A project study report

“Comparative study of Indian public, private and international banks”

Aims to analyse variousservices provided by private sector banks and public

I express my sincere thanks to my project guide, Ms.KainazPostwala, Dy. Manager- marketing Department for guiding me right from the inception till the successful completion of the project. I sincerely acknowledge her for extending their valuable guidance, support for literature, critical reviews of project and the report and above all the moral support she had provided to me with all stages of this project.

(VartikaSharma)

This study focuses on Indian public, private and international banks the Bank model.

It attempts to highlight their histories, institutional arrangements, the design of their saving and loan delivery systems and most importantly their strengths and weaknesses. Emerging out of this are a set of five general policy recommendations. In summary these recommendations are:

 The establishment of a Indian public, private and international banks the Bank Institutional arrangements;

 The conceptual design of a savings and loan delivery system that is membership driven and underpinned by the achievement of financial sufficiency;

 Assessing the feasibility of using “smart card” technology;

 A public and community partnership to solidify commitment to this initiative; and

 A capacitation team that oversees a well-defined capacitation process.

I hereby declare that the project work entitled

 

Ms Aparnakalla,

The world of commercial banking is undergoing a deep transformation as a result of marketable instruments competing with loans and demand deposits. Because of this strong competition, commercial banks are struggling to make acceptable margins from their traditional business entering into investment banking.

Increasing competition has forced banks to search for more income at the expense of more risk. Banks that lent heavily to Asia in search of better returns than those available in Western markets are now being blamed for bad credit decisions. The Asian crisis has renewed interest on credit risk management casting doubts on the effectiveness of current credit regulations. Technological changes have also heightened competition by making it easier to imitate bank services. The traditional advantage of physical proximity to clients given by extended networks of branches has vanished. Banks have to compete with money market mutual funds for deposit business, commercial papers, and medium-term notes for bank loans.

As margins are squeezed, commercial banks in the United States and Europe have been forced to cut costs and branches while diversifying into pensions, insurance, asset management, and investment banking. In the United States, many banks call themselves financial service companies even in their reported financial statements. Diversification, however, has not always proved to be an effective strategy, and many banks have had to revert to a concentrated business. These examples illustrate how commercial banks are reinventing themselves, not just once but many times. All these changes are creating an identity crisis for old-fashioned bankers, leading to the key question, “What is a bank today?” The question is difficult, but evidence suggests that the concept of banking is being modified and the traditional barriers among financial service Sub industries (retail banking, private banking, investment banking, asset management, insurance, etc.) are vanishing. Illustrating what an entity does or serves for often is a useful way to define it. The identity crisis of banks—especially commercial banks—stems from the deep and rapid changes in their traditional body of activities (particularly retail and corporate banking). On the other hand, investment banking, private banking, and banc assurance are the most profitable and fastest growing segments of the financial service industry. As banks undertake new activities, they also incur new risks. Since boundaries among sub industries are weakening, if not vanishing, banks—like all other financial service companies—must redefine themselves in terms of the products they offer and the customers they serve. The way banks pursue this redefinition is through a strategic repositioning in the financial service industry. All these factors represent a new challenge for commercial banks, provided this definition still has a unique meaning. Increased competition, diversification, new products, and new geographic markets mean that both the spectrum of risks and the risk profile for banks are dramatically changing.

The scenario commercial banks face today differs greatly from that of the past. Diversification among sub industries is defining an environment where banks compete with other financial-service companies to provide mutually exclusive products and services to the same customers. Traditional branch banking is under the threat of new competitors and technological innovation, leading some analysts to wonder whether banks are dying. Most likely what is dying is the old-fashioned concept of the bank and a new scenario is emerging. Banks are changing as economic markets integrate, providing opportunities for diversification. Only 15 to 20 years ago, most Western banks generated 90% of revenue from interest income. Now this percentage has fallen to 60%, sometimes as low as 40%. New sources of income, such as fee-based income from investment services and derivatives, are becoming increasingly relevant for the income statements of commercial banks.

