A bank is an institution that deals in money and its substitutes and provides other financial services. Banks accept deposits and make loans or make an investment to derive a profit from the difference in the interest rates paid and charged, respectively. In India the banks are being segregated in different groups. Each group has their own benefits and limitations in operating in India. Each has their own dedicated target market. Few of them only work in rural sector while others in both rural as well as urban. Many even are only catering in cities. Some are of Indian origin and some are foreign players. India’s economy has been one of the stars of global economics in recent years. It has grown by more than 9% for three years running. The economy of India is as diverse as it is large, with a number of major sectors including manufacturing industries, agriculture, textiles and handicrafts, and services. Agriculture is a major component of the Indian economy, as over 66% of the Indian population earns its livelihood from this area. Banking sector is considered as a booming sector in Indian economy recently. Banking is a vital system for developing economy for the nation. However, Indian banking system and economy has been facing various challenges and problems which have discussed in other parts of project.



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 dial a pizza. Money has become the order of the day. 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 Financial & Banking Sector Reforms after 1991.


After 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization 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. This resulted that Indian banking is growing at an astonishing rate, with Assets expected to reach US$1 trillion by 2010.

“The banking industry should focus on having a small number of large players that can compete globally and can achieve expected goals rather than having a large number of fragmented players."

Financial requirements in a modern economy are of a diverse nature, distinctive variety and large magnitude. Hence, different types of banks have been instituted to cater to the varying needs of the community. Banks in the organized sector may, however, be classified in to the following major forms:

o Commercial banks

o Co-operative banks o Specialized banks o Central bank • COMMERCIAL BANKS Commercial banks are joint stock companies dealing in money and credit. In India, however there is a mixed banking system, prior to July 1969, all the commercial banks-73 scheduled and 26 non-scheduled banks, except the state bank of India and its subsidiaries-were under the control of private sector. On July 19, 1969, however, 14 major commercial banks with deposits of over 50 Corers were nationalized. In April 1980, another six commercial banks of high standing were taken over by the government. At present, there are 20 nationalized banks plus the state bank of India and its 7 subsidiaries constituting public sector banking which controls over 90 per cent of the banking business in the country. • CO-OPERATIVE BANKS Co-operative banks are a group of financial institutions organized under the provisions of the Co-operative societies Act of the states. The main objective of co-operative banks is to provide cheap credits to their members. They are based on the principle of self-reliance and mutual cooperation. Co-operative banking system in India has the shape of a pyramid a three tier structure, constituted by:


• SPECIALIZED BANKS There are specialized forms of banks catering to some special needs with this unique nature of activities. There are thus, o Foreign exchange banks, o Industrial banks, o Development banks, o Land development banks,

Exim bank.

• CENTRAL BANK A central bank is the apex financial institution in the banking and financial system of a country. It is regarded as the highest monetary authority in the country. It acts as the leader of the money market. It supervises, control and regulates the activities of the commercial banks. It is a service oriented financial institution.

For instance. It is free from parliamentary control. the Reserve Bank of India (RBI). in 1949. A central bank is usually state owned but it may also be a private organization. 6 . CHALLENGES INDUSTRY FACED BY INDIAN BANKING The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. however. was started as a shareholders’ organization in 1935.India’s central bank is the Reserve Bank of India established in 1935. it was nationalized after independence. These multiple changes happening one after other has a ripple effect on a bank trying to graduate from completely regulated sellers market to completed deregulated customers market.

The banks are facing pricing pressure. and decontrolled interest rate and liberalized norms for foreign exchange. o DIFFUSED CUSTOMER LOYALTY This will definitely impact Customer preferences. squeeze on spread and have to give thrust on retail assets. There are multiple choices. o NEW RULES As a result. Banks need to access low cost funds and simultaneously improve the efficiency. Natural fall out of this has led to a series of innovative product offerings catering to various customer segments. specifically retail credit. adding new channels with lucrative pricing and freebees to offer. Banks are transforming to universal banking. operational flexibility. At the same time reduced corporate credit off take thanks to sluggish economy has resulted in large number of competitors battling for the same pie. Given the relatively low switching costs. Customers have become demanding and the loyalties are diffused. as they are bound to react to the value added offerings. The deregulation of the industry coupled with decontrol in interest rates has led to entry of a number of players in the banking industry. the wallet share is reduced per bank with demand on flexibility and customization.o DEREGULATION This continuous deregulation has made the Banking market extremely competitive with greater autonomy. customer 7 . o EFFICIENCY This in turn has made it necessary to look for efficiencies in the business. the market place has been redefined with new rules of the game.

Acceptance of technology is slowly creeping in but the utilization is not maximized. o MISALLIGNED MINDSET These changes are creating challenges. on escalating problems rather than solving them and on disposing customers instead of using the opportunity to cross sell. flawless service delivery. The competency gap needs to be addressed simultaneously otherwise there will be missed opportunities. There is resistance to change from employees and the Seller market mindset is yet to be changed coupled with Fear of uncertainty and Control orientation. The focus of people will be on doing work but not providing solutions. The major initiatives include: o Investing in state of the art technology as the back bone of to ensure reliable service delivery Leveraging the branch network and sales structure to mobilize low cost current and savings deposits 8 o . o COMPETENCE GAP Placing the right skill at the right place will determine success. as employees are made to adapt to changing conditions.retention calls for customized service and hassle free. STRATEGIES OPTIONS WITH BANKS TO COPE WITH THOSE CHALLENGES Leading players in the industry have embarked on a series of strategic and tactical initiatives to sustain leadership.

o Making aggressive forays in the retail advances segment of home and personal loans Implementing organization wide initiatives involving people. process and technology to reduce the fixed costs and the cost per transaction Focusing on fee based income to compensate for squeezed spread. (e. CMS.g. trade services) Innovating Products to capture customer ‘mind share’ to begin with and later the wallet share o o o o Improving the asset quality as per Basel II norms 9 .

