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A retrospect of the events clearly indicates that the Indian banking sector
has come far away from the days of nationalization. The Narasimham
Committee laid the foundation for the reformation of the Indian banking
sector. Constituted in 1991, the Committee submitted two reports, in
1992 and 1998, which laid significant thrust on enhancing the efficiency
and viability of the banking sector. As the international standards became
prevalent, banks had to unlearn their traditional operational methods of
directed credit, directed investments and fixed interest rates, all of which
led to deterioration in the quality of loan portfolios, inadequacy of capital
and the erosion of profitability.

The recent international consensus on preserving the soundness of the

banking system has veered around certain core themes. These are:
effective risk management systems, adequate capital provision, sound
practices of supervision and regulation, transparency of operation,
conducive public policy intervention and maintenance of macroeconomic
stability in the economy.

Until recently, the lack of competitiveness vis-à-vis global standards, low

technological level in operations, over staffing, high NPAs and low levels
of motivation had shackled the performance of the banking industry.

However, the banking sector reforms have provided the necessary

platform for the Indian banks to operate on the basis of operational
flexibility and functional autonomy, thereby enhancing efficiency,
productivity and profitability. The reforms also brought about structural
changes in the financial sector and succeeded in easing external
constraints on its operation, i.e. reduction in CRR and SLR reserves,
capital adequacy norms, restructuring and recapitulating banks and
enhancing the competitive element in the market through the entry of
new banks.

The reforms also include increase in the number of banks due to the entry
of new private and foreign banks, increase in the transparency of the
banks’ balance sheets through the introduction of prudential norms and
increase in the role of the market forces due to the deregulated interest
rates. These have significantly affected the operational environment of
the Indian banking sector.

To encourage speedy recovery of Non-performing assets, the Narasimham

committee laid directions to introduce Special Tribunals and also lead to
the creation of an Asset Reconstruction Fund. For revival of weak banks,
the Verma Committee recommendations have laid the foundation. Lastly,
to maintain macroeconomic stability, RBI has introduced the Asset
Liability Management System.

The East-Asian crisis has demonstrated the vital importance of financial

institutions in sustaining the momentum of growth and development. It is
no longer possible for developing countries like India to delay the
introduction of these reforms of strong prudential and supervisory norms,
in order to make the financial system more competitive, more transparent
and more accountable.

The competitive environment created by financial sector reforms has

nonetheless compelled the banks to gradually adopt modern technology
to maintain their market share. Thus, the declaration of the Voluntary
Retirement Scheme accounts for a positive development reducing the
administrative costs of Public Sector banks. The developments, in general,
have an emphasis on service and technology; for the first time that Indian
public sector banks are being challenged by the foreign banks and private
sector banks. Branch size has been reduced considerably by using
technology thus saving manpower.

The deregulation process has resulted in delivery of innovative financial
products at competitive rates; this has been proved by the increasing
divergence of banks in retail banking for their development and survival.

In order to survive and maintain strong presence, mergers and

acquisitions has been the most common development all around the
world. In order to ensure healthy competition, giving customer the best of
the services, the banking sector reforms have lead to the development of
a diversifying portfolio in retail banking, and insurance, trend of mergers
for better stability and also the concept of virtual banking.

The Narasimham Committee has presented a detailed analysis of various

problems and challenges facing the Indian banking system and made
wide-ranging recommendations for improving and strengthening its




1.1 Introduction 01
1.2 Reduction of SLR and CRR 04
1.3 Minimum Capital Adequacy Ratio 07
1.4 Prudential Norms 11
1.5 Disclosure Norms 17
1.6 Rationalisation of Foreign Operations in India

1.7 Special Tribunals and Asset Reconstruction Fund
1.8 Restructuring of Weak Banks 26
1.9 Asset Liability Management System
1.10 Reduction of Government Stake in PSBs
1.11 Deregulation of Interest Rate 39


2.1 Introduction 42
2.2 Voluntary Retirement Scheme 43
2.3 Universal Banking 52
2.4 Mergers and Acquisition 56
2.5 Banking and Insurance 62
2.6 Rural Banking 65
2.7 Virtual Banking 71
2.8 Retail Banking 73

3.1 The SCAM Story 74
3.2 Public Sector OR Private Sector – Point of
Views 76 3.3 And today... the
news say. . . 83
3.4 Future … what’s ahead 86
3.5 Conclusion 88

List of Illustrations and Visual Aids

Illustration Title Page no.

1 Trends in CRR and SLR 6
2 Growth In Investments In Government 10
Securities by Banks
3 Classification of Loan Assets of SCBs 15
4 Indian Banks: Trend in ROE 22
5 Capital Contributed by Government 37
6 Income and Expenses Profile of banks 41
7 VRS trends in Banks 50
8 ICICI pre merger and post merger 60
9 scenario 61
10 Comparison of classes of banks 70
Lendings in Rural India

List of Annexures

Annexure 1: List of banks 90

Annexure 2: Questionnaire 93

1.1 Introduction

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

The main recommendations of the Committee were: -

i. Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a

period of five years
ii. Progressive reduction in Cash Reserve Ratio (CRR)

iii. Phasing out of directed credit programmes and redefinition of the

priority sector
iv. Deregulation of interest rates so as to reflect emerging market
v. Stipulation of minimum capital adequacy ratio of 4 per cent to risk
weighted assets by March 1993, 8 per cent by March 1996, and 8
per cent by those banks having international operations by March

vi. Adoption of uniform accounting practices in regard to income
recognition, asset classification and provisioning against bad and
doubtful debts
vii. Imparting transparency to bank balance sheets and making more
viii. Setting up of special tribunals to speed up the process of recovery
of loans
ix. Setting up of Asset Reconstruction Funds (ARFs) to take over from
banks a portion of their bad and doubtful advances at a discount
x. Restructuring of the banking system, so as to have 3 or 4 large
banks, which could become international in character, 8 to 10
national banks and local banks confined to specific regions. Rural
banks, including RRBs, confined to rural areas
xi. Abolition of branch licensing

xii. Liberalising the policy with regard to allowing foreign banks to open
offices in India
xiii. Rationalisation of foreign operations of Indian banks

xiv. Giving freedom to individual banks to recruit officers

xv. Inspection by supervisory authorities based essentially on the

internal audit and inspection reports
xvi. Ending duality of control over banking system by Banking Division
and RBI
xvii. A separate authority for supervision of banks and financial
institutions which would be a semi-autonomous body under RBI
xviii. Revised procedure for selection of Chief Executives and Directors
of Boards of public sector banks
xix. Obtaining resources from the market on competitive terms by DFIs

xx. Speedy liberalisation of capital market

xxi. Supervision of merchant banks, mutual funds, leasing companies
etc., by a separate agency to be set up by RBI and enactment of a
separate legislation providing appropriate legal framework for
mutual funds and laying down prudential norms for such
institutions, etc.

Several recommendations have been accepted and are being

implemented in a phased manner. Among these are the reductions in
SLR/CRR, adoption of prudential norms for asset classification and
provisions, introduction of capital adequacy norms, and deregulation of
most of the interest rates, allowing entry to new entrants in private sector
banking sector, etc.

Keeping in view the need of further liberalisation the Narasimham

Committee II on Banking Sector reform was set up in 1997. This
committee’s terms of reference included review of progress in reforms in
the banking sector over the past six years, charting of a programme of
banking sector reforms required to make the Indian banking system more
robust and internationally competitive and framing of detailed
recommendations in regard to make the Indian banking system more
robust and internationally competitive.

This committee constituted submitted its report in April 1998. The major
recommendations are :

i. Capital adequacy requirements should take into account market

risks also
ii. In the next three years, entire portfolio of Govt. securities should be
marked to market
iii. Risk weight for a Govt. guaranteed account must be 100 percent

iv. CAR to be raised to 10% from the present 8%; 9% by 2000 and 10%
by 2002
v. An asset should be classified as doubtful if it is in the sub-standard
category for 18 months instead of the present 24 months
vi. Banks should avoid ever greening of their advances
vii.There should be no further re-capitalization by the Govt.
viii.NPA level should be brought down to 5% by 2000 and 3% by 2002.
ix. Banks having high NPA should transfer their doubtful and loss
categories to ARCs which would issue Govt. bonds representing the
realisable value of the assets.
x. International practice of income recognition by introduction of the
90-day norm instead of the present 180 days.
xi. A provision of 1% on standard assets is required.
xii.Govt. guaranteed accounts must also be categorized as NPAs under
the usual norms
xiii.There is need to institute an independent loan review mechanism
especially for large borrowal accounts to identify potential NPAs.
xiv.Recruitment of skilled manpower directly from the market be given
urgent consideration
xv.To rationalize staff strengths, an appropriate VRS must be
xvi.A weak bank should be one whose accumulated losses and net
NPAs exceed its net worth or one whose operating profits less its
income on recap bonds is negative for 3 consecutive years.

To start with, it has assigned a 2.5 per cent risk-weightage on gilts by

March 31, 2000 and laid down rules for provisioning; shortened the life of
sub-standard assets from 24 months to 18 months (by March 31, 2001);
called for 0.25 per cent provisioning on standard assets (from fiscal 2000);

100 per cent risk weightage on foreign exchange (March 31, 1999) and a
minimum capital adequacy ratio of 9 per cent as on March 31, 2000.

Only a few of these mainly constitute to the reforms in the banking sector.


1.2 Reduction of SLR and

The South East Asian countries introduced banking reforms wherein bank
CRR and SLR was reduced, this increased the lending capacity of banks.
The markets fell precipitously because banks and corporates did not
accurately measure the risk spread that should have been reflected in
their lending activities. Nor did they manage such risks or provide for
them in their balance sheets. And followed the South East Asian Crisis.

The monetary policy perspective essentially looks at SLR and CRR

requirements (especially CRR) in the light of several other roles they play
in the economy. The CRR is considered an effective instrument for
monetary regulation and inflation control. The SLR is used to impose
financial discipline on the banks, provide protection to deposit-holders,
allocate bank credit between the government and the private sectors, and
also help in monetary regulation. However bankers strongly feel that
these along with high non-performing assets (on which banks do not earn
any return) 10 percent CRR and 25 percent SLR (most banks have SLR
investments way above the stipulation) are affecting banks' bottomlines.
With an effective return of a mere 2.8 per cent, CRR is a major drag on
banks' profitability.

The Narasimham Committee had argued for reductions in SLR on the

grounds that the stated government objective of reducing the fiscal
deficits will obviate the need for a large portion of the current SLR.
Similarly, the need for the use of CRR to control secondary expansion of
credit would be lesser in a regime of smaller fiscal deficits. The
committee offered the route of Open Market Operations (OMO) to the
Reserve Bank of India for further monetary control beyond that provided
by the (lowered) SLR and CRR reserves. Ultimately, the rule was
Reduction in the reserve requirements of banks, with the Statutory

Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-97 in a
period of 5 years.

The recent trend in several developed countries (US, Switzerland,

Australia, Canada, and Germany) towards drastic lowering of reserve
requirements is often used to support the argument for reduced reserve
levels in India.

The arguments for higher or lower SLR and CRR ratios stem from two
different perspectives one which favours the banks, and the other which
favours the bank reserves as a monetary policy instrument. The bank
perspective seeks to maximise "lendable" resources, the banks' control
over resource deployment, and returns to the banks from the
"preempted" funds. It is also claimed that the low returns from the forced
investments in government securities adversely affect the bank
profitability - the cost of deposits for banks, which averages at 15-16 per
cent, was much greater than the (earlier) returns on the government
securities. This argument is sometimes carried further to state that RBI
makes profits on impounded money, at the cost of bank profitability. To
some extent, this argument has been weakened by the increase in
interest on government securities to 13.5 per cent.

Some problems with the stated aim of reducing SLR and CRR are:

1. The supporting condition of smaller fiscal deficits is not

happening in reality
2. Open market operations have not been used to any significant
extent in India for monetary control. The time required for
gaining experience with the use of such operations would be
much more than 5-6 years.

3. A commitment to a unidirectional movement of these vital
controls irrespective of the effects on, and the response of, other

economic factors (such as inflation), would be unwise.

This scenario thus indicates that despite the stated aim of reductions in
SLR and CRR, RBI may be forced to revert to higher reserve levels, if the
economic indicators become unfavourable, and RBI has already indicated
as much. Bank investment are, therefore, not likely to stabilize in the
near future.

The RBI had announced an increase in interest rate on CRR balance to 6%

from the present 4%. This will certainly boost the profits of banks, as they
have to maintain a minimum balance of 8% with the RBI.

Trends in CRR and SLR 1993 – 2001



Percentage of DTL





May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May-
93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01


1.3 Minimum Capital
Illustration 1 Adequacy

The committee recommended a Stipulation of minimum capital adequacy

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

Capital Adequacy

The growing concern of commercial banks regarding international

competitiveness and capital ratios led to the Basle Capital Accord 1988.
The accord sets down the agreement to apply common minimum capital
standards to their banking industries, to be achieved by year-end 1992.
Based on the Basle norms, the RBI also issued similar capital adequacy
norms for the Indian banks. According to these guidelines, the banks will
have to identify their Tier-I and Tier-II capital and assign risk weights to
the assets. Having done this they will have to assess the Capital to Risk
Weighted Assets Ratio (CRAR). The minimum CAR that the Indian banks
are required to meet is set at 9 percent.

• Tier-I Capital, comprising of

Paid-up capital
Statutory Reserves
Disclosed free reserves
Capital reserves representing surplus arising out of sale
proceeds of assets

• Tier-II Capital, comprising of

Undisclosed Reserves and Cumulative Perpetual Preference Shares

Revaluation Reserves
General Provisions and Loss Reserves

The Narasimham Committee had recommended that the capital adequacy

norms set by the Bank of International Settlements (BIS) be followed by
the Indian banks also. The BIS norm for capital adequacy is 8 per cent of
risk-weighted assets.


The structural inadequacy that is said to be responsible for the stock

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

The banking sector specialists have traditionally claimed that capital plays
several roles in all "depository institutions", such as banks. However,
these roles can vary significantly between the public sector banks and
those in the private sector. The justification for capital adequacy norms

for banks is brought out by the following arguments:

 Capital lowers the probability of bank failure more capital means

added ability to withstand unexpected losses, and more time for
the bank to work through potentially fatal problems. At the same
time, the Indian public sector banks may attract more
"punishments" in the form of politically motivated "loan waivers",
"loan melas", and non-performing assets.

 Capital increases the disincentive for the bank management to

take excessive risk: If significant amount of their own funds are
at stake, the equity-owners have a powerful incentive to control
the amount of risk the bank incurs. This may remain true for the
public sector banks only if the government acts as a vigilant
shareholder. However, the government's ability to play such a
role effectively is suspect. The Indian banks have traditionally
shown risk-aversion, but the recent stock scam showed that the
banks are perhaps being forced to take excessive risks to
improve the profitability. Since management control will remain
with bureaucrats - banking or government - the source of capital
would not make much difference in the Indian scenario.
 Capital acts as a buffer between the bank and the deposit
guarantee corporation (funded by the tax-payer): while this is
true for the private banks, the government-owned capital in the
public sector banks is itself taxpayer money.
 Capital helps avoid "credit crunches": a well-capitalized bank can
continue to lend in the face of losses. Similar losses might force
a poorly capitalized bank to restrict credit (to increase capital
ratios). In an economic downturn, well-capitalized banks may
provide a vital source of continuing credit.
 Capital increases the long-term competitiveness: more capital
allows a bank to build long-term customer relationships, and

respond to positive as well as negative changes in the economic
environment. New opportunities can be quickly made use of by
lending appropriately. If the bank is not constrained by capital, it
can give valuable time to customers with temporary repayment
problems. It can thereby recover more from the loans, which
would otherwise have to be called in.

The Dilemma
The foregoing discussion clearly brings out two conclusions: (a) increasing
the capital base of the nationalised banks is necessary, especially in view
of the large quantities of non-performing assets; and (b) however,
increase in capital owned directly by the government has several
attendant problems' The situation is complicated by the fact that " private
management" does not provide an answer in India, because of the size of
the institutions involved. Also, talent and expertise in bank management
is available mainly in the existing nationalised banks.

One short-term fallout of the capital adequacy norms has been the
massive increases in investments by the banks in government securities.
Since the risk-weight of government securities is zero, investments in
them do not add to the capital requirements. The banks are therefore
choosing to deploy funds mobilised through deposits in these long-term

In the first ten months of 1993-94, for example, the investments in

government securities shot up by 18.8 per cent while bank credit grew at
only 6.6 per cent. Despite a strong growth in aggregate deposits of 13.8

per cent, credit grew by only 6.65 per cent, while investments surged by
18.8 per cent. The problem with this practice of the banks is that it can
upset the balance of maturity patterns between deposits (many of ' which
are short-term) and investments (which have 10 year maturities). Now,
banks would have to develop much better investment management skills,
especially when interest rates are deregulated, and significant open
market operations are started.

Growth In Investments In Government Securities by Banks

1991- 1992- 1992-93 1993-94

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

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

Illustration 2

1.4 Prudential Norms

To get a true picture of the profitability and efficiency of the Indian Banks,
a code stating adoption of uniform accounting practices in regard to
income recognition, asset classification and provisioning against bad and
doubtful debts has been laid down by the Central Bank. Close to 16 per
cent of loans made by Indian banks were NPAs - very high compared to
say 5 per cent in banking systems in advanced countries.

Magnitude of the problem

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

What is ever greening or rescheduling of loans?

