72

SECTION 2 : INDUSTRY REVIEW

B an k i n g S ecto r
A. K. Purwar
Chairman
State Bank of India Ltd.
Financial sector reformswere initiated aspart of overall economic reformsin
the country and wide ranging reforms covering industry, trade, taxation,
external sector, banking and financial marketshave been carried out since mid
1991. A decade of economic and financial sector reforms has strengthened
the fundamentals of the Indian economy and transformed the operating
environment for banksand financial institutionsin the country. The sustained
and gradual pace of reforms has helped avoid any crisis and has actually
fuelled growth. As pointed out in the RBI Annual Report 2001-02, GDP
growth in the 10 years after reforms i.e. 1992-93 to 2001-02 averaged 6.0%
against 5.8% recorded during 1980-81 to 1989-90 in the pre-reform period.
The most significant achievement of the financial sector reformshasbeen the
marked improvement in the financial health of commercial banksin termsof
capital adequacy, profitability and asset quality asalso greater attention to risk
management. Further, deregulation has opened up new opportunities for
banksto increase revenuesby diversifying into investment banking, insurance,
credit cards, depository services, mortgage financing, securitisation, etc. At
the same time, liberalisation has brought greater competition among banks,
both domestic and foreign, aswell ascompetition from mutual funds, NBFCs,
post office, etc. Post-WTO, competition will only get intensified, as large
global players emerge on the scene. Increasing competition is squeezing
profitability and forcing banks to work efficiently on shrinking spreads. A
positive fallout of competition is the greater choice available to consumers,
and the increased level of sophistication and technology in banks. As banks
benchmark themselves against global standards, there has been a marked
increase in disclosuresand transparency in bank balance sheetsasalso greater
focuson corporate governance.
Major ReformInitiatives
Some of the major reform initiatives in the last decade that have changed the
face of the Indian banking and financial sector are:
Interest rate deregulation. Interest rateson depositsand lending have been
deregulated with banksenjoying greater freedom to determine their rates.
Adoption of prudential norms in terms of capital adequacy, asset
classification, income recognition, provisioning, exposure limits, investment
fluctuation reserve, etc.
Reduction in pre-emptions lowering of reserverequirements(SLR and CRR),
thusreleasing more lendable resourceswhich bankscan deploy profitably.
Shri Arun Kumar Purwar isChairman, State
Bank of India. He has more than three
decades of experience in banking having
successful l y handl ed si gni fi cant
assignments. His earler stints at the bank
included; Deputy Managing Director and
Chief Credit Officer of the bank responsible
for streamlining the working of the credit
process of the bank; chief executive officer
of theTokyo branch. Heisalso thechairman
of the associate banks of SBI.
73
Government equity in banks has been reduced and strong
banks have been allowed to access the capital market for
raising additional capital.
Banks now enjoy greater operational freedom in terms of
opening and swapping of branches, and banks with a good
track record of profitability have greater flexibility in
recruitment.
New private sector bankshave been set up and foreign banks
permitted to expand their operations in India including
through subsidiaries. Bankshave also been allowed to set up
Offshore Banking Unitsin Special Economic Zones.
New areas have been opened up for bank financing:
insurance, credit cards, infrastructure financing, leasing, gold
banking, besides of course investment banking, asset
management, factoring, etc.
New instrumentshave been introduced for greater flexibility
and better risk management: e.g. interest rate swaps, forward
rate agreements, cross currency forward contracts, forward
cover to hedge inflows under foreign direct investment,
liquidity adjustment facility for meeting day-to-day liquidity
mismatch.
Several new institutions have been set up including the
National Securities Depositories Ltd., Central Depositories
Services Ltd., Clearing Corporation of India Ltd., Credit
Information Bureau India Ltd.
Limits for investment in overseas markets by banks, mutual
funds and corporates have been liberalised. The overseas
investment limit for corporates has been raised to 100% of
net worth and the ceiling of $100 million on prepayment of
external commercial borrowingshasbeen removed. MFsand
corporates can now undertake FRAs with banks. Indians
allowed to maintain resident foreign currency (domestic)
accounts. Full convertibility for deposit schemes of NRIs
introduced.
