Financial Sector Reform in India

Objec­tives of Finan­cial Sec­tor Reforms#

The objec­tives of finan­cial sec­tor reforms in India were to improve the econ­omy. They were often made dur­ing the finan­cial cri­sis. These reforms help accom­mo­date the finan­cial con­di­tions. The objec­tives are:

• Finan­cial sta­bil­ity: The finan­cial sec­tor reforms aimed to make the sys­tem sta­ble. It should remain solid even in a finan­cial cri­sis.
• Resource allo­ca­tion: Finan­cial sec­tor reforms help in effec­tive resource allo­ca­tion. It helps busi­nesses and indi­vid­u­als get the nec­es­sary fund­ing.
• Finan­cial health: These reforms also made the finan­cial health of dif­fer­ent insti­tu­tions bet­ter. Banks, insur­ance com­pa­nies, and other busi­nesses shall be sta­ble and reg­is­ter prof­its.
• Acces­si­bil­ity: Finan­cial reforms aim to make ser­vices reach every­one. Peo­ple in remote loca­tions should also have finan­cial facil­i­ties.
• Com­pet­i­tive­ness: Finan­cial sec­tor reforms help make busi­nesses com­pet­i­tive. They ensure that Indian finan­cial com­pa­nies can cope with inter­na­tional stan­dards.

These sig­nif­i­cant objec­tives are real­ized with dif­fer­ent bank­ing sec­tor reforms. They help make the econ­omy more sta­ble and ensure bet­ter ser­vices.

Need for Finan­cial Sec­tor Reforms#

The finan­cial sec­tor reforms became nec­es­sary as the pre­vi­ous finan­cial sys­tem had faults. The sys­tem inher­ited at inde­pen­dence had fun­da­men­tal defects.

• The colo­nial finan­cial sys­tem had social and eco­nomic depri­va­tion. This pre­vi­ous sys­tem was not focused on devel­op­ment. It instead was for the ben­e­fit of the British­ers.
• The Maha­lanobis devel­op­ment strat­egy was fol­lowed, but its lim­i­ta­tions became clear by the 1980s.
• The gov­ern­ment planned to increase bor­row­ings for higher finan­cial activ­i­ties. It pro­vided these bor­row­ings at con­ces­sional rates. But, this step fur­ther led to a weak­ened mar­ket. The inter­est earn­ings were low, and there were sev­eral non-recov­er­able debts.
• The banks fur­ther came under gov­ern­ment con­trol as they were nation­al­ized. It sig­nif­i­cantly low­ered the mar­ket force's role.
• The higher gov­ern­ment con­trol also led to a bureau­cratic struc­ture. There were red tape issues. Also, it increased the non-per­form­ing assets for the banks.
• Major events such as the break-up of the USSR and the Gulf War also hit Indi­a's for­eign exchange reserves.

Finan­cial Sec­tor Reforms in India#

Sev­eral finan­cial sec­tor reforms were based on the 1991 report of the Narasimham Com­mit­tee. Its main sug­ges­tions were:

• The com­mit­tee sug­gested reduc­ing the cash reserve ratio and the statu­tory liq­uid­ity ratio. The CRR was to be at 10% and SLR at 25%.
• The report included pri­or­ity sec­tor lend­ing to small farm­ers, micro-busi­nesses, and cot­tage indus­try. It sug­gested that this be fixed at 10% of total credit.
• The report sug­gested inter­est rate dereg­u­la­tion. It pro­vided inde­pen­dence to the coun­try's banks to set their inter­est rates.

The finan­cial sec­tor reforms thus had these major rec­om­men­da­tions by the com­mit­tee. Below are the dif­fer­ent reforms in the finan­cial sec­tor.

