Madhavi Gaur
August 01, 2023 10:20
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Banking Sector Acts and Reforms: The transformation of India’s banking sector has been significantly influenced by a series of crucial reforms and acts aimed at aligning the industry with global standards. These reforms encompass a wide range of measures, including liberalization, deregulation, privatization, and technological advancements. Reforms initiated by the Narasimham Committee in the 1990s, such as enhanced capital adequacy norms and risk-based supervision, have played a pivotal role in reshaping the banking landscape. Additionally, the implementation of Basel Norms has bolstered the banking system’s resilience and risk management practices, ensuring a more stable and efficient sector.
The integration of technology-driven initiatives like core banking solutions, electronic fund transfers, and digital payment systems has been instrumental in promoting financial inclusion and streamlining banking operations. Schemes such as the Pradhan Mantri Jan Dhan Yojana and the Insolvency and Bankruptcy Code have also contributed to expanding access to financial services and resolving non-performing assets, further reinforcing the robustness of the banking sector. These reforms have collectively fostered a more competitive, transparent, and customer-centric banking industry, thereby significantly contributing to India’s economic growth and financial stability.
1. Reserve Bank of India Act, 1934: The RBI Act establishes the Reserve Bank of India as India’s central banking institution. It defines the objectives and functions of the RBI, such as controlling monetary policy, issuing and managing currency, regulating the banking system, and managing foreign exchange reserves. The act grants the RBI the authority to issue directives and guidelines to banks and financial institutions.
2. Banking Regulation Act, 1949: An important legislation, the Banking Regulation Act, regulates and supervises the banking sector in India. It empowers the Reserve Bank of India (RBI) to regulate banks and their operations. The act defines the powers and functions of the RBI, licensing of banks, provisions for capital requirements, and regulations related to the management and administration of banks. Additionally, it establishes the Deposit Insurance and Credit Guarantee Corporation (DICGC) to insure bank deposits.
3. Negotiable Instruments Act, 1881: The Negotiable Instruments Act provides a legal framework for negotiable instruments such as promissory notes, bills of exchange, and cheques. It governs the transferability, rights, and liabilities of parties involved and rules for their discharge and enforcement. This act is particularly important for the banking sector as cheques are widely used as a means of payment and settlement.
4. Prevention of Money Laundering Act, 2002: To combat money laundering and the financing of terrorism, the Prevention of Money Laundering Act (PMLA) was enacted. It establishes the Financial Intelligence Unit (FIU) as the central agency for receiving, analyzing, and disseminating information related to suspicious transactions. The act imposes obligations on banks and financial institutions to maintain records, report transactions, and verify customer identities.
5. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002: The SARFAESI Act provides a legal framework for the securitization and reconstruction of financial assets and the enforcement of security interests. It empowers banks to take possession of and sell assets of defaulting borrowers to recover outstanding dues without court intervention. This act grants banks the authority to issue notices, take possession of secured assets, and enforce security interests.
6. Insolvency and Bankruptcy Code (IBC), 2016: The IBC is a comprehensive legislation addressing insolvency and bankruptcy proceedings for individuals, partnership firms, and corporate entities. It aims to provide a time-bound and efficient resolution process for stressed assets. The IBC establishes the Insolvency and Bankruptcy Board of India (IBBI) to regulate insolvency professionals and entities involved in insolvency proceedings.
7. Foreign Exchange Management Act (FEMA), 1999: FEMA is a crucial act governing foreign exchange transactions, external trade, and payments in India. Replacing the earlier Foreign Exchange Regulation Act (FERA), FEMA empowers the RBI to regulate and control foreign exchange transactions, capital flows, and external borrowings. It also governs foreign direct investment (FDI) and overseas direct investment (ODI) in India.
Banking sector reforms in India encompass a series of initiatives and measures undertaken by the government and regulatory authorities to fortify and enhance the functioning of the country’s banking industry. The overarching goal of these reforms is to instill transparency, efficiency, and stability in the sector while fostering financial inclusion and ensuring adequate credit availability for economic growth. Several key elements characterize the banking sector reforms in India, each contributing to the sector’s advancement and resilience.
Liberalization: In the 1990s, the reforms commenced with the liberalization of the Indian economy, which involved reducing government control and opening up the sector to private and foreign banks. This move aimed to promote competition and diversity in the banking landscape.
