Lovely Professional university

TERM PAPER [MGT-636] TOPIC- Study on Banking Innovations in India

Submitted by
CHANDAN KUMAR SINGH Section-B Roll number ±RT1902A-27

Guided by
Mr. Lovey Aggarwal


S. No. 1 2 3 4 5 6 7 8 9 10 11 Topic
ACKNOWLEDGEMENT Objective of the study History of Banking Industry in India List of Banks in India PROCESS INNOVATION IN THE INDIAN BANKING INDUSTRY

Page No. 03 03 04 07 08

Innovations in the Banking Industry in India Technological Change & Financial Innovation in 10 Banking Recent Trends in Indian Banking Sector 20 Future of Indian Banking Sector Conclusion Bibliography

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I provide full justice to this term paper which is prepared by visiting various websites, magazines, articles etc. I would like to take an opportunity to thank all the people in collecting the necessary information and making of the report. I am grateful to all of them for their time and wisdom. My project becomes a reality only due to cooperation of many people who had helped me in completing this project. I sincerely extend my gratitude to


Lovey Aggarwal who

has given me this precious opportunity to have an know about the Indian Banking Sectors. And its recent technology changes. 

Objective of the study. 
To enhance knowledge about our banking sectors.  To know about the recent changes in banking sectors.  To enhance knowledge about banking operations.


History of Banking Industry in India.
Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India which started in 1786, and the Bank of Hindustan, both of which are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial, which, upon India's independence, became the State Bank of India.

The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:
y y y y

Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991. To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III.


Phase I
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 the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in india as the Central Banking Authority. During those days public has lesser confidence in the banks. As an aftermath deposit mobilisation 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 nationalised 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 nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. It was the effort


of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised. Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country:
y y y y y y y y

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 nationalisation 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%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.

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 liberalisation of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.


The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure. 

List of Banks in India
Public Banks. 

Private Banks
ICICI Bank HDFC Bank Axis Bank Kotak Mahindra Bank South Indian Bank Yes Bank Federal Bank

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


The crisis in the international financial markets had been simmering for quite some time. However, its effects are now evident with the collapse of some of the leading financial institutions. While India has not been as seriously impacted by the global financial turmoil, the current credit crunch has affected all sectors of the Indian economy. On the one hand, the Indian banking industry is witnessing rapid change given the evolving regulatory environment, rapid technological advancements, heightened competition and consolidation. On the other hand, with the global recession looming, the industry is now exploring process innovation and is more aggressively adopting technology. ValueNotes along with the Indian Banks' Association (IBA) conducted a conference on "Process Outsourcing in the Indian Banking Industry" on January 6th to address the immediate issues concerning the banking industry. There were several speakers from the banking industry including HDFC Bank, Punjab National Bank, Bank of India, IDBI, who spoke on the issues and concerns of the banks. There were also some service providers such as Intelenet, MphasiS BPO, HTMT Global and Shell Transource who were present at the conference. These service providers talked about their experience with the international banks and spoke about issues related to vendor selection and process transition. 

Outsourcing in the Indian Banking Industry
Globally, the banking and financial services sector has been at the forefront of the outsourcing movement. Third party service providers have also built greater processing and analytical capabilities and are able to handle more complex functions like financial modeling and equity research. In contrast with global evolution of outsourcing, the Indian banking industry has been slower to outsource. The Indian banking Industry is highly fragmented. There are banks ranging from small co-operative banks (presence limited to a few branches in a city) to large


nationalized commercial banks like SBI with over 10,000 branches (one of the largest banking network in the world). The Indian banking Industry is dominated by PSBs with 70% market share. Further, there are different issues that concern the Indian banks when outsourcing. 

Process Innovation and Technology
In India, outsourcing of processes is largely constrained by the RBI regulations and resistance from trade unions. According to Arun Jethmalani, CEO, ValueNotes, "Aggressive adoption of IT and centralization of operations have served as a key enabler to outsourcing of business processes in the banking industry." Other factors such as growth in the banking industry, deregulation, increasing competition, consolidation and improving benchmarks in the industry are driving the outsourcing of business processes. PSBs have been sluggish in adopting new technology as compared to global banks. Post liberalization, with RBI tightening its regulations, PSBs have undertaken massive computerization to achieve 'Total Branch Automation'. With privatization and increasing competition, all the large banks are now aggressively implementing 'Core Banking Solutions'. There is increasing focus on technology as evidenced by more and more PSU banks going for aggressive computerization and transferring their processes into some technology platform or other. While a few large PSBs have been quick to respond to competitive pressures by introducing new services, investing in technology and acquiring capabilities like marketing and sales, others lag behind.


