On the whole, M Narasimham would have been satisfied with the progress made in reforming banking in India, given the socio-economic conditions in the economy where it is not easy to change systems easily. Where it was urgent, like prudential norms, the change came with alacrity.
The demise of M Narasimham does strike a chord of melancholy, given his contribution to reforms in the financial sector. What we see in the banking system today in terms of the struggle to bring about change, had its genesis documented in Narasimham’s epochal reports (there were two of these). His reports were seminal because they brought in all the global wisdom at a time when the internet was non-existent in India, and were based on real hard work put in by the committee members. One can expect him to have had considerable satisfaction over the progress made in the last three decades. It would be interesting to see how the banking system took in these recommendations.
The first was bringing in prudential concepts as propounded by the Bank for International Settlements (BIS) regarding income recognition, capital adequacy, quality of assets, provisioning, etc. These concepts took time to digest, and the Reserve Bank of India (RBI) played a stellar role in bringing them in a calibrated manner so that the system was not disrupted. Basel II and Basel III were extensions of the same course. It may be recollected that RBI took time to bring the 90-day concept for recognising non-performing assets (NPAs) so that the system was able to absorb this rule.
Second, he had propagated the concept of having more private banks, which was very timely as the system was typified by public sector banks (PSBs), given the shadow of nationalisation. Getting in new private banks has brought about a technology revolution in the banking sector, which has now permeated all banks, making the system globally comparable. Along with this suggestion was the extended frame provided to foreign banks to operate in India, besides a firm signal that there would be no further nationalisation.
Third, interest rates on deposits and loans were to be freed, and this was significant because until that point of time all decisions came from ‘above’. Here, RBI had gradually moved towards giving banks the freedom to fix their rates on the deposits side, though the lending side is once again back to the fold of partial regulation, with the central bank asking them to follow a formula.
Fourth, the committee argued for sharp reductions in the CRR (Cash Reserve Ratio) and the SLR (Statutory Liquidity Ratio) of banks. Interestingly, while banks argue against having a CRR, the system had a rate of 15% in 1989 and again in 1994, after which it has been brought down to 4%. The SLR at its peak was at 38.5% in 1990! Therefore, the move to lower these pre-emption reserves owes a lot to the committee.
Fifth, the concept of marking-to-market the portfolio of government securities was again a takeaway from this report. This was a way of making them market-oriented and also ensuring that the real value of bonds was accounted for by banks.
Sixth, Narasimham had spoken about creating a four-tiered structure of banks, which is what we are seeing three decades down the line. The idea of having large banks that can be globally competitive, regional banks that serve specific purposes, niche banks that cater to communities, and finally new small banks and payments banks owes its genesis to this report. This was further buttressed subsequently by a RBI committee where differentiated banks were spoken of.
Seventh, exposing the concept of evergreening is something that was brought to the table by the committee. Here, attempts have been made, but as has been seen there is a fine line dividing evergreening and restructuring—the latter being legitimate even today. It was dodging this rule and classifying NPAs as restructured assets which brought the system to an embarrassing situation when the asset quality review was undertaken in 2015.
Eighth, the identification of weak banks and putting conditions was again a concept from this book and hence the PCA (Prompt Corrective Action) policy of RBI has drawn from this chapter. The ways to tackle such banks and get them out of the mess with narrow banking being an intermediate route was an idea that came from this report.
Ninth, the committee recommended introduction of transparency in bank accounts. Today, all annual reports include all disclosures and follow fixed formats, and it is possible for one to analyse any aspect pertaining to all banks in a uniform manner. This was not the case earlier, and hence RBI should be credited with this reform.
Tenth, the concept of mergers across the financial sector was envisioned in terms of synergies being created and the committee also spoke of mergers between PSBs, which is now a reality. The earlier mergers were more due to expediency, while the ones that were taken by the FM a couple of years ago were a planned move keeping in mind all these tenets.
There are, however, certain recommendations that are still to be fulfilled, even though there has been some urgency shown for a few of these.
—The first relates to privatisation of PSBs. This is something that the government is looking at seriously, as per the Union Budget of 2021-22.
Second, banks are being targeted for full disinvestment. Given that PSBs that have been merged are out of this loop, it does look like that the candidates would be smaller ones, which may not have the best financials, though are bestowed with strong infrastructure and processes.
—Two, the remuneration factor was something that Narasimham had spoken of for PSBs as recruitment was to be made independent as per this playbook. There has been no attempt here on the pay structure, which is still a bargaining process where the Indian Banks’ Association (IBA) plays a vital role. However, in a rather feeble manner, one can say that lateral hiring with market-related salaries for specialised posts has come in from the backdoor, with now even some of the large PSBs having a lateral recruit as a CFO.
—Three, the committee had spoken of reducing the amount of lending that had to go to the priority sector from 40% to 10%. This has been a disappointment as there has been no change and it looks unlikely that this issue will ever be discussed. Given the political economy, it looks expedient for governments to retain this limit to show that they are pro-poor. While there can be arguments on the legitimacy of such lending, the fact is that if 40% of lendable resources are to be directed at pre-decided sectors, there is less flexibility for banks when it comes to lending.
—Four, the committee had also recommended differentiated deposit insurance premium for banks. This is really interesting because based on the CAMELS (capital adequacy, asset quality, management quality, earnings, liquidity, and sensitivity to market risk) score of RBI, banks carrying a higher risk on their lending portfolio would be made to pay a higher premium for cover on their deposits. This will be quite appropriate to ensure that banks pay more attention to the quality of assets, which will mean honing skills in credit appraisal.
Therefore, on the whole, Narasimham would have been satisfied with the progress made, given the socio-economic conditions in the economy where it is not easy to change systems easily. Where it was urgent, like prudential norms, the change came with alacrity. However, structural changes take time, and three decades down the road a lot had changed, albeit gradually.
The author is Chief economist, CARE Ratings, and the author of ‘Hits & Misses: The Indian Banking Story’. Views are personal