Paper IPaper I · Economy
Banking and Financial Sector Reforms
The 1991 reforms, the Narasimham Committee I (1991) and II (1998), prudential norms and Basel CRAR, the twin balance-sheet problem and NPAs, the Insolvency and Bankruptcy Code 2016, bank recapitalisation and mergers, financial inclusion (Jan Dhan, PSL, RRBs, payments and small finance banks), DICGC cover, and the security angle on AML and counter-terror-financing for CAPF Paper I
CAPF wiki•11 min read•19 sections
After the 1991 balance-of-payments crisis, India shifted from a tightly controlled, largely State-owned banking system to a more competitive, prudentially regulated one. The two Narasimham Committees (1991 and 1998) set the reform agenda: deregulate interest rates, license new private banks, adopt international prudential norms (capital adequacy, asset classification, provisioning), and reduce the pre-emption of bank funds through high CRR and SLR. CAPF tests the reform milestones, the committee names and years, the meaning of prudential terms (CRAR, NPA, provisioning), the Insolvency and Bankruptcy Code, 2016, and the financial-inclusion architecture. These are clean recall facts with a strong security angle, since a formal, traceable banking system supports anti-money-laundering and counter-terror-financing. The standard references are the RBI website and Report on Trend and Progress of Banking, the latest Economic Survey, and Ramesh Singh's "Indian Economy".
Before 1991, Indian banking after nationalisation (14 banks in 1969, 6 more in 1980, see money and banking and the rbi) had achieved wide branch expansion and directed credit, but at a cost:
- Financial repression: high CRR and SLR pre-empted a large share of deposits for the Government, leaving little for productive lending.
- Administered interest rates: the RBI fixed deposit and lending rates, distorting credit allocation.
- Weak balance sheets: low capital, high bad loans, and no rigorous, internationally comparable asset-classification rules.
- Little competition: public sector banks dominated, with no new private entry for decades.
The 1991 crisis (forex reserves down to a few weeks of imports, the airlift of gold to raise loans) forced structural reform across the economy, of which banking reform was a central plank.
Chaired by M. Narasimham (a former RBI Governor), it recommended:
- Phased reduction of CRR and SLR to free funds for lending.
- Deregulation of interest rates.
- A capital-adequacy norm (Basel-style) and proper income recognition, asset classification and provisioning (IRAC) rules.
- A four-tier banking structure, with three or four large banks of international character at the top.
- Entry of new private sector banks and a level playing field with public sector banks.
- Reduced directed credit and a re-examination of priority-sector lending.
- A Board for Financial Supervision in the RBI and asset-reconstruction machinery for bad loans.
The second committee focused on strengthening the banking system:
- Raise capital adequacy further and tighten provisioning.
- Sharpen the definition of NPAs and move toward the 90-day overdue norm.
- Greater operational autonomy for public sector banks and a stronger legal framework for loan recovery.
- Consolidation of strong banks and a narrow-banking approach for weak ones.
- It paved the way for asset reconstruction companies and the later SARFAESI Act, 2002, which lets banks seize and sell the secured collateral of defaulters without a court decree.
- Capital adequacy (CRAR): the Capital to Risk-weighted Assets Ratio, the cushion of capital a bank must hold against its risk-weighted loans. India follows the Basel standards set by the Basel Committee on Banking Supervision (at the Bank for International Settlements, Basel, Switzerland). Basel I (capital), Basel II (capital, supervision, market discipline), Basel III (more and better capital, leverage and liquidity ratios after the 2008 crisis).
- Asset classification: loans are classified as standard, sub-standard, doubtful, or loss assets as repayment deteriorates.
- Non-Performing Asset (NPA): a loan on which interest or principal is overdue beyond 90 days.
- Provisioning: setting aside profits to cover expected losses on bad loans.
- Twin balance-sheet problem: simultaneous stress on bank balance sheets (high NPAs) and corporate balance sheets (over-leveraged firms unable to repay), which chokes fresh lending and investment.
The IBC, 2016 is the landmark reform for resolving bad loans and corporate distress. Key features:
- A time-bound resolution process (originally 180 days, extendable to 270, with an overall outer limit, since revised) run by a resolution professional under a Committee of Creditors.
- An adjudicating authority: the National Company Law Tribunal (NCLT) for companies and the Debt Recovery Tribunal (DRT) for individuals and partnerships.
- An Insolvency and Bankruptcy Board of India (IBBI) as the regulator.
- A clear waterfall of priority for distributing proceeds; resolution is preferred over liquidation.
- It shifted the balance of power from defaulting promoters to creditors, the "creditor in control" model.
The IBC, the SARFAESI Act, the DRTs, and Asset Reconstruction Companies (ARCs) together form the bad-loan resolution toolkit. The National Asset Reconstruction Company (NARCL), a "bad bank", was set up to aggregate and resolve large stressed assets (verify the latest status).
