ABSTRACT

The banking sector reforms in India were started as a follow up measures of the economic liberalization and financial sector reforms in the country. The banking sector being the life line of the economy was treated with utmost importance in the financial sector reforms. The reforms were aimed at to make the Indian banking industry more competitive, versatile, efficient, productive, to follow international accounting standard and to free from the governments control. The reforms in the banking industry started in the early 1990s have been continued till now. The paper makes an effort to first gather the major reforms measures and policies regarding the banking industry by the govt. of India and the Central Bank of India (i.,e. Reserve Bank of India) during the last fifteen years. Secondly, the paper will try to study the major impacts of those reforms upon the banking industry. A positive responds is seen in the field of enhancing the role of market forces, regarding prudential regulations norms, introduction of CAMELS supervisory rating system, reduction of NPAs and regarding the up gradation of technology. But at the same time the reform has failed to bring up a banking system which is at par with the international level and still the Indian banking sector is mainly controlled by the govt. as public sector banks being the leader in all the spheres of the banking network in the country.

1. INTRODUCTION
Commercial banking has been one of the oldest businesses in India and the earliest reference of commercial banking in India can be traced in the writings of Manu. Modern banking in India can be dated as far back as in 1786 with the establishment of General Bank of India. In the early nineteenth century three Presidency Banks were established in Bengal, Bombay and Madras and in 1921 they were merged in to newly form Imperial Bank of India. The Imperial Bank of India was converted in to State Bank of India under the State Bank of India Act, 1955. The swadeshi movement witnessed the birth of several indigenous banks such as Punjab National Bank, Bank of Baroda and Canara Bank (Chakraborty, 2006). In order to increase its control over the banking sector, the govt. of India had nationalized 14 major private sector banks with deposits exceeding Rs.500 million in 1969. This had raised the number of scheduled bank branches under govt. control to 84 percent from 31 percent (Chakraborty, 2006). But the poor performance of the public sector banks was increasingly becoming an area of concern. The continuous rise of nonperforming assets (NPAs) of banks posed a significant threat to the stability of the financial system. Hence, banking reforms were made an integral part of the liberalization process. The financial sector reforms started in 1991 had provided the necessary platform for the banking sector to operate on the basis of operational flexibility and functional autonomy enhancing productivity, efficiency and profitability (Talwar, 2005). While several committees have gone in to the problems of commercial banking in India, the two most important of them area) Narasimham Committee I (1991). b) Narasimham Committee II (1998).

1.1 REFORMS PROCESS

The Narasimham Committee Report I aimed at bringing about operational flexibility and functional autonomy so as to enhance efficiency, productivity and profitability. The Narasimham Committee Report II focused on bringing structural changes so as to strengthen the banking system to make it more stable. The Narasimham Committee had acknowledged the success of public sector banks in respect of branch expansion, deposit mobilization in household sector, priority sector lending and removal of regional disparities in banking. But during the post nationalization period, the banking sector suffered serious erosion in its efficiency and productivity (Dhar, 2003). Moreover, the sound banking system has been disturbed by the system of directed credit operation in the form of subsidized credit flow in the under banked and priority areas, IRDP lending, loan festival, etc. According to the committee the operational expenditure of the public sector banks has tremendously increased due to rise in number of branches, poor supervision, rising staff level and high unit cost administering loan to the priority sector. The major recommendations made by the Narasimham I committee report are listed below-

(1) Establishment of a four-tier hierarchy for the banking structure consisting of three to four large banks with SBI at the top. (2) The private sector banks should be treated equally with the public sector banks and govt. should contemplate to nationalize any such banks. (3) The ban on setting new banks in private sector should be lifted and the licensing policy in the branch expansion must be abolished. (4) The govt. has to be more liberal in the expansion of foreign bank branches and also foreign operations of Indian banks should be rationalized. (5) The Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) should be progressively brought down from 1991-92. (6) The directed credit program should be re-examined and the priority sector should be redefined to comprise small and marginal farmers, the tiny industrial sector, small business operators and weaker sections. (7) Banking industry should follow BIS/Basel norms for capital adequacy within three years. (8) Interest rates should be deregulated to suit the market conditions. (9) The govt. should tighten the prudential norms for the commercial banks. (10) The competition in lending between DFIs and banks should be increased and a shift from consortium lending to syndicated lending should be made. (11) In respect of doubtful debts, provisions should be created to the extent of 100 percent of the security shortfall. (12) The govt. share of public sector banks should be disinvested to a certain percentage like in case of any other PSU. (13) Each public sector banks should set up at least one rural banking subsidiary and they should be treated at par with RRBs. In order to initiate the second generation of financial sector reforms a committee on Banking Sector Reforms (BIS) was formed in 1998 under the chairmanship of M. Narasimham. The committee submitted
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its report on 23 April 1998 to the Finance Minister of Govt. of India. Narasimham committee report II had for mergers an acquisitions and had observed that Central Banks role should be separated from being monetary authority to that of regulator of the banking sector. The major recommendations of the second Narasimham II report were mentioned below(1) The committee favored the merger of strong public sector banks and closure of some weaker banks if their rehabilitation was not possible. (2) It recommended corrective measures like recapitalization is undertaken for weak banks and if required such banks should be closed down.

(3) The committee had also suggested an amicable golden handshake scheme for surplus banking sector staff. (4) Suggesting a possible short term solution to weak banks, the report observed that the narrow banks could be allowed as a mean of facilitating their rehabilitation. (5) Expressing concern over rising non-performing assets, the committee provided the idea of setting up an asset reconstruction fund to tackle the problem of huge non-performing assets (NPAs) of banks under public sector. (6) The report emphasized the need of enhancement of capital adequacy norms from the present level of 8 percent but did not specify the amount to which it should be raised. (7) The Banking Sector Reform Committee further suggested that existence of a healthy competition between public sector banks and private sector banks was essential. (8) The report envisaged flow of capital to meet higher and unspecified levels of capital adequacy and reduction of targeted credit.

