AMRITA SCHOOL OF BUSINESS

Recent Banking Developments in India
Commercial Bank Management – Assignment

Prepared By

Hariom Singh 09016

the services sector has emerged as a key growth driver of the economy. investment banking.6 per cent. Another key development over the past decade has been the favourable shift in India's consumer demographics. While retail credit has grown by over 40 per cent a year in the past five years.India evolve from a moderately growing traditional economy to one of the fastest growing economies of the world in the past decade—a period of rapid growth and transformation. large players offer the full range of financial services including banking. according to the RBI. The number of households earning over Rs 80. The composition of the GDP has also changed significantly. With such robust growth trends.000 a year has increased from 40 million in 1996 to about 60 million in 2005. the boundaries between the roles played by banks. These are the figures that have paved the way for the robust retail credit growth in India. But despite such fast growth. The globalisation of Indian companies has resulted in several international banking opportunities. with services now contributing about 56 per cent of the total. The significant NRI and PIO (persons of Indian origin) presence . household incomes have also increased substantially. institutions and various financial intermediaries have blurred. NCAER data for the top 24 cities in India shows migration to higher income levels at over 40 per cent per annum. played a vital role in this. internet. Less expensive and more convenient electronic channels such as ATMs. mutual funds. Our GDP has grown by over 8 per cent in fiscal 2004 and by around 7 per cent in the first half of fiscal 2005. Technology has. The Indian population also has a large working class (58 per cent). deposits have also recorded a robust average growth rate of about 16 per cent a year. Parallelly. the gross NPA level of the Indian financial services sector is one of the lowest in the world. the sector has not compromised on asset quality. insurance products and private equity. of course. Indian banks are now focusing more and more on building international operations to cater to the cross-border needs of their clients and to leverage on their domestic strengths to offer products all over the world. The banking sector has capitalised on these positive economic developments and has experienced rapid growth over the decade—and even higher over the past five years. With the emergence of universal banking in the late 1990s. Banks have introduced doorstep delivery to customers through agency networks. Net NPAs of the Indian retail credit segment are even lower at about 1. Banks have expanded their product portfolio to offer a wide variety of innovative products and services over and above their traditional offerings. India has the highest proportion of population below 35 years of age. Today. mobile and phone banking are fast replacing the traditional branch banking channel. At 70 per cent. thus improving customer convenience. Total credit has grown at a compounded average annual rate of about 16 per cent since fiscal 2000. At about four per cent of GDP.

with most smaller non-banking players becoming sourcing agents for the larger players. with an increasing shift to non-core products and greater focus on fee income.across various geographies has also been a good market for Indian banks and their products. innovative products and structures and effective and economical distribution channels such as rural ATMs. Retail growth will be driven by both acquisition of new customers and increased penetration of products in the existing customer base. with India emerging as a strong regional hub for banking and other financial services. the focus of Indian banks shifting from mainly leveraging on India linkages to leveraging on operating cost advantage and developing product and distribution capabilities to become truly regional (Asian) and subsequently global players. The right use of technology improve the distribution capability of players and increase consumer convenience. In spite of growing at about 40 per cent annually. The robust growth trends in retail to continue. There will be substantial changes in corporate banking over the next 10 years. International banking would increasingly contribute a significant portion of the total business of Indian banks. There is robust growth in currently underpenetrated segments such as the rural and small and medium enterprises (SME) segment. In addition to volume growth. Banks would also need to combine corporate and retail banking/lending practices to cater effectively to the SME segment. as compared to over 30 per cent for many of Southeast Asian peers. Technology will also improve . Estimate is that corporates will invest over $45 billion in projects over the next 12-18 months. retail credit still remains a sector of which only a little has been tapped. The retail credit industry will also witness increased consolidation activity. at both domestic and non-resident Indian levels. because corporates will move beyond traditional bank borrowing and find newer sources of fund-raising as the capital market deepens. results in wealth management and private banking as significant emerging opportunities. But banks would need to complement growth in such areas with deep understanding of the segments. In international banking. with greater use of emerging channels such as mobile banking service and rural ATMs. The growing income levels of the Indian population. robust processes and sound credit practices. Banks with the ability to structure innovative products and offer customised solutions are more likely to meet with success than banks with a traditional product focus. Consumer credit outstanding as a percentage of GDP is at a low 8 per cent. Technology will continue to drive product and process innovation in retail banking. banks will also zoom in on leveraging scale to reduce costs and improve operating margins. given the favourable demographics and the low penetration levels. Corporate banking too will see robust growth due to capacity additions in several key sectors over the medium term.

