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Introduction
During reforms of 1991 Banking industry was an important part of the broader agenda of structural economic reforms introduced in India in 1991. The first stage of reforms was shaped by the approvals of the Committee on the Financial System (Narasimha Committee), which proposed its report in 1991, advising reforms in banking, the government debt market, the stock markets, and in insurance, all intended at producing a more efficient financial sector.
Later, the East Asian crisis in 1997 led to a sharp appreciation of the importance of a strong banking system, not just for efficient financial intermediation but also as a vital condition for macroeconomic stability.
Recognizing this, the government assigned a Committee on Banking Sector Reforms to study the progress of reforms in banking and to consider further steps to reinforce the banking system in light of changes taking place in international financial markets and the experience of other developing countries. The two reports provided a guideline that has piloted the broad direction of reforms in this sector.
Before 1991 Reforms
India's commercial banking structure in 1991 had many of the complications typical of unreformed banking systems in many developing countries. There was financial depression, which was reflected in full controls on interest rates, and large prevention of bank resources to finance the government shortfall through the burden of high statutory liquidity ratio (SLR), which recommended investment in government securities at low interest rates.
The sector was also overshadowed by public sector banks, which had 90 percent of total banking sector assets, reflecting the influence of nationalization of private sector banks above a certain size, first in 1969 and then in 1983. These banks were nationalized because of the insight that it was necessary to impose social control over banking to give it a developmental thrust, with a special importance on extending banking in rural areas.
The system suffered from inadequate regulations, and non-transparent accounting practices. Supervision by the Reserve Bank of India (RBI) was also weak.
Reforms of 1991
The policy for banking reforms was similar to that followed in other countries, but with some crucial differences. It was similar to the amount that it focused on imposing prudential norms and refining regulatory supervision to meet Basel I standards, and it was meant at increasing competition to promote greater efficiency.
Though, there were two important differences compared with reforms in other countries. First, the reforms more gradualist than in most countries, a course of action that was in line with the general strategy of reforms in India, its because reforms were not introduced in the middle of a banking sector crisis.
Second, unlike the case in various other countries, there was never any intent to privatize public sector banks. It was clearly acclaimed that competition was desirable, and this indicated that both private sector banks and foreign banks should be allowed to expand their market share if they could. Though, the government also declared its aim to strengthen public sector banks and enable them to meet competition.
There was also a great deal of progress in presenting prudential norms for income recognition, asset grouping, and capital adequacy in a phased manner. Because of this process, income recognition norms and capital adequacy norms were achieved, with Basel I standards. While asset recognition norms, yet still falling short of international fine practice, are now close to existing international standards.
Impact of reforms
The effect of the reforms on the productivity of the banking system in accomplishing its dual roles of financial intermediation and resource allocation is tough to evaluate.
As far as the scale of bank intermediation is bothered, the ratio of total credit increased by the banking sector to India's gross domestic product has grown, but it is still comparatively low compared to countries such as China and other East Asian countries. The ratio in India increased from 51.5 percent in 1990 to 53.4 percent in 2000, whereas in China it increased from 90 percent to 132.7 percent in the same period.
It is significant that the Indian banking system did not suffer from the East Asian crisis. Though, this is not so much due to the enhancements brought about after 1991, as the fact that the capital account was not fully open.
Banks were not allowed to undertake unnecessary foreign currency exposure, and external borrowing was strictly regulated. This watchful policy helped protect India from the severe reversals of external flows witnessed in many emerging market countries in the 1990s.
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