Financial reforms related to Indian economics:

1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR):
An important financial reform has been the reduction in Statutory Liquidity Ratio (SLR) and Cash
Reserve Ratio (CRR) so that more bank credit is made available to the industry, trade and
agriculture. The statutory liquidity ratio (SLR) which was as high as 39 per cent of deposits with
the banks has been reduced in a phased manner to 25 per cent.

It may be noted that under statutory liquidity ratio banks are required to maintain a minimum
amount of liquid assets such as government securities and gold reserves of not less than 25 per
cent of their total liabilities. In 2008, statutory liquidity ratio was reduced to 24 per cent by RBI.

Similarly, cash reserve ratio (CRR) which was 15 per cent was reduced over phases to 4.5 per cent
in June 2003. It may be noted that reduction in CRR has been possible with reduction of monetized
budget deficit of the government and doing away with the automatic system of financing
government’s budget deficit through the practice of issuing ad hoc treasury bills to the Central
Government.

On the other hand, reduction in Statutory Liquidity Ratio (SLR) has been possible because efforts
have been made by government to reduce fiscal deficit and therefore its borrowing requirements.
Besides, reduction in SLR has become possible because of a shift to payment of market-related
rates of interest on government securities.

Since the government securities are free from any risk and now bear market-related interest rates,
the banks may themselves feel inclined to invest their surplus funds in these securities, especially
when demand for credit by the industry and trade is not adequate.

The reduction in CRR and SLR has made available more lendable resources for industry, trade
and agriculture. Reductions in CRR and SLR also made possible for Reserve Bank of India to use
open market operations and changes in bank rate as tools of monetary policy to achieve the
objectives of economic growth, price stability and exchange rate stability.
Thus, Dr. C. Rangarajan, the former Governor of Reserve Bank of India, says, “As we move away
from automatic monetisation of deficits, monetary policy will come into own. The regulation of
money and credit will be determined by the overall perception of the Central monetary authority
on what appropriate level of expansion of money and credit should be depending on how the real
factors in the economy are evolving”.

2. End of Administered Interest Rate Regime:

A basic weakness of the Indian financial system was that interest rates were administered by the
Reserve Bank/Government. In the case of commercial banks, both deposit rates and lending rates
were regulated by Reserve Bank of India. Before 1993, rate of interest on Government Securities
could be maintained at low levels through the means of high Statutory Liquidity Ratio (SLR).
The structure of administered rates has been almost totally done away with in a phased manner.
RBI no longer prescribes interest rates on fixed or time deposits paid by their banks to their
depositors. Banks have also been freed from any prescribed conditions of premature withdrawal
by depositors. Individual banks are free to determine their conditions for premature withdrawal.
Currently, there is prescribed rate of 3.5 per cent for Savings Bank Accounts.

Note that Savings Bank Account are actually used by the individuals as current account even with
cheque-book facility. Since the banks’ cost of servicing these accounts is high, rate of interest on
them is bound to be low. Besides, there is lower interest rate ceilings prescribed for foreign
currency denominated deposits from non-resident Indians (NRI). Such a lower prescribed ceiling
is required for managing external capital flows, especially short-term capital flows, till we switch
over to liberalisation of capital account.

Lending rates of interest for different categories which were earlier regulated have been gradually
deregulated. However, RBI insists upon transparency in this regard. Each bank is required to
announce prime lending rates (PLRs) and the maximum spread it charges. Maximum spread refers
to the difference between the lending rate and bank’s cost of funds.
Interest on smaller loans up to Rs. 2,00,000 are regulated at concessional rates of interest. At
present, the interest rate on these smaller loans should not exceed the prime lending rates. Besides,
lending interest rates for exports are also prescribed and are linked to the period of availment.
Changes in prescribed interest rates for exports have been often used as an instrument to influence
repatriation of export proceeds.
Thus, except prescribed lending rates for exports and small loans up to Rs. 2, 00,000, the lending
rates have been freed from control. Banks can now fix their lending rates as per their risk reward
perception of borrowers and purposes for which bank loans are sought.

