Executive Summary

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A healthy banking system is essential for any economy striving to achieve good
growth and yet remain stable in an increasingly global business environment. The
Indian Banking system has witnessed a series of reforms in the past like, deregulation
of interest rates, dilution of Government‘s stake in PSBs, and increased participation
of private sector banks. It has also undergone rapid changes, reflecting a number of
underlying developments. This trend has created new competitive threats as well as
new opportunities.

For some years, banks have been rethinking what, where and how they serve an
increasingly informed and demanding customer base. At the same time, the trend
toward consolidation is putting additional pressure on the operating models of banks
that have not merged and is raising questions about the viability of their strategies for
growth and value creation.

Any serious discussion of the future of the retail banking industry eventually raises a
basic question: will future customers still need retail banks? The answer, it turns out,
depends on banks themselves. With technology and non-bank businesses providing
new options for safeguarding and managing their finances, customers will continue to
depend on banks only as long as banks can provide service and value that cannot be
found anywhere else.

So, what will the future of the retail banking industry in the next few decades look
like? How will banks – large, medium and small – continue to grow revenues and
remain profitable? What will it take to create and maintain advantage in this highly
competitive industry? An examination of the forces shaping the marketplace suggests
that those institutions most adept at harnessing product service and process innovation
to anticipate and meet customer needs will become industry leaders.

This project report aims to foresee major future banking trends, based on the past and
current movements in the market.


It is said that banking sector is the backbone of any economy. The stronger and
efficient the banking sector in an economy the easier can business take place, the
more attractive the market is for companies and more beneficial it is for the

India is witness to a sea change in the way banking is done in the past more than two
decades. Since 1991, the Reserve Bank of India (RBI) took steps to reform the Indian
Banking system at a measured pace so that growth could be achieved without
exposure to any macro- environment and systematic risks. Some of these initiatives
was deregulation of interest rates, dilution of the Government stake in Public sector
banks (PSBs), guidelines being issued for risk management, asset classification and
provisioning. Technology has made tremendous impact in Banking. „Anywhere
banking‟ and „Anytime banking‟ have become a reality. The financial sector now
operates in a more competitive environment than before and intermediates relatively
large volume of international financial flows. In the wake of greater financial
deregulation and global financial integration, the biggest challenge before the
regulators is of avoiding instability in the financial system.

On the surface, the competitive landscape of the retail banking industry in 2020 will
not look much different than it does today. Mergers and acquisitions will likely have
reduced the total number of banks, especially mid-tier regional banks, and industry
specialists and non-bank banks will play a more prominent role. But most of today‘s
players, including universal banks, community banks, industry specialist banks and
non-bank banks, will still be vying to differentiate themselves in a crowded
marketplace. However, traditional approaches to creating value through growth and
efficiency will no longer be enough. Advantages gained through acquisition, new
market entry and reconfigured product offerings will be fleeting at best, while
partnering and outsourcing will make efficiency a basic requirement for all.


The first bank in India, though conservative, was established in 1786. From 1786 till
today, the journey of Indian Banking System can be segregated into four distinct
phases. They are as mentioned below:
   Early phase from 1786 to 1969 of Indian Banks.
   Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector
   New phase of Indian Banking System with the advent of Indian Financial &
    Banking Sector Reforms after 1991.
   Global exposure and technology driven phase from 2001 onwards.

Phase I: Early phase (1786-1969):

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan
and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank
of Bombay (1840) and Bank of Madras (1843) as independent units and called it
Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank
of India was established which started as private shareholders banks, mostly European

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab
National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906
and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian
Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase, the growth was very slow and banks also experienced periodic
failures between 1913 and 1948. There were approximately 1100 banks, mostly small.
To streamline the functioning and activities of commercial banks, the Government of
India came up with The Banking Companies Act, 1949 which was later changed to
Banking Regulation Act, 1949 as per amending Act of 1965 (Act No. 23 of 1965).
Reserve Bank of India was vested with extensive powers for the supervision of

banking        in        India           as    the    Central      banking          authority.

During those days public had lesser confidence in the Banks. As an aftermath, deposit
mobilisation was slow. Abreast of it the savings bank facility provided by the Postal
department was comparatively safer. Moreover, funds were largely given to traders.

Phase II: Nationalisation phase (1955-1991)

Government took major steps in the Indian Banking Sector Reform post
independence. In 1955, it nationalised Imperial Bank of India with extensive banking
facilities on a large scale, especially in rural and semi-urban areas. It formed State
Bank of India to act as the principal agent of RBI and to handle banking transactions
of     the    Union       and       State     Governments    all   over      the     country.

Seven banks forming subsidiary of State Bank of India were nationalised in 1960. It
was the effort of the then Prime Minister of India, Mrs. Indira Gandhi, that on 19 th
July, 1969, 14 major commercial banks in the country were nationalised.

Second phase of nationalisation of Indian Banking Sector was carried out in 1980,
with seven more banks being nationalised. This step brought 80% of the banking
segment             in           Inida        under         Government             ownership.

The following were the steps taken by the Government of India to Regulate Banking
Institutions in the Country:

    1949 : Enactment of Banking Regulation Act.
    1955 : Nationalisation of State Bank of India.
    1960 : Nationalisation of SBI subsidiaries.
    1961 : Insurance cover extended to deposits.
    1969 : Nationalisation of 14 major banks.
    1971 : Creation of credit guarantee corporation.
    1975 : Creation of regional rural banks.
    1980 : Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector banks in India
rose to approximately 800% in deposits and advances took a huge jump.

Banking in the sunshine of Government ownership, gave the public implicit faith and
immense confidence about the sustainability of these institutions.

Phase III: Banking Sector Reforms phase (post -1991)

Until 1991, the lack of competitiveness vis-à-vis global standards, low technological
level in operations, over staffing, high NPAs and low levels of motivation had
shackled the performance of the banking industry.

In 1991, under the chairmanship of M Narasimham, a committee was set up by his
name which worked for the liberalisation of banking practices. The Narasimham
Committee laid the foundation for the reformation of the Indian banking sector. The
Committee submitted two reports, in 1992 and 1998, which laid significant thrust on
enhancing the efficiency and viability of the banking sector.

The major recommendations constituted in the report submitted by the Narsimham
Committee in 1998 are as follows:

   i.   Capital adequacy requirements should take into account market risks also.
  ii.   In the next three years, entire portfolio of Govt. securities should be marked to
 iii.   Risk weight for a Govt. guaranteed account must be 100 percent.
 iv.    CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by 2002.
  v.    An asset should be classified as doubtful if it is in the sub-standard category
        for 18 months instead of the present 24 months.
 vi.    Banks should avoid ever greening of their advances.
vii.    There should be no further re-capitalization by the Govt.
viii.   NPA level should be brought down to 5% by 2000 and 3% by 2002.

 ix.    Banks having high NPA should transfer their doubtful and loss categories to
        ARCs which would issue Govt. bonds representing the realisable value of the
  x.    International practice of income recognition by introduction of the 90-day
        norm instead of the present 180 days.
 xi.    A provision of 1% on standard assets is required.
xii.    Govt. guaranteed accounts must also be categorized as NPAs under the usual
xiii.   There is need to institute an independent loan review mechanism especially
        for large borrowal accounts to identify potential NPAs.
xiv.    Recruitment of skilled manpower directly from the market be given urgent
 xv.    To rationalize staff strengths, an appropriate VRS must be introduced.
xvi.    A weak bank should be one whose accumulated losses and net NPAs exceed
        its net worth or one whose operating profits less its income on recap bonds is
        negative for 3 consecutive years.

As the international standards became prevalent, banks had to unlearn their traditional
operational methods of directed credit, directed investments and fixed interest rates,
all of which led to deterioration in the quality of loan portfolios, inadequacy of capital
and the erosion of profitability.

Thus, the banking sector reforms provided the necessary platform for the Indian banks
to operate on the basis of operational flexibility and functional autonomy, thereby
enhancing efficiency, productivity and profitability. The reforms also brought about
structural changes in the financial sector and succeeded in easing external constraints
on its operation, i.e. reduction in CRR and SLR reserves, capital adequacy norms,
restructuring and recapitulating banks and enhancing the competitive element in the
market through the entry of new banks.

The reforms also include increase in the number of banks due to the entry of new
private and foreign banks, increase in the transparency of the banks‘ balance sheets
through the introduction of prudential norms and increase in the role of the market

forces due to the deregulated interest rates. These have significantly affected the
operational environment of the Indian banking sector.

To encourage speedy recovery of Non-performing assets, the Narasimham committee
laid directions to introduce Special Tribunals and also lead to the creation of an Asset
Reconstruction Fund. For revival of weak banks, the Verma Committee
recommendations have laid the foundation. Lastly, to maintain macroeconomic
stability, RBI has introduced the Asset Liability Management System.

Phase IV: Global exposure phase (2001-2010)

On the growing influence of globalisation on the Indian banking industry, the
financial sector opened up for greater international competition. Opening up of the
financial sector from 2005, under WTO, saw a number of global banks taking large
stakes and control over banking entities in the country. They brought with them
capital, technology, and management skills which increased the competitive spirit in
the system leading to greater efficiency.

Globalisation also opened up opportunities for Indian corporate entities to expand
their business overseas. Thus, banks in India wanting to increase their international
presence, emerged as global players during the last decade. During this phase,
importance was being laid on rural and SME financing as well.