During the same period, the pattern of banking activities has changed through interactions with the developing security markets. The well-known phenomenon of disintermediation that has taken place in all Western countries since the 1970s has progressively reduced the monopoly of banks over the collection of savings from customers. This has created much tougher competition among financial service companies and has forced banks to find new and diversified sources of income. The traditional core business of commercial banks has been retail and corporate banking. As retail and corporate banking become less and less profitable, banks are diversifying into new businesses to stop the decline of profits. Investment banking, for example, is estimated to be worth US$14 million, with an annual growth rate of about 14% up to 2012. Derivative based earnings for larger commercial banks now account for about 15 to 20% of the total earnings. The drawback is that volatility of earnings has dramatically increased. The management of these new types of risk—typically, market risk and credit risk on traded assets—requires competence and expertise. Hence, the risk profile of commercial banks is changing as a consequence of diversification. Capital markets are playing a key role in defining the bank of the twenty-first century, but they are also making banks riskier. In fact, with a few exceptions, AAA ratings for banks have disappeared and consequently the importance of market risk management is being emphasized. Future competition will not be played in the classic retail banking industry that, at least in continental Europe (but not in the United Kingdom), is only slightly profitable. Global competition will take place in asset management and investment banking. Not casually, huge U.S. investment banks are merging among themselves and with asset management firms. Alliances and takeovers are occurring also on a transatlantic basis, confirming the global characters of these two sub industries (the most related to global capital markets).

The following trends are affecting the banking industry and most likely will shape the competition in the next several years:

• The market share for financial services that banks hold is declining, while securities firms, mutual funds, and finance companies are getting a growing share of available customers. In the United States, the share of total assets held by banks and other depository institutions relative to all financial intermediaries fell from 56% in 1982 to 42% in 1991, and this downward tendency is likely to continue. Banks will face growing competition from financial service companies and nonbank firms.

• Disintermediation is making traditional banking less and less necessary, leading to consolidation. The natural shrinkage of the market share held by commercial banks started this process in the past decade, but it has dramatically accelerated in the past few years because of global competition.

• To remain competitive, commercial banks will have to exploit new sources of income: Offering new services (selling mutual funds or insurance policies).Charging customers with noninterest fees. Offering new services through the phone and the web, Enteringinto joint ventures with independent companies, Entering new geographic markets yielding higher returns.

• Banks will need more expertise to manage new sources of risk. Market risk management models must become an integral part of a bank’s risk management culture

The two main forces changing the competitive environment in retail banking are technological change and aggressive new competitors:

1. Technological change is creating huge problems for traditional banks with extended and costly branch networks. The major technological issues affecting the retail banking business are the rise of telephone banking and the impressive diffusion of the Web-based banking. These innovations make branch networks less important and national boundaries irrelevant. Computer banking, either through the Internet or proprietary networks, is gaining a growing and growing importance.

2. New unrelated competitors are entering the retail banking market. In the United Kingdom, the country’s two biggest retailers, Sainsbury’s and Tesco, have gone into partnership with the Bank of Scotland and the Royal Bank of Scotland, respectively. Sainsbury’s Bank offers a savings account, two credit cards, and personal loans and mortgages, with more services to follow. Tesco Personal Finance offers only a savings account and a credit card, but aims to expand its range. These trends do not indicate that traditional branch banking is going to die, but that the competitive scenario is changing. High-street banks have expensive branch networks and relatively out-dated procedures, with far greater operating costs than their new, more flexible rivals.

One of the most interesting trends affecting the banking industry is the development of domestic private banking services. These services, once provided only to aristocrats, are gaining popularity and seem to be an attractive, fast-growing market. Retail banks are no longer targeting only the super-rich, who hold a small proportion of the total wealth, but also people with, relatively speaking, high income. Private banking is basically an asset management service and represents a natural area for banks in time of margin squeezing and increased competition. Risks of adverse market movements are transferred, at least partially, to customers, while banks increase their fee-based income. Nevertheless, commercial banks must be aware of actual and potential competitors including traditional private banks, investment banks, converted building societies, and insurers. Private banking creates opportunities for commercial banks, but also adds new problems in the following areas:

• Bank organization.

• Culture needed to manage private banking.

• Risk management

GLOBAL INVESTMENT BANKING

Investment banking is by far the most globalized segment of the financial service industries. Commercial banks today are starting to offer investment-banking and merchant banking services to larger corporations, thus entering in direct competition with prestigious investment houses.

These services include:

• Identifying possible merger targets.

• Financing acquisitions of other companies.

• Dealing in customers’ securities (i.e., security underwritings).

• Providing strategic advice.

• Offering hedging services against market risk.

