Submitted by: Group 6

Banking in India: Issues and challenges

Introduction
India has a fast-growing banking system. It has the potential to become
the fifth largest banking industry in the world by 2020 and the third largest
by 2025, according to an industry report. The face of Indian banking has
changed over the years. Banks are now reaching out to the masses with
technology to facilitate greater ease of communication, and transactions
are carried out through the Internet and mobile devices. The reforms of
the Indian financial system are the relevant factor of all these important
changes and this growth thanks to the creation of the Reserve Bank of
India (RBI) in 1991. Indian banking system saw the increased involvement
of Private Banks sector (19, 8% in 2004) and deposits (17, 5% in 2003).
Moreover, the greatest development in this financial system is certainly
retail banking with the growth of service sectors like information
technology or health care.
But, even if there are lot of successes this last decade, the banking system
in India should meet new challenges posed by the technology and any
other external and internal factors like regulatory practices as risk
management, consolidation, skilled manpower, overseas expansion,
skilled manpower, Non-Performing Assets (NPAs) or consumer protection.
So, this analysis will be about highlighting all issues and challenges that
Indian Banking system has to face.
The major challenges faced by the Indian banks are in terms of increased
competition, increased regulation, regaining balance sheet strength,
managing the NPAs and leveraging on the information technology to
satisfy the changing customer demand. Following is a brief look into the
different challenges and issues faced by the Indian banks

Risk management and BASEL II reforms

Under the Basel reforms the banks need to maintain a capital
specified under the minimum capital requirement as specified in the
reforms. The supervisory review process requires all banks to
develop internal capital assessment programs to ensure they have
adequate capital to meet contingencies while maintaining a
minimum buffer. It also calls for market discipline that ensures a
system for disclosure with specified intervals.

Reaching the Indian consumer

The Indian consumer is no longer concentrated in the top 10 cities
of the country but in the towns and rural areas as well. Banks need
to build an extensive network and devise ways to tap into this set of
potential customers. Also, with the changing banking needs of the
consumer a bank needs to come up with a full product offering from
saving deposit accounts to internet banking and automobile and
housing loans.

Revolution in information technology

Banks need to leverage on the information technology revolution
that has hit the market. Technology can be used effectively to
service different customer segments of the bank by offering

Submitted by: Group 6

convenience to the retail customer and generate operational
efficiencies for large scale corporate and government clients. The
use of right technology will help the bank be cost effective, maintain
high service and efficiency standards while delivering sustainable
returns.

Local and foreign competition

The lower entry barriers have led to increased competition from
new players such as private banks, NBFCs and the shadow-banking
sector.
There are around 36 foreign banks operating in India. The
competition from the foreign players after the liberalization stage is
a challenge to the nationalized and the private sector banks in
India. This intense competition calls for customer centric policies
and customer friendly procedures.

Financial inclusion
Several measures like no-frills accounts, PSL GCCs for small
deposits and credits introduced by the RBI further add to the cost
base and operational burden of the banks. The branch requirement
specified by the RBI in rural areas also cuts into the profit margins
of banks.

High transaction costs

The creation of NPAs on the banks balance sheet has caused an
increase in the carrying costs of the bank. The growth in NPAs has
led to drags in the operational efficiency of banks and a growing
NPA portfolio on their balance sheets.

Manpower requirement
As per a recent McKinsey report, the banking sector will face
shortage of skilled manpower in the next five years. With increase in
competition, there is poaching of skilled employees by
competition,which makes the current employees pay higher
salaries. This is another drag on the profitability of the bank.

