bfm project report in finance
TRANSCRIPT
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
Summary:
A spell of severe credit crunch, salary cuts, rehiring and a lot of news on loans going
bad lead this paper to test the hypothesis that the Indian Banking Industry has been
performing badly in contemporary times and was adversely impacted due to the
continuing Global Financial Crisis. The methodology adapted to analyse the
performance of all the Scheduled Commercial Banks of the Indian Banking Industry was
to study the trend of the three most significant parameters/ratios applicable for Banking
Industry. Among the parameters of performance, the most significant ones comprise
Net Non Performing Assets as a percentage of Net Advances, Capital Adequacy Ratio
and Return on Assets. A single composite weighted average of all Nationalized banks,
Private sector banks and Foreign banks in India has been considered to
View the trend in the period 2005-06 to 2007-08. The analysis shows that the Indian
Banking Industry is stable and still growing albeit at a slow pace.
The enhanced role of the banking sector in the Indian economy, the increasing levels of
deregulation along with the increasing levels of competition have facilitated globalisation
of the India banking system and placed numerous demands on banks. Operating in this
demanding environment has exposed banks to various challenges. The last decade has
witnessed major changes in the financial sector - new banks, new financial institutions,
new instruments, new windows, and new opportunities - and, along with all this, new
challenges. While deregulation has opened up new vistas for banks to augment
revenues, it has entailed greater competition and consequently greater risks. Demand
for new products, particularly derivatives, has required banks to diversify their product
mix and also effect rapid changes in their processes and operations in order to remain
competitive in the globalised environment.
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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HISTORY:
NEW PHASE OF INDIAN BANKING SYSTEM WITH THE ADVENT OF
INDIAN FINANCIAL & BANKING SECTOR REFORMS AFTER 1991.
The Bank of Bengal which later became the State Bank of India
Phase-I
the General Bank of India was set up in the year 1786. Next came Bank of Hindustan
and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of
Bombay (1840) and Bank of Madras (1843) as independent units and called it
Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of
India was established which started as private shareholders banks, mostly Europeans
shareholders
In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab
National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and
1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank,
and Bank of Mysore were set up. Reserve Bank of India came in 1935.
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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During those day‟s public has lesser confidence in the banks. As an aftermath deposit
mobilization was slow. Abreast of it the savings bank facility provided by the Postal
department was comparatively safer. Moreover, funds were largely given to traders.
Phase II
Nationalization of Imperial Bank of India with extensive banking facilities on a large
scale specially in rural and semi-urban areas. It formed State Bank of India to act as the
principal agent of RBI and to handle banking transactions of the Union and State
Governments all over the country. Seven banks forming subsidiary of State Bank of
India was nationalized in 1960 on 19th July, 1969, major process of nationalization was
carried out. 14 major commercial banks in the country was nationalized . Government took major steps in this Indian Banking Sector Reform after independence.
In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large
scale especially in rural and semi-urban areas. It formed State Bank of India to act as
the principal agent of RBI and to handle banking transactions of the Union and StateGovernments all over the country.
Second phase of nationalization Indian Banking Sector Reform was carried out in 1980
with seven more banks. This step brought 80% of the banking segment in India under
Government ownership.
The following are the steps taken by the Government of India to Regulate Banking
Institutions in the Country:
1949: Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore.
After the nationalization of banks, the branches of the public sector bank India rose to
approximately 800% in deposits and advances took a huge jump by 11,000%.
Phase-III –IIIThis phase has introduced many more products and facilities in the banking sector in its
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was
set up by his name which worked for the liberalization of banking practices. This phase
has introduced many more products and facilities in the banking sector in its reforms
measure. In 1991, under the chairmanship of M Narasimhama, a committee was set up
by his name which worked for the liberalization of banking practices.
Without a sound and effective banking system in India it cannot have a healthy
economy. The banking system of India should not only be hassle free but it should be
able to meet new challenges posed by the technology and any other external and
internal factors.
For the past three decades India's banking system has several outstanding
achievements to its credit. The most striking is its extensive reach. It is no longer
confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system
has reached even to the remote corners of the country. This is one of the main reasons
of India's growth process.
The government's regular policy for Indian bank since 1969 has paid rich divedend With
the nationalization of 14 major private banks of India.
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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INTRODUCTION:
In recent time, we has witnessed that the World Economy is passing through some
intricate circumstances as bankruptcy of banking & financial institutions, debt crisis in
major economies of the world and euro zone crisis. The scenario has become very
uncertain causing recession in major economies like US and Europe. This poses someserious questions about the survival, growth and maintaining the sustainable
development.
However, amidst all this turmoil India‟s Banking Industry has been amongst the few to
maintain resilience. The tempo of development for the Indian banking industry has been
remarkable over the past decade. It is evident from the higher pace of credit expansion,
expanding profitability and productivity similar to banks in developed markets, lower
incidence of non- performing assets and focus on financial inclusion have contributed to
making Indian banking vibrant and strong. Indian banks have begun to revise their
growth approach and re-evaluate the prospects on hand to keep the economy rolling.
THE MEANING OF BANK
From the Italian banca meaning 'bench', the table at which a dealer in money worked. A
bank is now a financial institution which offers savings and cheque accounts, makes
loans and provides other financial services, making profits mainly from the difference
between interest paid on deposits and charged for loans, plus fees for accepting bills
and other services. Other relevant legislation includes the Banks (Shareholdings) Act
and the Reserve Bank Act. The Reserve Bank Act gives the Reserve Bank of Australia
(the central bank) a wide range of powers over the banking sector.
“ Bank is an institution which trades in money, an establishment for the deposits,
custody and issue of money, as also for making loans and discounts and facilitating the
transmission of remittances from one place to another”.
Savings Bank: Running account for saving with restriction in number of withdrawal
Current Account: Running account without restriction on number of withdrawals
Term Deposit: Deposit of an amount for a fixed period where interest is paid
monthly/Quarterly.
Special Term Deposit: Deposit of an amount for a fixed period where interest is
compounded (Capitalized) and paid on maturity.
Recurring Deposit : Regular (Monthly) deposit of a fixed amount for a fixed period
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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BANKING SYSTEM OF INDIA
Modern banking in India is said to be developed during the British era. In the first half of
the 19th century, the British East India Company established three banks – the Bank ofBengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. But in
the course of time these three banks were amalgamated to a new bank called Imperial
Bank and later it was taken over by the State Bank of India in 1955. Allahabad Bank
was the first fully Indian owned bank. The Reserve Bank of India was established in
1935 followed by other banks like Punjab National Bank, Bank of India, Canara Bank
and Indian Bank.
In 1969, 14 major banks were nationalized and in 1980, 6 major private sector banks
were taken over by the government. Today, commercial banking system in India is
divided into following categories.
Types of Banks
Central Bank
The Reserve Bank of India is the central Bank that is fully owned by the Government. It
is governed by a central board (headed by a Governor) appointed by the Central
Government. It issues guidelines for the functioning of all banks operating within the
country.
Public Sector Banks Among the Public Sector Banks in India, United Bank of India is one of the 14 major
banks which were nationalized on July 19, 1969. Its predecessor, in the Public Sector
Banks, the United Bank of India Ltd., was formed in 1950 with the amalgamation of four
banks viz. Comilla Banking Corporation Ltd. (1914), Bengal Central Bank Ltd. (1918),
Comilla Union Bank Ltd. (1922) and Hooghly Bank Ltd. (1932).
State Bank of India and its associate banks called the State Bank Group 20 nationalized
banks Regional rural banks mainly sponsored by public sector banks
Private Sector Banks
Private banking in India was practiced since the beginning of banking system in India.
The first private bank in India to be set up in Private Sector Banks in India was IndusInd
Bank. It is one of the fastest growing Bank Private Sector Banks in India. ING Vysya,
yet another Private Bank of India was incorporated in the year 1930.
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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Old generation private banks
New generation private banks
Foreign banks operating in India
Scheduled co-operative banks
Non-scheduled banks
Co-operative Sector The co-operative sector is very much useful for rural people. The co-operative banking
sector is divided into the following categories.
State co-operative Banks
Central co-operative banks
Primary Agriculture Credit Societies
Development Banks/Financial Institutions
IFCI
IDBI
ICICI
North Eastern Development Finance Corporation
Small Industries Development Bank of India
IDBISCICI
National Housing Bank
IIBI
Export-Import Bank of India
NABARD
LOCAL AREA BANKS
The Local Area Bank Scheme was introduced in August 1996 aimed at bridging the
gaps in credit availability and enhancing the institutional credit framework in the rural
and semi urban areas and providing efficient and competitive services. Since then, five
LABs have been established.
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The review group, which was appointed by RBI in July 2002 to study and make
recommendations on the LABs scheme, has in its report, drawn attention to the
structural infirmities in the concept of the LABs and recommended that there, should be
no licensing of new LABs. It has pointed out several weaknesses in the concept of the
Local Area Bank model, particularly in regards to size, capital base and inherent inability
to absorb the losses in the course of business etc.Four LABS were functional at end-
march 2005. They were Coastal area bank ltd, Vijayawada, Andhra Pradesh,Capital
local area bank ltd,phagwara,Navsari,Gujrat, Krishna bhima samrudhdhi local area bank
limited , Mehboob Nagar,Subhadra local area bank limited, Kolhapur.
CO- OPERATIVE BANKS
The Co-operative banks have a history of almost 100 years. The Co-operative banks
are an important constituent of the Indian Financial System, judging by the role
assigned to them, the expectations they are supposed to fulfill, their number, and the
number of offices they operate. The co-operative movement originated in the West, butthe importance that such banks have assumed in India is rarely paralleled anywhere
else in the world. Their role in rural financing continues to be important even today, and
their business in the urban areas also has increased phenomenally in recent years
mainly due to the sharp increase in the number of primary co-operative banks.
While the co-operative banks in rural areas mainly finance agricultural based activities
including farming, cattle, milk, hatchery, personal finance etc. along with some small
scale industries and self-employment driven activities, the co-operative banks in urban
areas mainly finance various categories of people for self-employment, industries, small
scale units, home finance, consumer finance, personal finance, etc.
Some of the co-operative banks are quite forward looking and have developed sufficient
core competencies to challenge state and private sector banks.
Though registered under the Co-operative Societies Act of the Respective States
(where formed originally) the banking related activities of the co-operative banks are
also regulated by the Reserve Bank of India. They are governed by the Banking
Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.
