Financial Sector Reforms in India

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Economic ReformsFinancial Sector Reforms

in India


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Types of Reforms introduced

A) Economic Reform

B) Financial Sector Reform


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The term economic reform broadly indicates necessary

structural adjustments to external events.

It include the function of countrys spending to thelevel parallel to its income and thereby reducing fiscal

deficits.

This requires gradual reduction in import and increase

in export. These adjustments also requires market

change in order to make economy flexible.


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The present process of economic reforms was

born out of the crisis in the economy, which

climaxed in 1991. The crisis compelled thegovernment to adopt a new path-breaking

economic policy under which a series of

economic reform measures were initiated

with the objective to deal with the crisis andto take the economy on a high-growth path.


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Increase in Fiscal Deficit

Increase in adverse balance of Payment

Fall in foreign Exchange Reserve

Rise in Prices

Poor Performance of Public Sector


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Need for Financial sector reforms


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Till the early 1990s the Indian financial

sector could be described as a classic

example offinancialrepression .

Monetary policy was subservient to the

fiscal Policy.


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Resulting into

Government regulated the price at which firms couldissue equity, the rate of interest which they could offer on

their bonds, and the debt equity ratio that was permissible

in different Industries

Working capital management was even moreconstrained with detailed regulations on how much

inventory the firms could carry or how much credit they

could give to their customers.

Working capital was financed almost entirely by banksat interest rates laid down by the central bank

Working capital finance was related more to the credit

need of the borrower than to creditworthiness.


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BACKGROUND OF FINANCIAL SYSTEM

REFORM

The pre-reforms period i.e. from the mid 1960s to

the early 1990s was characterized by interest

rates, industrial licensing and controls dominated

by public sector and limited competition.

The government initiated economic reforms in

June 1991 to provide an environment for

sustainable growth and stability.


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ECONOMICREFORMS

LIBERALISATION

PRIVATISATION

GLOBALISATION


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It means to free the economy from direct or physical

controls imposed by the government.

Prior 1991, government had imposed several types of

controls on Indian economy e.g. industrial licensing

system, price control or financial control on goods,

import license, foreign exchange control,restriction on investment by big business houses,

etc.

These controls leads to fall in economy growth.

Economic reforms were based on the assumptionthat market forces could guide the economy in a

more effective manner than government control.


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Abolition of industrial licensing and Registration

with a few exceptions.

Freedom from Expansion and Production to

Industries Increase in the Investment Limit of the Small

Industries:

Freedom to import capital goods

Freedom to import technology


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Privatisation means allowing the private

sector to set up more and more of industries

that were previously reserved for public

sector.

It can take in three in forms:a. Change in ownership: Degree of privatisation

judged by the extent of ownership

transferred from public to private sector.

i) Public Private Partnershipii) Joint Venture


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It is defined as a process associated with

increasing openness, growing economic

independence and Deeping economic

integration in the world economy.

Reduction of trade barriers

Free flow of capital

Free flow of technology


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Reduction of import duties

Encouragement of foreigninvestment

Reducing custom duty

Devaluation of currencyPartial convertibility


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Financial Sector Reforms


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Major contours of the financial sector

reforms in India

Reduction in CRR and SLR in a phased manner

Deregulation of Interest Rate:

Fixing prudential Norms:

Introduction of CRAR:

Operational Autonomy

Banking Diversification


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New Generation Banks, thereby inducing competition

Improved Profitability and Efficiency:


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First Phase of Banking Sector Reforms

1)Reduction in SLR & CRR

2.) Deregulation of interest rates

3.) Transparent guidelines or norms for entry and exit of

private sector banks

4.) Public sector banks allowed for direct access to capital

markets

5.) Branch licensing policy has been liberalized

6.) Setting up of Debt Recovery Tribunals

7.) Asset classification and provisioning

8.) Income recognition

9. Asset Reconstruction Fund ARF


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Second Phase of Reforms measures

Merger of strong units of banks

Adaptation of the narrowbanking concept to

rehabilitate weak banks


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A NarrowBank in its narrow sense, can be defined as

the system of banking under which a bank places itsfunds in risk-free assets with maturity period matching

its liability maturity profile, so that there is no problem

relating to asset liability mismatch and the quality ofassets remains intact without leading to emergence of

sub-standard assets.


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What are advantages :

Such an approach can ensure the regular

deployment of funds in low risk liquid assets. With

such pattern of deployment of funds, these banks

are expected to remove the problems of bank

failures and the consequent systemic risks and loss

to depositors.


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What is status of narrow banking in India ?

The concept is practically being implemented by the

Indian banking system partly, as a large part of the

deposits mobilized (i.e. more than 46%) by the banks,

has been deployed in Govt. securities (against a

prescription of 25% in the form of SLR) as it provides a

safe avenue of investment but at a very low return. This

keeps the level of non-performing assets (rather than

advances) low and the requirement of capital adequacy

ratio also low, as the risk weight allotted to such

securities is only 2.5% compared to 100% in loan

assets

Financial Sector Reforms in India

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