Basel II norms, which dictate stricter risk management requirements, were adopted by
majority of the banks in 2008. The pressure on banks to gear up to meet stringent
prudential capital adequacy norms under Basel II, as well as a pressure on capital
structure, triggered a phase of consolidation in the banking industry. Mergers &
Acquisitions lead to decrease in the number of players in this industry, however, there
was qualitative growth, innovation and value creation.

The last decade witnessed a huge technological advancement in the banking sector
lead by fear of survival and growth in the global competitive arena. In order to reduce
the investment cost on technology, banks resorted to sharing facilities like ATM
networks, payment & settlement, back-office processing, data warehousing, and so

on. This lead to a faster flow of data and information, which in turn lead to faster
appraisal and decision-making.

Thus, the Indian Banking sector now compares favourably with global banking
sectors on metrics like growth, profitability, technology, non-performing assets
(NPAs) and management skills.



Voluntary Retirement Scheme in Banks was
formally taken up by the Government in
November 1999. According to Finance
Ministry on the basis of business per
employee (BPE) of Rs. 100 lakhs, there were
59,338 excess employees in 12 nationalised
banks, while based on a BPE of Rs. 125
lakhs, the number shot up to 1,77,405.

Government had cleared a uniform VRS for the banking sector, giving public sector
banks a seven-month time frame. The IBA has been allowed to circulate the scheme
among the public sector banks for adoption. The scheme was to remain open till
March 31, 2001. The scheme is envisaged to assist banks in their efforts to optimise
use of human resource and achieve a balanced age and skills profile in tune with their
business strategies.

To minimise the immediate impact on banks, the scheme has allowed them the
stagger the payments in two installments, with a minimum of 50 per cent of the
amount to be paid in cash immediately. The remaining payment can be paid within six
months either in cash or in the form of bonds. The total burden of the VRS on the
banking industry is about Rs 8,000 crore, and union activists feel that it will adversely
affect the profitability and capital adequacy of the banks. In fact, out of this Rs 8,000
crore, nearly Rs 2,200 crore will be borne by State Bank of India, the largest public
sector bank.

The Finance Ministry, with one VRS bullet, aims to achieve, at least, three objectives
immediately viz. the privatisation of banks at any cost, bailing out of the favoured

willful defaulters, and shielding of the corrupt bureaucrats. These are the measures
what exactly the IMF and World Bank have been urging upon the government,
without which the support of U.S. is not certain.
Are employees a problem or NPAs? : The policy-makers, RBI, IBA and the bankers,
who schemed unilaterally the VRS, think that by removing massively thousands of
able and experienced bankmen from services in their middle age, they could boost
profits in the nationalised banks. However, the truth is that it is the unrecovered and
unchecked cancerous growth of NPAs, piled up in the PSBs with the blessings of the
new regime, that eroded profits. The correct remedial measure is not demolishing
them by sending home several thousand employees enmass, but change the policy to
preserve and develop them.


The traditional working capital financing is no longer the banks major lending area.
The motive of universal banking is to fulfill all the financial needs of the customer
under one roof. The leaders in the financial sector will be aiming to become a one-
stop financial shop. Universal Banking includes not only services related to savings
and loans but also investments. However in practice the term 'universal banks' refers
to those banks that offer a wide range of financial services, beyond commercial
banking and investment banking, insurance etc. Universal banking is a combination of
commercial banking, investment banking and various other activities including

The main advantage of universal banking is that it results in greater economic
efficiency in the form of lower cost, higher output and better products. The spread of
universal banking ideas will bring to the fore issues such as mergers, capital adequacy
and risk management of banks. Universal banks may be comparatively better placed
to overcome such problems of asset-liability mismatches (for banks). However ,
larger the banks, the greater the effects of their failure on the system. Also there is the
fear that such institutions, by virtue of their sheer size, would gain monopoly power in
the market, which can have significant undesirable consequences for economic

efficiency. Also combining commercial and investment banking can gives rise to
conflict of interests.


Banking no longer remained a tedious process which included, standingin long queues
for withdrawals and deposits. Technology had taken over manual efforts, thus
reducing the time and improving the quality of service provided to the customer.

In recent years, the Reserve Bank endeavoured to improve the efficiency of the
Banking system by ensuring the presence of a safe, secure and effective payment and
settlement system. In the process, apart from performing regulatory and oversight
functions the Reserve Bank also played an important role in promoting the system‘s
functionality and modernization on an ongoing basis. The consolidation of the
existing payment systems revolves around strengthening computerized cheque
clearing, and expanding the reach of Electronic Clearing Services (ECS) and
Electronic Funds Transfer (EFT). The critical elements of the developmental strategy
were the opening of new clearing houses, interconnection of clearing houses through
the Indian Financial Network (INFINET) and the development of a Real-Time Gross
Settlement (RTGS) System, a Centralized Funds Management System (CFMS), a
Negotiated Dealing System (NDS) and the Structured Financial Messaging System
(SFMS). Similarly, integration of the various payment products with the systems of
individual banks has been another thrust area.


Increase in the functional and geographical spread of banks has necessitated the
switchover from hard cash to paper based instruments and now to electronic
instruments. Broadly speaking, virtual banking denotes the provision of banking and
related services through extensive use of information technology without direct
recourse to the bank by the customer. These include two very important modes of

banking, namely, ‘internet banking’ and ‘phone banking’. The salient features of
these services are the overwhelming reliance on information technology and the
absence of physical bank branches to deliver these services to the customers.

The advent of the Internet has enabled new ways to conduct banking business,
resulting in the creation of new institutions, such as online banks, online brokers and
wealth managers. With mobile technology, banks can offer services to their customers
such as doing funds transfer while travelling, receiving online updates of stock price
or even performing stock trading while being stuck in traffic. Smartphones and 3G
connectivity provide some capabilities that older text message-only phones do not.
Upwards of 70% of bank center call volume is projected to come from mobile phones.

The financial benefits of virtual banking services are manifold:

 Lower cost of handling a transaction and of operating branch network along with
   reduced staff costs via the virtual resource compared to the cost of handling the
   transaction via the branch.
 The increased speed of response to customer requirements; enhance customer
   satisfaction and, ceteris paribus, can lead to higher profits via handling a larger
   number of customer accounts.
 It also implies the possibility of access to a greater number of potential
 Manipulation of books by unscrupulous staff, frauds relating to local clearing
   operations will be prevented if computerisation in banks takes place.


Reserve Bank appointed the R V Gupta Committee in 1997. The committee was
asked to identify the constraints faced by banks in augmenting the flow of credit and
simplifying the procedures for agricultural credit. New institutions were over-
administered, and bureaucratic regimentation was the result. It is along such lines that
the rural credit co-operatives came up followed by the commercial banks‘
diversification into rural banking after the nationalisation of 14 big banks. Since the

commercial banks, too, did not perform as expected, the regional rural banks (RRBs)
were formed. At the national level NABARD was established. Even then, banking
progress in the rural sector was not able to take care of the growing credit needs of

The second Narasimham Committee (Committee on Banking Sector Reforms) has
suggested de-layering of the cooperative credit system with a view to reducing the
costs of intermediation and making NABARD credit cheaper for ultimate borrowers
[Government of India 1998:61].

One recent development under the leadership of NABARD and non-government
organisations (NGOs) is the formation of informal, self-help groups (SHGs) broadly
on the model of the ‗grameen banks‘ of Bangladesh. The mutual trust reflected in the
SHGs working is in tune with the true spirit of cooperation. The creditworthiness of
an SHG is linked to the amount of saving brought about by the group. The SHG
promotes thrift and savings, howsoever temporary and small they are, thereby to a
great extent weaning the poor away from moneylenders. The number of SHGs linked
to banks is now around 33,000.

The makers of banking policy are now focusing on technology-led banking in the
rural sector. This requires a restructuring of cooperatives to enable them to meet the
challenges of competition. It also requires a change in mindset. While the government
should promote the restructuring and modernisation of cooperatives through an
incentive/disincentive package and by providing adequate infrastructure in the rural
areas, the actual task should be left to the cooperative leadership and the apex bodies
of cooperatives.


One of the main factors responsible for mounting non-performing assets (NPAs) in
the financial sector has been the inability of banks/FIs to enforce the security held by
them on loans gone sour. Prior to the passage of the DRT Act, the only recourse
available to banks/FIs to cover their dues from recalcitrant borrowers, when all else

failed, was to file a suit in a civil court. The result was that by the late ‘80s, banks had
a huge portfolio of accounts where cases were pending in civil courts

Setting up of special tribunals to speed up the process of recovery of loans and setting
up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their
bad and doubtful advances at a discount was one of the crucial recommendations of
the Narasimham Committee.

To expedite adjudication and recovery of debts due to banks at the instance of the
Tiwari Committee (1984), appointed by the Reserve Bank of India (RBI), the
government enacted the Debt Recovery Tribunal Act, 1993 (DRT). Accordingly,
DRTs and Appellate DRTs have been established at different places in the country.
The act was amended in January 2000 to tackle some problems with the old act.