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

Asset Quality - Increased Transparency

Apart from the interest rate structure, the net interest income is also
affected by the asset quality of the bank. Asset quality is reflected by the
quantum of non-performing assets (NPAs) – the higher the level of NPAs,
the lower will be the asset quality and vice versa. Courtesy the

nationalization agenda and the directed credit, most of the public sector
banks were burdened with huge NPAs. While the government did
contribute to write-off these bad loans, the problem still remains. NPAs
expose the banks to not just credit risk but also to liquidity risk.
Considering the implications of the NPAs and also for imparting greater
transparency and accountability in banks operations and restoring the
credibility of confidence in the Indian financial system, the RBI introduced
prudential norms and regulations. The prudential norms which relate to
income recognition, asset classification and provisioning for bad and
doubtful debts serve two primary purposes – firstly, they bring out the
true position of a Bank’s loan portfolio, and secondly, they help
in arresting its deterioration.

The asset quality of the bank and its capital are closely associated. If the
assets of the bank go bad it is the capital that comes to its rescue. Implies
that the bank should have adequate capital to face the likely losses that
may arise from its risky assets. In the changed business environment,
where banks are exposed to greater and different types of risk, it
becomes essential to have a good capital base, which can help it sustain
unforeseen losses. As stated earlier, the one major move in this direction
was brought about by the Basle Committee, which laid the capital
standards that banks have to maintain. This became imperative, as banks
began to cross over their national boundaries and begin to operate in
international markets. Following the Basle Committee measures, RBI also
issued the Capital Adequacy Norms for the Indian banks also.


 The regulation for income recognition states that the Income on NPAs
cannot be booked.

Interest income should not be recognized until it is realized. An NPA is
one where interest is overdue for two quarters or more. In
respect of NPAs, interest is not to be recognized on accrual basis, but is to
be treated as income only when actually received. Income in respect of
accounts coming under Health Code 5 to 8 should not be recognized until
it is realized. As regards to accounts classified in Health Code 4, RBI has
advised the banks to evolve a realistic system for income recognition
based on the prospect of realisability of the security. On non-performing
accounts the banks should not charge or take into account the interest.

Income-recognition norms have been tightened for consortium banking

too. Member banks have to intimate the lead-bank to arrange for their
share of recovery. They will no more have the privilege of stating that the
borrower has parked funds with the lead-bank or with a member-bank and
that their share is due for receipt. The new notifications emanated after
deliberations held between the RBI and a cross-section of banks after a
working group headed by chartered accountant, PR Khanna, submitted its
report. The working group was set after the RBI’s Board for Financial
Supervision (BFS) wanted divergences in NPA accounting norms by banks
from central bank guidelines to be addressed. The working group had
identified three areas of divergence: non-compliance with RBI norms;
subjectivity arising out of the flexibility in norms; and differences in the
valuation of securities by banks, auditors and RBI.

As of now, for income recognition norms, the RBI has suggested that the
international norm of 90 days be implemented in a phased manner by
2002. The current norm is 180 days.


While new private banks are careful about their asset quality and
consequently have low non-performing assets (NPAs), public sector banks
have large NPAs due to wrong lending policies followed earlier and also
due to government regulations that require them to lend to sectors where
potential of default is high. Allaying the fears that bulk of the Non-
Performing Assets (NPAs) was from priority sector, NPA from priority sector
constituted was lower at 46 per cent than that of the corporate sector at
48 per cent.

Loans and advances account for around 40 per cent of the assets of SCBs.
However, delay/default in payment of interest and/or repayment of
principal has rendered a significant proportion of the loan assets non-
performing. As per RBI’s prudential norms, a Non-Performing Asset (NPA)
is a credit facility in respect of which interest/installment has remained
unpaid for more than two quarters after it has become past due. “Past
due” denotes grace period of one month after it has become due for
payment by the borrower. The Mid-Term Review of Monetary and Credit
Policy for 2000-01 has proposed to discontinue this concept with effect
from March 31, 2001.

Regulations for asset classification

Assets should be classified into four classes - Standard, Sub-standard,

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

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

Sub-standard Asset: An asset which remains as NPA for a period

exceeding 24 months, where the current net worth of the borrower,
guarantor or the current market value of the security charged to the bank
is not enough to ensure recovery of the debt due to the bank in full.

Doubtful Assets: An NPA which continued to be so for a period

exceeding two years (18 months, with effect from March, 2001, as
recommended by Narasimham Committee II, 1998).

Loss Assets: An asset identified by the bank or internal/ external

auditors or RBI inspection as loss asset, but the amount has not yet been
written off wholly or partly.

The banking industry has significant market inefficiencies caused by the

large amounts of Non Performing Assets (NPAs) in bank portfolios,
accumulated over several years. Discussions on non-performing assets
have been going on for several years now. One of the earliest writings on
NPAs defined them as "assets which cannot be recycled or disposed off
immediately, and which do not yield returns to the bank, examples of
which are: Overdue and stagnant accounts, suit filed accounts, suspense
accounts and miscellaneous assets, cash and bank balances with other
banks, and amounts locked up in frauds".

The following Table shows the distribution of total loan assets of banks in
the public private sectors and foreign banks for 1997-98 through 1999-
2000. It is worth noting that the ratio of incremental standard assets of
SCBs to their total loan assets increased from 83.1 per cent in 1998-99 to
97.2 percent in 1999-2000. In other words, the ratio of incremental NPAs

of SCBs to their total loan assets declined significantly from 16.9 per cent
in 1998-99 to 2.8 percent in 1999-2000.

Classification of Loan Assets of SCBs

(Percentage distribution of total loan assets)

Assets Public Private Foreign SCBs

A. Standard
1997-98 84.0 91.3 93.6 85.6
1998-99 86.1 91.2 92.4 85.3
1999-2000 86.0 91.5 93.0 87.2
B. Sub-standard
1997-98 5.0 5.8 3.9 4.9
1998-99 4.9 6.2 4.0 5.0
1999-2000 4.3 3.7 2.9 5.1
C. Doubtful
1997-98 9.1 0.9 1.7 1.8
1998-99 4.0 0.9 2.0 1.9
1999-2000 1.7 0.8 1.9 1.6
D. Loss
1997-98 1.9 0.9 1.2 1.8
1998-99 2.0 0.9 2.0 1.9
1999-2000 1.7 0.8 1.9 1.6
E. Total Assets (Rs. Crore)
1997-98 284971 36753 30972 352696
1998-99 325328 43049 31059 399436

1999-2000 380077 58249 37432 475758

Note: Addition of percentages for B to D may not add up to 100 minus the
percentage share of standard assets (A) due to rounding.
Illustration 3
The asset classification norms have resulted in a huge quantity of assets
being classified into the sub-standard, doubtful, and loss assets. As at 31
March 1993, the total of Non-Performing Assets (NPAs) for the public
sector banks (SBI, its seven associates, and 20 nationalised banks) stood
at Rs 36,588 crores. Of these, the sub-standard assets account for Rs
12,552 crores, doubtful assets Rs 20,106 crores, and loss assets Rs 3,930
crores (RBI Bulletin, 1994). For the future, the banks will have to tighten
their credit evaluation process to prevent this scale of sub-standard and
loss assets. The present evaluation process in several banks is burdened
with a bureaucratic exercise, sometimes involving up to 18 different
officials, most of whom do not add any value (information or judgment) to
the evaluation.


Banks will be required to make provisions for bad and doubtful debts on a
uniform and consistent basis so that the balance sheets reflect a true
picture of the financial status of the bank. The Narasimham Committee
has recommended the following provisioning norms

(i) 100 per cent of loss assets or 100 per cent of out standings for loss
(ii) 100 per cent of security shortfall for doubtful assets and 20 per cent to
50 per cent of the secured portion; and
(iii) 10 per cent of the total out standings for substandard assets.

A provision of 1% on standard assets is required as suggested by
Narasimham Committee II 1998. Banks need to have better credit
appraisal systems so as to prevent NPAs from occurring. The most
important relaxation is that the banks have been allowed to make
provisions for only 30 per cent of the "provisioning requirements" as
calculated using the Narasimham Committee recommendations on
provisioning (but with the diluted asset classification). The nationalised
banks have been asked to provide for the remaining 70 per cent of the
"provisioning requirements" by 31 March 1994. The encouraging profits
recently declared by several banks have to be seen in the light of
provisions made by them - Rs 10,390 crores pertaining to 1992-93, and
the additional provisions for 1993-94. To the extent that provisions have
1.5 would
not been made, the profits Disclosure
be fictitious. Norms

Banks should disclose in balance sheets maturity pattern of advances,

deposits, investments and borrowings. Apart from this, banks are also
required to give details of their exposure to foreign currency assets and
liabilities and movement of bad loans. These disclosures were to be made
for the year ending March 2000

In fact, the banks must be forced to make public the nature of NPAs being
written off. This should be done to ensure that the taxpayer’s money
given to the banks as capital is not used to write off private loans without
adequate efforts and punishment of defaulters.

# A Close look: For the future, the banks will have to tighten their credit
evaluation process to prevent this scale of sub-standard and loss assets.
The present evaluation process in several banks is burdened with a
bureaucratic exercise, sometimes involving up to 18 different officials,
most of whom do not add any value (information or judgment) to the
evaluation. But whether this government and its successors will continue
to play with bank funds remains to be seen. Perhaps even the loan
waivers and loan "melas" which are often decried by bankers form only a
small portion of the total NPAs. As mentioned above, much more
stringent disclosure norms are the only way to increase the
accountability of bank management to the taxpayers . A lot
therefore depends upon the seriousness with which a new regime of
regulation is pursued by RBI and the newly formed Board for Financial

RBI norms for consolidated PSU bank accounts

The Reserve Bank of India (RBI) has moved to get public sector banks to
consolidate their accounts with those of their subsidiaries and other
outfits where they hold substantial stakes.
Towards this end, RBI has set up a working group recently under its
Department of Banking Operations and Development to come out with
necessary guidelines on consolidated accounts for banks. The move is
aimed at providing the investor with a better insight into viewing a bank's
performance in totality, including all its branches and subsidiaries, and
not as isolated entities. According to a banker, earlier subsidiaries were
floated as external independent entities wherein the accounting details
were not incorporated in the parent bank's balance sheet, but at the same
time it was assumed that the problems will be dealt with by the parent.
This will be a path-breaking change to the existing norms wherein each
bank conducts its accounts without taking into consideration the
disclosures of its subsidiaries and other divisions for disclosure. As per the

proposed new policy guidelines, the banks will be required to consolidate
their accounts including all its subsidiaries and other holding companies
for better transparency.

# Result: This will require the banks to have a stricter monitoring system
of not only their own bank, but also the other subsidiaries in other sectors
like mutual funds, merchant banking, housing finance and others. This is
all the more important in the context of the recent announcements made
by some major public sector banks where they have said they would hive
off or close down some of their under performing subsidiaries.

The Investors Advantage

Getting all these accounts consolidated with that of the parent bank will
provide the investor a better understanding of the banks' performances
while deciding on their exposures. More so, since a number of public
sector banks are now listed entities whose stocks are traded on the stock
exchanges. Some public sector banks are even preparing their accounts in
line with US GAAP norms in anticipation of a US listing. These norms will
therefore be in line with the future plans of these banks as well. The
working group was set up following the need to bring about transparency
on the lines of international norms through better disclosures.

These new norms will necessitate not only that the problems are handled
by the parent, but investors are also aware of what exactly the problems
are and how they affect the bottomlines of the parent banks. Now, under
the new guidelines, this will no longer be an external disclosure to the
parent banks' books of accounts.

Rather, point out bankers, this will very much form an integral part of the
parent's balance sheet.

For instance, if a subsidiary is not performing well or making losses, this
will reflect in the parent's balance sheet.

1.6 Rationalisation of Foreign Operations

in India

Liberalising the policy with regard to allowing foreign banks to open

offices in India or rather Deregulation of the entry norms for private sector
banks and foreign sector.

Entry of New Banks in the Private Sector

As per the guidelines for licensing of new banks in the private sector
issued in January 1993, RBI had granted licenses to 10 banks. Based on a
review of experience gained on the functioning of new private sector
banks, revised guidelines were issued in January 2001. The main
provisions/requirements are listed below : -

• Initial minimum paid-up capital shall be Rs. 200 crore; this will be
raised to Rs. 300 crore within three years of commencement of
• Promoters’ contribution shall be a minimum of 40 per cent of the paid-
up capital of the bank at any point of time; their contribution of 40 per
cent shall be locked in for 5 years from the date of licensing of the
bank and excess stake above 40 per cent shall be diluted after one
year of bank’s operations.
• Initial capital other than promoters’ contribution could be raised
through public issue or private placement.
• While augmenting capital to Rs. 300 crore within three years,
promoters need to bring in at least 40 percent of the fresh capital,

which will also be locked in for 5 years. The remaining portion of fresh
capital could be raised through public issue or private placement.
• NRI participation in the primary equity of the new bank shall be to the
maximum extent of 40 per cent. In the case of a foreign banking
company or finance company (including multilateral institutions) as a
technical collaborator or a co-promoter, equity participation shall be
limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI
contribution to foreign equity can be met through contribution by
designated multilateral institutions.
• No large industrial house can promote a new bank. Individual
companies connected with large industrial houses can, however,
contribute up to 10 per cent of the equity of a new bank, which will
maintain an arms length relationship with companies in the promoter
group and the individual company/ies investing in equity. No credit
facilities shall be extended to them.
• NBFCs with good track record can become banks, subject to specified
• A minimum capital adequacy ratio of 10 per cent shall be maintained
on a continuous basis from commencement of operations.
• Priority sector lending target is 40 per cent of net bank credit, as in the
case of other domestic banks; it is also necessary to open 25 per cent
of the branches in rural/semi-urban areas.

"Our industry did not oppose the entry of private bankers because we
knew they will not be able to reach out to the rural markets” states, G.M.
Bhakey, president of the State Bank of India Officers Association. "Even
after privatisation not more than 10 per cent of the Indian population can
afford to open accounts in private banks."

Can the keenly supported private and foreign banks cater to the banking
needs of the people in India fairly? Takeover and merger dramas are in
progress in the world of private sector banks now and time only can tell

how many will live to render safe banking services in the days to come.
The bad debt figures even in the two to three year old new private sector
banks have crossed over 6% to the total advances, while the trends in the
old private banks are still higher, despite the fact that they have no social
commitment lendings in their portfolios.

In any case, the private banks, in the Indian context, cannot be the
alternative to our well-developed public sector banks. They are there in
the country to fill the private pockets with their typical selectivity of
business and costly operations. All those who beat their drums for the
privatisation parade, which is much on the move after globalisation, to
denationalise our public sector banks, do so with vested interests.

ICICI bank, HDFC bank, GTB, IndusInd, BOP and UTI Bank have come out
with IPOs as per licensing requirement. Their technological edge and
product innovation has seen them gaining market share from the slower,
less efficient older banks. These banks have targeted non-fund based
income as major source of revenue, with their level of contingent liabilities
being much higher then their other counterparts viz. PSU and old private
sector banks. The new private banks have been consistently gaining
market shares from the public sector banks. The major beneficiary of this
has been corporate clients who are most sought after now.

The new generation private sector banks have made a strong presence in
the most lucrative business areas in the country because of technology
upgradation. While, their operating expenses have been falling as
compared to the PSU banks, their efficiency ratios (employee’s
productivity and profitability ratios) have also improved significantly.

The new private sector banks have performed very well in the FY2000.
Most of these banks have registered an increase in net profits of over
50%. They have been able to make significant inroads in the retail market

of the public sector and the old private sector banks. During the year, the
two leading banks in this sector had set a new trend in the Indian banking
sector. HDFC Bank, as a part of its expansion plans had taken over Times
Bank. ICICI Bank became the first bank in the country to list its shares on

The Reserve Bank of India had advised the promoters of these banks to
bring their stake to 40% over a time period. As a result, most of these
banks had a foreign capital infusion and some of the other banks have
already initiated talks about a strategic alliance with a foreign partner.

The main problems concerning the nationalized / state sector banks are
as follows:

A. Large number of unprofitable branches

B. Excess staffing of serious magnitude
C. Non Performing Assets on account of politically directed lending and
industrial recession in last few years
D. Lack of computerization leading to low service delivery levels, non-
reconciliation of accounts, inability to control, misuse and fraud etc
E. Inability to introduce profitable new consumer oriented products like
credit cards, ATMs etc

The private’ edge

 Technology- The private banks have used technology to provide
quality service through lower cost delivery mechanisms. The
implementation of new technology has been going on at very rapid
pace in the private sector, while PSU banks are lagging behind in the

 Declining interest rates- in the present scenario of declining

interest rates, some of the new private banks are better able to

manage the maturity mix. PSU Banks by and large take relatively
long-term deposits at fixed rates to lend for working capital purposes
at variable rates. It therefore is negatively affected when interest
rates decline as it takes time to reduce interest rates on deposits
when lending has to be done at lower interest rates due to
competitive pressures.

 NPAs- The new banks are growing faster, are more profitable and
have cleaner loans. Reforms among public sector banks are slow, as
politicians are reluctant to surrender their grip over the deployment
of huge amounts of public money.

 Convergence- The new private banks are able to provide a range of

financial services under one roof, thus increasing their fee based

Illustration 4
Annexure 1
List of Banks Special
operating Tribunals and Asset
in India.
Reconstruction Fund

Setting up of special tribunals to speed up the process of recovery of

loans and setting up of Asset Reconstruction Funds (ARFs) to take over
from banks a portion of their bad and doubtful advances at a discount was
one of the crucial recommendations of the Narasimham Committee.

To expedite adjudication and recovery of debts due to banks and financial

institutions (FIs) at the instance of the Tiwari Committee (1984),
appointed by the Reserve Bank of India (RBI), the government enacted
the Debt Recovery Tribunal Act, 1993 (DRT). Accordingly, DRTs and
Appellate DRTs have been established at different places in the country.
The act was amended in January 2000 to tackle some problems with the
old act.

