1. The Committee suggests that pending the emergence of markets in India where market risks can be covered, it would be desirable that capital adequacy requirements take into account market risks in addition to the credit risks. (Chapter III Para 3.10)

2. In the next three years, the entire portfolio of Government securities should be marked to market and this schedule of adjustment should be announced at the earliest. It would be appropriate that there should be a 5% weight for market risk for Govt. and approved securities. (Chapter III para 3.11)

3. The risk weight for a Government guaranteed advance should be the same as for other advances. To ensure that banks do not suddenly face difficulties in meeting the capital adequacy requirement, the new prescription on risk weight for Government guaranteed advances should be made prospective from the time the new prescription is put in place. (Chapter III para 3.12)

5. The Committee believes that it would be appropriate to go beyond the earlier norms and set new and higher norms for capital adequacy. The Committee accordingly recommends that the minimum capital to risk assets ratio be increased to 10% from its present level of 8%. It would be appropriate to phase the increase as was done on the previous occasion. Accordingly, the Committee recommends that an intermediate minimum target of 9% be achieved by the year 2000 and the ratio of 10% by 2002. The RBI should also have the authority to raise this further in respect of individual banks if in its judgement the situation with respect to their risk profile warrants such an increase. The issue of individual banks' shortfalls in the CRAR needs to be addressed in much the same way that the discipline of reserve requirements is now applied, viz., of uniformity across weak and strong banks. (Chapter III, para 3.15 – 3.16)

6. In respect of PSBs, the additional capital requirement will have to come from either the Govt. or the market. With the many demands on the budget and the continuing imperative need for fiscal consolidation, subscription to bank capital funds cannot be regarded as a priority claim on budgetary resources. Those banks which are in a position to access the capital market at home or abroad should, therefore, be encouraged to do so. (Chapter III, para 3.17)

Asset quality, NPAs and Directed Credit:
7. The Committee recommends that an asset be classified as doubtful if it is in the substandard category for 18 months in the first instance and eventually for 12 months and loss if it has been so identified but not written off. These norms, which should be regarded as the minimum, may be brought into force in a phased manner.(Chapter III, para 3.18)

8. The Committee has noted that NPA figures do not include advances covered by Government guarantees which have turned sticky and which in the absence of such guarantees would have been classified as NPAs. The Committee is of the view that for the purposes of evaluating the quality of asset portfolio such advances should be treated as NPAs. If , however, for reason of the sovereign guarantee argument such advances are excluded from computation, the Committee would recommend that Government guaranteed advances which otherwise would have been classified as NPAs should be separately shown as an aspect of fuller disclosure and greater transparency of operations. (Chapter III, para 3.21)

9. Banks and financial institutions should avoid the practice of "evergreening" by making fresh advances to their troubled constituents only with a view to settling interest dues and avoiding classification of the loans in question as NPAs. The Committee notes that the regulatory and supervisory authorities are paying particular attention to such breaches in the adherence to the spirit of the NPA definitions and are taking appropriate corrective action. At the same time, it is necessary to resist the suggestions made from time to time for a relaxation of the definition of NPAs and the norms in this regard (Chapter III, para 3.22)

10. The Committee believes that the objective should be to reduce the average level of net NPAs for all banks to below 5% by the year 2000 and to 3% by 2002. For those banks with an international presence the minimum objective should be to reduce gross NPAs to 5% and 3% by the year 2000 and 2002, respectively, and net NPAs to 3% and 0% by these dates. These targets cannot be achieved in the absence of measures to tackle the problem of backlog of NPAs on a one time basis and the implementation of strict prudential norms and management efficiency to prevent the recurrence of this problem. (Chapter III, para 3.26)

11. The Committee is of the firm view that in any effort at financial restructuring in the form of hiving off the NPA portfolio from the books of the banks or measures to mitigate the impact of a high level of NPAs must go hand in hand with operational restructuring. Cleaning up the balance sheets of banks would thus make sence only if simultaneously steps were taken to prevent or limit the re-emergence of new NPAs which could only come about through a strict application of prudential norms and managerial improvement.(Chapter III, para 3.27)

13. An alternative approach could be to enable the banks in difficulty to issue bonds which could form part of Tier II capital. This will help the banks to bolster capital adequacy which has been eroded because of the provisioning requirements for NPAs. As the banks in difficulty may find it difficult to attract subscribers to bonds. Government will need to guarantee these instruments which would then make them eligible for SLR investments by banks and approve instruments by LIC, GIC and Provident Funds (Chapter III, para 3.29 )