The recent amendment (Jan 2000) to the DRT Act addresses many of the lacunae in
the original act. It empowers DRTs to attach the property on the borrower filing a
complaint of default. It also empowers the presiding officer to execute the decree of
the official receiver based on the certificate issued by the DRT. Transfer of cases from
one DRT to another has also been made easier. More recently, the Supreme Court has
ruled that the DRT Act will take precedence over the Companies Act in the recovery
of     debt,      putting      to     rest     all     doubts       on      that     score.


Basel II is the international capital adequacy framework tor banks that prescribes
capital requirements for credit risk, market risk and operational risk. Basel II is the
second of the Basel Accords recommended on banking laws and regulations issued by
Basel Committee on Banking Supervision.

The purpose behind applying Basel II norms to Indian banks is to help them comply
with international standards. These international standards can help protect the
international financial system from problems that may arise from the collapse of a
major bank.

   Basel II is stated to set up rigorous risk and capital management requirements to
    ensure that banks have capital reserves appropriate to their risk profile.
   The outcome is that the greater the risk to which a bank is exposed, greater is the
    amount of capital it will require to hold to protect its solvency and overall
    stability. It will also force banks to enhance disclosures, which will help create
    more transparency and trust in the banking system itself. We believe transparency
    in financial reporting will improve.
   Total CRAR and Tier I capital is expected to expand with implementation of
    Basel II norms.

While Basel I framework was confined to the prescription of only minimum capital
requirements for banks, the Basel II framework expands this approach not only to
capture certain additional risks in the minimum capital ratio but also includes two
additional areas, viz. Supervisory Review Process and Market Discipline through
increased disclosure requirements for banks. Thus, Basel II framework rests on the
following three mutually- reinforcing pillars:

Pillar 1: Minimum Capital Requirements — prescribes a risk-sensitive calculation of
capital requirements that, for the first time, explicitly includes operational risk along
with market and credit risk.

Pillar 2: Supervisory Review Process (SRP) — envisages the establishment of
suitable risk management systems in banks and their review by the supervisory

Pillar 3: Market Discipline — seeks to achieve increased transparency through
expanded disclosure requirements for banks.

The process of implementing Basel II norms in India is being carried out in phases.
Phase I has been carried out for foreign banks operating in India and Indian banks
having operational presence outside India with effect from March 31,2008.

In phase II, all other scheduled commercial banks (except Local Area Banks and
RRBs) will have to adhere to Basel II guidelines by March 31, 2009. With the
deadline of March 31, 2009 for full implementation of Basel II norms fast
approaching, banks are looking to maintain a cushion in their respective capital
reserves. The minimum capital to risk-weighted asset ratio (CRAR) in India is placed
at 9%, one percentage point above the Basel II requirement. All the banks have their
Capital to Risk Weighted Assets Ratio (CRAR) above the stipulated requirement of

Basel guidelines (8%) and RBI guidelines (9%). As per Basel II norms, Indian banks
should      maintain       tier      I      capital      of      at      least       6%.
The Government of India has emphasized that public sector banks should maintain
CRAR of 12%. For this, it announced measures to re-capitalize most of the public
sector banks, as these banks cannot dilute stake further, as the Government is required
to maintain a stake of minimum 51% in these banks.

Over the past decade, the banking industry has experienced an unprecedented level of
consolidation as mergers and acquisitions among large financial institutions have
taken place at record levels. To a large extent, this consolidation is based on a belief
that gains can accrue through expense reduction, increased market power, reduced
earnings volatility, and scale and scope economies.

The three main reasons for change in the structure of Indian Banks are as follows:
   1) Mergers & Acquisitions.
   2) Rationalisation of foreign operations in India.
   3) Reduction of Government stake in Public Sector Banks.


Within a span of three years there were more than 1500 mergers in the U.S market.
India is not far behind in this league. Banking industry has witnessed extensive
domestic as well as cross-border M&A activities in the last decade. This has reduced

the quantity of Banks and simultaneously increased the quality of services and value
creation to the customers.

Why M&A ???

To a question on achieving global competitiveness, consolidation in the financial
sector has emerged as the most significant measure required to create world class
banking system.


                                       Key source of value for the acquirer

     Cost        1 Collections         •   Ability to maximise the speed and recovery of NPAs
                 2 Processes
                                       •   Ability to redesign processes

                 3 Distribution        •   Ability to integrate and rationalise branches and other

                 4 Infrastructure
                                       •   Ability to combine corporate/regional infrastructure

                 5 IT
                                       •   Ability to upgrade overall technology

                 6 Operations
                                       •   Ability to quickly centralise operations

                 7 Product/Segments
     enhance-                          •   Ability to upgrade product range and increase cross-
     ment                                  sell
                 8 Geographies         •   Ability to ensure geographic growth and synergy

                 9 Cost of funds
                                       •   Ability to reduce cost of funds
                 10 Trading income
                                       •   Ability to leverage scale and improve trading income

        Some mergers till date:

    Banks                         Merged with                    Period
    United Western Bank           IDBI Bank                      Sept 2006
    Lord Krishna Bank             Centurion Bank                 Aug 2006
    Ganesh Bank of Kurundwad      The Federal Bank               Jan 2006
    Bank of Punjab                Centurion Bank                 Sep 2005
    IDBI Bank                     IDBI Limited                   Apr 2005
    Global Trust Bank             Oriental Bank of Commerce      Jul 2004
    Nedungadi Bank                Bank of Punjab                 Nov 2002
    Benares State Bank            Bank of Baroda                 Jun 2002
    ICICI Limited                 ICICI Bank                     Jan 2002
    Bank of Madura                ICICI Bank                     Mar 2001
    Times Bank                    HDFC Bank                      Feb 2000
    Sikkim Bank                   Union Bank                     Dec 1999
    Bareilly Corporation Bank     Bank of Baroda                 Jun 1999


Liberalising the policy with regard to allowing foreign banks to open offices in India
or rather Deregulation of the entry norms for private sector banks and foreign sector
was a major stimulus for changing structure of traditional Indian Banks.

Negatives: "Our industry did not oppose the entry of private bankers because we
knew they will not be able to reach out to the rural markets‖ states, G.M. Bhakey,
president of the State Bank of India Officers Association. "Even after privatisation not
more than 10 per cent of the Indian population can afford to open accounts in private
banks." The bad debt figures even in the two to three year old new private sector
banks have crossed over 6% to the total advances, while the trends in the old private
banks are still higher, despite the fact that they have no social commitment lendings in
their portfolios. In any case, the private banks, in the Indian context, cannot be the
alternative to our well-developed public sector banks. They are there in the country to
fill the private pockets with their typical selectivity of business and costly operations.
All those who beat their drums for the privatisation parade, which is much on the
move after globalisation, to denationalise our public sector banks, do so with vested

Positives: ICICI bank, HDFC bank, GTB, IndusInd, BOP and UTI Bank have come
out with IPOs as per licensing requirement. Their technological edge and product
innovation has seen them gaining market share from the slower, less efficient older
banks. These banks have targeted non-fund based income as major source of revenue,
with their level of contingent liabilities being much higher then their other
counterparts viz. PSU and old private sector banks. The new private banks have been
consistently gaining market shares from the public sector banks. The major
beneficiary of this has been corporate clients who are most sought after now.
The new generation private sector banks have made a strong presence in the most
lucrative business areas in the country because of technology upgradation. While,
their operating expenses have been falling as compared to the PSU banks, their
efficiency ratios (employee‘s productivity and profitability ratios) have also improved

Private Sector v/s Public Sector:

The main problems concerning the nationalized / state sector banks are as follows:

   Large number of unprofitable branches.
   Excess staffing of serious magnitude.
   Non Performing Assets on account of politically directed lending and industrial
    recession in last few years.
   Lack of computerization leading to low service delivery levels, non-reconciliation
    of accounts, inability to control, misuse and fraud etc.
   Inability to introduce profitable new consumer oriented products like credit cards,
    ATMs etc

Strengths of Private sector banks:

   Technology- The private banks have used technology to provide quality service
    through lower cost delivery mechanisms. The implementation of new technology
    has been going on at very rapid pace in the private sector, while PSU banks are
    lagging behind in the race.

   Declining interest rates- in the present scenario of declining interest rates, some
    of the new private banks are better able to manage the maturity mix. PSU Banks
    by and large take relatively long-term deposits at fixed rates to lend for working
    capital purposes at variable rates. It therefore is negatively affected when interest
    rates decline as it takes time to reduce interest rates on deposits when lending has
    to be done at lower interest rates due to competitive pressures.

   NPAs- The new banks are growing faster, are more profitable and have cleaner
    loans. Reforms among public sector banks are slow, as politicians are reluctant to
    surrender their grip over the deployment of huge amounts of public money.

   Convergence- The new private banks are able to provide a range of financial
    services under one roof, thus increasing their fee based revenues.


The Government decided to accept the recommendations of the Narasimham
Committee on Banking Sector Reforms for reducing the requirement of minimum
shareholding by government in nationalised banks to 33 per cent. This was done
without changing the public-sector character of banks and while ensuring that fresh
issue of shares is widely held by the public.

Banking is a business and not an extension of government. Banks must be self-reliant,
lean and competitive. The best way to achieve this is to privatise the banks and make
the managements accountable to real shareholders.

Salient features of the amendments were:

   Government would retain its control over the banks by stipulating that the voting
    rights of any investor would be restricted to one per cent, irrespective of the equity

   The government would continue to have the prerogative of the appointment of the
    chief executives and the directors of the nationalised banks.

