Global and regional developments in banking and financial

Services industry and challenges and opportunities

Venue : Centre for Banking Studies, Rajagiriya
Date : October 4, 2007

Respected Governor, Deputy Governors and distinguished audience

It gives me great pleasure in having been invited to deliver a speech as part of the Public
Lecture Series. The list of speakers who had already been a part of this Series is indicative of
the high quality of thoughts that have emanated from this forum. I thank the Centre for
Banking Studies for having added my name to that illustrious list.
This is my second visit to Sri Lanka and I thank the Governing Board of Institute of Bankers
of Sri Lanka for having invited me for their convocation, thus giving me an opportunity to
meet all of you. The one aspect that strikes me most is the aspirations of the financial sector
of this country to be part of a globalised financial world. This aspiration which gives rise to
various policy and structural changes, introduction of innovative financial services, is critical
to face the challenges in the near future. This aspiration is shared by all the developing
countries, India and Sri Lanka included, and the present times beckon us to identify the
opportunities, face the challenges and make a capital out of it. Today, I would like to dwell
upon developments in the banking and financial services industry, the various challenges
facing the industry and what in my view should be done to face the challenges as well as to
seize the opportunities.
Status of banking and financial services industry :
The financial services industry is the largest industry in the world in terms of earnings. It
refers to organizations that deal with the management of money. Banks, investment banks,
insurance companies, mutual fund companies, credit card companies, stock brokerages,
private banking, wealth management, advisory services, etc. come under the gamut of
financial services. The development of any economy is judged by the quantity and quality of
the financial services it can offer since these are the life lines for accelerating economic
development.

Services sector contribution to GDP in Sri Lanka and India ranges between 55% to 60% and
in such services dominated economies, financial services industry is emerging as the
dominant sector. And we are already beginning to see the benefits of this trend. I am given to
understand that in Sri Lanka the first quarter of 2007 recorded the lowest ever unemployment
rate of 6.2% which I believe is to a large extent due to the healthy growth experienced in
service sector, especially the financial service sector. The financial sector contributes 12% to
overall GDP of Sri Lanka which reflects the importance of the sector to the economy. In
particular, banking sector has shown a significant expansion during the first half of 2007
reflecting continued expansion in economic activity. Increase in assets, loans and deposits by
Rs. 20,300 crore (9.5 %), Rs. 14,400 crore (11.2 %) and Rs. 11,400 crore (7.6 %). In India
too the growth in banking indicators has been healthy. This trend is expected to continue as
the financial sector presents more opportunities. However concomitant with these
opportunities would be challenges that need to be addressed.
Opportunities :
1. Global integration :

The benefits of globalisation have been well documented and are being increasingly
recognised. Integration of domestic markets with international financial markets has been
facilitated by tremendous advancement in information and communications technology. This
increased confluence presents great opportunities for financial firms to spread their wings
over potential markets. In India this global integration has presented opportunities for
financial firms to tap the affluent Indian diaspora and also the Indian corporates with global
ambitions. Of late, there are many banks making their presence felt in China and Far East
Asian markets. This is a trend that will continue in view of the exciting opportunities those
markets present. We at Andhra Bank are proposing to set up representative offices in New
Jersey and a few cities in Gulf region.

Similarly the more than 7 lakh strong Sri Lankan diaspora offers great opportunities for banks
in Sri Lanka. The worker remittances is the second highest foreign exchange earner to the
country at USD 1.3 billion during the first half of 2007 helping to finance over 80 per cent of
the trade deficit. This has the potential to reach USD 4 billion. These can be tapped by going
global or by alliances with other financial firms. A possible model could be Sri Lankan banks

allying with Indian banks that have presence abroad. This makes business sense as the
diaspora of India, Pakistan, Bangladesh and Sri Lanka are primarily dominant in common
countries such as US, Canada, Britain and Australia. National Savings Bank signed up with
the ICICI Bank of India which also has operations in Colombo to provide a cheaper
remittance services to the expatriate Sri Lankans through ICICIs worldwide branch network.
I hope for more such alliances in the future.

