Narasimham Committee
The Narasimham Committee I, officially the Committee on the Financial System, was a nine-member panel appointed by the Government of India on 14 August 1991 and chaired by M. Narasimham, a former Governor of the Reserve Bank of India, to assess the banking sector's inefficiencies amid the 1991 economic crisis and liberalization efforts.[1][2] Its report, submitted in November 1991, emphasized reducing government controls to foster a market-oriented system capable of supporting industrial growth and international integration.[3] Key recommendations included progressively lowering the statutory liquidity ratio from 38.5% to 25% and the cash reserve ratio to 3-5%, phasing out directed credit programs that mandated lending to priority sectors, deregulating interest rates for greater flexibility, and requiring banks to meet Basel-like capital adequacy norms of 8% while classifying assets to address non-performing loans.[1][4] The panel also advocated consolidating public sector banks into three to four large entities for global competitiveness, establishing an asset reconstruction fund for bad debts, and granting banks operational autonomy from excessive regulatory interference.[1][5] A follow-up Narasimham Committee II, constituted in 1997 and reporting in April 1998 to Finance Minister Yashwant Sinha, reviewed implementation progress and proposed second-generation reforms such as incorporating market risk into capital requirements, adopting a 90-day norm for non-performing asset recognition, enhancing risk management through technology upgrades, and permitting banks to raise Tier II capital without government guarantees.[1][6] These measures aimed to build resilience against financial vulnerabilities while promoting consolidation and professional recruitment in banking.[1] Both committees' proposals influenced subsequent policies, including interest rate freedoms and private bank entry, marking a shift from state-dominated finance to a more competitive framework, though full adoption faced delays due to fiscal constraints and political resistance.[5][7]Overview
Formation and Purpose of the Committees
The Narasimham Committee I was appointed by the Government of India on August 14, 1991, comprising nine members under the chairmanship of M. Narasimham, a former Governor of the Reserve Bank of India, at the initiative of Finance Minister Manmohan Singh.[1] Its formation responded to systemic inefficiencies in the banking sector, including high non-performing assets and operational rigidities, amid the broader economic crisis that prompted liberalization measures.[8] The committee's mandate focused on analyzing the structure, organization, functions, and procedures of India's financial systems to recommend reforms for greater efficiency, autonomy, and alignment with market principles.[9] The Narasimham Committee II was established in April 1998, again chaired by M. Narasimham, to evaluate the implementation of reforms stemming from the 1991 report and the subsequent financial sector changes initiated in 1992.[10] This second iteration aimed to address persistent challenges such as inadequate capital adequacy, governance issues, and limited competitiveness in a globalizing economy, while proposing additional steps to foster a robust, diversified banking structure capable of supporting sustained growth.[11] The committees collectively laid the groundwork for transitioning India's banking from a controlled, public-sector-dominated model to one emphasizing prudential regulation and operational flexibility.[1]Composition and Key Figures
The Narasimham Committee I, formally known as the Committee on the Financial System, was appointed by the Government of India on August 14, 1991, and consisted of nine members chaired by M. Narasimham, the former 13th Governor of the Reserve Bank of India (1977–1985).[1][2] The panel included experts from banking, finance, and government sectors, though detailed rosters beyond the chairmanship are not comprehensively documented in official records. Narasimham's leadership drew on his extensive experience in central banking and economic policy, emphasizing structural reforms amid India's fiscal challenges.[11] The Narasimham Committee II, established in December 1997 to review banking sector progress and recommend further reforms, was also chaired by M. Narasimham and submitted its report in April 1998 to Finance Minister Yashwant Sinha.[7] Its composition featured a mix of public sector bankers, private industry leaders, and financial regulators, reflecting a balanced perspective on operational and governance issues:| Member | Affiliation |
