S.

S Jain Subodh Law College, Jaipur

Affiliated to

Dr. Bhimrao Ambedkar Law University

Session 2024-25

Banking Sector Reforms [1991]

Submitted by: Aarya soni Submitted to: Ms. Khushbu Rathore

Subject:Economics-III Assistant professor

Semester: V Economics

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 DECLARATION BY THE STUDENT

I hereby declare that the work reported in this project entitled “Banking Sector Reforms
[1991]” submitted to the S. S. Jain Subodh Law College, Jaipur is an authentic record of
my work carried out under the supervision of Asst. Prof.Ms. Khushbu Rathore. It is further
certified that there is no plagiarism in this work. I further attest that I am fully responsible for
its content.

(Signature of the Scholar)

Name: Aarya soni

Place: Jaipur, Rajasthan

Date:

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 SUPERVISOR’S CERTIFICATE

This is to certify that the work reported in the project entitled, “Banking Sector Reforms
[1991]”, submitted by Aarya Soni to the S. S. Jain Subodh Law College, Jaipur is a bona
fide record of her original work carried out under my supervision. It is further certified there
is no plagiarism in it. This work is being recommended for further evaluation by the external
examiner.

Place: Jaipur, Rajasthan (Signature of the Supervisor)

Date:

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 Acknowledgement

In successfully completing this project, many people have helped me. I would like to thank
all those who are related to this project.
Primarily, I would like thank God for being able to complete this project with success.
Then I will thank my principle and Political Science teacher, under whose guidance I learned
a lot about this project. Her suggestions and directions have helped in the completion of this
project.
Finally, I would like to thank my parents and friends who have helped me with their valuable
suggestions and guidance and have been very helpful in various stages of project completion.

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 Abstract

The banking sector reforms of 1991 in India marked a significant turning point in the
country's financial landscape. These reforms were initiated in response to a severe balance of
payments crisis and aimed at revitalizing the banking sector to promote efficiency,
competitiveness, and financial stability. The Narasimham Committee, constituted in 1991,
played a pivotal role in shaping these reforms, recommending sweeping changes to address
the inefficiencies in the banking system.

The reforms focused on several key areas: liberalization, regulation, and strengthening the
financial health of banks. Measures included reducing the statutory liquidity ratio (SLR) and
the cash reserve ratio (CRR), which provided banks with more flexibility and encouraged
lending to productive sectors. Additionally, the introduction of prudential norms, such as
capital adequacy requirements and asset classification, improved the risk management
practices of banks. These steps were complemented by measures to enhance the operational
autonomy of public sector banks, including a move towards market-determined interest rates
and the reduction of government control in decision-making processes.

Furthermore, the reforms opened the banking sector to greater competition by allowing new
private sector banks and facilitating the entry of foreign banks. This resulted in improved
customer services, the adoption of technology, and a broader range of financial products and
services. The liberalization of the banking sector also aimed to attract foreign investment,
contributing to the modernization of the banking infrastructure and practices.

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 TABLE OF CONTENTS

Sr.no Title Pg.no

1. Declaration by student 2.

2. Supervisor certificate 3.

3. Acknowledgement 4.

4. Abstract 5.

5. Table of content 6.

6. Chapter 1 7-8

7. Chapter 2 9-12

8. Chapter 3 13-15

9. Chapter 4 16-17

10. Chapter 5 18-19

11. Conclusion 20.

12. Bibliography 21

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 CHAPTER 1

INTRODUCTION

The 1991 banking sector reforms in India marked a significant shift in the country’s
economic and financial policies. These reforms were a response to a severe economic crisis
that India faced at the beginning of the 1990s, characterized by a high fiscal deficit, rising
inflation, and a critical balance of payments situation. The reforms aimed to revitalize the
banking sector to ensure it could play a crucial role in the country’s economic development,
enhance financial stability, and promote a more efficient, competitive, and market-oriented
financial system.

 Background of the Indian Banking Sector

Before the 1991 reforms, the Indian banking sector was predominantly controlled by the
public sector. Following two waves of nationalization in 1969 and 1980, public sector
banks (PSBs) accounted for more than 90% of the banking assets. These banks were
tasked with furthering the government's social and developmental objectives, such as
providing credit to priority sectors, including agriculture and small industries, and
expanding banking services to rural areas. However, this focus on social objectives often
came at the cost of efficiency and profitability. Banks were heavily regulated, and interest
rates were controlled, which led to suboptimal allocation of resources. Additionally, the
high statutory pre-emption in the form of a Statutory Liquidity Ratio (SLR) and Cash
Reserve Ratio (CRR) severely limited the funds available for commercial lending.

