Submitted by: Group 6

Banking in India: Issues and challenges

IntroductionIndia has a fast-growing banking system. It has the potential to become the fifth largest banking industry in the world by 2020 and the third largest by 2025, according to an industry report. The face of Indian banking has changed over the years. Banks are now reaching out to the masses with technology to facilitate greater ease of communication, and transactions are carried out through the Internet and mobile devices. The reforms of the Indian financial system are the relevant factor of all these important changes and this growth thanks to the creation of the Reserve Bank of India (RBI) in 1991. Indian banking system saw the increased involvement of Private Banks sector (19, 8% in 2004) and deposits (17, 5% in 2003). Moreover, the greatest development in this financial system is certainly retail banking with the growth of service sectors like information technology or health care. But, even if there are lot of successes this last decade, the banking system in India should meet new challenges posed by the technology and any other external and internal factors like regulatory practices as risk management, consolidation, skilled manpower, overseas expansion, skilled manpower, Non-Performing Assets (NPAs) or consumer protection. So, this analysis will be about highlighting all issues and challenges that Indian Banking system has to face.

The major challenges faced by the Indian banks are in terms of increased competition, increased regulation, regaining balance sheet strength, managing the NPAs and leveraging on the information technology to satisfy the changing customer demand. Following is a brief look into the different challenges and issues faced by the Indian banks

Risk management and BASEL II reformsUnder the Basel reforms the banks need to maintain a capital specified under the minimum capital requirement as specified in the reforms. The supervisory review process requires all banks to develop internal capital assessment programs to ensure they have adequate capital to meet contingencies while maintaining a minimum buffer. It also calls for market discipline that ensures a system for disclosure with specified intervals.

Reaching the Indian consumerThe Indian consumer is no longer concentrated in the top 10 cities of the country but in the towns and rural areas as well. Banks need to build an extensive network and devise ways to tap into this set of potential customers. Also, with the changing banking needs of the consumer a bank needs to come up with a full product offering from saving deposit accounts to internet banking and automobile and housing loans.

Revolution in information technologyBanks need to leverage on the information technology revolution that has hit the market. Technology can be used effectively to service different customer segments of the bank by offering convenience to the retail customer and generate operational efficiencies for large scale corporate and government clients. The use of right technology will help the bank be cost effective, maintain high service and efficiency standards while delivering sustainable returns.

Local and foreign competitionThe lower entry barriers have led to increased competition from new players such as private banks, NBFCs and the shadow-banking sector.There are around 36 foreign banks operating in India. The competition from the foreign players after the liberalization stage is a challenge to the nationalized and the private sector banks in India. This intense competition calls for customer centric policies and customer friendly procedures.

Financial inclusionSeveral measures like no-frills accounts, PSL GCCs for small deposits and credits introduced by the RBI further add to the cost base and operational burden of the banks. The branch requirement specified by the RBI in rural areas also cuts into the profit margins of banks.

High transaction costsThe creation of NPAs on the banks balance sheet has caused an increase in the carrying costs of the bank. The growth in NPAs has led to drags in the operational efficiency of banks and a growing NPA portfolio on their balance sheets.

Manpower requirementAs per a recent McKinsey report, the banking sector will face shortage of skilled manpower in the next five years. With increase in competition, there is poaching of skilled employees by competition,which makes the current employees pay higher salaries. This is another drag on the profitability of the bank.

Need for Consolidation: Indian Economy has grown at a steady pace since the launch of economic reforms in 1991 India is predicted to emerge as a global economic power in the future Currently only 6 banks feature in the The Bankers List of the top 500 banks in the world The combined assets of the top 5 Indian Banks was less than that of the largest Chinese Bank, which is roughly 7.8 times the size of SBI Even in Asia, only SBI features in top 25 (Tier I capital)

Benefits of Consolidation: Reduction in costs through rationalization of manpower, operational overheads and expenses on product development and delivery Greater geographical coverage and wider access to markets Risk reduction through diversification of loan portfolios

Overseas Expansion: Indias share in global trade was 0.8% which grew to 15% with the growth in IT. Banks have very keenly tapped up this growth from international expansion by taking some of these initiatives: SBI acquired a 51% stake in Mauritius-based Indian Ocean International Bank Ltd. It is also looking for acquisitions in African and Asian markets PNB has acquired stakes in banks in Bangaladesh, Nepal and Kabul Bank of Baroda derives 25% of its profits from operations in UK< Singapore, Emirates, Thailand and Singapore ICICI acquired Investitsionno-Kreditny Bank to gain entry into Russia

Technology to Consumer protection: Consumer protection involves robust resolution mechanism for client management issues, identifying patterns indicating potential problems and responding promptly to customer complaints. Post Enron collapse and subprime mortgage crisis, regulating authorities have laid down guidelines to ensure consumer protection with extensive use of technology. Information security programs and measures include risk assessment and mitigation plans, steps to maintain customer privacy policy and authentication& verification of its customers among a host of other activities. Electronic and Mobile banking has provided plethora of opportunities to enhance financial inclusion of the population devoid of a place in formal financial markets. Implementation of various monitoring mechanisms can detect unlawful intrusions into customers or banks accounts. Audit logs stored in databases enable careful inspection of all unwanted activities. Mobile banking is fraught with avenues that are prone to exploitation. Appropriate processes like consumer awareness program to educate consumers about their rights and duties. Use of technology has helped in reducing operational risks while securing logs in databases for future use. Incorporation of two-step identification process has provided to control identity theft and fraud in transactions. Use of technology to establish customer identity allows banking institutions to provide various services to customers. Following guidelines are to be followed by the banking institutions to ensure consumer protection: Risk Management and Internal Control Account Origination and Customer Verification Monitoring and Reporting of E-banking Transactions Disclosure and Business Availability Consumer Awareness Program Complaint Resolution In case of wire-lessbanking, followingsecuritymeasures areimprative: Implement adequate security controls on internal network Encryption technologies IT personnel training Due diligence in evaluating service providers Independent audit, Penetration tests and vulnerability tests

Future Outlook:The Indian Banking Association(IBA) had projected that the total assets size of the Indian banking to more than double from 2003 to 2010 and the projections did not disappoint.