REGIONAL RURAL BANKS IN INDIA
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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Rural banking in India started since the establishment of banking sector in India. Rural
Banks in those days mainly focused upon the agro sector. Regional rural banks in India
penetrated every corner of the country and extended a helping hand in the growth
process of the country.
SBI has 30 Regional Rural Banks in India known as RRBs. The rural banks of SBI are
spread in 13 states extending from Kashmir to Karnataka and Himachal Pradesh to
North East. The total number of SBIs Regional Rural Banks in India branches is 2349
(16%). Till date in rural banking in India, there are 14,475 rural banks in the country of
which 2126 (91%) are located in remote rural areas.
INDIAN BANKS’ OPERATIONS ABROAD
As on October 20,2005,fourteen Indian banks-nine from the public sector and five from
the private sector had operation overseas spread across 42 countries with a network of
101 branches,6 joint ventures,17 subsidiaries and representative offices.
HDFC Bank
ICICI Bank
SBI Bank
AXIS Bank
Yes Bank
Indian Overseas Bank
Kotak Mahindra Bank
Punjab National Bank
Andhra Bank
Corporation Bank
Allahabad Bank
Karur Vysya Bank
Canara Bank
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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RESERVE BANK OF INDIA
The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank Of India Act, 1934.The Central Office of the Reserve
Bank was initially established in Calcutta but was permanently moved to Mumbai in
1937. The Central Office is where the Governors its and where policies are formulated.Though originally privately owned, since nationalization in 1949, the Reserve Bank is
fully owned by government of India.
The Preamble of the Reserve Bank of India describes the basic functions of the
Reserve Bank as:
"...to regulate the issue of Bank Notes and keeping of reserves with a
view to securing monetary stability in India and generally to operate the
currency and credit system of the country to its advantage.
Organisation & Functions
Reserve Bank of India (RBI) is the Central Bank and all Banks in India are required to
follow the guidelines issued by RBI.
Financial Supervision
The Reserve Bank of India performs this function under the guidance of the Board
for Financial Supervision (BFS). The Board was constituted in November 1994 as a
committee of the Central Board of Directors of the Reserve Bank of India.
ConstitutionThe Board is constituted by co-opting four Directors from the Central
Board as membersfor a term of two years and is chaired by the Governor. The
Deputy Governors of theReserve Bank are ex-officio members. One Deputy Governor,
usually, the Deputy Governor in charge of banking regulation and supervision, is
nominated as the Vice-Chairman of the Board.
Current Focus
supervision of financial institutions
consolidated accounting
legal issues in bank frauds
divergence in assessments of non-performing assets and
supervisory rating model for banks.
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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Main FunctionsMonetary Authority:
Formulates, implements and monitors the monetary policy.
Objective: maintaining price stability and ensuring adequate flow of credit
toproductive sectors.
Regulator and supervisor of the financial system:
Prescribes broad parameters of banking operations within which the
country's banking and financial system functions.
maintain public confidence in the system, protect depositors' interest
and provide cost-effective banking services to the public.
Manager of Foreign Exchange
Manages the Foreign Exchange Management Act, 1999.
Objective: to facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India.
Issuer of currency:
Issues and exchanges or destroys currency and coins not fit for circulation.
Objective: to give the public adequate quantity of supplies of currency notes
andcoins and in good quality.
Developmental role
Performs a wide range of promotional functions to support national objectives.
Related Functions
Banker to the Government: performs merchant banking function for the
centra land the state governments; also acts as their banker..
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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Date 10/7/2013
Cash Reserve Ratios and Rates
(Per cen
Item/Week Ended2012 2013
Sep. 21 Aug. 23 Aug. 30 Sep. 6 Sep. 13 Sep. 20
1 2 3 4 5 6
Ratios
Cash Reserve Ratio (%) 4.75 4.00 4.00 4.00 4.00 4.0
Bank Rate 9.00 10.25 10.25 10.25 10.25 9.5
Base Rate 9.75/10.50 9.70/10.25 9.70/10.25 9.70/10.25 9.70/10.25 9.80/10.2
Term Deposit Rate 8.50/9.25 8.00/9.00 8.00/9.00 8.00/9.00 8.00/9.00 8.00/9.0
Call Money Rate (Weighted
Average) 8.02 10.21 10.23 10.10 10.38 10.2
(1) Cash Reserve Ratio relates to Scheduled Commercial Banks (excluding Regional
Rural
(2) Base Rate relates to five major banks since July 1, 2010. Earlier figures relate to
Benchmark Prime Lending Rate (BPLR)
(3) Deposit Rate relates to major banks for term deposits of more than one year
maturity.
(4) Data cover 90-95 per cent of total transactions reported by participants. Call Money
Rate (Weighted Average) is
volume –weighted average of daily call money rates for the week (Saturday to Friday).
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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PRE-GLOBALIZED SCENARIO OF BANKING IN INDIA
BANKS SERVICE CULTURE WAS EXTREMELY DEMOTIVATED: the services
offered by banks were not so good and it was demotivated because there was no
competition and no improvement in banking services previous to globalization
DISINTERESTED EMPLOYER & EMPLOYEE:. During pre-globalized period the
employee were totally disinterested they don‟t have any target to achieve and there
main motive is just to earn livelihood for them no feeling of competition was there and
even there senior executive don‟t motivate them to achieve some target.
NON COMPETETIVE ATTITUDE.: pre-globalization there were only government banks
who were major players in the field of banking so there is no way for competition so
even staff attitude was completely non competitive so no innovative service take place
and even no innovation in product line.
PRODUCT FOCUSED & NOT CUSTOMER SERVICE FOCUSED: The main focus of
banks were selling of product not customers. like today bank scenario customers are
treated as lifeline of banking sector during pre-globalized time it was nothing so
customers were given last priority.
CHALLENGES FACED BY BANK IN PRE-GLOBALIZED SCENARIO
HARD TO RETAIN CUSTOMER:
INNOVATION IN PRODUCT LINE NEW TECHNOLOGIES
DEFFERED LOYALTY FROM CUSTOMERS
EMERGING OF NEW BANKS
POOR SKILLS OF EMPLOYEES
HARD TO ESTABLISHING MARKET FRIENDLY IMAGE
INFRASTRUCTURE
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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THE PRESENT SCENARIO OF INDIAN BANKING SYSTEM
The current banking sector of India is Countrywide coverage even we can found bank at
small village level, district level and sate level also and current Indian banking system
involves Large number of players because not only government banks take activeparticipate in banking sector whereas there are private banks also, This sector is going
through major changes as a consequence of economic reforms. The changes affect the
ownership pattern of banks, availability of funds, the cost of funds as well as
opportunities to earn, range of services (fee-based and fund-based), and management
of priority sector lending. As a consequence of liberalization in interest rates, banks are
operating on reduced spread. Development financial institutions would have a lesser
impact on the Indian economy. Consumerism is here to stay..
SOME FOLLOWING FEATURES OF CURRENT INDIAN BANKING
SYSTEM
Increasing use of technology in operations
Poised to expand and deepen technology usage
Diversification
Emergence of integrated players
Diversifying capital deployment
Leveraging synergies
Robust regulatory system aligned to international standards
Efficient monetary management The landscape of the banking industryunderwent considerable changes during the last decade. The industry
witnessed:
Deregulation of lending and deposit rates.
Entry of new private sector banks.
Extensive use of technology for product innovation
Emergence of retail banking and new derivative products.
Stricter provisioning and asset classification norms.
Raising capital adequacy requirements.
.The freedom from administered policies and government regulation inmatters of day-to-day functioning has opened a new era of self-
governance and need for self-initiative
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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CURRENT CHALLENGES BEFORE INDIAN BANKING SYSTEM
Problems of Public Sector Banks (PSBs) in IndiaThe Indian Public Sector Banks occupy the pivotal position in the country‟s banking
topography but its market share has declined to some extent in recent years due to the
emergence of private sector and foreign banks. The major problems which Indian
public sector banks facing today are as follows:
Problem of Pressure on Profitability
The problem of pressure on productivity was experienced during 1993-95 as revealed
from the losses caused to banking sector . With continuous expansion in number of
branches and manpower, thrust on social and rural banking, directed sector lending,
maintenance of higher reserve ratios, waiver of loans under concessions, repayment
default by large industrial corporate and other borrowers, etc. had their telling impact
on the profitability of the banks. Further, with the introduction of prudential norms,
made effective from March end 1993, balance sheet of a majority of the commercialbanks had reflected huge losses. In order to improve financial health of these banks, the
Government provided a dose of hybrid capital and in return these banks were made to
sign a memorandum of understanding with RBI.
Problem of Low Productivity
Another problem which Indian public sector banks are confronting is low productivity.
The low productivity has been due to huge surplus manpower, poor work culture and
absence of employees‟ commitment to the organisation.
Problem of Non-Performing Assets (NPAs) A serious threat to survival and success of Indian PSBs is the emergence of
uncomfortably high level of non-performing assets. In its report on Trends and
Progress of Banking in India, 1997-98, the Reserve Bank of India (RBI) reported the
gross NPAs as percentage of advances of PSBs, which was 16 per cent as on March
31,2000 blocking about Rs. 52,000 crore in non-performing loans. The spiralling
nonperforming assets were hurting banks‟ profitability and even the basic inability of the
banking system by way of both non-recognition of interest income and loan loss
provisioning. In view of the further tightening of norms of income recognition and
provisioning norms in times to come, viz., overdue PSU accounts partly or fully
guaranteed by Government accounts to be classified as NPA based on one quarter
default. Size of NPA is likely to be surged unless strategic measures are taken by
thebanking sector.
Problem of Unionism
Another major problem of PSBs is the absence of aggressive marketing programme,
offering prompt service and new products. However, the PSBs are trying to computerise
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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their operations, the pace of progress in this direction has been decidedly slow. The 18
rather tardy progress in the area has been due to the initial reservation of the staff
unions against computerisation for the lurking fear of employment cut, as also the
existence of a huge number of branches in the rural areas, where suitable logistics are
not available. As a result, market share of the PSBs, both in deposits and lending has
declined. This has already become a serious cause of concern for the PSBs regulating
strategic efforts for thwarting the challenges from the new players.
