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PROJECT

Report
On

UNIVERSAL BANKING
International Experiences
Vis – A – Vis
Emerging Trends & Issues In
India

Submitted in the partial fulfillment of two year full time


MBA programme
(2002-2004)

Submitted by: Submitted to:


Poorvi Jain Ms Swati Singhal
28/MBA/RDIAS/02 (Project Guide)
RUKMINI DEVI INSTITUTE OF ADVANCE STUDIES
2A & 2B, Phase – I, Madhuban Chowk, Rohini, Delhi - 110085

ACKNOWLEDGEMENT

I would like to extend my heartfelt gratitude to all those people


who helped me in carrying out this project study. My special
thanks and gratitude goes to Miss Swati singhal (Faculty
Member) RDIAS for her invaluable assistance and constant
help, without which the project would not have been in the
shape that it is today. She acted as a guiding spirit behind the
completion of this project report.

Poorvi Jain
EXECUTIVE SUMMARY

Project work is a part of our curriculum, which help us to correlate our


theoretical concepts with practical experience. I prepared this report for my
two years of Master of Business Administration.

My topic of project is “UNIVERSAL BANKING – International


experiences vis – a – vis Emerging Trends & Issues in India”. Planned
economic development in India had greatly influenced the course of
financial development. Financial sector reforms were initiated as part of
overall economic reforms in the country and wide ranging reforms covering
industry, trade, taxation, external sector, banking and financial markets have
been carried out since mid 1991. A decade of economic and financial sector
reforms has strengthened the fundamentals of the Indian economy and
transformed the operating environment for banks and financial institutions in
the country.

Banking has traditionally remained a protected industry in many emerging


economies. It prohibited banks from owning non-banking assets. No
Company other than a commercial bank licensed by the RBI can include the
words "Bank" or "Banking" as part of its name. Thus the boundary for
banking and financial services was mutually demarcated and assigned
separately between commercial banks and non-banking financial companies
respectively. The initial move away from traditional concepts of banking
took place after nationalization of banks in 1969/70. Banks started lending
on medium Term basis repayable between 3 to 7 years. After Nationalization
banks also diversified credit extension comprehensively to cater different
sectors of the economy. On the one hand there is a declining role for the
Banks in direct financial intermediation. The dynamism, in terms of variety
and packages provided, as exhibited by the International Financial &
Banking market has led to the equating of Euro-banking operations, the
nerve center of global financial and banking services as "financial
engineering".
"The institution of banks continues to have a unique place within the
financial system. Over the last three decades, however, the role of banking in
the process of financial intermediation has been undergoing a profound
transformation, owing to changes in the global financial system. Firstly, the
proliferation of financial innovations has led to a blurring of the boundaries
between traditional banking and other types of financial intermediation.
Today, banks operate with a wide variety of financial assets and liabilities,
some of which are created by the non-bank constituents of the financial
system. Thirdly, banks undertake leveraging transformations as part of their
intermediation - asset-liability, debt-equity, collateralized/ non-
collateralized, maturity, size and risk. "Competitive pressures in the financial
sector are thus building up, both within and from outside the banking
system. Banks as well as other financial intermediaries are undergoing
radical organizational change with an objective of synergising strength and
shedding activities with comparative disadvantage. Specialization in
financial intermediation provides competitive efficiency, depth and
resilience to the financial system. Together, the spectrum of financial
institutions can bring about further financial deepening and encourage
financial saving in the community.

The general trend has been towards downstream universal banking where
banks have undertaken traditionally non-banking activities such as
investment banking, insurance, mortgage financing, securitisation, and
particularly, insurance. Upstream linkages, where non-banks undertake
banking business, are also on the increase. In India, the first impulses for a
more diversified financial intermediation were witnessed in the 1980s and
1990s when banks were allowed to undertake leasing, investment banking,
mutual funds, factoring, hire-purchase activities through separate
subsidiaries. In the recent period, the focus is on Development Financial
Institutions (DFIs), which have been allowed to set up banking subsidiaries
and to enter the insurance business along with banks. DFIs were also
allowed to undertake working capital financing and to raise short-term funds
within limits. It was the Narasimham Committee II Report (1998), which
suggested that the DFIs should convert themselves into banks or non-bank
financial companies, and this conversion was endorsed by the Khan
Working Group (1998). Large pre-emption of lendable resources of the
banks.

The financial sector was crying out for reform. Public sector banks, which
had a useful role to play earlier on, now faced deteriorating performance. It
is essential to assimilate history of banking as well as the role of the
financial institutions till recently. The share of private sector banks which is
distinctly known as old private sector banks' established before 1994, was
thus not substantial while operations of foreign banks were also restricted.
Public sector banks, by way of contrast never had to face such a constraint.

The issue of universal banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank. Reserve Bank of India also spelt
out to Parliamentary Standing Committee on Finance, its proposed policy
for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. "The issue of universal banking
resurfaced in Year 2000, when ICICI gave a presentation to RBI to discuss
the time frame and possible options for transforming itself into an universal
bank. Reserve Bank of India also spelt out to Parliamentary Standing
Committee on Finance, its proposed policy for universal banking, including
a case-by-case approach towards allowing domestic financial institutions to
become universal banks.

"Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. Reserve Bank will consider such
requests on a case-by-case basis.

From the point of view of the regulatory framework, the movement towards
universal banking should entrench stability of the financial system, preserve
the safety of public deposits, improve efficiency in financial intermediation,
ensure healthy competition, and impart transparent and equitable
regulation."

Convergence of service /product distribution channels in the universal banks


i.e. services like bancassurance. The impact of securtization bill on the banks
and the role of asset reconstruction companies.

Different activities of universal banks come under different regulatory


authority like RBI, SEBI, IRDA and CLB. Universal banks can make equity
investments, give loans, use their voting rights, and even have representation
on the boards of non-financial firms.

The challenges faced by old brick and mortar banks with the emergence
of new generation Internet banks. There is a cap of 49% on equity
investments by Foreign Investors in Indian banks. The far-reaching
changes in the banking and financial sector entail a fundamental shift in
the set of skills required in banking. Special skills in retail banking,
treasury, risk management, foreign exchange, development banking, etc.,
will need to be carefully nurtured and built. Following financial
liberalisation, as the ownership of banks gets broadbased, the importance
of institutional and individual shareholders will increase. The face of
banking is changing rapidly. For a strong and resilient banking and
financial system, therefore, banks need to go beyond peripheral issues
and tackle significant issues like improvements in profitability, efficiency
and technology, while achieving economies of scale through
consolidation and exploring available cost-effective solutions.
TABLE OF CONTENTS

S. No PARTICULARS Page No.


1. Objective
2. Indian financial System- An Overview
3. Current Scenario
4. Financial Sector reforms in Selected South East
Asian Countries
5. Universal Banking – Conceptual Viewpoint
6. International Experiences
7. Empirical Evidences
8. Universal Banking in India
9. ICICI- Universal Banking Model
10. IDBI- Case Study
11. IFCI- Proposed Merger
12. Future Role of DFI’s in India & Financing Needs
of Industry.
13. Role of Banks & DFI’s – Operational Issues
14. New Age of Universal Banking in India
15. Conclusion
16. Bibliography
OBJECTIVE

An efficient, articulate and developed financial system is indispensable for


the rapid economic growth of any country/economy. The process of
economic development is invariably accompanied by a corresponding and
parallel growth of financial organizations. The liberalization/ deregulation/
globalization of the Indian economy has had important implications for the
future course of development of the financial system/sector.

The objective of my project is


 To study the existing Indian Financial System.

 To have a conceptual viewpoint of Universal Banking.

 To study the international experience with respect to adoption of


Universal Banking Model, its advantages, limitations and other issues

 To analyse the emerging trends in universal banking, regulatory


requirements given by RBI & other committee recommendations in
India with respect to specific cases of ICICI, IDBI & IFCI.

 To determine the Future Role of DFI’s & Various Operational Issues


required to be considered.
INDIAN FINANCIAL SYSTEM – AN OVERVIEW

An efficient, articulate and developed financial system is indispensable for


the rapid economic growth of any country/economy. The process of
economic development is invariably accompanied by a corresponding and
parallel growth of financial organizations. However, their institutional
structure, operating policies, regulatory/legal framework differ widely, and
are largely influenced by the prevailing politico-economic environment.
Planned economic development in India had greatly influenced the course of
financial development. The liberalization/ deregulation/ globalization of the
Indian economy has had important implications for the future course of
development of the financial system/sector.

Financial sector reforms were initiated as part of overall economic reforms


in the country and wide ranging reforms covering industry, trade, taxation,
external sector, banking and financial markets have been carried out since
mid 1991. A decade of economic and financial sector reforms has
strengthened the fundamentals of the Indian economy and transformed the
operating environment for banks and financial institutions in the country.
The sustained and gradual pace of reforms has helped avoid any crisis and
has actually fuelled growth. As pointed out in the RBI Annual Report 2001-
02, GDP growth in the 10 years after reforms i.e. 1992-93 to 2001-02
averaged 6.0% against 5.8% recorded during 1980-81 to 1989-90 in the pre-
reform period.
INTRODUCTION TO BANKING SYSTEM

"Banking has traditionally remained a protected industry in many emerging


economies. However, a combination of developments has compelled banks
to change the old ways of doing business. These include, among others,
technological advancements, disintermediation pressures arising from a
liberalized marketplace, increased emphasis on shareholders' value and
macroeconomic pressures and banking crises in 1990s. As a consequence of
these developments, the dividing line between financial products, types of
financial institutions and their geographical locations have become less
relevant than in the past."

For several decades in the past banking continued to be viewed as a


conservative business and was conducted with strict adherence to traditional
prudence & principles, with predefined and listed DOs and DON'Ts. Profits
and profitability were indeed looked for, but this goal was preceded by
greater importance to norms of security and liquidity. Speculation was
considered a sin. Traditional banking services included accepting deposits
from the public, lending a part of the same on short term basis, and investing
another portion in gilt-edged securities, while also holding a certain
percentage in cash, as balance with the Central Bank of the country, and in
the call money market. Thus the definition of "Banking" as per the Banking
Regulation Act, 1949 says-

“Banking means the accepting, for the purpose of lending or


investment, of deposits of money from the public, repayable on
demand or otherwise, and withdrawable by cheque, draft, order or
otherwise".

The Act defined the functions that a commercial bank can undertake and
restricted their sphere of activities. It prohibited banks from owning non-
banking assets. No Company other than a commercial bank licensed by the
RBI can include the words "Bank" or "Banking" as part of its name. Thus
the boundary for banking and financial services was mutually demarcated
and assigned separately between commercial banks and non-banking
financial companies respectively. The one cannot encroach on the domain of
the other.

By way of banking services, banks provided remittance service, collection of


cheques and bills of exchange, Issue of Guarantees, Opening Letters of
Credit, Leasing Safe Deposit Lockers, and accepting articles under safe
custody. As distinguished from this financial services included long term
lending for industrial and infrastructure projects, housing finance, financing
hire purchase and leasing transactions, providing insurance cover, selling
mutual-fund products etc.

The initial move away from traditional concepts of banking took place after
nationalization of banks in 1969/70. Banks started lending on medium Term
basis repayable between 3 to 7 years. After Nationalization banks also
diversified credit extension comprehensively to cater different sectors of the
economy. Term Lending, lending extensively against hypothecation of
securities, financing qualified and technical entrepreneurs, financing
craftsmen and artisans, financing purchase of consumer durable, financing
acquisition & constructions of houses, office premises, vehicles, financing
agriculture & allied activities, small-scale industries and exports etc. came
into vogue. It was still a mere diversification of credit-delivery functions,
and a transition from commercial banking to development banking looking
towards social objectives of employment generation and poverty alleviation
under Government ownership covering the major segment of Indian Banking

Since the beginning of the Eighties, the International Financial Markets are
witnessing revolutionary structural changes in terms of financial instruments
and the nature of lenders and borrowers. On the one hand there is a declining
role for the Banks in direct financial intermediation. On the other hand there
is enormous increase in securitised lending, the growth of new financial
facilities of raising funds directly from investors. There is also the growth of
innovative techniques such as interest rate swaps, financial and foreign
exchange futures and foreign exchange and interest rate options.

International Finance has to deal with and cater to the complex financial
needs relating to the global economic activities. It has to satisfy to diverse
customers like individuals, commercial organizations and government
owned corporations spread over various countries. By nature these
requirements could not be uniform. A stream of financial products has
therefore come into usage to meet specific needs of both investors and
borrowers. The range of product covers fund raising, underwriting, hedging
or arbitrage instruments. The dynamism, in terms of variety and packages
provided, as exhibited by the International Financial & Banking market has
led to the equating of Euro-banking operations, the nerve center of global
financial and banking services as "financial engineering".
"The institution of banks continues to have a unique place within the
financial system. This is due to their 'franchise' i.e., their unique ability to
issue monetary liabilities by leveraging non-collateralized deposits. Over the
last three decades, however, the role of banking in the process of financial
intermediation has been undergoing a profound transformation, owing to
changes in the global financial system. It is now clear that a thriving and
vibrant banking system requires a well-developed financial structure with
multiple intermediaries operating in markets with different risk profiles.

Firstly, the proliferation of financial innovations has led to a blurring of the


boundaries between traditional banking and other types of financial
intermediation. Today, banks operate with a wide variety of financial assets
and liabilities, some of which are created by the non-bank constituents of the
financial system. Secondly, specialized markets have come into being for
each class of financial instruments and banks have to transact business in
various segments of the financial market spectrum in the process of their
routine day-to-day business. Thirdly, banks undertake leveraging
transformations as part of their intermediation - asset-liability, debt-equity,
collateralized/ non-collateralized, maturity, size and risk. This necessarily
involves other types of financial intermediaries as counter parties, in
syndications and co-financing strategies, as also in the sharing of risk.
Fourthly, active global capital movements and the growing volume of cross-
border trade in financial services have exerted external pressures for
reorientation and refocusing of activities for all players in financial markets.

"Competitive pressures in the financial sector are thus building up, both
within and from outside the banking system. Other financial intermediaries
are increasingly refocusing on core competencies and niche strategies.
Banks as well as other financial intermediaries are undergoing radical
organizational change with an objective of synergising strength and
shedding activities with comparative disadvantage. Specialization in
financial intermediation provides competitive efficiency, depth and
resilience to the financial system. Together, the spectrum of financial
institutions can bring about further financial deepening and encourage
financial saving in the community.

"Since the early 1990s, banking systems worldwide have been going through
a rapid transformation. Mergers, amalgamations and acquisitions have been
undertaken on a large scale in order to gain size and to focus more sharply
on competitive strengths. This consolidation has produced financial
conglomerates that are expected to maximize economies of scale and scope
by 'bundling' the production of financial services. The general trend has been
towards downstream universal banking where banks have undertaken
traditionally non-banking activities such as investment banking, insurance,
mortgage financing, securitisation, and particularly, insurance. Upstream
linkages, where non-banks undertake banking business, are also on the
increase. The global experience can be segregated into broadly three models.
There is the Swedish or Hong Kong type model in which the banking
corporate engages in in-house activities associated with banking. In
Germany and the UK, certain types of activities are required to be carried
out by separate subsidiaries. In the US type model, there is a holding
company structure and separately capitalized subsidiaries.

In India, the first impulses for a more diversified financial intermediation


were witnessed in the 1980s and 1990s when banks were allowed to
undertake leasing, investment banking, mutual funds, factoring, hire-
purchase activities through separate subsidiaries. By the mid-1990s, all
restrictions on project financing were removed and banks were allowed to
undertake several activities in-house. In the recent period, the focus is on
Development Financial Institutions (DFIs), which have been allowed to set
up banking subsidiaries and to enter the insurance business along with
banks. DFIs were also allowed to undertake working capital financing and to
raise short-term funds within limits. It was the Narasimham Committee II
Report (1998), which suggested that the DFIs should convert themselves
into banks or non-bank financial companies, and this conversion was
endorsed by the Khan Working Group (1998). The Reserve Bank's
Discussion Paper (1999) and the feedback thereon indicated the desirability
of universal banking from the point of view of efficiency of resource use,
but it also emphasized the need to take into account factors such as the status
of reforms, the state of preparedness of the institutions, and a viable
transition path while moving in the desired direction."

The strategy of banking development during the period 1969- 1992,


following nationalization of major banks, first in 1969 and later in 1980,
paid rich dividends to the Indian economy. This was demonstrated in the
expansion of the banking network, as well as, various indicators reflecting
financial deepening and widening. Nevertheless, from the vantage point of
2003, it seems that there were a number of costs associated with this
strategy.
Two major costs were:
(a) Sacrifice of the efficiency gains in banking (in terms of lack of
improvement of productivity), and

(b) Large pre-emption of lendable resources of the banks.

Besides, the instruments of “social control”, in the form of credit controls


and concessional lending, had the effect of segmenting financial markets,
blunting the process of price discovery and undermining the efficiency of
resource allocation.

Banking sector reforms, launched ten years ago in 1992-93, were a key
constituent in the wider macroeconomic strategy of financial liberalization.
The 1990s took the process of institution building to its logical conclusion
by creating an environment in which these institutions could function
effectively. The challenge before the Reserve Bank was, thus, to rejuvenate
the process of price discovery, without either sacrificing the social
imperatives of a developing economy or compromising financial stability.

Banking sector reforms involved a three-pronged macro-economic strategy


of dismantling the regime of administered interest rates, introducing
financial instruments and making financial markets capable of allocating
resources in line with market signals, and at the same time, ensuring credit
delivery for the relatively disadvantaged sections of society. This was
reinforced by a series of micro-economic measures to introduce more private
sector players (domestic and foreign) to infuse competition and accord
freedom of portfolio allocation across markets, especially centering around
withdrawal of balance sheet restrictions in the form of statutory pre –
emption, such as, the cash reserve ratio (CRR) and statutory liquidity ratio
(SLR). Besides, an incentive structure had to be put in place to channel
funds to areas of social concern in tune with the spirit of financial
liberalization and the imperatives of poverty eradication. A new
development is the experiment of micro-finance, through self-help groups
either funded by banks directly or through intermediaries. Finally, there was
the need to harness the developments in information technology to improve
the functional efficiency of the banking system.

The Reserve Bank now accords banks substantial freedom in determining


their portfolios as well pricing their products, except in specific cases such
as interest rates chargeable on small loans and priority sector advances. The
Reserve Bank has instituted a number of measures to ensure the healthy
functioning of the banking system including prudential norms pertaining to
capital adequacy, income recognition and asset classification backed by
strict provisioning norms. This is being supplemented by the institution of
asset- liability management and risk management systems in line with the
best international practices. In view of the growing complexities of the
economy, the Reserve Bank has supplemented the micro- on-site supervision
system with a macro-based supervisory strategy based on off-site monitoring
and control systems internal to the banks, on the lines of CAMELS (Capital
Adequacy, Management, Liquidity and Systems).

In the realm of carefully sequenced banking sector reforms, India has a lot to
cheer about. The improvement in the profitability of the banking system in
the recent years has been accompanied by an enhancement in asset quality.
There is, however, no room for complacency, and all the stake – holders in
the banking sector have to strive hard. As far as the Reserve Bank is
concerned, we have come a long way from micro – monitoring to macro-
supervision of the banking sector. Recent initiatives, such as, risk-based and
consolidated supervision, adoption of various international standards and
codes, as well as, moving closer towards Basel II are all symptomatic of the
Reserve Bank’s commitment towards building a robust and vibrant banking
sector. The key challenge in the future is to build in appropriate risk
management practices to consolidate the gains of the past and fully exploit
the opportunities while managing the threats emanating from increasing
financial globalization and integration.

The most significant achievement of the financial sector reforms has been
the marked improvement in the financial health of commercial banks in
terms of capital adequacy, profitability and asset quality as also greater
attention to risk management. Further, deregulation has opened up new
opportunities for banks to increase revenues by diversifying into investment
banking, insurance, credit cards, depository services, mortgage financing,
securitization, etc. At the same time, liberalization has brought greater
competition among banks, both domestic and foreign, as well as competition
from mutual funds, NBFCs, post office, etc. Post-WTO, competition will
only get intensified, as large global players emerge on the scene. Increasing
competition is squeezing profitability and forcing banks to work efficiently
on shrinking spreads. Positive fallout of competition is the greater choice
available to consumers, and the increased level of sophistication and
technology in banks. As banks benchmark themselves against global
standards, there has been a marked increase in disclosures and transparency
in bank balance sheets as also greater focus on corporate governance.

Major Reform Initiatives

Some of the major reform initiatives in the last decade that have changed the
face of the Indian banking and financial sector are:

• Interest rate deregulation: Interest rates on deposits and lending have been
deregulated with banks enjoying greater freedom to determine their rates.

• Adoption of prudential norms in terms of capital adequacy, asset


classification, income recognition, provisioning, exposure limits,
investment fluctuation reserve, etc.

• Reduction in pre-emption: lowering of reserve requirements (SLR and


CRR), thus releasing more lendable resources which banks can deploy
profitably for streamlining the working of the credit process of the bank;

• Government equity in banks has been reduced and strong banks have been
allowed to access the capital market for raising additional capital.

• Banks now enjoy greater operational freedom in terms of opening and


swapping of branches, and banks with a good track record of profitability
have greater flexibility in recruitment.

• New private sector banks have been set up and foreign banks permitted to
expand their operations in India including through subsidiaries. Banks
have also been allowed to set up Offshore Banking Units in Special
Economic Zones.

• New areas have been opened up for bank financing: insurance, credit cards,
infrastructure financing, leasing, gold banking, besides of course
investment banking, asset management, factoring, etc.

• New instruments have been introduced for greater flexibility and better risk
management: e.g. interest rate swaps, forward rate agreements, cross
currency forward contracts, forward cover to hedge inflows under foreign
direct investment, liquidity adjustment facility for meeting day-to-day
liquidity mismatch.