1.2 TYPES OF REFORM MEASURES FOR THE BANKING SECTOR

The banking sector reforms started in the early 1990s essentially followed a two pronged approach; first, the level of competition was gradually increased within the banking system while simultaneously introducing international best practices in prudential regulation supervision tailored to Indian requirements. In particular, special emphasis was placed on building up the risk management capabilities of Indian banks while measures were initiated to ensure flexibility, operational autonomy and competition in the banking sector. Secondly, active steps were initiated to improve the institutional arrangements like legal and technological frameworks (Mohan, 2006). Some of the measures undertaken in this regard are as follows Competition Enhancing Measures Allowing operational autonomy and reduction of public ownership in public sector banks by raising capital from equity market up to 49 percent of paid up capital. Transparent norms for entry of Indian private sector banks, foreign banks and joint venture banks. Permission for foreign investment in the financial sector through foreign direct investment (FDI) as well as portfolio investment. The banks are allowed to diversify product portfolio and business activities. Roadmap for foreign banks and guidelines for mergers and amalgamation of private sector banks with other banks and NBFCs. Instructions and guidelines on ownership and governance in private sector banks. Measures enhancing role of market forces

 Reduction in pre-emption through reserve requirement, market determined pricing for govt. securities, disbanding of administered interest rates and enhanced transparency and disclosure norms to facilitate market discipline. Introduction of auction-based repos and reverse repos for short term liquidity management, facilitation of improved payments and settlement mechanism. Significant advancement in dematerialization and markets for securitized assets are being developed. Prudential measures Introduction of international best practices norms on capital to risk asset ratio (CRAR) requirement, accounting, income recognition, provisioning and exposure. Measures to strengthen risk management though recognition of different component of risk, assignment of risk weights to various asset classes, norms of connected lending, risk concentration, application of market to market principle for investment portfolio limits on deployment of fund in sensitive activities. Introduction of capital charge for market risk, higher graded provisioning for NPAs, guidelines for ownership and governance, securitization and debt restructuring mechanism norms, etc. Introduction and roadmap for implementation of Basel II by 31 March 2007. Institutional and legal measures Setting up of debt recovery tribunals, asset reconstruction companies, settlement advisory committees, corporate debt reconstructing mechanism, Lok-Adalat (peoples court), etc. for quick recovery of debts. Promulgation of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its subsequent amendment to ensure creditor rights. Setting up of Clearing Corporation of India Limited (CCIL) to act as a counter party for facilitating payment and settlement system relating to fixed income securities and money market instruments. Setting up of Credit Information Bureau of India Limited (CIBIL) for information sharing on defaulters as also other borrowers.

Supervisory measures Establishment of Board of Financial Supervision as the apex supervisory authority for commercial banks, financial institutions and non-banking financial companies. move towards risk based supervision, consolidated supervision of conglomerates, strengthening of offsite surveillance through control returns. Recasting of the role of statutory auditors, increased internal control through strengthening of internal audit. Strengthening corporate governance, enhance due diligence on important shareholders, fit and proper test for directors.

 Technology related measures Setting up of INFINET as the communication backbone for the financial sector, introduction of Negotiated Dealing System (NDS) for screen based trading in govt. securities and Real Time Gross Settlement System (RTGS).

Impacts of reforms upon the banking industry

The Indian banking industry had made sufficient progress during the reforms period. The progress of the industry can be judged in terms of branch expansion and growth of credit and deposits. Though the branch expansion of the SCBs has slowed down during the post 1991 era but population per bank branch has not changed much and the figure is hovering around 15,000 per branch. Therefore, banking sector has maintained the gains in terms of branch network in the phase of social banking during the reform period. Table 1 shows the progress made by the commercial banks in India during the post reform period. Table 1: Progress of Scheduled Commercial Banks in India

Interest rate deregulation The main aim of the interest rate reforms was to simplify the complex and the tiered interest rate structure that India had during pre 1990. Different interest rates, based upon size, purpose, maturity of loan, group, sector, region, etc., were rationalized to converge at a single lending rate called as prime lending rate over a period of five years. The aim was to provide more options and flexibility to banks for their asset liability management operations and shift towards indirect monetary control (Kohli, 2005).

Table 2: Interest rate deregulation- Bank Rate, CRR & SLR

Along with the interest rate deregulation quantitative restrictions were initiated simultaneously. In 1990, 40 percent of the bank credit was directed towards priority sectors. The reserve requirement pre-emoted more than 40 percent of the net demand and time liabilities of the banking sector. The amount of money available with the banks for credit was very small. The reserve requirement was progressively brought down in time. The statutory liquidity ratio (SLR) was brought down from 38.5 percent in 1990 to 25 percent in 2001. The cash reserve ratio (CRR) was also steadily brought down to its statutory minimum of 3 percent (Table 2). The motive behind the liberalization of interest rates in the banking system was to allow the banks more flexibility and encourage competition. Banks can charge rates according to their cost of funds and to reflect the creditworthiness of different borrowers. Banks can vary nominal rates offered on deposits in line with changes in inflation to maintain real returns (Ahluwalia, 2002). The most important and far reaching impact of banking liberalization in India has been the deregulation of the interest rate. The Indian banks are now adopting a completely market driven interest rate structure which was in earlier a govt. driven interest rate structure. The interest rate deregulation has resulted in the integration of the lending rates across spectrum. The prime lending rate of each bank is now synchronized with the bank rate. The bank rate was revived by the RBI to serve as the reference rate for the banking sector. In India, interest rate deregulation has contributed to a downward movement of the domestic interest rates and a narrowing of the domestic-foreign rates differential. Indias high budget deficits have kept domestic borrowing cost high, a factor that serves to attract foreign equity capital (Kohli, 2005).

