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A spell of severe credit crunch, salary cuts, rehiring and a lot of news on
loans going bad lead this paper to test the hypothesis that the Indian
Banking Industry has been performing badly in contemporary times and
was adversely impacted due to the continuing Global Financial Crisis. The
methodology adapted to analyse the performance of all the Scheduled
Commercial Banks of the Indian Banking Industry was to study the trend of
the three most significant parameters/ratios applicable for Banking Industry.
Among the parameters of performance, the most significant ones comprise
Net Non Performing Assets as a percentage of Net Advances, Capital
Adequacy Ratio and Return on Assets. A single composite weighted
average of all Nationalized banks, Private sector banks and Foreign banks
in India has been considered to
View the trend in the period 2005-06 to 2007-08. The analysis shows that
the Indian Banking Industry is stable and still growing albeit at a slow pace.

The enhanced role of the banking sector in the Indian economy, the
increasing levels of deregulation along with the increasing levels of
competition have facilitated globalisation of the India banking system and
placed numerous demands on banks. Operating in this demanding
environment has exposed banks to various challenges. The last decade
has witnessed major changes in the financial sector - new banks, new
financial institutions, new instruments, new windows, and new opportunities
- and, along with all this, new challenges. While deregulation has opened
up new vistas for banks to augment revenues, it has entailed greater
competition and consequently greater risks. Demand for new products,
particularly derivatives, has required banks to diversify their product mix
and also effect rapid changes in their processes and operations in order to
remain competitive in the globalised environment.



The General Bank of India was set up in the year 1786. Next came Bank of
Hindustan and Bengal Bank. The East India Company established Bank of
Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as
independent units and called it Presidency Banks .
PHASE II :- Nationalization of Imperial Bank of India with extensive
banking facilities on a large scale specially in rural and semi-urban areas. It
formed State Bank of India to act as the principal agent of RBI and to
handle banking transactions of the Union and State Governments all over
the country. Seven banks forming subsidiary of State Bank of India was
nationalized in 1960 on 19th July, 1969, major process of nationalization
was carried out. 14 major commercial banks in the country was
nationalized .
PHASE III:- This phase has introduced many more products and facilities
in the banking sector in its reforms measure. In 1991, under the
chairmanship of M Narasimhama, a committee was set up by his name
which worked for the liberalization of banking practices.
Without a sound and effective banking system in India it cannot have a
healthy economy. The banking system of India should not only be hassle
free but it should be able to meet new challenges posed by the technology
and any other external and internal factors.
For the past three decades India's banking system has several outstanding
achievements to its credit. The most striking is its extensive reach. It is no
longer confined to only metropolitans or cosmopolitans in India. In fact,
Indian banking system has reached even to the remote corners of the
country. This is one of the main reasons of India's growth process.
The government's regular policy for Indian bank since 1969 has paid rich
divedend With the nationalization of 14 major private banks of India.





The Bank of Bengal which later became the State Bank of India
the General Bank of India was set up in the year 1786. Next came Bank of
Hindustan and Bengal Bank. The East India Company established Bank of
Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as
independent units and called it Presidency Banks. These three banks were
amalgamated in 1920 and Imperial Bank of India was established which
started as private shareholders banks, mostly Europeans shareholders

In 1865 Allahabad Bank was established and first time exclusively by

Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at
Lahore. Between 1906 and 1913, Bank of India, Central Bank of India,
Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set
up. Reserve Bank of India came in 1935.

During those days public has lesser confidence in the banks. As an

aftermath deposit mobilization was slow. Abreast of it the savings bank
facility provided by the Postal department was comparatively safer.
Moreover, funds were largely given to traders.


Phase II
Government took major steps in this Indian Banking Sector Reform after
independence. In 1955, it nationalized Imperial Bank of India with extensive
banking facilities on a large scale especially in rural and semi-urban areas.
It formed State Bank of India to act as the principal agent of RBI and to
handle banking transactions of the Union and State Governments all over
the country.
Second phase of nationalization Indian Banking Sector Reform was carried
out in 1980 with seven more banks. This step brought 80% of the banking
The following are the steps taken by the Government of India to Regulate
Banking Institutions in the Country:
1949: Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore.
After the nationalization of banks, the branches of the public sector bank
India rose to approximately 800% in deposits and advances took a huge
jump by 11,000%.
Phase -III
This phase has introduced many more products and facilities in the banking
sector in its reforms measure. In 1991, under the chairmanship of M
Narasimham, a committee was set up by his name which worked for the
liberalization of banking practices.


From the Italian banca meaning 'bench', the table at which a dealer in
money worked. A bank is now a financial institution which offers savings
and cheque accounts, makes loans and provides other financial services,
making profits mainly from the difference between interest paid on deposits
and charged for loans, plus fees for accepting bills and other services.
Other relevant legislation includes the Banks (Shareholdings) Act and the
Reserve Bank Act. The Reserve Bank Act gives the Reserve Bank of
Australia (the central bank) a wide range of powers over the banking
Bank is an institution which trades in money, an establishment for the
deposits, custody and issue of money, as also for making loans and
discounts and facilitating the transmission of remittances from one place to
Savings Bank: Running account for saving with restriction in number of
Current Account: Running account without restriction on number of
Term Deposit: Deposit of an amount for a fixed period where interest is
paid monthly/Quarterly.
Special Term Deposit: Deposit of an amount for a fixed period where
interest is compounded (Capitalized) and paid on maturity.
Recurring Deposit : Regular (Monthly) deposit of a fixed amount for a
fixed period




Modern banking in India is said to be developed during the British era. In
the first half of the 19th century, the British East India Company established
three banks the Bank of Bengal in 1809, the Bank of Bombay in 1840 and
the Bank of Madras in 1843. But in the course of time these three banks
were amalgamated to a new bank called Imperial Bank and later it was
taken over by the State Bank of India in 1955. Allahabad Bank was the first
fully Indian owned bank. The Reserve Bank of India was established in
1935 followed by other banks like Punjab National Bank, Bank of India,
Canara Bank and Indian Bank.
In 1969, 14 major banks were nationalized and in 1980, 6 major private
sector banks were taken over by the government. Today, commercial
banking system in India is divided into following categories.
Types of Banks
Central Bank

The Reserve Bank of India is the central Bank that is fully owned by the
Government. It is governed by a central board (headed by a Governor)
appointed by the Central Government. It issues guidelines for the
functioning of all banks operating within the country.
Public Sector Banks
Among the Public Sector Banks in India, United Bank of India is one of the
14 major banks which were nationalized on July 19, 1969. Its predecessor,
in the Public Sector Banks, the United Bank of India Ltd., was formed in
1950 with the amalgamation of four banks viz. Comilla Banking Corporation
Ltd. (1914), Bengal Central Bank Ltd. (1918), Comilla Union Bank Ltd.
(1922) and Hooghly Bank Ltd. (1932).
State Bank of India and its associate banks called the State Bank Group 20
nationalized banks Regional rural banks mainly sponsored by public sector


Private Sector Banks

Private banking in India was practiced since the beginning of banking
system in India. The first private bank in India to be set up in Private Sector
Banks in India was IndusInd Bank. It is one of the fastest growing Bank
Private Sector Banks in India. ING Vysya, yet another Private Bank of India
was incorporated in the year 1930.
Old generation private banks
New generation private banks
Foreign banks operating in India
Scheduled co-operative banks
Non-scheduled banks
Co-operative Sector
The co-operative sector is very much useful for rural people. The cooperative banking sector is divided into the following categories.
State co-operative Banks
Central co-operative banks
Primary Agriculture Credit Societies
Development Banks/Financial Institutions



