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A bank is an institution that deals in money and its substitutes and

provides other financial services. Banks accept deposits and make loans
or make an investment to derive a profit from the difference in the
interest rates paid and charged, respectively.

In India the banks are being segregated in different groups. Each

group has their own benefits and limitations in operating in India. Each
has their own dedicated target market. Few of them only work in rural
sector while others in both rural as well as urban. Many even are only
catering in cities. Some are of Indian origin and some are foreign players.

India’s economy has been one of the stars of global economics in

recent years. It has grown by more than 9% for three years running. The
economy of India is as diverse as it is large, with a number of major
sectors including manufacturing industries, agriculture, textiles and
handicrafts, and services. Agriculture is a major component of the Indian
economy, as over 66% of the Indian population earns its livelihood from
this area. Banking sector is considered as a booming sector in Indian
economy recently. Banking is a vital system for developing economy for
the nation.

However, Indian banking system and economy has been facing

various challenges and problems which have discussed in other parts of


Without a sound and effective banking system in India it cannot

have a healthy economy. The banking system of India should not only be
hassle free but it should be able to meet new challenges posed by the
technology and any other external and internal factors. For the past three
decades India's banking system has several outstanding achievements to
its credit. The most striking is its extensive reach. It is no longer confined
to only metropolitans or cosmopolitans in India. In fact, Indian banking
system has reached even to the remote corners of the country. This is one
of the main reasons of India's growth process. The government's regular
policy for Indian bank since 1969 has paid rich dividends with the
nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank
counters for getting a draft or for withdrawing his own money. Today, he
has a choice. Gone are days when the most efficient bank transferred
money from one branch to other in two days. Now it is simple as instant
messaging or dial a pizza. Money has become the order of the day.

The first bank in India, though conservative, was established in

1786. From 1786 till today, the journey of Indian Banking System can be
segregated into three distinct phases. They are as mentioned below:

• Early phase from 1786 to 1969 of Indian Banks

• Nationalization of Indian Banks and up to 1991 prior to Indian

banking sector Reforms.

• New phase of Indian Banking System with the advent of Indian

Financial & Banking Sector Reforms after 1991.

After 1991, under the chairmanship of M Narasimham, a
committee was set up by his name which worked for the liberalization of
banking practices. The country is flooded with foreign banks and their
ATM stations. Efforts are being put to give a satisfactory service to
customers. Phone banking and net banking is introduced. The entire
system became more convenient and swift. Time is given more
importance than money. This resulted that Indian banking is growing at
an astonishing rate, with Assets expected to reach US$1 trillion by 2010.

“The banking industry should focus on having a small number of

large players that can compete globally and can achieve expected goals
rather than having a large number of fragmented players."

Financial requirements in a modern economy are of a diverse
nature, distinctive variety and large magnitude. Hence, different types of
banks have been instituted to cater to the varying needs of the
community. Banks in the organized sector may, however, be classified in
to the following major forms:

o Commercial banks
o Co-operative banks
o Specialized banks
o Central bank

Commercial banks are joint stock companies dealing in money and
credit. In India, however there is a mixed banking system, prior to July
1969, all the commercial banks-73 scheduled and 26 non-scheduled
banks, except the state bank of India and its subsidiaries-were under the
control of private sector. On July 19, 1969, however, 14 major
commercial banks with deposits of over 50 Corers were nationalized. In
April 1980, another six commercial banks of high standing were taken
over by the government.
At present, there are 20 nationalized banks plus the state bank of
India and its 7 subsidiaries constituting public sector banking which
controls over 90 per cent of the banking business in the country.


Co-operative banks are a group of financial institutions organized

under the provisions of the Co-operative societies Act of the states. The
main objective of co-operative banks is to provide cheap credits to their
members. They are based on the principle of self-reliance and mutual co-
operation. Co-operative banking system in India has the shape of a
pyramid a three tier structure, constituted by:


There are specialized forms of banks catering to some special

needs with this unique nature of activities. There are thus,

o Foreign exchange banks,

o Industrial banks,
o Development banks,
o Land development banks,
o Exim bank.


A central bank is the apex financial institution in the banking and

financial system of a country. It is regarded as the highest monetary
authority in the country. It acts as the leader of the money market. It
supervises, control and regulates the activities of the commercial banks. It
is a service oriented financial institution.

India’s central bank is the Reserve Bank of India established in
1935. A central bank is usually state owned but it may also be a private
organization. For instance, the Reserve Bank of India (RBI), was started
as a shareholders’ organization in 1935, however, it was nationalized
after independence, in 1949. It is free from parliamentary control.


The banking industry in India is undergoing a major transformation
due to changes in economic conditions and continuous deregulation.
These multiple changes happening one after other has a ripple effect on a
bank trying to graduate from completely regulated sellers market to
completed deregulated customers market.


This continuous deregulation has made the Banking market

extremely competitive with greater autonomy, operational flexibility, and
decontrolled interest rate and liberalized norms for foreign exchange. The
deregulation of the industry coupled with decontrol in interest rates has
led to entry of a number of players in the banking industry. At the same
time reduced corporate credit off take thanks to sluggish economy has
resulted in large number of competitors battling for the same pie.


As a result, the market place has been redefined with new rules of
the game. Banks are transforming to universal banking, adding new
channels with lucrative pricing and freebees to offer. Natural fall out of
this has led to a series of innovative product offerings catering to various
customer segments, specifically retail credit.


This in turn has made it necessary to look for efficiencies in the

business. Banks need to access low cost funds and simultaneously
improve the efficiency. The banks are facing pricing pressure, squeeze on
spread and have to give thrust on retail assets.