Innovations in the Banking Industry in India

In the 1990s, the banking sector in India saw greater emphasis being placed on technology and innovation. Banks began to use technology to provide better quality of services at greater speed. Internet banking and mobile banking made it convenient for customers to do their banking from geographically diverse places. Banks also sharpened their focus on rural markets and introduced a variety of services geared to the special needs of their rural customers. Banking activities also transcended their traditional scope and new concepts like personal banking, retailing and banc assurance were introduced. The sector was also moving rapidly towards universal banking and electronic transactions, which were expected to change the way banking would be perceived in the future. Issues: y Examine the development of the banking system in India and understand the changes occurring in it. y Understand the need for innovations in banking to create greater value for customers and enhanced efficiency for the banks. y Appreciate the role of technology in increasing the convenience of customers and improving banking operations. y Study the banking needs of rural India and the initiatives taken up by banks to cater to these needs. y Analyze the changes occurring in the Indian banking sector and how these changes are likely to influence the way banking will be done in the future.


Types of Innovations
y E-BANKING y Enables people to carry out most of their banking transaction using a safe website which is operated by their respected bank. y Advantage y Faster & more convenient transaction y No longer required to wait in long queues y Opening of account simple & easy y Apply for bank loan y Cost effective for banker side y Fund transfer become faster & convenient y Stock trading, exchanging bonds & other investment 

Breakthrough in Funds Transfer
In May 2004, the curtain was finally lifted on the much discussed Real Time Gross Settlement (RTGS) system, which many analysts considered, would revolutionize funds transfer in the Indian banking sector. It enables companies to transfer outstanding funds between banks in real time, thus allowing them to settle payments instantaneously and manage their working capital better. It is also expected to save significant amounts of money in interest payments on floating funds lying in banks. Some of the early adopters of RTGS were SCB, SBI, Housing Development Finance Corporation (HDFC) and Saraswat Bank. IndusInd Bank was also close to implementing the system. Some of the systems implemented earlier included the electronic clearing service (1995), electronic funds transfer (EFT) facility (1997) and special electronic funds transfer system (2003). Changes in the Indian banking sector in the late 1990s and early 2000s, are expected to create high value for customers as well as the banks involved.


Background Note
While the history of banking in India can be traced back several centuries, banking in the modern sense of the word actually began towards the end of the 1700s. The Bank of Hindustan, set up in 1770, by the British rulers5 in India was the earliest bank in the country. Over the years, the British set up several other banks, notable among which were the three Presidency Banks in the Presidencies of Bengal (in 1809), Bombay (in 1840) and Madras (in 1843). These three banks were very powerful in their respective Presidencies and functioned as quasi-central banks, having even the power to issue currency notes. point stock banking companies with limited liability began to make their appearance in the early-1860s.Allahabad Bank Ltd. was the first joint stock bank established in India. The Swadeshi Movement6 in the early-1900s provided an impetus to the setting up of banks owned by Indians. In 1920, the British government in India passed the Imperial Bank of India Act and amalgamated the three Presidency banks. After India became independent from British rule in 1947, the newly formed government of the country passed the Banking Regulations Act, 1949, laying down the guidelines for the operation of commercial banks in the country. This regulation brought RBI under government control (under the RBI Act, 1934, the RBI did not have any government ownership). The RBI was also made the supervisory and regulatory authority of the banking sector. In 1955, the Imperial Bank was converted into the State Bank of India (SBI), through the passing of the State Bank of India Act, 1955. In 1959, SBI took over control of eight private banks floated in the erstwhile princely states, making them 100% subsidiaries. In 1969, the government of India (GoI) undertook a bank nationalization program with the objective of streamlining the banking operations in the country and strengthening the sector through government support.


