The Narasimham Committee II (Committee on Banking Sector Reforms) was tasked with conducting a progress review of the implementation of banking reforms since 1998, with the goal of further strengthening India's financial institutions. It concentrated on issues such as bank size and capital adequacy ratios, among other things.

What is Narasimham Committee II ?

• Despite optimistic views about the banking industry's growth in terms of branch expansion, deposit mobilisation, and so on, several distortions such as increasing NPAs and obsolete technology crept into the system, owing primarily to global economic changes.
• In this context, the Finance Ministry of the Government of India appointed Mr. M. Narasimham as chairman of yet another committee, this time titled the Banking Sector Reforms Committee (Narasimham Committee II).
• The committee was tasked with "reviewing the progress of banking sector reforms to date and charting a programme of financial sector reforms required to strengthen India's financial system and make it internationally competitive."
• This report was submitted to the government by the Narasimham committee on banking sector reforms in April 1998.

Historical Perspective

• When India liberalised its economy in 1991, it was felt that banks were underperforming.
• During the economic crises, it was recognised 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.
• The first Committee was formed in 1991 and is known as the Narasimham Committee – I.
• The second Committee (Narasimham Committee – II) was formed in 1998, this time with P Chidambaram as finance minister.
• 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).

Recommendations of Narasimham Committee II

1. Need for Stronger Banking System

• The Narasimham committee has proposed a stronger banking system in the country, particularly in the context of capital account convertibility (CAC), which would involve a large amount of capital inflow and outflow, complicating exchange rate management and domestic liquidity.
• To deal with this, India would require a strong and resilient banking and financial system.

2. Concept of Narrow Banking

• The Narasimham committee is deeply concerned about the rehabilitation of weak public sector banks that have amassed a high percentage of Non-Performing Assets (NPA), in some cases as much as 20% of their total assets.
• To rehabilitate such weak banks, they proposed the concept of narrow banking.

3. Small Local Banks

• According to the Narasimham committee, “while two or three banks with an international orientation and eight to ten larger banks should take care of their needs of the large and medium corporate sector as well as larger of the small enterprises, a large number of local banks will still be required.”
• The committee has proposed the establishment of small local banks that would be limited to states or clusters of districts in order to serve local trade, small industry, and so on.

4. Capital Adequacy Ratio

• The Narasimham committee also suggested that the government consider raising the prescribed capital adequacy ratio to improve banks' inherent strength and risk-taking ability.

5. Public Ownership and Real Autonomy

• According to the Narasimham committee, government ownership and management of banks does not increase autonomy and flexibility in the operation of public sector banks.
• As a result, the committee has recommended that the functions of bank boards be reviewed in order to make them accountable for increasing shareholder value through the formulation of corporate strategy.

6. Review and Update Banking Laws

• The Narasimham committee has recommended that the provisions of the RBI Act, Banking Regulation Act, State Bank of Act, and other laws be reviewed and amended as soon as possible in order to bring them in line with current banking needs.

7. Aside from these major recommendations, the committee has also advocated for faster computerization, technological advancement, staff training, depoliticization of banks, professionalism in banking, and a review of bank recruitment, among other things.

Conclusion

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.

FAQs

MCQs

1. In which year was the Narasimham Committee II set up?

A) 1991
B) 1998
C) 2000
D) 1995

2. What was one of the key recommendations of the Narasimham Committee II to deal with NPAs?

A) Introduction of Repo Rate
B) Establishment of an Asset Reconstruction Fund
C) Merging all weak banks
D) Privatization of all public sector banks

3. What did the Narasimham Committee II recommend regarding the capital adequacy ratio of banks?

A) Increase it to 10%
B) Reduce it to 6%
C) Maintain it at 8%
D) Remove the requirement

4. Which of the following was a suggestion made by the Narasimham Committee II regarding the restructuring of banks?

A) Merging all public and private banks
B) Merging strong banks and closing weak ones
C) Nationalizing private banks
D) Privatizing all banks

5. What was the Narasimham Committee II's stance on the governance structure of banks?

A) Keep it unchanged
B) Increase government intervention
C) Enhance the role of the Board for Financial Supervision (BFS)
D) Abolish the Board for Financial Supervision

GS Mains Questions and Answers

Q1: Analyze the impact of the recommendations of the Narasimham Committee II on the Indian banking sector.

Answer: The Narasimham Committee II had a significant impact on the Indian banking sector. Its recommendations, particularly in the areas of NPA management, capital adequacy, and bank consolidation, brought about much-needed reforms. The establishment of the Asset Reconstruction Fund and the focus on stricter NPA identification helped in addressing bad loans. The committee's push for higher capital adequacy standards improved the financial stability of banks, and the consolidation of stronger banks helped create more competitive and efficient banking entities. Overall, these reforms contributed to the modernization of the banking sector and enhanced its resilience in the face of financial challenges.

Q2: Discuss the role of the Narasimham Committee II in addressing the issue of non-performing assets (NPAs) in the Indian banking sector.

Answer: The Narasimham Committee II played a critical role in addressing the issue of non-performing assets (NPAs) in the Indian banking sector. It recommended the creation of an Asset Reconstruction Fund to take over and resolve NPAs, thus preventing them from impacting the overall health of the banking system. The committee also advocated for stricter NPA identification and better credit risk management practices to ensure that future NPAs are minimized. These measures, coupled with improved governance structures, significantly reduced the burden of NPAs on Indian banks.

Q3: Evaluate the recommendation of the Narasimham Committee II regarding the consolidation of Indian banks.

Answer: The Narasimham Committee II recommended the consolidation of strong banks to create globally competitive entities, while also advising against the merger of weak banks with strong ones. This recommendation aimed at creating a more robust banking system capable of withstanding global competition. The merger of strong banks was seen as a way to build economies of scale, improve efficiency, and enhance capital adequacy. While this recommendation was met with some resistance, it has gradually been implemented, with several bank mergers in recent years creating larger, more stable institutions.

Previous Year Questions on Narasimham Committee II

1. UPSC CSE Prelims 2017:

Question: The Narasimham Committee II was primarily concerned with which sector?

A) Agriculture
B) Industry
C) Banking
D) Defense

Answer: C

Explanation: The Narasimham Committee II was focused on reforms in the banking sector, aiming to modernize and stabilize India's banking system.

2. UPSC CSE Mains 2019 (GS Paper 3):

Question: The Narasimham Committee II led to significant reforms in India's banking sector. Discuss its major recommendations and their impact on the economy.

Answer: The Narasimham Committee II, set up in 1998, recommended several key reforms aimed at improving the efficiency and stability of India's banking sector. Its major recommendations included the establishment of an Asset Reconstruction Fund to address NPAs, raising the capital adequacy ratio to 10%, and encouraging the merger of strong banks. These reforms helped in reducing the burden of NPAs, strengthening the capital base of banks, and creating globally competitive banking institutions. The committee's recommendations contributed to the modernization of the Indian banking system, making it more resilient to financial challenges.