To provide customers with a broader spectrum of services, commercial banks in search of globalization are boosting takeovers of investment banks. All the major competitors have developed, or are in the process of developing, facilities in the world’s leading markets. The aim is to provide multinational corporations with a broad range of financial service products, including conventional investment banking such as merger and acquisition (M&A) advice, market trading, financial lending and fund management, at both the institutional and retail levels. Relationship banking is replacing transaction-based banking: What is important is to increase the loyalty of the client to the bank, almost irrespectively of the service needed or required.

Diversification is not the whole story. To face the rising costs and squeezing margins created by competition, investment banks need partners with large amounts of available capital.

The global banking industry has been undergoing deep transformation.

The following trends can be outlined:

• The technological breakthrough caused by the eruption of e-banking and e-finance.

• Worldwide consolidation and consequent restructuring.

• Increasing competition in terms of both markets (geographic diversification) and products.

•“Contamination” among different industries, thanks to a progressive relaxation of regulations and huge inter-industry acquisitions.

• A slowing population growth and increasing average life expectancy and per capita income. Since Western governments need to cut expenditures for old-age benefits to keep deficits under control, there will be an increase in the importance of private pensions, mutual funds, and private banking operations.

• The growing importance of a clear strategic intent in the banking industry. Banks, especially commercial banks, will be obliged to rethink their strategic positioning. While some banks are opting to offer a vast variety of products/services on a global scale, others are focusing on some specific market segment (retail banking, private banking, corporate banking) or specific geographic area.

• New competitors are entering the financial service business. In the retail banking industry, large department stores in the United Kingdom have entered the market for personal and mortgage loans, primarily to retain their customers.

These trends are having and will have a major impact on banks’ and financial institutions’ risk management process. Contamination also means that firms in the different sub industries will face risks that were once specific to another sub industry. The relaxation of the Glass-Steagall Act in the United States, and similar processes of deregulation in many other leading countries, is forcing even commercial banks to dedicate growing attention to market risk management and liquidity risk management, in addition to the more traditional credit risk and interest rate risk.

CONTAMINATION—THE RISE OF GLOBAL PLAYERS

Consolidation is also taking place also on an interindustry basis. By inter industry consolidation, we mean M&as taking place between firms of different sub industries in the financial service industry (e.g., insurance companies acquiring commercial banks or commercial banks acquiring Investment banks). There can be cost-saving potential, particularly in computer systems. But complexity explodes. Top managers have to handle a far more complicated business; front-line service staff has to sell a richer mix of products.

To be a global player, a banking conglomerate must satisfy three characteristics:

1. Size. It must be big enough to play on a global basis.

2. High degree of contamination. It must cover the full spectrum of financial products and services.

CHAPTER-2

INTRODUCTION OFINDIAN BANKING INDUSTRY

Banks are the most significant players in the Indian financial market. They are the biggest purveyors of credit, and they also attract most of the savings from the population. Dominated by public sector, the banking industry has so far acted as an efficient partner in the growth and the development of the country. Driven by the socialist ideologies and the welfare state concept, public sector banks have long been the supporters of agriculture and other priority sectors. They act as crucial channels of the government in its efforts to ensure equitable economic development.

The Indian banking can be broadly categorized into nationalized (government owned), private banks and specialized banking institutions. The Reserve Bank of India acts a centralized body monitoring any discrepancies and shortcoming in the system. Since the nationalization of banks in 1969, the public sector banks or the nationalized banks have acquired a place of prominence and has since then seen tremendous progress. The need to become highly customer focused has forced the slow-moving public sector banks to adopt a fast track approach. The unleashing of products and services through the net has galvanized players at all levels of the banking and financial institutions market grid to look anew at their existing portfolio offering. Conservative banking practices allowed Indian banks to be insulated partially from the Asian currency crisis. Indian banks are now quoting al higher valuation when compared to banks in other Asian countries (viz. Hong Kong, Singapore, Philippines etc.) that have major problems linked to huge Non Performing Assets (NPAs) and payment defaults. Co-operative banks are nimble footed in approach and armed with efficient branch networks focus primarily on the ‘high revenue’ niche retail segments.

The Indian banking has finally worked up to the competitive dynamics of the ‘new’ Indian market and is addressing the relevant issues to take on the multifarious challenges of globalization. Banks that employ IT solutions are perceived to be ‘futuristic’ and proactive players capable of meeting the multifarious requirements of the large customer’s base. Private Banks have been fast on the uptake and are reorienting their strategies using the internet as a medium The Internet has emerged as the new and challenging frontier of marketing with the conventional physical world tenets being just as applicable like in any other marketing medium.