Innovations in Banking in India
Over the years, the banking sector in India has seen a number of changes. Most of the banks have begun to take an innovative approach towards banking with the objective of creating more value for customers, and consequently, the banks. Some of the significant changes in the Indian banking sector are discussed below:

Technology for Value Creation
The use of information technology in the Indian banking sector was a corollary of the liberalization process initiated in the country in the early 1990s.

Rural India Catching Up
With a majority of the Indian population living in rural areas, rural banking forms a vital component of the Indian banking system. Besides, rural banking operations in India are rather different from urban operations, due to the strong disparity that exists between urban and rural life, and the needs of these two sections of people.

Banking Beyond Banking
While traditionally, banking meant 'borrowing and lending', in the latter part of the 20th century, the word took on a different meaning altogether. Banks no longer restricted themselves to traditional banking activities, but explored newer avenues to increase business and capture new markets. The Changing Face of Banking Many analysts predict still more revolutionary changes in the banking sector in India. The chief of these are likely to be the concept of Universal Banks and the introduction of Smart Card technology. The Other Side Although the Indian banking sector has made rapid progress particularly in the number of innovations introduced, some analysts are skeptical about the efficacy and practical use of many of these services.


Technological Change & Financial Innovation in Banking
When we discuss the technological change and financial innovation that commercial banking has experienced during the past twenty-five years. This article indicates the role of financial system in economics and how technological change and financial innovation can improve social welfare. The literature review is relating to several financial innovations, which focuses the new products or services, production processes or organizational forms. In this article to find out the past quarter century has been a period of substantial change in terms of banking products, services, and production technologies. Moreover, while much effort has been devoted to understanding the characteristics of users and adopters of financial innovations and the attendant welfare implications, and to know little about how and why financial innovations are initially developed. y Introduction The commercial banking business has changed dramatically over the past 25 years, due in large part to technological change. Advances in telecommunications, information technology, and financial theory and practice have jointly transformed many of the relationship focused intermediaries of yesteryear into data-intensive risk management operations of today. Consistent with this, we now find may commercial banks embedded as part of global financial institutions that engage in a wide variety of financial activities. To be more specific, technological changes relating to telecommunications and data processing have spurred financial innovations that have altered bank products and services and production processes. For example, the ability to use applied statistics cost-effectively (via software and computing power) has markedly altered the process of financial intermediation. Retail loan applications are now routinely evaluated using credit scoring tools, rather than using human judgment. Such an approach makes underwriting much more transparent to third parties and hence facilities secondary markets for retail credits (e.g., mortgages and credit card receivables) via securitization. Statistically based risk measurement tools are also used to measure and manage other types of credit risks- as well as interest rate risks-on an ongoing basis across entire portfolios. Indeed, tools like value-at-risk are even used to determine the appropriate allocation of risk-based capital for actively managed portfolios.


It will describe how technological change has spurred financial innovations that have driven the aforementioned changes in commercial banking over the past 25 years. In this respect, the analysis distinguishes itself by reviewing the literature on a large number of new banking technologies and synthesizing these studies in the context of the broader economics literature on innovation. The various innovations in banking and financial sector are ECS, RTGS, EFT, NEFT, ATM, Retail Banking, Debit & Credit cards, free advisory services, implementation of standing instructions of customers, payments of utility bills, fund transfers, internet banking, telephone banking, mobile banking, selling insurance products, issue of free cheque books, travel cheques and many more value added services.

y The Role of Finance and Financial Innovation
The primary function of a financial system is to facilitate the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment. This function encompasses a payments system with a medium of exchange; the transfer of resources from savers to borrowers; the gathering of savings for pure time transformation and the reduction of risk through insurance and diversification. The operation of a financial system involves real resource costs employed by financial intermediaries and by financial facilitators (e.g., mortgage brokers). Much of these resources are expended in the data collection and analyses in which financial market participants engage, so as to deal with problems of asymmetric information. There are also uncertainties about future states of the world that generate risks, which for risk-averse individuals represent costs. In this environment, new production process or new organisational forms. Hence, a Financial Innovation as something new that reduces costs, reduce risks or provides an improved product/service/instrument that better satisfies financial system participants demands. Financial innovations can be grouped as new products (e.g., subprime mortgage) or services (e.g., Internet banking) or new organisational forms (e.g., Internet-only banks). The Centrality of finance in an economy and its importance for economic growth naturally raises the importance of financial innovation ± and its diffusion. Since finance is a facilitator of virtually all production activity and much consumption activity, improvements in the financial sector will have direct positive