The next ten years may also welcome several leading international banks into India. The developments so far have brought the Indian financial system closer to global standards.0 per cent. Indian banks have a competitive edge in terms of their strong distribution network. Though their increased presence will mean competitive pressures. Further. technological capabilities. Statutory Pre-emptions In the pre-reforms phase.0 per cent of NDTL (net demand and time liabilities). . the leading Indian banks have developed the product capability and the technological expertise to successfully compete. The robust economic growth and relative under-penetration of financial services will continue to drive financial sector growth. 2005-06 to remove the limits on the SLR and CRR are expected to provide freedom to the Reserve Bank in the conduct of monetary policy and also lend further flexibility to the banking system in the deployment of resources. in the form of both the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR).payment and settlement systems of banks. strong processes and the ability to innovate will emerge as winners over the next 10 years. the CRR of the Scheduled Commercial Banks (SCBs) is currently placed at 5. the Indian banking system operated with a high level of statutory preemptions. The legislative changes proposed by the Government in the Union Budget. The Reserve Bank has been consistently working towards the establishment of an enabling regulatory framework with prompt and effective supervision as well as the development of technological and institutional infrastructure. Indian banks will increasingly adopt best practices such as Six Sigma from the non-banking sector to improve operating efficiencies and customer service levels as well as reduce costs. Boundaries between various financial service providers and geographical boundaries will blur further and banks with scale. Efforts in the recent period have been focused on lowering both the CRR and SLR. and while the Reserve Bank continues to pursue its medium-term objective of reducing the CRR to the statutory minimum level of 3. Source: Outlook India The Indian banking sector has witnessed wide ranging changes under the influence of the financial sector reforms initiated during the early 1990s. The emphasis has been on deregulation and opening up the banking sector to market forces. The statutory minimum of 25 per cent for the SLR was reached as early as 1997.

Other initiatives in the area of strengthening prudential norms include measures to strengthen risk management through recognition of different components of risk. and (iii) a minimum margin to cover regulatory requirements of provisioning and capital charge and profit margin. banks have been allowed to diversify product portfolio and business activities. Foreign investments in the financial sector in the form of Foreign Direct Investment (FDI) as well as portfolio investment have been permitted. banks became free to determine their own lending interest rates. assignment of risk-weights to various asset classes. As advised by the Indian Banks’ Association (a self-regulatory organisation for banks).2 lakh. Recently. Basel II is the second of the Basel Committee on Bank Supervision's recommendations. (iii) small loans up to Rs. a roadmap for the presence of foreign banks in India was released which sets out the process of the gradual opening-up of the banking sector in a transparent manner. norms on connected lending and risk concentration.25 per cent in March 2005 from 10.25-11.25-11. application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities. The BPLRs of public sector banks declined to 10. provisioning and exposure were introduced in 1992 and gradually these norms have been brought up to international standards. Prudential Regulation Prudential norms related to risk-weighted capital adequacy requirements. (ii) operating expenses. it has improved the competitiveness of the financial environment and strengthened the transmission mechanism of monetary policy. With a view to granting operational autonomy to public sector banks. accounting. and (iv) export credit. Interest rates have now been largely deregulated except in the case of: (i) savings deposit accounts. Furthermore. commercial banks determine their respective BPLRs (benchmark prime lending rates) taking into consideration: (i) actual cost of funds. After the interest rate deregulation. particularly in metropolitan areas. In recent years.50 per cent in March 2004. These factors differ from bank to bank and feed into the determination of BPLR and spreads of banks. public ownership in these banks was reduced by allowing them to raise capital from the equity market of up to 49 per cent of paid-up capital. The share of public sector banks in the banking business is going down. it has been decided to migrate to Basel II. and unlike . (ii) non-resident Indian (NRI) deposits. Transparency and disclosure standards have been enhanced to meet international standards in an ongoing manner.Interest Rate Structure Deregulation of interest rates has been one of the key features of financial sector reforms. income recognition. Keeping in view the Reserve Bank’s goal to achieve consistency and harmony with international standards and our approach to adopt these standards at a pace appropriate to our context.

