1

Lovely Professional university

TERM PAPER
[MGT-636]
TOPIC- Study on Banking Innovations in India

Submitted by Guided by
CHANDAN KUMAR SINGH Mr. Lovey Aggarwal

Section-B

Roll number –RT1902A-27

TABLE OF CONTENT
 2

S. No. Topic Page No.

1 ACKNOWLEDGEMENT 03
2 Objective of the study 03
3 History of Banking Industry in India 04
4 List of Banks in India 07
5 08
PROCESS INNOVATION IN THE INDIAN
BANKING INDUSTRY
6 09
Innovations in the Banking Industry in India
7 Technological Change & Financial Innovation in 10
Banking  
8 Recent Trends in Indian Banking Sector 20
9 Future of Indian Banking Sector 22
10 Conclusion 25
11 Bibliography 26

ACKNOWLEDGEMENT
 3

I provide full justice to this term paper which is prepared by visiting various web-
sites, magazines, articles etc.

I would like to take an opportunity to thank all the people in collecting the
necessary information and making of the report. I am grateful to all of them for
their time and wisdom.

My project becomes a reality only due to cooperation of many people who had
helped me in completing this project. I sincerely extend my gratitude to Mr.
Lovey Aggarwal who has given me this precious opportunity to have an
know about the Indian Banking Sectors. And its recent technology changes.

Objective of the study.

 To enhance knowledge about our banking sectors.

 To know about the recent changes in banking sectors.

 To enhance knowledge about banking operations.

 History of Banking Industry in India.

Banking in India originated in the last decades of the 18th century. The first banks
were The General Bank of India which started in 1786, and the Bank of Hindustan,
 4

both of which are now defunct. The oldest bank in existence in India is the State
Bank of India, which originated in the Bank of Calcutta in June 1806, which
almost immediately became the Bank of Bengal. This was one of the three
presidency banks, the other two being the Bank of Bombay and the Bank of
Madras, all three of which were established under charters from the British East
India Company. For many years the Presidency banks acted as quasi-central banks,
as did their successors. The three banks merged in 1921 to form the Imperial,
which, upon India's independence, became the State Bank of India.

The first bank in India, though conservative, was established in 1786. From 1786
till today, the journey of Indian Banking System can be segregated into 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.
 To make this write-up more explanatory, I prefix the scenario as Phase I,
Phase II and Phase III.

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
 5

(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.

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

During those days public 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.

Phase II

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 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 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 was nationalised.

Second phase of nationalisation Indian Banking Sector Reform was carried out in
 6

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 nationalisation 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%.

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

Phase III

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 liberalisation of banking
practices.

The country is flooded with foreign banks and their ATM stations. 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
 7

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.

 List of Banks in India

Public Banks. Private Banks

 Bank of India ICICI Bank

 Dena Bank HDFC Bank
 IDBI Bank Axis Bank
 Indian Bank Kotak Mahindra Bank
 Oriental Bank of Commerce South Indian Bank
 Punjab National Bank Yes Bank
 United Bank of India Federal Bank

 UCO Bank
 Allahabad Bank
 Andhra Bank
 Bank of Baroda
 Bank of Maharashtra
 Canara Bank
 Central Bank of India
 Corporation Bank
 Indian Overseas Bank
 Syndicate Bank
 Union Bank of India
 Vijaya Bank
 Punjab & Sind Bank

 PROCESS INNOVATION IN THE INDIAN BANKING

INDUSTRY
 8

The crisis in the international financial markets had been simmering for quite some
time. However, its effects are now evident with the collapse of some of the leading
financial institutions.

While India has not been as seriously impacted by the global financial turmoil, the
current credit crunch has affected all sectors of the Indian economy. On the one
hand, the Indian banking industry is witnessing rapid change given the evolving
regulatory environment, rapid technological advancements, heightened
competition and consolidation. On the other hand, with the global recession
looming, the industry is now exploring process innovation and is more
aggressively adopting technology.

ValueNotes along with the Indian Banks' Association (IBA) conducted a

conference on "Process Outsourcing in the Indian Banking Industry" on
January 6th to address the immediate issues concerning the banking industry.
There were several speakers from the banking industry including HDFC Bank,
Punjab National Bank, Bank of India, IDBI, who spoke on the issues and concerns
of the banks. There were also some service providers such as Intelenet, MphasiS
BPO, HTMT Global and Shell Transource who were present at the conference.
These service providers talked about their experience with the international banks
and spoke about issues related to vendor selection and process transition.