ramifications throughout an economy. Further, since better finance can encourage more saving and investment and can also encourage more productive investment decisions, these indirect positive effects from financial innovation and further to its value for an economy. Given its importance, an understanding of the conditions that encourage innovation would appear to be worthwhile. After all, observed streams of innovations are clearly not uniform across all enterprises, across all industries or across all time periods. The general innovation literature in economics has sought to uncover the environmental conditions that affect the stream of innovations-focusing on hypotheses concerning roughly five structural conditions: the market power of enterprises, the size of enterprises, technological opportunity, appropriability and product market demand conditions. Of course, when environmental changes occur, we expect to observe an initial wave of financial innovations followed by a new equilibrium flow consistent with the new environmental conditions. Over the past 25 years, each of these above environmental conditions was markedly altered ± resulting in substantial changes to the commercial banking industry.

y Financial Innovation and Banking
The literature pertaining to several specific financial innovations appearing over the past 25 years or so that were specifically driven by technological change. The major discussion is focusing on the lines of: new products & services, new production process and new organizational forms. y A1. Products: Mortgage loans are one suite of products that have experienced a great deal of change over the past 25 years in the United States. In 1980, long-term fully amortizing fixed-rate mortgages were the norm and this product was offered primarily by thrift institutions. Moreover, these loans required substantial down payments and a good credit history and the accumulated equity was relatively illiquid. These characteristics have markedly evolved. The first big change occurred in the early 1980s with the widespread introduction of various types of adjustable-rate mortgages (ARMs), which had previously been banned by federal regulators. The Tax Reform Act of 1986, which ended federal income tax deductions for nonmortgage consumer debt, spurred substantial growth in home equity lending. One


mortgage innovation more directly tied to technological change is subprime lending, which was originally predicated on the use of statistics for better risk measurement and risk-based pricing to compensate for these higher risks. However, the subprime mortgage crisis has uncovered significant shortcomings in the underlying statistical models. * Subprime Mortgages: Subprime mortgage lending, broadly defined, and relates to borrowers with poor credit histories or high leverage as measured by either debt/income or loan-to-value. This market grew rapidly in the U.S during the first decade of the twenty-first century ± averaging about 20% of residential mortgage originations between 2004 and 2006. At the end of 2007, subprime mortgages outstanding stood at $940 billion; down from over $1.2 trillion outstanding the previous year (Inside Mortgage Finance 2008). Since the onset of the subprime mortgage crisis, research has attempted to identify various sources of the problem. Mayer, Pence and Sherlund (forthcoming) provide an overview of the attributes of subprime mortgages outstanding during this time and investigate why delinquencies and defaults increases so substantially. These authors, as will as Gerarbi, Lehnert, Sherlund, and Willen (forthcoming), point to significant increase in borrower leverage during the mid-2000s, as measured by combined loan-to-value (CLTV) ratios, which was soon followed by falling house prices. A2. Services: Recent service innovations primarily relate to enhanced account access and new methods of payment-each of which better meets consumer demands for convenience and ease. Automated Teller Machines (ATMs), which were introduced in the early 1970s and diffused rapidly through the 1980s, significantly enhanced retail bank account access and value by providing customers with around the clock access to funds. ATM cards were then largely replaced through the 1980s and 1990s by debit cards, which bundle ATM access with the ability to make payment from a bank account at the point of sale. Over the past decade, remote access has migrated from the telephone to the personal computer. Online banking, which allows customers to monitor accounts and originate payments using "electronic bill payment," is now widely used. Stored-value, or prepaid, cards have also become ubiquitous. * Debit Cards: Debit cards are essentially "pay-now" instruments linked to a checking account whereby transactions can happen either instantaneously using