DRTs, a compulsion!
One of the main factors responsible for mounting non-performing assets
(NPAs) in the financial sector has been the inability of banks/FIs to enforce
the security held by them on loans gone sour. Prior to the passage of the
DRT Act, the only recourse available to banks/FIs to cover their dues from
recalcitrant borrowers, when all else failed, was to file a suit in a civil
court. The result was that by the late ’80s, banks had a huge portfolio of
accounts where cases were pending in civil courts. It was quite common
for cases to drag on interminably. In the interim, borrowers, more often
than not, stripped their premises of all assets so that that by the time the
final verdict came, there was nothing left of the security that had been
pledged to the bank.

The Advantage
DRTs, it was felt, would do away with the costly, time-consuming civil
court procedures that stymied recovery procedures since they follow a
summary procedure that expedites disposal of suits filed by banks/FIs.
Following the passage of the Act in August 1993, DRTs were set up at
Calcutta, Delhi, Bangalore, Jaipur and Ahmedabad along with an Appellate
Tribunal at Mumbai.

However, DRTs soon ran into rough weather. The constitutional validity of
the Act itself was questioned. It was only in March 1996, that the Supreme
court modified its earlier order — staying the operation of the Delhi High
Court order quashing the constitution of the DRT for Delhi — to allow the
setting up of three more DRTs in Chennai, Guwahati and Patna.
Subsequently, many more DRTs and ADRTs have been set up.

The truth undiscovered, CURRENT STATUS AND


Unfortunately, as a consequence of the numerous lacunae in the act and

the huge backlog of past cases where suits had been filed, DRTs failed to
make a significant dent. For instance, the tribunals did not have powers of
attachment before judgment, for appointment of receivers or for ordering
preservation of property.

Thus, legal infrastructure for the recovery of non-performing loans still

does not exist. The functioning of debt recovery tribunals has been
hampered considerably by litigation in various high courts. Complains
Bank of Baroda's Kannan: "Of the Rs 45,000-crore worth of gross NPAs,
over Rs 12,000 crore is locked up in the courts." So, the only solution to
the problem of high NPAs is ruthless provisioning. Till date, the banking
system has provided for about Rs 20,000 crore, which means it is still

stuck with net NPAs worth Rs 25,000 crore. Even that is an under estimate
as it does not include advances covered by government guarantees,
which have turned sticky. Nor does it include allowances for "ever
greening"--the practice of extending fresh advances to defaulting
corporates so that the prospective defaulter can make interest payments,
thus enabling the asset to escape the non-performing loan tag. Warns K.R.
Maheshwari, 60, Managing Director, IndusInd Bank: "NPA levels are going
to go up for all the banks." And so too will provisions.
Recent Developments

The recent amendment (Jan 2000) to the DRT Act addresses many of the
lacunae in the original act. It empowers DRTs to attach the property on the
borrower filing a complaint of default. It also empowers the presiding
officer to execute the decree of the official receiver based on the
certificate issued by the DRT. Transfer of cases from one DRT to another
has also been made easier. More recently, the Supreme Court has ruled
that the DRT Act will take precedence over the Companies Act in the
recovery of debt, putting to rest all doubts on that score.


As things stand, the DRT Act supersedes all acts other than The Sick
Industrial Companies Act (SICA). This means that recovery procedures can
still be stalled by companies declaring themselves sick under SICA. Once
the fact of their sickness has prima facie been accepted by the Board for
Industrial and Financial Reconstruction (BIFR), there is nothing a DRT can
do till such time as the case is disposed of by the BIFR. This lacuna too
must be addressed if DRTs are to live up to their promise.

The amendments would ensure speedy recovery of dues, iron out delays
at the DRT end, as well as ensure that promoters do not have the time
and opportunity to bleed their companies before they go into winding up.

Yet the number of cases pending before DRTs and courts make a telling
commentary on the inability of lenders to make good their threat. They
also reflect the ability of borrowers to dodge the lenders.

The main culprit for all this is the law. Existing recovery processes in the
country are aimed at recovering lenders' dues after a company has gone
sick and not nipping sickness in the bud. Since sickness is defined in law
as the erosion of capital of a company for three consecutive years, there
is little to recover from a sick company after it has been referred to the
Board of Industrial and Financial Revival (BIFR).

What's hurting banks now is the fact that these new issues have cropped
up even as they have been (unsuccessfully) wrestling with their NPAs
which, together, tot up to a staggering Rs 60,000 crore. The stratagem of
using Debt Recovery Tribunals has failed. Now these banks have to
explore the option of liquidating the assets of defaulting companies (a
litigitinous route), or writing off these debts altogether (which may not
find favour with shareholders). The solution could lie in better risk

1.8 Restructuring of Weak

How to deal with the weak Public Sector Banks is a major problem for the
next stage of banking sector reforms. It is particularly difficult because the
poor financial position of many of these banks is often blamed on the fact
that the regulatory regime in earlier years did not place sufficient
emphasis on sound banking, and the weak Banks are, therefore, not
responsible for their current predicament. This perception often leads to
an expectation that all weak Banks must be helped to restructure after
which they would be able to survive in the new environment.

Keeping in view the urgent need to revive the weak banks, the Reserve
Bank of India set up a Working Group in February, 1999 under the
Chairmanship of Shri M.S. Verma to suggest measures for the revival of
weak public sector banks in India.

 Identification of weak banks by using benchmarks for 7
critical ratios

 Recapitalisation of 3 weak banks conditional on their

achieving specified milestones

 Five-year freeze on all wage-increases, including the 12.25%

increase negotiated by the IBA

 A 25% reduction in staff-strength, either through VRSs or

through wage-cuts

 Branch rationalisation, including the closure of loss-making

foreign branches

 Transfer of non-performing assets to an Asset Reconstruction


 Reconstitution of bank boards to include professionals,

industrialists and financial experts

 Independent Financial Restructuring Authority to monitor

implementation of revival package

The major recommendations/points of the Working Group, which

submitted its Report in October, 1999, are listed below:-

 Seven parameters covering three areas have been identified;

these are (i) Solvency (capital adequacy ratio and coverage
ratio), (ii) Earning Capacity (return on assets and net interest
margin) and (iii) Profitability (ratio of operating profit to average

working funds, ratio of cost to income and ratio of staff cost to
net interest + income all other income).

 Restructuring of weak banks should be a two-stage operation;

stage one involves operational, organisational and financial
restructuring aimed at restoring competitive efficiency; stage
two covers options of privatisation and/or merger.

 Operational restructuring essentially involves building up

capabilities to launch new products, attract new customers,
improve credit culture, secure higher fee-based earnings, sell
foreign branches (Indian Bank and UCO Bank) to prospective
buyers including other public sector banks, and pull out from the
subsidiaries (Indian Bank), establish a common networking and
processing facility in the field of technology, etc.

 The action programme for handling of NPAs should cover

honouring of Government guarantees, better use of compromises
for reduction of NPAs based on recommendations of the
Settlement Advisory Committees, transfer of NPAs to ARF
managed by an independent AMC,etc.

 To begin with, ARF may restrict itself to the NPAs of the three
identified weak banks; the fund needed for ARF is to be provided
by the Government; ARF should focus on relatively larger NPAs
(Rs. 50 lakh and above).

 A 30-35 percent reduction in staff cost required in the three

identified weak banks to enable them to reach the median level
of ratio of staff cost to operating income.

 In order to control staff cost, the three identified weak banks
should adopt a VRS covering at least 25 percent of the staff
strength; for the three banks taken together, the estimated cost
of VRS ranges from Rs. 1100 to Rs. 1200 crore.

 The organisational restructuring includes delayering of the

decision making process relating to credit, rationalisation of
branch network, etc.

 Experts have also suggested the concept of narrow banking,

where only strong and efficient banks will be allowed to give
commercial loans, while the weak banks will take positions in
less risky assets such as government securities and inter-bank

The three identified banks on committee recommendations were UCO

bank, United Bank of India and Indian Bank.

In August 2001, the government of India directed UCO Bank to shut down
800 branches and also 4 international operations in line with the Verma
committee recommendation on sick banks. Three more PSBs declared sick
are Dena Bank, Allahabad Bank and Punjab and Sindh Bank. UCO bank
had been posting losses for the past eleven years.

1.9 Asset Liability Management

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

The necessity
The asset-liability management in the Indian banks is still in its nascent
stage. With the freedom obtained through reform process, the Indian
banks have reached greater horizons by exploring new avenues. The
government ownership of most banks resulted in a carefree attitude
towards risk management. This complacent behavior of banks forced the
Reserve Bank to use regulatory tactics to ensure the implementation of
the ALM. Also, the post-reform banking scenario is marked by interest rate
deregulation, entry of new private banks, gamut of new products and
greater use of information technology. To cope with these pressures banks
were required to evolve strategies rather than ad hoc fire fighting
solutions. Imprudent liquidity management can put banks' earnings and
reputation at great risk. These pressures call for structured and

comprehensive measures and not just ad hoc action. The Management of
banks has to base their business decisions on a dynamic and integrated
risk management system and process, driven by corporate strategy.
Banks are exposed to several major risks in the course of their business -
credit risk, interest rate risk, foreign exchange risk, equity / commodity
price risk, liquidity risk and operational risk. It is, therefore, important that
banks introduce effective risk management systems that address the
issues related to interest rate, currency and liquidity risks.

Implementation of asset liability management (ALM) system

RBI has issued guidelines regarding ALM by which the banks have to
ensure coverage of at least 60% of their assets and liabilities by Apr ’99.
This will provide information on bank’s position as to whether the bank is
long or short. The banks are expected to cover fully their assets and
liabilities by April 2000.

ALM framework rests on three pillars

ALM Organisation:
The ALCO consisting of the banks senior management including CEO
should be responsible for adhering to the limits set by the board as well as
for deciding the business strategy of the bank in line with the banks
budget and decided risk management objectives. ALCO is a decision-
making unit responsible for balance sheet planning from a risk return
perspective including strategic management of interest and liquidity risk.
Consider the procedure for sanctioning a loan. The borrower who
approaches the bank, is appraised by the credit department on various
parameters like industry prospects, operational efficiency, financial
efficiency, management evaluation and others which influence the
working of the client company. On the basis of this appraisal the borrower

is charged certain rate of interest to cover the credit risk. For example, a
client with credit appraisal AAA will be charged PLR. While somebody with
BBB rating will be charged PLR + 2.5 %, say. Naturally, there will be
certain cut-off for credit appraisal, below which the bank will not lend e.g.
Bank will not like to lend to D rated client even at a higher rate of interest.
The guidelines for the loan sanctioning procedure are decided in the ALCO
meetings with targets set and goals established
ALM Information System
ALM Information System for the collection of information accurately,
adequately and expeditiously. Information is the key to the ALM process. A
good information system gives the bank management a complete picture
of the bank's balance sheet.
ALM Process
The basic ALM process involves identification, measurement and
management of risk parameters. The RBI in its guidelines has asked
Indian banks to use traditional techniques like Gap Analysis for monitoring
interest rate and liquidity risk. However RBI is expecting Indian banks to
move towards sophisticated techniques like Duration, Simulation, VaR in
the future.
Is it possible ?

Keeping in view the level of computerisation and the current MIS in banks,
adoption of a uniform ALM System for all banks may not be feasible. The
final guidelines have been formulated to serve as a benchmark for those
banks which lack a formal ALM System. Banks that have already adopted
more sophisticated systems may continue their existing systems but they
should ensure to fine-tune their current information and reporting system
so as to be in line with the ALM System suggested in the Guidelines. Other
banks should examine their existing MIS and arrange to have an
information system to meet the prescriptions of the new ALM System. In
the normal course, banks are exposed to credit and market risks in view

of the asset-liability transformation. Banks need to address these risks in
a structured manner by upgrading their risk management and adopting
more comprehensive Asset-Liability Management (ALM) practices than
has been done hitherto

But, ultimately risk management is a culture that has to develop

from within the internal management systems of the banks. Its
critical importance will come into sharp focus once current restrictions on
banks’ portfolios are further liberalised and are subjected to the pressure
of macro economic fluctuations.

1.10 Reduction of Government Stake
in PSBs

This is what the finance minister said in his budget speech on February
29, 2000;

"In recent years, RBI has been prescribing prudential norms for
banks broadly consistent with international practice. To meet
the minimum capital adequacy norms set by the RBI and to
enable the banks to expand their operations, public-sector
banks will need more capital. With the Government budget
under severe strain, such capital has to be raised from the
public which will result in reduction in government
shareholding. To facilitate this process, the Government has
decided to accept the recommendations of the Narasimham
Committee on Banking Sector Reforms for reducing the
requirement of minimum shareholding by government in
nationalised banks to 33 per cent. This will be done without
changing the public-sector character of banks and while
ensuring that fresh issue of shares is widely held by the

Banking is a business and not an extension of government. Banks must be

self-reliant, lean and competitive. The best way to achieve this is to
privatise the banks and make the managements accountable to real
shareholders. If "privatisation" is a still a dirty word, a good starting point
for us is to restrict government stake to 33 per cent.

During the winter session of the Parliament, on 16 November 2000, the

Union Cabinet has taken certain decisions, which have far reaching
consequences for the future of the Indian banking sector cleared
amendment of the Banking Companies (Acquisitions and Transfer of
Undertakings) Act 1970/1980 for facilitating the dilution of government’s

equity to 33 per cent
Government’s action programme has expressed clearly its programme for
the dilution of its stake in bank equity. The Cabinet had taken this
decision, immediately on the next day after the bank employees went on
strike, is a clear indication of Government of India’s determination to
amend the concerned Acts, to pave the way for the reduction in its stake.
The proposal had been to reduce the minimum shareholding from 51 per
cent to 33 per cent, with adequate safeguards for ensuring its control on
the operations of the banks. However, it is not willing to give away the
management control in the nationalised banks. As a result public sector
banks may find it very difficult to attract strategic investors.

SALIENT FEATURES of the proposed amendments

 Government would retain its control over the banks by stipulating

that the voting rights of any investor would be restricted to
one per cent, irrespective of the equity holdings.
 The government would continue to have the prerogative of the
appointment of the chief executives and the directors of
the nationalised banks. There has been considerable delay in
the past in filling up the posts of the chairman and executive
director of some banks. It is not clear as to how this aspect would
be taken care of in future. It is said that the proposed amendment
to the Act would also give the board of banks greater autonomy
and flexibility.
 It has been decided to discontinue the mandatory practice of
nominating the representatives of the government of India
and the Reserve Bank in the boards of nationalised banks.
This decision is in tune with the recommendation of Narasimham
committee. However, the government would retain the right to

nominate its representative in the boards and strangely a
nominee of the government can be in more than one bank
after the amendment.
 The number of whole time directors would be raised to four
as against the present position of two, the chairman and
managing director and the executive director. While
conceptually it is desirable to decentralise power, operationally it
may be difficult to share power at peer level. In quite a few cases,
it was observed that inter personal relations were not cordial
among the two at the top. It has to be seen as to how the four full
time directors would function in unison.
 It is proposed to amend the provisions in the Banking Companies
(Acquisition and Transfer of Undertakings) Act to enable the bank
shareholders to discuss, adopt and approve the annual
accounts and adopt the same at the annual general
Paid-up capital of nationalised banks can now fall below 25 per
cent of the authorised capital.
 Amendment will also enable the setting up of bank-specific
Financial Restructuring Authority (FRA). Authority will be
empowered to take over the management of the weak banks.
Members of FRA will comprise of experts from various fields & will
be appointed by the government, on the advice of Reserve Bank of
The government has been maintaining that the nationalised
banks would continue to retain public sector character even
after the reduction in equity.

This is the reason why the banks would continue to be statutory bodies
even after the reduction in government equity below 51 per cent and the

banks would not become companies. This implies that they would
continue to be subject to parliamentary and other scrutiny despite
proposed relaxations.

The measures seen in totality are clearly aimed at enabling banks to

access the capital markets and raise funds for their operations. The
Government seems to have no plans to reduce its control over these
banks. The Act will also permit it to transfer its stake if the need arises,
apart from granting banks the freedom to restructure their equity.

Reserve Bank’s perception; the Reserve Bank has been emphatic in its
views on lowering the stake of the government in the equity of
nationalized banks:

The panel wants government stake to be diluted to less than 50 per

cent in order to make banks' decision-making more autonomous. It
has said, “in view of the severe budgetary strain of the government, the
capital has to be raised from the public, which leads to a reduction in
government shareholding.” The process of the transition from public
sector to the joint sector has already been initiated with 7 of the public
sector banks accessing the capital market for expanding their capital
base. Since total privatization is not contemplated, the banks in the joint
sector are expected to control the commanding heights of the banking
business in the years to come.

In the domestic context, the idea behind a reduction in government

stake is to free bank employees from being treated as "public
servants." Instead, by directly reducing the government stake below 50
per cent, the banks will be free from the shackles of the central vigilance

Official sources explained that this has been done to enable banks to
clean up their balance sheets so that they can access the capital market

easily. In terms of transferring equity, the government is arming itself with
powers to sell its stake if it so desires at a later date.


The Indira Gandhi government had nationalised 14 commercial banks

through the Banking Companies (Acquisitions and Transfer of
Undertakings) Ordinance in 1969. The 1970 and 1980 Acts brought about
after the nationalisation of 14 and 6 banks respectively were first
amended in 1994 to allow government to reduce its equity in them to up
to 49 per cent. The 20 nationalised banks became 19 subsequently after
New Bank of India merged with Punjab National Bank. Only six of these 19
banks have so far accessed the market and to gone for public issues meet
its additional capital needs. The government holds majority or entire
equity of 19 nationalised banks currently.

Till now, banks could reduce equity only up to 25 per cent of the paid up
capital on the date of nationalisation. Some banks like the Bank of Baroda
have returned equity to the government in the past, but that has been
within the prescribed 25 per cent cap.

The Nationalisation Act provides that the PSU banks cannot sell a single
share. This is the reason why banks have been tapping the market to fund
their expansion plans. Also the Act originally provided that the
government must mandatorily hold 100 per cent stake in banks. The 1994
amendments brought it down to 51 per cent, to help induction of public as
At this stage, the government provided that all shares, excluding
government shares could be transferred. This was necessary to permit the
transfer of shares when public shareholders sold their stake in banks. The

amendments remove restrictions on the transfer of government

What did they have to say ?

