DO WE REALLY HAVE ADEQUATE MONEY MARKET REFORMS

(REVIEW OF MONEY MARKET REFORMS IN INDIA)

by :
Dr. T.K. Jain
Chief Mentor
AFTERCHOOOL
centre for social entrepreneurship
Bikaner

Abstract :
In this paper, the author reviews money market reforms in India and tries to critically
evaluate the present money market status. The author suggest further liberalisation and
introduction of innovative money market instruments, particularly for the betterment of
small entrepreneurs, artisans, small farmers and poor people.

CONTENTS :
Introduction
Need of moneey market reforms
review of money market reforms
critical evaluation of the reform
inadequacy of the reforms

Introduction :

Money market is the pulse of the nation. It denotes the quantum of money available in the
system. It refers to all the institutions that operate in short term money transactions. It
includes all the instruments, which are intended to provide liquidity. Over the past years,
money market has evolved and the process of liberalisation, privatisation and globalisation
have contributed to the development of money market. All these have helped in the
development of a mature money market in India. Till 1991, we had a regulated and
controlled economy. The money market was confined to government regulated market,
and included few instruments. The scenario has changed since then.

Need of moneey market reforms

Till 80's, we followed closed economic system. Banks were expected to keep very high
CRR and SLR. They had to invest as per government guidelines. Very few money market
instruments were available.

Money market has become important in the context of globalisation, liberalisation and
privatisation across the globe. Economic slowdown affects nations. Central banks have to
promptly tackle these issues in order to enure that the economy grows on positive lines.
We cannot adopt close economies in order to workout the systems.

review of money market reforms

Liberalisation started in 1991. when the government realised that it has to start the process
of money market reforms, it set-up a committee under the Chairmanship of Mr. Narismhan
namely, the Committee on the Financial System in 1991. Thus the reform process started
in line with suggestions given by the committee. The government further appointed
another committee called the Banking Sector Reforms in 1998. During the past years, on
the basis of the recommendations of the First Committee following reforms were
introduced in the financial sectors.

The quantum of statutory liquidity ratio (SLR) and cash reserve ratio (CRR) were
steadily increased during 1980s to contain inflationary pressures occurring because
of large budgetary deficits. The measure resulted into adverse impact on banks’
profitability which pressurized them to levy higher interest rates on commercial
advances. The RBI has been using SLR and CRR to check excess liquidity in the
economy. After 1991, SLR and CRR were reduced, which enabled the banks to
give more credit and operate profitably. It also helped banks in introducing new
products. Banks started offering loans at lower interest rates. Consumer credit also
flourished. Reduction in CRR and SLR helped banks in bringing liquidity to the
economy and there was huge consumer credit. Banks liberally gave consumer
loans, housing loans, and industrial credit. All these measures lifted the economic
scenario and economy grew @ 6 to 8 % during this period due rise in demand. In
March, 2007, the CRR has raised to 6.5%.
i. Till 1991, banks had piled up huge NPAs due to priority sector lending and other
policies of the government. It was ususal for the borrowers not to pay assuming that
the government will waive off the loans. Banks were in difficult conditions. A number
of measures were taken up and these helped banks in improving their working. The
government tempered with the crdit system again when it announced waiver of
outstanding agricultural loans. These measures only create hurdles for sound
banking system in our country. While banks already work under tremendous
pressure and have to be accountable to public as well as to the shareholders, these
measures put them in tight rope walk. There is also a demand of higher capital
adquacy on behalf of banks. GATS and other such international meetings put
pressure on Government of India to open the banking sector and other such
services. Indian banks also aspire to be global banks. The RBI issued new norms
for income recognition, classification of assets, provision for bad debts and capital
adequacy. The minimum capital adequacy of 8% of the aggregate of the risk
weighted assets were prescribed to be followed by March 1996 in accordance with
the Basel Committee recommendations. It was increased to 9% to be attained by
March 2000. At the end of March 2006 the CRR for nationalized banks stood at
12.3%, for new private sector banks at 12.6% and for foreign banks operating in
India at 12.3%. Public sector banks, which were reeling under pressure of NPAs
demanded support from the govrnment. To attain CRR norms the public sector
banks received budgetary support amounting to Rs.20,046 crore. This being not
sufficient, banks raised debt and went in for Initial Public Offers (IPOs) and Follow
on Public Offers (FPOs) in the Capital Market. The Banks were required to prepare
their balance sheets and profit and loss accounts in new formats w.e.f .the
accounting year 1991-92 so as to reflect true and correct position.
ii. Banks have now been given freedom to expand and set up their branches. Earlier it
was a very difficult process. Further, branches were not opened on financial
viability, but on the demand from the region. Thus branches were matter of political
pressure, and not the economic neccesity.From 1991, there has been continuous
liberalisation and banks are given freedom to set up branches and grow. However,
freedom to set-up new branches without the RBI approval was linked to attaining
 capital adequacy norms and adoption of new accounting standards.
iii. For setting up banks in the private sector the RBI issued guidelines to see that
these banks were financially viable and there was no concentration of Credit and
Crossholding with industrial houses. They were also required to adhere to priority
sector lendings.
iv. The multi interest rates were reduced from 20 in 1989-90 to 2 in 1994-95. The
objective behind it was to prevent cross-subsidization. The Banks now have
freedom to decide their own interest rates.
v. To strengthen supervision over banks, the RBI has established a new Board for
Financial Supervision under the Chairmanship of a Deputy Governor. It looks after
the implementation of the regulations with respect to credit management, asset
classification, income recognition, provision for bad debts, capital adequacy and
treasury operations.
vi. The management information system, the internal audit and control mechanisms
have been improved, so as to monitor and improve bank’s performance.
vii. To improve debt recovery by the banks and other financial institutions, necessary
Act was enacted in 1993. Special Recovery Tribunals have been set-up under the
Act for faster recovery of loan arrears.
viii. The Banks have now more flexibility in determining permissible bank finance
keeping in view the borrowers’ needs.