The Indian economy has been stable and reliable in recent times. The process of globalization has been an integral part of the recent economic progress made by India. and a flourishing capital market. All of these positive changes have resulted in establishing the Indian economy as one of the largest and fastest growing in the world. Globalization has played a major role in export-led growth. a new consumer base has developed.INDIAN ECONOMY The Indian Economy is consistently posting robust growth numbers in all sectors leading to impressive growth in Indian GDP. while in the last few years it’s experienced a positive upward growth trend. leading to the enlargement of the job market in India. A consistent 8-9% growth rate has been supported by a number of favorable economic indicators including a huge inflow of foreign funds. This is helping to accelerate the growth of Indian economy. As a new Indian middle class has developed around the wealth that the IT and BPO industries have brought to the country. both an IT and real estate boom. The same thing has followed by international banks that are entering in Indian market and pulling their huge investments in Indian economy. Economy can be studied from two points of views… 10 . International companies are also expanding their operations in India to service this massive growth opportunity. growing reserves in the foreign exchange sector.

It is concerned with the interaction between individual buyers and sellers and the factors that influence the choices made by buyers and sellers. It focuses on the national economy as a whole and provides a basic knowledge of how things work in the business world. Macroeconomics examines economy-wide phenomena such as changes in unemployment. microeconomics focuses on patterns of supply and demand and the determination of price and output in individual markets. In particular. you need to have an understanding of economics at both the micro and macro levels. 11 . rate of growth. Thus. inflation and price levels. For example. for an overall perspective of how the entire economy works. gross domestic product. Microeconomics looks at the smaller picture and focuses more on basic theories of supply and demand and how individual businesses decide how much of something to produce and how much to charge for it. national income.  MACRO ECONOMIC POINT OF VIEW It is a field of economics that studies the behavior of the aggregate economy. MICRO ECONOMIC POINT OF VIEW The branch of economics that analyzes the market behavior of individual consumers and firms in an attempt to understand the decisionmaking process of firms and households. people who study this branch of economics would be able to interpret the latest Gross Domestic Product figures or explain why a 6% rate of unemployment is not necessarily a bad thing. Macroeconomics looks at the big picture (hence "macro").

In general. the assumptions of the market play a major role in deciding the right path for a country’s economic development. there are three major types of economic systems prevailing around the world they are.. o Market Economy o Planned Economy o Mixed Economy MARKET ECONOMY In a market economy. consumers and their buying decisions drive the economy. and the amount of regulation controlling different industrial sectors. In this type of economic system. PLANNED ECONOMY A planned economy is also sometimes called a command economy. Market decisions are mainly dominated by supply and demand. and the exact way in which its economic plan is carried out. The absence of central planning is one of the major features of this economic system. The role of the government in a market economy is to simply make sure that the market is stable enough to carry out its economic activities properly. national and state governments play a minor role. goods produced. Market economies aim to reduce or eliminate entirely subsidies for a particular industry. The most important aspect of this type of economy is that all major 12 ..ECONOMIC SYSTEMS An economic system is loosely defined as country’s plan for its services. Instead. the pre-determination of prices for different commodities.

This system prevails in many countries where neither the government nor the business entities control the economic activities of that country – both sectors play an important role in the economic decision-making of the country. the 13 . This type of economy lacks the kind of flexibility that is present a market economy. The planned economy is government directed. are all made by the government. the planned economy reacts slower to changes in consumer needs and fluctuating patterns of supply and demand. If RBI decides to increase the percent of this. a planned economy aims at using all available resources for developing production instead of allotting the resources for advertising or marketing.decisions related to the production. On the other hand. IMPORTANT BANKING AND ECONOMIC INDICATORS  CASH RESERVE RATIO Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. distribution. Mixed economies include both capitalist and socialist economic policies and often arise in societies that seek to balance a wide range of political and economic views. In a mixed economy there is flexibility in some areas and government control in others. and because of this. commodity and service prices. and market forces have very little say in such an economy. This means that certain features from both market and planned economic systems are taken to form this type of economy. MIXED ECONOMY A mixed economy combines elements of both the planned and the market economies in one cohesive system.

Act. The repo rate is dependent 14 . 1949 all Scheduled Commercial Banks. also known as the official bank rate. to drain out the excessive money from the banks. o In cash. The central bank makes this transaction with commercial banks to reduce some of the short-term liquidity in the system. Or o In unencumbered approved securities valued at a price as specified by the RBI from time to time.available amount with the banks comes down. is the discounted rate at which a central bank repurchases government securities. in addition to the average daily balance which they are required to maintain in the form of….R.  STATUTORY LIQUIDITY RATIO In terms of Section 24 (2-A) of the B. Or o In gold valued at a price not exceeding the current market price. The amount of which shall not be less than three per cent of the total of the Net Demand and Time Liabilities (NDTL) in India.  REPO RATE Repo rate. RBI is using this method (increase of CRR rate). on a fortnightly basis and RBI is empowered to increase the said rate of CRR to such higher rate not exceeding twenty percent of the Net Demand and Time Liabilities (NDTL) under the RBI Act. 1934.