The Indian banking has come from a long way from being a sleepy business institution to a highly proactive and dynamic entity. This transformation has been largely brought about by the large dose of liberalization and economic reforms that allowed banks to explore new business opportunities rather than generating revenues from conventional streams (i.e. borrowing and lending). The banking in India is highly fragmented with 30 banking units contributing to almost 50% of deposits and 60% of advances. Indian nationalized banks (banks owned by the government) continue to be the major lenders in the economy due to their sheer size and penetrative networks which assures them high deposit mobilization. The Indian banking can be broadly categorized into nationalized, private banks and specialized banking institutions.

The Reserve Bank of India acts as a centralized body monitoring any discrepancies and shortcoming in the system. It is the foremost monitoring body in the Indian financial sector. The nationalized banks (i.e. government-owned banks) continue to dominate the Indian banking arena. Industry estimates indicate that out of 274 commercial banks operating in India, 223 banks are in the public sector and 51 are in the private sector. The private sector bank grid also includes 24 foreign banks that have started their operations here.

The liberalize policy of Government of India permitted entry to private sector in the banking, the industry has witnessed the entry of nine new generation private banks. The major differentiating parameter that distinguishes these banks from all the other banks in the Indian banking is the level of service that is offered to the customer. Their focus has always centered around the customer – understanding his needs, preempting him and consequently delighting him with various configurations of benefits and a wide portfolio of products and services. These banks have generally been established by promoters of repute or by ‘high value’ domestic financial institutions.

The popularity of these banks can be gauged by the fact that in a short span of time, these banks have gained considerable customer confidence and consequently have shown impressive growth rates. Today, the private banks corner almost four per cent share of the total share of deposits. Most of the banks in this category are concentrated in the high-growth urban areas in metros (that account for approximately 70% of the total banking business). With efficiency being the major focus, these banks have leveraged on their strengths and competencies viz. Management,

Operational efficiency and flexibility, superior product positioning and higher employee productivity skills. 

The private banks with their focused business and service portfolio have a reputation of being niche players in the industry. A strategy that has allowed these banks to concentrate on few reliable high net worth companies and individuals rather than cater to the mass market. These well-chalked out integrates strategy plans have allowed most of these banks to deliver superlative levels of personalized services. With the Reserve Bank of India allowing these banks to operate 70% of their businesses in urban areas, this statutory requirement has translated into lower deposit mobilization costs and higher margins relative to public sector banks.

Government and RBI policies affect the banking sector. Sometimes looking into the political advantage of a particular party, the Government declares some measures to their benefits like waiver of short-term agricultural loans, to attract the farmer’s votes. By doing so the profits of the bank get affected. Various banks in the cooperative sector are open and run by the politicians. They exploit these banks for their benefits. Sometimes the government appoints various chairmen of the banks. Various policies are framed by the RBI looking at the present situation of the country for better control over the banks.

Banking is as old as authentic history and the modern commercial banking are traceable to ancient times. In India, banking has existed in one form or the other from time to time. The present era in banking may be taken to have commenced with establishment of bank of Bengal in 1809 under the government charter and with government participation in share capital. Allahabad bank was started in the year 1865 and Punjab national bank in 1895, and thus, others followed.

Every year RBI declares its 6 monthly policy and accordingly the various measures and rates are implemented which has an impact on the banking sector. Also the Union budget affects the banking sector to boost the economy by giving certain concessions or facilities. If in the Budget savings are encouraged, then more deposits will be attracted towards the banks and in turn they can lend more money to the agricultural sector and industrial sector, therefore, booming the economy. If the FDI limits are relaxed, then more FDI are brought in India through banking channels.

SOCIAL ENVIROMENTEL ANALYSIS

Before nationalization of the banks, their control was in the hands of the private parties and only big business houses and the effluent sections of the society were getting benefits of banking in India. In 1969 government nationalized 14 banks. To adopt the social development in the banking sector it was necessary for speedy economic progress, consistent with social justice, in democratic political system, which is free from domination of law, and in which opportunities are open to all. Accordingly, keeping in mind both the national and social objectives, bankers were given direction to help economically weaker section of the society and also provide need-based finance to all the sectors of the economy with flexible and liberal attitude. Now the banks provide various types of loans to farmers, working women, professionals, and traders. They also provide education loan to the students and housing loans, consumer loans, etc.

