SECOND GENERATIONAL FINANCE SECTOR REFORMS IN INDIA

Since mid-1991, a number of reforms have been introduced in the financial sector in India.
The main emphasis on the financial sector reform has been on the banking system so as to
improve the performance of public sector banks. The Narasimhan Committee constituted in
1991 laid the foundation for the revamping of the financial sector in India. The Committee
had submitted two reports- in 1992 and 1998 which gave immense importance on enhancing
the efficiency and viability of this sector.
Major contours of the financial sector reforms in India
On a general understanding, there are three groups of reform measures that are used to handle
the problems faced by the financial sector. These are that of removal of financial repression,
rehabilitation of the banking system and lastly, deepening and development of capital
markets.The focal issues addressed by financial sector reforms in India have primarily aimed
to include the following:
● Removal of the problem of financial repression.
● Creation of an efficient, profitable and healthy financial sector.
● Enabling the process of price discovery by market determination of interest rates
which leads to an improvement in the efficiency in the allocation of resources.
● Providing institutions with greater operational and functional autonomy.
● Prepping up the financial system for international exposure and competition.
● Introduction of private equity in public sector banks and their listing.
● Opening up of the external sector in a regulated manner.
● Promoting financial stability in the back-drop of domestic and external shocks.
The Two Phases of Financial Reform
To overcome the economic crisis that plagued the Indian economy in May 1991, the
government undertook extensive economic reform policies that brought along with them an
era of privitisation, deregulation, globalisation and most importantly, liberalisation.
The financial reforms since the 1990s can be classified into two phases. THE FIRST
PHASE, ALSO KNOWN AS THE FIRST GENERATION REFORMS, was aimed at the
creation of an efficient, productive, profitable and healthy financial sector which would
function in an environment of functional autonomy and operational flexibility. The first
phase was initiated in 1992 based on the recommendations of the Committee on Financial
System. While the early phase of reforms was being implemented, the global economy was
also witnessing prominent changes coinciding with the movement towards global integration
of financial services. Narasimhan Committee I noted that the objective of Financial Sector
Reforms in India should not focus on correcting the present financial weaknesses but should
strive to eliminate the roots of the cause of the present challenges being faced by the Indian
market economy.
THE SECOND GENERATION REFORMS OR THE SECOND PHASE commenced in
the mid-1990s and laid greater emphasis on strengthening the financial system and on the
introduction of structural improvements. Narasimhan Committee II was to look into the
extent of the effectiveness of the implementation of reforms suggested by Narasimhan
Committee I and was entrusted with the responsibility to lay down a course of future reforms
for the growth and integration of the Indian banking sector with international standards.
Second Generational Policy Reforms in the Financial Sector
Indian financial reforms can be explained by way of a four-pronged approach viz. (a) banking
reforms, (b) debt market, (c) forex market reforms, and (d) reforms in other segments of the
financial sector.
1 Banking Reforms
Despite the general approach of the financial sector reform process, many of the regulatory
and supervisory norms were started out first for commercial banks and thereafter were
expanded to other financial intermediaries. Banking reforms consisted of a two-fold process.
Firstly, the process involved recapitalisation of banks from government resources to bring
them at par with appropriate capitalisation standards. On a second level, an approach was
adopted replacing privatisation. Under this, increase in capitalisation has been brought about
through diversification of ownership to private investors up to a cap of 49 per cent and thus
keeping majority ownership and control with the government.
The main idea was to increase the competition in the banking system by a gradual process
and unlike other countries, banking reform in India, did not involve large-scale privatisation.
Due to such widening of ownership, majority of these banks have been publicly listed which
in turn has brought about greater transparency through enhanced disclosure norms. The
phased introduction of new banks in the private sector and expansion in the number of
foreign banks provided for a new level of competition. Furthermore, increasingly tight
capital adequacy norms, prudential and supervision norms were to apply equally across all
banks, regardless of their ownership.
