Chapter 5

Financial Sector Reforms

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 To discuss the context, need ,objective, approach and
appraisal of Financial sector reform in India.

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 1991 Financial System Reform- The new economic policy of
structural adjustment and stabilisation programme

 Financial Reform – Economic liberalisation,marketisation,

privatisation , autonomy , flexibility , market discipline,
deregulation and globalisation

 Stringent prudential regulation in a deregulated environment

 Pre-financial reform Features –Control over pricing of financial

assets ,barriers to entry ,high transaction costs, politicised, poor
investor protection ,fragmented regulatory system
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 Broad Issues

 Financial sector reforms in developing economies are

increasingly oriented toward mechanisms to induce effective
market discipline

 Twin objectives of “maintaining price stability” and

“ensuring availability of adequate credit to productive sectors
of the economy to support growth”

 In developing countries the most favourable form of

Financial system is Intermediaries-based or Indirect or
Credit-based (rather than Capital market based or Direct or
Securitised prevailed in most developed countries)
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Initiation of Financial Reform -As per the recommendation of
Raghuram Rajan’s Committee on Financial Sector Reform

1. To develop a market-oriented, competitive, world-integrated ,

diversified ,autonomous, transparent financial system

2. To increase allocative efficiency of available savings

3. To increase or bring about the effectiveness, accountability,

professionalism, profitability, viability, vibrancy, balanced
growth, operational economy, depoliticisation and flexibility
in financial sector

4. To promote accelerated growth of the real sector

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 contd.

5. To increase the rate of return on real investment

6. To promote competition by creating level playing
field
7. To dismantle the administrative system of interest
rates
8. To improve the effectiveness of directed credit
programe
9. To modernise the instruments of monetary control

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 The reform have been introduced at a gradual pace
combined with :

 Systematic Policy Reform

 Banking Reform
 Primary and Secondary Market Reforms
 Government Securities Market Reform
 External Financial Market Reform

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 Improvements in efficiency of the banking system in terms
of the asset quality and productivity

 A gradual reduction in costs of intermediation

 Enhanced competition and efficiency in Banking sector

 High standard Risk management practices

 large investment inflows, both direct and portfolio

 Significant change in the composition of India's balance of

payments

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 contd.
 Management of liquidity through Liquidity Adjustment
Facility - provided liquidity to the market and imparted
stability to financial markets

 Growth in foreign exchange reserve

 Impact of interest costs on corporate sector profits have turned

positive

 Introduced policy decentralisation in Indian financial system

as an answer to both private oligopoly and state monopoly

 reforms in the Government securities market enabled better

monetary management from the second half of the 1990s
onwards

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 contd.

 There are some negative observation with respect to financial

sector reform :

1. Little improvement in deficit/GDP ratio

2. Depreciation in exchange rate
3. Vulnerability to external shocks
4. Inefficient credit delivery system

 Major reasons of post-reform deficiencies:

1. Global economic slow down

2. Downward spiral in global assets markets
3. Uncertainty in global oil-market
4. Severe draught in 2002
5. Rigidities in fiscal structure

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 to enforce honest and prudent behaviour through self-
policing arrangement
 regulatory policies that minimize interference with the
functioning of the market

 Self-regulatory organizations (SROs) responsibilities

could encompass:

 regulation of market transactions

 regulation of market participants
 disputes resolution and enforcement actions
 pre-commitment of resources
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 contd.

 Limitations of financial self-regulation :

 SROs might transform themselves into cartels and jeopardize

competition

 Short-term tensions between the managers and the authorities

responsible for SROs either discourage participation or diminish
long-term confidence in the market

 Scarcity of institutional and human resources

 Lack of reasonably homogenous institutions for a balanced
structures within SROs

 With limited competition in securities markets, self-regulation

may not be enough to ensure safe and efficient markets

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 Helps a country to attain a high quality growth in a sustained
way by addressing issues of equity, social justice and
participation

 The second generation of reform in the Indian Financial

markets :

 Strengthening the oversight & risk management capacity of the

regulators
 Advancing discloser standards
 Faster trade reform
 Rationalisation of taxation
 Public sector disinvestment
 Restructuring of public expenditure
 Expanding investor education
 Supporting insurance and pension reform
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 A few broad challenges facing the Indian financial
sector are:

 threats of risks from globalisation

 implementation of Basel II
 improvement of risk management systems
 implementation of new accounting standards
 enhancement of transparency and disclosures
 enhancement of investor service
 application of technology and improvement of key
financial infrastructure
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 contd.
 convergence of prudential norms with international
best practices
 consistent refinement of the institutional framework
in the financial sector
 the reliance on the market to assess the critical
information describing the risk profile, capital
structure and capital adequacy
 the transition from capital adequacy to capital
efficiency
 enterprise-wide risk management system in Banks
 corporate governance in and across financial system
 focus on greater financial inclusion
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 contd.

 to attract vast sections of population, in particular

pensioners, self-employed and those employed in
unorganised sector
 absence of well-developed derivatives market
 financial education and Financial literacy as a matter
of public policy
 greater market discipline and investor confidence
 underdeveloped corporate bond market
 transition for Fuller Capital Account Convertibility
 the synchronisation of pace of financial sector
deregulation with sectoral and fiscal reforms.
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