Challenge of Competition from New Banks
The present era of competition has witnessed various large multinational banks like
American Bank, Hong Kong Bank, Swiss Bank, Citi Bank, etc. and other multinational
banks coming very aggressively. The new banks have set the tone and to an extent
also the standard for technological improvements with product innovations, which
dominated the traditional PSBs. So, these banks have to run in a market which has no
geographical barriers and will have to develop abilities of product innovation as wellas delivery comparable to the best in the world.
Challenge of Cross-Industry Competition
The internet provides people from other industry segments opportunities to succeed in
business where they have had little or no such resources before. The new non-financial
entrants such as Microsoft, AOL, Time Warner and Amazon.com are more threatening
to traditional financial service companies and banks than the new virtual entrants,
because these non-financial companies have established credibility, loyal consumers
and deep pockets. In fact, PSBs lacks the greatest threat to banking system.
Threat of Competition from Global Players
Globalisation and integration of Indian financial market with world and the consequent
entry of foreign players in domestic market has infused, in its wake, brutal competitive
pressures on the Indian commercial banks. Foreign players endowed with robust capital
adequacy, high quality assets, world-wide connectivity, benefits of economies of scale
and stupendous risk management skills are posing serious threats to the existing
business of the Indian banks. In order to compete successfully with the new entrants,
Indian banks need to possess matching financial muscle, as fair competition is possible
only among the equals. Average size of an Indian bank is niggardly low in comparison
to any foreign bank. The major question before the Indian commercial banks, therefore,
is to acquire competitive size.
Problem of Managing Dual Ownership
Managing duality of ownership is a peculiar problem which the PSBs have to encounter
because of participation of private shareholders in their share capital. A PSBs to survive
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K.C.COLLEGE CHALLENGES BEFORE INDIAN BANKING SYSTEM
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and grow successfully is expected to operate according to the expectations of one of its
principal shareholders. In the changed scenario, there would be two major groups of
shareholders, viz., the Government of India (GOI) and Reserve Bank of India (RBI) on
one hand and private shareholders on the other. Since the expectations of these two
categories of owners are not necessarily identical, the bankers will have to manage
conflicting interests.
19
Problem of IT Infrastructure
In the age of computerisation, although the banks have started computerisation
process, this has provided little comforts to the customers. Still the customer has to
wait for some time in long queues. Further, the operation by computer is delayed by
the fact that some operating staff are not very skilled and thus it takes more time. The
problem of breakdowns of electricity and even of the computers is so usual that the
whole work comes to a halt and no work is performed. It takes hours to get it rectifiedi.e., even the smaller problems take time as most of the branches do not have system
specialist who can look after the system and other operational problems. An
inexperienced person means more time and more delays in providing services to the
customers.
Bureaucratic Interference
Another very important reason for the plight of the customers of PSBs is the
bureaucratic set-up within the banks whereby it takes months together to get the loan
sanctioned. By the time loan gets sanctioned, the project cost gets escalated giving rise
to defaults in the payments by the organisation and ultimately bank is forced to havelarger NPAs in their hands. Being Government owned, these banks are politically led.
Political agenda tops at the cost of bank‟s profitability and stability. Delays in formation
of legislature that to full of pitfalls with easy escape route to defaulters are common.
Political interference in delaying credit instalments to bank and channeling of bank
funds are common features giving rise to NPAs. Political motives have led to the
problem of overstaffing in the banks. All those and much more have paralysed
Indian public sector banks and means to come out of this glut is not very easy.
Poor Environment
The dirty and poor environment is another problem of PSBs in India. The moment one
enters a bank it looks like a dirty dilapidated warehouse with broken and torn seats,
which discourages a customer to venture into and avail the services. It looks like
butchery where the customer is mentally tarnished such that he feels like taking a
medicine.
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Problem of Consumer Unfriendly
Another reason is that the people working in the banks have a very strong feeling that
they are Government “demands”. Thus nobody can shunt them out and therefore they
do not work. The productivity, output in banks is so low that one will find most of the
staff in the banks busy gossiping and the so-called „bechara‟ customer standing
helpless cursing his fate. Further, the union politics with strikes every seventh day
makes the life of the customer more miserable. It can be well imagined that one-day
closure of banks hits the economy with around Rs. 2000 crore loss, but who cared
about it. Further, the absence of implementation of relationship of performance rewards
and punishment has made the whole affair unmanageable, which leads to obstruction of
services to the customers.
Welfare Motivation
Another very specific reason is that banks being governmental organisation and in20
their objective towards a social state they have neglected the profitable customers atthe cost of loss accounts, their strategies do not exist at all. The same treatment to all
customer, whether one deposits Rs. 1 lakh or Rs. 500 may lead to poor bankercustomer
relationship. The dissatisfaction of the higher-end customer forces him to look
for other options. Foreign banks and private banks are there to serve customers beyond
expectations and provide the customers the dignity and pride of being associated with
them.
Lack of Knowledge
Though, Indian public sector banks have created a vast network of branches, having
huge customer base, they are not able to extract any knowledge, from the vast amountof overload data that they have on these customers. To build strategies to attract and
retain customers some knowledge is in implicit form with the employees about the
customer, which is there because of informal contacts. But private sector banks are
putting-up aggressive and technology savvy competition to public sector banks in the
form of innovative products and services such as round the clock banking facility,
netbanking, free home service to open a bank account and to withdraw/deposit money
by cheque/draft (home banking), free auto sweep facility in the saving account with
options to sweep excess funds in savings account to high interest fixed deposit, ATM
and 365 days service, providing an automatic terminal in a corporate office for company
to access its account from its office, offering attractive consumer durable
loans, educational loans, credit cards, etc.
Problem of Customer Adoption Issue
Nowadays the public sector banks are presenting various products and services to their
customers online, but its scope is limited. The problem of banks is that they must work
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hard to attract more number of customers. This is possible only when they assure
security of online transactions. Moreover, banks that have created a distinctive online
offering could attract more number of customers when compared to those banks which
are using almost similar products and services. The future of online banking
transactions depends on their ability to convince their customers to use their online
portals.
Problem of Choice of Banking Technology
Undoubtedly, online banking saves a lot of time. Two types of banking models like
integrated banking and stand-alone Internet banking are coming into existence. But
banks may encounter problems due to wrong choice of technology, insufficient control
processes and inappropriate system design. This wrong selection of technology may
lead to a loss in terms of financial losses well as loss of brand image and goodwill. Due
to this reason, many banks rely on third party service provider for banking
technology.
Challenges of the Survival of Public Sector Banks (PSBs) in India
The improvement of operational and distribution efficiency of commercial banks has
always been an issue for Government of India (GOI) in consultation with RBI. Over the
years, like Banking Commission (1972) under the Chairmanship of R.G. Saraiya and 21
1976 under the Chairmanship of Manubhai Shah and the Committee for the
functioning of PSBs (1978) under the Chairmanship of James S. Raj have suggested
structural changes towards this objective. However, the economic rise of 1990s gave
birth to the new economic macro level thinking to improve the economic health of the
Indian economy. Financial sector reforms, particularly banking sector, gave new soundand healthy direction to the Indian economy. Under the regime of Liberalisation,
Privatisation and Globalisation (LPG), some public sector banks are still facing very
serious problems as their survival has become very difficult in the competitive world.
Various challenges have taken place to tackle the problem.
Competitive Environment
The Foreign Banks and New Private Sector Banks have witnessed a significant growth
but on the other side, PSBs are at the edge of survival among them with huge capital
base, latest technology, innovative and globally tested products/services are fetching
the consumer‟s attention. However, to make Indian PSBs competitively strong, they
should follow the strategies of New Private Sector Banks and Foreign Banks as
benchmark with an introduction of latest technology, innovative and globally accepted
products/services followed by appointment of experienced, skilled and tech-friendly
professionals.
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Consumer Focus
Consumer is a king in today‟s market. The PSBs never try to focus on their needs and
hence lose their market share. The first and foremost thing that banks require to do is
to treat the consumer as a consumer of the bank and not as a consumer of any other
branch. The banks require improving on providing services and profitability efficiencyof
services. The banks have to explore out fastest and efficient means of providing
services with the use of IT applications, telebanking, internet banking and improving
delivery system by improving the attitude and behaviour of the staff also.
Marketing Strategies
The PSBs are required to devise suitable market strategies to augment the volume of
business level. So, the PSBs should research on the vast knowledge they have about
the consumer, devise about specific products for specific segments, differentiate
according to consumer potentials and its expectations, and focus on few potential
customers with customized products and services rather than serving all customers withuniversal products. Using CRM, appointment of young employees with fresh and
creative minds with expertise in latest technology, as a matter of choice is desirable to
survive in the globalised market.
Image building
The PSBs should start on massive scale the image-building exercise. The banks should
focus their attention on creation of such an outward look that it feels like anything
entering the bank. The regent of the bank should be user-friendly with good quality
furniture and other attractive infrastructure.
Transformation of human capital22
Another important challenge is the transformation of human capital. But the PSBs are
overloaded with much experienced senior old staff who are never ready to accept the
change. Now-a-days, it is the need of the hour to develop and manage the human
resources to make them adaptable to the changing environment. It is a challenge for
PSBs that how to manage their human capital to make it productive. However, PSBs
should provide on-the-job training to the efficient staff to make them capable to
understand and work with latest technology and its application. The performance of
staff should be evaluated on quarterly basis and it is also required to introduce
Voluntary Retirement Scheme (VRS) in a proper way.
Reorganisation, Restructuring and Reengineering (RRR)
The time is the most precious thing; banks should understand the value of consumer‟s
time. The unnecessary paper work and lengthy process need to be cut short in PSBs.
However, reorganisation, restructuring and reengineering (RRR) are the need of the
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hour. In order to lead, capture and retain the customer, banks have to utilise their
knowledge about consumer to determine about product configuration, promotion,
pricing and service level, channel mix all that suit the consumer better. The CRM
(Customer Relationship Management) system helps to make more accurate
commitment to customer based on informed judgment adding value to customer
relationship at every stage regardless of the interaction point, branch, call centre or the
internet and that full details of each interaction are always captured for analysis
anddecision-making
Continuous Strikes
Another important challenge is that the growth of trade unionism in banks resulting in
frequent strikes, lockouts, conflict amongst the management and employees leading to
loss of both the consumer as well as the banks. These strikes have the roots in
dissatisfaction of workers on the basis of non-fulfilment of promises, faulty appraisal
system and absence of accountability in the system. This leads to the rise of total NPAsof the scheduled commercial banks. This requires the improved credit skills for
appraisal of credit proposal and monitoring the loss.