Export-Import Bank of India


National Housing Bank


Small Industries Development Bank of India

North Eastern Development Finance Corporation



Figure 1: No. of banks in each category of Indian Banking Industry


The Local Area Bank Scheme was introduced in August 1996 aimed at
bridging the gaps in credit availability and enhancing the institutional credit
framework in the rural and semi urban areas and providing efficient and
competitive services. Since then, five LABs have been established.
The review group, which was appointed by RBI in July 2002 to study and
make recommendations on the LABs scheme, has in its report, drawn
attention to the structural infirmities in the concept of the LABs and
recommended that there, should be no licensing of new LABs. It has
pointed out several weaknesses in the concept of the Local Area Bank
model, particularly in regards to size, capital base and inherent inability to
absorb the losses in the course of business etc.Four LABS were functional
at end-march 2005. They were Coastal area bank ltd, Vijayawada, Andhra
Pradesh,Capital local area bank ltd,phagwara,Navsari,Gujrat, Krishna



bhima samrudhdhi local area bank limited , Mehboob Nagar,Subhadra local

area bank limited, Kolhapur.
The Co-operative banks have a history of almost 100 years. The Cooperative banks are an important constituent of the Indian Financial
System, judging by the role assigned to them, the expectations they are
supposed to fulfill, their number, and the number of offices they operate.
The co-operative movement originated in the West, but the importance that
such banks have assumed in India is rarely paralleled anywhere else in the
world. Their role in rural financing continues to be important even today,
and their business in the urban areas also has increased phenomenally in
recent years mainly due to the sharp increase in the number of primary cooperative
While the co-operative banks in rural areas mainly finance agricultural
based activities including farming, cattle, milk, hatchery, personal finance
etc. along with some small scale industries and self-employment driven
activities, the co-operative banks in urban areas mainly finance various
categories of people for self-employment, industries, small scale units,
home finance, consumer finance, personal finance, etc.
Some of the co-operative banks are quite forward looking and have
developed sufficient core competencies to challenge state and private
sector banks.
Though registered under the Co-operative Societies Act of the Respective
States (where formed originally) the banking related activities of the cooperative banks are also regulated by the Reserve Bank of India. They are
governed by the Banking Regulations Act 1949 and Banking Laws (Cooperative Societies) Act, 1965.




Rural banking in India started since the establishment of banking sector in

India. Rural Banks in those days mainly focused upon the agro sector.
Regional rural banks in India penetrated every corner of the country and
extended a helping hand in the growth process of the country.
SBI has 30 Regional Rural Banks in India known as RRBs. The rural banks
of SBI are spread in 13 states extending from Kashmir to Karnataka and
Himachal Pradesh to North East. The total number of SBIs Regional Rural
Banks in India branches is 2349 (16%). Till date in rural banking in India,
there are 14,475 rural banks in the country of which 2126 (91%) are
located in remote rural areas.
As on October 20,2005,fourteen Indian banks-nine from the public sector
and five from the private sector had operation overseas spread across 42
countries with a network of 101 branches,6 joint ventures,17 subsidiaries
and representative offices.

Punjab National Bank


Andhra Bank

SBI Bank

Corporation Bank


Allahabad Bank

Yes Bank

Karur Vysya Bank

Indian Overseas Bank

Canara Bank

Kotak Mahindra Bank



The Reserve Bank of India was established on April 1, 1935 in accordance
with the provisions of the Reserve Bank Of India Act, 1934.The Central
Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the
Governors its and where policies are formulated. Though originally privately
owned, since nationalization in 1949, the Reserve Bank is fully owned by
government of India.
The Preamble of the Reserve Bank of India describes the basic functions of
the Reserve Bank as:
" regulate the issue of Bank Notes and keeping of reserves
with a view to securing monetary stability in India and
generally to operate the currency and credit system of the country to
its advantage.
Organisation & Functions
Reserve Bank of India (RBI) is the Central Bank and all Banks in India are
required to follow the guidelines issued by RBI.
Financial Supervision
The Reserve Bank of India performs this function under the guidance of the
for Financial Supervision (BFS). The Board was constituted in November 1
994 as a committee of the Central Board of Directors of the Reserve Bank
of India.
ConstitutionThe Board is constituted by co-opting four Directors from the
Central Board as membersfor a term of two years and is chaired by
the Governor. The Deputy Governors of theReserve Bank are ex-officio
members. One Deputy Governor, usually, the Deputy Governor in charge of
banking regulation and supervision, is nominated as the Vice-Chairman of
the Board.
Current Focus

supervision of financial institutions

consolidated accounting
legal issues in bank frauds
divergence in assessments of non-performing assets and
supervisory rating model for banks.
Main FunctionsMonetary Authority:
Formulates, implements and monitors the monetary policy.
Objective: maintaining price stability and ensuring adequate flow of
credit toproductive sectors.
Regulator and supervisor of the financial system:
Prescribes broad parameters of banking operations within
which the country's banking and financial system functions.
maintain public confidence in the system, protect depositors'
interest and provide cost-effective banking services to the public.
Manager of Foreign Exchange
Manages the Foreign Exchange Management Act, 1999.
Objective: to facilitate external trade and payment and promote orderl
y development and maintenance of foreign exchange market in India.
Issuer of currency:
Issues and exchanges or destroys currency and coins not fit for
Objective: to give the public adequate quantity of supplies of currency
notes andcoins and in good quality.
Developmental role

Performs a wide range of promotional functions to support national

Related Functions
Banker to the Government: performs merchant banking
function for the centraland the state governments; also acts as
their banker..
Date: 10/07/2011
Cash Reserve Ratio and Interest Rates
(per cent per annum)

2010 2011

Item/Wee Sep. Aug.

k Ended 24


Sep. 2 Sep. 9 Sep. 16 Sep. 23

Ratio (per
















7.50/8 10.00/1 10.00/1 10.00/1 10.00/1 10.00/1 10.00/1



6.75/7 8.50/9. 8.50/9. 8.50/9. 8.50/9. 8.50/9. 8.50/9.2
















(1) Cash Reserve Ratio relates to Scheduled Commercial Banks

(2) Base Rate relates to five major banks since July 1, 2010. Earlier
figures relate to Benchmark Prime Lending Rate (BPLR).
(3) Deposit Rate relates to major banks for term deposits of more
(4) Data cover 90-95 per cent of total transactions reported by
volumeweighted average of daily call money rates for the week
(Saturday to Friday).


services offered by banks were not so good and it was demotivated
because there was no competition and no improvement in banking services
previous to globalization
period the employee were totally disinterested they dont have any target to
achieve and there main motive is just to earn livelihood for them no feeling
of competition was there and even there senior executive dont motivate
them to achieve some target.

NON COMPETETIVE ATTITUDE.: pre-globalization there were only

government banks who were major players in the field of banking so there
is no way for competition so even staff attitude was completely non
competitive so no innovative service take place and even no innovation in
product line.
main focus of banks were selling of product not customers. like today bank
scenario customers are treated as lifeline of banking sector during preglobalized time it was nothing so customers were given last priority.




The current banking sector of India is Countrywide coverage even we can

found bank at small village level, district level and sate level also and
current Indian banking system involves Large number of players because
not only government banks take active participate in banking sector
whereas there are private banks also, This sector is going through major
changes as a consequence of economic reforms. The changes affect the
ownership pattern of banks, availability of funds, the cost of funds as well
as opportunities to earn, range of services (fee-based and fund-based),
and management of priority sector lending. As a consequence of
liberalization in interest rates, banks are operating on reduced spread.

Development financial institutions would have a lesser impact on the Indian

economy. Consumerism is here to stay..

