The purpose of Narasimham Committee I (Committee on the Financial System – CFS) was to investigate all aspects of the financial systems' structure, organization, functions, and procedures in order to recommend improvements in their efficiency and productivity. This committee was appointed by then-Finance Minister Dr. Manmohan Singh.

Narasimham is arguably the most powerful banker in post-independence India. The reports produced by the two Committees he chaired — the Narasimham Committee on Financial System (1991) and the Narasimham Committee on Banking Sector Reforms (1998) — remain the foundational documents for any discussion of banking sector reforms and banking policy. He is also credited with laying the groundwork for historic events such as bank mergers, the emergence of new-generation private banks, and asset reconstruction firms.

What is Narasimham Committee-I?

• The Narasimham committee (1991) assumed that commercial banks' financial resources came from the general public and were held in trust by the banks and that the bank funds were to be used to the greatest extent possible for the benefit of depositors.
• This assumption implied that even the government had no business jeopardizing the solvency, health, and efficiency of nationalized banks under the guise of using bank funds for social banking, poverty alleviation, and so on.
• As a result, the Narasimham committee set out to effect three major changes in India's banking sector:
  • Assuring a certain level of operational flexibility.
  • Banks have internal autonomy in their decision-making processes.
  • Increased professionalism in banking operations.

Historical Perspective

• When India liberalized its economy in 1991, it was felt that banks were underperforming.
• During the economic crises, it was recognized that banks play an important role in the economy, and thus the banking sector needed to be more competitive and effective.
• For this purpose, the Ministry of Finance, led by then-Finance Minister Dr. Manmohan Singh, established the Narasimham Committee to examine India's banking sector and recommend reforms.
• Narasimham Committee I was a nine-member committee appointed by the Government of India on August 14, 1991.
• Maidavolu Narasimham was appointed as Chairman of the Committee.
• From 2 May 1977 to 30 November 1977, he was the 13th governor of the Reserve Bank of India (RBI).
• On November 16, 1991, the Committee delivered its report to the Government.
• On December 17, 1991, the report was introduced in Parliament.

Recommendations of Narasimham Committee I

Reduction in SLR and CLR

• The committee recommended that the higher proportions of the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) be reduced.
• At the time, both of these ratios were extremely high. The SLR was 38.5 percent at the time, and the CRR was 15%.
• Because of the large amount of SLR and CRR, the bank's resources were locked up for government use.
• It was a hindrance to the bank's productivity, so the committee recommended a gradual reduction.
• SLR should be reduced from 38.5 percent to 25 percent, and CRR should be reduced from 15 percent to 3 to 5 percent.

Phasing out Directed Credit Programme

• Since nationalization, the government of India has implemented directed credit programs. The committee recommended that this program be phased out.
• This program compelled banks to set aside funds for the needy and poor sectors at concessional interest rates.
• Because it was reducing bank profitability, the committee recommended that this program be discontinued.

Determination of Interest Rate

• The committee believed that interest rates in India were regulated and controlled by the government.
• The interest rate should be determined based on market forces such as the demand for and supply of funds.
• As a result, the committee recommended eliminating government interest rate controls and gradually phasing out concessional interest rates for the priority sector.

Structural Reorganization of Banking Sector

• The Narasimham committee (1991) proposed a significant reduction in the number of public sector banks through mergers and acquisitions to increase efficiency in banking operations.
• Three or four large banks, including SBI, should take on an international flavor.
• Eight to ten banks should be national banks with a widespread network of branches across the country.
• The remainder should remain as regional banks with operations limited to a specific region.
• The RBI should allow the establishment of new private-sector banks as long as they meet the minimum start-up capital and other requirements.
• The government should declare that no more banks will be nationalized.
• Foreign banks are permitted to open branches in India, either wholly-owned or as subsidiaries. This would increase productivity.
• Foreign banks and Indian banks are permitted to form joint ventures in merchant and investment banking.
• Since the country already had a network of rural and semi-urban branches, the system of licensing branches with the goal of spreading the banking habit should be phased out. Banks should be allowed to open branches wherever they see fit.