Decline in interest rates:
The decline of interest rates is due to reluctance to take loans. It is so lengthy and
complex that by the time it is approved, the project get delayed, which results in less
return and thus larger NPAs. The interest income as percentage of average working
funds of PSBs has fallen considerably from 10.3 in 1997-98 to 9.92 in 2000-01. While
the private banks interest income as percentage to average working funds is 10.41 in
2000-01 as against 10.35 in 1997-98 and that of foreign banks 9.43 as against 8.83 in1997-98.
This shows that private banks and foreign banks are able to increase interest income as
compared to PSBs. It is a clear indication of shift of consumers. This is a big challenge
before the PSBs to tackle with private sector banks and foreign banks.
Challenges of Governance, Risk and Compliance (GRC)
GRC is a recognised and a integrated approach. Without a focussed approach to GRC
Challenges Before Indian Banking System
K.C.College
23
framework, a bank would be more vulnerable to risks, as complexities and
interdependencies of risks increase with increase in international business. Further, the
implementation of GRC in the Indian banking sector will require serious commitment
of resources and management focus. It will also entail hiring and training employees in
India to develop expertise in handling specific overseas regulations.
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Profit Accountability
Another challenge is profit accountability that the PSBs give more stress on
profitability not on the accountability. If the required profit target is achieved, nobody
is accountable to reward and similarly, in case it is not achieved, then also nobody is
accountable for punishment. To cope up with the problem, PSBs should make proper
policies for profit accountability. Therefore, the PSBs should fix accountability with
targets on each unit and employee of the banks and award to those people who have
achieved the target.
Consolidation (Merger and Acquisitions)
“Competition, Convergence and Consolidation” will be the key challenges of the
banking industry in the future. The Indian banking sector is moving from a regime of
„large number of small banks‟ to „small number of large banks‟. Thus, the key
motivations behind mergers and acquisitions in India are to have enhanced size toenjoyeconomies of scale and scope, access to large amount of funds, wider penetration
and global presence. The consolidation and merger can have a number of positive
impacts on the Indian banking sector, which are competitive in international markets,
participate in a range of financial activities, avail the tax relief, maximising the
shareholder value, etc. The Table 1 depicts the bank mergers in India during the
pre-nationalisation (1961-1968), nationalisation (1969-1992) and post-reform period
(1993-2008).
Autonomy
The PSBs are in need of operational freedom and autonomy in their development. Onthe other hand, foreign banks and new private sector banks have the full autonomy in
day-to-day operations and that is why their performance is significantly better than
PSBs. It can be said that, to compete in the global market, PSBs should be given full
autonomy. RBI should provide full autonomy in the areas like insurance sector, free
merger and acquisitions, allowing the opening of rural branches, fix quota on private
sector, etc.
Challenges regarding Retention of Skilled Manpower
It is expected that from April 2009 onwards, there will be rapid changes in the Indian
banking sector. The regulatory guidelines for starting foreign banks and acquisition of
Indian private banks by foreign banks will become more liberal. As a consequence,
retention of skilled manpower will be a challenge to the nationalised banks, since
foreign and private banks will try to lure them with attractive pay packages.
Challenges of Technology
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Another important challenge is that Indian public sector banks should have used24
innovative technology to facilitate financial inclusion of the unbanked population ofIndia
through use of biometric techniques and burgeoning mobile network. However,
this customer experience and tailored offerings are increasingly becoming key to bank
profitability.
Challenges of Online Banking
Online banking has changed the face of the entire banking system. It opens a new
channel for banks to reach their customers and serve them better. Online banking has
several advantages when compared to the traditional banking systems, such as, access
irrespective of time and place, manage all his bank accounts from one secure site, and
using account aggregation, stock quotations and portfolio management programmes
for effective management of assets. But authentication, security trust, non-repudiation
and privacy issues are some of the challenges that online banks have to cope with.
Challenges of Mobile Banking
Mobile banking is enjoying a rapid growth. Mobile banking is different from Internet
banking and ATMs in many ways. The banks get valuable data about the customers
through mobile banking, which helps them in effective customer relationship
management practices. Through mobile banking, all mandatory alters are to be sent to
the customers in time, and the complete system should be very much disciplined and
robust. There should not be any change for any information leakage. If a wrong
transaction is done by mistake, there should be options to undo it. But if the customer
once loss his confidence, it is very difficult to convince them again regarding the same.
Hence, Indians living in villages and semi-urban areas need to be educated aboutmobile banking. There is a biggest challenge for banks that mobile banking education
should become a part of the promotional campaigns.
The PSBs should meet the above challenges, which will enable them to acquire, retain
and enhance the customer and will be able to fight the menace of competition with
private sector banks and foreign banks. But in the mean time, still banks have to strive
hard to come out of the deadly thaws of bureaucratic control to implement their will fully.
Globalisation – a challenge as well as an opportunity.
Theory:
The enhanced role of the banking sector in the Indian economy, the increasing levels of
deregulation along with the increasing levels of competition have facilitated globalization
of the India banking system and placed numerous demands on banks. Operating in this
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demanding environment has exposed banks to various challenges. The last decade has
witnessed major changes in the financial sector - new banks, new financial institutions,
new instruments, new windows, and new opportunities - and, along with all this, new
challenges. While deregulation has opened up new vistas for banks to augment
revenues, it has entailed greater competition and consequently greater risks. Demand
for new products, particularly derivatives, has required banks to diversify their product
mix and also effect rapid changes in their processes and operations in order to remain
competitive in the globalised environment.
Globalization – a challenge as well as an opportunity The benefits of globalization
have been well documented and are being increasingly recognized. Globalization of
domestic banks has also been facilitated by tremendous advancement in information
and communications technology. Globalization has thrown up lot of opportunities but
accompanied by concomitant risks. There is a growing realization that the ability of
countries to conduct business across national borders and the ability to cope with the
possible downside risks would depend, inter-alia, on the soundness of the financial
system and the strength of the individual participants
Basel & Capital Adequacy:
Amidst globalization Banking System in India has attained vital importance. Day by day
there has been increasing banking complexities in banking transactions, capital
requirements, liquidity, credit and risks associated with them.
The World Trade Organisation (WTO), of which India is a member nation, requires the
countries like India to get their banking systems at par with the global standards interms of financial health, safety and transparency, by implementing the Basel II Norms
by 2009.
BASEL COMMITTEE: The Basel Committee on Banking Supervision provides a forum
for regular cooperation on banking supervisory matters. Its objective is to enhance
understanding of key supervisory issues and improve the quality of banking supervision
worldwide. It seeks to do so by exchanging information on national supervisory issues,
approaches and techniques, with a view to promoting common understanding. The
Committee's Secretariat is located at the Bank for International Settlements (BIS) in
Basel, Switzerland.
NEED FOR SUCH NORMS:
The first accord by the name .Basel Accord I. was established in 1988 and was
implemented by 1992. It was the very first attempt to introduce the concept of minimum
standards of capital adequacy. Then the second accord by the name Basel Accord II
was established in 1999 with a final directive in 2003 for implementation by 2006 as
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Basel II Norms. Basel II Norms have been introduced to overcome the drawbacks of
Basel I Accord. For Indian Banks, its the need of the hour to buckle-up and practice
banking business at par with global standards and make the banking system in India
more reliable, transparent and safe. These Norms are necessary since India is and will
witness increased capital flows from foreign countries and there is increasing cross-
border economic & financial transactions.
Table 1: Analysis of Capital Adequacy Ratio for the period year 2011 to 12
S.No. Category of Indian Banks
(No of Banks in 10,'11,'12)
Capital Adequacy Ratio
( As on March 31, In Per cent)
2009-10 2010-11 2011-12
I Nationalised Banks (28,29,29) 12.2 12.27 12.05
II Private Sector Banks (27,21,19) 11.71 12.98 15.37
III Foreign Banks in India (29,29,32) 41.84 39.25 44.1
Weighted Average of I, II and III 22.27 22.03 24.38
Source: Derived from data of Indian Bankers Association and Reserve Bank of India
Capital adequacy ratios ("CAR") are a measure of the amount of a bank's core
capital expressed as a percentage of its assets weightedcredit exposures.
Capital adequacy ratio is defined as
TIER 1 CAPITAL -A) Equity Capital, B) Disclosed Reserves
TIER 2 CAPITAL -A) Undisclosed Reserves, B) General Loss reserves, C)
Subordinate Term Debts
where Risk can either be weighted assets ( ) or the respective national
regulator's minimum total capital requirement. If using risk weighted assets,
≥ 10%
The percent threshold varies from bank to bank (10% in this case, a common
requirement for regulators conforming to the Basel Accords) is set by the national
banking regulator of different countries.
Two types of capital are measured: tier one capital (T 1 above), which can absorb losses
without a bank being required to cease trading, andtier two capital (T 2 above), which
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can absorb losses in the event of a winding-up and so provides a lesser degree of
protection to depositors.
Capital adequacy ratio is the ratio which determines the bank's capacity to meet thetime liabilities and other risks such as credit risk, operational risk, etc. In the most simple
formulation, a bank's capital is the "cushion" for potential losses, and protects the bank's
depositors and other lenders. Banking regulators in most countries define and
monitor CAR to protect depositors, thereby maintaining confidence in the banking
system.
CAR is similar to leverage; in the most basic formulation, it is comparable to
the inverse of debt-to-equity leverage formulations (although CAR uses equity
over assets instead of debt-to-equity; since assets are by definition equal to debt plus
equity, a transformation is required). Unlike traditional leverage, however, CARrecognizes that assets can have different levels of risk.
Since different types of assets have different risk profiles, CAR primarily adjusts
for assets that are less risky by allowing banks to "discount" lower -risk assets. The
specifics of CAR calculation vary from country to country, but general approaches tend
to be similar for countries that apply the Basel Accords. In the most basic
application, government debt is allowed a 0% "risk weighting" - that is, they are
subtracted from total assets for purposes of calculating the CAR.
Tier 1 capital is the core measure of a bank's financial strength from a regulator 's point
of view. It is composed of core capital, which consists primarily of common stock anddisclosed reserves (or retained earnings) but may also include non-redeemable non-
cumulative preferred stock. The Basel Committee also observed that banks have used
innovative instruments over the years to generate Tier 1 capital; these are subject to
stringent conditions and are limited to a maximum of 15% of total Tier 1 capital.
