In the previous chapter we considered Reforms in Banking Sector, in the context of the views expressed by an eminent authority, reflecting the Government of India, Mr.P.Chidambaramn, former Finance Minister, who narrated about the programmes already executed and still to be taken up in a speech delivered at the Administrative Staff Training College. It is of interest to learn that Mr.Narasimhan, the author of the two Reports on Financial Sector Reforms happens to be the present chairman of the ASCI, Hyderabad.

Mr.P.Chidambaram as a former Finance Minister may be considered to reflect the thinking of the Government of India. In today's deregulated economic environment, banking is directly concerned with RBI. It is, therefore, worth considering the views expressed by a senior serving executive of the RBI, Mr.YV Reddy, an eminent scholar with his in-depth knowledge on contemporary issues relating to banking development and banking problems of our country.

Excerpts from the Speech of Mr.YV Reddy, Deputy Governor of the Reserve Bank of India, on the captain "Financial Sector Reforms: an Update" at the Annual General Meeting of the Indian Banks' Association and the Banks' Sports Board held in Mumbai, on 15 March 2001.
(extracted from web site of Bank of International Settlement (http://www.bis.org/review/r010328b.pdf)

SLR has been brought down to the statutory minimum. Progress in reduction in CRR continues to be closely related to the pace of reduction in fiscal deficit, monetary developments vis-�-vis growth in real output, and uncertainties in forex markets. On all these fronts, greater comfort in the past could have helped more rapid reduction in CRR, to achieve the medium term objective. In a structural sense, RBI has since progressed in the pursuit of the objective viz. proposal to amend the law relating to preemptions to give flexibility to RBI to bring the CRR and SLR even below 3 per cent and 25 per cent, as and when rendered possible. In a procedural sense, significant progress has been made in the prescribed manner of calculating and maintaining the reserve requirements.

Reducing preemption and imparting a greater flexibility and simplification of procedures continues to be at the top of the RBI's agenda for reform. In pursuing this objective, the RBI keeps in view not only the balance sheets of the banks but also the need to move towards universal banking, and diversifying financial intermediation which is heavily concentrated now in banks rather than non-banks. Reduction in refinance window and introduction of Liquidity Adjustment Facility have provided greater flexibility in this regard, and further progress in these two areas is bound to ensure lesser recourse to preemptions in the conduct of monetary policy.

On interest rates, the reform objectives in terms of greater deregulation and rationalisation of small savings rates etc. have been achieved to a significant degree. Further progress in deregulation continues to depend on some stability in inflationary expectations, which in turn is dependent on credibility of price-stability. The emphasis in future has to be to impart greater flexibility to interest rate regimes, in an environment of reasonable price-stability and a rational tax-regime. A rational tax-regime in the context of an appropriate interest regime should factor in several elements viz. treatment of interest-income vis-�-vis dividend income and of contractual savings vis-�-vis marketable debt instruments.

The statement of Finance Minister in the latest budget speech that an Expert Committee will be appointed to provide recommendations on the issue of better system for determination of the interest rates governing Provident Funds and Small Savings is welcome. It is hoped that the Expert Committee would address broader issues such as tax-regimes affecting all forms of savings, especially the possible distortions between debt and equity instruments. However, interest rate flexibility should not be taken to mean a continuous downward movement in interest rates. In fact, the reference in the Economic Advisory Council Report to stable real rates of interest does imply that depending on the inflation rates, the nominal interest rates would move up and down. Further more, it is necessary for banks to appreciate the need for reduction in their interest-spreads. Cost of debt funds to investors can come down, without hurting the saver, the goose that lays golden eggs, only and only as the interest-spreads of banking sector comes down further.

Here, the public sector banks continue to be on a different footing from private sector banks and approaches for reform do vary. In any case, impressive progress has been made in imparting a supervisory environment conducive to enhancing efficiency while maintaining stability of the system. The banking system of India has shown remarkable resilience in the face of several challenges and changes in external environment. In the medium term perspective, the main challenge will be to subscribe to the proposed New Basel Capital Accord meant to replace the existing 1988 Capital Accord. The new Accord is likely to be finalised by the end of 2001 and mandated for adoption by 2004. It should be clear to all concerned that the new Accord is likely to be more complex and more binding, warranting early and vigorous preparatory work by both banks and RBI.

The RBI's policy framework in regard to approach to universal banking has already been spelt out. An approach to reform of urban cooperative banks and rural cooperatives has been drawn up with the recommendations of the Madhava Rao Committee and the Jagdish Capoor Committee. There are significant legal and institutional changes that need to be addressed to ensure further progress in imparting competition without serious systemic implications, including ensuring availability of adequate credit to rural areas and agriculture. In fact, in the recent past, there has been a fast growth in urban banks and perhaps we should focus on the cooperative bank segment, which should get activated to serve the rural areas.

Since 1998, there have been dramatic developments in this sphere, especially in codifying the international practices and assessing the domestic standards. RBI has put out for discussion, several reports of Advisory Groups on a variety of Standards and Codes, and a road map for bringing about changes is bound to evolve out of these reports. Of particular interest to IBA are the reports on

1. Transparency in Monetary and Financial Policies,

2. Payments and Settlement System,

3. Banking Supervision, and

4. Bankruptcy Laws.

These are already in the public domain through RBI's website.