14. Directed credit has a proportionately higher share in NPA portfolio of banks and has been one of the factors in erosion in the quality of bank assets. There is continuing need for banks to extend credit to agriculture and small scale sector which are important segments of the national economy, on commercial considerations and on the basis of creditworthiness. In this process, there is scope for correcting the distortions arising out of directed credit and its impact on banks’ assets quality. (Chapter III, para 3.31)

15. The Committee has noted the reasons why the Government could not accept the recommendation for reducing the scope of directed credit under priority sector from 40% to 10%. The Committee recognises that the small and marginal farmers and the tiny sector of industry and small businesses have problems with regard to obtaining credit and some earmarking may be necessary for this sector. Under the present dispensation, within the priority sector 10% of net bank credit is earmarked for lending to weaker sections. A major portion of this lending is on account of Government sponsored poverty alleviation and employment generation schemes. The Committee recommends that given the special needs of this sector, the current practice may continue. The Branch Managers of banks should, however, be fully responsible for the identification of beneficiaries under the Government sponsored credit linked schemes. The Committee proposes that given the importance and needs of employment oriented sectors like food processing and related service activities in agriculture, fisheries, poultry and dairying, these sectors should also be covered under the scope of priority sector lending. The Committee recommends that the interest subsidy element in credit for the priority sector should be totally eliminated and even interest rates on loans under Rs.2 lakh should be deregulated for scheduled commercial banks as has been done in the case of Regional Rural Banks and co-operative credit institutions. The Committee believes that it is the timely and adequate availability of credit rather than its cost which is material for the intended beneficiaries. The reduction of the pre-empted portion of banks' resources through the SLR and CRR would, in any case, enlarge the ability of banks to dispense credit to these sectors. (Chapter III, para 3.32)

18. The Committee believes that in the case of future loans, the income recognition and asset classification and provisioning norms should apply even to Government guaranteed advances in the same manner as for any other advance. For existing Government guaranteed advances, RBI, Government and banks may work out a mechanism for a phased rectification of the irregularities in these accounts. (Chapter III, para 3.37)

19. There is a need for disclosure, in a phased manner, of the maturity pattern of assets and liabilities, foreign currency assets and liabilities, movements in provision account and NPAs. The RBI should direct banks to publish, in addition to financial statements of independent entities, a consolidated balance sheet to reveal the strength of the group. Full disclosure would also be required of connected lending and lending to sensitive sectors. Furthermore, it should also ask banks to disclose loans given to related companies in the bank's balance sheets. Full disclosure of information should not be only a regulatory requirement. It would be necessary to enable a bank’s creditors, investors and rating agencies to get a true picture of its functioning – an important requirement in a market driven financial sector. (Chapter III, para 3.38)

20. Banks should also pay greater attention to asset liability management to avoid mismatches and to cover, among others, liquidity and interest rate risks. (Chapter III, para 3.41).

Systems and Methods in Banks :

22. Banks should bring out revised Operational Manuals and update them regularly, keeping in view the emerging needs and ensure adherence to the instructions so that these operations are conducted in the best interest of a bank and with a view to promoting good customer service. These should form the basic objective of internal control systems, the major components of which are : (I) Internal Inspection and Audit, including concurrent audit, (2) Submission of Control Returns by branches/controlling offices to higher level offices (3) Visits by controlling officials to the field level offices (4) Risk management systems (5) Simplification of documentation, procedure and of inter office communication channels.(Chapter IV, para 4.3)

23. An area requiring close scrutiny in the coming years would be computer audit, in view of large scale usage and reliance on information technology (Chapter IV, para 4.7)

25. There is need to institute an independent loan review mechanism especially for large borrowal accounts and systems to identify potential NPAs. It would be desirable that banks evolve a filtering mechanism by stipulating in-house prudential limits beyond which exposures on single/group borrowers are taken keeping in view their risk profile as revealed through credit rating and other relevant factors. Further, in-house limits could be thought of to limit the concentration of large exposures and industry/sector/geographical exposures within the Board approved exposure limits and proper overseeing of these by the senior management/ boards. (Chapter IV, para 4.12 – 4.16)

30. Globally, banking and financial systems have undergone fundamental changes because of the ongoing revolution in information and communications technology. Information technology and electronic funds transfer systems have emerged as the twin pillars of modern banking development. This phenomenon has largely bypassed the Indian banking system although most technologies that could be considered suitable for India have been introduced in some diluted form. The Committee feels that requisite success in this area has not been achieved because of the following reasons:

• Inadequate bank automation.
• Not so strong commercially oriented inter-bank platform.
• Lack of a planned, standardised, electronic payment systems backbone.
• Inadequate telecom infrastructure.
• Inadequate marketing effort.
• Lack of clarity and certainty on legal issues and
• Lack of data warehousing network.