Capital Adequacy: The adoption of the Basel norms, specifically Basel I, II, and III, sought to enhance the capital adequacy of banks. These norms mandated that banks maintain a minimum level of capital to absorb potential losses and ensure financial stability.
Asset Quality: Addressing the issue of non-performing assets (NPAs) or bad loans was a critical aspect of the reforms. The introduction of the Insolvency and Bankruptcy Code (IBC) expedited the resolution of stressed assets and improved recovery mechanisms.
Governance and Risk Management: Reforms focused on strengthening corporate governance practices in banks, emphasizing transparency, accountability, and effective risk management. The establishment of the Banking Codes and Standards Board of India (BCSBI) bolstered customer protection.
Financial Inclusion: Initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY) aimed to achieve financial inclusion by providing unbanked segments of society access to banking services. The promotion of technology-driven solutions, such as mobile banking and digital payments, further enhanced financial access.
Regulatory Framework: The Reserve Bank of India (RBI) played a pivotal role in implementing banking sector reforms. It introduced various regulations and guidelines to strengthen prudential norms, risk management practices, and bank supervision.
Merger and Consolidation: Encouraging the merger and consolidation of public sector banks was another significant aspect of the reforms. This strategy aimed to create stronger and more efficient banks, enhancing operational efficiency, reducing costs, and meeting capital requirements more effectively.
Financial Technology (FinTech) and Innovation: The reforms also emphasized the adoption of financial technology and digital innovation. This included the development of payment systems, support for fintech startups, and the establishment of regulatory sandboxes to encourage experimentation and nurture innovation.
The banking acts and reforms have been instrumental in shaping a resilient and dynamic banking sector in India, fostering economic growth and financial stability in the country.
List of important Banking Sector Acts |
|
|---|---|
| Banking Sector Act | Year |
| Reserve Bank of India Act | 1934 |
| Banking Regulation Act | 1949 |
| Negotiable Instruments Act, 1881 | 1881 |
| Prevention of Money Laundering Act | 2002 |
| Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act | 2002 |
| Insolvency and Bankruptcy Code (IBC) | 2016 |
| Foreign Exchange Management Act (FEMA) | 1999 |
India has undergone significant transformations in its banking sector, spearheaded by a series of comprehensive reforms since 1991. The country recognized the need to modernize its banking system, align it with global standards, and promote financial stability and inclusion. To achieve these objectives, various committees were formed to recommend measures and suggest reforms that would bolster the efficiency and transparency of the banking sector.
These reforms have played a crucial role in shaping India’s banking landscape, ushering in a new era of growth and progress. Check out the table below to know all the important banking sector reform since 1991:
List of Banking Sector Reforms Since 1991 |
||
|---|---|---|
| Committee | Headed By | Key Recommendations |
| Narsimha Committee I | M. Narasimham | – Strengthen banking system |
| – Reduce government interference | ||
| – Increase RBI’s supervisory role | ||
| – Enhance transparency | ||
| Narsimha Committee II | M. Narasimham | – Review progress of reforms |
| – Emphasize structural reforms | ||
| – Consolidate banking sector | ||
| H. Khan Committee | R. H. Khan | – Improve credit delivery to small-scale sector |
| – Enhance functioning of primary dealers | ||
| Raghuram Rajan Committee | Raghuram Rajan | – Strengthen banking system |
| – Enhance financial inclusion | ||
| FSLRC | Justice B. N. Srikrishna | – Restructure legal and regulatory framework of financial sector |
| PJ Nayak Committee | P. J. Nayak | – Examine governance of PSBs |
| – Strengthen board’s role | ||
| Nachiket Mor Committee | Nachiket Mor | – Increase financial inclusion |
| – Establish payment banks and small finance banks | ||
| Indradhanush Framework | Government of India | – Improve efficiency, transparency, and governance of PSBs |
| – Strengthen banks’ balance sheets | ||
| HR Khan Committee | H. R. Khan | – Examine existing framework for monetary policy |
| 4R Framework | Government of India | – Address issue of bad loans |
| – Strengthen banks’ resilience | ||
| EASE Framework | Government of India | – Strengthen governance of PSBs |
| – Promote financial inclusion | ||
| – Enhance customer responsiveness | ||
| – Evaluate banks’ responsible banking practices | ||
| Bimal Jalan Committee | Bimal Jalan | – Review RBI’s economic capital framework |
| – Transfer portion of surplus reserves to government | ||
| – Revise framework for RBI’s capital requirements | ||
Banking sector reforms in India have been instrumental in transforming the country’s banking industry and bringing it in line with global standards. These reforms have encompassed a wide range of measures, including liberalization, deregulation, privatization, and technological advancements. The primary goal of these reforms has been to enhance the efficiency, transparency, and stability of the banking system and promote financial inclusion.