The economic environment of the late 1980s further strained the banking sector. India was
experiencing a macroeconomic crisis, characterized by a growing fiscal deficit, high inflation
rates, and an unsustainable current account deficit. The Gulf War in 1990 exacerbated these
problems by causing a spike in oil prices, which depleted India's foreign exchange reserves to
dangerously low levels. The country was on the brink of defaulting on its external debt
obligations, leading to a loss of investor confidence. These economic challenges underscored
the urgent need for comprehensive structural reforms, including in the banking sector.

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 Need for Reforms

The 1991 economic crisis exposed the underlying structural weaknesses of the Indian
economy, including an inefficient and poorly capitalized banking sector. The crisis
highlighted the need for a robust financial system that could effectively mobilize savings,
allocate resources, and support sustainable economic growth. The banking sector, in
particular, required reforms to address the issues of low productivity, high non-
performing assets (NPAs), and weak capital bases. It became evident that a sound,
competitive, and efficient banking system was essential to stabilize the economy, attract
foreign investment, and integrate with the global financial system.

 Objectives of the Reforms

The primary objectives of the 1991 banking sector reforms were to enhance efficiency,
promote competitiveness, and ensure financial stability. Enhancing efficiency involved
reducing the high levels of NPAs through better credit appraisal and risk management
practices, adopting international norms for asset classification and provisioning, and
introducing capital adequacy requirements to ensure banks had sufficient capital to absorb
losses.

Promoting competitiveness was another key objective. The reforms aimed to reduce the
dominance of PSBs by allowing new private sector banks to enter the market and
encouraging foreign banks to establish operations in India. This increased competition
was expected to improve customer service, drive innovation, and reduce the cost of
financial intermediation.

Ensuring financial stability was also a critical goal of the reforms. Strengthening the
regulatory framework, enhancing the supervisory role of the Reserve Bank of India
(RBI), and promoting greater transparency and accountability in the banking sector were
crucial steps taken to safeguard the financial system's integrity and maintain public
confidence.

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 CHAPTER 2

Narasimham Committee and Reform Recommendations

The Narasimham Committee, established in 1991, played a critical role in shaping the
direction of banking sector reforms in India. The committee's recommendations laid the
groundwork for the transformation of the Indian banking sector, addressing the inefficiencies
and structural weaknesses that were evident in the wake of the 1991 economic crisis. This
chapter provides an overview of the formation of the Narasimham Committee, its key
recommendations, and the implementation of these reforms.

 Formation of the Narasimham Committee

In response to the severe economic crisis of 1991, the Government of India recognized
the need for comprehensive reforms across various sectors, including banking. To address
the specific issues plaguing the banking sector, the government established the
Narasimham Committee in August 1991, under the chairmanship of M. Narasimham, a
former Governor of the Reserve Bank of India (RBI). The committee was tasked with
examining the state of the financial system, identifying key challenges, and
recommending measures to improve the efficiency, competitiveness, and stability of the
banking sector. The Narasimham Committee was pivotal in advocating a shift from a
heavily regulated and state-controlled banking environment to a more market-oriented
and competitive system.

 Key Recommendations of the Narasimham Committee

The Narasimham Committee made several landmark recommendations that aimed to

overhaul the Indian banking sector. These recommendations can be categorized into
several key areas:

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 Prudential Norms and Regulation

One of the most significant recommendations was the introduction of prudential norms to
enhance the soundness and stability of banks. The committee suggested adopting
internationally accepted norms for income recognition, asset classification, and
provisioning for non-performing assets (NPAs). This move aimed to ensure that banks
maintained a minimum capital adequacy ratio (CAR) of 8%, aligning with the Basel I
norms. The introduction of these norms was crucial for improving the risk management
practices of banks and ensuring they had sufficient capital buffers to absorb potential
losses.

 Reduction in Statutory Pre-emptions

The committee recommended reducing the high levels of statutory pre-emptions,

specifically the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). At that
time, the SLR and CRR were among the highest globally, restricting banks' ability to lend
and invest in productive sectors. The committee suggested gradually reducing the SLR to
25% and the CRR to 10%, which would provide banks with greater liquidity and
flexibility to allocate resources more efficiently and support economic growth.