|---|---|
| M. Narasimham | Chairman, Administrative Staff College of India, Hyderabad (former RBI Governor) |
| C. M. Vasudev | Member Secretary, Special Secretary, Banking Division, Department of Economic Affairs, Ministry of Finance |
| Dipankar Basu | Former Chairman, State Bank of India |
| Deepak Parekh | Chairman, Infrastructure Development Finance Company Ltd., Chennai |
| P. Kotaiah | Chairman, NABARD, Mumbai |
| Shiv Nadar | Chairman, HCL Corporation, Noida |
| M. V. Subbaiah | Chairman and Managing Director, EID Parry India Ltd., Chennai |
| Sunil Munjal | Executive Director, Hero Cycles, Ludhiana |
| S. S. Tarapore | Former Deputy Governor, Reserve Bank of India, Mumbai |
Historical Context
Pre-Reform Banking Sector Weaknesses
Prior to the 1991 reforms, the Indian banking sector, dominated by public sector banks following nationalizations in 1969 (14 major banks) and 1980 (6 more), exhibited structural inefficiencies stemming from heavy state control and financial repression.[12] Government directives mandated priority sector lending, which by the 1980s required banks to allocate 40% of net loans to agriculture, small-scale industries, and other specified areas, often irrespective of creditworthiness or repayment capacity.[13] [14] This policy, intended to promote social objectives, distorted resource allocation by prioritizing political and developmental goals over commercial prudence, leading to widespread lending to unviable projects and borrowers.[15] Asset quality deteriorated significantly, with non-performing assets (NPAs) in public sector banks ranging from 15% to 45% of advances by the early 1990s, exacerbated by lax recognition norms and inadequate provisioning.[16] Weak legal frameworks hindered loan recovery, as foreclosure processes were protracted and debtor-friendly, while accounting standards failed to reflect true financial health, masking the extent of bad loans accumulated from directed credit.[16] Political interference further undermined lending discipline, with banks pressured to extend credit to favored entities, resulting in eroded profitability and capital erosion; many nationalized banks operated at low or negative margins due to these non-commercial decisions.[15] High statutory pre-emptions compounded liquidity constraints and profitability issues, as cash reserve ratio (CRR) and statutory liquidity ratio (SLR) requirements together exceeded 60% of net demand and time liabilities by 1991, with CRR at 25% and SLR around 38.5%.[17] These mandatory holdings in low-yield government securities and cash limited banks' deployable funds for income-generating activities, enforcing financial repression through administered interest rates and restricted competition.[15] Branch expansion post-nationalization—rural branches surging from 1,443 in 1969 to over 15,000 by 1980—prioritized geographic spread over viability, yielding high operational costs and numerous unprofitable outlets without corresponding efficiency gains.[12] Governance weaknesses were pronounced, with bank managements lacking autonomy amid government ownership and oversight, fostering bureaucratic inertia and vulnerability to fraud, as evidenced by securities irregularities uncovered in the late 1980s and early 1990s. Absent robust risk management and supervisory mechanisms, the sector remained insulated from market discipline, with entry barriers and oligopolistic structure stifling innovation and competition, ultimately rendering banks ill-equipped to support efficient capital mobilization amid India's mounting economic imbalances.[16]Link to 1991 Economic Crisis and Liberalization
India's balance of payments crisis in 1991 stemmed from chronic fiscal deficits, high import dependence, and rigid licensing regimes under prior socialist policies, culminating in foreign exchange reserves dropping to approximately $1.1 billion by June 1991—sufficient for only about three weeks of imports.[18] To avert default, the Reserve Bank of India (RBI) pledged 46.91 tonnes of gold to the Bank of England and Bank of Japan in July 1991, securing $400 million in emergency funds, while the government negotiated $2.2 billion in IMF loans conditional on structural adjustments.[19] [20] These measures, including a 20% rupee devaluation, exposed deep structural flaws in the economy, particularly in the over-regulated banking sector characterized by directed credit allocations, suppressed interest rates, and weak asset quality, which had stifled capital flows and efficiency.