The Committee has tried to list out series of implementation steps for achieving rapid induction of information technology in the banking system. Further, information and control systems need to be developed in several areas like

• Better tracking of spreads, costs and NPAs for higher profitability.
• Accurate and timely information for strategic decisions to identify and promote profitable products and customers.
• Risk and Asset-Liability management; and
• Efficient Treasury management.

(Chapter IV, para 4.66 & 4.70)

Structural Issues :

31. The Committee has taken note of the twin phenomena of consolidation and convergence which the financial system is now experiencing globally. In India also banks and DFIs are moving closer to each other in the scope of their activities. The Committee is of the view that with such convergence of activities between banks and DFIs, the DFIs should, over a period of time, convert themselves to banks. There would then be only two forms of intermediaries, viz. banking companies and non-banking finance companies. If a DFI does not acquire a banking licence within a stipulated time it would be categorised as a non-banking finance company. A DFI which converts to a bank can be given some time to phase in reserve requirements in respect of its liabilities to bring it on par with the requirements relating to commercial banks. Similarly, as long as a system of directed credit is in vogue a formula should be worked out to extend this to DFIs which have become banks (Chapter V, para 5.6) .

32. Mergers between banks and between banks and DFIs and NBFCs need to be based on synergies and locational and business specific complimentarities of the concerned institutions and must obviously make sound commercial sense. Mergers of public sector banks should emanate from management of banks with Govt. as the common shareholder playing a supportive role. Such mergers, however, can be worthwhile if they lead to rationalisation of workforce and branch network; otherwise the mergers of public sector banks would tie down the managements with operational issues and distract attention from the real issue. It would be necessary to evolve policies aimed at "rightsizing" and redeployment of the surplus staff either by way of retraining them and giving them appropriate alternate employment or by introducing a VRS with appropriate incentives. This would necessitate the co-operation and understanding of the employees and towards this direction, managements should initiate discussions with the representatives of staff and would need to convince their employees about the intrinsic soundness of the idea, the competitive benefits that would accrue and the scope and potential for employees' own professional advancement in a larger institution. Mergers should not be seen as a means of bailing out weak banks. Mergers between strong banks/FIs would make for greater economic and commercial sense and would be a case where the whole is greater than the sum of its parts and have a "force multiplier effect".(Chapter V, para 5.13 – 5.15)

33. A ‘weak bank’ should be one whose accumulated losses and net NPAs exceed its net worth or one whose operating profits less its income on recapitalisation bonds is negative for three consecutive years. A case by case examination of the weak banks should be undertaken to identify those which are potentially revivable with a programme of financial and operational restructuring. Such banks could be nurtured into healthy units by slowing down on expansion, eschewing high cost funds/borrowings, judicious manpower deployment, recovery initiatives, containment of expenditure etc. The future set up of such banks should also be given due consideration. Merger could be a solution to the problem of weak banks but only after cleaning up their balance sheets. If there is no voluntary response to a take over of these banks, it may be desirable to think in terms of a Restructuring Commission for such public sector banks for considering other options including restructuring, merger amalgamation or failing these closure. Such a Commission could have terms of reference which, inter alia, should include suggestion of measures to safeguard the interest of depositors and employees and to deal with possible negative externalities. Weak banks which on a careful examination are not capable of revival over a period of three years, should be referred to the Commission. (Chapter V, para 5.16 – 5.18)

34. The policy of licensing new private banks (other than local area banks) may continue. The start up capital requirements of Rs.100 crore were set in 1993 and these may be reviewed. The Committee would recommend that there should be well defined criteria and a transparent mechanism for deciding the ability of promoters to professionally manage the banks and no category should be excluded on a priori grounds. The question of a minimum threshold capital for old private banks also deserves attention and mergers could be one of the options available for reaching the required capital thresholds. The Committee would also, in this connection, suggest that as long as it is laid down (as now) that any particular promoter group cannot hold more than 40% of the equity of a bank, any further restriction of voting rights by limiting it to 10% may be done away with.(Chapter V, para 5.20)