• Several new institutions have been set up including the National Securities
Depositories Ltd., Central Depositories Services Ltd., Clearing
Corporation of India Ltd., Credit Information Bureau India Ltd.

• Limits for investment in overseas markets by banks, mutual funds and


corporate have been liberalized. The overseas investment limit for
corporate has been raised to 100% of net worth and the ceiling of $100
million on prepayment of external commercial borrowings has been
removed. MFs and corporate can now undertake FRAs with banks. Indians
allowed to maintain resident foreign currency (domestic) accounts. Full
convertibility for deposit schemes of NRIs introduced.

• Universal Banking has been introduced. With banks permitted to diversify


into long-term finance and DFIs into working capital, guidelines have been
put in place for the evolution of universal banks in an orderly fashion.

• Technology infrastructure for the payments and settlement system in the


country has been strengthened with electronic funds transfer, Centralised
Funds Management System, Structured Financial Messaging Solution,
Negotiated Dealing System and move towards Real Time Gross
Settlement.

• Adoption of global standards: Prudential norms for capital adequacy, asset


classification, income recognition and provisioning are now close to global
standards. RBI has introduced Risk Based Supervision of banks (against
the traditional transaction based approach). Best international practices in
accounting systems, corporate governance, payment and settlement
systems, etc. are being adopted.

• Credit delivery mechanism has been reinforced to increase the flow of


credit to priority sectors through focus on micro credit and Self Help
Groups. The definition of priority sector has been widened to include food
processing and cold storage, software upto Rs. 1 crore, housing above Rs.
10 lakh, selected lending through NBFCs, etc.

• RBI guidelines have been issued for putting in place risk management
systems in banks. Risk Management Committees in banks address credit
risk, market risk and operational risk. Banks have specialised committees
to measure and monitor various risks and have been upgrading their risk
management skills and systems.

• The limit for foreign direct investment in private banks has been increased
from 49% to 74% and the 10% cap on voting rights has been removed. In
addition, the limit for foreign institutional investment in private banks is
49%.

• Wide ranging reforms have been carried out in the area of capital markets.
Fresh investment in CPs, CDs are allowed only in dematerialized form.
SEBI has reduced the settlement cycle from T+3 to T+2 from April 1,
2003 i.e. settlement of stock deals will be completed in two trading days
after the trade is executed, taking the Indian stock trading system ahead of
some of the developed equity markets. Stock exchanges will set up trade
guarantee funds. Retail trading in Government securities has been
introduced on NSE and BSE from January 16, 2003. A Serious Frauds
Office is proposed to be set up. Fungibility of ADRs and GDRs allowed.

Improvement in performance of Commercial Banks

There is no doubt that banking sector reforms have increased the


profitability, productivity and efficiency of banks. There has been an
improvement in overall capital adequacy of banks and as on March 31, 2002
92 out of 97 commercial banks operating in India had capital adequacy
above the statutory minimum level of 9%. Introduction of prudential norms
relating to asset classification, income recognition and provisioning, along
with legal and institutional reforms, has led to visible improvement in asset
quality in banks. Net NPAs (i.e. that portion of NPAs which is not provided
for) have declined gradually from 10.7% in 1994-95 to 5.8% in 2001-02.
Increase in the number of players has increased competition, which is
reflected in the decline in the bank concentration ratio. The share of top 5
banks in total assets declined from 51.7% in 1991-92 to 43.5% in 2001-02
while its share in profits fell from 54.5% to 41.4% in the same period.
Despite intensification of competition and introduction of prudential norms,
all major bank groups in India have remained profitable. The Return on
Assets has hovered in the range of 0.5-0.8% since the mid-1990s – while
this is on the lower side compared to many developing countries, it is higher
than the profitability at around 0.5% in industrialized countries. The
improvement in efficiency is also seen from the intermediation cost for
scheduled commercial banks, which declined from 2.85% in 1996-97 to
2.19% in 2001-02. According to data analyzed by RBI, there has been a
noticeable decline in the difference between real interest rates in India and
international benchmark rates (LIBOR 1 year) since the mid-1990s,
suggesting increased integration of the Indian banking sector with the rest of
the world.
CURRENT SCENARIO IN INDIA

The year 2002-03 was marked by a revival in industrial growth with a


buoyant services sector. Nevertheless, the drought situation inhibited the
farm sector, and the overall GDP growth for 2002-03 was moderate. In line
with the resurgence of industrial growth, there was some pickup in
scheduled commercial banks’ (SCBs) non-food credit, particularly in the
second half of 2002-03. Portfolios of SCBs, on the asset side, showed some
shift in favour of advances. Owing to the holding of Government securities
by SCBs, far in excess of stipulated requirements and a fall in interest rates,
their income profile continued to be driven by treasury operations. There has
been a reduction in the ratio of non-performing assets (NPAs) to advances
with various initiatives, such as, improved risk management practices and
greater recovery efforts, driven, inter alia, by the recently enacted
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002.

Co-operative banks recorded moderate growth with less than satisfactory


profitability. There was also some scaling down of activities of the
development financial institutions. The performance of the non-banking
financial companies during 2001-02 was less satisfactory. A number of
regulatory measures by the Reserve Bank, such as, alignment of interest
rates in this sector with the rates prevalent in the rest of the economy,
tightening of prudential norms, standardization of operating procedures and
harmonization of supervisory directions carried the financial sector reforms
further.

In the domestic economy, liquidity conditions remained comfortable during


the year. Broad money (M3) growth, net of the impact of the merger,
increased by 13.2 per cent on top of a 14.1 per cent growth a year ago ; this
was in line with the projected level of 14.0 per cent during 2002 - 03.
Among its components, aggregate deposits of scheduled commercial banks
in 2002-03 were somewhat lower (adjusted for mergers). Reflecting the
acceleration in industrial production, there was a sustained increase in credit
flow to the commercial sector. During 2002-03, growth in both non-food
credit (adjusted for mergers), as well as, investment in Government
securities was much higher. There was also a larger flow of resources from
non-banks, including issuance of Global and American Depository Receipts,
Foreign Currency Convertible Bonds, and Commercial Papers (CPs).
Against this backdrop, while continuing the preference for soft interest rates,
along with a vigil on movements in the price level, the overall stance of the
Reserve Bank’s monetary policy during 2002-03 continued to focus on the
provision of adequate liquidity to meet credit growth and support investment
demand in the economy. In line with the aforesaid objectives, the Cash
Reserve Ratio (CRR) was reduced from 5.5 per cent to 5.0 per cent in June
2002 and further to 4.75 per cent in November 2002, cumulatively
augmenting the lendable resources of banks by about Rs.10,000 crore. The
Bank Rate and repo rate have emerged as important tools for the Reserve
Bank to signal its policy intentions. In October 2002, the Bank Rate was
lowered to 6.25 per cent. The repo rate was also reduced to 5.75 per cent in
June 2002 and further cuts were effected in two stages, reducing it to 5 per
cent by March 2003.

The year 2002-03 was characterised by strong earnings for Indian


commercial banks with all major income categories showing significant
improvements. Return on assets (i.e., the ratio of net profit to total assets),
witnessed a marked improvement for SCBs to 1.0 per cent in 2002-03 - the
highest over the last six years. Record low interest rates continued to drive
the retail and housing segments, boosting both lending and fee-based income
of banks.

Given the buoyant Government securities market resulting from declining


yields arising from excess liquidity in the market, and soft interest rate
conditions, the banking industry witnessed significant activity in trading in
Government securities during the major part of the year. Notwithstanding
some dampening of sentiments during the last quarter of 2002-03, the
banking industry as a whole witnessed a sharp improvement in performance
during 2002-03, driven largely by containment in interest expense

The significant improvement in the performance of SCBs masks the wide


variation in performance across bank groups. For example, increase in
income was the lowest for old private banks, owing to a modest increase in
interest income. Foreign banks, on the other hand, experienced a decline in
both income and expenses, with the decline in the latter outpacing that in the
former, arising largely from containment in interest expenses. Taking
advantage of the easy liquidity conditions, public sector banks (PSBs)
contained their interest expenses within reasonable levels. Declining rates
also allowed banks to realize gains on the sale of appreciated securities.
Provisions and contingencies increased for most bank groups reflecting a
greater appreciation on their part to improve the credit portfolio; an
exception being the foreign banks for whom provisions in fact declined
reflecting improvements in their asset portfolio.

Capital levels of the banking sector improved markedly during the year with
the overall capital adequacy of SCBs rising from 10.4 per cent as at end-
March 1997 to 12.6 per cent as at end-March 2003, owing to ploughing back
of profits into reserves. All public sector banks had capital well above the
stipulated minimum. At the aggregate level, out of the 93 SCBs (excluding
RRBs), only two could not satisfy the stipulated 9.0 per cent capital
adequacy ratio.

A marked improvement in credit risk management of banks was also


evident. The overall non-performing assets (NPAs) of the banking sector
declined by over Rs.2,000 crore to 8.8 per cent of gross advances as at end-
March 2003. This was driven by the twin-track measures of improved risk
management practices and greater recovery efforts. The recently enacted
SARFAESI Act, which enabled banks to recover around Rs.500 crore till
end-June 2003, had a salutary effect in this regard. Notwithstanding the
improvement in asset quality, banks have been making pro-active efforts
towards increasing their provisioning levels. This is reflected in the fact that
the cumulative provisioning against gross NPAs of PSBs increased from
42.5 per cent in 2001-02 to 47.2 per cent in 2002-03. With increased
provisioning, the net NPA to net advances of PSBs witnessed a distinct
decline from 5.8 per cent in 2001-02 to 4.5 per cent in 2002-03.

Competitive pressures are increasingly making their presence felt in the


Indian banking system. The interest margin for SCBs, defined as the excess
of interest income over interest expense, normalised by total assets, has
exhibited a declining trend from 3.1 per cent in 1995-96 to 2.8 per cent in
2002-03. This has been effected in a soft interest rate scenario. Further, there
were expenditure curtailment and manpower rationalisation, as evidenced in
their reduction in operating expenses, while harnessing the beneficial
influence of technology.

Co-operative banks recorded moderate growth during the year under review
after the strong expansion in the latter half of the 1990s. The profitability of
co-operative banking continues to be less than satisfactory. This largely
reflects a narrowing of spreads – especially as co-operative banks typically
do not trade in the Government securities market, and are, thus, not able to
exploit lowered interest rates to their advantage. At the same time, there was
some improvement in asset quality in case of urban co-operative banks with
their gross non-performing assets (NPAs), as proportion of advances,
recording a marginal decline during 2002-03.

The performance of rural co-operatives was also in line with the long-term
trends. Profitability of the state co-operative banks continued to be strong
during 2002-03. The NPAs of rural co-operatives continued to be high –
with the asset quality of the lower tier being relatively worse than that of the
upper tier.

The sharp declining trend in financial assistance by all-India Financial


Institutions (FIs)1 ,noticed in the recent period, continued during 2002-03.
When the financial assistance of the FIs is adjusted for the gross flow for
repayments, flow of resources from some development financial institutions
to corporates is found to be negative. While the merger of ICICI with ICICI
Bank and the shrinkage in the size of balance sheets of some FIs explain, to
a great extent, this decline in financial assistance, the subdued performance
of the FIs is consistent with the increasing role of banks in financing of
Indian industries. Besides, a sluggish capital market, lack of demand for new
projects and increase in industrial production through utilisation of unused
capacities all may have contributed to lower demand for long-term financial
assistance.

The balance sheet of select FIs, as a group, showed a growth of 5.7 per cent
over the previous year. The pattern of liabilities and assets, however,
remained broadly similar. On the liability side, bonds and debentures
constituted a major share in the total, as they provide more flexibility of
structuring with call and put options as also the tradable facility in the
secondary market by way of listing on the stock market. Total sources and
deployment of funds of FIs (excluding ICICI) declined by 2.1 per cent
during 2002-03 as against an increase of 19.8 per cent in the previous year.
The performance of select FIs in respect of maintenance of a minimum
capital to risk weighted assets ratio (CRAR) reveals that, except IFCI and
IIBI, all FIs had a CRAR much above the norm of 9 per cent during 2002-
03. There was, however, an increase in net non-performing loans (NPLs) of
some FIs during 2002-03.
Resource mobilisation by mutual funds declined sharply during 2002-03
mainly due to the substantial net outflow of funds from UTI, which was
restructured during the year. Private sector mutual funds also recorded a
decline in mobilisation of funds while public sector funds (other than UTI)
recorded a modest increase.

The SARFAESI Act provides for sale of financial assets by banks and FIs to
securitisation companies (SCs) or reconstruction companies (RCs). Recently
IDBI, ICICI Bank, SBI and a few other banks jointly promoted the Asset
Reconstruction Company (India) Limited (ARCIL) with an initial authorised
capital of Rs.20 crore and paid-up capital of Rs.10 crore. ARCIL has been
given license by the Reserve Bank to commence operations.

The Indian economy is poised to record strong growth during 2003-04.


During the first quarter (April-June 2003), the growth in GDP accelerated to
5.7 per cent over the corresponding quarter of the previous year. There is
likely to be a recovery in agricultural production, following normal
monsoons after a year of drought. Besides, industrial growth continues to be
strong. The increase in the index of industrial production accelerated to 5.6
per cent during 2003-04 (April- August) from 5.2 per cent during the
corresponding period of the previous year, driven by an improved
performance in the manufacturing sector. There are indications of sustained
growth in the production of basic goods, capital goods and consumer goods.
Consequent to all these factors, the overall growth in GDP during 2003-04 is
expected to be around 6.5 - 7.0 per cent, with an upward bias. The surge in
capital flows continued during 2003-04 (up to October), reinforced by the
revival of FII investment. As a result, the Reserve Bank’s foreign exchange
reserves climbed to US $ 92.6 billion by end-October 2003. The exchange
rate of the rupee which was Rs.47.50 per US dollar at end-March 2003
appreciated by 4.8 per cent to Rs.45.32 per US dollar by end-October 2003
but depreciated by 2.3 per cent against Euro, 2.5 per cent against Pound
Sterling and 4.2 per cent against Japanese Yen during the period. During
April-September 2003, while growth in exports was lower, that of imports
was higher than those in the corresponding period of the previous year.

Liquidity conditions continued to be comfortable, driven by strong capital


flows. Road money (M3) growth, at 7.4 per cent during this year so far (up
to October 17, 2003) was somewhat lower than that of 8.1 per cent
experienced during the corresponding period of 2002- 03, after adjusting for
mergers. Overall, remained within the projections the growth in M3 of the
Monetary and Credit Policy of April 2003. SCBs’ non-food credit offtake at
5.7 per cent (up to October 17, 2003) was somewhat lower as compared with
7.4 per cent, adjusted for merger effects, during the comparable period of the
previous year. Nevertheless, some new trends in the credit market, such as,
growth of retail credit, particularly to the housing sector, are noteworthy.
The annual rate of WPI inflation, on a point-to-point basis, remained high in
the range of 6.3 – 6.9 per cent during the first two months of 2003-04;
thereafter it declined to 5.0 per cent by October 18, 2003.

Reflecting easy liquidity conditions as well as reductions in the repo rate by


the Reserve Bank, interest rates continued to soften further in the financial
markets. Another positive feature during the year was the revival of capital
markets, with the BSE Sensex gaining by as much as 61 per cent during
2003-04 (up to end-October).

The performance of the commercial banking system during the quarter


ended June 2003, as revealed from the supervisory returns of SCBs, indicate
a significant improvement in their performance over the corresponding
quarter of the previous year. The net profits to total assets of SCBs for the
quarter ended June 2003 stood at 0.32 per cent as compared with 0.24 per
cent during the comparable period of the previous year. The improvement in
net profits was driven by containment of expenses, in general, and interest
expended, in particular, and was achieved despite a sharp rise in provisions
and contingencies across bank groups. Operating expenditures, by and large,
remained at the same level as at end-June 2002; an exception being the new
private banks for whom these expenses increased marginally. Reflecting the
industrial recovery, financial assistance by FIs increased during April-
September 2003.
FINANCIAL SECTOR REFORMS IN SELECTED SOUTH
EAST ASIAN COUNTRIES

Both internal and external factors provided incentives for the selected
countries to reform their respective financial sector. Before the reform,
financial system served as a mere distributor of priority credits at a
concessional rate to targeted sectors and institutions in the countries. In
Malaysia, the crisis in real and financial sector in 1985 and 1986 was the
main driving force to reform the financial sector. In case of Thailand, the
large resource gap in the late 1970s to the mid – 1980s favored the
accelerated opening up of the financial sector. Moreover, after signing
Article VIII of the IMF agreements, Thailand was obliged to loose its
control on capital account. With respect to sequencing, countries usually
adopt a more flexible exchange rate to begin the reform process. Gradually,
government control in deciding the interest rate comes down. Next, the
domestic financial sector is thrown open to foreign competition and
eventually most capital controls would be abolished. While reforming the
financial sector some efforts are needed to implement the institutional and
legal changes if and when are necessary. All the above said countries more
or less followed this path. However, reform in Indonesia started off with an
unorthodox move in 1972 with complete liberalization of the capital
account. At the same time, the country maintained fixed exchange rate
system and the monetary authority determined interest rate. Initially the
system absorbed this imbalance due to steep rise in oil price but later on due
to pressure on the local currency, Indonesia had to change its policy towards
flexible exchange rate and ceiling on interest rate was removed. In general,
reform has encompassed the adoption of a more market – oriented approach
regarding monetary and financial policy and the use of monetary
instruments.

The Market Entry

Malaysia: It partly protects its domestic banks from foreign competition and
gives special market preference to the state controlled banks. At the end of
1997, the licensed banking system consisted of 35 commercial banks, of
which 22 are domestic banks and 13 are foreign controlled. Of these 35
banks, the total number of branch offices of domestic banks was 1,480 and
that of foreign controlled bank was 144.
Indonesia: The October 1988 banking reforms in Indonesia has significantly
strenghthened market competition. This was achieved by relaxing
restrictions on market entry, and by removing a 1967 regulation which gave
state owned banks special access to public sector funds. Foreign banks were
permitted to enter the Indonesian domestic market only through joint
ventures with local banks, their domestic partners being classified as
“sound” for atleast 20 of the last 24 months. The maximum share of foreign
partners in a joint venture bank was set at 85 percent.

Thailand: Thailand permits banks and business to borrow offshore in


foreign currencies. Since 1991, Thailand has permitted 100 percent foreign
ownership firms. In 1993, Bangkok International Banking Facilities was
launched and by mid – 1996, 45 banks have been allowed to do international
banking. These banks may mobilize deposits from outside the country and
also can lend internationally.

Prudential Rules and Regulations

Malaysia: Prior to the liberalization of interest rates and credit policy in


1987, Malaysia had managed to improve its norms for prudential
supervision. The shift of prudential measures from the system of reserve
requirement ratio to the risk based capital standard was started in September
1981, with the introduction of a minimum capital adequacy ratio. A
comprehensive revision of the CAR at 8 percent, along the Bis
recommendations, has been fully implemented since 1987.

Indonesia: Initially, bank supervision in Indonesia was focused very much


on regulatory functions. Relatively little emphasis was placed on
quantitative risk analysis or on in – depth risk appraisal of individual
institutions. This had a serious implication. When the risk positions of the
banks increased following the liberalization, there was neither clear warning
nor restraining action forthcoming from the supervisory authority. Soon the
need to implement new prudential standards was realized and hence new
guidelines were introduced in February 1991 onwards. Some of these are:

o The minimum required capital for newly established domestic and


joint venture banks was doubled.
o The risk based prudential rules and regulations required each bank to
raise its capital base in line with the size and quality of its assets.

o A special accounting system was introduced for the banks in January


1995 which aimed at improving bank supervision by standardizing
accounting and reporting system.

o From march 1995, banks were required to submit detailed credit plan
to bank Indonesia.

o The supervisory responsibilities of Bank Indonesia have been


substantially broadened to cover the credit banks ( Bank Perkreditan
Rakyat BPRs) and finance companies.

o Capital adequacy ratio as a percentage of risk weighted assets was


introduced from February 1991. it had to reach 8 percent by
December 1993.

o Bank Indonesia has expanded the organization of its bank supervision


from one department to three, so as to ensure better and effective
supervisory action.

Thailand: Thailand also took several steps so as ensure prudential


supervision. The Securities and Exchange Act was passed in May 1992,
giving qualified limited companies access to direct finance through issuing
common stocks and debt instruments.
o The Act established the Securities and Exchange Commission (SEC)
as an independent agency responsible for supervising capital market
activities related to equities, bonds, and derivatives.

o In 1993, the government spearheaded the formation of a credit rating


agency, Thai Rating and Information Services ( TRIS).

Credit System

Policies aimed at reducing distortions in the credit market have been an


integral part of financial sector reforms programme, in all these countries.
Malaysia: In Malaysia several measures have been taken by the government
to ensure an efficient credit allocation system. Following is the list of some
of the measures.
o Reduction of the SRR and the liquid asset ratio requirement.

o Lowering interest rates through the lowered Bank Negara Malaysia


( BNM) intervention rate and revision of the basic lending rate
framework.

o Freeing BIS to determine the margin of financing for credit facilities


granted for the purchase of broad properties.

o Encouragement of credits by imposing a minimum annual loan


growth target of 8 percent to be met by banking institutions by the end
of 1998.

o Removal of the specific provision requirement for relaxation of the


definition of NPLs.

However, it can be noted that such measures could seriously weaken


Malaysia’s already overstretched domestic banks. The new credit could find
its way into speculative investments and simply add to national leverage
levels that are already unacceptably high.

Indonesia: In June 1983, credit ceilings imposed on state banks, private and
foreign banks were eliminated. In October 1988, reserve requirements were
brought down from 15 percent to 2 percent of deposits. Moreover, between
1989 and 1990, four credit regulations were introduced in Indonesia, the
rules being implied in the legal lending limits regulations ( LLR). One of
these rules mandates domestic private and state owned banks to allocate at
least 20 percent of their loan portfolios to small-scale enterprises and co-
operatives. Another rule, introduced in January 1990, narrowed down the
scope of subsidized credit programmes.