Establishment of ARF Tribunal

• In those days, the proportion of bad debts and Non-Performing Assets (NPA) of public sector banks and development financial institutions was very concerning.
• The committee proposed the creation of an Asset Reconstruction Fund (ARF).
• This fund will assume a portion of the banks' and financial institutions' bad and doubtful debts. It would assist banks in getting rid of bad debts.

Removal of Dual Control

• Banks were under the dual control of the Reserve Bank of India (RBI) and the Ministry of Finance's Banking Division at the time.
• It considered and recommended that the RBI be the sole primary regulator of banking in India.

More Freedom to Banks

In order to improve the workings of banks, the Narasimham committee (1991) recommended that:

• Each bank is free and autonomous.
• Every bank should pursue radical changes in working technology and culture in order to become internally competitive and to keep up with the wide-ranging innovations that are taking place.
• Over-regulation and over-administration should be avoided, and internal audits and inspections should rely on more.
• The various guidelines issued by the government or the RBI regarding internal administration should be considered in the context of the bank's independence and autonomy.
• The appointment of the bank's CEO and board of directors should be based on professionalism and integrity rather than political considerations.

Government actions on Narasimhan Committee I

Since 1991, the government has implemented the following measures based on the recommendations of the Narasimhan Committee:

Lowering SLR and CRR

• Bank profits were harmed as a result of the high SLR and CRR. The SLR was reduced from 38.5 percent in 1991 to 25% in 1997.
  • As a result, banks now have more funds to allocate to agriculture, industry, trade, and other sectors.
• The Cash Reserve Ratio (CRR) is the cash ratio of a bank's total deposits with the RBI.
  • The CRR had been reduced from 15% in 1991 to 4.1 percent in June 2003. The goal is to free the funds held by the RBI.

Prudential Norms

• The RBI has begun to implement prudential standards in order to instill professionalism in commercial banks.
• Prudential norms aim to ensure that commercial banks' books reflect an accurate and correct picture of their financial position by requiring proper disclosure of income, asset classification, and provision for bad debts.
• Prudential guidelines required banks to make a full provision for all non-performing assets (NPAs).
• The funding for this purpose has been set at Rs. 10,000 crores, which will be phased over a two-year period.

Capital Adequacy Norms (CAN)

• The capital adequacy ratio is the minimum capital-to-risk-asset ratio.
• In April 1992, the RBI set CAN at 8%. By March 1996, all public sector banks had achieved the 8% ratio. Foreign banks also obtained it.

Deregulation of Interest Rates

• The Narasimhan Committee advocated allowing market forces to determine interest rates. Interest rates have become much simpler and more free since 1992.
• Scheduled commercial banks now have the freedom to set deposit interest rates subject to minimum floor rates and maximum ceiling rates.
• Domestic term deposit interest rates have been deregulated.
• SBI and other banks' prime lending rates on general advances of more than Rs. 2 lakhs have been reduced.
• The interest rate on bank loans exceeding Rs. 2 lakhs has been completely deregulated.
• All cooperative banks' interest rates on deposits and advances have been deregulated, subject to a minimum lending rate of 13%.

Recovery of Debts

• The Indian government enacted the "Recovery of Debts Due to Banks and Financial Institutions Act 1993" to facilitate and expedite the recovery of debts owed to banks and financial institutions.
• Six Special Recoveries Tribunals have been established. In addition, an Appellate Tribunal has been established in Mumbai.

Competition from New Private Sector Banks

• Banking is available to the private sector. New private-sector banks have already begun operations.
• These new private sector banks are permitted to raise capital contributions of up to 20% from foreign institutional investors and 40% from non-resident Indians. As a result, competition has increased.

Access to Capital Market

• The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to allow banks to raise capital via public offerings.
• This is subject to the condition that Central Government's holding does not fall below 51 percent of paid-up capital.
• SBI has already raised a significant amount of capital through equity and bonds.