bank rate ordinarily denotes to the current rate of interest acquired from savings certificate of Deposit.. The entity borrowing the security is often referred to as the buyer. which is the repo rate. When the sale is concluded. The central bank has the power to lower the repo rates while expanding the money supply in the country. This price is comprised of the original market price and interest. on certificate of deposit Bank rate on the credit of a credit card or other kind of loan 15 . while the lender of the securities is referred to as the seller. Bank rates are levied to control the money supply to and from the bank. This enables the banks to exchange their government security holdings for cash. i. Repo rate is short for repurchase rate. At times. In contrast. when the central bank decides to reduce the money supply.on the level of money supply that the bank chooses to fix in the monetary scheme of things. Bank rate varies based on some defined conditions as laid down the governing authority of the banks. the securities are subsequently resold at a predetermined price. it implements a rise in the repo rates. The securities that are being evaluated and sold are transacted at the current market price plus any interest that has accrued. the central bank of the nation makes a decision regarding the money supply level and the repo rate is determined by the market. and the pre-agreed interest rate.e. From the consumer's point of view. It is most frequently used by the consumers who are concerned in mortgage Some commonest types of bank interest rates are as follows: o o Bank rate on CD.  BANK RATE Bank rate is referred to the rate of interest charged by premier banks on the loans and advances.

including the LIBOR & MIBOR. it will need to borrow money in the interbank market to cover the shortfall. These banks will lend money in the interbank market. The interest rate charged depends on the availability of money in the market. There is a wide range of published interbank rates. to manage any potential withdrawals from clients. such as cash. on prevailing rates and on the specific terms of the contract. which is set daily based on the average rates on loans made within the London interbank market & Mumbai Interbank Market.  GROSS DOMESTIC PRODUCT 16 . Banks borrow and lend money in the interbank market in order to manage liquidity and meet the requirements placed on them. Banks are required to hold an adequate amount of liquid assets. have excess liquid assets above and beyond the liquidity requirements. such as term length.o Bank rate on real estate loan  INTERBANK RATE The rate of interest charged on short-term loans made between banks. Some banks. If a bank can't meet these liquidity requirements. receiving interest on the assets. on the other hand.

as well as to gauge a country's standard of living. investments and exports less imports that occur within a defined territory. in a  nation's economy. Basically. "NX" is the nation's total net exports. calculated as total exports minus  total imports. government outlays.Imports) GDP is commonly used as an indicator of the economic health of a country. GDP = C + G + I + NX Where: "C" is equal to all private consumption. Inflation also occurs when the amount of money exceeds the amount of goods and services available. (NX = Exports .The monetary value of all the finished goods and services produced within a country's borders in a specific time period. or consumer spending.  INFLATION Inflation can be defined as a rise in the general price level and therefore a fall in the value of money. It includes all of private and public consumption. refers 17 . "I" is the sum of all the country's businesses spending on capital. As to whether the fall in the value of money will affect the functions of money depends on the degree of the fall. Inflation occurs when the amount of buying power is higher than the output of goods and services. though GDP is usually calculated on an annual basis.   "G" is the sum of government spending.

either in the form of a reduction in government spending. resulting in higher prices. personal spending or investment spending. Deflation can also be brought about by direct contractions in spending. 18 . Disinflation is said to take place when deliberate attempts are made to curtail expenditure of all sorts to lower prices and money incomes for the benefit of the community. an increase in the supply of currency or credit relative to the availability of goods and services. Deflation occurs when the total expenditure of the community is not equal to the existing prices. since the process often leads to a lower level of demand in the economy. output and income. inflation can be measured in terms of percentages. which is usually in years.  DISINFLATION When prices are falling due to anti-inflationary measures adopted by the authorities. the supply of money decreases and as a result prices fall. Deflation has often had the side effect of increasing unemployment in an economy. disinflation is implemented as a cure. the result of this is disinflation. Deflation is just the opposite of inflation. The two basic price indexes are used when measuring inflation.  DEFLATION It is a condition of falling prices accompanied by a decreasing level of employment. with no corresponding decline in the existing level of employment. When acute inflation burdens an economy. as a rate per cent per unit of time. the producer price index (PPI) and the consumer price index (CPI) which is also known as the cost of living index number. Therefore. output and income. The percentage increase in the price index.

changing the supply of money or adjusting the interest rates. which is the opposite of disinflation. This gave rise to the second reason for stagflation. Governments can use economic policies such as reducing taxes. Some economists believe that there are two main reasons for stagflation. what happened was that there was plenty of liquidity in the system and people were spending money as quickly as they got it because prices were going up quickly. such as an increase in the price of oil in an oil importing country. Reflation is a means of motivating the economy to produce. Basically. REFLATION Reflation is a situation of rising prices. This is achieved by increasing the supply of money or in some instances reducing taxes. Basically.  FOREIGN INSTITUTIONAL INVESTMENTS 19 . The situation is described as semi-inflation or reflation. stagflation can occur when an economy is slowed by an unfavourable supply. when prices are increasing the economy is deceasing. which tends to raise prices at the same time that it slows the economy by making production less profitable.  STAGFLATION Stagflation is a stagnant economy that is combined with inflation. In the 1970's inflation and recession occurred in different economies at the same time. Firstly. which in turn motivates the country to increase their output. which is deliberately undertaken to relieve a depression.

