Draft Report of the High Level Group on Services Sector

Chapter 6: Financial Services

The importance of the financial sub-sector goes beyond the output and employment it directly generates, given its critical role in enabling broader economic activity, whether in industry, agriculture or other services. The financial sub-sector provides products for mobilizing household and corporate savings, credit for producing and consuming goods and creating long-term assets, transaction banking for facilitating economic activity and insurance for risk mitigation, long-term savings and social security. This report seeks to recommend the key measures that taken together would help in meeting the objectives of achieving greater financial inclusion, serving emerging customer needs and enhancing global competitiveness.

Banking

The banking sector reforms were carried out during the 1990s based on the recommendations of the Narasimham Committees in 1992 and 1998. Certain key recommendations continue to remain substantially unimplemented.

1. 
   There is a strong case for gradual reduction in SLR in line with other markets. Similarly, CRR which has been increased several times recently as a monetary measure, may be aligned over time with an appropriate globally benchmarked level.
   
2. 
   It is observed that the directed agricultural lending targets have not had the desired impact in terms of financial inclusion; banks have often mis-priced credit to achieve the volume targets and have suffered high credit losses. It would therefore be appropriate to move from a mandated directed lending target to a market-based approach, where banks develop sustainable models to engage a wider set of customers in the economic mainstream.
   
3. 
   There has been limited progress in consolidation in the Indian banking system. The issue of consolidation is particularly relevant for the mid-sized public sector banks that are currently duplicating investments in technology and other infrastructure, and not benefiting from economies of scale. There is an urgent need to catalyse consolidation among these players, and leverage the synergistic benefits.
   
4. 
   The branch licensing requirement emanates from statute, as well as from regulatory objectives. The statutory requirement can be eliminated by amendment to the statute, or an exemption from the licensing requirement under extant provisions. In any event, banks may be required to have a minimum proportion of branches in rural/ semi-urban or under-banked areas, as required by the existing banking license conditions for the new generation private sector banks.
   
5. 
   Banks majority owned by the government continue to account for about 70.0 per cent of the Indian banking system. The Narasimham Committee had recommended that the minimum government ownership in these banks be reduced to 33 per cent, and the banks should become board-managed companies. Firstly, the oversight of public sector banks by the Central Vigilance Commission (CVC) may be reviewed. The existence of CVC oversight creates a culture of avoidance and delay in decision-making that seriously damages the banks’ competitive positioning. Secondly, individual banks should be given the freedom to determine their recruitment, placement, promotion, performance evaluation and compensation policies, including performance bonuses and stock options. These are essential tools in attracting, retaining and leveraging human capital, which is a key competitive differentiator. Thirdly, the selection of non-executive board members, the CEO and other executive board members should be determined by the board of directors of each bank.