3. Prudential Norms: High Capital Adequacy Ratio:

In order to ensure that financial system operates on sound and competitive basis, prudential norms,
especially with regard to capital-adequacy ratio, have been gradually introduced to meet the
international standards. Capital adequacy norm refers to the ratio of paid-up capital and reserves
to deposits of banks. The capital base of Indian banks has been very much lower by international
standards and in fact declined over time.

As a part of financial sector reforms, capital adequacy norm of 8 per cent based on risk-weighted
asset ratio system has been introduced in India. Indian banks which have branches abroad were
required to achieve this capital-adequacy norm by March 31, 1994. Foreign banks operating in
India had to achieve this norm by March 31, 1993.

Other Indian banks had to achieve this capital adequacy norm of 8 per cent latest by March 31,
1996. Banks were advised by RBI to review their existing level of capital funds as compared to
the prescribed capital adequacy norm and take steps to increase their capital base in a phased
manner to achieve the prescribed norm by the stipulated date.

It may be noted that Global Trust Bank (GTB), a private sector bank, whose operations had to be
stopped by RBI on July 24, 2004 had a capital adequacy ratio much below the prescribed prudent
capital adequacy ratio norm. In this regard, link between capital adequacy and provisioning is
worth noting. Capital adequacy norm can be met by the banks after ensuring that adequate capital
provisions have been made.

To achieve this capital adequacy norm, Government had come in to provide capital funds to some
nationalized banks. Some stronger public sector banks raised funds from the capital market by
selling their equity. Law was passed to enable the public sector banks to go to the capital markets
for raising funds to enhance their capital base. Banks can also use a part of their annual profits to
enhance their capital base (that is, ploughing back of retained earnings into investment).

4. Competitive Financial System:

After nationalization of 14 large banks in 1969, no bank had been allowed to be set up in the private
sector. While the importance and role of public sector banks in Indian financial system continued
to be emphasised, it was however recognized that there was urgent need for introducing greater
competition in the Indian money market which could lead to higher efficiency of the financial
system.

Accordingly, private sector banks such as HDFC, Corporation Bank, ICICI Bank, UTI Bank, IDBI
Bank and some others have been set up. Establishment of these banks has made substantial
contribution to housing finance, car loans and retail credit through credit card system. They have
made possible the wider use of what is often called plastic money, namely, ITM cards, Debit Cards,
and Credit Cards.

In addition to the setting up of private sector Indian banks, competition has also sought to be
promoted by permitting liberal entry of branches of foreign banks, therefore, CITI Bank, Standard
Chartered Bank, Bank of America, American Express, HSBC Bank have opened more branches
in India, especially in the metropolitan cities

An important recent step is the liberalisation of foreign direct investment in banks. In the budget
for 2003-04, the limit of foreign direct investment in banking companies was raised from 49 per
cent to the maximum 74 per cent of the paid up capital of the banks. However, this did not apply
to the wholly owned subsidiaries of foreign banks.

A foreign bank may operate in India through any one of three channels, namely:
(1) As branches of foreign banks,

(2) A wholly owned subsidiary of a foreign bank,

(3) A subsidiary with aggregate foreign investment up to the maximum of 74 per cent of the paid-
up capital.
The above measures are expected to facilitate setting up of subsidiaries by foreign banks. Besides
fostering competition among banks they have also increased transparency and disclosure standards
to reach the international standards. Banks have to submit to RBI and SEBI, the maturity pattern
of their assets and liabilities, movements in the provision account and about non-performing assets
(NPA).

RBI’s annual publication ‘Trends and Progress of Banking in India’ provides detailed information
on individual bank’s financial position, that is, their losses, assets, liabilities, NPA etc. which
enable public assessment of the working of the banks.

5. Non-Performing Assets (NPA) and Income Recognition Norm:

Non-performing assets of banks have been a big problem of commercial banks. Non-performing
assets mean bad loans, that is, loans which are difficult to recover. A large quantity of non-
performing assets also lowers the profitability of bank. In this regard, a norm of income recognition
introduced by RBI is worth mentioning. According to this, income on assets of a bank is not
recognized if it is not received within two quarters after the last date.