Universal Banking has been introduced. With banks
permitted to diversify into long-term finance and DFIs into
working capital, guidelines have been put in place for the
evolution of universal banks in an orderly fashion.
Technology infrastructure for the payments and settlement
system in the country hasbeen strengthened with electronic
funds transfer, Centralised Funds Management System,
Structured Financial Messaging Solution, Negotiated Dealing
System and move towards Real Time Gross Settlement.
Adoption of global standards. Prudential norms for capital
adequacy, asset classification, income recognition and
provisioning are now close to global standards. RBI has
introduced Risk Based Supervision of banks (against the
traditional transaction based approach). Best international
practices in accounting systems, corporate governance,
payment and settlement systems, etc. are being adopted.
Credit delivery mechanism has been reinforced to increase
the flow of credit to priority sectors through focus on micro
credit and Self Help Groups. The definition of priority sector
has been widened to include food processing and cold
storage, software upto Rs1 crore, housing above Rs10 lakh,
selected lending through NBFCs, etc.
RBI guidelines have been issued for putting in place risk
management systems i n banks. Ri sk Management
Committees in banks address credit risk, market risk and
operational risk. Bankshavespecialised committeesto measure
and monitor variousrisksand have been upgrading their risk
management skillsand systems.
The limit for foreign direct investment in private banks has
been increased from 49% to 74% and the 10% cap on
voting rights has been removed. In addition, the limit for
foreign institutional investment in private banks is 49%.
Wide ranging reforms have been carried out in the area of
capital markets. Fresh investment in CPs, CDs are allowed
only in dematerialised form. SEBI hasreduced the settlement
cycle from T+3 to T+2 from April 1, 2003 i.e. settlement of
stock deals will be completed in two trading days after the
trade isexecuted, taking the Indian stock trading system ahead
of some of the developed equity markets. Stock exchangeswill
set up trade guarantee funds. Retail trading in Government
securitieshasbeen introduced on NSE and BSE from January
16, 2003. A Serious Frauds Office is proposed to be set up.
Fungibility of ADRsand GDRsallowed.
Improvement in performance of commercial banks
There is no doubt that banking sector reforms have increased
the profitability, productivity and efficiency of banks. There
has been an improvement in overall capital adequacy of banks
and as on March 31, 2002 92 out of 97 commercial banks
operating in India had capital adequacy above the statutory
minimum level of 9%. Introduction of prudential norms
relating to asset classification, income recognition and
Tha mosI s|gn|I|canI ach|avamanI oI
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FurIhar, daragu|aI|on has opanad up
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boIh domasI|c and Iora|gn, as wa|| as
compaI|I|on Irom muIua| Iunds,
h8F0s, posI oII|ca, aIc.
74
provisioning, along with legal and institutional reforms, hasled
to visible improvement in asset quality in banks. Net NPAs(i.e.
that portion of NPAs which is not provided for) have declined
gradually from 10.7% in 1994-95 to 5.8% in 2001-02.
Increase in the number of players has increased competition,
which is reflected in the decline in the bank concentration
ratio. The share of top 5 banks in total assets declined from
51.7% in 1991-92 to 43.5% in 2001-02 while its share in
profits fell from 54.5% to 41.4% in the same period.
Despite intensification of competition and introduction of
prudential norms, all major bank groupsin India have remained
profitable. The Return on Assets has hovered in the range of
0.5-0.8% since the mid-1990s while this is on the lower side
compared to many developing countries, it is higher than the
profitability at around 0.5% in industrialised countries. The
improvement in efficiency isalso seen from the intermediation
cost for scheduled commercial banks, which declined from
2.85% in 1996-97 to 2.19% in 2001-02

. According to data
analysed by RBI, there has been a noticeable decline in the
difference between real interest ratesin India and international
benchmark rates (LI BOR 1 year) since the mid-1990s,
suggesting increased integration of the Indian banking sector
with the rest of the world.