Capital in this sense is related to, but different from, the accounting concept
of shareholders' equity. Both Tier 1 and Tier 2 capital were first defined in the Basel
I capital accord and remained substantially the same in the replacement Basel
II accord. Tier 2 capital represents "supplementary capital" such as undisclosed
reserves, revaluation reserves, general loan-loss reserves, hybrid (debt/equity) capitalinstruments, and subordinated debt.
Each country's banking regulator, however, has some discretion over how
differing financial instruments may count in a capital calculation. This is appropriate, as
the legal framework varies in different legal systems.
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The theoretical reason for holding capital is that it should provide protection against
unexpected losses. Note that this is not the same as expected losses, which are
covered by provisions, reserves and current year profits. In Basel I agreement, Tier 1
capital is a minimum of 4%ownership equity but investors generally require a ratio of
10%. Tier 1 capital should be greater than 50% of the minimum requirement.
1.2) OPERATIONAL RISK
An operational risk is, as the name suggests, a risk arising from execution of a
company's business functions. It is a very broad concept which focuses on the risks
arising from the people, systems and processes through which a company operates. It
also includes other categories such as fraud risks, legal risks, physical or environmental
risks.
A widely used definition of operational risk is the one contained in the Basel
II regulations. This definition states that operational risk is the risk of loss resulting from
inadequate or failed internal processes, people and systems, or from external events.
The approach to managing operational risk differs from that applied to other types of
risk, because it is not used to generate profit. In contrast, credit risk is exploited by
lending institutions to create profit, market risk is exploited by traders and fund
managers, and insurance risk is exploited by insurers. They all however manage
operational risk to keep losses within their risk appetite - the amount of risk they are
prepared to accept in pursuit of their objectives. What this means in practical terms is
that organisations accept that their people, processes and systems are imperfect, and
that losses will arise from errors and ineffective operations. The size of the loss they are
prepared to accept, because the cost of correcting the errors or improving the systems
is disproportionate to the benefit they will receive, determines their appetite for
operational risk.
Determining appetite for operational risk is a discipline which is still in its infancy. Some
of the issues and considerations around this process are outlined in this Sound Practice
paper published by the Institute for Operational Risk in December 2009.
Background
Since the mid-1990s, the topics of market risk and credit risk have been the subject of
much debate and research, with the result that financial institutions have made
significant progress in the identification, measurement and management of both these
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forms of risk. However, it is worth mentioning that the near collapse of the U.S. financial
system in September 2008 is a clear indication that our ability to measure market and
credit risk is far from perfect.
Globalization and deregulation in financial markets, combined with increased
sophistication in financial technology, have introduced more complexities into theactivities of banks and therefore their risk profiles. These reasons underscore banks'
and supervisors' growing focus upon the identification and measurement of operational
risk.
Events such as the September 11 terrorist attacks, rogue trading losses at Société
Générale, Barings, AIB and National Australia Bank serve to
highlight the fact that the scope of risk management extends beyond
merely market and credit risk.
The list of risks (and, more importantly, the scale of these risks) faced by banks todayincludes fraud, system failures, terrorism and employee compensation claims. These
types of risk are generally classified under the term 'operational risk'.
Definition
The Basel Committee defines operational risk as:
"The risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events."
However, the Basel Committee recognizes that operational risk is a term that has a
variety of meanings and therefore, for internal purposes, banks are permitted to adopt
their own definitions of operational risk, provided that the minimum elements in the
Committee's definition are included.
Scope exclusions
The Basel II definition of operational risk excludes, for example, strategic risk - the risk
of a loss arising from a poor strategic business decision.
Other risk terms are seen as potential consequences of operational risk events. Forexample, reputational risk (damage to an organization through loss of its reputation or
standing) can arise as a consequence (or impact) of operational failures - as well as
from other events.
Basel II event type categories
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The following lists the official Basel II defined event types with some examples for each
category:
Internal Fraud - misappropriation of assets, tax evasion, intentional mismarking of
positions, bribery
External Fraud- theft of information, hacking damage, third-party theft and forgery
Employment Practices and Workplace Safety - discrimination, workers
compensation, employee health and safety
Clients, Products, & Business Practice- market manipulation, antitrust, improper
trade, product defects, fiduciary breaches, account churning
Damage to Physical Assets - natural disasters, terrorism, vandalism
Business Disruption & Systems Failures - utility disruptions, software failures,
hardware failures
Execution, Delivery, & Process Management - data entry errors, accounting errors,
failed mandatory reporting, negligent loss of client assets
Difficulties;It is relatively straightforward for an organization to set and observe
specific, measurable levels of market risk and credit risk because models exist which
attempt to predict the potential impact of market movements, or changes in the cost of
credit. It should be noted however that these models are only as good as the underlying
assumptions, and a large part of the recent financial crisis arose because the valuations
generated by these models for particular types of investments were based on incorrect
assumptions.
By contrast it is relatively difficult to identify or assess levels of operational risk and its
many sources. Historically organizations have accepted operational risk as an
unavoidable cost of doing business. Many now though collect data on operational
losses - for example through system failure or fraud - and are using this data to model
operational risk and to calculate a capital reserve against future operational losses. In
addition to the Basel II requirement for banks, this is now a requirement for European
insurance firms who are in the process of implementing Solvency II ,the equivalent of
Basel II for the banking sector
Methods of operational risk management
Basel II and various Supervisory bodies of the countries have prescribed various
soundness standards for Operational Risk Management for Banks and similar Financial
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Institutions. To complement these standards, Basel II has given guidance to 3 broad
methods of Capital calculation for Operational Risk
Basic Indicator Approach - based on annual revenue of the Financial Institution
Standardized Approach - based on annual revenue of each of the broad business linesof the Financial Institution
Advanced Measurement Approaches - based on the internally developed risk
measurement framework of the bank adhering to the standards prescribed (methods
include IMA, LDA, Scenario-based, Scorecard etc.)
The Operational Risk Management framework should include identification,
measurement, monitoring, reporting, control and mitigation frameworks for Operational
Risk.
1.3) Recapitalisation of Public Sector Banks
Public sector banks‟ performance is important. Public banks still dominate the banking
systems serving the majority of people in developing countries, despite the rash of
privatizations of the last 10 years. In 2002, public sector banks represented 60 percent
or more of the banking system‟s assets in Algeria, Bangladesh, China, Egypt, Ethiopia,
India, Iran, and Vietnam. In Indonesia, public banks, including those under control of
the Indonesian Bank Restructuring Agency, held over 60 percent of the banking
system‟s assets, up from about 45 percent before the East Asian crisis. In Brazil,despite closure, conversion into agencies or privatization of most provincial banks,
including the massive State Bank of Sao Paulo in 2001, federal banks, including the
federal development bank (BNDES), held about 1/3 of bank assets and dominate
lending for agriculture, housing and longer term projects
1.4) Fresh Capital for Private Banks
The standardized requirements in place for banks and other depository institutions,
which determines how much capital is required to be held for a certain level of assets
through regulatory agencies such as the Bank for International Settlements,FederalDeposit Insurance Corporation or Federal Reserve Board. These requirements are put
into place to ensure that these institutions are not participating or holding investments
that increase the risk of default and that they have enough capital to sustain operating
losses while still honoring withdrawals. Also known as "regulatory capital".
The Basel Accords, published by the Basel Committee on Banking Supervision housed
at the Bank for International Settlements, sets a framework on
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how banks and depository institutions must calculate their capital. In 1988, the
Committee decided to introduce a capital measurement system commonly referred to
as Basel I. This framework has been replaced by a significantly more complex capital
adequacy framework commonly known as Basel II. After 2012 it will be replaced
by Basel III Another term commonly used in the context of the frameworks is Economic
Capital, which can be thought of as the capital level bank shareholders would choose in
absence of capital regulation. For a detailed study on the differences between these two
definitions of capital, refer to
The capital ratio is the percentage of a bank's capital to its risk-weighted assets.
Weights are defined by risk-sensitivity ratios whose calculation is dictated under the
relevant Accord. Basel II requires that the total capital ratio must be no lower than 8%.
The 5 Cs of Credit - Character, Cash Flow, Collateral, Conditions and Capital- have
been replaced by one single criterion. While the international standards of bank capital
were laid down in the 1988 Basel I accord, Basel II makes significant alterations to theinterpretation, if not the calculation, of the capital requirement.
Examples of national regulators implementing Basel II include the FSA in the
UK, BaFin in Germany, OSFI in Canada, Banca d'Italia in Italy.
perceived credit risk associated with balance sheet assets, as well as certain off-
balance sheet exposures such as unfunded loan commitments, letters of credit,
andderivatives and foreign exchange contracts. The risk-based capital guidelines are
supplemented by a leverage ratio requirement. To be adequately capitalized under
federal bank regulatory agency definitions, a bank holding company must have a Tier 1capital ratio of at least 4%, a combined Tier 1 and Tier 2 capital ratio of at least 8%, and
a leverage ratio of at least 4%, and not be subject to a directive, order, or written
agreement to meet and maintain specific capital levels. To be well-capitalized under
federal bank regulatory agency definitions, a bank holding company must have a Tier 1
capital ratio of at least 6%, a combined Tier 1 and Tier 2 capital ratio of at least 10%,
and a leverage ratio of at least 5%, and not be subject to a directive, order, or written
agreement to meet and maintain specific capital levels.
Tier 1 capital
Tier 1 capital, the more important of the two, consists largely of shareholders' equity and
disclosed reserves. This is the amount paid up to originally purchase the stock (or
shares) of the Bank (not the amount those shares are currently trading for on the stock
exchange), retained profits subtracting accumulated losses, and other qualifiable Tier 1
capital securities (see below). In simple terms, if the original stockholders contributed
$100 to buy their stock and the Bank has made $10 in retained earnings each year
since, paid out no dividends, had no other forms of capital and made no losses, after 10
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years the Bank's tier one capital would be $200. Shareholders equity and retained
earnings are now commonly referred to as "Core" Tier 1 capital, whereas Tier 1 is core
Tier 1 together with other qualifying Tier 1 capital securities.
Tier 2 (supplementary) capital
Tier 2 capital, or supplementary capital, comprises undisclosed reserves, revaluation
reserves, general provisions, hybrid instruments and subordinated term debt.
