While the first phase of banking sector reforms contained in the report of Narasimhan Committee have been implemented, the second phase of reforms in the Banking sector is currently under implementation.

Sometime in early 1997, the then finance minister Mr.P.Chidambaram requested Mr.Narasimham to chair another committee to review what had been accomplished and to suggest a new vision for our banking industry. In April, 1998 Mr.Narasimhan submitted his blue print to the Government. Many of these recommendations have been accepted and are under process of implementation. Excerpts from the views expressed by a former Finance Minister Mr.P.Chidambaramn recently on the subject in a lecture delivered by him at the Administrative Staff College, Hyderabad are reproduced here under:

1. Government should divest its Equity in PSBs

   "Government should reduce its equity holding to below 51% in all banks. We can debate whether the reduction should be to 33% or 26%. But it must go below 51%. I might add that when I say government holding I mean government's plus the RBI's holding. Banks must become Board managed companies subject, of course, to effective supervision, regulation and monitoring by a single agency. This is the central issue in banking reform and, as long as we skip around it, we are not addressing the core of the problem. Needless to say, what we require is a political decision, and it will be my endeavour to convince my colleagues of the imperative of reducing government's holding in banks to below 51% immediately."

2. Net NPA to be pegged down to the level of 5% by 2000 and 3% soon thereafter

   "The Narasimham Committee has made many other useful suggestions with which I am in complete agreement. In particular, the goal of having a NNPA for all banks at around 5% by the year 2000 and 3% soon thereafter must inform our policies and strategies for reforms. This will call for sustained measures to tackle the problem of backlog NPAs on a one-time basis".

3. The capital adequacy norm of 8% must be increased to 10% but the additional capital requirements should in my view, not come from the Budget but must be raised in the capital market.(CAR already increased to 9% from March,2001.)

4. The problem of high interest rates

   "We must remove policy-induced pressures on the real interest rate. The effective rates of return offered by government's small savings schemes, relief bonds and provident funds are too high and they put a competitive pressures on the real interest rate on bank deposits. They have other consequences too, such as the stretching of the fiscal deficit. When inflation rises, as a result of other policy driven measures, there is further upward pressure on the interest rates. When inflation falls, the interest rate does not fall because it is "anchored" by the SSI rate and thus real interest rate rises. This is not the place to dwell on the disastrous consequences of a high interest rate economy. Most projects flounder - and many new entrepreneurs have gone broke - in a regime of high interest rates. Moreover, government's expenditure on debt-servicing goes up uncontrollably, leaving little for investment or development. In recent years, the central government's expenditure on interest payments has risen from Rs.27,000 crore in 1991-92 to Rs.75,000 crore in 1998-99. We must make a three-pronged attack on interest rates. Reduction of the fiscal deficit must be the first goal of budget making. Government promoted savings instruments must offer lower rates of interest. The new theology - or rather the new-found love for the old theology - of buying a little more growth through inflation must be given a final burial, and inflation control must regain primacy in economic management. Through these and other measures, we must lower real interest rates and pave the way for a truly competitive banking sector."

5. Debt recovery

   " The Narasimham Committee has reiterated its suggestion on the creation of a separate bad debts recovery institution. Many of us remain unconvinced. The moral hazard argument is too familiar to be dismissed summarily. Besides, the idea sends the wrong signals. We have to make our legal machinery more business-like and allow banks to settle bad accounts on what they consider commercially sensible terms. During my tenure, I encouraged banks to set up Settlement Advisory Boards headed by a judge. While there were some encouraging results, the process was halting and slow….. I have a suggestion: we may combine the objectives of the existing Debt Recovery Tribunals and the Settlement Advisory Boards and create a single authority for each group of banks, composed of a banker and a judge. This authority could be tasked to promote settlements as well as decree suits and direct recoveries. The alternative idea of an Asset Recovery Corporation, which will be another government body, and manned by officers who will also live in fear of investigative agencies, cannot do better".