   It has been decided to discontinue the mandatory practice of nominating the
    representatives of the government of India and the Reserve Bank in the boards of
    nationalised banks.

   The number of whole time directors was be raised to four as against the past
    position of two, the chairman and managing director and the executive director.

   While conceptually it is desirable to decentralise power, operationally it may be
    difficult to share power at peer level.

   It is proposed to amend the provisions in the Banking Companies (Acquisition and
    Transfer of Undertakings) Act to enable the bank shareholders to discuss, adopt
    and approve the annual accounts and adopt the same at the annual general

    meetings. Paid-up capital of nationalised banks can now fall below 25 per cent of
    the authorised capital.

   Amendment will also enable the setting up of bank-specific Financial
    Restructuring Authority (FRA).

The government has been maintaining that the nationalised banks would continue to
retain public sector character even after the reduction in equity.


More than 60% Indian population resides in Rural Areas, where Agriculture is the
main livelihood. The number of people living on less than Rs.60 per day in India is
significantly greater that the entire population of the United States. From a social
perspective, this is a humanitarian pandemic. From a commercial perspective, these
individuals are not considered a viable market given their miniscule purchasing
power. The poor of India represent an opportunity for a large, organized financial
service company.
Can lending to the poor be financially viable for banks? Are there alternate models of
credit evaluation, contract enforcement, and building trust in large institution among
the poor consumer? The Indian banking policies provides insights on how formal
banking can convert the poor into customers, at the same time empowering the poor.

It is verified that the financial crisis that hit US in 2008 was not only due to complex
financial engineering and a poor regulatory framework, but primarily because of the
quality of customers the banking system had picked.

Does it make sense to dole out cash to identity- less slum dwellers and villagers?

A significant evolution in rural development strategies has taken place over the last
decade, which represents a shift away from supply led and interventionist policies
towards a more liberal, market-oriented approach.

Out of the 134 million financially excluded households in India, 76% is rural and
large, uncontested market.

This signifies a large untapped customer base for the Banks. Also, India being an
Agri-based country, providing sound financial services to the agricultural community
will lead to advancement in Indian economy.

Indian Bank, Union Bank of India and Canara Bank have added their branches to the
congested landscape in Asia‘s largest slum– all looking to get a slice of Dharavi‘s Rs
4,400- crore leather business.

The multi-layered India banking system – comprising 82 SCBs, 92 RRBs, four LABs,
1813 UCBS and 107,497 rural co-operative credit institutions went through as
introspective phase in the 1990s, when prudential norms were tightened; banks
became risk averse and concentrated on strengthening their balance sheets. Today that
gives them the ability to convert what was largely perceived as social responsibility
into a viable growth plan: providing access to finance to all, irrespective of
geography, income or education.

RBI says that, “Banks had been bestowed with several privileges, especially of
seeking public deposits on a highly leveraged basis, and therefore, should be obliged
to provide banking services to all segments of the population on an equitable basis.”

Credit and Rural Economy:
Financial liberalization after 1991 decimated the formal system of institutional credit
in rural India. It represented a clear and explicit reversal of the policy of social and
development banking, such as it was, and contributed in no small way to the extreme

deprivation and distress of which the rural poor in India have been victims over the
last decade.

The policies of financial liberalization in India are classified into three types:

   Policies to curtail government intervention in the allocation of credit.
   Policies to dismantle the public sector and foster private banking.
   Policies to lower capital controls on the Indian banking system.

Need of finance in Rural India:
It is well known that the burden of indebtedness in rural India is very great, and that
despite major structural changes in credit institutions and forms of rural credit in the
post- Independence period, the exploitation of the rural masses in the credit market is
one of the most pervasive and persistent features of rural life in India. Rural
households need credit for a variety of reasons:

   They need credit to meet short-term requirements of working capital and for long-
    term investment in agriculture and other income-bearing activities.
   Agricultural and non-agricultural activities in rural areas typically are seasonal,
    and households need credit to smoothen out seasonal fluctuations in earnings and
   Rural households, particularly those vulnerable to what appear to others ‗minor
    shocks‘ with respect to income and expenditure, need credit as an insurance
    against risk.
   In a society that has no law of free, compulsory and universal school education, no
    arrangements for free and universal preventive and curative health care, a weak
    system for the public distribution of food and very few general social security
    programmes, rural households need credit for different types of consumption.
    These include expenditure on food, housing, health and education.
   In the Indian context, another important purpose of borrowing is to meet expenses
    on a variety of social obligations and rituals.

The Extra- Economic Need:
Historically, there have been four major problems with respect to the supply of credit
to the Indian countryside:

   The supply of formal sector credit to the countryside as a whole has been
   Rural credit markets in India themselves have been very imperfect and
   The distribution of formal sector credit has been unequal, particularly with respect
    to region and class, caste and gender in the countryside. Formal sector credit
    needs specially to reach backward areas, income-poor households, people of the
    oppressed castes and tribes, and women.
   The major source of credit to rural households, particularly income-poor working
    households, has been the informal sector. Informal sector loans typically are
    advanced at very high rates of interest.

The future is all about “ensuring that sufficient and timely credit, at reasonable rates
of interest, is made available to as large a segment of the rural population as


MFIs could play a significant role in facilitating inclusion, as they are uniquely
positioned in reaching out to the rural poor. Proposed micro finance services
regulation bill defines micro finance services as ―providing financial assistance to an
individual or an eligible client, either directly or through a group mechanism for:

   An amount, not exceeding Rs. 50,000 in aggregate per individual, for small and
    tiny enterprise, agriculture, allied activities (including for consumption purposes
    of such individual).
   An amount no exceeding Rs 1, 50,000 in aggregate per individual for housing
   Such other amounts, for any of the purposes mentioned at items, mentioned above
    or other purposes, as may be prescribed‖.

Greater legitimacy, accountability and transparency will not only enable MFIs to
source adequate debt and equity funds, but could eventually enable MFIs to take and
use savings as a low cost source for on-lending.

Earlier, all regulatory aspects of micro- finance were not centralized. For example,
while the RPCD in RBI looked after rural lending, MF-NBFCs were under control of
the DNBS and external commercial Borrowing was looked after by the Foreign
Exchange Department. Later it was felt that RBI may consider bringing all regulatory
aspects of microfinance under a single mechanism. Thus supervision of MF-NBFCs
has been delegated to NABARD by RBI.


Regional Rural Banks were created in the 1970s exclusively to serve the credit needs
of rural India, and specifically those individuals, social groups and regions most
excluded by the formal system of credit. For all their weaknesses, these banks passed
an important international test. A cross-country study of rural credit institutions threw
up the important finding that, in the period 1988-1992, of all the institutions studied;
Regional Rural Banks in India incurred the lowest costs of administration, 8.1 per
cent of the total portfolio.

An important feature of banking reforms has been to alter the equation between
different sectors of banking, in this case, to make the norms governing Regional Rural
Banks indistinguishable from those governing commercial banks, thus undermining
their capacity to serve the special needs of the rural economy and the rural poor.

Liberalization has had the effect of crippling Regional Rural Banks, rendering them
incapable of fulfilling their original mandate (stats on the figure). Though, the total
demand for the credit has ever been on rise, but the number of players is ever


SHGs represent a unique approach to financial intermediation. The approach
combines access to low-cost financial services with a process of self management and
development for the women who are SHG members. SHGs are formed and supported
usually by NGOs or by Government agencies. Linked not only to banks but also to
wider development programmes, SHGs are seen to confer many benefits, both
economic and social. SHGs enable women to grow their savings and to access the
credit which banks are increasingly willing to lend.

SHGs are formed by NGOs, Government agencies or Banks – the three types of ‗Self
Help Promoting Agencies‘ or SHPAs. SHPAs differ in their approaches to group
promotion, with varying emphasis on microfinance (the savings and credit
transactions, decisions, record-keeping and SHGs often being part of a wider village
development programme, with other social development inputs). NGOs and
Government SHPAs are society oriented; whereas Banks naturally are finance
oriented. In case, the pattern and intensity of inputs and guidance to SHGs varies,
there is variation between different types of SHPA but also within SHPAs due to
differences between individual field workers who are the actual group ‗promoters‘ or

Some SHPAs are now promoting federations or ‗cluster associations‘ of SHGs. For
such associations have strong potential for enabling women to act collectively on

different social and economic issues, and shift the capacity building requirements to a
different level.

Also, other than merely business, SHGs get tax rebates, and special no-frill accounts
from the government / private operators. This not only encourages their socially
responsible actions, but pushes them further to expand their business for the needy.


The opportunities for banking are enormous if the industry can transform and adapt to
the 21st century. Unfortunately little evidence exists that such a transformation will be
led from within the banking industry. Therefore banking may be subject to similar
threats that have disrupted mature markets in the past. The pace of change in society
and the growing power of consumers enabled by global technology changes will
present serious challenges to the status quo in financial services.

Banking is on the verge of changing forever. This change is being led by consumers
exercising their creativity and embracing new technologies which are fueling dramatic
societal changes driven over the last twenty years by widespread adoption of
Information and Communication Technologies (ICT). Consumers expect to use new
channels and have access to new solutions that leverage these powerful information
and communication technologies.