Challenges Ahead
(i) Improving profitability: The most direct result of the above
changesisincreasing competition and narrowing of spreads
and its impact on the profitability of banks. The challenge
for banksishow to manage with thinning marginswhile at
the same time working to improve productivity which
remains low in relation to global standards. This is
particularly important because with dilution in banks
equity, analysts and shareholders now closely track their
performance. Thus, with falling spreads, rising provision
for NPAs and falling interest rates, greater attention will
need to be paid to reducing transaction costs. This will
require tremendous efforts in the area of technology and
for banks to build capabilities to handle much bigger
volumes.
(ii) Reinforcing technology: Technology has thus become a
strategic and integral part of banking, driving banks to
acquire and implement world classsystemsthat enable them
to provide products and services in large volumes at a
competitive cost with better risk management practices.
The pressure to undertake extensive computerisation isvery
real as banks that adopt the latest in technology have an
edge over others. Customershave become very demanding
and banks have to deliver customised products through
multiple channels, allowing customers access to the bank
round the clock.
(iii) Risk management: The deregulated environment bringsin
its wake risks along with profitable opportunities, and
technology plays a crucial role in managing these risks. In
addition to being exposed to credit risk, market risk and
operational risk, the businessof bankswould be susceptible
to country risk, which will be heightened ascontrolson the
movement of capital are eased. In this context, banks are
upgrading their credit assessment and risk management
skills and retraining staff, developing a cadre of specialists
and i nt roduci ng t echnol ogy dri ven management
information systems.
(iv) Sharpening skills: The far-reaching changesin the banking
and financial sector entail a fundamental shift in the set of
skills required in banking. To meet increased competition
and manage risks, the demand for specialised banking
functions, using IT as a competitive tool is set to go up.
Special skills in retail banking, treasury, risk management,
foreign exchange, development banking, etc., will need to
be carefully nurtured and built. Thus, the twin pillars of
the banking sector i.e. human resourcesand IT will have to
be strengthened.
(v) Greater customer orientation: In todays competitive
environment, bankswill have to strive to attract and retain
customersby introducing innovative products, enhancing
the quality of customer service and marketing a variety of
products through diverse channels targeted at specific
customer groups.
(vi) Corporate governance: Besides using their strengths and
strategic initiatives for creating shareholder value, banks
have to be conscious of their responsibilities towards
corporate governance. Following financial liberalisation, as
the ownership of banks gets broadbased, the importance
of institutional and individual shareholders will increase.
In such a scenario, bankswill need to put in place a code for
corporate governance for benefiting all stakeholders of a
corporate entity.
(vii) International standards: Introducing internationally
followed best practicesand observing universally acceptable
standards and codes is necessary for strengthening the
domestic financial architecture. Thisincludesbest practices
in the area of corporate governance along with full
transparency in disclosures. In todays globalised world,
focusing on the observance of standards will help smooth
integration with world financial markets.
Conclusion
The face of banking is changing rapidly. Competition is going
to be tough and with financial liberalisation under the WTO,
banks in India will have to benchmark themselves against the
best in the world. For a strong and resilient banking and financial
system, therefore, banks need to go beyond peripheral issues
and tackle significant issues like improvements in profitability,
efficiency and technology, while achieving economies of scale
through consolidation and exploring available cost-effective
solutions. These are some of the issuesthat need to be addressed
if banksare to succeed, not just survive, in the changing milieu.
75
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a
v
e
o
n
Y
o
u
r
c
o
s
t
s
:
E
n
h
a
n
c
e
Y
o
u
r
S
k
i
l
l
s
:
M
a
x
i
m
u
m
P
r
o
t
e
c
t
i
o
n
f
o
r
I
n
v
e
s
t
o
r
s
: :
w
w
w
.
b
s
e
i
n
d
i
a
.
c
o
m