Thailand: The following measures were taken to improve the credit


situation.
o Interest rate ceilings on long-term time deposits were abolished in
June 1989, on savings and short-term time deposits in January 1992,
and on loan rates in June 1992.
o The central bank in 1992-93 gave commercial banks more flexibility
by loosening the requirements of government bond holding as a
prerequisite for opening up new branches.

o The obligations of commercial banks to extend credits to rural


borrowers or those in the vicinity were also relaxed to cover more
related occupations and wider geographical areas.

o The definition of “liquid reserves” was broadened to include Bank of


Thailand and state enterprise bonds, as well as debt instruments issued
by financial institutions or government agencies approved by the
central bank.

Thus all the nations realized that unless pre-emption of the banks resources
was eliminated and they were allowed to earn profitable return on their
resources, it will not be possible to have an efficient banking sector.

Response to the Asian Crisis

The Asian currency crisis, in July 1997 had a major adverse effect on the
growth performance of the countries – Malaysia, Indonesia and Thailand. In
the aftermath of the crisis, all the three nations have made significant effort
in undertaking the immense task of financial and corporate sector
restructuring. The main focus of their efforts has been on resolving the
problem of insolvent financial institutions by closure, merger or
recapitalisation, addressing the corporate debt overhang; and improving
corporate governance. Although the broad principles of financial and
corporate restructuring have been similar, the actual patterns of
implementation have varied.

Malaysia: Malaysia has adopted restructuring measures that have stressed


coordination by the central government. Malaysia now has a NPL ratio for
commercial banks of less than 10 percent. During 2000, debt restructuring
through asset management companies (AMCs) has made a significant
progress. Danaharta – the agency set up to purchase and rehabilitate the
financial sector’s debt had a little more than 40 percent of NPLs by August
2000. it is estimated that, as of June 2000, it has disposed of 61 percent of
the NPLs under his jurisdiction. The main thrust of policy measures have
been in three major directions:
o Improvement in credit allocation.

o Strengthening of prudential regulations.

o Resolution of NPLs and recapitalization and consolidations.

Indonesia: It adopted restructuring programmes like Malaysia that have


stressed coordination by the central government. They have established
central agencies to manage non-performing loans (NPLs) and carry forward
the recapitalization process. As a result of adequate efforts being made, the
NPL ratio had fallen in Indonesia. As of june-2000, it was reported to be
about 30 percent for the country’s banking system as a whole, down from a
peak of 70 percent. More than 75 percent of the total NPLs in the banking
system are now under the control of the Indonesian Bank Restructuring
Agency. However, the performance of the Agency has not been up to the
mark. As of June 2000, the Agency has disposed of only 0.35 percent of
acquired NPLs. Second, as economic growth has slowed down, some
restructured loans have resurfaced as re-entry NPLs. New NPLs have
continued to emerge, particularly in those industries that continue to
struggle, such as real estate and construction.

Thailand: Thailand has followed a more market-oriented approach, though


it has restructured public banks and finance companies and absorbed some
of their losses. Significant progress has been made in the reduction of NPLs,
which has declined from a peak of about 48 percent in May 1999 to 18
percent by December 2000. However, for two reasons the resolution of the
NPL problem is incomplete and remains a significant challenge to the
government. First, the sharp decline in the NPLs was largely due to the
transfer of some NPLs to AMCs, which were created to remove bad loans
from bank balance sheets. Secondly, these NPLs were included in the
calculation of the NPL ratio. May be with new and re-entry NPL, the NPL
ratio would have been around 30 percent rather than 18 percent.
UNIVERSAL BANKING: A CONCEPTUAL VIEWPOINT

Since the early 1990s, structural and functional changes of profound


magnitude came to be witnessed in global banking systems. Large-scale
mergers, amalgamations and acquisitions among banks and financial
institutions resulted in the growth in size and competitive strengths of the
merged entities. There thus emerged new financial conglomerates that could
maximize economies of scale and scope by 'bundling' the production of
financial services. This heralded the advent of a new financial service
organization, i.e. Universal Banking, bridging the gap between banking and
financial-service-providing institutions. Universal Banks entertain, in
addition to normal banking functions, other services that are traditionally
non-banking in character such as investment-financing, insurance, mortgage-
financing, securitisation, etc. Parallelly, in contrast to this phenomenon, non-
banking companies too entered upon banking business.

What is Universal Banking?

It is a multi-purpose and multi-functional financial supermarket providing


both banking and financial services through a single window. As per website
of World Bank (www.worldbank.org) the concept is explained as follows -
"In universal banking, large banks operate extensive networks of branches,
provide many different services, hold several claims on firms (including
equity and debt), and participate directly in the corporate governance of
firms that rely on the banks for funding or as insurance underwriters."

Universal Banking includes not only services related to savings and loans
but also investments. However in practice the term 'universal banks' refers to
those banks that offer a wide range of financial services, beyond commercial
banking and investment banking, insurance etc. Universal banking is a
combination of commercial banking, investment banking and various other
activities including insurance. If specialized banking is the one end universal
banking is the other. This is most common in European countries.

Universal banking has some advantages as well as disadvantages. The main


advantage of universal banking is that it results in greater economic
efficiency in the form of lower cost, higher output and better products.
However, larger the banks, the greater the effects of their failure on the
system. Also there is the fear that such institutions, by virtue of their sheer
size, would gain monopoly power in the market, which can have significant
undesirable consequences for economic efficiency. Also combining
commercial and investment banking can gives rise to conflict of interests.
Conflict of interests was one of the major reasons for introduction of Glass-
Steagall Act in US.

To put in simple words, a “universal bank” is a superstore for financial


products. Under one roof, corporate can get loans and avail of other handy
services, while individuals can bank and borrow. To convert itself into a
universal bank, an entity has to negotiate several regulatory requirements.
Therefore, universal banks in a nutshell have been in the form of a group-
concerns offering a variety of financial services like deposits, short term and
long term loans, insurance, investment banking etc, under an umbrella
brand. Citicorp is a reasonably good example of a global UB. JB Morgan is
another. The concept has been prevalent in developed countries like France,
Germany and US.

The term ‘universal banks’ in general refers to the combination of


commercial banking and investment banking, i.e., issuing, underwriting,
investing and trading in securities. In a very broad sense, however, the term
‘universal banks’ refers to those banks that offer a wide range of financial
services, beyond commercial banking and investment banking, such as,
insurance. However, universal banking does not mean that every institution
conducts every type of business with every type of customer. Universal
banking is an option; a pronounced business emphasis in terms of products,
customer groups and regional activity can, in fact, be observed in most
cases. In the spectrum of banking, specialized banking is on the one end and
the universal banking on the other.

Universal banks are financial institutions that may offer the entire range of
financial services. They may sell insurance, underwrite securities, and carry
out securities transactions on behalf of others. They may own equity interest
in firms, including nonfinancial firms.

They are multi-product firms in the financial services sector whose


complexity is difficult to manage. In their historical development,
organizational structure, and strategic direction, universal Banks constitute
multi-product firms, within the financial services sector. This stylized profile
of universal banks presents shareholders with an anagram of more or less
distinct businesses that are linked together in a complex network which
draws on as set of centralized financial, information, human and
organizational resources - a profile that tends to be extraordinarily difficult
to manage in a way that achieves optimum use of invested capital

Economics of Universal Banking:

From a production -function perspective, the structural form of universal


banking appears to depend on the ease with which operating efficiencies and
scale and scope economies can be exploited - determined in large part by
product and process technologies - as well as the comparative organisational
effectiveness in optimally satisfying client requirements and bringing to bear
market power.

Economies of Scale:
Bankers regularly argue that 'Bigger is better' from a shareholder
perspective, and usually point to economies of scale as a major reason.
Individually economies (diseconomies) of scale in universal banks will
either be captured as increased profit margins or passed along to clients in
the forms of lower (higher) prices resulting in a gain (loss) of market share.
They are directly observable in cost functions of financial service suppliers
and in aggregate performance measures.

Economies of Scope:
Economies of scope arise in multi-product firms because costs of offering
various activities by different units are greater than the costs when they are
offered together. On the supply side, scope economies relate to cost-savings
through sharing of overheads and improving technology through sharing of
overheads and improving technology through joint production of generically
similar groups of services.

On the demand side, economies of scope arise when the all-in cost to the
buyer of multiple financial services from a single supplier - including the
price of the service, plus information, search, monitoring, contracting and
other transaction costs - is less than the cost of purchasing them from
separate suppliers.

X-efficiency:
Besides economies of scale and scope, it seems likely that universal banks of
roughly the same size and providing roughly the same range of services may
have very different cost levels per unit of output. The reasons may involve
efficiency-differences in the use of labour and capital, effectiveness in the
sourcing and application of available technology, and perhaps effectiveness
in the acquisition of productive inputs, organisational design, compensation
and incentive systems - and just plain better management.

Absolute Size and Market Power:


Universal Banks are able to extract economic rents from the market by
application of market power. Indeed, in many national markets for financial
services suppliers have shown a tendency towards oligopoly but may be
prevented by regulation or international competition from fully exploiting
monopoly positions.

Value of Income -stream Diversification:


There are potential risk-reduction gains from diversification in universal
financial service organizations, and that these gains increase with the
number of activities undertaken. The main risk-reduction gains appear to
arise from combining commercial banking with insurance activities, rather
than with securities activities.

Access to Bailouts:
In such a case, failure of one of the major institutions is likely to cause
unacceptable systemic problems. If this turns out to be the case, then too-
big-to-fail organizations create a potentially important public subsidy for
universal banking organizations and therefore implicitly benefit the
institutions' shareholders.

Conflicts of Interest:
The potential for conflicts of interest is endemic in universal banking, and
runs across the various types of activities in which the bank is engaged:
Salesman's Stake: it has been argued that when banks have the power to sell
affiliates' products, managers will no longer dispense 'dispassionate' advice
to clients. Instead, they will have a salesman's stake in pushing 'house'
products, possibly to the disadvantage of the customer.

 Stuffing fiduciary accounts: A bank that is acting as an underwriter


and is unable to place the securities in a public offering - and is
thereby exposed to a potential underwriting loss - may seek to
ameliorate this loss by stuffing unwanted securities into accounts
managed by its investment department over which the bank has
discretionary authority.
 Bankruptcy - risk transfer: a bank with a loan outstanding to a firm
whose bankruptcy risk has increased, to the private knowledge of the
banker, may have an incentive to induce the firm to issue bonds or
equities - underwritten by its securities unit - to an unsuspecting
public. The proceeds of such an issue could then be used to pay-down
the bank loan. In this case the bank has transferred debt-related risk
from itself to outside investors, while it simultaneously earns a fee
and/or spread on the underwriting.

 Third party loans: To ensure that an underwriting goes well, a bank


may make below-market loans to third party investors on condition
that this finance is used to purchase securities underwritten by its
securities unit.

 Tie-ins: A bank may use its lending power activities to coerce or tie-
in a customer or its rivals that can be used in setting prices or helping
in the distribution of securities unit. This type of information flow
could work in the other direction as well.

Issues of concern for Universal Banking:

Deployment of capital:
If a bank were to own a full range of classes of both the firm’s debt and
equity the bank could gain the control necessary to effect reorganization
much more economically. The bank will have greater authority to intercede
in the management of the firm as dividend and interest payment performance
deteriorates.

Unhealthy concentration of power:


In many countries such a risk prevails in specialized institutions, particularly
when they are government sponsored. Indeed public choice theory suggests
that because Universal Banks serve diverse interest, they may find it difficult
to combine as a political coalition – even this is difficult when number of
members in a coalition is large.
Impartial Investment Advice:
There is a lengthy list of problems, involving potential conflicts between the
bank’s commercial and investment banking roles. For example there may be
possible conflict between the investment banker’s promotional role and
commercial bankers obligation to provide disinterested advice. Or where a
Universal Bank’s securities department advises a bank customer to issue
new securities to repay its bank loans. But a specialized bank that wants an
unprofitable loan repaid also can suggest that the customer issues securities
to do so.

Advantages and Limitations

Universal banking has some advantages as well as disadvantages. Merits and


demerits of universal banking have been examined on theoretical grounds,
and there have been some studies to test them on a firm basis. Some of the
important conclusions emerging from a review of these are discussed below.

Advantages

 The main argument in favour of universal banking is that it results in


greater economic efficiency in the form of lower cost, higher output
and better products. This logic stems from the reason that when sector
participants are free to choose the size and product-mix of their
operations, they are likely to configure their activities in a manner that
would optimise the use of their resources and circumstances. In
particular, the following advantages are often cited in favour of
universal banking.

 Economies of scale mean lower average costs which arise when larger
volume of operations are performed for a given level of overhead on
investment. Economies of scope arise in multi-product firms because
costs of offering various activities by different units are greater than
the costs when they are offered together. Economies of scale and
scope have been given as the rationale for combining the activities. A
larger size and range of operations allow better utilisation of
resources/inputs. It is sometimes argued that acquisition of some
information technologies becomes profitable only beyond certain
production scales. Larger scale could also avoid the wasteful
duplication of marketing, research and development and information-
gathering efforts.
 Due to various shifts in business cycles, the demand for products also
varies at different points of time. It is generally held that universal
banks could easily handle such situations by shifting the resources
within the organisation as compared to specialised banks. Specialised
firms are also subject to substantial risks of failure, because their
operations are not well diversified. Proponents of universal banking
thus argue that specialised banking system can present considerable
risks and costs to the economy. By offering a broader set of financial
products than what a specialised bank provides, it has been argued
that a universal bank is able to establish long-term relationship with
the customers and provide them with a package of financial services
through a single window. It is important to note that this benefit stems
from the very nature/purpose of universal banking.

Limitations

 The larger the banks, the greater the effects of their failure on the
system. The failure of a larger institution could have serious
ramifications for the entire system in that if one universal bank were
to collapse, it could lead to a systemic financial crisis. Thus, universal
banking could subject the economy to the increased systemic risk.

 Universal bankers may also have a feeling that they are too big to be
allowed to fail. Hence they might succumb to the temptation of taking
excessive risks. In such cases, the government would be forced to step
in to save the bank. Furthermore, it is argued that universal banks are
particularly vulnerable because of their role in underwriting and
distributing securities.

 Historically, an important reason for limiting combinations of


activities has been the fear that such institutions, by virtue of their
sheer size, would gain monopoly power in the market, which can have
significant undesirable consequences for economic efficiency. Two
kinds of concentration should be distinguished, viz., the dominance of
universal banks over non-financial companies and concentration in the
market for financial services. The critics of universal banks blame
universal banking for fostering cartels and enhancing the power of
large non-banking firms.

 Some critics have also observed that universal banks tend to be


bureaucratic and inflexible and hence they tend to work primarily with
large established customers and ignore or discourage smaller and
newly established businesses. Universal banks could use such
practices as limit pricing or predatory pricing to prevent smaller
specialised banks from serving the market. This argument mainly
stems from the economies of scale and scope.

 Combining commercial and investment banking gives rise to conflict


of interests as universal banks may not objectively advise their clients
on optimal means of financing or they may have an interest in
securities because of underwriting activities.

 Saunders [1985] points out that conflict of interests might arise from
the following:
(a) conflict between the investment banker’s promotional role and the
commercial banker’s obligation to provide disinterested advice;

(b) Using the bank’s securities department or affiliate to issue new


securities to repay unprofitable loans;

(c) Placing unsold securities in the bank’s trust accounts;

(d) Making bank loans to support the price of a security that is


underwritten by the bank or its securities affiliate;

(e) Making imprudent loans to issuers of securities that the bank or its
securities affiliate underwrites;

(f) Direct lending by a bank to its securities affiliate; and

(g) Informational advantages regarding competitors.

 Conflict of interests was one of the major reasons for introduction of


Glass-Steagall Act. Three well-defined evils were found to flow from
the combination of investment and commercial banking as detailed
below.
(a) Banks were deploying their own assets in securities with
consequent risk to commercial and savings deposits.

(b) Unsound loans were made in order to shore up the price of


securities or the financial position of companies in which a bank
had invested its own assets.
(c) A commercial bank’s financial interest in the ownership, price, or
distribution of securities inevitably tempted bank officials to press
their banking customers into investing in securities which the bank
itself was under pressure to sell because of its own pecuniary stake
in the transaction.

The provisions of the Glass-Steagall Act were directed at these abuses. It is


argued that universal banks are more difficult to regulate because their ties
to the business world are more complex. In the case of specialised
institutions, government/supervisory agencies could effectively monitor
them because their functions are limited.

Universal Banking - Benefits arising from & Challenges Faced

Banks can very effectively exploit economies of scale and scope. In this way
they are able to reduce average costs and thereby improve spreads if it
expands its scale of operations and diversifies its activities. It entails less
cost in performing all the functions by one entity instead of separate
specialized bodies. A bank possesses information on the risk characteristics
of its clients that it can use to pursue other activities of the same client. The
bank's existing network of branches can act as shop for selling products like
insurance.

Benefits Accruing to Customers

The idea of "one-shop shopping" saves a lot of transaction cost and increases
the speed of economic activity. It is truly the retail customer who gains the
most from Universal banking. The wide range of financial products and
services offered holds a greater appeal for the customer than specialized
banks due to the comprehensive service provided by a universal bank.
Challenges in Universal Banking

There are certain challenges that need to be effectively met by the universal
banks. Such challenges need to build effective supervisory infrastructure,
volatility of prices in the stock market, comprehending the nature and
complexity of new financial instruments, complex financial structures,
determining the precise nature of risks associated with the use of particular
financial structure and transactions, increased risk resulting from
asymmetrical information sharing between banks and regulators among
others. Moreover norms stipulated by RBI treat DFIs at par with the existing
commercial banks. Thus all Universal banks have to maintain the CRR and
the SLR requirement on the same lines as the commercial banks. Also they
have to fulfill the priority sector lending norms applicable to the commercial
banks. These are the major hurdles as perceived by the institutions, as it is
very difficult to fulfill such norms without hurting the bottom-line.
INTERNATIONAL EXPERIENCE

The traditional home of universal banking is central and northern Europe, in


particular, Germany, Austria, Switzerland and Scandinavian countries.
Universal banking in countries like Germany, Austria and Switzerland
evolved in response to a combination of environmental factors besides
regulation. The direct involvement of German banks in industry through
equity holdings was the result partly of banks converting their loans into
equity stakes in companies experiencing financial pressures. A combination
of environmental factors and unique historical events enabled banks in
different European countries to establish themselves in particular segments
of the corporate financing market

While countries like Germany and Switzerland never imposed any


restriction on combining commercial and investment banking activities, the
U.S. passed the Banking Act, 1933(Glass-Steagall Act has come to mean
those sections of the Banking Act, 1933 that refer to bank’s securities
operations), whereby banks were prohibited from combining investment and
commercial banking activities. The Glass-Steagall Act was enacted to
remedy the speculative abuses that infected commercial banking prior to the
collapse of the stock market and the financial panic of 1929-33. The legal
provisions of the Banking Act, 1933 (Glass-Steagall Act) established a
distinct separation between commercial banking and investment banking and
made it almost impossible for the same organisation to combine these
activities.

The competition in the banking industry has intensified following financial


deregulation and innovations and introduction of new information
technologies. Regulators in many countries have decompartmentalised their
credit systems by extending the range of permissible activities and removing
legal and other restrictions.

The restrictions on banks engaged in securities business have been relaxed


considerably worldwide during the last two decades. Three groups of
countries can be distinguished. While countries, such as Germany, the
Netherlands, and several Nordic countries, have imposed very little
restriction on the combination of traditional banking and securities business,
Canada and most European countries have entirely removed barriers to
acquisition of securities firms and hence access to stock exchanges. Even in
the U.S., where commercial and investment banking have been legally
separated, market participants have tried to take advantage of some of the
loopholes in the Glass-Steagall Act. For example, taking advantage of
Section 20, banks have already been allowed to step into securities
underwriting through separate affiliates. In comparison with deregulation
concerning the combination of commercial and investment banking
activities, deregulation relating to combination of banking and insurance
business has been limited.

Universal banking usually takes one of three forms, i.e., in-house, through
separately capitalised subsidiaries, or through a holding company structure.
Universal banking in its fullest or purest form would allow a banking
corporation to engage ‘in-house’ in any activity associated with banking,
insurance, securities, etc. That is, these activities would be undertaken in
departments of the organisation rather than in separate subsidiaries. Three
well-known countries in which these three structures prevail are Germany,
the U.K. and the U.S. In Germany, banking and investment activities are
combined, but separate subsidiaries are required for certain other activities.
Under German banking statutes, all activities could be carried out within the
structure of the parent bank except insurance, mortgage banking, and mutual
funds, which require legally separate subsidiaries. In the U.K., broad range
of financial activities are allowed to be conducted through separate
subsidiaries of the bank. The third model, which is found in the U.S.,
generally requires a holding company structure and separately capitalised
subsidiaries. Apart from the U.S. and Japan, where the separation between
commercial banking and investment banking has been more rigid, there have
been many other countries which continue to have restrictions on combining
of commercial banking and investment activities. A synoptic view of
universal banking practices prevailing in various countries including India is
presented in Statement 1.
The following general observations can be made from Statement 1 on the
practice of Universal Banking (UB).

 First, the practice of UB varies across different countries.

 Second, for convenience, it is possible to differentiate between UB in


the narrow sense and in broader terms. The narrow definition of UB
would combine lending activities and investment in equities and
bonds/debentures. The broader definition would include all other
financial activities, especially insurance.

 Third, it is possible to envisage UB activities in-house or through


subsidiary route, or even through a combination of in-house and
subsidiary route.