This consumer-led transformation joins three key trends that define the future
evolution of the banking industry:
   Demographic: Increasing US diversity, aging baby boomers, rise of ―Digital
   Technology Evolution: Multi-channel integration, emerging digital
    distribution/mobile, non-traditional banking competitors, cloud computing
   Macro-economic Changes: Increased wealth concentration, regulatory pressure,
    economic uncertainty, the rise of the rest (previously economically
    disadvantaged), globalisation.

These trends bring challenges and significant opportunities. The companies that
harness these shifts will capture portions of the two largest profit pools in the world:
Banking with its financial services and Payments of all forms.
Traditional models of banking and payments have demonstrated that they are not as
stable as once believed. The loss of confidence in traditional institutions revealed by

the recent financial system collapse highlights complex, systemic problems within the
financial system that has not adjusted to the needs of its customers and lacks the
leadership needed to make the necessary improvements to secure their future.

The short term focus on operational controls, that is prevalent in banking, has
undermined its very survival for the longer-term. Little evidence is apparent within
the Banking Industry of the profound innovations that are needed or of longer-term
investments in rebuilding the foundations of Banking. However, there is some
evidence that appropriate innovations and investments are being made by non-
traditional companies adjacent to banking- related activities. These non-traditional
players are destined to truly threaten traditional banks as they collide in the pursuit of
satisfying the expectations of customers.


India‘s banking sector is growing rapidly and is expected to enjoy even greater
growth opportunities in the future. Several Indian banks are pursuing global
strategies, as Indian companies globalise and people of Indian origin increase their
investment in India. At the same time, a large number of global banks have stepped
up their focus on India.

Today the question often asked is: How competitive are Indian Banks and how do the
practices at work in these banks compare against global best practices.

Over the last few years, India‘s economy has been on a high growth trajectory,
creating unprecedented opportunities for its banking sector. Most banks have enjoyed
high growth and their valuations have appreciated significantly during this period.
Looking ahead, the most pertinent issue is how well the banking sector is positioned
to cater to continued growth. A holistic assessment of the banking sector is possible
only by looking at the roles and actions of banks, their core capabilities and their
ability to meet systemic objectives, which include increasing shareholder value,
fostering financial inclusion, contributing to GDP growth, efficiently managing
intermediation cost, and effectively allocating capital and maintaining system

Results of a survey conducted by McKinsey & Company:

A survey conducted by McKinsey & Company of 14 leading banks in India, shows
that banks have done remarkably well in increasing shareholder value, allocating
capital effectively, and contributing to GDP growth. However, in comparison to
international peers, Indian banks can do more to foster financial inclusion and manage
intermediation costs.


As per a report published by Pricewaterhouse Coopers, the seven Emerging
Economies (China, India, Brazil, Russia, Mexico, Indonesia and Turkey) are likely to
become increasingly significant in the world of banking. Specifically, their
projections suggest that:

   Over time, the banking sector is going to grow significantly faster than GDP in
    these emerging economies as they develop;
   In our main scenario, total domestic credit in the E7 economies is likely to
    overtake total domestic credit in the G7 economies within the next 40 years;
   Total domestic credit in China is likely to overtake the UK and Germany by 2010,
    Japan by around 2020 and the US by 2045;
   India is likely to emerge as the third largest domestic banking market in the world
    by 2040 and could grow faster than China in the long run;
   Brazil, Indonesia, Mexico, Russia and Turkey all have the potential to develop
    banking sectors of comparable scale to major European economies such as France
    and Italy before 2050;
   Many E7 economies already have relatively profitable banking sectors, and our
    estimates suggest that total profits from domestic banking in the E7 will be around
    half those in the G7 by 2025 and larger than in the G7 before 2050;
   M&A activity in the emerging market banking sectors is likely to show
    correspondingly strong growth over the next few decades as domestic and
    international banks jockey for prime position;
   Restructuring of emerging market economies will give rise to many more
    opportunities for private equity firms; and
   Banks from emerging economies will start to make major acquisitions in
    developed markets to gain better access to capital markets and to acquire expertise
    and know-how.

In short, no bank can afford to ignore the E7 in its future strategy, but this also means
that these markets will be highly competitive. Adopting the right strategy and

maintaining a competitive edge in these emerging markets will pose a major challenge
for North American and European banks seeking to make the most of these markets
and identify the right local acquisition targets and strategic or joint venture partners.

GDP Growth model used for the purpose of study:
The starting point for the analysis was a baseline projection for GDP growth to 2050.
These projections reflect the combined effect of projected working age population
growth (from UN projections), investment rates, education levels and trends, and the
scope for emerging economies to catch up with the global technological frontier.
Likely real exchange rate increases over time in the emerging economies was also
allowed by distinguishing between real GDP growth in domestic currency terms and
in dollar terms. As illustrated in the figure below, the baseline GDP projections see
growth being significantly higher in the E7 (7 emerging Economies) than the
established developed economies, particularly when growth is measured in dollar
terms to allow for rising real exchange rates in the E7 (reflecting stronger productivity
growth in these economies).

Interestingly, this analysis suggests that India is likely to be the fastest growing of the
E7 economies in the long run. The model suggests that China will continue to grow
somewhat faster than India over the next 5-10 years but, after that, Chinese growth
will be held back by its rapidly ageing population (due in large part to its one child
policy) and diminishing returns to its investment-led strategy. In contrast, India and
other emerging economies like Brazil, Mexico, Indonesia and Turkey have much
younger populations with faster-growing labour forces.

                   Pojected Average Real GDP growth 2005-50












               0      2           4          6           8          10

Projecting forward domestic credit levels:
The baseline projections are derived by assuming an underlying upward trend in the
domestic credit to GDP ratio (subject to a maximum limit of 200% of GDP), but then
to allow for gradual convergence to the norm for outliers at a rate of 2% per annum.
The resulting projected domestic credit to GDP ratios for the G7 (Developed
Economies), the E7 (Emerging Economies) and the world as a whole are then
obtained. Initially, the weight of the E7 in global banking assets is low, so the global
average is close to the G7 average. Over time, however, the E7 ratio rises much faster
than the G7 ratio so that near convergence is achieved by 2050. In absolute terms,
with total E7 GDP projected to be around 25% higher in 2050 than G7 GDP by 2050,
this implies slightly higher total banking assets in the E7 than the G7 by 2050. Even
by 2025, E7 banking assets would have reached just under half of the G7 total,
compared with less than 15% now.

E7 banking sectors are not going to rival those in China and India in terms of size, but
they could come by 2050 to be of the same order of magnitude as the banking sectors
in countries like France and Italy, from much lower levels today.

Possible Strategic implications of the rise of the E7 banking markets:

The analysis above reinforces the significance of China, India and the other E7
markets as by far the greatest potential growth areas in global banking in coming
decades. This growth potential is illustrated by the numbers in Figure 14 opposite,
which also summarises recent trends and key
market drivers for each of the E7 banking markets, ranked in order of current size.

Retail banking sectors seem likely to see particularly rapid growth, since
mortgage and consumer credit lending is generally not well developed yet in these
markets compared with corporate and government lending (although both these areas
also offer considerable opportunities as well).

The rise of the E7 is likely to be associated both with rapid organic growth of the key
players in these banking markets, and with rapid increases in M&A activity, both
within the E7 countries (due to consolidation of often fragmented banking sectors at
present), and across borders.

Restructuring of the E7 economies should also create major opportunities for
private equity firms. It is anticipated in the short and medium term that private
equity finance will be able to participate through investment in the evolution of
banking markets in the E7 countries, ahead of and alongside domestic and
international banks.

For North American and European banks the analysis also emphasises the
importance not just of being active in the E7 markets but also of having the right
strategy in terms of:

   choosing the right local targets for acquisitions, joint ventures and strategic
   understanding the preferences of local banking customers and the local
    competitive environment, so as to offer the right kind of product mix and pricing
    strategy; and

   understanding the local legal and regulatory environment and other relevant
    aspects of local custom and practice in the banking sector.

At the same time, some of the major banks in India and other E7 countries are likely
over the next 10-20 years to become significant regional or global players through
outward expansion by E7 banks, both organically and through M&A. This will
be driven by a number of factors, including:

   the desire to access large developed markets;
   the need for local branches to provide banking services to other E7 companies
    expanding into overseas markets;
   the need to access capital; and
   the need, at least in the short term, to access expertise and know-how through
    acquisitions (e.g. in areas such as wealth management, mortgages and credit

E7 banks will also become major competitors in the global ‘war for talent’. In
fact, we are already seeing signs of this, with Russian banks hiring investment
bankers from London, some Chinese banks importing US or European executives,
and Indian banks seeking to attract back staff with experience of working for major
G7 institutions. As the E7 banks internalise the knowledge of these staff, so their
competitiveness in both domestic and global markets will increase. However, some
major E7 banks may also come under foreign ownership, subject to domestic
government policy towards such acquisitions. In short, the banking world in 2050 will
look radically different from the one we see today, with the E7 economies becoming
at least as important as the G7.