Undisclosed reserves are not common, but are accepted by some regulators where a
Bank has made a profit but this has not appeared in normal retained profits or in general
reserves. Most of the regulators do not allow this type of reserve because it does not
reflect a true and fair picture of the results.
Revaluation reserves
A revaluation reserve is a reserve created when a company has an asset revalued andan increase in value is brought to account. A simple example may be where a bank
owns the land and building of its headquarters and bought them for $100 a century ago.
A current revaluation is very likely to show a large increase in value. The increase would
be added to a revaluation reserve.
General provisions
A general provision is created when a company is aware that a loss may have occurred
but is not sure of the exact nature of that loss. Under pre -IFRS accounting standards,
general provisions were commonly created to provide for losses that were expected inthe future. As these did not represent incurred losses, regulators tended to allow them
to be counted as capital.
Hybrid debt capital instruments
They consist of instruments which combine certain characteristics of equity as well as
debt. They can be included in supplementary capital if they are able to support losses
on an on-going basis without triggering liquidation.
Subordinated-term debt
Subordinated debt is classed as Lower Tier 2 debt, usually has a maturity of a minimum
of 10 years and ranks senior to Tier 1 debt, but subordinate to senior debt. To ensure
that the amount of capital outstanding doesn't fall sharply once a Lower Tier 2 issue
matures and, for example, not be replaced, the regulator demands that the amount that
is qualifiable as Tier 2 capital amortises (i.e. reduces) on a straight line basis from
maturity minus 5 years (e.g. a 1bn issue would only count as worth 800m in capital
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4years before maturity). The remainder qualifies as senior issuance. For this reason
many Lower Tier 2 instruments were issued as 10yr non-call 5 year issues (i.e. final
maturity after 10yrs but callable after 5yrs). If not called, issue has a large step - similar
to Tier 1 - thereby making the call more likely.
Different International Implementations
Regulators in each country have some discretion on how they implement capital
requirements in their jurisdiction.
For example, it has been reported[6] that Australia's Commonwealth Bank is measured
as having 7.6% Tier 1 capital under the rules of the Australian Prudential Regulation
Authority, but this would be measured as 10.1% if the bank was under the jurisdiction of
the UK's Financial Services Authority. This demonstrates that international differences
in implementation of the rule can vary considerably in their level of strictness.
1.5 CREDIT RISK
Credit risk is an investor's risk of loss arising from a borrower who does not make
payments as promisedSuch an event is called a default. Other terms for credit risk
are default risk and counterparty risk.
Investor losses include lost principal and interest, decreased cash flow, andincreased collection costs, which arise in a number of circumstances
A consumer does not make a payment due on a mortgage loan, credit card, line of
credit, or other loan
A business does not make a payment due on a mortgage, credit card, line of credit, or
other loan
A business or consumer does not pay a trade invoice when due
A business does not pay an employee's earned wages when due
A business or government bond issuer does not make a payment on a coupon or
principal payment when due
Types of credit risk
There are three primary types of credit riskDefault risk - when the borrower fails to make
contractual payments
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Credit spread risk - risk due to volatility in the difference between interest rates on
investments and the risk-free rate of return
Credit analysis and consumer credit risk
Significant resources and sophisticated programs are used to analyze and manageriskSome companies run a credit risk department whose job is to assess the financial
health of their customers, and extend credit (or not) accordingly. They may use in house
programs to advise on avoiding, reducing and transferring risk. They also use third party
provided intelligence. Companies like Standard & Poor's, Moody's Analytics, Fitch
Ratings, and Dun and Bradstreet provide such information for a fee.
Most lenders employ their own models (credit scorecards) to rank potential and existing
customers according to risk, and then apply appropriate strategies. With products such
as unsecured personal loans or mortgages, lenders charge a higher price for higher risk
customers and vice versa. With revolving products such as credit cards and overdrafts,risk is controlled through the setting of credit limits. Some products also require security,
most commonly in the form of property.
Credit scoring models also form part of the framework used by banks or lending
institutions grant credit to clients. For corporate and commercial borrowers, these
models generally have qualitative and quantitative sections outlining various aspects of
the risk including, but not limited to, operating experience, management expertise, asset
quality, and leverage and liquidity ratios, respectively. Once this information has been
fully reviewed by credit officers and credit committees, the lender provides the funds
subject to the terms and conditions presented within the contract (as outlined above).Credit risk has been shown to be particularly large and particularly damaging for very
large investment projects, so-called megaprojects. This is because such projects are
especially prone to end up in what has been called the "debt trap," i.e., a situation
where – due to cost overruns, schedule delays, etc. – the costs of servicing debt
becomes larger than the revenues available to pay interest on and bring down the debt.
Sovereign risk
Sovereign risk is the risk of a government becoming unwilling or unable to meet its loan
obligations, or reneging on loans it guarantees.[9] The existence of sovereign risk meansthat creditors should take a two-stage decision process when deciding to lend to a firm
based in a foreign country. Firstly one should consider the sovereign risk quality of the
country and then consider the firm's credit quality.[10]
Five macroeconomic variables that affect the probability of sovereign debt rescheduling
are: Debt service ratio
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Import ratio
Investment ratio
Variance of export revenue
Domestic money supply growth
The probability of rescheduling is an increasing function of debt service ratio, importratio, variance of export revenue and domestic money supply growth. Frenkel, Karman
and Scholtens also argue that the likelihood of rescheduling is a decreasing function of
investment ratio due to future economic productivity gains. Saunders argues that
rescheduling can become more likely if the investment ratio rises as the foreign country
could become less dependent on its external creditors and so be less concerned about
receiving credit from these countries/investors.
Counterparty risk
Counterparty risk, known as default risk, is the risk that an organization does not payout on a bond, credit derivative, credit insurance contract, or other trade or transaction
when it is supposed to. Even organizations who think that they have hedged their bets
by buying credit insurance of some sort still face the risk that the insurer will be unable
to pay, either due to temporary liquidity issues or longer term systemic issues.
Large insurers are counterparties to many transactions, and thus this is the kind of risk
that prompts financial regulators to act, e.g., the bailout of insurer AIG.
On the methodological side, counterparty risk can be affected by wrong way risk,
namely the risk that different risk factors be correlated in the most harmful direction.Including correlation between the portfolio risk factors and the counterparty default into
the methodology is not trivial, see for example Brigo and Pallavicini
Mitigating credit risk
Lenders mitigate credit risk using several methods:
Risk-based pricing: Lenders generally charge a higher interest rate to borrowers who
are more likely to default, a practice called risk-based pricing. Lenders consider factors
relating to the loan such as loan purpose, credit rating, and loan-to-value ratio and
estimates the effect on yield (credit spread).
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Covenants: Lenders may write stipulations on the borrower, called covenants, into
loan agreements:
Periodically report its financial condition
Refrain from paying dividends, repurchasing shares, borrowing further, or other specific,voluntary actions that negatively affect the company's financial position
Repay the loan in full, at the lender's request, in certain events such as changes in the
borrower's debt-to-equity ratio or interest coverage ratio
.Tightening: Lenders can reduce credit risk by reducing the amount of credit extended,
either in total or to certain borrowers. For example, a distributor selling its products to a
troubled retailer may attempt to lessen credit risk by reducing payment terms from net
30 to net 15 .
Diversification: Lenders to a small number of borrowers (or kinds of borrower) face ahigh degree of unsystematic credit risk, called concentration risk. Lenders reduce this
risk by diversifying the borrower pool.
Deposit insurance: Many governments establish deposit insurance to guarantee
bank deposits of insolvent banks. Such protection discourages consumers from
withdrawing money when a bank is becoming insolvent, to avoid a bank run, and
encourages consumers to hold their savings in the banking system instead of in cash.
Credit risk related acronyms
ACPM Active credit portfolio management
EAD Exposure at default
EL Expected loss
ERM Enterprise risk management
LGD Loss given default
PD Probability of default
INCREASING ROLE OF INSURANCE COMPANIES
The Insurance sector in India governed by Insurance Act, 1938, the Life Insurance
Corporation Act, 1956 and General Insurance Business (Nationalisation) Act, 1972,
Insurance Regulatory and Development Authority (IRDA) Act, 1999 and other related
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Acts. With such a large population and the untapped market area of this population
Insurance happens to be a very big opportunity in India. Today it stands as a business
growing at the rate of 15-20 per cent annually. Together with banking services, it adds
about 7 per cent to the country‟s GDP .In spite of all this growth the statistics of the
penetration of the insurance in the country is very poor. Nearly 80% of Indian
populations are without Life insurance cover and the Health insurance.
This is an indicator that growth potential for the insurance sector is immense in India. It
was due to this immense growth that the regulations were introduced in the insurance
sector and in continuation “Malhotra Committee” was constituted by the government in
1993 to examine the various aspects of the industry. The key element of
the reform process was Participation of overseas insurance companies with 26%
capital. Since then the insurance industry has gone through many sea changes .The
competition LIC started facing from these companies were threatening to the existence
of LIC .since the liberalization of the industry the insurance industry has never lookedback and today stand as the one of the most competitive and exploring industry in India.
3.1) RISE OF INSURANCE SECTOR
The business of life insurance in India in its existing form started in India in the year
1818 with the establishment of the Oriental Life Insurance Company in Calcutta. Some
of the important milestones in the life insurance business in India are given in the table
Table 1: milestone’s in the life insurance business in India
Year Milestones in the life insurance business in India
1912 The Indian Life Assurance Companies Act enacted as the first
statute to regulate the life insurance business
1928 The Indian Insurance Companies Act enacted to enable the
government to collect statistical information about both life and
non-life insurance businesses
1938 Earlier legislation consolidated and amended to by the Insurance
Act with the objective of protecting the interests of the insuring
public.
1956 245 Indian and foreign insurers and provident societies taken over
by the central government and nationalised. LIC formed by an Act
of Parliament, viz. LIC Act, 1956, with a capital contribution of Rs.
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5 crore from the Government of India.
3.3 insurance sector growt
The General insurance business in India, on the other hand, can trace its roots to the
Triton Insurance Company Ltd., the first general insurance company established in theyear 1850 in Calcutta by the British. Some of the important milestones in the general
insurance business in India are given in the table 2.
Table 2: milestone’s in the general insurance business in India
Year Milestones in the general insurance business in India
1907 The Indian Mercantile Insurance Ltd. set up, the first company to
transact all classes of general insurance business
1957 General Insurance Council, a wing of the Insurance Association of
India, frames a code of conduct for ensuring fair conduct and
sound business practices
1968 The Insurance Act amended to regulate investments and set
minimum solvency margins and the Tariff Advisory Committee set
up.