Banks having big clients or big companies have to provide services like personalized banking to their clients because these customers do not believe in running about and waiting in queues for getting their work done. The bankers also have to provide these customers with special provisions and at times with benefits like food and parties. But the banks do not mind incurring these costs because of the kind of business these clients bring for the bank.

Banks have changed the culture of human life in India and have made life much easier for the people.

Technology plays a very important role in bank’s internal control mechanisms as well as services offered by them. It has in fact given new dimensions to the banks as well as services that they cater to and the banks are enthusiastically adopting new technological innovations for devising new products and service.

The latest developments in terms of technology in computer and telecommunication have encouraged the bankers to change the concept of branch banking to anywhere banking. The use of ATM and Internet banking has allowed ‘anytime, anywhere banking’ facilities. Automatic voice recorders now answer simple queries, currency accounting machines makes the job easier and self-service counters are now encouraged. Credit card facility has encouraged an era of cashless society. Today MasterCard and Visa card are the two most popular cards used world over. The banks have now started issuing smartcards or debit cards to be used for making payments. These are also called as electronic purse. Some of the banks have also started home banking through telecommunication facilities and computer technology by using terminals installed at customers home and they can make the balance inquiry, get the statement of accounts, give instructions for fund transfers, etc. Through ECS we can receive the dividends and interest directly to our account avoiding the delay or chance of loosing the post.

Today banks are also using SMS and Internet as major tool of promotions and giving great utility to its customers. For example SMS functions through simple text messages sent from your mobile. The messages are then recognized by the bank to provide you with the required information. All these technological changes have forced the bankers to adopt customer-based approach instead of product-based approach.

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 dividends with the nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dials a pizza. Money has become the order of the day.

From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:

• 
  Early phase from 1786 to 1969 of Indian Banks
  
• 
  Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms.
  
• 
  New phase of Indian Banking System with the advent of Indian Financial & Banking sector reforms after 1991.
  

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

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

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

During those day’s public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.
PhaseII

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

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

Second phase of nationalisation 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: Nationalisation of State Bank of India.
  
• 
  1959: Nationalisation of SBI subsidiaries.
  
• 
  1961: Insurance cover extended to deposits.
  
• 
  1969: Nationalisation of 14 major banks.
  
• 
  1971: Creation of credit guarantee corporation.
  
• 
  1975: Creation of regional rural banks.
  
• 
  1980: Nationalisation of seven banks with deposits over 200 crore.
  

This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberation of banking practices.

Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

The nationalization of banks in India took place in 1969 by Mrs. Indira Gandhi the then prime minister. It nationalized 14 banks then. These banks were mostly owned by businessmen and even managed by them. 

Before the steps of nationalization of Indian banks, only State Bank of India (SBI) was nationalized. It took place in July 1955 under the SBI Act of 1955. Nationalization of Seven State Banks of India (formed subsidiary) took place on 19th July, 1960.

The State Bank of India is India's largest commercial bank and is ranked one of the top five banks worldwide. It serves 90 million customers through a network of 9,000 branches and it offers -- either directly or through subsidiaries -- a wide range of banking services. 

The second phase of nationalisation of Indian banks took place in the year 1980. Seven more banks were nationalised with deposits over 200 crores. Till this year, approximately 80% of the banking segments in India were under government ownership.

After the nationalisation of banks in India, the branches of the public sector banks rose to approximately 800% in deposits and advances took a huge jump by 11,000%.

BANKING STRUCTURE

The Indian banking industry, which has Reserve Bank of India as its regulatory authority, is a mix of the public sector, private sector, and foreign banks. The private sector banks are again split into old banks and new banks.

SCHEDULED BANKS

Scheduled commercial banks are those that come under the purview of the Second Schedule of Reserve Bank of India (RBI) Act, 1934. The banks that are included under this schedule are those that satisfy the criteria laid down vide section 42 (60 of the Act). Some co-operative banks come under the category of scheduled commercial banks though not all co-operative banks.

PUBLIC SECTOR BANKS

Public sector banks are those in which the Government of India or the RBI is a majority shareholder. These banks include the State Bank of India (SBI) and its subsidiaries, other nationalized banks, and Regional Rural Banks (RRBs). Over 70% of the aggregate branches in India are those of the public sector banks. Some of the leading banks in this segment include Allahabad Bank, Canara Bank, Bank of Maharashtra, Central Bank of India, Indian Overseas Bank, State Bank of India, State Bank of Patiala, State Bank of Bikaner and Jaipur, State Bank of Travancore, Bank of Baroda, Bank of India, Oriental Bank of Commerce, UCO Bank, Union Bank of India, Dena Bank and Corporation Bank.