This will definitely impact Customer preferences, as they are

bound to react to the value added offerings. Customers have become
demanding and the loyalties are diffused. There are multiple choices; the
wallet share is reduced per bank with demand on flexibility and
customization. Given the relatively low switching costs; customer
retention calls for customized service and hassle free, flawless service


These changes are creating challenges, as employees are made to

adapt to changing conditions. There is resistance to change from
employees and the Seller market mindset is yet to be changed coupled
with Fear of uncertainty and Control orientation. Acceptance of
technology is slowly creeping in but the utilization is not maximized.


Placing the right skill at the right place will determine success. The
competency gap needs to be addressed simultaneously otherwise there
will be missed opportunities. The focus of people will be on doing work
but not providing solutions, on escalating problems rather than solving
them and on disposing customers instead of using the opportunity to cross



Leading players in the industry have embarked on a series of

strategic and tactical initiatives to sustain leadership. The major initiatives

o Investing in state of the art technology as the back bone of to

ensure reliable service delivery
o Leveraging the branch network and sales structure to
mobilize low cost current and savings deposits

o Making aggressive forays in the retail advances segment of
home and personal loans
o Implementing organization wide initiatives involving people,
process and technology to reduce the fixed costs and the cost
per transaction
o Focusing on fee based income to compensate for squeezed
spread, (e.g. CMS, trade services)
o Innovating Products to capture customer ‘mind share’ to
begin with and later the wallet share
o Improving the asset quality as per Basel II norms


The Indian Economy is consistently posting robust growth

numbers in all sectors leading to impressive growth in Indian GDP. The
Indian economy has been stable and reliable in recent times, while in the
last few years it’s experienced a positive upward growth trend.

A consistent 8-9% growth rate has been supported by a number of

favorable economic indicators including a huge inflow of foreign funds,
growing reserves in the foreign exchange sector, both an IT and real
estate boom, and a flourishing capital market. All of these positive
changes have resulted in establishing the Indian economy as one of the
largest and fastest growing in the world.

The process of globalization has been an integral part of the recent

economic progress made by India. Globalization has played a major role
in export-led growth, leading to the enlargement of the job market in

As a new Indian middle class has developed around the wealth that
the IT and BPO industries have brought to the country, a new consumer
base has developed. International companies are also expanding their
operations in India to service this massive growth opportunity. The same
thing has followed by international banks that are entering in Indian
market and pulling their huge investments in Indian economy. This is
helping to accelerate the growth of Indian economy.

Economy can be studied from two points of views…


The branch of economics that analyzes the market behavior of

individual consumers and firms in an attempt to understand the decision-
making process of firms and households. It is concerned with the
interaction between individual buyers and sellers and the factors that
influence the choices made by buyers and sellers. In particular,
microeconomics focuses on patterns of supply and demand and the
determination of price and output in individual markets. Microeconomics
looks at the smaller picture and focuses more on basic theories of supply
and demand and how individual businesses decide how much of
something to produce and how much to charge for it.


It is a field of economics that studies the behavior of the aggregate

economy. Macroeconomics examines economy-wide phenomena such as
changes in unemployment, national income, rate of growth, gross
domestic product, inflation and price levels. Macroeconomics looks at the
big picture (hence "macro"). It focuses on the national economy as a
whole and provides a basic knowledge of how things work in the
business world. For example, people who study this branch of economics
would be able to interpret the latest Gross Domestic Product figures or
explain why a 6% rate of unemployment is not necessarily a bad thing.

Thus, for an overall perspective of how the entire economy works,

you need to have an understanding of economics at both the micro and
macro levels.


An economic system is loosely defined as country’s plan for its

services, goods produced, and the exact way in which its economic plan
is carried out. In general, there are three major types of economic systems
prevailing around the world they are...

o Market Economy

o Planned Economy

o Mixed Economy


In a market economy, national and state governments play a minor

role. Instead, consumers and their buying decisions drive the economy. In
this type of economic system, the assumptions of the market play a major
role in deciding the right path for a country’s economic development.
Market economies aim to reduce or eliminate entirely subsidies for a
particular industry, the pre-determination of prices for different
commodities, and the amount of regulation controlling different industrial
sectors. The absence of central planning is one of the major features of
this economic system. Market decisions are mainly dominated by supply
and demand. The role of the government in a market economy is to
simply make sure that the market is stable enough to carry out its
economic activities properly.


A planned economy is also sometimes called a command economy.

The most important aspect of this type of economy is that all major

decisions related to the production, distribution, commodity and service
prices, are all made by the government. The planned economy is
government directed, and market forces have very little say in such an
economy. This type of economy lacks the kind of flexibility that is
present a market economy, and because of this, the planned economy
reacts slower to changes in consumer needs and fluctuating patterns of
supply and demand. On the other hand, a planned economy aims at using
all available resources for developing production instead of allotting the
resources for advertising or marketing.


A mixed economy combines elements of both the planned and the

market economies in one cohesive system. This means that certain
features from both market and planned economic systems are taken to
form this type of economy. This system prevails in many countries where
neither the government nor the business entities control the economic
activities of that country – both sectors play an important role in the
economic decision-making of the country. In a mixed economy there is
flexibility in some areas and government control in others. Mixed
economies include both capitalist and socialist economic policies and
often arise in societies that seek to balance a wide range of political and
economic views.



Cash reserve Ratio (CRR) is the amount of funds that the banks
have to keep with RBI. If RBI decides to increase the percent of this, the
available amount with the banks comes down. RBI is using this method
(increase of CRR rate), to drain out the excessive money from the banks.
The amount of which shall not be less than three per cent of the total of
the Net Demand and Time Liabilities (NDTL) in India, on a fortnightly
basis and RBI is empowered to increase the said rate of CRR to such
higher rate not exceeding twenty percent of the Net Demand and Time
Liabilities (NDTL) under the RBI Act, 1934.