Need for Consolidation:

Indian Economy has grown at a steady pace since the launch of
economic reforms in 1991
India is predicted to emerge as a global economic power in the
future
Currently only 6 banks feature in the The Bankers List of the top
500 banks in the world
The combined assets of the top 5 Indian Banks was less than that of
the largest Chinese Bank, which is roughly 7.8 times the size of SBI
Even in Asia, only SBI features in top 25 (Tier I capital)
Benefits of Consolidation:

Reduction in costs through rationalization of manpower, operational

overheads and expenses on product development and delivery
Greater geographical coverage and wider access to markets

Submitted by: Group 6

Risk reduction through diversification of loan portfolios

Overseas Expansion:

Indias share in global trade was 0.8% which grew to 15% with the
growth in IT. Banks have very keenly tapped up this growth from
international expansion by taking some of these initiatives:
SBI acquired a 51% stake in Mauritius-based Indian Ocean
International Bank Ltd. It is also looking for acquisitions in African
and Asian markets
PNB has acquired stakes in banks in Bangaladesh, Nepal and Kabul
Bank of Baroda derives 25% of its profits from operations in UK<
Singapore, Emirates, Thailand and Singapore
ICICI acquired Investitsionno-Kreditny Bank to gain entry into Russia

Technology to Consumer protection:

Consumer protection involves robust resolution mechanism for
client management issues, identifying patterns indicating potential
problems and responding promptly to customer complaints. Post
Enron collapse and subprime mortgage crisis, regulating authorities
have laid down guidelines to ensure consumer protection with
extensive use of technology.
Information security programs and measures include risk
assessment and mitigation plans, steps to maintain customer
privacy policy and authentication& verification of its customers
among a host of other activities. Electronic and Mobile banking has
provided plethora of opportunities to enhance financial inclusion of
the population devoid of a place in formal financial markets.
Implementation of various monitoring mechanisms can detect
unlawful intrusions into customers or banks accounts. Audit logs
stored in databases enable careful inspection of all unwanted
activities.
Mobile banking is fraught with avenues that are prone to
exploitation. Appropriate processes like consumer awareness
program to educate consumers about their rights and duties. Use of
technology has helped in reducing operational risks while securing
logs in databases for future use.
Incorporation of two-step identification process has provided to
control identity theft and fraud in transactions. Use of technology to
establish customer identity allows banking institutions to provide
various services to customers.
Following guidelines are to be followed by the banking institutions
to ensure consumer protection:
Risk Management and Internal Control
Account Origination and Customer Verification
Monitoring and Reporting of E-banking Transactions
Disclosure and Business Availability
Consumer Awareness Program
Complaint Resolution

In case of wire-lessbanking, followingsecuritymeasures

areimprative :
Implement adequate security controls on internal network

Submitted by: Group 6

Encryption technologies
IT personnel training
Due diligence in evaluating service providers
Independent audit, Penetration tests and vulnerability tests

Future Outlook:

The Indian Banking Association(IBA) had projected that the total assets
size of the Indian banking to more than double from 2003 to 2010 and the
projections did not disappoint.

The last decade was impressive for the Indian banking

industry Growth with rising profitability

Remarkableimprovement in financialmetrics : Improvement

in return on assets, operationalefficiency, stable margins

Ten Major Trends that will Shape the Indian Banking Industry
1. Mortgages to cross Rs 40 trillion by 2020:
The total mortgages in the books of the banks have grown from 1.5
percent to 10 percent of the total bank advances, in a period of ten years.
If by 2020, this ratio were to reach 20 percent, a number similar to that of
China, we could expect the mortgage industry growing at an average rate
of over 20 percent during the next decade. The outstanding mortgages are
expected to cross Rs 40 trillion which is higher than the entire loan book of
the banking industry pegged at Rs 30 trillion.
2. Wealth management will be big business with 10X growth:
Going forward, wealth is expected to get further concentrated in the hands
of a few. As illustrated in Exhibit 1d, the top band of income distribution is
expected to grow most rapidly over the next decade.
3. The Next Billion will be the largest segment:
The fact that the income group right below the middle class in the
house hold income range of Rs 90,000 to Rs 200,000 per annum
the largest group of customers. These customers will be profitably
only with low cost business models having low break even ticket
business.

annual
will be
served
size of

4. The number of branches to grow 2X; ATMs to grow 5X:

It is evident that the bank branches and ATMs are by far the most popular
channels, despite a decade of promotion of alternate channels. The
experience in developed economies also corroborates that branches and
ATMs continue to be the critical channels, although certain transactions
have shifted to alternate channels.
5. Mobile banking to see huge growth and will redefine
transaction banking paradigm:
The uptake of internet and call centers is low in all segments other than
foreign banks. The penetration of internet and broad band access in India

