Unit - IV Banking and Its Functions Dr.U.Ramesh.pdf
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Unit IV: BANKING AND ITS FUNCTIONS Banking: Functions of Commercial banks - Credit creation: Process and limitations - Role of Commercial banks after nationalization and after reforms - Role of RBI – Regulation of money supply and credit- Narasimham Committee Reports– 1991 and 1998- RaguramRajan Committee’s Report -2007.
Unit - IV Banking and Its Functions Dr.U.Ramesh.pdf
- 1. 1 Unit IV: BANKING AND ITS FUNCTIONS Banking: Functions of Commercial banks - Credit creation: Process and limitations - Role of Commercial banks after nationalization and after reforms - Role of RBI – Regulation of money supply and credit- Narasimham Committee Reports– 1991 and 1998- RaguramRajan Committee’s Report -2007. BANKING Banking refers to the business activity of accepting deposits and lending money to individuals, businesses, and governments. Banks are regulated financial institutions that facilitate the flow of funds in the economy, ensuring liquidity and credit availability. FUNCTIONS OF COMMERCIAL BANKS 1. Primary Functions These are the core services offered by commercial banks: Accepting Deposits: o Savings Deposits: Allow individuals to save and earn interest on their money. o Fixed Deposits: Deposits for a fixed tenure with higher interest rates. o Current Account Deposits: Designed for businesses, allowing unlimited transactions without interest. o Recurring Deposits: Enable customers to deposit a fixed amount regularly. Granting Loans and Advances: o Term Loans: Loans for a specific period, often for business or personal use. o Cash Credit: Short-term credit extended to businesses against security. o Overdrafts: Facility to withdraw more than the available balance in a current account. o Discounting Bills of Exchange: Providing funds before the maturity of trade bills. 2. Secondary Functions Support services that enhance financial stability and convenience: Agency Functions: o Collecting and paying cheques, dividends, and bills. o Acting as trustees or executors for estates. o Facilitating foreign exchange transactions. Utility Functions: o Providing safe deposit lockers for valuables. o Issuing letters of credit and guarantees. o Conducting credit card and debit card transactions. o Offering investment services like mutual funds and bonds. 3. Credit Creation Banks create credit by accepting deposits and lending out a portion of these deposits, effectively increasing the money supply in the economy. 4. Promoting Economic Growth By financing trade, industries, agriculture, and infrastructure, commercial banks contribute to the overall economic development of a nation. 5. Digital Services Modern commercial banks also provide: Internet and mobile banking. E-wallets and payment gateways. Real-time fund transfers (NEFT, RTGS, IMPS, etc.).
- 2. 2 CREDIT CREATION BY COMMERCIAL BANKS Credit creation is one of the most significant functions of commercial banks. It refers to the process through which banks generate credit by lending money, thereby expanding the total money supply in the economy. Process of Credit Creation The process of credit creation can be explained in steps: 1. Initial Deposit When customers deposit money in banks, these deposits are considered as liabilities for the bank. Banks keep a portion of this deposit as reserves (Cash Reserve Ratio - CRR) as mandated by the central bank and lend out the rest. 2. Lending and Loan Creation The bank lends the excess reserves (after keeping the required reserves) to borrowers in the form of loans. Borrowers generally spend the loaned amount, which eventually gets deposited into other banks. 3. Secondary Deposits The money loaned out by the bank is spent and redeposited into the banking system, either in the same bank or another. These deposits become the base for further lending, and the process repeats. 4. Multiplier Effect Each time money is deposited and re-lent, it creates new deposits in the system. The total money supply created by the banking system is determined by the money multiplier, which is the reciprocal of the reserve ratio: Money Multiplier= 1/ Reserve Ratio (CRR) Example: Suppose the reserve ratio is 10% (0.10) and the initial deposit is $10,000. o The bank keeps $1,000 as reserves and lends $9,000. o This $9,000 gets deposited elsewhere, of which $900 is kept as reserves, and $8,100 is lent out. o The process continues, creating multiple rounds of deposits and loans. The total credit created in the system can be calculated as: Total Credit Created=Initial Deposit× 1 / Reserve Ratio ROLE OF COMMERCIAL BANKS AFTER NATIONALIZATION OF BANKS The nationalization of banks in India in 1969 (14 banks) and 1980 (6 banks) marked a transformative shift in the banking sector. The primary aim was to align banking services with the socio-economic objectives of the government, particularly promoting financial inclusion and equitable economic growth. Here’s how the role of commercial banks evolved post-nationalization: 1. Promoting Financial Inclusion Rural Penetration: Banks opened branches in rural and semi-urban areas to provide financial services to underserved populations. Priority Sector Lending (PSL): Commercial banks were mandated to direct a significant portion of their credit to sectors like agriculture, small-scale industries, and weaker sections.
