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, disinter mediation 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."

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.

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.

"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%.

THE CONCEPT OF UNIVERSAL BANKING

The entry of banks into the realm of financial services was followed very soon after the

introduction of liberalization in the economy. Since the early 1990s structural changes of

profound magnitude have been witnessed in global banking systems. Large scale mergers,

amalgamations and acquisitions between the banks and financial institutions resulted in the

growth in size and competitive strengths of the merged entities. Thus, emerged new financial

conglomerates that could maximize economies of scale and scope by building the production of

financial services organization called Universal Banking.

By the mid-1990s, all the restrictions on project financing were removed and banks were allowed

to undertake several in-house activities. Reforms in the insurance sector in the late 1990s, and

opening up of this field to private and foreign players also resulted in permitting banks to

undertake the sale of insurance products. At present, only an 'arm's length relationship between a

bank and an insurance entity has been allowed by the regulatory authority, i.e. IRDA (Insurance

Regulatory and Development Authority).

The phenomenon of Universal Banking as a distinct concept, as different from Narrow Banking

came to the forefront in the Indian context with the Narsimham Committee (1998) and later the

Khan Committee (1998) reports recommending consolidation of the banking industry through

mergers and integration of financial activities.

Definition of Universal Banking: As per the World Bank, "In Universal Banking, large

banks operate extensive network 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".

According to Saunders, Anthony. A and Walter Ingo, 1994 Universal banking is defined as

“the conduct of range of financial services comprising deposit taking and lending, trading of

financial instruments and foreign exchange (and their derivatives) underwriting of new debt and

equity issues, brokerage investment management and insurance”.

Universal banking helps service provider to build up long-term relationships with clients by

catering to their different needs. The client also benefits as he gets a whole range of services at

lower cost and under one roof.

In a nutshell, a Universal Banking is a superstore for financial products under one roof.

Corporate can get loans and avail of other handy services, while can deposit and borrow. It

includes not only services related to savings and loans but also investments.

However in practice the term 'universal banking' refers to those banks that offer a wide range of

financial services, beyond the commercial banking functions like Mutual Funds, Merchant

Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans, Investment

banking, Insurance etc. Universal Banking is a multi-purpose and multi-functional financial

supermarket (a company offering a wide range of financial services e.g. stock, insurance and

real-estate brokerage) providing both banking and financial services through a single window.

This is most common in European countries.For example, in Germany commercial banks accept

time deposits, lend money, underwrite corporate stocks, and act as investment advisors to large

corporations. In Germany, there has never been any separation between commercial banks and

investment banks, as there is in the United States.

Universal banking is a combination of commercial banking, investment banking and various

other activities, including insurance. It seeks to provide the entire gamut of financial products

under one roof and reflects the global convergence between commercial banks, investment

banking and insurance companies. The convergence is an attempt by banks to fulfill the lifelong

needs of the customer by following the cradle-to-grave concept. Commercial banks have a long-

term relationship with their customers when compared to other financial intermediaries.

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.

Universal Banking, means the financial entities – the commercial banks, Financial Institutions,

NBFCs, - undertake multiple financial activities under one roof, thereby creating a financial

supermarket. The entities focus on leveraging their large branch network and offer

wide range of services under single brand name. 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.

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.

Universal banking generally takes one of the three forms:

a. In-house Universal banking. Eg. Germany, Switzerland

BANK

Securities Investments Mutual funds Insurance

Underwriting Advisory

b. Through separately capitalized subsidiaries. Eg. England, Japan.

Bank

Subsidiary

c. Operations carried through a holding company ,Eg. USA, Japan

Bank Holding Company

Securities

History Of Universal Banking

Economic historians have long emphasized the importance of financial institutions in

industrialization. More recently, economists have begun more intensive investigation of the links

between financial system structure and real economic outcomes. In theory, the organization of

financial institutions partly determines the extent of competition among financial intermediaries,

the quantity of financial capital drawn into the financial system, and the distribution of that

capital to ultimate uses. The choice between universal and specialized banking may affect

interest rates, underwriting costs, and the efficiency of secondary markets in securities.

Furthermore, the presence or absence of formal bank relationships may affect the quality of

investments undertaken, strategic decision-making, and even the competitiveness of industry.

Thus, financial systems theoretically can influence the costs of finance at two levels: general

effects on the economy as a whole and localized influences on individual firms and industries.

Modern problems in developing and transitional economies, diminishing regulatory barriers in

the United States, and progressive economic integration in western Europe make it all the more

important to understand the economic impact of financial system structure.

Particularly since World War II, many economists and historians have argued that

German-style banks offer advantages for industrial development and economic growth.

Universal banking efficiency combined with close relationships between banks and industrial

firms, they hypothesize, spurred Germany's rapid development at the end of the nineteenth

century and again in the post-World War II reconstruction. A corollary to this view holds that

countries that failed to adopt the universal-relationship system suffered as a consequence.

Adherents suggest that British industry has declined over the past hundred years or more, and

that the American economy has failed to reach its full potential, due to short-comings of the

Bank

financial system that lead to relatively high costs of capital (Kennedy, 1987, Chandler, 1990, and

Calomiris, 1995).

In the 1990s, however, recession and bank-related scandals in Germany raised doubts about the

benefits of universal banking systems. Even more recently, the introduction of the Euro seems

to have brought the so-called bank-based systems a wave of market-oriented finance: IPOs,

hostile takeovers, and corporate bond issues. Likewise, recent research questions many common

beliefs about the organization and impact of the universal banks in the post-World War II

German economy (Edwards and Fischer, 1994). Yet in the heat of the furious `battle of the

systems,' large-scale international comparisons reveal no consistent relationship between

financial system design and real economic growth in the late twentieth century (Levine, 2000).

India followed a very compartmentalized financial intermediaries allowed to operate strictly in

their own respectively fields. However, in the 1980s banks were allowed to undertake various

non-traditional activities through subsidiaries. This trend got momentum in the early 1990s i.e.,

after initiation of economic reforms with banks allowed to undertake certain activities, such as,

hire-purchase and leasing in –house. While this in a way represented a gradual move towards

universal banking, the current debate about universal banking in India started with the demand

from the DFIs that they should be allowed to undertake banking activity in-house. In the wake of

this demand, the Reserve Bank of India constituted in December 1997, a working group under

the chairmanship of Shri S.H. Khan, the Chairman & the Managing Director of IDBI (hereafter

referred to as Khan Working Group-KWG). The KWG, which submitted its report in May 1998,

recommended a progressive move towards universal banking. The Second Narsinham

Committee appointed by Government in 1998 also echoed the same sentiment. In January 1999,

the Reserve Bank issued a Discussion Paper setting out issues arising out of recommendations of

the KWG and the Second Narsinham Committee. Since then a debate has been going on about

universal banking in general and conversion of DFIs into universal banks in particular. With the

opening up of the insurance sector to the private participation, the debate has gone beyond the

narrow concept of universal banking.

UNIVERSAL BANKING IN SELECTED COUNTRIES

1) 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.

2) 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. 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 organization to combine these activities.

3) The competition in the banking industry has intensified following financial

deregulation and innovations and introduction of new information technologies.

4) 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 [Borio and Filosa, 1994]. 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 practices and institutional structure as well.

5) Universal banking usually takes one of three forms, i.e., in-house, through separately

Capitalized 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. 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.

Statement 1: Universal Banking Practices in Select Countries

Type of UniversalBanking

Features Countries Practicing Position in India

(1) (2) (3) (4)

I. Narrow Universal Banking

Combination of commercial banking and investment bank- ing, i.e., issuing, underwriting, investing and trading securities.

In India, presently there are no restrictions on banks’ investments in preference shares/non-convertible debentures/bonds of private corporate bodies. Banks are also allowed to invest in corporate stocks. However, such investments are

a) In-house Australia, Austria, Denmark, Finland,

France, Germany, Hong Kong@, Pakistan#, Poland, Sweden, Switzerland

restricted to 5 per cent of incremental deposit of the previous year. Banks are also allowed to underwrite, subject to the limit of 15 per cent of the issue size. In case there are devolvement and the aforementioned 5 per cent limit is exceeded, banks are required to offload the excess holdings. Banks are also allowed to own 100 per cent investment banks and undertake mutual fund activity through separate entities.

b) Through conglomerate route (By setting up subsidiaries)

Brazil, Canada, China, Japan@@, Korea, Mexico, Netherlands, New Zealand, Norway$, Thailand, U.K.

c) Permitted to some extent

Chile*, Belgium

Like-wise, DFIs which have traditionally been engaged in the medium to long-term financing have recently started undertaking short-term lending including working capital finance. They have also been allowed to accept short to medium-term deposits in the form of term deposits and CDs, albeit within limits. DFIs have also set up subsidiaries for undertaking banking and various other activities. For instance, IDBI and ICICI have already set up banking subsidiaries and mutual funds, besides setting up subsidiaries in the field of investor services, stock broking registrars’ services. IFCI has also set up subsidiaries for undertaking merchant banking, stock broking, providing registrars’ services, etc.

d) Not permitted In U.S., banks are permitted to deal in government securities; stock brokerage activities are also generally permitted; however, corporate securities underwriting and dealing activities must be conducted through specially authorised affiliates, which must limit such activities to 10 per cent of gross revenues.