[21] The crisis precipitated India's economic liberalization under Prime Minister P.V. Narasimha Rao and Finance Minister Manmohan Singh, shifting from import substitution to market-oriented policies via the New Economic Policy announced on July 24, 1991, which dismantled industrial licensing, reduced tariffs, and encouraged foreign investment.[22] Banking reforms became integral to this agenda, as the sector's inefficiencies—such as non-performing assets exceeding 15% in public sector banks and inadequate capital buffers—had fueled inflationary pressures and resource misallocation, undermining export competitiveness and fiscal stability.[14] The Narasimham Committee I, appointed by the RBI on August 14, 1991, under former RBI Governor M. Narasimham, directly addressed these linkages by recommending a transition to prudential norms, reduced government interference, and market-driven interest rates to align banking with liberalization goals.[11] This committee's formation marked the financial sector's pivot toward globalization, enabling banks to compete internationally and support private investment, which causal analysis attributes to resolving the crisis's root causes: over-reliance on state-directed finance that distorted incentives and amplified vulnerabilities during external shocks. Implementation of its suggestions, including capital adequacy targets phased to 8% by 1996-97, facilitated reserve rebuilding to $5.8 billion by end-1991-92 and laid groundwork for sustained growth post-crisis.Narasimham Committee I (1991)
Core Objectives and Report Submission
The Narasimham Committee I, officially the Committee on the Financial System, was established in April 1991 by the Government of India to evaluate the structure, organization, and operational efficiency of the banking sector amid the 1991 economic liberalization and balance-of-payments crisis. Its core objectives centered on identifying structural weaknesses in public sector banks and development financial institutions, such as high non-performing assets, inadequate capital adequacy, and inefficient resource allocation, with the aim of recommending measures to enhance competitiveness, financial stability, and customer service. The committee sought to promote a market-oriented framework by advocating reduced government intervention, improved prudential regulations, and alignment with international standards to foster a robust financial system capable of supporting economic growth.[11][1] A key focus was addressing the below-par performance of banks, including poor asset quality management and over-reliance on directed credit, which had contributed to systemic vulnerabilities exposed by the 1991 crisis. The objectives emphasized reforming governance to grant greater autonomy to banks, strengthening supervisory mechanisms under the Reserve Bank of India, and facilitating the entry of new private and foreign players to inject competition, all while prioritizing financial health over social banking mandates that had previously strained profitability. These goals were grounded in the recognition that India's pre-reform banking sector, dominated by nationalized entities, required urgent modernization to handle liberalization's demands without risking instability.[2][23] The committee submitted its report on November 16, 1991, which was tabled in Parliament for review on December 17, 1991, outlining 29 specific recommendations across areas like capital adequacy norms, interest rate deregulation, and asset classification. This timely submission aligned with the government's broader reform agenda under Finance Minister Manmohan Singh, influencing subsequent legislative and regulatory actions to implement phased banking sector changes.[11][8]Recommendations on Bank Autonomy and Governance
The Narasimham Committee I recommended enhancing autonomy for public sector banks by minimizing government interference in operational decisions, arguing that such control led to inefficiencies and poor resource allocation. It proposed that banks be granted freedom to set interest rates on deposits and loans independently, determine staff salaries, and recruit personnel directly without prior governmental approval, aiming to align incentives with market realities and improve competitiveness.[24][25] On governance, the committee advocated restructuring bank boards to prioritize professional expertise over bureaucratic representation, including the appointment of independent directors with banking and financial sector experience. This shift was intended to foster accountability, strategic oversight, and merit-based management, reducing the influence of non-professional government nominees. The recommendations emphasized internal autonomy in credit appraisal and risk management, while maintaining regulatory supervision by the Reserve Bank of India to prevent moral hazard.