EXECUTIVE SUMMARY

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--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 functions.

TABLE OF CONTENTS
CH.NO. PAGE NO CHAPTER - 1 REFORMS IN THE INDIAN BANKING SECTOR TITLE

1.1 Introduction 1.2 Reduction of SLR and CRR 1.3 Minimum Capital Adequacy Ratio 1.4 Prudential Norms 1.5 Disclosure Norms 1.6 Rationalisation of Foreign Operations in India 19

01 04 07 11 17

1.7 Special Tribunals and Asset Reconstruction Fund 23 1.8 Restructuring of Weak Banks 1.9 Asset Liability Management System 29 1.10 1.11 Reduction of Government Stake in PSBs 32 Deregulation of Interest Rate 39 26

CHAPTER - 2

DEVELOPMENTS IN THE INDIAN BANKING SECTOR 42 43 52 56 62 65 71 73

2.1 Introduction 2.2 Voluntary Retirement Scheme 2.3 Universal Banking 2.4 Mergers and Acquisition 2.5 Banking and Insurance 2.6 Rural Banking 2.7 Virtual Banking 2.8 Retail Banking

CH.NO. PAGE NO CHAPTER 3 3.1 3.2 Views news say. . . 3.4 76 83 The SCAM Story

TITLE

74 3.3 And today... the 86

Public Sector OR Private Sector Point of

Future whats ahead

3.5

Conclusion

88

List of Illustrations and Visual Aids Illustration No. 1 2 3 4 5 6 7 8 9 10 Trends in CRR and SLR Growth In Investments In Government Securities by Banks Classification of Loan Assets of SCBs Indian Banks: Trend in ROE Capital Contributed by Government Income and Expenses Profile of banks VRS trends in Banks ICICI pre merger and post merger scenario Comparison of classes of banks Lendings in Rural India 6 10 15 22 37 41 50 60 61 70 Title Page no.

List of Annexures Annexure 1: List of banks Annexure 2: Questionnaire 90 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. ii.

Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years Progressive reduction in Cash Reserve Ratio (CRR)

iii. iv. v.

Phasing out of directed credit programmes and redefinition of the priority sector Deregulation of interest rates so as to reflect emerging market conditions 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

vi.

Adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts

vii. viii. ix. x.

Imparting transparency to bank balance sheets and making more disclosures Setting up of special tribunals to speed up the process of recovery of loans Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount 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. xii. xiii. xiv. xv. xvi. xvii. xviii. xix. xx.

Abolition of branch licensing Liberalising the policy with regard to allowing foreign banks to open offices in India Rationalisation of foreign operations of Indian banks Giving freedom to individual banks to recruit officers Inspection by supervisory authorities based essentially on the internal audit and inspection reports Ending duality of control over banking system by Banking Division and RBI A separate authority for supervision of banks and financial institutions which would be a semi-autonomous body under RBI Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks Obtaining resources from the market on competitive terms by DFIs 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 committees 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 8

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. xvi. To rationalize staff strengths, an appropriate VRS must be A weak bank should be one whose accumulated losses and net introduced. 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.

REFORMS

10

1.2

Reduction of SLR and CRR

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

11

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 in deployment, government and returns to the banks affect from the the bank "preempted" funds. It is also claimed that the low returns from the forced investments securities adversely 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. much more than 5-6 years. The time required for gaining experience with the use of such operations would be

12

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.

13

Trends in CRR and SLR 1993 2001

40 35 30

Percentage of DTL

25 20 15 10 5 0
May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01

SLR

CRR

14

1.3

Minimum Capital Adequacy Illustration 1 Ratio

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

15

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. Inadequacy? 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

16

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

17

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 gilts.

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

18

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- 199292 93 36441 Aggregate deposits growth [19.6 %] 26390 [21.0 %] 1992-93 [Up to Jan 93] 32364 [14.0 %] 20966 [16.7 %] 11042 [12.2 %] 1993-94 [Up to Jan 94] 37187 [13.8 %] 9999 [6.6 %] 19857 [18.8 %]

Bank credit growth

9291 [8.0 %]

Investments

15131 15460

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 2002

19

20

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

21

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 Banks 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.

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

22

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 RBIs 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.

ASSET CLASSIFICATION

23

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 NonPerforming 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 nonperforming. As per RBIs 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:

24

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 19992000. 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

25

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 A. Standard 1997-98 1998-99 1999-2000 1997-98 1998-99 1999-2000 C. Doubtful 1997-98 1998-99 1999-2000 D. Loss 1997-98 1998-99 1999-2000 1997-98 1998-99 1.9 2.0 1.7 284971 325328 0.9 0.9 0.8 36753 43049 1.2 2.0 1.9 30972 31059 1.8 1.9 1.6 352696 399436 9.1 4.0 1.7 0.9 0.9 0.8 1.7 2.0 1.9 1.8 1.9 1.6 84.0 86.1 86.0 5.0 4.9 4.3 91.3 91.2 91.5 5.8 6.2 3.7 93.6 92.4 93.0 3.9 4.0 2.9 85.6 85.3 87.2 4.9 5.0 5.1 Public Private Foreign SCBs

B. Sub-standard

E. Total Assets (Rs. Crore)

26

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.

