FSIB, Public Sector Banks and Financial Institutions

History of Indian Banking and Reforms

• Modern India banking started in the 18th century.
• English Agency Houses were founded in Calcutta and Bombay.
• Three presidency banks established in the first half of the 19th century were:
  • Bank of Bengal (1806)
  • Bank of Bombay (1840)
  • Bank of Madras (1843)
• Private and foreign banks entered the market after the introduction of limited liability in 1860.
• Joint stock banks showed up at the beginning of the 20th century.
• The three presidency banks merged in 1921 and created the Imperial Bank of India.
• The Imperial Bank of India performed normal commercial bank functions.
• It also performed functions of a Central Bank in India until 1935.
• In 1947 there were over 600 commercial banks operating in India.
• The banks were seen as biased toward working capital loans for trade and large firms, and against small enterprises, agriculture, and commoners.
• The government nationalized the Imperial Bank in 1921.
• The Imperial Bank was transformed into the State Bank of India (SBI) in 1955.
• The banking needs of small-scale industries and agriculture were not sufficiently covered in the 50s and 60s
• Commercial/industry houses had close ties with established commercial banks which gave an advantage in obtaining credit.
• Banks needed to play a role in India's development strategy by mobilizing resources crucial for economic expansion.
• The policy of social control over banks was announced to cause changes in management and credit distribution by banks.
• The Government nationalized 14 banks in July 1969 whose nation-wide deposits were greater than Rs. 50 crores.
• The purpose of the bank nationalization in July 1969 was to:
  • 'Control the commanding heights of the economy
  • Meet progressively the needs of development of the economy
  • Conform to national policy and objectives
• Two purposes of nationalization were rapid branch expansion and channeling of credit according to plan priorities.
• After nationalization bank branches expanded rapidly in rural and urban areas.
• There was growth in deposits mobilized by the banks/credit expansions especially in priority sectors.
• In April 1980, the government undertook a second round of nationalization.
• Six private banks were put under government control whose nationwide deposits were above Rs. 200 crores.
• Public sector bank's share of deposits rose to 92%.
• More nationalizations occurred to ensure priority sector lending reached the poor through a widening branch network and to fund rising government deficits.
• Priority sector lending targets raised to 40% from 33.3%.
• Government took control over banks funds by raising the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR).
• The CRR was 2% and SLR was 25% in 1960 and it both increased until 1991 to 15% and 38.5% respectively.
• Bank branches increased a lot from 1969 to 1991, but banks remained unprofitable, inefficient, and unsound.
• The banks had poor lending strategies and a lack of internal risk management under government ownership. Major factors that contributed to deteriorating bank performance:
  • Regulatory requirements of CRR and SLR required banks to hold a certain amount in government and eligible securities
  • Low interest rates charged on government bonds as compared to commercial advances
  • Directed and concessional lending
  • Administered interest rates and
  • Lack of competition
• Banks' incentives to operate properly were reduced.
• Regulators incentives to prevent banks from taking risks were undermined.
• Initial government involvement in the financial sector can be justified.
• Prolonged presence of excessively large public sector banks often means inefficient resource allocation and concentration of power in a few banks.
• The policies promoted an equal distribution but lead to inefficiencies.
• India's banking system until 1991 was part of the government's spending policy.
• Directed credit rules and statutory pre-emptions, led to being a captive source of funds for the fiscal deficit and the key industries
• Through the CRR and the SLR, more than 50% of the savings was deposited with the RBI or used to buy government security
• 40% of the remaining savings was directed to set priority sectors defined by the government.
• The government had control over the prices of the funds, that is, the interest rates on saving and loans.
• By the end of the 1980s, the Indian banking sector had structural problems like unprofitability, inefficiency and financial unsoundness.
• By international standards, even with rapid deposit growth, Indian banks were extremely unprofitable.
• Bank's progress after nationalization led to government reinforcing excessive controls which created rigidities and inefficiencies in banks.
• The banking system's development was hindered and profitability was eroded.

