Major reforms that shaped Indian banking system
The banking system has drastically changed leaving no trace of the old ways. Fourteen major commercial banks accounting for 70 percent of the resources of the banking system were nationalised on 19th July1969. The objective of nationalisation was: “in order to control the heights of the economy and to meet progressively, and serve better, the needs of development of the economy in conformity with national policy and objectives and for matters connected therewith or incidental thereto.”
Change in ownership of major commercial banks was an important step that changed the orientation in spreading the branch network to reach out to people and places, mobilisation of deposits and in dispensation of credit. As public sector organisations these banks also started to advertise and make open recruitment of personnel instead of taking people based on internal references.
Reforms and changes that followed Nationalisation
As one who joined the public sector Indian Bank in 1970 in the first batch of officers after nationalisation I have been witness to the reforms and changes in the banking sector ever since. The intended thrust on development was obvious in the operations of the public sector banks (PSBs).
The branch licensing policy of the RBI prescribed that urban outlets would be permitted in proportion to the rural branches opened. There was massive expansion of the branch network of commercial banks. Sectors so far neglected were given importance in extension of credit.
The market share of PSBs increased to 90 % by 1990. Rapid expansion of the PSB system raised concerns about the quality of assets and absence of competition among banks. With the liberalisation process initiated by the Government of India in 1991 a review of the banking sector was undertaken.
Loans/advances and investments are major assets of a bank, deposits being the main liability. Income is earned from assets by way of interest. Prudential norms in respect of income recognition, asset classification, provisioning and capital adequacy were introduced in 1992. If interest and instalments are not recovered for two quarters (subsequently reduced to 90 days) the loan/asset is required to be classified as nonperforming asset (NPA) and interest on such loans is not allowed to be taken as income.
Entry of new banks
In order to introduce more competition, guidelines on entry of new private sector banks were announced in 1993. A dozen new generation banks were set up during the ensuing period. The entry of these banks resulted in not only infusion of competition but also introduction of technology for ease of doing transactions and improving customer service. Public sector banks which enjoyed virtual monopoly in business were shaken and were forced to adopt modern technology to counter the competition.
Resisting pressures for liberal expansion of foreign banks in India, the RBI through a policy announcement in 2005 brought in the concept of reciprocity by way of Indian banks being allowed to open branches in the host countries. Thereafter, limited expansion of foreign banks in India was allowed and a few Indian banks improved their overseas presence.
Banks are regulated by the Reserve Bank of India under the Banking Regulations Act,1949. Banks included under Section 42 of the Reserve Bank of India Act,1934 are called scheduled banks. They are required to maintain prescribed daily reserves with the RBI to meet obligations to depositors and submit returns to RBI. Presently all the commercial banks - PSBs and private sector banks (PVSBs) are scheduled banks.
The Banking Regulation (Amendment) Act, 2017 was passed authorising the RBI to issue directions to any banking company to initiate insolvency resolution process in respect of defaulting corporate borrowers under the provisions of the Insolvency and Bankruptcy Code (IBC), 2016. This important reform measure is expected to be used to recover the dues especially from the large and influential defaulters.
Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)
Banks are required by law to keep a prescribed percentage of demand and time liabilities as SLR by way of investment in government securities and as CRR in the form of balance with the RBI to meet obligations without any difficulty. However, these legal provisions had been used to pre-empt banks’ resources for use by the government to finance its own requirements and to drain liquidity from the system.
Deregulation of Interest Rates
Reserve Bank of India used to have micro control on the banking system by prescribing the interest rate to be paid on deposits and to be charged on loans. After a series of relaxations, in October,1997 interest rates on deposits other than those on savings accounts and foreign currency deposits (FCNR(B)) were fully deregulated. Interest on savings bank deposits also was deregulated subsequently in 2017.
Legal reforms for recovery of NPA
The rapid expansion of the banking system after nationalisation had impacted the asset quality of commercial banks. The gross NPAs of PSBs were as high as 23.2% in 1993. Legal reforms were initiated to help banks recover their NPAs. The Recovery of Debts Due to Banks and Financial Institutions Act was enacted in 1993 providing for setting up of Debt Recovery Tribunals (DRTs) as special courts to deal with only recovery suits filed by banks.
Ownership and governance
In Octobeer,1993 the State Bank of India Act,1955 was amended to facilitate partial private shareholding. The Banking Companies Acquisition and Transfer of Undertakings Act,1970/1980 was also amended to allow nationalised banks to access capital market subject to the condition that the government stake remained at least at 51%. After listing of shares in Stock Exchanges, banks are required to publish quarterly results improving accountability. Majority stake in SBI was transferred from the RBI to Government of India in 2007 to avoid conflict of interest of the regulator supervising a bank owned by it.
Foreign direct investment (FDI) in private sector banks was raised to 74% by the Government of India Press Note dated March 5,2004. Many of the private sector banks are under foreign ownership although they are registered in India.
The entry of new generation private sector banks triggered technological advancements in the banking system. Computerisation of operations and adoption of the core banking system connecting banks across the organisation in last decade enabled banks to offer access to modern banking facilities to customers. It also improved the housekeeping which was a virtual nightmare in the manual mode. However, unbreachable cyber security to prevent frauds is a new challenge. Customers also need to exercise utmost caution by keeping information like passwords safe as their accounts can be accessed from anywhere in the world now.
In addition to improvement in service through technology institutional mechanisms have been put in place to address customer complaints. The Ombudsman scheme was introduced under the aegis of the RBI in 1995 to enable customers to seek redressal in respect of complaints about services offered by commercial banks. The Banking Standards Board of India was set up in February, 2006 to ensure that the banking codes and standards adopted/published by banks are adhered to.
Improving the information flow
Credit Information Bureau Limited (CIBIL) was set up in 2000 to track credit history of retail customers who are given credit score based on repayment of loans. The Credit Information Companies (CICs) Regulation Act, 2005 was passed and the Regulations and Rules were framed in 2006. Banks report information on repayment of retail loans to CICs.
PSBs did commendable work in reaching out to the economically weaker segments of our society. Group lending was introduced through Self- Help Groups (SHGs). 19 lakh SHGs were credit linked with `38,800 crore during 2016-17. Basic savings accounts -” no frills accounts”- with zero balance were introduced in 2005.
Aadhaar, the unique identity concept introduced in 2009 received legal backing in 2016 and is now linked to bank accounts. The Supreme Court verdict of 26th September, 2018 makes such linking not mandatory except for getting government subsidies. Various eligible subsidies (eg. on cooking gas) are now credited to the Aadhaar linked bank accounts. Mobile numbers are already noted in the Aadhaar card. Jan Dhan-Aadhaar- Mobile combination (JAM) is expected to plug leakages of benefits extended to weaker sections.
(The author is Dr.K.Cherian Varghese, Former Chairman: BIFR, Union Bank of India, Corporation Bank and South Indian Bank)