Table 3: Lending Rates in India, 1990-2001

The interest rate deregulation has able to alter the borrowing cost for the domestic borrowers. Till 1993, borrowing from abroad was costlier than domestic loans but foreign loans become cheaper than domestic loans from 1994. This was partly because resident firms were selectively allowed to access international capital markets after 1990 as part of capital account liberalization. Table 3 measures the relative borrowing costs faced by firms after interest rates liberalization. The corporate loan market in India is still not appearing to have fully equilibrated over time. Recent studies by Banerjee and Duflo (2003) shows that banks are still under lending to corporate and companies remain loanstarved. Hence, interest rates have shown some upward stickiness as well as not worked perfectly in allocating credit. Though there has been a marginal decline in the lending rates of commercial banks in India, it is still one of the highest lending rates in the world (Chakraborty, 2006). Another noteworthy feature of the banking sector reforms has been the stickiness of the credit volume. The share of credit in the pool of credit and investments was 72 percent in 1969 and declined to 61 percent in 1991 in the portfolio of commercial banks. In the post 1991 period, the share of credit has not shown a particular rise and it is still below 60 percent though there has been a decline in the rate of fall. The situation is not improving even though SLR has been reduced gradually from as high as 31 percent to 25 percent. One of the reasons for this is the incentive structure of the bank employees, specially the public sector banks. Employees in public sector banks work under the threat of enquiries by Central Vigilance Commission (CVC) for every loan that goes bad. On the other hand, they have very little to gain from successful lending. As a result, bankers are reluctant to grant loans to the clients (Banerjee, 2004). The alternative to lending is investment in govt. securities which are default free by nature. This explains the high and sticky proportions of investments in bank portfolio.

Directed credit Directed credit policies have been an important part of Indias financial sector reforms. Under the directed credit policy commercial banks are required to provide 40 percent of their commercial loans to the priority sectors which include agriculture, small-scale industry, small transport operators, artisans, etc. Within the aggregate ceiling there are various sub-ceilings for agriculture and also for loans to poverty related target groups. The Narasimham committee had recommended reduction of the directed credit to 10 percent from 40 percent. The committee had also suggested narrowing down the definition of priority sector to focus on small farmers and low income target groups. The policy of 40 percent of loans to the priority sectors has not been abolished by the govt. However, the definition of the priority sector activities has been broadened with the new inclusion and reclassifications. The Committee on Banking Reforms has suggested inclusion of activities related to food processing, dairying and poultry in the priority sector list. This will increase the list of activities under the priority sector credit and also improve the quality of the portfolio. The priority sector should be considered as a percentage of the total assets of the banking system and not as a percentage of commercial advances as at present. The issue of priority sector lending, an important concern against privatization, is no longer that crucial, since in 2003 the share of credit of private sector banks going to the priority sector had surpassed that of public sector banks (Table 4). Table 4: Priority Sector Lending by Scheduled Commercial Banks (In INR/ Million)

Figures in brackets represent percentages to net bank credit for the respective bank group. Despite a decline, direct lending to the disadvantaged segments of the under the priority sector advances remained high during the reform period (Mohan, 2004). The decline in priority sector lending since the initiation of reform infect reflects greater flexibility provided to banks to meet such targets. At present if a bank fails to fulfill the target for priority sector lending, it can invest the shortfall amount in RBI securities dealing with flow of funds towards agriculture and small-scale industries but it still desirable that banks adhere to the priority sector lending target. The current arrangement shows how the banking sector reforms have provided operational flexibility to the banks even while meeting social objectives. The priority sector lending norms have been fulfilled by a good margin by both public and private sector banks at present. While public sector banks, as a group, achieved the overall priority sector targets 40 percent, they failed to achieve the various sub-targets for agriculture, tiny sector within the SSI sector, advances to weaker sections, etc. Significant variation was also observed in the performance of different banks within the public sector banks with regard to the achievement of sub-targets (RBI, Annual Report, 2004-05). The performance of the private sector banks in the area of priority sector lending remain less satisfactory with 12 out of 30 private sector banks failing to achieve the overall priority sector targets. Only one private sector bank, ICICI Bank, could achieve the sub-targets within the priority sector. Private sector banks credit to weaker sections at 1.2 percent of net bank credit is much lower than the stipulated target of 10 percent for the sector. Foreign banks have achieved the overall priority sector targets and sub-targets for export credit and nearly achieve the sub-target with respect to SSI as well. Regulatory reforms Since the beginning of the financial sector reforms, an important task of the policy makers was to bring in an appropriate regulatory framework. The design of an appropriate regulatory framework which encourages competition and efficiency in banking services and at the same time ensures a safe and sound banking sector may be very difficult and complex component of the banking sector liberalization process. The Narasimham Committee Report I have provided guidance on the actual design of the regulatory mechanism. The regulatory framework for banks known as Prudential Regulation in the literature consists of broadly of capital adequacy norms, restrictions on the lines of activities that banks can participate in, restrictions on entry and deposit insurance (Sen & Vaidya, 1997). The prudential regulatory framework for banks has been design to address the following five issues Market structure, Capital adequacy norms Accounting and provision for NPAs, Supervision of banks and Privatization of banks

These issues as mentioned above are discussed in details below. Market structure Following the recommendation of the Narasimham committee, RBI had issued a policy guideline in January, 1993 regarding the entry of private sector banks in to the industry in large scale. The first new
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private sector banks entering the market was UTI bank in 2 private sector banks had entered the banking industry till 1995.