 Autonomy and Operational Efficiency

To enhance the autonomy and operational efficiency of public sector banks (PSBs), the
Narasimham Committee recommended measures to reduce government interference in
the management and functioning of banks. It proposed that PSBs be granted greater
autonomy in decision-making, particularly in matters related to lending, interest rates, and
branch expansion. The committee also suggested that the government reduce its equity
stake in PSBs to 33%, allowing banks to raise capital from the market and reducing
political interference in their operations.

 Strengthening the Supervisory Framework

The committee emphasized the need to strengthen the supervisory framework of the
banking sector. The committee emphasized the need to strengthen the supervisory
framework of the banking sector

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 It recommended enhancing the role of the Reserve Bank of India (RBI) as the central
regulator, with increased powers to oversee and regulate the banking sector effectively.
The committee also suggested the establishment of a Board for Financial Supervision
(BFS) under the aegis of the RBI to improve the quality of supervision and ensure
compliance with prudential norms.

 Promoting Competition and Diversification

To promote competition and diversification in the banking sector, the Narasimham

Committee recommended allowing the entry of new private sector banks and encouraging
the establishment of foreign banks in India. This was aimed at reducing the dominance of
public sector banks and fostering a more competitive environment that would drive
improvements in efficiency, customer service, and innovation. The committee also
suggested the development of a more diversified financial system, including the
promotion of non-banking financial companies (NBFCs) to complement the banking
sector.

 Implementation of the Recommendations

The implementation of the Narasimham Committee's recommendations began soon after the
report was submitted in November 1991. The government and the RBI initiated several
measures to operationalize the proposed reforms:

 Prudential Norms and Capital Adequacy:

The RBI introduced new prudential norms for income recognition, asset classification, and
provisioning for NPAs in 1992. Banks were required to maintain a minimum CAR of 8%,
which was gradually raised in subsequent years to align with international standards.

 Reduction in SLR and CRR:

The government gradually reduced the SLR and CRR, freeing up more funds for banks to
lend and invest in productive sectors. This helped increase the credit availability in the
economy and improved the overall efficiency of the banking sector.

 Enhancing Autonomy and Governance:

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The government took steps to enhance the autonomy of public sector banks by reducing its
direct control and influence over their operations. The RBI was given greater powers to
regulate and supervise banks, and the BFS was established in 1994 to strengthen the
supervisory framework.

 Promoting Competition:

The RBI allowed the entry of new private sector banks in 1993, marking a significant shift
towards a more competitive banking environment. The entry of foreign banks was also
liberalized, which brought in new technologies, products, and best practices, further
enhancing the efficiency and competitiveness of the Indian banking sector.

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 Chapter 3
Major Reforms Introduced

The banking sector reforms of 1991, driven by the recommendations of the Narasimham
Committee, marked a watershed moment in the history of India's financial system. These
reforms were aimed at addressing the structural weaknesses of the banking sector and
transforming it into a more competitive, efficient, and resilient system. This chapter provides
an in-depth overview of the major reforms introduced in the Indian banking sector post-1991
and their impact on the overall economy.

 Prudential Norms and Regulatory Reforms

One of the cornerstone reforms introduced in the wake of the 1991 crisis was the adoption
of prudential norms to strengthen the regulatory framework governing banks. The
Reserve Bank of India (RBI) introduced internationally recognized standards for income
recognition, asset classification, and provisioning for non-performing assets (NPAs).
These measures were aimed at improving transparency, enhancing risk management, and
ensuring that banks maintained a sound financial position.

 Introduction of Capital Adequacy Norms

The implementation of the capital adequacy ratio (CAR) based on the Basel I guidelines
was a significant reform. Banks were required to maintain a minimum CAR of 8%,
ensuring they had sufficient capital to absorb potential losses and protect depositors'
interests. This reform aimed to enhance the financial stability of banks and ensure that
they were better equipped to manage risks associated with their lending and investment
activities.

 Asset Quality and Provisioning

The introduction of stricter norms for asset classification and provisioning helped
improve the quality of bank assets. Banks were required to classify their assets into
standard, substandard, doubtful, and loss categories based on the repayment status of
borrowers. Additionally, they were mandated to set aside provisions for potential loan
losses, which helped in early identification and resolution of stressed assets..