[23][25] The committee critiqued high government equity stakes—typically over 50% in public sector banks—as incompatible with true autonomy, suggesting a review of ownership structures to enable disinvestment and potentially reduce state holding to minority levels over time. This was posited to encourage market discipline without full privatization, though it warned against hasty mergers or sales that could disrupt stability. Such measures were seen as essential for transforming banks from administrative arms of policy into commercially oriented entities.[4][26]Prudential Norms for Asset Quality and Capital Adequacy
The Narasimham Committee I emphasized the adoption of international prudential norms to address pervasive issues in asset quality and capital adequacy within India's banking sector, where weak classification of non-performing assets (NPAs) and inadequate capitalization had masked systemic risks. These recommendations sought to enforce stricter standards for identifying and provisioning bad loans, while mandating sufficient capital buffers to mitigate potential losses from credit exposures. By aligning with Basle Committee guidelines, the norms aimed to promote transparency, solvency, and risk management, reducing the moral hazard from government-directed lending that had previously prioritized quantity over quality of assets.[23] On capital adequacy, the committee prescribed a minimum capital adequacy ratio (CAR) of 8% applied to risk-weighted assets, to be implemented progressively over three years starting from April 1992. This risk-weighted approach differentiated between low-risk assets like government securities and higher-risk loans, requiring banks to hold Tier I and Tier II capital accordingly to absorb shocks from defaults or market volatility. The RBI subsequently enforced this through directives, marking a shift from the pre-reform era's focus on statutory liquidity ratios toward solvency-focused metrics, though full compliance was delayed for many public sector banks due to recapitalization needs funded by the government.[23][27] For asset quality, the committee advocated uniform norms for income recognition, asset classification, and provisioning to curb evergreening of loans—where banks extended fresh credit to service interest on dud accounts. It recommended classifying loans as NPAs if principal or interest payments were overdue for 90 days (reduced from the prior 180-day threshold), with sub-categories of substandard (up to 18 months overdue), doubtful (beyond 18 months), and loss assets requiring immediate write-offs. Provisioning was to be graduated: 10% for substandard assets, rising to 20-50% for doubtful ones based on duration, and 100% for losses, ensuring balance sheets reflected realistic valuations rather than inflated profits from accrued but unrealized interest. These measures, though initially resisted by banks citing profit erosion, laid the groundwork for cleaner portfolios by compelling early recognition of credit risks.[26][23]Role of RBI and Market-Oriented Reforms
The Narasimham Committee I emphasized transforming the Reserve Bank of India's (RBI) role from an interventionist regulator directing credit allocation and interest rates to a supervisory authority focused on monetary stability, prudential oversight, and fostering competitive markets. It recommended that RBI phase out its extensive administrative controls, including directed lending obligations that tied banks to priority sectors at subsidized rates, arguing these distorted resource allocation and encouraged inefficiency. Instead, RBI should prioritize enforcing capital adequacy norms and asset classification standards while enabling banks to operate on commercial principles responsive to market signals. To promote market-oriented lending, the committee advocated gradual reductions in pre-emptive reserve requirements: lowering the cash reserve ratio (CRR) from 15% to 3-5% and the statutory liquidity ratio (SLR) from 38.5% to 25% over time, thereby freeing bank funds from mandatory holdings in government securities and low-yield assets for productive private sector deployment. These cuts aimed to diminish RBI's fiscal support role—where high reserves effectively financed government deficits—and align liquidity management with market dynamics rather than statutory mandates. Implementation began in the early 1990s, with SLR reductions starting from 38.5% in 1992, reflecting partial adoption to balance fiscal needs with reform imperatives.