INDIAN FINANCIAL SYSTEM – AN OVERVIEW

An efficient, articulate and developed financial system is indispensable for the rapid economic
growth of any country/economy. The process of economic development is invariably
accompanied by a corresponding and parallel growth of financial organizations. However, their
institutional structure, operating policies, regulatory/legal framework differ widely, and are
largely influenced by the prevailing politico-economic environment. Planned economic
development in India had greatly influenced the course of financial development. The
liberalization/ deregulation/ globalization of the Indian economy has had important implications
for the future course of development of the financial system/sector.

Financial sector reforms were initiated as part of overall economic reforms in the country and
wide ranging reforms covering industry, trade, taxation, external sector, banking and financial
markets have been carried out since mid 1991. A decade of economic and financial sector
reforms has strengthened the fundamentals of the Indian economy and transformed the operating
environment for banks and financial institutions in the country. The sustained and gradual pace
of reforms has helped avoid any crisis and has actually fuelled growth. As pointed out in the RBI
Annual Report 2001-02, GDP growth in the 10 years after reforms i.e. 1992-93 to 2001-02
averaged 6.0% against 5.8% recorded during 1980-81 to 1989-90 in the pre-reform period.
 INTRODUCTION TO BANKING SYSTEM

"Banking has traditionally remained a protected industry in many emerging economies.

However, a combination of developments has compelled banks to change the old ways of doing
business. These include, among others, technological advancements, disinter mediation pressures
arising from a liberalized marketplace, increased emphasis on shareholders' value and
macroeconomic pressures and banking crises in 1990s. As a consequence of these developments,
the dividing line between financial products, types of financial institutions and their geographical
locations have become less relevant than in the past."
Profits and profitability were indeed looked for, but this goal was preceded by greater
importance to norms of security and liquidity. Speculation was considered a sin. Traditional
banking services included accepting deposits from the public, lending a part of the same on short
term basis, and investing another portion in gilt-edged securities, while also holding a certain
percentage in cash, as balance with the Central Bank of the country, and in the call money
market. Thus the definition of "Banking" as per the Banking Regulation Act, 1949 says-

“Banking means the accepting, for the purpose of lending or investment, of

deposits of money from the public, repayable on demand or otherwise, and
withdrawable by cheque, draft, order or otherwise".

The Act defined the functions that a commercial bank can undertake and restricted their sphere
of activities. It prohibited banks from owning non-banking assets. No Company other than a
commercial bank licensed by the RBI can include the words "Bank" or "Banking" as part of its
name. Thus the boundary for banking and financial services was mutually demarcated and
assigned separately between commercial banks and non-banking financial companies
respectively. The one cannot encroach on the domain of the other.

The initial move away from traditional concepts of banking took place after nationalization of
banks in 1969/70. Banks started lending on medium Term basis repayable between 3 to 7 years.
After Nationalization banks also diversified credit extension comprehensively to cater different
sectors of the economy. Term Lending, lending extensively against hypothecation of securities,
financing qualified and technical entrepreneurs, financing craftsmen and artisans, financing
purchase of consumer durable, financing acquisition & constructions of houses, office premises,
vehicles, financing agriculture & allied activities, small-scale industries and exports etc. came
into vogue. It was still a mere diversification of credit-delivery functions, and a transition from
commercial banking to development banking looking towards social objectives of employment
generation and poverty alleviation under Government ownership covering the major segment of
Indian Banking

Since the beginning of the Eighties, the International Financial Markets are witnessing
revolutionary structural changes in terms of financial instruments and the nature of lenders and
borrowers. On the one hand there is a declining role for the Banks in direct financial
intermediation. On the other hand there is enormous increase in securitised lending, the growth
of new financial facilities of raising funds directly from investors. There is also the growth of
innovative techniques such as interest rate swaps, financial and foreign exchange futures and
foreign exchange and interest rate options.

International Finance has to deal with and cater to the complex financial needs relating to the
global economic activities. It has to satisfy to diverse customers like individuals, commercial
organizations and government owned corporations spread over various countries. By nature these
requirements could not be uniform. A stream of financial products has therefore come into usage
to meet specific needs of both investors and borrowers. The range of product covers fund raising,
underwriting, hedging or arbitrage instruments. The dynamism, in terms of variety and packages
provided, as exhibited by the International Financial & Banking market has led to the equating of
Euro-banking operations, the nerve center of global financial and banking services as "financial
engineering".
"The institution of banks continues to have a unique place within the financial system. This is
due to their 'franchise' i.e., their unique ability to issue monetary liabilities by leveraging non-
collateralized deposits. Over the last three decades, however, 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.

Firstly, the proliferation of financial innovations has led to a blurring of the boundaries between
traditional banking and other types of financial intermediation. Today, banks operate with a wide
variety of financial assets and liabilities, some of which are created by the non-bank constituents
of the financial system. Secondly, specialized markets have come into being for each class of
financial instruments and banks have to transact business in various segments of the financial
market spectrum in the process of their routine day-to-day business. Thirdly, banks undertake
leveraging transformations as part of their intermediation - asset-liability, debt-equity,
collateralized/ non-collateralized, maturity, size and risk. This necessarily involves other types of
financial intermediaries as counter parties, in syndications and co-financing strategies, as also in
the sharing of risk. Fourthly, active global capital movements and the growing volume of cross-
border trade in financial services have exerted external pressures for reorientation and refocusing
of activities for all players in financial markets.

"Since the early 1990s, banking systems worldwide have been going through a rapid
transformation. Mergers, amalgamations and acquisitions have been undertaken on a large scale
in order to gain size and to focus more sharply on competitive strengths. This consolidation has
produced financial conglomerates that are expected to maximize economies of scale and scope
by 'bundling' the production of financial services. The general trend has been towards
downstream universal banking where banks have undertaken traditionally non-banking activities
such as investment banking, insurance, mortgage financing, securitisation, and particularly,
insurance. Upstream linkages, where non-banks undertake banking business, are also on the
increase. The global experience can be segregated into broadly three models. There is the
Swedish or Hong Kong type model in which the banking corporate engages in in-house activities
associated with banking. In Germany and the UK, certain types of activities are required to be
carried out by separate subsidiaries. In the US type model, there is a holding company structure
and separately capitalized subsidiaries.
In India, the first impulses for a more diversified financial intermediation were witnessed in the
1980s and 1990s when banks were allowed to undertake leasing, investment banking, mutual
funds, factoring, hire-purchase activities through separate subsidiaries. By the mid-1990s, all
restrictions on project financing were removed and banks were allowed to undertake several
activities in-house. In the recent period, the focus is on Development Financial Institutions
(DFIs), which have been allowed to set up banking subsidiaries and to enter the insurance
business along with banks. DFIs were also allowed to undertake working capital financing and to
raise short-term funds within limits. It was the Narasimham Committee II Report (1998), which
suggested that the DFIs should convert themselves into banks or non-bank financial companies,
and this conversion was endorsed by the Khan Working Group (1998). The Reserve Bank's
Discussion Paper (1999) and the feedback thereon indicated the desirability of universal banking
from the point of view of efficiency of resource use, but it also emphasized the need to take into
account factors such as the status of reforms, the state of preparedness of the institutions, and a
viable transition path while moving in the desired direction."
The strategy of banking development during the period 1969- 1992, following nationalization of
major banks, first in 1969 and later in 1980, paid rich dividends to the Indian economy. This was
demonstrated in the expansion of the banking network, as well as, various indicators reflecting
financial deepening and widening. Nevertheless, from the vantage point of 2003, it seems that
there were a number of costs associated with this strategy.

Two major costs were:

(a) Sacrifice of the efficiency gains in banking (in terms of lack of improvement of productivity),
and

(b) Large pre-emption of lendable resources of the banks.

Besides, the instruments of “social control”, in the form of credit controls and concessional
lending, had the effect of segmenting financial markets, blunting the process of price discovery
and undermining the efficiency of resource allocation.
Banking sector reforms, launched ten years ago in 1992-93, were a key constituent in the wider
macroeconomic strategy of financial liberalization. The 1990s took the process of institution
building to its logical conclusion by creating an environment in which these institutions could
function effectively. The challenge before the Reserve Bank was, thus, to rejuvenate the process
of price discovery, without either sacrificing the social imperatives of a developing economy or
compromising financial stability.

Banking sector reforms involved a three-pronged macro-economic strategy of dismantling the

regime of administered interest rates, introducing financial instruments and making financial
markets capable of allocating resources in line with market signals, and at the same time,
ensuring credit delivery for the relatively disadvantaged sections of society. This was reinforced
by a series of micro-economic measures to introduce more private sector players (domestic and
foreign) to infuse competition and accord freedom of portfolio allocation across markets,
especially centering around withdrawal of balance sheet restrictions in the form of statutory pre –
emption, such as, the cash reserve ratio (CRR) and statutory liquidity ratio (SLR). Besides, an
incentive structure had to be put in place to channel funds to areas of social concern in tune with
the spirit of financial liberalization and the imperatives of poverty eradication. A new
development is the experiment of micro-finance, through self-help groups either funded by banks
directly or through intermediaries. Finally, there was the need to harness the developments in
information technology to improve the functional efficiency of the banking system.

The Reserve Bank now accords banks substantial freedom in determining their portfolios as well
pricing their products, except in specific cases such as interest rates chargeable on small loans
and priority sector advances. The Reserve Bank has instituted a number of measures to ensure
the healthy functioning of the banking system including prudential norms pertaining to capital
adequacy, income recognition and asset classification backed by strict provisioning norms. This
is being supplemented by the institution of asset- liability management and risk management
systems in line with the best international practices. In view of the growing complexities of the
economy, the Reserve Bank has supplemented the micro- on-site supervision system with a
macro-based supervisory strategy based on off-site monitoring and control systems internal to
the banks, on the lines of CAMELS (Capital Adequacy, Management, Liquidity and Systems).
In the realm of carefully sequenced banking sector reforms, India has a lot to cheer about. The
improvement in the profitability of the banking system in the recent years has been accompanied
by an enhancement in asset quality. There is, however, no room for complacency, and all the
stake – holders in the banking sector have to strive hard. As far as the Reserve Bank is
concerned, we have come a long way from micro – monitoring to macro-supervision of the
banking sector. Recent initiatives, such as, risk-based and consolidated supervision, adoption of
various international standards and codes, as well as, moving closer towards Basel II are all
symptomatic of the Reserve Bank’s commitment towards building a robust and vibrant banking
sector. The key challenge in the future is to build in appropriate risk management practices to
consolidate the gains of the past and fully exploit the opportunities while managing the threats
emanating from increasing financial globalization and integration.

The most significant achievement of the financial sector reforms has been the marked
improvement in the financial health of commercial banks in terms of capital adequacy,
profitability and asset quality as also greater attention to risk management. Further, deregulation
has opened up new opportunities for banks to increase revenues by diversifying into investment
banking, insurance, credit cards, depository services, mortgage financing, securitization, etc. At
the same time, liberalization has brought greater competition among banks, both domestic and
foreign, as well as competition from mutual funds, NBFCs, post office, etc. Post-WTO,
competition will only get intensified, as large global players emerge on the scene. Increasing
competition is squeezing profitability and forcing banks to work efficiently on shrinking spreads.
Positive fallout of competition is the greater choice available to consumers, and the increased
level of sophistication and technology in banks. As banks benchmark themselves against global
standards, there has been a marked increase in disclosures and transparency in bank balance
sheets as also greater focus on corporate governance.
 Major Reform Initiatives

Some of the major reform initiatives in the last decade that have changed the face of the Indian
banking and financial sector are:

• Interest rate deregulation: Interest rates on deposits and lending have been deregulated with
banks enjoying greater freedom to determine their rates.
• Adoption of prudential norms in terms of capital adequacy, asset classification, income
recognition, provisioning, exposure limits, investment fluctuation reserve, etc.
• Reduction in pre-emption: lowering of reserve requirements (SLR and CRR), thus releasing
more lendable resources which banks can deploy profitably for streamlining the working of the
credit process of the bank;
• Government equity in banks has been reduced and strong banks have been allowed to access
the capital market for raising additional capital.
• Banks now enjoy greater operational freedom in terms of opening and swapping of branches,
and banks with a good track record of profitability have greater flexibility in recruitment.
• New private sector banks have been set up and foreign banks permitted to expand their
operations in India including through subsidiaries. Banks have also been allowed to set up
Offshore Banking Units in Special Economic Zones.
• New areas have been opened up for bank financing: insurance, credit cards, infrastructure
financing, leasing, gold banking, besides of course investment banking, asset management,
factoring, etc.
• New instruments have been introduced for greater flexibility and better risk management: e.g.
interest rate swaps, forward rate agreements, cross currency forward contracts, forward cover
to hedge inflows under foreign direct investment, liquidity adjustment facility for meeting day-
to-day liquidity mismatch.
• Several new institutions have been set up including the National Securities Depositories Ltd.,
Central Depositories Services Ltd., Clearing Corporation of India Ltd., Credit Information
Bureau India Ltd.
• Limits for investment in overseas markets by banks, mutual funds and corporate have been
liberalized. The overseas investment limit for corporate has been raised to 100% of net worth
 and the ceiling of $100 million on prepayment of external commercial borrowings has been
removed. MFs and corporate can now undertake FRAs with banks. Indians allowed to maintain
resident foreign currency (domestic) accounts. Full convertibility for deposit schemes of NRIs
introduced.
• Universal Banking has been introduced. With banks permitted to diversify into long-term
finance and DFIs into working capital, guidelines have been put in place for the evolution of
universal banks in an orderly fashion.
• Technology infrastructure for the payments and settlement system in the country has been
strengthened with electronic funds transfer, Centralised Funds Management System, Structured
Financial Messaging Solution, Negotiated Dealing System and move towards Real Time Gross
Settlement.
• Adoption of global standards: Prudential norms for capital adequacy, asset classification,
income recognition and provisioning are now close to global standards. RBI has introduced
Risk Based Supervision of banks (against the traditional transaction based approach). Best
international practices in accounting systems, corporate governance, payment and settlement
systems, etc. are being adopted.
• Credit delivery mechanism has been reinforced to increase the flow of credit to priority sectors
through focus on micro credit and Self Help Groups. The definition of priority sector has been
widened to include food processing and cold storage, software upto Rs. 1 crore, housing above
Rs. 10 lakh, selected lending through NBFCs, etc.
• RBI guidelines have been issued for putting in place risk management systems in banks. Risk
Management Committees in banks address credit risk, market risk and operational risk. Banks
have specialised committees to measure and monitor various risks and have been upgrading
their risk management skills and systems.
• The limit for foreign direct investment in private banks has been increased from 49% to 74%
and the 10% cap on voting rights has been removed. In addition, the limit for foreign
institutional investment in private banks is 49%.
 THE CONCEPT OF UNIVERSAL BANKING

The entry of banks into the realm of financial services was followed very soon after the
introduction of liberalization in the economy. Since the early 1990s structural changes of
profound magnitude have been witnessed in global banking systems. Large scale mergers,
amalgamations and acquisitions between the banks and financial institutions resulted in the
growth in size and competitive strengths of the merged entities. Thus, emerged new financial
conglomerates that could maximize economies of scale and scope by building the production of
financial services organization called Universal Banking.

By the mid-1990s, all the restrictions on project financing were removed and banks were allowed
to undertake several in-house activities. Reforms in the insurance sector in the late 1990s, and
opening up of this field to private and foreign players also resulted in permitting banks to
undertake the sale of insurance products. At present, only an 'arm's length relationship between a
bank and an insurance entity has been allowed by the regulatory authority, i.e. IRDA (Insurance
Regulatory and Development Authority).

The phenomenon of Universal Banking as a distinct concept, as different from Narrow Banking
came to the forefront in the Indian context with the Narsimham Committee (1998) and later the
Khan Committee (1998) reports recommending consolidation of the banking industry through
mergers and integration of financial activities.

Definition of Universal Banking: As per the World Bank, "In Universal Banking, large
banks operate extensive network of branches, provide many different services, hold several
claims on firms(including equity and debt) and participate directly in the Corporate
Governance of firms that rely on the banks for funding or as insurance underwriters".

According to Saunders, Anthony. A and Walter Ingo, 1994 Universal banking is defined as
“the conduct of range of financial services comprising deposit taking and lending, trading of
financial instruments and foreign exchange (and their derivatives) underwriting of new debt and
equity issues, brokerage investment management and insurance”.
Universal banking helps service provider to build up long-term relationships with clients by
catering to their different needs. The client also benefits as he gets a whole range of services at
lower cost and under one roof.

In a nutshell, a Universal Banking is a superstore for financial products under one roof.
Corporate can get loans and avail of other handy services, while can deposit and borrow. It
includes not only services related to savings and loans but also investments.

However in practice the term 'universal banking' refers to those banks that offer a wide range of
financial services, beyond the commercial banking functions like Mutual Funds, Merchant
Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans, Investment
banking, Insurance etc. Universal Banking is a multi-purpose and multi-functional financial
supermarket (a company offering a wide range of financial services e.g. stock, insurance and
real-estate brokerage) providing both banking and financial services through a single window.

This is most common in European countries.For example, in Germany commercial banks accept
time deposits, lend money, underwrite corporate stocks, and act as investment advisors to large
corporations. In Germany, there has never been any separation between commercial banks and
investment banks, as there is in the United States.

Universal banking is a combination of commercial banking, investment banking and various

other activities, including insurance. It seeks to provide the entire gamut of financial products
under one roof and reflects the global convergence between commercial banks, investment
banking and insurance companies. The convergence is an attempt by banks to fulfill the lifelong
needs of the customer by following the cradle-to-grave concept. Commercial banks have a long-
term relationship with their customers when compared to other financial intermediaries.

To put in simple words, a “universal bank ” is a superstore for financial products. Under one
roof, corporate can get loans and avail of other handy services, while individuals can bank and
borrow. To convert itself into a universal bank, an entity has to negotiate several regulatory
requirements. Therefore, universal banks in a nutshell have been in the form of a group-concerns
offering a variety of financial services like deposits, short term and long term loans, insurance,
investment banking etc, under an umbrella brand. Citicorp is a reasonably good example of a
global UB. JB Morgan is another. The concept has been prevalent in developed countries like
France, Germany and US.
Universal Banking, means the financial entities – the commercial banks, Financial Institutions,
NBFCs, - undertake multiple financial activities under one roof, thereby creating a financial
supermarket. The entities focus on leveraging their large branch network and offer
wide range of services under single brand name. The term ‘universal banks’ in general refers to
the combination of commercial banking and investment banking, i.e., issuing, underwriting,
investing and trading in securities. In a very broad sense, however, the term ‘universal banks’
refers to those banks that offer a wide range of financial services, beyond commercial banking
and investment banking, such as, insurance. However, universal banking does not mean that
every institution conducts every type of business with every type of customer. Universal banking
is an option; a pronounced business emphasis in terms of products, customer groups and regional
activity can, in fact, be observed in most cases. In the spectrum of banking, specialized banking
is on the one end and the universal banking on the other.

They are multi-product firms in the financial services sector whose complexity is difficult to
manage. In their historical development, organizational structure, and strategic direction,
universal Banks constitute multi-product firms, within the financial services sector. This stylized
profile of universal banks presents shareholders with an anagram of more or less distinct
businesses that are linked together in a complex network which draws on as set of centralized
financial, information, human and organizational resources - a profile that tends to be
extraordinarily difficult to manage in a way that achieves optimum use of invested capital.
Universal banking generally takes one of the three forms:

a. In-house Universal banking. Eg. Germany, Switzerland

BANK

Securities Investments

Mutual funds Insurance

Underwriting Advisory

b. Through separately capitalized subsidiaries. Eg. England, Japan.

 Bank

Subsidiary

c. Operations carried through a holding company ,Eg. USA, Japan

Bank Holding Company

Bank
Securities

History Of Universal Banking

Economic historians have long emphasized the importance of financial institutions in
industrialization. More recently, economists have begun more intensive investigation of the links
between financial system structure and real economic outcomes. In theory, the organization of
financial institutions partly determines the extent of competition among financial intermediaries,
the quantity of financial capital drawn into the financial system, and the distribution of that
capital to ultimate uses. The choice between universal and specialized banking may affect
interest rates, underwriting costs, and the efficiency of secondary markets in securities.
Furthermore, the presence or absence of formal bank relationships may affect the quality of
investments undertaken, strategic decision-making, and even the competitiveness of industry.
Thus, financial systems theoretically can influence the costs of finance at two levels: general
effects on the economy as a whole and localized influences on individual firms and industries.
Modern problems in developing and transitional economies, diminishing regulatory barriers in
the United States, and progressive economic integration in western Europe make it all the more
important to understand the economic impact of financial system structure.

Particularly since World War II, many economists and historians have argued that
German-style banks offer advantages for industrial development and economic growth.
Universal banking efficiency combined with close relationships between banks and industrial
firms, they hypothesize, spurred Germany's rapid development at the end of the nineteenth
century and again in the post-World War II reconstruction. A corollary to this view holds that
countries that failed to adopt the universal-relationship system suffered as a consequence.
Adherents suggest that British industry has declined over the past hundred years or more, and
that the American economy has failed to reach its full potential, due to short-comings of the
financial system that lead to relatively high costs of capital (Kennedy, 1987, Chandler, 1990, and
Calomiris, 1995).

In the 1990s, however, recession and bank-related scandals in Germany raised doubts about the
benefits of universal banking systems. Even more recently, the introduction of the Euro seems
to have brought the so-called bank-based systems a wave of market-oriented finance: IPOs,
hostile takeovers, and corporate bond issues. Likewise, recent research questions many common
beliefs about the organization and impact of the universal banks in the post-World War II
German economy (Edwards and Fischer, 1994). Yet in the heat of the furious `battle of the
systems,' large-scale international comparisons reveal no consistent relationship between
financial system design and real economic growth in the late twentieth century (Levine, 2000).

India followed a very compartmentalized financial intermediaries allowed to operate strictly in

their own respectively fields. However, in the 1980s banks were allowed to undertake various
non-traditional activities through subsidiaries. This trend got momentum in the early 1990s i.e.,
after initiation of economic reforms with banks allowed to undertake certain activities, such as,
hire-purchase and leasing in –house. While this in a way represented a gradual move towards
universal banking, the current debate about universal banking in India started with the demand
from the DFIs that they should be allowed to undertake banking activity in-house. In the wake of
this demand, the Reserve Bank of India constituted in December 1997, a working group under
the chairmanship of Shri S.H. Khan, the Chairman & the Managing Director of IDBI (hereafter
referred to as Khan Working Group-KWG). The KWG, which submitted its report in May 1998,
recommended a progressive move towards universal banking. The Second Narsinham
Committee appointed by Government in 1998 also echoed the same sentiment. In January 1999,
the Reserve Bank issued a Discussion Paper setting out issues arising out of recommendations of
the KWG and the Second Narsinham Committee. Since then a debate has been going on about
universal banking in general and conversion of DFIs into universal banks in particular. With the
opening up of the insurance sector to the private participation, the debate has gone beyond the
narrow concept of universal banking.

UNIVERSAL BANKING IN SELECTED COUNTRIES

1) The traditional home of universal banking is Central and Northern Europe, in
particular, Germany, Austria, Switzerland and Scandinavian countries. Universal
banking in countries like Germany, Austria and Switzerland evolved in response to a
combination of environmental factors besides regulation. The direct involvement of
German banks in industry through equity holdings was the result partly of banks
converting their loans into equity stakes in companies experiencing financial
pressures. A combination of environmental factors and unique historical events
enabled banks in different European countries to establish themselves in particular
segments of the corporate financing market.

2) While countries like Germany and Switzerland never imposed any restriction on
combining commercial and investment banking activities, the U.S. passed the Banking
Act, 1933(Glass-Steagall Act has come to mean those sections of the Banking Act,
1933 that refer to bank’s securities operations), whereby banks were prohibited from
combining investment and commercial banking activities. The Glass-Steagall Act was
enacted to remedy the speculative abuses that infected commercial banking. The legal
provisions of the Banking Act, 1933(Glass-Steagall Act) established a distinct
separation between commercial banking and investment banking and made it almost
impossible for the same organization to combine these activities.

3) The competition in the banking industry has intensified following financial

deregulation and innovations and introduction of new information technologies.

4) The restrictions on banks engaged in securities business have been relaxed

considerably worldwide during the last two decades. Three groups of countries can be
distinguished. While countries, such as Germany, the Netherlands, and several
Nordic countries, have imposed very little restriction on the combination of
traditional banking and securities business, Canada and most European countries
have entirely removed barriers to acquisition of securities firms and hence access to
stock exchanges [Borio and Filosa, 1994]. Even in the U.S., where commercial and
 investment banking have been legally separated, market participants have tried to take
advantage of some of the loopholes in the Glass-Steagall Act. For example, taking
advantage of practices and institutional structure as well.

5) Universal banking usually takes one of three forms, i.e., in-house, through separately
Capitalized subsidiaries, or through a holding company structure. Universal banking
in its fullest or purest form would allow a banking corporation to engage ‘in-house’ in
any activity associated with banking, insurance, securities. Three well-known
countries in which these three structures prevail are Germany, the U.K. and the U.S.
In Germany, banking and investment activities are combined, but separate
Subsidiaries.

Statement 1: Universal Banking Practices in Select Countries

Type of Features Countries Practicing Position in India

Universal
Banking
(1) (2) (3) (4)

I. Narrow Combination of In India, presently there are

Universal commercial banking no restrictions on banks’
Banking and investment bank- investments in preference
ing, i.e., issuing, shares/non-convertible
underwriting, investing debentures/bonds of private
and trading securities. corporate bodies. Banks
are also allowed to invest in
a) In-house Australia, Austria, corporate stocks. However,
Denmark, Finland, such investments are
France, Germany, Hong restricted to 5 per cent of
Kong@, Pakistan#, incremental deposit of the
Poland, Sweden, previous year. Banks are
Switzerland also allowed to underwrite,
subject to the limit of 15
b) Through Brazil, Canada, China, per cent of the issue size. In
conglomerate Japan@@, Korea, case there are devolvement
route (By setting Mexico, Netherlands, and the aforementioned 5
up subsidiaries) New Zealand, Norway$, per cent limit is exceeded,
Thailand, U.K. banks are required to
offload the excess holdings.
*
c) Permitted to Chile , Belgium Banks are also allowed to
 some extent own 100 per cent
investment banks and
undertake mutual fund
activity through separate
entities.