Unit Trust of India, which has characteristics of both a mutual fund, and Development Financial Institution under a statute, also has a banking subsidiary. HDFC, a non-banking financial company (NBFC) has also set up a commercial bank.

@ Except for limitation on shareholding in certain listed companies and subject to limits based on the capital of the bank.

# Except for some specifically disallowed securities.@@ Except for equity brokerage for the time being.

$ Stock brokerage activities need no longer be conducted in separate subsidiaries.* Certain activities through subsidiaries.

Statement 1: Universal Banking Practices in Select Countries

Type of Universal

Features Countries Practicing Position in India

Banking(1) (2) (3) (4)

II. Broad Universal

Combination of commercial banking, investment banking and various other

activities including insurance.

Banking

a) In-house Hongkong**, Poland, Sweden

Australia, Austria, Belgium, Brazil,

Canada, China, Den- mark, France, Germany,

Mexico, Netherlands, New Zealand, Norway, Portugal, Singapore##,

Thailand, Spain, Switzerland, U.K.

Presently insurance business in India is

allowed only by LIC, GIC and itssubsidiaries.

b) Through conglomerate

route (By setting up

subsidiaries).

c) Permitted to some extent

Italy***

d) Not permitted Chile, Japan, Korea, Pakistan,

Panama, Peru, U.S.$$

** Subject to limits based on the capital of the bank.## Locally incorporated banks may own insurance company with MAS’s approval.*** Limited to 10 per cent of own funds for each insurance company and 20 per cent

aggregate investment in insurance companies.$$ Allowed through a separate holding company.

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.

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].

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 In 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 Of Universal Banking

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.

Profitable Diversions. By diversifying the activities, the bank can use its existing

expertise in one type of financial service in providing other types. So, it entails less cost

in performing all the functions by one entity instead of separate bodies.

Resource Utilization. A bank possesses the information on the risk characteristics of the

clients, which can be used to pursue other activities with the same clients. A data

collection about the market trends, risk and returns associated with portfolios of Mutual

Funds, diversifiable and non diversifiable risk analysis, etc, is useful for other clients and

information seekers. Automatically, a bank will get the benefit of being involved in the

researching .

Easy Marketing on the Foundation of a Brand Name. A bank's existing branches can

act as shops of selling for selling financial products like Insurance, Mutual Funds without

spending much efforts on marketing, as the branch will act here as a parent company or

source. In this way, a bank can reach the client even in the remotest area without having

to take resource to an agent.

One-stop shopping. The idea of 'one-stop shopping' saves a lot of transaction costs and

increases the speed of economic activities. It is beneficial for the bank as well as its

customers.

Investor Friendly Activities. Another manifestation of Universal Banking is bank holding

stakes in a form : a bank's equity holding in a borrower firm, acts as a signal for other

investor on to the health of the firm since the lending bank is in a better position to

monitor the firm's activities.

Disadvantages of Universal Banking

Grey Area of Universal Bank. The path of universal banking for DFIs is strewn with

obstacles. The biggest one is overcoming the differences in regulatory requirement for a

bank and DFI. Unlike banks, DFIs are not required to keep a portion of their deposits as

cash reserves.

No Expertise in Long term lending. In the case of traditional project finance, an area

where DFIs tread carefully, becoming a bank may not make a big difference to a DFI.

Project finance and Infrastructure finance are generally long- gestation projects and

would require DFIs to borrow long- term. Therefore, the transformation into a bank may

not be of great assistance in lending long-term.

NPA Problem Remained Intact. The most serious problem that the DFIs have had to

encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Universal

Banking or installation of cutting-edge-technology in operations are unlikely to improve

the situation concerning NPAs.

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 IN INDIA

In India Development financial institutions (DFIs) and refinancing institutions (RFIs) were

meeting specific sect oral 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.

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 harmonization 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 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.

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

themselves by offering cash management products, utilising the same branch network! All these

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.

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.

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 (Khan Working Group) 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.

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)

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 license within a stipulated time, it would be categorized 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.

SALIENT OPERATIONAL AND REGULATORY ISSUES OF

RBI TO BE ADDRESSED BY THE FIs FOR CONVERSION INTO

A UNIVERSAL BANK

a) 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.

b) 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..

c) 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.

d) 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.  

e) 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.

f) 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.

g) 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.

h) 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. 

i) Licensing. An FI converting into a universal bank would be required to obtain a banking

license from RBI under Section 22 of the B. R. Act, for carrying on banking business in India,

after complying with the applicable conditions.  

j) 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 least

25 per cent of their total number of branches in semi-urban and rural areas.

k) 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.

l) 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 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.   

m) 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.  

n) 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.

o) Authorized Dealer's License. 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 full-fledged 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.

p) 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.

q) 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).

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

THE TREND OF UNIVERSAL BANKING IN DIFFERENT

COUNTRIES

Universal banks have long played a leading role in Germany, Switzerland, and other Continental

European countries. The principal Financial institutions in these countries typically are universal

banks offering the entire array of banking services. Continental European banks are engaged in

deposit, real estate and other forms of lending, foreign exchange trading, as well as underwriting,

securities trading, and portfolio management. In the Anglo-Saxon countries and in Japan, by

contrast, commercial and investment banking tend to be separated. In recent years, though, most

of these countries have lowered the barriers between commercial and investment banking, but

they have refrained from adopting the Continental European system of universal banking. In the

United States, in particular, the resistance to softening the separation of banking activities, as

enshrined in the Glass-Steagall Act, continues to be stiff.

In Germany and Switzerland the importance of universal banking has grown since the end of

World War II. Will this trend continue so that universal banks could completely overwhelm the

specialized institutions in the future? Are the specialized banks doomed to disappear? This

question cannot be answered with a simple "yes" or "no". The German and Swiss

experiences suggest that three factors will determine future growth of universal banking.

First, universal banks no doubt will continue to play an important role. They possess a number

of advantages over specialized institutions. In particular, they are able to exploit economies of

scale and scope in banking. These economies are especially important for banks operating on a

global scale and catering to customers with a need for highly sophisticated financial services. As

we saw in the preceding section, universal banks may also suffer from various shortcomings.

However, in an increasingly competitive environment, these defects will likely carry far less

weight than in the past.

Second, although universal banks have expanded their sphere of influence, the smaller

specialized institutions have not disappeared. In both Germany and Switzerland, they are

successfully coexisting and competing with the big banks. In Switzerland, for example, the

specialized institutions are firmly entrenched in such areas as real estate lending, securities

trading, and portfolio management. The continued strong performance of many specialized

institutions suggests that universal banks do not enjoy a comparative advantage in all areas of

banking.

Third, universality of banking may be achieved in various ways. No single type of universal

banking system exists. The German and Swiss universal banking systems differ substantially in

this regard. In Germany, universality has been strengthened without significantly increasing the

market shares of the big banks. Instead, the smaller institutions have acquired universality

through cooperation. It remains to be seen whether the cooperative approach will survive in an

environment of highly competitive and globalized banking.

EXAMPLES OF UNIVERSAL BANKING IN FOREIGN COUNTRIES

IN USA: -

1] Chase Manhattan Bank: the reorganization of a universal bank

Chase Manhattan Bank, founded in 1877 in New York, is one of the large money center

banks and , right from the beginning has followed a universal banking strategy, seeking to cover

all the segments of financial intermediation: commercial banking, wholesale banking , money

markets, capital markets, and foreign markets. A major part of Chase Manhattan’s business is

concentrated in lending to large corporations and governments, both in United States and abroad.

After a decade of meteoric growth during 1960s, Chase Manhattan’s performance started to

fall off in the 1970s for external & internal reasons.

One of the external reasons was the ground lost in the North American bond market in the

strong advance by other specialized banks such as Salomon Brothers or Citicorp. One of the

main internal reasons was the lack of consistent strategic vision in the bank, whose efforts were

divided into different businesses.