 Outsourcing in the Indian Banking Industry

Globally, the banking and financial services sector has been at the forefront of the
outsourcing movement. Third party service providers have also built greater
processing and analytical capabilities and are able to handle more complex
functions like financial modeling and equity research. In contrast with global
evolution of outsourcing, the Indian banking industry has been slower to outsource.

The Indian banking Industry is highly fragmented. There are banks ranging from
small co-operative banks (presence limited to a few branches in a city) to large
nationalized commercial banks like SBI with over 10,000 branches (one of the
largest banking network in the world). The Indian banking Industry is dominated
 9

by PSBs with 70% market share. Further, there are different issues that concern the
Indian banks when outsourcing.

 Process Innovation and Technology

In India, outsourcing of processes is largely constrained by the RBI regulations and
resistance from trade unions. According to Arun Jethmalani, CEO, ValueNotes,
"Aggressive adoption of IT and centralization of operations have served as a key
enabler to outsourcing of business processes in the banking industry." Other factors
such as growth in the banking industry, deregulation, increasing competition,
consolidation and improving benchmarks in the industry are driving the
outsourcing of business processes.

PSBs have been sluggish in adopting new technology as compared to global banks.
Post liberalization, with RBI tightening its regulations, PSBs have undertaken
massive computerization to achieve 'Total Branch Automation'. With privatization
and increasing competition, all the large banks are now aggressively implementing
'Core Banking Solutions'.

There is increasing focus on technology as evidenced by more and more PSU

banks going for aggressive computerization and transferring their processes into
some technology platform or other. While a few large PSBs have been quick to
respond to competitive pressures by introducing new services, investing in
technology and acquiring capabilities like marketing and sales, others lag behind.

 Innovations in the Banking Industry in India

 10

In the 1990s, the banking sector in India saw greater emphasis being placed on
technology and innovation. Banks began to use technology to provide better
quality of services at greater speed.

Internet banking and mobile banking made it convenient for customers to do their
banking from geographically diverse places. Banks also sharpened their focus on
rural markets and introduced a variety of services geared to the special needs of
their rural customers.
Banking activities also transcended their traditional scope and new concepts like
personal banking, retailing and banc assurance were introduced.

The sector was also moving rapidly towards universal banking and electronic
transactions, which were expected to change the way banking would be perceived
in the future.

Issues:

 Examine the development of the banking system in India and understand the
changes occurring in it.

 Understand the need for innovations in banking to create greater value for
customers and enhanced efficiency for the banks.

 Appreciate the role of technology in increasing the convenience of

customers and improving banking operations.

 Study the banking needs of rural India and the initiatives taken up by banks
to cater to these needs.

 Analyze the changes occurring in the Indian banking sector and how these
changes are likely to influence the way banking will be done in the future.
 11

 Types of Innovations
 E-BANKING
 Enables people to carry out most of their banking transaction using a safe
website which is operated by their respected bank.
 Advantage
 Faster & more convenient transaction
 No longer required to wait in long queues
 Opening of account simple & easy
 Apply for bank loan
 Cost effective for banker side
 Fund transfer become faster & convenient
 Stock trading, exchanging bonds & other investment

 Breakthrough in Funds Transfer

In May 2004, the curtain was finally lifted on the much discussed Real Time Gross
Settlement (RTGS) system, which many analysts considered, would revolutionize
funds transfer in the Indian banking sector.

It enables companies to transfer outstanding funds between banks in real time, thus
allowing them to settle payments instantaneously and manage their working capital
better. It is also expected to save significant amounts of money in interest
payments on floating funds lying in banks.
Some of the early adopters of RTGS were SCB, SBI, Housing Development
Finance Corporation (HDFC) and Saraswat Bank. IndusInd Bank was also close to
implementing the system. 

Some of the systems implemented earlier included the electronic clearing service
(1995), electronic funds transfer (EFT) facility (1997) and special electronic funds
transfer system (2003). Changes in the Indian banking sector in the late 1990s and
early 2000s, are expected to create high value for customers as well as the banks
involved.
 12

 Background Note

While the history of banking in India can be traced back several centuries, banking
in the modern sense of the word actually began towards the end of the 1700s.

The Bank of Hindustan, set up in 1770, by the British rulers5 in India was the
earliest bank in the country.  Over the years, the British set up several other banks,
notable among which were the three Presidency Banks in the Presidencies of
Bengal (in 1809), Bombay (in 1840) and Madras (in 1843).
These three banks were very powerful in their respective Presidencies and
functioned as quasi-central banks, having even the power to issue currency notes.

point stock banking companies with limited liability began to make their
appearance in the early-1860s.Allahabad Bank Ltd. was the first joint stock bank
established in India. The Swadeshi Movement6 in the early-1900s provided an
impetus to the setting up of banks owned by Indians. In 1920, the British
government in India passed the Imperial Bank of India Act and amalgamated the
three Presidency banks.