online (PIN based) methods or in the near future with offline (signature based) methods. Consumers typically have the choice of using online or offline methods, and their selection often hinges on the respective benefits. Online debit allows the cardholder also to withdraw cash at the point-of-sale, and offline provides float. According to ATM & Debit News (2007), there were approximately 26.5 billion debit transactions in the U.S. during 2006. This is up from 6.5 billion transactions in 1999 ± a four-fold increase. * Online Banking: As households and firms rapidly adopted internet access during the late-1990s, commercial banks established an online presence. According to De Young (2005), the first bank websites were launched in 1995: and by 2002 nearly one-half of all U.S. banks and thrifts operated transactional websites. As of 2007, bank call report data suggests that 77.0 percent of commercial banks offer transactional websites (and these banks control 96.8 percent of commercial bank deposits). The primary line of research relating to online banking has been aimed at understanding the determinants of bank adoption and how the technology has affected bank performance. In terms of online adoption. Furst, Lang, and Nolle (2002) find that U.S. national banks (by the end of the third quarter of 1999) were more likely to offer transactional websites if they were: larger, younger, affiliated with a holding company, located in an urban area, and had higher fixed expenses and non-interested income. Turning to online bank performance, De Young, Lang, and Nolle (2007) report that internet adoption improved U.S. community bank profitability ± primarily through deposit-related charges. In a related study, Hernando and Nieto (2007) find that, over time, online banking was associated with lower costs and higher profitability for a sample of Spanish banks. Both papers conclude that the internet channel is a complement to ± rather than a substitute for ± physical bank branches. * Prepaid cards: As the name implies, prepaid cards are instruments whereby cardholders "pay early" and set aside funds in advance for future purchases of goods and services. (By contrast, debit cards are "pay-now", and credit cards are "pay later"). The monetary value of the prepaid card resides either of the card or at a remote database. According to Mercator Advisory Group, prepaid cards accounted for over $180 billion in transaction volume in 2006. Prepaid cards can be generally delineated as either "closes" systems (e.g., a retailer-specific gift card, like Macy's or Best Buy) or "open" systems (e.g., a payment-network branded card, like Visa or MasterCard). Closed-system prepaid


cards have been effective as a cash substitute on university campuses, as well as for mass transit systems and retailers. A3. Production Processes The past 25 years have witnessed important changes in banks production processes. The use of electronic transmission of bank-to-bank retail payments, which had modest beginnings in the 1970s, has exploded owing to greater retail acceptance, online banking and check conversion. In terms of intermediation, there has been a steady movement toward a reliance on statistical models. For example, credit scoring has been increasingly used to substitute for manual underwriting ± and has been extended even into relationship-oriented products like small business loans. Similar credit risk measurement models are also used when creating structured financial products through "securitization". Statistical modelling has also become central in the overall risk management processes at banks through portfolio stress testing and value-at-risk models ± each of which is geared primarily to evaluating portfolio value in the face of significant changes in financial asset returns. * Asset Securitization: Asset securitization refers to the process by which non traded assets are transformed into the U.S., securitization is widely used by large originators of retail credit ± specifically mortgages, credit cards and automobile loans. As of year-end 2007, federally sponsored mortgage pools and privately arranged ABS issues (including private-label mortgage-backed securities) totalled almost $9.0 trillion in U.S. credit market debt outstanding. By contrast, as of year-end 1990, these figures were $1.3 trillion, respectively. One recent innovation in the structured finance/securitization area is the introduction of collateralized debt obligations (CDOs). According to Longstaff and Rajan (2006) these instruments, which were first introduced in the mid-1990s, are now in excess of $1.5 trillion. Like ABS, CDOs are also liabilities issued by financialinstitution-sponsored trusts, which essentially pool and restructure the priority of cash flows associated with other types of risky financial assets, including senior and mezzanine ABS, high-yield corporate bonds and bank loans. * Risk Management: Advances in information technology (both hardware and software) and financial theory spurred a revolution in bank risk management over the past two decades. Two popular approaches to measuring and managing financial risks are stress-testing and value-at-risk (VaR). In either case, the idea is to identify the level of capital required for the bank to remain solvent in the face of





* Organisational Forms: new bank organizational forms have emerged in the United States over the past few decades. Securities affiliates (so-called "section 20" subsidiaries or the creation of "financial holding companies") for very large banks and Subchapter S status for very small banks, were the by product of regulatory/legal evolution. Indeed, only one new organizational form, the internetonly bank, arose from technological change. These institutions, which quickly emerged and disappeared, may represent an interesting laboratory for the study of "failed" financial innovations. We believe that understanding such experimental failures may hold important insights for understanding the keys to successful innovations. 

