Evaluating the Current State of Indian Banking

The commercial banking structure in India consists of the following entities:

Scheduled Commercial Banks and Unscheduled Banks

Scheduled commercial Banks constitute those banks, which have been included in the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI includes only those banks in this schedule, which satisfy the criteria laid down vide section 42 (6) (a) of the Act.

Further, Indian banks can be broadly classified into public sector banks, private banks and foreign banks. Public sector banks are those banks in which the Government of India holds a stake whereas in private banks government does not have a stake in these banks; they may be publicly listed and traded on stock exchanges.

Foreign banks have brought latest technology and latest banking practices in India. They have helped made Indian Banking system more competitive and efficient. Government has come up with a road map for expansion of foreign banks in India.

Currently nationalised banks dominate the Indian banking system. In India the history of nationalised banks dates back to mid-20th century, when Imperial Bank of India was nationalised under the SBI Act of 1955 and re-christened as State Bank of India (SBI) in July 1955. Initially, all the banks in India were private banks, which were founded in the pre-independence era to cater to the banking needs of the people. In 1921, three major banks i.e. Banks of Bengal, Bank of Bombay, and Bank of Madras, merged to form Imperial Bank of India.

Reserve Bank of India has the role of central banking in India and is responsible for controlling the monetary policies of the nation, in 1935 it formally took over these responsibilities from the then Imperial Bank of India. In 1947, Reserve Bank was nationalized and was given broader powers. In 1969, 14 largest commercial banks were nationalized followed by six next largest in 1980. But with adoption of economic liberalization in 1991, private banking was again allowed.

The chart below gives a view on the current state of banking sector in India.

From the charts given above, we get a fairly right idea about the mix of types of banks present in Indian banking sector.

On a detailed analysis of the Indian banking sector, we came across to the following salient points:

Global scale: The lack of global scale for Indian banks came into sharp focus during the recent international financial crisis which saw several reputed international banks reneging on their funding commitments to Indian companies; however the local banks could not step into the breach because of balance sheet limitations. Small and weak banks pose systemic risk with their low capital adequacy ratio and high NPAs. Consolidation could be a timely response to augment efficiency, which in turn would lead to income generation and add to the GDP of the nation. The smaller banks are apprehensive about losing their identities while bigger banks fear that the assets might become a liability for them in the long term. The idea of creating bigger banks to take on competition sounds attractive but one must realise even the biggest among Indian banks are small by global standards.

Increase in scope: Over the last three decades, there has been a remarkable increase in the size, spread and scope of activities of banks in India. The business profile of banks has transformed dramatically to include non-traditional activities like merchant banking, mutual funds, new financial services and products.

Within retail operations, banks rate product development and differentiation; innovation and customization; cost reduction; cross selling and technological up-gradation as equally important to the growth of their retail operations. Additionally we can also find pro-active financial inclusion, credit discipline and income growth of individuals and customer orientation to be significant factors for their retail growth.

Technology (Core banking solutions): Technology has enabled banks to consolidate their various legacy platforms across functions and geographies which helped them in leveraging cost and at the same time acquiring flexibility and scalability to adapt to a fast changing and competitive environment. Also, the shift to IFRS standards by 2011 with valuation of assets on the basis of current rather than historical cost would be one of the major driving forces for the implementation of new technology. The future would require banks to have increased business agility and operational efficiency, which makes the implementation of Core Banking Systems (CBS) by banks increasingly important.

Competition: There have been limited signs of increased competition within the banking sector. Public sector banks have attempted to improve the quality of services through technology up-gradation, but such attempts still remain small by relative standards. Significant differences in profitability and efficiency continue to persist between public sector banks and the new private sector and foreign banks.

Non-performing assets: While most public sector and old private sector banks have attained the BIS capital adequacy norm of 8 percent, this achievement is somewhat neutralized by the existence of high volumes of NPAs, the periodic injections of capital by the government, and the absence of sound banking practices

Also, we note that In spite of new entry and expansion of private sector banks, the oligopolistic dominance of public sector banks continues.

Financial Inclusion:

Financial inclusion is delivery of banking services at an affordable cost to the vast sections of disadvantaged and low income groups, which can happen through:

state-driven intervention by way of statutory enactments, for instance we can take the example of USA, the Community Reinvestment Act and making it a statutory right to have bank account in France.

voluntary effort by the banking community itself for evolving various strategies to bring within the ambit of the banking sector the large strata of society.