April 1994, In this way, there are 10 new

Some of the important guidelines regarding the entry of private sector banks issued by RBI in1993 were1) New private sector banks have to be registered as public limited companies under Companies Act, 1956. 2) The RBI may grant license to the new private sector banks under Banking Regulation Act, 1949. 3) The new banks have to list their shares in stock exchanges. 4) Preference will be given in issuing license to those banks whose headquarters are located in areas which do not have headquarters of any other bank. 5) No one will be allowed to be a director of a new bank who is already a director of any other banking company which among themselves are entitled to exercise voting rights in excess of 20 percent of the voting fights of all shareholders of the banking company. 6) New banks must have a paid up capital of Rs.1000 million. They are also to follow the prudential norms in respect of banking operations, accounting practices and other policies as laid down by RBI. 7) The new private sector banks are to follow the priority sector lending requirements as applicable to other domestic banks. 8) The existing policy of branch licensing for commercial banks will be applicable to new banks.

The Narasimham committee, 1991 has suggested the following market structure for the Indian banking sector during the post reform eraa) Three or four large bank should try to acquire multinational character by starting overseas business. b) Eight to ten banks with presence throughout the country should engage in general or universal banking. c) Existence of local banks with activities confining to a particular area or region. d) Rural banks with operations limited to rural areas and their predominant business should be to finance agriculture and allied activities (Sen & Vaidya, 1997). Even during the reform period the public sector banks are still having the largest banking network in India comprising around 90 percent of the total branches in 2005 (Table 5). In 1994 the share of public sector banks in total branch network was 93.5 percent and that of private sector banks was a meager 6.5 percent. Thus the market structure of the Indian banking sector has not change much during the reform era. Though many new private sector banks have come up during the liberalization period but they are very slow and

apprehensive regarding the opening of new offices as they are always guided by the profit motives. Therefore, the expansion of the private sector bank branches is not taking place at a fast rate as it is supposed to be. The foreign banks are mainly operating in the metropolitan and the urban areas only and they are also restrained by the govt. policy regarding opening of new branches by the foreign banks (Kohli, 2005). Table 5: Structure of Commercial Banks in India (Figures in decimal are in percent)

In recent years, a number of public sector banks and the private banks have set up ATMs and have expanded branch network to rural and semi urban areas. Table 6 has shown the branch network and number of ATMs in recent years. The computerization of bank branches has also taken momentum since 1993 and the process has got boosted with the entry of hi-tech private sector banks. From table 6 it is clear that the State Bank of India Group is the market leader with the largest number of branches specially in the rural and semi urban areas. The domestic private sector banks are also expanding their network of branches but concentrating more on semi urban, urban and metropolitan areas. The foreign banks in India are mainly operating in urban and metropolitan areas with not a single branch in rural and semi urban places. Table 6: Branches and ATMs of SCBs in India, 2005

During the post reform period, there has been a consistent decline in the share of public sector banks in the total assets of commercial banks. This has been happening mainly because of greater competition from the private sector banks and as well as entry and expansion of several foreign banks. Notwithstanding such transformation, the public sector banks still account for nearly three fourth of assets and income. The public sector banks have also responded to the challenges and it has been reflected in their increased share in the overall profit of the banking sector. Share of Indian private sector banks in the income and assets of the industry have improved consistently (Table 7). The share of foreign banks has got reduced partially due to their increased focus on off-balance sheet non-found based business. Table 7: Bank Group-wise Share: Select Indicators (In percent)

Another major impact of banking sector reforms in India has been the emergence of changing business strategy of the commercial banks. Before the start of banking sector reforms, more than 90 percent of the income of the banks in India came from interest income. But this has gone down very significantly to 80 percent in recent years. It shows the diversification into non-fund business and also into the treasury and foreign exchange business as source of profit for the Indian banks (Mohan, 2004). It is found that there has

been a general decline in the operating expenditure as a proportion of total assets (Table 8). This is achieved by the banking sector in spite of huge expenditure made on the installation and up gradation of the information technology of the banks Table 8: Earnings and Expenses of the Scheduled Commercial Banks in India (In billion)

Again the efficiency of the Indian banking industry can be determined from the significant reduction in the interest spread over the reform period. The reduction has taken place across the bank groups but the spread is highest for the foreign banks and it the lowest for the new private sector banks (Table 9). Table 9: Important indicators of Indias Banking Sector (In percent)

 Capital Adequacy Norms One of the most important components of prudential regulation of banks is the maintenance of minimum capital ratios. The Basel Committee on Banking Regulation and Supervisory Practices,1988 known as Basel I, appointed by the Bank of International Settlements (BIS) recommended adoption of a common capital adequacy standard known as the Cook Ratio. The Cook Ratio is a risk-weighted approach to capital adequacy so that institutions with a higher risk profile maintain higher levels of capital. For the purpose of calculation capital, BIS classifies capital into two broad categories (Sen & Vaidya, 1997), Tier I capital constituting share capital and disclosed reserves and Tier II capital consisting of undisclosed and latent reserves, general provision, hybrid capital and subordinated debt. BIS recommends that Tier II capital must not exceed Tier I capital. The Capital to Risk Asset Ratio (CRAR) suggested by BIS in 1992 was 8 percent, i.e. Tier I and Tier II capital should be equal to minimum of 8 percent of the total assets of the bank. The Narasimham committee 1991 has recommended that all banks in India must reach the figure in a phased manner latest by March 1996. In 1995, 13 of the 27 public sector banks had attained the 8 percent capital to risk assets ratio, 11 had reached 4 percent and remaining less than 4 percent. This move to achieve capital adequacy norms has been greatly boosted by the infusion of fresh capital in several public sector banks by the govt. in its 1993-94 and 1994-95 budgets by the amount of Rs.57000 million and Rs.56000 million respectively. Subsequently the strategy to attain CRAR of 8 percent was gradually raised to 9 percent with effect from 1999-2000. The overall capital position of commercial sector banks Table 10: Distribution of commercial banks according to the CRAR

had witnessed a mark improvement during the reform period (Table 10). At the end of March 2005, 86 out of the 88 commercial banks in India maintain CRAR at or above 9 percent. The corresponding figure for 1995-96 was 54 out of 92 banks.