With regard to the Second Committee, Banking Sector Reforms, Committee made the
following recommendations :

i. The Banking sector to become strong and competitive should consolidate. It is

because of this reason many weak banks have merged with the strong banks (IDBI
took over United Western Bank; ICICI took over Sangli Bank; State Bank of India
has been allowed to merge State Bank of Saurashtra; and Centurion Bank of
Punjab to take over Lord Krishna Bank). The developmental financial institutions
were permitted to convert into banks (ICICI became ICICI Bank, IDBI became IDBI
Bank and even UTI started UTI Bank known as AXIS Bank).
ii. It suggested new norms for capital adequacy—10% minimum capital to CRR.
iii. For recapitalization the method of Budgetary support be avoided.
iv. Legal framework for credit recovery be further strengthened.
v. Net Non-Performing Assets (NPA) be brought down to 3% by 2002.
vi. There should be rationalization of branches and staff.
vii. The banks need to be depolitised under the supervision of the RBI.
viii. The policy of licensing new private sector banks may be continued.
ix. Foreign banks may be allowed to set-up subsidiaries and Joint Ventures in India
and be given national treatment with regard to branches and directed credit.
x. For regulation and supervision there should be one integrated agency named as
Board for Financial Regulation and Supervision.

Strengthening the regulation and supervision of banks became particularly important in the
aftermath of the South-East Asian crisis of 1996 which led to bank failures. Keeping in
view the recommendation of the Committee, the Government undertook many measures :

 CRR was raised from 8% to 9%.

  Accounting norms were strengthened.
 Asset liability Management and Risk Management Guidelines were laid down.
 Enactment of securitization & Reconstruction of Financial Assets and Enforcement
of Security Act was passed for efficient recovery of bank credit.

Banks have introduced a number of money market instruments like Commercial paper,
Certificate of deposit etc. Some products have been introduced for the betterment of
farmers, and people at the bottom of pyramid also. Farmers are now given credit cards.
Plastic money is spreading fast in India.

CRITICAL EVALUATION OF MONEY MARKET REFORMS

The initiation of money market reforms has completed eighteen years and now it is the
right time to critically appraise their impact on Indian economy. During the last eighteen
years, a number of new money market instruments have been introduced like Certificate of
deposit, commercial paper, etc. Banks have also introduced a number of innovative
products and services. The RBI and the government are working closely to ensure proper
economic growth. A number of changes have been made in the policies of the central
bank, giving commercial banks much desired freedom and at the same time, these efforts
have resulted in better regulation of inflation and fiscal deficit. A look at the facts relating to
inflation and fiscal deficit lead to the conclusion that the objectives behind the reforms
have been achieved partially. The fiscal deficit of centre and the states in 2005-06 was as
high as 7.4% of GDP. However, on the forex reserve front we are surely comfortable as it
crossed $ 200 billion in April, 2007 and around $ 350 billion in October,2009.In fact, our
market is overflowing with forex inflows, which has naturally led to rupee appreciation
subsequently in terms of the dollars.

Despite a gradual increase in total tax revenue since the previous Review, India's tax to
GDP ratio is relatively low and seemingly insufficient to meet its developmental needs.
Further public spending on infrastructure and social services is constrained by the Fiscal
Responsibility and Budget Management (FRBM) Act, 2003, which requires India to reduce
its fiscal and revenue deficits and to eliminate the revenue deficit by 31 March 2009.
Private investment is also deterred by high real rates of interest, while foreign direct
investment (FDI) at around 1% of GDP has remained disappointing. In order to meet its
FRBM targets, the Government has introduced tax reform to improve collection and
increase revenue. Expenditure reductions include further reform of the targeted public
distribution system (TPDS) and a partial dismantling of administered pricing for petroleum.
However, state-owned enterprises remain a considerable demand on government
resources and the recent decision to "pause" privatization will have implications for future
government support for these enterprises.

Today banks are comparatively free to set their own policies. Consolidation in banking
industry is on the cards. Banks are planning to become global players. SBI, PNB, BOB,
ICICI, IDBI, Axis Bank and some other banks have taken massive steps to introduce latest
technology, improve operational performance, and to become a global bank.

Inadequcy of the reform

inspite of all the reforms that we have witnessed, there remains a need for greater reforms.
Indian economy is still a closed economy in comparison to other economies. Our debt
market has not yet developed Our OTC market has yet to develop fully. There are still
large number of regions, which have inadequate banks. Rural areas still witness banks
with old technology. Most banks are not able to train their staff in latest technology,
especially those working in rural areas. Banks are unable to introduce innovative products
and services.

Money market needs further reforms, as we need a system, which can promote excellence
and social accountability both. We have commercial paper and other such instruments, but
we dont have adequate instruments for small entrepreneurs, small farmers, and artisans.
We have large number of products and services for HNIs, corporate players, and public
sector organisations, but we dont have adequate number of products and services for
small entrepreneurs, artisans, small farmers. Microfinance has not yet become popular
with the banks in India. Most microfinance players are NGOs, who lack expertise in
bankiing and lack resources. Banks should enter in this field – as one third of India is still
very poor. We need banking in India to come up with innovative products, services and
solutions for the small entrepreneurs, artisans and farmers, because they are the
backbone of India. That will bring the marketing to the bottom of the pyramid.