Banking - Yojana

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Generated by PDFKit.NET Evaluation of percentage of total assets, gross and net NPAs have declined to 7.0 per cent and 3.3 per cent respectively by the same time. Yet the progress is not satisfactory everywhere. While on 'the regulatory aspects and relevant financial ratios, there was discernable progress, on structural aspects, especially public ownership and incentive structures including autonomy of public sector banks, ,reform process fell short of expectations of Committee on Financial System (Reddy, 1999). Against this background the governm'ent thinks it necessary to examine the problems afresh and review some of the recommendations of the committee in the context of changed circumstances. Circumstances have changed a lot. There have been major changes in domestic macro environment in recent years, 'the most important of which has been the greater focus on containing fiscal deficit, subsidence of inflationary pressures and restoring to monetary policy, its defining function of regulating money and credit. These changes have coincided with movement towards global financial integration which would call for greater measure of competitive efficiency in the banking system to be able to face the challenges of increasing competition from abroad. Inspired by these changes, the government appointed, in November 1997, another committee, Committee on <strong>Banking</strong> Sector Reform, again under the Chairmanship of Mr M Narasimham. The second Narasimham committee submitted its report on April 1998 which addressed a number of vital issues pertaining to the health and stability of financial system and the 8 Click here to unlock PDFKit.NET action necessary to strengthen it. Here we shall discuss some recommendations of the second Narasimham Committee. Capital Adequacy Let us first take up the issue of capital adequacy ratio. Regarding this the recommendations of the Committee are to assign risk weights to government approved securities, to take care of the market risks and also assign risk weights to open position in forex and gold. The Committee has also suggested increase in this ratio to 10 percent, nine per cent t~ be achieved by March 2000 and 10 per cent by 2002. On the issue of income recognition the Committee's recommendation is to change the definition of NPA in line with the international norm. According to the international norm income on any asset is not recognised if it is not received within 90 days after it is past due. In this context the committee recommended that an asset be classified as doubtful if it is in the sub-standard category for 18 months in the first instance and eventually for 12 more months. The Committee also recommended that for the purpose of evaluating the quality of asset portfolio, governmentguaranteed advances which have turned sticky should be treated as' NPAs. However, if for sovereign guarantee argument such advances are excluded from computation they should be shown separately for transparency of operations. The Committee, in this connection, also expressed its resentment over the extent of NPAs in the banking sector as a whole. Presently, a large number of public sector banks have net NPAs ranging between 10-20 per cent of net advances. The committee opined that the average level of net NPAs for all banks is to be reduced to 3 per centby 2002 and to zero fOf banks with international presence. In this context the committee recommended that in case of all future loans, asset classification and provisioning norms should apply even to governmentguaranteed advances in the same manner as for any other advances. For existing government advances a mechanism for a phased. rectification should be worked out. Another major recommendation of the second committee is on the issue of reorientation of banking structure. A restructuring is necessary because factors like nonremunerative branches, lqw productivity, over manning also affect the profitability of banks. The main thrust in restructuring is on merger of banks. Unlike normal practice the committee put stress on the merger of strong uni ts as a means of strengthening them and providing for greater opportunities for competition. For the weak banks the ,committee prescribed that these banks should resort to 'narrow banking', i.e., they should restrict ,their operations only in gilt-edged securities and other securities of zero-risk variety. If, even after following this safe track of investment, the weak banks failt. recover themselves, the units should be closed altogether. Directed credits pose a serious problem before the banks. These credits generally turn to be bad debts. Previously directed credit, in general, indicated priority sector lending. But nowadays there are a variety of government sponsored programmes which are to be funded by banks. The second YOJANAJuly 2002
Generated by PDFKit.NET Evaluation Narasimham Committee has recommended that given the special needs of this sector, the current practice may continue. However, for ensuring greater involvement and accountability and also appraisal of schemes on commercial considerations without any extraneous influences, the branch managers of banks should be fully responsible for the identification of beneficiaries under the government sponsored • credit linked schemes. However, this recommendation is yet to be acted upon. Generally, beneficiaries in such schemes are political persons or persons favoured by poli tical parties. Implementation of this recommendation means direct attack on political interest. There is no doubt that the first phase of financial reform yielded fruitful results. The second phase of the process also got started with the implementation of some ofthe recommendations of the s~cond Narrasimham Committee in the 1998 monetary and credit policy, announced by the Reserve Bank of India, Governor Dr BimalJalan. Let us start with the issue of capital adequacy ratio. In his first report Mr Narasimham proposed that the capital base of a bank can be increased in two ways. First by building a fund with the recovered bad loans of the banking sector as • a whole. This fund will be termed Asset Reconstruction Fund (ARF) and capitalwillbe infused from this fund for recapitalization of weak banks with low capital adequacy ratio. In the second method recapitalisation will be made by using massivebudgetary funds. The committeewasin favouroffallowing the first route, because the second one is not only costly but is unsustainable over time. . YOJANAJuly2002 Click here to unlock PDFKit.NET Unfortunately the government, in the lastcouple ofyears,followedthe second route in order to get quick and immediate result.For example, the State Bank of India and the Oriental Bank of Commerce were the onlypublicsectorbanksto access the market and follow the conventional wayof boosting their capital, while other nationalised banks haveboosted their capitalwith infusion of funds from the government. However,thispolicy is against the long-run objective of reducing fiscal deficit of the governmen t and is totally undersirable. In his second report, Mr Narasimham again recommended the constitution of ARF,both to meet the problems of NPAs and low capital adequacy rations. Merger Coming to the problem of merger of bank branches in the line proposed by the second Narasimham Committee. The Committee disfavoured the idea of merger among .strong and weak units on the argument'that it might produce adverse impact on the asset quality of the stronger unit as a result of acquiring the hollow portfolio of the weaker unit in the absence of any systemof written off the NPAsof the weaker unit before merger. On the other hand, according to the committee, merger of strong units may produce better multiplier effect. However, many economists conveyed their dissen t on this prescription of the second committee. They argued that such merger between stronger banks in different countries, e.g. in the U.S.A.,Japan, Singapore, failed to produce positive result in recent past. The most important point to argue is that merger in those countries were the result of pressure of competition. Hence that was inevitable. But here such merger is going to be imposed on them. That might have adverse impact. Argument is also there against the method of 'narrow' banking' prescribed by the second committee for the recovery ofweak banks. It is argued that there is insufficient supply of risklessassets to back potential demand for riskless deposits. Moreover, increased demand for riskless assets would raise their prices in a narrow banking world. Some have also argued that instead of narrow banking these banks require aggressive banking. This means that this banks should not resort to riskless investment which are generally lowyielding; instead they should invest in securities of'first classcommercial companies which are risky but high-yielding. With this aggressive banking they would be more attentive and give more effort in recovering bad debts. It may be said that there may be arguments and counter arguments on various issues. But this does not mean that the reform should be halted and the debate be solved first. Rather we have to advance following trial and error method. Let us finish with the words of the second Narasimham Committee (Narasimham Committee Report on <strong>Banking</strong> Sector Reform, 1998) which sounds like: "The process of strengthening the banking system has to be viewed as a continuing one. There is no finite end to improving the levels of efflciency and profitability. In fact, the situation is one where the system has to cope constantly with changes in the broader environment in which it functions and face new challenges thanhese developments impose on it." 0 9
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