PRIVATE SECTOR BANKS

Private Banks are essentially comprised of two types: the old and the new. The old private sector banks comprise those, which were operating before Banking Nationalization Act was passed in 1969. On account of their small size, and regional operations, these banks were not nationalized. These banks face intense rivalry from the new private banks and the foreign banks. The banks that are included in this segment include: Bank of Madura Ltd. (now a part of ICICI Bank), Bharat Overseas Bank Ltd., Bank of Rajasthan, Karnataka Bank Ltd., Lord Krishna Bank Ltd., The Catholic Syrian Bank Ltd., The Dhanalakshmi Bank Ltd., The Federal Bank Ltd., The Jammu & Kashmir Bank Ltd., The KarurVysya Bank Ltd., The Lakshmi Vilas Bank Ltd., The Nedungadi Bank Ltd. and Vysya Bank. The new private sector banks were established when the Banking Regulation Act was amended in 1993. Financial institutions promoted several of these banks. After the initial licenses, the RBI has granted no more licenses. These banks are gearing up to face the foreign banks by focusing on service and technology. Currently, these banks are on an expansion spree, spreading into semi-urban areas and satellite towns. The leading banks that are included in this segment include Bank of Punjab Ltd., Centurion Bank Ltd., Global Trust Bank Ltd., HDFC Bank Ltd., ICICI Banking Corporation Ltd., IDBI Bank Ltd., IndusInd Bank Ltd. and UTI Bank Ltd.

FOREIGN BANKS

The operations of foreign banks, though similar to that of other commercial Indian banks, are mainly confined to metropolitan areas. Foray of foreign banks depends on reciprocity, economic and political bilateral relations. An inter-departmental committee has been set up to endorse applications for entry and expansion. Foreign banks, in the wake of the liberalization era, are looking to expand and diversify. Some of the leading foreign banks that operate in India are Citibank, Standard Chartered Grindlays Bank, Hong Kong Shanghai Banking Corporation, Bank of America, Deutsche Bank, Development Bank of Singapore and Banque National De Paris.

Indian banks and the global challenges

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.

GLOBALISATION – A CHALLENGE AS WELL AS AN OPPORTUNITY

The benefits of globalisation have been well documented and are being increasingly recognised. Globalisation of domestic banks has also been facilitated by tremendous advancement in information and communications technology. Globalisation has thrown up lot of opportunities but accompanied by concomitant risks. There is a growing realisation 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. Adoption of appropriate prudential, regulatory, supervisory, and technological framework on par with international best practices enables strengthening of the domestic banking system, which would help in fortifying it against the risks that might arise out of globalisation. In India, strengthening of the banking sector for facing the pressures that may arise out of globalisation by adopting the banking sector reforms in a calibrated manner, which followed the twin governing principles of non-disruptive progress and consultative process.

GLOBAL CHALLENGES IN BANKING

Few broad challenges faced by the Indian banks in the following areas, viz., enhancement of customer service; application of technology; implementation of Basel II; improvement of risk management systems; implementation of new accounting standards; enhancement of transparency & disclosures; and compliance with KYC aspects. If we were to identify a few global challenges which banks face today, I am sure we would cover some common ground. An overview of the global challenges would include the following: Basel II implementation; enhancing corporate governance; alignment of regulatory and accounting requirements; outsourcing risks; and application of advanced technology. I propose to cover these aspects now.

BASE II IMPLEMENTATION

Basel II implementation is widely acknowledged as a significant challenge faced by both banks and the regulators internationally. It is true that Basel II implementation may be seen as a compliance challenge. While it may be so for some banks, Basel II implementation has another dimension which offers considerable opportunities to banks. Highlighting two opportunities that are offered to banks, viz., refinement of risk management systems; and improvement in capital efficiency.