In terms of Section 24 (2-A) of the B.R. Act, 1949 all Scheduled

Commercial Banks, in addition to the average daily balance which they
are required to maintain in the form of….

o In cash,
o In gold valued at a price not exceeding the current market
o In unencumbered approved securities valued at a price as
specified by the RBI from time to time.


Repo rate, also known as the official bank rate, is the discounted
rate at which a central bank repurchases government securities. The
central bank makes this transaction with commercial banks to reduce
some of the short-term liquidity in the system. The repo rate is dependent

on the level of money supply that the bank chooses to fix in the monetary
scheme of things. Repo rate is short for repurchase rate. The entity
borrowing the security is often referred to as the buyer, while the lender
of the securities is referred to as the seller. The central bank has the power
to lower the repo rates while expanding the money supply in the country.
This enables the banks to exchange their government security holdings
for cash. In contrast, when the central bank decides to reduce the money
supply, it implements a rise in the repo rates. At times, the central bank of
the nation makes a decision regarding the money supply level and the
repo rate is determined by the market.

The securities that are being evaluated and sold are transacted at
the current market price plus any interest that has accrued. When the sale
is concluded, the securities are subsequently resold at a predetermined
price. This price is comprised of the original market price and interest,
and the pre-agreed interest rate, which is the repo rate.


Bank rate is referred to the rate of interest charged by premier

banks on the loans and advances. Bank rate varies based on some defined
conditions as laid down the governing authority of the banks. Bank rates
are levied to control the money supply to and from the bank. From the
consumer's point of view, bank rate ordinarily denotes to the current rate
of interest acquired from savings certificate of Deposit. It is most
frequently used by the consumers who are concerned in mortgage

Some commonest types of bank interest rates are as follows:

o Bank rate on CD, i.e., on certificate of deposit

o Bank rate on the credit of a credit card or other kind of loan

o Bank rate on real estate loan


The rate of interest charged on short-term loans made between

banks. Banks borrow and lend money in the interbank market in order to
manage liquidity and meet the requirements placed on them. The interest
rate charged depends on the availability of money in the market, on
prevailing rates and on the specific terms of the contract, such as
term length.

Banks are required to hold an adequate amount of liquid assets,

such as cash, to manage any potential withdrawals from clients. If a bank
can't meet these liquidity requirements, it will need to borrow money in
the interbank market to cover the shortfall. Some banks, on the other
hand, have excess liquid assets above and beyond the liquidity
requirements. These banks will lend money in the interbank market,
receiving interest on the assets. There is a wide range of published
interbank rates, including the LIBOR & MIBOR, which is set daily based
on the average rates on loans made within the London interbank market
& Mumbai Interbank Market.


The monetary value of all the finished goods and services produced
within a country's borders in a specific time period, though GDP is
usually calculated on an annual basis. It includes all of private and
public consumption, government outlays, investments and exports less
imports that occur within a defined territory.

GDP = C + G + I + NX


 "C" is equal to all private consumption, or consumer spending, in a

nation's economy.

 "G" is the sum of government spending.

 "I" is the sum of all the country's businesses spending on capital.

 "NX" is the nation's total net exports, calculated as total exports minus
total imports. (NX = Exports - Imports)

GDP is commonly used as an indicator of the economic health of a

country, as well as to gauge a country's standard of living.


Inflation can be defined as a rise in the general price level and

therefore a fall in the value of money. Inflation occurs when the amount
of buying power is higher than the output of goods and services. Inflation
also occurs when the amount of money exceeds the amount of goods and
services available. As to whether the fall in the value of money will affect
the functions of money depends on the degree of the fall. Basically, refers

to an increase in the supply of currency or credit relative to the
availability of goods and services, resulting in higher prices. Therefore,
inflation can be measured in terms of percentages. The percentage
increase in the price index, as a rate per cent per unit of time, which is
usually in years. The two basic price indexes are used when measuring
inflation, the producer price index (PPI) and the consumer price index
(CPI) which is also known as the cost of living index number.


It is a condition of falling prices accompanied by a decreasing level

of employment, output and income. Deflation is just the opposite of
inflation. Deflation occurs when the total expenditure of the community
is not equal to the existing prices. Consequently, the supply of money
decreases and as a result prices fall. Deflation can also be brought about
by direct contractions in spending, either in the form of a reduction in
government spending, personal spending or investment spending.
Deflation has often had the side effect of increasing unemployment in an
economy, since the process often leads to a lower level of demand in the


When prices are falling due to anti-inflationary measures adopted

by the authorities, with no corresponding decline in the existing level of
employment, output and income, the result of this is disinflation. When
acute inflation burdens an economy, disinflation is implemented as a cure.
Disinflation is said to take place when deliberate attempts are made to
curtail expenditure of all sorts to lower prices and money incomes for the
benefit of the community.


Reflation is a situation of rising prices, which is deliberately

undertaken to relieve a depression. Reflation is a means of motivating the
economy to produce. This is achieved by increasing the supply of money
or in some instances reducing taxes, which is the opposite of disinflation.
Governments can use economic policies such as reducing taxes, changing
the supply of money or adjusting the interest rates; which in turn
motivates the country to increase their output. The situation is described
as semi-inflation or reflation.


Stagflation is a stagnant economy that is combined with inflation.

Basically, when prices are increasing the economy is deceasing. Some
economists believe that there are two main reasons for stagflation. Firstly,
stagflation can occur when an economy is slowed by an unfavourable
supply, such as an increase in the price of oil in an oil importing country,
which tends to raise prices at the same time that it slows the economy by
making production less profitable. In the 1970's inflation and recession
occurred in different economies at the same time. Basically, what
happened was that there was plenty of liquidity in the system and people
were spending money as quickly as they got it because prices were going
up quickly. This gave rise to the second reason for stagflation.