6. The Rural Credit System is in a shambles

   "The second item on the agenda for financial sector reforms should be a revamp of rural credit system. As I have indicated earlier, NABARD's resources base has been augmented substantially. Successive Budgets have also provided about Rs.400 crore for the revitalisation of 50 Regional Rural Banks. I continued with the scheme of Rural Infrastructure Development Fund (RIDF) under the aegis of NABARD. Sanctions under the RIDF have amounted to Rs.5800 crore in the last three years. Institutional credit to agriculture has increased from Rs.15,000 crore in 1992-93 to Rs.34,000 crore in 1997-98. "

   "But structural problems in the rural financial system remain. There still exists a substantial gap between the demand (leave alone the "need") and the supply of agricultural credit. The increasing credit needs of the fast growing rural non-farm sector have also to be factored in. The planning Commission in its Ninth Plan document estimates that the growth rate in agricultural credit flow, broadly defined, has to be maintained at about 16% per year, while the growth rate has been around 10% per year over the past decade. Moreover 50% of the credit demand will be from small and marginal farmers which our present day institutions are ill-equipped to serve. It is farmers holding more than 5 acres of land who dominate cooperative membership; consequently, they also corner the bulk of agriculture credit from commercial banks.

   Small and marginal farmers are denied access to credit. It has been estimated that over half their credit needs are met by non-institutional sources. Inevitably, they pay usurious interest rates. This could well be one of the factors contributing to the distress of ryots manifested most tragically in suicides in states like Andhra Pradesh, Karnataka and Maharashtra.

7. Other problems concerning rural credit

   " I wish to briefly dwell upon an irony in our credit delivery system. A large number of people have very small savings - you may call them micro-savers. No effort is made to mobilise these micro savings, thanks to the transactional costs of our banks and other institutions. On the other side, there are a large number of people whose credit requirements are also very small - you may call them micro-borrowers. They are the most neglected segment. Small and marginal farmers, village artisans and craftsmen and service providers in villages like the dhobi, tailors and hairdressers fall in this segment. They cannot buy fertilizer or new tools; they cannot upgrade their skills. They remain entrenched in poverty. For some time now, I have reflected on the need to build an institutional bridge between micro-servers and micro-lenders. The most notable example in this region is the Grameen Bank of Bangladesh. In a small way, SEWA of Ahmedabad caters to the credit needs of working women. I suggest that loans to successful self-help groups like SWEA should be treated as priority sector lending and as an alternative to IRDP and similar schemes. I also suggest that we should encourage new forms of local institutions which can take up this task. The idea of Local Area Banks which I mooted two years ago was a step in that direction. The opposition to the proposed LABs was led by the existing inefficiently run banks, including the Regional Rural Banks. I regret to say that it is an idea whose time has sadly not yet come."

   "politics has played havoc with the rural financial system and has eroded the viability of credit institutions. Contrary to popular belief, farmers are more concerned with the easy and timely availability of inputs and services than their costs per se. Credit is one such service which must be made available on timed and at the lowest possible cost. Perversely, we have allowed interest rates to be raised to make rural financial institutions viable. The result is that while some institutions are profitable, most borrowers are broke. The more enduring ways lie elsewhere-in reducing transaction and risk costs, in improving productivity and in better recovery."

   "Commercial banks account for about 34% of short term credit and about 55% of term credit disbursements to agriculture. In many ways, the growth of commercial bank activities is a reflection of the complete failure of the Regional Rural Banks and the precarious financial condition of the cooperative credit structure. The build - up of overdues is severely restricting the capability of rural credit institutions to expand their activities by availing of refinance. 50% of the primary agriculture credit societies that have reported their working results have incurred losses. Overdues of primary land development banks is now close to 40% and of State land development banks close to 46%. That is the price we have paid for allowing political parties and politicians to take virtual control of cooperative institutions. It seems to me that we can no longer put off the case for selective Recapitalisation of Rural Financial Institutions, but obligatorily linked to the introduction of norms and monitoring by fan agency like NABARD. Recapitalisation cannot be open-ended or be divorced from performance parameters. Otherwise, the exchequer will go bankrupt

8. "There is another sensitive issue, namely, priority sector lending. Today, Commercial banks are mandated to lend 18% to agriculture. This target was fixed at a time when the reserve requirements of CRR and SLR combined were as high as 63%. Today, these reserve requirements are at 36%. The lending base has, in fact, doubled in the last five years. Two questions arise. First, does it make sense to continue to insist on 18% ? Second, if larger sums are available for lending why do most banks fall short of the 18% target? There are no simple answers. I suspect it has something to do with the way our banks have evolved - looking more towards the cities and towns, trade and industry and large borrowers, and to a distaste of bank officers to rub shoulders with farmers. We treat the priority sector as a sacred cow, and we starve it. It is not enough to make lending to agriculture mandatory; it must be made profitable. Refinance at lower rates will help, but such lending will be truly profitable only when the transaction costs of banks are sharply reduced".