They have been advised to familiarise themselves with the QIS 5 requirements to enable them to . the BCBS is currently undertaking the Fifth Quantitative Impact Study (QIS 5). 2007. private and foreign) with representation from the Indian Banks’ Association and the Reserve Bank has been constituted. Encouraging banks to formalise their CAAP in alignment with their business plan and performance budgeting system. India will be participating in the study. Banks need to put aside capital to reduce the risks associated with its investing and lending practices. risk philosophy. The capital requirements are uniformly applied to all banks. and has selected 11 banks which form a representative sample for this purpose. 4. Basel I. Banks have also been advised to formulate and operationalise the Capital Adequacy Assessment Process (CAAP) as required under Pillar II of the New Framework.the first accord. 5.20 per cent of market share in terms of assets. With a view to ensuring migration to Basel II in a non-disruptive manner. market perceptions and expected level of capital. Some of the other regulatory initiatives relevant to Basel II that have been implemented by the Reserve Bank are: 1. On the basis of recommendations of the Steering Committee. Ensuring that banks have a suitable risk management framework oriented towards their requirements and dictated by the size and complexity of their business. Banks are required to maintain a minimum CRAR (capital to risk weighted assets ratio) of 9 per cent on an ongoing basis. These banks account for 51. Commercial banks in India have started implementing Basel II with effect from March 31. A Steering Committee comprising senior officials from 14 banks (public. a consultative and participative approach has been adopted for both designing and implementing the New Framework. at both bank and supervisory level. Building capacity to ensure the regulator’s ability to identify eligible banks and permit them to adopt IRB/Advanced Measurement approaches. In order to assess the impact of Basel II adoption in various jurisdictions and re-calibrate the proposals. together with the adoption of RBS. including foreign banks operating in India. 3. should aid in fulfilling the Pillar II requirements under Basel II. where focus was mainly on credit risk. After adequate skills have been developed. 2. some banks may be allowed to migrate to the Internal Ratings-Based (IRB) Approach. They initially adopted the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk. Introducing Risk-Based Supervision (RBS) in select banks on a pilot basis. Expanding the area of disclosures (Pillar III) so as to achieve greater transparency regarding the financial position and risk profile of banks. draft guidelines on implementation of the New Capital Adequacy Framework have been issued to banks. This. the purpose of Basel II was to create standards and regulations on how much capital financial institutions must have put aside. by way of prudential guidelines on capital adequacy.

Asset-Liability Management In view of the growing need for banks to be able to identify. banks are also required to observe certain statutory and regulatory limits in respect of their exposures to capital markets. adopting the Risk-Adjusted Return on Capital (RAROC) framework of pricing. banks were required to examine the various options available under the Framework and draw up a roadmap for migration to Basel II. pricing loans on the basis of risk rating. market risk. Exposure Norms The Reserve Bank has prescribed regulatory limits on banks’ exposure to individual and group borrowers to avoid concentration of credit. and has advised banks to fix limits on their exposure to specific industries or sectors (real estate) to ensure better risk management. etc. banks are at different stages of drawing up a comprehensive credit rating system. These guidelines are intended to serve as a benchmark for banks to establish an integrated risk management system. The Reserve Bank is currently focusing on the issue of recognition of the external rating agencies for use in the Standardised Approach for credit risk. In addition. including guidelines on Asset-Liability Management (ALM). monitor and control risks.participate in the exercise effectively. banks desirous of adopting the advanced approaches must perform a stringent assessment of their compliance with the minimum requirements before they shift gears to migrate to these approaches. analyse rating-wise distribution of borrowers in various industries. measure. As a well-established risk management system is a pre-requisite for implementation of advanced approaches under the New Capital Adequacy Framework. However. Detailed guidelines on the management of credit risk. . Basel II provides that banks should be allowed to adopt/migrate to advanced approaches only with the specific approval of the supervisor. operational risk. The progress made by the banks is monitored on a quarterly basis. With regard to risk management techniques. banks can also develop their own systems compatible with type and size of operations as well as risk perception and put in place a proper system for covering the existing deficiencies and the requisite upgrading. undertaking a credit risk assessment on a half yearly basis. The feedback received from banks suggests that a few may be keen on implementing the advanced approaches. Some banks stipulate a quantitative ceiling on aggregate exposures in specified risk categories. looking to migrate to the advanced approaches at a later date. not all are fully equipped to do so straightaway and are. etc. after ensuring that they satisfy the minimum requirements specified in the Framework. etc. but on a continuing basis. However. appropriate risk management guidelines have been issued from time to time by the Reserve Bank. have also been issued to banks by the Reserve Bank. not only at the time of adoption/migration. Hence. therefore.

The role of Credit Information Bureau of India Ltd.performing loans). almost all banks have an Asset-Liability Management Committee. 2005. capital to risk-weighted assets ratio (CRAR). the Lok Adalat (people’s court) forum. The structured actions in the case of RoA falling below the trigger level may include. coupled with a move towards risk-based supervision. urban banks and NBFCs. Three financial indicators. financial institutions. and fit and proper tests for directors. Board for Financial Supervision (BFS) An independent Board for Financial Supervision (BFS) under the aegis of the Reserve Bank has been established as the apex supervisory authority for commercial banks. The promulgation of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act. and have undertaken studies of behavioral maturity patterns of various components of on-/off-balance sheet items. the PCA scheme envisages certain structured/discretionary actions to be taken by the regulator. the legal framework has been put in place to facilitate the full-fledged operationalisation of CIBIL and the introduction of other credit bureaus. net non-performing assets (net NPA) and Return on Assets (RoA) have been identified with specific threshold limits. Significant progress has been made in implementation of the Core Principles for Effective Banking Supervision. When the indicators fall below the threshold level (CRAR. Debt Recovery Tribunals. Another significant measure has been the setting-up of the Credit Information Bureau for information sharing on defaulters and other borrowers. sale to securitisation/reconstruction companies and other banks or to nonbanking finance companies (NBFCs). Corporate Debt Restructuring (CDR). Consolidated supervision of financial conglomerates has since been introduced with bi-annual discussions with the financial conglomerates. With the enactment of the Credit Information Companies (Regulation) Act. restriction on accessing/renewing costly deposits and CDs. among other things. They have articulated market risk management policies and procedures.In respect of market risk. a requirement to take steps to increase fee-based income . There have also been initiatives aimed at strengthening corporate governance through enhanced due diligence on important shareholders. A scheme of Prompt Corrective Action (PCA) is in place for attending to banks showing steady deterioration in financial health. 2002 and its subsequent amendment have strengthened the position of creditors. Banks resolve/recover their NPLs through compromise/one time settlement. (CIBIL) in improving the quality of credit analysis by financial institutions and banks need hardly be overemphasised. The supervisory rating system under CAMELS has been established. RoA) or go above it (net NPAs). filing of suits. viz. NPL Management Banks have been provided with a menu of options for disposal/recovery of NPLs (non.