These circumstances alarmed the bank shareholders and financial community. As a result

of the combination of factors and increasing competition, Chase’s return on assets fell below 0.5

% in the first half of the 1970s. In a way, the situation of Chase Manhattan reflects the

consequences of dramatic changes that took place in the financial system during 1970s –

particularly intense in USA- & the considerable difficulties experienced at that time by the

universal banks (which they continue to experience to adapt to new situation)

The year 1982 was particularly bad one for Chase Manhattan reflects the consequences of

the dramatic changes. The reason was the occurrence of three financial fiascos within a very

short : two loans operations to brokerage companies on North American Public debt market ($

117 million and $42 million, respectively ) and investment in a bank that failed as a result of

energy crisis ($ 161 million).

The perception of the urgent need for a change led to Chase’s senior management to

implement a new action plan in 1985. the purpose of this plan was to strengthen its presence in

commercial and wholesale banking in the united states, leaving the international market

somewhat to one side. To this end, the bank’s executive committee took a series of steps, two of

which we consider particularly important.

First was the purchase of a bank, First Lincoln Corporation of Rochester, New York, with 172

branches, and the purchase of six savings and loan associations, which Chase immediately turned

into commercial banks. The purpose of these actions was to increase market share in the

commercial banking and medium-sized company loans segments. The second measure was to

reorganize the bank into three main areas: retail banking, investment banking, and institutional

banking (including relations with financial institutions, cash management, portfolio management,

and leasing).

However these efforts failed to achieve the hoped-for results. In 1990, the bank’s pretax

income was so low that Chase’s share price on the New York Stock exchange fell to an all-time

low. Rumours of a hostile take-over bid or the advisability of a merger with chemical or

Manufacturers Hanover were rife in 1990. However, with the change of executive management

in 1991, the bank started to climb out of its trough.

This new period opened with three major decisions. The first was the alienation of those

business units that were clearly unprofitable or in which Chase had no particular expertise which

include discontinuation of commercial banking in Europe, which Chase had found unprofitable

and fiercely competitive.

The second decision was to consolidate several business units that were clearly important

for Chase: the retail banking division, which accounted for 50 per cent of the bank’s total

revenues in 1989, and cash management, portfolio management and safekeeping services. The

third decision, which was closely related to the other two, was reorganization of its business into

three units, from which all of the banks were co- ordinate:

a) A commercial banking and retail-banking unit concentrated on the east coast, seeking to

operate with private households and small & medium-sized companies;

b) A retail financial products unit for the entire Unite States, including credit cards, investment

products, mortgages, and financing consumer durables such as automobiles;

c) A general financial services unit, mainly targeting North American companies and chase

customers. This unit was concerned with risk management, portfolio management and

international corporate banking.

Chase’s merger with Chemical Banking will allow the new bank to cut down on costs & gain

market share in some businesses.

2] Citicorp: a global universal bank

Citicorp: First National City Corporation, Citicorp, is the name of the holding company of

a group of financial institutions operating in various segments of the financial industry. This

bank was formed in 1812 and its original name was City Bank of New York. In 1955, it merged

with first National Bank of New York, thus marking the birth of Citicorp.

By the close of the nineteenth century, it was already the largest bank in the United States,

with a tradition of innovation and service acknowledged by corporate customers an rival banks

alike. Before the Great Depression of the 1930s, Citibank had started on a major diversification

of business, entering the capital market, investment banking, and international banking

businesses. However, this diversification process came to a stop when Congress approved the

Glass-Stegal Act.

After the Second World War, innovation in Citicorp, as in the other large American Banks

dropped off considerably. The main reason for this was that the package of regulatory majors

approved in the early 1930s considerably limited the banks penetration into new businesses. In

fact, this restriction was one of the reasons that Citicorp started to promote its international

banking business in the early 1960s, under the influence of its CEO, George Moore. Moore’s

vision consisted of two clear principles. First, give the best possible service to the American

Companies that were starting to expand abroad, particularly in Europe. The aim was to make

Citicorp the naturals choice for those American companies with business abroad. The second

principle was to recruit young professionals with significant entrepreneurial and innovative

potential as a key to developing financial services that the large companies might need.

As a result of this expansion in its financial businesses, the bank started to redefine its

mission: from being a mere financial intermediary, the bank wished to become an organization

that offered all the financial services that another, non-financial organization could possibly

need. This vision of banking would probably be shared nowadays by all banks with a vocation in

universal banking. However, in the early 1960s, this vision was far from common. Bank

redefined its mission from being a mere financial intermediary, to become an organization that

offered all financial services to non-financial organization. The expansion of Citicorp in U.S. and

rest of the world was based on 3 critical actions –

1) Creation of a holding co in 1967, to guarantee that each of the bank’s businesses had the

decentralization.

2) Consolidation of a strong retail banking sales network in US and rest of the world, to

provide all types of financial services to household and private individuals,

3) Penetration of financial markets particularly in exchange market

4) Major investment in information technologies.

George Moore stepped down in 1967 and was succeeded by Walter Wriston, who was

CEO until 1984. Wriston consolidated this strategy under the general formulation, the five I’s:

institutional banking, individual banking, investment banking, information technology, & finally

insurance. John Reed succeeded Wriston in 1984. Until then, Reed had been chairman of retail

banking unit. Then he decided to enlarge the retail-banking unit, in which he had worked

previously, and which was profitable and less risky for Citicorp. In early 1990s, Citicorp was the

US universal bank that offered the most financial services. In credit cards, Citicorp was the top

US bank and the second largest institution, after American Express.

Citicorp’s clout in the financial services world is undeniable. Citicorp can adequately

manage its different businesses in so many geographical markets with the same efficiency as a

local specialist.

IN UNITED KINGDOM ( UK)

BARCLAYS BANK

1.Goldsmith Bankers

Barclay’s origins can be traced back to a modest business founded more than 300 years ago in

the heart of London's financial district.

In the late 17th century, the streets of the City of London may not have been paved with gold,

but they were filled with goldsmith-bankers. They provided monarchs and merchants with the

money they needed to fund their ventures around the world.

John Freame and his partner Thomas Gould in Lombard Street founded one such business in

1690. The name Barclay became associated with the company in 1736, when James Barclay -

who had married John Freame's daughter - became a partner.

2. A new joint-stock bank

Private banking businesses were commonplace in the 18th century, keeping their clients' gold

deposits secure and lending to credit-worthy merchants. In 1896, 20 of them formed a new joint-

stock bank.

A web of family, business and religious relationships already connected the leading partners of

the new bank, which was named Barclay and Company. The company became known as the

Quaker Bank, because this was the family tradition of the founding families.

3. Domestic growth

The new bank had 182 branches, mainly in the East and South East, and deposits of £26 million -

a substantial sum of money in those days. It expanded its branch network rapidly by taking over

other banks, including Bolithos in Cornwall and the South West in 1905 and United Counties

Bank in the Midlands in 1916.

In 1918 the company amalgamated with the London, Provincial and South Western Bank to

become one of the UK's 'big five' banks. By 1926 the bank had 1,837 outlets.

Barclays acquired Martins Bank in 1969, the largest UK bank to have its head office outside

London. And in 2000 it took over The Woolwich, a leading mortgage bank and former building

society founded in 1847.

4. International growth

The development of today's global business began in earnest in 1925, with the merger of three

banks - the Colonial Bank, the Anglo Egyptian Bank and the National Bank of South Africa to

form Barclays international operations. This added businesses in much of Africa, the Middle

East and the West Indies.

In 1981, Barclays became the first foreign bank to file with the US Securities and Exchange

Commission and raise long-term capital on the New York market. In 1986 it became the first

British bank to have its shares listed on the Tokyo and New York stock exchanges.

Barclays' global expansion was given added impetus in 1986 with the creation of an

investment banking operation. This has developed into Barclays Capital, a major division of the

bank that now manages larger corporate and institutional business.

In 1995 Barclays purchased the fund manager Wells Fargo Nikko Investment Advisers. The

business was integrated with BZW Investment Management to form Barclays Global Investors.

5. Recent Developments

Innovation has proceeded apace. The telephone banking service Barclaycall was introduced in

1994 and on-line PC banking in 1997, whilst customized services have also developed with the

introduction of Barclays Private Bank and Premier Banking. In 2001 Barclays formed a strategic

alliance with Legal & General to sell life pensions and investment products throughout its UK

network. Barclays has recently set itself the goal of becoming the employer of choice' and has

led the way in the implementation of equal opportunities policies.

Objectives of the Study

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 objectives of my project are :

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 & SBI.

To determine the Future Role of DFI’s & Various Operational Issues required to be

considered.

Research Methodology

Research in common parlance refers to a search of knowledge. One can also define research as

a scientific and systematic search for pertinent information on a specific topic. Research is, thus,

an original contribution to the existing stock of knowledge making for its advancement.