Reforms in the Bank­ing Sec­tor#

The dif­fer­ent reforms that were in the bank­ing sec­tor are:

• The reduc­tion of the cash reserve and statu­tory liq­uid­ity ratios pro­vided more resources to banks. They could lend these extra funds to indus­tries like agri­cul­ture or small busi­nesses.
• The banks got more inde­pen­dence with inter­est rates. There were no admin­is­tered rates for bank deposits. Banks could decide for them­selves.
• It allowed for­eign and domes­tic pri­vate banks to have branches. It helped ensure that banks could inde­pen­dently increase oper­a­tions.
• Bod­ies such as tri­bunals, Lok Adalat, and civil courts were present to resolve mat­ters of non-per­form­ing assets.
• There was no fur­ther selec­tive credit con­trol. Banks could decide their lend­ing terms and vol­ume.

Reforms in the Debt Mar­ket#

The finan­cial sec­tor reforms included the debt mar­ket. The major changes are:

• The auto­matic mon­e­ti­za­tion of the fis­cal deficit pol­icy was removed. It allowed the gov­ern­ment to bor­row funds from the mar­ket sale of its secu­ri­ties.
• The gov­ern­ment bor­row­ings inter­est hap­pens as per mar­ket forces. It has made the gov­ern­ments more cau­tious of the coun­try's fis­cal deficit.
• Auc­tions of 91-day trea­sury bills helped meet short-term needs. These instru­ments also pro­vided liq­uid­ity.
• A deliv­ery and pay­ment set­tle­ment sys­tem was present to improve liq­uid­ity.

Reforms in The For­eign Exchange Mar­ket#

The finan­cial sec­tor reforms were also for the forex mar­ket. The reforms are:

• India moved to a mar­ket-deter­mined exchange rate in 1993, and the rupee was made con­vert­ible on the cur­rent account in 1994.
• Com­mer­cial banks could also par­tic­i­pate in the for­eign exchange mar­ket. It helped bring bet­ter inter­na­tional stan­dards.
• Cur­rency swap trans­ac­tions also began with new play­ers in the mar­ket. How­ever, these swap trans­ac­tions still had cer­tain lim­i­ta­tions.
• The FERA reg­u­la­tions were changed in 1999 with the FEMA. It led to higher free­dom for Indi­a's for­eign exchange sys­tem.
• Exchange-traded deriv­a­tives were allowed to Indian non-res­i­dents and for­eign investors. These con­tracts were still sub­ject to some lim­i­ta­tions.

These reforms were as per the mar­ket needs. They helped bring trans­parency, func­tion­al­ity, com­pe­ti­tion, and ease into the finan­cial sec­tor.

Impact of Finan­cial Sec­tor Reforms#

The finan­cial sec­tor reforms had sev­eral pos­i­tive impacts on the econ­omy. The main achieve­ments were:

• The Indian econ­omy became more resilient and sta­ble. The growth rate also jumped to 6% from 3.5% PA.
• The Indian econ­omy came through the 1997-98 Asian cri­sis and the 2008 global sub­prime cri­sis, helped by a sta­ble bank­ing sys­tem.
• The for­eign and pri­vate banks increased the com­pe­ti­tion. It induced the banks to per­form bet­ter.
• Stock exchanges adopted inter­na­tional stan­dards. It improves the over­all per­for­mance.
• These reforms improved areas such as fis­cal imbal­ance, pub­lic debt, and bud­get man­age­ment.

Impor­tance of Finan­cial Sec­tor Reforms#

Finan­cial sec­tor reforms have become essen­tial in every econ­omy.

• Finan­cial sec­tor reforms answer the chang­ing needs. It helps finan­cial insti­tu­tions cater to bet­ter liv­ing stan­dards and increas­ing indus­try demands.
• Finan­cial sec­tor reforms help go through var­i­ous crises. The econ­omy can han­dle such times when the finan­cial sys­tem is solid.
• These reforms bring more com­pe­ti­tion. It helps in bet­ter stan­dards and induces com­pa­nies to grow.
• These reforms are nec­es­sary to pro­vide bet­ter credit facil­i­ties. The econ­omy is dri­ven by more demand and eco­nomic activ­i­ties.
• Finan­cial sec­tor reforms aid the devel­op­ment of all sec­tors. Small busi­nesses, agri­cul­ture, or other mar­gin­al­ized activ­i­ties ben­e­fit from these changes.