Global integration would provide greater opportunities for tapping segments such as
expatriates, opening up of markets for exports such as apparel, scope for FDI. Also,
throughout its history Sri Lanka has been a beneficiary of being an active partner in global
trade due to its location on a very convenient naval route and a major transshipment hub. I am
sure Sri Lanka will be a major beneficiary of the globalisation wave that is sweeping the
world especially in the financial services segment.

I even visualize, if not suggest, that it is not far off when joint venture banks having partners
from India and Sri Lanka together with other countries can be opened up in other countries.
2. Rising income levels and changing demographic profile :

Asian countries are blessed with a relatively young demographic profile compared to
developed countries in the West. This would be one of the defining edges in the coming
decades. Two thirds of the Sri Lankan population is below 35 years. The figure is similar in
India where nearly 70% of Indias population is less than 35 years of age. With rising income
levels and demographic profile skewed in favour of young population, these are important
factors to be considered in the financial services space. This young population means there
would be a greater working force with more financial resources to be managed. This may not
necessarily be in form of savings but could also be in expenditure like purchase of property.
Wealth management, financial advisory services and the like create lot of opportunities.

With changing demographics, the challenge is to capture the new generation as customers,
those who are high on technology and are more demanding. These customers are required to
be serviced beyond the traditional brick and mortar branches. They require access to multiple
delivery channels as ATMs, Internet banking, telebanking and internet banking. They require
access to their accounts and the flexibility to operate their accounts from anywhere in the

country. It is only through adopting state of the art technology that banks can deliver such
flexible distribution channels.
3. Technology :
Another major opportunity provided for the financial services in the present era is the
development of technology. Financial sector and banking sector in particular can take credit
for the inculcation of technology in a large way in their day-to-day operations. In a short span
of less than two decades this has opened up many new opportunities. Customers of banks
have felt the positive impact of technological solutions implemented by banks. The customer
of banks of today have a virtual menu of options as far as delivery channels are concerned
and all these are the benefits of technology, with the most visible benefits happening in the
areas of payments for retail transactions. A variety of cards, Automated Teller Machines,
electronic based funds transfers, internet banking, mobile banking are all some of the latest
technology based payment solutions, which have gained large acceptance amongst the
banking public. Today banking, thanks to technology, has broken all geographical barriers
and demand from customers relates to 'anywhere and anytime banking'. Currently, IT based
offerings such as internet and mobile banking have provided customers with the means for
meeting the requirement of being able to perform banking transactions from anywhere.

Though technology has made exciting changes possible and will continue to do so, security
issues pose a major challenge. It is widely accepted that security is as effective as the weakest
link in a chain. In the case of banking, the weakest link does not relate to the components of
technology, but on the person who is part of the information supply chain, and is typically the
insider in the bank itself. With growing dependence on technology banks must develop high
security systems, build up impregnable firewalls in case of use of internet, implement disaster
recovery systems and Business Continuity Plans all of which are highly technological and
need intricate knowledge.
4. Financial services outsourcing :

Offshoring has become a competitive necessity as firms recognize the improvement in quality
they can realize through the well- qualified people and cost savings attainable by scaling up
their operations, particularly in areas like India, Sri Lanka, Philippines, Malaysia, China and
other markets in Asia Pacific. According to findings, the financial services industry could

triple the cost savings from offshore operations. India is fast becoming the financial research
hub of the world and the largest destination for outsourced financial services due to skilled
manpower availability. Already the top 12 investment banks of the world have captive
operations doing high-end analysis work in India. This new variant of outsourcing is
popularly referred to as KPO (Knowledge Process Outsourcing). KPO implies outsourcing of
knowledge intensive business processes that require specialized domain expertise. KPO
business is estimated to a USD 17 billion industry globally by 2010. Of this, at least 70% or
US$ 12 billion is estimated to be outsourced to India. Financial services KPO deals with
areas such as financial research, M&A valuation, insurance underwriting, fund management,
risk assessment, actuarial analytics, debt collection and recovery, equity research, financial
data mining, corporate and market research. This provides lot of opportunities to financial
services firms not to mention the employment opportunities.