For the past one year definitely and in fact for the past several years one of the important new objectives of the Reserve Bank of India has been financial inclusion. The movement towards financial inclusion rose to a crescendo in the current year because the demand for financial inclusion has become a national and a governmental imperative.

The Reserve Bank of India had set up a commission, Khan Commission in 2004 to look into financial inclusion and the recommendations of the commission were incorporated into the mid-term review of the policy (2005âAsA 06). In the report, RBI urged the banks with a view of achieving greater financial inclusion to make available a basic "no-frills" banking account to common man. Financial Inclusion first featured in 2005, when it was introduced from a pilot project in UT of Pondicherry, by K C Chakraborthy, the then chairman of Indian Bank. Mangalam Village became the first village in India where all households were served with banking facilities. In addition to this, KYC (Know your Customer) norms were relaxed for potential customers who intended to open accounts with annual deposits of less than Rs. 50,000. Also, General Credit Cards (GCC) were issued to the poor and the disadvantaged with a view to help them access easy credit as per their requirement.

However, illiteracy and the low income savings and lack of bank branches in rural areas continue to be a road block to financial inclusion in many states. Apart from this there is inadequate legal and financial structure in the nation as of now to support a complete financial inclusion and these needs to be taken care of as soon as possible.

In India the focus of the financial inclusion at present is confined to ensuring a bare minimum access to a savings bank account without frills and providing such facilities and services there are some challenges faced by the banks.

The main challenges are:

Products designed by the banks are not satisfying the low income families. The provision of uncomplicated, small, affordable products will help to bring the low income families into the formal financial sector

Banks have limitations to reach directly to the low income consumers. Correspondents can be considered to be an excellent channel which banks can use to distribute their product information.

Educating the consumers about the financial benefits and products of banks which are beneficial to low income groups will be a great step to tap their potential.

In order to mitigate the above mentioned challenges banks are now using new technologies like mobile phones to reach low income consumers and the recent simplification of KYC norms are another milestone. Financial service providers should learn more about the consumers and new business models to reach them and provide them with the bare minimum financial products and services.

Consequences of financial exclusion will vary depending on the nature and extent of services denied. It may lead to increased travel requirements, higher incidence of crime, general decline in investment, difficulties in gaining access to credit or getting credit from informal sources at exorbitant rates, and increased unemployment, etc. The small business may suffer due to loss of access to middle class and higher-income consumers, higher cash handling costs, delays in remittances of money.

Priority Sector Lending Norms Branch Licensing

The RBI guidelines to banks highlights that 40% of domestic and 32% of foreign NBCaAsA AzA advance should be to the priority sector. This mainly consists of agriculture, small scale industries, retail trade etc. In order to increase banking penetration and promote financial inclusion, the Reserve Bank relaxed branch opening norms for lenders allowing banks to appoint kirana, medical shop owners, agents of small savings schemes, petrol pump owners, retired teachers among others as correspondents. Transition from class banking to mass banking and increased customer focus is drastically changing the landscape of Indian banking.

The scope and breadth of this emerging market can be estimated if we consider the following facts.

India has a middle class of 250 to 300 million people in need of varied banking services. Only 60% of our population has access to banks and out of these only 15% of them having loan accounts

An overwhelming 70% of farmers have no access to formal sources of credit, reflective of immense potential for the banking system

Steps towards financial inclusion:

In order to address financial exclusion banks will require a holistic approach in creating awareness about financial products, education, and advice on money management, debt counseling, savings and affordable credit. The banks would have to evolve specific strategies to expand the outreach of their services in order to promote financial inclusion.

One of the ways in which this can be achieved in a cost-effective manner is through forging linkages with microfinance institutions (MFIs), which are very well established and have considerable penetration in the rural community, and local communities. Banks should give wide publicity to the facility of no frills account. Nonetheless, use of technology like smart cards, mobile banking can be a very valuable tool in providing access to banking products in remote areas. ATMs cash dispensing machines can be modified suitably to make them user friendly for people who are illiterate. Banks have to make use of all available resources including technology and expertise available with them as well as the network of MFIs and NGOs.

Cite this page