Table 11: Capital Adequacy Ratio- Bank Group-Wise (Percent)

As far as the individual bank groups are concerned, all the five bank groups in India are maintaining CRAR above 12 percent in 2005. The CRAR level across the bank groups has been continuously increasing over the reform period. The foreign banks are having the highest level of CRAR in 2005 with 14 percent followed by nationalized banks with 13.2 percent. The new private sector banks have the lowest CRAR in 2005 that stood at 12.1 percent (Table 11). Basel I proposals forced the bank to look at credit risk and regulatory capital more closely than they had done earlier. Subsequently, some weaknesses in Basel I framework came up and the Basel committee finally came up with International Convergence of Capital Measurement and Capital Standards: A Revised Framework, popularly known as Basel II in June 2004 (Leeladhar, 2005). The Basel II rests on three pillars, pillar minimum capital requirements, pillar II- supervisory reviews and pillar III- market
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discipline. India has agreed to conform to the Basel II norm by 31 March 2007. The norms are expected to raise capital requirement anywhere from 2 percent to 8 percent (Chakraborty, 2006). The first pillar of Basel II moves beyond the one size fits all approach of 1998 and allow banks to follow one of two choices. The second pillar stresses oversight and monitoring of banks risk management by the top management and board of the bank. The third pillar refers to periodic reporting of specific variables by banks so as to allow the financial markets to appropriately value and discipline them. Finally, transition from the old system to the Basel II norms would be very hard sailing for the Indian banks or to the RBI. For the next few years, this may be the greatest challenges for the Indian banking sector (Chakraborty, 2006). Accounting and Provisioning of NPAs Following the recommendation made by Narasimham committee (1991), RBI had introduced regulation relating to income recognition, asset classification and provisioning in the banks borrowal accounts and to reflect actual health of banks in their balance sheets starting from 1992-93. The regulations have put in place objective criteria for asset classification, recognition of income and provisioning which are

lacking hitherto (Kapila & Kapila, 2000). This change has brought in the necessary quantification and objectivity in to assessment of non-performing assets (NPAs) and provisioning in respect of problem credit. With increasing freedom given to banks, a uniform and transparent accounting standard is critical to the effective monitoring of bank solvency. To start with, it is important to have a definition of the nonperforming asset popularly called as NPA. NPA is an advance where payment of interest or repayment of installments of principal (in case Term Loans) or both remains unpaid for a period of two quarters or more. An amount under any of the credit facilities is to be treated as past due when it remains unpaid for thirty days beyond due date for four quarters up to March 1993, three quarters up to 1994 and two quarters in March 1995. Based on the status of the asset, an asset is classified on to four categories- standard, substandard, doubtful and loss asset. In India, standard assets are defined as credit facilities of which interest or principal or both are paid by due date. Generally, Sub-standard assets are called NPAs. A sub-standard asset is called doubtful asset if it remains NPA for two years 2000 (reduced to 18 months in 2001and further reduced to 12 months over a four year period starting from March 2005). An asset is called as loss, without any waiting period, where the dues are considered uncollectible or marginally collectible. The concept of past due in the identification of NPA was dispensed with from March 2001 and the 90 days delinquency norm was adopted for the classification of NPAs with effect from March 2004. Depending upon the asset classification shown above, banks are to make provisions against NPAs as- 100 percent for loss assets; 100 percent for the unsecured portion plus 20 to 30 percent of the secured portion depending on the period for which the account has remained in doubtful category and general provision of 10 percent on the outstanding balance in respect of sub-standard assets from March 2000. Banks are also to classify small advances of Rs.25,000 and below in these four categories by March 1998 or they are to make provision at the rate of 15 percent of aggregate outstanding including performing loans. Commercial banks are also asked to make provision @ 0.25 percent on their standard advances from year ending March 31, 2000. Banks are also required to create provisions on govt. guaranteed NPAs from first April 2000.

In June 2004, RBI had advised banks to adopt graded higher provisioning in respect of (a) secured portion of NPAs included in doubtful for more than three years category, and (b) NPAs which have remained in doubtful category for more than three years as on March 31, 2004. Provisioning ranging from 60 percent to 100 percent over a period of three years in a phased manner, from the year ending March 31, 2005 has been prescribed. However, advances classified as doubtful for more than three years on or after April 1, 2004, the provisioning requirement has been stipulated at 100 percent. The provisioning requirement for the unsecured portion of NPAs under the above category was retained at 100 percent (RBI Annual Report, 2004-05).