- Bank recapitalisation: the Government injects capital into public sector banks (including through recapitalisation bonds) so they meet Basel norms and can lend again.
- Bank mergers: the State Bank of India absorbed its associate banks and the Bharatiya Mahila Bank (2017), and a 2019-2020 round merged several public sector banks, reducing their number. The aim is fewer, larger, better-capitalised banks (verify the current count of public sector banks).
Bringing the unbanked into the formal system is a development and a security objective.
| Instrument |
Role |
| Lead Bank Scheme |
A lead bank per district for credit planning |
| Regional Rural Banks (RRBs) |
Rural and agricultural credit (RRB Act 1976) |
| Priority Sector Lending (PSL) |
Banks must lend a set share (broadly 40 percent of adjusted net bank credit) to agriculture, MSMEs, weaker sections, etc. |
| Self-Help Group (SHG) bank linkage |
NABARD-led microfinance to groups, mostly women |
| Business Correspondents |
Agents extending banking to remote areas |
| Payments banks |
Deposits and payments only, cannot lend (e.g. India Post Payments Bank) |
| Small finance banks |
Lend to small borrowers and meet PSL norms |
| PM Jan Dhan Yojana (2014) |
Mass basic bank accounts; see major economic schemes |
| JAM trinity |
Jan Dhan accounts + Aadhaar + Mobile, enabling Direct Benefit Transfer |
- DICGC deposit insurance covers up to 5 lakh rupees per depositor per bank (raised from 1 lakh in 2020).
| Item |
Value or definition |
| Reform trigger |
1991 balance-of-payments crisis |
| Narasimham Committee I |
1991 (reform agenda, new private banks, prudential norms) |
| Narasimham Committee II |
1998 (strengthening, NPA tightening, recovery law) |
| Capital adequacy ratio |
CRAR (Capital to Risk-weighted Assets Ratio) |
| Capital-standards setter |
Basel Committee (Bank for International Settlements) |
| NPA threshold |
Overdue beyond 90 days |
| Secured-asset recovery law |
SARFAESI Act, 2002 |
| Insolvency law |
Insolvency and Bankruptcy Code, 2016 |
| Insolvency regulator |
IBBI |
| Adjudicating authority (companies) |
NCLT |
| Priority-sector lending target |
Broadly 40 percent of adjusted net bank credit |
| Deposit insurance cover |
Up to 5 lakh rupees per depositor per bank |
| Rural-credit apex body |
NABARD (1982) |
A formal, well-regulated and inclusive banking system is a dimension of state capacity and a direct internal-security asset:
- Anti-money-laundering (AML) under the Prevention of Money Laundering Act, 2002 and counter-terror-financing (CFT) depend on banks knowing their customers (KYC) and reporting suspicious transactions to the Financial Intelligence Unit (FIU-IND).
- Bringing households into the banking net through Jan Dhan accounts and the JAM trinity shrinks the cash economy, improves the traceability of funds, and plugs benefit leakage through Direct Benefit Transfer.
- The Enforcement Directorate uses banking trails (and IBC proceedings) to pursue economic offenders; fugitive-economic-offender cases turn on cross-border money flows.
- Currency integrity and payment-system security (UPI, the e-rupee pilot) are recognised national-security concerns because fake currency and laundering have financed terrorism and cross-border crime. India is a member of the Financial Action Task Force (FATF), the global AML and CFT standard-setter.
All items below are authored practice, not verbatim PYQs.
-
The Narasimham Committee (1991) was set up mainly to recommend reform of the:
a) tax system b) banking and financial sector c) public distribution system d) labour laws
Answer: b. Narasimham Committee I (1991) set the banking and financial-sector reform agenda.
-
A loan becomes a Non-Performing Asset when interest or principal is overdue beyond:
a) 30 days b) 60 days c) 90 days d) 180 days
Answer: c. The standard NPA threshold is 90 days overdue.
-
CRAR, the capital-adequacy ratio that Indian banks must meet, is set under the:
a) Basel norms b) FRBM Act c) Maastricht criteria d) Bretton Woods rules
Answer: a. CRAR follows the Basel Committee's capital-adequacy standards.
-
The law that gives banks a time-bound, creditor-driven process to resolve corporate default is the:
a) SARFAESI Act, 2002 b) Companies Act, 2013 c) Insolvency and Bankruptcy Code, 2016 d) RBI Act, 1934
Answer: c. The IBC, 2016, run through the NCLT with a Committee of Creditors.
-
The "twin balance-sheet problem" refers to simultaneous stress on:
a) the Centre and the States b) banks and corporate borrowers c) imports and exports d) revenue and capital accounts
Answer: b. High bank NPAs alongside over-leveraged corporates.
