Time to revisit Narasimham report

It has been 35 years since the Committee on the Financial System (Narasimham Committee) submitted its report in November 1991. This report was called Narasimham I because another committee under M Narasimham on banking-sector reforms submitted its report in 1998, referred to as Narasimham II.

 The report makes an interesting read. It is difficult to find fault with its recommendations, even with the hindsight of 35 years. The report has a road map for the financial sector. Many recommendations took years to implement, and many are unfinished.  The committee had some 40 proposals for the reform.

 The main recommendations were aimed at taking the Indian banking system towards global standards of capitalisation, accounting, governance, and supervision. Surprisingly the report did not suggest privatising state-owned banks but vehemently advocated professional management insulated from state (departmental) interference. They argued that governance systems should be decoupled from ownership and the strategy should be driven professionally rather than bureaucratically. It went to the extent of indicating that the Reserve Bank of India (RBI) should not have a nominee on bank boards and the state should have only one representative to represent its proprietary interests (two members of the committee wrote a dissent on this, suggesting that there should be no representative of the state, and those should be governed as fully autonomous institutions; they even went to the extent of suggesting that the banking division of the Ministry of Finance should be abolished!).

 The committee recommended a separate settlement process for sticky loans. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfeisi) Act came more than 10 years later in 2002. It suggested that sticky loans be transferred to an asset-reconstruction fund and a separate mechanism be created to recover sticky assets. The first asset-reconstruction company, Arcil, started operating in 2003. It recommended capital-adequacy requirements be on a par with the recommendations of the Bank for International Settlements, which was eventually implemented. But what is interesting are the recommendations of the committee yet to be implemented or are still in the works. They seem to be relevant today.

 The committee recommended that the Indian banking sector should consolidate with having three-four large banks (including State Bank of India) and 8-10 national banks. The large banks were expected to be international in nature. The committee even suggested that the international presence of state-owned banks be consolidated into one or two entities so that there could be a substantial global footprint that the world would reckon. While we are increasingly inviting international players to the country, and with greater vigour, the internationalisation of Indian banks has not happened to the extent that the committee recommended. State Bank of India and Bank of Baroda have some international presence, but is that significant enough?

 On the issue of consolidation to have 8-10 national banks, we have achieved it, but not through sequencing that the committee suggested and therefore this consolidation may have been a suboptimal exercise. The committee advocated the process be market-determined and organic, the pre-condition being autonomy to state-owned banks. That has not happened.

 The committee had an interesting formulation on rural banking. It suggested that rural operations of each of the banks be hived off into a wholly owned subsidiary and the regional rural banks (RRBs) be consolidated into that subsidiary of the sponsor bank. What we have instead is status quo ex-ante with state-owned banks and a consolidation of multiple RRBs into a single RRB under the one-state-one-RRB formula.

 The committee recommended ending directed lending; and reducing priority-sector lending targets to 10 per cent with a narrow definition, consisting of small and marginal farmers, artisans, micro enterprises, and small transport operators. The suggestion was that the achievement of priority-sector targets should be reckoned after considering the portfolio of the bank and its rural subsidiary.

 It is fascinating that the Narasimham committee was so forward-looking. We have not been able to come to terms with some of the obvious recommendations. There are multiple reforms that could be undertaken in the banking sector, including reform of state-owned banks, without necessarily privatising them. Here are the points of unfinished agenda of the 1991:

 1. Governance reform of state-owned banks should start by repealing the Bank Nationalisation Act and getting these under the Companies Act. This is an easy and important step. The banks then will then be governed within the ambit of the Companies Act and the listing norms of the Securities and Exchange Board of India, and will make direct intervention by the ministry a bit more difficult.

 2. However, the idea of fully owned subsidiaries of banks to carry out specialised rural activities may be an idea worth testing.  As banks have their insurance and asset-management subsidiaries, it may be a good idea to think of a low-cost no-frill subsidiary for rural operations. Many commercial banks having acquired microfinance institutions have surrendered the licence for their non-banking finance company and are operating those as business correspondents for acquiring inclusive clients in an inexpensive format. Having a rural bank as a subsidiary may be a good idea. It would be similar to asset-management and insurance subsidiaries that the banks run.

 3. The priority-sector targets at 40 per cent have remained with a wide and liberal definition where it is possible to achieve all its targets including agriculture without issuing a single kisan card or making a crop loan – taking shelter under the broad definition which includes tractors, farm implements, dairying, fisheries and poultry. This part needs to be sharply defined, with reasonable but stiff targets. Considering the current requirements, a 20 per cent target sharply defined between small and marginal farmers and micro enterprises may be adequate.

 It may be a good idea to have a compulsory annual reading of the Narasimham committee report for

the brass in the Department of Financial Services and the RBI to remind them of the unfinished agenda

of reform. 

 

The writer is professor, Centre for Public Policy, Indian Institute of Management Bangalore