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REIMAGINING INDIA
policy focus is on streamlining banking
operations, upgrading risk management
systems and enhancing the level of bank
compliance with accounting standards
and operationalizing consolidated accounting
practices (RBI, 2003b). However,
progress in this direction has been
gradual. The RBI notes: “Within the
process of convergence with best practices,
finetuning is undertaken keeping
in view the country specific circumstances.”
(RBI, 2003c). For example,
NPA have been defined as loans in
which interest has remained unpaid for
four quarters in 1992-93. This period
was shortened to three quarters in
1993-94 and two quarters in 1994-95.
The central bank now plans to further
shorten the period (in March 2004) to
match the international norm of one
quarter. Thus NPA were underestimated
by Indian accounting standards. The
main reason behind such a policy was
the political lobbying of borrowers. A
summary of some aspects of the regulatory
framework used by the RBI is given
in Table 4.
The financial sector reform process
in India can be described as a graduated
approach in the direction of liberalization.
Figure 5 plots major banking
indicators for the pre-reform and postreform
period. There are still some
weaknesses in the financial sector
which contribute to its inefficiencies.
Though reduced from 40 percent to 25
percent, the SLR has remained at high
levels. Moreover, bank investment in
government bonds and securities is still
around 40 percent of their assets (Bhattacharya
and Patel, 2003). This is because
interest rates paid by the government
are more market based due to the
auction mechanism of its securities such
as Treasury Bills; and also because
banks prefer to invest in government
securities as they are relatively risk free
and more liquid. Banks are reluctant to
take risks in alternative markets because
of stricter prudential norms and
accounting standards. The high investment
in government securities is convenient
for government which is running
high fiscal deficits. However, when
economic growth accelerates, high SLR
can adversely affect the credit formation
role of banks. Banks will be reluctant
to lay off their securities in order
to satisfy increased dem-and for credit.
The CRR also remains higher than its
Table 5: Non Performing Assets 0f Commercial Banking Sector: 1997-2003
Year Public Sector Old Private New Private Foreign Banks
Banks Sector Banks Sector Banks in India
1997 17.80 10.70 2.60 4.30
1998 16.00 10.90 3.50 6.40
1999 15.90 13.10 6.20 7.60
2000 14.00 10.80 4.10 7.00
2001 12.40 11.10 5.10 6.80
2002 11.09 11.01 8.86 5.38
2003 9.36 8.90 7.64 5.22
Definition: Gross NPA/Gross Advances (%)
statuary minimum of three percent.
The deregulation in interest rates is
also incomplete. Interest rates on saving
deposits and other saving schemes
such as National Savings Certificates,
public provident funds etc. remain regulated.
7 Such rigidities reduce the effectiveness
of the transmission of monetary
policy (Sharma, 2004). The
lending rate for advances of over
Rs.200000 was subjected to a ceiling of
16.5 percent in 1987-88. This was eventually
removed in 1994. The Prime
Lending Rate (PLR) was set as a floor
rate and banks are now free to set lending
rates without any upper restriction.
The lending rates though, officially
flexible, are affected by public sector
banks which are the dominant players
in the banking sector. These banks offer
rates below the PLR because of their
advantage in market share and quality
of borrowers. Therefore other banks’
lending rates do not diverge much from
the rates set by PSB thereby making
PLR ineffective. The banks still have to
make some loans based totally on the
political agenda of the government. For
example banks are forced to provide
concessional loans to individuals or
firms belonging to scheduled caste or
scheduled tribes.
4.1 High Transaction Costs
One of the major concerns of the banking
sector is the high transaction costs
involved in the lending operations of
banks. Transaction costs are particularly
high in rural sector areas which
are one of the priority sectors defined
by government. Puhazhendhi (1995)
estimated the transaction costs of lending
to the rural poor in India. He con-
126 THE IIPM THINK TANK