Increasing use of technology in operations

Poised to expand and deepen technology usage
Emergence of integrated players
Diversifying capital deployment
Leveraging synergies
Robust regulatory system aligned to international standards
Efficient monetary management The landscape of the banking
industry underwent considerable changes during the last
decade. The industry witnessed:
Deregulation of lending and deposit rates.
Entry of new private sector banks.
Extensive use of technology for product innovation
Emergence of retail banking and new derivative products.
Stricter provisioning and asset classification norms.
Raising capital adequacy requirements.
.The freedom from administered policies and government
regulation in matters of day-to-day functioning has opened a
new era of self-governance and need for self-initiative


Globalisation a challenge as well as an opportunity.
The enhanced role of the banking sector in the Indian economy, the
increasing levels of deregulation along with the increasing levels of
competition have facilitated globalization of the India banking system and

placed numerous demands on banks. Operating in this demanding

environment has exposed banks to various challenges. The last decade
has witnessed major changes in the financial sector - new banks, new
financial institutions, new instruments, new windows, and new opportunities
- and, along with all this, new challenges. While deregulation has opened
up new vistas for banks to augment revenues, it has entailed greater
competition and consequently greater risks. Demand for new products,
particularly derivatives, has required banks to diversify their product mix
and also effect rapid changes in their processes and operations in order to
remain competitive in the globalised environment.
Globalization a challenge as well as an opportunity The benefits of
globalization have been well documented and are being increasingly
recognized. Globalization of domestic banks has also been facilitated by
tremendous advancement in information and communications technology.
Globalization has thrown up lot of opportunities but accompanied by
concomitant risks. There is a growing realization that the ability of countries
to conduct business across national borders and the ability to cope with the
possible downside risks would depend, inter-alia, on the soundness of the
financial system and the strength of the individual participants
Basel & Capital Adequacy:
Amidst globalization Banking System in India has attained vital importance.
Day by day there has been increasing banking complexities in banking
transactions, capital requirements, liquidity, credit and risks associated with
The World Trade Organisation (WTO), of which India is a member nation,
requires the countries like India to get their banking systems at par with the

global standards in terms of financial health, safety and transparency, by

implementing the Basel II Norms by 2009.
BASEL COMMITTEE: The Basel Committee on Banking Supervision
provides a forum for regular cooperation on banking supervisory matters.
Its objective is to enhance understanding of key supervisory issues and
improve the quality of banking supervision worldwide. It seeks to do so by
exchanging information on national supervisory issues, approaches and
techniques, with a view to promoting common understanding. The
Committee's Secretariat is located at the Bank for International Settlements
(BIS) in Basel, Switzerland.
The first accord by the name .Basel Accord I. was established in 1988 and
was implemented by 1992. It was the very first attempt to introduce the
concept of minimum standards of capital adequacy. Then the second
accord by the name Basel Accord II was established in 1999 with a final
directive in 2003 for implementation by 2006 as Basel II Norms. Basel II
Norms have been introduced to overcome the drawbacks of Basel I Accord.
For Indian Banks, its the need of the hour to buckle-up and practice
banking business at par with global standards and make the banking
system in India more reliable, transparent and safe. These Norms are
necessary since India is and will witness increased capital flows from
foreign countries and there is increasing cross-border economic & financial
Table 1: Analysis of Capital Adequacy Ratio for the period year 2006 to 08

Category of Indian Banks

(No of Banks in '06,'07,'08)

Capital Adequacy Ratio

(As on March 31, In Per cent)



Nationalised Banks (28,28,28)





Private Sector Banks (27,25,23)





Foreign Banks in India (29,29,28)




Weighted Average of I, II and III




Source: Derived from data of Indian Bankers Association and Reserve

Bank of India
2: Calculated Trend Vs Actual of Capital Adequacy Ratio of Indian

Capital adequacy ratios ("CAR") are a measure of the amount of a

bank's core capital expressed as a percentage of
its assets weightedcredit exposures.
Capital adequacy ratio is defined as

TIER 1 CAPITAL -A) Equity Capital, B) Disclosed Reserves

TIER 2 CAPITAL -A) Undisclosed Reserves, B) General Loss reserves, C)
Subordinate Term Debts
where Risk can either be weighted assets ( ) or the respective national
regulator's minimum total capital requirement. If using risk weighted assets,

The percent threshold varies from bank to bank (10% in this case, a
common requirement for regulators conforming to the Basel Accords) is set
by the national banking regulator of different countries.
Two types of capital are measured: tier one capital (T1 above), which can
absorb losses without a bank being required to cease trading, andtier two
capital (T2 above), which can absorb losses in the event of a winding-up
and so provides a lesser degree of protection to depositors.

Capital adequacy ratio is the ratio which determines the bank's capacity to
meet the time liabilities and other risks such as credit risk, operational risk,
etc. In the most simple formulation, a bank's capital is the "cushion" for
potential losses, and protects the bank's depositors and other
lenders. Banking regulators in most countries define and monitor CAR to
protect depositors, thereby maintaining confidence in the banking system.
CAR is similar to leverage; in the most basic formulation, it is comparable
to the inverse of debt-to-equity leverage formulations (although CAR uses
equity over assets instead of debt-to-equity; since assets are by definition
equal to debt plus equity, a transformation is required). Unlike
traditional leverage, however, CAR recognizes that assets can have
different levels of risk.
Since different types of assets have different risk profiles, CAR primarily
adjusts for assets that are less risky by allowing banks to "discount" lowerrisk assets. The specifics of CAR calculation vary from country to country,
but general approaches tend to be similar for countries that apply the Basel
Accords. In the most basic application, government debt is allowed a 0%
"risk weighting" - that is, they are subtracted from total assets for purposes
of calculating the CAR.
Tier 1 capital is the core measure of a bank's financial strength from
a regulator's point of view. It is composed of core capital, which consists

primarily of common stock and disclosed reserves (or retained

earnings) but may also include non-redeemable non-cumulative preferred
stock. The Basel Committee also observed that banks have used
innovative instruments over the years to generate Tier 1 capital; these are
subject to stringent conditions and are limited to a maximum of 15% of total
Tier 1 capital.
Capital in this sense is related to, but different from, the accounting
concept of shareholders' equity. Both Tier 1 and Tier 2 capital were first
defined in the Basel I capital accord and remained substantially the same in
the replacement Basel II accord. Tier 2 capital represents "supplementary
capital" such as undisclosed reserves, revaluation reserves, general loanloss reserves, hybrid (debt/equity) capital instruments, and subordinated
Each country's banking regulator, however, has some discretion over how
differing financial instruments may count in a capital calculation. This is
appropriate, as the legal framework varies in different legal systems.
The theoretical reason for holding capital is that it should provide protection
against unexpected losses. Note that this is not the same as expected
losses, which are covered by provisions, reserves and current year profits.
In Basel I agreement, Tier 1 capital is a minimum of 4%ownership
equity but investors generally require a ratio of 10%. Tier 1 capital should
be greater than 50% of the minimum requirement.


An operational risk is, as the name suggests, a risk arising from execution
of a company's business functions. It is a very broad concept which
focuses on the risks arising from the people, systems and processes
through which a company operates. It also includes other categories such
as fraud risks, legal risks, physical or environmental risks.
A widely used definition of operational risk is the one contained in
the Basel II regulations. This definition states that operational risk is the

risk of loss resulting from inadequate or failed internal processes, people

and systems, or from external events.
The approach to managing operational risk differs from that applied to other
types of risk, because it is not used to generate profit. In contrast, credit
risk is exploited by lending institutions to create profit, market risk is
exploited by traders and fund managers, and insurance risk is exploited by
insurers. They all however manage operational risk to keep losses within
their risk appetite - the amount of risk they are prepared to accept in pursuit
of their objectives. What this means in practical terms is that organisations
accept that their people, processes and systems are imperfect, and that
losses will arise from errors and ineffective operations. The size of the loss
they are prepared to accept, because the cost of correcting the errors or
improving the systems is disproportionate to the benefit they will receive,
determines their appetite for operational risk.
Determining appetite for operational risk is a discipline which is still in its
infancy. Some of the issues and considerations around this process are
outlined in this Sound Practice paper published by the Institute for
Operational Risk in December 2009[

Since the mid-1990s, the topics of market risk and credit risk have been the
subject of much debate and research, with the result that financial
institutions have made significant progress in the identification,
measurement and management of both these forms of risk. However, it is
worth mentioning that the near collapse of the U.S. financial system in
September 2008 is a clear indication that our ability to measure market and
credit risk is far from perfect.
Globalization and deregulation in financial markets, combined with
increased sophistication in financial technology, have introduced more
complexities into the activities of banks and therefore their risk profiles.