Under this scheme. These are assets of the central bank held in different reserve currencies.usually to stabilize the foreign exchange rates to provide a more favorable economic environment.Foreign Institutional Investors (FIIs). This broader figure is more readily available. euro and yen. Non-Resident Indians (NRIs). 20 . FIIs/NRIs can acquire shares/debentures of Indian companies through the stock exchanges in India. the term in popular usage commonly includes foreign exchange and gold.g. However. The ceiling for overall investment for FIIs is 24 per cent of the paid up capital of the Indian company and 10 per cent for NRIs/PIOs. SDRs and IMF reserve positions. and used to back its liabilities. including the State Bank of India. e. the local currency issued. by the government or financial institutions. such as the dollar. and Persons of Indian Origin (PIOs) are allowed to invest in the primary and secondary capital markets in India through the portfolio investment scheme (PIS). but it is more accurately termed official reserves or international reserves. Large reserves of foreign currency allow a government to manipulate exchange rates . The limit is 20 per cent of the paid up capital in the case of public sector banks. and the various bank reserves deposited with the central bank.  FOREIGN EXCHANGE RESERVES Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits held by central banks and monetary authorities.

deregulation and advances in information technology in recent years have brought about significant changes in the operating environment for banks and other financial institutions. 21 . in turn.ROLE OF BANKS IN DEVELOPING OF ECONOMY A safe and sound financial sector is a prerequisite for sustained growth of any economy. These institutions are faced with increased competitive pressures and changing customer demands. they have also posed some serious risks. While these developments have enabled improvement in the efficiency of financial institutions. have engendered a rapid increase in product innovations and changes in business strategies. These. Globalization.

The entrepreneur in innovation is largely dependent on the 22 . saving is very low.Banks play a very useful and dynamic role in the economic life of every modern state. the industrial revolution would not have taken place in Europe. The economic importance of commercial banks to developing countries may be viewed thus: o Promoting capital formation o Encouraging innovation o Monetsation o Influence economic activity o Facilitator of monetary policy Above all view we can see in briefly. Unfortunately. thus encourage the habits of thrift and industry in the community. A study of the economic history of western country shows that without the evolution of commercial banks in the 18th and 19th centuries. Banks afford facilities for saving and. in underdeveloped countries. which are given below: PROMOTING CAPITAL FORMATION A developing economy needs a high rate of capital formation to accelerate the tempo of economic development. They mobilize the ideal and dormant capital of the country and make it available for productive purposes. but the rate of capital formation depends upon the rate of saving. ENCOURAGING INNOVATION Innovation is another factor responsible for economic development.

Banks may follow a cheap money policy with low interest rates which will tend to stimulate economic activity.manner in which bank credit is allocated and utilized in the process of economic growth. 23 . MONETSATION Banks are the manufactures of money and they allow many to play its role freely in the economy. They can influence the rate of interest in the money market through its supply of funds. an efficient and comprehensive banking system is a crucial factor of the developmental process of economy. Under-developed countries cannot afford to ignore this fact. But a well-developed banking system is on essential pre-condition to the effective implementation of monetary policy. INFLUENCE ECONOMIC ACTIVITY Banks are in a position to influence economic activity in a country by their influence on the rate interest. FACILITATOR OF MONETARY POLICY Thus monetary policy of a country should be conductive to economic development. Bank credit enables entrepreneurs to innovate and invest. Banks monetize debts and also assist the backward subsistence sector of the rural economy by extending their branches in to the rural areas. They must be replaced by the modern commercial bank’s branches. and thus uplift economic activity and progress. A fine.

RESERVE BANK OF INDIA REGULATORY INSTITUTION IN ECONOMY AS A INDIAN The RBI was established under the Reserve Bank of India Act. 1935 as a private shareholders' bank but since its nationalization in 1949. to operate the currency and credit system of the country to its advantage'. 1934 on April 1. The Preamble of the Reserve Bank describes the basic functions as 'to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally. The twin objectives of monetary policy in India have evolved over the years as those of maintaining price stability and ensuring adequate flow of credit to facilitate the growth process. is fully owned by the Government of India. The relative emphasis between the twin objectives is modulated as per the prevailing circumstances and is 24 .

its founding statute mandates it to be the manager of market borrowing of the Government of India and banker to the Government. independent directors nominated by the Government. The Reserve Bank is also entrusted with the management of foreign exchange reserves (which include gold holding also). Besides. IMPORTANT FUNCTIONS PLAYED BY RESERVE BANK OF INDIA IN ECONOMY  MAIN FUNCTIONS o MONITORY AUTHORITY The Reserve Bank of India formulates implements and monitors the monetary policy.articulated in the policy statements by the Reserve Bank from time to time. in addition to the Governor and up to four Deputy Governors. The Reserve Bank's affairs are governed by a Central Board of Directors. Consideration of macro-economic and financial stability is also subsumed in the mandate. consisting of fourteen non-executive. Its main objective is maintaining price stability and ensuring adequate flow of credit to productive sectors. one Government official is also nominated on the Board who participates in the Board meetings but cannot vote. which are reflected in its balance sheet. While the Reserve Bank is essentially a monetary authority. o REGULATOR AND SUPERVISOR OF FINANCIAL SYSTEM 25 .

protect depositors’ interest and provide cost-effective banking services to the public. 1999. o DEVELOPMENTAL ROLE The reserve bank of India performs a wide range of promotional functions to support national objectives. and many more…. coupons. o ISSUER OF THE CURRENCY The person who is issuer issues and exchanges or destroys currency and coins not fit for circulation..Prescribes broad parameters of banking operations within which the country’s banking and financial system functions. o MANAGER OF EXCHANGE CONTROL The manager of the exchange control department manages the Foreign Exchange Management Act. His main objective is to give the public adequate quantity of supplies of currency notes and coins and in good quality. maintaining good public relations. Its main objective is to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. Their main objective is to maintain public confidence in the system. o RELATED FUNCTIONS 26 . The promotional functions are such as contests.

