1. Liberalisation 1991

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School of Management Studies, Nagaland University

MFM 108 Securities & Portfolio Analysis

1

Liberalisation of the Indian Financial System

By

Rokov N. Zhasa

(NU Reg. No. 111291 of 2011-2012)

Content

1.1 Introduction

1.2 Financial Sector Reforms

1.2.1 Narasimham Committee

1.3 Capital Market Reforms

1.4 Reforms in Development Banking Sector

1.5 Conclusion

Reference

1.1 Introduction

The main aim of the liberalisation was to dismantle the excessive regulatory framework that

curtailed the freedom of enterprise. Over the years, the country had developed a system of

licencepermit raj. The aim of the new economic policy was to save the entrepreneurs

from unnecessary harassment of seeking permission from Babudom (the bureaucracy of the

country) to start an undertaking.

Similarly, the big business houses were unable to start new enterprises because the

Monopolies and Restrictive Trade Practices (MRTP) Act had prescribed a ceiling on asset

ownership to the extent of Rs.100 crores. In case a business house had assets of more than

Rs.100 crores, its application after scrutiny by the MRTP Commission was rejected. It was

believed that on account of the rise in prices this limit had become outdated and needed a

review. The second objection by the private sector lobby was that it prevented big industrial

houses from investing in heavy industry and infrastructure, which required lump sum

investment. In order that the big business could be enthused to enter the core sectors-

heavy industry, infrastructure, petrochemicals, electronics etc., with big projects, the

irrelevance of MRTP limit was recognized and hence scrapped.

The major purpose of liberalisation was to free the large private corporate sector

from bureaucratic controls. It, therefore, started dismantling the regime of industrial

licensing and controls. In pursuance of this policy, the industrial policy of 1991 abolished

industrial licensing for all projects except for a short set of 18 industries. This long list also

got truncated to six by 1999.


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1.2 Financial Sector Reforms

The experience of successful developing countries indicates that rapid growth requires a

sustained effort at mobilizing savings and resources and deploying them in ways, which

encourage efficient production. Financial sector reform thus constitutes an importantcomponent of the programme of stablisation and structural reform.

1.2.1 Narasimham Committee

At the outset the Government had recognised that financial sector reform was an integral

part of the new economic policy. A high level committee headed by Mr. M.N. Narasimham

was appointed to consider all relevant aspects of the structure, organisation, functions and

procedures of the financial system.

Following the committees report in November 1991, the Government embarked ona farreaching processes of reform covering both the banking system and the capital

market. The need for a thorough going reform of the financial system was further

underscored by the now famous securities scam (or irregularities of the banks) news of

which broke out in April 1992.

The Narasimham Committee recognised the fact that the quantitative success of the

public sector banks in India was achieved at the expenses of deterioration in qualitative

factors such as profitability, efficiency and the most important the quality of the loan

portfolio which now needed to take the centre stage. The elements of the recovery

programme reiterated by the committee are as follows:

Reduce presumption of lending capacity through staged reductions in SLR and CRR,while moving the yield on government debt to marketrelated levels.

Stress availability rather than subsidy in provision of credit to the priority sector, andrestrict cross-subsidy only to the smaller borrowers. The goal should be to establish

incentives that induce adequate flows of credit to priority uses, especially

agriculture, without compromising on prudential and commercial consideration.

Move to objective, internationally recognised accounting standards, with suitabletransitional provisions to give banks time to adjust. These accounting norms will

clarify and strengthen the incentives for bank managements to exercise greater care

in credit assessment and recover.

Make additional capital available from the government and the capital markets tostrengthen banks financial position and provide a basis for future growth. Provision

of capital by the government will be conditional on monitorable improvements in

the management and recovery performance of each bank. Access to the markets

will impose the additional discipline of prospectus registration or assessment by

credit rating agencies and accountability to non-governmental shareholders.


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Improve prospects for recovery by setting up special recovery tribunals in majormetropolitan areas.

Set up a credit information database for exchange of information on the credithistory of large borrowers subject to confidentiality.

Upgrade the caliber of appointees to board level posts, stressing longevity andsecurity of tenure.

Enhance managerial accountability and stress performancerelated promotion. Encourage technological modernization in banks through computerization and

greater labour flexibility.

Encourage greater competition for public sector banks through the controlled entryof modern, professional private sector banks including foreign banks.

Create a new board for financial supervision to devote exclusive attention to issuesof compliance and supervision and review the Banking Regulation Act.

Ensure viable mechanisms for supply of credit to the rural sector, small-scaleindustry and weaker sections.