Comprehensive risk management:Under Basel I banks were focused on credit and market risks. Basel II has brought into focus a larger number of risks requiring banks to focus on a larger canvas. Besides the increase in the number of risks, banks are now beginning to focus on their inter-linkages with a view to achieve a more comprehensive risk management framework. Basel II implementation, therefore, is being increasingly seen as a medium through which banks constantly endeavour to upgrade the risk management systems to address the changing environment. Further, in the initial stages, banks were managing each risk in isolation. It is no longer adequate to manage each risk independently. Enterprises worldwide are, therefore, now putting in place an integrated framework for risk management which is proactive, systematic and spans across the entire organisation. Banks in India are also moving from the individual silo system to an enterprise wide risk management system. While the first milestone would be risk integration across the entity, banks are also aware of the desirability of risk aggregation across the group both in the specific risk areas as also across the risks. Banks would, therefore, be required to allocate significant resources towards this endeavour.

Capital efficiency:Basel II prescriptions have ushered in a transition from the traditional regulatory measure of capital adequacy to an evaluation of whether a bank has found the most efficient use of its capital to support its business i.e., a transition from capital adequacy to capital efficiency. In this transition, how effectively capital is used will determine return on equity and a consequent enhancement of shareholder value. In effect, banks may adopt a more dynamic approach to use of capital, in which capital will flow quickly to its most efficient use. This revised efficiency approach is expected to guide the return-on-equity strategy and influence banks’ business plans. With the extension of capital charge for market risks to the AFS portfolio this year and the coming into force of Basel II norms in March 2007, banks would need to shore up the capital levels not only for complying with these requirements but also for supporting the balance sheet growth. With a view to enhancing the options available to banks for augmenting their capital levels, the Reserve Bank has recently permitted banks to issue new capital instruments, including perpetual instruments. A notable feature of these instruments is that these are designed to help banks in not only managing their capital effectively but also efficiently.

ENHANCING CORPORATE GOVERNANCE

The issues related to corporate governance have continued to attract considerable national and international attention in light of a number of high-profile breakdowns in corporate governance. This becomes all the more relevant for banks since they not only accept and deploy large amount of uncollateralized public funds in fiduciary capacity, but also leverage such funds through credit creation. Banks are also important participants in the payment and settlement systems. In view of the above, legal prescriptions for ownership and governance of banks in Banking Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI from time to time.

In view of the importance of the banking system for financial stability, sound corporate governance is not only relevant at the level of the individual bank, but is also a critical ingredient at the system level. Effective risk management systems determine the health of the financial system and its ability to survive economic shocks. To a large extent, many risk management failures reflect a breakdown in corporate governance which arise due to poor management of conflicts of interest, inadequate understanding of key banking risks, and poor Board oversight of the mechanisms for risk management and internal audit. Corporate governance is, therefore, the foundation for effective risk managements in banks and thus the foundation for a sound financial system². Therefore, the choices which banks make when they establish their risk management and corporate governance systems have important ramifications for financial stability. These systems can affect how the institution functions and how others perceive it in the marketplace.

A good “governance culture” is crucial for financial stability but since it is an ‘intangible’, rules may not be able to capture its essence effectively. Therefore, banks may have to cultivate a good governance culture building in appropriate checks and balances in their operations. There are four important forms of oversight that should be included in the organisational structure of any bank in order to ensure appropriate checks and balances: (1) oversight by the board of directors or supervisory board; (2) oversight by individuals not involved in the day-to-day running of the various business areas; (3) direct line supervision of different business areas; and (4) independent risk management, compliance and audit functions. In addition, it is important that key personnel are fit and proper for their jobs. Although some ownership structures might have the potential to alter the strategies and objectives of a bank, these banks will also face many of the same risks associated with weak corporate governance.

COMPLIANCE WITH INTERNATIONAL ACCOUNTING STANDARDS

One of the prime international standards considered relevant for ensuring a safe and sound banking system is the ‘Core Principles for Effective Banking Supervision’ issued by the Basel Committee on Banking Supervision (BCBS). Accounting standards are now a part of the set of twelve standards that have been identified by the Financial Stability Forum as conducive to a robust financial infrastructure. Financial reporting and prudential supervision have slightly different perspectives. While the former is oriented towards capturing the historical position, the latter has a forward looking element particularly with reference to measurement of impairment and capital. An important challenge, therefore, is to ensure that accounting standards and prudential frameworks are mutually consistent. While working towards achieving this consistency between the two sets of standards, it is essential for the regulators to be in a position to address any implications that the changes in accounting standards may have for the safety and soundness of banks^.