 Fourth, where it is predominantly through subsidiary route, it can be


inferred that a conglomerate approach to financial services is invoked.

 Fifth, in India, the regulatory environment permits provision of a


range of financial services in-house in a bank subject to some
restrictions. Banks have the option of undertaking investment activity,
etc. through subsidiaries. DFIs have also been permitted to set up
banking subsidiaries. DFIs are also permitted to operate at the short
end of the market, by performing bank like functions, such as,
providing working capital finance or tapping deposits, subject to some
restrictions. In brief, both banks and DFIs are permitted, in a limited
way, to undertake a range of financial services, at their option, in-
house and through subsidiaries.
EMPIRICAL EVIDENCE

The empirical studies to test the existence of “economies of scale” in


universal banks do not provide any conclusive evidence. Some studies found
that the economies of scale in commercial banking were exhausted at very
low deposit levels, i.e., less than 100 million dollars in deposit [Benston,
Berger, Hanweck and Humphrey, 1983; Clark, 1988]. Noulas, Ray and
Miller [1990], in a study of North American banks, in which very small local
banks were not included, found certain economies of scale for assets
exceeding 600 million dollars. Some studies even show diseconomies
[Mester, 1992 and Saunders and Walter, 1994]. Using the historical evidence
of the 1980s, Saunders and Walter [1994] found that very large banks grew
more slowly than the smallest among the big banks in the world.

The empirical evidence of “economies of scope” is also not clear. Though


some studies suggest that economies of scope emerge with the joint use of
information technologies [e.g. Gilligen, Smirlock and Marshall, 1984], such
economies are admittedly small. It may be noted that there are also
difficulties in measuring economies of scope. One could measure economies
of scope only if the firms studied produce different kinds of output of
sufficient variety to produce measurable differences in costs. Because most
banks offer almost the same kinds and proportion of services, it is difficult,
if not impossible, to conduct meaningful empirical studies of economies of
scope [Benston, 1990].

While analysing the cost efficiency of universal banking in India, Ray


[1994] found that the Indian banks have been gradually assuming the
responsibility of developmental financing which is also cost efficient. The
study clearly reveals that the banks have been found to realize overall scale
economies if output is defined in terms of term loans, other loans and
deposits.

Furthermore, the study also indicates the presence of substantial economies


of scale with respect to the developmental banking activities and confirms
the presence of scope economies for development financing among banks.

Thus, the empirical evidence available on economies of scale and scope,


which the literature suggests, is not categorical. Historical experience as to
whether universal banks are more risky offers contradictory evidence as
detailed below:
i) In the U.S., during the banking crisis of the 1930s, universal banks that
offered commercial and investment banking services had a lower rate of
failures than the specialised banks. This was because the securities trading
business provided a significant diversification of revenues [Benston, 1990].

ii) A critical examination of the financial crisis that affected Germany and
France during the post-war period revealed that the financial crisis was not
due to the presenc of universal banks. On the contrary, because of their
diversity in their business, they could reduce the risks. Franke and Hudson
[1984], who analysed the three most serious banking crises recorded in
Germany in the 20 th century and their bearing on the universal banking
system prevailing in that country, concluded that it did not seem possible to
establish a close relationship between universal banks and financial crisis.

iii) Many banks suffered crises in several European countries during the
recession of the second half of the 1970s and the recession of the early
1990s. The banks that suffered most from these recessions and went
bankrupt were the medium and large sized universal banks and, in particular,
universal banks that had major stakes in the industrial sector [Cuervo, 1988].
Although many German financial institutions offer almost all kinds of
financial services, the universal banks do not dominate the market. The
evidence from Germany indicates that universal banking does not result in
limited sources of credit or other financial services. In Germany, both
universal banks and specialised institutions offer their services to the public.
For that matter, in no country, universal banks seem to have been able to
eliminate specialized institutions from business.

In Germany, a 1979 Banking Commission Report (Gessler Commission) did


not find universal banks exerting excessive influence. The checks and
balances implicit in market competition among 4,000 financial institutions
as well as insurance companies and other non-banks, together with German
banking and commercial law, were found to be sufficient safeguards. The
Gessler Commission, however, did find that universal banks had the
information advantage obtained by them in the course of their credit
business.

Regarding the overall efficiency of investment, Boyd, Chang and Smith


[1998] found that under universal banking a larger portion of the surplus
generated by externally financed investment accrues to banks and loss
accrues to the originating investors. This clearly can have far-reaching
implications for aggregate investment activity. They also demonstrated that
problems of moral hazard in investment would often be of greater concern
under universal banking than under commercial banking. In sum, the authors
suggested universal banking could easily have adverse consequences for the
overall efficiency of investment.

As can be seen from above, empirical evidence does not establish clearly
either overwhelming advantages or disadvantages of universal banking.

Universal Banking: Regulatory and Supervisory Challenges

Universal banking generally implies complexity of regulation and


supervision. Following deregulation, domestic financial markets become
closely inter-linked and a wide range of innovations and new products are
introduced. These together with integration with international financial
markets add one more dimension to sector activities and increase the
problems of effective control by national regulators. These developments
throw up policy challenges that are often too technical and for adequate
understanding of their implications; detailed data and information are
required. As the participants innovate newer products to circumvent the
applicable regulatory constraints, more and more complex legal and
administrative arrangements are required to be put in place for effective
response. Correspondingly, regulatory institutions also need to be equipped
with sufficient policy guidelines and resources to analyse and interpret vast
amount of data and information very quickly.

Regulatory institutions and frameworks in many countries on the other hand,


are traditionally compartmentalised and geared to overseeing specialised
financial service providers. Rapid expansion in the size and the variety of
financial activity let alone its complexity following deregulation, easily
overwhelms the resources as well as the legal framework for regulation. The
resultant lack of adequate supervision of the liberalised financial sector leads
to serious distortions and malfunctioning.

A notable development in the 1980s and 1990s is the emergence of financial


conglomerates providing a large range of financial services in various
locations and this also includes banking, non-banking financial services,
insurance, securities, asset management, advisory services, etc.
Consequently, the job of the regulators becomes difficult because failure in
any particular segment could easily spread to other parts and finally this
could become systemic. The level of preparation of the regulatory
mechanism to meet such contingencies also becomes challenging. In
countries like Britain, efforts have already been made to move towards a
unified regulatory authority for financial regulation with the responsibility
for bank supervision, securities market, investments and insurance
regulation. With further financial liberalisation reforms, the expectations of
depositors and investors also increase. The experience to a greater extent
suggests that with a view to minimising the contagion, it becomes
imperative that the regulators adopt conglomerate approach to financial
institutions.

Another important consideration that advocates caution in moving to


universal banking relates to the possible impact of “non-core” banking
activities on “core” banking activities. The “core” banking activities
comprise accepting unsecured deposits from public and providing payment
services as an integral part of the payment system in the economy. The
central bank’s obligation to act as the ‘lender of the last resort’ and maintain
safety net to support banks in times of trouble follows from this relationship.
Mixing of financial services and other banking activities with the “core”
banking activities may result in substantial increase in the burden on the
central bank on two counts. It might create expectation among public as well
as investors that central bank’s safety net may be extended to all the
activities of a bank in times of need. This would place far too much demand
on the central bank’s resources, besides aggravating the problem of ‘moral
hazard’. Second, commercial bank’s ability to fulfill its obligation in respect
of its non-core activity (say, mutual fund) might affect depositors’
confidence in the bank, causing a run on the bank with possible adverse
effects on the entire banking sector.
It is to maintain a distinction between the “core” and “non-core” banking
activities that many authorities insist on a formal separation by requiring the
two sets of activities to be carried out under separately capitalised subsidiary
of a holding company. However, recent experience in the U.K. and the U.S.
casts doubts on the efficacy of ‘firewalls’ due to market perceptions as well
as interdependencies between the two sets of activities when undertaken too
closely together within a group structure. Historically, banks have been
considered ‘special’ for various reasons. In the evolution of financial sector
in any type of economy, viz., industrial, developing and transition, banks are
the first set of institutions to develop, followed by others, viz., investment
banks, security houses, capital markets, insurance companies, etc. Hence due
to their age, they are considered as a vital segment. Secondly, they mobilise
deposits and hence are a major contributor in enhancing financial savings of
the economy. In this context, the vast area of network they have, no doubt,
helps them to mobilise savings not only from the urban centres, but also
from the remote corners of the country. Thirdly, they assume an important
position in the payment and settlement mechanism. In recent years, it has
been the common practice to measure the strength of the economy by the
effectiveness of payment and settlement mechanism. Hence the soundness of
banks is continuously evaluated and remedial policies are put in place once
any kind of weakness is identified. Even the IMF, World Bank and other
international organisations give importance for banking soundness due to
banks’ effective role in the payment and settlement system. Fourthly, banks
are the principal source of non-market finance to various segments of the
economy.

The experience the world over shows that major banks everywhere have
increasingly diversified the products and services they offer, such as,
investment banking, life insurance, etc., either in-house or through separate
subsidiaries. However, even these developments have not fundamentally
altered the special characteristics of banks. On the liability side, although
some close substitutes for deposits, such as, money market mutual funds
have taken place which have eroded banks’ market share as a repository for
liquid asset holdings, such erosion has generally been very small and bank
deposits still constitute a single largest source of liquid asset holdings. Even
though in recent years some new facilities have been developed for making
payments, such as, debit cards or credit cards, most transactions are still
settled through banks. On the asset side, there is some evidence of a gradual
erosion of the role of banks in financial intermediation. For instance, in the
U.K., bank lending to the corporate sector declined from 27 per cent of total
corporate borrowing outstanding in 1985 to less than 17 per cent recently,
due mainly to larger corporate borrowers accessing domestic and
international capital markets directly. Small corporates, on the other hand,
continue to remain heavily dependent upon bank finance.

Thus, while there certainly have been important changes affecting banks and
the environment in which they work, they have not yet been such as to
substantially alter their key functions or the importance of those functions to
the economy; nor have they altered fundamentally the distinctive
characteristics of either the banks’ liabilities or their assets. In some respects,
they may be less special than they were; they remain special nonetheless.
They continue to remain special in terms of the particular characteristics of
their balance sheets, which are necessary to perform those functions [Eddie
George, 1997].

If banks continue to remain special for systemic reasons, they are more so in
developing countries, due to a number of factors. Banks in India have
extensive branch network; they are the single largest source of domestic
savings, and the main source of finance for small-scale, agriculture, trade,
especially the foodgrains, exports and other priority sectors. This dominant
position is likely to continue in the medium to long-term requiring distinct
treatment in terms of regulatory and supervisory framework.

Universal Banking: Evolving Process and Contextual

Notwithstanding the foregoing, experience in Germany and Switzerland


seems to assure that universal banking is not incompatible with the
maintenance of the safety of financial system or with protecting the central
bank against excessive demands as the lender of last resort. The answer lies
perhaps in that, in these countries, universal banking evolved gradually over
a long period of time, giving time for appropriate institutions, practices,
experience, and conventions to be developed, and a body of formal as well
as non-formal guidelines for regulatory purposes to be established. The stage
of development of the financial markets also presents an important issue in
considering the pace of financial deregulation and movement towards
universal banking.

To realise efficiency gains from universal banking, ideally financial markets


need to operate in a relatively competitive environment.
Universal banking can exist in different organisational settings, under
varying regulatory regimes, and with varying degrees of specialisation or
universalisation of financial services, especially commercial and investment
banking, by the participants concerned. Finally, the practice is both evolving
and contextual – especially in the country context. The focus for policy
purpose, therefore, has to be on the country practices and institutional
structure as well.

UNIVERSAL BANKING IN INDIA

In the early Nineties the forces of globalisation were unleashed on the


hitherto protected Indian environment. The financial sector was crying out
for reform. Public sector banks, which had a useful role to play earlier on,
now faced deteriorating performance. For these and certain other reasons
private banking was sought to be encouraged in line with the Narasimham
Committee's recommendations.

It would be pertinent to recapitulate the prevailing conditions in the banking


industry in the early Nineties: the nationalised sector had outlived its utility;
in fact they became burdened with unwelcome legacies; customer service
had become a casualty; need for computerisation, including networking
among the vast branch network was felt. Private banking in that context was
viewed a brand new approach, to bypass the structural and other
shortcomings of the public sector. A few of the new ones that were
promoted by the institutions such as the IDBI and ICICI did establish
themselves, though in varying degrees, surviving the market upheavals of
the 1990.That was possible apart from other factors due to the highly
professional approach some of them adopted: it helped them stay clear of the
pitfalls of nationalised banking. Yet in less than a decade after the advent of
these new generation banks, some of the successful ones are being forced to
change organisationally and in every other way. Who benefits after this
restructuring is something that has to be asked.

It is essential to assimilate history of banking as well as the role of the


financial institutions till recently. The branch-banking concept with which
we are familiar and practised since inception is basically on certain
`protected' fundamentals. The insulated economy till the Nineties provided
comforts to public sector banks, in areas of liquidity management while in
an administered interest regime, discretion of managements was limited and
consequently, the risk parameters in these spheres were hazy and not
quantifiable. The share of private sector banks which is distinctly known as
old private sector banks' established before 1994, was thus not substantial
while operations of foreign banks were also restricted. Staff orientation
especially at the branch level is a key ingredient for success and neither the
older private banks nor the nationalised banks were successful in that
respect.
The woes of the public sector banks till date relate to handling volumes, be it
in the area of transactions or staff complement or branch offices. Post
nationalisation, mass banking sans commercial or professional goals,
indiscreet branch expansion, lack of networking, wide gaps/inefficiency at
the levels of control apart from environmental impacts, contributed to their
present status.

Turning to recent merger announcement between the ICICI and its more
recently promoted banking subsidiary the following become relevant. One of
the main motivations has been the need to access a low cost retail deposit
base. Public sector banks, by way of contrast never had to face such a
constraint.

Today, in a market driven economy, to face the competition, one factor is


the size and hence, mergers are advocated. Talking of the PSBs it is relevant
to note that except for a build up of savings accounts (as low cost deposits),
the advantage of vast branch network is yet to be exploited by them while on
the other hand, most of the complaints, irregularities, mounting arrears in
reconciliation are attributable to such branch expansion.

At the same time, this has enabled a few of the smart foreign/new private
sector banks to enrich them by offering cash management products, utilising
the same branch network! These entire pose a question to the recent merger
of Bank of Madura - will the ICICI Bank decide to shed unwanted,
unremunerative branches? Pertinently for all banks the RBI has already
provided an exit route but there have been no takers among the public sector
banks, for obvious reasons.

Pertinent again is to note that another set of banks, namely, foreign banks
prospered during all these difficult days. Even today, these banks do not
have branch network to speak of but in terms of volume, profitability they
are far ahead of the public sector banks. Only a couple of new private sector
banks have posed any challenge to them in the recent years.

Development financial institutions (DFIs) and refinancing institutions (RFIs)


were meeting specific sectoral needs and also providing long-term resources
at concessional terms, while the commercial banks in general, by and large,
confined themselves to the core banking functions of accepting deposits and
providing working capital finance to industry, trade and agriculture.
Consequent to the liberalisation and deregulation of financial sector, there
has been blurring of distinction between the commercial banking and
investment banking.

Indian Banks pursuant to the nationalisation and state ownership of the main
players took upon themselves the role of developoment bankers and
diversified thier credit dispensations. Term Lending and credit delivery
against hypothecaton of assets, which were unheard of earlier, came to be
accepted as a common measure of credit policy. All sectors of Indian
economy were brought under purview of banks' financial support. A group
of banks joined together as a consortium and diversified risk in financing
bulk ventures sharing portions both amonst themselves and also along with
the Term Lending Institutions. The entry of banks into the realm of financial
services was to follow very soon. The first impulses for a more diversified
financial intermediation were witnessed in the late 1980s and early 1990s
when banks were allowed to undertake leasing, investment banking, mutual
funds, factoring, hire-purchase activities through separate subsidiaries. By
the mid-1990s, all restrictions on project financing were removed and banks
were allowed to undertake several activities in-house. Reforms in the
Insurance Sector in the late Nineties and opening up of this field to private
and foreign players, also resulted in permitting banks to undertake sale of
insurance products. At present, only an 'arms-length' relationship between a
bank and an insurance entity has been allowed by the regulatory authority,
i.e. the Insurance Regulatory and Development Authority (Irda). Which
means that commercial banks can enter insurance business either by acting
as agents or by setting up joint ventures with insurance companies. And the
RBI allows banks to only marginally invest in equity (5 per cent of their
outstanding credit).

The phenomenon of universal banking as a distinct concept, as different


from narrow banking, came to the fore-front in the Indian context with the
second Narasimham Committee (1998) and later the Khan Committee
(1998) reports recommending consolidation of the banking industry through
mergers and integration of financial activities.

At this point it became relevant to consider opening Development finance


Institutions to avail the options to involve in deposit banking and short-term
lending as well. DFIs were set up with the objective of taking care of the
investment needs of industries. They have, over time, built up expertise in
merchant banking and project evaluation. Yet they have also backed bad
investments and, as a result, become equity holders in defaulting enterprises
through conversion of loans into equity. They also extend soft loans by way
of equity contribution to medium and large industries. DFIs have developed
core competence in investment banking. They take a lot of risks to prop up
industries. They finance industries such as infrastructure industries, which
have long gestation periods and have contributed significantly to the
country's industrialisation process.

However the access of Developmental Finance Institutions to low cost funds


has been denied. Saddled with obligations to fund long gestation projects,
the DFIs have been burdoned with serious mismatches between their assets
and liabilities side of the balance sheets. Their traditional lending to
industries such as textiles and iron and steel has caused them serious
problems at a time when the method of classifying balance-sheets has
become more transparent. The Narasimham Committee (II) had suggested
that DFIs should convert into banks or non-banking finance companies.
Some of the issues addressed in the transition path relate to compliance with
cash reserve ratio and statutory liquidity ratio requirements, disposal of non-
banking assets, composition of the board, prohibition on floating charge of
assets, restrictions on investments, connected lending and banking license.
Converting into UBs will grant them ready access to cheap retail deposits
and increase the coverage of the advances to include short-term working
capital loans to corporates with greater operational flexibility. The
institutions can then effectively compete with the commercial banks. They
will be able to attract more volumes because they meet most of the needs of
their customers under one roof.

Reserve Bank of India constituted on December 8, 1997, a Working Group


under the Chairmanship of Shri S.H. Khan to bring about greater clarity in
the respective roles of banks and financial institutions for greater
harmonisation of facilities and obligations . Also report of the Committee on
Banking Sector Reforms or Narasimham Committee (NC) has major bearing
on the issues considered by the Khan Working Group.

The Commitee submitted comprehensive recommendations of which one


was about Universal Banking. The working group made a strong pitch for
"eventually" giving full banking licenses to the development financial
institutions (DFIs) and called for mergers between strong banks and
institutions. Till the time the DFIs are given full banking licenses, they
should be permitted to have wholly-owned banking subsidiaries."Size,
expertise and reach are now deemed crucial to sustained viability and future
survival in the financial sector," the report says, and recommends that
managements and shareholders of banks and DFIs be allowed to explore the
possibility of gainful mergers not only of banks but also of banks and DFIs.

The issue of universal banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank. Reserve Bank of India also spelt
out to Parliamentary Standing Committee on Finance, its proposed policy
for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. FIs need to formulate a road map for
the transition path and strategy for smooth conversion into an universal bank
over a specified time frame. A universal bank can be a single company, a
holding company with wholly owned subsidiaries, a group of entities with
cross-holdings or even a flagship company which may or may not have
independent shareholders. The panel has argued that the regulator should not
impose the appropriate corporate structure. Calling for an enabling
regulatory framework to ensure the transition towards universal banking, the
panel said a function-specific and institution-neutral regulatory framework
must be developed. "This concept of neutrality should be applicable to both
foreign and local entities," it said.

Recent Developments & Crystalisation of RBI's Policy

"The issue of universal banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank. Reserve Bank of India also spelt
out to Parliamentary Standing Committee on Finance, its proposed policy
for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

"Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. FIs need to formulate a road map for
the transition path and strategy for smooth conversion into a universal bank
over a specified time frame. The plan should specifically provide for full
compliance with prudential norms as applicable to banks over the proposed
period."

The Approach of RBI

"... The RBI released a 'Discussion Paper' (DP) in January 1999 for wider
public debate. The feedback on the discussion paper indicated that while the
universal banking is desirable from the point of view of efficiency of
resource use, there is need for caution in moving towards such a system by
banks and DFIs. Major areas requiring attention are the status of financial
sector reforms, the state of preparedness of the concerned institutions, the
evolution of the regulatory regime and above all a viable transition path for
institutions, which are desirous of moving in the direction of universal
banking. It is proposed to adopt the following broad approach for
considering proposals in this area:

 "Though the DFIs would continue to have a special role in the Indian
financial System, until the debt market demonstrates substantial
improvements in terms of liquidity and depth, any DFI, which wishes
to do so, should have the option to transform into bank (which it can
exercise), provided the prudential norms as applicable to banks are
fully satisfied. To this end, a DFI would need to prepare a transition
path in order to fully comply with the regulatory requirement of a
bank. The DFI concerned may consult RBI for such transition
arrangements. Reserve Bank will consider such requests on a case-by-
case basis.

 "The regulatory framework of RBI in respect of DFIs would need to


be strengthened if they are given greater access to short-term
resources for meeting their financing requirements, which is
necessary.
 "In due course, and in the light of evolution of the financial system,
Narasimham Committee's recommendation that, ultimately there
should be only banks and restructured NBFCs can be
operationalised."