Key trends and prospects for E7 banking markets:

Country Domestic      Projected         Recent trends and key market drivers
        credit        domestic
        in 2004       credit in 2050
         ($trillion)  ($trillion: at
                      2004 prices)
China             2.8                45 • Sale of major state banks with progress on reducing
                                        non-performing loans
                                        • Profitability starting to rise from low base
                                        • Large increase in foreign bank investment
                                        • Rapid growth in retail banking from low base, with huge potential
                                        in mortgage and consumer credit markets as incomes rise
India             0.4                23 • Major financial sector reforms since 1991
                                        • Public sector banks still dominant but private/foreign banks
                                        gaining market share
                                        • Entry barriers being eased gradually but still significant for
                                        foreign banks
                                        • Middle class growing strongly in cities
Brazil            0.3                 8 • More stable economy in recent years
                                        • High profitability and automation in banking
                                        • Foreign banks entering via acquisition
                                        • Relatively underleveraged corporate sector
Mexico            0.2                 6 • Economy has stabilised recently after financial and banking
                                         crises of 1990s
                                        • Improved bank regulation and accounting standards, helped by
                                        significant entry of foreign banks
                                        • Low share of banking sector in GDP gives scope for strong future
                                        growth if economic and political stability can be maintained
Russia            0.2                 5 • Largest two state banks still dominant; rest of banking sector
                                         quite fragmented
                                        • Regulatory regime has been weak with only gradual progress on
                                        banking reforms
                                        • Heavy bank focus on major cities
                                        • Buoyant energy sector, but economy needs to become more
                                        diversified in long run, including stronger banking sector
Turkey            0.2                 4 • Macroeconomic environment much improved since late 1990s
                                        (lower inflation)
                                        • European banks increasing active in Turkey
                                        • New Banking Law strengthened banking supervision/regulation
                                        • Strong consumer lending growth potential
Indonesia         0.1                 7 • Still a relatively low income country but with good long-term scope
                                        for growth if political situation remains relatively stable
                                        • Crisis of late-1990s stimulated banking reform and restructuring
                                        • Growing foreign investment in domestic commercial banks and
                                        shift from corporate to consumer lending since late 1990s
E7 Total          4.2                98 • High growth, with potential to mitigate high individual risks
                                        through portfolio approach
G7 Total           30                83 • Moderate growth but lower risk


Huge potential for banking industry lies ahead if the following analysis is to be

The vast business potential for banking can be ascertained from a brief empirical
exercise and a projection on the housing loan in India. The housing loan is an
important component of the loans and advances portfolio of the SCBs (Table 2). As at
end-March 2009, the housing loans constituted 44 per cent of the retail loan portfolio
of SCBs and 9 per cent of the total loans and advances of SCBs. The growth rate of
housing loans, which witnessed very high growth during 2004-05 and 2005-06, has
however been witnessing a deceleration since then.

A statistical analysis of the data on GDP, housing loan and educational loan for the
period March 2004 to March 2009 suggests that a 1 per cent increase in GDP growth
is associated with 3 per cent increase in housing loan and 5 per cent increase in
education loan. Assuming a real GDP growth rate of 6.25 per cent in 2009-10 and 8
per cent each in 2010-11 and 2011-12, and 9 per cent each during 2012-13 to 2014-
2015, the housing loan is expected to grow at 20.3 per cent in 2009-10, 25.0 per cent
each in 2010-11 and 2011-12 and at 28.1 per cent during the period 2012-13 to 2014-
05. The education loan is expected to grow at a rate of 32.3 per cent in 2009-10 and
at 39.8 per cent each in 2010-11 and 2011-12 and 44.8 per cent during the period
2012-13 to 2014-15.

The figures would ideally be larger as it is based on historic data.


An area of concern which impacts on investment is the relatively high inte rest rate
structure that prevails in the country. Interest rates are no doubt related to inflation in
a trend sense but this relationship is primarily with respect to the rates received by the
savers. With a decrease in inflationary expectations in the economy the nominal
deposit rates should be amenable to reduction without materially affecting the
expected real returns to the savers. The Government would have to clearly signal an
anti-inflationary stance in a credible manner and also the actual rate of inflation would
need to be brought down to its target level and maintained there for a sufficient period
of time for inflationary expectations to be adjusted downwards. A beginning has been
made by reducing the interest rates on small savings schemes run by the Government
as well as on bank deposits. However interest rates paid by borrowers are also
dependent on the level of efficiency of the financial system. The spread between the
deposit and lending rates in India is high by international standards and reflects both
the constraints faced by and the relatively low level of efficiency in the financial
intermediation system. Although in recent years there has been considerable
liberalisation in the banking sector with tightening of prudential norms and
accounting practices which have led to an improvement in the health of the banking
sector, there are some areas of concern which need to be examined.

The banking industry has a high level of non-performing assets (NPAs) to contend
with. High NPAs raise the cost of bank operations and thereby the spread and efforts
need to be made to bring these down. However, a balance has to be drawn between
the reduction in NPAs on one hand and ensuring adequate supply of credit to the
economy on the other. Excessive pressure on banks to reduce NPAs is likely to lend
to a high degree of selectivity in the credit disbursal process and consequently, a
reduction of the total level of credit as dictated by the growth of deposits. The rate of
reduction of NPAs will therefore have to be fairly gradual keeping in mind the
notional lending risks associated with the Indian economy and the speed at which debt
recovery and settlement processes operate. In addition, the factors other than NPAs
which affect the level of spread required for the viability of banks would need to be
considered in the context of national priorities and policy objectives. To achieve this,

action has to be taken on strengthening and professionalising the internal control and
review procedures of banks and financial institutions with a view to ensuring
autonomy with accountability. Also the process of judicial review and implementation
of debt recovery processes and decisions need to be given further impetus and the role
of the States is critical in this regard. In this context, the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002
will go a long way in allowing the banks to take control of the assets of willful
defaulters without going through cumbersome and time consuming litigation.

The ability of the banks to increase their loan portfolio is not only determined by a
growth in their deposits, but also by the need to conform with prudential norms
relating to capital adequacy. Once a bank has reached a level of advances
commensurate with the capital adequacy norms, any increase in loan assets has to be
preceded by a proportionate increase in capital. This can be achieved either by tapping
the market or by the Government providing the capital in case of public sector banks.
It was earlier difficult for public sector banks to raise fresh equity from the market
unless the Government subscribed to the issue in order to maintain its majority share.
This was limiting the options for some banks to enter the market. With the
Government‘s decision to bring down its stake in banks to 33 per cent, this immediate
bottleneck will be removed. The Government is also seized with the need to find
remedial measures to improve the health of weak banks, which have poor bottom
lines and high costs, principally staff costs. The Government has recapitalised some of
the weak banks and restructuring exercises have been undertaken to bring about a
turnaround in their health.

Another point of policy intervention by the Government in the operation of the
banking system has been the statutory liquidity ratio (SLR) through which banks are
compelled to hold Government and public sector securities. The negative effects of
SLR have been mitigated to a considerable extent in recent years both by progressive
reduction in SLR rates and by having market determined rates of interest on public
debt instead of rates prescribed by Government. However in the absence of an active
debt market in Government securities, the SLR is characterised by a certain degree of
illiquidity with the banks and an interest rate on public debt, which is not determined
in a truly competitive market. On the whole, however, the SLR is desirable both as a

prudential measure and in view of the need to generate debt resources for the

Priority sector lending by banks in another area, which needs examination. The role
that priority sector lending has played in making credit available to sectors which are
of national importance in terms of their effects on employment and poverty
alleviation, such as agriculture and small scale industries which have strong
externalities, cannot be over emphasised. However there is a case for reviewing the
system of directed lending in so far as development of specialized institutions not
only on a sectoral basis but also on a regional basis is concerned. In this context,
institutions such as NABARD, SIDBI, Local Area Banks (LABs) Regional Rural
Banks (RRBs) and cooperative financial institutions need to be strengthened and
professionalised and linkages between themselves and with the commercial banking
sector established on a firmer and more formal footing. The institutional structure of
branch networks which are critical for effective implementation of priority sector
lending should, however, not be diluted even with greater autonomy and private
participation in pubic sector banks. Micro-credit, which has been a focus in India and
has proved successful in social sector lending needs to be pursued much more

The advent of liberalisation and greater integration of the financial architecture
globally, major challenges face the financial sector and it is critical that the necessary
skills are acquired and upgraded to meet the new demands. Globalisation has brought
about fierce competitive pressures on Indian banks from international banks. In order
to compete with the new entrants effectively, Indian commercial banks need to
possess matching financial muscle, and size has therefore assumed criticality.
However in the days of ‗virtual‘ banking, the size of a bank measured by its branch
network may not be as important as the size of its balance sheet. Indian banks would
therefore have to acquire a competitive size. Mergers and acquisitions route provides
a quick step forward in this direction offering opportunities to share synergies and
reduce the cost of product development and delivery. There are however legal and
social constraints to these moves at present but it is possible that market compulsions
will soon force their removal. A beginning has already been made in the area of
private sector banking.

There has been a paradigm shift in Indian banking with the absorption of the latest
technology and the need to meet the client‘s expectations in a customised manner.
However, the race for customers could lead to adverse selection. To succeed in the
changed environment, banks would need highly efficient assets and liabilities
management systems to take care of the need to identify, anticipate, manage and
mitigate risks which are known today as well as those which may appear in relation to
the products of the future. Growing disintermediation and competition will also put
pressure on bank spreads and even fee based and service generated incomes will come
under pressure. The way out seems to be compensation through higher turnover
without compromising on asset quality, as well as product innovation, which would
include relationship banking to a significant degree.