Submitted by: Group 6

has been low so far. However, with the advent of mobile banking, the
access to banking facilities could completely get revolutionized over the
next decade.
6. Customer Relationship Management (CRM) and data
warehousing will drive the next wave of technology in banks:
The average number of banking products per customer in India is
significantly lesser than the global benchmarks. There is a significant
potential for cross selling amongst all categories of banks in India. Given
that cross selling is highly costeffective as compared to all other means
of customer acquisition, banks will adopt CRM strategies aggressively in
pursuit of costeffective business models described in point 3 above.
7. Banking margins will come under pressure:
The next decade will see a dramatic change in margins as the wholesale
debt markets deepen and corporate customers access the whole sale
markets directly. Further, should the savings bank rate be liberalized,
banks will move to a regime of low margins. The Net Interest Margins of
the public sector banks has consistently declined and this perhaps reflects
in the pessimistic view on future margins adopted by the public sector.
8. New models to serve the Small and Medium Enterprises (SME):
As per the results of a survey conducted by FICCI to gauge the level of
satisfaction among large, medium and small business customers with
regard to banking services; the smallest businesses are most dissatisfied.
Due to higher risk and lower ticket size, the SME typically get less
attention. Banks are yet to create innovative models to serve SMEs with
sufficient and timely credit at the right price. As the yields in large
corporate banking falls with further deepening of wholesale debt markets,
the banking industry in India will find costeffective ways to serve the SME
customers where yields are quite high. The SMEs hope to get the basics
good relationship management, fast credit decisions and a complete
product range all at one place.
9. Investment banking will grow over tenfold:
Investment banking will be among the fastest growing segments in the
banking industry rising from 4 percent to 7 percent of the entire corporate
banking revenue pool. The larger corporate customers expect to demand
higher support for international expansion and mergers and acquisitions
over next decade. Further, as the wholesale debt markets deepen, the
larger corporates would avail of advisory and capital market services from
banks to access capital markets. The revenue pool will shift from
traditional corporate banking to investment banking and advisory. Banks
with international presence stand to benefit.
10. Infrastructure financing to hit over Rs 20 trillion on
commercial banks books:
As India continues to rely on private funding for infrastructure
development, infrastructure will occupy a larger share of the balance
sheets of about 12-15% of the total advances of a bank. Half of the debt
finance for infrastructure today comes from banks. Even as the asset
liability mismatch issues are resolved by IIFCL and the government, the
real challenge for banks would be to develop skills to undertake the risks

Submitted by: Group 6

of long gestation infrastructure projects and manage concentration risk in
infrastructure.
Two Challenges of the Decade
1. Financial inclusion:
The issue of financial inclusion is at the centre stage of the agenda of the
government. While the expectation from banks is high, the government is
also starting to look at non banking industries to come forward with a
solution. Needless to say, if the answer does not come from banking
industry, non banks will be welcome to nibble at its revenue pool. It is a
strategic priority given that the customer segment in question will be the
largest in number over the next decade and banks stand to lose this
relationship.
2. The HR challenge in the public sector:
The public sector banks enter the next decade with the same expectations
as their private sector peers but with a severe disadvantage in human
resources. The HR challenge of public sector banks has reached a tipping
point. Due to a legacy of several decades, the public sector banks will
witness unprecedented loss of skills and competencies in form of retiring
senior and middle management executives over the next few years. That
coupled with the need for large scale reskilling, attracting and retaining
fresh talent, controlling the growing employee costs, and introduction of
performance discipline are significant challenges.
References:
http://www.iosrjournals.org/iosr-jbm/papers/Vol16-issue2/Version1/G016215261.pdf
Banking in India Issues and Challenges for the Future, ICMR, IBS Center for
management research
Uppal R.K., Customer Perception of E Banking Services of Indian Banks:
Some Survey Evidence, The ICFAI Journal of Bank Management
http://vikalpa.com/pdf/articles/2003/2003_july_sep_83_99.pdf