After India became independent from British rule in 1947, the newly formed
government of the country passed the Banking Regulations Act, 1949, laying down
the guidelines for the operation of commercial banks in the country. 
This regulation brought RBI under government control (under the RBI Act, 1934,
the RBI did not have any government ownership).
The RBI was also made the supervisory and regulatory authority of the banking
sector. 
In 1955, the Imperial Bank was converted into the State Bank of India (SBI),
through the passing of the State Bank of India Act, 1955.

 In 1959, SBI took over control of eight private banks floated in the erstwhile
princely states, making them 100% subsidiaries. In 1969, the government of India
(GoI) undertook a bank nationalization program with the objective of streamlining
the banking operations in the country and strengthening the sector through
government support.
 13

Innovations in Banking in India

Over the years, the banking sector in India has seen a number of changes. Most of
the banks have begun to take an innovative approach towards banking with the
objective of creating more value for customers, and consequently, the banks. Some
of the significant changes in the Indian banking sector are discussed below:

Technology for Value Creation

The use of information technology in the Indian banking sector was a corollary of
the liberalization process initiated in the country in the early 1990s.

Rural India Catching Up

With a majority of the Indian population living in rural areas, rural banking forms a
vital component of the Indian banking system. Besides, rural banking operations in
India are rather different from urban operations, due to the strong disparity that
exists between urban and rural life, and the needs of these two sections of people.

Banking Beyond Banking

While traditionally, banking meant 'borrowing and lending', in the latter part of the
20th century, the word took on a different meaning altogether. Banks no longer
restricted themselves to traditional banking activities, but explored newer avenues
to increase business and capture new markets.

The Changing Face of Banking

Many analysts predict still more revolutionary changes in the banking sector in
India. The chief of these are likely to be the concept of Universal Banks and the
introduction of Smart Card technology.

The Other Side

Although the Indian banking sector has made rapid progress particularly in the
number of innovations introduced, some analysts are skeptical about the efficacy
and practical use of many of these services.
 14

 Technological Change & Financial Innovation in

Banking  
When we discuss the technological change and financial innovation that
commercial banking has experienced during the past twenty-five years. This article
indicates the role of financial system in economics and how technological change
and financial innovation can improve social welfare. The literature review is
relating to several financial innovations, which focuses the new products or
services, production processes or organizational forms. In this article to find out
the past quarter century has been a period of substantial change in terms of banking
products, services, and production technologies. Moreover, while much effort has
been devoted to understanding the characteristics of users and adopters of financial
innovations and the attendant welfare implications, and to know little about how
and why financial innovations are initially developed.

 Introduction

The commercial banking business has changed dramatically over the past 25 years,
due in large part to technological change. Advances in telecommunications,
information technology, and financial theory and practice have jointly transformed
many of the relationship focused intermediaries of yesteryear into data-intensive
risk management operations of today. Consistent with this, we now find may
commercial banks embedded as part of global financial institutions that engage in a
wide variety of financial activities.

To be more specific, technological changes relating to telecommunications and

data processing have spurred financial innovations that have altered bank products
and services and production processes. For example, the ability to use applied
statistics cost-effectively (via software and computing power) has markedly altered
the process of financial intermediation. Retail loan applications are now routinely
evaluated using credit scoring tools, rather than using human judgment. Such an
approach makes underwriting much more transparent to third parties and hence
facilities secondary markets for retail credits (e.g., mortgages and credit card
receivables) via securitization. Statistically based risk measurement tools are also
used to measure and manage other types of credit risks- as well as interest rate
risks-on an ongoing basis across entire portfolios. Indeed, tools like value-at-risk
are even used to determine the appropriate allocation of risk-based capital for
actively managed portfolios.
 15

It will describe how technological change has spurred financial innovations that
have driven the aforementioned changes in commercial banking over the past 25
years. In this respect, the analysis distinguishes itself by reviewing the literature on
a large number of new banking technologies and synthesizing these studies in the
context of the broader economics literature on innovation.

The various innovations in banking and financial sector are ECS, RTGS, EFT,
NEFT, ATM, Retail Banking, Debit & Credit cards, free advisory services,
implementation of standing instructions of customers, payments of utility bills,
fund transfers, internet banking, telephone banking, mobile banking, selling
insurance products, issue of free cheque books, travel cheques and many more
value added services.

