Narasimham Committee 1 & 2: Recommendations & Purpose for Formation (UPSC Notes)

The Narasimham Committee was established in 1991. After economic liberalisation, a significant government challenge was enhancing bank efficiency and competitiveness. To address this, the Finance Minister established the Narasimham Committee, led by M Narasimham, a former RBI Governor. This committee aimed to analyze the financial sector and propose banking reforms. In 1998, a second Narasimham Committee was formed with similar objectives. M Narasimham, a prominent post-independence Indian banker, is credited for foundational recommendations influencing discussions on NBFC and banking reforms. 

Let’s see in greater detail all the recommendations of the first and second Narasimham committees. 

Recommendations of this committee and subsequent actions taken by the government of India are important topics for UPSC IAS exams. It is also a very important topic for the economics section of Mains general studies paper 3 because of the recent huge frauds unearthed in banks. 

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History of Narasimham Commitee 1991

India had gone for the much-needed economic liberalisation in 1991 after we faced an acute balance of payment crisis in which India did not have enough foreign exchange reserves to pay for crucial import bills. After the new economic reforms of 1991 had kicked in, the government started to review the performance of the financial sector and banks. 

During this review, it was found that banks could not perform their duties and help the economy in times of crisis. There was a unanimous view among government officials, experts, and industry leaders that banking sector reforms were the need of the hour. These reforms would have catapulted India’s banking industry to be more competitive and efficient. 

Given these developments, the then Finance Minister, Dr. Manmohan Singh, formed a committee led by India's eminent post-independence banker, Maidavolu Narasimham. This committee was referred to as Narasimham Committee 1, with another committee under his leadership in 1998 becoming Narasimham Committee 2.

Narasimham Committee 1, comprising nine members, was established on August 14, 1991. Its mandate was to assess India's banking system's existing structure, organization, and functioning. The committee aimed to propose government actions to enhance the sector's efficiency and competitiveness. The committee submitted its report to the government on November 16, 1991, and the findings were presented for Parliament's review on December 17, 1991.

Recommendations of Narasimham Committee I

The first Narasimham Committee recommendations are as follows: 

Phasing out Directed Credit Response 

The government had been following directed credit response since the nationalisation of banks. This committee recommended that the respective program has outlived its utility and advocated phasing it out. 

Establishing ARF Tribunal 

The proportion of bad loans and non-performing assets was very high in the financial sector. In light of these, the committee recommended the creation of an asset reconstruction fund (ARF) tribunal. The ARF would assume a percentage of these bad debts and help clean the balance sheets of banks and other financial institutions.

Removal of Dual Control 

Regulation of banks was under the dual control of the Ministry of Finance banking department and the Reserve Bank of India. It created avoidable problems in the bank’s functioning and hampered the efficiency of the overall financial system. The Narasimham committee recommended entrusting the Reserve Bank of India with the sole responsibility of regulating banks and financial services. The function of RBI would be to ensure that banks' fundamentals remain strong. 

Reduction in CRR and SLR

Both SLR and CRR are statutory requirements that need to be adhered to by all banks and financial institutions. Narasimham committee recommended reducing both these requirements as it was very high and created an undue burden on financial institutions. It advocated reducing SLR from 38.5% to 25% and CRR from 15% to 3-5%. 

Interest rate determination 

In the Indian financial system, interest rates were controlled by the government. However, the committee recommended phasing out government controls to achieve better efficiency and productivity. Instead, interest rates should be organically determined by demand and supply market forces. 

More Freedom to banks 

The Narasimham committee was selected to usher in banking sector reforms. It did so by advocating more freedom for banks and other financial institutions. Managing directors and boards of governors of respective banks should be given adequate leverage to undertake certain actions necessary to improve banks' financial health and enhance efficiency. 

Reorganistaion of the banking sector

This is another important recommendation of Narasimham Committee I. Under this, it said that public sector banks should be rationalized by carrying out mergers and acquisitions. Apart from this, RBI should license private banks if they meet regulatory criteria and conditions. It also recommended allowing foreign banks to join with Indian partners in the investment banking segment. 

To effectively restructure the banking sector, this committee said that banks should be allowed to open more branches as and when they deem fit.

Narasimham Committee II, 1998

The first Narasimham committee suggested some critical reforms which the government had initialised. These recommendations proved to be a grand success as the banking and other financial service sectors flourished. However, with time, new challenges demand some analysis and taking corrective steps.

The government appointed another committee under the leadership of M Narsimham in 1998 to focus on second-generation banking reforms and make Indian banks future ready. Many recommendations given by this committee were accepted, and several are at various stages of implementation. The second Narasimham committee relates to banking industry reforms in human resources, technological upgradation, and restructuring. 

Recommendations of Narasimham Committee II, 1998

Some recommendations of the Narasimham committee are as follows: 

Narrow banking

The public sector banks faced a high incidence of bad debts and non performing assets. The non-performing assets level was as high as 20% in some banks. To solve this problem, this committee introduced a new concept named arrow banking. As a part, highly impacted financial institutions will be allowed to put their funds in risk free assets. 

Government ownership

The earlier report had recommended granting greater autonomy to banks so that they can perform professionally. However, government ownership and autonomy did not go hand in hand. Therefore, it suggested that the government should divest controlling stake in most PSBs and allow banks to function independently. 

Capital adequacy ratio

The capital adequacy ratio is the percentage of capital concerning a bank's risk weighted liabilities and assets. The Indian banking system was structurally weak and could not absorb shocks. Therefore, to build its capacity and inherent strength, the committee recommended increasing the capital adequacy requirements of banks and other financial institutions. 

Strong banking system 

The committee was of the firm view for stronger and more resilient banks which can compete with large multi national banking companies. It advocated for the creation of strong banks by merging two or more banks. However, it cautioned against merging strong banks with weaker institutions as it would defeat the purpose of reforms. 

Change in RBI’s role 

There should be a reform in RBI’s role as well. The Reserve Bank of India should function only as a regulator or administrator of India’s financial system by forming rules and regulations and ensuring compliance. It should divest any controlling stake in banks and other financial institutions. 

Non-performing assets 

With burgeoning NPAs, the sustainability of the Indian banking system was under threat. Narasimham committee recommended reducing the total gross NPA of the banking sector to 3% by 2002. To achieve the same, it suggested the establishment of asset reconstruction companies. The government of India passed the SARFAESI Act 2002 in order to incorporate 

these recommendations. 

Foreign banks 

The earlier committee had already opened the doors for foreign banks in India. Moving ahead on that development, the second Narasimham committee suggested that minimum start-up capital for foreign banks should be raised from $10 million to $25 million. 

Criticisms

Protests emerged from bank employee unions in India in response to the report. The RBI employees' union strongly protested the Narasimham II Report. The United Forum of Bank Unions (UFBU), representing around 1.3 million bank employees, planned to gather in Delhi and devise an action strategy following the Narasimham Committee's banking reforms report. Criticism was directed at the committee, labeling it as "anti-poor." Some argued that the committees failed to suggest measures for swiftly reducing poverty in India by creating new job opportunities. Consequently, this led to difficulties for small borrowers, including individuals and businesses in micro and small sectors.

Conclusion 

Narasimham committee prepared one of the most comprehensive reports on the banking sector reforms in India. Its suggestions and recommendations are the basis for formulating every policy, regulation, law, etc for the financial sector. 

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