The supervisory functions of the RBI have helped a great deal in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation. at one time were regarded as outside the 27 .  BANKER TO THE GOVERNMENT It performs merchant banking function for the central and the state governments. also acts as their banker.  PROMOTIONAL FUNCTIONS With economic growth assuming a new urgency since Independence. The bank now performs a variety of developmental and promotional functions. They are such as Banker to the Government. management and methods of working.  SUPERVISORY FUNCTIONS The Reserve Bank act.There are also some of the relating functions to the above mentioned main functions. Banker to banks etc…. the range of the Reserve Bank’s functions has steadily widened. relating to licensing and establishments. amalgamation. reconstruction. branch expansion. liquidity of their asset. which. The RBI is authorized to carry out periodical inspections of banks and to call for returns and necessary information from them. 1949 have given the RBI wide powers of supervision and control over commercial and co-operative banks. 1934 and the Banking Regulation act.  BANKER TO THE BANKS Maintains banking accounts of all scheduled banks. and liquidation.

significant rise in interest rates and slowdown in economic growth. extend banking facilities to rural and semi-urban areas. The RBI was asked to promote banking habit. and establish and promote new specialized financing agencies. surge in inflation and continued strong growth in money supply (M3) have forced the government and RBI to take strong fiscal and monetary measures leading to liquidity tightening. Economic shocks are events which adversely affect the economy and the government’s macroeconomic objectives such as growth. Unprecedented rise in crude prices.normal scope of central banking. unemployment and the balance of payments. PROBLEMS FACED BY INDIAN ECONOMY Macro-economic environment in India has taken a serious turn since the beginning of the year. inflation. CERTAIN PROBLEMS FACED BY INDIAN ECONOMY 28 .

Therefore. This is now a potential problem in the India. A fall in the savings ratio implies that consumer spending is increasing.  ECONOMY MORE SENSITIVE TO INTEREST RATES With a fall in the savings ratio interest rate changes will have a bigger effect in reducing spending. However. often this is financed through increased borrowing. rising Aggregate Demand may cause inflation. It is the rise in confidence which encourages borrowing and consumers to run down savings. Inflation will occur when growth is faster than the long run trend rate. The increase in AD will cause an increase in economic growth and lower unemployment. This is because levels of borrowing are higher and therefore a rise in interest rates has 29 . Inflation has recently gone above 12%  BOOM AND BUST A fall in the savings ratio is usually accompanied by a rise in confidence.o FALL IN SAVINGS RATIO The savings ratio is the % of income that is saved not spent. EFFECTS OF FALL IN SAVINGS RATIO  HIGHER LEVEL OF CONSUMPTION This results in increase in Aggregate Demand. there is always a danger that a falling savings ratio can be a precursor to a boom and bust situation.

but. Since Jan’08 onwards. The current account deficit could put downward pressure on the exchange rate in the long term. it is just a reflection of strong economy and booming housing market. some people argue a fall in the savings ratio is not a problem. Also.2% to hit a 13-year high of ~12%. M3 growth in the economy too continued to remain strong at 20% (in July’08). higher rates will not be increasing incomes from savings as much. o INFLATION Inflation is posing a serious challenge to the economic growth of India.  BALANCE OF PAYMENT With higher levels of consumer spending. o GLOBAL RECESSION 30 . even though very small part of global crude price increase has been passed on to the Indian consumers. Therefore this will lead to deterioration in the current account. there will be an increase in imports. However. well above the RBI’s comfort level of 17%.a significant impact on increasing interest repayments. which increases scope for equity withdrawal. inflation in the country has surged by 8. The WPI inflation rate flared up during the period driven by significant increase in the prices of commodities. primary articles and manufactured products.

Falling house prices. Many argue that India’s growth is not so dependent on growth in the West. with the worst still to come. But continued rise in crude prices and its resultant impact on inflation. Hence. However. o RISE IN CRUDE PRICES How global crude prices would behave probably has no easy answers. This coupled with the outflow of FII investments has resulted in INR to depreciate sharply against dollar further fueling inflation. interest rates and government finances has the potential to do so.It appears that Europe. resulting in pressure on government coffers on back of rising crude prices. India’s growing service sector and manufacturing sector would be adversely impacted by a global downturn. Japan and the US are entering into recession. India currently imports 70% of its crude requirement. crisis in the financial system. the Indian stock markets have been hit by the global crisis. however we believe that the current challenging and uncertain macro-economic conditions does not lead Indian financials into a state of crisis. In the last couple of months oil prices have surged by 45% from US$ 100 to US$ 145 (and now back to US$ 115). crude price remains the key risk to our positive stance on the Indian financials. and lower confidence could lead to a sharp downturn. 31 . o DEPRICIATING INR Surge in crude prices has severely impacted current account deficit of the country.

This would 32 . Risks and uncertainties in the system have increased given the higher crude and commodity prices and its inflationary impact.IMPACT OF ECONOMIC PROBLEMS ON INDIAN FINANCIALS The current macro-economic conditions are expected to result in o SLOWDOWN IN CREDIT GROWTH o IMPACT ON MARGINS OF BANKS o PREASURE ON CREDIT QUALITY • SLOWDOWN IN CREDIT GROWTH While the rise in interest rates should lead to a moderation in demand for credit. 22% in FY08. Indian banks too are exercising caution while lending. Credit growth of 18% in FY09E and 17% in FY10E vs.