Several procedural initiatives have been taken in this regard. The two major areas that need immediate attention to ensure credit delivery are :

1. the fast growing services sector and

2. the critical 'peoples sector' viz. agriculture on which a large part of our population depends

Over the last three years, impressive growth can be observed in all the three segments of financial markets that are of direct concern to the RBI viz.

1. money,

2. government securities and

3. forex.

The markets have grown in size, depth, instruments and participants while imparting both efficiency and stability to the system. The next landmark development would be the operation of Clearing Corporation, an organisation being promoted by several banks. A successful operation of the Clearing Corporation would inter alia help quicker forex settlement, enlargement of repo market and retailing of government securities market. The Finance Minister in his budget speech has set a clear timetable in this regard.

There are some developments in the financial sector, which had not been flagged a few years ago but have received attention recently.

1. First, changes in Deposit Insurance that have been proposed by RBI to government.

2. Second, establishment of a Regulations Review Authority to review procedural requirements. As IBA is aware, Master Circulars have replaced hundreds of earlier circulars and thes will be updated annually.

3. Third, setting up of Credit Information Bureau in which some members of IBA had taken initiative.

4. Fourth, banks' foray into insurance business, which has been carefully crafted.

5. Fifth, the extremely complex task of bringing an almost totally unregulated non-banking financial companies sector into a system of focussed regulation of those which accept public deposits.

6. Sixth, technological upgradation, which has several dimensions. These include computerisation in RBI and projects for use of banks and financial institutions mainly in the areas of payment and settlement as well as public debt office.

7. RBI also closely monitors upgradation of technology in banks.

8. Eighth, and a related measure under implementation is RBI's Central Database Management System, which will become a pioneering project among emerging countries.

9. Ninth, there has been an increasing recourse to auditors as a supervisory resource from RBI. Finally, to monitor developments in financial markets and take prompt actions a Financial Markets Committee (FMC) has been constituted within the RBI which meets at least once a day and often several times during periods of excess activity in the financial markets. The FMC provides crucial inputs in assessment of short-term liquidity and operation of Liquidity Adjustment Facility. FMC also helps in designing of development of financial markets. Thus, RBI has not only focussed on a medium term agenda for financial sector reform outlined earlier but has refined and reoriented the agenda from time to time, as warranted by developments.

Three broad areas were identified as critical for reform viz.

1. fiscal deficit,

2. legislative changes and

3. structural issues affecting public sector banks.

Undoubtedly, Government has devoted some attention in regard to all the three areas, and the measures taken are well known. Yet, it will be interesting to recall the relevant budget pronouncements.

The Budget for 1999-2000 concentrated on reform of the banking sector i.e. Debt Recovery Tribunals, restructuring of weak banks, Settlement Advisory Committees, and tax deductibility for provisions made by banks. The reform of capital markets focussed on UTI and mutual funds but of interest to financial markets was abolition of Stamp Duty on transfer of debt instruments within the depository mode.

The budget for 2000-2001 carried forward reform on public sector banking by announcing intention for a more diversified ownership of public sector banks, establishment of Financial Restructuring Authority, debt recovery, etc. Of particular interest are announcements relating to establishment of a Credit Information Bureau and possible legislative amendments to accord greater operational flexibility to the RBI. Most important of all was the intention to bring about a Fiscal Responsibility Act. The canvass gets further enlarged beyond public sector banks and fiscal management to development of debt markets and interest rate flexibility in the budget for 2001-02. No doubt, in all the budgets there is progressive liberalisation of capital account.

In brief, the budgets over the last three years have contained larger and wider reference to reforms in the financial sector. The canvass is spreading from banks to financial markets. During the period, the regulatory jurisdiction of RBI was fine tuned and clarified through amendments to Securities Contract Regulations Act, and enactment of Foreign Exchange Management Act. While these are some of the several governmental initiatives, significant changes in legal and institutional framework are necessary for further progress in reform of financial sector.

There has been noticeable progress in respect of all the four issues flagged before viz.

1. Internal control systems,

2. placement and work practices,

3. flexibility in hiring people and

4. use of technology in banks.

However, there is a long way for public sector banks to traverse from current industry-wise approaches to bank-wise autonomy to enhance efficiency and profitability. It may be worthwhile to chart a roadmap for genuine autonomy for public sector banks consistent with principles of good corporate governance.

In brief, a notable part of agenda for reform has been completed and in the process, some items not in the original medium-term agenda became necessary for reform. Currently, the focus is rightly shifting to legislation, markets, technology and beyond banks to non-banks. It is also evident that reforms can succeed only and only if coordinated efforts are made by RBI, Government of India and banks, themselves. It must, however, be recognized that key to financial sector reform is banking reform; key to banking reform is public sector banking reform; and key to public sector banking sector reform is Government's initiative.

Finally, you would appreciate that, by and large, we in RBI try to be aware of what is desirable and we are implementing whatever is feasible.