- 3. 3 Government Schemes Implementation: Banks became instrumental in implementing schemes like Jan Dhan Yojana, Kisan Credit Card (KCC), and others to improve financial accessibility. 2. Economic Development Agriculture and Rural Development: Banks provided credit to farmers for purchasing seeds, fertilizers, and equipment. Industrial Growth: Credit facilities were extended to small, medium, and large-scale industries to boost production and employment. Infrastructure Financing: Banks funded projects related to transportation, power, and urban development. 3. Reduction of Regional Imbalances Branch Expansion: The Lead Bank Scheme and other initiatives encouraged opening branches in remote and backward areas, reducing regional disparities in banking services. Credit Allocation: Directed lending policies ensured that underdeveloped regions received adequate financial resources. 4. Social Banking Banks shifted focus from profit-making to serving societal needs. Loans were provided at concessional rates to weaker sections, promoting inclusivity and reducing poverty. Encouraged self-employment through schemes like the Integrated Rural Development Programme (IRDP). 5. Mobilization of Savings Post-nationalization, banks actively encouraged savings by introducing a variety of deposit schemes with attractive features. Increased rural branch presence significantly contributed to mobilizing household savings. 6. Credit Control and Economic Stability Banks supported the government in regulating money supply, controlling inflation, and ensuring economic stability. Focused on reducing the dominance of informal moneylenders by offering formal credit at reasonable rates. 7. Support for Government Policies Nationalized banks became key players in executing government programs like poverty alleviation schemes, rural employment generation, and small savings mobilization. Extended financial support to Public Sector Enterprises (PSEs). 8. Technology Adoption and Modernization Although initially slow, post-nationalization banks began adopting technology for better service delivery. Later reforms like computerization, core banking solutions (CBS), and ATMs were driven by the need to compete and remain efficient. Conclusion
- 4. 4 The nationalization of banks transformed commercial banks into agents of economic and social development. It enabled the government to direct credit to priority sectors, address regional imbalances, and promote inclusive growth, thereby playing a crucial role in shaping India's development trajectory. ROLE OF COMMERCIAL BANKS AFTER NEW ECONOMIC REFORMS (1991) The economic reforms of 1991 in India introduced liberalization, privatization, and globalization (LPG), transforming the banking sector. These reforms aimed to enhance efficiency, competitiveness, and market orientation in commercial banks. Post-reform, the role of commercial banks expanded significantly, adapting to the changing economic landscape. 1. Promoting Financial Liberalization Market-Oriented Lending: Banks shifted from directed credit policies to market- driven lending based on demand and risk assessment. Deregulation of Interest Rates: Allowed banks to set competitive interest rates for deposits and loans, enhancing customer options. 2. Enhancing Efficiency and Profitability Focus on Operational Efficiency: Banks improved service quality, adopted cost- effective practices, and increased focus on profit maximization. Privatization of Banking: Entry of private sector banks like HDFC, ICICI, and Axis Bank led to improved competitiveness and service delivery. 3. Technology Adoption and Digital Banking Computerization: Core banking solutions (CBS) and automation of processes revolutionized service delivery. Online Banking Services: Introduced internet banking, ATMs, mobile banking, and e-wallets, enabling 24/7 banking services. RTGS and NEFT: Implemented real-time gross settlement and electronic fund transfers for faster and secure transactions. 4. Expanding Credit to Priority Sectors Support for Agriculture: Despite reduced mandates, banks continued lending to agriculture through initiatives like Kisan Credit Card (KCC). MSME Financing: Special focus on providing credit to micro, small, and medium enterprises (MSMEs) to encourage entrepreneurship. 5. Global Integration and Foreign Trade Financing Forex Management: Banks played a vital role in managing foreign exchange transactions, facilitating exports and imports. External Commercial Borrowings (ECBs): Assisted businesses in raising capital from international markets. NRI Accounts: Enhanced services for non-resident Indians, promoting foreign remittances and investment. 6. Financial Inclusion Initiatives Microfinance Services: Expanded credit and financial services to self-help groups (SHGs) and marginalized populations.