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 Reduction in Statutory Pre-emptions

Prior to the 1991 reforms, Indian banks were heavily burdened by high statutory pre-
emptions in the form of the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio
(CRR). These requirements restricted banks' ability to lend freely and invest in productive
sectors, limiting their operational efficiency.

 Granting Greater Autonomy

To enhance the autonomy of PSBs, the reforms reduced the government’s interference in
their operational decisions, such as lending policies, branch expansion, and interest rate
determination. Banks were encouraged to operate on commercial lines and were given the
freedom to recruit personnel and determine compensation packages based on market
conditions. These measures were aimed at promoting a more professional approach to
banking management and decision-making.

 Focus on Professional Management and Governance

The reforms also sought to improve corporate governance in public sector banks by
introducing measures to professionalize their boards and management. The government
encouraged banks to induct experienced professionals from the private sector into their
management teams to bring in new skills and perspectives. These steps helped in reducing
political interference, enhancing accountability, and fostering a culture of performance
and efficiency.

 Liberalization and Increased Competition

To foster a more competitive and dynamic banking environment, the 1991 reforms
encouraged the entry of new private sector banks and allowed greater participation of foreign
banks.

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 Entry of New Private Sector Banks

The RBI allowed the establishment of new private sector banks in 1993, breaking the
monopoly of public sector banks and fostering a competitive environment. This move led
to the entry of several new private banks, such as HDFC Bank and ICICI Bank, which
introduced innovative products and services, leveraged technology for efficient
operations, and enhanced customer service standards.

 Increased Role of Foreign Banks

The reforms also liberalized the entry and operation of foreign banks in India. Foreign
banks brought in international best practices, new technologies, and innovative financial
products, which helped improve the overall quality of banking services in the country.
The increased competition from private and foreign banks pushed public sector banks to
improve their performance, adopt new technologies, and offer better customer service.

 Technological Advancements and Modernization

 Adoption of Core Banking Solutions

Banks began adopting core banking solutions (CBS), which enabled seamless integration
of various banking functions and provided customers with a unified and real-time banking
experience across branches. This technological upgrade helped reduce transaction costs,
improve customer service, and enhance data management and risk assessment
capabilities.

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 Chapter 4
Impact of the Reforms

The banking sector reforms initiated in 1991 had a profound impact on the Indian
financial system, significantly altering its structure, performance, and efficiency. These
reforms were pivotal in transforming the banking sector into a more resilient and
competitive component of the economy.

 Improved Financial Stability and Soundness

The introduction of prudential norms, including stricter asset classification and

provisioning standards, greatly enhanced the stability of the banking sector. By
mandating higher capital adequacy ratios in line with international standards, banks were
better equipped to absorb financial shocks and manage risks effectively. This shift helped
reduce the levels of non-performing assets (NPAs) over time, improving the overall
soundness of the banking system.

 Enhanced Efficiency and Competitiveness

The reduction in statutory pre-emptions, such as the Statutory Liquidity Ratio (SLR) and
Cash Reserve Ratio (CRR), provided banks with greater flexibility to lend more actively
and allocate resources more efficiently. The deregulation of interest rates further
contributed to a more competitive environment, fostering innovation in product offerings
and pricing strategies. The entry of new private sector banks and foreign banks
heightened competition, prompting public sector banks to improve their operational
efficiency, customer service, and technological adoption.

 Technological Advancement and Modernization

Reforms also spurred technological advancements in the banking sector. The adoption of
core banking solutions (CBS) and electronic payment systems, such as ATMs and
internet banking, modernized banking operations and enhanced customer convenience.
This digital transformation helped reduce transaction costs, improve service delivery, and
broaden financial inclusion by extending banking services to a larger segment of the
population.

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 Strengthened Regulatory and Supervisory Framework

The enhanced autonomy of the Reserve Bank of India (RBI) and the establishment of the
Board for Financial Supervision (BFS) strengthened the regulatory and supervisory
framework of the banking sector. This led to improved oversight, risk management, and
compliance practices, further reinforcing the stability and integrity of the financial
system.

Overall, the 1991 banking sector reforms were instrumental in fostering a more dynamic,
efficient, and resilient banking environment in India. They laid the foundation for
sustained economic growth by creating a robust financial system capable of supporting
the diverse needs of a rapidly expanding economy. The reforms not only addressed the
immediate challenges of the early 1990s but also set the stage for future growth .