A very important challenge before Indian banking will be to manage the different
segments of the economy. Banking services have to be delivered in keeping with the
different levels of economic prosperity enjoyed by the population in rural, semi-
urban, urban and metropolitan areas, and their relative needs. Providing high
technology driven banking in the metros on the one hand to ensuring availability of
basic banking services in the rural areas on the other, form the two ends of the
spectrum and banks need to manage both equally competently.

Issues in Integration:

At present the structure of the financial sector is such that while the different sub-
sectors are highly stratified within the sub-sectors, particularly those which do not any
more belong to the State sector, there is a high proliferation of constituents of varying
levels of size and efficiency. These sub-sectors are commercial banking, investment
banking, development banking, asset management, securities trading and distribution,
insurance and NBFCs. The current trend worldwide and the present debate within the
country, suggests that the end of stratification between sectors and consolidation
within sub-sectors would be inevitable. Deregulation of the sector and the lowering of
entry barriers would speed up this process. Unification in the shape of cross-over
between banking and insurance and the emergence of bancassurance has begun and
shades of universal banking are already evident and the larger of the constituents are

expected to adopt this strategy. However regional and niche players will continue to
be relevant.

The wide area covered by the financial sector in terms of an array of products and
geographical reach makes regulation critical and both institutional regulation and self-
regulation assume importance. The regulatory system today is far more conscious and
better equipped, institutionally and legally, to demand and enforce necessary
disclosures and compliance with laid norms for protection of the users of the system
as well as the credibility and efficacy of the system itself. The aim would be to
achieve international standards in this area within the shortest possible time frame.

An area, which requires considerable streamlining is the lack of free flow of
information within the financial system regarding the credit worthiness of borrowers
and solvency of institutions. The high level of NPAs can in some measure be traced to
this lacuna. Unless information sharing and early warning systems are instituted, the
dangers to the financial system will get multiplied as the level of complexity of
financial transactions in the economy increases. The institutionalisation of such an
information system has been recognized as a high priority area requiring legislative
action to make it credible. The setting up of the Credit Information Bureau is a
beginning in this process.

In the field of technology based banking, information technology and electronic funds
transfer system have emerged as the twin pillars of modern banking development.
Products offered by banks have moved way beyond conventional banking and access
to these services have become round the clock . This, indeed, is a revolution in Indian
banking but some systemic changes are urgently required. Cyber laws and other
procedures which are commensurate with modern technology based banking have to
be put in place immediately and sufficient regulatory mechanism has to be instituted
so that the fast strides in banking automation does not go on undesirable lines.

Corporate governance in banks and financial institutions has assumed great
importance in India and there is still some ground to cover to making all banking
institutions safe, sound and efficient. It is necessary that institutions, which form a
part of the financial system, have internal management, governance and

accountability structures, which measure up to the highest standards. Some of the
issues, which need to be debated are those of compatibility of corporate governance
with public ownership of banks and making the system accountable to economic
institutions and regulators. It is also imperative that there is complete alignment
between the goals of the management of the banks and the goals of shareholders.

The various steps taken by the Government to meet the challenges of a complex
financial architecture have ensured that a new face of the Indian financial sector is
emerging to culminate into a strong, transparent and resilient system. The situation
however is quite dynamic and there would be changes, which we are unable to
anticipate now. It is clear, however, that the financial sector players of the future will
emerge larger in size, technologically better equipped and stronger in capital base.
The regulatory as well as the selfregulatory mechanisms will match up to the best
worldwide thereby ensuring that the health of the Indian financial system is not only
preserved but improved upon and its ability to withstand shocks, which are inevitable
with global integration, remains strong.


The current „TSUNAMI‟ IN THE FINANCIAL SECTOR triggered by the subprime
crises has had a telling impact on the Global economy from which it will take some
time for the economy to recover. If India wants to stay as world‘s second fastest
growing economy Role of banking sector will be vital for India. Study of Business
World, „Banking in 2050‟, shows that the structure of global banking will undergo a
complete realignment with the E7 driving growth.

   Growing Customer demands:
Customer expectations are rapidly changing as they use enabling technology in ways
unanticipated by the inventors and designers. The demands on banks to catch-up are
growing, yet the ability of banking systems to adjust and the willingness to service the
customers in ways that match their rapid adoption is lacking.

The ―anytime, everywhere‖, informational needs of the average person are staggering
and growing. To manage the information overload, consumers need trusted brokers to
help them navigate options and personalize their experiences so that they get ―just-in-
time,‖ trusted information that is relevant and enriched with knowledge about the
person‘s preferences and goals.

The network is king: networks of people, things, places, events, and the information
about them. These networks are intersecting and creating new social fabrics that
enlarge the opportunities for commerce. Banking, as we know it, and the foundations
of entire industries are changing rapidly. Information drives the value inherent in
banking systems, and this is changing the way that consumers think of their assets.
Consumers understand that their assets are not just financial, but include all the
information about their lives that is accumulated on-line and stored in various
locations in various forms. These assets, which are behavioral indicators, have
demonstrated value, as markers of the person‘s preferences and aspirations.

This change in the importance of networks and information flows means that the
understanding of risk is different than in the past, but so too is the opportunity. Scale
and globalization take on new meaning when connectivity is pervasive and ubiquitous
for consumers.

   Fragile Infrastructure:
The legacy systems within Banking have reached a point of un-maintainability. Many
systems are too large and not integrated, creating discontinuous information flows.
The infrastructure may need to be replaced, but no straightforward solutions exist for
doing this without disruption and risk, especially given the scale of the conglomerated
banking system with its high levels of interdependence and lack of diagnostics to
assess the impact of changes.

   Regulatory Climate:
New regulations continue to be debated and even more are likely to be introduced in
the near future as a result of industry failures and abuses. Perceived disregard for
consumers and dubious risk management practices are generally thought to have put
the general welfare of the global economy at risk. Lack of leadership has forced
governments worldwide to impose regulations that may burden commerce with

additional cost, but may be necessary to safeguard the public and the industry against
practices that jeopardized banking status as a trusted industry.

   Information Overload:
As the banking industry consolidates and simultaneously expands its reach into the
lives of its customers and merchant businesses, the amount of data that is generated is
beyond the capacity of most traditional banking systems to manage and extract value.
The lack of reliable analytics with valid indicators of the financial health of the
company, its customers, and the markets they transact in, is a clear evidence of the
inability to deal with the volume of data collected. Inter-related data is often used to
assess very narrow risks, but most banks have failed to create critical connections
between related data points that could predict widespread risks. Thus, the traditional
methods have lacked the performance that provides great confidence in existing risk
management analytical methods.

   Trust Brokers:
Banks historically held the position of trusted brokers, enabling commerce and trade
to be conducted. That role is now commoditized. Moreover, the growth of banking
conglomerates and their lack of leadership and innovation has eroded much of the
remaining trust in the systems. This is not just a brand issue but a systematic failure to
provide safeguards against check and credit card fraud, money laundering, identity
theft, and many modern banking system vulnerabilities. Using financial risk models to
bet against systemic losses is inadequate for customers who are affected by a fraud or
identity theft. Once customer‘s accounts are affected, they experience the lack of trust
directly and are naturally intolerant of the excuses that their banks would provide for
not guaranteeing their financial safety. The banking industry has yet to set the
appropriate bar for customer risk issues, - zero tolerance for fraud and absolute
safeguards for the wealth entrusted to banks. Today risk models have broken down,
fraud continues to be a problem for consumers, and many customers perceive that
they receive excessive and incomprehensible punitive fees, which drive bank profits.
Each of these elements combines to erode trust.

   Archaic Business Models:
The branch model of banking is a remnant of traditional banking that could be
impacted directly by competitive threats. Lack of change in the basic branch format
speaks to the inability to create innovation from within the industry. A typical branch
provides a range of paper-based services (check cashing, cash handling, etc.) and a
face-to-face venue for more complex customer service tasks, many of which could be
handled by newer technologies. The continuing existence of paper forms, signatures,
and other traditional operations demonstrate how far banking is from more leading-
edge paperless industries that affect customer‘s daily lives. These paper-based tasks
take critical time away from one of the highest-value added activities that occurs in
bank branches – customized sales and service activity. Instead of spending time
getting to know the customer needs, the largest banks have turned banking from
personalized, community-based institutions, with all its former dignity and
connectedness, into the equivalent of the franchise fast food of financial services in a
sanitized branch box.


As a result of the multiple challenges within banking, many new players are aligning
to take advantage of the inherent weaknesses in the traditional banking industry.
These new competitors are looking beyond their current profit pools, increasingly
attracted by adjacent strategies that could redefine their businesses or create new ones,
all by attacking the current banking incumbents who are vulnerable to fast-moving,
innovative companies who understand the new power that customer have to make
informed choices.

Additionally, incumbent banks are under pressure for near-term company
performance, stock value and to stem existing market erosion, as well as the pressures
of government involvement following the TARP investments. These banks have
minimal resources at their command to maintain current operating environment, let
alone create new platforms that could differentiate themselves or fend off attacks from
this new breed of competitor. Some savvy banks may use partnerships to off-set
threats and maintain the status quo, but this will not solve the endemic problems of
the banking industry which require investments in innovation and research.
Consequently, the non-banks that attack the edges of banking could have devastating
effects on the banking industry and its existing profit pools.