17 to 0.4 per . and increase of stake in subsidiaries. taking steps to upgrade credit appraisal skills and systems and to strengthen follow-up of advances. The Reserve Bank/Government may take steps to change promoters/ ownership and may even take steps to merge/amalgamate/liquidate the bank or impose a moratorium on it if its position does not improve within an agreed period. Similarly. among other things. In the case of increasing net NPAs. and expanding the reach of Electronic Clearing Services (ECS) and Electronic Funds Transfer (EFT). with the funding volatility ratio at -0. putting in place proper credit risk management policies/processes/procedures/prudential limits.8 per cent as against the regulatory requirement of 9 per cent which itself is higher than the Basel norm of 8 per cent. reducing loan concentration. not to enter new lines of business. expansion in staff.11 per cent. Technological Infrastructure In recent years.and to contain administrative expenses. undertaking a special drive to reduce the stock of NPAs and containing the generation of fresh NPAs. imposition of restrictions on borrowings from the inter-bank market. including a loan review mechanism for large loans.17 per cent as compared with a global range of -0. following up suit filed/decreed debts effectively. An Assessment These reform measures have had a major impact on the overall efficiency and stability of the banking system in India. a Centralised Funds Management System (CFMS). a Negotiated Dealing System (NDS) and the Structured Financial Messaging System (SFMS). The critical elements of the developmental strategy are the opening of new clearing houses. Discretionary action may include restrictions on capital expenditure. interconnection of clearing houses through the Indian Financial Network (INFINET) and the development of a Real-Time Gross Settlement (RTGS) System. The consolidation of the existing payment systems revolves around strengthening computerised cheque clearing. There has been a marked improvement in asset quality with the percentage of gross NPAs to gross advances for the banking system declining from 14. secure and effective payment and settlement system. The overall capital adequacy ratio of banks at end-March 2005 was 12. The capital adequacy ratio was broadly comparable with the global range. the Reserve Bank has endeavoured to improve the efficiency of the financial system by ensuring the presence of a safe. apart from performing regulatory and oversight functions the Reserve Bank has also played an important role in promoting the system’s functionality and modernisation on an ongoing basis. etc. structured actions will include. integration of the various payment products with the systems of individual banks has been another thrust area. reviewing the loan policy of the bank. In the process. etc. The dependence of the Indian banking system on volatile liabilities to finance its assets is quite limited.

3 per cent to 3. Globally. overall balance of payments alignment.68 per cent and vis-à-vis 0.46 per cent to 0. the Indian economy has been undergoing a phase of high growth coupled with internal and external stability characterised by price stability. Indian banks are well placed.cent in 1998 to 5. RoA rose from 0. This has provided the backdrop for a more sustained development of financial markets and reform. globally.2 per cent for 2004. The cost to income ratio of 0.0 per cent in several Latin American economies.4 per cent in the year 1991-92 to 0.2 per cent in 2005.2 to 6.48 per cent to 1. The reform measures have also resulted in an improvement in the profitability of banks. enhanced competitiveness. increased emphasis on infrastructure. Source: Vittaldas Leeladhar . In recent years. the NPL ratio varies widely from a low of 0. to over 10.9 per cent in 2004-05.0 per cent in developed economies.5 per cent for Indian banks compares favourably with the global range of 0.16 per cent for the world’s largest banks. fiscal consolidation. The banking sector reforms have also emphasised the need to review manpower resources and rationalise requirements by drawing up a realistic plan so as to reduce operating cost and improve profitability. improvement in the performance of financial institutions and stable financial market conditions and the service sector taking an increasing share. RoA was in the range -1. Considering that. improved market microstructure. an enabling legislative environment and significant capital inflows.

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