In order to improve the performance of commercial banks recovery management has been greatly
strengthened in recent years. Measures taken to reduce non-performing assets include restructuring
at the bank level, recovery of bad debt through Lok Adalats, Civil Courts, setting up of Recovery
Tribunals and compromise settlements. The recovery of bad debt got a great boost with the
enactment of ‘Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest’ (SARFAESI). Under this Act, Debt Recovery Tribunals have been set up which will
facilitate the recovery of bad debts by the banks.

As a result of the above measures gross NPA declined from Rs. 70,861 crores in 2001-02 to Rs.
68, 715 crores in 2002-03. But there are substantial amounts of non-performing assets whose
recovery is still to be made. Besides, as a result of introduction of risk-based supervision by RBI,
the ratio of gross NPA to gross advances of scheduled commercial banks declined from 12.7 per
cent in 1999-2000 to 8.8 per cent in 2002-03.

6. Elimination of Direct Credit Controls:

Another significant financial sector reform is the elimination of direct or selective credit controls.
Selective credit controls have been done way with. Under selective credit controls RBI used to
control through the system of changes in margin for provision of bank credit to traders against
stocks of sensitive commodities and to stock brokers against shares. As a result, there is now
greater freedom to both the banks and borrowers in respect of credit.

But it is worth mentioning that banks are required to observe the guidelines issued by RBI
regarding lending to priority sectors such as small scale industries and agriculture. The advances
eligible for priority sectors lending have been increased at deregulated interest rates.

This is in accordance with the recognition that the main problem is more of availability of credit
than the cost of credit. In June 2004 UPA Government announced that credit to farmers for
agriculture will be available at 2 per cent below PLR of banks. Further, credit for agriculture will
be doubled in three years time.

7. Promoting Micro-Finance to Increase Financial Inclusion:

To promote financial inclusion the government has started the scheme of micro finance. RBI
provides guidelines to banks for mainstreaming micro-credit providers and enhancing the outreach
of micro-credit providers inter alia stipulated that micro-credit extended by banks to individual
borrowers directly or through any intermediary would henceforth be reckoned as part of their
priority-sector lending. However, no particular model was prescribed for micro-finance and banks
have been extended freedom to formulate their own model(s) or choose any conduit/intermediary
for extending micro-credit.

Though there are different models for pursuing micro-finance, the Self-Help Group (SHG)-Bank
Linkage Programme has emerged as the major micro-finance programme in the country. It is being
implemented by commercial banks, regional rural banks (RRBs), and cooperative banks.

Under the SHG-Bank Linkage Programme, as on 31 March 2012, 79.60 lakh SHG-held savings
bank accounts with total savings of? 6,551 crore were in operation. By November 2012 another
2.14 lakh SHGs had come under the ambit of the programme, taking the cumulative number of
savings-linked groups to 81.74. As on 31 March 2012, 43.54 lakh SGHs had outstanding bank
loans of Rs. 36,340 crore (Table 35.1). During 2012-13 (up to November 2012), 3.67 lakh SHGs
were financed with an amount Rs. 6, 664.15 crore.

Extension of Swabhimaan Scheme:

Under the Swabhimaan financial inclusion campaign, over 74,000 habitations with population in
excess of 2,000 had been provided banking facilities by March 2012, using various models and
technologies including branchless banking through business correspondents (BCs).

The Finance Minister in his Budget Speech of 2012-13 had announced that Swabhimaan would be
extended to habitations with population more than 1,000 in the north-eastern and hilly states and
population more than 1,600 in the plains areas as per Census 2001.

Accordingly, about 45,000 such habitations had been identified for coverage under the extended
Swabhimaan campaign. As per the progress received through the conveners of State Level
Bankers’ Committee (SLBC), out of the identified habitations, 10,450 have been provided banking
facilities by end of December, 2012. This will extend the reach of banks to all habitations above a
threshold population.

8. Setting up of Rural Infrastructure Development Fund (RIDF):

The Government of India set up the RIDF in 1995 through contribution from commercial banks to
the extent of their shortfall in priority sector lending by banks with the objective of giving low cost
fund support to states and state-owned corporations for quick completion of ongoing projects
relating to medium and minor irrigation, soil conservation, watershed management, and other
forms of rural infrastructure.