 The Role of Finance and Financial Innovation

The primary function of a financial system is to facilitate the allocation and
deployment of economic resources, both spatially and across time, in an uncertain
environment. This function encompasses a payments system with a medium of
exchange; the transfer of resources from savers to borrowers; the gathering of
savings for pure time transformation and the reduction of risk through insurance
and diversification.

The operation of a financial system involves real resource costs employed by

financial intermediaries and by financial facilitators (e.g., mortgage brokers). Much
of these resources are expended in the data collection and analyses in which
financial market participants engage, so as to deal with problems of asymmetric
information. There are also uncertainties about future states of the world that
generate risks, which for risk-averse individuals represent costs. In this
environment, new production process or new organisational forms.

Hence, a Financial Innovation as something new that reduces costs, reduce risks or
provides an improved product/service/instrument that better satisfies financial
system participants demands. Financial innovations can be grouped as new
products (e.g., subprime mortgage) or services (e.g., Internet banking) or new
organisational forms (e.g., Internet-only banks).

The Centrality of finance in an economy and its importance for economic growth
naturally raises the importance of financial innovation – and its diffusion. Since
finance is a facilitator of virtually all production activity and much consumption
activity, improvements in the financial sector will have direct positive
 16

ramifications throughout an economy. Further, since better finance can encourage

more saving and investment and can also encourage more productive investment
decisions, these indirect positive effects from financial innovation and further to its
value for an economy.

Given its importance, an understanding of the conditions that encourage innovation

would appear to be worthwhile. After all, observed streams of innovations are
clearly not uniform across all enterprises, across all industries or across all time
periods. The general innovation literature in economics has sought to uncover the
environmental conditions that affect the stream of innovations-focusing on
hypotheses concerning roughly five structural conditions: the market power of
enterprises, the size of enterprises, technological opportunity, appropriability
and product market demand conditions. Of course, when environmental
changes occur, we expect to observe an initial wave of financial innovations
followed by a new equilibrium flow consistent with the new environmental
conditions. Over the past 25 years, each of these above environmental conditions
was markedly altered – resulting in substantial changes to the commercial banking
industry.

 Financial Innovation and Banking

The literature pertaining to several specific financial innovations appearing over
the past 25 years or so that were specifically driven by technological change. The
major discussion is focusing on the lines of: new products & services, new
production process and new organizational forms.

 A1. Products:

Mortgage loans are one suite of products that have experienced a great deal of
change over the past 25 years in the United States. In 1980, long-term fully
amortizing fixed-rate mortgages were the norm and this product was offered
primarily by thrift institutions. Moreover, these loans required substantial down
payments and a good credit history and the accumulated equity was relatively
illiquid.

These characteristics have markedly evolved. The first big change occurred in the
early 1980s with the widespread introduction of various types of adjustable-rate
mortgages (ARMs), which had previously been banned by federal regulators. The
Tax Reform Act of 1986, which ended federal income tax deductions for non-
mortgage consumer debt, spurred substantial growth in home equity lending. One
 17

mortgage innovation more directly tied to technological change is subprime

lending, which was originally predicated on the use of statistics for better risk
measurement and risk-based pricing to compensate for these higher risks.
However, the subprime mortgage crisis has uncovered significant shortcomings in
the underlying statistical models.

* Subprime Mortgages: Subprime mortgage lending, broadly defined, and relates

to borrowers with poor credit histories or high leverage as measured by either
debt/income or loan-to-value. This market grew rapidly in the U.S during the first
decade of the twenty-first century – averaging about 20% of residential mortgage
originations between 2004 and 2006. At the end of 2007, subprime mortgages
outstanding stood at $940 billion; down from over $1.2 trillion outstanding the
previous year (Inside Mortgage Finance 2008).

Since the onset of the subprime mortgage crisis, research has attempted to identify
various sources of the problem. Mayer, Pence and Sherlund (forthcoming) provide
an overview of the attributes of subprime mortgages outstanding during this time
and investigate why delinquencies and defaults increases so substantially. These
authors, as will as Gerarbi, Lehnert, Sherlund, and Willen (forthcoming), point to
significant increase in borrower leverage during the mid-2000s, as measured by
combined loan-to-value (CLTV) ratios, which was soon followed by falling house
prices.

A2. Services:

 Recent service innovations primarily relate to enhanced account access and new
methods of payment-each of which better meets consumer demands for
convenience and ease. Automated Teller Machines (ATMs), which were
introduced in the early 1970s and diffused rapidly through the 1980s, significantly
enhanced retail bank account access and value by providing customers with around
the   clock access to funds. ATM cards were then largely replaced through the
1980s and 1990s by debit cards, which bundle ATM access with the ability to
make payment from a bank account at the point of sale. Over the past decade,
remote access has migrated from the telephone to the personal computer. Online
banking, which allows customers to monitor accounts and originate payments
using "electronic bill payment," is now widely used. Stored-value, or prepaid,
cards have also become ubiquitous.