Narasimhan Committee I and II

• A high-level committee under Shri. M. Narasimhan was created due to defects in the financial sector during the 1991 crisis.
• The committee (Committee on Financial System) had to review the progress and working of India's sector and suggest reform measures.
• The following were some of the recommendations of the committee:
  • The Statutory Liquidity Ratio (SLR) should be based on requirements for banks.
  • The SLR should not have the view of an instrument for government budget.
  • SLR should be brought down to 25 per cent.
  • Interest rates should be deregulated gradually.
  • The RBI should resort more to open market operations than changing Cash Reserve Ratio (CRR) to control the secondary expansion of credit in the deregulation of interest rates.
  • Interest rates on SLR investments should be related to the market.
  • Interest rates on CRR should be broadly related to banks' cost of deposits.
  • The directed credit programme should be phased out/redefined.
  • There should be a level playing field between the public sector, private sector and foreign sector banks.
  • An Asset Reconstruction Company (ARC) should be established which could take over from banks/financial institutions a portion of the bad and doubtful debts at an appropriate discount.
  • The ARC should be provided with special powers of recovery.
  • Select few large banks to become international in character and eight to ten national level banks with branches throughout the country.
  • The duality of control over the banking system between the RBI and the Ministry of Finance should end and RBI should be the primary agency for the regulation of the banking system.
• The Government of India felt by the end of 1997 that the banking system could become stronger and better equipped by reforms.
• A committee specifically called Committee on banking Sector Reforms was constituted in 1997 under M. Narasimhan.
• Following were the major recommendations of Narasimhan Committee - II:
  • Autonomy in Banking: Public sector banks should have greater autonomy.
  • This will give the banks professionalism equal to their international counterparts.
  • Recruitment procedures, training and remuneration policies of public sector banks be brought in line with best-market-practices.
  • The GOI equity in nationalized banks be reduced to 33 per cent for increased autonomy.
  • Recommendation for merger of large Indian banks to become strong allowing them to support international trade.

Nachiket Mor and P J Nayak Committees

• The "Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households” was set up by the RBI in Sep 2013 under chairman Nachiket Mor.
• The committee gave its report in January 2014 and made these recommendations:
  • Each Indian resident, above the age of 18 years, should have a safe bank account providing full service.
  • Aadhaar should rapidly expand the number of bank accounts
  • Every resident in India should have a payment access point within 15 minutes walking distance.
  • Each low-income household/small business would have access to providers that can offer investment/deposit products.
  • Services must be available to them at reasonable charges.
• Public Sector Banks (PSBs) have been established through the “State Bank of India Act 1955" and "The banking companies act, 1970".
• These Acts require Govt. of India to have majority shareholding/voting power in PSBs which empowers the Govt.
• The government's power allows them to appoint Board of Directors and involve in the decision making of the PSBs leading to governance issues.
• People appointed on the board are not that qualified for their job but are close to Govt. and Government can start manipulating.
• Manipulation by appointees lead to frauds/corruption.
• The P J Nayak committee was constituted in January 2014 to review governance of boards of banks in India.
• The committee submitted its report in May 2014 and it examined the workings of banks' boards.
• P J Nayak examined RBI guidelines on representation in the board, and investigate conflicts of interest.
• The main recommendations were:
  • Government should setup a Bank Investment Company (BIC), under Companies act, 2013
  • Govt. should transfer its present ownership in PSBs to BIC and all the PSBs will be incorporated as subsidiaries of BIC and will be registered under the Companies Act 2013.
  • The PSBs will become limited companies.
  • Ex: “State Bank of India" will become "State Bank of India Limited". If State Bank of India Limited becomes bankrupt, Govt. of India/BIC will not be liable.
  • Government should reduce its stake in PSBs (through BIC) to less than 50%.
  • The BIC will become a holding company owned by Govt. of India.
  • BIC will have the voting powers to appoint Board of directors and other policy decisions of the banks.
  • Government will sign shareholding agreement with BIC, promising its autonomy meaning the Government will be majority shareholders in BIC, but it will not intervene in its working.
  • BIC will select banks directors/top management.
    • Government may reduce its ownership to less than 50% in BIC to preserve BIC's autonomy.
  • BBB (Banks Board Bureau) can be established through an executive order and will select and appoint directors/top management in public sector banks and public sector financial institutions until BIC is set up.
• The Financial Services Institutions Bureau (FSIB) replaced the Banks Board Bureau (BBB) from July 1, 2022.
• The functions of the FSIB are:
  • To recommend persons for appointment as whole-time directors (WTDs) and non- executive chairpersons the Boards of Directors in Public Sector Banks, institutions and Insurers
  • To advise the Government on matters relating to appointments, transfer or extension of term of office and termination of services of the said directors
  • To advise the Government on the desired management structure at the Board level for PSBs, FIs and PSIs
  • To advise the Government on a performance appraisal system for WTDs and NECs in PSBs, FIs and PSIs
  • To build databank containing data related to the performance of PSBs, FIs and PSIs
• To advise the Government on formulating and enforcing a code of conduct and ethics for directors in PSBs, FIs and PSIs
  • To advise the Government on evolving suitable training and development programs for management personnel in PSBs, FIs and PSIs
  • To help PSBs, FIs and PSIs in terms of developing business strategies and capital raising plan
  • To carry out such process and draw up a panel for consideration of competent authority for any other bank, financial institution or insurer for which the Government makes a reference