PROVISIONING NORMS 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 assets; (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.

27

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 Disclosure not been made, the profits would 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 taxpayers money given to the banks as capital is not used to write off private loans without adequate efforts and punishment of defaulters.

28

# 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 Supervision. 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

29

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.

30

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 business.

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 banks operations.

Initial capital other than promoters contribution could be raised While augmenting capital to Rs. 300 crore within three years,

through public issue or private placement.

promoters need to bring in at least 40 percent of the fresh capital,

31

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 A minimum capital adequacy ratio of 10 per cent shall be Priority sector lending target is 40 per cent of net bank credit, as in

specified criteria

maintained on a continuous basis from commencement of operations.

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

32

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 (employees 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

33

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 NYSE. 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, nonreconciliation 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 race.

34

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 revenues.

35

Illustration 4 Annexure 1

1.7 Special List of Banks operating in India.

Tribunals and Asset 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

36

pledged

to

the The Advantage

bank.

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 BANKERS COMPLAINS ! 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

37

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.

SOME MORE ISSUES 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

38

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 management

39

1.8

Restructuring of Weak Banks

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.

40

THE VERMA PRESCRIPTIONa brief

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 Fund 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

41

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.

42

 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 lending. 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.

43

1.9

Asset Liability Management System

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

44

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 banks 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 decisionmaking 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

45

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

46

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.

47

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 public." 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 governments

48

equity

to

33

per

cent

Governments 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 Indias 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

49

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 meetings. 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 India. 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 proposed that they would continue to be subject to parliamentary and other scrutiny despite relaxations.

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

50

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 Banks 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 commission. 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.

51

A LOOK AT PAST 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 shareholders. 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 shareholding. What did they have to say ?

52

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. privatisation? 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 governments 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.

53

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 Crores] 90 150 400 635 150 365 490 45 130 220 705 50 415 160 680 535 200 215 65 5700

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

Source: Reserve Bank of India Bulletin [1994]. Illustration 5 THE STATE BANK STORY 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

54

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 SBIs 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.

55

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 Assurance.

1.11 Deregulation on Interest 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 borrowers. 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

56

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 Banks. 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 dont 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 assetliability 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

57

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.

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Income and Expenses Profile of Banks

Interest Income Interest/discount on advances/bills Interest on investments Interest on balances with RBI and other interbank funds Others Other Income Commission, Exchange and Brokerage Profit on sale of investments Profit on revaluation of investments Profit on sale of land, building and other assets Profit on exchange transactions Income earned by way of dividends, etc. Miscellaneous Interest Expenses Interest on deposits Interest on Refinance/interbank borrowings Others

Operating Expenses Payments to and provisions for employees Rent, taxes and lighting Printing and stationery Advertisement and publicity Depreciation on Banks property Director/Auditors fees and expenses Law charges, Postage, etc. Repairs and Maintenance, Insurance. Other expenses

59

60

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.

DEVELOPMENTS
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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 business strategies.

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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.

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Salient Features of Voluntary Retirement Scheme of Banks

Eligibility All permanent employees with 15 years of service or 40 years of age are eligible. Employees not eligible for this scheme include: 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 Board. 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 maybe. Pensions (including commuted value of pension)/banks contribution towards PF, as the case may be. Leave encashment as per rules. Other Features It will be the prerogative of the banks 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.

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 There will be no recruitment against vacancies arising due to VRS. 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.

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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?

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"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

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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. ARE EMPLOYEES A PROBLEM OR NPAs ? 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.

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THE EFFECTS Negatives 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. Positives 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.

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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, thats 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!!!

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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.

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Gone for GOOD !

Illustration 7

72

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

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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.

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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

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

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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 lowcost 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.

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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 banking.

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ICICI

gearing

to

become

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

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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 network. 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. ICICIs 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, once the units are referred topossible and the units are restructuring, mergers. If these options arent BIFR, the lenders were unable to enforce securities, she pointed out not viable, it will go in for one time settlement.

2.4

Mergers & Acquisitions

Divided they fall, united they may strive !

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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

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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 !

Customer Rigid Distinction Disintermediati Volatabilit Thats

82 Capital A/c Globalisatio Convertibility n

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 income. 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 markets. 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

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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.

THE SCENARIO TODAY 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.
And INTERNATIONALLY 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

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''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 Assets No of Pre-merger 12063 crores Postmerger 16051 crores % Change 33.06 239.62

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branches Deposits Customers Employees Equity EPS

106 9728 15 lakhs 1700 197 crores Rs 7.10 /

360 13123 27 lakhs 4300 220 crores Rs 8.70 /

34.90 80 152.94 10.5 23

share share Illustration 8 Will mergers be the norm in the industry? What about the future? Will THE STRATEGY MERGER UNIVERSAL BANKS 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. It is a fact that through mergers The Liabilities growth Increases risks of mismatch between assets acquisitions and and liabilities Multiple focus could lead to conflicts of 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 banks.