 "Accordingly, the mid-term review of monetary and credit policy,


October 1999 and the annual policy statements of April 2000 and
April 2001 enunciated the broad approach to universal banking and
the Reserve Bank's circular of April 2001 set out the operational and
regulatory aspects of conversion of DFIs into universal banks. The
need to proceed with planning and foresight is necessary for several
reasons. The move towards universal banking would not provide a
panacea for the endemic weaknesses of a DFI or its liquidity and
solvency problems and/or operational difficulties arising from
undercapitalisation, non-performing assets, and asset liability
mismatches, etc. The overriding consideration should be the
objectives and strategic interests of the financial institution concerned
in the context of meeting the varied needs of customers, subject to
normal prudential norms applicable to banks. From the point of view
of the regulatory framework, the movement towards universal
banking should entrench stability of the financial system, preserve the
safety of public deposits, improve efficiency in financial
intermediation, ensure healthy competition, and impart transparent
and equitable regulation."

KHAN WORKING GROUP

In the light of a number of reform measures adopted in the Indian financial


system since 1991, and keeping in view the need for evolving an efficient
and competitive financial system, the Reserve Bank constituted on
December 8, 1997, a Working Group under the Chairmanship of the then
Chairman and Managing Director of Industrial Development Bank of India,
Shri S. H. Khan, with the following terms of reference:

 To review the role, structure and operations of Development Financial


Institutions (DFIs) and commercial banks in emerging operating
environment and suggest changes;
 To suggest measures for bringing about harmonization in the lending
and working capital finance by banks and DFIs;

 To examine whether DFIs could be given increased access to short-


term funds and the regulatory framework needed for the purpose;

 To suggest measures for strengthening of organisation, human


resources, risk management practices and other related issues in DFIs
and commercial banks in the wake of Capital Account Convertibility;

 To make such other recommendations as the Working Group may


deem appropriate to the subject.

The Working Group submitted its interim Report in April and final Report in
May 1998. In the Monetary and Credit Policy announced in April 1998, it
was indicated that a ‘Discussion Paper’ would be prepared which will
contain Reserve Bank’s draft proposals for bringing about greater clarity in
the respective roles of banks and financial institutions for greater
harmonisation of facilities and obligations applicable to them. It was also
mentioned that the Paper would also take into account those
recommendations of the Committee on Banking Sector Reforms (Chairman:
Shri M. Narasimham) which have a bearing on the issues considered by the
Khan Working Group (KWG).

The thrust of the KWG was on a progressive move towards universal


banking and the development of an enabling regulatory framework for this
purpose. In the interim, the Group recommended that DFIs might be
permitted to have a banking subsidiary (with holdings up to 100 per cent).
Among the changes in regulatory practices, the focus of the KWG was on
the function-specific regulatory framework that targets activities and is
institution-neutral. Keeping in view the increasing overlap in functions being
performed by various participants in the financial system, the KWG
recommended the establishment of a ‘super regulator’ to supervise and co-
ordinate the activities of the multiple regulators. With regard to supervisory
practices, it was recommended that the supervisory authority should
undertake primarily off-site supervision and that DFIs/banks should be
supervised on a consolidated basis, covering both domestic and global
activities. For meaningful consolidated supervision, the KWG recommended
the development of a ‘risk-based supervisory framework’.

The KWG also made a number of recommendations relating to statutory


obligations of banks. These, inter-alia, included progressive reduction in
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) to
international levels. It recommended an alternative mechanism for
permitting credit to the priority sector and in the interim; the infrastructure
lending should not be included in the definition of the ‘net bank credit’ used
in computing the priority sector obligations. For harmonising the role,
operations and regulatory framework of DFIs and banks, the thrust of the
recommendations was on removal of ceiling for DFIs’ mobilisation of short
to medium term resources by way of term deposits, CDs, borrowings from
the term money market and inter-corporate deposits with a suitable level of
SLR on such borrowings on an incremental basis. Other important
recommendations were: to exclude investments made by banks in SLR
securities issued by a DFI while calculating the exposures and DFIs should
be granted full Authorised Dealer’s licence. With regard to State level
institutions, the KWG recommended immediate corporatisation to improve
their competitive efficiency, to encourage strong State Financial
Corporations (SFCs) to go public by making Initial Public Offer (IPO), to
transfer the present shareholding of IDBI in the State level institutions to
Small Industries Development Bank of India (SIDBI) and transfer of
ownership of SIDBI from IDBI to the Reserve Bank of India
(RBI)/Government.

The Second Narasimham Committee observed that, for the same market
reasons as have influenced the growth of universal banking elsewhere, a
similar trend is visible in India too. It recommended that if FIs engage
themselves in commercial bank like activities, they should be subject to the
same discipline regarding reserve and liquidity requirements as well as
capital adequacy and prudential norms. It, however, recommended phasing
out of reserve requirements and suggested a formula for directed credit in
case FIs become banks. It felt that DFIs, over a period of time, should
convert themselves into banks in which case there would only be two forms
of intermediaries, viz., banking companies and non-banking finance
companies (NBFCs). And if a DFI does not become a bank, it would be
categorised as a non-banking finance company. It emphasised the mergers
between strong banks/FIs as they would make for greater economic and
commercial sense. It recommended that IDBI should be corporatised and
converted into a joint stock company under the Companies Act. For
providing focused attention to the work of SFCs, IDBI shareholding in them
should be transferred to SIDBI. It recommended that SIDBI should be
delinked from IDBI. It recommended that supervisory function of National
Bank for Agricultural and Rural Development (NABARD) relating to rural
financial institutions should vest with the Board for Financial Regulation
and Supervision (BFRS). For effective supervision, it underlined the need
for formal accession to ‘core principles’ announced by the Basle Committee
in September 1997. It recommended an integrated system of regulation and
supervision to regulate the activities of banks, financial institutions and non-
banking finance companies. The Committee emphasised the importance of
having in place dedicated and effective machinery for debt recovery for
banks and financial institutions. It underlined the need for clarity in the law
regarding the evidentiary value of computer-generated documents. It also
emphasised that with electronic funds transfer several issues regarding
authentication of payments, etc. required to be clarified.

MAJOR RECOMMENDATIONS OF KHAN WORKING GROUP

The main recommendations of the Khan Working Group are set out below:

A. CHANGES IN ROLE, STRUCTURE AND OPERATIONS

 A progressive move towards universal banking and the


development of an enabling regulatory framework for the purpose.

 A full banking licence is eventually granted to DFIs. In the interim,


DFIs may be permitted to have a banking subsidiary (with holdings
up to 100 per cent), while the DFIs themselves may continue to
play their existing role.

 The appropriate corporate structure of universal banking should be


an internal management/shareholder decision and should not be
imposed by the regulator.

 Management and shareholders of banks and DFIs should be


permitted to explore and enter into gainful mergers.
 The RBI/Government should provide an appropriate level of
financial support in case DFIs are required to assume any
developmental obligations.

B. CHANGES IN REGULATORY AND LEGAL FRAMEWORK

 A function-specific regulatory framework must develop that


targets activities and is institution-neutral with regard to the
regulatory treatment of identical services rendered by any
participant in the financial system.
 The establishment of a ‘super-regulator’ to supervise and co-
ordinate the activities of multiple regulators in order to ensure
uniformity in regulatory treatment.

 A speedy implementation of legal reforms in the debt recovery


areas of banks and financial institutions should be given top
priority. A thorough revamp of the 1993 Act on Recovery of Debt
from Banks and DFIs.

 There is a need to redraft other codified laws impacting operations


of DFIs/banks. v) For effective computerisation, amendments to
the Banking Companies (Period of Preservation of Records) Rules,
1985 and other suitable enactments on the lines of Electronic Fund
Transfer Act in USA be examined for implementation.

C. CHANGES IN SUPERVISORY PRACTICES

 The supervisory authority should undertake primarily off-site


supervision based on periodic reporting by the banks or DFIs as
the case may be. On-site supervision should be undertaken only in
exceptional cases.

 DFIs/banks should be supervised on a consolidated basis. Future


accounting standards must consequently include rules on
consolidated supervision for financial subsidiaries and
conglomerates. Further, as domestic financial activities assume an
international character, banking supervisors should adopt global
consolidated supervision.
 A “risk-based supervisory framework” along the lines of the
Report of the Task Force on Conglomerate Supervision, published
by the Institute of International Finance, in February 1997 may be
adopted.

D. STATUTORY OBLIGATIONS

 The application of CRR should be confined to cash and cash-like


instruments. CRR should be brought down progressively within a
time-bound frame to international levels.
 It may be useful to consider phasing out SLR in line with
international practice.

 Rather than imposing the priority sector obligation on the entire


banking system, there is a need for an alternate mechanism to be
developed for financing these sectors. Such a mechanism will aim
to balance the need for funds with the need to bring better-suited
structures and specialised skills to bear in dealing with the sectors.
The concessional funding for certain sectors can be provided by
specifically targeted subsidies to that sector.

 In the interim, the following modifications may be done in priority


sector lending:

(a) infrastructure lending should be excluded from the definition of


‘net bank credit’ used in computing the priority sector
obligations,

(b) to facilitate efficient loan disbursals, the priority sector


obligation should be linked to the net bank credit at the end of
the previous financial year, and

(c) the definition of the priority sector may be widened to enable


the inclusion of the whole industry/class of activities.

E. RE-ORGANISATION OF STATE-LEVEL INSTITUTIONS (SLIs)

 While the consolidation of SLIs should form part of the short-term


agenda of the financial sector reforms; an immediate term
imperative is the corporatisation of these entities to improve their
competitive efficiency.

 Following restructuring/re-organisation, strong SFCs could be


encouraged to go public by making IPOs.

 It would be desirable to transfer the present shareholding of IDBI


in these SLIs to SIDBI.

 Ownership in SIDBI should, as a logical corollary, stand


transferred to RBI/Government on the same lines as NABARD.
 SIDBI’s role in State Level Institutions should be both as stake
holder as well as resource provider. For this purpose, SIDBI should
have access to assured sources of concessional funding from RBI.

 SLIs should be brought under the supervisory ambit of RBI.

F. HARMONISING THE ROLE, OPERATIONS AND


REGULATORY FRAMEWORK OF DFIs AND BANKS

 A Standing (Co-ordination) Committee be set up on which Banks


and DFIs would be represented.

 The extant overall ceiling for DFIs’ mobilisation of resources by


way of term money/bonds (having maturities of 3-6 months),
Certificates of Deposits (maturities of 1-3 years), Term Deposits
(fixed deposits from the public with maturity of 1-5 years) and
inter-corporate deposits at 100 per cent of net owned funds (NOF)
of DFIs may be removed. A suitable level of SLR may be
stipulated for DFIs on incremental outstanding fixed deposits
raised from the public (excluding inter-bank deposits).

 The restrictions stipulated by the RBI, whereby bond issues by


DFIs with either a maturity of less than 5 years or maturity of 5
years and above but with interest rate not exceeding 200 bps over
the yield on Government of India securities of equal residual
maturity require prior approval should be withdrawn.
 CRR should not be applicable to DFIs under the present structure,
where they are not permitted to access cash and cash-like
instruments.

 A uniform risk weightage of 20 per cent may be assigned for


investment made by commercial banks in bonds of “AAA” rated
DFIs.

 Banks is permitted to exclude investments in SLR securities issued


by a DFI while calculating the exposure to that DFI.

 The DFIs should be granted full Authorised Dealer’s licence.

G. ORGANISATION REDESIGN

 Best practices in the area of corporate governance such as


imparting full operational autonomy and flexibility to
managements and Boards of Banks and DFIs should be
implemented.

 A complete redesign of the business system of banks/DFIs, with


the Top Management spelling out the strategic objectives for
principal stakeholders (clients, employees, shareholders, etc.), a
proactive relationship-based approach in corporate culture, a
consensus-driven committee-based approach for loan sanctions and
decisions on organisation structure based purely on commercial
judgement.

H. RISK MANAGEMENT

 There should be a clear strategy approved by the Board of


Directors as to their risk management policies and procedures.

 An Integrated Treasury and a proactive Asset-Liability


Management (ALM), including both on-and off-balance sheet
items.

 Robust internal operational controls, including audit must be in


place.
I. INFORMATION TECHNOLOGY AND MIS

 Existing laws may not be adequate or have the clarity to deal with
some of the key issues that are likely to emerge following
introduction of computerisation and technologically advanced
communications in banking. There is compelling logic to revisit
the legal framework in information technology area and render it
compatible with the requirements of a technology-driven banking
environment.

 DFIs/banks should urgently establish, create employee/customer


awareness and familiarity with e-mail, Internet and Intranet
Banking, Smart Cards and Electronic Data Interchange (EDI) in a
strategically sequenced fashion.

 A perspective plan/blue print for automation of financial sector


be prepared.

J. HUMAN RESOURCE DEVELOPMENT

 Prescient management and leadership with accent on teamwork.

 Broad-based recruitments, both at entry level from campus as


well as lateral entry of professionals at higher levels to fill skill
gaps in critical areas.

 Systematic training programmes.

 Skill building and upgradation.

 Market-related compensation packages.

 Viable and enforceable exit option for employees.

 A Special Vigilance Machinery exclusively for the financial


sector on the lines of Serious Fraud Office (SFO) of the U.K may
be set up.
NARASIMHAM COMMITTEE

To review the progress of banking sector reforms so far and to suggest


second stage of reforms, The committee on banking sector reforms was set
up in December '97 under the chairmanship of Narsimham. Apart from
reviewing the banking sector reforms, the committee was required to suggest
remedial measures to strengthen the banking system, covering areas such as
banking policy, institutional structure, supervisory system, legislative and
technological changes. Some of the recommendations made are as follows.
The recommendations have been accepted and were announced as part of
mid-term credit policy for 1998-99. RBI has given guidelines to implement
the recommendations.

MAJOR RECOMMENDATIONS OF THE COMMITTEE ON


BANKING SECTOR REFORMS (NARASIMHAM COMMITTEE-II)

The main recommendations of the Narasimham Committee-II insofar as they


relate to DFIs are set out below.

 With convergence of activities between banks and DFIs, the DFIs


should over a period of time, convert themselves into banks. There
would then be only two form of intermediaries, viz., banking
companies and non-banking finance companies. If a DFI does not
acquire a banking licence within a stipulated time, it would be
categorised as a non-banking finance company.
 A DFI which converts into a bank can be given some time to phase in
reserve requirements in respect of its liabilities to bring it on par with
the requirements relating to commercial banks. Similarly, as long as a
system of directed credit is in vogue a formula should be worked out
to extend this to DFIs which have become banks.

 Mergers between banks and DFIs and NBFCs need to be based on


synergies and locational and business specific complementarities of
the concerned institutions and must obviously make sound
commercial sense. Merger between strong banks/FIs would make for
greater economic and commercial sense and would be a case where
the whole is greater than the sum of its parts and have a “force
multiplier effect”.

 To provide the much-needed flexibility in its operations, IDBI should


be corporatised and converted into a Joint Stock Company under the
Companies Act on the lines of ICICI, IFCI and IIBI. For providing
focused attention to the work of State Financial Corporations, IDBI
shareholding in them should be transferred to SIDBI which is
currently providing refinance assistance to State Financial
Corporations. To give it greater operational autonomy, SIDBI should
also be de-linked from IDBI.

 The supervisory function over rural financial institutions has been


entrusted to NABARD. While this arrangement may continue for the
present, over the longer-term, the Committee would suggest that all
regulatory and supervisory functions over rural credit institutions
should vest with the Board for Financial Regulation and Supervision
(BFRS).

 For effective supervision, there is a need for formal accession to ‘core


principles’ announced by the Basle Committee in September 1997.

 An integrated system of regulation and supervision be put in place to


regulate and supervise the activities of banks, financial institutions
and non-bank finance companies (NBFCs) and the agency (Board for
Financial Supervision) be renamed as the Board for Financial
Regulation and Supervision (BFRS).
 To have in place a dedicated and effective machinery for debt
recovery for banks and financial institutions.

 With the advent of computerisation, there is a need for clarity in the


law regarding the evidentiary value of computer-generated
documents. Also, issues regarding authentication of payment
instruments, etc. require to be clarified. A group should be constituted
by the Reserve Bank to work out the detailed proposals in this regard
and implement them in a time-bound manner.

RBI GUIDELINES FOR EXISTING BANKS/FIS FOR CONVERSION


INTO UNIVERSAL BANKS

Salient operational and regulatory issues to be addressed by the FIs for


conversion into a Universal Bank

Reserve requirements

Compliance with the cash reserve ratio and statutory liquidity ratio
requirements (under Section 42 of RBI Act, 1934, and Section 24 of the
Banking Regulation Act, 1949, respectively) would be mandatory for an FI
after its conversion into a universal bank

Permissible activities

Any activity of an FI currently undertaken but not permissible for a bank


under Section 6(1) of the B. R. Act, 1949, may have to be stopped or
divested after its conversion into a universal bank.

Disposal of non-banking assets

Any immovable property, howsoever acquired by an FI, would, after its


conversion into a universal bank, be required to be disposed of within the
maximum period of 7 years from the date of acquisition, in terms of Section
9 of the B. R. Act.
Composition of the Board

Changing the composition of the Board of Directors might become


necessary for some of the FIs after their conversion into a universal bank, to
ensure compliance with the provisions of Section 10(A) of the B. R. Act,
which requires at least 51% of the total number of directors to have special
knowledge and experience.

Prohibition on floating charge of assets

The floating charge, if created by an FI, over its assets, would require, after
its conversion into a universal bank, ratification by the Reserve Bank of
India under Section 14(A) of the B. R. Act, since a banking company is not
allowed to create a floating charge on the undertaking or any property of the
company unless duly certified by RBI as required under the Section.
Nature of subsidiaries If any of the existing subsidiaries of an FI is engaged
in an activity not permitted under Section 6(1) of the B R Act , then on
conversion of the FI into a universal bank, delinking of such subsidiary /
activity from the operations of the universal bank would become necessary
since Section 19 of the Act permits a bank to have subsidiaries only for one
or more of the activities permitted under Section 6(1) of B. R. Act.

Restriction on investments

An FI with equity investment in companies in excess of 30 per cent of the


paid up share capital of that company or 30 per cent of its own paid-up share
capital and reserves, whichever is less, on its conversion into a universal
bank, would need to divest such excess holdings to secure compliance with
the provisions of Section 19(2) of the B. R. Act, which prohibits a bank from
holding shares in a company in excess of these limits.

Connected lending

Section 20 of the B. R. Act prohibits grant of loans and advances by a bank


on security of its own shares or grant of loans or advances on behalf of any
of its directors or to any firm in which its director/manager or employee or
guarantor is interested. The compliance with these provisions would be
mandatory after conversion of an FI to a universal bank Licensing
An FI converting into a universal bank would be required to obtain a
banking licence from RBI under Section 22 of the B. R. Act, for carrying on
banking business in India, after complying with the applicable conditions.

Branch network

An FI, after its conversion into a bank, would also be required to comply
with extant branch licensing policy of RBI under which the new banks are
required to allot at east 25 per cent of their total number of branches in semi-
urban and rural areas.

Assets in India

An FI after its conversion into a universal bank, will be required to ensure


that at the close of business on the last Friday of every quarter, its total
assets held in India are not less than 75 per cent of its total demand and time
liabilities in India, as required of a bank under Section 25 of the B R Act.

Format of annual reports

After converting into a universal bank, an FI will be required to publish its


annual balance sheet and profit and loss account in the in the forms set out in
the Third Schedule to the B R Act, as prescribed for a banking company
under Section 29 and Section 30 of the B. R. Act .

Managerial remuneration of the Chief Executive Officers

On conversion into a universal bank, the appointment and remuneration of


the existing Chief Executive Officers may have to be reviewed with the
approval of RBI in terms of the provisions of Section 35 B of the B. R. Act.
The Section stipulates fixation of remuneration of the Chairman and
Managing Director of a bank by Reserve Bank of India taking into account
the profitability, net NPAs and other financial parameters. Under the
Section, prior approval of RBI would also be required for appointment of
Chairman and Managing Director.

Deposit insurance

An FI, on conversion into a universal bank, would also be required to


comply with the requirement of compulsory deposit insurance from DICGC
up to a maximum of Rs.1 lakh per account, as applicable to the banks.
Authorised Dealer's Licence

Some of the FIs at present hold restricted AD licence from RBI, Exchange
Control Department to enable them to undertake transactions necessary for
or incidental to their prescribed functions. On conversion into a universal
bank, the new bank would normally be eligible for fulfledged authorised
dealer licence and would also attract the full rigour of the Exchange Control
Regulations applicable to the banks at present, including prohibition on
raising resources through external commercial borrowings.

Priority sector lending

On conversion of an FI to a universal bank, the obligation for lending to


"priority sector" up to a prescribed percentage of their 'net bank credit'
would also become applicable to it.

Prudential norms

After conversion of an FI in to a bank, the extant prudential norms of RBI


for the all-India financial institutions would no longer be applicable but the
norms as applicable to banks would be attracted and will need to be fully
complied with. (This list of regulatory and operational issues is only
illustrative and not exhaustive)

 Income recognition - Prior to the introduction of prudential norms,


banks used to book interest income on loans, which were bad or not
performing. Thus banks used to carry a huge amount of loans on
which they never received interest or principal. To bring sound
accounting policies to match international standards banks were
hitherto allowed to book income only on performing assets.

 Asset classification - Loans or advances or credit represent a major


asset for banks. To be able to distinguish the quality of loans given by
banks and to make adequate provisioning, it was necessary to classify
the advances depending upon whether they were performing or not.
The following rules were introduced.
 Standard assets - These are performing assets i.e. the interest and
principal repayments on these loans are not outstanding for more than
two quarters.

 Sub-standard assets - These are non-performing assets for a period


not exceeding two years i.e. the interest and principal repayments are
outstanding for more than two quarters. The condition of period for
which interest or principal remains outstanding, was made applicable
in a phased manner i.e. when the norms were first introduced the
condition was outstanding for four quarters later on it was made three
quarters and now stands at two quarters.

 Doubtful assets - These are assets, which have remained non-


performing for more than two years.

