The Narasimham Committee for Financial Sector Reforms has suggested reduction in

1. Understanding CRR and SLR: The Liquidity Anchors (basic)

To understand banking in India, we must first look at how banks manage the money you deposit. When you put money in a bank, it becomes a liability for the bank because they owe it back to you. The total of these deposits—divided into those you can withdraw anytime (Demand) and those locked for a period (Time)—is called the Net Demand and Time Liabilities (NDTL) Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.63. To ensure your money is safe and the economy doesn't overheat, the Reserve Bank of India (RBI) mandates two "liquidity anchors": CRR and SLR.

Cash Reserve Ratio (CRR) is the portion of NDTL that banks must keep exclusively in cash with the RBI. Think of it as a safety vault kept with the regulator. Banks do not earn any interest on this amount. Its primary job is to control the money supply; if the RBI raises the CRR, banks have less money to lend, which slows down inflation Macroeconomics (NCERT class XII 2025 ed.), Money and Banking, p.42. By acting as a limit on credit creation, it ensures banks don't lend out every single rupee they receive.

Statutory Liquidity Ratio (SLR), on the other hand, is the portion of NDTL that banks must maintain with themselves in liquid assets like Gold, Cash, or Government Securities (G-Secs). While CRR is about cash with the RBI, SLR is about maintaining high-quality liquid assets that can be quickly sold if depositors suddenly rush to withdraw their money Indian Economy, Nitin Singhania (ed 2nd 2021-22), Financial Market, p.236. Historically, SLR was also a way for the government to ensure banks bought their bonds, but modern reforms (like those suggested by the Narasimham Committee) have focused on reducing these ratios to give banks more freedom to lend to the productive sectors of the economy.

Feature	Cash Reserve Ratio (CRR)	Statutory Liquidity Ratio (SLR)
Kept with	The Reserve Bank of India (RBI)	The Bank itself
Form	Only Cash	Cash, Gold, and RBI-approved Securities
Returns	No interest earned by the bank	Banks earn interest/profit (on Securities/Gold)

Sources: Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.63; Macroeconomics (NCERT class XII 2025 ed.), Money and Banking, p.40-42; Indian Economy, Nitin Singhania (ed 2nd 2021-22), Financial Market, p.236

2. The 1991 Balance of Payments Crisis and Financial Repression (intermediate)

To understand why India changed its banking laws in the 1990s, we first need to look at the "pressure cooker" environment of the 1980s. Before 1991, the Indian banking system suffered from what economists call Financial Repression. This essentially means the government used the banking system as a captive source of funds to finance its own fiscal deficits. Instead of banks lending money based on commercial viability, they were forced to lock up a massive portion of their deposits in government-mandated channels.

During this period, the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) were used as tools of resource mobilization for the state rather than for bank safety. In fact, by 1991, more than 50% of every rupee a citizen deposited in a bank had to be either kept with the RBI or invested in government securities Indian Economy, Vivek Singh, Money and Banking - Part II, p.126. When you add Directed Credit (where 40% of the remaining funds had to go to specific "priority sectors"), banks were left with very little capital to lend to the wider industry, leading to massive inefficiencies and low productivity.

This internal fragility met a perfect storm in 1991. Externally, the Gulf War caused international crude oil prices to skyrocket, ballooning India's import bill Indian Economy, Nitin Singhania, Balance of Payments, p.483. Internally, years of high fiscal deficits and reliance on debt meant India had no cushion. The crisis hit a breaking point when India’s foreign exchange reserves plummeted to roughly $0.9 billion—enough to pay for only about three weeks of imports Indian Economy, Nitin Singhania, Balance of Payments, p.484. Facing a default, India had to airlift gold to London and Zurich as collateral for an IMF bailout.

Feature	Pre-1991 "Repressed" System	Post-1991 Vision
SLR/CRR Purpose	Financing the Government's deficit.	Prudential safety and liquidity.
Interest Rates	Strictly regulated by the Government.	Market-determined (Liberalized).
Credit Allocation	Heavy "Directed Credit" mandates.	Commercial and efficient lending.

Sources: Indian Economy, Vivek Singh, Money and Banking - Part II, p.126; Indian Economy, Nitin Singhania, Balance of Payments, p.483-484; Indian Economy, Nitin Singhania, Economic Planning in India, p.135

3. Priority Sector Lending (PSL) Mandates (basic)

At its heart, Priority Sector Lending (PSL) is a regulatory tool used by the RBI to ensure that credit flows to those sectors of the economy that are high on social impact but might be overlooked by banks in favor of more profitable corporate lending. Think of it as 'directed credit' to ensure inclusive growth. These sectors typically include Agriculture, MSMEs, Education, Housing, Social Infrastructure, and Renewable Energy. Interestingly, since 2020, the RBI has also included the Startup sector under this umbrella to foster innovation Indian Economy, Nitin Singhania (2nd ed. 2021-22), Financial Market, p.241. While these mandates ensure money reaches the grassroots, the Narasimham Committee (1991) actually recommended scaling them down, arguing that excessive directed credit was hurting bank productivity and profitability Indian Economy, Vivek Singh (7th ed. 2023-24), History of Indian Banking and Reforms, p.127.

