign banks to operate in India.
  • This led to the establishment of new private banks like HDFC Bank, ICICI Bank, and Axis Bank.

12. Reduction in Government Role

• The committee emphasised that the government should focus on policy formulation, not bank management.
• Suggested creating banking tribunals for speedy resolution of disputes.

Implementation of the Recommendations

The government and the RBI implemented several key recommendations from the First Narasimham Committee during the 1990s:

• Reduction of CRR and SLR.
• Introduction of prudential norms for NPAs and capital adequacy.
• Deregulation of interest rates.
• Granting of licences to new private banks.
• Strengthening of bank supervision under RBI.
• Gradual autonomy to public sector banks.

These reforms transformed India’s banking sector into a more competitive, transparent, and efficient system, laying the groundwork for modern banking practices.

Impact of the Narasimham Committee Reforms

1. Improved financial health and profitability of banks.
2. Introduction of Basel norms and better capital adequacy.
3. Decline in NPAs due to prudential norms and better recovery systems.
4. Development of financial markets and modern payment systems.
5. Emergence of private sector and foreign banks, increasing competition.
6. Enhanced autonomy and professionalism in public sector banks.

Criticisms of the Committee

• Reduction in priority sector lending was criticised for neglecting rural and weaker sections.
• The recommendation to reduce government equity in PSBs faced political opposition.
• Implementation was gradual and uneven across institutions.
• Some measures increased competition but also led to consolidation pressure on smaller banks.