 Loss assets - These are the assets which are non-performing for more
than three years or where the loss has been proved
ICICI-UNIVERSAL BANKING MODEL

History of ICICI
1955: The Industrial Credit and Investment Corporation of India Limited
(ICICI) incorporated at the initiative of the World Bank, the
Government of India and representatives of Indian industry, with the
objective of creating a development financial institution for
providing medium-term and long-term project financing to Indian
businesses. Mr. A. Ramaswami Mudaliar elected as the first
Chairman of ICICI Limited
ICICI emerges as the major source of foreign currency loans to
Indian industry. Besides funding from the World Bank and other
multi-lateral agencies, ICICI also among the first Indian companies
to raise funds from International markets.
1956: ICICI declared its first Dividend at 3.5%.
1958: Mr.G.L.Mehta was appointed the 2nd Chairman of ICICI Ltd.
1960: ICICI building at 163, Back bay Reclamation was inaugurated.
1961: The first West German loan of DM 5 million from Kredianstalt was
obtained by ICICI.
1967: ICICI made its first debenture issue for Rs.6 crore, which was
oversubscribed.
1969: First two regional offices in Calcutta and Madras were opened.
1972: Second entity in India to set-up merchant banking services.
Mr. H. T. Parekh appointed as the third Chairman of ICICI.
1977: ICICI sponsors the formation of Housing Development Finance
Corporation. Managed its first equity public issue
1978: Mr. James Raj appointed as the fourth Chairman of ICICI.
1979: Mr.Siddharth Mehta appointed as the fifth Chairman of ICICI.
1982: Becomes the first ever Indian borrower to raise European Currency
Units.
ICICI commences leasing business.
1984: Mr. S. Nadkarni appointed as the sixth Chairman of ICICI.
1985: Mr.N.Vaghul appointed as the seventh Chairman and Managing
Director of ICICI.
1986: ICICI first Indian Institution to receive ADB Loans. First public
issue by an Indian entity in the Swiss Capital Markets.
ICICI along with UTI sets up Credit Rating Information Services of
India Limited, (CRISIL) India's first professional credit rating
agency.
ICICI promotes Shipping Credit and Investment Company of India
Limited. (SCICI)
The Corporation made a public issue of Swiss Franc 75 million in
Switzerland, the first public issue by any Indian equity in the Swiss
Capital Market.
1987: ICICI signed a loan agreement for Sterling Pound 10 million with
Commonwealth Development Corporation (CDC), the first loan by
CDC for financing projects in India.
1988: ICICI promotes TDICI - India's first venture capital company.
1993: ICICI sets-up ICICI Securities and Finance Company Limited in
joint venture with J. P. Morgan.
ICICI sets up ICICI Asset Management Company.
1994: ICICI sets up ICICI Bank.
1996: ICICI becomes the first company in the Indian financial sector to
raise GDR.
ICICI announces merger with SCICI.
Mr.K.V.Kamath appointed the Managing Director and CEO of
ICICI Ltd
1997: ICICI was the first intermediary to move away from single prime
rate to three-tier prime rates structure and introduced yield-curve
based pricing.
The name "The Industrial Credit and Investment Corporation of
India Limited " was changed to "ICICI Limited".
ICICI announces takeover of ITC Classic Finance.
1998: Introduced the new logo symbolizing a common corporate identity
for the ICICI Group.
ICICI announces takeover of Anagram Finance.
1999: ICICI launches retail finance - car loans, house loans and loans for
consumer durables.
ICICI becomes the first Indian Company to list on the NYSE
through an issue of American Depositary Shares.
2000: ICICI Bank becomes the first commercial bank from India to list its
stock on NYSE.
ICICI Bank announces merger with Bank of Madura.
2001: The Boards of ICICI Ltd and ICICI Bank approved the merger of
ICICI with ICICI Bank.
2002: Moody assign higher than sovereign rating to ICICI.
Merger of ICICI Limited, ICICI Capital Sercvices Ltd and ICICI
Personal Financial Services Limited with ICICI Bank.

ICICI Bank is India's second-largest bank with total assets of about Rs.112,
024 crore and a network of about 450 branches and offices and about 1750
ATMs. ICICI Bank offers a wide range of banking products and financial
services to corporate and retail customers through a variety of delivery
channels and through its specialized subsidiaries and affiliates in the areas of
investment banking, life and non-life insurance, venture capital, asset
management and information technology. ICICI Bank's equity shares are
listed in India on stock exchanges at Chennai, Delhi, Kolkata and Vadodara,
the Stock Exchange, Mumbai and the National Stock Exchange of India
Limited and its American Depositary Receipts (ADRs) are listed on the New
York Stock Exchange (NYSE).

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian


financial institution, and was its wholly owned subsidiary. ICICI's
shareholding in ICICI Bank was reduced to 46% through a public offering of
shares in India in fiscal 1998, an equity offering in the form of ADRs listed
on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of Madura
Limited in an all-stock amalgamation in fiscal 2001, and secondary market
sales by ICICI to institutional investors in fiscal 2001 and fiscal 2002. ICICI
was formed in 1955 at the initiative of the World Bank, the Government of
India and representatives of Indian industry. The principal objective was to
create a development financial institution for providing medium-term and
long-term project financing to Indian businesses. In the 1990s, ICICI
transformed its business from a development financial institution offering
only project finance to a diversified financial services group offering a wide
variety of products and services, both directly and through a number of
subsidiaries and affiliates like ICICI Bank. In 1999, ICICI become the first
Indian company and the first bank or financial institution from non-Japan
Asia to be listed on the NYSE.
After consideration of various corporate structuring alternatives in the
context of the emerging competitive scenario in the Indian banking industry,
and the move towards universal banking, the managements of ICICI and
ICICI Bank formed the view that the merger of ICICI with ICICI Bank
would be the optimal strategic alternative for both entities, and would create
the optimal legal structure for the ICICI group's universal banking strategy.
The merger would enhance value for ICICI shareholders through the merged
entity's access to low-cost deposits, greater opportunities for earning fee-
based income and the ability to participate in the payments system and
provide transaction-banking services. The merger would enhance value for
ICICI Bank shareholders through a large capital base and scale of
operations, seamless access to ICICI's strong corporate relationships built up
over five decades, entry into new business segments, higher market share in
various business segments, particularly fee-based services, and access to the
vast talent pool of ICICI and its subsidiaries. In October 2001, the Boards of
Directors of ICICI and ICICI Bank approved the merger of ICICI and two of
its wholly owned retail finance subsidiaries, ICICI Personal Financial
Services Limited and ICICI Capital Services Limited, with ICICI Bank. The
merger was approved by shareholders of ICICI and ICICI Bank in January
2002, by the High Court of Gujarat at Ahmedabad in March 2002, and by
the High Court of Judicature at Mumbai and the Reserve Bank of India in
April 2002. Consequent to the merger, the ICICI group's financing and
banking operations, both wholesale and retail, have been integrated in a
single entity.

ICICI became the first Indian Company to get listed on the NYSE on
September 22, 1999. ICICI, the only FI having private participation since its
inception, is the second largest in the sector with an asset base of
Rs734.14bn as at FY2001 end.

Indian financial system comprises financial institutions, which were set up


with the objective of providing long term finance, commercial banks
fulfilling working capital and general banking needs, specialized investment
institutions like LIC, GIC, UTI and private sector Non-Banking Finance
Companies (NBFCs). This demarcation no longer exists. Historically, the
sector has been dominated by State owned institutions. The twin forces of
deregulation and technology have increased the degree of competition in the
Indian financial sector to unprecedented levels.
Concessional funding is no longer available. Government guaranteed SLR
and other bonds, which used to be the pre-dominant source of funding till
1993, has been phased out in accordance with the reform process. These
account for less than 10% of asset base of FIs and are due for repayment
within 3-4 years. On the other hand interest rates have fallen sharply and
disintermediation has grown rapidly. Banks are competing in each area
(banks have a much wider access to deposits, especially low cost demand
deposits) spreads are under pressure, long-term outlook looks unfavourable.

ICICI has transformed itself from the role of a FI to a Universal Bank. The
company is making constant efforts to take first mover advantage in the
technology-related businesses. In the past, there has considerable amount of
influence and direction from the government in ICICI’s policies. However,
of late, under the direction of Mr.K.V.Kamath, ICICI has quite successfully
broken away from direct government interference. Private participation in
equity since inception and its image of a professionally managed company
has enabled ICICI to recruit professional managers and fresh MBAs from
premier institutes consistently. Key rest with professional managers.

ICICI is undoubtedly one of India’s best-managed financial institutions.


ICICI’s project loans’ team has considerable depth and wide experience in
project and loan appraisals. With excellent quality manpower, ICICI is
forging ahead very strongly on its mission to transform itself from a project-
finance /development banking institution to a universal bank catering to all
kinds of needs of both retail and corporate customers. The company has
placed itself in a perfect position to take any benefit accruing in the Indian
Financial sector because of further technological changes. Its diversification
of business portfolio will also help it to leverage its strength from one
segment to another.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF


OPERATIONS AND FINANCIAL CONDITION

The Board of Directors of ICICI Limited and ICICI Bank Limited, approved
the merger of ICICI with ICICI Bank on October 25, 2001. The merger of
two wholly-owned subsidiaries of ICICI, ICICI Personal Financial Services
Limited and ICICI Capital services Limited, with ICICI Bank was also
approved by the respective Boards. The proposal has been submitted to the
Reserve Bank of India for its consideration and approval, and shall be
subject to various other approvals, including the approval of the shareholders
of the respective companies, the High Courts of Mumbai and Gujarat, and
the Government of India as may be required. Consequently, the Appointed
Date of merger is proposed to be March 31, 2002, or the date from which
RBI’s approval becomes effective, whichever is later. The Scheme of
Amalgamation (“the Scheme”) approved by the respective Boards envisages
a share exchange ratio of one equity share of ICICI Bank for two equity
shares of ICICI.

As on September 30, 2001, the equity share capital of ICICI Bank was Rs.
220.36 crore consisting of 22.036 crore shares of Rs. 10 each and Reserves
and Surplus of Rs. 1223.66 crore. ICICI Bank has emerged as the leading
private sector bank in India. Deposits grew 80 per cent to Rs. 17,515 crore at
September 30, 2001 as against Rs. 9,728 crore at september 30, 2000 and
Rs. 16,378 crore at March 31, 2001. The share of ICICI Bank in total
deposits of the banking system increased to 1.52 per cent as on September
30, 2001 from 0.97 per cent at September 30, 2000. Retail deposits
constituted 67 per cent of total deposits as on September 30, 2001, compared
to 48 per cent at September 30, 2000, reflecting ICICI Bank’s retail thrust
and benefits arising from Bank of Madura merger. Savings deposits
registered a growth of 159 per cent to Rs. 2,186 crore as on September 30,
2001 from Rs. 843 crore at September 30, 2000. ICICI Bank’s customer
assets (including credit substitutes) increased 80 percent to Rs. 11,409 crore
at September 30, 2001 from Rs. 6,324 crore at September 30, 2000. ICICI
Bank’s market share in customer assets increased to 2.01 per cent at
September 30, 2001 from 1.26 per cent at September 30, 2000. As per its
audited accounts, ICICI Bank recorded profit after tax (PAT) of Rs. 66.15
crore in Q2-2002, an increase of 120% from Rs. 30.06 crore in Q2-2001.

On the merger being effective, the merged entity would be the second largest
bank in India in terms of assets with total assets of about Rs. 95,000 crore
(pro forma at September 30, 2001), 396 existing branches/ extension
counters of ICICI Bank, 140 existing retail finance offices and centres of
ICICI, and 8,275 employees. The merged entity would leverage on its large
capital base, comprehensive suite of products and services, extensive
corporate and retail customer relationships, technology-enabled distribution
architecture, strong brand franchise and vast talent pool. The merged entity
would benefit from the access to low-cost deposits, greater opportunities for
earning fee-based income and the ability to participate in the payments
system and provide transaction-banking services. The retail segment will be
a key driver of growth for the merged entity, with respect to both assets and
liabilities. The merged entity will have a combined cost-to-income ratio of
27 per cent (pro forma for the half-year ended September 30, 2001).

ICICI currently holds 46% of the paid-up equity share capital of ICICI Bank.
This holding would not be cancelled under the scheme of amalgamation. It
is proposed to be held in trust for the benefit of the merged entity, and
divested through appropriate placement by fiscal 2003, subject to the
provisions of the Scheme. The proceeds from the divestment will accrue to
the merged entity.

At the time of the merger, ICICI Bank would align the Indian GAAP
accounting policies of ICICI to those of ICICI Bank, including a higher
general provision against standard assets. Further, ICICI Bank has decided
to adopt the “purchase method” of accounting, which is mandatory under US
GAAP, to account for the merger under Indian GAAP as well. ICICI’s assets
and liabilities will therefore be fair valued for the purpose of incorporation
in the accounts of ICICI Bank on the Appointed Date.

The higher proportion of deposits in the sources of funding of the merged


entity, as compared to long-term wholesale borrowings, may result in an
excess of maturing liabilities over maturing assets. However, the merged
entity’s focus on raising resources through retail deposits, which is
recognised as a stable source of funding for banks, will impart greater
stability to the liability base. Further, the merged entity will maintain cash
reserves and liquid investments in Government securities, in compliance
with statutory norms applicable to banks, which will ensure adequate
liquidity at all times. The merged entity will continue to manage its asset-
liability position carefully and adopt appropriate strategies to mitigate any
risks arising therefrom. Consequent to the merger, the businesses presently
being carried on by ICICI would become subject for the first time to various
regulations applicable to banks. These include the prudential reserve and
liquidity requirements, namely Statutory Liquidity Ratio (SLR) under
Section 24 of the Banking Regulation Act, 1949, and Cash Reserve ratio
(CRR) under Section 42 of the Reserve Bank of India Act, 1934. At present,
the stipulated SLR is 25% of a bank’s net demand and time liabilities in
India and the stipulated CRR is 5.5% of the net demand and time liabilities
in India. SLR is required to be maintained in the form of Government
securities and other approved securities, while CRR is required to be
maintained in the form of cash balances with RBI. In addition to the above,
the directed lending norms of RBI require that every bank should extend
40% of net bank credit to certain eligible sectors, which are categorised as
“priority sector”. ICICI and ICICI Bank have submitted to RBI the proposal
for compliance with regulatory norms applicable to banks, and would adhere
to RBI’s decision in the matter. Full compliance with the prudential norms
applicable to banks on all of ICICI’s existing liabilities is likely to have an
adverse impact on the overall profitability of both ICICI and ICICI Bank in
fiscal 2002, which cannot be quantified at this stage.

The top management of ICICI `enbloc' will form the top corporate
management of the ICICI Bank; among banks ICICI Bank may be the first
to be headed by a non-executive Chairman and except for him, all others in
the top management, after the merger might be non-bankers. Also the
proposed merger is the first of its kind that a non-bank of a larger balance
sheet size (Rs. 74,371 crores as on March 31, 2001) is proposed with a
commercial bank (Rs. 203,809 crores); post-merger again, the larger
complement of ICICI staff will be non-bankers again, having exposure to
`credit' only and would probably require a refresher course on diverse
banking activities, the several enactments as well as the peculiar banking
practices.

Staff incompatibility

It is pertinent to mention that amalgamation between banks in the past, from


a personnel angle has not been at all compatible - the striking example of the
New Bank of India with the Punjab National Bank is a case in point. But
here, larger strength of non-bankers need to be groomed and accepted for
banking counters! Dealings in financial institutions are structured in an
easier convenient ``one to one basis''unlike in commercial banks where the
personnel are rotated among different functions. There are sharp variations
even in lending practices. For instance, in the FIs loan disbursals are
structured over a period as compared to running accounts of borrowers in
banks where they need to respond on the spot to the situations.
In the context of RBI's dictates, in conformity with Basle Committee
prescriptions at the international level, to banks on `risk management',
apparent risks in all spheres may call for special dispensations to the merged
entity and thus one more class of banks (apart from public sector, old/new
private sector, foreign banks) will emerge for the central bank to deal with.
Lest unhealthy precedents are permitted, the central bank may have to
envision a long term strategy to respond to emerging situations. In fact,
RBI's policy to have permitted private banks to be established in the early
Nineties has already been reviewed and yet another phase is now seen in
regard to few banks which were then established. In fact, ever since RBI
talked of `risk management' since 1998, except for some sporadic responses,
it is yet to percolate at the top levels of management. So far it has been yet
another jugglery with figures. One has to see the kind of disclosures in
annual report of banks abroad on the risk parameters. The time is not far off
for such compulsions from the international arenas (as the attraction for
GAAP registration increases) to take hold. Failure or inaccuracies in
disclosures may do greater harm at the national levels. For example, recently
the regulatory authorities in the U.S. demanded policy documents on certain
aspects of banking business: here, practices exist sans any documents,
notwithstanding the infamous securities scam of the 1990's; such
permissiveness need to be contained. The RBI has on its record, such
prescriptions but these need to be enforced with rigour to match the U.S.
practices. It is time that a long term approach, which should be sustained,
sans pressures from any quarters is the need of the hour.

IDBI – A CASE STUDY

IDBA has been promoted by Industrial Development Bank of India, one of


the largest DFIs in the country. The bank, incorporated in 1994, has
performed very well during the FY1999-2000. It has recorded a 100%
increase in its net profit at Rs609mn as against Rs307mn in FY1998-99. At
the end of March’2000, its deposits stood at Rs34bn while its advances were
Rs16bn.

While liberalization and reforms have thrown up a few challenges, it has


also created opportunities for banks to increase revenues by diversifying into
Investment banking, Insurance, Credit Cards, mortgage financing,
depository services and more. With the emergence of e-commerce, the way
in which banking business is presently conducted would undergo a radical
change. Future competition among banks will be essentially based on the
twin platforms of technology savviness and ability to attract talent.
Telephone and Internet banking will gain importance and the future will see
the emergence of Internet driven operations without a broad-based branch
network. Increasing competition will exert pressure on bottomlines, forcing
banks to cope with thinning margins.

Margins in fund based business have come under pressure due to a sharp fall
in interest rates, with disproportionate reduction in cost of deposits.
Increasing disintermediation by corporates has led to rising investments by
banks in lower yielding CDs, NCDs and preference shares. Pressure on CAR
has forced many players to focus on zero risk instruments like G-Secs.

IDBA has grown at a slower rate as compared to the other new private sector
banks. While most of the new generation banks were focussing on retail and
technology, the bank took its time to adapt to the changing environment. But
in the last few months, the bank has planned some major changes in its
strategy and is organizing its structure in a new way to increase its presence
in the market and improve its growth rates. The bank has also launched
some new products in the market such as Smart Card to increase its retail
business. It is also in the process of entering into a strategic alliance for its
technology set up.

Recently, there has been a change in the top management of the bank. It has
appointed Mr. Gunit Chadha (ex Citibanker) as its new CEO and Managing
Director. It is expected that under his leadership the bank would be able to
make further progress in its tech and retail initiatives, which has been the
focus area of the new private sector banks. The bank is also in the process of
recruiting professionals who would be able to support its growth plans.
The Bank was incorporated at Gwalior under Companies Act on 15th of
September 1994 with its Registered Office at Indore. The Certificate for
Commencement of Business was received on 2nd of December 1994.

The promoters of the bank are Industrial Development Bank of India (IDBI)
and Small Industries Development Bank of India (SIDBI). The Government
of India under an Act of Parliament, the IDBI Act 1964, established IDBI in
1964. IDBI's role as a catalyst to industrial development has encompassed a
broad spectrum of activities. It provides finance to all types of industrial
concerns and also has a special role for coordinating the activities of
institutions engaged in financing, promoting or developing industries as also
for provisions of technical, legal and marketing assistance to industry and
undertaking market surveys, investment research as well as tech-economic
studies in connection with the development of industry. SIDBI, the second
promoter, was established as a wholly owned subsidiary of IDBI in 1990
when IDBI's portfolio relating to the small industrial sector was transferred
to them.

The Bank came out with its maiden public issue in February 1999. The paid-
up capital of the Bank after the public issue stands enhanced to Rs1400mn.
Out of this, IDBI has contributed Rs800mn (57%), SIDBI Rs200mn (14%)
and the rest Rs400mn (29%) were mobilized during the public issue.

The bank has planned its branch expansion to cover adequately most of the
important locations in the country relevant to the banking business. At the
end of November’00, the bank had a network of 50 branches and 66 ATMs.
It was also one of the first banks to join the SWADHAN network in
Mumbai.

Feasibility of Industrial Development Bank of India (IDBI) Merging


with Bank of Baroda (BoB)

The report aims at evaluating the feasibility of a merger between IDBI and
BoB. The objective is to try to chart the future course of business for IDBI in
light of the recent developments in the financial sector. The report takes into
account IDBI’s stated objectives to provide complete solution banking in the
near future.

In our attempts, we consulted experts from the industry to guide us. Officers
from IDBI were very helpful in providing us with data and in providing
useful insights to our approach. We consulted VANSCOM and PROWESS
software for further data. The Internet and the IIM Ahmedabad library were
a rich source of information for our analysis.

The merged entity, we believe, will be in a better position to be operationally


efficient with a lower operating cost-to-income ratio. The merger will reduce
the extent of non-performing assets (NPAs) and make the combined entity
financially stronger.

Since the consolidation is about increasing revenues, lowering costs, and


increasing shareholder value, the merger is a viable and an attractive option.
We chose Bank of Baroda as a target financial company with which IDBI
can merge to become competitive in the emerging scenario.

The financial sector in India is in a state of turmoil because of the changes


being introduced by the government. The entrance of the global giants into
the Indian banking industry makes it imperative for IDBI to search for a
suitable partner for merging. The merger should be done after considering
the operational synergies.

IDBI has a very strong presence in the field of project finance. Its expertise
lies in the field of funding long-term projects as in the field of infrastructure.
BoB has a very good retail banking structure and a focus on short term
lending. Similarly the ability of the BoB to raise loans at competitive costs
would be helpful for the merged entity.