The last decade was impressive for the Indian banking industry Growth with rising profitabilityRemarkableimprovement in financialmetrics: Improvement in return on assets, operationalefficiency, stable margins

Ten Major Trends that will Shape the Indian Banking Industry1. Mortgages to cross Rs 40 trillion by 2020:The total mortgages in the books of the banks have grown from 1.5 percent to 10 percent of the total bank advances, in a period of ten years. If by 2020, this ratio were to reach 20 percent, a number similar to that of China, we could expect the mortgage industry growing at an average rate of over 20 percent during the next decade. The outstanding mortgages are expected to cross Rs 40 trillion which is higher than the entire loan book of the banking industry pegged at Rs 30 trillion.

2. Wealth management will be big business with 10X growth:Going forward, wealth is expected to get further concentrated in the hands of a few. As illustrated in Exhibit 1d, the top band of income distribution is expected to grow most rapidly over the next decade.

3. The Next Billion will be the largest segment:The fact that the income group right below the middle class in the annual house hold income range of Rs 90,000 to Rs 200,000 per annum will be the largest group of customers. These customers will be profitably served only with low cost business models having low break even ticket size of business.

4. The number of branches to grow 2X; ATMs to grow 5X:It is evident that the bank branches and ATMs are by far the most popular channels, despite a decade of promotion of alternate channels. The experience in developed economies also corroborates that branches and ATMs continue to be the critical channels, although certain transactions have shifted to alternate channels.

5. Mobile banking to see huge growth and will redefine transaction banking paradigm:The uptake of internet and call centers is low in all segments other than foreign banks. The penetration of internet and broad band access in India has been low so far. However, with the advent of mobile banking, the access to banking facilities could completely get revolutionized over the next decade.

6. Customer Relationship Management (CRM) and data warehousing will drive the next wave of technology in banks:The average number of banking products per customer in India is significantly lesser than the global benchmarks. There is a significant potential for cross selling amongst all categories of banks in India. Given that cross selling is highly costeffective as compared to all other means of customer acquisition, banks will adopt CRM strategies aggressively in pursuit of costeffective business models described in point 3 above.

7. Banking margins will come under pressure:The next decade will see a dramatic change in margins as the wholesale debt markets deepen and corporate customers access the whole sale markets directly. Further, should the savings bank rate be liberalized, banks will move to a regime of low margins. The Net Interest Margins of the public sector banks has consistently declined and this perhaps reflects in the pessimistic view on future margins adopted by the public sector.

8. New models to serve the Small and Medium Enterprises (SME):As per the results of a survey conducted by FICCI to gauge the level of satisfaction among large, medium and small business customers with regard to banking services; the smallest businesses are most dissatisfied. Due to higher risk and lower ticket size, the SME typically get less attention. Banks are yet to create innovative models to serve SMEs with sufficient and timely credit at the right price. As the yields in large corporate banking falls with further deepening of wholesale debt markets, the banking industry in India will find costeffective ways to serve the SME customers where yields are quite high. The SMEs hope to get the basics good relationship management, fast credit decisions and a complete product range all at one place.

9. Investment banking will grow over tenfold:Investment banking will be among the fastest growing segments in the banking industry rising from 4 percent to 7 percent of the entire corporate banking revenue pool. The larger corporate customers expect to demand higher support for international expansion and mergers and acquisitions over next decade. Further, as the wholesale debt markets deepen, the larger corporates would avail of advisory and capital market services from banks to access capital markets. The revenue pool will shift from traditional corporate banking to investment banking and advisory. Banks with international presence stand to benefit.

10. Infrastructure financing to hit over Rs 20 trillion on commercial banks books:As India continues to rely on private funding for infrastructure development, infrastructure will occupy a larger share of the balance sheets of about 12-15% of the total advances of a bank. Half of the debt finance for infrastructure today comes from banks. Even as the asset liability mismatch issues are resolved by IIFCL and the government, the real challenge for banks would be to develop skills to undertake the risks of long gestation infrastructure projects and manage concentration risk in infrastructure.

Two Challenges of the Decade1. Financial inclusion:The issue of financial inclusion is at the centre stage of the agenda of the government. While the expectation from banks is high, the government is also starting to look at non banking industries to come forward with a solution. Needless to say, if the answer does not come from banking industry, non banks will be welcome to nibble at its revenue pool. It is a strategic priority given that the customer segment in question will be the largest in number over the next decade and banks stand to lose this relationship. 2. The HR challenge in the public sector:The public sector banks enter the next decade with the same expectations as their private sector peers but with a severe disadvantage in human resources. The HR challenge of public sector banks has reached a tipping point. Due to a legacy of several decades, the public sector banks will witness unprecedented loss of skills and competencies in form of retiring senior and middle management executives over the next few years. That coupled with the need for large scale reskilling, attracting and retaining fresh talent, controlling the growing employee costs, and introduction of performance discipline are significant challenges.

References:http://www.iosrjournals.org/iosr-jbm/papers/Vol16-issue2/Version-1/G016215261.pdf

Banking in India Issues and Challenges for the Future, ICMR, IBS Center for management research

Uppal R.K., Customer Perception of E Banking Services of Indian Banks: Some Survey Evidence, The ICFAI Journal of Bank Management

http://vikalpa.com/pdf/articles/2003/2003_july_sep_83_99.pdf