36. All NBFCs are statutorily required to have a minimum net worth of Rs.25 lakhs if they are to be registered. The Committee is of the view that this minimum figure should be progressively enhanced to Rs.2 crores which is permissible now under the statute and that in the first instance it should be raised to Rs.50 lakhs. (Chapter V, para 5.36)

37. Deposit insurance for NBFCs could blur the distinction between banks, which are much more closely regulated, and the non banks as far as safety of deposit is concerned and consequently lead to a serious moral hazard problem and adverse portfolio selection. The Committee would advise against any insurance of deposits with NBFCs.(Chapter V, para 5.38)

38. RBI should undertake a review of the current entry norms for urban cooperative banks and prescribe revised prudent minimum capital norms for these banks. Though cooperation is a state subject, since UCBs are primarily credit institutions meant to be run on commercial lines, the Committee recommends that this duality in control should be dispensed with. It should be primarily the task of the Board of Financial Supervision to set up regulatory standards for Urban Cooperative Banks and ensure compliance with these standards through the instrumentality of supervision. (Chapter V, para 5.39)

39. The Committee is of the view that there is need for a reform of the deposit insurance scheme. In India, deposits are insured upto Rs.1 lakh. There is no need to increase the amount further. There is, however, need to shift away from the 'flat' rate premiums to 'risk based' or 'variable rate' premiums. Under risk based premium system all banks would not be charged a uniform premium. While there can be a minimum flat rate which will have to be paid by all banks on all their customer deposits, institutions which have riskier porfolios or which have lower ratings should pay higher premium. There would thus be a graded premium. As the Reserve Bank is now awarding CAMELS ratings to banks, these ratings could form the basis for charging deposit insurance premium. (Chapter V, para 5.42)

40. The Committee is of the view that the inter-bank call and notice money market and inter-bank term money market should be strictly restricted to banks. The only exception should be the primary dealers who, in a sense, perform a key function of equilibrating the call money market and are formally treated as banks for the purpose of their inter-bank transactions. All the other present non-bank participants in the inter-bank call money market should not be provided access to the inter-bank call money market. These institutions could be provided access to the money market through different segments.(Chapter V, Annexure para A7)

42. The RBI support to the market should be through a Liquidity Adjustment Facility under which the RBI would periodically, if necessary daily, reset its Repo and Reverse Repo rates which would in a sense provide a reasonable corridor for market play. While there is much merit in an inter-bank reference rate like a LIBOR, such a reference rate would emerge as banks implement sound liquidity management facilities and the other suggestions made above are implemented. Such a rate cannot be anointed, as it has to earn its position in the market by being a fairly stable rate which signals small discrete interest rate changes to the rest of the system.(Chapter V, Annexure para A8).

43. The minimum period of FD be reduced to 15 days and all money market instruments should likewise have a similar reduced minimum duration.(Chapter V, Annexure para A9)

45. With the progressive expansion of the forward exchange market, there should be an endeavour to integrate the forward exchange market with the spot forex market by allowing all participants in the spot forex market to participate in the forward market upto their exposures. Furthermore, the forex market, the money market and the securities should be allowed to integrate and the forward premia should reflect the interest rate differential. As instruments move in tandem in these markets the desiderative of a seamless and vibrant financial market would hopefully emerge (Chapter V, Annexure para A 11).

Rural and Small Industrial Credit :

46. The Committee also recommends that a distinction be made between NPAs arising out of client specific and institution specific reasons and general (agro-climatic and environmental issues) factors. While there should be no concession in treatment of NPAs arising from client specific reasons, any decision to declare a particular crop or product or a particular region to be distress hit should be taken purely on techno-economic consideration by a technical body like NABARD.(Chapter VI, para 6.6)

47. As a measure of improving the efficiency and imparting a measure of flexibility the committee recommends consideration of the debt securitisation concept within the priority sector. This could enable banks, which are not able to reach the priority sector target to purchase the debt from the institutions, which are able to lend beyond their mandated percentage.(Chapter VI, para 6.8)

48. Banking policy should facilitate the evolution and growth of micro credit institutions including LABs which focus on agriculture, tiny and small scale industries promoted by NGOs for meeting the banking needs of the poor. Third-tier banks should be promoted and strengthened to be autonomous, vibrant, effective and competitive in their operations.(Chapter VI, para 6.16)

49. Banks should devise appropriate criteria suited to the small industrial sector and be responsive to its genuine credit needs but this should not be by sacrificing cannons of sound banking. Borrowers also need to accept credit discipline. There is also need to review the present institutional set up of state level financial/industrial development institutions.(Chapter VI, para 6.19).