Freedom of Operation

• After meeting capital adequacy and prudential accounting standards, Scheduled Commercial Banks are permitted to open new branches and upgrade extension counters.
• Banks are also allowed to close non-viable branches that are not located in rural areas.

Local Area Banks (LABs)

• In 1996, the RBI issued guidelines for the establishment of Local Area Banks (LABs), and it approved the establishment of seven LABs in the private sector.
• LABs will aid in mobilizing rural savings and channeling them into local investment.

Supervision of Commercial Banks

• To strengthen the bank and financial institution supervision, the RBI established a Board of Financial Supervision with an advisory Council.
• In 1993, the RBI established a new department known as the Department of Supervision as an independent unit for commercial bank supervision.

Conclusion

The recommendations of the Narasimham Committee - I (1991) were revolutionary in many ways, and they were opposed by trade unions, the central government's finance ministry, and, of course, the progressive economists who generally supported public sector banks. The government, on the other hand, accepted many of the Narasimham committee's recommendations (1991).

GS Mains Questions and Model Answers 

Q1: What was the impact of the Narasimham Committee I on banking reforms in India?

Answer: The Narasimham Committee I, established in 1991, significantly transformed India’s banking sector. Its recommendations focused on reducing the CRR and SLR to enhance liquidity and bank profitability. The committee highlighted the need for financial autonomy, which led to the entry of private and foreign banks, fostering competition. The focus on NPAs laid the foundation for transparent accounting practices, compelling banks to adopt stricter lending norms. Moreover, the reduction in government ownership was recommended to improve operational efficiency and governance. These reforms were crucial in integrating Indian banking with global standards and increasing its responsiveness to economic changes.

Q2: Explain the challenges addressed by the Narasimham Committee I and how it reshaped India's financial sector.

Answer: The committee confronted challenges like low profitability, high CRR/SLR requirements, and NPAs that affected bank performance. It proposed reducing CRR and SLR, increasing operational freedom, and tightening NPA norms. Additionally, it recommended government disinvestment in public sector banks to improve governance and efficiency. By fostering competition through the entry of private and foreign banks, it reshaped the sector, aligning it with global standards and enhancing customer service. These reforms played a crucial role in stabilizing the financial system in the post-liberalization era.

Q3: Discuss the relevance of the Narasimham Committee I recommendations in the current banking scenario.

Answer: The recommendations of the Narasimham Committee I remain relevant today, especially in addressing NPAs and improving bank governance. With the current challenges faced by public sector banks, such as capital inadequacy and stressed assets, the push for privatization and operational autonomy is still valid. The need for transparency in accounting practices continues to guide reforms, ensuring financial stability. As India’s banking sector adapts to technological advancements and competition, the principles of efficiency and financial discipline emphasized by the committee remain critical.

Previous Year Questions on  Narasimham Committee

1. UPSC CSE Prelims 2015

Question:  What was a key recommendation of the Narasimham Committee I regarding public sector banks?

Answer: Reducing government ownership and increasing. The Narasimham Committee I emphasized that public sector banks should have operational autonomy, with the government reducing its stake to promote efficiency and competitiveness.

2. UPSC CSE Mains 2019

Question: "Discuss the significance of the Narasimham Committee I in the context of India's financial reforms." 

Answer: The Narasimham Committee I, constituted in 1991, was a milestone in India’s economic reforms. It aimed at restructuring the banking sector to align it with global standards. The committee proposed reducing the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) to boost liquidity. Additionally, it highlighted the need to address non-performing assets (NPAs) and recommended stricter norms for loan recovery and transparency. A major suggestion was to reduce government ownership in public sector banks, enabling them to operate with more autonomy and compete with private entities. The reforms also encouraged the entry of private and foreign banks, fostering a competitive banking environment. These recommendations laid the foundation for a more liberalized and efficient financial system, playing a pivotal role in stabilizing the economy during the post-liberalization period. Today, the committee's emphasis on governance, financial discipline, and operational autonomy remains relevant in tackling current banking challenges.