Over the years, several committees were formed to recommend measures and suggest reforms to strengthen the banking sector. Let’s delve into the key committees and their significant recommendations:
1. Narsimham Committee I (1991):
Headed by M. Narasimham, former RBI Governor, this committee suggested measures to strengthen the banking system. The recommendations included reducing government interference, increasing the role of the RBI in supervising banks, and enhancing transparency. The committee also proposed reducing the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) to improve banks’ liquidity. Additionally, it emphasized the need for the recapitalization of weak banks, strengthening bank management, and introducing prudential norms.
2. R. H. Khan Committee (1997):
Chaired by R. H. Khan, former Deputy Governor of the RBI, this committee examined the effectiveness of the financial system for the small-scale sector and the role of primary dealers. It made recommendations to improve credit delivery to the small-scale sector and enhance the functioning of primary dealers.
3. Narsimham Committee II (1998):
Following up on Narsimham Committee I, this committee focused on reviewing the progress of reforms. It emphasized the need for structural reforms, consolidation of the banking sector, and the establishment of strong and autonomous regulatory bodies. The committee recommended reducing the government’s stake in public sector banks (PSBs) to less than 33% and enhancing corporate governance standards in PSBs. Moreover, the committee suggested the adoption of international accounting standards and the introduction of risk-based supervision.
4. Raghuram Rajan Committee (2008):
Chaired by Raghuram Rajan, former Chief Economist of the IMF, this committee was appointed to examine financial sector reforms in India. It provided recommendations to strengthen the banking system, enhance financial inclusion, and promote financial stability.
5. Financial Sector Legislative Reforms Commission (FSLRC) (2011):
Headed by Justice B. N. Srikrishna, the FSLRC aimed to review and restructure the legal and regulatory framework of the financial sector in India. It aimed to consolidate and streamline the laws governing the financial sector, including banking, insurance, securities, and pensions.
6. PJ Nayak Committee (2014):
Led by P. J. Nayak, this committee examined the governance of PSBs. It highlighted the need for reforms in the governance structure, such as strengthening the board’s role, empowering bank management, and professionalizing the appointment process of top executives. The committee recommended reducing government interference and advocated for a greater role of the board in key decisions, including appointments and capital allocation.
7. Nachiket Mor Committee (2014):
This committee, chaired by Nachiket Mor, was formed to examine comprehensive financial services for small businesses and low-income households. It recommended measures to increase financial inclusion, such as establishing payment banks, small finance banks, and the creation of a universal electronic bank account (Jan Dhan Yojana). The concept of “payment banks” was proposed to provide basic banking services, including payments and remittances, to underserved sections of society.
8. Indradhanush Framework:
The Indradhanush framework, introduced in 2015 by the Government of India, aimed to revitalize and reform PSBs in the country. The framework focused on seven pillars to address key areas of banking sector reforms, including appointments, Bank Board Bureau (BBB), capitalization, de-stressing, empowerment, a framework of accountability, and governance reforms. This framework sought to improve the efficiency, transparency, and governance of PSBs, thereby strengthening their ability to support economic growth.
9. HR Khan Committee (2015):
Led by H. R. Khan, former Deputy Governor of the RBI, this committee examined the existing framework for monetary policy in India. It made recommendations on issues such as inflation targeting, monetary policy transmission, and improving the decision-making process of the RBI’s Monetary Policy Committee (MPC).
10. 4R Framework (Recognition, Recapitalization, Resolution, and Reforms):
Introduced in 2017, the 4R framework was part of the government’s strategy to address the issue of mounting bad loans in the banking system. It focused on recognizing stressed assets as non-performing assets (NPAs) promptly, recapitalizing banks to improve their financial health, establishing mechanisms for the timely resolution of stressed assets, and undertaking structural reforms to improve the governance, risk management, and operational efficiency of banks.
These reforms have played a pivotal role in fostering a more competitive, transparent, and customer-centric banking sector in India. They have contributed significantly to the country’s economic growth and financial stability, and remain crucial for UPSC aspirants to understand as they prepare for the examination.
Important Banking Terms You Must Know in 2023
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