Research methodology is a way to systematically solve the research problem. Thus,

when we talk of research methodology we not only talk of the research methods but also

consider the logic behind the methods we use in the context of our research study and explain

why we are using a particular method or technique and why we are not using others so that

research results are capable of being evaluated either by the researcher himself or by others. The

study of research methodology gives the student the necessary training in gathering materials

from the various sources.

Here , descriptive and analytical research has been used.

For carrying out this project study, various sources of data were used. The data used were

of two types, i.e. Primary as well as Secondary.

PRIMARY DATA:- This constituted mainly the information provided by my

project guide and interviews conducted at the ICICI Bank, SBI and IDBI.

SECONDARY DATA:- This constituted mainly of information collected through

Internet;

Audited Financial statements of respective organizations.

Various publications of ICICI, IDBI and SBI and related to RBI.

Technical and trade journals to banking industry.

Books and magazines;

Reports and publications of various associations connected with banks, etc

The Following Articles have also helped in understanding the concept while

preparing the project

I)

INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI) LIMITED

Analyst's Meet held on MAY 31, 2002

Universal banking

IDBI is moving towards universal banking and it will take nine to 12 months to complete

the whole process as the IDBI Act will require necessary changes,` said Vora. The

corporatisation of IDBI will provide necessary flexibility in day to day working of the

institution.

IDBI Bank

IDBI is looking out for a strategic partner to offload its equity in IDBI Bank. As of March 31,

2002 IDBI holds 58 per cent in IDBI Bank. `We have set an internal deadline of September

2002 to bring down our stake to 40 per cent and we are in talk with various parties. We could

offload equity in two stages, where we bring down our stake to 44 per cent in the first phase

and to 40 per cent in the second phase,` said Vora.

Vora categorically denied any move to merge IDBI Bank with IDBI.

Financial performance

IDBI reported a 38.64 per cent decline in net profit to Rs 424 crore for the fiscal ended

March 31, 2002, compared to Rs 691 crore in the previous fiscal. Total income decreased

from Rs 8,828 crore to Rs 7,949 crore.

The bank has taken several steps to reduce interest costs by retiring high-cost debt raised

in the past, and raising fresh debt from retail customers. This is reflected in decline in the

marginal and average cost of borrowing.

Total assets as on March 31, 2002 stood at Rs.66,625 crore. IDBI continued to maintain

sound capital adequacy with a capital adequacy ratio (CAR) of 17.66 per cent at end-

March 2002 (15.8 per cent) as against the RBI stipulation of nine per cent. The debt to

equity ratio (including contingent liabilities) also was at 8.6:1.

II)

Sunday 27 January,2002

Universal banking by DFIs: Handy, but no solution to NPAs

UNIVERSAL banking, believed to be the panacea for beleaguered development financial

institutions (DFIs), is almost here. Last October, ICICI set in motion the process to transform

itself into a universal bank.

It was soon followed by IDBI in submitting a universal banking proposal to the regulator, the

Reserve Bank of India. For a while, it appeared that DFIs had finally found a solution to their

problems. Just for a while though. A few days ago none other than the RBI Governor, Mr Bimal

Jalan, publicly suggested that universal banking was unlikely to be the antidote to DFIs'

historical baggage. Now, we are back to asking a basic question: What can universal banking

actually do?

Universal banks

Simply put, a universal bank is a supermarket for financial products. Under one roof, corporates

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 the Indian context have been in the form of a group offering a

variety of services under an umbrella brand such as ICICI or HDFC. Even finance companies

such as Sundaram Finance use the goodwill associated with their brand, and the years of

information and insight, to offer a number of services under an umbrella brand.

Need to move farther

Since ICICI already practices a form of universal banking, the company's decision to merge with

ICICI Bank begs the question, why change the system now? The answer to that question lies in

the complex and messy past of DFIs — in this context ICICI, IDBI and IFCI.

The DFIs were established to assess and finance viable industrial projects that required long-term

funds. The government made available subsidised funds to help carry out on-lending. In the early

1990s, subsidised funding to DFIs was terminated, thereby forcing them to rely on the market for

resources.

ICICI was the earliest to articulate a new strategy to combat the problems. Once loans to

commodity industries began to turn bad, the company's incremental lending was directed at

short-term loans for working capital and retail customers. At the same time, ICICI lobbied for

years to reverse-merge itself with ICICI Bank — a commercial bank promoted by ICICI in

January 1994. Banks, by virtue of collecting savings and time deposits, have the cheapest source

of funds, and a merger with ICICI Bank should help ICICI access the funds at the lowest

possible cost for a commercial entity. After years of lobbying, ICICI took the step to convert

itself into a universal bank last October. IDBI, still owned largely by the Government and subject

to a different set of rules, has begun to work towards a merger with a commercial bank. Though

IDBI has promoted a commercial bank, IDBI Bank, the DFI is believed to be exploring the

possibility of a merger with a state-owned commercial bank.

III)Online edition of India's National Newspaper

Wednesday, Sep 10, 2003

SBI to leverage network to become universal bank

The Asset Reconstruction Company (ARC), jointly floated by SBI, IDBI, ICICI and HDFC, has

identified 11 accounts for acquisition in the first tranche of NPA (non-performing assets) buying.

The size of these assets put together will be around Rs. 6000 crores.

Addressing a press conference here today to mark the computerisation of all branches in Chennai

Circle and also to launch a couple of new products, A. K. Purwar, Chairman of SBI, reckoned

that the ARC would play an `important' role in the resolution of NPAs.

Fielding a range of questions, Mr. Purwar said SBI was doing well so far this year with the retail

business showing a growth of 40 per cent plus. Nonetheless, he said the overall credit growth

was not up to the mark. To a query, he said the retail asset portfolio of the bank was around 18

per cent. The proposal was to take this up to 30 per cent. He, however, was quick to add that he

"does not propose to sacrifice other segments in the bargain".

Responding to questions on RIBs (Resurgent India Bonds), which are coming up for service

soon, Mr. Purwar was confident that the two new products that the SBI had proposed during road

shows abroad would be attractive enough for NRIs (non-resident Indians) to invest. He was

hopeful that SBI would retain at least 35 per cent of the RIB money with it through subscription

to these new products. In his view, the interest rate obtaining in India was far higher to that

prevailing in the U.S. and Europe.

The LIBOR plus dollar rate was around one per cent. The rupee rate was, however, hovering

around 4.5 per cent, he said. To queries on effecting a cut in deposit and lending rates, Mr.

Purwar was unwilling to hazard any guess on the thinking of the bank at this point in time. He

said the bank was "evaluating the situation".

Nonetheless, he pointed to the RBI signals and actions on the ground by some banks vis-a-vis

deposit rates.

On the NPA, Mr. Purwar said there was no clear-cut policy. Yet, the bank, he said, was pining to

reduce the net NPA to 2 per cent by March 2005.

The SBI Chairman said, "We are converting ourselves into a universal bank, leveraging the

distribution network". To a question on associate banks of SBI, Mr. Purwar said they were all

loosely integrated through one technology platform and similar business process. "In the coming

days, there will be much more integration and co-ordination," he said. Questioned on the

possibility of swapping branches between SBI and its associates, he said, "we have not looked at

it now. We may perhaps do it at the right time as it comes along".

Earlier in his opening remark, Mr. Purwar said all the 590 branches had been fully computerised.

Chennai Circle was the third only to be fully automated besides Bangalore and Chandigarh.

He also launched two new products — State Bank Cash Plus and SBI Credit Khazana. State

Bank Cash Plus is a global ATM-cum-debit card, which allows customers to draw cash from

Maestro/Cirru branded ATMs across the globe. The card usage is, however, subject to forex

regulations.

SBI Credit Khazana is a scheme for customers who have availed themselves of housing loans

and regular in serving them. Under the scheme, customers can enjoy lower interest rates and

margins for other retail products of the bank.

India’s Universal banks : Size does matter

I) ICICI -UNIVERSAL BANKING MODEL

India’s First Universal Bank

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.

2003 :

The first Integrated Currency Management Centre launched in Pune.

: The first offshore banking unit (OBU) at Seepz Special Economic Zone, Mumbai, launched.

: Representative office set up in China. : ICICI Bank’s UK subsidiary launched.

: India’s first ever "Visa Mini Credit Card", a 43% smaller credit card in dimensions launched.

2004 : Max Money, a home loan product that offers the dual benefit of higher eligibility and affordability to a customer, introduced.

: Mobile banking service in India launched in association with Reliance Infocomm.

: India’s first multi-branded credit card with HPCL and Airtel launched.

: ICICI Bank introduced 8-8 Banking wherein all the branches of the Bank

would remain open from 8a.m. to 8 p.m. from Monday to Saturday.

2005: "Free for Life" credit cards launched wherein annual fees of all ICICI Bank Credit Cards were waived off.

