Financial Sector Reforms in India

Banking Sector Reforms in INDIA

Executive Summary

A retrospect of the events clearly indicates that the Indian banking sector has come far away from the days of nationalization. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector. 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. The recent international consensus on preserving the soundness of the banking system has veered around certain core themes. These are: effective risk management systems, adequate capital provision, sound practices of supervision and regulation, transparency of operation, conducive public policy intervention and maintenance of macroeconomic stability in the economy. Until recently, 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.

However, the banking sector reforms have 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. The competitive environment created by financial sector reforms has nonetheless compelled the banks to gradually adopt modern technology to maintain their market share.

Thus, the declaration of the Voluntary Retirement Scheme accounts for a positive development reducing the administrative costs of Public Sector banks. The developments, in general, have an emphasis on service and technology; for the first time that Indian public sector banks are being challenged by the foreign banks and private sector banks. Branch size has been reduced considerably by using technology thus saving manpower. The deregulation process has resulted in delivery of innovative financial products at competitive rates; this has been proved by the increasing divergence of banks in retail banking for their development and survival. In order to survive and maintain strong presence, mergers and acquisitions has been the most common development all around the world. In order to ensure healthy competition, giving customer the best of the services, the banking sector reforms have lead to the development of a diversifying portfolio in retail banking, and insurance, trend of mergers for better stability and also the concept of virtual banking. The Narasimham Committee has presented a detailed analysis of various problems and challenges facing the Indian banking system and made wide-ranging recommendations for improving and strengthening its functions.

Introduction of Financial Sector Reforms in India

India has had more than a decade of financial sector reforms during which there has been substantial transformation and liberalization of the whole financial system. The article takes stock and assesses the efficacy of approach towards the reforms. As the company grows and becomes more sophisticated, the banking sector has to develop an equal platform in a manner that it supports and stimulates such growth. With increasing global integration, the Indian banking system and financial system has as a whole had to be strengthened so as to be able to compete. Now is the appropriate time to take stock and assess the efficacy of our approach. It is useful to evaluate how the financial system has performed in an objective quantitative manner. This is important because India's path of reforms has been different from most other emerging market economics: it has been a measured, gradual, cautious, and steady process, devoid of many flourishes that could be observed in other countries. Until the beginning of the 1990's the state of the financial sector in India could be described as a classic example of “financial repression” a la MacKinnon and Shaw. The sector was characterized, inter alia, by administered interest rates, large pre-impression of resources by the authorities and extensive micro-regulations directing the major portion of the flow of funds to and from financial intermediaries. While the true health of intermediaries, most of them public sector entities was masked by relatively opaque accounting normal and limited disclosure, there were general concerns about their viability. Insurance companies- both life and non-life - were all publicly owned and offered very little product choice. In the securities market, new equity issues are governed by a plethora of complex regulations and extensive restrictions. There was very little transparency and depth in the secondary market trading of such securities. Interest rates on government securities, the pre-dominant segment of fixed- income securities, were decided through administered fiat. The market for such securities was a captive one where the players were mainly financial intermediaries, who had to invest in government securities to fulfill high statutory reserve requirements. The end result was low levels of competitions, efficiency and productivity in the financial sector, on the one hand, and severe credit constraints of the productive entities, on the other, especially for those in the privet sector. The other major drawback of this regime was the scant attention that was placed on the financial health of the intermediaries. The predominance of the government securities in the fixed income securities market of India mainly reflects the captive nature of this market has most financial intermediaries need to invest a sizeable portion of funds mobilized by them in such securities. The phase of nationalization and ‘social control' of financial intermediaries, how-ever, was not without considerable positive implications as well. The sharp increase in rural branches of banks increased deposit and savings growth considerable. There was a marked rise in credit flow towards economically important but hitherto neglected activities most notably agriculture and small scale industries. There was no major episode of failure of financial intermediaries in this period. Starting from such a position, it is widely recognized that the Indian financial sector over the last decade has been transformed into a reasonably sophisticated, diverse and resilient system. However, this transformation has been the culmination of extensive well sequenced and coordinated policy measures aimed at making the Indian financial sector efficient, competitive and stable. The main objectives, therefore, of the financial sector reform process in India initiated in the early 1990s have been to: 1) Remove financial repression that existed earlier 2) Create an efficient, productive and profitable financial sector industries; 3) Enable price discovery, particularly, by the market determination of interest rates that then helps in efficient allocation of resources. 4) Provide operational and functional autonomy to institutions; 5) Prepare the financial system for increasing international competition. 6) Open the external sector in a calibrated fashion; 7) Promote the maintenance of financial stability even in the face of domestic and external. There is a rich array of literature analyzing the anthology of the reform process. What is less probed is the outcome. In fact, from the vantage point of 2008-09, one of the successes of the Indian financial sector reforms has been the maintenance of financial stability and avoidance of any major financial crisis during the reform period- a period that has been turbulent for the financial sector in most emerging market countries. The initiation of financial reforms in the country during the early 1990s was to a large extent conditioned by the analysis and recommendation of various committees/working groups set up to address specific issues. The process has been marked by ‘gradualism' with measures being undertaken after extensive consultations with experts and market participants. From the beginning of financial reforms, India has resolved to attain standards of international best practices but to fine tune the process keeping in view the underlying institution and operational considerations. Reforms measures introduced across sectors as well as within each sector were planned in such a way so as to reinforce each other. Attempts were made to simultaneously strengthen for commercial decision-making and market forces in increasingly competitive frameworks. At the same time, the process did not lose sight of the social responsibilities of the financial sector. However, for fulfilling such objectives, rather than using administrative fiat or coercive, attempts were made to provide operational flexibility and incentives so that the desired ends are attended through broad interplay of market forces. Despite several changes in government there has not been any reversal of direction in the financial sector reform process over the last 15 years. As pointed by governor Reddy, the approach toward financial sector reforms in India is based on panchasutra or five principles: 1) Cautious and appropriate sequencing of reforms measures. 2) Introduction of norms that are mutually reinforcing. 3) Introduction of complimentary reforms across sectors (most importantly, monetary, fiscal and external sector). 4) Development of financial institutions. 5) Development of financial markets. A salient feature of the move towards globalization of the Indian financial system has been the intent of the authorities to move towards international best practices. This is illustrated by the appointment of several advisory groups designed to benchmark India practices with international standards in several crucial areas of importance like monetary policy, banking supervision, data dissemination, corporate governance and the like. Towards this end, a standing committee on international financial standards and codes (chairman: Dr Y.V Reddy) was constituted and the recommendations contained therein have either been implemented or are in the process of implemented or are in the process of implementation.

POLICY REFORMS:

Commercial banking constitutes the largest segment of the Indian financial system. Despite the general approach of the financial sector process to establish regulatory convergence among institutions involved in broadly similar activities, given the large systematic implications of the commercial banks and were late extended to other types of financial intermediaries. After the nationalization of major banks in two waves, starting in 1969, the Indian banking system became predominantly government owned by the early 1990s. Banking sector reform essentially consisted of two-pronged approach. While nudging the Indian banking system to better health through the introduction of international best practices in prudential regulation and supervision early in the reform cycle, the idea was to increase competition in the system gradually. The implementation periods for such norms, were, however, chosen to suit the Indian situation. Special emphasis was placed on building up the risk management capabilities of the Indian banks. Unlike in other emerging market countries, many of which had the presence of government owned banks and financial institution, banking reform has not involved large-scale privatization of such banks. The approach, instead, first involved recapitalization of banks from government resources to bring them to appropriate capitalization has been done through diversification of ownership to private investors up to a limit of 49%, there by keeping majority ownership and control with the government. With such widening of ownership most of these banks have been publicly listed; this was designed to introduce greater market discipline in bank management and greater transparency through enhanced disclosure norms. The phased introduction of new private sector banks, and expansion in the number of foreign bank branches, provided for new competition. Meanwhile, increasingly tight capital adequacy, prudential and supervision norms were applied equally to all banks, regardless of ownership.

Introduction to Banking Reforms

As the real sector reforms began in 1992, the need was felt to restructure the Indian banking industry. The reform measures necessitated the deregulation of the financial sector, particularly the banking sector. The initiation of the financial sector reforms brought about a paradigm shift in the banking industry. In 1991, the RBI had proposed to from the committee chaired by M. Narasimham, former RBI Governor in order to review the Financial System viz. aspects relating to the Structure, Organizations and Functioning of the financial system. The Narasimham Committee report, submitted to the then finance minister, Manmohan Singh, on the banking sector reforms highlighted the weaknesses in the Indian banking system and suggested reform measures based on the Basle norms. The guidelines that were issued subsequently laid the foundation for the reformation of Indian banking sector.

The main recommendations of the Committee were: - 1) Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years. 2) Progressive reduction in Cash Reserve Ratio (CRR). 3) Phasing out of directed credit programmes and redefinition of the priority sector. 4) Deregulation of interest rates so as to reflect emerging market conditions. 5) Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994. 6) Adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts. 7) Imparting transparency to bank balance sheets and making more disclosures. 8) Setting up of special tribunals to speed up the process of recovery of loans. 9) Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount. 10) Restructuring of the banking system, so as to have 3 or 4 large banks, which could become international in character, 8 to 10 national banks and local banks confined to specific regions. Rural banks, including RRBs, confined to rural areas. 11) Abolition of branch licensing. 12) Liberalizing the policy with regard to allowing foreign banks to open offices in India. 13) Rationalization of foreign operations of Indian banks. 14) Giving freedom to individual banks to recruit officers. 15) Inspection by supervisory authorities based essentially on the internal audit and inspection reports. 16) Ending duality of control over banking system by Banking Division and RBI. 17) A separate authority for supervision of banks and financial institutions which would be a semi-autonomous body under RBI. 18) Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks. 19) Obtaining resources from the market on competitive terms by DFIs. 20) Speedy liberalization of capital market. 21) Supervision of merchant banks, mutual funds, leasing companies etc., by a separate agency to be set up by RBI and enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc. Several recommendations have been accepted and are being implemented in a phased manner.

Among these are the reductions in SLR/CRR, adoption of prudential norms for asset classification and provisions, introduction of capital adequacy norms, and deregulation of most of the interest rates, allowing entry to new entrants in private banking sector, etc. Keeping in view the need of further liberalization the Narasimham Committee II on Banking Sector reform was set up in 1997. This committee's terms of reference included review of progress in reforms in the banking sector over the past six years, charting of a programme of banking sector reforms required to make the Indian banking system more robust and internationally competitive and framing of detailed recommendations in regard to make the Indian banking system more robust and internationally competitive. This committee constituted submitted its report in April 1998. The major recommendations are: 1) Capital adequacy requirements should take into account market risks also. 2) In the next three years, entire portfolio of Govt. securities should be marked to market. 3) Risk weight for a Govt. guaranteed account must be 100 percent. 4) CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by 2002. 5) An asset should be classified as doubtful if it is in the sub-standard category for 18 months instead of the present 24 months. 6) Banks should avoid ever greening of their advances. 7) There should be no further re-capitalization by the Govt. 8) NPA level should be brought down to 5% by 2000 and 3% by 2002. 9) Banks having high NPA should transfer their doubtful and loss categories to ARCs which would issue Govt. bonds representing the realizable value of the assets. 10) International practice of income recognition by introduction of the 90-day norm instead of the present 180 days. 11) A provision of 1% on standard assets is required. 12) Govt. guaranteed accounts must also be categorized as NPAs under the usual norms. 13) There is need to institute an independent loan review mechanism especially for large borrowable accounts to identify potential NPAs. 14) Recruitment of skilled manpower directly from the market to be given urgent consideration. 15) 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. To start with, it has assigned a 2.5 per cent risk-weight-age on gilts by March 31, 2000 and laid down rules for provisioning; shortened the life of sub-standard assets from 24 months to 18 months (by March 31, 2001); called for 0.25 per cent provisioning on standard assets (from fiscal 2000); 100 per cent risk weight-age on foreign exchange (March 31, 1999) and a minimum capital adequacy ratio of 9 per cent as on March 31, 2000. Only a few of these mainly constitute to the reforms in the banking sector.

Reduction of SLR and CRR:

The South East Asian countries introduced banking reforms wherein bank CRR and SLR was reduced; this increased the lending capacity of banks. The markets fell precipitously because banks and corporate did not accurately measure the risk spread that should have been reflected in their lending activities. Nor did they manage such risks or provide for them in their balance sheets. And it followed the South East Asian Crisis. The monetary policy perspective essentially looks at SLR and CRR requirements (especially CRR) in the light of several other roles they play in the economy. The CRR is considered an effective instrument for monetary regulation and inflation control. The SLR is used to impose financial discipline on the banks, provide protection to deposit-holders, allocate bank credit between the government and the private sectors, and also help in monetary regulation. However bankers strongly feel that these along with high non-performing assets (on which banks do not earn any return) 3-20 percent CRR and 20-45 percent SLR (most banks have SLR investments way above the stipulation) are affecting banks' bottom-line. Ø The Narasimham Committee had argued for reductions in SLR on the grounds that the stated government objective of reducing the fiscal deficits will obviate the need for a large portion of the current SLR. Similarly, the need for the use of CRR to control secondary expansion of credit would be lesser in a regime of smaller fiscal deficits.