Like-wise, DFIs which

d) Not permitted In U.S., banks are have traditionally been
permitted to deal in engaged in the medium to
government securities; long-term financing have
stock brokerage recently started undertaking
activities are also short-term lending
generally permitted; including working capital
however, corporate finance. They have also
securities underwriting been allowed to accept
and dealing activities short to medium-term
must be conducted deposits in the form of term
through specially deposits and CDs, albeit
authorised affiliates, within limits. DFIs have
which must limit such also set up subsidiaries for
activities to 10 per cent undertaking banking and
of gross revenues. various other activities. For
instance, IDBI and ICICI
have already set up banking
subsidiaries and mutual
funds, besides setting up
subsidiaries in the field of
investor services, stock
broking registrars’ services.
IFCI has also set up
subsidiaries for undertaking
merchant banking, stock
broking, providing
registrars’ services, etc.

Unit Trust of India, which

has characteristics of both a
mutual fund, and
Development Financial
Institution under a statute,
also has a banking
subsidiary. HDFC, a non-
banking financial company
(NBFC) has also set up a
commercial bank.
 @ Except for limitation on shareholding in certain listed companies and subject to limits based on
the capital of the bank.
# Except for some specifically disallowed securities.
@@ Except for equity brokerage for the time being.
$ Stock brokerage activities need no longer be conducted in separate subsidiaries.
* Certain activities through subsidiaries.

Statement 1: Universal Banking Practices in Select Countries

Type of Features Countries Practicing Position in India

Universal
Banking
(1) (2) (3) (4)

II. Broad Combination of

Universal commercial banking,
Banking investment banking
and various other
activities including
insurance.

a) In-house Hongkong**, Poland, Presently insurance

Sweden business in India is
Australia, Austria, allowed only by LIC,
Belgium, Brazil, GIC and its
Canada, China, Den- subsidiaries.
b) Through mark, France, Germany,
conglomerate Mexico, Netherlands,
route (By New Zealand, Norway,
setting up Portugal, Singapore##,
subsidiaries). Thailand, Spain,
Switzerland, U.K.

c) Permitted to Italy***
some extent

d) Not permitted Chile, Japan, Korea,

Pakistan,
Panama, Peru, U.S.$$

** Subject to limits based on the capital of the bank.

## Locally incorporated banks may own insurance company with MAS’s approval.
*** Limited to 10 per cent of own funds for each insurance company and 20 per cent
aggregate investment in insurance companies.
$$ Allowed through a separate holding company.
 International Experience

The traditional home of universal banking is central and northern Europe, in particular, Germany,
Austria, Switzerland and Scandinavian countries. Universal banking in countries like Germany,
Austria and Switzerland evolved in response to a combination of environmental factors besides
regulation. The direct involvement of German banks in industry through equity holdings was the
result partly of banks converting their loans into equity stakes in companies experiencing
financial pressures. A combination of environmental factors and unique historical events enabled
banks in different European countries to establish themselves in particular segments of the
corporate financing market

While countries like Germany and Switzerland never imposed any restriction on combining
commercial and investment banking activities, the U.S. passed the Banking Act, 1933(Glass-
Steagall Act has come to mean those sections of the Banking Act, 1933 that refer to bank’s
securities operations), whereby banks were prohibited from combining investment and
commercial banking activities. The Glass-Steagall Act was enacted to remedy the speculative
abuses that infected commercial banking prior to the collapse of the stock market and the
financial panic of 1929-33. The legal provisions of the Banking Act, 1933 (Glass-Steagall Act)
established a distinct separation between commercial banking and investment banking and made
it almost impossible for the same organisation to combine these activities.

The competition in the banking industry has intensified following financial deregulation and
innovations and introduction of new information technologies. Regulators in many countries
have decompartmentalised their credit systems by extending the range of permissible activities
and removing legal and other restrictions.

The restrictions on banks engaged in securities business have been relaxed considerably
worldwide during the last two decades. Three groups of countries can be distinguished. While
countries, such as Germany, the Netherlands, and several Nordic countries, have imposed very
little restriction on the combination of traditional banking and securities business, Canada and
most European countries have entirely removed barriers to acquisition of securities firms and
hence access to stock exchanges. Even in the U.S., where commercial and investment banking
have been legally separated, market participants have tried to take advantage of some of the
loopholes in the Glass-Steagall Act. For example, taking advantage of Section 20, banks have
already been allowed to step into securities underwriting through separate affiliates. In
comparison with deregulation concerning the combination of commercial and investment
banking activities, deregulation relating to combination of banking and insurance business has
been limited.
Universal banking usually takes one of three forms, i.e., in-house, through separately capitalised
subsidiaries, or through a holding company structure. Universal banking in its fullest or purest
form would allow a banking corporation to engage ‘in-house’ in any activity associated with
banking, insurance, securities, etc. That is, these activities would be undertaken in departments
of the organisation rather than in separate subsidiaries. Three well-known countries in which
these three structures prevail are Germany, the U.K. and the U.S. In Germany, banking and
investment activities are combined, but separate subsidiaries are required for certain other
activities. Under German banking statutes, all activities could be carried out within the structure
of the parent bank except insurance, mortgage banking, and mutual funds, which require legally
separate subsidiaries. In the U.K., broad range of financial activities are allowed to be conducted
through separate subsidiaries of the bank. The third model, which is found in the U.S., generally
requires a holding company structure and separately capitalised subsidiaries. Apart from the U.S.
and Japan, where the separation between commercial banking and investment banking has been
more rigid, there have been many other countries which continue to have restrictions on
combining of commercial banking and investment activities. A synoptic view of universal
banking practices prevailing in various countries including India is presented in Statement 1.

The following general observations can be made from Statement 1 on the practice of Universal
Banking (UB).

 First, the practice of UB varies across different countries.

 Second, for convenience, it is possible to differentiate between UB in the narrow sense

and in broader terms. The narrow definition of UB would combine lending activities and
investment in equities and bonds/debentures. The broader definition would include all
other financial activities, especially insurance.

 Third, it is possible to envisage UB activities in-house or through subsidiary route, or

even through a combination of in-house and subsidiary route.
  Fourth, where it is predominantly through subsidiary route, it can be inferred that a
conglomerate approach to financial services is invoked.

 Fifth, in India, the regulatory environment permits provision of a range of financial

services in-house in a bank subject to some restrictions. Banks have the option of
undertaking investment activity, etc. through subsidiaries. DFIs have also been permitted
to set up banking subsidiaries. DFIs are also permitted to operate at the short end of the
market, by performing bank like functions, such as, providing working capital finance or
tapping deposits, subject to some restrictions. In brief, both banks and DFIs are
permitted, in a limited way, to undertake a range of financial services, at their option, in-
house and through subsidiaries.

EMPIRICAL EVIDENCE

The empirical studies to test the existence of “economies of scale” in universal banks do not
provide any conclusive evidence. Some studies found that the economies of scale in commercial
banking were exhausted at very low deposit levels, i.e., less than 100 million dollars in deposit
[Benston, Berger, Hanweck and Humphrey, 1983; Clark, 1988]. Noulas, Ray and
Miller [1990], in a study of North American banks, in which very small local banks were not
included, found certain economies of scale for assets exceeding 600 million dollars. Some
studies even show diseconomies [Mester, 1992 and Saunders and Walter, 1994]. Using the
historical evidence of the 1980s, Saunders and Walter [1994] found that very large banks grew
more slowly than the smallest among the big banks in the world.
The empirical evidence of “economies of scope” is also not clear. Though some studies suggest
that economies of scope emerge with the joint use of information technologies [e.g. Gilligen,
Smirlock and Marshall, 1984], such economies are admittedly small. It may be noted that there
are also difficulties in measuring economies of scope. One could measure economies of scope
only if the firms studied produce different kinds of output of sufficient variety to produce
measurable differences in costs. Because most banks offer almost the same kinds and proportion
of services, it is difficult, if not impossible, to conduct meaningful empirical studies of
economies of scope [Benston, 1990].

While analysing the cost efficiency of universal banking in India, Ray [1994] found that the
Indian banks have been gradually assuming the responsibility of developmental financing which
is also cost efficient. The study clearly reveals that the banks have been found to realize overall
scale economies if output is defined in terms of term loans, other loans and deposits.

Furthermore, the study also indicates the presence of substantial economies of scale with respect
to the developmental banking activities and confirms the presence of scope economies for
development financing among banks.

Thus, the empirical evidence available on economies of scale and scope, which the literature
suggests, is not categorical. Historical experience as to whether universal banks are more risky
offers contradictory evidence as detailed below:
i) In the U.S., during the banking crisis of the 1930s, universal banks that offered commercial
and investment banking services had a lower rate of failures than the specialised banks. This was
because the securities trading business provided a significant diversification of revenues
[Benston, 1990].
ii) A critical examination of the financial crisis that affected Germany and France during the
post-war period revealed that the financial crisis was not due to the presenc of universal banks.
On the contrary, because of their diversity in their business, they could reduce the risks. Franke
and Hudson [1984], who analysed the three most serious banking crises recorded in Germany in
the 20 th century and their bearing on the universal banking system prevailing in that country,
concluded that it did not seem possible to establish a close relationship between universal banks
and financial crisis.

iii) Many banks suffered crises in several European countries during the recession of the second
half of the 1970s and the recession of the early 1990s. The banks that suffered most from these
recessions and went bankrupt were the medium and large sized universal banks and, in particular,
universal banks that had major stakes in the industrial sector [Cuervo, 1988].
Although many German financial institutions offer almost all kinds of financial services, the
universal banks do not dominate the market. The evidence from Germany indicates that universal
banking does not result in limited sources of credit or other financial services. In Germany, both
universal banks and specialised institutions offer their services to the public. For that matter, in
no country, universal banks seem to have been able to eliminate specialized institutions from
business.

In Germany, a 1979 Banking Commission Report (Gessler Commission) did not find universal
banks exerting excessive influence. The checks and balances implicit in market competition
among 4,000 financial institutions as well as insurance companies and other non-banks, together
with German banking and commercial law, were found to be sufficient safeguards. The Gessler
Commission, however, did find that universal banks had the information advantage obtained by
them in the course of their credit business.

Regarding the overall efficiency of investment, Boyd, Chang and Smith [1998] found that under
universal banking a larger portion of the surplus generated by externally financed investment
accrues to banks and loss accrues to the originating investors. This clearly can have far-reaching
implications for aggregate investment activity. They also demonstrated that problems of moral
hazard in investment would often be of greater concern under universal banking than under
commercial banking. In sum, the authors suggested universal banking could easily have adverse
consequences for the overall efficiency of investment.

Universal Banking: Regulatory and Supervisory Challenges

Universal banking generally implies complexity of regulation and supervision. Following

deregulation, domestic financial markets become closely inter-linked and a wide range of
innovations and new products are introduced. These together with integration with international
financial markets add one more dimension to sector activities and increase the problems of
effective control by national regulators. These developments throw up policy challenges that are
often too technical and for adequate understanding of their implications; detailed data and
information are required. As the participants innovate newer products to circumvent the
applicable regulatory constraints, more and more complex legal and administrative arrangements
are required to be put in place for effective response. Correspondingly, regulatory institutions
also need to be equipped with sufficient policy guidelines and resources to analyse and interpret
vast amount of data and information very quickly.
Regulatory institutions and frameworks in many countries on the other hand, are traditionally
compartmentalised and geared to overseeing specialised financial service providers. Rapid
expansion in the size and the variety of financial activity let alone its complexity following
deregulation, easily overwhelms the resources as well as the legal framework for regulation. The
resultant lack of adequate supervision of the liberalised financial sector leads to serious
distortions and malfunctioning.

A notable development in the 1980s and 1990s is the emergence of financial conglomerates
providing a large range of financial services in various locations and this also includes banking,
non-banking financial services, insurance, securities, asset management, advisory services, etc.
Consequently, the job of the regulators becomes difficult because failure in any particular
segment could easily spread to other parts and finally this could become systemic. The level of
preparation of the regulatory mechanism to meet such contingencies also becomes challenging.
In countries like Britain, efforts have already been made to move towards a unified regulatory
authority for financial regulation with the responsibility for bank supervision, securities market,
investments and insurance regulation. With further financial liberalisation reforms, the
expectations of depositors and investors also increase. The experience to a greater extent
suggests that with a view to minimising the contagion, it becomes imperative that the regulators
adopt conglomerate approach to financial institutions.