These reasons underscore banks' and supervisors' growing focus upon the
identification and measurement of operational risk.
Events such as the September 11 terrorist attacks, rogue trading losses
at Socit Gnrale, Barings, AIB and National Australia Bank serve to
highlight the fact that the scope of risk management extends beyond
merely market and credit risk.
The list of risks (and, more importantly, the scale of these risks) faced by
banks today includes fraud, system failures, terrorism and employee
compensation claims. These types of risk are generally classified under the
term 'operational risk'.
The Basel Committee defines operational risk as:
"The risk of loss resulting from inadequate or failed internal processes,
people and systems or from external events."
However, the Basel Committee recognizes that operational risk is a term
that has a variety of meanings and therefore, for internal purposes, banks
are permitted to adopt their own definitions of operational risk, provided that
the minimum elements in the Committee's definition are included.
Scope exclusions
The Basel II definition of operational risk excludes, for example, strategic
risk - the risk of a loss arising from a poor strategic business decision.
Other risk terms are seen as potential consequences of operational risk
events. For example, reputational risk (damage to an organization through
loss of its reputation or standing) can arise as a consequence (or impact) of
operational failures - as well as from other events.
Basel II event type categories
The following lists the official Basel II defined event types with some
examples for each category:

Internal Fraud - misappropriation of assets, tax evasion, intentional

mismarking of positions, bribery
External Fraud- theft of information, hacking damage, third-party theft and
Employment Practices and Workplace Safety - discrimination, workers
compensation, employee health and safety
Clients, Products, & Business Practice- market manipulation, antitrust,
improper trade, product defects, fiduciary breaches, account churning
Damage to Physical Assets - natural disasters, terrorism, vandalism
Business Disruption & Systems Failures - utility disruptions, software
failures, hardware failures
Execution, Delivery, & Process Management - data entry errors,
accounting errors, failed mandatory reporting, negligent loss of client
Difficulties;It is relatively straightforward for an organization to set and
observe specific, measurable levels of market risk and credit risk because
models exist which attempt to predict the potential impact of market
movements, or changes in the cost of credit. It should be noted however
that these models are only as good as the underlying assumptions, and a
large part of the recent financial crisis arose because the valuations
generated by these models for particular types of investments were based
on incorrect assumptions.
By contrast it is relatively difficult to identify or assess levels of operational
risk and its many sources. Historically organizations have accepted
operational risk as an unavoidable cost of doing business. Many now
though collect data on operational losses - for example through system
failure or fraud - and are using this data to model operational risk and to
calculate a capital reserve against future operational losses. In addition to
the Basel II requirement for banks, this is now a requirement for European

insurance firms who are in the process of implementing Solvency II ,the

equivalent of Basel II for the banking sector
Methods of operational risk management
Basel II and various Supervisory bodies of the countries have prescribed
various soundness standards for Operational Risk Management for Banks
and similar Financial Institutions. To complement these standards, Basel II
has given guidance to 3 broad methods of Capital calculation for
Operational Risk
Basic Indicator Approach - based on annual revenue of the Financial
Standardized Approach - based on annual revenue of each of the broad
business lines of the Financial Institution
Advanced Measurement Approaches - based on the internally developed
risk measurement framework of the bank adhering to the standards
prescribed (methods include IMA, LDA, Scenario-based, Scorecard etc.)
The Operational Risk Management framework should include identification,
measurement, monitoring, reporting, control and mitigation frameworks for
Operational Risk.

1.3) Recapitalisation of Public Sector Banks

Public sector banks performance is important. Public banks still dominate
the banking systems serving the majority of people in developing countries,
despite the rash of privatizations of the last 10 years. In 2002, public sector
banks represented 60 percent or more of the banking systems assets in
Algeria, Bangladesh, China, Egypt, Ethiopia, India, Iran, and Vietnam. In
Indonesia, public banks, including those under control of the Indonesian
Bank Restructuring Agency, held over 60 percent of the banking systems
assets, up from about 45 percent before the East Asian crisis. In Brazil,
despite closure, conversion into agencies or privatization of most provincial
banks, including the massive State Bank of Sao Paulo in 2001, federal

banks, including the federal development bank (BNDES), held about 1/3 of
bank assets and dominate lending for agriculture, housing and longer term
1.4) Fresh Capital for Private Banks
The standardized requirements in place for banks and other depository
institutions, which determines how much capital is required to be held for a
certain level of assets through regulatory agencies such as the Bank for
International Settlements,Federal Deposit Insurance Corporation or Federal
Reserve Board. These requirements are put into place to ensure that these
institutions are not participating or holding investments that increase the
risk of default and that they have enough capital to sustain operating losses
while still honoring withdrawals. Also known as "regulatory capital".
The Basel Accords, published by the Basel Committee on Banking
Supervision housed at the Bank for International Settlements, sets a
framework on how banks and depository institutions must calculate
their capital. In 1988, the Committee decided to introduce a capital
measurement system commonly referred to as Basel I. This framework has
been replaced by a significantly more complex capital adequacy framework
commonly known as Basel II. After 2012 it will be replaced by Basel
III Another term commonly used in the context of the frameworks
is Economic Capital, which can be thought of as the capital level bank
shareholders would choose in absence of capital regulation. For a detailed
study on the differences between these two definitions of capital, refer to
The capital ratio is the percentage of a bank's capital to its riskweighted assets. Weights are defined by risk-sensitivity ratios whose
calculation is dictated under the relevant Accord. Basel II requires that the
total capital ratio must be no lower than 8%.
The 5 Cs of Credit - Character, Cash Flow, Collateral, Conditions and
Capital- have been replaced by one single criterion. While the international
standards of bank capital were laid down in the 1988 Basel I accord, Basel
II makes significant alterations to the interpretation, if not the calculation, of
the capital requirement.

Examples of national regulators implementing Basel II include the FSA in

the UK, BaFin in Germany, OSFI in Canada, Banca d'Italia in Italy.
perceived credit risk associated with balance sheet assets, as well as
certain off-balance
sheet exposures
as unfunded
commitments, letters of credit, andderivatives and foreign exchange
contracts. The risk-based capital guidelines are supplemented by
a leverage ratio requirement. To be adequately capitalized under federal
bank regulatory agency definitions, a bank holding company must have
a Tier 1 capital ratio of at least 4%, a combined Tier 1 and Tier 2
capital ratio of at least 8%, and a leverage ratio of at least 4%, and not be
subject to a directive, order, or written agreement to meet and maintain
specific capital levels. To be well-capitalized under federal bank regulatory
agency definitions, a bank holding company must have a Tier 1 capital ratio
of at least 6%, a combined Tier 1 and Tier 2 capital ratio of at least 10%,
and a leverage ratio of at least 5%, and not be subject to a directive, order,
or written agreement to meet and maintain specific capital levels.
Tier 1 capital
Tier 1 capital, the more important of the two, consists largely of
shareholders' equity and disclosed reserves. This is the amount paid up to
originally purchase the stock (or shares) of the Bank (not the amount those
shares are currently trading for on the stock exchange), retained profits
subtracting accumulated losses, and other qualifiable Tier 1 capital
securities (see below). In simple terms, if the original stockholders
contributed $100 to buy their stock and the Bank has made $10 in retained
earnings each year since, paid out no dividends, had no other forms of
capital and made no losses, after 10 years the Bank's tier one capital would
be $200. Shareholders equity and retained earnings are now commonly
referred to as "Core" Tier 1 capital, whereas Tier 1 is core Tier 1 together
with other qualifying Tier 1 capital securities.
Tier 2 (supplementary) capital