1972 The General Insurance Business (Nationalisation) Act, 1972
nationalised the general insurance business in India with effectfrom 1st January 1973.
107 insurers amalgamated and grouped into four companies viz.
the National Insurance Company Ltd., the New India Assurance
Company Ltd., the Oriental Insurance Company Ltd. and the
United India Insurance Company Ltd. GIC incorporated as a
company.
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4.Training the HR
Human resource training and development (HR T&D) in manufacturing firms is a
critical aspect of the development of a knowledge-workforce in Malaysia. The objective
of this study is to examine challenges to the effective management of HR T&D activitiesin manufacturing firms in Malaysia. In order to achieve this objective, in-depth interviews
were conducted with 58 HR managers managing employees‟ training and development,
employing a purposive or judgmental sampling technique. The study revealed three
major challenges to the effective management of HR T&D. These include a shortage of
intellectual HRD professionals to manage HR T&D ctivities, coping with the demand for
knowledge workers and fostering learning and development in the workplace. It is
hoped that the findings of this study will provide HR professionals with a clear
understanding and awareness of the various challenges in managing effective HR
training and development. Hence, relevant and appropriate policies and procedures can
be developed and implemented for an effective management of HR T&D.
4.1Technology Alien HR:
Acquiring the technical expertise should be the focus of future human resource
management given the changing paradigm of banking sector
regulations. For instance, the implementation of the new Capital Accord (Basel II)
whereby capital adequacy requirements have been made more risk-oriented by linking
capital to operational risk and changing the risk measurement approaches for credit and
market risks. However, its implementation is not going to be an easy task especially in
countries (including Pakistan) where risk management systems are at nascent stage.
This is because of one of the prerequisite for Basel II implementation which requires
that the banking institutions should have a robust risk management setup which is
capable of effectively managing all major risks that an institution is exposed to.
Similarly, the banking institutions are also required to carry out stress testing, a
technique used around the globe by financial institutions to assess risk exposures
across the institution and to estimate the changes in the value of the portfolio, if
exposed to various risk factors. Initially, although, SBP has advised banks to carry out
the simple „sensitivity analysis‟ keeping in the view the varying levels of skill and
available resources among banks; however, going forward more sophisticated
techniques will be adopted. Certainly, this process would require technical expertise at
least in three areas: identifying, analyzing and proper recording of the assumptions
used for stress testing; adjusting the situation or shocks applied to the data and
interpreting the results; and an effective management information system that ensures
flow of information to the senior management to take proper measures to avoid certain
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extreme conditions. Therefore, going forward, the focus of human resource
management should be to acquire technical expertise if the institutions intend to go
along with the changing regulatory environment.
EMERGING CHALLENGES BEFORE INDIAN BANKING SYSTEM
CONSUMER:The biggest challenge for the Indian banking system today is the Indian
consumer. Demographic shifts in terms of income levels and cultural shifts in terms of
lifestyle aspirations are changing the profile of the Indian consumer
CHANGES IN BEHAVIOR:In the post-VRS scenario, banks have been able to bring
down their operating costs without upsetting their business .However, the average age
profile andt he skill sets of employees continue to remain unfavourable to meet the
challenges of change. The next five years would see the average profile of staff
worsening particularly with banks going slow on fresh recruitment. Manpower planning
would be a major challenge before banks
Target market place: The challenge before the Indian retail banking industry is two-
fold: focus and execution. Each bank must sharply focus on its target marketplace and
rapidly execute its services
Application of advanced technology:Technology is a key driver in the banking
industry, which creates new business models and processes, and also revolutionisesdistribution channels. Banks which have made inadequate investment in technology
have consequently faced an erosion of their market shares. The beneficiaries are those
banks which have invested in technology. Adoption of technology also enhances the
quality of risk management systems in banks. A further challenge which banks face in
this regard is to ensure that they derive maximum advantage from their investments in
technology and avoid wasteful expenditure which might arise on account of
uncoordinated and piecemeal adoption of technology; adoption of inappropriate/
inconsistent technology and adoption of obsolete technology.
CUSTOMER ORIENTED SERVICES :In India, currently, there are two types ofcustomers one who is a multi-channel user and the other who still relies on a branch as
the anchor channel. The primary challenge is to give consistent service to customers
irrespective of the kind of channel they choose to use. The channels broadly cover the
primary channels of branch (i.e., teller, platform, ATM) phone banking, (i.e., call centre,
interactive voice response unit), and internet channel (i.e., personal computer, browser,
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wireless). A retail customer selects a bank based on two criteria – convenience and
relationship and would continue with a bank if it provides good service.
Regulatory and Supervisory Challenges in Banking
As the financial landscape in the last few years has changed significantly, there has
been rethinking on several aspects of regulatory and supervisory practices/
framework/structure among the regulators and supervisors all over the world. In some
countries such as UK, supervision has been hived off from the central bank to avoid
perceived conflict of interest with monetary policy. In response to blurring of distinctions
among providers of financial services and emergence of financial conglomerates, a
single regulator approach has been adopted in some countries. The fast evolving
financial sector and the ever expanding rule books of the regulatory bodies have made
some countries such as UK to adopt principles-based supervision.
The Indian banking sector is faced with multiple and concurrent challenges such as
increased competition, rising customer expectations, and diminishing customer loyalty.
The banking industry is also changing at a phenomenal speed. While at the one end,
we have millions of savers and investors who still do not use a bank, another segment
continues to bank with a physical branch and at the other end of the spectrum,
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FUTURE SCENARIO OF INDIAN BANKING SYSTEM
Liberalization and de-regulation process started in 1991-92 has made a sea change in
the banking system. From a totally regulated environment, we have gradually moved
into a market driven competitive system. Our move towards global benchmarks has
been, by and large, calibrated and regulator driven. The pace of changes gainedmomentum in the last few years. Globalization would gain greater speed in the coming
years particularly on account of expected opening up of financial services under WTO.
Four trends change the banking industry world over, viz Consolidation of players
through mergers and acquisitions, Globalisation of operations, Development of new
technology and Universalisation of banking. With technology acting as a catalyst, we
expect to see great changes in the banking scene in the coming years. The Committee
has attempted to visualize the financial world 5-10 years from now. The picture that
emerged is somewhat as discussed below. It entails emergence of an integrated and
diversified financial system. The move towards universal banking has already begun.
This will gather further momentum bringing non-banking financial institutions also, into
an integrated financial system.
The competitive environment in the banking sector is likely to result in individual players
working out differentiated strategies based on their strengths and market niches. For
example, some players might emerge as specialists in mortgage products, credit cards
etc. whereas some could choose to concentrate on particular segments of business
system, while outsourcing all other functions. Some other banks may concentrate on
SME segments or high net worth individuals by providing specially tailored services
beyond traditional banking offerings to satisfy the needs of customers they understand
better than a more generalist competitor.
Retail lending will receive greater focus. Banks would compete with one another to
provide full range of financial services to this segment. Banks would use multiple
delivery channels to suit the requirements and tastes of customers. While some
customers might value relationship banking (conventional branch banking), others might
prefer convenience banking (e-banking).
One of the concerns is quality of bank lending. Most significant challenge before banks
is the maintenance of rigorous credit standards, especially in an environment of
increased competition for new and existing clients. Experience has shown us that theworst loans are often made in the best of times. Compensation through trading
gains is not going to support the banks forever. Large-scale efforts are needed to
upgrade skills in credit risk measuring, controlling and monitoring as also revamp
operating procedures. Credit evaluation may have to shift from cash flow based
analysis to “borrower account behaviour”, so that the state of readiness of Indian banks
for Basle II regime improves.
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FUTURE CHALLENGES :
THE FOLLOWING ARE MAJOR CHALLENGES THAT ARE LIKELY TO
BE FACED BY INDIAN BANKING INDUSTRY IN COMING FEW YEARS:-
Managing Resource Mobilization :
Growth of Deposits Till now: The deposit growth of SCBs in the post-nationalization
period could be analysed broadly in four phases. In the first phase (1969-84) beginning
immediately after nationalization of banks in July 1969, deposit growth accelerated
sharply as the rapid branch expansion. enabled banks to tap savings from the rural
areas. In the second phase (1985-95), deposit growth decelerated as banks faced
increased competition from alternative savings instruments, especially capital marketinstruments (shares/debentures/units of mutual funds) and non-banking financial
companies. This was the phase of disintermediation as savings instead of being
deployed in bank deposits, were increasingly deployed in alternative financial
instruments. Deposit growth decelerated further during the third phase (1995-2004) in
the wake of competition from post office deposits and other small saving instruments,
which carried significantly higher tax-adjusted returns than bank deposits. efforts by
banks to meet the increased demand for credit. As a result, the share of bank deposits
in the financial savings of the household sector increased sharply.
Future challenges for resource mobilization : Banks have a major role to play inmeeting the resource requirements of India‟s fast growing economy. Although bank
deposits have all along been the mainstay of the saving process in the Indian economy
and banks have played an increasingly important role in stepping up the financial
savings rate, physical savings, nevertheless, have tended to grow in tandem with the
financial savings. A major challenge, thus, is to convert unproductive physical savings
into financial savings. Also, in view of the shrinking share of household sector deposits
in total deposits, banks need to explore ways of broadening the depositor base,
especially in rural and semi-urban areas by offering customised products and features
suitable to individual risk-return requirements.
Thus, we can sum up saying that despite India having a reasonably high and
growing savings rate, there is a need to increase financial savings. “The substitution of
unproductive physical savings in favour of financial savings can generate large
resources for investment. There is an enormous untapped saving potential in rural and
semi-urban areas. For this purpose banks are in a better position to develop innovative
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and cost effective products due to their “outreach as also special features of deposits,
viz, safety and liquidity.”
Managing Capital and Risk / Implementation of Basel II norms :
Why there is need for Managing Capital and Risk: The importance of maintaining
bank capital in line with the risks involved in the banking business has assumed greater
significance in view of the need for maintaining the safety and soundness of the
financial system. The Basel I framework was adopted in over 100 countries. However,
over the years, several deficiencies of Basel I surfaced partly due to its inherent
features and partly due to rapid financial innovations. The major limitation of BaselI was
its 'one-size-fits-all' approach. The inadequacies of Basel I also became evident
following the recent financial turmoil as it failed to capture off-balance sheet exposures.