Another important consideration that advocates caution in moving to universal banking relates to
the possible impact of “non-core” banking activities on “core” banking activities. The “core”
banking activities comprise accepting unsecured deposits from public and providing payment
services as an integral part of the payment system in the economy. The central bank’s obligation
to act as the ‘lender of the last resort’ and maintain safety net to support banks in times of trouble
follows from this relationship. Mixing of financial services and other banking activities with the
“core” banking activities may result in substantial increase in the burden on the central bank on
two counts. It might create expectation among public as well as investors that central bank’s
safety net may be extended to all the activities of a bank in times of need. This would place far
too much demand on the central bank’s resources, besides aggravating the problem of ‘moral
hazard’. Second, commercial bank’s ability to fulfill its obligation in respect of its non-core
activity (say, mutual fund) might affect depositors’ confidence in the bank, causing a run on the
bank with possible adverse effects on the entire banking sector.

It is to maintain a distinction between the “core” and “non-core” banking activities that many
authorities insist on a formal separation by requiring the two sets of activities to be carried out
under separately capitalised subsidiary of a holding company. However, recent experience in the
U.K. and the U.S. casts doubts on the efficacy of ‘firewalls’ due to market perceptions as well as
interdependencies between the two sets of activities when undertaken too closely together within
a group structure. Historically, banks have been considered ‘special’ for various reasons. In the
evolution of financial sector in any type of economy, viz., industrial, developing and transition,
banks are the first set of institutions to develop, followed by others, viz., investment banks,
security houses, capital markets, insurance companies, etc. Hence due to their age, they are
considered as a vital segment. Secondly, they mobilise deposits and hence are a major
contributor in enhancing financial savings of the economy. In this context, the vast area of
network they have, no doubt, helps them to mobilise savings not only from the urban centres, but
also from the remote corners of the country. Thirdly, they assume an important position in the
payment and settlement mechanism. In recent years, it has been the common practice to measure
the strength of the economy by the effectiveness of payment and settlement mechanism. Hence
the soundness of banks is continuously evaluated and remedial policies are put in place once any
kind of weakness is identified. Even the IMF, World Bank and other international organisations
give importance for banking soundness due to banks’ effective role in the payment and
settlement system. Fourthly, banks are the principal source of non-market finance to various
segments of the economy.

The experience the world over shows that major banks everywhere have increasingly diversified
the products and services they offer, such as, investment banking, life insurance, etc., either in-
house or through separate subsidiaries. However, even these developments have not
fundamentally altered the special characteristics of banks. On the liability side, although some
close substitutes for deposits, such as, money market mutual funds have taken place which have
eroded banks’ market share as a repository for liquid asset holdings, such erosion has generally
been very small and bank deposits still constitute a single largest source of liquid asset holdings.
Even though in recent years some new facilities have been developed for making payments, such
as, debit cards or credit cards, most transactions are still settled through banks. On the asset side,
there is some evidence of a gradual erosion of the role of banks in financial intermediation. For
instance, in the U.K., bank lending to the corporate sector declined from 27 per cent of total
corporate borrowing outstanding in 1985 to less than 17 per cent recently, due mainly to larger
corporate borrowers accessing domestic and international capital markets directly. Small
corporates, on the other hand, continue to remain heavily dependent upon bank finance.

Thus, while there certainly have been important changes affecting banks and the environment in
which they work, they have not yet been such as to substantially alter their key functions or the
importance of those functions to the economy; nor have they altered fundamentally the
distinctive characteristics of either the banks’ liabilities or their assets. In some respects, they
may be less special than they were; they remain special nonetheless. They continue to remain
special in terms of the particular characteristics of their balance sheets, which are necessary to
perform those functions [Eddie George, 1997].

Economics of Universal Banking

From a production -function perspective, the structural form of universal banking appears to
depend on the ease with which operating efficiencies and scale and scope economies can be
exploited - determined in large part by product and process technologies - as well as the
comparative organisational effectiveness in optimally satisfying client requirements and bringing
to bear market power.

 Economies of Scale: Bankers regularly argue that 'Bigger is better' from a shareholder
perspective, and usually point to economies of scale as a major reason.
Individually economies (diseconomies) of scale in universal banks will either be captured as
increased profit margins or passed along to clients in the forms of lower (higher) prices resulting
in a gain (loss) of market share. They are directly observable in cost functions of financial
service suppliers and in aggregate performance measures.

 Economies of Scope: Economies of scope arise in multi-product firms because costs of

offering various activities by different units are greater than the costs when they are
offered together. On the supply side, scope economies relate to cost-savings through
sharing of overheads and improving technology through sharing of overheads and
improving technology through joint production of generically similar groups of services.

On the demand side, economies of scope arise when the all-in cost to the buyer of multiple
financial services from a single supplier - including the price of the service, plus information,
search, monitoring, contracting and other transaction costs - is less than the cost of purchasing
them from separate suppliers.

 X-efficiency: Besides economies of scale and scope, it seems likely that universal banks
of roughly the same size and providing roughly the same range of services may have very
different cost levels per unit of output. The reasons may involve efficiency-differences in the
use of labour and capital, effectiveness in the sourcing and application of available
technology, and perhaps effectiveness in the acquisition of productive inputs, organisational
design, compensation and incentive systems - and just plain better management.

 Absolute Size and Market Power: Universal Banks are able to extract economic rents
from the market by application of market power. Indeed, in many national markets for
financial services suppliers have shown a tendency towards oligopoly but may be
prevented by regulation or international competition from fully exploiting monopoly
positions.

 Value of Income -stream Diversification: There are potential risk-reduction gains from
diversification in universal financial service organizations, and that these gains increase
 with the number of activities undertaken. The main risk-reduction gains appear to arise
from combining commercial banking with insurance activities, rather than with securities
activities.

 Access to Bailouts: In such a case, failure of one of the major institutions is likely to
cause unacceptable systemic problems. If this turns out to be the case, then too-big-to-fail
organizations create a potentially important public subsidy for universal banking
organizations and therefore implicitly benefit the institutions' shareholders.

 Conflicts of Interest: The potential for conflicts of interest is endemic in universal

banking, and runs across the various types of activities in which the bank is engaged:
Salesman's Stake: it has been argued that when banks have the power to sell affiliates' products,
managers will no longer dispense 'dispassionate' advice to clients. Instead, they will have a
salesman's stake in pushing 'house' products, possibly to the disadvantage of the customer.

 Stuffing fiduciary accounts: A bank that is acting as an underwriter and is unable to

place the securities in a public offering - and is thereby exposed to a potential
underwriting loss - may seek to ameliorate this loss by stuffing unwanted securities into
accounts managed by its investment department over which the bank has discretionary
authority.
 Bankruptcy - risk transfer: a bank with a loan outstanding to a firm whose bankruptcy
risk has increased, to the private knowledge of the banker, may have an incentive to
induce the firm to issue bonds or equities - underwritten by its securities unit - to an
unsuspecting public. The proceeds of such an issue could then be used to pay-down the
bank loan. In this case the bank has transferred debt-related risk from itself to outside
investors, while it simultaneously earns a fee and/or spread on the underwriting.

 Third party loans: To ensure that an underwriting goes well, a bank may make below-
market loans to third party investors on condition that this finance is used to purchase
securities underwritten by its securities unit.
 Tie-ins: A bank may use its lending power activities to coerce or tie-in a customer or its
rivals that can be used in setting prices or helping in the distribution of securities unit.
This type of information flow could work in the other direction as well.

Issues In Universal Banking

 Deployment of capital: If a bank were to own a full range of classes of both the firm’s
debt and equity the bank could gain the control necessary to effect reorganization much
more economically. The bank will have greater authority to intercede in the management
of the firm as dividend and interest payment performance deteriorates.

 Unhealthy concentration of power: In many countries such a risk prevails in

specialized institutions, particularly when they are government sponsored. Indeed public
choice theory suggests that because Universal Banks serve diverse interest, they may find
 it difficult to combine as a political coalition – even this is difficult when number of
members in a coalition is large.

 Impartial Investment Advice: There is a lengthy list of problems, involving potential

conflicts between the bank’s commercial and investment banking roles. For example
there may be possible conflict between the investment banker’s promotional role and
commercial bankers obligation to provide disinterested advice. Or where a Universal
Bank’s securities department advises a bank customer to issue new securities to repay its
bank loans. But a specialized bank that wants an unprofitable loan repaid also can suggest
that the customer issues securities to do so.

Advantages Of Universal Banking

 The main argument in favour of universal banking is that it results in greater economic
efficiency in the form of lower cost, higher output and better products. This logic stems
from the reason that when sector participants are free to choose the size and product-mix
of their operations, they are likely to configure their activities in a manner that would
optimise the use of their resources and circumstances. In particular, the following
advantages are often cited in favour of universal banking.
 Economies of scale mean lower average costs which arise when larger volume of
operations are performed for a given level of overhead on investment. Economies of
scope arise in multi-product firms because costs of offering various activities by different
units are greater than the costs when they are offered together. Economies of scale and
scope have been given as the rationale for combining the activities. A larger size and
range of operations allow better utilisation of resources/inputs. It is sometimes argued
that acquisition of some information technologies becomes profitable only beyond certain
production scales. Larger scale could also avoid the wasteful duplication of marketing,
research and development and information-gathering efforts.

 Due to various shifts in business cycles, the demand for products also varies at different
points of time. It is generally held that universal banks could easily handle such
situations by shifting the resources within the organisation as compared to
specialised banks. Specialised firms are also subject to substantial risks of failure,
because their operations are not well diversified. Proponents of universal banking thus
argue that specialised banking system can present considerable risks and costs to the
economy. By offering a broader set of financial products than what a specialised bank
provides, it has been argued that a universal bank is able to establish long-term
relationship with the customers and provide them with a package of financial services
through a single window. It is important to note that this benefit stems from the very
nature/purpose of universal banking.

 Profitable Diversions. By diversifying the activities, the bank can use its existing
expertise in one type of financial service in providing other types. So, it entails less cost
in performing all the functions by one entity instead of separate bodies.

 Resource Utilization. A bank possesses the information on the risk characteristics of the
clients, which can be used to pursue other activities with the same clients. A data
collection about the market trends, risk and returns associated with portfolios of Mutual
Funds, diversifiable and non diversifiable risk analysis, etc, is useful for other clients and
 information seekers. Automatically, a bank will get the benefit of being involved in the
researching .

 Easy Marketing on the Foundation of a Brand Name. A bank's existing branches can
act as shops of selling for selling financial products like Insurance, Mutual Funds without
spending much efforts on marketing, as the branch will act here as a parent company or
source. In this way, a bank can reach the client even in the remotest area without having
to take resource to an agent.

 One-stop shopping. The idea of 'one-stop shopping' saves a lot of transaction costs and
increases the speed of economic activities. It is beneficial for the bank as well as its
customers.

 Investor Friendly Activities. Another manifestation of Universal Banking is bank holding

stakes in a form : a bank's equity holding in a borrower firm, acts as a signal for other
investor on to the health of the firm since the lending bank is in a better position to
monitor the firm's activities.

Disadvantages of Universal Banking

 Grey Area of Universal Bank. The path of universal banking for DFIs is strewn with
obstacles. The biggest one is overcoming the differences in regulatory requirement for a
bank and DFI. Unlike banks, DFIs are not required to keep a portion of their deposits as
cash reserves.

 No Expertise in Long term lending. In the case of traditional project finance, an area
where DFIs tread carefully, becoming a bank may not make a big difference to a DFI.
 Project finance and Infrastructure finance are generally long- gestation projects and
would require DFIs to borrow long- term. Therefore, the transformation into a bank may
not be of great assistance in lending long-term.

 NPA Problem Remained Intact. The most serious problem that the DFIs have had to
encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Universal
Banking or installation of cutting-edge-technology in operations are unlikely to improve
the situation concerning NPAs.

 The larger the banks, the greater the effects of their failure on the system. The failure of a
larger institution could have serious ramifications for the entire system in that if one
universal bank were to collapse, it could lead to a systemic financial crisis. Thus,
universal banking could subject the economy to the increased systemic risk.

 Universal bankers may also have a feeling that they are too big to be allowed to fail.
Hence they might succumb to the temptation of taking excessive risks. In such cases, the
government would be forced to step in to save the bank. Furthermore, it is argued that
universal banks are particularly vulnerable because of their role in underwriting and
distributing securities.

 Historically, an important reason for limiting combinations of activities has been the fear
that such institutions, by virtue of their sheer size, would gain monopoly power in the
market, which can have significant undesirable consequences for economic efficiency.
Two kinds of concentration should be distinguished, viz., the dominance of universal
banks over non-financial companies and concentration in the market for financial
services. The critics of universal banks blame universal banking for fostering cartels and
enhancing the power of large non-banking firms.
 Some critics have also observed that universal banks tend to be bureaucratic and
inflexible and hence they tend to work primarily with large established customers and
ignore or discourage smaller and newly established businesses. Universal banks could use
such practices as limit pricing or predatory pricing to prevent smaller specialised banks
from serving the market. This argument mainly stems from the economies of scale and
scope.

 Combining commercial and investment banking gives rise to conflict of interests as

universal banks may not objectively advise their clients on optimal means of financing or
they may have an interest in securities because of underwriting activities.

 Saunders [1985] points out that conflict of interests might arise from the following:
(a) conflict between the investment banker’s promotional role and the commercial
banker’s obligation to provide disinterested advice;

(b) Using the bank’s securities department or affiliate to issue new securities to repay
unprofitable loans;

(c) Placing unsold securities in the bank’s trust accounts;

(d) Making bank loans to support the price of a security that is underwritten by the bank
or its securities affiliate;

(e) Making imprudent loans to issuers of securities that the bank or its securities affiliate
underwrites;

(f) Direct lending by a bank to its securities affiliate; and

(g) Informational advantages regarding competitors.