The committee offered the route of Open Market Operations (OMO) to the Reserve Bank of India for further monetary control beyond that provided by the (lowered) SLR and CRR reserves. Ultimately, the rule was Reduction in the reserve requirements of banks, with the Statutory Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-97 in a period of 5 years. The recent trend in several developed countries (US, Switzerland, Australia, Canada, and Germany) towards drastic lowering of reserve requirements is often used to support the argument for reduced reserve levels in India. Ø The arguments for higher or lower SLR and CRR ratios stem from two different perspectives one which favors the banks, and the other which favors the bank reserves as a monetary policy instrument. The bank perspective seeks to maximize "lend able" resources, the banks' control over resource deployment, and returns to the banks from the "pre-empted" funds. It is also claimed that the low returns from the forced investments in government securities adversely affect the bank profitability - the cost of deposits for banks, which averages at 15-16 per cent, was much greater than the (earlier) returns on the government securities.

This argument is sometimes carried further to state that RBI makes profits on impounded money, at the cost of bank profitability. To some extent, this argument has been weakened by the increase in interest on government securities to 13.5 per cent. Some problems with the stated aim of reducing SLR and CRR are: 1) The supporting condition of smaller fiscal deficits is not happening in reality. 2) Open market operations have not been used to any significant extent in India for monetary control. The time required for gaining experience with the use of such operations would be much more than 5-6 years. 3) A commitment to a unidirectional movement of these vital controls irrespective of the effects on, and the response of, other economic factors (such as inflation), would be unwise. This scenario thus indicates that despite the stated aim of reductions in SLR and CRR, RBI may be forced to revert to higher reserve levels, if the economic indicators become unfavorable, and RBI has already indicated as much. Bank investment are, therefore, not likely to stabilize in the near future. The RBI had announced an increase in interest rate on CRR balance to 6% from the present 4%. This will certainly boost the profits of banks, as they have to maintain a minimum balance of 8% with the RBI.

Trends in CRR and SLR 1996 - 2004:

Minimum Capital Adequacy Ratio

The committee recommended a Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994. Later, all banks required attaining the capital adequacy norm of 8 per cent, as per the Basle Committee Recommendations, by March 31, 1996.

Capital Adequacy:

The growing concern of commercial banks regarding international competitiveness and capital ratios led to the Basle Capital Accord 1988. The accord sets down the agreement to apply common minimum capital standards to their banking industries, to be achieved by year-end 1992. Based on the Basle norms, the RBI also issued similar capital adequacy norms for the Indian banks. According to these guidelines, the banks will have to identify their Tier-I and Tier-II capital and assign risk weights to the assets. Having done this they will have to assess the Capital to Risk Weighted Assets Ratio (CRAR). The minimum CAR that the Indian banks are required to meet is set at 9 percent. 1) Tier-I Capital, comprising of Paid-up capital, Statutory Reserves, Disclosed free reserves, Capital reserves representing surplus arising out of sale proceeds of assets. 2) Tier-II Capital, comprising of Undisclosed Reserves and Cumulative Perpetual Preference Shares, Revaluation Reserves, General Provisions and Loss Reserves. The Narasimham Committee had recommended that the capital adequacy norms set by the Bank of International Settlements (BIS) be followed by the Indian banks also. The BIS norm for capital adequacy is 8 per cent of risk-weighted assets.  

Inadequacy

The structural inadequacy that is said to be responsible for the stock scam was the compartmentalization of the capital and money markets; and the availability of "illegal" arbitrage opportunities. Such interconnections between various parts of the financial system will continue to develop as the demands made by the rest of the economy on the financial system increase in the next two decades. Also, a short-term danger of the new provisioning and capital adequacy norms arises from the inefficiency of the Asset Reconstruction Fund (ARF), or some alternative arrangement. The need to make massive provisions obviously results in a depletion of capital. But the capital adequacy norm means the banks have to find additional, costly money to refurbish the capital base. In this situation, the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. Where time and legal efforts might have forced them to pay more, errant loanees are now getting away with token payments which the funds starved banks are only too willing to accept. Thus, the need for ARF is now paramount. The banking sector specialists have traditionally claimed that capital plays several roles in all "depository institutions", such as banks. However, these roles can vary significantly between the public sector banks and those in the private sector.

The justification for capital adequacy norms for banks is brought out by the following arguments: Ø Capital lowers the probability of bank failure more capital means added ability to withstand unexpected losses, and more time for the bank to work through potentially fatal problems. At the same time, the Indian public sector banks may attract more "punishments" in the form of politically motivated "loan waivers", "loan melas", and non-performing assets. Ø Capital increases the disincentive for the bank management to take excessive risk: If significant amount of their own funds are at stake, the equity-owners have a powerful incentive to control the amount of risk the bank incurs. This may remain true for the public sector banks only if the government acts as a vigilant shareholder.

However, the government's ability to play such a role effectively is suspect. The Indian banks have traditionally shown risk-aversion, but the recent stock scam showed that the banks are perhaps being forced to take excessive risks to improve the profitability. Since management control will remain with bureaucrats - banking or government - the source of capital would not make much difference in the Indian scenario. Ø Capital acts as a buffer between the bank and the deposit guarantee corporation (funded by the tax-payer): while this is true for the private banks, the government-owned capital in the public sector banks is itself taxpayer money. Ø Capital helps avoid "credit crunches": a well-capitalized bank can continue to lend in the face of losses. Similar losses might force a poorly capitalized bank to restrict credit (to increase capital ratios). In an economic downturn, well-capitalized banks may provide a vital source of continuing credit. Ø Capital increases the long-term competitiveness: more capital allows a bank to build long-term customer relationships, and respond to positive as well as negative changes in the economic environment. New opportunities can be quickly made use of by lending appropriately. If the bank is not constrained by capital, it can give valuable time to customers with temporary repayment problems. It can thereby recover more from the loans, which would otherwise have to be called in.

The Dilemma:

The foregoing discussion clearly brings out two conclusions: (a) increasing the capital base of the nationalized banks is necessary, especially in view of the large quantities of non-performing assets; and (b) however, increase in capital owned directly by the government has several attendant problems' The situation is complicated by the fact that " private management" does not provide an answer in India, because of the size of the institutions involved. Also, talent and expertise in bank management is available mainly in the existing nationalized banks. One short-term fallout of the capital adequacy norms has been the massive increases in investments by the banks in government securities. Since the risk-weight of government securities is zero, investments in them do not add to the capital requirements. The banks are therefore choosing to deploy funds mobilized through deposits in these long-term gilts. In the first ten months of 1993-94, for example, the investments in government securities shot up by 18.8 per cent while bank credit grew at only 6.6 per cent. Despite a strong growth in aggregate deposits of 13.8 per cent, credit grew by only 6.65 per cent, while investments surged by 18.8 per cent. The problem with this practice of the banks is that it can upset the balance of maturity patterns between deposits (many of ' which are short-term) and investments (which have 10 year maturities). Now, banks would have to develop much better investment management skills, especially when interest rates are deregulated, and significant open market operations are started.

Growth in Investments in Government Securities by Banks:

	1991-92	1992-93	1992-93 [Up to Jan 93]	1993-94 [Up to Jan 94]
Aggregate deposits growth		36441 [19.6 %]	32364 [14.0 %]	37187 [13.8 %]
Bank credit growth	9291 [8.0 %]	26390 [21.0 %]	20966 [16.7 %]	9999 [6.6 %]
Investments	15131	15460	11042 [12.2 %]	19857 [18.8 %]
Source: Reserve Bank of India Bulletin [1994] Supplement - Report on Trends and Progress of Banking in India 1991-92 [July - June]; Jan 1993.

The Narasimham Committee II, 1998, suggested further revision i.e. CAR to be raised to 10% from the present 8%(1998); 9% by 2000 and 10% by 2002

Renaissance in Risk Management in Banking

The Basel committee of banking supervision was constituted by the central bank governors of group-10-countries in the year 1975 primarily with the objectives of undertaking eclectic analysis of the working of banks in various countries and to offer hand made Remedies on an on going basis. To begin with its mammoth task Basel committee came out with its first document on international convergence of capital measurement and capital standards in JULY 1988 as a harbinger to tone-up the safety and stability of commercial banking in particular world over. Over time Basel committee issued number of operational directives enabling central banking authorities to consider and to implement the prescriptions as may be possible in their efforts of fine tuning its overall objectives mentioned above. Basel accord-II was since after strenuous efforts of Basel committee over five full years from JUNE 1995, born in may 2004 and the revised document-containing framework on international convergence of capital measurement and capital standards was released over the internet in JUNE 2004. The rationale behind this accord along-side the existence of earlier accord (Accord-I) lies with the efforts of the committee to develop a revised framework for further strengthening the soundness and stability of international banking system with provision for sufficient consistency and further to ensure that capital adequacy regulation does not impose any element of competitive inequality among internationally active banks.

BASEL ACCORD-II: - The Three Dimensional Approach:

One of the most distinguishing features of the current accord is with respect to its three dimensional approach. Firstly risk segments in commercial banking have been classified into three distinct categories viz. credit risk, market risk, and operational risk. Further another direction of the accord is with respect of development of three pillars (Viz. minimum capital, supervisory review process and market discipline) An initial analysis of the accord will reflect that for professional management of all the three risk categories as above the element of capital requirements, regulatory review process, transparency and disclosures by way of market discipline from the basic super structure of a healthy, sound consistent and proactive risk management system in business entities.

CATEGORIES OF RISK:

Risk in business environment may take any form and dept and it is difficult to foresee only a particular category of risk prevailing in any environment. While one may conceive a wide range of risks (Some international writers have jokingly identified phantom risk”). For the sake administration of risk management system across business entities, commercial banking commercial banking in particular, the committee has clubbed various risk situations in three categories:

1. Credit risk,
2. Market risk,
3. Operational risk.

In simple terms credit risk emanates owning to default of the counter party in respect of funded and non-funded exposure including treasury operations. Market risk arises on change of market variable in the form of liquidity constraints, prices, exchange rates etc. Operational risk, on the other hand, is an omnibus group and in the strict sense it contains the ingredients of credit risk and market risk in as much as human failure intentional and unintentional, which is a part of operational risk, may exist both in credit transaction and market related transaction. However, Basel committee has now come out with a consensus definition of operational risk stated here under in an attempt to avoid intermingling of operational risk with aforesaid two categories of risk:- “The risk of loss resulting from inadequate of failed internal process, people and systems of from external events”. (This definition includes legal risk but excludes strategic and Reputation risk). Internationally the significance of credit risk, market risk and operational risk in banking business is not uniform and varies considerably in view of size complexity risk philosophy and risk appetite of each organization. Some experts consider as a very rough guide the intensity in between these risks to the extent as under in commercial banking:

• Credit risk - 95%
• Market risk -4%
• Operational risk-1%

The above percentage is only indicative and as stated above may widely vary in different banking environment and again bank to bank position however what is important is that in commercial banking highest amount of focus is on credit risk management followed by market risk and finally by operational risk Notwithstanding this risk management architecture and implementation process to manage the above risk on a consistent basis is the crying need of the millennium in the risk management system here comes the sanctity and validity of the three-pillar approach enunciated by Basel-II committee.

Three Pillar Approach

Pillar of a building / hose how strong weak determines its safety and longevity same is the case with risk management system Basel committee has clearly identified three pillars as under so that they serve as positive strength of the risk management system in an organization;-

Pillar I

- minimum capital Requirements

Pillar II

- Supervisory review process

Pillar III

- Market discipline

I. The first pillar

i.e. The prescription of minimum capital requirement is nothing new. Basel Accord-I since 1988 has been in operation requiring banks to maintain minimum 8% capital adequacy ratio (in India presently minimum prescribed is 1% more i.e.9%) This minimum capital otherwise known as regulatory capital acts as sort of insurance for the interest of the depositors. Basel committee, while initially suggesting aforesaid regulatory capital towards credit risk, subsequently in 1996 covered market risk transactions. Now in the recent accord (accord-II) regulatory capital requirement for operational risk has also been prescribed in other words now banks will have to maintain separate regulatory capital for credit risk market risk and operational risk. The methodology of computations of capital under Basel Accord-II covers a simple system as well as a very advanced statistical based system. It is left to Regulatory Authorities of the respective countries to decide on the modalities they would like to adopt subject to the precondition that minimum 8% capital adequacy must be maintained for credit risk and market risk and in addition suitable capital ratio to be maintained for operational risk segment. Indian banking system has, by now, matured itself sufficiently to face the global competition in the area of capital regulation of Basel committee. The computation aspect of capital adequacy for credit risk and market risk has been strengthened. RBI,(Reserve Bank of India) has recently issued a revised guideline for computation of capital for market risk in consonance with Basel committee recommendations. The need for capital adequacy for credit risk and market risk is fairly understood by the existing system but the emerging requirement of capital regulation for operational risk will be altogether be a new cup of tea.

II. Second pillar of Basel committee

i.e. supervisory review process is definitely enlightened version of various regulatory systems and procedure across the countries. But the primary focus under Basel-II from supervisory angle will be towards sound capital assessment of risks internal control as well as assessment of adequacy of risk components and compliance standard of the various banks. This therefore calls for necessary action by central banks of the respective countries in order that the identified risk categories are properly assessed and due safeguards initiated on an on going basis, thereby ensuing that any sudden hiccups do not cause serious impact in the system.