The overall capital adequacy position of commercial banks has shown a great improvement during the reform period. At the end March 2005, 86 out of 88 commercial banks operating in India had maintained CRAR at above 9 percent which was 54 out of 92 banks in 1995-96.Regarding the asset quality of commercial banks, it has shown considerable improvement. The Indian banking industry has accepted a 90 days NPL recognition norm (from 180 days norm) in 2004. Non-Performing Loans (NPLs) as ratio of both total advances and assets have declined substantially and consistently since mid 1990s (Table 12).This has been caused by improvement in the credit appraisal process, upturn of the business cycle, new initiatives of NPLs like promulgation Table 12: Non-performing loans (NPLS) of SCB (In percent)

of SARFAESI Act, greater provisioning and write-off of NPLs enabled by greater profitability, have kept incremental NPLs low. In 1992-93 RBI introduced prudential regulations regarding income recognition, asset classification and provisioning as suggested by Narasimham committee. These strict provisioning rules posed big challenges for the banks but they prevented the NPA situation in India from getting out of control and destabilizing the entire financial structure (Chakraborty, 2006) The reasons and the factors leading to NPA may be listed under the following broad categories (Kapila & Kapila, 2000)a) Diversion of funds for expansion/modernization/setting up new projects etc. b) Time/cost over run while implementing the project. c) External factors like shortage of raw materials, input price escalation, power shortage, natural calamities, industrial recession, etc. d) Business failure like failing to capture market, inefficient management, strike, etc. e) Govt. policies like excise, import duty changes, deregulation, etc. f) Windfall default, siphoning of funds, fraud, misappropriation, management dispute, etc. g) Deficiencies on the part of banks, viz., in credit appraisal, monitoring and follow up, delay in release of limits, delay in settlements of payments/subsidies by govt. bodies, etc.

It has been observed and also backed by evidence from a study of NPAs of 33 banks by RBI that the priority sector lending generates a higher proportion of NPAs than the non-priority sectors. But in recent years the relative contribution of non-priority sectors in the NPAs of banks has been increasing (Mukherjee, 2003). Study has shown that the proportion of NPAs in the priority sector to the total NPAs was 48.27
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percent as on 31 March 1996 and came down to 46.40 percent as on 31 March 1998.An important point to be noted here is that the priority sector advances constitute only 30 percent of gross bank credit during that period. However, gradual increase in the proportion of NPAs in the non-priority sectors could indicate that NPAs are increasingly occurring on borrowal accounts of industrial sector during the recent years. Table 13 shows sector-wise NPAs Bank Group-wise at the end March 2004 and 2005. Table 13: Sector-wise NPAs Bank Group-wise (As on end March) (In percent)

The above table indicates that both public sector banks and old private sector banks have higher NPAs caused by the priority sector lending in 2004 and 2005. But the new private sector banks have far less NPAs created by the 40 percent of total credit priority sector norm. In fact the NPA figure in the priority sector lending of new private sector banks are merely 11.44 percent and 8.91 percent of the total credit for the year 2004 and 2005 respectively. They are accumulating NPAs mainly from the non-priority sector with 87.45 percent and 90.34 percent of their total credit going bad or doubtful in 2004 and 2005 respectively. It is also clear that gradually contribution of non-priority sector to the gross NPAs are increasing. The reason for higher NPAs by the priority sector in public sector banks is mainly due to the social obligations of these banks which always associated with them. The Committee on Capital Account Convertibility (CAS) in 1997 had identified the strengthening of banking sector as very important. The progress in the reduction of the NPAs has been very slow over the years. Given the slow progress in reducing NPAs, the govt. announced in

2002 the creation of asset management companies. More recently, legal constraints on the seizure of defaulters had been removed by the Securities and Contract Empowerment Bill, 2002, which was expected to expedite the recovery process. Other initiative like one time settlement of dues is also in operation but this is a compromise scheme for the banks. The process of strengthening banking sector through reforms in prudential norms and supervision has made considerable progress. However, placing the public sector banks at par with internationally competent banks has not been achieved so far. This requires structural and institutional reforms. Again institutional reform is intrinsically linked ownership and governance issues, on which progress has yet to take place (Kohli, 2005). However, in spite of all the progresses in banking sector reforms, some weaknesses remain and need urgent attentions. Some important weaknesses are like large volume of NPAs, high operational costs, dependence on interest income, slow technological up gradation, relatively low level of human skills, etc. The provisions against bad loans are lower for public sector banks (0.9 percent) in 1999-00 compared to foreign banks (2.1percent). This has to be increased and is urgently required for strengthening banks balance sheets. Further, the commercial banks should try to earn non-interest revenue and that too on a sustainable basis. This has become more important with the declining interest revenue due to fall in rate of interest. Banks can gather revenues from borrowing and investments in market abroad or through services to the corporate sectors in setting or expanding business overseas. In this way banks in India can exploit the potential gains from liberalized economy if they possess the required capacities Ahluwalia (2002).

1.3 PRIVATIZATION OF BANKS

The gradual privatization of public sector banks has been an important component of banking sector reforms in India. This has been prompted more by the need to raise capital to meet the revise capital adequacy norms, rather than a conscious policy decision on the part of the govt. to withdraw from banking operations (Kohli, 2006). In 1994, the committee on Banking Sector Reforms (CBSR) suggested to dilute the govt.s shareholding in public sector banks to 51 percent. But still the govt. has to recapitalize public sector banks to large extent through budgetary support. In 2001, govt. ownership in banks was further reduced to 33 percent with the condition that no individual shareholder can hold more than1 percent of the shares. However, the privatization of public sector banks in India is not yielding the expected result. By 1998, only 9 public banks (out of 20) had gone for public equity to strengthen their capital base. The dismal performance of these banks in raising capital from the market could be gauged from the fact that in 1998-99 the minimum shareholding of govt. was 66 percent. By March 2001, 11 public sector banks were listed at the National Stock Exchange, but the share of top 5 banks accounted for 95 percent of the total traded shares of them. Majority ownership of public sector banks by govt. has been a symbol of faith in India and it is an important point in the process of privatization. The CBSR had suggested functional autonomy of public

sector banks for sound banking system in India. But this has not been possible due to govt. accountability to parliament. Therefore, the govt. will unlikely to distance itself sufficiently from management by delegating all powers of supervision to an entirely independent non-govt. board of directors. This has been delaying the process of privatization of public sector banks in India.