Union parliamentary affairs minister Pramod Mahajan said:
“The amendment is an enabling provision. We are only making it
easier for banks to access funds from the market...It is not the
intention of the government to privatise these banks or enter
Who is afraid of
into strategic alliances with private sector.”

Why should the taxpayers’ money be used repeatedly for

improving the capital base of the public sector banks?
The Indian Banks' Association had, in its memo to the committee, called
for 100 per cent divestment of the government stake. “Banks should be
allowed to access 100 per cent capital from public, either from the
domestic or international capital markets. This will increase the
accountability of banks to shareholders”.

Employees of the public sector banks went on a token strike on 15

November, protesting against the government’s policy of privatisation of
public sector banks. It was as usual, reported that the strike was total and
successful. The inconveniences caused to millions of customers,
unconnected with the issues involved, went unnoticed, though one or two
TV channels interviewed a couple of people, who could not articulate their
views properly.

This is an expedient decision contributing to the process of liberalisation

of the economy.

As for current status, Union bank will issue an IPO next year, in order to
reduce the 100 percent government stake to 70 percent and then
gradually to 33 percent.

From 1992-93 to 1998-99, the government has injected into the 19 public
sector banks, an amount of Rs.20,446 crore as additional capital. Of this,
three banks-UCO Bank, Indian Bank and United Bank of India, have
received Rs.5729 crore

Capital Contributed by Government

Capital Added [Rs in

Allahabad Bank 90
Andhra Bank 150
Bank of Baroda 400
Bank of India 635
Bank of Maharashtra 150
Canara Bank 365
Central Bank of India 490
Corporation Bank 45
Dena Bank 130
Indian Bank 220
Indian Overseas Bank 705
Oriental Bank of
Punjab National Bank 415
Punjab & Sind Bank 160
Syndicate Bank 680
UCO Bank 535
Union Bank of India 200
United Bank of India 215
Vijaya Bank 65
Total 5700

Source: Reserve Bank of India Bulletin [1994].

Illustration 5


The demand for funds by the SBI is even more acute than even the
Corporation Bank since the SBI Act provides for a minimum 55 per cent

RBI holding in SBI, and the bank is already close to breaching this
threshold. The immediate beneficiary of this move would be Corporation
Bank where government equity is down to 66 per cent. The bank would be
able to access funds from the market without being hampered by the 51
per cent minimum government holding threshold, which currently limits
the ability of banks to expand beyond a certain level. Since a decision on
the new threshold has been taken in the case of the nationalised banks,
the government is expected to follow suit by moving an ordinance to
reduce the RBI stake in the SBI to 33 %

The issue of reducing government stake in the nationalised banks has

come about on account of demand from the SBI which had demanded
that either RBI as the stakeholder pump in funds for the SBI’s massive
expansion plans or permit it to issue shares to the public to raise the
necessary funds.

Both the Banking Regulation Act and the SBI Act provide that government
shares cannot be divested and since the government has decided that it
would no longer support banks through budgetary support, they have no
option but to go to the market to meet their fund requirements.
Though there is no special significance attached to the 33 per cent
threshold in the Company Law — which recognised only 26 per cent and
74 per cent as two major thresholds for management and ownership
control — the government has opted for 33 per cent on the basis of the
recommendations of the Narasimham Committee. The committee had felt
that this threshold would provide comfort to the employees. The banks,
like insurance companies, have strong unions and, hence, a phased
reduction in government equity was recommended.

The State would continue to be the single largest shareholder in banks

even after its stake had been brought down to 33 per cent.

The government is also proposing to move an ordinance for demerger of
four subsidiaries of GIC. The law ministry has already cleared both
proposals of the finance ministry. In the case of GIC, the ordinance would
amend the GIC Act, 1972, and demerge its four subsidiaries - National
Insurance Corp, Oriental Insurance, United Insurance and New India
1.11 Deregulation on Interest
Assurance. Rates

The interest rate regime has also undergone a significant change. For
long, an administered structure of interest rate has been in vogue in India.
The 1998 Narasimham Reforms suggested deregulation of interest rates
on term deposits beyond a period of 15 days. At present, the Reserve
Bank prescribes only two lending rates for small borrowers. Banks are free
to determine the interest rate on deposits and lending rates on all
lendings above Rs. 200,000.

In the last couple of years there has been a clear downward trend in
interest rates. Initially lending rates came down, leading to a decline in
yields on advances and investments.

Interest rates in the banking system have been liberalised very

substantially compared to the situation prevailing before 1991, when the
Reserve Bank of India controlled the rates payable on deposits of different
maturities. The rationale for liberalising interest rates in the banking
system was to allow banks greater flexibility and encourage competition.
Banks were able to vary rates charged to borrowers according to their
cost of funds and also to reflect the credit worthiness of different

With effect from October 97 interest rates on all time deposits, including
15-day deposits, have been freed. Only the rate on savings deposits
remains controlled by RBI. Lending rates were similarly freed in a series of

steps. The Reserve Bank now directly controls only the interest rate
charged for export credit, which accounts for about 10% of commercial
advances. Interest rates on time deposits were decontrolled in a sequence
of steps beginning with longer-term deposits and the liberalisation was
progressively extended to deposits of shorter maturity.

Interest rates on loans upto Rs 2,00,000, which account for 25% of total
advances, is not fixed at a level set by the RBI, but is now aligned with the
Prime Lending Rate (PLR) which is determined by the boards of individual

Earlier interest rates on loans below Rs 2,00,000 were fixed at a highly

concessional level. The new arrangement sets a ceiling on these rates at
the PLR, which reduces the degree of concessionality but does not
eliminate it.

Cooperative Banks were freed from all controls on lending rates in 1996
and this freedom was extended to Regional Rural Banks and private local
area banks in 1997. RBI also considers removal of existing controls on
lending rates in other Commercial Banks as the Indian economy gets used
to higher interest rate regime on shorter loan duration.

The line to control is the cost of funds, since the markets determine asset
yields. The opportunity to improve yields on the corporate side tends to
be limited if banks don’t want to increase the risk profile of the portfolio.
Banks’ income will depend on the interest rate structure and the pricing
policy for the deposits and the credit. With the deregulation of the interest
rates banks are given the freedom to price their assets and liabilities
effectively and also plan for a proper maturity pattern to avoid asset-
liability mismatches. Nevertheless, with the increase in the number of
players, competition for the funds and the other banking services rose.
The consequential impact is being felt on the income profile of the banks

especially due to the fact that the interest income component of the total
income is significantly larger than the non-interest income component. As
far as the interest costs are concerned, the prevailing interest rate
structure will be a major deciding factor for the rates. But what influence
both the interest costs and the intermediation costs is the time factor as it
is directly related to costs. The solution for these two influencing factors
lies predominantly on technology. In this regard, the new private banks
and the foreign banks, which are equipped with the latest technology,
have a better edge over the nationalized banks, which are yet to be
automated at the branch level.

Income and Expenses Profile of Banks

Interest Income Interest Expenses

• Interest/discount on • Interest on deposits

advances/bills • Interest on
• Interest on investments Refinance/interbank borrowings
• Interest on balances with • Others
RBI and other interbank
• Others

Other Income Operating Expenses

• Commission, Exchange and  Payments to and provisions

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

Illustration 6

2.1 Introduction

The financial sector reforms have brought about significant improvements

in the financial strength and the competitiveness of the Indian banking
system. The efforts on the part of the Reserve Bank of India to adopt and
refine regulatory and supervisory standards on a par with international
best practices, competition from new players, gradual disinvestments of
government equity in state banks coupled with functional autonomy,
adoption of modern technology, etc are expected to serve as the major
forces for change. New businesses, new customers, and new products
beckon, but bring increased risks and competition. How might that change
banks? To attract and retain customers, the banks need to optimise their
networks, speed up decision-making, cut down on bureaucratic layers,
and sharpen response times.

The reform has lead to new trends of being ahead and being with, by and
for the customer. While the private sector banks are on the threshold of
improvement, the Public Sector Banks (PSBs) are slowly contemplating
automation to accelerate and cover the lost ground. VRS introduced to
bring up the productivity, the concept of universal competition set in just
to ensure customer convenience all the time.

Also, the strength factor has lead to mergers and Indian banks will explore
this opportunity.

The following will state the development in Indian banking sector.

2.2 Voluntary Retirement Schemes …

Please leave ?

Public Sector Banks which together (there are 27 of them) account for
77.34 per cent of the bank deposits in India. The most ambitious
downsizing exercise undertaken by the PSBs has set them back by close
to Rs 7,490 crore.

Voluntary Retirement Scheme in Banks was formally taken up by the

Government in November 1999. According to Finance Ministry on the
basis of business per employee (BPE) of Rs. 100 lakhs, there were 59,338
excess employees in 12 nationalised banks, while based on a BPE of Rs.
125 lakhs, the number shot up to 1,77,405.

Government had cleared a uniform VRS for the banking sector, giving
public sector banks a seven-month time frame. The IBA has been allowed
to circulate the scheme among the public sector banks for adoption. The
scheme was to remain open till March 31, 2001. It would become
operational after adoption by the respective bank board of directors. No
concession had been made to weak banks under the scheme. The scheme
is envisaged to assist banks in their efforts to optimise use of human
resource and achieve a balanced age and skills profile in tune with their

As per estimates the average outgo per employee under the banking VRS
scheme would range between Rs. 3 lakhs and Rs. 4
lakhs. However, the aggregate burden on the banking
industry is difficult to work out. To minimise the
immediate impact on banks, the scheme has allowed
them the stagger the payments in two installments,
with a minimum of 50 per cent of the amount to be
paid in cash immediately. The remaining payment can
be paid within six months either in cash or in the form
of bonds. The total burden of the VRS on the banking
industry is about Rs 8,000 crore, and union activists
feel that it will adversely affect the profitability and capital adequacy of
the banks. In fact, out of this Rs 8,000 crore, nearly Rs 2,200 crore will be
borne by State Bank of India, the largest public sector bank.

Salient Features of Voluntary Retirement Scheme of
Eligibility – All permanent employees with 15 years of service or 40
years of age are eligible. Employees not eligible for this scheme
• Specialists officers/employees, who have executed service
bonds and have not completed it, employees/officers serving
abroad under special arrangements/bonds, will not be eligible for
VRS. The Directors may however waive this, subject to fulfillment
of the bond & other requirements.
• Employees against whom Disciplinary Proceedings are
contemplated/pending or are under suspension.
• Employees appointed on contract basis.
• Any other category of employees as may be specified by the

Amount of Ex-gratia – 60 days salary (pay plus stagnation increments

plus special allowance plus dearness relief) for each completed year of
service or the salary for the number of months service is left, whichever
is less.

Other Benefits
• Gratuity as per Gratuity Act/Service Gratuity, as the case
• Pensions (including commuted value of pension)/bank’s
contribution towards PF, as the case may be.
• Leave encashment as per rules.
Other Features
• It will be the prerogative of the bank’s management either to
accept a request for VRS or to reject the same depending upon
the requirement of the bank.
• Care will have to be taken to ensure that highly skilled and
qualified workers and staff are not given the option.

• There will be no recruitment against vacancies arising due to
• Before introducing VRS banks must complete their manpower
planning and identify the number of officers/employees who can
be considered under the scheme.
• Sanction of VRS and any new recruitment should only be in
accordance with the manpower plan.

Funding of the Scheme

• Coinciding with their financial position and cash flow, banks
may decide payment partly in cash and partly in bonds or in
installments, but minimum 50 percent of the cash instantly and
in remaining 50 percent after a stipulated period.
• Funding of the scheme will be made by the banks themselves
either from their own funds or by taking loans from other
banks/financial institutions or any other source.
Periodicity – The scheme may be kept open up to 31.3.2001
Sabbatical – An employee/officer who may not be interested to take
voluntary retirement immediately can avail the facility of sabbatical
for five years, which can be further extended by another term of five
year. After the period of sabbatical is over he may re-join the bank on
the same post and at the same stage of pay where he was at the time
of taking sabbatical. The period of sabbatical will not be considered for
increments or qualifying service for person, leave, etc.

While the right of refusal to give voluntary retirement has been

granted to the bank management, recruitment against vacancies
arising through the VRS route has been disallowed.

Nearly half the VRS benefits are by way of an ex-gratia ‘golden

handshake’ payment to the employees to encourage them to leave.

Banks have been allowed to amortise half the retirement benefits
provided to those opting for VRS over a period of five years.

VRS and its effect on Capital Adequacy norms

There are immediate concerns for PSBs. The weaker among them may not
be able to maintain the Reserve Bank of India stipulated capital adequacy
ratio of 9 per cent, primarily because of the huge outflow of funds for the
VRS. UCO Bank, for instance, ended up with a bill for Rs 360 crore; Union
Bank, Rs 292 crore, and United Bank, Rs 150 crore. The obvious way out is
to tap the capital market, but PSBs are constrained as they cannot reduce
their stake below 50 per cent. The result? ''If these banks cannot meet the
capital adequacy norms, their ability to do incremental business will be
curtailed,'' explains Rohit Sarkar, a Consultant with the Planning
Commission. ''... irrespective of their deposits.'' The Finance Ministry, with
one VRS bullet, aims to achieve, at least, three objectives immediately
viz. the privatisation of banks at any cost, bailing out of the favoured
willful defaulters, and shielding of the corrupt bureaucrats. These are the
measures what exactly the IMF and World Bank have been urging upon
the government, without which the support of U.S. is not certain.

VRS now best walk out too!

There's the issue of the VRS weeding out non-targets like investment
bankers and treasury managers, leaving most PSBs short of the very
people they'll need to implement any services-initiative. ''Recruiting the
right kind of people will be difficult for these banks, given the poor work
culture and uncompetitive salaries,'' says Ravi Trivedy, a Partner at
Pricewaterhouse Coopers. A mid-level treasury manager, for instance,
comes with a tag of between Rs 15 lakh and Rs 20 lakh; few PSBs can pay
that kind of money.

Why did he opt for VRS?

"It is because opportunities outside the banking sector are more in the
western zone," says a union activist. Apart from the lure of money, bad
working conditions also contributed to this deluge," says Bhakey. "They
are transferred anywhere, are held accountable in case of problems in
rural areas and don't get residential accommodation. "Apart from all the
VRS benefits, they will be entitled to pension as well. So they have a
continuous source of income even if they don't work," said a director of
Bank of Maharashtra.

What did they say last !

V. V. Phatak, 55, is special assistant in Punjab National Bank who opted for
VRS after 32 years' service. With the Rs 16 lakh severance package that
he received, he sees deliverance from the dreary chawl-life in Mumbai. He
has spent all his earnings on a flat in Vile Parle.

On Sabbatical.......S.Balachandran
Sabbatical as a measure for reducing surplus staff will not be cost
effective in the long run for the following reasons: Even though the banks
can save on the salaries & allowances during the leave period, but once
the employee returns, he will have to be absorbed and as such
redundancy or surplus cannot be cut totally. Retraining cost for the
returning staff that are 45 plus, in a totally changed banking environment
will be much higher than the cost bank saves during their leave. Hence it
would be better to offer the sabbatical to junior level employees for whom
the retraining cost will be much lower.

R. Krishnamurthy
An employee should be free to exercise Sabbatical option at any point of
time in his career, rather than a specific period. It should be an open
option and should normally be granted by the Bank Management provided
the employee does not have any disciplinary proceedings against him.

The option may also be a one-time option during his/her (employees)
service. Banks should not insist that the employees should close the loan
accounts, but can take an undertaking that the employees should service
their loans during the sabbatical period. This will help employees to
search for a suitable job and then exercise the Sabbatical option. He can
service the loans from his new employment.


They are in the fools' paradise. The policy-makers, RBI, IBA and the
bankers, who schemed unilaterally the VRS, think that by removing
massively thousands of able and experienced bankmen from services in
their middle age, they could boost profits in the nationalised banks.

Is it the 10 to 12 percent wage factor that affects adversely the

profitability in the nationalised banks? Certainly not. Then what is
the truth? At least the apex bank in the country has all the latest figures
of the banks and as such, would agree honestly that it is the unrecovered
and unchecked cancerous growth of over Rs.100000 crore of the bad
debts, called as NPA in the international terms, piled up in the PSBs with
the blessings of the new regime, that eroded profits and made one or two
banks less profitable. Added to this, when large numbers of employees of
all stages are shunted away, a number of branches of these banks will
come to a grinding halt.

Amidst the disastrous Asian contagion, the Indian economy survived,

mainly because of the strength and stability of our public sector banks.
The correct remedial measure is not demolishing them by sending home
several thousand employees enmass, but change the policy to preserve
and develop them, said a member of IBA.

Banks had approached the government and warned that only efficient
people will leave by way of VRS. It will take away most of the staff from
more than 22,000 rural branches of public sector banks. "They will have
to be merged or closed down in favour of a satellite branch which will
operate just once a week", says G.M. Bhakey, president of the State Bank
of India Officers Association. If these fears come true, rural India may be
the biggest victim of VRS. In fact the United Federation of Bank Unions
has decided to oppose the whimsical closure of branches in the post-VRS
scenario. "The management will have to discuss the post VRS merger of
branches with the unions first," says P Jayaraman, the general secretary
of the State Bank's union. "It is true that more than 90,000 employees will
be relieved, but what about the remaining 8.1 lakh?" asks a union activist.
The unions will still have to fight for them. The way the VRS contagion is
spreading at the instance of the government, it is imminent that a chaotic
situation with grave consequences will emerge soon, causing irreparable
losses to the clients of all types and great hardships to the remaining
work force. Also, large number of staff might be transferred and more and
more branches might be closed.