Recent Trends in Indian Banking Sector
Today, we are having a fairly well developed banking system with different classes of banks ± public sector banks, foreign banks, private sector banks ± both old and new generation, regional rural banks and co-operative banks with the Reserve Bank of India as the fountain Head of the system. In the banking field, there has been an unprecedented growth and diversification of banking industry has been so stupendous that it has no parallel in the annals of banking anywhere in the world. During the last 41 years since 1969, tremendous changes have taken place in the banking industry. The banks have shed their traditional functions and have been innovating, improving and coming out with new types of the services to cater to the emerging needs of their customers. Massive branch expansion in the rural and underdeveloped areas, mobilisation of savings and diversification of credit facilities to the either to neglected areas like small scale industrial sector, agricultural and other preferred areas like export sector etc. have resulted in the widening and deepening of the financial infrastructure and transferred the fundamental character of class banking into mass banking. There has been considerable innovation and diversification in the business of major commercial banks. Some of them have engaged in the areas of consumer credit, credit cards, merchant banking, leasing, mutual funds etc. A few banks have already set up subsidiaries for merchant banking, leasing and mutual funds and many more are in the process of doing so. Some banks have commenced factoring business. The major challenges faced by banks today are as to how to cope with competitive forces and strengthen their balance sheet. Today, banks are groaning with burden


of NPA¶s. It is rightly felt that these contaminated debts, if not recovered, will eat into the very vitals of the banks. Another major anxiety before the banking industry is the high transaction cost of carrying Non Performing Assets in their books. The resolution of the NPA problem requires greater accountability on the part of the corporate, greater disclosure in the case of defaults, an efficient credit information sharing system and an appropriate legal framework pertaining to the banking system so that court procedures can be streamlined and actual recoveries made within an acceptable time frame. The banking industry cannot afford to sustain itself with such high levels of NPA¶s thus, ³lend, but lent for a purpose and with a purpose ought to be the slogan for salvation.´ The Indian banks are subject to tremendous pressures to perform as otherwise their very survival would be at stake. Information technology (IT) plays an important role in the banking sector as it would not only ensure smooth passage of interrelated transactions over the electric medium but will also facilitate complex financial product innovation and product development. The application of IT and e-banking is becoming the order of the day with the banking system heading towards virtual banking. As an extreme case of e-banking World Wide Banking (WWB) on the pattern of World Wide Web (WWW) can be visualised. That means all banks would be interlinked and individual bank identity, as far as the customer is concerned, does not exist. There is no need to have large number of physical bank branches, extension counters. There is no need of person-to-person physical interaction or dealings. Customers would be able to do all their banking operations sitting in their offices or homes and operating through internet. This would be the case of banking reaching the customers. Banking landscape is changing very fast. Many new players with different muscle powers will enter the market. The Reserve Bank in its bid to move towards the best international banking practices will further sharpen the prudential norms and strengthen its supervisor mechanism. There will be more transparency and disclosures. In the days to come, banks are expected to play a very useful role in the economic development and the emerging market will provide ample business opportunities to harness. Human Resources Management is assuming to be of greater importance. As banking in India will become more and more knowledge supported, human capital will emerge as the finest assets of the banking system. Ultimately banking is people and not just figures.