III. Third and final pillar

goes under the nomenclature “Market Discipline”. In simple terms market discipline demands that operating units should continue its operations with transparency and disclosure to the public proprietary and confidential information which may affect bank's business from the angle of competition or in terms of legal requirements of a particular country would not be required to be disclosed but where possible “general information” on such matters may be disclosed. This will mean that a bank or an organization is fully market discipline oriented. The nitty-gritty of each risk category and each pillar stated above is not intended to be covered in this endeavor since they demand an exhaustive treatment and analysis which is not the focus here.

Basic issues on implementation in Indian context:

v Basel-II Accord is applicable for internationally active banks. No specific criteria of identification of such Banks has been laid down. It is understood that USA has decided to identify their first -10-banks as internationally active banks. v The guidelines as framed are quite extensive and presuppose a compact techno savvy environment and sound MIS in banks. At the prevailing pace of technological progress and data base creation, it may not be possible to implement a major portion of package under Basel-II within the outer time limit of year 2010, looking to the varied size of commercial Baking operations in India. v Staff skill development in banks to handle the various new issues technicalities in risk management on an ongoing basis remains a focus area. With the exodus of large number of skilled personnel from public sector banks under VRS(VOLUNTARILY RETIREMENT SCHEME), energetic steps need be token to upgrade skill of existing personnel and also to bring in specialist personnel from open market on appropriate pay package. v Risk culture on enterprise basis has to be developed with more active involvement of top executives. Business proposals of significant value must pass through risk management criteria. v To take care of newly developed operational risk parameters bank would have to re-look to their existing guidelines/Instructions on operational areas their manual of instructions book of instructions may have to be substantially updated. v Clear cut credit risk policy Market risk policy, and operational risk policy, must be developed with necessary, flexibility of their operations and provision for up-gradation preferably on annual basis. v Quarterly risk management meetings of zonal/Regional Heads must take place with TOP Officials of corporate office so as to monitor risk management implications of the entire bank. v RBI (reserve Bank Of India) also in turn should organize similar quarterly risk management meetings with each bank's Top Officials so that their supervision review process role under pillar-III is discharged smoothly. v One of the most distinguishing features of the current Basel Accord is with respect to its three dimensional approach. Firstly risk segments in commercial Banking have been classified into three distinct categories- credit risk, market risk and operational risk.

Some Conflicting Areas:

Default of counterparties on payment of Interest/Installment generates credit risk. Interest rate charged comes under market risk category. If arising out of upward revision of rate of interest in a borrower account from time to time due to market volatility, there is any default-which risk category it will come under: Credit Risk or Market Risk? v

Failure of people taking usual precautions falls under operational risk. Suppose if due to defective/inadequate documentation a bank is not in a position to recover its loan-which category of risk will apply- Credit Risk or Operational Risk?

Conclusion:

New Basel-II Accord guidelines cannot be implemented in Indian banking in Toto. Hence it is expected RBI will analyses each component of the guidelines as to its viability of implementation in Indian Banking environment wile at the sometime taking care to ensure that improved Risk Management frame work adds further vigor and strength to Indian Banking so as to face international banking competition smoothly. It may be appropriate if the Regulatory Authorities adopt simplified version to being with e.g. Standardized Approach for Risk Rating and consequential computation of Regulatory capital requirements for Credit Risk. Similarly for capital charge for Marking Risk and Operational Risk, will it be a funny idea to say that in place of 8% minimum capital requirements under Basel capital requirement under Basel Accord-II for credit Risk Market, and Operational Risk Why not RBI straightway without going into complexities for the time being increase regulatory capital requirements to 10%-11% (from 9% at present in India) w.e.f. to take care of all the three risk. One of the most distinguishing features of the current Basel Accord is with respect to its three dimensional approach firstly risk segments in commercial Banking have been classified into three distinct categories credit risk market risk and operational risk viz. Credit, market and Operational Risk as a reparatory step to be fully Basel-II compliant over a period of time. As most of the banks are maintaining high level of Capital Adequacy Ratio, this may not be a handicap and at the same time international Authorities may view such an initiative favorably.

Prudential Norms

Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI. An amount due under any credit facility is treated as "past due" when it has not been paid within 30 days from the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where i. Interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, ii. The account remains 'out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit (OD/CC), iii. The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and v. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts. With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the '90 days overdue' norm for identification of NPAs, form the year ending March 31, 2004. Accordingly, with effect form March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where; i. Interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, ii. The account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit (OD/CC), iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose.

Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. To get a true picture of the profitability and efficiency of the Indian Banks, a code stating adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts has been laid down by the Central Bank. Close to 16 per cent of loans made by Indian banks were NPAs - very high compared to say 5 per cent in banking systems in advanced countries.

Magnitude of the problem:

According to the latest RBI figures, gross NPAs in the banking sector stands at Rs 45,563 crore which is about 16 per cent of the total loan assets of the banks. The present net NPAs (gross NPAs minus provisioning) stands at Rs 21,232 crore which is about 7 per cent of loans advanced by the banking sector. Though in percentage terms, the NPAs have come down over the last 5-6 years, in absolute terms they have grown, signifying that while new NPAs are being added to banks' operations every year, recovery of older dues is also taking too long.

Ever greening or rescheduling of loans:

Sometimes, to avoid classifying problem assets as NPAs, banks give another loan to the company with the help of which it can pay the due interest on the original loan. While this allows the bank to project a healthy image, it actually makes the problems worse, and creates more NPAs in the long run. RBI discourages such practices.

Asset Quality - Increased Transparency:

Apart from the interest rate structure, the net interest income is also affected by the asset quality of the bank. Asset quality is reflected by the quantum of non-performing assets (NPAs) - the higher the level of NPAs, the lower will be the asset quality and vice versa. Courtesy the nationalization agenda and the directed credit, most of the public sector banks were burdened with huge NPAs. While the government did contribute to write-off these bad loans, the problem still remains. NPAs expose the banks to not just credit risk but also to liquidity risk. Considering the implications of the NPAs and also for imparting greater transparency and accountability in banks operations and restoring the credibility of confidence in the Indian financial system, the RBI introduced prudential norms and regulations. The prudential norms which relate to income recognition, asset classification and provisioning for bad and doubtful debts serve two primary purposes - firstly, they bring out the true position of a Bank's loan portfolio, and secondly, they help in arresting its deterioration. The asset quality of the bank and its capital are closely associated. If the assets of the bank go bad it is the capital that comes to its rescue. This implies that the bank should have adequate capital to face the likely losses that may arise from its risky assets. In the changed business environment, where banks are exposed to greater and different types of risk, it becomes essential to have a good capital base, which can help it sustain unforeseen losses. As stated earlier, the one major move in this direction was brought about by the Basle Committee, which laid the capital standards that banks have to maintain. This became imperative, as banks began to cross over their national boundaries and begin to operate in international markets. Following the Basle Committee measures, RBI also issued the Capital Adequacy Norms for the Indian banks also.

Current Status of NPAs and Indian Banks - A Statistical Introspection:

There was a significant decline in the non-performing assets (NPAs) of Scheduled Commercial Banks (SCBs) in 2003-04, despite adoption of 90-day delinquency norm from March 31, 2004. The gross NPAs of SCBs declined from 4.0 percent of total assets in 2002-03 to 3.3 percent in 2003-04. The corresponding decline in net NPAs was from 1.9 percent to 1.2 percent. This is due to the multidimensional strategies adopted by banks for recoveries in the form of: - Ø One-Time Settlements Or Compromise Schemes Ø Lok Adalat Ø Debt Recovery Tribunals Ø Securitization Act Provisions Ø Corporate Debt Restructuring Ø Asset Restructuring Companies Act There was also a significant decline in the proportion of net NPAs to net advances from 4.4 percent in 2002-03 to 2.9 percent in 2003-04. The significant decline in the net NPAs by 24.7 percent in 2003-04 as compared to 8.1 percent in 2002-03 was mainly on account of higher provisions (up to 40.0 per cent) for NPAs made by SCBs. The table given below gives a bird eye view of the performance of banks in terms of their NPAs: -

Non-Performing Assets of Scheduled Commercial Banks (SCBS):

The above table shows that the decline in NPAs in 2003-04 was witnessed across all bank groups. The decline in net NPAs as a proportion of total assets were quite significant in the case of new private sector banks, followed by PSBs. The ratio of net NPAs to net advances of SCBs declined from 4.4 percent in 2002-03 to 2.9 percent in 2003-04. Among the bank groups, old private sector banks had the highest ratio of net NPAs to net advances at 3.8 percent followed by PSBs (3.0 percent) new private sector banks (2.4 per cent) and foreign banks (1.5 percent).

Income Recognition:

The regulation for income recognition states that the Income on NPAs cannot be booked. Interest income should not be recognized until it is realized. An NPA is one where interest is overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on accrual basis, but is to be treated as income only when actually received. Income in respect of accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic system for income recognition based on the prospect of reliability of the security. On non-performing accounts the banks should not charge or take into account the interest. Income-recognition norms have been tightened for consortium banking too. Member banks have to intimate the lead-bank to arrange for their share of recovery. They will no more have the privilege of stating that the borrower has parked funds with the lead-bank or with a member-bank and that their share is due for receipt. The new notifications emanated after deliberations held between the RBI and a cross-section of banks after a working group headed by chartered accountant, PR Khanna, submitted its report. The working group was set after the RBI's Board for Financial Supervision (BFS) wanted divergences in NPA accounting norms by banks from central bank guidelines to be addressed. The working group had identified three areas of divergence: non-compliance with RBI norms; subjectivity arising out of the flexibility in norms; and differences in the valuation of securities by banks, auditors and RBI. As of now, for income recognition norms, the RBI has suggested that the international norm of 90 days be implemented in a phased manner by the end of 2010. The current norm is 180 days.

Asset Classification:

While new private banks are careful about their asset quality and consequently have low non-performing assets (NPAs), public sector banks have large NPAs due to wrong lending policies followed earlier and also due to government regulations that require them to lend to sectors where potential of default is high. Allaying the fears that bulk of the Non-Performing Assets (NPAs) was from priority sector, NPA from priority sector constituted was lower at 46 per cent than that of the corporate sector at 48 per cent. Loans and advances account for around 40 per cent of the assets of SCBs. However, delay/default in payment of interest and/or repayment of principal has rendered a significant proportion of the loan assets non-performing. As per RBI's prudential norms, a Non-Performing Asset (NPA) is a credit facility in respect of which interest/installment has remained unpaid for more than two quarters after it has become past due. “Past due” denotes grace period of one month after it has become due for payment by the borrower.

Regulations for asset classification:

Assets should be classified into four classes - Standard, Sub-standard, Doubtful, and Loss assets.NPAs are loans on which the dues are not received for two quarters. NPAs consist of assets under three categories: sub-standard, doubtful and loss. RBI for these classes of assets should evolve clear, uniform, and consistent definitions. The health code system earlier in use would have to be replaced. The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories: 1)

Standard Assets:

: It carries not more than the normal risk attached to the business and is not an NPA. 2)

Sub-standard Asset:

An asset which remains as NPA for a period not exceeding 24 months, where the current net worth of the borrower, guarantor or the current market value of the security charged to the bank is not enough to ensure recovery of the debt due to the bank in full. 3)

Doubtful Assets

: An NPA which continued to be so for a period exceeding two years (18 months, with effect from March, 2001, as recommended by Narasimham Committee II, 1998). 4)

Loss Assets:

An asset identified by the bank or internal/ external auditors or RBI inspection as loss asset, but the amount has not yet been written off wholly or partly. The banking industry has significant market inefficiencies caused by the large amounts of Non Performing Assets (NPAs) in bank portfolios, accumulated over several years. Discussions on non-performing assets have been going on for several years now. One of the earliest writings on NPAs defined them as "assets which cannot be recycled or disposed off immediately, and which do not yield returns to the bank, examples of which are: Overdue and stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and bank balances with other banks, and amounts locked up in frauds".

Provisioning Norms:

Banks will be required to make provisions for bad and doubtful debts on a uniform and consistent basis so that the balance sheets reflect a true picture of the financial status of the bank. The Narasimham Committee has recommended the following provisioning norms: a) 100 per cent of loss assets or 100 per cent of out standings for loss assets; b) 100 per cent of security shortfall for doubtful assets and 20 per cent to 50 per cent of the secured portion; and c) 10 pr cent of the total out standings for substandard assets. A provision of 1% on standard assets is requiredas suggested by Narasimham Committee II. Banks need to have better credit appraisal systems so as to prevent NPAs from occurring. The most important relaxation is that the banks have been allowed to make provisions for only 30 per cent of the "provisioning requirements" as calculated using the Narasimham Committee recommendations on provisioning (but with the diluted asset classification). The nationalized banks have been asked to provide for the remaining 70 per cent of the"provisioning requirements". Securitization Securitization as a financial tool has been in existence in the western world for more than 25 years, and is traded in both primary and secondary markets. It has also made a good beginning in India since early 1990s. Securitization is basically a process of liquidating the illiquid and long-term debts like loans and receivables of financial institutions or banks by issuing marketable securities. In India, though the concept of securitization gained a foothold over a decade ago, its use as a financial instrument has gained momentum only during the recent past and still remains far below its potential. A typical securitization process consists of the following steps: - 1) Segregating of loans/ receivables by the originator or the lender, who is the holder of financial assets, into relatively homogeneous pools. 2) Creation of special purpose vehicles (SPV) to hold the pools of financial assets. SPV is usually a trust and it can be floated jointly by the originator/ individuals/banks/institutions who are interested in the deal. 3) Sale of financial assts by the originator to the SPV, which holds the assts and realize them. 4) Issuance of securities by the SPV to investors, against the financial assets held by them.

