Narasimhan committee recommendation on Banking sector

India has both public and private sector banks. As India liberalized its economy in 1991, it was felt that banks were not performing efficiently. During the economic crises, it was recognized that banks have a crucial role to play in the economy and, hence, the banking sector had to be more competitive and effective. For that, the Ministry of Finance under then finance minister Dr. Manmohan Singh set up Narasimham Committee to analyze India’s banking sector and recommend reforms.

The Committee was set up under the chairmanship of Maidavolu Narasimham. He was the 13th governor of the Reserve Bank of India (RBI) from 2 May 1977 to 30 November 1977. There was another Committee, this time under P Chidambaram as the finance minister, headed by Narasimham, which was formed in 1998. The first Committee was set up in 1991 and is referred to as the Narasimham Committee- I and the 1998 Committee is known as the Narasimham Committee – II.

The first Narasimhan Committee made the following recommendations for the growth of the banking sector.

  1. A 4-tier hierarchy for the Indian banking system with 3 or 4 major public sector banks at the top and rural development banks for agricultural activities at the bottom
  2. A quasi-autonomous body under RBI for supervising banks and financial institutions
  3. Reduction in statutory liquidity ratio
  4. Reaching of 8% capital adequacy ratio
  5. Deregulation of Interest rates
  6. Full discloser banks’ accounts and proper classification of assets
  7. Setting up Asset Reconstruction fund

Narasimham Committee- II : This Committee is also known as the Banking Sector Committee. The task of the Committee was to review the progress of the implementation of reforms and to suggest a design for further strengthening of the sector.

The major recommendations submitted by the Committee were:

  1. Stronger banking system: The Committee recommended the merger of major public sector banks to boost international trade. However, the Committee warned against merging stronger banks with weaker banks.
  2. Narrow Banking: Some of the public sector banks at that time had the problem of high non-performing assets (NPAs). For successful rehabilitation of such banks, the Committee recommended Narrow Banking Concept where the banks were allowed to put their funds in short-term and risk-free assets.
  3. Reform in the role of RBI: The Committee also recommended reforms in the role of the RBI in the banking sector. The Committee felt that RBI being the regulator, it should not have ownership in any bank.
  4. Government ownership: It also recommended that government ownership of banks should be reviewed as it hampers the autonomy of banks resulting in mismanagement.
  5. NPAs: The Committee wanted the banks to reduce their NPAs to 3% by 2002. It also recommended the formation of Asset Reconstruction Funds or Asset Reconstruction Companies. The recommendations led to the introduction of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
  6. Capital Adequacy Ratio: It also proposed that the government should raise the Capital Adequacy Ratio norms.
  7. Foreign banks: It also proposed to raise the minimum start-up capital to $25 million for foreign banks from $10 million