Tier 2 capital, or supplementary capital, comprises undisclosed reserves,

revaluation reserves, general provisions, hybrid instruments and
subordinated term debt.
Undisclosed reserves are not common, but are accepted by some
regulators where a Bank has made a profit but this has not appeared in
normal retained profits or in general reserves. Most of the regulators do not
allow this type of reserve because it does not reflect a true and fair picture
of the results.
Revaluation reserves
A revaluation reserve is a reserve created when a company has an asset
revalued and an increase in value is brought to account. A simple example
may be where a bank owns the land and building of its headquarters and
bought them for $100 a century ago. A current revaluation is very likely to
show a large increase in value. The increase would be added to a
revaluation reserve.
General provisions
A general provision is created when a company is aware that a loss may
have occurred but is not sure of the exact nature of that loss. Under preIFRS accounting standards, general provisions were commonly created to
provide for losses that were expected in the future. As these did not
represent incurred losses, regulators tended to allow them to be counted as
Hybrid debt capital instruments
They consist of instruments which combine certain characteristics of equity
as well as debt. They can be included in supplementary capital if they are
able to support losses on an on-going basis without triggering liquidation.
Subordinated-term debt
Subordinated debt is classed as Lower Tier 2 debt, usually has a maturity
of a minimum of 10 years and ranks senior to Tier 1 debt, but subordinate
to senior debt. To ensure that the amount of capital outstanding doesn't fall

sharply once a Lower Tier 2 issue matures and, for example, not be
replaced, the regulator demands that the amount that is qualifiable as Tier
2 capital amortises (i.e. reduces) on a straight line basis from maturity
minus 5 years (e.g. a 1bn issue would only count as worth 800m in capital
4years before maturity). The remainder qualifies as senior issuance. For
this reason many Lower Tier 2 instruments were issued as 10yr non-call 5
year issues (i.e. final maturity after 10yrs but callable after 5yrs). If not
called, issue has a large step - similar to Tier 1 - thereby making the call
more likely.
Different International Implementations
Regulators in each country have some discretion on how they implement
capital requirements in their jurisdiction.
For example, it has been reported[6] that Australia's Commonwealth Bank is
measured as having 7.6% Tier 1 capital under the rules of theAustralian
Prudential Regulation Authority, but this would be measured as 10.1% if the
bank was under the jurisdiction of the UK's Financial Services Authority.
This demonstrates that international differences in implementation of the
rule can vary considerably in their level of strictness.


Credit risk is an investor's risk of loss arising from a borrower who does
not make payments as promisedSuch an event is called a default. Other
terms for credit risk are default risk and counterparty risk.
Investor losses include lost principal and interest, decreased cash flow, and
increased collection costs, which arise in a number of circumstances
A consumer does not make a payment due on a mortgage loan, credit
card, line of credit, or other loan

A business does not make a payment due on a mortgage, credit card, line
of credit, or other loan
A business or consumer does not pay a trade invoice when due
A business does not pay an employee's earned wages when due
A business or government bond issuer does not make a payment on
a coupon or principal payment when due
Types of credit risk
There are three primary types of credit riskDefault risk - when the borrower
fails to make contractual payments
Credit spread risk - risk due to volatility in the difference between interest
rates on investments and the risk-free rate of return
Credit analysis and consumer credit risk
Significant resources and sophisticated programs are used to analyze and
manage riskSome companies run a credit risk department whose job is to
assess the financial health of their customers, and extend credit (or not)
accordingly. They may use in house programs to advise on avoiding,
reducing and transferring risk. They also use third party provided
intelligence. Companies like Standard & Poor's, Moody's Analytics, Fitch
Ratings, and Dun and Bradstreet provide such information for a fee.
Most lenders employ their own models (credit scorecards) to rank potential
and existing customers according to risk, and then apply appropriate
strategies. With products such as unsecured personal loans or mortgages,
lenders charge a higher price for higher risk customers and vice versa.
With revolving products such as credit cards and overdrafts, risk is
controlled through the setting of credit limits. Some products also
require security, most commonly in the form of property.
Credit scoring models also form part of the framework used by banks or
lending institutions grant credit to clients. For corporate and commercial
borrowers, these models generally have qualitative and quantitative

sections outlining various aspects of the risk including, but not limited to,
operating experience, management expertise, asset quality, and leverage
and liquidity ratios, respectively. Once this information has been fully
reviewed by credit officers and credit committees, the lender provides the
funds subject to the terms and conditions presented within the contract (as
outlined above).
Credit risk has been shown to be particularly large and particularly
damaging for very large investment projects, so-called megaprojects. This
is because such projects are especially prone to end up in what has been
called the "debt trap," i.e., a situation where due to cost overruns,
schedule delays, etc. the costs of servicing debt becomes larger than the
revenues available to pay interest on and bring down the debt.
Sovereign risk
Sovereign risk is the risk of a government becoming unwilling or unable to
meet its loan obligations, or reneging on loans it guarantees. [9] The
existence of sovereign risk means that creditors should take a two-stage
decision process when deciding to lend to a firm based in a foreign country.
Firstly one should consider the sovereign risk quality of the country and
then consider the firm's credit quality.[10]
Five macroeconomic variables that affect the probability of sovereign
debt rescheduling are: Debt service ratio

Import ratio
Investment ratio
Variance of export revenue
Domestic money supply growth

The probability of rescheduling is an increasing function of debt service

ratio, import ratio, variance of export revenue and domestic money supply
growth. Frenkel, Karman and Scholtens also argue that the likelihood of
rescheduling is a decreasing function of investment ratio due to future
economic productivity gains. Saunders argues that rescheduling can
become more likely if the investment ratio rises as the foreign country could

become less dependent on its external creditors and so be less concerned

about receiving credit from these countries/investors. [12]
Counterparty risk
Counterparty risk, known as default risk, is the risk that an organization
does not pay out on a bond, credit derivative, credit insurance contract, or
other trade or transaction when it is supposed to. [13] Even organizations
who think that they have hedged their bets by buying credit insurance of
some sort still face the risk that the insurer will be unable to pay, either due
to temporary liquidity issues or longer term systemic issues.[14]
Large insurers are counterparties to many transactions, and thus this is the
kind of risk that prompts financial regulators to act, e.g., the bailout of
insurer AIG.
On the methodological side, counterparty risk can be affected by wrong
way risk, namely the risk that different risk factors be correlated in the most
harmful direction. Including correlation between the portfolio risk factors
and the counterparty default into the methodology is not trivial, see for
example Brigo and Pallavicini

Mitigating credit risk

Lenders mitigate credit risk using several methods:
Risk-based pricing: Lenders generally charge a higher interest rate to
borrowers who are more likely to default, a practice called risk-based
pricing. Lenders consider factors relating to the loan such as loan
purpose, credit rating, and loan-to-value ratio and estimates the effect on
yield (credit spread).
Covenants: Lenders may write stipulations
called covenants, into loan agreements:




Periodically report its financial condition

Refrain from paying dividends, repurchasing shares, borrowing further, or
other specific, voluntary actions that negatively affect the company's
financial position
Repay the loan in full, at the lender's request, in certain events such as
changes in the borrower's debt-to-equity ratio or interest coverage ratio
.Tightening: Lenders can reduce credit risk by reducing the amount of
credit extended, either in total or to certain borrowers. For example,
a distributor selling its products to a troubled retailer may attempt to lessen
credit risk by reducing payment terms from net 30to net 15.
Diversification: Lenders to a small number of borrowers (or kinds of
borrower) face a high degree of unsystematic credit risk, called
concentration risk. Lenders reduce this risk by diversifying the borrower
Deposit insurance: Many governments establish deposit insurance to
guarantee bank deposits of insolvent banks. Such protection discourages
consumers from withdrawing money when a bank is becoming insolvent, to
avoid a bank run, and encourages consumers to hold their savings in the
banking system instead of in cash.