The mandate is not uniform across all banks. While standard Scheduled Commercial Banks (SCBs) are usually required to lend 40% of their Adjusted Net Bank Credit (ANBC) to these sectors, the burden is higher for banks with a specific developmental mandate. For instance, Regional Rural Banks (RRBs) and Small Finance Banks (SFBs) must allocate a massive 75% of their credit to priority sectors Indian Economy, Nitin Singhania (2nd ed. 2021-22), Financial Market, p.241. To make the system more efficient, banks can now engage in 'on-lending' through NBFCs (up to 5% of their PSL target) to reach the last mile Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.72.

What happens if a bank fails to meet these targets? They don't just get a slap on the wrist. The shortfall must be deposited into funds like the Rural Infrastructure Development Fund (RIDF) managed by NABARD, which earns them a lower rate of interest, effectively acting as a penalty Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.71. Alternatively, banks can use Priority Sector Lending Certificates (PSLCs)—a market-based mechanism where a bank that has over-achieved its target sells 'credits' to a bank that has fallen short, allowing the market to solve the compliance issue Indian Economy, Nitin Singhania (2nd ed. 2021-22), Financial Market, p.241.

Bank Category	PSL Target (% of ANBC)
Domestic Commercial Banks	40%
Regional Rural Banks (RRBs)	75%
Small Finance Banks (SFBs)	75%

Sources: Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.71; Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.72; Indian Economy, Nitin Singhania (2nd ed. 2021-22), Financial Market, p.241; Indian Economy, Vivek Singh (7th ed. 2023-24), History of Indian Banking and Reforms, p.127

4. Monetary Policy Tools: Quantitative vs Qualitative (intermediate)

At its heart, Monetary Policy is the process by which the central bank (RBI) manages the supply of money and the cost of credit to balance two often-competing goals: maintaining price stability (controlling inflation) and supporting economic growth. Since 2016, the RBI has a specific statutory mandate to keep inflation at 4% (with a margin of ±2%) Indian Economy, Nitin Singhania, Money and Banking, p.172. To achieve this, the RBI uses two distinct types of toolkits: Quantitative and Qualitative.

Quantitative Tools (also called General Tools) are designed to regulate the total volume of money flowing in the entire banking system. They are "blind" to which sector the money goes to; they simply aim to make credit generally cheaper or costlier. A primary example is Open Market Operations (OMO), where the RBI buys or sells Government Securities (G-Secs) Indian Economy, Vivek Singh, Money and Banking- Part I, p.63. If the RBI sells G-Secs, it sucks cash out of the banks, reducing the money supply to cool down inflation Indian Economy, Nitin Singhania, Money and Banking, p.167.

Qualitative Tools (also called Selective Tools), on the other hand, focus on the direction or quality of credit. Instead of changing the total amount of money in the economy, these tools tell banks where or how to lend. For instance, the RBI might set a "Margin Requirement," which determines how much collateral a borrower must provide for a loan in a specific sector (like real estate) to prevent bubbles.

Feature	Quantitative Tools	Qualitative Tools
Objective	Control the total volume/quantity of money.	Control the flow/direction of credit to specific sectors.
Examples	Repo Rate, CRR, SLR, OMOs.	Margin requirements, Moral Suasion, Credit Rationing.
Impact	Affects the entire economy uniformly.	Affects specific sectors (e.g., Agriculture, Housing).

Historically, Indian banking was heavily controlled by high quantitative requirements (like SLR and CRR) and rigid qualitative mandates (like directed credit). However, following the Narasimham Committee (1991) recommendations, there has been a shift toward reducing these rigidities to improve bank productivity and allow market forces to play a larger role in credit distribution.

Sources: Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking- Part I, p.60, 63; Indian Economy, Nitin Singhania (ed 2nd 2021-22), Money and Banking, p.167, 172

5. Asset Quality and Banking Health Concepts (intermediate)

In the world of banking, the terminology of "assets" can feel upside down. For a bank, the money you deposit is a liability because they owe it back to you. Conversely, the loans they give out are assets because they generate income through interest. However, when a borrower stops paying, that asset stops "performing," leading to what we call Non-Performing Assets (NPAs). Generally, if the interest or principal remains overdue for more than 90 days, the loan is classified as an NPA Indian Economy, Nitin Singhania (ed 2nd 2021-22), Financial Market, p.228.

To ensure transparency and consistent accounting, the RBI requires banks to categorize these bad loans based on how long they have remained unpaid. This isn't just a labeling exercise; it tells the regulator how much risk the bank's balance sheet is carrying Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.135.

Asset Category	Criteria (Time Period)
Sub-standard	NPA for a period less than or equal to 12 months.
Doubtful	NPA for a period exceeding 12 months.
Loss Asset	Identified as uncollectible by the bank or auditors, though not yet written off.

Beyond NPAs, we often hear the term Stressed Assets. This is a broader umbrella that includes NPAs and Restructured Loans. Restructuring happens when a bank modifies the loan terms—perhaps by lowering the interest rate or extending the repayment period—to help a struggling borrower avoid default Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.135.