Though India has got on the outsourcing bus pretty early and is now a dominant outsourcing
destination, the potential in the Sri Lankan BPO sector is also enormous to be part of this
growing outsourcing market. Sri Lanka labour cost is competitive with other low cost
destinations such as India, Phillipines and Thailand. With these advantages, Sri Lanka is
poised to take a major part of the USD 11.5 billion BPO market which is expected to grow
ten-fold to around USD 120 billion.

In particular, the opportunities in financial outsourcing needs to be tapped by Sri Lanka. Sri
Lanka has one of the largest number of qualified accountants per head of population in the
world. CIMA UK, one of the world's largest professional accounting bodies, has its second
biggest division in Sri Lanka. Sri Lankan accountants and analysts are performing
marvelously in international companies in Australia and UK. Sri Lanka has the potential to
attract BPO clients that need high-end specialized financial services and attract investment.
Challenges :
1. Education :
More than ever before in human history, the wealth-or poverty-of nations now depends on the
quality of their education. Those with a larger repertoire of skills and a greater
capacity for learning can look forward to a lifetime of unprecedented economic fulfillment.

With literacy rate of more than 90%, Sri Lanka is a model for education excellence in the
developing world. Sri Lankas education system has been celebrated around the world as one
that has achieved universal primary education and high levels of literacy. The achievement of
high rate of literacy rate in Sri Lanka while being a developing country can be attributed to
the government sponsored free education from grade 1 to university level, sufficiently high
school density and other welfare programmes implemented for decades.

However the challenge in the future would not just be primary education but skill sets to take
part in the opportunities being offered in the emerging business domains. Indias ascent to a
formidable global ICT power has been mainly driven by economic reforms, establishment of
a free market democracy, perseverance of some unbeatable private entrepreneurs and above
all, continuous human capital development in engineering and electronic fields. The last
development came from the high educational standards maintained by a web of reputed state
owned Indian Institutes of Technology (IITs) and permission given to private sector to set up
higher learning institutes. Sri Lanka needs to encourage privately owned institutes of higher
learning to make a significant contribution to education and training. With quality output
emanating from institutes of excellence such as Institute of Bankers of Sri Lanka, I am sure
there would be good number of skilled finance professionals to take advantage of the
opportunities permeating the Asian countries.
2. Size :
As argued by Thomas L Friedman, the world has become flat and the world nations should
recognize the flattening process of the world. If a country stubbornly and arrogantly refuses
to accept this fact, it stands to lose, while others continue to move forward on an accelerated
high gear.
The increased global integration presents a few challenges as well. A problem in one
country has now a greater chance of adversely impacting other countries. It also results in
greater competition and consequently greater risks. Cross-border flows and entry of new
products have impacted significantly on the banking sector, forcing banks to adjust the
product mix and processes in order to remain competitive in the globalised environment. In
Sri Lanka, some of the foreign banks have begun strong competition in retail banking. They
are also engaged in lending to SMEs and microfinance. Some banks have taken the initiative
of making agency arrangements with establishments that have wide operations networks

such as the postal network to widen the access to their services. Further, having seen the
business potential in large infrastructure projects, some foreign banks are arranging new
funding sources through own borrowings from abroad and loan syndication to provide
necessary funding for such projects. Local firms need to have necessary armoury to face
this foreign onslaught.
One effective way is to increase size. Consolidation is a widely discussed area in the Indian
banking sphere. With the entry of foreign players with their huge resources, size is bound to
be of scale consolidation in the banking sector will be required to face them. With assets of
close to Rs. 5,00,000 crore, India's largest bank SBI is ranked only 84 among the world's
largest banks. The same is the case in Sri Lanka also where banks are miniscule compared
to global giants. If Sri Lanka hopes to open up its market and if local banks were to compete
on an equal footing with global players, then we will need larger banks. There is a greater
need for banks to grow much faster.
3. Regulatory compliance :
In the face of an increasingly complex and uncertain environment, financial services
organisations need to develop a more proactive approach to risk management and corporate
governance . Regulatory compliance, disclosure requirements, transparency are primarily
seen as a regulatory obligation rather than a value driver. However, it need be realised that
these present hidden opportunities.
A survey of more than 100 financial services executives carried out by Pricewaterhouse
Coopers, found that respondents now regard reputational risk as the greatest threat. More
effective embedding of compliance and related governance and risk management into
frontline operations could help financial services organisations to realise the business benefits
of their investment. For example, the scenario analysis required by Basel II could help to
provide a more forward looking approach to capital allocation and the setting of credit limits.
Compliance costs are modest when compared to the billions that can be wiped off if lapses in
probity or financial reporting come to light. Indeed, the increasing pressure to improve
controls and accountability is coming from investors, customers, employees and other key
stakeholders, not just governments and supervisory bodies. Companies therefore need to look
beyond narrow regulatory expectations to develop a more holistic and proactive approach to