- 5. 5 Branch Network Expansion: Banks continued to open branches in underserved areas to support financial inclusion goals. Jan Dhan Accounts (Post-Reform): Encouraged opening of zero-balance accounts for the unbanked population. 7. Credit for Infrastructure Development Financing Mega Projects: Played a crucial role in funding infrastructure projects like roads, ports, power plants, and telecommunications. Public-Private Partnerships (PPP): Supported government initiatives to build infrastructure through PPP models. 8. Supporting Economic Growth Industrial Financing: Provided loans to industries for capacity building, modernization, and expansion. Consumer Credit: Increased focus on personal loans, vehicle loans, and housing loans, driving consumption-led growth. 9. Strengthening Regulatory Compliance Adopting Basel Norms: Implemented international banking norms like Basel I, II, and III to ensure financial stability and risk management. Compliance with RBI Policies: Followed Reserve Bank of India’s reforms on asset classification, provisioning norms, and capital adequacy. 10. Contribution to Capital Markets Merchant Banking Services: Provided services related to IPOs, corporate advisory, and underwriting. Investment Banking: Supported companies in raising capital through debt and equity instruments. Challenges Alongside Opportunities While the role of commercial banks expanded post-reforms, challenges like rising NPAs, competition from private and foreign banks, and maintaining a balance between profitability and social banking persisted. Conclusion After the 1991 reforms, commercial banks emerged as dynamic institutions driving economic growth, supporting globalization, and fostering financial inclusion. Their enhanced role in the liberalized economy contributed significantly to India’s transformation into a more market- oriented and globally integrated financial system. ROLE OF THE RESERVE BANK OF INDIA (RBI) IN REGULATING AND SUPERVISING COMMERCIAL BANKS The Reserve Bank of India (RBI), as the central bank of India, plays a crucial role in overseeing and regulating the functioning of commercial banks to ensure financial stability, protect depositors’ interests, and promote economic growth. Its responsibilities include policy formulation, supervision, and guidance of commercial banks. 1. Regulatory Role The RBI acts as the apex authority for framing and implementing policies governing commercial banks:
- 6. 6 Licensing and Approvals: o Grants licenses for the establishment of new banks, opening new branches, and introducing new products. o Monitors mergers, acquisitions, and liquidations in the banking sector. Capital Adequacy Norms: o Enforces capital adequacy standards under Basel norms to ensure banks maintain sufficient reserves to manage risks. Prudential Norms: o Sets guidelines for asset classification, provisioning, and income recognition to manage Non-Performing Assets (NPAs). 2. Monetary Authority RBI uses monetary policy tools to regulate credit availability and liquidity in the economy through commercial banks: Repo Rate and Reverse Repo Rate: o Adjusts interest rates at which banks borrow from and lend to the RBI, influencing lending rates and credit availability. Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR): o Mandates commercial banks to maintain a portion of their deposits as reserves with the RBI or in liquid assets. Open Market Operations (OMO): o Buys or sells government securities in the open market to control liquidity and money supply. 3. Supervisory Role RBI ensures the sound functioning of commercial banks by monitoring their operations: Bank Inspections: o Conducts regular on-site and off-site inspections to assess compliance, financial health, and operational efficiency. Risk Management: o Evaluates risk management practices and ensures banks have appropriate measures in place to mitigate risks. Fraud Detection and Prevention: o Monitors banking activities to identify and curb fraudulent practices. 4. Developmental Role RBI facilitates the growth and modernization of the banking sector: Financial Inclusion: o Promotes initiatives like Basic Savings Bank Deposit Accounts (BSBDAs) and Jan Dhan Yojana to increase banking access. o Encourages commercial banks to lend to priority sectors, including agriculture, MSMEs, and weaker sections. Technology Adoption: o Supports digital transformation, including UPI, mobile banking, and Real- Time Gross Settlement (RTGS). Training and Capacity Building: o Organizes training programs for bank officials through institutions like the National Institute of Bank Management (NIBM). 5. Role as a Lender of Last Resort