Regulation and Supervision :

50. The Committee recommends that to improve the soundness and stability of the Indian banking system, the regulatory authorities should make it obligatory for banks to take into account risk weights for market risks. The movement towards greater market discipline in a sense would transform the relationship between banks and the regulator. By requiring greater internal controls, transparency and market discipline, the supervisory burden itself would be relatively lighter.(Chapter VII, para 7.13)

52. Proprietorial concerns in the case of public sector banks impact on the regulatory function leading to a situation of ‘regulatory capture’ affecting the quality of regulation.(Chapter VII, para 7.16)

53. The Committee recommends that the regulatory and supervisory authorities should take note of the developments taking place elsewhere in the area of devising effective regulatory norms and to apply them in India taking into account the special characteristics but not in any way diluting the rigour of the norms so that the prescriptions match the best practices abroad. It is equally important to recognise that pleas for regulatory forbearance such as waiving adherence to the regulations to enable some (weak) banks more time to overcome their deficiencies could only compound their problems for the future and further emasculate their balance sheets.(Chapter VII, para 7.17)

54. An important aspect of regulatory concern should be ensuring transparency and credibility particularly as we move into a more market driven system where the market should be enabled to form its judgement about the soundness of an institution. There should be punitive penalties both for the inaccurate reporting to the supervisor or inaccurate disclosures to the public and transgressions in spirit of the regulations.(Chapter VII, para 7.19).

55. The Committee is of the view that banks should be required to publish half yearly disclosure requirements in two parts. The first should be a general disclosure, providing a summary of performance over a period of time, say 3 years, including the overall performance, capital adequacy, information on the bank’s risk management systems, the credit rating and any action by the regulator/supervisor. The disclosure statement should be subject to full external audit and any falsification should invite criminal procedures. The second disclosure, which would be a brief summary aimed at the ordinary depositor/ investor should provide brief information on matters such as capital adequacy ratio, non performing assets and profitability, vis-à-vis, the adherence to the stipulated norms and a comparison with the industry average. This summary should be in a language intelligible to the depositor and be approved by the supervisors before being made fully public when soliciting deposits. Such disclosure, the Committee believes, will help the strong banks to grow faster than the weaker banks and thus lead to systematic improvement.(Chapter VII, para 7.20)

56. The Committee recommends that an integrated system of regulation and supervision be put in place to regulate and supervise the activities of banks, financial institutions and non banking finance companies (NBFCs). The functions of regulation and supervision are organically linked and we propose that this agency be renamed as the Board for Financial Regulation and Supervision (BFRS) to make this combination of functions explicit. An independent regulatory supervisory system which provides for a closely coordinated monetary policy and banking supervision would be the ideal to work towards.(Chapter VII, para 7.24).

57. The Board for Financial Regulation and Supervision (BFRS) should be given statutory powers and be reconstituted in such a way as to be composed of professionals. At present, the professional inputs are largely available in an advisory board which acts as a distinct entity supporting the BFS. Statutory amendment which would give the necessary powers to the BFRS should develop its own autonomous professional character. The Committee, taking note of the formation of BFS, recommends that the process of separating it from the Reserve Bank qua central bank should begin and the Board should be invested with requisite autonomy and armed with necessary powers so as to allow it to develop experience and professional expertise and to function effectively. However, with a view to retain an organic linkage with RBI, the Governor, RBI should be head of the BFRS. The Committee has also set out specific measures to ensure an effective regulatory/supervisory system which are detailed in para 7.27 (Chapter VII, para 7.24)

Legal and Legislative Framework :

58. With the advent of computerisation there is need for clarity in the law regarding the evidentiary value of computer generated documents. The Shere Committee had made some recommendations in this regard and the Committee notes that the Government is having consultations with public sector banks in this matter. With electronic funds transfer several issues regarding authentication of payment instruments, etc. require to be clarified. The Committee recommends that a group be constituted by the Reserve Bank to work out the detailed proposals in this regard and implement them in a time bound manner. (Chapter VIII, para. 8.15 8.16)