  Conflict of interests was one of the major reasons for introduction of Glass-Steagall Act.
Three well-defined evils were found to flow from the combination of investment and
commercial banking as detailed below.
(a) Banks were deploying their own assets in securities with consequent risk to
commercial and savings deposits.

(b) Unsound loans were made in order to shore up the price of securities or the financial
position of companies in which a bank had invested its own assets.
(c) A commercial bank’s financial interest in the ownership, price, or distribution of
securities inevitably tempted bank officials to press their banking customers into
investing in securities which the bank itself was under pressure to sell because of its
own pecuniary stake in the transaction.

The provisions of the Glass-Steagall Act were directed at these abuses. It is argued that universal
banks are more difficult to regulate because their ties to the business world are more complex. In
the case of specialised institutions, government/supervisory agencies could effectively monitor
them because their functions are limited.

UNIVERSAL BANKING IN INDIA

In India Development financial institutions (DFIs) and refinancing institutions (RFIs) were
meeting specific sect oral needs and also providing long-term resources at concessional terms,
while the commercial banks in general, by and large, confined themselves to the core banking
functions of accepting deposits and providing working capital finance to industry, trade and
agriculture. Consequent to the liberalisation and deregulation of financial sector, there has been
blurring of distinction between the commercial banking and investment banking.
Reserve Bank of India constituted on December 8, 1997, a Working Group under the
Chairmanship of Shri S.H. Khan to bring about greater clarity in the respective roles of banks
and financial institutions for greater harmonization of facilities and obligations . Also report of
the Committee on Banking Sector Reforms or Narasimham Committee (NC) has major bearing
on the issues considered by the Khan Working Group.

The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to RBI
to discuss the time frame and possible options for transforming itself into an universal bank.
Reserve Bank of India also spelt out to Parliamentary Standing Committee on Finance, its
proposed policy for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

Now RBI has asked FIs, which are interested to convert itself into a universal bank, to submit
their plans for transition to a universal bank for consideration and further discussions. FIs need to
formulate a road map for the transition path and strategy for smooth conversion into a universal
bank over a specified time frame. The plan should specifically provide for full compliance with
prudential norms as applicable to banks over the proposed period.

IN The early Nineties the forces of globalisation were unleashed on the hitherto protected Indian
environment. The financial sector was crying out for reform. Public sector banks which had a
useful role to play earlier on now faced deteriorating performance. For these and certain other
reasons private banking was sought to be encouraged in line with the Narasimham Committee's
recommendations.

It would be pertinent to recapitulate the prevailing conditions in the banking industry in the early
Nineties: the nationalised sector had outlived its utility; in fact they became burdened with
unwelcome legacies; customer service had become a casualty; need for computerisation,
including networking among the vast branch network was felt. Private banking in that context
was viewed a brand new approach, to bypass the structural and other shortcomings of the public
sector. A few of the new ones that were promoted by the institutions such as the IDBI and ICICI
did establish themselves, though in varying degrees, surviving the market upheavals of the
1990.That was possible apart from other factors due to the highly professional approach some of
them adopted: it helped them stay clear of the pitfalls of nationalised banking. Yet in less than a
decade after the advent of these new generation banks, some of the successful ones, are being
forced to change organisationally and in every other way. Who benefits after this restructuring is
something that has to be asked.

It is essential to assimilate history of banking as well as the role of the financial institutions till
recently. The branch banking concept with which we are familiar and practised since inception is
basically on certain `protected' fundamentals. The insulated economy till the Nineties provided
comforts to public sector banks, in areas of liquidity management while in an administered
interest regime, discretion of managements was limited and consequently, the risk parameters in
these spheres were hazy and not quantifiable. The share of private sector banks which is
distinctly known as old private sector banks' established before 1994, was thus not substantial
while operations of foreign banks were also restricted. Staff orientation especially at the branch
level is a key ingredient for success and neither the older private banks nor the nationalised
banks were successful in that respect.

The woes of the public sector banks till date relate to handling volumes, be it in the area of
transactions or staff complement or branch offices. Post nationalisation, mass banking sans
commercial or professional goals, indiscreet branch expansion, lack of networking, wide
gaps/inefficiency at the levels of control apart from environmental impacts, contributed to their
present status.

Turning to recent merger announcement between the ICICI and its more recently promoted
banking subsidiary the following become relevant. One of the main motivations has been the
need to access a low cost retail deposit base. Public sector banks, by way of contrast never had to
face such a constraint.

Today, in a market driven economy, to face the competition, one factor is the size and hence,
mergers are advocated. Talking of the PSBs it is relevant to note that except for a build up of
savings accounts (as low cost deposits), the advantage of vast branch network is yet to be
exploited by them while on the other hand, most of the complaints, irregularities, mounting
arrears in reconciliation are attributable to such branch expansion.

At the same time, this has enabled a few of the smart foreign/new private sector banks to enrich
themselves by offering cash management products, utilising the same branch network! All these
pose a question to the recent merger of Bank of Madura - will the ICICI Bank decide to
shed unwanted, unremunerative branches? Pertinently for all banks the RBI has already provided
an exit route but there have been no takers among the public sector banks, for obvious reasons.

Pertinent again is to note that another set of banks, namely, foreign banks prospered during all
these difficult days. Even today, these banks do not have branch network to speak of but in terms
of volume, profitability they are far ahead of the public sector banks. Only a couple of new
private sector banks have posed any challenge to them in the recent years.

Turning to recent merger announcement between the ICICI and its more recently promoted
banking subsidiary the following become relevant. One of the main motivations has been the
need to access a low cost retail deposit base. Public sector banks, by way of contrast never had to
face such a constraint.

Today, in a market driven economy, to face the competition, one factor is the size and hence,
mergers are advocated. Talking of the PSBs it is relevant to note that except for a build up of
savings accounts (as low cost deposits), the advantage of vast branch network is yet to be
exploited by them while on the other hand, most of the complaints, irregularities, mounting
arrears in reconciliation are attributable to such branch expansion.

At the same time, this has enabled a few of the smart foreign/new private sector banks to enrich
them by offering cash management products, utilising the same branch network! These entire
pose a question to the recent merger of Bank of Madura - will the ICICI Bank decide to shed
unwanted, unremunerative branches? Pertinently for all banks the RBI has already provided an
exit route but there have been no takers among the public sector banks, for obvious reasons.
Pertinent again is to note that another set of banks, namely, foreign banks prospered during all
these difficult days. Even today, these banks do not have branch network to speak of but in terms
of volume, profitability they are far ahead of the public sector banks. Only a couple of new
private sector banks have posed any challenge to them in the recent years.

Development financial institutions (DFIs) and refinancing institutions (RFIs) were meeting
specific sectoral needs and also providing long-term resources at concessional terms, while the
commercial banks in general, by and large, confined themselves to the core banking functions of
accepting deposits and providing working capital finance to industry, trade and agriculture.
Consequent to the liberalisation and deregulation of financial sector, there has been blurring of
distinction between the commercial banking and investment banking.

Indian Banks pursuant to the nationalisation and state ownership of the main players took upon
themselves the role of developoment bankers and diversified thier credit dispensations. Term
Lending and credit delivery against hypothecaton of assets, which were unheard of earlier, came
to be accepted as a common measure of credit policy. All sectors of Indian economy were
brought under purview of banks' financial support. A group of banks joined together as a
consortium and diversified risk in financing bulk ventures sharing portions both amonst
themselves and also along with the Term Lending Institutions. The entry of banks into the realm
of financial services was to follow very soon. The first impulses for a more diversified financial
intermediation were witnessed in the late 1980s and early 1990s when banks were allowed to
undertake leasing, investment banking, mutual funds, factoring, hire-purchase activities through
separate subsidiaries. By the mid-1990s, all restrictions on project financing were removed and
banks were allowed to undertake several activities in-house. Reforms in the Insurance Sector in
the late Nineties and opening up of this field to private and foreign players, also resulted in
permitting banks to undertake sale of insurance products. At present, only an 'arms-length'
relationship between a bank and an insurance entity has been allowed by the regulatory authority,
i.e. the Insurance Regulatory and Development Authority (Irda). Which means that commercial
banks can enter insurance business either by acting as agents or by setting up joint ventures with
insurance companies. And the RBI allows banks to only marginally invest in equity (5 per cent of
their outstanding credit).
The phenomenon of universal banking as a distinct concept, as different from narrow banking,
came to the fore-front in the Indian context with the second Narasimham Committee (1998) and
later the Khan Committee (1998) reports recommending consolidation of the banking industry
through mergers and integration of financial activities.

At this point it became relevant to consider opening Development finance Institutions to avail the
options to involve in deposit banking and short-term lending as well. DFIs were set up with the
objective of taking care of the investment needs of industries. They have, over time, built up
expertise in merchant banking and project evaluation. Yet they have also backed bad investments
and, as a result, become equity holders in defaulting enterprises through conversion of loans into
equity. They also extend soft loans by way of equity contribution to medium and large industries.
DFIs have developed core competence in investment banking. They take a lot of risks to prop up
industries. They finance industries such as infrastructure industries, which have long gestation
periods and have contributed significantly to the country's industrialisation process.

However the access of Developmental Finance Institutions to low cost funds has been denied.
Saddled with obligations to fund long gestation projects, the DFIs have been burdoned with
serious mismatches between their assets and liabilities side of the balance sheets. Their
traditional lending to industries such as textiles and iron and steel has caused them serious
problems at a time when the method of classifying balance-sheets has become more transparent.
The Narasimham Committee (II) had suggested that DFIs should convert into banks or non-
banking finance companies. Some of the issues addressed in the transition path relate to
compliance with cash reserve ratio and statutory liquidity ratio requirements, disposal of non-
banking assets, composition of the board, prohibition on floating charge of assets, restrictions on
investments, connected lending and banking license.
Converting into UBs will grant them ready access to cheap retail deposits and increase the
coverage of the advances to include short-term working capital loans to corporates with greater
operational flexibility. The institutions can then effectively compete with the commercial banks.
They will be able to attract more volumes because they meet most of the needs of their
customers under one roof.
Reserve Bank of India constituted on December 8, 1997, a Working Group under the
Chairmanship of Shri S.H. Khan to bring about greater clarity in the respective roles of banks
and financial institutions for greater harmonisation of facilities and obligations . Also report of
the Committee on Banking Sector Reforms or Narasimham Committee (NC) has major bearing
on the issues considered by the Khan Working Group.

The Commitee submitted comprehensive recommendations of which one was about Universal
Banking. The working group made a strong pitch for "eventually" giving full banking licenses to
the development financial institutions (DFIs) and called for mergers between strong banks and
institutions. Till the time the DFIs are given full banking licenses, they should be permitted to
have wholly-owned banking subsidiaries."Size, expertise and reach are now deemed crucial to
sustained viability and future survival in the financial sector," the report says, and recommends
that managements and shareholders of banks and DFIs be allowed to explore the possibility of
gainful mergers not only of banks but also of banks and DFIs.

The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to RBI
to discuss the time frame and possible options for transforming itself into an universal bank.
Reserve Bank of India also spelt out to Parliamentary Standing Committee on Finance, its
proposed policy for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.

Now RBI has asked FIs, which are interested to convert itself into a universal bank, to submit
their plans for transition to a universal bank for consideration and further discussions. FIs need to
formulate a road map for the transition path and strategy for smooth conversion into an universal
bank over a specified time frame. A universal bank can be a single company, a holding company
with wholly owned subsidiaries, a group of entities with cross-holdings or even a flagship
company which may or may not have independent shareholders. The panel has argued that the
regulator should not impose the appropriate corporate structure. Calling for an enabling
regulatory framework to ensure the transition towards universal banking, the panel said a
function-specific and institution-neutral regulatory framework must be developed. "This concept
of neutrality should be applicable to both foreign and local entities," it said.

KHAN WORKING GROUP

In the light of a number of reform measures adopted in the Indian financial system since 1991,
and keeping in view the need for evolving an efficient and competitive financial system, the
Reserve Bank constituted on December 8, 1997, a Working Group under the Chairmanship of the
then Chairman and Managing Director of Industrial Development Bank of India, Shri S. H.
Khan, with the following terms of reference:

 To review the role, structure and operations of Development Financial Institutions (DFIs)
and commercial banks in emerging operating environment and suggest changes;

 To suggest measures for bringing about harmonization in the lending and working capital
finance by banks and DFIs;

 To examine whether DFIs could be given increased access to short-term funds and the
regulatory framework needed for the purpose;

 To suggest measures for strengthening of organisation, human resources, risk

management practices and other related issues in DFIs and commercial banks in the wake
of Capital Account Convertibility;

 To make such other recommendations as the Working Group may deem appropriate to the
subject.

