Banking sector reforms is the need of the hour

While going ahead with the processes and procedures for allowing new banks, the RBI should, simultaneously, reopen the banking reforms agenda. If this is not done corporates and small borrowers will continue to disbelieve the banking system and find out escape roots for deploying their surpluses and meeting their financial needs

Perhaps because of a sense of futility in the present coalition scenario, the Government of India (GOI) and the Reserve Bank of India (RBI), in the recent past, have been making sub-sector-specific or issue-based observations on financial sector reforms. Reforms, to be successful, need a holistic treatment. There appears to be a studied silence on structural reforms in the financial sector, except for passing references to additional banking licenses to private players or changes in regulatory environment for NBFCs. These are more with the interests of certain stakeholders in view than the overall health of the financial sector.


The RBI governor’s recent observation about GOI’s liquidity problems for allowing further expansion of public sector banks adds to the confusion. If the financial sector has to rise to the expectations in regard to credit delivery, especially to agriculture and service sectors, the banking infrastructure will need structural reforms, skill development and a change in outlook on HRD-related issues. 


Public sector banks continue to shoulder more than their real share of the burden of lending to traditional priority sector which includes agriculture and small borrowers. Even if they come into being, the proposed additional private sector banks may not be immediately in a position to support the critical areas which are neglected by private sector banks to a large extent, as of now.


In this context, any further delay in comprehensive financial sector reforms, for political reasons (“compulsions of coalition politics”, government not having adequate dependable numbers in both the Houses), may have long-term adverse impact on the country’s economic development. Perhaps, this is the right time for the finance minister to open a debate for a consensus in the matter.


Here one has to admit that it is quite natural that as a regulatory body responsible for the health of the financial sector, RBI’s concerns go farther from just the net worth of the promoter or his professional capability to run a bank. RBI’s intention to regularize and ratify the parallel banks which can conform to regulatory norms and rehabilitate some RRBs (regional rural banks) which may have manpower and infrastructure in place but may be finding it difficult to perform for want of leadership as also the central bank’s desire to keep the business of banking trustworthy is evident from the cautious approach of RBI in regard to new bank licenses despite perceivable pressure from industry and to some extent from GOI.


Read New banking license announcement is first major reform in two decades


Even when the RBI came out with the discussion paper on the issue of new bank licenses, it was known that the idea of setting up some more private sector banks was loaded with compulsions much beyond the government’s stated intention to give a greater role for private sector in banking to promote financial inclusion and reduce government’s financial commitments for running banks. The role so far played by the private sector banks which came into being post-LPG (Liberalisation-Privatisation-Globalisation), which are driven by profit-motive, in lending to traditional priority sector, penetration to semi-urban and rural areas and financial inclusion has not been very impressive.


It has to be said to the credit of RBI that the central bank effectively brought to the fore the real issues and concerns of all stakeholders in the financial sector, about new banking licenses. In the present scenario, the central bank should take initiative to reopen the banking reforms agenda which was kept in the backburner after allowing some banks in the private sector during the introductory years of financial sector reforms. 


In 1991, the Committee on Financial System (Narasimham Committee) visualized a structure for Indian banking system with “three or four large banks that could become international in character; eight-10 banks with a network of branches throughout the country engaged in ‘universal banking’; local banks whose operations would be generally confined to a specific region and rural banks (including RRBs) whose operations would be confined to the rural areas and whose business would be predominantly engaged in financing of agriculture and allied activities”. As more than two decades have passed, though there may be reason to re-evaluate a suitable model in the present context, the relevance of structural reforms has not lost validity.


Although the recommendations of the Narasimham Committee were realistic and had kept in view the long-term credit needs and the inability of large banks to reach out to un-banked and under-banked rural India, for various reasons including compulsions of coalition politics, RBI and the Centre did not take a serious look at reorganization of banking infrastructure. Banking services, in India evolved through a multi-agency system and through different limbs, supported the credit needs of small borrowers to a great extent.


The need of the hour is to ensure that all players in the business of banking in the formal sector, namely, commercial banks, cooperatives and RRBs remain healthy and perform their assigned roles effectively and the informal sector, through which banks and NBFCs support microfinance needs, is also brought under financial discipline through regulatory arms such as RBI, NABARD and state governments.


To read about other initiatives of RBI, click here.