[28] Interest rate deregulation formed a cornerstone, with the committee urging RBI to relinquish administered caps and floors, allowing deposit and lending rates to be market-determined to better reflect supply-demand imbalances and risk premia. This shift was intended to end cross-subsidization—where savers subsidized borrowers—and incentivize efficient intermediation, though RBI retained some oversight on lending rate ceilings initially to prevent volatility. Additionally, the panel proposed RBI facilitate secondary markets for government securities through auctions of treasury bills and bonds, reducing direct placement with banks and introducing yield-based pricing to deepen money and debt markets. These measures sought to insulate RBI's monetary policy from quasi-fiscal activities, enhancing its focus on inflation control via indirect tools like open market operations.[29]Narasimham Committee II (1998)
Review of Prior Implementation
The Narasimham Committee II, constituted in December 1997 and submitting its report in April 1998, evaluated the implementation of the 1991 Narasimham Committee I recommendations over the preceding six years, focusing on strengthening the banking system's foundations through prudential regulation, autonomy, and market orientation. The review acknowledged partial successes in enhancing transparency and financial health but highlighted persistent structural weaknesses, including high non-performing assets (NPAs) and inadequate restructuring of weak institutions. Progress was uneven, with regulatory changes advancing faster than governance or legal reforms, amid fiscal constraints and resistance to reducing directed lending.[7] Prudential norms for asset classification, income recognition, and provisioning, introduced progressively from 1992, were largely adopted, with assets categorized as standard, sub-standard, doubtful, or loss based on overdue interest periods reduced from four quarters in 1993 to two by 1995, aiming for 90 days by 2002. Capital adequacy under Basel norms reached an 8% capital-to-risk-weighted assets ratio (CRAR) for all but two public sector banks by March 1997, supported by government recapitalization of Rs. 20,046 crore and market infusions of Rs. 6,035 crore by February 1998. Statutory Liquidity Ratio (SLR) declined to 25% by October 1997 from higher levels, and Cash Reserve Ratio (CRR) fell from 15% in 1989 to 10% by April 1998, freeing resources for lending. Interest rates were deregulated over five to six years, except for small loans, with the Prime Lending Rate system in place since 1994 and Bank Rate reactivation in 1997. Competition increased via licenses for 10 new private banks and 19 foreign banks (adding 47 branches) since 1992.[7] NPAs showed improvement in relative terms but remained a drag: gross NPAs as a percentage of advances dropped from 23.2% in March 1993 to 17.8% in March 1997, while net NPAs fell from 14.5% in March 1994 to 9.2%, despite absolute gross NPAs rising from Rs. 39,000 crore to Rs. 43,500 crore. Profitability metrics advanced, with public sector banks' gross profits rising from 0.42% of assets in 1992-93 to 1.26% in 1996-97, and the State Bank Group's from 1.8% to 2.18%. These gains stemmed from recapitalization (totaling Rs. 20,000 crore), stricter NPA recognition excluding unrealized income, and transparent reporting since 1992. Bank autonomy saw limited strides, including operational freedoms for qualifying banks in 1997 and depoliticized CEO appointments via an RBI-led board, alongside Audit Committees and internal controls reviewed in 1995.[7] Shortcomings included failure to cut directed credit from 40% to 10% of net bank credit, perpetuating NPAs (47% from priority sectors, 36.5% in rural regional banks, 17% in district cooperative banks), and delays in merging weak banks or establishing an Asset Reconstruction Fund. Governance lagged, with government ownership constraining managerial independence, unresolved non-official director roles, and weak legal recovery mechanisms. Reasons cited were fiscal limits on recapitalization, administrative hurdles, statutory barriers, and policy inertia against diluting state control. The Committee urged accelerating reductions in net NPAs to below 5% by 2000 and 3% by 2002, alongside CRAR hikes to 10%, to address these gaps.[7]| Metric | 1992-93 / March 1993 | 1996-97 / March 1997 |
|---|---|---|
| Gross NPAs (% of advances) | 23.2% | 17.8% |
| Net NPAs (% of advances) | - | 9.2% (from 14.5% in 1994) |
| Public Sector Banks Gross Profit (% of assets) | 0.42% | 1.26% |
| CRAR Achievement | Partial (phased) | 8% for most banks |