: ICICI Bank and Visa jointly launched mChq – a revolutionary credit card on the mobile phone.

: ICICI Bank became the first private entity in India to offer a discount to retail investors for its follow-up offer.

2006 : ICICI Bank became the first Indian bank to issue hybrid Tier-1 perpetual debt in the international markets.

: Introduced a new product - ‘NRI smart save Deposits’ – a unique fixed deposit scheme for nonresident Indians.

2007 : ICICI Bank‘s USD 2 billion 3-tranche international bond offering was the largest bond offering by an Indian bank.

: Sangli Bank amalgamated with ICICI Bank.

: ICICI Bank raised Rs 20,000 crore (approx $5 billion) from both domestic and international markets through a follow-on public offer.

: Launched India’s first ever jewellery card in association with jewelry major Gitanjali Group.

: Launched Bank@home services for all savings and current a/c customers residing in India

2008 : ICICI Bank enters US, launches its first branch in New York

: ICICI Bank launched iMobile, a breakthrough innovation in banking where practically all internet banking transactions can now be simply done on mobile phones.

ICICI As A Universal Bank

REVERSE MERGER OF ICICI & ICICI BANK

ICICI Bank is India's second-largest bank with total assets of Rs. 3,767.00 billion (US$ 96

billion) at December 31, 2007 and profit after tax of Rs. 30.08 billion for the nine months ended

December 31, 2007. ICICI Bank is second amongst all the companies listed on the Indian stock

exchanges in terms of free float market capitalization. The Bank has a network of about 955

branches and 3,687 ATMs in India and presence in 17 countries. 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 and asset management. The Bank currently

has subsidiaries in the United Kingdom, Russia and Canada, branches in Unites States,

Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre and

representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand,

Malaysia and Indonesia. Our UK subsidiary has established a branch in Belgium.

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 2001, 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 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

policiesICICI 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.

Universal Banking, ICICI StyleICICI: Bonds, loans, corporate finance, and infrastructure finance

ICICI Web Trade: Online stock trading

ICICI Bank: Retail and ICICI Home: Housing

corporate banking, and cash management

finance

ICICI Capital: Financial products marketing and distribution

ICICI Securities: I-Banking, corporate finance, and advisory

ICICI Prudential: Life Insurance joint venture

ICICI Brokerage: Broking and equity research

ICICI Lombard: General Insurance joint venture

ICICI Venture: Private equity investments

ICICI Infotech: Software solutions and IT-enabled services

ICICI Kinfra: Infrastructure financing in Kerala

ICICI Personal Financial Services: Retail loan distribution

ICICI Winfra: Infrastructure financing in West Bengal

ICICI International: Offshore investment and fund management

ICICI Knowledge Park: Infrastructure and support facilities

Reasons Behind Merger

The reasons that compelled ICICI Ltd. to become a ‘Universal bank’ had much to do with the

change in global banking environment rather than its internal dynamics. The reasons for the

merger merely reflect the dilemma faced by the entire Indian banking community in general and

the development banking sector in particular.

1.) Commercial banks have access to low cost funds in the form of savings and current account

deposits. But development banks can access public money only through bonds of at least five

years’ maturity and at a fairly high rate of return. So the attraction of cheap source of funds lured

ICICI Ltd. to reverse merge itself with its commercial offspring.

2.) It became quite clear after 1992 that concentrating was a very risky strategy. ICICI Ltd.

needed to spread its risks. And the only way for it was to become a financial conglomerate – a

financial superstore that provides banking, insurance, fund management, mutual funds and

securities trading under the same umbrella. This was reflected in the words of ICICI chief when

he said, “I see the process of becoming a financial conglomerate as a de-risking exercise”.

3.) Development banks provide long-term project finance. So they need cheap source of long-

term funds. The lowering of the Bank Rate and the cash reserve ratio (CRR) by RBI has led to a

fall in the Prime Lending Rate (PLR) leading to erosion in bank’s income.This falling interest

rate regime, as mirrored by the following chart, has led to serious asset-liability mismatch for the

banks. This is another reason for development banks like ICICI Ltd. to convert themselves into

universal banks.

4.) One of the prime reasons for the merger was to derive operational synergies as both the

entities were in the same line of business with slightly different specialisation. While ICICI Ltd.

was expert in long-term management of finance and dealing with large institutional (both

domestic and foreign) clients, ICICI Bank focused on the domestic consumer and small to

medium sized corporates. Moreover, the merger was also expected to lead to greater tax

efficiencies and consolidation of holdings.

5.) Indians are now following the global trend of ‘spending tomorrow’s money today’, i.e., the

practice of using credit to finance purchases of all kinds of goods – from houses to mixer

grinders. Banks from both the public and private domain are now providing consumer loans at

cheap rates of interest But again development banks cannot provide consumer loans until they

get converted into commercial ones.

6.) India is slowly becoming a global economy. So inevitably every industry has to reach global

scale to survive. But out of 95 scheduled commercial banks, only State Bank of India ranks

among top 200 banks in the world. So all types of banks are frantically trying to grow in size in

any way possible. And the shortest way to achieve it is through the way of merger. During the

last 35 years, about 36 banks and non-banking finance companies have merged. But the great

wave is yet to come. ICICI Ltd. has shown the way.

II) IDBI History Of IDBI

July 1964: Set up under an Act of Parliament as a wholly owned subsidiary of Reserve

Bank of India.

February 1976: Ownership transferred to Government of India. Designated Principal

Financial Institution for coordinating the working of institutions at national and State levels

engaged in financing, promoting and developing industry.

March 1982: International Finance Division of IDBI transferred to Export-Import Bank of

India, established as a wholly owned corporation of Government of India, under an Act of

Parliament.

April 1990: Set up Small Industries Development Bank of India (SIDBI) under SIDBI Act as

a wholly owned subsidiary to cater to specific needs of small-scale sector. In terms of an

amendment to SIDBI Act in September 2000, IDBI divested 51% of its shareholding in

SIDBI in favour of banks and other institutions in the first phase. IDBI has subsequently

divested 79.13% of its stake in its erstwhile subsidiary to date.

January 1992: Accessed domestic retail debt market for the first time with innovative Deep

Discount Bonds; registered path-breaking success.

December 1993: Set up IDBI Capital Market Services Ltd. as a wholly owned subsidiary to

offer a broad range of financial services, including Bond Trading, Equity Broking, Client Asset

Management and Depository Services. IDBI Capital is currently a leading Primary Dealer in the

country.

September 1994: Set up IDBI Bank Ltd. in association with SIDBI as a private sector

commercial bank subsidiary, a sequel to RBI's policy of opening up domestic banking sector to

private participation as part of overall financial sector reforms.

October 1994: IDBI Act amended to permit public ownership up to 49%.

July 1995: Made Initial Public Offer of Equity and raised over Rs.2000 crore, thereby

reducing Government stake to 72.14%.

March 2000: Entered into a JV agreement with Principal Financial Group, USA for

participation in equity and management of IDBI Investment Management Company Ltd.,

erstwhile a 100% subsidiary. IDBI divested its entire shareholding in its asset management

venture in March 2003 as part of overall corporate strategy.

March 2000: Set up IDBI Intech Ltd. as a wholly owned subsidiary to undertake IT-related

activities.

June 2000: A part of Government shareholding converted to preference capital, since

redeemed in March 2001; Government stake currently 58.47%.

August 2000: Became the first All-India Financial Institution to obtain ISO 9002:1994

Certification for its treasury operations. Also became the first organization in Indian financial

sector to obtain ISO 9001:2000 Certification for its forex services.

March 2001: Set up IDBI Trusteeship Services Ltd. to provide technology-driven information

and professional services to subscribers and issuers of debentures.

February 2002: Associated with select banks/institutions in setting up Asset Reconstruction

Company (India) Limited (ARCIL), which will be involved with the strategic management of

non-performing and stressed assets of Financial Institutions and Banks.

September 2003: IDBI acquired the entire shareholding of Tata Finance Limited in Tata

Home finance Ltd, signaling IDBI's foray into the retail finance sector. The housing finance

subsidiary has since been renamed 'IDBI Home finance Limited'.

December 2003: On December 16, 2003, the Parliament approved The Industrial

Development Bank (Transfer of Undertaking and Repeal Bill) 2002 to repeal IDBI Act 1964.

The President's assent for the same was obtained on December 30, 2003. The Repeal Act is

aimed at bringing IDBI under the Companies Act for investing it with the requisite operational

flexibility to undertake commercial banking business under the Banking Regulation Act 1949 in

addition to the business carried on and transacted by it under the IDBI Act, 1964.