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 Chapter 5
Subsequent Reforms and Developments

Following the landmark reforms of 1991, the Indian banking sector continued to evolve
through a series of subsequent reforms and developments aimed at further modernizing and
strengthening the financial system. These continued efforts were crucial in adapting to
emerging challenges and leveraging new opportunities in a dynamic economic environment.

 Base l II and Basel III Implementation

In the early 2000s, India adopted the Basel II framework, which introduced more
sophisticated risk management practices compared to Basel I. Basel II emphasized risk-
sensitive capital requirements, including credit risk, market risk, and operational risk, and
introduced the concept of the Supervisory Review Process (SRP) and Market Discipline.
Following this, Basel III norms were adopted starting in 2013 to address weaknesses
highlighted by the global financial crisis of 2008. Basel III introduced stricter capital
requirements, enhanced liquidity standards, and leverage ratios to ensure that banks are
better equipped to handle financial stress and shocks.

 Financial Sector Legislative Reforms

To enhance the legal and regulatory framework, several legislative changes were made.
The enactment of the Banking Regulation (Amendment) Act, 2002, provided greater
autonomy to the Reserve Bank of India (RBI) in regulating and supervising banks.
Additionally, the Sarfaesi Act, 2002, empowered banks to take possession of non-
performing assets (NPAs) and auction them off, improving recovery processes. The
Insolvency and Bankruptcy Code (IBC), introduced in 2016, further streamlined the
process of resolving distressed assets and insolvencies, enhancing the efficiency of the
credit market.

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 Expansion of Financial Inclusion and Digital Banking

In recent years, there has been a strong emphasis on financial inclusion and digital
banking. The introduction of the Pradhan Mantri Jan Dhan Yojana (PMJDY) aimed to
provide banking services to the unbanked population, significantly increasing the number
of bank accounts in the country. Simultaneously, digital banking initiatives, such as the
Unified Payments Interface (UPI) and digital wallets, have revolutionized payment
systems, making financial transactions more accessible and efficient for the masses.

 Strengthening Corporate Governance and Risk Management

Efforts to improve corporate governance and risk management practices have been
ongoing. The introduction of the Companies Act, 2013, and guidelines from the RBI and
other regulatory bodies aimed to enhance transparency, accountability, and governance
standards in banks and financial institutions. Enhanced risk management frameworks and
internal controls have been put in place to better manage operational, credit, and market
risks.

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 CONCLUSION

The banking sector reforms of 1991 represent a watershed moment in India's economic
history, marking a profound shift from a heavily regulated and inefficient financial system to
a more competitive, efficient, and globally integrated sector. These reforms were a critical
response to the severe economic crisis that India faced at the beginning of the 1990s,
characterized by high fiscal deficits, inflation, and a balance of payments crisis.

The introduction of prudential norms, such as capital adequacy requirements and stricter asset
classification, significantly strengthened the stability and soundness of the banking sector. By
reducing statutory pre-emptions like the Statutory Liquidity Ratio (SLR) and Cash Reserve
Ratio (CRR), banks gained greater operational flexibility, enabling them to better allocate
resources and support economic growth. The deregulation of interest rates fostered
competition, leading to improved financial products and services.

The Narasimham Committee's recommendations were pivotal in shaping these reforms,

emphasizing the need for a modernized banking environment characterized by increased
autonomy for public sector banks, enhanced risk management practices, and a more
competitive market structure. These changes not only addressed the immediate weaknesses
exposed by the economic crisis but also laid the groundwork for future growth and stability in
the banking sector.

Subsequent reforms, including the adoption of Basel II and Basel III norms, legislative
changes, and advancements in financial inclusion and digital banking, have further
strengthened and modernized the Indian banking system. These ongoing efforts have
improved the sector's resilience, operational efficiency, and ability to meet the diverse needs
of a growing economy.

In conclusion, the 1991 banking sector reforms were instrumental in transforming India's
financial landscape. They created a more robust, competitive, and globally integrated banking
system, capable of supporting sustained economic growth and effectively managing the
complexities of an evolving global financial environment.

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 Bibliography

 BOOKS

 M. Narasimham "India's Financial Sector: A Review"

 B. Mishra "The Indian Economy: Performances and Policies"

 WEB SOURCES

 https://www.rbi.org.in/
 https://www.rbi.org.in/
 https://www.business-standard.com/

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