The present scenario is partly the result of GOI and RBI keeping the residual banking sector reforms in the backburner after allowing some banks in the private sector in the initial days of reforms. The debate in the media during the last couple of years about “new private sector bank licenses” shows that a bank or a financial institution is a different animal to different persons, depending on the person’s financial status and banking needs. 


At this delayed hour at least, a total view of banking needs of agriculture, industries and service/export sectors and institutional infrastructure for meeting them may have to be taken by the central bank. If this is not done, corporates at the national level and small borrowers at the ground level will continue to bypass the banking system.


The RBI has been consistently playing a proactive role in institution-building in the financial sector, since early 1950s. SBI, IDBI, NABARD and new private sector banks are some examples of the central bank’s success stories in institution-building. Despite its efforts, along with GOI, to improve the health of the rural financial infrastructure by rehabilitation of existing cooperatives, trying experiments like Regional Rural Banks and Local Area Banks and promoting financial inclusion, adequate and cost-effective institutional credit is yet to arrive in rural India. The proposed new private banks will initially be able to focus on large investors and borrowers only, which will definitely have an impact on the sources and uses of funds available to banks and financial institutions. In the circumstances, the central bank should, while going ahead with the processes and procedures for allowing new banks, simultaneously, reopen the banking reforms agenda.


The diversions so far provided for bigger banks to dilute their priority sector and rural lending responsibilities should be reviewed with a view to ensure that deposit-mobilization gets tied up to the social responsibility of meeting the genuine credit needs of all sectors considered relevant for overall economic development. If this is not done corporates at the national level and small borrowers at the ground level will continue to disbelieve the banking system and find out escape roots for deploying their surpluses and meeting their financial needs.


The public sector-private sector divide in meeting social responsibilities also needs a closer look. If this is not done corporates at the national level and small borrowers at the ground level will continue to bypass the banking system.   


Overlap of functions, large-scale outsourcing of activities and challenges from business houses who are telling that if you will object to owning a bank, the same objective will be achieved through an NBFC or some other arm or instrument which can achieve desired objectives and reluctance of banks in the private sector to directly penetrate below the creamy layer of the large majority which is waiting for “financial inclusion” are all major areas of concern needing immediate response from RBI.


GOI, at this late stage, should think in terms of (a) encouraging individual banks to do business in functional and geographic areas in which they are better equipped and have competitive advantage in terms of outreach (b) redefine the role of various categories of banks considering their background, skills and capabilities and (c) involving the regulator, namely RBI, for conveying GOI’s expectations, so that multiplicity of guidances is avoided.  A comprehensive review of the banking needs and institutional infrastructure for meeting them with focus on how best the existing banks can be guided to meet the genuine credit needs of various sectors of clientele is the need of the hour.  


Read other articles by MG Warrier, here.


(The writer is a former general manager of RBI. He can be contacted at [email protected])

Dr Anantha K Ramdas
1 decade ago
Thank you for this interesting article on the banking system and the urgent needs to bring in various improvements.

One of the many problem areas includes the issue of protecting the "savings" and deposits of the account holders.

I believe the insurance coverage for the loss of deposit or savings in an account for any reason is limited to Rs 1 lakh. Time is now for this coverage to be increased to a reasonable level bearing in mind the fact that the amount was fixed decades ago and Rupee value and savings capacities have gone up
Replied to Dr Anantha K Ramdas comment 1 decade ago
Safety of deposits is important. Insurance cover ceiling is Rs1 lakh per account. While I agree that the comfort level will improve if the ceiling is raised, normally it may not be of much significance to small savers as our country has not been allowing many bank failures in the recent past and the position may not change for the worse unless we mimic developed countries in banking practices. Most of the small savers are with public sector banks. A hike in the ceiling may mean higher outgo of fee and lead to cost escalation for banks. I am for status quo.
1 decade ago

Why are banks operating like kirana stores; selling all types of products from insurance, mutual funds, gold, foreign currency, credit cards, equity & what have you . . . While NBFCs and MFIs are focused on extending credit/loans which is supposed to be a core banking function.

Is there any way, that RBI can get Banks to do what they are primarily supposed to do?
Replied to Nilesh KAMERKAR comment 1 decade ago
You have raised a valid point, which needs to be addressed while formulating a comprehensive policy for financial sector. Short answer to your question is, every ‘shop-keeper’ including banker has an eye on expansion of business in areas which are less risky to improve profit. Thus banks try to add more products and services in their bouquet to attract customers. On the other side, you will find NBFCs, Industrial Houses, Postal Department and even governments wanting to start banks.
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