Relationship between RBI and Government of India

• According to the RBI Act, the Central Board is made up of 21 members.
• It includes a Governor, four Deputy Governors, Four Directors (one each from the four regional boards of the RBI), 10 directors nominated by the Centre, and two government officials also nominated by the Centre.
• The Board and the Governor is not a corporate set-up with Directors who report to the Manager.
• The Governor's powers come from the RBI Act, and not the Central Board.
• He is appointed by the Prime Minister in consultation with the Finance Minister.
• The RBI Board has no role in the Governors appointment.
• In the RBI, the Governor secures board membership only after he is appointed to the post, so it is wrong to compare a corporate board to it.
• Policy decisions are taken by the Governor along with the bank's 4 deputy governors.
• The Board provides a broader vision.
• The Board functions in an advisory role and the Governor takes its advice into consideration while making policy decisions.
• There is mutual respect between the Board and the Governor, with both operating in a spirit of accommodation.
• The Centre (Government of India) and the RBI should work in close coordination.
• If the Centre and the Governor have a serious disagreement and cannot reach a common ground the Centre can use Section 7 of the RBI Act.
• Section 7 allows the Centre to give written direction to RBI.
• RBI decision making will pass to the RBI (Central) Board and then RBI Governor will have no say.
• Section 7 has never been unleashed in the 85 -year existence of RBI. Things were sorted out quietly behind the scenes before it got out of hand.
• The Centre also understands using Sections 7 will necessarily set a bad precedent. RBI has its own independence.
• The Centre is the spender and the RBI is the creator of money, and there has to be a natural separation between the two.
• The Center arming itself with powers to run the RBI runs afoul of this precept.
• The RBI Act has the veto option for Government through Section 7.
• It is the rulers in Delhi who carry the can for the policies they frame. Ultimately, it is the elected representative ruling the country who is answerable to the citizen every five years.
• The representative cannot blame the RBI for the economy.
• It is undemocratic to have an autonomous institution that is unaccountable to the people.
• The limits to the RBI's autonomy will be clear.
• It is autonomous and accountable to the people through government.
• There is enough creative tension between the two built into the system.
• The Governor is conscious of limits/the government has to consider the advice seriously.

Previous Governors

• Dr. Manmohan Singh: The finance minister insists on action if RBI doesn't prevail.
• Bimal Jalan: RBI is accountable to the government and should make policies within government's framework.
• D. Subbarao: RBI operates within the framework of RBI Act 1934 and is not fully autonomous.
• Y. V. Reddy: Operational issues offer total freedom/RBI prior consults on policy related matters. Having a continuous dialogue is needed.

Should large corporate be allowed to open their own banks?

• The India total banks balance sheet is less than 70% of the GDP.
• China's ratio is closer to 175%.
• China, Japan, the US and Korea have over 150% domestic bank credit to the private sector versus India's 50%.
• The India private sector needs money (credit) to grow.
• Government-owned banks are struggling with NPAs.
• With growth faltering, the government has limited ability to push for growth through the public sector banks.
• Large corporates, with deep pockets, are the ones with the financial resources to fund India's future growth but does comes serious risks.
• Risks include:
  • Conflict of Interest: Inter-connected occurs when a bank owner is also a borrower so a promoter can channel depositors' money into their own group companies/cronies at more relaxed terms.
  • Banks can finance to customers/suppliers of their businesses. Concentrating economic power.
• RBI can only react to interconnected lending ex-post and is unlikely to prevent exposure for entities of the corporate house.
• Corporations are adept at routing funds through a maze of entities/subsidiaries and it will challenge monitoring of transactions requiring cooperation various law enforcement agencies whom corp. can thwart.
• Any RBI reaction could cause a flight of deposits from the bank. The challenges posed by lending this way are formidable.
• Inter-connected lending was exampled in ICICI Bank, Yes Bank, DHFL etc. The so-called ever-greening of loans (where one loan after another is extended to enable the borrower to pay back the previous one) is often the starting point of such lending.
• Risks of banks extends to corporate houses in the group and it will need the depositors to be protected through the use of public safety net. Deposit taking bank for common public is risker than NBFCs backed by big corporates.
• Keep the class of borrowers separate from the class of lenders, unless corporations strengthen large conglomerates

The Financial Services Institutions Bureau (FSIB) plays a crucial role in recommending individuals for key positions in Public Sector Banks and Financial Institutions. It advises the government on appointments, transfers, and management structures. The FSIB also assists these institutions in developing strategies and raising capital.