Foreign Institutional Investors (FIIs), Non-Resident Indians
(NRIs), and Persons of Indian Origin (PIOs) are allowed to invest in the
primary and secondary capital markets in India through the portfolio
investment scheme (PIS). Under this scheme, FIIs/NRIs can acquire
shares/debentures of Indian companies through the stock exchanges in

The ceiling for overall investment for FIIs is 24 per cent of the paid
up capital of the Indian company and 10 per cent for NRIs/PIOs. The
limit is 20 per cent of the paid up capital in the case of public sector
banks, including the State Bank of India.


Foreign exchange reserves (also called Forex reserves) in a strict

sense are only the foreign currency deposits held by central banks and
monetary authorities. However, the term in popular usage commonly
includes foreign exchange and gold, SDRs and IMF reserve positions.
This broader figure is more readily available, but it is more accurately
termed official reserves or international reserves. These are assets of
the central bank held in different reserve currencies, such as the dollar,
euro and yen, and used to back its liabilities, e.g. the local currency
issued, and the various bank reserves deposited with the central bank, by
the government or financial institutions.

Large reserves of foreign currency allow a government to

manipulate exchange rates - usually to stabilize the foreign exchange
rates to provide a more favorable economic environment.


A safe and sound financial sector is a prerequisite for sustained

growth of any economy. Globalization, deregulation and advances in
information technology in recent years have brought about significant
changes in the operating environment for banks and other financial
institutions. These institutions are faced with increased competitive
pressures and changing customer demands. These, in turn, have
engendered a rapid increase in product innovations and changes in
business strategies. While these developments have enabled improvement
in the efficiency of financial institutions, they have also posed some
serious risks.

Banks play a very useful and dynamic role in the economic life of
every modern state. A study of the economic history of western country
shows that without the evolution of commercial banks in the 18th and
19th centuries, the industrial revolution would not have taken place in
Europe. The economic importance of commercial banks to developing
countries may be viewed thus:

o Promoting capital formation

o Encouraging innovation
o Monetsation
o Influence economic activity
o Facilitator of monetary policy

Above all view we can see in briefly, which are given below:


A developing economy needs a high rate of capital formation to

accelerate the tempo of economic development, but the rate of capital
formation depends upon the rate of saving. Unfortunately, in
underdeveloped countries, saving is very low. Banks afford facilities for
saving and, thus encourage the habits of thrift and industry in the
community. They mobilize the ideal and dormant capital of the country
and make it available for productive purposes.


Innovation is another factor responsible for economic

development. The entrepreneur in innovation is largely dependent on the

manner in which bank credit is allocated and utilized in the process of
economic growth. Bank credit enables entrepreneurs to innovate and
invest, and thus uplift economic activity and progress.


Banks are the manufactures of money and they allow many to play
its role freely in the economy. Banks monetize debts and also assist the
backward subsistence sector of the rural economy by extending their
branches in to the rural areas. They must be replaced by the modern
commercial bank’s branches.


Banks are in a position to influence economic activity in a country

by their influence on the rate interest. They can influence the rate of
interest in the money market through its supply of funds. Banks may
follow a cheap money policy with low interest rates which will tend to
stimulate economic activity.


Thus monetary policy of a country should be conductive to

economic development. But a well-developed banking system is on
essential pre-condition to the effective implementation of monetary
policy. Under-developed countries cannot afford to ignore this fact.

A fine, an efficient and comprehensive banking system is a crucial

factor of the developmental process of economy.


The RBI was established under the Reserve Bank of India Act,
1934 on April 1, 1935 as a private shareholders' bank but since its
nationalization in 1949, is fully owned by the Government of India. The
Preamble of the Reserve Bank describes the basic functions as 'to regulate
the issue of Bank notes and keeping of reserves with a view to securing
monetary stability in India and generally, to operate the currency and
credit system of the country to its advantage'. The twin objectives of
monetary policy in India have evolved over the years as those of
maintaining price stability and ensuring adequate flow of credit to
facilitate the growth process. The relative emphasis between the twin
objectives is modulated as per the prevailing circumstances and is

articulated in the policy statements by the Reserve Bank from time to
time. Consideration of macro-economic and financial stability is also
subsumed in the mandate. The Reserve Bank is also entrusted with the
management of foreign exchange reserves (which include gold holding
also), which are reflected in its balance sheet.

While the Reserve Bank is essentially a monetary authority, its

founding statute mandates it to be the manager of market borrowing of
the Government of India and banker to the Government.

The Reserve Bank's affairs are governed by a Central Board of

Directors, consisting of fourteen non-executive, independent directors
nominated by the Government, in addition to the Governor and up to four
Deputy Governors. Besides, one Government official is also nominated
on the Board who participates in the Board meetings but cannot vote.





The Reserve Bank of India formulates implements and monitors

the monetary policy. Its main objective is maintaining price stability and
ensuring adequate flow of credit to productive sectors.


Prescribes broad parameters of banking operations within which
the country’s banking and financial system functions. Their main
objective is to maintain public confidence in the system, protect
depositors’ interest and provide cost-effective banking services to the


The manager of the exchange control department manages the

Foreign Exchange Management Act, 1999. Its main objective is to
facilitate external trade and payment and promote orderly development
and maintenance of foreign exchange market in India.


The person who is issuer issues and exchanges or destroys

currency and coins not fit for circulation. His main objective is to give the
public adequate quantity of supplies of currency notes and coins and in
good quality.