Benefits of Securitization:

1) It improves the liquidity position of the originator of the assets. 2) It restructures the balance sheet on the lending institutions. 3) It serves as a tool for better asset- liability-management. 4) It enables recycling of assets more frequently and thus, improves earnings. 5) It facilitates better project evaluation and management because the investors will opt for viable SPVs. 6) It helps to reduce NPAs in the financial sector, which in turn benefits the economy as a whole.

Rationalization of Foreign Operation in INDIA

It means liberalizing 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.

Entry of New Banks in the Private Sector:

As per the guidelines for licensing of new banks in the private sector issued in January 1993, RBI had granted licenses to 10 banks. Based on a review of experience gained on the functioning of new private sector banks, revised guidelines were issued in year 2008-09. The main provisions/requirements are as below: - Ø Initial minimum paid-up capital shall be Rs. 200 crore; this will be raised to Rs. 300 crore within three years of commencement of business. Ø Promoters' contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time; their contribution of 40 per cent shall be locked in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one year of bank's operations. Ø Initial capital other than promoters' contribution could be raised through public issue or private placement. Ø While augmenting capital to Rs. 300 crore within three years, promoters need to bring in at least 40 percent of the fresh capital, which will also be locked in for 5 years. The remaining portion of fresh capital could be raised through public issue or private placement. Ø NRI participation in the primary equity of the new bank shall be to the maximum extent of 40 per cent. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter, equity participation shall be limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI contribution to foreign equity can be met through contribution by designated multilateral institutions. Ø No large industrial house can promote a new bank. Individual companies connected with large industrial houses can, however, contribute up to 10 per cent of the equity of a new bank, which will maintain an arms length relationship with companies in the promoter group and the individual company/ies investing in equity. No credit facilities shall be extended to them. Ø NBFCs with good track record can become banks, subject to specified criteria Ø A minimum capital adequacyratio of 10 per cent shall be maintained on a continuous basis from commencement of operations. Ø Priority sector lending target is 40 percent of net bank credit, as in the case of other domestic banks; it is also necessary to open 25 per cent of the branches in rural/semi-urban areas.

The main problems concerning the nationalized / state sector banks

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

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. Ø

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. Ø

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. Ø

Convergence-

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

Restructuring of Weak Banks

How to deal with the weak Public Sector Banks is a major problem for the next stage of banking sector reforms. It is particularly difficult because the poor financial position of many of these banks is often blamed on the fact that the regulatory regime in earlier years did not place sufficient emphasis on sound banking, and the weak Banks are, therefore, not responsible for their current predicament. This perception often leads to an expectation that all weak Banks must be helped to restructure after which they would be able to survive in the new environment. Keeping in view the urgent need to revive the weak banks, the Reserve Bank of India set up a Working Group in February, 1999 under the Chairmanship of Shri M.S. Verma to suggest measures for the revival of weak public sector banks in India. The major recommendations/points of the Working Group, which submitted its Report in October, 1999, are as below:- Ø Seven parameters covering three areas have been identified; these are (i) Solvency (capital adequacy ratio and coverage ratio), (ii) Earning Capacity (return on assets and net interest margin) and (iii) Profitability (ratio of operating profit to average working funds, ratio of cost to income and ratio of staff cost to net interest + income all other income). Ø Restructuring of weak banks should be a two-stage operation; ü

stage one:

involves operational, organizational and financial restructuring aimed at restoring competitive efficiency; ü

Stage two

: covers options of privatization and/or merger. Ø Operational restructuring essentially involves building up capabilities to launch new products, attract new customers, improve credit culture, secure higher fee-based earnings, sell foreign branches (Indian Bank and UCO Bank) to prospective buyers including other public sector banks, and pull out from the subsidiaries (Indian Bank), establish a common networking and processing facility in the field of technology, etc. Ø The action programme for handling of NPAs should cover honoring of Government guarantees, better use of compromises for reduction of NPAs based on recommendations of the Settlement Advisory Committees, transfer of NPAs to ARF managed by an independent AMC, etc. Ø To begin with, ARF may restrict itself to the NPAs of the three identified weak banks; the fund needed for ARF is to be provided bythe Government; ARF should focus on relatively larger NPAs (Rs. 50 lakh and above).

Ø

The organizational restructuring includes de-layering of the decision making process relating to credit, rationalization of branch network, etc. Ø Experts have also suggested the concept of narrow banking, where only strong and efficient banks will be allowed to give commercial loans, while the weak banks will take positions in less risky assets such as government securities and inter-bank lending. Ø A 30-35 percent reduction in staff cost required in the three identified weak banks to enable them to reach the median level of ratio of staff cost to operating income. In order to control staff cost, the three identified weak banks should adopt a VRS covering at least 25 percent of the staff strength; for the three banks taken together, the estimated cost of VRS ranges from Rs. 1100 to Rs. 1200 crore. The three identified banks on committee recommendations were UCO bank, United Bank of India and Indian Bank. In August 2008, the government of India directed UCO Bank to shut down 800 branches and also 4 international operations in line with the Verma committee recommendation on sick banks. Three more PSBs declared sick are Dena Bank, Allahabad Bank and Punjab and Sindh Bank.

Asset Liability Management System

The critical role of managing risks has now come into the open, especially against the experience of the recent East Asian crisis, where markets fell precipitously because banks and corporate did not accurately measure the risk spread that should have been reflected in their lending activities. Nor did they manage such risks or provide for them in their balance sheets. In India, the Reserve Bank has recently issued comprehensive guidelines to banks for putting in place an asset-liability management system. The emergence of this concept can be traced to the mid 1970s in the US when deregulation of the interest rates compelled the banks to undertake active planning for the structure of the balance sheet. The uncertainty of interest rate movements gave rise to interest rate risk thereby causing banks to look for processes to manage their risk. In the wake of interest rate risk came liquidity risk and credit risk as inherent components of risk for banks. The recognition of these risks brought Asset Liability Management to the centre-stage of financial intermediation.

The Necessity:

The asset-liability management in the Indian banks is still in its nascent stage. With the freedom obtained through reform process, the Indian banks have reached greater horizons by exploring new avenues. The government ownership of most banks resulted in a carefree attitude towards risk management. This complacent behavior of banks forced the Reserve Bank to use regulatory tactics to ensure the implementation of the ALM. Also, the post-reform banking scenario is marked by interest rate deregulation, entry of new private banks, and gamut of new products and greater use of information technology. To cope with these pressures banks were required to evolve strategies rather than ad hoc fire fighting solutions. Imprudent liquidity management can put banks' earnings and reputation at great risk. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their business - credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk, liquidity risk and operational risk. It is, therefore, important that banks introduce effective risk management systems that address the issues related to interest rate, currency and liquidity risks.

Implementation of Asset liability management (ALM) system:

RBI has issued guidelines regarding ALM by which the banks have to ensure coverage of at least 60% of their assets and liabilities by April 2010. This will provide information on bank's position as to whether the bank is long or short. The banks are expected to cover fully their assets and liabilities by October 2010. This process is carried out on annual basis after the necessary guidance provided by the RBI. ALM framework rests on three pillars:

I.

ALM Organization:

The ALMO consisting of the banks senior management including CEO should be responsible for adhering to the limits set by the board as well as for deciding the business strategy of the bank in line with the banks budget and decided risk management objectives. ALMO is a decision-making unit responsible for balance sheet planning from a risk return perspective including strategic management of interest and liquidity risk. Consider the procedure for sanctioning a loan. The borrower, who approaches the bank, is apprised by the credit department on various parameters like industry prospects, operational efficiency, financial efficiency, management evaluation and others which influence the working of the client company. On the basis of this appraisal the borrower is charged certain rate of interest to cover the credit risk. For example, a client with credit appraisal AAA will be charged PLR. While somebody with BBB rating will be charged PLR + 2.5 %, say. Naturally, there will be certain cut-off for credit appraisal, below which the bank will not lend e.g. Bank, will not like to lend to D rated client even at a higher rate of interest. The guidelines for the loan sanctioning procedure are decided in the ALMO meetings with targets set and goals established.

II.

ALM Information System:

ALM Information System is for the collection of information accurately, adequately and expeditiously. Information is the key to the ALM process. A good information system gives the bank management a complete picture of the bank's balance sheet.

III. ALM Process:

The basic ALM process involves identification, measurement and management of risk parameters. The RBI in its guidelines has asked Indian banks to use traditional techniques like Gap Analysis for monitoring interest rate and liquidity risk. However RBI is expecting Indian banks to move towards sophisticated techniques like Duration, Simulation, and VAR in the future.

It's Possibility:

Keeping in view the level of computerization and the current MIS in banks, adoption of a uniform ALM Systemfor all banks may not be feasible. The finalguidelines have been formulated to serve as a benchmark for those banks which lack a formal ALM System. Banks that have already adopted more sophisticated systems may continue their existing systems but they should ensure to fine-tune their current information and reporting system so as to be in line with the ALM System suggested in the Guidelines. Other banks should examine their existing MIS and arrange to have an information system to meet the prescriptions of the new ALM System. In the normal course, banks are exposed to credit and market risks in view of the asset-liability transformation. Banks need to address these risks in a structured manner by upgrading their risk management and adopting more comprehensive Asset-Liability Management (ALM) practices than has been done hitherto. But, ultimately risk management is a culture that has to develop from within the internal management systems of the banks.

Its critical importance will come into sharp focus once current restrictions on banks' portfolios are further liberalized and are subjected to the pressure of macro economic fluctuations.

Deregulation on Interest Rates

The interest rate regime has also undergone a significant change. For long, an administered structure of interest rate has been in vogue in India. The 1998 Narasimham Reforms suggested deregulation of interest rates on term deposits beyond a period of 15 days. At present, the Reserve Bank prescribes only two lending rates for small borrowers. Banks are free to determine the interest rate on deposits and lending rates on all lending's above Rs. 200,000. In the last couple of years there has been a clear downward trend in interest rates. Initially lending rates came down, leading to a decline in yields on advances and investments. Interest rates in the banking system have been liberalized very substantially compared to the situation prevailing before 1991, when the Reserve Bank of India controlled the rates payable on deposits of different maturities. The rationale for liberalizing interest rates in the banking system was to allow banks greater flexibility and encourage competition. Banks were able to vary rates charged to borrowers according to their cost of funds and also to reflect the credit worthiness of different borrowers. With effect from October 97 interest rates on all time deposits, including 15-day deposits, have been freed. Only the rate on savings deposits remains controlled by RBI. Lending rates were similarly freed in a series of steps. The Reserve Bank now directly controls only the interest rate charged for export credit, which accounts for about 10% of commercial advances. Interest rates on time deposits were decontrolled in a sequence of steps beginning with longer-term deposits and the liberalization was progressively extended to deposits of shorter maturity. Interest rates on loans upto Rs 2,00,000. which account for 25% of total advances, is not fixed at a level set by the RBI, but is now aligned with the Prime Lending Rate (PLR) which is determined by the boards of individual Banks. Earlier interest rates on loans below Rs 2,00,000 were fixed at a highly concessional level. The new arrangement sets a ceiling on these rates at the PLR, which reduces the degree of concessionality but does not eliminate it. Cooperative Banks were freed from all controls on lending rates in 1996 and this freedom was extended to Regional Rural Banks and private local area banks in 1997. RBI also considers removal of existing controls on lending rates in other Commercial Banks as the Indian economy gets used to higher interest rate regime on shorter loan duration. The line to control is the cost of funds, since the markets determine asset yields. The opportunity to improve yields on the corporate side tends to be limited if banks don't want to increase the risk profile of the portfolio. Banks' income will depend on the interest rate structure and the pricing policy for the deposits and the credit. With the deregulation of the interest rates banks are given the freedom to price their assets and liabilities effectively and also plan for a proper maturity pattern to avoid asset-liability mismatches. Nevertheless, with the increase in the number of players, competition for the funds and the other banking services rose. The consequential impact is being felt on the income profile of the banks especially due to the fact that the interest income component of the total income is significantly larger than the non-interest income component. As far as the interest costs are concerned, the prevailing interest rate structure will be a major deciding factor for the rates. But what influences both the interest costs and the intermediation costs is the time factor as it is directly related to costs. The solution for these two influencing factors lies predominantly on technology. In this regard, the new private banks and the foreign banks, which are equipped with the latest technology, have a better edge over the nationalized banks, which are yet to be automated at the branch level.

Income and Expenses Profile of Banks:

Interest Income	Interest Expenses
Interest/discount on advances/bills

Interest on investments

Interest on balances with RBI and other interbank funds

Others

Interest on deposits

Interest on Refinance / inter bank borrowings.