As can be seen in the exhibit below.0% currently and RBI has also discontinued with interest payment on CRR balances. Every 50 bps hike in CRR generally negatively impacts margins by ~5 bps. However on account of recent measures by RBI. which would impact economic growth adversely.5% in FY07 to ~13% in FY08. CRR has increased by 400 bps to 9. retail loan growth has slowed down significantly from 26.7%. SLR Ratio of the system has started rising since mid FY08 and currently stands at 28. the banks tend to regain the pricing power. This coupled with elections next year could lead to some postponement of capex plans of corporate. leading to negative impact on demand for credit. Apart from hiking PLRs. In fact in an environment.curtail consumption. where liquidity is tight. Till June’08. interest rates are at elevated levels and risk premiums have increased. most of the banks had restrained from hiking lending rates despite significant monetary tightening. Further higher rates will not only impact the profitability of Indian corporate but also impact IRRs of various proposed capex projects. banks have resorted to hiking PLRs in July/August by 50-150 bps to preserve their margins. • IMPACT ON MARGINS OF BANKS During the past 18 months. Higher rates have particularly impacted retail loan growth. This would not only help the banks to adequately price in risks but also help protect their margins. Given the expected negative impact on credit growth. banks are also resorting to reprising (in fact right-pricing) 33 .

corporate). The extent of the impact on credit quality would also be bank specific given the loan mix (retail vs. dramatically improved asset quality. airlines industry) might feel the stress due to the changing macro environment and rise in interest rates. Similarly. • PRESSURE ON CREDIT QUALITY Higher lending rates are expected to impact credit quality for the banking system. 34 . Even Certain sectors (like real estate. stronger recovery mechanisms (legal provisions) and with adequate capitalization and provisioning. would face higher delinquencies if interest rates strengthen further by 100-200 bps. Many companies where crude forms a key raw material component are expected to get hit more severely. which are interest rate sensitive. proportion of unsecured lending. credit profile of corporate loan book and industry wise exposure. Indian banks’ fundamentals are relatively resilient with better risk management systems. Significant portion of fixed rate loans would also get re-priced over the period of 12-18 months. sectors like real estate and SMEs.the loans that were sanctioned well below PLRs.

To come out of these problems RBI and ministry of finance and other relevant government and regulatory entities are taking various initiatives which are as follows. • RBI MONITORY POLICY With the introduction of the Five year plans..NECESSARY INITIATIVES TAKEN BY RBI & MINISTRY OF FINANCE TO TACKLE ECONOMIC PROBLEMS As most of economists feel that the most horrible problem which India is facing currently is inflation which has crossed 12%.. the need for appropriate adjustment in monetary and fiscal policies to suit the pace 35 .

i. The monitory policy since 1952 emphasized the twin aims of the economic policy of the government: o Spread up economic development in the country to raise national income and standard of living.and pattern of planned development became imperative. and o To control and reduce inflationary pressure in the economy. OBJECTIVES OF MONITORY POLICY  PRICE STABILITY  MONITORY TARGETTING  INTEREST RATE POLICY  RESTRUCTURING OF MONEY MARKET  REGULATION OF FOREIGN EXCHANGE MARKET WEAPONS OF MONITORY POLICY Central banks generally use the three quantitative measures to control the volume of credit in an economy.e. namely: 36 . RBI helped the economy to expand via expansion of money and credit and attempted to check in rise in prices by the use of selective controls. Accordingly. a policy of “adequate financing of economic growth and at the same time the time ensuring reasonable price stability”. This policy of RBI since the First plan period was termed broadly as one of controlled expansion.. Expansion of currency and credit was essential to meet the increased demand for investment funds in an economy like India which had embarked on rapid economic development.

and they are very close to being money. Growth requires credit expansion but to check inflation. and diversifying the flow of credit towards the most desirable needs of productive and growthinducing sector. wealth is typically represented by claims in the form of securities. there is need to contract credit. as they are called. When 37 . by themselves. etc. the best course is to resort to credit control. in controlling inflation moderate monetary measures.o Raising bank rates o Open market operations and o Variable reserve ratio However. restricting the flow of credit into the unproductive. bonds. In fact. On the other hand. as is normally conceived by the traditional quantity theories. there is no immediate and direct relationship between money supply and the price level. tangible. it is not so simple to control the rate of spending or total outlays merely by controlling the quantity of money. drastic monetary measures are not good for the economic system because they may easily send the economy into a decline. monetary measures to control inflation are weakened. In such a encounter. In these circumstances. They increase the general liquidity of the economy. Such near moneys are highly liquid assets. Thus. to that extent. there are various limitations on the effective working of the quantitative measures of credit control adapted by the central banks and. In a developing economy there is always an increasing need for credit. or near moneys. inflation-infected sectors and speculative activities. In modern community.. are relatively ineffective. It should be noted that the impression that the rate of spending can be controlled rigorously by the contraction of credit or money supply is wrong in the context of modern economic societies.

Along with public expenditure. also the magnitude of the inflationary gap in regards to the availability of the supply of goods and services. this may lead to a further rise in prices of goods and services. monetary restraints can.there is inflation in an economy. It can be cleared noted that during a period of full employment inflation. To curve the effects of inflation and changes in the total expenditure. • FISCAL POLICY Fiscal policy is another type of budgetary policy in relation to taxation. excise duties or sales tax on various commodities may take away the buying power from the consumer goods market without discouraging the level of production. and inflation can spread from one sector of the economy to another and from one type of goods and services to another. and public expenditure. in an effect to minimise inflationary pressures. As a result. play a useful role in controlling inflation. public borrowing. the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures are shortened. some economists point out that this is not a correct way of combating inflation because it may lead to a regressive status within the economy. During inflationary periods the government is supposed to counteract an increase in private spending. It is known that when more taxes are imposed. However. For example. governments must simultaneously increase taxes that would effectively reduce private expenditure. the size of the disposable income diminishes. in conjunction with other measures. In some instances. Therefore. and an increase in taxes produces a cash 38 . a reduction in public expenditure. fiscal measures would have to be implemented which involves an increase in taxation and decrease in government spending. tax policy has been directed towards restricting demand without restricting level of production.

