The reforms of the financial sector in India have been guided by the report of the Narasimham Committee which was issued in November 1991. These reforms aimed at improving the efficiency of the banking system, introducing transparency in operations, and ensuring that the sector is operating on a sound financial footing.
The Narasimham Committee drew attention to the poor loan recovery, weak capital position, high cost and low profitability of public sector banks and attributed this not to public ownership but pointed instead to the managerial and policy environment within which banks had operated (Bery, 1994). On this basis controls on interest rates were
removed, the pre-emption of bank assets were reduced, and regulatory and supervisory standards were strengthened. The new norms of asset classification, income recognition, and capital adequacy requirements that were introduced resulted in many public sector banks reporting losses – as a group these banks reported a net loss of Rs. 3,293 crore in 1992-93 and Rs. 4,349 crore in 1993-94 – and the non-performing loansof these banks were found to be about 21% of their loan portfolio in 1992-93.
The public sector banks, however, constitute two sets of banks. The State Bankof India (SBI) and its seven associate banks were the only public sector banks from 1955 to 1969 when the Nationalization Act nationalized the 14 largest private sector banks and another 6 banks were nationalized in 1980.1 The 27 public sector banks dominate the commercial banking sector with a share of 87.2% of assets in 1992-93 and 79.7% in 1999-2000. 91.3% of the bank branches in the country in 1992-93 and 89.8% of the branches in 1999-00 belonged to the public sector banks. About 65.8% of these branches of the public sector were in rural and semi-urban areas. By contrast, 57.2% of the private sector bank branches were in rural and semi-urban areas whereas foreign banks had no presence at all in these areas with all their branches located in urban and metropolitan areas2.
The expansion of private sector and foreign banks was strictly regulated and only since 1993 have new private and foreign banks been allowed to enter the market. Currently there are 32 private sector banks (8 of them having set
up since April 1994) and 42 foreign banks operating in India.
The performance of the domestic private and foreign banks has been stronger than that of the public sector banks. Many explanations have been advanced for this phenomenon ranging from them not having the burden of a large network of branches especially in low diversity business areas such as in rural areas, they have been able to
introduce technology to upgrade operational efficiency, and their business strategy has concentrated more on high yielding fee based activities and advisory services.
The nonperforming assets of public sector banks have been considerable. At the end of 1999- 00, the net NPAs of public sector banks were 7.60% of advances for public sector banks (7.22% for the SBI group), 4.58% for the private banks, and 2.12% for the foreign banks. Five public sector banks – State Bank of Bikaner & Jaipur, Indian Bank,
Allahabad Bank, United Bank of India, and Dena Bank – had particularly high levels of NPAs over 10 per cent of advances, whereas six private sector banks – The Catholic Syrian Bank Ltd., The Nedungadi Bank Ltd., the Dhanalakshmi Bank Ltd., The Benares State Bank Ltd., Lord Krishna Bank Ltd., and SBI Commercial & International Bank Ltd. –had similar NPA-advances ratios.