Others

Other Income

Operating Expenses

Commission, Exchange and Brokerage Ø Profit on sale of investments Ø Profit on revaluation of investments Ø Profit on sale of land, building and other assets Ø Profit on exchange transactions Ø Income earned by way of dividends, etc. Ø Miscellaneous Ø Payments to and provisions for employees. Ø Rent, taxes and lighting Ø Printing and stationery Ø Advertisement and publicity Ø Depreciation on Bank's property Ø Director'/Auditor's fees and expenses Ø Law charges, Postage, etc. Ø Repairs and Maintenance, Ø Insurance. Ø Other expenses

Competition Enhancing Measures

Introduction:

The financial sector reforms have brought about significant improvements in the financial strength and the competitiveness of the Indian banking system. The efforts on the part of the Reserve Bank of India to adopt and refine regulatory and supervisory standards on a par with international best practices, competition from new players, gradual disinvestments of government equity in state banks coupled with functional autonomy, adoption of modern technology, etc are expected to serve as the major forces for change. New businesses, new customers, and new products beckon, but bring increased risks and competition. How might that change banks? To attract and retain customers, the banks need to optimize their networks, speed up decision-making, cut down on bureaucratic layers, and sharpen response times. The reform has lead to new trends of being ahead and being with, by and for the customer. While the private sector banks are on the threshold of improvement, the Public Sector Banks (PSBs) are slowly contemplating automation to accelerate and cover the lost ground. VRS introduced to bring up the productivity, the concept of universal competition set in just to ensure customer convenience all the time.

Universal banking … just one stop ahead!

RBI states

: "The emerging scenario in the Indian banking system points to the likelihood of the provision of multifarious financial services under one roof. This will present opportunities to banks to explore territories in the field of credit/debit cards, mortgage financing, infrastructure lending, asset securitization, leasing and factoring. At the same time it will throw challenges in the form of increased competition and place strain on the profit margins of banks" The evolving scenario in the Indian banking system points to the emergence of universal banking. The traditional working capital financing is no longer the banks major lending area while FIs are no longer dominant in term lending. 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.

An Overview:

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

Banks v/s DFIs:

Indian Development financial institutions (DFIs) and Re-Financing Institutions (RFIs) were meeting specific sectoral needs and also providing long-term resources at concessional terms, while the commercial banks in general, by and large, confined themselves to the core banking functions of accepting deposits and providing working capital finance to industry, trade and agriculture. Consequent to the liberalization and deregulation of financial sector, there has been blurring of distinction between the commercial banking and investment banking. The comparative advantage or disadvantage of DFIs vis-a-vis banks in this regard depends to a large extent on the quality of their portfolios, the accounting policies that are practiced and personnel management. The banks, on the other hand, have a competitive edge in resource mobilization through the route of retail deposits. The RBI has identified certain regulatory issues that need to be addressed to make harmonization of the needs of commercial banking with institutional banking successful.

First, banks are subject to CRR stipulations on their liabilities. DFIs face no such pre-emption on their funds.

Secondly , DFIs do not enjoy the advantage of branch network for resource mobilization. This in effect curtails DFIs' ability to raise low-cost deposits.

Thirdly , with the larger part of new loans going to capital-intensive projects like power, telecom, etc., the DFIs would need to extend loans with longer maturities. On the other hand, due to interest rate uncertainties, DFIs are finding it attractive to raise more of short-term resources. Due to their past borrowings of long-term nature, the mismatch is still in their favor. This, however, raises a challenge for the DFIs to manage the maturity match of their assets and liabilities on an ongoing basis.

In India:

The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to RBI to discuss the time frame and possible options for transforming itself into a universal bank. Reserve Bank of India also spelt out to Parliamentary Standing Committee on Finance, its proposed policy for universal banking, including a case-by-case approach towards allowing domestic financial institutions to become universal banks. Now RBI has asked FIs, which are interested to convert itself into a universal bank, to submit their plans for transition to a universal bank for consideration and further discussions. FIs need to formulate a road map for the transition path and strategy for smooth conversion into a universal bank over a specified time frame. The plan should specifically provide for full compliance with prudential norms as applicable to banks over the proposed period. The Narsimham Committee II suggested that DFIs should convert ultimately into either commercial banks or non-bank finance companies. The Khan Working Group held the view that DFIs should be allowed to become banks at the earliest. The RBI released a 'Discussion Paper' (DP) for wider public debate. The feedback indicated that while the universal banking is desirable from the point of view of efficiency of resource use, there is need for caution in moving towards such a system. Major areas requiring attention are the status of financial sector reforms, the state of preparedness of the concerned institutions, the evolution of the regulatory regime and above all a viable transition path for institutions which are desirous of moving in the direction of universal banking.

ICICI gearing to become a universal bank ICICI envisages a timeframe of 12 to 18 months in converting itself into a universal bank. ICICI has received favorable response from Indian investors and FIIs on its move to merge with ICICI Bank and become a universal bank. ICICI was the first one to propagate universal banking as an ideal concept for the DFIs to support industries with low cost funds. In August, ICICI executive director Kalpana Morparia said that ICICI has to obtain a separate banking license from RBI for becoming a universal bank. It can avoid the stamp duty burden by first converting ICICI into bank, instead of going for a direct merger of ICICI into ICICI Bank. “We have created fire walls and functioning as separate legal entities only for complying with statutory obligations,” she noted. There is clear demarcation in the operation of ICICI and the bank. The bank takes care of liabilities of less than one year by offering short-term loans to corporates and personal loans. Medium to long-term products like home loans, auto loans are handled by the parent; absolute coordination between them while marketing the products exist. Crisil has reaffirmed its triple A rating for ICICI and FIIs also expects its profit margins to improve after the merger due to the access to low cost deposits and the scope to increase income from fee-based activities. She said ICICI has started increasing its international presence and associating closely with NRI community in various countries. ICICI InfoTech is based in US and has an office in Singapore. ICICI Securities has been registered as a broking firm in the US. ICICI Bank is leveraging on strong network of 400 branches and extension counters and 600 ATMs for offering products to NRIs; NRIs can transfer their money to 200 locations in India by internet. The payment will be made within 72 hours. It also offers loan products for helping their relatives in India. Besides, the Visa card helps them to withdraw cash through the ATM network. Morparia said NPA of banks in India are < 10 per cent of GDP when compared to emerging economies like China, Korea and Thailand. It should not be compared with developed countries like Europe and US. ICICI's gross NPA comes to Rs 6,000 crore. Asked about a approach to resolve the problem, she said if the units are viable, it supported financial restructuring, mergers. If these options arent possible and the units are not viable, it will go in for one time settlement.

 

II.

Mergers and Acquisitions - Divided they fall, united they may strive!

Mergers moves in Indian banking:

The financial regulator has recently given the hint that It ill consolidate some banks and make four to five bigger banks like citi bank, bank of America etc this move will have many positive and negative impacts on stakeholders. Customer will get innovative and international level products, batter interpersonal interface, shareholders will get batter returns, employee will be better incentivized for good performance, there will be retrenchment of excess employees, etc Organizations compete with each other to grab more market share and reach the pinnacle of success by being the leader. To achieve this end, there are various strategic alternatives. Corporate growth is sine-qua-non and for this there are mainly two approaches. Organic growth is a time consuming process and of internal nature, whereas inorganic growth is short-cut to corporate growth and is of external nature. Mergers and acquisitions are inorganic in nature and with lesser time the organization grows in disproportionate manner in comparison with organic growth. Merger is nothing but submerging the individual corporate identities of two or more companies of similar size and strength to form a single entity in a friendly atmosphere. It is a consolidation process which creates synergies and additional benefits or competitive advantage which in principle benefits all stakeholders. Mergers motivations are multifarious. Indian banking since the financial sectors reforms process has undergone sea changes there are entry of new generation banks there have been major technological changes product innovations structural changes business process re- engineering entry of more specialized personnel additional product range an overall change in mindset etc, at present there are about 90scheduled commercial banks four non scheduled commercial banks and 196 regional rural banks (RRBs) the state bank and its seven associates have about 14000 branches and foreign banks around 225 branches however only state bank of India is among the top 200 banks in the world as on 31.03.2009 the top five banks in India and their performance highlight is given below in terms of business turnover and profit Total deposits and advances of all scheduled commercial banks as on march 2003 was 1,304,37 cr anc 741770 cr respectively from the above data it is understood that out of the total business of 20.46 lack cr the top five banks contribute about 42.58 percentage . Whereas the numero-uno state bank of India has captured more than 21.20 percentages of market share all the other top five banks have on an average a market share of little over 5 percentages presently as on 26.03.05 total deposits and advances of scheduled commercial banks have skyrocketed to 1,708,610 cr and 1,02,008 cr respectively and eventhough there is a minor variation the capital and reserves there has been sumptuous growth in profits which have strengthened the bottomlines table-1 figures have been graphically represented in chart 1 to 4

(figure in cr. of rupees)
Sr.	Name of banks	Deposits	Advances	Total Business	Capital and reserves	Profit
1) 1	SBI	296123	137758	433881	17203	3105
2) 2	PNB	75814	40228	116042	4033	842
3) 3	Canara bank	72095	40472	112567	4149	1019
4) 4	Bank of India	64454	42633	107087	3541	851
5) 5	Bank of baroda	66366	35348	101714	4387	773
	Top 5 Total	574852	296439	871291	33313	6569
	All Scheduled Bank's Total	1304347	741770	2046117	n/a	n/a

Compulsions for Mergers of PSU Banks:

There is strong case for arguing in favor of mergers and acquisitions in the financial sector which is seen as a consequence rather than a direct cause. The Narasimham committee recommendations also called for emergence of 4-5 global banks with mergers of public sector banks.

The financial sector reforms removed the structural regulatory barriers which were corralling banks to work within a closed system. With goings getting global, liberty is liberal and competition is carnival. “Survival of the fittest” principle has great influence in this context and with consolidation via mergers route, the strength can be acquired in the short run.

The Basel-II prescriptions had been fulfilled by 2006, for which capital position has been improved substantially to mitigate credit risk, market risk and operational risks, apart from maintaining benchmark CAR (i.e. capital adequacy ratio)

Optimum market share and assets size is the call of the hour. If we compare our country's premier bank, state bank of India (SBI) with American giant, city bank, in term of assets size, turnover, profit capital employed, it will be just like a small fish before a dolphin.

The core banking solutions and the underlying huge investment in technology is also a driving force for mergers.

It is also felt that consolidation of the industry will help banks to raise capital for growth in a better manner, from the financial market without further liquidating the public sector character in ownership and management.

Core banking and tech savvy delivery channels etc., lead to increased competition which may pose a threat to long term survival of many. This makes mergers inevitable.

With LPG Environment, it is definitely a fact that risk and exposure to risk has enlarged for which consolidation in banking sector has become sine qua non for strengthening their backbone. Opening up of the economy and competition with the international banks is most important factor.

Impact on Consumer:

The move for M&A in banking sector is primarily for consolidation as its effect on the economy is complex and it leads to multi-various impacts on various stake holders, micro economic environment and macro economic environment. While its impact on employees, employment level and share value will be visible and quantifiable in the short run, its impacts upon consumers will observable over medium term to long-term.

Viewpoints:

1) The government should have development banks, specifically to look, into the needs of lower strata of the society. 2) Banks also should take into account regional and ethnic consideration and maximize synergies in regional balances, address HR issues and ensure assets synergies in the drive towards consolidation. Their skills and practices need to be improved before they aspire to go global. 3) They should improve the credit quality and proper monitoring of the same. There should be more diversification of loans spreading to different consumer segments. Bank should understand and implement risk scoring techniques. There is a strong need for reducing operating expanses. In the soft interest regime. The banks have become complacent in handling market risks, for which they should pay more attention to management of market risks. 4) It is a mater of fact that technology has become the driving force of the banking sector. Hence merger and acquisition activity should conform to the issue as to whether the technology being used by each other is scalable or not. The Post Merger Scenario at ICICI: Take a look at what happened post merger to ICICI Bank. The bank has shot up to the number one position among new private sector banks.

Elements	Pre-merger	Post-merger	% Change
Assets No of branches Deposits Customers Employees Equity EPS	12063 crores 106 9728 15 lakhs 1700 197 crores Rs 7.10 / share	16051 crores 360 13123 27 lakhs 4300 220 crores Rs 8.70 / share	33.06 239.62 34.90 80 152.94 10.5 23

Will mergers be the norm in the industry?

THE STRATEGY MERGER UNIVERSAL BANKS

The Assets Enables rapid growth in new markets and new products Combats the trend towards disintermediation The Liabilities Increases risks of mismatch between assets and liabilities. Multiple focus could lead to conflicts of interest

Analysts and bank observers feel that merger acquisition activity will speed up in times ahead. It is a fact that growth through acquisitions and mergers is cheaper and quicker in comparison to setting up new units. What will acquiring banks look for while choosing their targets? One, financial viability and two strong geographical reach and large asset base; However staffing/employee costs and technological infrastructure will also play an important role in acquiring target banks. For example, Karnataka Bank has employee strength of over 4,200 and business per employee of just Rs 1.80 crore. Compare this with Indusind Bank, which, with only 510 employees commands a business per employee of Rs 20 crore. Banks which boast of high business per employee include names such as Bank of Punjab Rs 7.10 crore, Centurion Bank Rs 6.90 crore and Global Trust Bank Rs 8.60 crore. The following table shows a general comparison of three main classes of banks.