To clean up these balance sheets, the Narasimham Committee (1998) recommended the creation of specialized entities called Asset Reconstruction Companies (ARCs) Indian Economy, Nitin Singhania (ed 2nd 2021-22), Financial Market, p.231. An ARC acts as a "Bad Bank"; it buys NPAs from banks at a discount, allowing the banks to focus on their core business while the ARC takes over the messy job of recovering the debt. A major milestone in this journey was the SARFAESI Act (2002), which provided the legal teeth for ARCs to operate. Recently, the government intensified this effort by creating the NARCL (National Asset Reconstruction Company Ltd.), a public-sector-led "Bad Bank" designed to handle large-scale stressed assets Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.137.

Sources: Indian Economy, Nitin Singhania, Financial Market, p.228, 231; Indian Economy, Vivek Singh, Money and Banking - Part II, p.135, 136, 137

6. Narasimham Committee I (1991): Recommendations on Structure (exam-level)

Concept: Narasimham Committee I (1991): Recommendations on Structure

7. Narasimham Committee II (1998): Banking Sector Reforms (exam-level)

By 1997, the first wave of reforms had stabilized the Indian economy, but the global financial landscape was changing rapidly. The Government realized that for Indian banks to compete internationally, they needed more than just lower reserve requirements—they needed structural strength and operational freedom. This led to the Narasimham Committee II (1998), often called the Committee on Banking Sector Reforms, which focused on "second-generation" reforms. Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.127

A primary focus of the 1998 committee was Capital Adequacy. To ensure banks had enough "skin in the game" to absorb potential losses, the committee recommended raising the prescribed capital adequacy norms. This was designed to improve the inherent strength and risk-taking ability of the banking system. Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.128. Furthermore, the committee identified a significant Conflict of Interest: the Reserve Bank of India (RBI) was acting as both the regulator of the banking system and the owner of major banks like SBI. On the committee's recommendation, the RBI eventually transferred its shareholdings in institutions like SBI, NHB, and NABARD to the Government of India to maintain its neutrality as a regulator. Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.128

The committee also addressed the crippling issue of Non-Performing Assets (NPAs). At the time, banks had no legal power to take possession of securities from defaulters without lengthy court battles. The Narasimham Committee II suggested a new legislative framework for securitisation, empowering banks to recover loans by selling pledged assets without court intervention—a recommendation that eventually paved the way for the SARFAESI Act. Indian Economy, Vivek Singh (7th ed. 2023-24), Money and Banking - Part II, p.136

To help you distinguish between the two committees, here is a summary of the second committee's key pillars:

Focus Area	Recommendation
Autonomy	Greater professional independence for Public Sector Banks (PSBs) to compete with international banks.
Regulation	Separation of RBI’s role as a regulator from its role as a bank owner.
Asset Recovery	Creation of a legal framework for the out-of-court takeover of securities (Securitisation).
Prudential Norms	Higher Capital Adequacy Ratios and stricter asset classification.

Sources: Indian Economy, Vivek Singh (7th ed. 2023-24), 3.1 History of Indian Banking and Reforms, p.127; Indian Economy, Vivek Singh (7th ed. 2023-24), 3.1 History of Indian Banking and Reforms, p.128; Indian Economy, Vivek Singh (7th ed. 2023-24), 3.1 History of Indian Banking and Reforms, p.136

8. Solving the Original PYQ (exam-level)

You have just mastered the mechanics of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) as tools for liquidity management. This question tests your ability to apply those building blocks to the historical evolution of Indian banking. In the pre-1991 era, these ratios were excessively high—often referred to as 'financial repression'—because they forced banks to lend the majority of their deposits to the government at low interest rates. The Narasimham Committee (1991) was the turning point that sought to transition Indian banking from this state-dominated model toward a market-driven one to improve bank productivity and profitability. As noted in Indian Economy, Vivek Singh (7th ed. 2023-24), these high ratios were specific targets for reduction to unlock bank resources.

To arrive at the correct answer, think like a reformer: if your goal is to make banks more commercially viable, you must reduce the mandatory burdens that restrict their lending capacity. The committee recommended a phased reduction of both SLR and CRR to free up loanable funds for the wider economy. Crucially, it also addressed the 'directed credit' programs, recommending that Priority Sector Financing be scaled down and redefined to focus only on the most vulnerable groups. This logical 'trio of reductions'—freeing up cash (CRR), reducing government-mandated investments (SLR), and lowering directed lending (Priority Sector)—makes (B) SLR, CRR and Priority Sector Financing the only comprehensive and correct choice.

UPSC often uses 'half-truths' and 'red herrings' to test your precision. Option (A) is a classic incomplete trap; while true, it misses the committee's major stance on directed credit. Options (C) and (D) introduce 'Financing to the capital goods sector,' which is a distractor. The committee focused on systemic regulatory ratios and broad credit categories rather than targeting specific industrial sectors like capital goods for reduction. By remembering that the Narasimham Committee aimed for operational flexibility and a move away from 'administered' interest rates and credit, you can easily filter out these irrelevant additions.