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Particulars Cost of funds Branch network

PSU Banks Low Wide

Pvt. Banks (Old) Moderate Regional Moderate Low Low Moderate High

Pvt. Banks(New) High Low High Low High High High

Spread Level of Automation Low NPAs High Capital Adequacy Moderate Employee Productivity Low Focus on Non- interest Low Income

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 RESCUE MERGER BANK BAILOUTS 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

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88

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.

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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 thirdlargest 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 The India, the French has insurer has the expertise concept in of bancassurance. company pioneered

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

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different segments of the market. SBI intends to fully integrate the insurance business into its banking activities with appropriate sales support SBI will become and the largest marketing. 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

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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 few industrialbusiness in Bombay Dyeing, Aditya Birla, Tata It is felt that volume of new house like the insurance sector could touch $25 billion. Rural Banking Indigenous Route to 2.6 Group, Godrej Group are in the picture.

Convenient Credit ?

ECONOMICALLY empowering, i.e. access to inexpensive credit and other micro-finance services, including savings and insurance, India's rural

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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 Indias 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

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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 structures

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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 smallterm/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 multiagency 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

95

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

96

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
sufficient

banking are a

and

giving The

branch Gupta

managers Committees

powers

must.

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 nongovernment 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,

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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 cooperatives. 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?

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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 smalltime 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 followup 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

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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 Amount Percen Indirect Amount (Rs Crore) NA Percen t 12.9 Total Amount (Rs Crore) 8,218

(Rs Crore) t Primary cooperative credit society Land development banks Commercial banks RRBs Total 12,940 25.2 8,218 15.9

NA

20.3 49.2 8.3 100.0

12,940 31,313 4,044 63,666

26,327 51.1 4,986 4,044 7.8 NA 51,529 100.0 12,137 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

Virtual interference. letting them function 2.7 without governmentBanking 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

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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

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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 sector. 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 addressed. # 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,

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dematerialisation, Anywhere/Anytime

centralized Banking,

funds

querying

for

Banks

and are

FIs, being

Inter-Branch

Reconciliation

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

2.8 to gain the most.

Retail Banking the in thing !

The Customer is now in an enviable position where he can demand With increased competition, spreads competitivelending have decreased superior services at in corporate prices. 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

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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 revenues. 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 Bank.

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3.1
Ahmedabad-based

The SCAM Story !

Mercantile Cooperative Bank was

Madhavpura

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

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

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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 views

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?

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At ICICI 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. At PSBs 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? Whats the whole point of having something like that, its like a better way of declaring losses and turning away from efficiencies? At ICICI Banks should be able to account for it independently.

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At PSBs 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? At ICICI 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. At PSBs 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 PSBs have a definite priority sector lending Maintenance of PPF accounts, taxes, etc Minimum deposit for credit cards and FD sector banks

Take the case of UTI returns when all others were down, thats 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. At ICICI

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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. At ICICI Besides, banking regulation norms, the government needs to make a certain service level mandatory. This could be: At PSBs 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 system. 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

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At ICICI 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. At PSBs 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 rates? At ICICI

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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? At PSBs 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? At ICICI 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.

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At PSBs 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. At ICICI 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. At PSBs 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? At ICICI 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. At PSBs

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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, its just an additional service of convenience given to customers.

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

On VRS 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

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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
CHURCHGATE

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 dont 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.

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3.3

And todaythe 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

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

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 didnt 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 didnt go down well among the bankers who fear that the proposed law could terrorise bank officials to such an extent that business would suffer.

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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 banks 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

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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.

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3.4

THE FUTURE . . . whats 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 deposits. 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

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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 lead. 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 valueadded services may also need to be provided, which will call for innovation standardisation. Virtual Banking will set in as a trend successfully. 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. 122

3.5

CONCLUSION

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

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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. Its 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 acknowledged. 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 useful. 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.

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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 problem. 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.

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Annexure 1
LIST OF PUBLIC SECTOR BANKS State Bank of India and its subsidiaries are :

State State State State State State State State

Bank Bank Bank Bank Bank Bank Bank Bank

of of of of of of of of

India Bikaner & Jaipur Hyderabad Indore Mysore Patiala Saurashtra 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 are

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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

LIST OF PRIVATE SECTOR BANKS: 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

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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

LIST OF FOREIGN BANKS:

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.

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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

** CLOSED INDIAN OPERATION

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.

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# Is the transfers on NPAs to state owned ARF, just about shifting the responsibility to the ARF? Whats the whole point of having something like that, its like a better way of declaring losses and turning away from efficiencies? 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 system. 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.

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# 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 rates? 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?

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