July 2004: The Industrial Development Bank (Transfer of Undertaking and Repeal) Act 2003

came into force from July 2, 2004.

July 2004: The Boards of IDBI and IDBI Bank Ltd. take in-principle decision regarding

merger of IDBI Bank Ltd. with proposed Industrial Development Bank of India Ltd. in their

respective meetings on July 29, 2004.

September 2004: The Trust Deed for Stressed Assets Stabilization Fund (SASF) executed by

its Trustees on September 24, 2004 and the first meeting of the Trustees was held on September

27, 2004.

September 2004: The new entity "Industrial Development Bank of India" was incorporated on

September 27, 2004 and the Registrar of Companies issued Certificate of commencement of

business on September 28, 2004.

September 2004:Notification issued by Ministry of Finance specifying SASF as a financial

institution under Section 2(h)(ii) of Recovery of Debts due to Banks & Financial Institutions Act,

1993.

September 2004:Notification issued by Ministry of Finance on September 29, 2004 for issue

of non-interest bearing GOI IDBI Special Security, 2024, aggregating Rs.9000 crore, of 20-year

tenure.

September 2004: Notification for appointed day as October 1, 2004, issued by Ministry of

Finance on September 29, 2004.

September 2004: RBI issues notification for inclusion of Industrial Development Bank of

India Ltd. in Schedule II of RBI Act, 1934 on September 30, 2004.

October 2004: Appointed day - October 01, 2004 - Transfer of undertaking of IDBI to IDBI

Ltd. IDBI Ltd. commences operations as a banking company. IDBI Act, 1964 stands repealed.

January 2005: The Board of Directors of IDBI Ltd., at its meeting held on January 20, 2005,

approved the Scheme of Amalgamation, envisaging merging of IDBI Bank Ltd. with IDBI Ltd.

Pursuant to the scheme approved by the Boards of both the banks, IDBI Ltd. will issue 100

equity shares for 142 equity shares held by shareholders in IDBI Bank Ltd. EGM has been

convened on February 23, 2005 for seeking shareholder approval for the scheme.

IDBI As A Universal Bank

Merger of IDBI Bank Ltd. with IDBI Ltd.

+ =

During the four decades of its existence, IDBI has been instrumental not only in establishing a

well developed, diversified and efficient industrial and institutional structure but also adding a

qualitative dimension to the process of industrial development in the country. Cumulative

assistance sanctioned and disbursed by IDBI since inception up to end-September 2004

aggregated around Rs.2, 23,000 crore and Rs 1,78,000 crore respectively. IDBI's asset base stood

in the vicinity of Rs.63850 crores at end- September 2004.

As a considered response to changes in its operating environment following initiation of

reforms since the early nineties and the resultant concerns of IDBI's sustained viability

therein in its current avatar, IDBI, in consultation with the Government of India, decided

to transform into a commercial bank without eschewing its secular development finance

obligations. The migration to the new business model of commercial banking, with its gateway

to low-cost current/savings bank deposits, it was felt, would help overcome most of the

limitations of the current business model of development finance while simultaneously enabling

it to diversify its client/asset base.

Towards this end, the IDBI (Transfer of Undertaking and Repeal) Act 2003 was passed by

Parliament on December 16, 2003 and received the President's assent on December 30, 2003.

The provisions of the Act came into force from July 2, 2004 in terms of a Government

Notification to this effect. The Notification enabled IDBI to obtain the requisite statutory and

regulatory approvals, including those from RBI, for conversion into a banking company. The

new company viz. "Industrial Development Bank of India Limited" (IDBIL) was

incorporated on September 27, 2004 and the Registrar of Companies, Mumbai, issued the

certificate for commencement of business to IDBI Ltd. on September 28, 2004.

Subsequently, the Central Government notified October 1, 2004 as the 'Appointed Date'

and RBI issued the requisite notification on September 30, 2004 incorporating IDBI Ltd. as a

'scheduled bank' under the RBI Act, 1934. Consequently, IDBI, the erstwhile Development

Financial Institution of the country, formally entered the portals of banking business as IDBIL

from October 1, 2004, over and above the business currently being transacted.

On July 29, 2004, the Board of Directors of IDBI and IDBI Bank accorded in principle

approval to the merger of IDBI Bank with the Industrial Development Bank of India Ltd.

to be formed incorporated under the Companies Act, 1956 pursuant to the IDB (Transfer

of Undertaking and Repeal) Act, 2003 (53 of 2003), subject to the approval of shareholders

and other regulatory and statutory approvals. A mutually gainful proposition with positive

implications for all stakeholders and clients, the merger process is expected to be completed

during the current financial year ending March 31, 2005.

The merger of IDBI Bank with IDBI Ltd. seeks to consolidate businesses across the value

chain. The merger will provide a win-win situation for both the institutions and also enable

the merged entity to provide an array of customer-friendly services to its existing and

prospective clients. In a physical sense, this would enable IDBI to complete the integration

across the board.

The board of directors of the two financial intermediaries, decided that IDBI Bank, the 57 per

cent subsidiary of IDBI, will merge with its parent. The merger of IDBI Bank with IDBI will

see the resultant entity occupy a key slot in the Indian banking sweepstakes after State

Bank of India and ICICI Bank. Further, the long-cherished dream of IDBI to metamorphose

into a universal bank appears ready to be fulfilled. While the IDBI stock finally settled at Rs

66.75, up from Rs 63.15, the IDBI Bank stock hit the upper circuit of 20 per cent, closing at Rs

50.55, from the previous close of Rs 42.15 after the merger.The merged entity had a minimum

government shareholding of 51%. IDBI had a 55.5% stake in IDBI Bank while the Small

Industries Development Bank of India (Sidbi) holded 13.9%. LIC also has a 6.4% in IDBI Bank.

The government's stake in IDBI was 58.5%, while the other majority stakeholders are LIC with

4.4%, followed by SBI with 2.6% and UTI with 1.5%.

IDBI would continue to provide the extant products and services as part of its development

finance role even after its conversion into a banking company. In addition, the new entity would

also provide an array of wholesale and retail banking products, designed to suit the specific

needs cash flow requirements of corporates and individuals. In particular, IDBI would leverage

the strong corporate relationships built up over the years to offer customised and total financial

solutions for all corporate business needs, single-window appraisal for term loans and working

capital finance, strategic advisory and “hand-holding” support at the implementation phase of

projects, among others.

IDBI’s transformation into a commercial bank would provide a gateway to low-cost deposits like

Current and Savings Bank Deposits. This would have a positive impact on the Bank’s overall

cost of funds and facilitate lending at more competitive rates to its clients. The new entity would

offer various retail products, leveraging upon its existing relationship with retail investors under

its existing Suvidha Flexi-bond schemes. In the emerging scenario, the new IDBI hopes to

realize its mission of positioning itself as a one stop super-shop and most preferred brand for

providing total financial and banking solutions to corporates and individuals, capitalising on its

intimate knowledge of the Indian industry and client requirements and large retail base on the

liability side.

III) State Bank Of India (SBI)

The State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet

size, number of branches, market capitalization and profits is today going through a

momentous phase of Change and Transformation – the two hundred year old Public sector

behemoth is today stirring out of its Public Sector legacy and moving with an agility to give

the Private and Foreign Banks a run for their money.

 The bank is entering into many new businesses with strategic tie ups – Pension Funds, General

Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant

Acquisition, Advisory Services, structured products etc – each one of these initiatives having a

huge potential for growth.

 The Bank is forging ahead with cutting edge technology and innovative new banking models, to

expand its Rural Banking base, looking at the vast untapped potential in the hinterland and

proposes to cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale banking capabilities to provide

India’s growing mid / large Corporate with a complete array of products and services. It is

consolidating its global treasury operations and entering into structured products and derivative

instruments. Today, the Bank is the largest provider of infrastructure debt and the largest

arranger of external commercial borrowings in the country. It is the only Indian bank to feature

in the Fortune 500 list.

 

The Bank is changing outdated front and back end processes to modern customer friendly

processes to help improve the total customer experience. With about 8500 of its own 10000

branches and another 5100 branches of its Associate Banks already networked, today it offers the

largest banking network to the Indian customer. The Bank is also in the process of providing

complete payment solution to its clientele with its over 8500 ATMs, and other electronic

channels such as Internet banking, debit cards, mobile banking, etc.

 The bank is also looking at opportunities to grow in size in India as well as Internationally. It

presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in

India – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI

Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising

capital for its growth and also consolidating its various holdings.

 

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and

take all employees together on this exciting road to Transformation. In a recently concluded

mass internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two

day workshops across the country and covered over 130,000 employees in a period of 100 days

using about 400 Trainers, to drive home the message of Change and inclusiveness. The

workshops fired the imagination of the employees with some other banks in India as well as

other Public Sector Organizations seeking to emulate the programme.The elephant has indeed

started to dance.