The combined entity was analysed to look for the advantages that would
result from the merger. It was also observed that one of the major problems
would be regarding the handling of the manpower after the merger.
The major criteria for the evaluation of the merger were Non performing
assets, cost of capital, capital adequacy ratio and other operating ratios. After
a proper SWOT analysis it was observed that the benefits that would accrue
to the resulting company from the merger would far outweigh the
shortcomings in the short and medium term. In the long term it was very
much possible to tackle even these problems.

So the conclusion of the report is that the merger of IDBI with BoB would
be beneficial for both of them in the long term.

IDBI and Bank of Baroda: Feasibility of a Merger

The report aims at evaluating the feasibility of a merger between IDBI and
BoB. The overall aim is to chart the future course of action for IDBI. This is
in line with IDBI’s stated objectives to provide complete banking solutions
in the near future.

Indian financial system comprises financial institutions (FI), which were set
up with the objective of providing long-term finance, commercial banks
fulfilling working capital and specialised investment institutions. This
demarcation no longer exists.

With inflation rate ruling at its historic low levels, further softening of
interest rates is being anticipated. The foreign investment, both portfolio and
direct, have become buoyant in recent months. The international financial
crisis is settling down and adverse external factors affecting industrial
performance would reduce in intensity.

In the new millennium, the sources of competitive advantage would emerge


from the quality and speed of response and ability to provide total financial
solutions. From IDBI's viewpoint, the challenges and opportunities are likely
to flow from: Further international deregulation in the financial market
place, resulting in greater overlapping in the profiles of FIs and commercial
banks. Greater global integration through opening up of some segments of
India's financial services sector, under the WTO agreement.

Indian FIs will face increasing competition from both domestic and foreign
players. Global investment banks, which can raise capital abroad at cheaper
rates, are eyeing emerging markets like India. As Mr. P Chidambaram said,
"it might be better for the Indian FIs and banks to compete globally rather
than with each other." In the new environment, what will matter most are
financial power, and the ability to offer diverse and innovative products. At
present, the Indian FIs falter in both these areas. Many experts, like Mr.
Narasimham, who head the new committee on financial sector reforms have
maintained that India should start thinking in terms of creating two or three
banks, through the merger of strong Indian institutions, with international
character.

IDBI: Present Status

Government guaranteed SLR and other bonds, which used to be the


predominant source of funding for IDBI till 1993, have been phased out in
line with the reform process. These account for less than 10% of asset base
of Fls and are due for repayment. Interest rates have also fallen sharply and
disintermediation has grown rapidly. Banks are competing in each area and
thus spreads are under pressure and the long-term outlook looks
unfavourable. Asset quality of IDBI is poorer compared to banks. This is
because it had aggressively lent to commodity sectors in the early 90s. Since
then a large number of companies in these sectors have become unviable due
to overcapacity or bringing down of tariff barriers. IDBI’s capital adequacy
is well over the required 8%, and yet it does not give any indication of
comfort primarily due to the high NPAs. Before its Initial public offering
(IPO), IDBI's assets were considered to be good. However, post-IPO, it has
turned aggressive especially in lending to commodity sectors with the largest
exposures. It is thus facing tough times as competition from
disintermediation has pushed down spreads, low market sentiment has wiped
off sources of cheap funds and low economic activity has driven away
disbursal growth.

IDBI- Business Strategy in emerging scenario

The stated thrust areas for IDBI in the future are:


 Infrastructure to continue to be the key driver.

 Restructuring and consolidation making take-over financing an


attractive business proposition.

 Corporate advisory services would make fee based business one of the
important components of income.
 Maintaining focus on the core competence of project finance.
 Structured products and total solutions would be introduced to meet
diverse client needs.

 Cost-effective resource mobilisation efforts, both in the domestic as


well as international markets, will be the hallmark of IDBI's business
approach.

Bank of Baroda (BoB): Present Status

BoB, is the second largest bank in India in terms of deposits. Its deposits and
advances stood at Rs 446 bn and Rs 211 bn as at FY99 end. Its network of
2,522 branches, inclusive of 52 specialised branches and 39 foreign
branches, is the second largest in India. BOB has bettered its capital base
recently placing it among the stronger public sector banks. Its financial
strength is above par with CAR at 12%. However, net NPAs account for
about 56% of the net worth. Profit growth and business sustainability will
critically depend upon NPA management, which are expected to worsen in
the medium term. BoB is one of the better quality PSU banks and has a
workforce of around 45,000 employees. However, it has one of the most
productive employee statistics among PSBs. But the management is
restricted with lower autonomy and authority. Thus, speed is hindered and it
is less aggressive than private banks. A large number of metro & urban
branches are mechanised and are capable of handling business with speed &
accuracy. It is accelerating the pace of computerisation at the branch level so
that maximum business can be captured.

Compulsions for IDBI and BoB

Prudential norms require banks to maintain 35.50 per cent of their assets
under SLR and CRR, which is not applicable to FIs. Also, according to a
report on the banking sector by Merrill Lynch, although FIs have insisted on
financing only projects of globally competitive sizes, the commodity nature
exposes their loan portfolio to higher risks. The banks have a cushion with
NPAs calculated on only 60 per cent of the assets. According to the report,
"Regulations limit the banks from deploying more than 10 per cent of the
total funding in short-term lending, a level not sufficient to achieve any
meaningful risk-diversification of portfolio." A merger would thus lead to a
stronger entity.
IDBI and BoB - A Merger

A partnership between the BoB and IDBI could provide operational synergy,
aid resource mobilisation, and improve asset quality. Operationally, a FI,
with its project financing & appraisal skills and term lending activities, and
similarly sized bank with its retail-funding base can be used to complement
the individual efficiencies of the two organisations. As a working capital
lender, BoB has a much wider fee product line in terms of remittance
products and earns a much higher fee income from a corporate compared to
a FI. The merged institution will be in a better position for mopping up
money in the retail market. The credit costs, as a percentage of returns are
higher in case of FIs by about 20 percent vis-a-vis the bank and a merger
would help. The combined entity will be operationally efficient with a lower
operating cost-to-income ratio of 35.80 per cent against 53.50 per cent in the
case of BoB.

The merger will reduce the extent of non-performing assets (NPAs) and
make the combined entity financially stronger. Despite an asset base of Rs
84,173.49 crore ($20.23 billion), the entity will still be small compared to
the Rs 1,10,000-crore asset-base State Bank of India (SBI), and its global
competitors such as the Bank of Tokyo-Mitsubishi (asset base: $648 billion)
of Japan.

Merged
Evaluation Criteria BoB IDBI
Entity
Cost of capital (%)A 7.50 10.50 8.50
Operating Cost to Income Ratio
53.50 25.10 38.50

Profitability (% of assets) 0.86 2.00 1.11


Non performing assets (% of net
56.0 12.0 40.00
assets)
Capital adequacy (% of reserves) 13.31 12.70 13.10
RONW 18.33 15.10 17.43
A
Capital Base of BoB is Rs. 44600 crores and that of IDBI is Rs. 11400 crores

Strengths and Opportunities


A ‘SWOT ‘analysis of the merged entity yields the following results.

Short Term
Global scale: It will enable IDBI to play bigger roles in infrastructure
projects, and raise resources at more competitive rates. In 1998-99, the FIs
disbursed Rs 31,500 crore for projects. Assuming that the total
disbursements grow at a compounded annual rate of 15 per cent, the figure
will climb to Rs 2,44,000 crore over the next five years. But this will still
fall short of the country's needs by Rs 1,26,000 crore.

Long Term
At present, most of the Indian FIs and banks feel constrained while lending
to infrastructure projects. For example, the numerous power projects require
funds totaling Rs 72,000 crore. To reduce risks, a FI normally lends no more
than 15 per cent of its total outstanding loan portfolio to the power sector.
With such low exposure limits, all these institutions will not be able to
finance power projects in the next century. A larger entity could take on
larger exposures, and will be in a better position to absorb the increased risks
in the form of bad loans. The number of sick companies in the portfolio of
the FIs as on March 31, 1998, stood at 425, and the total loan
outstanding in respect of these companies was Rs 2,495 crore. IDBI has
written off Rs 2,504 crore as bad loans over the past two years. However, the
size argument has a limitation. A larger wholesale bank would be exposed to
larger systemic risks and regulatory attention. An institution’s ability to raise
large volumes of funds in a cost-effective manner is critical as credit costs as
a percentage of returns, are in the range of 25 to 35 in the case of banks and
55 in the case of FIs. IDBI has been forced in recent times to seek alternative
fund sources at market-related rates as low cost funds have dried up.
Moreover, the FIs are restrained by the Reserve Bank of India, and cannot
offer a deposit rate that exceeds that of the SBI. This is where the branch
network of BoB will be helpful.

Weaknesses and Threats

Short Term

A major issue to be tackled is the post-merger redeployment of the


workforce. Both IDBI and BoB have huge workforces and a large part will
have to be retrained taking into consideration the thrust areas of operation.
They will also have to consider the option of VRS for pruning down the
workforce to manageable and efficient levels. The cost of an attractive
Voluntary Retirement Scheme (VRS) can be Rs 80 crore. Trade unions of
IDBI and BoB will probably oppose such moves. BoB will also bring to the
balance sheet of the merged entity, a huge NPA, which will increase the
liability of the merged entity in absolute terms. Though the net NPAs would
be higher, higher net assets would offset them.

Long Term
Integrating two large institutions is not an easy task because each has its
own culture, which may be difficult to merge. The government seems keen
to help the process, going by the tax initiatives that Finance Minister
announced in his budget .Even so, since the consolidation is about
increasing revenues, lowering costs, and increasing shareholder value, the
merger is a viable and an attractive option.

IFCI- PROPOSED MERGER WITH PNB

The Industrial Finance Corporation of India (IFCI) is the country's first


development financial institution and there ends the tally of distinctions
scored by this beleaguered financial institution. In fact, today, IFCI figures
at the bottom of the list in terms of NPA, CAR or performance from an
investor's point of view. To put it briefly, IFCI is on the verge of a collapse
and only timely government intervention may save the institution.
Most of the problems being faced by IFCI are self-inflicted. By throwing
prudent banking norms to the winds while appraising the projects, either due
to external pressure or otherwise, this premier DFI is facing liquidity crunch
and is sending an SOS to the government to rescue it from sinking. In fact,
IFCI, like its clients, has become a habitual defaulter. It was not long ago
that it approached the government for help. It seems the institution has not
learnt from any of its past mistakes otherwise how does it justify its current
predicament.

Due to its poor financial health IFCI could raise money from the market only
at higher cost compared to other DFIs like ICICI or IDBI. Since its cost of
borrowing is higher it could lend only at higher rates compared to other
DFIs, thereby driving away blue chip clients. As a result, it could only lend
to second-rung companies where the risks were high, thus driving up its
NPAs. Little wonder that Prakash Industries, Mardia Chemicals &
Industries, Parasrampuria Synthetics, J.K. Synthetics, SM Dyechem and
Torrent Gujarat Biotech are some of its important clients. The institution has
not been able to come out of this vicious cycle even though warning signals
were evident long ago. But they were invariably ignored.

Of the total disbursements during the year, by IFCI, 17.27 per cent went
towards new projects. Interestingly (and unfortunately), 36.28 per cent of the
disbursements were to meet cost overrun in order to ensure that projects
were completed. Further, of the total outstanding assets of Rs 18,483 crore,
51.7 per cent constituted companies that were in operation while the rest
were either under implementation or referred to BIFR. In order to avoid
being classified as doubtful assets the institution has resorted to funding
through the preference share route rather than via the debt route. During the
year ended March 31, 2001, funding through the preference share route
increased from Rs 10 crore to Rs 94.8 crore. One can point to the umpteen
number of blunders IFCI has committed while lending. For example, of the
of the total outstandings of the institution, 19.5 per cent is owed by the steel
industry. The poor health of the steel sector has not stopped the institution
from granting more loans to it during the year 2000-01 when disbursements
touched nearly 15 per cent. The institution lent more to the steel industry
during the year just to keep the projects going. Textile is another sector
where the institution has a sizeable exposure of 11.38 per cent.

IFCI's problems are only going to worsen in the coming days. From March
31, 2002 onwards, financial institutions should classify an asset as non-
performing if interest and/or principal remain overdue for 180 days. As of
now, an asset should be classified as NPA if interest is overdue for 180 days
and principal for 365 days. This duration will reduced further in the coming
years so as to be in sync with international practice. This means that IFCI
will have to make increased provisions for NPAs in the coming years.

PNB to takeover IFCI

The Boards of Punjab National Bank (PNB) and IFCI on Friday accorded in-
principle approval for the taking over of the troubled state-run financial
institution (FI) by the former. The acquisition would create an entity that
would rank among the top five Indian banks with a market capitalisation of
about US$1.85bn.

According to reports, IFCI Board has become defunct and its Chairman
V.P.Singh put in his papers today after a Board meeting. With the exit of
Singh, the day-to-day running of IFCI would be overseen by two Executive
Directors, R.M. Malla and M.V. Muthu, who would report to the Board.

The move to merge IFCI with PNB was first announced by Finance Minister
Jaswant Singh early this month. However, the deal is still subject to due
diligence and other conditions as may be stipulated by the Board besides
other requisite approvals connected with the same.

The bailout of IFCI comes as a final measure in a series of steps to


restructure the FI's huge liabilities. IFCI has been suffering from huge losses
for some time as lending to large projects did not pay off. Last August, the
Government sought parliamentary approval to convert loans to IFCI into
grants as part of a Rs15.73-bn restructuring package.
After the merger, PNB's asset base would rise from Rs860bn as at March 31,
2003 to over Rs1,010bn. The merger would take place after the transfer of
IFCI's bad assets - estimated at over Rs60bn - to an asset reconstruction
company. It would most likely be over by the end of March 2003.

Meanwhile, IFCI reported a net loss of Rs11.15bn during Oct-Dec quarter


compared with Rs951.2mn in the same quarter a year earlier. The near 10-
fold jump in loss was largely due to a four-fold jump in provisions and
write-offs for bad debts.
IFCI provided Rs9.82bn for bad and doubtful debts and also wrote-off some
of its assets during the quarter-ended December 31, 2003. In the
corresponding period of the previous fiscal year, IFCI had provided
Rs2.33bn. For the nine month ended December 31, 2003, IFCI reported a
loss of Rs24.65bn as against Rs6.1bn in the corresponding period of the
year-ago period.

FUTURE ROLE OF DFIs IN INDIA AND FINANCING


NEEDS OF INDUSTRY

In India, a well-knit structure of Financial Institutions (FIs) has developed


over the years. The Industrial Finance Corporation of India (IFCI) was
established in 1948 under an Act of Parliament to meet the medium and
long-term financial needs of industrial concerns in India. To take care of the
financial needs of smaller units at the state-level, State Financial
Corporations (SFCs) were set up under the State Financial Corporation Act
in 1951. In 1955, Industrial Credit and Investment Corporation of India
(ICICI) was set up as a public limited company under the Companies Act
with the primary objective of providing foreign currency loans to industrial
projects and promote industries in the private sector. In 1964, Industrial
Development Bank of India (IDBI) was created as the apex body for
catering to the growing and diverse needs of medium and large scale
industries. State Industrial Development Corporations (SIDCs) established
under the Companies Act, 1956 act as catalyst for promotion and
development of medium and large scale industries in their respective states.

Industrial Investment Bank of India-IIBI (formerly the Industrial


Reconstruction Bank of India - IRBI), which is wholly owned by the
Government of India was set up in 1985 under the IRBI Act, 1984, as the
principal credit and reconstruction agency for aiding rehabilitation of sick
and closed industrial units. However, in March 1997, IRBI was converted
from a statutory body into a public limited company and since then it has
been acting as a full-fledged all-purpose development financial institution.
SIDBI was set up in 1990 as the principal financial institution for promotion,
financing and development of industry in the small, tiny and cottage sectors.

Apart from specialised financial institutions in the industrial sector, FIs were
also set up in the export-import, agriculture and rural sector, and the housing
sector. National Bank for Agriculture and Rural Development (NABARD)
was set up in 1982 as an apex development bank for promotion of
agriculture, small-scale industries, cottage and village industries, handicrafts
and other activities in rural areas. Export-Import Bank of India (EXIM
Bank) established in 1982 acts as the principal financial institution for
financing, facilitating and promoting India’s foreign trade. National Housing
Bank was set up in 1988 under the National Housing Bank Act as the
principal agency to promote housing finance institutions and to provide
financial and other support to such institutions. In January 1997,
Infrastructure Development Finance Company (IDFC) was incorporated
under the Companies Act, 1956 to provide impetus to the infrastructure
sector.

All the above-referred FIs, except NABARD, EXIM Bank and SIDCs, have
been notified as ‘public financial institutions’ (PFIs) under Section 4A of the
Companies Act, 1956. There are some FIs which have been notified as
‘public financial institutions’ under Section 4A of the Companies Act, 1956,
such as, Power Finance Corporation (PFC), which perform the functions of
DFIs but are subject to the NBFCs regulation. The Reserve Bank following
its ‘Mid-term Review of Monetary and Credit Policy for the year 1998-99’
has treated some PFIs selectively for the purpose of applying 20 per cent risk
weight on investments in bonds/debentures of such PFIs. Thus, there is some
ambiguity regarding the constituents of ‘Development Financial
Institutions’. However, for convenience, as mentioned earlier, ‘DFIs’ in this
paper refer to IDBI, ICICI, IFCI, IIBI (IRBI), EXIM Bank and TFCI, while
‘RFIs’ refer to SIDBI, NABARD and NHB.

Thus, over the years, a wide variety of DFIs/RFIs have come into existence
and they perform the developmental role in their respective sectors. Apart
from the fact that they cater to the financial needs of different sectors, there
are some significant differences among them. While most of them extend
direct finance, IDBI extends direct finance as well as refinance. IDBI also
extends finance by discounting and rediscounting of bills/promissory notes
arising out of sales/purchase of machinery/equipment on deferred payment
basis. IDBI also refinances term loans given by State level institutions/banks
to medium scale units. Thus, IDBI has a sizeable share of indirect finance
(refinance of industrial loans, loans and investments in shares and bonds of
other FIs, etc.), which ICICI and IFCI do not have. IDBI also exercises
supervisory role over State level institutions. SIDBI, NABARD and NHB
are mainly refinancing institutions. SIDBI’s activities include refinancing of
term loans granted by SFCs/SIDCs/commercial banks and other eligible
institutions and direct discounting/rediscounting of bills arising out of sale of
machinery/capital equipment/components by manufacturers in the small
scale sector. Two of the three refinancing institutions, viz., NABARD and
NHB have supervisory role. NABARD supervises Regional Rural Banks
and other institutions engaged in financing the agriculture and the rural
sector. NHB supervises housing finance companies. Even in case of three
major financial institutions in the industrial sector, i.e., IDBI, ICICI and
IFCI, there is a difference in the focus. For instance, ICICI has historically
maintained a relatively higher share of foreign loan portfolio as compared
with that of IDBI and IFCI.

While FIs are homogenous in the sense that they are all engaged in the
promotion and development of their respective sectors, there are some
significant differences among them which make them heterogeneous in more
than one sense. In fact, the ownership pattern and the organisational
structure apart from operating environment are varying and have also been
changing as part of reform. The current status is presented in Statement 7. It
is evident that: First, among DFIs, there is a diversity of ownership except
with respect to IIBI and Exim Bank. IIBI has recently been converted from a
statutory body into a company under the Companies Act, 1956. Apparently,
the condition of the balance sheet of IIBI has not permitted its profitable
diversification. Second, among DFIs, Government has majority ownership
in IDBI. Third, in respect of refinancing institutions, while NABARD is
owned both by the Government and the RBI, NHB is fully owned by the
RBI and SIDBI by IDBI. Fourth, only IDBI and EXIM Bank among DFIs
are under statutes although they perform functions similar to ICICI/IFCI.
Fifth, all the refinancing institutions, viz., NABARD/NHB/SIDBI are under
statutes. Sixth, as regards supervisory framework, IDBI carries out
supervisory functions of the State level institutions, NABARD of RRBs and
other institutions engaged in rural lending and NHB of housing finance
companies.

The KWG recommended that a full banking licence be eventually granted to


DFIs. In the interim, DFIs may be permitted to have banking subsidiaries
(with holdings up to 100 per cent), while the DFIs themselves may continue
to play their existing role. It also recommended that management and
shareholders of banks and DFIs should be permitted to explore and enter
into gainful mergers. These mergers should be possible not only between
banks but also between banks and DFIs, and not only between strong and
weak though viable entities but even between two strong banks and DFIs.
4.08 On the same subject, the Narasimham Committee observed that it took
note of the twin phenomena of consolidation and convergence which the
financial system is now experiencing globally. In India also, banks and DFIs
are moving closer to each other in the scope of their activities. With such
convergence of activities between banks and DFIs, the Committee was of
the view that DFIs should, over a period of time, convert themselves into
banks. There would then be only two forms of intermediaries, viz., banking
companies and non-banking finance companies. If a DFI does not acquire a
banking licence within a stipulated time it would be categorised as a non-
banking finance company. A DFI which converts into a bank can be given
some time to phase in reserve requirements in respect of its liabilities to
bring it on par with the requirements relating to commercial banks.
Similarly, as long as a system of directed credit is in vogue a formula should
be worked out to extend this to DFIs which have become banks.

The Narasimham Committee further observed that mergers between banks


and DFIs and NBFCs need to be based on synergies and location and
business specific complementarities of the concerned institutions and must
obviously make sound commercial sense. Mergers between strong banks/FIs
would make for greater economic and commercial sense and would be a
case where the whole is greater than the sum of its parts and have a “force
multiplier effect”.