- 7. 7 RBI provides emergency liquidity assistance to commercial banks facing financial crises or liquidity shortages, ensuring stability in the banking system. 6. Foreign Exchange Management Forex Reserves Oversight: o Regulates foreign currency dealings of banks and ensures stability in the foreign exchange market. FEMA Compliance: o Ensures commercial banks adhere to the Foreign Exchange Management Act (FEMA) regulations. 7. Consumer Protection RBI ensures that commercial banks maintain transparency and accountability: Fair Practices Code: o Mandates banks to disclose interest rates, fees, and terms of service clearly to customers. Banking Ombudsman Scheme: o Provides a platform for addressing grievances of bank customers. 8. Crisis Management Resolution of Distressed Banks: o Oversees restructuring, mergers, or liquidation of failing banks to safeguard the financial system. Monitoring Systemic Risks: o Identifies and mitigates risks that could destabilize the banking sector. Conclusion The RBI plays a pivotal role in ensuring the stability, efficiency, and inclusiveness of commercial banks. Through its regulatory, supervisory, monetary, and developmental roles, the RBI enables commercial banks to contribute effectively to the growth and stability of the Indian economy. REGULATION OF MONEY SUPPLY AND CREDIT IN COMMERCIAL BANKS The regulation of money supply and credit by commercial banks is primarily overseen by the central bank (Reserve Bank of India, RBI in India) to maintain economic stability, control inflation, and support growth. This regulation involves various tools and mechanisms that influence how commercial banks create and manage credit and contribute to the overall money supply in the economy. 1. Role of Commercial Banks in Money Supply and Credit Creation Money Supply Contribution: o Commercial banks contribute to the money supply by accepting deposits and lending money. o Through the process of credit creation, they multiply deposits, expanding the money supply. Credit Creation Process: o When banks lend money, the amount circulates and re-enters the banking system as deposits, which can be further lent out. o This cycle creates a multiplier effect, increasing the total money supply.
- 8. 8 2. Regulation by the Central Bank The central bank employs monetary policy tools to regulate money supply and credit in commercial banks: Quantitative Tools (General Credit Control) These tools aim to control the overall volume of money and credit in the economy: Cash Reserve Ratio (CRR): o The percentage of deposits that commercial banks must keep with the central bank. o A higher CRR reduces the lending capacity of banks, contracting money supply; a lower CRR does the opposite. Statutory Liquidity Ratio (SLR): o The percentage of net demand and time liabilities (NDTL) that banks must hold in the form of liquid assets like cash, gold, or approved securities. o A higher SLR limits the funds available for lending, thus reducing credit. Repo Rate and Reverse Repo Rate: o Repo Rate: The rate at which the central bank lends to commercial banks. An increase in repo rate raises borrowing costs for banks, reducing credit availability. o Reverse Repo Rate: The rate at which the central bank borrows from commercial banks, influencing their liquidity. Open Market Operations (OMO): o Buying and selling government securities in the open market to control liquidity. o Selling securities absorbs liquidity, reducing credit availability, while purchasing securities injects liquidity. Qualitative Tools (Selective Credit Control) These tools are aimed at specific sectors or types of credit: Credit Rationing: o Limits the amount of credit available to certain sectors or individuals to ensure balanced economic development. Margin Requirements: o Adjusting the margin between the loan amount and the value of the collateral to control speculative activities. Moral Suasion: o The central bank persuades commercial banks to align their credit policies with national economic goals. Direct Action: o Penalties or restrictions imposed on banks for non-compliance with central bank regulations. 3. Objectives of Regulation Inflation Control: o By restricting or expanding credit, the central bank regulates inflation. Tight monetary policy during inflation reduces money supply, while expansionary policy during deflation increases it. Economic Growth: o Ensures adequate credit flow to productive sectors like agriculture, MSMEs, and infrastructure to support growth. Liquidity Management: o Maintains sufficient liquidity in the banking system to prevent financial crises.