* Debit Cards: Debit cards are essentially "pay-now" instruments linked to a

checking account whereby transactions can happen either instantaneously using
 18

online (PIN based) methods or in the near future with offline (signature based)
methods. Consumers typically have the choice of using online or offline methods,
and their selection often hinges on the respective benefits. Online debit allows the
cardholder also to withdraw cash at the point-of-sale, and offline provides float.
According to ATM & Debit News (2007), there were approximately 26.5 billion
debit transactions in the U.S. during 2006. This is up from 6.5 billion transactions
in 1999 – a four-fold increase.

* Online Banking: As households and firms rapidly adopted internet access during
the late-1990s, commercial banks established an online presence. According to De
Young (2005), the first bank websites were launched in 1995: and by 2002 nearly
one-half of all U.S. banks and thrifts operated transactional websites. As of 2007,
bank call report data suggests that 77.0 percent of commercial banks offer
transactional websites (and these banks control 96.8 percent of commercial bank
deposits).

The primary line of research relating to online banking has been aimed at  
understanding the determinants of bank adoption and how the technology has
affected bank performance. In terms of online adoption. Furst, Lang, and Nolle
(2002) find that U.S. national banks (by the end of the third quarter of 1999) were
more likely to offer transactional websites if they were: larger, younger, affiliated
with a holding company, located in an urban area, and had higher fixed expenses
and non-interested income. Turning to online bank performance, De Young, Lang,
and Nolle (2007) report that internet adoption improved U.S. community bank
profitability – primarily through deposit-related charges. In a related study,
Hernando and Nieto (2007) find that, over time, online banking was associated
with lower costs and higher profitability for a sample of Spanish banks. Both
papers conclude that the internet channel is a complement to – rather than a
substitute for – physical bank branches.

* Prepaid cards: As the name implies, prepaid cards are instruments whereby
cardholders "pay early" and set aside funds in advance for future purchases of
goods and services. (By contrast, debit cards are "pay-now", and credit cards are
"pay later"). The monetary value of the prepaid card resides either of the card or at
a remote database. According to Mercator Advisory Group, prepaid cards
accounted for over $180 billion in transaction volume in 2006.

Prepaid cards can be generally delineated as either "closes" systems (e.g., a

retailer-specific gift card, like Macy's or Best Buy) or "open" systems (e.g., a
payment-network branded card, like Visa or MasterCard). Closed-system prepaid
 19

cards have been effective as a cash substitute on university campuses, as well as

for mass transit systems and retailers.

A3. Production Processes

The past 25 years have witnessed important changes in banks production

processes. The use of electronic transmission of bank-to-bank retail payments,
which had modest beginnings in the 1970s, has exploded owing to greater retail
acceptance, online banking and check conversion. In terms of intermediation, there
has been a steady movement toward a reliance on statistical models. For example,
credit scoring has been increasingly used to substitute for manual underwriting –
and has been extended even into relationship-oriented products like small business
loans. Similar credit risk measurement models are also used when creating
structured financial products through "securitization". Statistical modelling has
also become central in the overall risk management processes at banks through
portfolio stress testing and value-at-risk models – each of which is geared
primarily to evaluating portfolio value in the face of significant changes in
financial asset returns.

* Asset Securitization: Asset securitization refers to the process by which non

traded assets are transformed into the U.S., securitization is widely used by large
originators of retail credit – specifically mortgages, credit cards and automobile
loans. As of year-end 2007, federally sponsored mortgage pools and privately
arranged ABS issues (including private-label mortgage-backed securities) totalled
almost $9.0 trillion in U.S. credit market debt outstanding.

By contrast, as of year-end 1990, these figures were $1.3 trillion, respectively. One
recent innovation in the   structured finance/securitization area is the introduction
of collateralized debt obligations (CDOs). According to Longstaff and Rajan
(2006) these instruments, which were first introduced in the mid-1990s, are now in
excess of $1.5 trillion. Like ABS, CDOs are also liabilities issued by financial-
institution-sponsored trusts, which essentially pool and restructure the priority of
cash flows associated with other types of risky financial assets, including senior
and mezzanine ABS, high-yield corporate bonds and bank loans.