In addition. however. Fiscal policy by itself may not be very effective in combating inflation. include devices for increasing savings. in order to prevent an increase in the circulation of money. which is mainly responsible for inflation.surplus in the budget. Keynes. Furthermore. such as deferred pay as an anti-inflationary measure. A strong savings drive reduces the spendable income of the consumers. without any harmful effects of any kind that are associated with higher taxation. Anti-inflationary debt management also includes cancellation of public debt held by the central bank out of a budgetary surplus. this is sometimes called forced savings. It should be noted that it is only government borrowing from non-bank lenders that has a disinflationary effect. the effects of a large deficit budget. public debt may be managed in such a way that the supply of money in the country may be controlled. Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which. therefore a combination of fiscal and monetary tools can work together in achieving the desired outcome. is a sort of public borrowing). Government policy should therefore. • DIRECT MEASURES 39 . The government should avoid paying back any of its past loans during inflationary periods. private savings have a strong disinflationary effect on the economy and an increase in these is an important measure for controlling inflation. of course. suggested a programme of compulsory savings. which are redeemable after a particular period of time. Additionally. can be partially offset by covering the deficit through public borrowings.

However. rationing becomes essential when necessities. In times of the severe scarcity of certain goods. therefore the total effective demand for goods and services. Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. 40 . beyond which prices of particular goods may not increase. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons. food grains. inflation is suppressed. even though there may be a pressure of excessive demand forcing it up. producers cannot raise the price beyond a specified level. On the other hand. Therefore. Ceilings on wages and profits keep down disposable income and. Another control measure that was suggested is the control of wages as it often becomes necessary in order to stop a wage-price spiral. depending upon the balance of payments situation. restrictions on imports may also help to increase supplies of essential commodities and ease the inflationary pressure. Under price control. government may have to enforce rationing. During galloping inflation. are relatively scarce. such as food grains. along with price control. to make the commodity more available to a larger number of households. it means prices are not allowed to rise further and so. Similarly. exports may also be reduced in an effort to increase the availability of the domestic supply of essential commodities so that inflation is eased. such as. When ceiling prices are fixed and enforced. The function of price control is a fix a legal ceiling.Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. Rationing has the effect of limiting the variety of quantity of goods available for the good cause of price stability and distributive impartiality. this is possible only to a limited extent. it may be necessary to apply a wage-profit freeze. particularly.

monetary and fiscal controls may be used to repress excess demand but direct controls can be more useful when they are applied to specific scarcity areas. Welcome to one of the myriad ways in which bankers have been trying to innovate. innovation has become the hottest banking game in town. They’re bringing ATMs. taken from Tendon’s credit or debit card. anti-inflationary policies should involve varied programmes and cannot exclusively depend on a particular type of measure only. RECENT BANKING INNOVATIONS IN INDIAN HDFC Bank’s ‘Net Safe’ card is a one-time use card with a limit that’s specified. 41 . cash and even foreign exchange to their customers’ doorsteps. the card simply dies and the unspent amount in the temporary card reverts to his original credit or debit card. Even if Tandon fails to utilize the full amount within 24 hours of creating the card.In general. Indeed. As a result.

traffic jams and both spouses working). Don’t fret if you’ve already bought your house or car – you can do other things with both. for instance.5 lakh. Kotak Mahindra Bank. vice president. till it’s about five years old. Loans are available to all car owners for almost all brands of cars manufactured in India that are up to five years old. And if. If the balance tops Rs 1. It’s ready to come every step of the way for you to buy a house. the excess runs into Kotak’s liquid mutual fund. Kotak Mahindra Bank introduced a variant of the sweep-in account. “Even if the money is there only for the weekend. Standard Chartered. marketing. meanwhile. Your bank will tackle all this.” points out Shashi Arora. They also lend a hand with the cumbersome documentation formalities and the registration. you want to buy a big-ticket home theatre system.Want to buy a house but don’t want to go through the hassles of haggling with brokers and the mounds of paperwork? Not to worry. the minute you swipe your card the invested sum will return to your account. That’s not a small gain considering that your current account does not pay you any interest.5 per cent per annum. beyond conventional 42 . a liquid fund can earn you a clean 4. Last month. has property advisors to guide a customer through the entire process of selecting and buying a house. You can leverage your new house or car these days with banks like ICICI Bank and Stanchart ready to extend loans against either. Banks are also attempting to reach out to residents of metropolitan cities where people are pressed for time (what with long commuting hours.

HDFC Bank even has a 24-hour branch at Mumbai’s international airport. freedom to deploy capital. and support for creating industry utilities and service bureaus. ICICI Bank. for example. corporate governance.banking hours. Management success will be determined on three fronts: fundamentally upgrading organizational capability to stay in tune with the changing market. regulatory coverage. introduced eight to eight banking hours. some of the other private banks have also done this too. in major cities. labor reforms and human capital development. seven days of the week. INDIAN BANKING IN 2010 The interplay between policy and regulatory interventions and management strategies will determine the performance of Indian banking over the next few years. and continually 43 . adopting value-creating M&A as an avenue for growth. Not to be outdone. Legislative actions will shape the regulatory stance through six key elements: industry structure and sector consolidation.

