M Narasimham was the doyen of banking reforms in India

Image credit: Suneesh K

Former Reserve Bank of India (RBI) Governor M Narasimham passed away on April 20 due to COVID-19-related illness. Narasimham has the distinction of being the only person who rose from the RBI cadre officer (Economics Research) to become RBI Governor. He also served as Banking Secretary in the government, Executive Director of the International Monetary Fund and World Bank, Vice-President of the Asian Development Bank, etc.

In 2002, he wrote a memoir ‘From Reserve Bank to Finance Ministry and Beyond: Some Reminiscences’ (I have been searching for a copy but to no avail). Economist Anand Chandavarkar in a book review mentioned that Narasimham was a budding cricketer and if not for myopia he could have made it to the team of St John’s College at Cambridge University which had Test-level cricketers. Clearly it was cricket’s loss and banking’s gain.

Narasimham was appointed RBI Governor in trying times. In the 1977 general elections (held after Emergency), the Janata Party terminated the tenure of KR Puri and reached out to IG Patel to become the RBI Governor. However, Patel could not as he was on an away assignment. This led to appointment of Narasimham as the 13th (interim) RBI Governor from May 1977 to November 1977.

Narasimham’s seven month tenure was quite eventful. His May ’77 policy to keep interest rates unchanged brought criticism from stalwart economists CN Vakil and PR Brahmananda who wanted higher rates to dampen inflation. There was also this incident of Finance Minister HM Patel addressing bankers right after the credit policy, a first in RBI’s history. But no one from the media raised questions over the RBI’s autonomy which was hardly an issue at that time. His tenure also saw demarcation of savings deposits into demand and time liabilities.

Becoming the RBI Governor is generally seen as epitome of one’s career and the careers of most governors end with this tenure. But this was not true Narasimham. This had to wait till the 1991 reforms of which the banking sector was a critical component.

The RBI appointed Narasimham as the Chair of Committee on the Financial System and the rest is history. The committee report etched Narasimham’s name on the history of Indian Economy.

Before discussing the report, let me point to the passing way of another notable economist whose work is connected to Narasimham, and India’s reforms in general.

Renowned Economist John Williamson passed on April 11. Williamson coined the term ‘Washington Consensus’ (WC) to suggest what US leaders (and economists) thought of as reforms to generate growth. Williamson presented ‘10 policy instruments’ as reforms which reads much like what India did with 1991 reforms: fiscal discipline, tax reform, liberalising exchange rate, and so on. This is not to suggest that India’s reforms were copied or pushed by the West. But to argue whether it was Williamson’s WC or Montek Singh Ahluwalia’s M document which is seen as key to India’s 1991 reforms, the broad ideas were the same.

One of the 10 reforms was deregulating interest rate markets and ensuring positive real interest rates to encourage savings. He adds as if reflecting on India that there is a need to examine whether low cost credit to ‘priority sectors’ has any economic rationale. He deems priority sector credit as a ‘prime environment for corruption to flourish’.

The Narasimham Committee (NC)’s canvas was much wider, but had elements of the WC. One of the suggestions of the NC was to deregulate administered interest rates and phase out directed credit programmes. The committee advocated priority sector lending to be fixed at 10 percent of aggregate credit, which was of course not just implemented but even rose across time.

The committee’s basic recommendations were to enhance competition in the financial system focusing on banking given India’s reliance on its banks. For these objectives, the NC suggested ways to adhere to Basel capital adequacy norms, improve governance, standardising accounting norms and the NPAs, reduce overregulation and over-administration, promote computerisation, etc.

A good way to start thinking on banking reforms is to see whether we have ticked boxes suggested by the NC. In fact, the RBI had appointed another NC in 1998 which reviewed works of the first NC. The 1998 NC suggested allowing Development Finance Institutions (DFIs) to convert to banks, incorporate Basel-II capital adequacy norms, etc.

Yet recommendations by these committees were not always followed. The ignorance of an important suggestion to end dual regulation of Public Sector Banks has become core to today’s problems in the PSBs. The NC had recommended a four-tiered structure for Indian banking going forward which is still a work in progress: 3-4 large international banks, including the State Bank of India, 10 universal national banks, local banks for specific regions and rural banks for rural and agricultural lending. The NC had suggested active licencing of new private banks but it has been a stop-and-go approach.

The impact of the Narasimham Committee reports continues to weigh on the Indian banking system. It is fair to say that most developments in the Indian banking have some foundation in the Narasimham reports. One can visualise Narasimham perched on his heavenly abode singing this song by The Police to the RBI and every banker: “…Every move you make, Every bond you break, Every step you take, I'll be watching you!”