59. Although there is a provision in our legislation effectively prohibiting loans by banks to companies in which their directors are interested as directors or employees of the latter with liberalisation and the emergence of more banks on the scene and with the induction of private capital through public issue in some of the nationalised banks there is a possibility that the phenomenon of connected lending might reappear even while adhering to the letter of law. It is necessary to have prudential norms which are addressed to this problem by stipulating concentration ratios in terms of which no bank can have more than a specified proportion of its net worth by way of lending to any single industrial concern and a higher percentage in respect of lending to an industrial group. At present, lending to any single concern is limited to 25% of a bank’s capital and free reserves. This would seem to be appropriate along with the existing enhanced figure of 50% for group exposure except in the case of specified infrastructure projects. Similarly, concentration ratios would need to be indicated, even if not specifically prescribed, in respect of any bank’s exposure to any particular industrial sector so that in the event of cyclical or other changes in the industrial situation, banks have an element of protection from over exposure in that sector. Prudential norms would also need to be set by way of prescription of exposure limits to sectors particularly sensitive to asset price fluctuations such as stock markets and real estate. As it happens, Indian banks do not have much exposure to the real estate sector in the form of lending for property development as distinct from making housing loans. The example of banks in East and South East Asia which had over extended themselves to these two sectors has only confirmed the need for circumspection in this regard. We would leave the precise stipulation of these limits and, if necessary, loan to collateral value ratios to the authorities concerned. The implementation of these exposure limits would need to be carefully monitored to see that they are effectively implemented and not circumvented, as has sometimes happened abroad, in a variety of ways. Another salutary prescription would be to require full disclosure of connected lending and lending to sensitive sectors. (Chapter III, para. 3.40)

60. The Committee recommends that to improve the soundness and stability of the Indian banking system, the regulatory authorities should make it obligatory for banks to take into account risk weights for market risks. The movement towards greater market discipline in a sense would transform the relationship between banks and the regulator. By requiring greater internal controls, transparency and market discipline, the supervisory burden itself would be relatively lighter.(Chapter VII, para. 7.13 )

61. The Committee recommends that the RBI should totally withdraw from the primary market in 91 days Treasury Bills; the RBI could, of course, have a presence in the secondary market for 91 days Treasury Bills. If the 91 days Treasury Bill rate reflects money market conditions, the money and securities market would develop an integral link. ….The Committee also recommends that foreign institutional investors should be given access to the Treasury Bill market. (Chapter V, Annexure, para. A-10 )

(i) So far, a sum of Rs.20,000 crore has been expended for recapitalisation and to the extent to which recapitalisation has enabled banks to write off losses, this is the cost which the Exchequer has had to bear for the bad debts of the banks. Recapitalisation is a costly and, in the long run, not a sustainable option. Recapitalisation involves budgetary commitments and could lead to a large measure of monetisation. The Committee urges that no further recapitalisation of banks be undertaken from the Government budget. As the authorities have already proceeded on the recapitalisation route it is perhaps not necessary to consider de novo the institution of an ARF of the type envisaged by the earlier CFS Report. The situation would perhaps have been different if the recapitalisation exercise had not been undertaken in the manner in which it has been.

(ii) As an incentive to banks to make specific provisions, the Committee recommends that consideration be given to making such provisions tax deductible. (Chapter III, para. 3.39)

(iii) It would be appropriate if the management committees are reconstituted to have only whole time functionaries in it, somewhat on the pattern of Central Office Credit Committee constituted in the State Bank of India. All decisions taken by these committees could be put up to the Board of Directors for information.(Chapter IV, para. 4.12 – 4.16)

(iv) It would be appropriate to induct an additional whole time director on the Board of the banks with an enabling provision for more whole time directors for bigger banks. (Chapter IV, para.4.17)

(v) There are opportunities of outsourcing in other activities like building maintenance, cleaning, security, despatch of mail and more importantly, in computer related areas. The Committee has been informed that in some areas banks are unable to subcontract work because of a notification issued by the Labour Ministry under Contract Labour (Regulation and Abolition) Act, 1970. The Committee would urge that this be looked into by the authorities so that banks are enabled to effect efficiency and productivity improvements. The global trend in the banking and financial sector also reflects an increasing reliance on outsourced services. In an increasingly competitive environment, statutory provisions should not lead to banks having to carry on internally functions and tasks which can be performed more efficiently by outside service provides. (Chapter IV, para. 4.18).