Credit risk related acronyms

ACPM Active credit portfolio management
EAD Exposure at default
EL Expected loss
ERM Enterprise risk management
LGD Loss given default
PD Probability of default


The Insurance sector in India governed by Insurance Act, 1938, the Life
Insurance Corporation Act, 1956 and General Insurance Business
(Nationalisation) Act, 1972, Insurance Regulatory and Development
Authority (IRDA) Act, 1999 and other related Acts. With such a large
population and the untapped market area of this population Insurance
happens to be a very big opportunity in India. Today it stands as a business
growing at the rate of 15-20 per cent annually. Together with banking
services, it adds about 7 per cent to the countrys GDP .In spite of all this
growth the statistics of the penetration of the insurance in the country is
very poor. Nearly 80% of Indian populations are without Life insurance
cover and the Health insurance.
This is an indicator that growth potential for the insurance sector is
immense in India. It was due to this immense growth that the regulations
were introduced in the insurance sector and in continuation
Malhotra Committee was constituted by the government in 1993 to
examine the various aspects of the industry. The key element of
the reform process was Participation of overseas insurance companies with
26% capital. Since then the insurance industry has gone through many
sea changes .The competition LIC started facing from these companies
were threatening to the existence of LIC .since the liberalization of the
industry the insurance industry has never looked back and today stand as
the one of the most competitive and exploring industry in India.
The business of life insurance in India in its existing form started in India in
the year 1818 with the establishment of the Oriental Life Insurance
Company in Calcutta. Some of the important milestones in the life
insurance business in India are given in the table
Table 1: milestones in the life insurance business in India

Milestones in the life insurance business in India


The Indian Life Assurance Companies Act enacted as

the first statute to regulate the life insurance business


The Indian Insurance Companies Act enacted to enable

the government to collect statistical information about
both life and non-life insurance businesses


Earlier legislation consolidated and amended to by the

Insurance Act with the objective of protecting the
interests of the insuring public.


245 Indian and foreign insurers and provident societies

taken over by the central government and nationalised.
LIC formed by an Act of Parliament, viz. LIC Act, 1956,
with a capital contribution of Rs. 5 crore from the
Government of India.

3.3 insurance sector growt

The General insurance business in India, on the other hand, can trace its
roots to the Triton Insurance Company Ltd., the first general insurance
company established in the year 1850 in Calcutta by the British. Some of
the important milestones in the general insurance business in India are
given in the table 2.
Table 2: milestones in the general insurance business in India

in India







The Indian Mercantile Insurance Ltd. set up, the first

company to transact all classes of general insurance


General Insurance Council, a wing of the Insurance

Association of India, frames a code of conduct for

ensuring fair conduct and sound business practices


The Insurance Act amended to regulate investments and

set minimum solvency margins and the Tariff Advisory
Committee set up.


The General Insurance Business (Nationalisation) Act,

1972 nationalised the general insurance business
in India with effect from 1st January 1973.
107 insurers amalgamated and grouped into four
companies viz. the National Insurance Company Ltd.,
the New India Assurance Company Ltd., the Oriental
Insurance Company Ltd. and the United India Insurance
Company Ltd. GIC incorporated as a company.

4.Training the HR
Human resource training and development (HR T&D) in manufacturing
firms is a
critical aspect of the development of a knowledge-workforce in Malaysia.
The objective of this study is to examine challenges to the effective
management of HR T&D activities in manufacturing firms in Malaysia. In
order to achieve this objective, in-depth interviews were conducted with 58
HR managers managing employees training and development, employing
a purposive or judgmental sampling technique. The study revealed three
major challenges to the effective management of HR T&D. These include a
shortage of intellectual HRD professionals to manage HR T&D ctivities,
coping with the demand for knowledge workers and fostering learning and
development in the workplace. It is hoped that the findings of this study will

provide HR professionals with a clear understanding and awareness of the

various challenges in managing effective HR training and development.
Hence, relevant and appropriate policies and procedures can be developed
and implemented for an effective management of HR T&D.
4.1Technology Alien HR:
Acquiring the technical expertise should be the focus of future human
resource management given the changing paradigm of banking sector
regulations. For instance, the implementation of the new Capital Accord
(Basel II) whereby capital adequacy requirements have been made more
risk-oriented by linking capital to operational risk and changing the risk
measurement approaches for credit and market risks. However, its
implementation is not going to be an easy task especially in countries
(including Pakistan) where risk management systems are at nascent stage.
This is because of one of the prerequisite for Basel II implementation which
requires that the banking institutions should have a robust risk
management setup which is capable of effectively managing all major risks
that an institution is exposed to.
Similarly, the banking institutions are also required to carry out stress
testing, a technique used around the globe by financial institutions to
assess risk exposures across the institution and to estimate the changes in
the value of the portfolio, if exposed to various risk factors. Initially,
although, SBP has advised banks to carry out the simple sensitivity
analysis keeping in the view the varying levels of skill and available
resources among banks; however, going forward more sophisticated
techniques will be adopted. Certainly, this process would require technical
expertise at least in three areas: identifying, analyzing and proper recording
of the assumptions used for stress testing; adjusting the situation or shocks
applied to the data and interpreting the results; and an effective
management information system that ensures flow of information to the
senior management to take proper measures to avoid certain extreme
conditions. Therefore, going forward, the focus of human resource

management should be to acquire technical expertise if the institutions

intend to go along with the changing regulatory environment.


CONSUMER:The biggest challenge for the Indian banking system today is
the Indian consumer. Demographic shifts in terms of income levels and
cultural shifts in terms of lifestyle aspirations are changing the profile of the
Indian consumer
CHANGES IN BEHAVIOR:In the post-VRS scenario, banks have been
able to bring down their operating costs without upsetting their
business .However, the average age profile andt he skill sets of employees
continue to remain unfavourable to meet the challenges of change. The
next five years would see the average profile of staff worsening particularly

with banks going slow on fresh recruitment. Manpower planning would be a

major challenge before banks
Target markete place: The challenge before the Indian retail banking
industry is two-fold: focus and execution. Each bank must sharply focus on
its target marketplace and rapidly execute its services
Application of advanced technology:Technology is a key driver in the
banking industry, which creates new business models and processes, and
also revolutionises distribution channels. Banks which have made
inadequate investment in technology have consequently faced an erosion
of their market shares. The beneficiaries are those banks which have
invested in technology. Adoption of technology also enhances the quality of
risk management systems in banks. A further challenge which banks face
in this regard is to ensure that they derive maximum advantage from their
investments in technology and avoid wasteful expenditure which might
arise on account of uncoordinated and piecemeal adoption of technology;
adoption of inappropriate/ inconsistent technology and adoption of obsolete
CUSTOMER ORIENTED SERVICES :In India, currently, there are two
types of customers one who is a multi-channel user and the other who still
relies on a branch as the anchor channel. The primary challenge is to give
consistent service to customers irrespective of the kind of channel they
choose to use. The channels broadly cover the primary channels of branch
(i.e., teller, platform, ATM) phone banking, (i.e., call centre, interactive voice
response unit), and internet channel (i.e., personal computer, browser,
wireless). A retail customer selects a bank based on two criteria
convenience and relationship and would continue with a bank if it provides
good service.
Regulatory and Supervisory Challenges in Banking
As the financial landscape in the last few years has changed significantly,
there has been rethinking on several aspects of regulatory and supervisory
practices/ framework/structure among the regulators and supervisors all
over the world. In some countries such as UK, supervision has been hived

off from the central bank to avoid perceived conflict of interest with
monetary policy. In response to blurring of distinctions among providers of
financial services and emergence of financial conglomerates, a single
regulator approach has been adopted in some countries. The fast evolving
financial sector and the ever expanding rule books of the regulatory bodies
have made some countries such as UK to adopt principles-based
The Indian banking sector is faced with multiple and concurrent challenges
such as increased competition, rising customer expectations, and
diminishing customer loyalty. The banking industry is also changing at a
phenomenal speed. While at the one end, we have millions of savers and
investors who still do not use a bank, another segment continues to bank
with a physical branch and at the other end of the spectrum,