* Risk Management: Advances in information technology (both hardware and

software) and financial theory spurred a revolution in bank risk management over
the past two decades. Two popular approaches to measuring and managing
financial risks are stress-testing and value-at-risk (VaR). In either case, the idea is
to identify the level of capital required for the bank to remain solvent in the face of
 20

unlikely adverse environments. 

* Organisational Forms: new bank organizational forms have emerged in the

United States over the past few decades. Securities affiliates (so-called "section 20"
subsidiaries or the creation of "financial holding companies") for very large banks
and Subchapter S status for very small banks, were the by product of
regulatory/legal evolution. Indeed, only one new organizational form, the internet-
only bank, arose from technological change. These institutions, which quickly
emerged and disappeared, may represent an interesting laboratory for the study of
"failed" financial innovations. We believe that understanding such experimental
failures may hold important insights for understanding the keys to successful
innovations.

 Recent Trends in Indian Banking Sector

Today, we are having a fairly well developed banking system with different classes
of banks – public sector banks, foreign banks, private sector banks – both old and
new generation, regional rural banks and co-operative banks with the Reserve
Bank of India as the fountain Head of the system.
In the banking field, there has been an unprecedented growth and diversification of
banking industry has been so stupendous that it has no parallel in the annals of
banking anywhere in the world.
During the last 41 years since 1969, tremendous changes have taken place in the
banking industry. The banks have shed their traditional functions and have been
innovating, improving and coming out with new types of the services to cater to
the emerging needs of their customers.
Massive branch expansion in the rural and underdeveloped areas, mobilisation of
savings and diversification of credit facilities to the either to neglected areas like
small scale industrial sector, agricultural and other preferred areas like export
sector etc. have resulted in the widening and deepening of the financial
infrastructure and transferred the fundamental character of class banking into mass
banking.
There has been considerable innovation and diversification in the business of major
commercial banks. Some of them have engaged in the areas of consumer credit,
credit cards, merchant banking, leasing, mutual funds etc. A few banks have
already set up subsidiaries for merchant banking, leasing and mutual funds and
many more are in the process of doing so. Some banks have commenced factoring
business.
The major challenges faced by banks today are as to how to cope with competitive
forces and strengthen their balance sheet. Today, banks are groaning with burden
 21

of NPA’s. It is rightly felt that these contaminated debts, if not recovered, will eat
into the very vitals of the banks. Another major anxiety before the banking
industry is the high transaction cost of carrying Non Performing Assets in their
books. The resolution of the NPA problem requires greater accountability on the
part of the corporate, greater disclosure in the case of defaults, an efficient credit
information sharing system and an appropriate legal framework pertaining to the
banking system so that court procedures can be streamlined and actual recoveries
made within an acceptable time frame. The banking industry cannot afford to
sustain itself with such high levels of NPA’s thus, “lend, but lent for a purpose and
with a purpose ought to be the slogan for salvation.”
The Indian banks are subject to tremendous pressures to perform as otherwise their
very survival would be at stake. Information technology (IT) plays an important
role in the banking sector as it would not only ensure smooth passage of
interrelated transactions over the electric medium but will also facilitate complex
financial product innovation and product development. The application of IT and
e-banking is becoming the order of the day with the banking system heading
towards virtual banking.
As an extreme case of e-banking World Wide Banking (WWB) on the pattern of
World Wide Web (WWW) can be visualised. That means all banks would be
interlinked and individual bank identity, as far as the customer is concerned, does
not exist. There is no need to have large number of physical bank branches,
extension counters. There is no need of person-to-person physical interaction or
dealings. Customers would be able to do all their banking operations sitting in their
offices or homes and operating through internet. This would be the case of banking
reaching the customers.
Banking landscape is changing very fast. Many new players with different muscle
powers will enter the market. The Reserve Bank in its bid to move towards the best
international banking practices will further sharpen the prudential norms and
strengthen its supervisor mechanism. There will be more transparency and
disclosures.
In the days to come, banks are expected to play a very useful role in the economic
development and the emerging market will provide ample business opportunities to
harness. Human Resources Management is assuming to be of greater importance.
As banking in India will become more and more knowledge supported, human
capital will emerge as the finest assets of the banking system. Ultimately banking
is people and not just figures.
 22