The Basel II framework, finalized in July 2006, attempts to align regulatory capital more
closely with the inherent risks in banking by using enhanced risk measurementtechniques and a more disciplined approach to risk management. In addition, Basel II
has in place a variety of safeguards, which also have the benefit of reinforcing
supervisors' objective of strengthening risk management and market discipline.
Challenges in Implementation of Basel II / Managing Capital and Risk : In keeping
with the international best practices, India also decided to implement Basel II. Foreign
banks operating in India and Indian banks having operational presence outside India
have already adopted the standardised approach (SA) for credit risk and the basic
indicator approach (BIA) for operational risk for computing their capital requirements
with effect from March 31, 2008. All other commercial banks (excluding local area banksand regional rural banks) are expected to adopt Basel II not later than March 31, 2009.
The parallel runs for these banks are in progress. A significant improvement in risk
management practices, asset-liability management and corporate governance in Indian
banks under regulatory pressure to adopt Basel II framework has been observed.
.
While the Basel II framework, by making the capital requirements risk sensitive, would
enhance the stability of the financial system, its implementation also raises several
issues/challenges. India follows a three track approach with commercial banks, co-operative banks and regional rural banks having been placed at different levels of
capital adequacy norms.
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Lending and Investment Operations of Banks
GROWTH OF CREDIT TILL NOW: Credit extended by scheduled commercial banks
from the early 1990s witnessed three distinct phases. Bank credit growth was erratic in
the first phase (from 1990-91 to 1995-96). In the second phase (from 1996-97 to 2001-
02), credit growth decelerated sharply and remained range bound due to the industrial
slowdown, high level of NPAs and introduction of prudential norms, which made banks
risk averse. The third phase (from 2002-03 to 2006-07) was generally marked by high
credit growth attributable to several factors, including pick-up in economic growth, sharp
improvement in asset quality, moderation in inflation and inflation expectations, decline
in real interest rates, increase in the income levels of households and increased
competition with the entry of new private sector banks.
Although the share of credit to industry in total bank credit declined in the current
decade, the credit intensity of industry increased sharply. A cross country surveysuggests that the reliance of industry on the banking sector in India was far greater than
that in many other countries. Credit growth to the SME sector, which slowed down
significantly between 1996-97 and 2003-04, picked up sharply from 2004-05. However,
the share of the SME sector in the total non-food bank credit declined almost
consistently from 15.1 per cent in 1990-91 to 6.5 per cent in 2006-07. This suggests that
it is the large corporates that have increased their dependence on the banking sector.
The share of retail credit comprising housing loans, credit to individuals, credit cards
receivables and lending for consumer durables, in total bank credit increased sharply
from 6.4 per cent in 1990 to 25.4 per cent in 2007.
CHALLENGES FOR INCREASING CREDIT: Notwithstanding some pick-up in credit
growth to the agriculture and SME sectors in recent years, there is need for more
concerted efforts to increase the flow of credit to these sectors given their significance
to the economy. Creating enabling conditions, i.e., providing irrigation facilities, rural
roads and other infrastructure in rural areas, is necessary to augment the credit
absorptive capacity. Devising products to suit the specific needs of the farmers is
critical. There is also a need for comprehensive public policy on risk management in
agriculture. Computerisation of land records can go a long way in smoothening the flow
of credit to agriculture. Similarly the credit assessment capabilities of banks need
improvement to ensure flow of credit to SMEs. There is need to increase the use of
cluster based lending and credit scoring, which has proved quite effective in many
countries as also in India. In view of the increased exposure of banks to infrastructure
and retail credit segments, banks need to guard against exposures to attendant
risks. The corporate sector needs to gradually reduce its dependence on the banking
sector and move towards tapping the capital market so as to enable the banking sector
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to meet the growing requirements of agriculture, SMEs and other small and tiny
enterprises, which are unable to tap funds from other sources
CHALLENGES FOR FINANCIAL INCLUSION: While there has been a significant
improvement in financial inclusion in recent years, moving ahead several challenges
remain to be addressed. A proper assessment of the problem of financial exclusion isnecessary. There is, therefore, a need to conduct specific survey for gathering
information relating to financial inclusion/exclusion. There is need to reduce the
transaction cost for which technology can be very helpful. RRBs and co-operative
banks, are expected to play a greater role in financial inclusion in future. There would be
need to design appropriate products tailor made to suit the requirements of the people
with low income supported by financial literacy and credit counselling. There is also a
need to improve the absorptive capacity of financial services by providing the basic
infrastructure. Investment in human development such as health, water sanitation, and
education, in particular, would be very helpful.
Competition and Consolidation in Recent Years : There has been a significant
increase in the number of bank amalgamations in India in the post-reform period. While
amalgamations of banks in the pre-1999 period were primarily triggered by the weak
financials of the bank being merged, in the post-1999 period, mergers occurred
between healthy banks, driven by the business strategy and commercial considerations.
Significantly, despite increase in the number of bank mergers and acquisitions, the
Indian banking system has become less concentrated during the post-reform period. In
fact, the degree of concentration in the Indian banking system, based on the
concentration ratio and Hirschman-Herfindhal Index, was one of the lowest among theselect countries studied for the year 2006. The level of competition declined somewhat
in the initial years of reforms, but improved significantly thereafter. Based on the
empirical evidence, the Indian banking industry could be characterised as a
monopolistic competitive structure, as is the case with most other advanced countries
and EMEs
The empirical analysis also suggests that mergers andamalgamation had a positive
impact on efficiency both in terms of increase in return on assets and reduction in cost,
when the transferees were public sector banks
CHALLENGES OF COMPETITION AND CONSOLIDATION: The ownership of public
sector banks is not an issue from the efficiency viewpoint as public sector banks in India
now are as efficient as new private and foreign banks, as revealed by the various
measures. However, the operating environment for banks has been changing rapidly
and banks in the changed operating environment need flexibility to respond to the
evolving situation. Another issue that needs to be considered is the funding of capital
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requirements of public sector banks given the present floor of minimum 51 per cent on
Government equity in public sector banks. In the medium term, this can become an
issue hampering the growth of public sector banks if Government is not able to provide
adequate capital for their expansion.
The roadmap of foreign banks is due for review in 2009. This would involve severalissues. The increased presence of foreign banks, by intensifying competition, may
accelerate the consolidation process that is underway. However, at the same time, this
may also raise the risk of concentration if mergers/amalgamations involve large banks.
The experience of some other countries also suggests that the emergence of large
banks due to consolidation has resulted in reduced lending to small enterprises
significantly. All these issues would need to be carefully weighed at the time of review.
The policy relating to ownership of banks by commercial interests may have to take full
account of international practices, given the issues relating to potential conflict of
interests, increased potential of contagion effects and increased concentration.
EFFICIENCY, PRODUCTIVITY AND SOUNDNESS OF THE BANKING SECTOR
IN INDIA:8.1 PAST TRENDS : The efficiency and productivity of scheduled
commercial banks (SCBs) in India was analysed empirically, using both the accounting
and economic measures.. The most significant improvement has occurred in the
performance of public sector banks and has converged with those of the foreign banks
and new private sector banks. Intermediation cost as also the net interest margin
declined across the bank groups. Despite this, however, profitability of the banking
sector improved. Business per employee and per branch also increased significantly
across the bank groups.
The improvement of various accounting measures, however, varied across the bank
groups. In terms of cost ratios (operating cost to income) foreign banks, and with regard
to labour productivity, foreign and new private banks were ahead of their peer groups. In
terms of net interest margins and intermediation cost, new private sector banks and
public sector banks, respectively, were more efficient than the other bank groups. The
cost of deposits of foreign banks was the lowest in the industry. However, this was not
passed on to the borrowers, leading to higher net interest spread. The empirical
exercise suggested that the operating cost was the main factor affecting the net interest
margin. Non-interest income and the asset quality were the other determinants of netinterest margin.
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CHALLENGES: . Similarly, there is a need for increased absorption of enhanced
technological capability (innovation) by several banks to further augment productivity of
the banking sector through changes in processes and improvement in human resource
skills.
The recent events in global financial markets in the aftermath of US subprime crisis
have evoked rethinking on several regulatory and supervisory aspects of the banking
industry, viz ., how to cope with liquidity stresses under unusual circumstances; whether
„pro-cyclicality‟ of capital requirements is one of the factors with inherent tendency that
escalate the impact of booms and busts. Regulation of complex products and
monitoring of derivatives is becoming an important issue. Further, a question has been
raised whether institutions should be allowed to become so big and so complex that
their problems can have system-wide repercussions.
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OVERALL ASSESSMENT :
The Report has attempted an in-depth analysis of various aspects of the banking sector
in India against the backdrop of the evolution of the Indian banking sector beginning the
18th century with a focus on the post-independence period. The analysis suggests that
the Indian banking sector has witnessed several structural changes from time to time.
India now has a well-developed banking infrastructure, conducive regulatory
environment and sound supervisory system. Banks have become efficient and sound
and compare well with banks around the world. Banks in India have benefitted from the
robust growth in the last few years, which enabled them to produce strong financial
performance
An important lesson emerging from the recent financial market developments is that the
focus should not be on how the turmoil should be managed, but on what policies could
be put in place to strengthen the financial system on a longer-term basis regardless of
specific sources of disturbances. These issues point towards the challenges that lie
ahead to preserve the safety and soundness of the financial
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CONCLUSION
A robust banking and financial sector is critical for facilitating higher economic growth
Kainth (2008). The analysis of the Indian Banking Industry shows stability and growth.
The Government of India and the RBI have attempted to implement a proactive and
responsive monetary policy and fiscal policy with timely, targeted, and temporary
measures. While the RBI has reversed its earlier stance of a tight monetary policy, the
government recently announced a fiscal stimulus package to push overall economic
activity. Indian Banks have put in place a constellation of measures both on interest
rates and liquidity to ward off the impending crisis.
As a result Indian Banks have been able to perform well globally. Certain aspects and
learning‟s from the Indian Banking Industry can be adopted as best practices by other financial crisis affected countries.
The global challenges which banks face are not confined only to the global banks.
These aspects are also highly relevant for banks which are part of a globalised banking
system. Further, overcoming these challenges by the other banks is expected to not
only stand them in good stead during difficult times but also augurs well for the banking
system to which they belong and will also equip them to launch themselves.
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