(vi) The Committee feels that the issue of remuneration structure at managerial levels prevailing in public sector banks and financial institutions needs to be addressed. There is an urgent need to ensure that public sector banks are given flexibility to determine managerial remuneration levels taking into account market trends. The Committee recommends that the necessary authority in this regard be given to the Boards of the banks initially in the case of profit making public sector banks which have gone public, for they would, in any case, be required to operate with an accountability to the market. The forthcoming wage negotiations provide an opportunity to review the existing pattern of industry-wise negotiations and move over to bank-wise negotiations.(Chapter IV, para. 4.26 )

(ix) The Committee attaches the greatest importance to the issue of functional autonomy with accountability within the framework of purposive, rule bound, non-discretionary prudential regulation and supervision. Autonomy is a prerequisite for operational flexibility and for critical decision making whether in terms of strategy or day to day operations. There is also the question whether full autonomy with accountability is consistent and compatible with public ownership. Given the dynamic context in which the banks are operating and considering the situational experience further capital enhancement would be necessary for the larger Indian banks. Against the background of the need for fiscal consolidation and given the many demands on the budget for investment funds in areas like infrastructure and social services, it cannot be argued that subscription to the equity of public sector banks to meet their enhanced needs for capital should command priority. Public sector banks should be encouraged, therefore, to go to the market to raise capital to enhance their capital. At present, the laws stipulate that not less than 51% of the share capital of public sector banks should be vested with the Government and similarly not less than 55% of the share capital of the State Bank of India should be held by the Reserve Bank of India.

The current requirement of minimum Government of India/Reserve Bank of India shareholding is likely to become a constraint for raising additional capital from the market by some of the better placed banks unless Government also decides to provide necessary budgetary resources to proportionately subscribe to the additional equity, including the necessary premium on the share price, so as to retain its minimum stipulated shareholding. The Committee believes that these minimum stipulations should be reviewed. It suggests that the minimum shareholding by Government/RBI in the equity of nationalised banks and SBI should be brought down to 33%.

The Reserve Bank as a regulator of the monetary system should not be also the owner of a bank in view of the potential for possible conflict of interest. It would be necessary for the Government/RBI to divest their stake in these nationalised banks and in the State Bank of India. A reduction in their shares would come about through additional subscription by the market to their enhanced capital. A portion of upto 5 or 10% of the equity of the bank concerned may be reserved for employees of the bank with a provision of some later date for the introduction of stock options. The appointment by the Government of Boards and top executives of banks derives from its majority holding and if, as suggested above, the majority holding itself were to be given up, the appointment of Chairmen and Managing Directors should be left to the Boards of the banks and the Boards themselves left to be elected by shareholders.

Needless to say, with a significant stock holding of not less than 33% Government would have a say in the election of Boards and indirectly of the chief executives without their being seen as administrative appointments. The reduction in the minimum holding of Government below 51% would in itself be a major and clear signal about the restoration to banks and financial institutions of autonomy in their functioning. The Committee makes this recommendation in the firm belief that this is essential for enhancing the effectiveness and efficiency of the system and not on any other consideration.(Chapter V, para 5.27 – 5.33)

(x)

(xi) Though cooperation is a state subject, since UCBs are primarily credit institutions meant to be run on commercial lines, the Committee recommends that this duality in control should be dispensed with. It should be primarily the task of the Board for Financial Supervision to set up regulatory standards for Urban Cooperative banks and ensure compliance with these standards through the instrumentality of supervision. (Chapter V, para 5.39)

(xii) The Committee is of the view that the banking system should be in a position to equip itself to identify the eligible clients based on prescribed norms in the Government sponsored programmes so that the full responsibility for all aspects of the credit decision remains with it. This should also help improve the client bank relationship instead of the present system of virtually imposed clientele and build a credit culture and discipline . (Chapter VI, para 6.3)

(xiii) The Committee strongly urges that there should be no recourse to any scheme of debt waiver in view of its serious and deleterious impact on the culture of credit. (Chapter VI, para 6.7)

(xiv) Evolution of a risk management system would provide the needed comfort to the banking system to finance agriculture. At present, under the Income Tax Act, provision for bad and doubtful debts not exceeding 5% of income and 10% of the aggregate average advances made by rural branches of a scheduled or a non scheduled bank are allowed as deduction in computing the income chargeable to tax. Consideration could be given to increasing this to 5% of income and 20% of average aggregate advances of rural branches to provide incentive to banks for lending to rural sectors.(Chapter VI, para 6.10)