- 9. 9 Financial Stability: o Monitors credit distribution to prevent excessive lending to high-risk sectors, ensuring stability. Exchange Rate Stability: o Regulates foreign currency transactions to manage the balance of payments and stabilize the currency. 4. Challenges in Regulation High NPAs: Rising non-performing assets reduce the effectiveness of credit policies. Transmission of Policy Rates: Commercial banks may not always pass on changes in repo rates to borrowers, reducing policy impact. Global Factors: External economic factors like global interest rates and trade influence credit flows, complicating regulation. Shadow Banking: Activities of non-banking financial institutions (NBFCs) may bypass central bank regulations. Conclusion The regulation of money supply and credit in commercial banks is critical for maintaining macroeconomic stability, controlling inflation, and promoting inclusive growth. By using a mix of quantitative and qualitative tools, the central bank ensures that commercial banks function efficiently while aligning with national economic objectives. However, effective implementation and coordination between policy and practice remain vital for achieving these goals. NARASIMHAM COMMITTEE REPORTS (1991) The Narasimham Committee on Financial System (1991) was constituted by the Government of India under the chairmanship of M. Narasimham, a former Governor of the Reserve Bank of India, to recommend measures for reforming the Indian banking and financial system. This was part of broader economic reforms aimed at liberalizing the Indian economy. The Committee's recommendations became a landmark in shaping the modern banking system in India. Below are the key highlights of the 1991 report: Key Recommendations 1. Strengthening the Banking System Capital Adequacy Norms: o Recommended a minimum Capital to Risk-Weighted Assets Ratio (CRAR) of 8% for banks to ensure financial stability. o Emphasized the need for better risk management. Reduction in Non-Performing Assets (NPAs): o Suggested stricter norms for classifying NPAs to enhance the financial health of banks. o Proposed periodic review of asset quality and provisioning for bad debts. Autonomy of Public Sector Banks (PSBs): o Advocated for reduced government interference and greater operational independence for PSBs. o Encouraged professional management of banks. 2. Structural Reforms Privatization and Consolidation:
- 10. 10 o Recommended gradual privatization of public sector banks to improve efficiency and competition. o Encouraged the merger of weak banks with strong ones to create financially viable institutions. Entry of New Private Banks: o Allowed private entities to establish banks to foster competition and improve customer service. Foreign Banks and Joint Ventures: o Supported greater participation of foreign banks in India to bring in expertise and modern practices. 3. Efficiency Improvement Deregulation of Interest Rates: o Proposed market-driven interest rates instead of administratively fixed rates. o Banks were allowed more flexibility in setting lending and deposit rates. Operational Efficiency: o Suggested measures to reduce overstaffing and enhance productivity. o Focused on technology adoption to modernize banking operations. 4. Rural and Priority Sector Lending Rationalizing Priority Sector Lending: o Recommended reducing the mandatory priority sector lending target from 40% to ensure efficient credit allocation. o Emphasized proper monitoring to avoid misuse of credit. Rural Banking: o Proposed integrating rural and cooperative banking systems into the mainstream financial system. 5. Role of the RBI Regulatory Reforms: o Suggested that the RBI focus on its core function of monetary policy while delegating non-core activities like direct banking supervision to a separate entity. Monetary Policy Framework: o Recommended improving the transparency and effectiveness of monetary policy. 6. Banking Sector Liberalization Entry of Private and Foreign Players: o Encouraged competition by allowing new private banks and increasing foreign bank operations. Development of Capital Markets: o Urged the development of a robust capital market to provide alternative financing options, reducing dependency on banks. 7. Human Resource Development Training and Development: o Highlighted the need for training banking personnel to equip them with modern financial practices. Staff Reduction:
- 11. 11 o Recommended voluntary retirement schemes (VRS) to address overstaffing in public sector banks. Impact of Narasimham Committee Report (1991) The recommendations led to significant reforms in the Indian banking sector, including: 1. Introduction of Capital to Risk-Weighted Assets Ratio (CRAR) norms: Strengthened the financial health of banks. 2. Entry of new private banks: HDFC Bank, ICICI Bank, and Axis Bank emerged as key players. 3. NPAs classification and management: Improved the transparency of bank balance sheets. 4. Deregulation of interest rates: Enhanced competition and better customer services. 5. Adoption of technology: Led to modernization through computerization and digitization. Challenges and Criticisms Social Banking Concerns: Critics argued that the reduced focus on priority sector lending might neglect marginalized sections. Privatization Risks: Rapid privatization was seen as a potential threat to rural banking and financial inclusion. Resistance from Unions: Bank employee unions opposed reforms like VRS and reduced staffing. Conclusion The Narasimham Committee Report of 1991 laid the foundation for India's banking sector liberalization. Its recommendations played a pivotal role in making the banking system more competitive, efficient, and resilient, aligning it with global standards. These reforms have had a lasting impact on the Indian financial landscape, driving economic growth and stability. NARASIMHAM COMMITTEE REPORTS (1998) The Narasimham Committee II, also known as the Committee on Banking Sector Reforms, was constituted in 1998 under the chairmanship of M. Narasimham to review the progress made since the 1991 reforms and suggest further measures to strengthen the banking system. This report aimed to address the emerging challenges in the banking and financial sector and ensure its alignment with global standards. Key Recommendations 1. Strengthening the Banking System Capital Adequacy: o Recommended raising the Capital to Risk-Weighted Assets Ratio (CRAR) from 8% to 10% in a phased manner to improve financial resilience. o Suggested stricter norms for Tier I capital (equity and retained earnings). Asset Quality: o Proposed reducing Net Non-Performing Assets (NPAs) to below 5% by 2000 and to 3% by 2002. o Introduced tighter norms for asset classification and provisioning to ensure transparency. 2. Consolidation and Privatization Consolidation of Banks:
- 12. 12 o Suggested merging strong banks to create globally competitive institutions. o Recommended classifying banks into three categories: international, national, and local, based on their capabilities and reach. Privatization of Public Sector Banks (PSBs): o Advocated reducing government ownership in PSBs to 33% to enhance autonomy and efficiency. 3. Non-Performing Assets (NPAs) Management Debt Recovery Tribunals (DRTs): o Strengthened the role of DRTs to expedite loan recovery processes. Asset Reconstruction Companies (ARCs): o Recommended setting up ARCs to deal with the resolution of bad loans and reduce the burden of NPAs on banks. 4. Autonomy and Governance of Banks Autonomy to Public Sector Banks: o Emphasized granting greater operational freedom to PSBs to compete with private and foreign banks. o Suggested reforms to reduce political and bureaucratic interference in the functioning of PSBs. Corporate Governance: o Advocated professional management of banks and strengthening the role of boards to improve decision-making. 5. Banking Regulation and Supervision Role of RBI: o Focused on the separation of ownership and regulatory roles of the RBI. o Suggested that the RBI concentrate on monetary policy and delegate supervisory functions to a new body. Prudential Norms: o Advocated stricter prudential norms for income recognition, asset classification, and provisioning. 6. Human Resources Staff Restructuring: o Proposed voluntary retirement schemes (VRS) to reduce overstaffing in PSBs. o Focused on training and skill development to modernize the workforce. 7. Development of Financial Markets Integrated Financial Services: o Recommended creating a more robust financial system with integration across banking, capital markets, and insurance. Risk Management: o Encouraged banks to adopt advanced risk management practices to handle market, credit, and operational risks effectively. Impact of Narasimham Committee Report (1998) Positive Outcomes 1. Strengthened CRAR: Banks improved their capital adequacy, ensuring financial stability.