Particulars	PSU Banks	Pvt. Banks (Old)		Pvt. Banks(New)
Cost of funds	Low	Moderate	High
Branch network	Wide Spread	Regional	Low
Level of Automation	Low	Moderate	High
NPAs	High	Low	Low
Capital Adequacy	Moderate	Low	High
Employee Productivity	Low	Moderate	High
Focus on Non-interest Income	Low	High	High

Mergers for private banks will be much smoother and easier as against that of PSBs. To survive, banks need to diversify into non-fund-based activities (investment banking) and new fund-based activities (mutual funds, leasing, housing finance, infrastructure finance, or, maybe, even insurance). M& A's offer a cheaper and, certainly, quicker diversification option than organic growth. Indeed, for activities like infrastructure finance, which requires a huge critical mass, mergers, may well be the only option. Only a large, strong entity with deep reservoirs of capital will be able to provide funds without bumping against prudential exposure limits, and have the requisite skills to evaluate mega-projects.

THE RESCUE MERGER BANK BAILOUTS

The Assets Provides the stronger bank with a relatively cheap deposit network. Minimizes the likelihood of systemic failure The Liabilities Saddles the stronger bank with huge NPAs, Erodes the profitability of the stronger bank.

III.

Banking and Insurance … much more to service!

What will the future of Indian banking and insurance look like? Will the reform in these sectors face the same fate as in power? It is increasingly evident that the economy offers opportunities but no security.The future will belong to those who develop good internal controls, regular checks and balances and a sound market strategy. The latest to be opened up for private investment, including foreign direct investment, is the insurance sector.On a rough reckoning, commercial bank deposits account for 25 per cent of GDP and credit extended by banks may be 15 per cent of GDP. Thus, regular bank credit transactions alone account for a substantial percentage of GDP by way of servicing economic activities.A gradual convergence is taking place in the banking and insurance sectors. Several major banks are floating subsidiaries to enter both life and non-life insurance businesses. Some of them are looking at niche markets such as corporate insurance. Reform of the insurance sector began with the decision to open up this sector for private participation with foreign insurance companies being allowed entry with a maximum of 26 per cent capital investment. The Insurance Regulatory and Development Authority (IRDA), in its guidelines for the new private sector insurance companies, have stipulated that at least 20 per cent of the total premium revenue of these companies should come from rural India.

The government permits banks to distribute or market insurance products

. It is amending the Banking Regulation Act to this effect. Only banks with a three-year track record of positive growth as well as with a strong financial background will be entitled to do insurance business. In anticipation of the government move, some banks have begun talking of alliances with foreign insurance players. Keeping in view the limited actuarial and technical expertise of Indian banks in undertaking insurance business; RBI has found it necessary to restrict entry into insurance to financially sound banks. Permission to undertake insurance business through joint ventures on risk participation basis will therefore be restricted to those banks which: i. have a minimum net worth of Rs. 500 crore

and ii. Satisfy other criteria in regard to capital adequacy, profitability, etc. Banks which do not satisfy these criteria will be allowed as strategic investors (without risk participation) up to 10 per cent of their net worth or Rs. 50 crore, whichever is lower. However, any bank or its subsidiary can take up distribution of insurance products on fee basis as an agent of insurance company. In all cases, banks need prior approval of RBI for undertaking insurance business.

Insuring the SBI way!

State Bank of India (SBI) has identified Cardif, a wholly owned subsidiary of BNP Paribas, to enter into a joint venture for life insurance with an equity stake of 26 per cent. SBI has incorporated a wholly owned subsidiary SBI Life Insurance Company Ltd with an authorized capital of Rs 250 crore. Cardif SA and its sister company Natio-Vie together rank as the third-largest French insurers with a premium income of $9 billion and assets under management of over $59 billion. Although Cardif is a lesser known name in the life insurance business, compared to some of the global giants present in India, the French insurer has expertise in banc assurance. The company has pioneered the concept of banc assurance in France by selling insurance products through branches of commercial banks and non-banking finance companies. The joint venture plans to bring into India a number of products, which would suit different segments of the market. SBI intends to fully integrate the insurance business into its banking activities with appropriate sales support and marketing. SBI will become the largest insurance outfit in terms of distribution with its network of around 13,000 branches. The key to success will be the ability to integrate the savings products of the bank, insurance product line of the Joint Venture Company and network of branches.

Insuring it the Private way!

Explains Hemant Chaturvedi, Senior Relationship Executive Manager, ICICI Prudential Bank: "We have unit managers and agents to cater to the rural market. These field staffs are linked to the city offices and keep on visiting the rural areas." ICICI Prudential keeps on sending regular vans with doctors to underwrite the policies. Additionally, the company has tied up with NGOs to sell social sector policies, like SEWA in Gujarat. ICICI Prudential Life Insurance, also, has tied up with two Chennai-based corporate houses, Madras Cements Ltd and Lucas TVS, to serve underprivileged children. ICICI Prudential has also come out with its social sector policy, Salam Zindagi, which is aimed at the economically weaker sections. HDFC Standard Life is customizing its approach to cater to the rural markets so as to address the special needs of these areas. The life insurance company has tied up with NGOs and self help groups. One such NGO is LEAD (League for Education and Development) and the insurance company covers the members of the SHGs associated with the NGO. All this is being done to cater to the IRDA norms. As per norms, two per cent of insurance premia of the new age insurance companies have to come from rural areas. In addition, the insurance watchdog has put in some policy stipulation on insurance companies to cover life in the social sector for the under-privileged. Dabur CGU Life Insurance - in which Dabur holds the majority 74 percent stake while the remaining 26 percent is owned by CGU - has recently forged a marketing alliance with the Lakshmi Vilas Bank. Lakshmi Vilas Bank -- with 208 branches and 800,000 customers -- has a strong regional presence in the southern part of the country.

"Typically we are looking to tie up with banks with strong regional presence and knowledge of both rural and urban segments of their markets. We feel that banks have got the expertise to give financial advice to its customers, helping them make right decision," he said.

"For selling specialized financial products such as life insurance policies a lot depends on the distributor's relationship with its customer and in India, customers share a strong and long-term relationship with banking institutions," he added. Quite a few banks are desirous of undertaking life insurance or general insurance business State Bank of India, Bank of Baroda, Bank of India, Global Trust Bank, Vysya Bank, Centurion Bank, Oriental Bank of Commerce, ICICI Bank and HDFC Bank have or are intending to enter insurance business after various procedural formalities have been clearly defined in Insurance Regulatory Authority Bill. From the NBFC sector Alphic Finance and Kotak Mahindra has already made their presence in to this sector. Also a few industrial houses like Bombay Dyeing, Aditya Birla, Tata Group, Godrej Group are in the picture.

IV.

RURAL BANKING … Indigenous Route to Convenient Credit

Banks are now concentrating more on the rural area then before. ICICI bank alone has set up a target of RS.2000 cr for micro finance in rural areas. Conducive policies of the government like doubling the agriculture credit within next three years will increase bank finance in rural area. Low default rate, greater opportunities, reducing margins in other sectors, governments commitment to free the farmers from money lenders clutches are encouraging the banks to lend more in rural areas. Despite the changing façade of rural India, Today an increasing number of villagers are taking interest in nontraditional ways of earning livelihood. Low cost technology and some strong initiatives in the recent years have given a good thrust to an otherwise ailing rural economy. Recent initiatives of the central and the various state governments also underline their sincere commitment towards the central and the various state governments also underline their sincere commitment towards agriculture and development. With a planned allocation of RS. 2600 cr towards accelerated irrigation benefit program, RS 8000 cr for rural infrastructure development fund and a commitment to double the agriculture credit within three years, the government has portrayed that agriculture remains an area of prime concern. However, all good policy measures aside, one notable feature of the Indian economy has been the flawed and lopsided implementation at operational levels. The former prime minister, rajiv Gandhi had once derisively remarked that the rural sector received only15 paise for every rupee spent for its welfare and development- the rest was gobbled by politicians, bureaucrats and other intermediaries.

Usage of Banking Services by Indian Households (Hhs) As Per Census of INDIA 2001 (Figure in Cr.)
	Total No.	% of Hhs.	Rural	% of Total Hhs.	Urban	% of Total Hhs.
Total No. of Hhs.	19.19	100	13.83	72.00	5.36	28.00
No. of Hhs. Which use Banking Services	6.8	35.5	4.16	30.10	2.65	49.50
Source: www.indiatogether.org/2004/apr/ecoruralbank.hmt

Banking Profile at Metro / Urban / Semi - Urban / Rural / RRBs (As on 31st March 2003) as per RBI Quarterly Handout
	No. of Bank Branches	Deposits (Rs. In Cr.)	Credit (Rs. In Cr.)	Credit / Deposit Ratio (%)
All INDIA	66436	1278667	759210	59.30
Metro Cities	8664	571852	474461	83.00
Top 100 Centers (incl. of Metro centers)	15066	780291	575946	74.30
Urban Centers (Incl. of Metro & Other Centers)	19379	861875	599751	69.50
Semi - Urban Centers	14813	240523	84683	35.00
Rural Centers	32244	176268	74755	42.00
RRBs	14462	49778	22068	44.00
Combined CD Ratio of Banks at Semi Urban and Rural Centers				38.00
Source: www.indiatogether.org/2004/apr/ecoruralbank.hmt

Farmers Reliance on the Banking System
Year	Farmers Deposit (Rs. In Cr.)	Farmers Borrowing (Rs. In Cr.)	No. of Farmers assisted (In Lakhs)
1992	26211	17835	273
1993	29825	19493	257
1994	36583	19669	251
1995	43341	21334	198
1996	47433	23813	194
1997	53611	27448	188
1998	57442	29442	173
1999	78881	33094	169
2000	91009	36446	162
2001	99812	43420	195
2002	108233	47430	197
Source: www.indiatogether.org/2004/apr/ecoruralbank.hmt

V.

Virtual Banking … the Transformation!

The practice of banking has undergone a significant transformation in the nineties. While banks are striving to strengthen customer relationship and move towards 'relationship banking', customers are increasingly moving away from the confines of traditional branch-banking and are seeking the convenience of remote electronic banking services. And even within the broad spectrum of electronic banking, the aspect of banking that has gained currency is virtual banking. 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. The origin of virtual banking in the developed countries can be traced back to the seventies with the installation of Automated Teller Machines (ATMs). It is possible to delineate the principal types of virtual banking services. These include Shared ATM networks, Electronic Funds Transfer at Point of Sale (EFTPoS), Smart Cards, Stored-Value Cards, phone banking, and more recently, internet and intranet 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 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 customers

Manipulation of books by unscrupulous staff, frauds relating to local clearing operations will be prevented

if computerisation in banks takes place. On the flip side of the coin, however, it needs to be recognized that such high-cost technological initiatives need to be undertaken only after the viability and feasibility of the technology and its associated applications have been thoroughly examined. Virtual banking has made some beginning in the Indian banking system. ATMs have been installed by almost all the major banks in major metropolitan cities, the Shared Payment Network System (SPNS) has already been installed in Mumbai and the Electronic Funds Transfer (EFT) mechanism by major banks has also been initiated. The operationalisation of the Very Small Aperture Terminal (VSAT) is expected to provide a significant thrust to the development of INDIAN FINANCIAL NETWORK (INFINET) which will further facilitate connectivity within the financial sector. The popularity which virtual banking services have won among customers, owing to the speed, convenience and round-the clock access they offer, is likely to increase in the future. However, several issues of concern would need to be pro-actively attended. While most of electronic banking have built-in security features such as encryption.

 Prescriptions of maximum monetary limits and authorizations, the system operators have to be extremely vigilant and provide clear-cut guidelines for operations. On the large issue of electronically initiated funds transfer, issues like authentication of payments instructions, the responsibility of the customer for secrecy of the security procedure would also need to be addressed. The INFINET is a Closed User Group (CUG) Network for the exclusive use of Member Banks and Financial Institutions. It uses a blend of communication technologies such as VSATs and Terrestrial Leased Lines. Presently, the network consists of over 689 VSATs located in 127 cities of the country and utilises one full transponder on INSAT 3B. Inaugurated onJune 19, 1999, various inter-bank and intra-bank applications ranging from simple messaging, MIS, EFT (Retail, RTGS), ECS, Electronic Debit, online processing and trading in Government securities, dematerialisation, centralized funds querying for Banks and FIs, Anywhere/Anytime Banking, Inter-Branch Reconciliation are being implemented using the INFINET. The INFINET will be the communication backbone for the National Payments System, which will cater mainly to inter-bank applications like RTGS, Delivery Vs Payment (DVP), Government Transactions, Automatic Clearing House (ACH) etc. Major issues plaguing the banking industry are the lack of standardisation of operating systems, systems software and application software throughout the banking industry. In a tight competitive environment where banks are making a thrust towards technology to provide superior services to its customers, customers stand to gain the most.

VI.

Retail Banking … the ‘in' Thing

The Customer is now in an enviable position where he can demand superior services at competitive prices. With increased competition, spreads in corporate lending have decreased significantly. Banks are thus moving into the retail mode to tide over the global slowdown and boost the bottom line. Retail banking had been a neglected segment accounting to 10.5 percent of all banks loans of India. The main advantages of retail banking are assured spread, widely distributed risks and lower NPAs due to limited risk associated with the salaried class. However, transactions cost are higher as compared to of corporate lendings. Thus the target clientele is consumers and mid size companies. The product offerings include home loans, car loans, credit cards, personal loans and also customized loans like equipment loan for doctors. In India, out of 100 houses sold, 30 are bought by housing loans and out of 100 cars sold, 28 are brought by car loans.