The major resistance in the privatization of the public sector banks has been the opposition from the employees and the officers of these banks. The large and powerful trade unions are resisting tooth and nail the policy of privatizing these banks (Talwar, 2003). Further, the general economic slowdown of Indian economy during second half of the last decade of the 20 century had slowed down the pace of banks privatization process. People did not feel attracted enough to buy the shares of the public sector banks due to the market slowdown. Another reason for the slow progress of the privatization of public sector banks in India has been the poor performance of the majority of these banks. Except two or three major public sector banks, performance of the other has been very poor (Chakraborty, 2006). Different studies undertaken to evaluate the performance of these banks in respect of profitability, volume of NPAs, capital adequacy ratio, etc. reveal that public sector banks perform very badly in the above stated parameters. Though the situations have changed, somewhat, over the years, but still a lot of to be done by the public sector banks to improve their performance. People are apprehensive regarding banks performance in the future and as a result they do not feel excited enough to invest in public sector banks. But few argue that privatization is not the only solution for the woes of public sector banks (Chakraborty, 2006). It is the existence of corporate control along with autonomy on managerial decisions and not the ownership issue that will make a difference in the situation (Sarkar, 1998). With the rise in the level of competition, public sector banks are already trying very hard to keep their market shares intact. It has been argued that many a time the issue of privatization is made on the basis of perception and not based on facts. It also argued by many that there is no strong systematic evidence that private banks are doing better than the public sector banks during the emerging market (Mathur, 2002).
th

2. FINDINGS OF THE STUDY

Following are the major findings from the discussions made above1) The number of Scheduled Commercial Banks in India has increased by not a very significant manner during the period of reforms. 2) The number of bank branches has also not increased much and the population per bank branch office has in fact increased during the reform period. 3) The per capita deposits and credits of the Scheduled Commercial Banks have gone up by 6 to 7 times during the period. 4) The borrowing made from the foreign sources by Indian firms, which are costlier compared to domestic sources prior to reforms, becomes cheaper due to the banking sector reforms undertaken in India. 5) In recent years all the commercial bank groups operating in India have been able to fulfill the priority sector norms laid down by RBI and competitions and opening up of the banking sector has not affected this at all. 6) Public sector banks still comprise the largest share of commercial banks (almost 90 percent) even if various new private (domestic and foreign) banks have entered the Indian market. 7) In terms of share of gross profit and net profit of SCBs, the public sector banks are far ahead of private sector banks in India. 8) Almost all the major Scheduled Commercial Banks operating in India have been able to fulfill the Basel I norms and by March 2008 all banks are to follow the Basel II norms. In 2005, 86 SCBs out of 88 in India have maintained CRAR above 9 percent. 9) The volume of NPAs has also come down by a very significant amount during the banking sector reform period. The NPAs of the public sector banks are generally higher than the private sector banks in India. 10) Non-priority sector NPA comprises the largest share in the total NPA of private sector banks (around 90 percent for new private sector banks and about 60 percent for old private sector banks)) whereas that is for the public sector is about 50 percent. 11) The banking sector in India has given a measured responds to the reforms in terms of profitability of banks as almost all the commercial banks have been able to increase the volume of profits. 12) Last but not the least the banking sector reforms has failed measurably in India when it comes to the privatization of the public sector banks as only 11 out of 20 banks have gone public by 2001 and faired very badly at the stock markets.

3. CHANGE IN BANKING SECTOR

The Indian banking sector has seen unprecedented growthalong with remarkable improvement in its quality of assets and efficiency since economic liberalisation began in the early 1990s. From providing plain vanilla banking services, banks have gradually transformed themselves into universal banks. ATMs, Internet banking, mobile banking and social banking have made "anytime anywhere banking" the norm now. In 2011/12, non-cash payments comprised 91 per cent of total transactions in terms of value and 48 per cent in terms of volume. Within noncash payments, too, the share of payments through cheques has come down from 85 per cent to nine per cent in value, and 83 per cent to 52 per cent in volume between 2005/06 and 2011/12. Banks have taken other measures to improve their functioning, too. As a result, there were 20 Indian banks in the UK-based Brand Finance's annual international ranking of top 500 in 2010, as compared to only six in 2007, according to a report in a leading financial daily. The growth is not restricted to the metropolitan or urban areas. Financial inclusion has been at the forefront of regulators and policy makers in India, a country where approximately half of the population still does not have access to banking services. There have been occasions when banks have acted beyond their role of finance providers. For example, a financial daily reported that Aryavart Gramin Bank, a regional rural bank sponsored by Bank of India, tied up with Tata BP Solar to finance "Solar Home Lighting System" for village homes in Uttar Pradesh. It extended finance of around Rs 10,000 with Rs 3,000 as margin money to be contributed by the beneficiary. The equated monthly installment towards the repayment of the loan amount was less than the amount the villagers had to spend on kerosene requirements per month. The bank's initiative resulted in 20,000 houses getting solar power. It also meant an annual saving of about 192 tanker loads of kerosene.

India's banking system was probably one of the few large banking systems which remained unscathed by the 2008 global financial crisis. However, there is a lot more to be done to make it a truly worldclass sector.