The reserve bank of India performs a wide range of promotional

functions to support national objectives. The promotional functions are
such as contests, coupons, maintaining good public relations, and many


There are also some of the relating functions to the above
mentioned main functions. They are such as Banker to the Government,
Banker to banks etc….


It performs merchant banking function for the central and

the state governments; also acts as their banker.


Maintains banking accounts of all scheduled banks.

The Reserve Bank act, 1934 and the Banking Regulation act, 1949
have given the RBI wide powers of supervision and control over
commercial and co-operative banks, relating to licensing and
establishments, branch expansion, liquidity of their asset, management
and methods of working, amalgamation, reconstruction, and liquidation.
The RBI is authorized to carry out periodical inspections of banks
and to call for returns and necessary information from them. The
supervisory functions of the RBI have helped a great deal in improving
the standard of banking in India to develop on sound lines and to improve
the methods of their operation.

With economic growth assuming a new urgency since
Independence, the range of the Reserve Bank’s functions has steadily
widened. The bank now performs a variety of developmental and
promotional functions, which, at one time were regarded as outside the

normal scope of central banking. The RBI was asked to promote banking
habit, extend banking facilities to rural and semi-urban areas, and
establish and promote new specialized financing agencies.


Macro-economic environment in India has taken a serious turn

since the beginning of the year. Unprecedented rise in crude prices, surge
in inflation and continued strong growth in money supply (M3) have
forced the government and RBI to take strong fiscal and monetary
measures leading to liquidity tightening, significant rise in interest rates
and slowdown in economic growth.

Economic shocks are events which adversely affect the economy

and the government’s macroeconomic objectives such as growth,
inflation, unemployment and the balance of payments.



The savings ratio is the % of income that is saved not spent. A fall
in the savings ratio implies that consumer spending is increasing; often
this is financed through increased borrowing.



This results in increase in Aggregate Demand. The

increase in AD will cause an increase in economic growth
and lower unemployment. However, rising Aggregate
Demand may cause inflation. Inflation will occur when
growth is faster than the long run trend rate. This is now a
potential problem in the India. Inflation has recently gone
above 12%


A fall in the savings ratio is usually accompanied by a

rise in confidence. It is the rise in confidence which encourages
borrowing and consumers to run down savings. Therefore, there
is always a danger that a falling savings ratio can be a precursor
to a boom and bust situation.


With a fall in the savings ratio interest rate changes will

have a bigger effect in reducing spending. This is because levels
of borrowing are higher and therefore a rise in interest rates has

a significant impact on increasing interest repayments. Also,
higher rates will not be increasing incomes from savings as


With higher levels of consumer spending, there will be an

increase in imports. Therefore this will lead to deterioration in
the current account. The current account deficit could put
downward pressure on the exchange rate in the long term.

However, some people argue a fall in the savings ratio is not a

problem, but, it is just a reflection of strong economy and booming
housing market, which increases scope for equity withdrawal.


Inflation is posing a serious challenge to the economic growth of

India. Since Jan’08 onwards, inflation in the country has surged by 8.2%
to hit a 13-year high of ~12%. M3 growth in the economy too continued
to remain strong at 20% (in July’08), well above the RBI’s comfort level
of 17%.
The WPI inflation rate flared up during the period driven by
significant increase in the prices of commodities, primary articles and
manufactured products, even though very small part of global crude price
increase has been passed on to the Indian consumers.


It appears that Europe, Japan and the US are entering into
recession. Falling house prices, crisis in the financial system, and lower
confidence could lead to a sharp downturn, with the worst still to come.
Many argue that India’s growth is not so dependent on growth in the
West. However, the Indian stock markets have been hit by the global
crisis. India’s growing service sector and manufacturing sector would be
adversely impacted by a global downturn.


How global crude prices would behave probably has no easy

answers; however we believe that the current challenging and uncertain
macro-economic conditions does not lead Indian financials into a state of
crisis. But continued rise in crude prices and its resultant impact on
inflation, interest rates and government finances has the potential to do
so. Hence, crude price remains the key risk to our positive stance on the
Indian financials.
In the last couple of months oil prices have surged by 45% from
US$ 100 to US$ 145 (and now back to US$ 115). India currently imports
70% of its crude requirement, resulting in pressure on government coffers
on back of rising crude prices.


Surge in crude prices has severely impacted current account deficit

of the country. This coupled with the outflow of FII investments has
resulted in INR to depreciate sharply against dollar further fueling


The current macro-economic conditions are expected to result in




While the rise in interest rates should lead to a moderation in

demand for credit, Indian banks too are exercising caution while lending.
Credit growth of 18% in FY09E and 17% in FY10E vs. 22% in FY08.
Risks and uncertainties in the system have increased given the higher
crude and commodity prices and its inflationary impact. This would

curtail consumption, which would impact economic growth adversely.
Further higher rates will not only impact the profitability of Indian
corporate but also impact IRRs of various proposed capex projects. This
coupled with elections next year could lead to some postponement of
capex plans of corporate, leading to negative impact on demand for
Higher rates have particularly impacted retail loan growth. As can
be seen in the exhibit below, retail loan growth has slowed down
significantly from 26.5% in FY07 to ~13% in FY08. SLR Ratio of the
system has started rising since mid FY08 and currently stands at 28.7%.
Given the expected negative impact on credit growth.


During the past 18 months, CRR has increased by 400 bps to 9.0%
currently and RBI has also discontinued with interest payment on CRR
balances. Every 50 bps hike in CRR generally negatively impacts
margins by ~5 bps. Till June’08, most of the banks had restrained from
hiking lending rates despite significant monetary tightening. However on
account of recent measures by RBI, banks have resorted to hiking PLRs
in July/August by 50-150 bps to preserve their margins.
In fact in an environment, where liquidity is tight, interest rates are
at elevated levels and risk premiums have increased, the banks tend to
regain the pricing power. This would not only help the banks to
adequately price in risks but also help protect their margins. Apart from
hiking PLRs, banks are also resorting to reprising (in fact right-pricing)

the loans that were sanctioned well below PLRs. Significant portion of
fixed rate loans would also get re-priced over the period of 12-18 months.