The Working Group submitted its interim Report in April and final Report in May 1998. In the
Monetary and Credit Policy announced in April 1998, it was indicated that a ‘Discussion Paper’
would be prepared which will contain Reserve Bank’s draft proposals for bringing about greater
clarity in the respective roles of banks and financial institutions for greater harmonisation of
facilities and obligations applicable to them. It was also mentioned that the Paper would also take
into account those recommendations of the Committee on Banking Sector Reforms (Chairman:
Shri M. Narasimham) which have a bearing on the issues considered by the Khan Working
Group (KWG).

The thrust of the KWG (Khan Working Group) was on a progressive move towards universal
banking and the development of an enabling regulatory framework for this purpose. In the
interim, the Group recommended that DFIs might be permitted to have a banking subsidiary
(with holdings up to 100 per cent). Among the changes in regulatory practices, the focus of the
KWG was on the function-specific regulatory framework that targets activities and is institution-
neutral. Keeping in view the increasing overlap in functions being performed by various
participants in the financial system, the KWG recommended the establishment of a ‘super
regulator’ to supervise and co-ordinate the activities of the multiple regulators. With regard to
supervisory practices, it was recommended that the supervisory authority should undertake
primarily off-site supervision and that DFIs/banks should be supervised on a consolidated basis,
covering both domestic and global activities. For meaningful consolidated supervision, the KWG
recommended the development of a ‘risk-based supervisory framework’.

The KWG also made a number of recommendations relating to statutory obligations of banks.
These, inter-alia, included progressive reduction in Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR) to international levels. It recommended an alternative mechanism for
permitting credit to the priority sector and in the interim; the infrastructure lending should not be
included in the definition of the ‘net bank credit’ used in computing the priority sector
obligations. For harmonising the role, operations and regulatory framework of DFIs and banks,
the thrust of the recommendations was on removal of ceiling for DFIs’ mobilisation of short to
medium term resources by way of term deposits, CDs, borrowings from the term money market
and inter-corporate deposits with a suitable level of SLR on such borrowings on an incremental
basis. Other important recommendations were: to exclude investments made by banks in SLR
securities issued by a DFI while calculating the exposures and DFIs should be granted full
Authorised Dealer’s licence. With regard to State level institutions, the KWG recommended
immediate corporatisation to improve their competitive efficiency, to encourage strong State
Financial Corporations (SFCs) to go public by making Initial Public Offer (IPO), to transfer the
present shareholding of IDBI in the State level institutions to Small Industries Development
Bank of India (SIDBI) and transfer of ownership of SIDBI from IDBI to the Reserve Bank of
India (RBI)/Government.

The Second Narasimham Committee observed that, for the same market reasons as have
influenced the growth of universal banking elsewhere, a similar trend is visible in India too. It
recommended that if FIs engage themselves in commercial bank like activities, they should be
subject to the same discipline regarding reserve and liquidity requirements as well as capital
adequacy and prudential norms. It, however, recommended phasing out of reserve requirements
and suggested a formula for directed credit in case FIs become banks. It felt that DFIs, over a
period of time, should convert themselves into banks in which case there would only be two
forms of intermediaries, viz., banking companies and non-banking finance companies (NBFCs).
And if a DFI does not become a bank, it would be categorised as a non-banking finance
company. It emphasised the mergers between strong banks/FIs as they would make for greater
economic and commercial sense. It recommended that IDBI should be corporatised and
converted into a joint stock company under the Companies Act. For providing focused attention
to the work of SFCs, IDBI shareholding in them should be transferred to SIDBI. It recommended
that SIDBI should be delinked from IDBI. It recommended that supervisory function of National
Bank for Agricultural and Rural Development (NABARD) relating to rural financial institutions
should vest with the Board for Financial Regulation and Supervision (BFRS). For effective
supervision, it underlined the need for formal accession to ‘core principles’ announced by the
Basle Committee in September 1997. It recommended an integrated system of regulation and
supervision to regulate the activities of banks, financial institutions and non-banking finance
companies. The Committee emphasised the importance of having in place dedicated and
effective machinery for debt recovery for banks and financial institutions. It underlined the need
for clarity in the law regarding the evidentiary value of computer-generated documents. It also
emphasised that with electronic funds transfer several issues regarding authentication of
payments, etc. required to be clarified.
MAJOR RECOMMENDATIONS OF KHAN WORKING GROUP

The main recommendations of the Khan Working Group are set out below:

A. CHANGES IN ROLE, STRUCTURE AND OPERATIONS

 A progressive move towards universal banking and the development of an enabling

regulatory framework for the purpose.

 A full banking licence is eventually granted to DFIs. In the interim, DFIs may be
permitted to have a banking subsidiary (with holdings up to 100 per cent), while the
DFIs themselves may continue to play their existing role.

 The appropriate corporate structure of universal banking should be an internal

management/shareholder decision and should not be imposed by the regulator.

 Management and shareholders of banks and DFIs should be permitted to explore and
enter into gainful mergers.

 The RBI/Government should provide an appropriate level of financial support in case

DFIs are required to assume any developmental obligations.

B. CHANGES IN REGULATORY AND LEGAL FRAMEWORK

 A function-specific regulatory framework must develop that targets activities and is

institution-neutral with regard to the regulatory treatment of identical services
rendered by any participant in the financial system.
  The establishment of a ‘super-regulator’ to supervise and co-ordinate the activities of
multiple regulators in order to ensure uniformity in regulatory treatment.

 A speedy implementation of legal reforms in the debt recovery areas of banks and
financial institutions should be given top priority. A thorough revamp of the 1993 Act
on Recovery of Debt from Banks and DFIs.

 There is a need to redraft other codified laws impacting operations of DFIs/banks. v)

For effective computerisation, amendments to the Banking Companies (Period of
Preservation of Records) Rules, 1985 and other suitable enactments on the lines of
Electronic Fund Transfer Act in USA be examined for implementation.

C. CHANGES IN SUPERVISORY PRACTICES

 The supervisory authority should undertake primarily off-site supervision based on

periodic reporting by the banks or DFIs as the case may be. On-site supervision
should be undertaken only in exceptional cases.

 DFIs/banks should be supervised on a consolidated basis. Future accounting

standards must consequently include rules on consolidated supervision for financial
subsidiaries and conglomerates. Further, as domestic financial activities assume an
international character, banking supervisors should adopt global consolidated
supervision.

 A “risk-based supervisory framework” along the lines of the Report of the Task Force
on Conglomerate Supervision, published by the Institute of International Finance, in
February 1997 may be adopted.

D. STATUTORY OBLIGATIONS
  The application of CRR should be confined to cash and cash-like instruments. CRR
should be brought down progressively within a time-bound frame to international
levels.
 It may be useful to consider phasing out SLR in line with international practice.

 Rather than imposing the priority sector obligation on the entire banking system,
there is a need for an alternate mechanism to be developed for financing these sectors.
Such a mechanism will aim to balance the need for funds with the need to bring
better-suited structures and specialised skills to bear in dealing with the sectors. The
concessional funding for certain sectors can be provided by specifically targeted
subsidies to that sector.

 In the interim, the following modifications may be done in priority sector lending:

(a) infrastructure lending should be excluded from the definition of ‘net bank credit’
used in computing the priority sector obligations,

(b) to facilitate efficient loan disbursals, the priority sector obligation should be linked to
the net bank credit at the end of the previous financial year, and

(c) the definition of the priority sector may be widened to enable the inclusion of the
whole industry/class of activities.

E. RE-ORGANISATION OF STATE-LEVEL INSTITUTIONS (SLIs)

 While the consolidation of SLIs should form part of the short-term agenda of the
financial sector reforms; an immediate term imperative is the corporatisation of these
entities to improve their competitive efficiency.

 Following restructuring/re-organisation, strong SFCs could be encouraged to go

public by making IPOs.
  It would be desirable to transfer the present shareholding of IDBI in these SLIs to
SIDBI.

 Ownership in SIDBI should, as a logical corollary, stand transferred to

RBI/Government on the same lines as NABARD.
 SIDBI’s role in State Level Institutions should be both as stake holder as well as
resource provider. For this purpose, SIDBI should have access to assured sources of
concessional funding from RBI.

 SLIs should be brought under the supervisory ambit of RBI.

F. HARMONISING THE ROLE, OPERATIONS AND REGULATORY

FRAMEWORK OF DFIs AND BANKS

 A Standing (Co-ordination) Committee be set up on which Banks and DFIs would be

represented.

 The extant overall ceiling for DFIs’ mobilisation of resources by way of term
money/bonds (having maturities of 3-6 months), Certificates of Deposits (maturities
of 1-3 years), Term Deposits (fixed deposits from the public with maturity of 1-5
years) and inter-corporate deposits at 100 per cent of net owned funds (NOF) of DFIs
may be removed. A suitable level of SLR may be stipulated for DFIs on incremental
outstanding fixed deposits raised from the public (excluding inter-bank deposits).

 The restrictions stipulated by the RBI, whereby bond issues by DFIs with either a
maturity of less than 5 years or maturity of 5 years and above but with interest rate
not exceeding 200 bps over the yield on Government of India securities of equal
residual maturity require prior approval should be withdrawn.
  CRR should not be applicable to DFIs under the present structure, where they are not
permitted to access cash and cash-like instruments.

 A uniform risk weightage of 20 per cent may be assigned for investment made by
commercial banks in bonds of “AAA” rated DFIs.

 Banks is permitted to exclude investments in SLR securities issued by a DFI while

calculating the exposure to that DFI.

 The DFIs should be granted full Authorised Dealer’s licence.

G. ORGANISATION REDESIGN

 Best practices in the area of corporate governance such as imparting full operational
autonomy and flexibility to managements and Boards of Banks and DFIs should be
implemented.

 A complete redesign of the business system of banks/DFIs, with the Top Management
spelling out the strategic objectives for principal stakeholders (clients, employees,
shareholders, etc.), a proactive relationship-based approach in corporate culture, a
consensus-driven committee-based approach for loan sanctions and decisions on
organisation structure based purely on commercial judgement.

H. RISK MANAGEMENT

 There should be a clear strategy approved by the Board of Directors as to their risk
management policies and procedures.
  An Integrated Treasury and a proactive Asset-Liability Management (ALM),
including both on-and off-balance sheet items.

 Robust internal operational controls, including audit must be in place.

I. INFORMATION TECHNOLOGY AND MIS

 Existing laws may not be adequate or have the clarity to deal with some of the key
issues that are likely to emerge following introduction of computerisation and
technologically advanced communications in banking. There is compelling logic to
revisit the legal framework in information technology area and render it compatible
with the requirements of a technology-driven banking environment.

 DFIs/banks should urgently establish, create employee/customer awareness and

familiarity with e-mail, Internet and Intranet Banking, Smart Cards and Electronic
Data Interchange (EDI) in a strategically sequenced fashion.

 A perspective plan/blue print for automation of financial sector be prepared.

J. HUMAN RESOURCE DEVELOPMENT

 Prescient management and leadership with accent on teamwork.

 Broad-based recruitments, both at entry level from campus as well as lateral entry of
professionals at higher levels to fill skill gaps in critical areas.

 Systematic training programmes.

 Skill building and upgradation.

 Market-related compensation packages.

  Viable and enforceable exit option for employees.

NARASIMHAM COMMITTEE

To review the progress of banking sector reforms so far and to suggest second stage of reforms,
The committee on banking sector reforms was set up in December '97 under the chairmanship of
Narsimham. Apart from reviewing the banking sector reforms, the committee was required to
suggest remedial measures to strengthen the banking system, covering areas such as banking
policy, institutional structure, supervisory system, legislative and technological changes. Some of
the recommendations made are as follows. The recommendations have been accepted and were
announced as part of mid-term credit policy for 1998-99. RBI has given guidelines to implement
the recommendations.

MAJOR RECOMMENDATIONS OF THE COMMITTEE ON

BANKING SECTOR REFORMS (NARASIMHAM COMMITTEE-
II)

 With convergence of activities between banks and DFIs, the DFIs should over a period of
time, convert themselves into banks. There would then be only two form of
intermediaries, viz., banking companies and non-banking finance companies. If a DFI
does not acquire a banking license within a stipulated time, it would be categorized as a
non-banking finance company.

 A DFI which converts into a bank can be given some time to phase in reserve
requirements in respect of its liabilities to bring it on par with the requirements relating to
commercial banks. Similarly, as long as a system of directed credit is in vogue a formula
should be worked out to extend this to DFIs which have become banks.

 Mergers between banks and DFIs and NBFCs need to be based on synergies and
locational and business specific complementarities of the concerned institutions and must
obviously make sound commercial sense. Merger between strong banks/FIs would make
for greater economic and commercial sense and would be a case where the whole is
greater than the sum of its parts and have a “force multiplier effect”.
  To provide the much-needed flexibility in its operations, IDBI should be corporatised and
converted into a Joint Stock Company under the Companies Act on the lines of ICICI,
IFCI and IIBI. For providing focused attention to the work of State Financial
Corporations, IDBI shareholding in them should be transferred to SIDBI which is
currently providing refinance assistance to State Financial Corporations. To give it
greater operational autonomy, SIDBI should also be de-linked from IDBI.

 The supervisory function over rural financial institutions has been entrusted to
NABARD. While this arrangement may continue for the present, over the longer-term,
the Committee would suggest that all regulatory and supervisory functions over rural
credit institutions should vest with the Board for Financial Regulation and Supervision
(BFRS).