As part of the banking sector reforms, public sector banks are trimming
the staff strength by launching VRS. This is likely to bring not only higher
cash flows to banks in future but also long term benefits like improvement
in efficiency level.
Bank of Maharashtra will be accepting applications of 2,000 VRS optees
800 officers and 1,200 class III and IV employees. Reduce the annual
wage bill by about Rs 56 crore.
Andhra Bank Substantial reduction in overheads and significant
improvement in per employee productivity.

Bank of India (BoI) has embarked on a major organisational recast
exercise. After the launch of the voluntary retirement scheme (VRS) which
was opted by 7,780 employees , the bank is set to abolish one tier (zonal
offices) from its four-tier organisational structure. The bank will now have
three tiers -- branch offices, regional offices and head office.
Newly-formed association of VRS optees of Punjab National Bank (PNB) --
the PNB Voluntarily Retired Staff Association (PNBVRSA) -- has filed
a case against the bank for settling outstanding issues arising out of the

T h e h u m a n s i d e…
He still went by the same train, he sat on the same place, he admired the
same table, that’s all he did there and came back home in the evening.
VRS has disturbed the comfort zone of many, when he is back at home,
children are to be disciplined the whole day, as they come back home,
they are told to be studying, not playing much, etc; wife cant visit her
neighbour at the afternoon, her TV serials alls is gone; clashes and
arguments arise, families breaking, the comfort zone is shaken up. A
dissatisfied issue arises out of VRS, a person working for 15 to 20 years, is
now to do nothing? All are seeking physiatrists’ help now. What about
this? Social activities for these people, some kind of work, tie up with
service organisation, keeping them busy may be the only way out!

Close on the heels of public sector banks implementing Voluntary

Retirement Scheme, public sector giant, SAIL has launched VRS. SAIL
aims to cut down its personnel by 60,000 over the next 3 years.

ANOTHER OPTION could have been!!!

“They could have developed business by expanding into sectors like

insurance which relies heavily on the expertise of the banking industry.”
Mr. Sanghavi, senior manager of Canara Bank states, “It would have been

much sensible to invest and divert these funds in Tech banking and
installation of new systems. These firstly, retain the existing functions,
also in the long run there would be a good payback, after this if the VRS
was declared then may be it would have been a wise decision”.

And the numbers say . . .

The VRS, as on July 2001, which bankers rushed to grab, has become a
drag on the bottomline of the State-owned banking segment.
 Heavy provisioning made towards VRS has pushed the combined
net profit of PSU banks down 16 per cent to Rs 4,315.70 crore in
2000-01, from Rs 5,116 crore in the previous year.
 In the banking sector close to 1,26,000 employees opted for the
VRS in ‘00-01.
 The total benefits received by these employees has been close to
Rs 15,000 crore.

Gone for GOOD !

Illustration 7

VRS – The SBI Way

State Bank of India's VRS, which closed on January 31, has attracted
35,380 applications. I.e.15 per cent of the bank's employee base of
233,000. Of the 35,380 applications, 54 per cent are from officers, 36 per
cent from clerical staffs, and 3,137 are from the sub-staff category.

STATE Bank of India has kick started its post-VRS restructuring

programme, with plans to merge 440 loss making branches and virtually
eliminate its network of regional offices across the country. The bank is
also working to redeploy additional administrative manpower to frontline
banking jobs. This is in line with practices followed by private sector banks
and is meant to enhance the overall productivity. One of the major tasks
for SBI in its restructuring programme is merger of loss making branches.
SBI has identified 440 branches out of 8,000 as weak branches. The bank
management has asked all its 13 circle offices to initiate the process and
start merger of loss making branches in their respective areas. SBI has
also decided to reduce its regional office network as a part of its
downsizing programme. The bank is planning to reduce its regional offices
from 10 to 1/2 in each circle.

The unions had earlier expressed the view that the bank management
should not merge loss making branches but should shift them to other
areas with profit potential, in order to retain branch license.

For example, in the Gujarat circle, SBI has four regional offices in
Gandhinagar and three each in Ahmedabad and Baroda. Plans are to shut
all these down and have a single regional office in Ahmedabad. The
excess administrative manpower will be utilised at branch level. Post VRS,
in some branches of the bank, important posts are lying vacant and at

some places shortage of staff is also being felt. SBI has appointed
National Institute of Bank Management as consultant for manpower
planning. The final decisions on redeployment of administrative staff and
reduction in regional offices will be taken only after NIBM report.

2.3 Universal Banking … just one
stop ahead !

RBI states: "The emerging scenario in the Indian banking

system points to the likelihood of the provision of multifarious
financial services under one roof. This will present
opportunities to banks to explore territories in the field of
credit/debit cards, mortgage financing, infrastructure lending,
asset securitisation, leasing and factoring. At the same time it
will throw challenges in the form of increased competition and
place strain on the profit margins of banks"

The evolving scenario in the Indian banking system points to the

emergence of universal banking. The traditional working capital financing
is no longer the banks major lending area while FIs are no longer
dominant in term lending. The motive of universal banking is to fulfill all
the financial needs of the customer under one roof. The leaders in the
financial sector will be aiming to become a one-stop financial shop.

In recent times, ICICI group has expressed their aim to function on the
concept of the Universal Bank and was willing to go for a reverse merger
of ICICI ltd. with ICICI Bank. But due to some regulatory constraints, the
matter seems to have been delayed. Sooner or later, the group would be
working towards its aim. Even some of the other groups in the financial
sector like HDFC, IDBI have started functioning on the same concept.

An Overview
Universal Banking includes not only services related to savings and loans
but also investments. However in practice the term 'universal banks'
refers to those banks that offer a wide range of financial services, beyond
commercial banking and investment banking, insurance etc. Universal
banking is a combination of commercial banking, investment banking and

various other activities including insurance. If specialised banking is the
one end universal banking is the other. This is most common in European

The main advantage of universal banking is that it results in

greater economic efficiency in the form of lower cost, higher output
and better products. The spread of universal banking ideas will bring to
the fore issues such as mergers, capital adequacy and risk
management of banks. Universal banks may be comparatively better
placed to overcome such problems of asset-liability mismatches (for
banks). However, larger the banks, the greater the effects of their
failure on the system. Also there is the fear that such institutions, by
virtue of their sheer size, would gain monopoly power in the market,
which can have significant undesirable consequences for economic
efficiency. Also combining commercial and investment banking can
gives rise to conflict of interests.

Banks v/s DFIs

India Development financial institutions (DFIs) and refinancing institutions

(RFIs) were meeting specific sectoral needs and also providing long-term
resources at concessional terms, while the commercial banks in general,
by and large, confined themselves to the core banking functions of
accepting deposits and providing working capital finance to industry,
trade and agriculture. Consequent to the liberalisation and deregulation of
financial sector, there has been blurring of distinction between the
commercial banking and investment banking.

The comparative advantage or disadvantage of DFIs vis-a-vis banks in this

regard depends to a large extent on the quality of their portfolios, the

accounting policies that are practiced and personnel management. The
banks, on the other hand, have a competitive edge in resource
mobilisation through the route of retail deposits. The RBI has identified
certain regulatory issues that need to be addressed to make
harmonisation of the needs of commercial banking with institutional
banking successful.

First, banks are subject to CRR stipulations on their liabilities. DFIs

face no such pre-emptions on their funds.

Secondly, DFIs do not enjoy the advantage of branch network for

resource mobilisation. This in effect curtails DFIs' ability to raise low-
cost deposits.

Thirdly, with the larger part of new loans going to capital-intensive

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

In India
The issue of universal banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank. Reserve Bank of India also spelt
out to Parliamentary Standing Committee on Finance, its proposed policy
for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. FIs need to formulate a road map
for the transition path and strategy for smooth conversion into an
universal bank over a specified time frame. The plan should specifically
provide for full compliance with prudential norms as applicable to banks
over the proposed period.

The Narsimham Committee II suggested that DFIs should convert

ultimately into either commercial banks or non-bank finance companies.
The Khan Working Group held the view that DFIs should be allowed to
become banks at the earliest. The RBI released a 'Discussion Paper' (DP)
in January 1999 for wider public debate. The feedback indicated that while
the universal banking is desirable from the point of view of efficiency of
resource use, there is need for caution in moving towards such a system.
Major areas requiring attention are the status of financial sector reforms,
the state of preparedness of the concerned institutions, the evolution of
the regulatory regime and above all a viable transition path for
institutions which are desirous of moving in the direction of universal

ICICI gearing to become a universal bank
ICICI envisages a timeframe of 12 to 18 months in converting itself into an
universal bank. ICICI has received favourable response from Indian
investors and FIIs on its move to merge with ICICI Bank and become a
universal bank. ICICI was the first one to propagate universal banking as
an ideal concept for the DFIs to support industries with low cost funds.

In August, ICICI executive director Kalpana Morparia said that ICICI has to
obtain a separate banking licence from RBI for becoming a universal bank.
It can avoid the stamp duty burden by first converting ICICI into bank,
instead of going for a direct merger of ICICI into ICICI Bank.

“We have created fire walls and functioning as separate legal

entities only for complying with statutory obligations,” she noted.
There is clear demarcation in the operation of ICICI and the bank.
The bank takes care of liabilities of less than one year by offering short-
term loans to corporates and personal loans. Medium to long-term
products like home loans, auto loans are handled by the parent; absolute
coordination between them while marketing the products exist.

Crisil has reaffirmed its triple A rating for ICICI and FIIs also expects its
profit margins to improve after the merger due to the access to low cost
deposits & the scope to increase income from fee-based activities.

She said ICICI has started increasing its international presence and
associating closely with NRI community in various countries. ICICI InfoTech
is based in US & has an office in Singapore. ICICI Securities has been
registered as a broking firm in the US.

ICICI Bank is leveraging on strong network of 400 branches and extension

counters & 600 ATMs for offering products to NRIs; NRIs can transfer their
money to 200 locations in India by internet. The payment will be made
within 72 hours. It also offers loan products for helping their relatives in

India. Besides, the Visa card helps them to withdraw cash through the ATM

Morparia said NPA of banks in India are < 10 per cent of GDP when
compared to emerging economies like China, Korea & Thailand. It should
not be compared with developed countries like Europe and US. ICICI’s
gross NPA comes to Rs 6,000 crore. Asked about a approach to resolve the
problem, she said if the units are viable, it supported financial
Because of law,mergers.
restructuring, once theIf units
these are referred
options arenttopossible
BIFR, the
andlenders were
the units are
unable to enforce
not viable, it will securities, shetime
go in for one pointed out

2.4 Mergers & Acquisitions…

Divided they fall, united they may strive !

For the irresistible compulsions of competitiveness have created a
situation where the only route for survival for many a bank in India may
be to merger with another. With the Union Finance Ministry thinking along
the same lines, it may not be long before mega-mergers between banks
materialise. World over banks have been merging at a furious pace,
driven by an urge to gain synergies in their operation, derive economies
of scale and offer one stop facilities to a more aware and demanding
consumer. In the eighties and nineties mergers were used as means to
strengthen the banking sector. Small, weak and inefficient non-scheduled
banks were merged with scheduled banks when the running of such banks
becomes non-viable. However, mergers in the current era will be driven
by the motive of establishing a bigger market share in the industry and to
improve the profitability. Mergers may prove to be an effective remedial
measure in a competitive environment where margins/spreads are under
pressure for the banking sector. Though Indian systems were not keen on
the mergers and acquisitions in the banking sector, of late the systems
have started encouraging the global trends of M&A's.

Why the urge to merge?

The big question is why is there a sudden urge to merge? The answer is
simple as it is obvious. To beat competition for which suddenly size has
become an important matter. Mergers will help banks with added money
power, extended geographical reach with diversified branch networks,
improved product-mix, and economies of scale of operations. Mergers will
also help the banks to reduce their borrowing cost and to spread total risk
associated with the individual banks over the combined entity. Revenues
of the combined entity are likely to shoot up due to more effective
allocation of bank funds. One such big merger between banks globally

was that of Industrial Bank of Japan, Fuji and Dai-Ichi-Kangyo bank, all of
which were merged to be nicknamed as Godzilla Bank, implying the size
of the post merged entity. Another instance that comes to mind is that of
Bank of America's merger with that of Nation's Bank. Financial
consolidation was becoming necessary for the growth of the bank.

Do you consider the reasons why one does not need banks in
large numbers any more ?

? A depositor today can open an account with a money market mutual

fund and obtain both higher returns and greater flexibility. Indian MF is
queuing up to offer this facility.
? A draft can be drawn or a telephone bill paid easily through credit cards.
? Even if a bank is just a safe place to put away your savings, you need
not go to it. There is always an ATM you can do business with.
? If you are solvent and want to borrow money, you can do so on your
credit card- with far fewer hassles.
? An 'AAA' corporate can directly borrow from the market through
commercial papers and get better rates in the bargain. Infact the banks
may indeed be left with bad credit risk or those that cannot access the
capital market. This once again makes a shift to non-fund based activities
all the more important.

Of course, one would still need a bank to open letters of credit, offer
guarantees, handle documentation, and maintain current account
facilities etc. So banks will not suddenly become superfluous. But nobody
needs so many of them any more !

Capital A/c
Rigid Distinction Globalisatio
Disintermediati Volatabilit
That’s Convertibility
CUSTOMER may also want from a bank efficient cash management,
advisory services and market research on his product. Thus the
importance of fee based is increasing in comparison with the fund-based

The once RIGID DISTINCTION between the providers of term-finance

and the providers of working-capital finance is blurring, leading to an
increasing convergence in the asset-liability structure of the banks and
the FIs. Mergers would position the combined entity for rapid growth not
only in the working capital and term-lending segments, but also in the
growing fee-income business. And that would be in consonance with the
global trend towards universal banking.

GLOBALISATION. Competition from abroad is also set to intensify. The

foreign banks are looking to expand beyond their narrow niches to acquire
retail reach. Restrictions on branch expansion of the foreign banks are
being relaxed in line with the commitments made to the World Trade
Organisation, under the Financial Services Agreement, by India. The
archaic restriction on the number of Automated Teller Machines has gone.
Already, the number of foreign banks operating in the country has jumped
to 41, and 28 more have set up representative offices.

CAPITAL ACCOUNT CONVERTABILTY will grant Indian corporates access

to capital markets abroad as well as provide foreign banks access to
Indian firms and investors. Given their undoubted financial muscle and
technical expertise, the foreign banks are likely to dominate the new

DISINTERMEDIATION As capital markets deepen and widen, the core

banking functions--deposit taking and lending--come under attack. And
the number of alternative savings vehicles multiply, limiting bank deposits

growth. Mutual funds, in particular, are a potent long-term threat because
they appropriate what was once the USP of bank deposits.

VOLATILITY A large capital-base provides the necessary cushion to

withstand nasty shocks. The classic illustration of the absorptive capacity
of capital is, of course, the deeply divergent fates of Barings Bank and
Daiwa Bank. Both banks chalked up huge derivatives-trading losses. But
while losses of $1.20 billion were enough to topple a 233-year-old British
institution, Daiwa Bank managed to survive losses of a similar magnitude
simply because of its abundant capital reserves.


It began with HDFC Bank and Times Bank last year, which took
everyone by surprise. However, the latest merger of ICICI Bank with
Bank of Madura is even more astonishing as well as surprising,
though a welcome change. ICICI Bank had also initiated merger
talks with Centurion Bank, but due to differences arising over swap
ratio the merger didn't materialized.

The merger of the Citibank with Travelers Group and the merger of Bank
of America with NationsBank have triggered the mergers and acquisition
market in the banking sector worldwide. Europe and Japan are also on
their way to restructure their financial sector through M&A's.

The merger of Malaysia's 58 domestic banks into six anchor groups is part
of a global trend that will strengthen the financial sector and enable it to
compete internationally, Second Finance Minister Mustapa Mohamed says.
In a seminar on Malaysia's recovery efforts, organized by the World Bank
in Washington, Mustapa said it was important for the government to

''move aggressively'' in strengthening the banking system because ''the
WTO (World Trade Organization) is knocking on our doors and asking us to
liberalize our financial sector.

When asked why the government intervened in bank mergers rather then
letting the markets decide for themselves, Mustapa said the banks were
urged to merge in the 1980s, ''but our advice fell on deaf ears. We spent
no less than RM60 billion ($15.78 billion) in those days to bail them out
and frankly we're fed up and tired of bailing them out.'' After the mergers,
he added, the government hoped to divert those resources to building
schools and hospitals.
At the height of the crisis, depositors of the ''smaller banks'' themselves
felt unsafe and moved their savings to the bigger banks.

Witness the alliance between Chase Manhattan and Chemical Bank in the
US, the fusion of two Japanese monoliths, Bank of Tokyo and Mitsubishi
Bank, and, more recently, the mega-merger of the Swiss giants, United
Bank of Switzerland and Switzerland Banking Corporation.

In Europe, the prospect of a single currency system has sparked off a

merger mania among banks.

The post merger scenario at ICICI

Take a look at what happens post merger to ICICI Bank. The bank will have
shot up to the number one position among new private sector banks.

Elements Pre-merger Post- %

merger Change
Assets 12063 crores 16051 crores 33.06
No of 106 360 239.62
branches 9728 13123 34.90
Deposits 15 lakhs 27 lakhs 80

Customers 1700 4300 152.94
Employees 197 crores 220 crores 10.5
Equity Rs 7.10 / Rs 8.70 / 23
share share
Illustration 8
Will mergers be the norm in the industry?