2)Government Debt Market Reforms
A myriad of reforms have been introduced in the government securities debt market. Only in
the 1990s a proper G-Securitites debt market had been initiated which had progress from
strategy of pre-emption of resources from banks at administered rates of interest to a system
that is more market oriented.The main instrument of pre-emption of bank resources in the
pre-reform period was through the prescription of a Statutory Liquidity Ratio i.e. the ratio at
which banks are required to invest in approved securities. It was initially introduced as a
prudential measure.The high SLR reserve requirements lead to the creation of a captive
market for government securities which were issued at low administered interest rates. After
the introduction of reforms, the SLR ratio has been brought down to a statutory minimum
level of 25 per cent. Numerous measure have been taken to broaden the G-Sec market and to
increase the transparency. Automatic monetisation of the government’s deficit has been given
a go-by. At present, the market borrowings of the central government are undertaken through
a system of auctions at market-related rates.
3)Forex Market Reforms
The foreign exchange market in India had been characterised by heavy control since the
1950s commensurate with increasing trade controls designed to foster import substitution.
As a result of these practises, the current and capital accounts were shut and forex was made
available through a complex licensing system undertaken by the RBI. Thus, the major task
before the government was to move away from a system of total control to a market-based
exchange rate system. This transformation in 1993 and the subsequent adoption of current
account convertibility were the highlights of the forex reforms introduced in the Indian
market. Under these reforms, authorised dealers of foreign exchange as well as banks have
been given greater autonomy to carry out a wide range of activities and operations.
Furthermore, the entry of new players has been allowed in the market. The capital account
has become effectively convertible for non-residents but still has some reservations on
foreign residents.
4) Reforms in other segments of the Finance Sector
Several measures have been introduced for non-banking financial intermediaries as well. Non
banking financial companies (NBFCs) including those involved in public deposit taking
activities, have been brought under the supervision of the RBI.As for Development
Finance Institutions (DFIs), NBFCs, urban cooperative banks, specialised term-lending
institutions and primary dealers- all of these have been brought under the regulation of the
Board for Financial Supervision. Reforms were introduced in phases for this segment as well.
Till the 1990s, insurance business was under the public ownership. After the passage of the
Insurance Regulation and Development Act in 1999, many changes have been introduced.
The most prominent among these was the setting up of the Insurance Regulatory and
Development Agency as well as the setting up of joint ventures to handle insurance business
on a risk sharing or commission basis.
Another important step has been the setting of the Securities and Exchange Board of India
as a regulator for equity markets and to improve market efficiency and integration of national
markets and to prevent unfair practices regarding trading. The reform measures in the equity
market since 1992 have laid emphasis mainly on regulatory effectiveness, enhancement of
competitive conditions, reduction of information asymmetries, development of modern
technological infrastructure, mitigation of transaction costs and lastly, controlling of
speculation in the securities market. Furthermore, the reform process had the effect of
putting an end to the monopoly of the United Trust of India by opening up of mutual
funds to the private sector in 1992. Mutual funds have been permitted to open offshore
funds for the purpose of investing in equities in other jurisdictions. Another development
which took place in 1992 was the opening up of the Indian capital market for foreign
institutional investors. The Indian corporate sector has been granted permission to tap
international capital markets through American Depository Receipts, Foreign Currency
Convertible Bonds, Global Depository Receipts and External Commercial Borrowings.
Moreover, now Overseas Corporate Bodies and non-resident are allowed to invest in Indian
companies.
Major Reforms In The Banking Sector In The Year 2019
1. Ten Public Sector Banks Merged into four :In the bid to strengthen the role of the
public sector banks in the Economy, the Government of India rolled out the third
round of Bank merger plan in September. The ministry decided to merge ten public
sector banks into a total of four. As per the merger, selected acquirer banks were to
take over the allotted Bank(s). Punjab National Bank was decided to merge with
Oriental Bank of Commerce, and the United Bank of India; Indian Bank with
Allahabad Bank, Canara Bank with Syndicate Bank, and Union Bank of India with
Andhra Bank and Corporation Bank.
By merging the PSBs, the Government aimed to reduce the number of Public Sector Banks,
which can help fulfill the vision of creating 3-4 global sized banks. Further, the merger could
indeed help raise a large capital base for the Economy, as banks would be able to allow more
loans with merged capitals. Also, this could make it easier for the authorities to monitor a
limited number of banks. The merger comes into effect latest by April 2020.
