Recommendations of Narsimham

Committee 1&2

Sub.- Banking and Insurance

Prof. Dr. Dhaivat Shah
MBA(Evening) Sem-6

Prepared by,
Sagar Galani - 22115
Imtiyazhusen Ghanchi - 22116
 Introduction
• Finance Ministry of the Government of India set up various
committees with the task of analyzing India's banking sector
and recommending legislation and regulations to make it
more effective, competitive and efficient.
• Two such expert Committees were set up under the
chairmanship of Maidavolu Narasimham. They submitted their
recommendations in the 1990s in reports widely known as the
Narasimham Committee-I (1991) report and the Narasimham
Committee-II (1998) Report. These recommendations not only
helped unleash the potential of banking in India, they are also
recognized as a factor towards minimizing the impact of global
financial crisis starting in 2007.
 Background
• During the decades of the 60s and the 70s, India nationalized most of
its banks. This culminated with the balance of payments crisis of
the Indian economy where India had to airlift gold to International
Monetary Fund (IMF) to loan money to meet its financial obligations.
This event called into question the previous banking policies of India
and triggered the era of economic liberalization in India in 1991.

• Given the rigidities and weaknesses had made serious inroads into
the Indian banking system by the late 1980s, the Government of
India, post-crisis, took several steps to remodel the country's financial
system. The banking sector, handling 80% of the flow of money in the
economy, needed serious reforms to make it internationally
reputable, accelerate the pace of reforms and develop it into a
constructive usher of an efficient, vibrant and competitive economy
by adequately supporting the country's financial needs.
 Background
• In the light of these requirements, two expert Committees were set
up in 1990s under the chairmanship of M. Narasimham,
former Reserve Bank of India governor which are widely credited
for spearheading the financial sector reform in India.

• The first 9 members Narasimham Committee (Committee on the

Financial System – CFS) was appointed by Manmohan Singh as
India's Finance Minister on 14 August 1991, and the second one
(Committee on Banking Sector Reforms) was appointed
by P.Chidambaram as Finance Minister in December
1997. Subsequently, the first one widely came to be known as
the Narasimham Committee-I (1991) and the second one
as Narasimham-II Committee(1998).[
 Purpose
• The purpose of the Narasimham-I Committee was to study all aspects
relating to the structure, organization, functions and procedures of the
financial systems and to recommend improvements in their efficiency
and productivity. The Committee submitted its report to the Finance
Minister in November 1991 which was tabled in Parliament on 17
December 1991.

• The Narasimham-II Committee was tasked with the progress review of

the implementation of the banking reforms since 1992 with the aim of
further strengthening the financial institutions of India.It focussed on
issues like size of banks and capital adequacy ratio among other
things.M. Narasimham, chairman, submitted the report of
the Committee on Banking Sector Reforms (Committee-II) to
the Finance Minister Yashwant Sinha in April 1998.
 Recommendations of Narasimham
Committee I
• Phasing out Directed Credit Response

The government had been following directed credit

response since the nationalization of banks. This
committee recommended that the respective
program has outlived its utility and advocated
phasing it out. Since nationalization, the
government has pushed low-interest loans to
agricultural and small-scale industry. The program is
known as the direct credit program.
 Recommendations of Narasimham
Committee I
• Establishing ARF Tribunal

The proportion of bad loans and

non-performing assets was very
high in the financial sector. In light
of these, the committee
recommended the creation of an
Asset Reconstruction Fund (ARF)
tribunal. The ARF would assume a
percentage of these bad debts and
help clean the balance sheets of
banks and other financial
institutions.
 Recommendations of Narasimham
Committee I
• Removal of Dual
Control
Regulation of banks was under the dual
control of the Ministry of Finance
banking department and the Reserve
Bank of India. It created avoidable
problems in the bank’s functioning and
hampered the efficiency of the overall
financial system. The Narasimham
committee recommended entrusting
the Reserve Bank of India with the sole
responsibility of regulating banks and
financial services. The function of RBI
would be to ensure that banks'
fundamentals remain strong.
 Recommendations of Narasimham
Committee I
• Reduction in CRR and SLR

Both SLR and CRR are statutory

requirements that need to be
adhered to by all banks and
financial institutions. Narasimham
committee recommended reducing
both these requirements as it was
very high and created an undue
burden on financial institutions. It
advocated reducing SLR from
38.5% to 25% and CRR from 15% to
3-5%.
 Recommendations of Narasimham
Committee I
• Interest rate
determination

In the Indian financial system,

interest rates were controlled by
the government. However, the
committee recommended
phasing out government controls
to achieve better efficiency and
productivity. Instead, interest
rates should be organically
determined by demand and
supply market forces.
 Recommendations of Narasimham
Committee I
• More Freedom to banks

The Narasimham committee was selected to usher

in banking sector reforms. It did so by advocating
more freedom for banks and other financial
institutions. Managing directors and boards of
governors of respective banks should be given
adequate leverage to undertake certain actions
necessary to improve banks' financial health and
enhance efficiency.
 Recommendations of Narasimham
Committee II
• Narrow banking

The public sector banks faced a

high incidence of bad debts
and non performing assets. The
non-performing assets level was
as high as 20% in some banks. To
solve this problem, this
committee introduced a new
concept named narrow banking.
As a part, highly impacted
financial institutions will be
allowed to put their funds in risk
free assets.
 Recommendations of Narasimham
Committee II
• Government ownership

The earlier report had recommended granting

greater autonomy to banks so that they can
perform professionally. However, government
ownership and autonomy did not go hand in hand.
Therefore, it suggested that the government
should divest controlling stake in most PSBs and
allow banks to function independently.
 Recommendations of Narasimham
Committee II
• Capital adequacy ratio

The capital adequacy ratio is the

percentage of capital concerning
a bank's risk weighted liabilities
and assets. The Indian banking
system was structurally weak and
could not absorb shocks.
Therefore, to build its capacity
and inherent strength, the
committee recommended
increasing the capital adequacy
requirements of banks and other
financial institutions.
 Recommendations of Narasimham
Committee II
• Strong banking system

The committee was of the firm view for stronger

and more resilient banks which can compete with
large multi national banking companies. It
advocated for the creation of strong banks by
merging two or more banks. However, it cautioned
against merging strong banks with weaker
institutions as it would defeat the purpose of
reforms.
 Recommendations of Narasimham
Committee II
• Change in RBI’s role

There should be a reform in RBI’s role as well.

The Reserve Bank of India should function
only as a regulator or administrator of India’s
financial system by forming rules and
regulations and ensuring compliance. It should
divest any controlling stake in banks and other
financial institutions.
 Recommendations of Narasimham
Committee II
• Non-performing assets

With burgeoning NPAs, the sustainability of the

Indian banking system was under threat.
Narasimham committee recommended reducing the
total gross NPA of the banking sector to 3% by 2002.
To achieve the same, it suggested the establishment
of asset reconstruction companies. The government
of India passed the SARFAESI Act 2002 in order to
incorporate these recommendations.
 Recommendations of Narasimham
Committee II
• Foreign banks

The earlier committee had already opened the

doors for foreign banks in India. Moving ahead
on that development, the second Narasimham
committee suggested that minimum start-up
capital for foreign banks should be raised from
$10 million to $25 million.
Thank you,