- 13. 13 2. Focus on NPAs: Reforms like ARCs and stricter NPA norms enhanced transparency in financial statements. 3. Consolidation: Initiated mergers of weak banks with stronger ones to create robust institutions. 4. Governance Reforms: Enhanced autonomy of PSBs and encouraged professional management practices. 5. Market Modernization: Banks adopted advanced risk management and became more market-oriented. Challenges in Implementation 1. Resistance to Privatization: Strong opposition from unions and political stakeholders hindered privatization efforts. 2. NPA Reduction: Although NPAs were addressed, structural issues in sectors like agriculture and MSMEs persisted. 3. Slow Progress: Recommendations on reducing government ownership and granting full autonomy were implemented gradually. Conclusion The Narasimham Committee Report of 1998 played a pivotal role in advancing the banking reforms initiated in 1991. By focusing on capital adequacy, asset quality, governance, and consolidation, it laid the groundwork for a more resilient and globally competitive banking system. However, the success of these reforms required sustained efforts and alignment between the banking sector and policymakers. The report remains a cornerstone in India's financial sector transformation. RAGHURAM RAJAN COMMITTEE REPORT (2007) The Raghuram Rajan Committee on Financial Sector Reforms was set up in 2007 by the Planning Commission of India under the chairmanship of Dr. Raghuram Rajan, a prominent economist and former Chief Economist of the IMF. The committee was tasked with outlining a comprehensive strategy to reform India's financial sector, aimed at fostering inclusive growth, improving financial stability, and enhancing the efficiency of the financial system. The report, titled "A Hundred Small Steps", focused on incremental reforms to create a competitive and efficient financial system. Key Recommendations 1. Financial Inclusion Universal Access to Finance: o Advocated measures to ensure every citizen has access to basic financial services like savings accounts, credit, insurance, and pensions. o Suggested using technology, such as mobile banking and biometric authentication, to increase outreach. Simplifying KYC Norms: o Recommended streamlining Know Your Customer (KYC) norms to make banking more accessible, especially for low-income households. Microfinance Institutions (MFIs): o Emphasized strengthening the regulatory framework for MFIs to ensure better service delivery to underserved regions. 2. Banking Sector Reforms Tiered Banking Structure:
- 14. 14 o Proposed creating a multi-tiered banking system, including: Small local banks to serve specific regions. Larger banks with a national and international presence. Privatization of Public Sector Banks (PSBs): o Suggested reducing the government stake in PSBs to below 50% to improve efficiency and autonomy. Greater Competition: o Recommended allowing greater participation of foreign banks and new private banks to enhance competition. 3. Development of Financial Markets Bond Markets: o Focused on developing a vibrant corporate bond market to provide alternative financing options. o Encouraged reducing reliance on banks for long-term infrastructure financing. Derivatives Market: o Proposed the development of robust derivative markets to help businesses manage risks effectively. Market Regulation: o Suggested strengthening the regulatory framework to improve market transparency and prevent fraud. 4. Improving Credit Delivery Priority Sector Lending (PSL): o Recommended revisiting PSL targets and rationalizing them to ensure efficient credit delivery. Agricultural Credit: o Advocated enhancing access to credit for small and marginal farmers through innovative financial products. Credit Information Systems: o Proposed improving credit information bureaus to ensure better credit assessment and reduce defaults. 5. Financial Sector Governance Regulatory Reforms: o Called for a unified financial regulatory framework to reduce overlaps and improve coordination among regulators like RBI, SEBI, and IRDAI. Autonomy of Regulators: o Suggested granting greater independence to financial regulators to ensure effective oversight. Corporate Governance in Banks: o Highlighted the need for professional management and better board governance in banks. 6. Risk Management and Financial Stability Capital Adequacy: o Recommended adopting Basel II norms and strengthening risk management practices in banks. Crisis Management:
- 15. 15 o Proposed creating a Financial Sector Development Council (FSDC) to monitor systemic risks and manage financial crises. 7. Technology Adoption Digitization of Financial Services: o Encouraged greater use of technology to reduce transaction costs and improve service delivery. o Suggested promoting fintech innovations to enhance customer experience. Impact of the Raghuram Rajan Committee Report (2007) Financial Inclusion Drive: o The report influenced initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY) and the expansion of digital payments through platforms like UPI. Development of Bond Markets: o The corporate bond market saw gradual improvement, though challenges remain. Banking Sector Reforms: o Steps were taken to improve governance in PSBs and reduce NPAs. Regulatory Reforms: o Led to better coordination among financial regulators and the creation of the Financial Stability and Development Council (FSDC). Criticisms and Challenges Slow Implementation: o Many recommendations, particularly on privatization and regulatory reforms, faced delays due to political and bureaucratic resistance. PSB Dominance: o The dominance of public sector banks continues to hinder competition and efficiency in the banking sector. Infrastructure Financing: o Reliance on banks for long-term infrastructure financing persists, with limited progress in bond market development. Conclusion The Raghuram Rajan Committee Report (2007) provided a roadmap for modernizing India's financial sector and making it more inclusive, efficient, and competitive. While its recommendations have influenced significant policy measures, their full implementation remains a work in progress. The report's emphasis on financial inclusion, market development, and governance continues to guide reforms in India's financial system.