. leaving managements free to drive far reaching changes.innovating to develop new business models to access untapped opportunities. as measured by total loans as a percentage of GDP. Management is able 44 . at one extreme. innovation and productivity. the sector could generate employment to the tune of 1. These actions will have dramatically different outcomes. Through these scenarios. nonperforming loan (NPL) write offs and investments in IT and human capital up gradation to reach the high-performing scenario.5 million compared to 0. 600 billion (US$ 14 billion) in capital to fund growth in advances. 2.400 billion. the costs of inaction or insufficient action will be high.3 per cent of GDP with a market cap of Rs. Today availability of capital would be a key factor — the banking sector will require as much as Rs. we can paint a picture of the events and outcomes that will be the consequence of the actions of policy makers and bank managements.9 million. Banking sector intermediation. policy makers intervene only to the extent required to ensure system stability and protection of consumer interests. Specifically. 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. while at the other it could account for just 3. Banking becomes an even greater driver of GDP growth and employment and large sections of the population gain access to quality banking products. the sector could account for over 7.500 billion in market cap. In all of this.7 per cent of GDP with over Rs. Three scenarios can be defined to characterize these outcomes: o HIGH PERFORMANCE In this scenario. 7. Changes in regulations and bank capabilities reduce intermediation costs leading to increased growth.

M&A activity is driven primarily by new private banks. some constraints still exist. Some M&A activity also begins to take place between private and public sector banks. it has still not come of age in comparison to developed markets. Funding this dramatic growth will require as much as Rs. while the sector emerges as an important driver of the economy and wealth in 2010. which take over some old private banks and also merge among 45 . As a result of this. Significant changes are still required in policy and regulation and in capabilitybuilding measures. foreign and new private banks grow at rates of 50 per cent. focus on industry consolidation and transform the banks into industry shapers. Thus. Foreign banks begin to be active in M& overhaul bank organizational structures. buying out some old private and newer private banks. In this scenario we witness consolidation within public sector banks (PSBs) and within private sector banks. especially by public sector and old private sector banks.5 per cent.7 per cent. In this scenario. 600 billion in capital over the next few years. As a result. Processes to create highly efficient organizations have been initiated but most banks are still not best-in-class operators. from current levels of 2. o EVOLUTION Policy makers adopt a pro-market stance but are cautious in liberalizing the industry. The share of banking sector value adds in GDP increases to over 7. 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 to GDP increases to over 4. This scenario sees limited consolidation in the sector and most banks remain sub-scale. This will spur on the performance of the sector. The share of foreign banks remains at 7 per cent of total assets. o STAGNATION In this scenario.7 per cent. while that of foreign banks increases to over 12 per cent of total assets. growth and productivity levels are low and the banking sector is unable to support a fast-growing economy. refers to the Ministry of Finance and the RBI and includes the other relevant government and regulatory entities for the banking sector. There is a slowdown in PSB and old private sector bank growth. growth of these banks increases to 35 per cent. Banking sector value adds meanwhile.3 per cent of GDP. Foreign banks also grow faster at 30 per cent due to a relaxation of some regulations. New private sector banks continue on their growth trajectory of 25 per cent. The coordinated efforts between the various entities are required to enable positive action. NEED TO CREATE A MARKET DRIVEN BANKING SECTOR o WITH ADEQUATE FOCUS ON SOCIAL DEVELOPMENT The term “policy makers”. As a result.themselves. 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. from current levels of 18 per cent. is only 3. As a result. The policy makers need to make coordinated efforts on six fronts: 46 . The share of private sector banks increases to 30 per cent of total sector assets.

47 . payments.• Help shape a superior industry structure in a phased manner through “managed consolidation” and by enabling capital availability. back-office utilities) to help the banking sector focus on core activities. • Create a unified regulator. credit bureaus.. asset reconstruction companies (ARCs). 6-8 national banks controlling 20-25 per cent of the market. private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets. • Improve corporate governance primarily by increasing board independence and accountability. in a phased manner to overcome supervisory difficulties and reduce compliance costs. • 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.g. and the rest being specialist players (geographical or product/ segment focused). This would create 3-4 global sized banks controlling 35-45 per cent of the market in India. • Accelerate the creation of world class supporting infrastructure (e. 4-6 foreign banks with 15-20 per cent share in the market. distinct from the central bank of the country.

focusing on enriching human capital. • Old private sector banks also have the need to fundamentally strengthen skill levels.. developing and retaining more leadership capacity would be key to achieving this and would pose the biggest challenge. Attracting.e. However. there will be common themes across classes of banks: • PSBs need to fundamentally strengthen institutional skill levels especially in sales and mar marketing. 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. actively adopting acquisitions as a means to grow and reaching the next level of performance in their service platforms. i. service operations. 48 . to help public sector and old private banks become competitive. However. • 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.• Enable labor reforms. risk management and the overall organizational performance ethic. The last. o NEED FOR DECISIVE ACTION BY BANK MANAGEMENT Management imperatives will differ by bank. strengthening human capital will be the single biggest challenge.

Economy of any country faces lots of challenges and problems. CONCLUSION We can conclude that the financial sector is a nerve system of Indian economy. The financial sector makes the economy efficient to the extent where it can rival other developed economies in the world. The extent to which Indian policy makers and bank managements develop and execute such a clear and complementary agenda to tackle emerging discontinuities will lay the foundations for a high-performing sector in 2010. At the same time. To tackle those problems financial sector plays a vital role.• 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. they should stay in the game for potential acquisition opportunities as and when they appear in the near term. Banking plays an important role in development of economy. Maintaining a fundamentally longterm value-creation mindset will be their greatest challenge. 49 . For steady growth in economy innovations and development in financial sector is very important.

BIBLIOGRAPHY  FINANCIAL SRVICES AND MARKET GORDAN AND NATRAJAN  INDIAN BANKING SYSTEM V. BHALLA 50 .K.Financial sector also faces lots of problems but it should develop certain strategies to come out of these problems which is very important for healthy growth of economy.


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