-
Deposits in a scheduled bank are insured by the DICGC up to:
a) 1 lakh rupees b) 2 lakh rupees c) 5 lakh rupees d) the full deposit
Answer: c. Up to 5 lakh rupees per depositor per bank (raised in 2020).
- SARFAESI versus IBC: SARFAESI (2002) lets a bank seize and sell secured collateral without a court; the IBC (2016) is a full insolvency-resolution process for the whole firm through the NCLT.
- Narasimham I versus II: I (1991) opened the sector and set prudential norms; II (1998) strengthened it and tightened NPA recognition and recovery.
- NPA versus provisioning: an NPA is the bad loan itself; provisioning is the money set aside to cover the expected loss on it.
- Recapitalisation versus merger: recapitalisation injects fresh capital; a merger combines banks. Both aim at stronger balance sheets.
- Payments bank versus small finance bank: a payments bank cannot lend (only deposits and payments); a small finance bank lends to small borrowers and meets PSL norms.
- "91 opened, 98 strengthened" for the two Narasimham Committees.
- "90 days makes an NPA."
- "JAM unlocks inclusion: Jan Dhan, Aadhaar, Mobile."
- "SARFAESI seizes, IBC resolves."
- 1991 crisis triggered reform; Narasimham Committee I (1991) and II (1998) set the agenda.
- CRAR follows Basel norms; an NPA is a loan overdue beyond 90 days.
- SARFAESI (2002) seizes secured assets; the IBC (2016) resolves insolvency through the NCLT, regulated by IBBI.
- Twin balance-sheet problem: stressed banks plus over-leveraged corporates.
- Financial inclusion runs on RRBs, PSL (about 40 percent), Jan Dhan and the JAM trinity; DICGC insures up to 5 lakh rupees.
- A formal banking net aids AML and counter-terror-financing; India is in the FATF.
- The 1991 balance-of-payments crisis triggered banking and financial-sector reform.
- The Narasimham Committee I (1991) opened the sector to new private banks and set prudential norms.
- The Narasimham Committee II (1998) strengthened the system and tightened NPA recognition.
- CRAR is the capital-adequacy ratio Indian banks must meet under the Basel norms.
- An NPA is a loan with interest or principal overdue beyond 90 days.
- The SARFAESI Act, 2002 lets banks seize and sell secured collateral without a court decree.
- The Insolvency and Bankruptcy Code, 2016 gives a time-bound, creditor-driven resolution through the NCLT.
- The IBBI is the insolvency regulator; the NCLT is the adjudicating authority for companies.
- The twin balance-sheet problem is stressed banks plus over-leveraged corporate borrowers.
- Bank recapitalisation injects capital; the 2019-2020 mergers reduced the number of public sector banks.
- Priority-sector lending is broadly 40 percent of adjusted net bank credit.
- The JAM trinity (Jan Dhan, Aadhaar, Mobile) powers Direct Benefit Transfer.
- DICGC insures bank deposits up to 5 lakh rupees per depositor per bank.
- AML rests on the Prevention of Money Laundering Act, 2002 and reporting to FIU-IND.
- India is a member of the Financial Action Task Force (FATF).
- CRAR: Capital to Risk-weighted Assets Ratio, the bank capital-adequacy measure.
- Basel norms: international bank capital and liquidity standards.
- NPA: a non-performing asset, a loan overdue beyond 90 days.
- Provisioning: profits set aside to cover expected loan losses.
- Twin balance-sheet problem: stressed banks alongside over-leveraged corporates.
- SARFAESI Act, 2002: law to recover secured assets without a court decree.
- IBC, 2016: the Insolvency and Bankruptcy Code, a time-bound resolution law.
- IBBI: the Insolvency and Bankruptcy Board of India, the regulator.
- NCLT: the National Company Law Tribunal, the corporate adjudicating authority.
- Priority Sector Lending (PSL): mandated lending to agriculture, MSMEs and weaker sections.
- JAM trinity: Jan Dhan accounts, Aadhaar, and Mobile, enabling Direct Benefit Transfer.
- DICGC: the deposit insurer, covering up to 5 lakh rupees per depositor per bank.
- AML / CFT: anti-money-laundering and counter-terror-financing measures.
- FIU-IND: the Financial Intelligence Unit, which receives suspicious-transaction reports.
- FATF: the Financial Action Task Force, the global AML and CFT standard-setter.
Bank balance sheets have improved as NPAs fell from their mid-2010s peak, and public sector banks returned to profit, but the exact figures are currency-sensitive, so carry the latest RBI Trend and Progress report and Economic Survey numbers. The progress of the National Asset Reconstruction Company (the "bad bank"), the proposed amendments to the IBC, and India's FATF mutual evaluation outcome are recurring current-affairs hooks. Verify the latest count of public sector banks after the mergers.