The Fund has continued, with its corpus being announced every year in the Budget. Over the years,
coverage under the RIDF has been made more broad-based in each tranche and, at present, a wide
range of 31 activities under various sectors is being financed.

The annual allocation of funds for the RIDF announced in the Union Budget has gradually
increased from Rs. 2000 crore in 1995- 96 (RIDF 1) to Rs. 20,000 crore in 2012-13. Further, a
separate window was introduced in 2006-07 for funding the rural roads component of the Bharat
Nirman Programme with a cumulative allocation of Rs. 18,500 crore till 2009-10.

From inception of the RIDF in 1995-6 to March 2012, 462,229 projects have been sanctioned with
a sanctioned amount of Rs. 1, 43,230 crore. Of the cumulative RIDF loans sanctioned to state
governments, 42 per cent have gone to the agriculture and allied sector, including irrigation and
power; 15 per cent to health, education, and rural drinking water supply; while the share of rural
roads and bridges has been 31 per cent and 12 per cent, respectively. The annual allocation of
funds under the RIDF has gradually increased from Rs. 2,000 crore in 1995-6 (RIDF I) to Rs.
20,000 crore in 2012-13 (RIDF XVIII).

As against the total allocation of Rs. 1, 72,500 crore, encompassing RIDFI to XVIII, sanctions
aggregating Rs. 1, 51,154 crore have been accorded to various state governments and an amount
of Rs. 1, 00,051 crore disbursed up to the end of November 2012. Nearly 55 per cent of allocation
has been made to southern and northern regions. The National Rural Roads Development Agency
(NRRDA) has disbursed the entire amount of Rs. 18,500 crore sanctioned for it (under RIDF XII-
XV) by March 2010. During 2012-13 (up to end November 2012), Rs. 5,829 crore was disbursed
to the states under the RIDF (Table 35.2).
Pension Reforms:
Since October 2003, a New Pension Scheme (NPS) was introduced by the Central Government
for its employees. Later many States have also joined the scheme for their employees. The New
Pension Scheme is a contributory retirement scheme.

All employees joining Central Government after January 1, 2004 have to join the scheme and
contribute to it to obtain pension after their retirement. Later many states have also joined the
scheme for their employees. It is now also open to private individuals and eight fund managers
manage the scheme.

The pension authority was named as Pension Fund Regulatory and Development (PFRDA). Till
September 2013, this pension authority has been functioning under executive authority since
October 2003. Now in September 2013, the Indian Parliament passed the Pension Fund Regulatory
Development Authority Bill, eight years after it was introduced in March 2005. This bill seeks to
empower PFRDA to regulate the pension scheme (NPS).

The corpus of PFRDA has Rs. 34,965 crore. NPS has been there with us for nine years and to
manage such a large amount of Rs. 35,000 crore was not good to be managed by a non-statutory
authority. It should be managed by a statutory authority. All that this new legislation does is to
make the non-statutory authority a statutory authority.

The legislation regarding Pension Fund Regulatory and Development Authority passed by the
Parliament is an important financial reform that will pave the way for foreign investment in the
sector. At present the new pension scheme has about 5.3 million subscribers and the scheme has a
corpus of around Rs. 35,000 crore.

The Finance Minister has clarified that foreign investment in the pension sector will be 26% and
linked to that in the insurance sector. The government has already approved 49% foreign
investment in the insurance sector.

“I am confident that the Pension Bill will be passed in Rajya Sabha,” Chidambaram said adding
that the government had accepted all but one suggestion of the Standing Committee on Finance
that gave its recommendations on the Bill in August 2011. The PFRDA will notify New Pension
System schemes that provide minimum assured returns, incorporated after the standing committee
suggested some sort of guaranteed returns.

The NPS will also provide for withdrawal for some limited purposes, which was not the case
earlier. The reform will go a long way in increasing the coverage of formal pension and social
security plans in India, where only about 12% of the active workforce has any formal pension or
social security plan.

The opening of the pension sector, even at 26%, will encourage foreign investors to put their
money, as India has a huge population that needs social security cover. We do not have much
pension products now but once there are more players, there will be more products which will help
to channelize this pension money into the economy. The Bill will further empower the PFRDA to
regulate the NPS and other pension schemes that are not covered under any Act.