What about the future? Will THE STRATEGY MERGER

mergers stop here or will
The Assets
they speed up? Analysts and Enables rapid growth in new markets and
bank observers feel that new products
Combats the trend towards
merger acquisition activity disintermediation
will speed up in times ahead.
The Liabilities
It is a fact that growth Increases risks of mismatch between assets
through acquisitions and and liabilities
Multiple focus could lead to conflicts of
mergers is cheaper and interest
quicker in comparison to setting up new units. What will acquiring banks
look for while choosing their targets? One, financial viability and two
strong geographical reach and large asset base. However
staffing/employee costs and technological infrastructure will also play an
important role in acquiring target banks. For example, Karnataka Bank has
employee strength of over 4,200 and business per employee of just Rs
1.80 crore. Compare this with Indusind Bank, which, with only 510
employees commands a business per employee of Rs 20 crore. Banks
which boast of high business per employee include names such as Bank
of Punjab Rs 7.10 crore, Centurion Bank Rs 6.90 crore and Global Trust
Bank Rs 8.60 crore.

The following table shows a general comparison of three main classes of


Particulars PSU Banks Pvt. Banks Pvt.
(Old) Banks(New)
Cost of funds Low Moderate High
Branch network Wide Regional Low
Level of Automation Low Moderate High
NPAs High Low Low
Capital Adequacy Moderate Low High
Employee Productivity Low Moderate High
Focus on Non- interest Low High High
Illustration 9

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


The Assets
Provides the stronger bank with a relatively cheap
deposit network
Minimises the likelihood of systemic failure

The Liabilities
Saddles the stronger bank with huge NPAs
Erodes the profitability of the stronger bank

2.5 Banking and Insurance … much more to
service !

What will the future of Indian banking and insurance look like? Will the
reform in these sectors face the same fate as in power? It is increasingly
evident that the economy offers opportunities but no security. The future
will belong to those who develop good internal controls, checks and
balances and a sound market strategy.

The latest to be opened up for private investment, including foreign direct

investment, is the insurance sector. On a rough reckoning, commercial
bank deposits account for 25 per cent of GDP and credit extended by
banks may be 15 per cent of GDP. Thus, regular bank credit transactions
alone account for a substantial percentage of GDP by way of servicing
economic activities. A gradual convergence is taking place in the banking
and insurance sectors. Several major banks are floating subsidiaries to
enter both life and non-life insurance businesses. Some of them are
looking at niche markets such as corporate insurance.

Reform of the insurance sector began with the decision to open up this
sector for private participation with foreign insurance companies being
allowed entry with a maximum of 26 per cent capital investment? The
Insurance Regulatory and Development Authority (IRDA), in its guidelines
for the new private sector insurance companies, has stipulated that at
least 20 per cent of the total premium revenue of these companies should
come from rural India. The government permits banks to distribute
or market insurance products. It is amending the Banking Regulation
Act to this effect. Only banks with a three-year track record of positive
growth as well as with a strong financial background will be entitled to do
insurance business. In anticipation of the government move, some banks
have begun talking of alliances with foreign insurance players.

Keeping in view the limited actuarial and technical expertise of Indian
banks in undertaking insurance business. RBI has found it necessary to
restrict entry into insurance to financially sound banks. Permission to
undertake insurance business through joint ventures on risk participation
basis will therefore be restricted to those banks which
(I) have a minimum net worth of Rs. 500 crore and
(ii) satisfy other criteria in regard to capital adequacy, profitability, etc.
Banks which do not satisfy these criteria will be allowed as strategic
investors (without risk participation) up to 10 per cent of their net worth
or Rs. 50 crore, whichever is lower. However, any bank or its subsidiary
can take up distribution of insurance products on fee basis as an agent of
insurance company. In all cases, banks need prior approval of RBI for
undertaking insurance business.

Insuring the SBI way !

State Bank of India (SBI) has identified Cardif, a wholly owned subsidiary
of BNP Paribas, to enter into a joint venture for life insurance with an
equity stake of 26 per cent. SBI has incorporated a wholly owned
subsidiary SBI Life Insurance Company Ltd with an authorised capital of
Rs 250 crore.

Cardif SA and its sister company Natio-Vie together rank as the third-
largest French insurers with a premium income of $9 billion and assets
under management of over $59 billion. Although Cardif is a lesser known
name in the life insurance business, compared to some of the global
giants present in India, the French insurer has expertise in bancassurance.
The company has pioneered the concept of bancassurance in France by
selling insurance products through branches of commercial banks and
non-banking finance companies. The joint venture plans to bring into India
a number of products, which would suit different segments of the market.

SBI intends to fully integrate the insurance business into its banking
activities with appropriate sales support and marketing.

SBI will become the largest insurance outfit in terms of

distribution with its network of around 13,000 branches. The
key to success will be the ability to integrate the savings
products of the bank, insurance product line of the Joint
Venture Company & network of branches.

Insuring it the Private way !

Explains Sugata Gupta, vice-president-marketing, ICICI Prudential: "We

have unit managers and agents to cater to the rural market. These field
staffs are linked to the city offices and keep on visiting the rural areas."
ICICI Prudential keeps on sending regular vans with doctors to underwrite
the policies. Additionally, the company has tied up with NGOs to sell social
sector policies, like SEWA in Gujarat. ICICI Prudential Life Insurance, also,
has tied up with two Chennai-based corporate houses, Madras Cements
Ltd and Lucas TVS, to serve underprivileged children. ICICI Prudential has
also come out with its social sector policy, Salam Zindagi, which is aimed
at the economically weaker sections.

HDFC Standard Life is customising its approach to cater to the rural

markets so as to address the special needs of these areas. The life
insurance company has tied up with NGOs and self help groups. One such
NGO is LEAD (League for Education and Development) and the insurance
company covers the members of the SHGs associated with the NGO.

All this is being done to cater to the IRDA norms. As per norms, two per
cent of insurance premia of the new age insurance companies have to
come from rural areas. In addition, the insurance watchdog has put in
some policy stipulation on insurance companies to cover life in the social
sector for the under-privileged.

Dabur CGU Life Insurance - in which Dabur holds the majority 74 percent
stake while the remaining 26 percent is owned by CGU - has recently
forged a marketing alliance with the Lakshmi Vilas Bank. Lakshmi Vilas
Bank -- with 208 branches and 800,000 customers -- has a strong regional
presence in the southern part of the country.

"Typically we are looking to tie up with banks with strong

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

"For selling specialised financial products such as life insurance policies a

lot depends on the distributor's relationship with its customer and in India,
customers share a strong and long-term relationship with banking
institutions," he added.

Quite a few banks are desirous of undertaking life insurance or general

insurance business. State Bank of India, Bank of Baroda, Bank of
India, Global Trust Bank, Vysya Bank, Centurion Bank, Oriental
Bank of Commerce, ICICI Bank and HDFC Bank have or are intending
to enter insurance business after various procedural formalities have been
clearly defined in Insurance Regulatory Authority Bill. From the NBFC
sector Alphic Finance and Kotak Mahindra will be entering this sector. Also
a is
It few
feltindustrial house
that volume likebusiness
of new Bombayin Dyeing, Adityasector
the insurance Birla,could
Tata touch
$25 2.6
Godrej GroupRural Banking
are in the picture. … Indigenous Route to
Convenient Credit ?

ECONOMICALLY empowering, i.e. access to inexpensive credit and other

micro-finance services, including savings and insurance, India's rural
population will have a significant impact on India's economic growth.
Economic empowerment is defined here as. The modern banking system
has failed to deliver inexpensive credit to India’s 600,000 villages -

despite several expensive attempts to do so. Do we need to rethink the
appropriate institutional structure for rural banking in India? The problems
of widespread poverty, growing inequality, rapid population growth and
rising unemployment all find their origins in the stagnation of economic
life in rural areas.

Since the days of the Rural Credit Survey Committee (1954), India has
come a long way in its search for an appropriate rural banking set-up.
Though there has been some improvement, the problem remains. There
has been tremendous progress in quantitative terms but quality has
suffered, progress has been slow and halting and significant regional
disparities persist. Stagnation in rural banking is noticed in the north and
northeastern regions. The focus should be on assisting and guiding small
farmers. It is in this context that the role of rural banking institutions has
to be reconsidered.

The development strategy adopted and the increasing diversification

and commercialisation of agriculture underline the need for the rapid
development of rural infrastructure and a larger flow of credit. Activities
allied to agriculture – livestock breeding, dairy farming, sericulture etc are
being taken up on commercial lines. Further, hi-tech agriculture with an
export orientation has brought about higher productivity in cotton,
oilseeds, etc.

Progressive and not-so-small farmers have no difficulty in obtaining credit

from the commercial banks. Credit for the poorer households is the
real problem.

The Narasimham Committee observed that the manning of rural

branches “has posed problems for banks owing to the
reluctance of urban-oriented staff to work in the rural branches
and the lack of motivation to do so. More local recruitment and

improved working conditions in rural areas should help to meet
this problem.”

Experience of RRBs that have locally-recruited employees; the

employees are unhappy in view of the lack of adequate career
prospects. Apart from having a basic knowledge of agriculture and rural
development, a rural banker is required to handle credit extension work,
scheme appraisal work in connection with farm and non-farm investments
and the production of different crops, the monitoring/supervision and
recovery of loans spread over villages which are not even connected by
all-weather roads and in an environment in which vested interests are
quite powerful. A person who says he has been in bank service for more
than 25 years writes: “That rural credit has become unfashionable is
evident from the fact that the subject is accorded only residual focus in
the various congregations of our bankers. The placement policy in vogue
in our banks is such that exposures in rural credit or agro-financing rarely
count for promotions.

Unfortunately a uniform standardized approach to lending has led

to rigidities as a result of which a farmer-borrower becomes a defaulter
for no fault of his. Also, the agricultural sector is beset with considerable
uncertainties – the weather and rainfall problem, the pest problem and
the market and price problem.

Government interference that leaves no scope for these apex bodies to

show initiative and work out action plans for development on their own is
partly responsible for this situation. Another reason for such a state of
affairs is that the apex bodies have expanded and prospered at the cost of
primary bodies by taking over functions like deposit mobilisation even at
the rural level. By way of liberalisation of the federal structure’s working,
societies that want to work independently of the federal system should be
allowed to exit.

WORKING OF RRBs and Rural Cadre

It is the view that rural banking is simple that has landed the RRBs in a
mess. The poor performance of the RRB personnel is largely due to the
fact that the personnel hurriedly recruited and trained in a routine way
have been given the difficult task of dealing with a large number of small-
term/composite loans advanced to small farmers and other poor rural
families who, not knowing how to deal with banks, require assistance and
guidance at each stage – from loan application to loan recovery.

Neither the cooperative channel nor public sector one is able to meet
local needs in regard to savings and loans due to a rigid all-India approach
and lack of flexibility in their operations. This in fact is one of the reasons
for informal banking surviving and for the emergence of non-banking
financial companies (NBFCs) in rural districts. Though there is a multi-
agency set-up for rural banking, nearly 45 per cent of rural credit is from
cooperatives. But the commercial banks are a more important source of
credit as can be seen from Table 1.

What did the RBI do?

Reserve Bank appointed the R V Gupta Committee in 1997. The
committee was asked to identify the constraints faced by banks in
augmenting the flow of credit and simplifying the procedures for
agricultural credit. New institutions were over-administered, and
bureaucratic regimentation was the result. It is along such lines that the
rural credit co-operatives came up followed by the commercial banks’
diversification into rural banking after the nationalisation of 14 big banks.
Since the commercial banks, too, did not perform as expected, the
regional rural banks (RRBs) were formed. At the national level NABARD

was established. Even then, banking progress in the rural sector was not
able to take care of the growing credit needs of agriculture.

Think about it !

There should be credit societies at the village level. Such societies,

however, tend to become weak. A strong society at the tehsil
level would serve the farmers in a better, more effective and
efficient manner. After all, a farmer has to deal with a credit society
only a few times in a year; he can go up to the tehsil headquarters
for the purpose.

Advance a tailor-made package of credit with a consumption

component and closely supervise its disbursement to a large
number of farmers in far-flung villages and provide technical
guidance and marketing links. Such an approach would ensure that
scarce resources have properly utilised and that small producers
can reach a higher plane of technology and earn enough extra
income to improve their standard of living after repaying the loan.

Since the merger of the RRBs in their respective sponsor banks has
been ruled out, the RRBs should atleast be made fully owned
subsidiaries of the sponsor banks so that the banks can develop
for both their rural branches and their RRBs in a unified way.
Besides placing all the RRB employees in the rural banking cadre,
the sponsor bank should throw this cadre open and give its own
staff, including those not working in the rural branches, the option
of joining the cadre. The best option seems to be to have
managerial cadre at the district level and at the same time, each
primary should have the choice to choose its manager from the

panel of managers given by the district union district central
cooperation bank (DCCB). At the district and state levels,
managerial cadres can be created as a collaborative effort of
DCCBs, state cooperative banks (SCBs) and state and all-India
cooperative Unions.

Decentralised banking and giving branch managers

sufficient powers are a must. The Gupta Committee’s
recommendation that at least 90 per cent of loan applications
“should be decided at the branch level”, though desirable in itself,
does not go far enough. It does not take care of the need for giving
the branch manager the power to reschedule loan installments on
the merits of each case. Without such empowerment the spectre of
non-performing assets (NPAs) would harass the farmers.

Recent Developments

The second Narasimham Committee (Committee on Banking Sector

Reforms) has suggested de-layering of the cooperative credit system with
a view to reducing the costs of intermediation and making NABARD credit
cheaper for ultimate borrowers [Government of India 1998:61].

One recent development under the leadership of NABARD and non-

government organisations (NGOs) is the formation of informal, self-help
groups (SHGs) broadly on the model of the ‘grameen banks’ of
Bangladesh. The mutual trust reflected in the SHGs working is in tune with
the true spirit of cooperation. The creditworthiness of an SHG is linked to
the amount of saving brought about by the group. The SHG promotes
thrift and savings, howsoever temporary and small they are, thereby to a
great extent weaning the poor away from moneylenders. The number of
SHGs linked to banks is now around 33,000.

The makers of banking policy are now focusing on technology-led banking
in the rural sector. This requires a restructuring of cooperatives to enable
them to meet the challenges of competition. It also requires a change in
mindset. While the government should promote the restructuring and
modernisation of cooperatives through an incentive/disincentive package
and by providing adequate infrastructure in the rural areas, the actual
task should be left to the cooperative leadership and the apex bodies of

If and when rural banking becomes a separate entity in each bank, that
would ensure full attention for the rural sector and motivate personnel
who opt for this cadre, besides providing them with career prospects. The
staff requirement of the rural banking cadre (RBC) will be on a big scale.

One objective of policy-makers is to subject the banking system to greater

competition and for this purpose introduce new players in the market.
This objective is expected to be achieved by permitting the establishment
of large private banks and by encouraging the setting up of small private
local area banks (LABs) in the rural areas. LABs are envisaged as private
enterprises in rural localities for mobilizing rural savings and making them
available for investment locally. The LAB policy gives agriculturists an
opportunity to form self-help groups in the form of LABs for their banking
needs and to look after the development of their respective areas. This is
in line with the multi-agency approach to rural credit. Each banking
channel has to meet competition, and together they are to meet the
growing banking needs of rural India.

What did they have to say?

According to bank unions the aim of local area banks will be to snatch a
share of the savings and divert them into profitable investment in cities.
The weaker sections of society living in rural areas will be starved of bank
credit in consequence” Another argument against LABs is that “any small-
time trader can come into banking”.

If this were true, the Reserve Bank would by now have been flooded with
applications for starting LABs. The fact is that the mobilisation of even Rs
5 crore by way of promoters’ contribution is very difficult for a small
trader or even for large farmers. The bank employees’ unions refuse to
appreciate the logic behind the establishment of LABs. The logical follow-
up of the new economic policy is to encourage private enterprise in all
fields, including banking. In the rural sector, such private banking really
means self-help efforts.

Yet another point raised is that as there are already a large number of
branches of banks and RRBs, and cooperative credit institutions too, there
is no need for LABs. The trade unions did not object when the public
sector banks started competing with the cooperative credit institutions,
including urban banks. They do not even mind the banks competing with
the RRBs, which they have sponsored. They only fear that when the LABs
come up they will compete with the public sector banks and take away
their deposit business.

Commercial Bank v/s RRB

There are 28 PSB with 19423 branches and 196 RRBs with 12311
branches. This means that there is a public sector bank branch for every
20 villages. In addition, there are 12,357 semi urban branches (10,535 of
public sector banks and 1,822 of RRBs), which also mainly serve the rural
hinterland. This spectacular spread in the villages is a significant

achievement of banks in India. The banks’ achievement in respect of
mobilisation of rural deposits and advancement of loans to rural families
is equally commendable.
Lendings in Rural India, 1999 2000
Source Direct Indirect Total
Amount Percen Amount Percen Amount
(Rs Crore) t (Rs Crore) t (Rs
Primary co- 8,218 15.9 NA 12.9 8,218
operative credit
Land development 12,940 25.2 NA 20.3 12,940
Commercial banks 26,327 51.1 4,986 49.2 31,313
RRBs 4,044 7.8 NA 8.3 4,044
Total 51,529 100.0 12,137 100.0 63,666
Illustration 10
The new context compels us to think on new lines and, instead of
approaching the issue in a routine way, to work out the restructuring of
selected branches to suit the needs of specialised banking for agriculture,
bank managements being left free to work out programmes for this task.
As regards co-operative rural banking, the primary credit societies hold
the key to success. Banking policy should aim at encouraging the viable
ones through incentives, including direct access to NABARD finance, and
letting them function 2.7 Virtual Banking
without government interference. … the
transformation !

The practice of banking has undergone a significant transformation in the

nineties. While banks are striving to strengthen customer relationship and
move towards 'relationship banking', customers are increasingly moving
away from the confines of traditional branch-banking and are seeking the
convenience of remote electronic banking services. And even within the
broad spectrum of electronic banking, the aspect of banking that has

gained currency is virtual banking. Increase in the functional and
geographical spread of banks has necessitated the switchover from hard
cash to paper based instruments and now to electronic instruments.
Broadly speaking, virtual banking denotes the provision of banking and
related services through extensive use of information technology without
direct recourse to the bank by the customer. The origin of virtual banking
in the developed countries can be traced back to the seventies with the
installation of Automated Teller Machines (ATMs). It is possible to
delineate the principal types of virtual banking services. These include
Shared ATM networks, Electronic Funds Transfer at Point of Sale (EFTPoS),
Smart Cards, Stored-Value Cards, phone banking, and more recently,
internet and intranet banking. The salient features of these services are
the overwhelming reliance on information technology and the absence of
physical bank branches to deliver these services to the customers.