0. Loan Rates came down as RBI reduced Lending Rates: The Reserve Bank of India
is the central bank, and thus being the regulatory authority of all banks, RBI took the required
steps by changing and revising its charges from time to time throughout the year. In the year
2019, the RBI cut its lending rates six times in a row, by splashing down repo rate, (the rate at
which the RBI lends funds to the banks), by 135 basis points bringing it to 5.15% and reverse
repo rate (rate at which the central bank borrows money from commercial banks) at 4.90%.
Both repo rate and reverse repo rate are essential tools used by RBI to regulate the liquidity
and credit availability in the market. A lower repo rate by RBI is an attempt to spur credit
growth in the Economy.
Further, to provide more in the Economy, in September 2019, RBI made it compulsory for
Banks to link the floating interest rates on loans to RBI’s repo rate or to the other external
benchmarks set by RBI by October 1. The interest rates on loans were earlier affected by the
MCLR. However, the repo linked interest rate as an effective benchmark is a great move to
benefit the customers and to encourage more liquidity in the market, as it will bring in more
transparency.All the measures taken by RBI were set to benefit the loan borrowers as it can
help customers save more on their interests.
0. Aadhaar and PAN Card Authentication Mandatory to Fill ITR: The authorities
introduced the Aadhar Amendment Bill 2019, in June. The bill allows the Aadhaar card to be
used as a valid Id Proof for opening a bank account. After this recognition, Aadhaar became a
compulsory tool in any financial activity, such as to deposit large cash deposits. Later,
Aadhaar linked KYC became a compulsion for existing and new account holders in banks.
However, this was ruled out by the Supreme court’s judgment in September 2019, which
indeed made Aadhaar a necessary document to fill ITR by emphasizing on PAN cards linked
to Aadhaar as the only valid PAN cards. With effect from April 1, 2020, any PAN Card not
linked to Aadhaar will be considered invalid and people will not be able to file their income
tax returns. The deadline for this has been extended from December 31, 2019, to March 31,
2020.
0. Banking became Easier with Digital Options: Digitalization is the talk of the hour,
especially when it comes to factors like upgrading and ease. The Indian Banking sector
experienced a great uproar in the digital services in the year 2019. Many Banks, including the
popular ones like SBI, Kotak Mahindra, and Axis Bank, planned to go onboard with digital
services by incorporating artificial intelligence and analytics in their banking mechanism. A
majority of banks have started offering almost all of their offline services on online platforms,
such as the Public Sector Banks online platform launched in August 2019,
‘psbloansin59minutes’, or Axis Bank’s ‘Express FD’ platform launched in October 2019 to
open an FD account online. Indeed, even public sector lenders like India Post went all-digital
in the year, by providing a mobile facility for PPFs and Savings account.

Digital moves by the banks to shift towards the cashless Economy, have uplifted the financial
sector well, by providing access to easier payments. E-commerce, mobile commerce, and
online payments have been successful. The upliftment of UPI (Unified Payments Interface) in
the year 2019 is evident in the ease and convenience that digital payments provide users with.
UPI transactions crossed around 1 billion transactions in the month of October 2019. Also,
the Point of Sale Terminals rose to 3.99 million in June 2019, by 20.5% than the previous
June. Thus, the year 2019 contributed well to make the Indian Economy digitalized and
cashless.
5.Revised ATM Mechanisms for Safe and Secure Transactions: The year began with the
reform in ATM transactions. With effect from January 1, 2019, ATM cards without chips
were unacceptable, and the chip-based magnetic striped card was brought to effect. This
changed the way the ATM cards operated. Earlier the card needed to be swiped once for
verification; however, now the card remains inserted in the ATM machine until the
transaction completes. This move was initiated to make ATM transactions more secure and
safe.
In addition to that, various Banks like SBI, HDFC, Axis, and ICICI revised the number of
free transactions to five each month that can be availed with an ATM card after RBI posted a
notification in June 2019 to do the same. Charges on exceeding the number of free
transactions were increased than the earlier ones and were inclusive of GST. Apart, as per the
August notification by RBI, Banks were instructed to treat failed transactions ( failed
transactions due to technical reasons or unavailability of the fund in the ATM) not as a part of
the available five free transactions. Thus, in total various ATM changes were incorporated in
the year 2019.