Dr. Y. V. Reddy, Governor, Reserve Bank of India
recently came to Pakistan to attend a meeting of Asian Clearing Union.
Taking advantage of his presence, Dr. Ishrat Husain, Governor, State
Bank of Pakistan invited him to deliver a talk on banking sector
reforms in India. His presentation was keenly attended by a large
number of bankers and executives from other financial institutions.
Following are the excerpts from his very comprehensive presentation.
The Indian financial system, prior to commencement
of reforms in the early nineties, was essentially catering to the
needs of planned development on a mixed economy framework where the
public sector plays a dominant role in the economic activities. The
strategy required huge development expenditure, which was met through
government's dominance of ownership of banks, automatic monetization
of the fiscal deficit and subjecting banking sector to large
preemptions. There was a complex structure of administered interest
rates guided by the social concerns and cross-subsidization.
The reforms measures were initialized and sequenced
to create an enabling environment for banks to overcome the external
constraints. Sequencing of interest rate deregulation was an important
component of the reform process. The process was gradual and
predicated upon the institution of prudential regulation for the
banking system, market behavior, financial opening, and above all, the
underlying macroeconomic conditions.
As part of the reforms program, initially there was
infusion of capital by the government in public sector banks, which
was followed by expanding the capital base with equity participation
by the private investors. Diversification of ownership led to greater
market accountability and improved efficiency.
One of the major objectives of banking sector
reforms has been to enhance efficiency through competition. Since
1993, twelve new private sector banks have been set up. Foreign direct
investment in the private banks is now allowed up to 74%, subject to
conformity with the guidelines issues from time to time.
Consolidation in the banking sector has been
another feature of the reform process. This also encompassed DFIs,
which have been providers of long-term finance while the distinction
between short-term and long-term finance provider has increasingly
become blurred over time. The complexities involved in harmonizing the
role and operations of DFIs were examined and Reserve Bank of India
enabled the merger of a large DFI with its commercial banking
In 1994, a Board for Financial Supervision (BFS)
was constituted. It comprised of selected members of the RBI Board
with a variety of professional expertise to exercise 'undivided
attention to supervision'. The BFS also ensure an integrated approach
to the supervision of commercial banks, DFIs, non-banking finance
companies, urban cooperative banks and primary dealers.
While the regulatory framework and supervisory
practices have almost converged with the best practices elsewhere in
the world, two points are noteworthy. The minimum capital to risk
assets ratio has been kept at 9% and banks are required maintain
separate Investment Fluctuation Reserve out of profit at 5% of their
investment portfolio under the categories 'held for trading' and
'available for sale'.
In order to ensure timely and effective
implementation of the measures, RBI has been adopting a consultative
approach. Suitable mechanisms have been instituted to deliberate upon
various issues so that the benefits of financial efficiency and
stability percolate to the common person and the services of the
Indian financial system can be benchmarked against international best
standards in a transparent manner.
The banking reforms have had major impact on the
overall efficiency and stability of the banking system in India. The
present capital adequacy of Indian banks is comparable to those at
international level. There has been a marked improvement in the asset
quality. The reform measures have also resulted in an improvement in
the profitability of banks and return on assets of bank has also
Considerable emphasis is on appropriate mix between
elements of continuity and change in the process of reform, but the
dynamic elements in the mix are determined by the context. While there
is usually a consensus on the broad direction, relative emphasis on
various elements of the process of reform keeps changing, depending on
the evolving circumstances.
Banks are constantly pushing the frontiers of risk
management. Compulsions arising out of increasing competition are
inducing banks to explore new avenues to augment revenues along with
trimming costs. Consolidation, competition and risk management are
critical to the future of banking, but governance and financial
inclusion would also emerge as key issues for a country like India, at
this stage of socio-economic development.
After hearing Dr. Reddy one tends to arrive at the
conclusion that there is great similarity between the banking sectors
and the reforms initiated by Pakistan and India. The only difference
is in the size and the level of conservatism. The positive point about
Pakistan is that smaller size makes Pakistani banking sector easy to
manage and the attitude of sponsors towards following global standards
also makes the reform process easier to manage. However, there is no
room for complacency as lot more remains to be done that too at a
faster pace. Pakistani banks have been able to contain the level of
non-performing loans, which was one of the reasons for the fragile
state of banks, when they were operating under the state control.