In India today …

Among PSBs, SBI, Bank of Baroda, Union Bank of India and Bank of India have diverged into the retail segment, whereas in the private sector, opportunity seekers like ICICI and HDFC have focused on retail lendings. Banks have a stronger influence on profits due to individual customers. This is best proved by the success of HDFC which has achieved breakeven on its operations in the fiscal year 2001. Even though retail loans account for 18 percent of total loans, these account for 40 percent of bank revenues.

Technological Reforms

No other sector of the economy is more affected by the spirit of globalization liberalization than the financial sector in general and the banking sector in particular. In the era of liberalization and financial reforms, banks and financial services are about information and competitiveness. And we can see the change in the mindset coming on at an inspiring pace. All leading public sector unit banks have already started investing sizeable amount in technology to match the private sector banks. The new generation private sector banks that had the advantage of starting off on a clean slate, have already taken the majority share of corporate business and consumer banking. No longer just insular custodians of cash, banks have become dynamic, multichannel organizations operating in a highly charged arena-where shifting markets, profit pressures and increased competition are the constant challenges. To be successful in this evolving environment, public sector unit banks need the right technology coupled with flexibility to quickly develop new products, sales tactics and services. At the same time, it's vital that banks provide security, confidentiality and give the customers what they want. Using core banking solution (CBS) banks can provide all their services like ATM (Automatic teller machine), debit cards, Tele-banking, internet banking, etc. through a single channel. CBS helps connect all branches and offices to the central host. It helps manage the enormous data under the Basel-II environment, besides helping banks comply with evolving supervisory practices. Despite the huge benefits, some banks have failed to implement CBS due to the fear of complexities in operations and the massive costs involved.

Progress in Banking

Most public sector unit banks are actively looking at centralized core baking solutions as a tool for their future business growth. ATMs are being looked upon as the preferred way to expand retail presence. Multiple channels of banking are getting integrated. Banks are now looking to provide a “one-view” solution to customers across all services lines. Operationally, the banks are looking at the advance solutions to handle areas like cash and treasury management and putting risk management solutions in place. AMT are getting shared through ATM networks. And security of the technological infrastructure is assured by disaster recovery centers that are being set up. Every ATM center has become so customer-friendly that the customer now prefers to transact his business through machines. Internet banking has given an entirely new shape to the business of banking. Taken together, these developments are nothing short of a revolution. In the near feature a branch's day-to-day banking transaction will be replaced by electronic banking or in other words a bank's entire gamut of services will be transferred to the drawing room of the client at a click of the mouse. In the present scenario when consolidation and merger is the hot topic doing the rounds in banking circles, core banking solution (CBS) will act as facilitator in brining synergy between different banks.

Concept of CBS (Core Banking Solution):

Core banking solution is a model in which all branches of a bank are connected to the central host. Multiple services like ATMs, debit card, Tele-banking, internet banking, mobile banking etc, are provided through a single channel. The process ensures connectivity of identified branches, service branches, regional offices, zonal offices and central office departments. Putting in place a core banking system is perhaps the most complex IT project a bank can undertake. Costs can run into several hundred million dollars and project typically take anywhere between three and four years to complete. Banks have been slow to undertake these projects, as they continue to be haunted by past failures, fears of complexity and the prospect of alienating customers. At the same time there is the example of the new generation of private sector banks who have performed exceedingly well with that same system. The time has come for public sector unit banks to act. Replacing the existing system with a core banking systems is likely to increase banks IT expenditure over the next few years. Core banking solution will be ensure the establishment of a reliable centralized data repository for the bank. It will ensure the implementation of integrated customer centric services like on line ATM's, tele-banking, cash management services, etc. Beside it will enable centralized management information system and decision support and executive information system to help the top management take quick decisions. The work of the MIS, ALM and risk management department will be streamlined.

Real Time Gross Settlement (RTGS):

The reserve bank of India (RBI) has already implemented real time gross settlement (RTGS).RTGS will provide for a new generation of high -value payment systems that will enable the core of the banking system across the country make secure inter bank payments across the country. These transactions will cover all general transactions and central accounting of the RBI, including the bank's general ledger. This process can be effectively implemented only when all banks implement CBS. The implementation of CBS followed an interesting pattern in 2003-2004 when most private sector and MNC banks and even large public sector unit banks adopted the system. Therefore, it is the turn of the remaining smaller public sector unit banks as well as the cooperative banks still in the Total Branch Automation (TBA) phase to go in for core banking with a vengeance. With RBI directives necessitating the adoption of centralized solutions, many banks that are yet to adopt CBS have opted at least for consolidated MIS solutions. This is particularly true for a number of smaller cooperative banks for whom core banking product solutions are exorbitantly priced at Rs. 5-8 cr. As per the latest guidelines of the CVC, major business of a bank's branches should be done in a computerized environment and in this light CBS will act a stool to check fraud and other inimical activities. Besides, in view of the proposed mergers and consolidations. Banks should be compatible so that there will be no operational problems.

Conclusion:

Development on the regularly side also created a compelling case for the automation of Indian banks. Recently, RBI Goaded Indian banks to improve their risk management system by building an Investment Fluctuation Reserve (IFR), by making provisions for problem assets and by putting in place systems that monitor unhedged external liabilities. The RBI insisted that along with risk-based internal audit, banks must also put in place a proper risk management architecture, strengthen IT, address human resources and set up compliance units. While many have already adopted some of these measures, a host of other banks are expected to do so this year. All these new require the help of CBS, if they are to be implemented throughout the banking industry for the smooth operation of banks.

Banking Cash Transaction Tax

This new reforms is proposed to be made applicable to the whole of India except the state Jammu and Kashmir. This will come into force with effect from 1st June 2005. The levy of tax under this is proposed on every person as defined in section 2 (31) of the income tax act and also on an officer or establishment of the central government or government of a state. Tax is to be levied at 0.1% of the value of each taxable banking transaction. Taxable banking transaction for this purpose is defined as follows: A transaction of withdrawal of cash exceeding ten thousand rupees on any single day by a person from any scheduled bank or

A transaction of purchase of a bank draft or a banker's cheque or any other financial instrument on payment of cash exceeding ten thousand on a single day by a person from any scheduled bank; or Ø Receipt of cash from a scheduled bank exceeding ten thousand rupees on any single day by a person on an enhancement of term deposit, whether on maturity or otherwise, from that bank. It may noted that the proposal does not seek to tax a withdrawal from a deposit account, which is not a term deposit such as withdrawal from a recurring deposit account. It is proposed to provide that the banking cash transaction tax shall be payable by the following persons: Ø In case of withdrawals exceeding ten thousand rupees, by person withdrawing the cash from any scheduled bank. Ø In respect of purchase of bank draft or a banker's cheque or any other financial instrument on payment of cash exceeding ten thousand, by the person purchasing any such instrument from the bank. Ø In respect of receipt of cash on encashment of term deposit, by the concerned depositor. Ø In respect of cash withdrawal exceeding ten thousand rupees by way of banker's cheques or instrument. It is also proposed to provide that no banking cash transaction tax shall be payable if the amount of term deposit is credited to any account with the bank. The value of taxable banking transactions is proposed as follows: Ø In case of cash withdrawals exceeding ten thousand rupees, the amount of cash withdrawn Ø In respect of purchase of a bank draft or a banker's cheques or any other financial instrument on payment of cash exceeding ten thousand, the amount of cash deposited: Ø In respect of receipt of cash on encashment of tern deposit, the amount of cash received on encashment of term deposit.

And Today … the news says

99  

Banking Sector Reforms in INDIA

New thrust  areas in post banking reforms processA changing environment due to environment due to globalization and innovation is forcing banks to change their focus this article provides a set of 4 ps, personal computer, personnel, peers and people, on which banks should focus this will make Indian banks globally competitive and help in a smooth implementation of base 2 besides focusing on these 4ps, banks should continue the current process of reforms in product innovation, process reengineering and customer capturing.

INTRODUCION

The Rosetta stone “of Marketing Education, the concept of “ four ps “ of mc carthy is thought to have completed its life cycle at least in the metamorphosed globalized Indian Banking sector where the new thrust areas are a different set of ‘4ps” are There has been a growing recognition of India in the world as a strong financial entity, being Asia's forth largest economy. International perception of the Indian banking sector is of great potentialities. The banking industry witnessed sea changes after the financial sector reforms in 1991. Simultaneously, there was also the entry of technology and new generation banks, which have caused concern among old generation banks and public sector banks. Technology has altogether changed branch ambience and delivery channels. The sector is witnessing an inflow of specialized and technically qualified personnel in large scale in an attempt to imbibe professionalism. The safety umbrella concept of the government is slowly vanishing as the government dilutes its holding in public sector banks. The industry is moving very fast to achieve international standards. After the implementation of CAMEL models and Basel -I, now Basel-II known's at the doors, the compliance of which is sine-qua-non in globalized banking operations. The days of poor bottom lines, lethargy and dullness and low risk models of operation are facts of the past in public sector banks. Now the banking industry is moving with all enthusiasm in pursuit of excellence to reach the pinnacle of success in both the domestic and international arena.

PERSONAL COMPUTER

:- Today both IT and communication are inspirable for carrying out any business activity. As far as the banking sector is concerned, it has witnessed radical changes in its operations after the introduction of IT. The banking industry has drawn a banking vision- 2010 to chart its future course. Techno-savvy services in the form of interconnected ATMs (automatic teller machine), Tele-banking, Mobile banking, point of sale terminals, Electronic delivery channels (EDC) and shared payment network system (SPNS), Real time gross settlements (RTGS) etc, are becoming the order of the day. As there has been a shift in focus from on-site banking, the unique selling point (USP) has been an electronic delivery channels. The age of branchless banking is round the corner, when account information and data pertaining to a specific spectrum of customers will be stored in electronic gadgets in LHOs. Small outlets at strategic points will come to the rescue of clientele as SoS. The core banking technology will be of prominence in this decade and its implementation has gained momentum. Virtual branches like the ATMs, net banking, and mobile banking with limited personnel and round the clock service have shown the advantage of virtual banking. In this changed scenario in the financial sector, technology is the enabler and all the changes call for huge does of technology and their up gradation. There has been a great desire to have technology based inter-bank settlements, clearing and collection of instruments. The real time gross settlement system, has been introduced as a pilot project in the Indian banking sector, which has the facility of payment on the spot over the net, there by reducing the time and distance inside Indian subcontinent.

PERSONNEL:-

In money, material, machine and man, it is “Man” who has a large impact on the other three. It is man who handles/manipulates all others for his own interest. With the help of the other three Ms it is Man who can determine the destiny of the organization. With reforms implementation in full force, there has been a greater thrust on personnel. The new interest in HRD and HRM has been tremendous in the reforms dynamics. Human capital, which is a major force in the change process along with technology, has been focused to manage the change. In the globalized banking arena, the success of a banking institution largely depends on technology and manpower. The reforms have a salutary effect in building a compact team of dynamic personnel with professionalism in each division of work and echelon so as to reap the full benefit of the change process. The post reforms years have witnessed a lot of ripples in HRM. Redundant labour was removed from organizations. Specialist officers as IT personnel, MBA, CA, CFAs, engineers and doctors became the new role models. The industry is in the process of grooming young and energetic talent in various fields including treasury management, credit, risk management, technology management, change management, knowledge management and last but not the least human resource management so as to proliferate dynamism and youthfulness at all levels. Fast track merit and performance and appraisal-based promotions are no longer decided on the basis on seniority. Proactive banks have started the exercise of spotting and nurturing talents in the system. Banks are also vying for talent from different streams so as to refurbish competitive edge vis-a vis peers and global players. The integration and sustenance of talent with little turnover is sine qua non in the present banking landscape, for which succession, planning, promotions, talent management, knowledge management, etc, are necessary. Indian banking is in the transition process, for which there may be frequent shifts in the various variables such as system, process, strategy, procedure, technology. With the intention of creation new competencies, a continuous learning process is being stressed upon with on the job and off the job trainings.

PEERS:-

“Dive, survive and Thrive” is the driving force in the era of competition. The new thrust area in the emerging scenario is observing and watching the peer. Public sector banks had 90% share in Indian banking in the pre-financial sector reforms period. With the opening up of the sector, new generation private banks have emerged as the main propellers of complacent in their approach and behavior. With the entry of new and vibrant players, public sector banks became alert and began pushing their moves and countermoves in competitive spirit. The very essence of competition is to focus on SWOT (i.e.-strength, weakness, opportunities, and traits). The strength and opportunities are to be made best use of. The weaknesses are to be shed and the ensuing threats are to be successfully combated. The strengths of the peers are to be exploited to the maximum. The opportunities available to the peers objectives, strategies, perceptions and resources, as without knowing the peer and his moves, a bank cannot survive the competitive environment. There have been competitive products/services and delivery channels by different banks, which have flooded the banking sector. Product alliances in the form of selling insurance or MF scheme are on the rise. Plastic money in the form of credit cards has attracted clients in good number. Whether it is deposits or advances, there has been service orientation. The proactive banks implement strategic moves in their attempt to supersede their peers. The peers, conscious of competition watch moves by their counterparts and never fail to put counter their strategies through newer products and/or process reengineering.