Higher lending rates are expected to impact credit quality for the
banking system. The extent of the impact on credit quality would also be
bank specific given the loan mix (retail vs. corporate), proportion of
unsecured lending, credit profile of corporate loan book and industry wise
exposure. Indian banks’ fundamentals are relatively resilient with better
risk management systems, dramatically improved asset quality, stronger
recovery mechanisms (legal provisions) and with adequate capitalization
and provisioning.

Even Certain sectors (like real estate, airlines industry) might feel
the stress due to the changing macro environment and rise in interest
rates. Many companies where crude forms a key raw material component
are expected to get hit more severely. Similarly, sectors like real estate
and SMEs, which are interest rate sensitive, would face higher
delinquencies if interest rates strengthen further by 100-200 bps.


As most of economists feel that the most horrible problem which

India is facing currently is inflation which has crossed 12%. To come out
of these problems RBI and ministry of finance and other relevant
government and regulatory entities are taking various initiatives which
are as follows...


With the introduction of the Five year plans, the need for
appropriate adjustment in monetary and fiscal policies to suit the pace

and pattern of planned development became imperative. The monitory
policy since 1952 emphasized the twin aims of the economic policy of
the government:

o Spread up economic development in the country to raise national

income and standard of living, and
o To control and reduce inflationary pressure in the economy.

This policy of RBI since the First plan period was termed broadly
as one of controlled expansion, i.e.; a policy of “adequate financing of
economic growth and at the same time the time ensuring reasonable price
stability”. Expansion of currency and credit was essential to meet the
increased demand for investment funds in an economy like India which
had embarked on rapid economic development. Accordingly, RBI helped
the economy to expand via expansion of money and credit and attempted
to check in rise in prices by the use of selective controls.




Central banks generally use the three quantitative measures to
control the volume of credit in an economy, namely:

o Raising bank rates
o Open market operations and
o Variable reserve ratio

However, there are various limitations on the effective working of

the quantitative measures of credit control adapted by the central banks
and, to that extent, monetary measures to control inflation are weakened.
In fact, in controlling inflation moderate monetary measures, by
themselves, are relatively ineffective. On the other hand, drastic monetary
measures are not good for the economic system because they may easily
send the economy into a decline.
In a developing economy there is always an increasing need for
credit. Growth requires credit expansion but to check inflation, there is
need to contract credit. In such a encounter, the best course is to resort to
credit control, restricting the flow of credit into the unproductive,
inflation-infected sectors and speculative activities, and diversifying the
flow of credit towards the most desirable needs of productive and growth-
inducing sector. It should be noted that the impression that the rate of
spending can be controlled rigorously by the contraction of credit or
money supply is wrong in the context of modern economic societies. In
modern community, tangible, wealth is typically represented by claims in
the form of securities, bonds, etc., or near moneys, as they are called.
Such near moneys are highly liquid assets, and they are very close to
being money. They increase the general liquidity of the economy. In these
circumstances, it is not so simple to control the rate of spending or total
outlays merely by controlling the quantity of money. Thus, there is no
immediate and direct relationship between money supply and the price
level, as is normally conceived by the traditional quantity theories. When

there is inflation in an economy, monetary restraints can, in conjunction
with other measures, play a useful role in controlling inflation.


Fiscal policy is another type of budgetary policy in relation to

taxation, public borrowing, and public expenditure. To curve the effects
of inflation and changes in the total expenditure, fiscal measures would
have to be implemented which involves an increase in taxation and
decrease in government spending. During inflationary periods the
government is supposed to counteract an increase in private spending. It
can be cleared noted that during a period of full employment inflation, the
aggregate demand in relation to the limited supply of goods and services
is reduced to the extent that government expenditures are shortened.
Along with public expenditure, governments must simultaneously
increase taxes that would effectively reduce private expenditure, in an
effect to minimise inflationary pressures. It is known that when more
taxes are imposed, the size of the disposable income diminishes, also the
magnitude of the inflationary gap in regards to the availability of the
supply of goods and services. In some instances, tax policy has been
directed towards restricting demand without restricting level of
production. For example, excise duties or sales tax on various
commodities may take away the buying power from the consumer goods
market without discouraging the level of production. However, some
economists point out that this is not a correct way of combating inflation
because it may lead to a regressive status within the economy.
As a result, this may lead to a further rise in prices of goods and
services, and inflation can spread from one sector of the economy to
another and from one type of goods and services to another. Therefore, a
reduction in public expenditure, and an increase in taxes produces a cash
surplus in the budget. Keynes, however, suggested a programme of
compulsory savings, such as deferred pay as an anti-inflationary measure.
Deferred pay indicates that the consumer defers a part of his or her wages
by buying savings bonds (which, of course, is a sort of public borrowing),
which are redeemable after a particular period of time, this is sometimes
called forced savings. Additionally, private savings have a strong
disinflationary effect on the economy and an increase in these is an
important measure for controlling inflation. Government policy should
therefore, include devices for increasing savings. A strong savings drive
reduces the spendable income of the consumers, without any harmful
effects of any kind that are associated with higher taxation. Furthermore,
the effects of a large deficit budget, which is mainly responsible for
inflation, can be partially offset by covering the deficit through public
borrowings. It should be noted that it is only government borrowing from
non-bank lenders that has a disinflationary effect. In addition, public debt
may be managed in such a way that the supply of money in the country
may be controlled. The government should avoid paying back any of its
past loans during inflationary periods, in order to prevent an increase in
the circulation of money. Anti-inflationary debt management also
includes cancellation of public debt held by the central bank out of a
budgetary surplus.
Fiscal policy by itself may not be very effective in combating
inflation; therefore a combination of fiscal and monetary tools can work
together in achieving the desired outcome.