STATE BANK OF INDIABANKING: Largest bank in the country, 9,043 branches, Rs 19,680.3 crore in deposits.

MUTUAL FUNDS: 100 per cent subsidiarySBI Mutual Fund manages 20 schemes, Rs 3,500 crore in assets.

MERCHANT BANKING: SBI Capital, a 100 per cent subsidiary, is one of the oldest merchant banks in India.

CREDIT CARDS: SBI-GE, a 60:40 joint

venture with GE Capital has 700,000 card members.

CONSUMER FINANCE: SBI markets consumer finance through its personal loan schemes and has a loan portfolio of Rs 233 crore.

GOVERNMENT SECURITIES TRADING: SBI Gilts, a 100 per cent subsidiary, trades in gilts.

INSURANCE: SBI-Life, a JV with Cardiff SA, is entering the bancassurance business

SBI: Charging Ahead

  SBI dominates the Indian banking sector with a market share of around 20% in terms of total

banking sector deposits. The increasing focus on upgrading the technology back-bone of the bank

will enable it to leverage its reach better, improve service levels, provide new delivery platforms,

and improve operating efficiency to counter the threat of competition effectively. Once the core

banking solution (CBS) is fully implemented, it will cover over 10,000 branches and ATMs of the

State Bank group, and emerge as the strongest technology enabled distribution network in

India.The increasing integration of SBI with its associate banks (associates) and subsidiaries will

further strengthen its dominant position in the banking sector and position it as the country’s

largest universal bank.

Resource-raising capabilities

SBI’s funding profile is strong, underpinned by its strong retail deposit base. The bank is facing

increasing competition in its metropolitan and urban franchise. SBI’s strong franchise gives it

access to a steady source of stable retail funds, which constitute around 59% of the total resources

as on March 31, 2005 (56% as at March 31, 2004).

Savings deposits have shown a strong three-year growth of 19%. Thus, despite a reduction in the

proportion of current account deposits, low-cost deposits have continued to constitute over 40% of

total deposits as at March 31, 2005. The bank’s cost of deposits (excluding IMD) has significantly

reduced to 4.70% for the 2004-05 (refers to financial year from April 1 to March 31), compared

with 5.48% in 2003-04. The bank’s liquidity position is very strong due to healthy accretion to

deposits, large limits in the call market, and significant surplus SLR investments. SBI will maintain

its strong funding profile and a low cost resource position in view of its strong retail base and wide

geographical reach.

Management strategies

In retail finance, the bank has leveraged its corporate relationships, pursued business growth

selectively, and has not competed based on interest rate. The bank has taken initiatives like on-line

tax returns filing and faster transfer of funds to protect its dominant position in the government

business. The bank also has a clear technology strategy that will enable it to compete with the new

generation private sector banks in customer service and operational efficiency.

Business description

SBI along with its associate banks offer a wide range of banking products and services across its

different client markets. The bank has entered the market of term lending to corporates and

infrastructure financing, traditionally the domain of the financial institutions. It has increased its

thrust in retail assets in the last two years, and has built a strong market position in housing loans.

SBI, through its non-banking subsidiaries, offers a host of financial services, viz., merchant

banking, fund management, factoring, primary dealership, broking, investment banking and credit

cards. SBI has commenced its life insurance business by setting up a subsidiary, SBI Life

Insurance Company Limited, which is a joint venture with Cardiff S.A., one of the largest

insurance companies in France. SBI currently holds 74% equity in the joint venture.

Industry prospects

To leverage benefits such as access to low cost resources and the facility to provide a larger gamut

of services, a number of finance companies such as Kotak Mahindra Finance Limited and HDFC

Limited have promoted banks. Simultaneously, yet another emerging trend is that of foreign banks

promoting NBFCs to benefit from regulatory flexibility available to such entities in areas like

absence of statutory liquidity ratio and cash reserve ratio requirements, priority sector

requirements, and corporate exposure limits.

 

I)---ICICI After Reverse Merger And Conversion

As A Universal Bank

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.

Financial Position After MergerICICI posts Rs 285-cr consolidated net profit for the second quarter of 2002-2003.

Financial Position After Merger

Year Ending 2002(Rs Billion) Year Ending 2003(Rs Billion)

Net interest income and other incomes

11.76 6.25

Operating Profits5.45 2.90

Provisions and 1.29

Contingencies 2.87

Profit after tax 2.58 1.61

Financial Performance of ICICI Bank

Particulars 00-

001

2001-

02

02-03 03-04 04-05 05-06 06-07

Total Income (Rs. cr.)

1,462 2,726 12,526

11,958 12,826 18,767.6 28923

Operating Profit (Rs. cr.)

290 545 2,571 2,372 2,956 4,690.67 5874

Net Profit (Rs.

cr.)

161 258 1,206 1,637 2,005 2,540.07 3110

Equity 220 613 613 616 737 889.83 899

Capital (Rs. Cr )

E.P.S. (diluted) (Rs)

8.13 11.61 19.65 26.44 27.33 32.15 34.84

Deposits(Rs. cr.)

16,378 32,085

48,16

9

68,109 99,819 165,0

83

230510

C.R.A.R. (%) 11.57 11.44 11.10 10.36 11.78 13.35% 11.69%

The Year of Reverse Merger

II)---IDBI As A Universal Bank

Conversion into a Banking Company

Oct 1, 2004, converted into a banking company

Mandated to continue playing the Development Financing role, with expansion into

commercial banking space.

April 2, 2005, merged its Banking arm (IDBI Bank) with itself; effective date of merger

October 1, ’04.

Post-merger –

GoI holding at around 53%.

Wider branch network and access to low-cost funds

Proven technology platform (Finacle from Infosys)

Broader range of products; cross selling opportunities

Large pool of professionally qualified employees to cater to both wholesale as well as

retail segment

Oct 3,2006, amalgamated the erstwhile United Western Bank (UWB) with itself

Strong Capital Position (IDBI)

Capital considerably higher than the current RBI requirement of 9%.

Scope for raising further capital by way of Perpetual Tier I and Upper Tier II capital of

around Rs.1200 crore (USD 277 mln) and Rs.2766 crore (USD 636 mln)

respectively .Growth in Business (Rs.crore)Deposits at Rs.43,354 Cr;

growth of 67%

Retail Deposits grow by 27%

CASA at 25.4% of total deposits

Advances at Rs.62,471 Cr; growth of 18.5%

Retail Advances constitute 15.7% of total advances (Previous Year 16.2%)

Strong Retail Growth

Financials of The Merged Entity

IDBI IDBI Bank

C FY 04 FY 04 FY 04

ROA 0.60% 1.30% 0.95%

Investments (Rs in m) 98,800 39,100 137,900

Advances (Rs in m) 451,100 74,000 525,100

Deposits (Rs in m) 49,800 100,500 150,300

Net NPAs (Rs m) 11,244 623 11,867

Net NPA to advances 2% 0.80% 2.26%

Credit / Deposit Ratio 85% 73.60% 349%

No. of Branches 101 92 193

ATMs NA 298 298

No. of Employees 1,400 1,700 3,100

Business/employee (Rs m) - 108.0 108

Business / branch (Rs m) - 1,517 1,517

Profits/employee (Rs m) 2.7 0.8 3.5

Profit after Tax (Rs m) 3,789 1,326 5,115

No. of shares outstanding (m) 652.8 214.2

No of shares held by IDBI in IDBI Bank

(m)

120.0

No. of shares outdg post merger (m) 684.2

EPS (Rs) 5.8 6.3 7.48

Consolidated Entity

III)--- State Bank Of India

STATE BANK OF INDIA -FINANCIAL HIGHLIGHTS-2002-2007

Rs. in Billion FY2002 FY2003 FY2004  FY2005  FY 2006  FY2007

Deposits 2705.6 2961.24 3186.19  3670.48  3800.46  4355.21 

             

Advances 1208.06 1377.58 1579.34  2023.74  2618.01 3373.36 

             

Investments 1451.42 1723.48 1856.76  1970.98  1625.34 1491.49

             

Total Assets 3482.28 3758.76 4078.15  4598.83  4940.29 5665.65

             

Interest Income 298.10 310.87 304.60    324.28    359.80  394.91

             

Interest Expenses 207.29 211.09 192.74    184.83    203.90 234.37

             

Net Interest Income 90.81 99.78 111.86     139.45     155.89 160.54

             

Non-Interest Income 41.74 57.40 76.12       71.20       74.35 57.69

             

Total Operating Income 132.55 157.18 187.98     210.65     230.24 218.23

             

Staff Expenses 51.53 56.89 64.48       69.07       81.23 79.33

             