PEOPLE

The thrust area covering various groups of people has expanded after financial sector reforms process. Various segments of people and their interests have become the main focus. Efforts are made to find out consumer need, so as to improve the service rendered. There has been a greater transparency and cost reduction with focus on consumerism and retail banking. Lauterborn's “Four cs” is gaining momentum in the world of consumerism. In his best-selling book

Integrated marketing communication

, lauterborn emphasizes the following four Cs so as to have command in the market and the same is very vital to the banking sector in an international competitive environment. With customer delight as the focus, banks are busy understanding wants and needs, the convenience to buy, consumers willingness and ability to pay for the product or service and marketing orientation. Lauterborn's four ‘Cs' are: “consumers” include depositors, borrowers and stakeholders.

Customer

Banks vying for new clientele make the customer the king. Every bank has the customer as the focus to shower him with new product, new services, alternative delivery system, and basket of products, branch ambience and other amenities; in the process banks try to polish their brand equity and customer loyalty concepts. A competitive market is the buyer's market. Brining products home, need based help to customers, various product alliances, interfaces with customers are various competitive strategies to retain and attract customers. The “

May I Help You Counter”

is becoming a vibrant exercise. Unique buying proposition (UBP); this new concept is all about some thing the consumer wishes to hear and some thing that the marketer can provide. Banks are now busy in listening to customers to know their UBS so that they can make those product/services for them.

DEPOSITORS:-

Depositors as a major sub-group of customers are being provided with innovative product lines which were never dreamt of in the past. Flexi-deposit accounts, floating rate deposits, gold deposits, global credit cards are some such products. Technology based ATM service round the clock, mobile banking, net banking, plastic money, etc. are products that have revolutionized the banking sector. Core banking solution which is in the initial stage, will bring many more products and services with multi delivery channels, which will reduce time and distance to the minimum for any transaction. The road ahead is definitely smooth for the depositors.

BORROWERS:-

The borrower segment of people have definitely reaped the benefits of the reforms and many innovation lines, delivery systems have increased their number. The retail banking products have been a boon to the borrower in particular and the nation in general. There has been a great demand for consumer durables like four wheelers, home and consumption loans to name a few. Education loans, which was only a nomenclature in bank advances, has been growing at an accelerated pace in recent years. Credit is available at competitive interest rates, lower or no upfront charges and lower service charges. Rural India saw the birth of the kisan credit card which is the simplest way to take a loan from a bank for the illiterate and ignorant rural mass, saving time and energy.

SHAREHODERS:-

The public, as the shareholders of public sector banks, are to be reckoned as a strong force with the dilution of government's stake in these entities. Profit has been given a prime position so as to thrive in the competitive scenario through internal generation. During this period public sector banks have seen witnessing great profits. This has been a prime position so as to thrive in the competitive scenario through internal generation. Due to this has resulted in high dividend payment to shareholders. With profit and dividend as well as improvement in various parameters, the public sector bank's banking stocks have moved northwards. There has been a huge amount of market capitalized and multiplication of shareholders wealth. With improvements in the reforms era, there is further scope of value addition to the shareholders in terms of higher market prices, right issues and higher dividends. In the area of transparency and disclosures, public sector banks are moving towards international standards. More discloser and transparency has been beneficial to the various stakeholders.

Conclusion

The thrust areas explained are dynamic in nature. Product innovation, process reengineering and customer capturing tendencies have to continue on an ongoing basis. As the reforms have a long journey to go, it should be endeavored to maximize the benefits of reforms with the aim of strengthening the Indian banking sector. Simultaneously, there is a strong need to improve credit quality and batter monitoring of credit. There is a necessity of diversification of loan across different consumer segments, particularly SME, agriculture and other retail sections. As the effects of various risks loom large, bank should implement risk scoring techniques and prepare for mitigation/management of the various risks. Reduction of operating expanses to the barest minimum and motivation of personnel for higher productivity can provide the necessary vibration for the emergence of stronger Indian banks. Risk management of corporate and other clients may be the function of banks with a basket of risk management products like options, swaps, futures, commodity derivatives and hedges products. In the consolidation process and after, bank may be the most likely to grab business.

In public sector banks, a conductive atmosphere is warranted to take decisions without any fear or favor. Political intervention/favor on the one side and fear of the CVC on the other can hamper judicious commercial decisions. Individual bank boards may be empowered to have their own system of checks and balances as well as accountability in lieu of CVC linkages. Keeping in view the high cost of technology and its up gradation, it is suggested that bank explore the possibility of a global partnership on technology and skill sharing. With the M&A bandwagon permeating the banking sector, the feature will see the emergence of at least 4-5 banks that can compete globally. Finance minister, Chidambaram in his message recently, has categorically sent feelers to bank managements to educate the workforce on the need for mergers and acquisition to become competitive in global financial markets. M&As(mergers & acquisitions) add size, scale, muscle, technology and reduce cost of operations with the help of multi-various synergies created. There were apprehensions over competition and convergence when the banking sector was opened up in the 1990s, but as the reforms process that has progress the public sector banks had become stronger in the last 15 years with a wide array of product and services. The consolidation phase has just been ignited and in the resultant scenario banks are going to be stronger, increase lending, reduce cost, expand business and foray into un chartered areas and try out new ideas. 99

Banking Sector Reforms in INDIA

THE FUTURE . . . what's ahead!

The Indian Banks even after a decade full of reforms for the sector have a long way to go. Product innovations, better information technology and operating mechanisms not only enhance the income and reduce expenses but also act as a catalyst to retain customers. The question is will this suffice for the future? With the continued integration of the Indian markets with the global markets, the volatility is rising. To survive this dynamism and the risks arising from the same, banks need to have resources in place to understand and manage them on a regular basis. Markets, which have so far witnessed a deluge in the number of banks, will now witness consolidation. With the onset of globalization in each and every sector, Indian Banks need to be much more sustainable, efficient, transparent in working and also competitive. Now the bank mergers will not be a new phenomenon since synergies are derived from the alliances in the recent mergers. The following seem to be what the Indian Banking sector is heading for: Ø As the economy revives fee based activities and asset quality of banks could improve. Ø After adjusting for Non Performing Loans some public sector banks may have to go in for fresh capital infusion. Ø Banks will have to compete with mutual funds as an alternative to bank deposits. Ø As public sector banks find their margins squeezed, they may become more active in trading to make up for the margin squeeze. The risk profile of these public sector banks may increase as their trading in money and forex markets increase. Thus, a sound risk management i.e. the ALMs needs to be in place. Ø As competition compress spreads earned on lending business, banks will have to focus on fee income. Private Banks are likely to generate better fee income due to their focus on having adequate technology and having skilled personnel to generate such business. Ø RBI is examining the feasibility of introduction of half yearly audit of accounts by external auditors towards improving the quality of auditing standards further.

Ø New arenas for advancing may be surveyed, the housing loan sector has gained a considerable boosts as per the recent budgetary measures; banks are allowed to lend 3 per cent of their advances to this sector, also infrastructure and film financing remain untapped. Ø With the opening of the insurance sector and recent relaxation of regulation by RBI for entry of banks in this area of business, some of the big banks are expected to enter this business in a big way. Public sector banks with their wide reach and higher confidence levels can take the lead. Ø All banks will have to adapt to new emerging technologies in order to exploit the new business opportunities it offers. It will be a new challenge and will require investment in technology and new systems. Some value-added services may also need to be provided, which will call for innovation standardization. Virtual Banking will set in as a trend successfully. Today, the banks have to compete with their peers as well as with other financial companies. But tomorrow, competitors might zoom in from completely unexpected industries, as deregulation and new technology blur old boundaries, these rewrites the conventional definition of a bank. Those forces offer as many opportunities as threats. A reinvention or a renewal or a rediscovery, the way you term it, shall root the structural changes in the Indian Banking Sector.

Conclusion

A personal view on reforms and developments in the Indian Banking Sector is stated below. The reduction in SLR and CRR has been effective in the sense that the lendable resources of banks have increased. The anticlimax is about the current recession in the economy and decreasing need of investments by the corporate sector. The CRR requirements are necessary for financial soundness of Indian banks; also; a need to assign risk weight age to government securities seems to be coming up due to increasing investments of banks portfolios. The NPA trend has been fortunately declining in the recent years, initially the NPAs were amounting to total of 16 %, and however banks should note that ever greening of loans would de prove the circumstances in the long run; the asset quality is the determinant of banks profitability today. The present evaluation process of banks states requires around 18 officials for quality inspection; the bureaucracy involved can be reduced only by way of better bank supervision.

The Disclosure norms shall avoid situations like in case of South East Asian Crisis; with this respect, RBI proves to be a quite proactive institution. Globalization has but lead to the liberalization of the Indian Banking sector; like the other sectors opened up, today, the Indian banks need to learn much more from competition; customers and not advances and customer service is the call for the day. The DRT Act supersedes all acts but the SICA which clearly states that companies can very easily stall recovery procedures. It's a fact in our country that for every law made there is one more to escape from it. However, the conceptualization of this structure needs to be acknowledged. Increasing risks and imprudent liability management constitute to asset liability mismatch. Complacent behavior of Indian banks with this context has lead to ALM reforms. This shall positively improve and get bankers alert. The ALM framework if correctly implemented shall prove useful. Reduction of government stake seems to be a good decision of RBI, but on deeper analysis, the control strongly remains with the government and it is a truth that bureaucracy has become a side business.

We still need to see what happens next! The corporate can now have a good deal with loans and advances; the interest rate deregulation has been in line with the international standards. The current trend of falling rates shall indeed give the corporate customers fair access with better services. About universal banking, due to increasing competition banks need to strive for customers, thus, offering all at the same desks for corporate as well as individuals i.e. retail banking is required; public sector needs to have a pace in this arena. A merger to improve the overall health, reach and customer base has given a rise to the trend of mergers globally. The recent merger of ICICI and BoM (Bank of Maharashtra) proves that customer base has to develop for sustainability. Mergers constitute as a cheaper and a quicker form of expansion and Indian banks should explore such an opportunity. The opening of insurance has given banks a new opportunity to make the best out of their resources; how much advantage does our PSBs make is yet to see. As far as rural banks are concerned, GOI has to give personnel better career prospects in order to get them working, better products and convenience and safety has to be guaranteed by the bank. Personalized service in a crude form will help. Lastly, technological up gradation will be what will lead to customer retention on the grounds of accessibility and convenience.

Annexure 1:

The personnel in public sector and the private sector bank were interviewed on basis of the following questionnaire (this is customized for ICICI Bank):

About REFORMS in the Indian banking sector:

Ø The legal infrastructure for the recovery of non-performing loans still does not exist. The functioning of debt recovery tribunals has been hampered considerably by litigation in various high courts. This ultimately leads to one solution i.e. ruthless provisioning, any better ways; it is a major drawback of this ruling. Q.) What is the procedure being a private player (ICICI) in this industry, is it different and more effective as far as recoveries are concerned? Ø The need to make massive provisions obviously results in a depletion of capital. But the capital adequacy norm means the banks have to find additional, costly money to refurbish the capital base. In this situation, the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. Thus, the need for ARF is now paramount. Q.) Is the transfers on NPAs to state owned ARF, just about shifting the responsibility to the ARF? What's the whole point of having something like that, it's like a better way of declaring losses and turning away from efficiencies? Ø Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money.

Q.) As a private player what are the problems that you face while communicating with the government? Ø Government intends to reduce its stake to 33% in nationalized banks, please comment on this reform, its positive and negative effects on private players. Ø Introduction of prudential norms, Income Recognition and Asset Classificationand compulsory disclosure of accounts has lead to transparency in the working of banks. Any other recommendations as a private bank.

Ø Consolidation of the Banking industry by merging strong banks is the latest development in the Indian Banking Sector. ICICI has had a recent merger with BoM, ANZ and Stanchart, etc. Please state your views on the overall development of India with this major development in the financial system. About DEVELOPMENTS in the Indian Banking Sector: Ø The 1992 reforms gave scope for diversified product profile. New products and new operating styles exposed the banks to newer and greater risks. Q.) ICICI, as a company holds a diversified portfolio, is the main aim to increase the non-fund based revenue due the trend of falling interest rates? Ø The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to RBI to discuss the time frame and possible options for transforming itself into an universal bank.

Q.) Can you please state the benefits of universal banking, may be in terms of revenue or utilisation of resources or others? Ø SBI Insurance - just confusing customers by lot of Insurance companies. Your comments on distinguishing factor from a public sector bank which has a low reputation as compared to private sector. Q.) What is the viability of “Insurance and Banking” in India, how would you rate the success of ICICI Prudential - Joy Hope Freedom Life, on a scale of 1 to 10 (10 being highest), do you think PSBs should also go for insurance and why? Ø Due to increasing competition all banks are now heading towards developing areas or rather towns in the country. Especially ICICI, it is known for its network in rural areas, please comment on the potentials in the rural area. Ø How do you see the scope of Internet banking in India, well / bad and why? How much revenue do you see from this business as a percentage of the total business, in the future 5 years down the line? What is the current revenue from this business?

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