Liberalization and de-regulation process started in 1991-92 has made a
sea change in the banking system. From a totally regulated environment,
we have gradually moved into a market driven competitive system. Our
move towards global benchmarks has been, by and large, calibrated and
regulator driven. The pace of changes gained momentum in the last few
years. Globalization would gain greater speed in the coming years
particularly on account of expected opening up of financial services under
WTO. Four trends change the banking industry world over, viz

Consolidation of players through mergers and acquisitions, Globalisation

of operations, Development of new technology and Universalisation


banking. With technology acting as a catalyst, we expect to see great

changes in the banking scene in the coming years. The Committee has
attempted to visualize the financial world 5-10 years from now. The picture
that emerged is somewhat as discussed below. It entails emergence of
an integrated and diversified financial system. The move towards universal
banking has already begun. This will gather further momentum bringing
non-banking financial institutions also, into an integrated financial system.
The competitive environment in the banking sector is likely to result in
individual players working out differentiated strategies based on their
strengths and market niches. For example, some players might emerge as
specialists in mortgage products, credit cards etc. whereas some could
choose to concentrate on particular segments of business system, while
outsourcing all other functions. Some other banks may concentrate on
SME segments or high net worth individuals by providing specially tailored
services beyond traditional banking offerings to satisfy the needs of
customers they understand better than a more generalist competitor.
Retail lending will receive greater focus. Banks would compete with one
another to provide full range of financial services to this segment. Banks
would use multiple delivery channels to suit the requirements and tastes of
customers. While some customers might value relationship banking
(conventional branch banking), others might prefer convenience banking
One of the concerns is quality of bank lending. Most significant challenge
before banks is the maintenance of rigorous credit standards, especially in
an environment of increased competition for new and existing clients.

Experience has shown us that the worst loans are often made in the
best of times. Compensation through trading gains is not going to support
the banks forever. Large-scale efforts are needed to upgrade skills in credit
risk measuring, controlling and monitoring as also revamp operating

Credit evaluation may have to shift from cash flow based

analysis to borrower account behaviour, so that the state of readiness of

Indian banks for Basle II regime improves.

Growth of Deposits Till now: The deposit growth of SCBs in the postnationalization period could be analysed broadly in four phases. In the first
phase (1969-84) beginning immediately after nationalization of banks in
July 1969, deposit growth accelerated sharply as the rapid branch
expansion. enabled banks to tap savings from the rural areas. In the
second phase (1985-95), deposit growth decelerated as banks faced
increased competition from alternative savings instruments, especially
capital market instruments (shares/debentures/units of mutual funds) and

non-banking financial companies. This was the phase of disintermediation

as savings instead of being deployed in bank deposits, were increasingly
deployed in alternative financial instruments. Deposit growth decelerated
further during the third phase (1995-2004) in the wake of competition from
post office deposits and other small saving instruments, which carried
significantly higher tax-adjusted returns than bank deposits. efforts by
banks to meet the increased demand for credit. As a result, the share of
bank deposits in the financial savings of the household sector increased
Future challenges for resource mobilization : Banks have a major role
to play in meeting the resource requirements of Indias fast growing
economy. Although bank deposits have all along been the mainstay of the
saving process in the Indian economy and banks have played an
increasingly important role in stepping up the financial savings rate,
physical savings, nevertheless, have tended to grow in tandem with the
financial savings. A major challenge, thus, is to convert unproductive
physical savings into financial savings. Also, in view of the shrinking share
of household sector deposits in total deposits, banks need to explore ways
of broadening the depositor base, especially in rural and semi-urban areas
by offering customised products and features suitable to individual riskreturn requirements.
Thus, we can sum up saying that despite India having a reasonably high
and growing savings rate, there is a need to increase financial savings.
The substitution of unproductive physical savings in favour of financial
savings can generate large resources for investment. There is an
enormous untapped saving potential in rural and semi-urban areas. For
this purpose banks are in a better position to develop innovative and cost
effective products due to their outreach as also special features of
deposits, viz, safety and liquidity.
Managing Capital and Risk / Implementation of Basel II norms :
Why there is need for Managing Capital and Risk: The importance of
maintaining bank capital in line with the risks involved in the banking

business has assumed greater significance in view of the need for

maintaining the safety and soundness of the financial system. The Basel I
framework was adopted in over 100 countries. However, over the years,
several deficiencies of Basel I surfaced partly due to its inherent features
and partly due to rapid financial innovations. The major limitation of BaselI
was its 'one-size-fits-all' approach. The inadequacies of Basel I also
became evident following the recent financial turmoil as it failed to capture
off-balance sheet exposures. The Basel II framework, finalized in July
2006, attempts to align regulatory capital more closely with the inherent
risks in banking by using enhanced risk measurement techniques and a
more disciplined approach to risk management. In addition, Basel II has in
place a variety of safeguards, which also have the benefit of reinforcing
supervisors' objective of strengthening risk management and market
Challenges in Implementation of Basel II / Managing Capital and Risk :
In keeping with the international best practices, India also decided to
implement Basel II. Foreign banks operating in India and Indian banks
having operational presence outside India have already adopted the
standardised approach (SA) for credit risk and the basic indicator approach
(BIA) for operational risk for computing their capital requirements with effect
from March 31, 2008. All other commercial banks (excluding local area
banks and regional rural banks) are expected to adopt Basel II not later
than March 31, 2009. The parallel runs for these banks are in progress. A
significant improvement in risk management practices, asset-liability
management and corporate governance in Indian banks under regulatory
pressure to adopt Basel II framework has been observed.
While the Basel II framework, by making the capital requirements risk
sensitive, would enhance the stability of the financial system, its
implementation also raises several issues/challenges. India follows a three
track approach with commercial banks, co-operative banks and regional

rural banks having been placed at different levels of capital adequacy


Lending and Investment Operations of Banks

GROWTH OF CREDIT TILL NOW: Credit extended by scheduled
commercial banks from the early 1990s witnessed three distinct phases.
Bank credit growth was erratic in the first phase (from 1990-91 to 1995-96).
In the second phase (from 1996-97 to 2001-02), credit growth decelerated
sharply and remained range bound due to the industrial slowdown, high
level of NPAs and introduction of prudential norms, which made banks risk
averse. The third phase (from 2002-03 to 2006-07) was generally marked
by high credit growth attributable to several factors, including pick-up in
economic growth, sharp improvement in asset quality, moderation in
inflation and inflation expectations, decline in real interest rates, increase in
the income levels of households and increased competition with the entry
of new private sector banks.
Although the share of credit to industry in total bank credit declined in the
current decade, the credit intensity of industry increased sharply. A cross
country survey suggests that the reliance of industry on the banking sector
in India was far greater than that in many other countries. Credit growth to
the SME sector, which slowed down significantly between 1996-97 and
2003-04, picked up sharply from 2004-05. However, the share of the SME
sector in the total non-food bank credit declined almost consistently from
15.1 per cent in 1990-91 to 6.5 per cent in 2006-07. This suggests that it is
the large corporates that have increased their dependence on the banking
sector. The share of retail credit comprising housing loans, credit to
individuals, credit cards receivables and lending for consumer durables, in
total bank credit increased sharply from 6.4 per cent in 1990 to 25.4 per
cent in 2007.
CHALLENGES FOR INCREASING CREDIT: Notwithstanding some pickup in credit growth to the agriculture and SME sectors in recent years,