(xv) The Committee recommends that the RRBs and cooperative banks should reach a minimum of 8% capital to risk weighted assets over a period of five years. A review of the capital structure of RRBs should be undertaken with a view to enlarging public subscription and give the sponsor banks greater ownership and responsibility in the operation of RRBs. While considering the issue of salaries of employees of RRBs the Committee strongly urges that there should be no further dilution of the basic feature of RRBs as low cost credit delivery institutions. Cooperative credit institutions also need to enhance their capital through subscription by their members and not by Government. There should be a delayering of the cooperative credit institutions with a view to reducing the intermediation cost and thus providing the benefit of cheaper NABARD credit to the ultimate borrowers. (Chapter VI, para 6.12 )

(xvii) The present duality of control over the cooperative credit institutions by State Government and RBI/NABARD should be eliminated and all the cooperative banking institutions should come under the discipline of Banking Regulation Act, under the aegis of RBI/NABARD/BFS. Thus would require amendments to the Banking Regulation Act. The control of the Registrar of cooperative sector over cooperatives would then be somewhat on the lines of control that Registrar of Companies has over the Banking Institutions, registered under the Companies Act.(Chapter VI, para 6.14 )

(xviii) A legal framework that clearly defines the rights and liabilities of parties to contracts and provides for speedy resolution of disputes is essential for financial intermediation. The evolution of the legal framework has not kept pace with the changing commercial practices and with the financial sector reforms. The Transfer of Property Act enacted in 1882 is a case in point.(Chapter VIII, para 8.1 )

(xix) Given the unsatisfactory state of the law of mortgage, the response has been to vest through special statute the power of sale in certain institutions like Land Development Banks and State Finance Corporations. This approach could be extended to other financial institutions and, if possible, to banks. The other approach is to set up special tribunals for recovery of dues to banks and financial institutions. These Tribunals need to have powers of attachment before judgement, for appointment of receivers and for ordering preservation of property. For this purpose, an amendment to the concerned legislation may be necessary. The Committee would like to emphasise the importance of having in place a dedicated and effective machinery for debt recovery for banks and financial institutions.(Chapter VIII, para 8.2 – 8.4 )

(xx) Securitisation of mortgages is also critically dependent on the ease of enforcement and the costs associated with transfer of mortgages. The power of sale without judicial intervention is not available to any class of mortgages except where the mortgages is the Government or the mortgage agreement so provides and the mortgaged property is situated in Mumbai, Chennai and Calcutta and other towns so notified. Even if the power of sale without judicial intervention were available there would need to be measure to put the buyer in possession. (Chapter VIII, para 8.5 – 8.6 )

(xxi) The question of stamp duties and registration fees also requires review. There is a case for reducing stamp duties and registration fees substantially.(Chapter VIII, para 8.7 )

(xxii) In view of the recent amendments to Section 28 of Indian Contract Act, banks have expressed a fear that they can no longer limit their liabilities under bank guarantees to a specified period and that they would have to carry such guarantee commitments for long periods as outstanding obligations. Government departments do not generally return the original guarantee papers even after the purpose is served. This whole issue needs to be re-examined and bank guarantees exempted from the purview of the recent amendment to Section 28 of the Indian Contract Act. The issue of enforcing securities in the form of book debts also calls for review. The Committee also agrees with the proposal to amend the Sick Industrial Companies Act, seeking to trigger off the remedial mechanism on the sight of incipient sickness.

(Chapter VIII, para 8.9 – 8.14)

(xxiii) Certain legislative requirements would also be needed to implement some of the Committee's recommendations regarding the structure of the banking system and matters pertaining to regulation and supervision. The Banking Regulation Act is structured on the premise that bank supervision is essentially a Government function and that the Reserve Bank of India’s position is somewhat on the lines of an agent. The Act also provides appellate powers to Government over the decisions of the RBI in this regard. It also provides original powers in certain instances. The Committee feels that these provisions should be reviewed. (Chapter VIII, para

8.17)

(xxiv) With respect to recommendations regarding constitution of a Board for Financial Regulation and Supervision, it would be necessary for amendments in the Banking Regulation Act and Reserve Bank of India Act. Amendments would also be needed in the Bank Nationalisation Acts to enable grant of greater managerial autonomy to public sector banks for lowering the minimum requirements of 51% Government ownership and as regards the constitution of Boards of Directors and of the Management Committees. The provisions relating to prior approval of Government for regulations framed under the Act would also need to be reviewed. In line with the above, amendments would also be needed in the State Bank of India Act with regard to shareholding of the RBI and constitution of its Central Board. (Chapter VIII, para 8.19 – 8.23 )