Overhead Expenses 20.58 22.53 27.97       31.67       36.02 38.91

             

Total Operating Expenses 72.11 79.42 92.45     100.74     117.25 118.24

             

Operating Profit 60.44 77.76 95.53     109.91    112.99 100.00

             

Total Provisions 36.14 46.70 58.72       66.86      68.93  54.59

             

Net Profit 24.30 31.06 36.81       43.05      44.07  45.41

STATE BANK OF INDIA

KEY FINANCIAL INDICATORS(%) FY2002 FY2003 FY2004  FY2005 FY2006  FY2007

ROA 0.73 0.86 0.94      0.99     0.89 0.84

ROE 15.97 18.05 18.19    18.10   15.47 14.24

EPS(Rs.) 46.20 59.00 69.94    81.79   83.73 86.29

BVS(Rs.) 289 327 384      450      525 606

Dividend Pay out Ratio 12.98 14.40 15.73    15.29   16.72 16.22

Cost/Income Ratio 54.40 50.53 49.18    47.83   58.70 54.18

Capital Adequacy Ratio 13.35 13.50 13.53    12.45   11.88 12.34

Cost of Deposits 7.60 7.11 6.02      5.11     4.77 4.79

Yield on Advances 9.66 8.97 8.17      7.68     7.78 8.67

Yield on Resources Deployed 10.06 9.53 8.62      7.94     7.10 6.88

Net Interest Margin 2.91 2.95 3.04      3.39     3.40 3.31

Gross NPA Ratio 11.95 9.33 7.75      5.96     3.61 2.92

Net NPA Ratio 5.63 4.50 3.48      2.65     1.88 1.56

Provision Coverage 56 54 57         57        49 47

Balance Sheet Of SBI

(Rs. in billion)MARCH

  2002 

MARCH

2003

MARCH

2004

 MARCH

   2005MARCH 

2006 

MARCH

2007

CAPITAL & LIABILITIES    

Capital        5.26 5.26 5.26     5.26     5.26 5.26

Reserves & Surplus    146.98 166.77 197.05   235.46  271.18 307.72

Deposits  2705.60 2961.23 3186.19  3670.48  3800.46 4355.21

Borrowings      93.24 93.04 134.31    191.84    306.41 397.03

Other Liabilities & Provisions      531.20 532.46 555.34    495.79    556.98 600.42

Total  3482.28 3758.76 4078.15  4598.83  4940.29 5665.65

ASSETS    

Cash & balances with

Reserve Bank of India   218.73 127.38 190.41     168.10  216.53 290.76

Balances with banks and

money at call & short notice   430.58 324.43 245.25     225.12   229.07 228.92

Investments  1451.42 1723.48 1856.76  1970.98  1625.34 1491.49

Advances  1208.06 1377.58 1579.34  2023.74  2618.01 3373.36

Fixed Assets      24.15 23.89 26.45      26.98      27.53    28.19

Other Assets    149.34 182.01 179.94     183.91    223.81 252.92

Total  3482.28 3758.77 4078.15   4598.83  4940.29 5665.65

Contingent Liabilities  1022.13 1061.06 1118.92   1593.97  2288.51 3065.90

Bills for Collection    101.77 75.71 101.94     167.77    205.93 233.68

Limitations of the Study

1. All the information’s were not included as most of the information were confidential

and was not approachable.

2. The project is mainly confined to only three organizations.

3. Staff although were very helpful but were not able to give much of their time due to

their own job constraints.

4. Study was not very exhaustive and many concepts were not studied due to time and

other constraints.

5. The scope of the topic chosen was very wide.

6. The data collected by secondary sources sometimes comes out to be wrong

Challenges Ahead Of Universal Banking

(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

Universal Banking, means the financial entities – the commercial banks, DFIs, NBFCs, -

undertake multiple financial activities under one roof, thereby creating a financial supermarket.

The entities focus on leveraging their large branch network and offer wide range of services

under single brand name. . Ever since the process of liberalization hit the Indian shores, the

banking sector saw the emergence of new-generation private sector banks. Public sector banks

which played a useful role earlier on are now facing deterioration in their performance. For very

long, the banks in India were not allowed to have access to stock markets. So their dealing in

other securities were minimal. But the financial sector reforms changed it all, Indian banks

started to deal on the stock market but their bitter experience with scams, they became averse to

deal in equities and debentures. Off late, commercial banks in India have been permitted to

undertake a range of in-house financial services. Some banks have even setup their own

subsidiaries for their investment activities. Subsidiaries include in the area of merchant banking,

factoring, credit cards, housing finance etc.

Merger and acquisition is nothing new in the Indian banking industry. But there has been with

the banks firmly under the control of RBI, mergers were forced upon to save weak banks from

collapsing. The gradual privatization and globalization of the banking industry has now forced

banks themselves to go in for merger. Increase in profitability, synergies in operation, global

scale and other such reasons have replaced the social and political motives of yesteryears.

Successful mergers can lead to prosperity both for the shareholders of the merged company and

for the economy as a whole. The true catalyst of a successful merger is the top executive whose

pragmatic and dynamic leadership and a clear foresight can help a merger click. The trick is to

neutralize the expected pitfalls while bringing the best out of operational synergies. The making

of ICICI Bank, IDBI and others into a ‘Universal bank’ has shown the way. The reverse merger

of ICICI has thus opened up a challenge to the banks and financial institutions in India to merge

and become ‘financial conglomerate(s)’ by exploiting the present favourable business

environment and also to de-risk their operating environment.

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.

Due to globalization and liberalization our economy is opening its door for reforms. The onset

of universal banking will undoubtedly accelerate the pace of structural change within the Indian

banking system. The financial institutions as a segment will essentially convert into banks. This

can potentially impose a better corporate control structure on the firms, they can be sources of

long-term finance, and they can contribute to real sector restructuring. Thus Universal banking,

in fact, provides for a cafeteria approach or, if one were to vary the metaphor, it would take on

the role of a one-stop financial supermarket.

Caution must be applied on Universal banking because of the following considerations:

. Dis-intermediation (i.e replacement of traditional bank intermediation between savers

and borrowers by a capital market process) is only a decade old in India and has badly

slowed down due to loss of investor’s confidence.

There is an ample room for financial deepening (by banks & DFIs) since loan market will

continue to grow.

DFIs as a folder of equity in most of the projects promoted in the past have never used

the tool advantageously. DFIs are now only moving into working capital finance, an area in

which they need to gain lot of expertise and this involves creation of network of services

(including branches) in all fields .

Reforms in the Indian capital market is still in the half way stage. The priority will be to

ensure branch expansions, financial deepening of credit markets, and creation of an efficient

credit delivery mechanism that can compete with the capital market.

The following are the steps suggested :

Equalise the net regulatory burden across the financial system (including banks, DFIs,

mutual funds, NBFCs and Insurance companies.

Lower the regulatory burden on the over regulated entities.

Promote and encourage strong competition.

Do not allow the merger of a weak bank with a viably strong DFI or vice-versa.

DFIs should be permitted to set up a 100 percent owned banking subsidiaries.

Need is felt to re-examine the minimum level of SLR requirement in to meet the

international standards.

References

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

MAGAZINES

Annual Report of ICICI bank,IDBI,SBI.

Indian Institute Journal

AppendixIDBI mandated BCG for universal banking strategy in 2003

Industrial Development Bank of India has mandated the Boston Consulting Group(BCG) for

drawing a detailed strategy for the term-lending institution's metamorphosis into a universal

bank.

The strategy was aimed at reviewing the entire business perspective of the institution and giving

it the sharper competitive edge required to take on future competition.

The US-based consulting group devised a strategy that equipped IDBI's existing businesses to

meet future challenges, the official said.

Also, BCG spotted new business areas and new products for IDBI that hold promising future

business potential. The fundamental changes expected in IDBI's business perspective may in turn

require alterations in the regulatory framework for the institution itself, according to the official.

At 2003, the IDBI fall under a special regulatory act called the IDBI Act, and was not

accountable to either Banking Regulations Act or the Companies Act.

"Fundamental changes are likely because we can't go on competing in the marketplace and at the

same time be a development financial institution, without feeling the impact on our balance

sheet," the official said. "Our cost of funds is too high, when compared to bank which are

allowed to take deposits."

In 2003 "The choices are two, basically," the official said. "IDBI can either become a full-

fledged commercial bank, or it can become a non-banking finance company."

This mandate to BCG was seen as a significant fresh initiative on the part of the development

financial institution, after a yearlong spell of lethargy. The IDBI Board had taken up a report by

M B Athreya, but subsequently decided "the resources of a globally experienced consultant were

required to prepare the roadmap to universal banking."