there is need for more concerted efforts to increase the flow of credit to
these sectors given their significance to the economy. Creating enabling
conditions, i.e., providing irrigation facilities, rural roads and other
infrastructure in rural areas, is necessary to augment the credit absorptive
capacity. Devising products to suit the specific needs of the farmers is
critical. There is also a need for comprehensive public policy on risk
management in agriculture. Computerisation of land records can go a long
way in smoothening the flow of credit to agriculture. Similarly the credit
assessment capabilities of banks need improvement to ensure flow of
credit to SMEs. There is need to increase the use of cluster based lending
and credit scoring, which has proved quite effective in many countries as
also in India. In view of the increased exposure of banks to infrastructure
and retail credit segments, banks need to guard against exposures to
attendant risks. The corporate sector needs to gradually reduce its
dependence on the banking sector and move towards tapping the capital
market so as to enable the banking sector to meet the growing
requirements of agriculture, SMEs and other small and tiny enterprises,
which are unable to tap funds from other sources
significant improvement in financial inclusion in recent years, moving ahead
several challenges remain to be addressed. A proper assessment of the
problem of financial exclusion is necessary. There is, therefore, a need to
conduct specific survey for gathering information relating to financial
inclusion/exclusion. There is need to reduce the transaction cost for which
technology can be very helpful. RRBs and co-operative banks, are
expected to play a greater role in financial inclusion in future. There would
be need to design appropriate products tailor made to suit the requirements
of the people with low income supported by financial literacy and credit
counselling. There is also a need to improve the absorptive capacity of
financial services by providing the basic infrastructure. Investment in
human development such as health, water sanitation, and education, in
particular, would be very helpful.

Competition and Consolidation in Recent Years : There has been a

significant increase in the number of bank amalgamations in India in the
post-reform period. While amalgamations of banks in the pre-1999 period
were primarily triggered by the weak financials of the bank being merged,
in the post-1999 period, mergers occurred between healthy banks, driven
by the business strategy and commercial considerations. Significantly,
despite increase in the number of bank mergers and acquisitions, the
Indian banking system has become less concentrated during the postreform period. In fact, the degree of concentration in the Indian banking
system, based on the concentration ratio and Hirschman-Herfindhal Index,
was one of the lowest among the select countries studied for the year
2006. The level of competition declined somewhat in the initial years of
reforms, but improved significantly thereafter. Based on the empirical
evidence, the Indian banking industry could be characterised as a
monopolistic competitive structure, as is the case with most other advanced
countries and EMEs
The empirical analysis also suggests that mergers andamalgamation had a
positive impact on efficiency both in terms of increase in return on assets
and reduction in cost, when the transferees were public sector banks
ownership of public sector banks is not an issue from the efficiency
viewpoint as public sector banks in India now are as efficient as new
private and foreign banks, as revealed by the various measures.
However, the operating environment for banks has been changing rapidly
and banks in the changed operating environment need flexibility to respond
to the evolving situation. Another issue that needs to be considered is the
funding of capital requirements of public sector banks given the present
floor of minimum 51 per cent on Government equity in public sector banks.
In the medium term, this can become an issue hampering the growth of
public sector banks if Government is not able to provide adequate capital
for their expansion.

The roadmap of foreign banks is due for review in 2009. This would involve
several issues. The increased presence of foreign banks, by intensifying
competition, may accelerate the consolidation process that is underway.
However, at the same time, this may also raise the risk of concentration if
mergers/amalgamations involve large banks. The experience of some other
countries also suggests that the emergence of large banks due to
consolidation has resulted in reduced lending to small enterprises
significantly. All these issues would need to be carefully weighed at the time
of review. The policy relating to ownership of banks by commercial interests
may have to take full account of international practices, given the issues
relating to potential conflict of interests, increased potential of contagion
effects and increased concentration.
SECTOR IN INDIA:8.1 PAST TRENDS : The efficiency and productivity of
scheduled commercial banks (SCBs) in India was analysed empirically,
using both the accounting and economic measures.. The most significant
improvement has occurred in the performance of public sector banks and
has converged with those of the foreign banks and new private sector
banks. Intermediation cost as also the net interest margin declined across
the bank groups. Despite this, however, profitability of the banking sector
improved. Business per employee and per branch also increased
significantly across the bank groups.
The improvement of various accounting measures, however, varied across
the bank groups. In terms of cost ratios (operating cost to income) foreign
banks, and with regard to labour productivity, foreign and new private
banks were ahead of their peer groups. In terms of net interest margins and
intermediation cost, new private sector banks and public sector banks,
respectively, were more efficient than the other bank groups. The cost of
deposits of foreign banks was the lowest in the industry. However, this was
not passed on to the borrowers, leading to higher net interest spread. The
empirical exercise suggested that the operating cost was the main factor
affecting the net interest margin. Non-interest income and the asset quality
were the other determinants of net interest margin.
CHALLENGES: . Similarly, there is a need for increased absorption of
enhanced technological capability (innovation) by several banks to further

augment productivity of the banking sector through changes in processes

and improvement in human resource skills.
The recent events in global financial markets in the aftermath of US
subprime crisis have evoked rethinking on several regulatory and
supervisory aspects of the banking industry, viz., how to cope with liquidity
stresses under unusual circumstances; whether pro-cyclicality of capital
requirements is one of the factors with inherent tendency that escalate the
impact of booms and busts. Regulation of complex products and monitoring
of derivatives is becoming an important issue. Further, a question has been
raised whether institutions should be allowed to become so big and so
complex that their problems can have system-wide repercussions.
The Report has attempted an in-depth analysis of various aspects of the
banking sector in India against the backdrop of the evolution of the Indian
banking sector beginning the 18th century with a focus on the postindependence period. The analysis suggests that the Indian banking sector
has witnessed several structural changes from time to time. India now has
a well-developed banking infrastructure, conducive regulatory environment
and sound supervisory system. Banks have become efficient and sound
and compare well with banks around the world. Banks in India have
benefitted from the robust growth in the last few years, which enabled them
to produce strong financial performance
An important lesson emerging from the recent financial market
developments is that the focus should not be on how the turmoil should be
managed, but on what policies could be put in place to strengthen the
financial system on a longer-term basis regardless of specific sources of
disturbances. These issues point towards the challenges that lie ahead to
preserve the safety and soundness of the financial

A robust banking and financial sector is critical for facilitating higher
economic growth Kainth (2008). The analysis of the Indian Banking
Industry shows stability and growth.
The Government of India and the RBI have attempted to implement a
proactive and responsive monetary policy and fiscal policy with timely,
targeted, and temporary measures. While the RBI has reversed its earlier
stance of a tight monetary policy, the government recently announced a
fiscal stimulus package to push overall economic activity. Indian Banks
have put in place a constellation of measures both on interest rates and
liquidity to ward off the impending crisis.
As a result Indian Banks have been able to perform well globally. Certain
aspects and learnings from the Indian Banking Industry can be adopted as
best practices by other financial crisis affected countries.
The global challenges which banks face are not confined only to the global
banks. These aspects are also highly relevant for banks which are part of a

globalised banking system. Further, overcoming these challenges by the

other banks is expected to not only stand them in good stead during difficult
times but also augurs well for the banking system to which they belong and
will also equip them to launch themselves.

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