Direct controls refer to the regulatory measures undertaken to
convert an open inflation into a repressed one. Such regulatory measures
involve the use of direct control on prices and rationing of scarce goods.
The function of price control is a fix a legal ceiling, beyond which prices
of particular goods may not increase. When ceiling prices are fixed and
enforced, it means prices are not allowed to rise further and so, inflation
is suppressed. Under price control, producers cannot raise the price
beyond a specified level, even though there may be a pressure of
excessive demand forcing it up.
In times of the severe scarcity of certain goods, particularly, food
grains, government may have to enforce rationing, along with price
control. The main function of rationing is to divert consumption from
those commodities whose supply needs to be restricted for some special
reasons; such as, to make the commodity more available to a larger
number of households. Therefore, rationing becomes essential when
necessities, such as food grains, are relatively scarce. Rationing has the
effect of limiting the variety of quantity of goods available for the good
cause of price stability and distributive impartiality.
Another control measure that was suggested is the control of wages
as it often becomes necessary in order to stop a wage-price spiral. During
galloping inflation, it may be necessary to apply a wage-profit freeze.
Ceilings on wages and profits keep down disposable income and,
therefore the total effective demand for goods and services. On the other
hand, restrictions on imports may also help to increase supplies of
essential commodities and ease the inflationary pressure. However, this is
possible only to a limited extent, depending upon the balance of
payments situation. Similarly, exports may also be reduced in an effort to
increase the availability of the domestic supply of essential commodities
so that inflation is eased.

In general, monetary and fiscal controls may be used to repress
excess demand but direct controls can be more useful when they are
applied to specific scarcity areas. As a result, anti-inflationary policies
should involve varied programmes and cannot exclusively depend on a
particular type of measure only.


HDFC Bank’s ‘Net Safe’ card is a one-time use card with a limit
that’s specified, taken from Tendon’s credit or debit card. Even if Tandon
fails to utilize the full amount within 24 hours of creating the card, the
card simply dies and the unspent amount in the temporary card reverts to
his original credit or debit card. Welcome to one of the myriad ways in
which bankers have been trying to innovate. They’re bringing ATMs,
cash and even foreign exchange to their customers’ doorsteps. Indeed,
innovation has become the hottest banking game in town.

Want to buy a house but don’t want to go through the hassles of
haggling with brokers and the mounds of paperwork? Not to worry. Your
bank will tackle all this. It’s ready to come every step of the way for you
to buy a house. Standard Chartered, for instance, has property advisors to
guide a customer through the entire process of selecting and buying a
house. They also lend a hand with the cumbersome documentation
formalities and the registration.

Don’t fret if you’ve already bought your house or car – you can do
other things with both. You can leverage your new house or car these
days with banks like ICICI Bank and Stanchart ready to extend loans
against either, till it’s about five years old. Loans are available to all car
owners for almost all brands of cars manufactured in India that are up to
five years old.

Last month, Kotak Mahindra Bank introduced a variant of the

sweep-in account. If the balance tops Rs 1.5 lakh, the excess runs into
Kotak’s liquid mutual fund. “Even if the money is there only for the
weekend, a liquid fund can earn you a clean 4.5 per cent per annum,”
points out Shashi Arora, vice president, marketing, Kotak Mahindra
Bank. That’s not a small gain considering that your current account does
not pay you any interest. And if, meanwhile, you want to buy a big-ticket
home theatre system, the minute you swipe your card the invested sum
will return to your account.

Banks are also attempting to reach out to residents of metropolitan

cities where people are pressed for time (what with long commuting
hours, traffic jams and both spouses working), beyond conventional
banking hours. ICICI Bank, for example, introduced eight to eight

banking hours, seven days of the week, in major cities. Not to be outdone,
some of the other private banks have also done this too. HDFC Bank
even has a 24-hour branch at Mumbai’s international airport.


The interplay between policy and regulatory interventions and

management strategies will determine the performance of Indian banking
over the next few years. Legislative actions will shape the regulatory
stance through six key elements: industry structure and sector
consolidation; freedom to deploy capital; regulatory coverage; corporate
governance; labor reforms and human capital development; and support
for creating industry utilities and service bureaus. Management success
will be determined on three fronts: fundamentally upgrading
organizational capability to stay in tune with the changing market;
adopting value-creating M&A as an avenue for growth; and continually

innovating to develop new business models to access untapped
Through these scenarios, we can paint a picture of the events and
outcomes that will be the consequence of the actions of policy makers
and bank managements. These actions will have dramatically different
outcomes; the costs of inaction or insufficient action will be high.
Specifically, at one extreme, the sector could account for over 7.7 per
cent of GDP with over Rs.. 7,500 billion in market cap, while at the other
it could account for just 3.3 per cent of GDP with a market cap of Rs.
2,400 billion. Banking sector intermediation, as measured by total loans
as a percentage of GDP, could grow marginally from its current levels of
~30 per cent to ~45 per cent or grow significantly to over 100 per cent of
GDP. In all of this, the sector could generate employment to the tune of
1.5 million compared to 0.9 million. Today availability of capital would
be a key factor — the banking sector will require as much as Rs. 600
billion (US$ 14 billion) in capital to fund growth in advances, non-
performing loan (NPL) write offs and investments in IT and human
capital up gradation to reach the high-performing scenario. Three
scenarios can be defined to characterize these outcomes:


In this scenario, policy makers intervene only to the extent required

to ensure system stability and protection of consumer interests, leaving
managements free to drive far reaching changes. Changes in regulations
and bank capabilities reduce intermediation costs leading to increased
growth, innovation and productivity. Banking becomes an even greater
driver of GDP growth and employment and large sections of the
population gain access to quality banking products. Management is able
to overhaul bank organizational structures, focus on industry
consolidation and transform the banks into industry shapers.
In this scenario we witness consolidation within public sector
banks (PSBs) and within private sector banks. Foreign banks begin to be
active in M&A, buying out some old private and newer private banks.
Some M&A activity also begins to take place between private and public
sector banks. As a result, foreign and new private banks grow at rates of
50 per cent, while PSBs improve their growth rate to 15 per cent. The
share of the private sector banks (including through mergers with PSBs)
increases to 35 per cent and that of foreign banks increases to 20 per cent
of total sector assets. The share of banking sector value adds in GDP
increases to over 7.7 per cent, from current levels of 2.5 per cent. Funding
this dramatic growth will require as much as Rs. 600 billion in capital
over the next few years.


Policy makers adopt a pro-market stance but are cautious in

liberalizing the industry. As a result of this, some constraints still exist.
Processes to create highly efficient organizations have been initiated but
most banks are still not best-in-class operators. Thus, while the sector
emerges as an important driver of the economy and wealth in 2010, it has
still not come of age in comparison to developed markets. Significant
changes are still required in policy and regulation and in capability-
building measures, especially by public sector and old private sector
In this scenario, M&A activity is driven primarily by new private
banks, which take over some old private banks and also merge among
themselves. As a result, growth of these banks increases to 35 per cent.
Foreign banks also grow faster at 30 per cent due to a relaxation of some
regulations. The share of private sector banks increases to 30 per cent of
total sector assets, from current levels of 18 per cent, while that of foreign
banks increases to over 12 per cent of total assets. The share of banking
sector value adds to GDP increases to over 4.7 per cent.


In this scenario, policy makers intervene to set restrictive

conditions and management is unable to execute the changes needed to
enhance returns to shareholders and provide quality products and services
to customers. As a result, growth and productivity levels are low and the
banking sector is unable to support a fast-growing economy. This
scenario sees limited consolidation in the sector and most banks remain
sub-scale. New private sector banks continue on their growth trajectory of
25 per cent. There is a slowdown in PSB and old private sector bank
growth. The share of foreign banks remains at 7 per cent of total assets.
Banking sector value adds meanwhile, is only 3.3 per cent of GDP.



The term “policy makers”, refers to the Ministry of Finance and the
RBI and includes the other relevant government and regulatory entities
for the banking sector. The coordinated efforts between the various
entities are required to enable positive action. This will spur on the
performance of the sector. The policy makers need to make coordinated
efforts on six fronts:

• Help shape a superior industry structure in a phased manner
through “managed consolidation” and by enabling capital
availability. This would create 3-4 global sized banks controlling
35-45 per cent of the market in India; 6-8 national banks
controlling 20-25 per cent of the market; 4-6 foreign banks with
15-20 per cent share in the market, and the rest being specialist
players (geographical or product/ segment focused).

• Focus strongly on “social development” by moving away from

universal directed norms to an explicit incentive-driven framework
by introducing credit guarantees and market subsidies to encourage
leading public sector, private and foreign players to leverage
technology to innovate and profitably provide banking services to
lower income and rural markets.

• Create a unified regulator, distinct from the central bank of the

country, in a phased manner to overcome supervisory difficulties
and reduce compliance costs.

• Improve corporate governance primarily by increasing board

independence and accountability.

• Accelerate the creation of world class supporting infrastructure

(e.g., payments, asset reconstruction companies (ARCs), credit
bureaus, back-office utilities) to help the banking sector focus on
core activities.

• Enable labor reforms, focusing on enriching human capital, to help
public sector and old private banks become competitive.


Management imperatives will differ by bank. However, there will

be common themes across classes of banks:

• PSBs need to fundamentally strengthen institutional skill levels

especially in sales and mar marketing, service operations, risk
management and the overall organizational performance ethic. The
last, i.e., strengthening human capital will be the single biggest

• Old private sector banks also have the need to fundamentally

strengthen skill levels. However, even more imperative is their
need to examine their participation in the Indian banking sector and
their ability to remain independent in the light of the discontinuities
in the sector.

• New private banks could reach the next level of their growth in the
Indian banking sector by continuing to innovate and develop
differentiated business models to profitably serve segments like the
rural/low income and affluent/ HNI segments; actively adopting
acquisitions as a means to grow and reaching the next level of
performance in their service platforms. Attracting, developing and
retaining more leadership capacity would be key to achieving this
and would pose the biggest challenge.
• Foreign banks committed to making a play in India will need to
adopt alternative approaches to win the “race for the customer” and
build a value-creating customer franchise in advance of regulations
potentially opening up post 2009. At the same time, they should
stay in the game for potential acquisition opportunities as and when
they appear in the near term. Maintaining a fundamentally long-
term value-creation mindset will be their greatest challenge.

The extent to which Indian policy makers and bank managements

develop and execute such a clear and complementary agenda to tackle
emerging discontinuities will lay the foundations for a high-performing
sector in 2010.


We can conclude that the financial sector is a nerve system of

Indian economy. Banking plays an important role in development of
economy. For steady growth in economy innovations and development in
financial sector is very important.
Economy of any country faces lots of challenges and problems. To
tackle those problems financial sector plays a vital role. The financial
sector makes the economy efficient to the extent where it can rival other
developed economies in the world.

Financial sector also faces lots of problems but it should develop
certain strategies to come out of these problems which is very important
for healthy growth of economy.