Targets set

The steadfast pursuit of this agenda promised to transform Indian banking and the public

sector banks in particular (By June 1996 the following targets had to be attained).

a) all public sector banks achieving 8 percent capital to riskassets ratiob) half the public sector banks (weighted by deposits) should be quoted on thec) stock market with appropriate representation of shareholders on bank boards.d) significant entry of new private sector bankse) SLR and CRR appreciably reducedf) interest rates deregulatedg) at least 500 branches of public sector banks would be fully computerized.

1.3 Capital Market Reforms

The Securities Exchange Board of India (SEBI) has been issuing guidelines from time to time

for establishing a fair and transparent capital market. Some of the major measuresannounced by SEBI are briefly enumerated below:

In October 1993, regulations for underwriters of capital issues and capital adequacynorms for the stock brokers in the stock exchanges were announced. As per

modified guidelines, bonus issues can be made out of free reserves built out of the

genuine profits or share premium collected and the interest of holders of fully or

partly convertible debentures will have to be taken into account while issuing bonus

shares.

The stock exchanges have been directed to broadbase their governing boards andchange the composition of their arbitration, default and disciplinary committees.


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SEBI notified regulations for bankers to issues in July 1994. The regulations makeregistration of bankers to issues with SEBI compulsory. It stipulates the general

obligations and responsibilities of the bankers to issues and contains a code of

conduct. Under the regulations, inspection of bankers to an issue will be done by the

Reserve Bank on request from SEBI.

RBI has liberalized the investment norms evolved for NRIs by allowing companies toaccept capital contributions and issue shares or debentures to NRIs or overseas

corporate bodies without prior permission.

The government has allowed foreign institutional investors (FIIs) such as pensionfunds, mutual funds, investment trusts, asset or portfolio management companies

etc. to invest in the Indian Capital market provided they register with SEBI.

SEBI has made it compulsory for credit rating of debentures and bonds of more than18 months maturity.

The maximum debt-equity ratio of banks is 2:1 and the minimum debt servicecoverage ratio required is 1:2.

Reductions in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) According to the Narasimham Committee, one of the problems facing our banking

system was that the levels of SLR and CRR had been progressively increased over the

past several years. In the case of SLR this happened because of the desire to mobilize

even larger resources through so-called market borrowing (at below-market rates) in

support of the central and state budgets. In the case of the CRR this happened

because of the need to counter the expansionary impact on money supply of largebudget deficits. Together the SLR and CRR stipulations preempted a large part of

bank resources into low income earning assets thus reducing bank profitability and

pressurising banks to charge high interest on their commercial advances. The high

SLR and CRR were in effect a tax on financial savings in the banking system and

served to encourage flows in the market where this tax did not apply. The

Government therefore decided to (and has) reduced SLR in stages over a three year

period from 38.5 per cent to 25 per cent and that of CRR over a forty-year period to

a level of 10 per cent.

1.4 Reforms in Development Banking Sector

The Narasimham Committee recognized that the development financial institutions

operation in India was marked by the total absence of competition in the matter of

provision of loans and medium-term finances. The system had evolved into a segmentation

of business between DFIs and the banks, the latter concentrating on working capital finance

and the former on investment finance. Borrowers as a consequence had no choice in

selecting an institution to finance their projects. The committee suggested delinking of

these institutions from the state governments for better efficiency. The operations of the

DFIs in respect of loan sanctions should be the sole responsibility of the institutions


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themselves based on a professional appraisal of projects. The Government also embarked

on a process of disinvestments in some of the bigger institutions like IDBI etc.

1.5 Conclusion

With a looming finaincial crisis facing the nation, the Government of India appointed the

high-level committee headed by Mr. M.N. Narasimhan. The committee considered all

relevant aspects of the structuring, organisation, functioning and procedures of the Indian

financial system. The Committee placed its report before Parliament in December, 1991.

The committee many far reaching recommendations with regard to carrying out reforms

covering the length and breadth of the Indian Financial system. The reform measures that

followed have been credited for the creation of the framework that has enabled India

become one of the fastest growing economies of the world.

Reference:

1. MS 03 Economic and Social Environment, Block 5 Economic Reforms Since 1991, Unit19 ECONOMIC REFORMS : LIBERALISATION, GLOBALISATION AND PRIVATISATION, pp

33-48 (IGNOU)

2. MS 03 Economic and Social Environment, Block 5 Economic Reforms Since 1991, Unit20 FINANCIAL SECTOR REFORMS, pp 49-72 (IGNOU)

Documents

1. Liberalisation 1991