Future of Indian Banking Sector
The interplay between policy and regulatory interventions and management strategies will determine the performance of Indian banking over the next few years. Legislative actions will shape the regulatory stance through six key elements: industry structure and sector consolidation; freedom to deploy capital; regulatory coverage; corporate governance; labor reforms and human capital development; and support for creating industry utilities and service bureaus. Management success will be determined on three fronts: fundamentally upgrading organizational capability to stay in tune with the changing market; adopting valuecreating M&A as an avenue for growth; and continually innovating to develop new business models to access untapped opportunities. Through these scenarios, we can paint a picture of the events and outcomes that will be the consequence of the actions of policy makers and bank managements. These actions will have dramatically different outcomes; the costs of inaction or insufficient action will be high. Specifically, at one extreme, the sector could account for over 7.7 per cent of GDP with over Rs.. 7,500 billion in market cap, while at the other it could account for just 3.3 per cent of GDP with a market cap of Rs. 2,400 billion. Banking sector intermediation, as measured by total loans as a percentage of GDP, could grow marginally from its current levels of ~30 per cent to ~45 per cent or grow significantly to over 100 per cent of GDP. In all of this, the sector could generate employment to the tune of 1.5 million compared to 0.9 million. Today availability of capital would be a key factor ² the banking sector will require as much as Rs. 600 billion (US$ 14 billion) in capital to fund growth in advances, non-performing loan (NPL) write offs and investments in IT and human capital up gradation to reach the high-performing scenario. Three scenarios can be defined to characterize these outcomes: 

In this scenario, policy makers intervene only to the extent required to ensure system stability and protection of consumer interests, leaving managements free to drive far reaching changes. Changes in regulations and bank capabilities reduce intermediation costs leading to increased growth, innovation and productivity. Banking becomes an even greater driver of GDP growth and employment and large sections of the population gain access to quality banking products. Management is able to overhaul bank organizational structures, focus on industry consolidation and transform the banks into industry shapers. In this scenario we witness consolidation within public sector banks (PSBs) and within private sector banks. Foreign banks begin to be active in M&A, buying out


some old private and newer private banks. Some M&A activity also begins to take place between private and public sector banks. As a result, foreign and new private banks grow at rates of 50 per cent, while PSBs improve their growth rate to 15 per cent. The share of the private sector banks (including through mergers with PSBs) increases to 35 per cent and that of foreign banks increases to 20 per cent of total sector assets. The share of banking sector value adds in GDP increases to over 7.7 per cent, from current levels of 2.5 per cent. Funding this dramatic growth will require as much as Rs. 600 billion in capital over the next few years. 

Policy makers adopt a pro-market stance but are cautious in liberalizing the industry. As a result of this, some constraints still exist. Processes to create highly efficient organizations have been initiated but most banks are still not best-in-class operators. Thus, while the sector emerges as an important driver of the economy and wealth in 2010, it has still not come of age in comparison to developed markets. Significant changes are still required in policy and regulation and in capability-building measures, especially by public sector and old private sector banks. In this scenario, M&A activity is driven primarily by new private banks, which take over some old private banks and also merge among themselves. As a result, growth of these banks increases to 35 per cent. Foreign banks also grow faster at 30 per cent due to a relaxation of some regulations. The share of private sector banks increases to 30 per cent of total sector assets, from current levels of 18 per cent, while that of foreign banks increases to over 12 per cent of total assets. The share of banking sector value adds to GDP increases to over 4.7 per cent. 

In this scenario, policy makers intervene to set restrictive conditions and management is unable to execute the changes needed to enhance returns to shareholders and provide quality products and services to customers. As a result, growth and productivity levels are low and the banking sector is unable to support a fast-growing economy. This scenario sees limited consolidation in the sector and most banks remain sub-scale. New private sector banks continue on their growth trajectory of 25 per cent. There is a slowdown in PSB and old private sector bank growth. The share of foreign banks remains at 7 per cent of total assets. Banking sector value adds meanwhile, is only 3.3 per cent of GDP.


NEED TO CREATE A MARKET DRIVEN BANKING SECTOR WITH ADEQUATE FOCUS ON SOCIAL DEVELOPMENT The term ³policy makers´, refers to the Ministry of Finance and the RBI and includes the other relevant government and regulatory entities for the banking sector. The coordinated efforts between the various entities are required to enable positive action. This will spur on the performance of the sector. The policy makers need to make coordinated efforts on six fronts: Help shape a superior industry structure in a phased manner through ³managed consolidation´ and by enabling capital availability. This would create 3-4 global sized banks controlling 35-45 per cent of the market in India; 6-8 national banks controlling 20-25 per cent of the market; 4-6 foreign banks with 15-20 per cent share in the market, and the rest being specialist players (geographical or product/ segment focused). Focus strongly on ³social development´ by moving away from universal directed norms to an explicit incentive-driven framework by introducing credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets. Create a unified regulator, distinct from the central bank of the country, in a phased manner to overcome supervisory difficulties and reduce compliance costs. Improve corporate governance primarily by increasing board independence and accountability. Accelerate the creation of world class supporting infrastructure (e.g., payments, asset reconstruction companies (ARCs), credit bureaus, back-office utilities) to help the banking sector focus on core activities. Enable labor reforms, focusing on enriching human capital, to help public sector and old private banks become competitive.