 Future of Indian Banking Sector

The interplay between policy and regulatory interventions and management
strategies will determine the performance of Indian banking over the next few
years. Legislative actions will shape the regulatory stance through six key
elements: industry structure and sector consolidation; freedom to deploy capital;
regulatory coverage; corporate governance; labor reforms and human capital
development; and support for creating industry utilities and service bureaus.
Management success will be determined on three fronts: fundamentally upgrading
organizational capability to stay in tune with the changing market; adopting value-
creating M&A as an avenue for growth; and continually innovating to develop new
business models to access untapped opportunities.
Through these scenarios, we can paint a picture of the events and outcomes that
will be the consequence of the actions of policy makers and bank managements.
These actions will have dramatically different outcomes; the costs of inaction or
insufficient action will be high. Specifically, at one extreme, the sector could
account for over 7.7 per cent of GDP with over Rs.. 7,500 billion in market cap,
while at the other it could account for just 3.3 per cent of GDP with a market cap
of Rs. 2,400 billion. Banking sector intermediation, as measured by total loans as a
percentage of GDP, could grow marginally from its current levels of ~30 per cent
to ~45 per cent or grow significantly to over 100 per cent of GDP. In all of this, the
sector could generate employment to the tune of 1.5 million compared to 0.9
million. Today availability of capital would be a key factor — the banking sector
will require as much as Rs. 600 billion (US$ 14 billion) in capital to fund growth in
advances, non-performing loan (NPL) write offs and investments in IT and human
capital up gradation to reach the high-performing scenario. Three scenarios can be
defined to characterize these outcomes:

 HIGH PERFORMANCE

In this scenario, policy makers intervene only to the extent required to ensure
system stability and protection of consumer interests, leaving managements free to
drive far reaching changes. Changes in regulations and bank capabilities reduce
intermediation costs leading to increased growth, innovation and productivity.
Banking becomes an even greater driver of GDP growth and employment and
large sections of the population gain access to quality banking products.
Management is able to overhaul bank organizational structures, focus on industry
consolidation and transform the banks into industry shapers.
In this scenario we witness consolidation within public sector banks (PSBs) and
within private sector banks. Foreign banks begin to be active in M&A, buying out
 23

some old private and newer private banks. Some M&A activity also begins to take
place between private and public sector banks. As a result, foreign and new private
banks grow at rates of 50 per cent, while PSBs improve their growth rate to 15 per
cent. The share of the private sector banks (including through mergers with PSBs)
increases to 35 per cent and that of foreign banks increases to 20 per cent of total
sector assets. The share of banking sector value adds in GDP increases to over 7.7
per cent, from current levels of 2.5 per cent. Funding this dramatic growth will
require as much as Rs. 600 billion in capital over the next few years.

 EVOLUTION

Policy makers adopt a pro-market stance but are cautious in liberalizing the
industry. As a result of this, some constraints still exist. Processes to create highly
efficient organizations have been initiated but most banks are still not best-in-class
operators. Thus, while the sector emerges as an important driver of the economy
and wealth in 2010, it has still not come of age in comparison to developed
markets. Significant changes are still required in policy and regulation and in
capability-building measures, especially by public sector and old private sector
banks.
In this scenario, M&A activity is driven primarily by new private banks, which
take over some old private banks and also merge among themselves. As a result,
growth of these banks increases to 35 per cent. Foreign banks also grow faster at
30 per cent due to a relaxation of some regulations. The share of private sector
banks increases to 30 per cent of total sector assets, from current levels of 18 per
cent, while that of foreign banks increases to over 12 per cent of total assets. The
share of banking sector value adds to GDP increases to over 4.7 per cent.

 STAGNATION

In this scenario, policy makers intervene to set restrictive conditions and

management is unable to execute the changes needed to enhance returns to
shareholders and provide quality products and services to customers. As a result,
growth and productivity levels are low and the banking sector is unable to support
a fast-growing economy. This scenario sees limited consolidation in the sector and
most banks remain sub-scale. New private sector banks continue on their growth
trajectory of 25 per cent. There is a slowdown in PSB and old private sector bank
growth. The share of foreign banks remains at 7 per cent of total assets. Banking
sector value adds meanwhile, is only 3.3 per cent of GDP.
 24

 NEED TO CREATE A MARKET DRIVEN BANKING SECTOR

WITH ADEQUATE FOCUS ON SOCIAL DEVELOPMENT

The term “policy makers”, refers to the Ministry of Finance and the RBI and
includes the other relevant government and regulatory entities for the banking
sector. The coordinated efforts between the various entities are required to enable
positive action. This will spur on the performance of the sector. The policy makers
need to make coordinated efforts on six fronts:
 Help shape a superior industry structure in a phased manner through
“managed consolidation” and by enabling capital availability. This would create
3-4 global sized banks controlling 35-45 per cent of the market in India; 6-8
national banks controlling 20-25 per cent of the market; 4-6 foreign banks with
15-20 per cent share in the market, and the rest being specialist players
(geographical or product/ segment focused).
 Focus strongly on “social development” by moving away from universal
directed norms to an explicit incentive-driven framework by introducing credit
guarantees and market subsidies to encourage leading public sector, private and
foreign players to leverage technology to innovate and profitably provide banking
services to lower income and rural markets.
 Create a unified regulator, distinct from the central bank of the country, in a
phased manner to overcome supervisory difficulties and reduce compliance costs.
 Improve corporate governance primarily by increasing board independence
and accountability.
 Accelerate the creation of world class supporting infrastructure (e.g.,
payments, asset reconstruction companies (ARCs), credit bureaus, back-office
utilities) to help the banking sector focus on core activities.
 Enable labor reforms, focusing on enriching human capital, to help public
sector and old private banks become competitive.

