Chapters :

Development  Banks – 05

Banking Sector: Issues and Reforms

The economic reforms of 1991 created more role for the private sector in the economy and hence the role of financial system also had to be expanded to cater to the need.  The government set up a high level committee of financial system aka Narasimahan Committee I. it aimed to increase the degree of operational flexibility; internal autonomy for PSBs in decision making and greater degree of professionalism in banking operations. The committee came up with the following recommendations:

  • The RBI was advised to use more of open market operations rather than only depending on strict CCR limits.
  • Move towards market based borrowing
  • Decrease in the SLR limits.
  • The need to bring a scheme for weaker section in lending hence Priority Sector Lending concept was redefined.
  • Interest rates to be based on the market forces.
  • For structural aspects of banks they suggested mergers to reduce the number of PSBs in order to bring greater efficiency in banking operations.
  • PSBs to be made autonomous
  • To tackle the problems of NPAs it recommended Asset Reconstruction companies.

Narasimahan Committee II (on banking reforms – 1998)

  • Merger of PSBs and financial institutions (AIFIs) and DFIs for stronger banks.
  • 3 tier banking structure:
    1. Tier 1 to have 2 to 3 banks of international orientation
    2. Tier 2 have 8 to 10 banks of national orientation
    3. Tier 3 to have large number of small banks

The first and the second tier to take care of the corporate sector.

  • Higher norms for capital adequacy ratio (CRAR) to be 10%.
  • Recapitalization of PSBs.
  • Legal framework for loan recovery
  • Rationalization of bank branches.
  • License to new private banks
  • Bank board should be depoliticised

NPA: Non Performing Assets

The assets of the banks which don’t perform (that is – don’t bring any return) are called Non Performing Assets (NPA) or bad loans. Bank’s assets are the loans and advances given to customers. If customers don’t pay either interest or part of principal or both, the loan turns into bad loan.

NPA definition

According to RBI, terms loans on which interest or installment of principal remain overdue for a period of more than 90 days from the end of a particular quarter is called a Non-performing Asset. 

However, in terms of Agriculture / Farm Loans; the NPA is defined as under-For short duration crop agriculture loans such as paddy, Jowar, Bajra etc. if the loan (installment / interest) is not paid for 2 crop seasons, it would be termed as a NPA. For Long Duration Crops, the above would be 1 Crop season from the due date.

NPAs are classified into three types of loans:

  1. Sub-Standard Assets: NPAs for less than or equal to 12 months
  2. Doubtful asset: When loan account remains in the NPA classification for more than 12 months.
  3. Loss Asset: When a bank, its auditor or RBI declares that given doubtful asset has little or no salvageable value.

Loan write- off:

When loan is written off from the ‘asset-side’ of the bank balance sheet, to save corporation tax. Loan write-off doesn’t waive bank’s right to recover that bad loan; it’s merely an accounting exercise for tax-benefits.

Restructured loan:  When principal / interest rate / tenure of the loan is modified. Banks may do it when borrower facing difficulty in repaying loans.

Stressed Asset

NPA + Loans Written-Off + Restructured Loans = Stressed Assets.

Various measures to tackle the NPA crisis:


Provisioning is a part of the RBI’s prudential regulation norm to tackle the NPA or bad asset problem. Under provisioning, banks have to set aside or provide funds to a prescribed percentage of their bad assets. The percentage of bad asset that has to be ‘provided for’ is called provisioning coverage ratio.For example, if the provisioning coverage ratio is 70% for a particular category of bad loans, banks have to set aside funds equivalent to 70% those bad assets out of their profits (in most cases).

RBI 3R” Framework for Revitalizing Stressed Assets


In 2015, RBI ordered the Banks to conduct Asset Quality Review (AQR) and begin rectification of bad loans i.e. Bank doesn’t change in loan interest, tenure or terms, but asks client to rectify his irregularity in loan-repayment.

In genuine case, additional loan may be given. Bank may also try to find a new partner / investor for reviving the project.

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