NEED FOR DECISIVE ACTION BY BANK MANAGEMENT Management imperatives will differ by bank. However, there will be common themes across classes of banks: PSBs need to fundamentally strengthen institutional skill levels especially in sales and mar marketing, service operations, risk management and the overall






organizational performance ethic. The last, i.e., strengthening human capital will be the single biggest challenge. Old private sector banks also have the need to fundamentally strengthen skill levels. However, even more imperative is their need to examine their participation in the Indian banking sector and their ability to remain independent in the light of the discontinuities in the sector. New private banks could reach the next level of their growth in the Indian banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income and affluent/ HNI segments; actively adopting acquisitions as a means to grow and reaching the next level of performance in their service platforms. Attracting, developing and retaining more leadership capacity would be key to achieving this and would pose the biggest challenge. Foreign banks committed to making a play in India will need to adopt alternative approaches to win the ³race for the customer´ and build a value-creating customer franchise in advance of regulations potentially opening up post 2009. At the same time, they should stay in the game for potential acquisition opportunities as and when they appear in the near term. Maintaining a fundamentally long-term value-creation mindset will be their greatest challenge. 

The banking industry of India has been completely transformed and modernized with the advent of numerous technological and operational innovations. There is a paradigm shift from traditional banking to modern banking, where the emphasis is on providing better quality banking services with greater speed and accuracy. Eliminating barriers of time and distance so as to facilitate customer convenience and ease is an important consideration. Banking facilities like ATMs, Round the clock banking, Internet Banking, Tele banking, have indeed made it convenient, for the vast variety of customers to carry out their banking operations from diverse geographical areas at any time during the day. Further, Banks have introduced Innovative products and services, specially tailored to meet the requirements of specific customers. The horizon of banking activities has been widened to areas like bancassurance, universal banking and further virtual banking. This paper titled ³Revolutionizing Banking through Innovations´ focuses on those significant, noteworthy banking innovations which have absolutely transitioned the very nature


of banking industry and its operations. It highlights the major technological, operational and IT enabled innovations that have brought about a breakthrough in attaining effective banking services and augmenting customer convenience. Further, it also mentions those emerging banking innovations that are gaining foothold in the banking sector but still are at nascent stage. Over the last three decades the role of banking in the process of financial intermediation has been undergoing a profound transformation, owing to changes in the global financial system. It is now clear that a thriving and vibrant banking system requires a well developed financial structure with multiple intermediaries operating in markets with different risk profiles. Taking the banking industry to the heights of international excellence will require a combination of new technologies, better processes of credit and risk appraisal, treasury management, product diversification, internal control and external regulations and not the least, human resources. Fortunately, we have a comparative advantage in almost all these areas. Our professionals are at the forefront of technological change and financial developments all over the world. It is time to harness these resources for development of Indian banking in the new century. 

https://encrypted.google.com/search?hl=en&biw=1366&bih=667&q=curren t+innovation+in+indian+banking+sectors&aq=f&aqi=&aql=&oq=&gs_rfai=  http://www.icmrindia.org/casestudies/catalogue/Innovation/Banking%20Ind ustry%20-%20Business%20Report%20-%20Excerpts.htm  http://www.icmrindia.org/casestudies/catalogue/Innovation/BREP005.htm  http://www.scribd.com/doc/29381388/Innovation-in-Indian-banking-sector  http://www.slideshare.net/Dreamgains/white-paper-india-banking-2010  http://www.oppapers.com/subjects/innovations-in-banking-by-indiapage1.html  http://www.mbaknol.com/management-articles/article-on-indian-bankingsector-innovation-in-banking/  http://www.managementparadise.com/forums/innovations-bankinginsurance/

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