 For effective supervision, there is a need for formal accession to ‘core principles’
announced by the Basle Committee in September 1997.

 An integrated system of regulation and supervision be put in place to regulate and

supervise the activities of banks, financial institutions and non-bank finance companies
(NBFCs) and the agency (Board for Financial Supervision) be renamed as the Board for
Financial Regulation and Supervision (BFRS).

 To have in place a dedicated and effective machinery for debt recovery for banks and
financial institutions.

SALIENT OPERATIONAL AND REGULATORY ISSUES OF RBI

TO BE ADDRESSED BY THE FIs FOR CONVERSION INTO A
UNIVERSAL BANK
a) Reserve requirements. Compliance with the cash reserve ratio and statutory liquidity ratio
requirements (under Section 42 of RBI Act, 1934, and Section 24 of the Banking Regulation
Act, 1949, respectively) would be mandatory for an FI after its conversion into a universal bank.
b) Permissible activities. Any activity of an FI currently undertaken but not permissible for a
bank under Section 6(1) of the B. R. Act, 1949, may have to be stopped or divested after its
conversion into a universal bank..
c) Disposal of non-banking assets. Any immovable property, howsoever acquired by an FI,
would, after its conversion into a universal bank, be required to be disposed of within the
maximum period of 7 years from the date of acquisition, in terms of Section 9 of the B. R. Act.
d) Composition of the Board. Changing the composition of the Board of Directors might
become necessary for some of the FIs after their conversion into a universal bank, to ensure
compliance with the provisions of Section 10(A) of the B. R. Act, which requires at least 51% of
the total number of directors to have special knowledge and experience.
e) Prohibition on floating charge of assets. The floating charge, if created by an FI, over its
assets, would require, after its conversion into a universal bank, ratification by the Reserve Bank
of India under Section 14(A) of the B. R. Act, since a banking company is not allowed to create a
floating charge on the undertaking or any property of the company unless duly certified by RBI
as required under the Section.
f) Nature of subsidiaries. If any of the existing subsidiaries of an FI is engaged in an activity not
permitted under Section 6(1) of the B R Act , then on conversion of the FI into a universal bank,
delinking of such subsidiary / activity from the operations of the universal bank would become
necessary since Section 19 of the Act permits a bank to have subsidiaries only for one or more
of the activities permitted under Section 6(1) of B. R. Act.
g) Restriction on investments. An FI with equity investment in companies in excess of 30 per
cent of the paid up share capital of that company or 30 per cent of its own paid-up share capital
and reserves, whichever is less, on its conversion into a universal bank, would need to divest
such excess holdings to secure compliance with the provisions of Section 19(2) of the B. R. Act,
which prohibits a bank from holding shares in a company in excess of these limits.
h) Connected lending . Section 20 of the B. R. Act prohibits grant of loans and advances by a
bank on security of its own shares or grant of loans or advances on behalf of any of its directors
or to any firm in which its director/manager or employee or guarantor is interested. The
compliance with these provisions would be mandatory after conversion of an FI to a universal
bank.
i) Licensing. An FI converting into a universal bank would be required to obtain a banking
license from RBI under Section 22 of the B. R. Act, for carrying on banking business in India,
after complying with the applicable conditions.
j) Branch network An FI, after its conversion into a bank, would also be required to comply with
extant branch licensing policy of RBI under which the new banks are required to allot at least
25 per cent of their total number of branches in semi-urban and rural areas.
k) Assets in India. An FI after its conversion into a universal bank, will be required to ensure that
at the close of business on the last Friday of every quarter, its total assets held in India are not
less than 75 per cent of its total demand and time liabilities in India, as required of a bank under
Section 25 of the B R Act.
l) Format of annual reports. After converting into a universal bank, an FI will be required to
publish its annual balance sheet and profit and loss account in the forms set out in the Third
Schedule to the B R Act, as prescribed for a banking company under Section 29 and Section 30
of the B. R. Act.
m) Managerial remuneration of the Chief Executive Officers. On conversion into a universal
bank, the appointment and remuneration of the existing Chief Executive Officers may have to be
reviewed with the approval of RBI in terms of the provisions of Section 35 B of the B. R. Act.
The Section stipulates fixation of remuneration of the Chairman and Managing Director of a
bank by Reserve Bank of India taking into account the profitability, net NPAs and other financial
parameters. Under the Section, prior approval of RBI would also be required for appointment of
Chairman and Managing Director.
n) Deposit insurance . An FI, on conversion into a universal bank, would also be required to
comply with the requirement of compulsory deposit insurance from DICGC up to a maximum of
Rs.1 lakh per account, as applicable to the banks.
o) Authorized Dealer's License. Some of the FIs at present hold restricted AD licence from RBI,
Exchange Control Department to enable them to undertake transactions necessary for or
incidental to their prescribed functions. On conversion into a universal bank, the new bank
would normally be eligible for full-fledged authorised dealer licence and would also attract the
full rigour of the Exchange Control Regulations applicable to the banks at present, including
prohibition on raising resources through external commercial borrowings.
p) Priority sector lending. On conversion of an FI to a universal bank, the obligation for lending
to "priority sector" up to a prescribed percentage of their 'net bank credit' would also become
applicable to it.
q) Prudential norms. After conversion of an FI in to a bank, the extant prudential norms of RBI
for the all-India financial institutions would no longer be applicable but the norms as applicable
to banks would be attracted and will need to be fully complied with.
(This list of regulatory and operational issues is only illustrative and not exhaustive).

Prudential norms

After conversion of an FI in to a bank, the extant prudential norms of RBI for the all-India
financial institutions would no longer be applicable but the norms as applicable to banks would
be attracted and will need to be fully complied with. (This list of regulatory and operational
issues is only illustrative and not exhaustive)

 Income recognition - Prior to the introduction of prudential norms, banks used to book
interest income on loans, which were bad or not performing. Thus banks used to carry a
huge amount of loans on which they never received interest or principal. To bring sound
accounting policies to match international standards banks were hitherto allowed to book
income only on performing assets.

 Asset classification - Loans or advances or credit represent a major asset for banks. To
be able to distinguish the quality of loans given by banks and to make adequate
provisioning, it was necessary to classify the advances depending upon whether they
were performing or not. The following rules were introduced.

 Standard assets - These are performing assets i.e. the interest and principal repayments
on these loans are not outstanding for more than two quarters.

 Sub-standard assets - These are non-performing assets for a period not exceeding two
years i.e. the interest and principal repayments are outstanding for more than two
 quarters. The condition of period for which interest or principal remains outstanding, was
made applicable in a phased manner i.e. when the norms were first introduced the
condition was outstanding for four quarters later on it was made three
quarters and now stands at two quarters.

 Doubtful assets - These are assets, which have remained non-performing for more than
two years.

 Loss assets - These are the assets which are non-performing for more than three years or
where the loss has been proved

THE TREND OF UNIVERSAL BANKING IN DIFFERENT

COUNTRIES
Universal banks have long played a leading role in Germany, Switzerland, and other Continental
European countries. The principal Financial institutions in these countries typically are universal
banks offering the entire array of banking services. Continental European banks are engaged in
deposit, real estate and other forms of lending, foreign exchange trading, as well as underwriting,
securities trading, and portfolio management. In the Anglo-Saxon countries and in Japan, by
contrast, commercial and investment banking tend to be separated. In recent years, though, most
of these countries have lowered the barriers between commercial and investment banking, but
they have refrained from adopting the Continental European system of universal banking. In the
United States, in particular, the resistance to softening the separation of banking activities, as
enshrined in the Glass-Steagall Act, continues to be stiff.

In Germany and Switzerland the importance of universal banking has grown since the end of
World War II. Will this trend continue so that universal banks could completely overwhelm the
specialized institutions in the future? Are the specialized banks doomed to disappear? This
question cannot be answered with a simple "yes" or "no". The German and Swiss
experiences suggest that three factors will determine future growth of universal banking.

First, universal banks no doubt will continue to play an important role. They possess a number
of advantages over specialized institutions. In particular, they are able to exploit economies of
scale and scope in banking. These economies are especially important for banks operating on a
global scale and catering to customers with a need for highly sophisticated financial services. As
we saw in the preceding section, universal banks may also suffer from various shortcomings.
However, in an increasingly competitive environment, these defects will likely carry far less
weight than in the past.

Second, although universal banks have expanded their sphere of influence, the smaller
specialized institutions have not disappeared. In both Germany and Switzerland, they are
successfully coexisting and competing with the big banks. In Switzerland, for example, the
specialized institutions are firmly entrenched in such areas as real estate lending, securities
trading, and portfolio management. The continued strong performance of many specialized
institutions suggests that universal banks do not enjoy a comparative advantage in all areas of
banking.
Third, universality of banking may be achieved in various ways. No single type of universal
banking system exists. The German and Swiss universal banking systems differ substantially in
this regard. In Germany, universality has been strengthened without significantly increasing the
market shares of the big banks. Instead, the smaller institutions have acquired universality
through cooperation. It remains to be seen whether the cooperative approach will survive in an
environment of highly competitive and globalized banking.

EXAMPLES OF UNIVERSAL BANKING IN FOREIGN COUNTRIES

IN USA: -
1] Chase Manhattan Bank: the reorganization of a universal bank

Chase Manhattan Bank, founded in 1877 in New York, is one of the large money center
banks and , right from the beginning has followed a universal banking strategy, seeking to cover
all the segments of financial intermediation: commercial banking, wholesale banking , money
markets, capital markets, and foreign markets. A major part of Chase Manhattan’s business is
concentrated in lending to large corporations and governments, both in United States and abroad.

After a decade of meteoric growth during 1960s, Chase Manhattan’s performance started to
fall off in the 1970s for external & internal reasons.

One of the external reasons was the ground lost in the North American bond market in the
strong advance by other specialized banks such as Salomon Brothers or Citicorp. One of the
main internal reasons was the lack of consistent strategic vision in the bank, whose efforts were
divided into different businesses.

These circumstances alarmed the bank shareholders and financial community. As a result of
the combination of factors and increasing competition, Chase’s return on assets fell below 0.5 %
in the first half of the 1970s. In a way, the situation of Chase Manhattan reflects the
consequences of dramatic changes that took place in the financial system during 1970s –
particularly intense in USA- & the considerable difficulties experienced at that time by the
universal banks (which they continue to experience to adapt to new situation)

The year 1982 was particularly bad one for Chase Manhattan reflects the consequences of
the dramatic changes. The reason was the occurrence of three financial fiascos within a very
short : two loans operations to brokerage companies on North American Public debt market ($
117 million and $42 million, respectively ) and investment in a bank that failed as a result of
energy crisis ($ 161 million).

The perception of the urgent need for a change led to Chase’s senior management to
implement a new action plan in 1985. the purpose of this plan was to strengthen its presence in
commercial and wholesale banking in the united states, leaving the international market
somewhat to one side. To this end, the bank’s executive committee took a series of steps, two of
which we consider particularly important.

First was the purchase of a bank, First Lincoln Corporation of Rochester, New York, with 172
branches, and the purchase of six savings and loan associations, which Chase immediately turned
into commercial banks. The purpose of these actions was to increase market share in the
commercial banking and medium-sized company loans segments. The second measure was to
reorganize the bank into three main areas: retail banking, investment banking, and institutional
banking (including relations with financial institutions, cash management, portfolio management,
and leasing).

However these efforts failed to achieve the hoped-for results. In 1990, the bank’s pretax
income was so low that Chase’s share price on the New York Stock exchange fell to an all-time
low. Rumours of a hostile take-over bid or the advisability of a merger with chemical or
Manufacturers Hanover were rife in 1990. However, with the change of executive management
in 1991, the bank started to climb out of its trough.

This new period opened with three major decisions. The first was the alienation of those
business units that were clearly unprofitable or in which Chase had no particular expertise which
include discontinuation of commercial banking in Europe, which Chase had found unprofitable
and fiercely competitive.

The second decision was to consolidate several business units that were clearly important
for Chase: the retail banking division, which accounted for 50 per cent of the bank’s total
revenues in 1989, and cash management, portfolio management and safekeeping services. The
third decision, which was closely related to the other two, was reorganization of its business into
three units, from which all of the banks were co- ordinate:

a) A commercial banking and retail-banking unit concentrated on the east coast, seeking to
operate with private households and small & medium-sized companies;

b) A retail financial products unit for the entire Unite States, including credit cards, investment
products, mortgages, and financing consumer durables such as automobiles;
c) A general financial services unit, mainly targeting North American companies and chase
customers. This unit was concerned with risk management, portfolio management and
international corporate banking.

Chase’s merger with Chemical Banking will allow the new bank to cut down on costs & gain
market share in some businesses.

2] Citicorp: a global universal bank

Citicorp: First National City Corporation, Citicorp, is the name of the holding company of
a group of financial institutions operating in various segments of the financial industry. This bank
was formed in 1812 and its original name was City Bank of New York. In 1955, it merged with
first National Bank of New York, thus marking the birth of Citicorp.