compliance. Compliance cannot simply be turned over to the functional group, rather it must
be woven into the business and the process.
Action plan :
May I now take the liberty of sharing with you some steps being taken by Indian banks to
become vibrant players in financial services sphere. These, I believe, are equally applicable
for Sri Lankan banks also.
Several banks have introduced innovative products and services to suit the customer
requirements such as remittance products targeted for migrant workers, facilities to settle
utility bills, deposits products with added features, access to on-line investments facilities
and arrangements to provide banking services through mobile phones. However it needs
to be remembered that unlike physical products, financial services are easy to be copied
and therefore there exists a need for frequent innovation. As direct customer access and
pricing pressures lead to commoditization, customer focus must become central to
strategy. With increasing competition, there is a greater need for providing efficient
service to the customers as service is the only differentiator.
An increasing source of innovation in services is coming from collaboration between
different industries as in co-branded cards. We are seeing financing tie-ups between
banks and autombile manufacturers, tie ups between mobile phone network providers and
entertainment industry and tie ups between computer manufacturers and search engines.
This trend will only increase in the future. Organisations will tap into each other
customers enabling cross selling and in the process enhance customer satisfaction as well.
Consolidation of all types of financial services, which a customer of a bank may require
needs to be offered by banks. While some steps have been taken by banks in the form of
universal banking and the offering of related financial services such as insurance, tax
advice, securities market operations, depository functions and the like, the future may
witness alliances with service providers who may in today's context appear to have to
relationship with traditional banking concepts. For example, a mobile phone user, who is
a customer of particular telecommunication service provider, may switch preferences to
another bank if the phone company does not link its services to that of a particular bank

with whom the user is banking with. Thus strategic alliances with varied service providers
may become a necessity.
From Basel II to new laws of tougher enforcement, firms face an expensive and confusing
regulatory landscape. Given the number and mandates of regulators, it is no longer
possible to adopt a reactive, piecemeal approach to compliance. Instead, institutions are
gaining a competitive advantage by introducing principle-based compliance into their
governance and management culture and embedding it into the business. Organizations
with the right processes can turn compliance into a real professional advantage.
Compliance cannot simply be turned over to the functional group; rather, it must be
woven into the business and the process.
Former CEO of GE Jack Welch used to emphasise a lot on the concept of boundaryless
organisation where learning is not confined to sources from within the organisation but
from any organisation. Called as "legitimaite plagiarism", we need to be open to practices
followed by other institutions. For example in US, Commerce Bank reimburses customers
for fees incurred at the ATMs of other banks, Bank of America allows enrolled customers
to have debit purchases rounded to the nearest dollar and the difference deposited into a
savings account, Citigroup's CitiMobile service lets customers use cell phones to locate
an ATM or branch. The opportunities for learning is within our industry, we just need to
be open for them.
Conclusion :
I would finally like to end my speech by saying that we are passing through "very interesting
times". The developing economies have much to gain in these times as a result of
globalisation. The opportunities for youth are opening up and growth rates are forward
looking. I am optimistic that the global and regional developments in banking and finance
industry augur well and if challenges are squarely defined and addressed our economies are
bound to be benefited by these developments. I thank each one of you for your patient
hearing. Thank you.
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