ABM ECONOMIC REFORMS – PART 2
In this article, we will further discuss about the ABM Economic reforms in Banking sector for CAIIB Advanced Bank Management 2023.
This article is the continuation of our previous post of ‘Economic Reforms that have transpired in the Indian Banking Sector’. As the paper of Advanced Bank Management of CAIIB 2023 Exams will fall due in the month of June 2023, we keep on coming up with easy-to read & remember notes for the banking candidates. As we previously mentioned that as a banker you must know the kind of reforms the banking sector had gone through & the reasons for why they were required. So, keeping that in mind, we will begin our discussion of the same & then move on to the applicable Certified Associate of the Indian Institute of Bankers Exams ABM Study Material 2023!
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CAIIB | ABM ECONOMIC REFORMS – PART 2
In the previous post we understood that the Quantity wasn’t much of a concern in the idea of ‘progress in rural banking in India’ in comparison to the quality of rural banking services & the matter related to reforms has been mostly concerned with making it more be suitable for rural areas with tailor-made credit packages and providing the rural people technical guidance and marketing support.
Then we talked about:
- The history of Banking Sector Reforms in India in Pre Independence & Post Independence
- The Reasons behind the Banking Reforms in India:
- Structure of the Indian Banking System
- Various committees on whose recommendations the reforms took place.
- First phase of economic reforms: policy framework, institutional framework & financial health
Now, we will talk about:
SECOND PHASE OF ABM ECONOMIC REFORMS:
The second phase of reforms in the banking sector came with the strengthening the very establishment of the banking system. It happened in 3 ways:
- Reformation in the banking industry’s structure,
- up gradation in technology, and
- development of human resource.
Two types of banking regulations were formed: economic regulations and prudential regulations.
Before the reforms came into picture, RBI used to regulate the banks by imposing restrictions on interest rates, narrowing down the entry norms & by directing the lending to ensure judicious end use of bank credit. However, such economic regulation on banks affected their productivity & efficiency. Hence, the Reserve Bank of India came up with prudential regulation instead.
There was imposition of minimum limit on the capital level(s) of banks with the objective of maintaining the wealth of banks in particular and so that the reliability of the financial system in general can be ensured. It has allowed much greater scope for the market forces to freely play than what was previously permitted by economic regulations alone.
Prudential Norms were issued by RBI on the basis of Recommendations of the Committee (the 2nd Narasimhan Committee) on Banking Sector Reforms. The main objective behind the prudential norms was to ensure the financial safety, soundness and solvency of banks. These prudential norms are directed toward ensuring that the banks operate as prudent entities, remain free from undue risk-takings, and do not breach banking regulations in pursuit of their objective of profit.
The main focus of Prudential Reforms was in 3 areas:
- Capital adequacy
- Diversification of operations
Non-Performing Assets (NPAs):
In 1990’s the main problem which PSBs were facing was a high proportion of NPAs (an asset from which income is overdue for > 6 months).
The 2nd Narasimhan Committee report (1998) stated that other than NPA, there was no other indicator to reflect the quality of assets & their impact on banks’ viability in relation to advances.
Gross NPAs of Scheduled Commercial Banks (SCBs) increased over the period 31-03-1998 to 31-03-2002 from Rs. 51,815 crores to Rs. 70,924 crores while the Gross NPA of public sector banks (PSBs) was also correspondingly higher.
However, the share of Public Sector Banks in total NPAs declined from 90% to 82% during the 1998 to 2002. Furthermore, there was also a decrease in the ratio of gross NPAs and net NPAs which are measured as % age of advances as well as assets. These ratios represent the quality of banks assets & are therefore, were taken as measures of reliability of the banking system. Gross and net NPAs of SCBs declined substantially during this period.
However, the ratio of gross and net NPAs as a proportion of gross advances and of total assets increased significantly for new private sector banks from period between 2001 to 2002 as weak banks were merged with strong banks. These NPAs originate due to increase of bad debt. You would be surprised that there are some banks, whose net NPAs had exceeded their net worth leading to negative net worth.
Capital Adequacy Ratio:
Capital Adequacy Ratio (CAR) was implemented to initiate banking sector reforms. Reforms of this nature have focused on bringing prudential norms into line with international standards. By tying a bank’s CAR to the riskiness of the loans it makes, the Basel Committee for international banking supervision sought to reduce bank failures worldwide. Commercial banks around the world are required to maintain minimum capital funds for safety reasons because a bank’s capital base plays a significant role in its long-term performance. Furthermore, it gives the power to absorb shocks and, therefore, reduces the risk of bankruptcy in the medium term.
Diversification in Bank Operations:
During the period of economic liberalization, public sector banks have substantially diversified their activities. Their activities have expanded to include mutual funds, merchant banking, venture capital funding, and para-banking activities such as leasing (lease financing), hire-purchase, factoring, forfaiting, etc. Providing a variety of banking services under one umbrella (directly and through subsidiaries) has been the main objective, in order to generate maximum profits. Many banks including the SBI have turned out to be an one-stop financial services centre.
You can check out our other easy notes on the paper of Advanced Bank Management for CAIIB June 2023 exams.
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