The Narasimham Committee recommended that to provide the much needed


flexibility in its operations, IDBI should be corporatised and converted into a
joint stock company under the Companies Act on the lines of ICICI, IFCI
and IIBI. For providing focussed attention to the work of State Financial
Corporations, IDBI shareholding in them should be transferred to SIDBI,
which is currently providing refinance assistance to them. To give it greater
operational autonomy, SIDBI should also be delinked from IDBI.

With regard to State level institutions (SLIs), the KWG recommended that
the agenda for their reform should incorporate the following:

i) Eventual merger of SFCs, SIDCs and SSIDCs in each state


into a single entity. While the consolidation of SLIs should
form part of the short-term agenda of reforms in the
financial sector, an immediate-term imperative is the
corporatisation of these entities to improve their competitive
efficiency.
ii) Following restructuring/reorganisation, strong SFCs could
be encouraged to go public by making IPOs. In the process,
the State Government’s holding in these Corporations may
be allowed to be brought down to below 50 per cent.
iii) Since the credit requirements of small-scale industries are
being taken care of by SIDBI since its establishment in
1990, it would be desirable to transfer the present
shareholding of IDBI in these SLIs to SIDBI. It should be
vested with the overall responsibility for enacting policy and
procedural guidelines with regard to the operations of SFCs.

iv) SIDBI should be accorded the same role and status as the
nodal/co-ordinating agency for financing of small (and
medium) industries as is now available to NABARD in the
field of agricultural development. Ownership in SIDBI
should, as a logical corollary, stand transferred to the
RBI/Government on the same lines as NABARD.
v) SIDBI’s role in the State level institutions should be both as
stakeholder as well as resource provider. For this purpose,
SIDBI should have access to assured sources of
concessional funding from the RBI.

Financial institutions have historically played a very significant role in


financing the long-term requirements of funds of the economy as the
alternative sources of long-term funds, i.e., capital market, particularly debt
segment, had not developed. However, in the recent years significant
developments have taken place in the capital market and as a result the
relative importance of capital market in meeting the long-term requirements
of funds has certainly increased notwithstanding the present depressed
conditions. However, capital market in India has not yet developed to a stage
where it could immediately meet long-term requirement of funds on an
ongoing basis.

There are also constraints on supply of long-term funds. Household sector is


the major source of savings. However, most of the savings in the long-term
instruments, such as, LIC policies, pension and provident funds are still
subjected to heavy pre-emption by the Government of India. Such savings
constitute the largest source of long-term funds for industry in industrial
countries.

It can be argued that the cross-country experience concerning DFIs


(Industrial Bank of Japan, Korean Development Bank and the Development
Bank of Singapore) from the East-Asia region shows that declining
involvement in the term business by DFIs did not adversely affect the
availability of finance for projects. It is necessary to appreciate that, in these
countries, the transition in their role took place against the background of
very high rates of growth in the GDP and domestic savings, strong inflows
of foreign capital and rapid expansion of capital markets. In India, savings
rate and FDI inflows are not as high and capital market, particularly for debt
finance, is yet to be developed. Thus, there are gaps in the long-term finance
which could be met by DFIs as long as the gap exists. At the same time, it is
necessary to recognise that over longer term, DFIs may have to adapt to the
changing needs and move either towards greater specialisation or greater
universalisation - a process that may involve mergers, acquisitions and
diversification.
Insofar as commercial banks are concerned, their asset structure is different
from that of development financial institutions. While banks’ asset portfolio
consists largely of short-term assets, that of DFIs comprises long-term
assets. This difference stems mainly from the reason that banks’ major
sources of funds are of short to medium-term in nature. For instance, as at
end-March 1996 (the latest period for which data are available), term-
deposits with maturity up to 3 years constituted 71.4 per cent of total term
deposits. Deposits with ‘more than 3 years and up to 5 years’ maturity
constituted 16.9 per cent and those with maturity ‘above 5 years’ constituted
11.7 per cent. Predominance of short to medium-term deposits of banks
constrain their ability to enlarge long-term commitments on a large scale.
Term transformation by the banking system is kept within the prudent limits
by the RBI.

Further, over the years, DFIs have emerged as the pre-eminent source of
expertise and experience in term-lending and have developed considerable
specialisation in project formulation, risk management and project
monitoring.

Developing capabilities necessary for term-lending is a costly and time-


consuming process. For this reason, it is also beyond the resources of many
small and weak bank participants.

Likewise, capital markets also cannot be relied upon to provide project


finance adequately due to lack of a well-developed long-term debt market in
the country. All of this is likely to lead to significant under-supply of term-
lending activity in the event of DFIs moving away from it prematurely.

Banks have played an important role in mobilisation of financial savings of


the household sector and purveying of credit on short and medium term
basis not only for agriculture, trade and industry but also for small-scale
industries and weaker sections of the society. DFIs were set up
with a specific mandate to provide long term finance to industry, agriculture,
housing, trade and commerce and these institutions operate mainly in the
urban and metropolitan centres. Drastic changes in their respective roles at
this stage may have serious implications for financing requirements of funds
of crucial sectors of the economy. Given the unique position of DFIs in
relation to term-lending at this stage, it is desirable that they remain engaged
in term-lending activity even as they diversify into new opportunities opened
to them by progressive desegmentation of the sector.
At the same time, it is necessary to recognise that the role of DFIs, in an
increasingly market-oriented economy, will have to be redefined, i.e.,
differentiating clearly supervisory, refinancing, investment banking and
other functions on the one hand, and specialised activity and universal
banking on the other. Indeed, the real challenges for a DFI in due course are,
as envisaged by the Narasimham Committee, to decide whether to be an
NBFC or a bank and managing of transition, i.e., how to transform itself to
be either of the two. Similar logic would be equally applicable to State level
institutions except that their constitution under a statute limits flexibility in
transition.

ROLE OF BANKS AND DFIs - OPERATIONAL ISSUES

DFIs traditionally had access to long-term sources of funds in the form of


Government guaranteed bonds and LTO Funds of the RBI. After these
sources were withdrawn in the early 1990s, DFIs started raising resources
from the capital market largely by way of debt. In order to provide them
with some flexibility in their resource management, DFIs were given access
to term deposits, CDs and the term money market within the limit stipulated
for each institution and under some other terms and conditions.
Subsequently, instrument-wise limit was replaced with an umbrella limit
(comprising term deposits, CDs, borrowings from the term money market
and inter-corporate deposits) linked to net owned funds (NOF) in respect of
select DFIs. The maturity period of term deposits was stipulated from 1 to 5
years and those of CDs from 1 to 3 years. Borrowings from the term money
market were allowed in a maturity range of 3 to 6 months.

The KWG recommended that overall ceiling for DFIs’ mobilisation of


resources by way of term money borrowings, Certificate of Deposits (CDs),
term deposits and inter-corporate deposits at 100 per cent of NOF of DFIs
may be removed. The maturity ceiling of five years on deposits from the
public, the capping of interest rate on deposits of DFIs at interest rates
offered by SBI for similar maturities and the restriction relating to minimum
size of deposits that may be accepted by DFIs may also be removed. The
current restriction with regard to premature withdrawal not being permitted
for two years may be reduced to one year. With the introduction of the above
relaxations and having regard to the minimum maturity of one year for fixed
deposits from the public, the KWG recommended that a suitable level of
SLR may be stipulated for DFIs on incremental outstanding fixed deposits
raised from the public (excluding inter-bank deposits). It recommended that
CRR should not be applicable to DFIs under the present structure where they
are not permitted to access cash and cash-like instruments.

The KWG recommended that


(a) the application of CRR should be confined to cash and cash-like
instruments;

(b) CRR should be brought down progressively within a time bound


frame to international levels;

(c) SLR should be phased out in line with international practice; and

(d) definition of priority sector should be widened to include the whole


industry/class of activities.

Infrastructure lending should not be included in ‘net bank credit’ while


computing priority sector obligations. To facilitate efficient loan disbursals,
the priority sector obligations should be linked to the net bank credit at the
end of the previous financial year.
In addition, the KWG recommended that banks may be permitted to exclude
from group exposure limit its investments in SLR securities issued by DFIs.
A Standing (co-ordination) Committee be set up on which banks and DFIs
would be represented. DFIs should be granted full Authorised Dealer’s
licence.

To manage risks, the KWG recommended

(a) a prudent risk-return optimisation strategy;

(b) a clear strategy approved by the Board of Directors as to their risk


management policies and procedures; and

(c) an integrated treasury and pro-active asset-liability management and


robust (internal) operational controls.

It recommended that IT systems and MIS of international standards be


stablished. In respect of human resources management, the KWG
recommended
(a) prescient management and leadership with accent on teamwork;

(b) broad-based recruitment both at entry level from campus as well as


lateral entry of professionals at higher levels;

(c) systematic training programme;

(d) skill building and upgradation;

(e) market-related compensation packages;

(f) viable and enforceable exit option for employees; and

(g) special vigilance machineryexclusively for the financial sector on the


lines of Serious Frauds Office (SFO) in the UK.

The above recommendations may be broadly divided into the following:

(a) DFIs’ access to short-term funds, cap on interest rates and access to
money market;
(b) Statutory obligations, viz., CRR, SLR, risk weights and exposure norms;

(c) Directed credit, viz., priority sector lending;

(d) Authorised Dealer’s licence;

(e) Risk management issues;

(f) Internal management issues, such as, Information Technology, MIS and
HRD.

Statement 8 gives, in a summary form, the current status in regard to each of


them. It is clear therefore that discernible progress has been made with
respect to some of the recommendations of the KWG and the Narasimham
Committee, both with respect to banks and DFIs. These are:

a) SLR has been reduced and brought to the statutory minimum level of
25 per cent. CRR has also been reduced, but moving to the statutory
minimum of 3 per cent is a medium to long-term goal. Any further
reduction in CRR will depend on the fiscal, monetary and exchange
rate situation.

b) prudential norms, which comprehensively cover banks have been


introduced. As regards DFIs, asset classification and provisioning
norms as well as exposure norms relating to a single/group of
borrowers have been introduced.

c) draft Asset-Liability Management (ALM) guidelines have been


finalised in discussion with banks. In regard to DFIs, draft ALM
guidelines are under preparation in consultation with DFIs.

d) with regard to enhancing and rationalising access to short-term funds


for DFIs, the matter is being resolved through discussion with DFIs.

e) technology issues are being accorded top priority in banks and DFIs.
The RBI is in the process of expediting the installation of VSAT
network. The RBI is also monitoring Y2K compliance. Commrecial
banks are also being encouraged to put in place risk management
systems, which will be formalised when the ALM system is
introduced.
REGULATORY, SUPERVISORY AND OTHER RELATED ISSUES

The KWG recommended a function-specific regulatory framework that


targets activities and is institutional-neutral. In view of the increasing
overlap in functions being performed by various participants in the financial
system, the KWG recommended the establishment of a ‘super-regulator’ to
supervise and coordinate the activities of these multiple regulators in order
to ensure uniformity in regulatory treatment.

It also recommended that the Supervisory Authority should undertake


primarily off-site supervision based on periodic reporting by the banks or
DFIs as the case may be. On-site supervision should be undertaken only in
exceptional cases, mainly to oversee the quality of self regulation by
financial sector participants. The assistance of statutory auditors may be
taken by the Supervisory Authority to get special reports on selected areas of
supervision every year. The emphasis of the supervisory system should be
more on macro-management and health of the institution rather than on
micro-level regulation at the individual transaction/account level.

It recommended that the banks/DFIs should be supervised on a consolidated


basis. Future accounting standards must consequently include rules on
consolidated supervision for financial subsidiaries and conglomerates.
Further, as domestic financial entities assume an international character,
banking supervisors should adopt global consolidated supervision (instead of
mere national regulation). For meaningful consolidated supervision – both
domestic and global – the Group recommended the development of a “risk-
based supervisory framework” along the lines of the Report of the Task
Force on Conglomerate Supervision, published by the Institute of
International Finance, in February 1997.

The KWG recommended that the State level institutions should be brought
under the supervisory ambit of the RBI.

The Narasimham Committee observed that an integrated system of


regulation and supervision be put in place to regulate and supervise the
activities of banks, financial institutions and non-bank finance companies
(NBFCs) and the agency (Board for Financial Supervision) be renamed as
the Board for Financial Regulation and Supervision (BFRS). For effective
supervision, it observed that there is a need for formal accession to ‘core
principles’ announced by the Basle Committee. It observed that the
supervisory function over rural financial institutions has been entrusted to
NABARD. While this arrangement may continue for the present, over the
longer-term, the Committee suggested that all regulatory and supervisory
functions over rural credit institutions should vest with the Board for
Financial Regulation and Supervision (BFRS).

As long as DFIs were mostly instruments of providing capital in line with


plan priorities and industrial licensing regime of the Government of India,
funded through concessional sources, they were not subject to market
discipline or the RBI’s supervisory regime. It was in 1990 that the RBI
started overseeing the operations of major all-India financial institutions for
bringing about better functioning of the financial system and to achieve
greater coordination between banks and financial institutions. In March
1994, the RBI prescribed prudential guidelines relating to income
recognition, asset classification and provisioning and capital adequacy
standards to major DFIs.

The regulatory and supervisory regimes for DFIs and banks differ, the main
features are summarized in Statement 9. In view of the recommendation of
the Narasimham Committee that DFIs have to be either NBFCs or banks, the
Statement 9 indicates the regime for NBFCs also. The salient features are
listed below:

a) banks are required to obtain a license to commence business.


DFIs/RFIs barring ICICI were set up under the Acts of Parliament.
Though ICICI was set up as a company under the Companies Act,
1956, it was notified as a ‘public financial institution’ under Section
4A of the Companies Act. IRBI and IFCI have since become
companies. Thus the status of DFIs in this respect is rather nebulous.
NBFCs are public limited companies under the Companies Act, 1956.

b) Second, asset classification and provisioning norms replacing the


health code system for banks exist since April 1992. These norms for
DFIs and NBFCs were prescribed in 1994.
c) banks and DFIs/RFIs are required to maintain 8 per cent risk weighted
capital adequacy ratio. This ratio has been increased to 9 per cent to
be achieved by March 31, 2000. NBFCs are required to maintain a
capital adequacy ratio of 12 per cent with effect from March 31, 1999.

d) exposure norms have been prescribed for banks/DFIs and NBFCs.

e) currently, while CRR and SLR have been prescribed for banks, there
are no such prescriptions for DFIs. NBFCs too have liquid asset
prescription.

f) while banks have prescription for priority sector advances, there is no


such prescription for DFIs and NBFCs.

g) with regard to banks, ALM guidelines are being finalised. In respect


of DFIs, guidelines are being finalised in consultation with them.

h) banks are subject to on-site and off-site supervision. DFIs have been
brought under BFS but off-site supervision is yet to be put in place.
The on-site supervisory approach for banks and NBFCs is structured
on the basis of CAMELS. This rating system is yet to be put in place
for DFIs.

NEW AGE OF UNIVERSAL BANKING IN INDIA

A universal bank is a ‘one-stop’ supplier of all financial products and


services such as deposits, short-term and long-term loans, insurance,
investment banking, etc. Global experience with universal banking has been
varied. After the banking crisis of 1930s, the US banned all forms of
universal banking through what is known as the Glass-Steagal Act of 1933.
This prohibited commercial banks from investment banking activities,
taking equity positions in borrowing firms, selling insurance products etc.
The idea was to discourage risky behaviour by restricting commercial banks
to their traditional activity of accepting deposits and lending.

However, universal banking has been prevalent in different forms in many


European countries, such as Germany, Switzerland, France, Italy, etc. Banks
like ABN-AMRO, BNP Paribas, and Deutsche Bank have been universal
banks for a long time. Nevertheless, the United States once again started
moving cautiously towards universal banking through the Gramm-Leach-
Bliley Act of 1999 which rolled back many of the earlier restrictions. This
resulted in the grand merger of Citicorp (banking group) with Travelers
(insurance group).

Scenario in India has also changed after the Narasimham Committee (1998)
and the Khan Committee (1998) reports recommended consolidation of the
banking industry through mergers, and integration of financial activities.
Today, the shining example is ICICI Bank, second largest bank (in India) in
terms of the size of assets, which has consolidated all the services after the
merger of ICICI Ltd with ICICI Bank. There are rumors of merger of IDBI
with IDBI Bank. With the launch of retail banking, Kotak Mahindra has also
embarked on the path of Universal banking. There are many others
following similar path apart from these, with Information Technology
enabling this integration.

But the move towards integration of all financial services and products isn’t
a very smooth one; there are many questions to be answered, and many
regulatory requirements to be met before the formation of such an entity. In
this seminar, we propose to look at how well diversified financial services
companies function, their advantages, and the impact of integration on the
present day brick and mortar banks.

Some analyst argue that the non-banking activities of the universal banks
would increase the efficiency and thus the profitability of the banks while
others predict that this would cause rise in the business risk and hence the
bankruptcy.

Convergence of service /product distribution channels in the universal banks


i.e. services like bancassurance. New dimension(s) in customer relationship
due to the advent of new distribution or delivery channels, and the
consequent loss of human interface. The impact of securtization bill on the
banks and the role of asset reconstruction companies.
Different activities of universal banks come under different regulatory
authority like RBI, SEBI, IRDA and CLB. Universal banks can make equity
investments, give loans, use their voting rights, and even have representation
on the boards of non-financial firms.

Challenges to RBI in effective implementation of monetary policy with the


advent of electronic money that could cross national boundaries with a
mouse click. The challenges faced by old brick and mortar banks with the
emergence of new generation Internet banks. There is a cap of 49% on
equity investments by Foreign Investors in Indian banks. What are the
reasons (if any) for this cap, particularly when there are no such limits on
their investments in other sectors excepting telecom, and insurance.

CHALLENGES AHEAD

(i) Improving profitability: The most direct result of the above changes is
increasing competition and narrowing of spreads and its impact on the
profitability of banks. The challenge for banks is how to manage with
thinning margins while at the same time working to improve productivity
which remains low in relation to global standards. This is particularly
important because with dilution in banks’ equity, analysts and shareholders
now closely track their performance. Thus, with falling spreads, rising
provision for NPAs and falling interest rates, greater attention will need to
be paid to reducing transaction costs. This will require tremendous efforts in
the area of technology and for banks to build capabilities to handle much
bigger volumes.

(ii) Reinforcing technology: Technology has thus become a strategic and


integral part of banking, driving banks to acquire and implement world class
systems that enable them to provide products and services in large volumes
at a competitive cost with better risk management practices. The pressure to
undertake extensive computerisation is very real as banks that adopt the
latest in technology have an edge over others. Customers have become very
demanding and banks have to deliver customised products through multiple
channels, allowing customers access to the bank round the clock.

(iii) Risk management: The deregulated environment brings in its wake


risks along with profitable opportunities, and technology plays a crucial role
in managing these risks. In addition to being exposed to credit risk, market
risk and operational risk, the business of banks would be susceptible to
country risk, which will be heightened as controls on the movement of
capital are eased. In this context, banks are upgrading their credit assessment
and risk management skills and retraining staff, developing a cadre of
specialists and introducing technology driven management information
systems.

(iv) Sharpening skills: The far-reaching changes in the banking and


financial sector entail a fundamental shift in the set of skills required in
banking. To meet increased competition and manage risks, the demand for
specialised banking functions, using IT as a competitive tool is set to go up.
Special skills in retail banking, treasury, risk management, foreign exchange,
development banking, etc., will need to be carefully nurtured and built.
Thus, the twin pillars of the banking sector i.e. human resources and IT will
have to be strengthened.

(v) Greater customer orientation: In today’s competitive environment,


banks will have to strive to attract and retain customers by introducing
innovative products, enhancing the quality of customer service and
marketing a variety of products through diverse channels targeted at specific
customer groups.

(vi) Corporate governance: Besides using their strengths and strategic


initiatives for creating shareholder value, banks have to be conscious of their
responsibilities towards corporate governance. Following financial
liberalisation, as the ownership of banks gets broadbased, the importance of
institutional and individual shareholders will increase. In such a scenario,
banks will need to put in place a code for corporate governance for
benefiting all stakeholders of a corporate entity.

(vii) International standards: Introducing internationally followed best


practices and observing universally acceptable standards and codes is
necessary for strengthening the domestic financial architecture. This
includes best practices in the area of corporate governance along with full
transparency in disclosures. In today’s globalised world, focusing on the
observance of standards will help smooth integration with world financial
markets.
CONCLUSION

The face of banking is changing rapidly. Competition is going to be tough


and with financial liberalisation under the WTO, banks in India will have to
benchmark themselves against the best in the world. For a strong and
resilient banking and financial system, therefore, banks need to go beyond
peripheral issues and tackle significant issues like improvements in
profitability, efficiency and technology, while achieving economies of scale
through consolidation and exploring available cost-effective solutions. These
are some of the issues that need to be addressed if banks are to succeed, not
just survive, in the changing millenium.

BIBLIOGRAPHY

Books

 Khan M Y, “Indian Financial System”, Tata McGraw Hill,2000.

 Francis J C, “Investment analysis and Management”, Tata McGraw


Hill, 1991.
 Committee on Banking Reforms (Narasimham Committee II) Report,
1998.

 Development Research and Policy division, Financial Sector Reforms


In Selected Asian Countries (1999a).

 Sengupta A., “Financial Sector And Economic Reforms In India”,


Economic and political weekly, 1995.

 Soesastro, H, and M.C. Basri, “ Survey of Recent Economic


Developments “ Bulletin of Indonesian Economic Studies, 1998.

 Reserve Bank Of India, Report of the Narasimham Committee on


Financial System, 1991.

 Reserve Bank Of India, RBI Annual Report (Various issues).

SITES

 www.rbi.org.in
 www.indiainfoline.com
 www.icici.com
 www.idbi.com
 www.ifci.com
 www.economictimes.com
 www.businessindia.com
 www.domain-b.com
 www.businessstandard.com