9. Reform of the Insurance Sector

   "Financial sector reforms are more than banking sector reforms. I turn now to the third item on the agenda. The insurance industry in India has been a public sector monopoly. The Malhotra Committee gave us a blueprint for its liberalisation. I tried to implement that blueprint. My approach was a three-stage one. First the establishment of a statutory Insurance Regulatory Authority. Second the opening of the heath insurance business and the pensions business on the ground that just about 20 million Indians have organised pension cover and 2 million Indians have health insurance. Third the opening of the life insurance business itself. I saw this as a three to five year exercise."

   " Since the debaters have now exhausted themselves, I would now advocate an immediate and simultaneous opening of all segments of the insurance business. I am glad that the Finance Minister sees the need for this now which, sadly, his party did not see a year ago. I would also say that foreign participation is necessary for the technology and product expertise that they will bring, and we should allow foreign equity up to 49% in insurance joint ventures. Currently, LIC and GIC provide about Rs.6000-7000 crore annually for various infrastructure projects in water supply, power, sanitation and housing. If we open the insurance business, each new company would be able to generate at least another Rs.5000 crore annually from the tenth year onwards for investment in infrastructure sectors. The opening of the insurance and pensions industry is the only way we will be able to mobilise increasing amounts of resources for long-gestation infrastructure projects. Over time, government must also reduce its stake in LIC and GIC. What is true of banks is also true of insurance companies - government ownership is a strong deterrent to professionalism, managerial freedom, customer-friendliness and entrepreneurial behaviour."

10. Infrastructure financing

    "The fourth item is the need for innovation in relation to infrastructure financing. Government guarantees may have been needed in the initial stages of attracting private investment but they have run their course. I have already spoken of the need to open the insurance and pensions businesses. We have much to learn from countries like Chile and Singapore. Singapore is a state-based system, while in Chile the system is being increasingly privatized. There is need for new financial instruments like asset-backed securitisation and municipal bonds. Innovative and diverse financing techniques must allocate risks optimally in private infrastructure projects. The Ahmedabad Municipal Corporation recently raised, successfully, large resources through a bond issue. For smaller cities and towns that may not be in a position to do likewise, there is need for an urban infrastructure financing agency that will float 20-30 year securities and on-lend to the municipal bodies. Along with much needed resources, it will also bring much needed financial discipline into these bodies. Both the elected bodies and the electorate may in due course realise that user charges - which are now too low - would have to be raised to service the long-term bonds. Following an announcement made in my 1996 Budget speech, the Infrastructure Development Finance Company with an authorised capital base of Rs.5000 crore established in January 1997. Foreign investors have taken a keen interest in the IDFC and the Company has made a promising beginning. The development of a long-term debt market will also underpin the growth of private infrastructure."

11. Regulatory Authorities

    "My fifth item on the reform agenda is the special need for regulation and supervision in a world of capital mobility. The East Asian crisis has reminded us forcefully once again that liberalization and globalisation of financial markets must be accompanied by strong financial systems capable of handling large flows and assessing the potential risks involved in foreign exchange exposure both by the banks and their clients. There is no simple way of ensuring that banks are strong. Effective regulation and supervision must be based on a transparent set of rules, as close as possible to international standards, combined with free and timely availability of information, and strong, proactive action again those breaking the rules. Such regulation is different from controls or bureaucratic interventions which come naturally to us. There is a case for continuing with controls over the inflow of short-term capital. There may also be a case for hastening slowly on the road to capital account convertibility. But there is no case at all for going slow on liberalisation. In most areas, we must move from old approach of controls that impede markets to regulations that do not interfere with markets but discipline the transgressors. Our regulatory agencies must be made more professional and specialised. Economic, financial and market research must inform their decisions and actions. And information technology can make a greater difference to organisational efficiency in the financial sector."