The financial benefits of virtual banking services are manifold.

 Lower cost of handling a transaction and of operating branch

network along with reduced staff costs via the virtual resource
compared to the cost of handling the transaction via the branch.

 The increased speed of response to customer requirements;

enhance customer satisfaction and, ceteris paribus, can lead to
higher profits via handling a larger number of customer accounts.

 It also implies the possibility of access to a greater number of

potential customers

 Manipulation of books by unscrupulous staff, frauds relating to

local clearing operations will be prevented if computerisation in
banks takes place.

On the flip side of the coin, however, it needs to be recognized that

such high-cost technological initiatives need to be undertaken only

after the viability and feasibility of the technology and its associated
applications have been thoroughly examined.
Virtual banking has made some beginning in the Indian banking system.
ATMs have been installed by almost all the major banks in major
metropolitan cities, the Shared Payment Network System (SPNS) has
already been installed in Mumbai and the Electronic Funds Transfer (EFT)
mechanism by major banks has also been initiated. The operationalisation
of the Very Small Aperture Terminal (VSAT) is expected to provide a
significant thrust to the development of INdian FInancial NETwork
(INFINET) which will further facilitate connectivity within the financial

The popularity which virtual banking services have won among

customers, owing to the speed, convenience and round-the clock access
they offer, is likely to increase in the future. However, several issues of
concern would need to be pro-actively attended. While most of electronic
banking have built-in security features such as encryption. Prescriptions of
maximum monetary limits and authorizations, the system operators have
to be extremely vigilant and provide clear-cut guidelines for operations.
On the large issue of electronically initiated funds transfer, issues like
authentication of payments instructions, the responsibility of the
customer for secrecy of the security procedure would also need to be

# The INFINET is a Closed User Group (CUG) Network for the exclusive use
of Member Banks and Financial Institutions. It uses a blend of
communication technologies such as VSATs and Terrestrial Leased Lines.
Presently, the network consists of over 689 VSATs located in 127 cities of
the country and utilises one full transponder on INSAT 3B. Inaugurated
on June 19, 1999, various inter-bank and intra-bank applications ranging
from simple messaging, MIS, EFT (Retail, RTGS), ECS, Electronic Debit,
online processing and trading in Government securities, dematerialisation,

centralized funds querying for Banks and FIs, Anywhere/Anytime Banking,
Inter-Branch Reconciliation are being implemented using the INFINET. The
INFINET will be the communication backbone for the National Payments
System, which will cater mainly to inter-bank applications like RTGS,
Delivery Vs Payment (DVP), Government Transactions, Automatic Clearing
House (ACH) etc.

Major issues plaguing the banking industry are the lack of

standardisation of operating systems, systems software and
application software throughout the banking industry. In a tight
competitive environment where banks are making a thrust towards
technology to provide superior services to its customers, customers stand
to gain the most. Retail Banking …the ‘in’
thing !
The Customer is now in an enviable position where he can demand
With increasedsuperior
competition, spreads
services in corporate lending
at competitive prices.have decreased
significantly. Banks are thus moving into the retail mode to tide over the
global slowdown and boost the bottomline.

Retail banking had been a neglected segment accounting to 10.5 percent

of all banks loans of India. The main advantages of retail banking are
assured spread, widely distributed risks and lower NPAs due to limited risk
associated with the salaried class. However, transactions cost are higher
as compared to of corporate lendings. Thus. The target clientele is
consumers and mid size companies.

The product offerings include home loans, car loans, credit cards, personal
loans and also customized loans like equipment loan for doctors.

In India, out of 100 houses sold, 30 are bought by housing loans and out
of 100 cars sold, 28 are brought by car loans.

In India today …

Among PSBs, SBI, Bank of Baroda, Union Bank of India and Bank of India
have diverged into the retail segment, whereas in the private sector,
opportunity seekers like ICICI and HDFC have focused on retail lendings.

Banks have a stronger influence on profits due to individual customers.

This is best proved by the success of HDFC which has achieved breakeven
on its operations in the fiscal year 2001. Even though retail loans account
for 18 percent of total loans, these account for 40 percent of bank

“In retail banking, you need a higher physical presence, in the form of
ATMs as well as branches. State-of-art technology has to be used to
enable convenient customer transactions.” States, Mr.Swaroop of HDFC

3.1 The SCAM Story … !

Ahmedabad-based Madhavpura Mercantile Cooperative Bank was

established on October 10, 1968 to cater to the varied financial needs of
wholesale grocery traders in the Madhavpura. It had 12 directors on its
board that included its chairman, Ramesh Parikh and its CEO and MD
Devendra Pandya.

The bank received a scheduled bank status from the RBI just a couple of
years ago, which allowed the bank to expand its banking operations and
start lending to stock brokers. The scheduled bank status also allowed the
bank to invest 10% of its net worth in the capital markets.

Until recently, the bank had managed to resist the allure and glamour of
investing heavily in the capital market. But, the relation between the
bank's chairman Ramesh Parikh and big bull Ketan Parekh did the trick
and the bank is reported to have made huge advances in the last couple
of months. The advance made by the bank to Ketan Parekh are pegged at
around Rs2bn.

However, the bank faced its worst crisis on the 8th of March when
depositors panicked and started withdrawing money from the bank. This
was following reports that the bank had given a huge bank guarantee to
Ketan Parekh. The result, the bank was left with very little cash. The
problems of the bank were further compounded when it had to down its
shutters in Ahmedabad and Mumbai. Many cooperative banks also faced
payment problems. Those who resorted to the call money market found
no lenders as commercial banks kept away from them.

The crisis forced the RBI to step in and take some action to limit the
damage. A preliminary inquiry by the central bank showed that the bank
had a very bad liquidity position after it issued pay-orders worth Rs650mn
to the depositors. The RBI was left with no other option but to recommend

the Central Registrar of Co-operative Banks to supercede the board of the

Several public sector banks have been hit very hard by the Madhavpura
Bank's misdemeanor. The banks include such big names as the State
Bank of India, Bank of India and the Punjab National Bank, all of which
have lost hefty sum of money in the Madhavpura scam. Bank of India lost
about Rs1.2bn as pay orders issued by Madhavpura Bank to Ketan Parekh
bounced. This was because the bank was unable to honor its
commitment. Ketan Parekh reportedly used his seven Bank of India
accounts to discount 248 payorders worth about Rs24bn in nine weeks
between January 3 and March 9. Out of this, Rs11.95bn were routed to
three of his shell companies, namely, Nakshatra Software, Chitrakoot
Computer and Goldfish Computer.

These payorders were reportedly issued by the Mandvi branch of

Madhavpura Bank, Fort branch of Standard Chartered Bank, UTI Bank and
GTB. Parekh had several accounts in all these branches. The banks in
question were, the SBI, Bank of India, Punjab National Bank and Standard
Chartered Bank. RBI said their exposure was to the tune of Rs696mn.
Ketan Parekh's pay orders, which were drawn on Madhavpura and
discounted by various banks, including Bank of India, Punjab National
Bank, Standard Chartered Bank and Global Trust Bank, bounced.
Meanwhile, the scam has also brought to light the fact that
loopholes within the banking system exist and the RBI as a
banking regulator failed to respond quickly to the challenge
posed by the recent scam.

However, the central bank seems to have learnt its lessons, albeit a little
too late, and has decided to plug the loopholes that allowed Madhavpura
Bank and stock brokers to play havoc with the market. The RBI has
reportedly drawn plans to revise payorder and demand draft discounting
norms; stock lending norms; banks capital market exposure norms and

gold lending norms. Taking into consideration the enormity of the crisis,
calls have increased for a greater role for the RBI as a regulator of the
cooperative banking sector. At present, cooperative societies are under
the dual control of the RBI and the Registrar of Cooperative Societies.
Under this system, the RBI only has jurisdiction over the banking
operations of the cooperative society while the registrar looks after the
managerial and administrative functions.

A high power committee of the RBI set up in 1999 and headed by K

Madhav Rao, said it was "absolutely necessary that the RBI should be the
sole regulator of the banking business carried on by the Urban
Cooperative Banks." The committee also added that it was "convinced
that the dual control must end, and end soon."However, the greatest
challenge in cleansing the system would be the state governments and
the domestic industries, both of which enjoy a tremendous amount of
influence on the cooperative banks. The High Power Committee on Urban
Cooperative Banks noted RBI's attempts to get even model bye-laws
adopted by state governments had drawn blank.

With big banks and small banks caught in a trap, who can the customer
bank on?
3.2 Public sector OR Private Sector – the point of
About REFORMS in the Indian banking sector
The legal infrastructure for the recovery of non-performing loans still
does not exist. The functioning of debt recovery tribunals has been
hampered considerably by litigation in various high courts. This ultimately
leads to one solution i.e. ruthless provisioning, any better ways; it is a
major drawback of this ruling.
# What is the procedure being a private player (ICICI) in this industry, is it
different and more effective as far as recoveries are concerned?

Considering the effect of high level of NPAs on the efficiency of banks,
ICICI follows a certain procedure as far as loan advancements are
concerned. Unlike most of the PSBs, the root cause for a high NPA level is
considered; being solvency of the borrower.

The procedure differs as per the amount of loan; for loan amount of Rs
500000/- and below, the customer profile is scrutanised at the branch
level. The Branch Manager and the Assistant Branch Manager evaluate
the solvency of the borrower, individually and then approval for the same
is forwarded to the concerned department. In cases where the loan
amount exceeds Rs 500000/-, the customer profile is further forwarded to
the corporate level. After evaluation at this level a confirmation is sent to
the respective branch, and then the borrowers offer is confirmed. This
system has ensured the low level of NPAs in this private sector bank.

Today, PSBs need to be given more power to enforce their security rights;
the banks cannot sell any collateral of a borrower without the court
intervention. Even as far as DRT working is concerned, an issue is
resolved in a year and a half inspite of stipulated norms of 6 months.

The need to make massive provisions obviously results in a depletion of

capital. But the capital adequacy norm means the banks have to find
additional, costly money to refurbish the capital base. In this situation,
the banks are being forced to accept the minimum possible amounts from
sub-standard and bad loans. Thus, the need for ARF is now paramount.
# Is the transfers on NPAs to state owned ARF, just about shifting the
responsibility to the ARF? What’s the whole point of having something like
that, it’s like a better way of declaring losses and turning away from
Banks should be able to account for it independently.

Frankly, ARFs seem to be like pointless transfers, its just another
committee with more heads made by GOI.

Reforms among public sector banks are slow, as politicians are

reluctant to surrender their grip over the deployment of huge amounts of
public money.
# As a private player what are the problems that you face while
communicating with the government?

The government imposes a lot of restrictions on the private players. A PSB
anyway needs to open a branch in rural areas; but for private banks need
to have branches in certain areas like Amravati or Ratnagiri, the cost of
these is not really feasible to these banks but they have no alternative.
Government does co-operate; the GOI is good, this is no form of defence,
please note the following:
- Consider the number of customers in private as compared to public
sector banks
- PSBs have a definite priority sector lending
- Maintenance of PPF accounts, taxes, etc
- Minimum deposit for credit cards and FD
Take the case of UTI returns when all others were down, that’s a
government cost.

Government intends to reduce its stake to 33% in nationalized banks,

please comment on this reform, its positive and negative effects on
private players.


As far as an effect of reducing government stake is concerned, the
competition to private players will increase. The ownership pattern and
capital structure will change and this will lead to better efficiencies and
customer service level; the management approach will be by
professionalism. However, being a government rule, it will be gradually
implemented so no immediate impact on private players.

Introduction of prudential norms, Income Recognition, Asset

Classification and compulsory disclosure of accounts has lead to
transparency in the working of banks. Any other recommendations as a
private bank.
Besides, banking regulation norms, the government needs to make a
certain service level mandatory. This could be:
- Customer service increase, i.e. basic training to employees
- Decrease NPA level by better evaluation of customer profile
- Technological upgradation, this has been implemented in PSBs
- Diversified portfolio, not just traditional ‘Banking’ functions
Any PSB is answerable at the Parliament level to the GOI; thus, disclosure
should be higher in PSBs.

Consolidation of the Banking industry by merging strong banks is the

latest development in the Indian Banking Sector. ICICI has had a recent
merger with BoM, ANZ and Stanchart, etc. Please state your views on the
overall development of India with this major development in the financial
In a competitive scenario, banks need to increase their emphasis on
customer service; the customers have a lot of choices to make. As per
Relationship Manager, ICICI, a bank with large network of branches and

diversified portfolio will stand in the market. Ultimately, a branch that
gives all in ‘one-stop’ will survive. For ICICI and BoM merger, BoM has 277
branches in South India, thus ICICI now stands to create regional balance
of branches and high connectivity throughout the country.
A merger should consider the human aspect, initially Balance Sheets will
look good, but then working of two different human cultures, one may
look down upon the other. Such trivial issues hamper the working.

About DEVELOPMENTS in the Indian Banking Sector

About VRS …At PSBs

The good people are out, so the existing people work like good soldiers
without any increase in pay. One issue is, after 1985, the recruitment in
the banking sector has been negligible; many employees would retire in a
few years, may be after that VRS could have been introduced.

The 1992 reforms gave scope for diversified product profile. New
products and new operating styles exposed the banks to newer and
greater risks.
# ICICI, as a company holds a diversified portfolio, is the main aim to
increase the non-fund based revenue due the trend of falling interest
The basic aim is to retain customers. A bank needs to push its products in
the market and establish a strong presence for survival. The measure to
increase revenues is by increasing customer base by increasing portfolio
aided with aggressive marketing. For each and every sector, ICICI has ‘n’

number of brokers and agents appointed which are well connected
throughout a majority of the country.

The issue of universal banking resurfaced in Year 2000, when ICICI gave
a presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank.
# Can you please state the benefits of universal banking, may be in
terms of revenue or utilisation of resources or others?
Anyways PSBs have multifunction, its old wine in a new bottle.

Banks and Insurance.

SBI Insurance – just confusing customers by lot of Insurance companies.
Your comments on distinguishing factor from a public sector bank which
has a low reputation as compared to private sector.
# What is the viability of “Insurance & Banking” in India, how would you
rate the success of ICICI Prudential – Joy Hope Freedom Life, on a scale of
1 to 10 (10 being highest), do you think PSBs should also go for insurance
and why?
The general attitude of employees in PSBs is laid back. The average
employee age at private sector is 24 to 29 years as compared to 35+ at
PSBs. The enthusiasm and efficiency level differs and so does the
productivity. Thus, with the existing workload and VRS, it will be very
difficult for PSBs to work. The concept of PSBs and insurance may not
work unless supported by better employee productivity.
Insurance would be better utilisation of existing resources e.g. SBI has
13000 branches. The viability may term at 6 as of now mainly due to long
paybacks. Also, for PSBs you can exploit the strength of reputation of trust
and safety.

Due to increasing competition all banks are now heading towards
developing areas or rather towns in the country. Especially ICICI, it is
known for its network in rural areas, please comment on the potentials in
the rural area.

RBI norms state that for every 5 urban branches, 1 rural branch needs to
be introduced. Considering the increasing importance of education in rural
market and their literacy w.r.t banking, rural India has a considerable
scope. There is a section of people which wants to know what are the
services banks can offer, this itself proves that banks need to come up
with better schemes in customized to rural requirements.
Private players have been operating at in urban areas, adjusting with rural
India will take time.

How do you see the scope of Internet banking in India, well / bad and
why? How much revenue do you see from this business as a percentage
of the total business, in the future 5 years down the line? What is the
current revenue from this business?
The trend today is to ape the West. People look forward and inquire for
new technologies because they offer convenience. At ICICI, they have a
Demo service with a personnel explaining what are the e-banking services
available how are they used etc. In 5 years, the usage of e-banking
technology is expected to double.
Internet has a future in India, people adjust to technology very fast; take
the case when STD booths were introduced in India. Anyways, the Internet
is not a form of direct revenue, it’s just an additional service of
convenience given to customers.

Canara Bank – Interview of Mr. Sanghavi – Senior
Manager – Andheri (W)

In the long run, it will be fruitful, salary expenditure will drop, and also
cost of related perks would reduce. But they lay an immediate
disadvantage; the VRS was introduced in a very disorganized manner,
there was no provision made for the payment of VRS dues earlier. The
cost at Canara Bank is around Rs 139 Crores; if these funds were used to
make public sector banks technology savvy then VRS could have been
introduced after a period of 5 years. The banks would also have the power
to retain clients, currently, the clients who can pay more for better
services are moving away.

On diversifying portfolio
The private players have limited clients to cater; hence they can manage
a varied portfolio easily. Canara Bank had introduced single window
system for their clients; when you have a large database of customers,
service quality deproves.

On ECS – tech banking

UTI is the largest user of ECS credit, and BSES and MTNL are one of the
greatest beneficiaries, a problem here is when a cheque is bounced on
account of inadequate cash. The government needs to make clear laws on
use of ECS.

Debt Recovery Tribunals
Interview of Mrs Rama Pendharkar - Advocate
Mr R S Chehel – Advocate

In Maharashtra, there are around 5 DRT, 3 in Mumbai. These have a

specific area of jurisdiction. DRT are authorised to handle DRT, the profile
amount exceeding Rs 10 Crores, all below Rs 10 crores need to approach
the civil courts.

The procedure

Banks send a notice to their client and if they don’t give a reply; the bank
i.e. applicant files a suit in the DRT. Section 19 of DRT Act states the banks
permitted to be an applicant, only scheduled banks and nationalised
banks are permitted. DRTs have their own procedure distinct from the civil
courts; and are headed by the Presiding Officer who is said to be
equivalent to the District Judge.