Derivative activity in banks in India has been increasing at a brisk pace. While the risk management framework for derivative trading, which is a relatively new area for Indian banks (particularly more in respect of structured products), is an essential pre-requisite, the absence of clear accounting guidelines in this area is matter of significant concern. It is widely accepted that as the volume of transactions increases, which is happening in the Indian banking system, the need to upgrade the accounting framework needs no emphasis. The World Bank’s ROSC on Accounting and Auditing in India has commented on the absence of an accounting standard which deals with recognition, measurement, presentation and disclosures pertaining to financial instruments. The Accounting Standards Board of the Institute of Chartered Accountants of India (ICAI) is considering issue of Accounting Standards on the above aspects pertaining to financial Instruments. These will be the Indian parallel to International Financial Reporting Standard 7, International Accounting Standards 32 and 39. The proposed Accounting Standards will be of considerable significance for financial entities and could therefore have implications for the financial sector. The formal introduction of these Accounting Standards by the ICAI is likely to take some time in view of the processes involved. In the meanwhile, the Reserve Bank is considering the need for banks and financial entities adopting the broad underlying principles of IAS 39. Since this is likely to give rise to some regulatory / prudential issues all relevant aspects are being comprehensively examined. The proposals in this regard would, as is normal, be discussed with the market participants before introduction. Adoption and implementation of these principles are likely to pose a great challenge to both the banks and the Reserve Bank.

OUTSOURCING RISKS

Banks are increasingly using outsourcing for achieving strategic aims leading to either rationalisation of operational costs or tapping specialist expertise which is not available internally. 'Outsourcing' may be defined as a bank's use of a third party, including an affiliated entity within a corporate group, to perform activities on a continuing basis that would normally be undertaken by the bank itself. Typically outsourced financial services include applications processing (loan origination, credit card), document processing, investment management, marketing and research, supervision of loans,data processing and back office related activities etc.

Outsourcing might give rise to several risks including, strategic risk, reputation risk, compliance risk, operational risk, exit strategy risk, counterparty risk, country risk, access risk, concentration risk and systemic risk. The failure of a service provider to provide a specified service, ensure security/ confidentiality, and comply with legal and regulatory requirements can lead to financial losses/ reputational risk for the bank and could also lead to systemic risks for the entire banking system in a country. It would therefore be imperative for the bank outsourcing its activitiesto ensure effective management of these risks.

It is in this background that RBI has issued draft guidelines on outsourcing, which is intended to provide direction and guidance to banks to effectively manage risks arising from such outsourcing activities. The underlying principles for any outsourcing arrangement by a bank are that such arrangements should neither diminishthe bank’sability to fulfill its obligations to its customers and the RBI nor impede effective supervision by RBI. Outsourcing banks, therefore, should take steps to ensure that the service provider employs the same high standard of care in performing the services as would be employed by the banks if the activities were conducted within the banks and not outsourced. Accordingly, banks are not expected to outsource any activity that would result in their internal control, business conduct, or reputation being compromised or weakened.

APPLICATION OF ADVANCED TECHNOLOGY

Technology is a key driver in the banking industry, which creates new business models and processes, and also revolutionises distribution 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. Recognising the benefits of modernising their technology infrastructure banks are taking the right initiatives. While doing so, banks have four options to choose from: they can build a new system themselves, or buy best of the modules, or buy a comprehensive solution, or outsource. In this context banks need to clearly define their core competencies to be sure that they are investing in areas that will distinguish them from other market players, and give them a competitive advantage⁶. 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.

CAPACITY BUILDING

As dictated by the changing environment, banks need to focus on appropriate capacity building measures to equip their staff to handle advanced risk management systems and supervisors also need to equally equip themselves with appropriate skills to have effective supervision of banks adopting those systems. In the likelihood of a high level of attrition in the system, banks need to focus on motivating their skilled staff and retaining them⁷. Skill requirements would be significantly higher for banks planning to migrate to the advanced approaches under Basel II. Capacity building gains greater relevance in these banks, so as to equip themselves to take advantage of the incentives offered under the advanced approaches.

A relevant point in this regard is that capacity building should be across the institution and not confined to any particular level or any particular area. The demand for better skills can be met either from within or from outside. It would perhaps be worthwhile to first glean through the existing resources to identify misplaced or hidden or forgotten resources and re-position them to boost the bank’s efforts to capitalise on available skills. This does not undermine the benefits that a bank may derive by meeting their requirements from the market, but is only intended to prioritise the process.

CONCLUSION

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 as a global bank.

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