 NEED FOR DECISIVE ACTION BY BANK MANAGEMENT

Management imperatives will differ by bank. However, there will be common

themes across classes of banks:
 PSBs need to fundamentally strengthen institutional skill levels especially in
sales and mar marketing, service operations, risk management and the overall
 25

organizational performance ethic. The last, i.e., strengthening human capital will
be the single biggest challenge.
 Old private sector banks also have the need to fundamentally strengthen skill
levels. However, even more imperative is their need to examine their
participation in the Indian banking sector and their ability to remain independent
in the light of the discontinuities in the sector.
 New private banks could reach the next level of their growth in the Indian
banking sector by continuing to innovate and develop differentiated business
models to profitably serve segments like the rural/low income and affluent/ HNI
segments; actively adopting acquisitions as a means to grow and reaching the
next level of performance in their service platforms. Attracting, developing and
retaining more leadership capacity would be key to achieving this and would pose
the biggest challenge.
 Foreign banks committed to making a play in India will need to adopt
alternative approaches to win the “race for the customer” and build a value-
creating customer franchise in advance of regulations potentially opening up post
2009. At the same time, they should stay in the game for potential acquisition
opportunities as and when they appear in the near term. Maintaining a
fundamentally long-term value-creation mindset will be their greatest challenge.

 Conclusion
The banking industry of India has been completely transformed and modernized
with the advent of numerous technological and operational innovations. There is a
paradigm shift from traditional banking to modern banking, where the emphasis is
on providing better quality banking services with greater speed and accuracy.
Eliminating barriers of time and distance so as to facilitate customer convenience
and ease is an important consideration. Banking facilities like ATMs, Round the
clock banking, Internet Banking, Tele banking, have indeed made it convenient,
for the vast variety of customers to carry out their banking operations from diverse
geographical areas at any time during the day. Further, Banks have introduced
Innovative products and services, specially tailored to meet the requirements of
specific customers. The horizon of banking activities has been widened to areas
like bancassurance, universal banking and further virtual banking. This paper titled
“Revolutionizing Banking through Innovations” focuses on those significant,
noteworthy banking innovations which have absolutely transitioned the very nature
 26

of banking industry and its operations. It highlights the major technological,

operational and IT enabled innovations that have brought about a breakthrough in
attaining effective banking services and augmenting customer convenience.
Further, it also mentions those emerging banking innovations that are gaining
foothold in the banking sector but still are at nascent stage. Over the last three
decades the role of banking in the process of financial intermediation has been
undergoing a profound transformation, owing to changes in the global financial
system. It is now clear that a thriving and vibrant banking system requires a well
developed financial structure with multiple intermediaries operating in markets
with different risk profiles. Taking the banking industry to the heights of
international excellence will require a combination of new technologies, better
processes of credit and risk appraisal, treasury management, product
diversification, internal control and external regulations and not the least, human
resources. Fortunately, we have a comparative advantage in almost all these areas.
Our professionals are at the forefront of technological change and financial
developments all over the world. It is time to harness these resources for
development of Indian banking in the new century.

 Bibliography:
 https://encrypted.google.com/search?
hl=en&biw=1366&bih=667&q=current+innovation+in+indian+banking+sec
tors&aq=f&aqi=&aql=&oq=&gs_rfai=
 http://www.icmrindia.org/casestudies/catalogue/Innovation/Banking
%20Industry%20-%20Business%20Report%20-%20Excerpts.htm
 http://www.icmrindia.org/casestudies/catalogue/Innovation/BREP005.htm
 http://www.scribd.com/doc/29381388/Innovation-in-Indian-banking-sector
 http://www.slideshare.net/Dreamgains/white-paper-india-banking-2010
 http://www.oppapers.com/subjects/innovations-in-banking-by-india-
page1.html
 http://www.mbaknol.com/management-articles/article-on-indian-banking-
sector-innovation-in-banking/
 http://www.managementparadise.com/forums/innovations-banking-
insurance/