Some of the key developments which could shape the future are:

Basel III: India figures among the very few countries which have issued final guidelines on Basel III

implementation so far. The Reserve Bank of India has given five years for the gradual achievement of Basel III global banking standard. But it seems a tall order for many banks. The challenges of implementing Basel III are further accentuated by the fact that the law mandates the Central government to hold a majority share in public sector banks (PSBs), which control more than 70 per cent of the banking business in India. Further, the high fiscal deficit is likely to limit the government's ability to infuse capital in the PSBs to meet Basel III guidelines, which will require approximately Rs 4.05 trillion to Rs 4.25 trillion over the next five to six years. (One trillion equals to Rs 100,000 crore.) The high capital requirement will also add pressure on return of equity of banks.

New banks: Although there has been little progress on the draft norms for issuing new banking licences, the entry of new banks could have a significant impact on the Indian banking system. Given the huge unbanked population, there is surely a scope for more banks .

Foreign banks: RBI has been keen on allowing foreign banks a larger role in the Indian banking system since February 2005, when it first issued the road map for presence of foreign banks in India. In May 2012, the government also facilitated the process by proposing to exempt foreign banks from the 30 per cent tax on capital gains and stamp duty while converting branches into a new entity. RBI has also mandated foreign banks with 20 and more branches to achieve priority sector targets and sub-targets at par with their domestic counterparts.

Developing corporate bond markets: Developing corporate bond markets is an important link in a well developed financial market. Although the government has taken some steps in this direction, a lot more needs to be done. Unique Identification (UID) project: Among the many initiatives, the government's UID project is likely to have significant impact. Given the numbers out of the reach of organised banking, it can prove to be transformational by giving banks an access to a large untapped customer base. The whole range of government payments - under subsidies and benefits of various welfare schemes - will be routed through banks.

Social media: This adds another dimension for banks to manage their relationship with customers. It already had over 45 million users in India in 2011, which is expected to grow to over 88 million by the next year with over 75 per cent under the age of 35, according to media reports. Although banks in India have been a little late in using social media, they have been making fast progress. With increasing volume and complexity of the banking business, it will be imperative for the regulator to move gradually towards more offsite monitoring than onsite. Technology will play a much larger role in the overall supervision of the banking system. There are likely to be transformational changes in the entire regulatory system for financial services. Given the significant overlap between various sub-sectors, the Financial Sector Legislative Reforms Commission, headed by former Justice B.N. Srikrishna, in its approach paper, had suggested large scale consolidation. This is expected to lead to reduced intermediation cost, benefit from the economies of scale and consistent treatment across sub-sectors.

"The future belongs to those who prepare for it today," goes a famous quote. The changes in the banking landscape will require banks to also adapt to their new environment. Banks of the future will have to be

nimble and lean organisations with technology integrated to support a sustainable and scalable business. They will need to have a flexible organisational structure with decentralised decision making to reduce turnaround time for various processes. This will be especially true when a number of new entities including non-banking finance companies (NBFCs), large corporate houses and microfinance institutions (MFIs) get banking licences. In order to serve potential customers in unbanked areas, banks should be willing to experiment with various business models to build a scalable and profitable business. Technology resources will have to be shared to reduce cost. At the same time, banks of the future will need to understand the technology-savvy Gen-Y customers and design products accordingly. Banks will have to deploy the majority of their employees in sales and marketing roles to cross-sell services to existing customers. There will be an increased demand for skilled personnel from other disciplines. Banks will have to use data analytics tools to gain insights from their existing customers' data to increase their business and customer loyalty. One of the prominent ingredients for the success of a bank will be its ability to partner with multiple agencies to increase its business . The Indian banking landscape is expected to evolve to have regional as well as national players. Except for a few large banks having pan-India presence, many of the mid and small banks will specialise in certain functions/regions in diverse markets. Rather than every bank trying to carry out all the banking functions throughout the country, banks are likely to identify their core competencies and build on those. A bank that avoids "one-size-fits-all products", acts as a knowledge banker, provides all financial needs at a click, is fundamentally strong, manages risk and adheres to global regulations, harness iOS and Android platforms to the fullest, design better, faster and convenient delivery channels will no doubt be called a successful bank.

CONCLUSION
It has been observed that the banking sector in India has provided a mixed response to the reforms initiated by the RBI and the Govt. of India since the 1991. The sector has responded very positively in the field of enhancing the role of market forces, regarding measures of prudential regulations of accounting, income recognition, provisioning and exposure, introduction of CAMELS supervisory rating system, reduction of NPAs and regarding the up gradation of technology. But at the same time the reform has failed to bring up a banking system which is at par with the international level and still the Indian banking sector is mainly controlled by the govt. as public sector banks being the leader in all the spheres of the banking network in the country.

REFERENCES
Chakraborty, Rajesh (2006), The Financial Sector in India: Emerging Issues, P. 156, Oxford University Press. Talwar, S. P. (2003), Competition, Consolidation and Systematic Stability in the Indian Banking Industry, BIS paper no. 4 Mohan, Rakesh (2004b), Financial Sector Reforms in India: Policies and Performance Analysis, Reserve Bank of India Bulletin, October. Dhar, P. K. (2002), Indian Economy its Growing Dimensions, Kalyani Publishers. Committee on Financial System (1991), p.30. Mohan, Rakesh (2006), Financial Sector Reforms and Monetary Policy: The Indian Experience, Lecture delivered at the Conference on Economic Policy in Asia at Stanford, June 2. Kohli, Renu (2005), Liberalizing Capital Flows: Indias Experience and Policy Issues, Oxford University Press. Ahluwalia, M. S. (2002), Reforming Indias Financial Sector: An Overview, Oxford University Press. Sen, Kunal, and R. R. Vaidya (1997), The Process of Financial Liberalisation in India, Oxford University Press. http://businesstoday.intoday.in/story/best-banks-2012-indian-banking-challenges/1/189858.html