Within a month of filing a suit, the defaulted borrower i.e. the defendant
requires to reply back. No oral evidence is permitted, the defendant has to
file an affidavit. The issue is resolved only by affidavits. Within 6 month,
the presiding officer resolves to the issue.

Issues Resolved
The number of issues resolved is not disclosed on account of disclosure
regulations with respect to the same.

3.3 And today…the news says …

The following states recent status of the Indian Banking sector.

Foreign allies can hold up to 49% in private banks
The RBI-SEBI panel has decided that a foreign collaborator can hold up to
49 per cent in a private bank as against 20 per cent allowed earlier. As
per earlier norms, a foreign bank or financial institution stepping in as a
technical collaborator can pick up a maximum 20 per cent stake directly,
while another 20 per cent can come as direct investments by NRIs.

Life after VRS: Nationalised banks facing shortage of staff

Shedding flab was fine till, of course, shortage of right man for the right
job started surfacing.

A voluntary retirement scheme, leaner, smarter, and manageable

workforce, lower overheads may all have been relevant reasons to get
onto best business practices. But what many of these nationalised banks
did not consider was acute shortage of manpower (read officers) for
supervisory banking functions. Outsourcing administrative services has
arrived in the banks. But this is not proving to be a catch-all-solution
either. Most banks are rushing in officers to branches where senior officers
have left. “Reducing workforce is fine. But post-VRS manning structures
had obviously not been clearly forecast. As a fall-out, daily operations that
are being affected, will have to be outsourced in the long run,” the
sources said.

IDBI to focus more on retail banking

IDBI is to focus more on retail banking as part of its revised functional
strategy for future growth, bank's managing director Gunit Chadha said.
He said the rolling out of the bank's RPU underlined the increased focus
the bank had placed on retail banking. The RPU has armed the bank with
the necessary systems and structure to roll out new products in retail

banking and will greatly reduce time to market the new products," he

A sharp rise
A study of the performance of banking sector stocks over the past one
year has shown that while several public sector banks have shown a
sharp rise in prices, many of their private counterparts are high on the
losers list. Leading the gainers list is Corporation bank whose scrip has
nearly doubled in the last one year. It is followed by Bank of India with a
gain of 75 per cent, and Jammu & Kashmir Bank which, despite a majority
holding by the J&K government, is classified as a private bank.
"Corporation bank takes only select clients and a lot of effort goes into
this selection," says a merchant banker explaining the low NPA levels in
the bank.

Bankers jittery over proposed laws

Rattled by scams, bankers are now jittery that new laws could push them
further towards the edge. The financial regulators are now pitching for a
change in the statutes that would put the responsibility on banks,
financial institutions and other intermediaries to first prove themselves
innocent when a `serious fraud’ hits the system.

So it didn’t come as a surprise when bankers were visibly upset and later
voiced their protest last week after the committee on fraud made a final
presentation before submitting its report to the government. In its final
recommendations the panel headed by Prof N L Mitra has said that when
a fraud over Rs 10 crore is committed, the onus will be on banks and FIs
to prove themselves innocent, failing which the law will take its own
course. Understandably, it didn’t go down well among the bankers who
fear that the proposed law could terrorise bank officials to such an extent
that business would suffer.

The central bank, which took the initiative to form the committee, is
understood to be supportive of the different changes that the panel has
prescribed. For instance, the committee has asked for changes in the
Indian Penal Code to enable the legal system handle `financial fraud’.
Currently, Indian laws with provisions for crimes like cheating, forgery and
criminal breach of trust, are vague about financial frauds. The committee
aims to make it more difficult for scamsters to take refuge in legal
loopholes by making financial frauds a crime.

The recommendations, which assume a special significance after the

string of scams that have rocked the Indian markets and institutions, will
be submitted to the finance ministry in the first week of September. The
committee on fraud has further recommended a special investigative
agency for the purpose. This will require professionals from different fields
and could be in line with the Serious Fraud Office, UK, which has teams
comprising lawyers, accountants, bankers, software experts etc — all of
whom give their inputs so that the case can be presented in a
comprehensive way before the court of law.
Allahabad Bank gets a sock for hiking CAR
The Governement on Wednesday pulled up the CMD of Allahabad Bank, B
Samal, and his management team for falsely reporting the bank’s capital
adequacy at 11.51 per cent against the actual 8.61 per cent. At a review
presided by finance secretary Ajit Kumar here, the bank was asked to turn
around or close down 136 loss-making branches. The ministry team also
criticised the management for letting standard assets turn NPAs again. On
Tuesday, the government had asked UCO Bank to shut down 800 of its
loss-making domestic branches besides four international ones. The
government is meeting all the weak banks to take stock of their
operations, indicating a change in the mindset and a resolve to chide
shoddy performers. Indian Bank, however, was the odd man out. Although

the government did not promise capital, it complimented the bank for its
improved performance in recent months.

On sabbatical
The scheme launched by PSBs along with VRS, sabbatical has got around
200 optees as of August 2001, comparing this to the VRS response of 11%
of the employees in the industry; an observation was that only highly
qualified employees opted for this scheme.

ATMs in India
The BoI is planning to install 225 ATMs in nine major cities. The growth of
ATMs in India has been exponential; currently there are over one lakh
ATMs in India and the growth rate is 40 %. As far as cost are concerned,
Mr. Loney Antony, NCR Corporation India, Country Manager, states that
cost of branch transaction is Rs 50 to Rs 100 whereas cost on an ATM is
not more than Rs 25.

3.4 THE FUTURE . . . what’s ahead !

The Indian Banks even after a decade full of reforms for the sector have a
long way to go. Product innovations, better information technology and
operating mechanisms not only enhance the income and reduce expenses
but also act as a catalyst to retain customers. The question is will this
suffice for the future? With the continued integration of the Indian
markets with the global markets, the volatility is rising. To survive this
dynamism and the risks arising from the same, banks need to have
resources in place to understand and manage them on a regular basis.
Markets, which have so far witnessed a deluge in the number of banks,
will now witness consolidation.

With the onset of globalisation in each and every sector, Indian Banks
need to be much more sustainable, efficient, transparent in working and
also competitive. Now the bank mergers will not be a new phenomenon
since synergies are derived from the alliances in the recent mergers. The
following seem to be what the Indian Banking sector is heading for:

As the economy revives fee based activities and asset quality of banks
could improve.
After adjusting for Non Performing Loans some public sector banks may
have to go in for fresh capital infusion.
Banks will have to compete with mutual funds as an alternative to bank
As public sector banks find their margins squeezed, they may become
more active in trading to make up for the margin squeeze. The risk profile
of these public sector banks may increase as their trading in money and
forex markets increase. Thus, a sound risk management i.e. the ALMs
need to be in place.
As competition compress spreads earned on lending business, banks

will have to focus on fee income. Private banks are likely to generate
better fee income due to their focus on having adequate technology and
having skilled personnel to generate such business.
RBI is examining the feasibility of introduction of half yearly audit of
accounts by external auditors towards improving the quality of auditing
standards further.
New arenas for advancing may be surveyed, the housing loan sector has
gained a considerable boosts as per the recent budgetary measures;
banks are allowed to lend 3 per cent of their advances to this sector, also
infrastructure and film financing remain untapped.
With the opening of the insurance sector and recent relaxation of
regulation by RBI for entry of banks in this area of business, some of the
big banks are expected to enter this business in a big way. Public sector
banks with their wide reach and higher confidence levels can take the
All banks will have to adapt to new emerging technologies in order to
exploit the new business opportunities it offers. It will be a new challenge
and will require investment in technology and new systems. Some value-
added services may also need to be provided, which will call for
innovation standardisation. Virtual Banking will set in as a trend

Today, the banks have to compete with their peers as well as with other
financial companies. But tomorrow, competitors might zoom in from
completely unexpected industries, as deregulation and new technology
blur old boundaries, these rewrites the conventional definition of a bank.
Those forces offer as many opportunities as threats.

A reinvention or a renewal or a rediscovery, the way you

term it, shall root the structural changes in the Indian
Banking Sector.

A personal view on reforms and developments in the Indian Banking

Sector is stated below.

The reduction in SLR and CRR has been effective in the sense that the
lendable resources of banks have increased. The anticlimax is about the
current recession in the economy and decreasing need of investments by
the corporate sector. The CRAR requirements are necessary for financial
soundness of Indian banks; also; a need to assign risk weightage to
government securities seems to be coming up due to increasing
investments of banks portfolios.

The NPA trend has been fortunately declining in the recent years, initially
the NPAs were amounting to total of 16 %, and however banks should
note that ever greening of loans would deprove the circumstances in the
long run; the asset quality is the determinance of banks profitability today.
The present evaluation process of banks states requires around 18

officials for quality inspection, the bureaucracy involved can reduced only
by way of better bank supervision. The Disclosure norms shall avoid
situations like in case of South East Asian Crisis; with this respect, RBI
proves to be a quite proactive institution.

Globalisation has but lead to the liberalisation of the Indian Banking

sector; like the other sectors opened up, today, the Indian banks need to
learn much more from competition; customers and not advances and
customer service is the call for the day.

The DRT Act supersedes all acts but the SICA which clearly states that
companies can very easily stall recovery procedures. It’s a fact in our
country that for every law made there is one more to escape from it.
However, the conceptualization of this structure needs to be

Increasing risks and imprudent liability management constitute to asset

liability mismatch. Complacent behaviour of Indian banks with this
context has lead to ALM reforms. This shall positively improve and get
bankers alert. The ALM framework if correctly implemented shall prove

Reduction of government stake seems to be a good decision of RBI, but on

deeper analysis, the control strongly remains with the government and it
is a truth that bureaucracy has become a side business. We still need to
see what happens next !

The corporates can now have a good deal with loans and advances; the
interest rate deregulation has been in line with the international
standards. The current trend of falling rates shall indeed give the
corporate customers fair access with better services.

VRS was a government decision and about 11 % of the employees retired.

It was no form of a structural change but is a very effective tool to

improve efficiency of the Indian PSBs. I think a better plan would have
been of investments in technology partially and then a VRS. Currently,
lots of banks are facing problems of inadequate staffing; a good
manpower planning in advance would not have lead to the current

About universal banking, due to increasing competition banks need to

strive for customers, thus, offering all at the same desks for corporates as
well as individuals i.e. retail banking is required; public sector needs to
have a pace in this arena. A merger to improve the overall health, reach
and customer base, has given a rise to the trend of mergers globally. The
recent merger of ICICI and BoM proves that customer base has to develop
for sustainability. Mergers constitute as a cheaper and a quicker form of
expansion and Indian banks should explore such an opportunity.

The opening of insurance has given banks a new opportunity to make the
best out of their resources; how much advantage do our PSBs make is yet
to see.

As far as rural banks are concerned, GOI has to give personnel better
career prospects in order to get them working, better products and
convenience and safety has to be guaranteed by the bank. Personalized
service in a crude form will help.

Lastly, technological upgradation will be what will lead to customer

retention on the grounds of accessibility and convenience.

Annexure 1

State Bank of India and its subsidiaries are :

• State Bank of India

• State Bank of Bikaner & Jaipur
• State Bank of Hyderabad
• State Bank of Indore
• State Bank of Mysore
• State Bank of Patiala
• State Bank of Saurashtra
• State Bank of Travancore

Other nationalized banks are:

• Allahabad Bank
• Andhra Bank
• Bank of Baroda
• Bank of India
• Bank of Maharastra
• Canara Bank
• Central Bank of India
• Corporation Bank
• Dena Bank
• Indian Bank
• Indian Overseas Bank
• Oriental Bank of Commerce
• Punjab & Sind Bank
• Punjab National Bank
• Syndicate Bank
• UCO Bank
• Union Bank of India
• United Bank of India
• Vijaya Bank

Some of Public Sector banks have issued equity shares for general public
and are listed on various stock exchanges. The listed public sector banks

• State Bank of India

• State Bank of Bikaner and Jaipur
• State Bank of Travancore
• Bank of Baroda
• Bank of India

• Oriental Bank of Commerce
• Dena bank
• Corporation bank


Old private sector banks

• **Bank of Madurai Ltd

• Bank of Rajasthan Ltd
• Bareilly Corporation Bank Ltd
• Bharat Overseas Bank Ltd
• City Union Bank Ltd
• Development Credit Bank Ltd
• Ganesh Bank of Kurundwad Ltd
• Karnataka Bank Ltd
• Lord Krishna Bank Ltd
• Nainital Bank Ltd
• SBI Comm & Int Bank Ltd
• Tamilnad Mercantile Bank Ltd
• The Benares State Bank Ltd
• The Catholic Syrian Bank Ltd
• The Dhanalakshmi Bank Ltd
• The Federal Bank Ltd
• The Jammu & Kashmir Bank Ltd
• The Karur Vysya Bank Ltd
• The Lakshmi Vilas Bank Ltd
• The Nedungadi Bank Ltd
• The Ratnakar Bank Ltd
• The Sangli Bank Ltd
• The South Indian Bank Ltd
• The United Western Bank Ltd
• The Vysya Bank Ltd

New private sector banks

• Bank of Punjab Ltd

• Centurion Bank Ltd
• Global Trust Bank Ltd
• HDFC Bank Ltd
• ICICI Banking Corporation Ltd
• IDBI Bank Ltd
• IndusInd Bank Ltd
• *Times Bank Ltd
• UTI Bank Ltd

*since merged with HDFC Bank
**since merged with ICICI Bank


• ABN-AMRO Bank N.V.

• Abu Dhabi Commercial Bank Ltd.
• American Express Bank Ltd.
• Arab Bangladesh Bank Ltd.
• ANZ Stanchart Bank
• Bank International Indonesia
• Bank of America NT&SA
• Bank of Bahrain and Kuwait BSC
• Bank of Ceylon
• Banque Nationale De Paris
• Barclays Bank PLC
• Chase Manhattan Bank
• Chinatrust Commercial Bank
• Cho Hung Bank
• Citibank N.A.
• Commercial Bank of Korea, **
• Commerzbank AG
• Credit Agricole Indosuez
• Credit Lyonnais
• Deutsche Bank AG
• Dresdner Bank AG
• Fuji Bank Ltd.
• Hanil Bank **
• Hongkong Bank
• ING Barrings Bank N.V.
• Krung Thai Bank
• Mashreq Bank
• Oman International Bank S.A.O.G.
• Overseas Chinese Banking Corp. Ltd.
• Siam Commercial Bank
• Societe Generale
• Sonali Bank
• State Bank of Mauritius Ltd.
• Sumitomo Bank Ltd.
• The Bank of Nova Scotia
• The Bank of Tokyo-Mitsubishi Ltd.
• The British Bank of Middle East
• The Development Bank of Singapore Ltd.
• The Sakura Bank Ltd.

• The Sanwa Bank Ltd.
• Toronto-Domonion Bank
• Bank Muscat International SAOG,
• Morgan Guaranty Trust company of New York
• KBC Bank, NV


Annexure 2
The personnel in public sector and the private sector bank were
interviewed on basis of the following questionnaire (this is customized for
ICICI Bank):

About REFORMS in the Indian banking sector

The legal infrastructure for the recovery of non-performing loans still

does not exist. The functioning of debt recovery tribunals has been
hampered considerably by litigation in various high courts. This ultimately
leads to one solution i.e. ruthless provisioning, any better ways; it is a
major drawback of this ruling.
# What is the procedure being a private player (ICICI) in this industry, is it
different and more effective as far as recoveries are concerned?

The need to make massive provisions obviously results in a depletion of

capital. But the capital adequacy norm means the banks have to find
additional, costly money to refurbish the capital base. In this situation,
the banks are being forced to accept the minimum possible amounts from
sub-standard and bad loans. Thus, the need for ARF is now paramount.
# Is the transfers on NPAs to state owned ARF, just about shifting the
responsibility to the ARF? What’s the whole point of having something like
that, it’s like a better way of declaring losses and turning away from

Reforms among public sector banks are slow, as politicians are
reluctant to surrender their grip over the deployment of huge amounts of
public money.
# As a private player what are the problems that you face while
communicating with the government?

Government intends to reduce its stake to 33% in nationalized banks,

please comment on this reform, its positive and negative effects on
private players.
Introduction of prudential norms, Income Recognition & Asset
Classification and compulsory disclosure of accounts has lead to
transparency in the working of banks. Any other recommendations as a
private bank.
Consolidation of the Banking industry by merging strong banks is the
latest development in the Indian Banking Sector. ICICI has had a recent
merger with BoM, ANZ and Stanchart, etc. Please state your views on the
overall development of India with this major development in the financial

About DEVELOPMENTS in the Indian Banking Sector

The 1992 reforms gave scope for diversified product profile. New
products and new operating styles exposed the banks to newer and
greater risks.
# ICICI, as a company holds a diversified portfolio, is the main aim to
increase the non-fund based revenue due the trend of falling interest

The issue of universal banking resurfaced in Year 2000, when ICICI gave
a presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank.

# Can you please state the benefits of universal banking, may be in terms
of revenue or utilisation of resources or others?

SBI Insurance – just confusing customers by lot of Insurance companies.

Your comments on distinguishing factor from a public sector bank which
has a low reputation as compared to private sector.
# What is the viability of “Insurance & Banking” in India, how would you
rate the success of ICICI Prudential – Joy Hope Freedom Life, on a scale of
1 to 10 (10 being highest), do you think PSBs should also go for insurance
and why?

Due to increasing competition all banks are now heading towards

developing areas or rather towns in the country. Especially ICICI, it is
known for its network in rural areas, please comment on the potentials in
the rural area.

How do you see the scope of Internet banking in India, well / bad and
why? How much revenue do you see from this business as a percentage
of the total business, in the future 5 years down the line? What is the
current revenue from this business?