Net Neutrality continues to fuel opportunity growth, and economic systems will be
open and managed the same way. Cloud banking will drive common infrastructure
and commoditize the ―utility‖ functions of banking, enabling horizontal segmentation
of the banking market and technology. This new foundation will give way to next
generation peer-to-peer enablement. Banking becomes owned and operated by the
users‘ network.


   First generation systems become last generation legacy,

   Leaders become trailing companies due to bloated legacy systems.

   Incumbents show no evolutionary path forward, leaving the market open for
    discontinuous innovation.

   Infrastructure replacement is needed to respond to the market, but difficult to

   Incumbents have no simple way of future-proofing banks.

New competitors:

   Secure devices such as mobiles phones or PCs with appropriate software enable
    information transfer and transaction to occur. Any large entity with sufficient
    resources can provide the services to make information deposits and withdrawals
    as commonly done by billions of users now connected to the global network.

   Secure and trusted accounting already is done by many companies. Bill payment,
    credit processing, loan origination and servicing, prepaid debit, money transfers
    and other bank-like activities are already done in various forms by third party
    processors, retailers and technology companies. Large retailers like Wal-Mart
    certainly have the scale and customer base to seize large opportunities in financial
    services. The cell phone carriers are in a similar position. At the same time, the
    continued survival of credit unions highlights the willingness of people to form
    smaller collectives to serve their interests.
   While many existing regulatory constructs prevent non-banks from performing
    some very specific banking functions, these regulations do not prevent non-banks
    from participating in the transactions or creating relationships with bank
    customers. Thus, these regulations may also enable innovations from outside the
    banking system that dis-intermediate banks from all but the most commoditized
    customer transactions. For example, the growth of pre-paid gift cards has moved
    large amounts of cash into plastic, mostly outside the banking system.

One of the most significant consequences of ICT adoption is the emergence of the
―Brand of Me‖, an age of unprecedented user control over their own experiences and
identity management and proliferation of content. Each person is able to manage
aspects of their identity much as traditional Brands are managed. MySpace and
Facebook can be viewed as personal brand building systems that leverage the power
of social networks to transmit attitudes, sentiments, knowledge, and culture. The
impacts of these changes are not yet fully understood by social scientists or marketing
companies, both currently studying their potential implications.

No one argues that these developments have changed the relationship between Brands
and their consumers. However, traditional Industries like Banking are disadvantaged
in this fast paced environment, because, they are constrained by internal cultures of
risk aversion and conformity to allow greater control over employees and customers,
and thus, most are at a loss as to how to react to the new power for information flows
afforded by these self-organizing networks.

Fragmentation of broadcast advertising media further erodes old models of brand
building. A new strategy is needed that is suited to the reality of the consumer control
that will instill trust in financial institutions by having them become an integral part of
the emerging networks instead of ‖bolting on‖ old business models to the new media.

By combining the current information leaders‘ platforms and with non-traditional
companies - one can envision a radically different environment that solves much of
the issues of financial transparency and redefines what banking may be on a global
scale. It is conceivable this new state will create significant new revenue

With an opportunity to provide service and solutions to customers in novel ways, it is
possible to give them control and co-create and co-configure compelling solutions
that are of great value to customers accustomed to the user-controlled, Web 2.0/3.0
reality. In addition, Web 3.0 will have an intelligent layer to augment people's lives in
ways that assist them to improve their lot by using the power of computation.

   Customer configures their own customized and relevant solutions.

   Banking evolves to help customers secure their entire digital life.

   Zero tolerance for error and risk related to customers‘ information.

   Transactional, product specific ―Life Logging‖ turns into Life Advising.

   Risk is managed and turned into opportunity

This emerging reality will require companies that want to capture this opportunity to

   how to handle a billion accounts with infinitely configured product bundles.
   how to address large unbanked market coming on-line.
   how to stop thinking of accounts and instead clusters of money pools controlled
    by the household and the community.
   how to make banking simpler and more streamlined, with personalized solutions
    bundling that are relevant and valuable to each stage in a customer‘s life.
   how to structure an industry that deals with large and small banks so that the
    industry grows as a network instead of a monolith.

According to a survey carried out by IBM, the four strategic imperatives banks
must follow to cultivate innovation and position themselves for sustainable growth:

Banks will focus on four key imperatives in order to gain optimum competitive
advantage by 2020: focus on core strengths, optimize the potential of each customer
relationship, and partner for everything else, harness the potential of the workforce
through effective performance management and recognize that technology will be a
critical element of success. Each of these imperatives centers on optimizing the results
of innovation initiatives.

1) Focus on core strengths and partner for everything else:

Successful execution of specialization strategies will require banks to take a
component-based view of their businesses and assess each component to determine
where and how it should be managed. Banks will need to identify which components
(or business modules) are truly differentiating and strategic, as opposed to those
components that would be better served by leveraging best-in-class specialists.

Specialization will help ensure that banks invest and focus their innovation efforts on
strategic components. If, as Bridge Bank determined , certain information
technologies are not considered strategic in nature, firms may choose not to invest
heavily in IT innovation. Rather, as that bank has done, they should partner with best-
in-class specialists to attain IT proficiency, and invest instead in product, service and
process innovations that enable real differentiation.

2) Optimize the potential of each customer relationship:

 To help ensure that they can be highly responsive to the changing needs and
purchasing patterns of their empowered customers, banks will have to transform
themselves into customer-centric firms. Cultivating a truly customer-centric culture
requires getting to know customers and continually improving the customer
experience. In doing so, banks will be able to identify who their most profitable
customers are and can focus on building the right relationships with the right
customers – rather than attempting to be all things to all people.

Pushing innovation in the areas of customer analytics and service techniques will
become more and more important as a means of getting closer to customers and
differentiating a bank from competitors, both traditional and emerging. Process
innovation, including the use of incentives and rewards as part of employee
performance management, will be essential to successfully executing these customer-
centric strategies.

3) Harness the potential of the workforce through effective performance management:

According to one survey of financial services executives, 88 percent of their firms
believe talent is a very important or important contributor to business performance,
and 92 percent believe that talent management is one of the top three sources of
competitive advantage. In light of this widespread recognition that an organization's
people are critical to business results, banks will need to drastically change their

existing talent development programs to better take into account projected industry
trends and to establish effective incentive and performance management strategies.

Additionally, banks will have to focus on optimizing the collaboration of workers,
both inside and outside the organization. Facilitating the exchange of knowledge
among individuals and teams can fuel innovative ideas and generate new capabilities.
Accompanying organizational design changes should include initiatives such as
streamlining vertical line management structures, developing knowledge and talent
marketplaces, and deploying teams to explore innovation opportunities.

4) Recognize that technology will be a critical element of success:

Forward-thinking banks will leverage advanced technologies that can support the four
strategic imperatives. Most importantly, banks must conduct a technology capability
assessment to prioritize areas of technological investment and to determine how best
to leverage business process outsourcing for non-core functions.

Clearly, investment in advanced technologies can contribute significantly to
optimizing the return on a bank's innovation investment. Use of service oriented
architectures, open standard applications, advanced computing power and enhanced
global connectivity can all help speed the pace of innovation development and reduce
the time to market.


What do these new realities of ‗banking‘ mean for the future? A list of future
possibilities, many of which are already technically possible, can illustrate how
banking might be radically different than it is today:

   Information itself will emerge as a new form of currency, and the industry will
    need to support this new paradigm, with the ability to store much more data than
    simple financial transactions and assets.
   Cloud banking will enable ―micro credit unions‖ and other small, context-specific
    financial services with Google- style data center container, banking anywhere.
   Non-banks also have opportunities to play utility service provider roles in areas
    where banks no longer need to compete.
   Banks could become the repository of large datasets and the processing models to
    extract insights. Transparent banking and early warning systems.
   Opportunities exist to create privacy preserving techniques where security is no
    longer an issue since it is embedded into the process and data at the lowest level.
   International   retail   banking   will     become   more    important.   Even        as
    telecommunications reduce the need for physical travel, it increases opportunity
    for cross-national collaboration and commerce. The industry therefore must allow
    business to be conducted seamlessly and electronically across international
   Opportunities exist to become the trusted center point for opt-in marketing,
    promotion, and advertising.
   Dramatic reduction in the use of cash and the emergence of new virtual currencies
    is likely to occur. Systems support thousands of currencies, this including forms of
    loyalty points but other variations might be created.
   Nano-banking, micro-payments and macro-banking router requirements create
    still other opportunities that allow for complete integration with total autonomy.
    All messages become part of the repository for analysis.
   Total life long financial management for individuals, the household, and the
    community, cost consequence tracking, beyond budgeting, behavioral decision
    making is another area of opportunity.

   Healthcare-related banking and DNA storage may become opportunities. This
    would extend beyond secure medical records to managing processes to help
    advise individuals on daily health management.

There is no debating change in society and the power that consumers are gaining with
the global adoption of technologies will present a challenge to the status quo. These
possibilities highlight a potential way forward for the future of the banking industry.
The opportunities are enormous if the industry and its technology and information
partners are able to transform into 21st century institutions. Players with awareness of
these possibilities and the willingness to invest in seamless, customer-centric
solutions will be well-positioned to take advantage of this new environment.