By the close of the nineteenth century, it was already the largest bank in the United States,
with a tradition of innovation and service acknowledged by corporate customers an rival banks
alike. Before the Great Depression of the 1930s, Citibank had started on a major diversification
of business, entering the capital market, investment banking, and international banking
businesses. However, this diversification process came to a stop when Congress approved the
Glass-Stegal Act.

After the Second World War, innovation in Citicorp, as in the other large American Banks
dropped off considerably. The main reason for this was that the package of regulatory majors
approved in the early 1930s considerably limited the banks penetration into new businesses. In
fact, this restriction was one of the reasons that Citicorp started to promote its international
banking business in the early 1960s, under the influence of its CEO, George Moore. Moore’s
vision consisted of two clear principles. First, give the best possible service to the American
Companies that were starting to expand abroad, particularly in Europe. The aim was to make
Citicorp the naturals choice for those American companies with business abroad. The second
principle was to recruit young professionals with significant entrepreneurial and innovative
potential as a key to developing financial services that the large companies might need.
 As a result of this expansion in its financial businesses, the bank started to redefine its
mission: from being a mere financial intermediary, the bank wished to become an organization
that offered all the financial services that another, non-financial organization could possibly
need. This vision of banking would probably be shared nowadays by all banks with a vocation in
universal banking. However, in the early 1960s, this vision was far from common. Bank
redefined its mission from being a mere financial intermediary, to become an organization that
offered all financial services to non-financial organization. The expansion of Citicorp in U.S. and
rest of the world was based on 3 critical actions –

1) Creation of a holding co in 1967, to guarantee that each of the bank’s businesses had the
decentralization.
2) Consolidation of a strong retail banking sales network in US and rest of the world, to
provide all types of financial services to household and private individuals,
3) Penetration of financial markets particularly in exchange market
4) Major investment in information technologies.

George Moore stepped down in 1967 and was succeeded by Walter Wriston, who was
CEO until 1984. Wriston consolidated this strategy under the general formulation, the five I’s:
institutional banking, individual banking, investment banking, information technology, & finally
insurance. John Reed succeeded Wriston in 1984. Until then, Reed had been chairman of retail
banking unit. Then he decided to enlarge the retail-banking unit, in which he had worked
previously, and which was profitable and less risky for Citicorp. In early 1990s, Citicorp was the
US universal bank that offered the most financial services. In credit cards, Citicorp was the top
US bank and the second largest institution, after American Express.

Citicorp’s clout in the financial services world is undeniable. Citicorp can adequately
manage its different businesses in so many geographical markets with the same efficiency as a
local specialist.

IN UNITED KINGDOM ( UK)

BARCLAYS BANK
1.Goldsmith Bankers
Barclay’s origins can be traced back to a modest business founded more than 300 years ago in
the heart of London's financial district.
In the late 17th century, the streets of the City of London may not have been paved with gold, but
they were filled with goldsmith-bankers. They provided monarchs and merchants with the money
they needed to fund their ventures around the world.

John Freame and his partner Thomas Gould in Lombard Street founded one such business in
1690. The name Barclay became associated with the company in 1736, when James Barclay -
who had married John Freame's daughter - became a partner.
2. A new joint-stock bank
Private banking businesses were commonplace in the 18th century, keeping their clients' gold
deposits secure and lending to credit-worthy merchants. In 1896, 20 of them formed a new joint-
stock bank.
A web of family, business and religious relationships already connected the leading partners of
the new bank, which was named Barclay and Company. The company became known as the
Quaker Bank, because this was the family tradition of the founding families.

3. Domestic growth
The new bank had 182 branches, mainly in the East and South East, and deposits of £26 million -
a substantial sum of money in those days. It expanded its branch network rapidly by taking over
other banks, including Bolithos in Cornwall and the South West in 1905 and United Counties
Bank in the Midlands in 1916.
In 1918 the company amalgamated with the London, Provincial and South Western Bank to
become one of the UK's 'big five' banks. By 1926 the bank had 1,837 outlets.
Barclays acquired Martins Bank in 1969, the largest UK bank to have its head office outside
London. And in 2000 it took over The Woolwich, a leading mortgage bank and former building
society founded in 1847.
4. International growth
The development of today's global business began in earnest in 1925, with the merger of three
banks - the Colonial Bank, the Anglo Egyptian Bank and the National Bank of South Africa to
form Barclays international operations. This added businesses in much of Africa, the Middle East
and the West Indies.
In 1981, Barclays became the first foreign bank to file with the US Securities and Exchange
Commission and raise long-term capital on the New York market. In 1986 it became the first
British bank to have its shares listed on the Tokyo and New York stock exchanges.
Barclays' global expansion was given added impetus in 1986 with the creation of an
investment banking operation. This has developed into Barclays Capital, a major division of the
bank that now manages larger corporate and institutional business.
In 1995 Barclays purchased the fund manager Wells Fargo Nikko Investment Advisers. The
business was integrated with BZW Investment Management to form Barclays Global Investors.

5. Recent Developments
Innovation has proceeded apace. The telephone banking service Barclaycall was introduced in
1994 and on-line PC banking in 1997, whilst customized services have also developed with the
introduction of Barclays Private Bank and Premier Banking. In 2001 Barclays formed a strategic
alliance with Legal & General to sell life pensions and investment products throughout its UK
network. Barclays has recently set itself the goal of becoming the employer of choice' and has
led the way in the implementation of equal opportunities policies.
 Objectives of the Study

An efficient, articulate and developed financial system is indispensable for the rapid economic
growth of any country/economy. The process of economic development is invariably
accompanied by a corresponding and parallel growth of financial organizations. The
liberalization/ deregulation/ globalization of the Indian economy has had important implications
for the future course of development of the financial system/sector.

The objectives of my project are :

 To study the existing Indian Financial System.

 To have a conceptual viewpoint of Universal Banking.

 To study the international experience with respect to adoption of Universal Banking

Model, its advantages, limitations and other issues

 To analyse the emerging trends in universal banking, regulatory requirements given by

RBI & other committee recommendations in India with respect to specific cases of ICICI,
IDBI & SBI.

 To determine the Future Role of DFI’s & Various Operational Issues required to be
considered.
 Research Methodology

Research in common parlance refers to a search of knowledge. One can also define research as
a scientific and systematic search for pertinent information on a specific topic. Research is, thus,
an original contribution to the existing stock of knowledge making for its advancement.
Research methodology is a way to systematically solve the research problem. Thus,
when we talk of research methodology we not only talk of the research methods but also
consider the logic behind the methods we use in the context of our research study and explain
why we are using a particular method or technique and why we are not using others so that
research results are capable of being evaluated either by the researcher himself or by others. The
study of research methodology gives the student the necessary training in gathering materials
from the various sources.
Here , descriptive and analytical research has been used.

For carrying out this project study, various sources of data were used. The data used were
of two types, i.e. Primary as well as Secondary.
 PRIMARY DATA:- This constituted mainly the information provided by my project

guide and interviews conducted at the ICICI Bank, SBI and IDBI.

 SECONDARY DATA:- This constituted mainly of information collected through

 Internet;

 Audited Financial statements of respective organizations.

 Various publications of ICICI, IDBI and SBI and related to RBI.

 Technical and trade journals to banking industry.

 Books and magazines;

 Reports and publications of various associations connected with banks, etc

The Following Articles have also helped in understanding the concept while

preparing the project

I)

INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI) LIMITED

Analyst's Meet held on MAY 31, 2002

Universal banking

 IDBI is moving towards universal banking and it will take nine to 12 months to complete
the whole process as the IDBI Act will require necessary changes,` said Vora. The
corporatisation of IDBI will provide necessary flexibility in day to day working of the
institution.

IDBI Bank

IDBI is looking out for a strategic partner to offload its equity in IDBI Bank. As of March 31,
2002 IDBI holds 58 per cent in IDBI Bank. `We have set an internal deadline of September
2002 to bring down our stake to 40 per cent and we are in talk with various parties. We could
offload equity in two stages, where we bring down our stake to 44 per cent in the first phase
and to 40 per cent in the second phase,` said Vora.

 Vora categorically denied any move to merge IDBI Bank with IDBI.

Financial performance

 IDBI reported a 38.64 per cent decline in net profit to Rs 424 crore for the fiscal ended
March 31, 2002, compared to Rs 691 crore in the previous fiscal. Total income decreased
from Rs 8,828 crore to Rs 7,949 crore.
  The bank has taken several steps to reduce interest costs by retiring high-cost debt raised
in the past, and raising fresh debt from retail customers. This is reflected in decline in the
marginal and average cost of borrowing.

 Total assets as on March 31, 2002 stood at Rs.66,625 crore. IDBI continued to maintain
sound capital adequacy with a capital adequacy ratio (CAR) of 17.66 per cent at end-
March 2002 (15.8 per cent) as against the RBI stipulation of nine per cent. The debt to
equity ratio (including contingent liabilities) also was at 8.6:1.

II)

Sunday 27 January,2002

Universal banking by DFIs: Handy, but no solution to NPAs

UNIVERSAL banking, believed to be the panacea for beleaguered development financial

institutions (DFIs), is almost here. Last October, ICICI set in motion the process to transform
itself into a universal bank.
It was soon followed by IDBI in submitting a universal banking proposal to the regulator, the
Reserve Bank of India. For a while, it appeared that DFIs had finally found a solution to their
problems. Just for a while though. A few days ago none other than the RBI Governor, Mr Bimal
Jalan, publicly suggested that universal banking was unlikely to be the antidote to DFIs'
historical baggage. Now, we are back to asking a basic question: What can universal banking
actually do?

Universal banks

Simply put, a universal bank is a supermarket for financial products. Under one roof, corporates
can get loans and avail of other handy services, while individuals can bank and borrow. To
convert itself into a universal bank, an entity has to negotiate several regulatory requirements.
Therefore, universal banks in the Indian context have been in the form of a group offering a
variety of services under an umbrella brand such as ICICI or HDFC. Even finance companies
such as Sundaram Finance use the goodwill associated with their brand, and the years of
information and insight, to offer a number of services under an umbrella brand.

Need to move farther

Since ICICI already practices a form of universal banking, the company's decision to merge with
ICICI Bank begs the question, why change the system now? The answer to that question lies in
the complex and messy past of DFIs — in this context ICICI, IDBI and IFCI.

The DFIs were established to assess and finance viable industrial projects that required long-term
funds. The government made available subsidised funds to help carry out on-lending. In the early
1990s, subsidised funding to DFIs was terminated, thereby forcing them to rely on the market for
resources.

ICICI was the earliest to articulate a new strategy to combat the problems. Once loans to
commodity industries began to turn bad, the company's incremental lending was directed at
short-term loans for working capital and retail customers. At the same time, ICICI lobbied for
years to reverse-merge itself with ICICI Bank — a commercial bank promoted by ICICI in
January 1994. Banks, by virtue of collecting savings and time deposits, have the cheapest source
of funds, and a merger with ICICI Bank should help ICICI access the funds at the lowest
possible cost for a commercial entity. After years of lobbying, ICICI took the step to convert
itself into a universal bank last October. IDBI, still owned largely by the Government and subject
to a different set of rules, has begun to work towards a merger with a commercial bank. Though
IDBI has promoted a commercial bank, IDBI Bank, the DFI is believed to be exploring the
possibility of a merger with a state-owned commercial bank.

III)
Online edition of India's National Newspaper
Wednesday, Sep 10, 2003

SBI to leverage network to become universal bank

The Asset Reconstruction Company (ARC), jointly floated by SBI, IDBI, ICICI and HDFC, has
identified 11 accounts for acquisition in the first tranche of NPA (non-performing assets) buying.
The size of these assets put together will be around Rs. 6000 crores.

Addressing a press conference here today to mark the computerisation of all branches in Chennai
Circle and also to launch a couple of new products, A. K. Purwar, Chairman of SBI, reckoned
that the ARC would play an `important' role in the resolution of NPAs.

Fielding a range of questions, Mr. Purwar said SBI was doing well so far this year with the retail
business showing a growth of 40 per cent plus. Nonetheless, he said the overall credit growth
was not up to the mark. To a query, he said the retail asset portfolio of the bank was around 18
per cent. The proposal was to take this up to 30 per cent. He, however, was quick to add that he
"does not propose to sacrifice other segments in the bargain".

Responding to questions on RIBs (Resurgent India Bonds), which are coming up for service
soon, Mr. Purwar was confident that the two new products that the SBI had proposed during road
shows abroad would be attractive enough for NRIs (non-resident Indians) to invest. He was
hopeful that SBI would retain at least 35 per cent of the RIB money with it through subscription
to these new products. In his view, the interest rate obtaining in India was far higher to that
prevailing in the U.S. and Europe.

The LIBOR plus dollar rate was around one per cent. The rupee rate was, however, hovering
around 4.5 per cent, he said. To queries on effecting a cut in deposit and lending rates, Mr.
Purwar was unwilling to hazard any guess on the thinking of the bank at this point in time. He
said the bank was "evaluating the situation".

Nonetheless, he pointed to the RBI signals and actions on the ground by some banks vis-a-vis
deposit rates.

On the NPA, Mr. Purwar said there was no clear-cut policy. Yet, the bank, he said, was pining to
reduce the net NPA to 2 per cent by March 2005.

The SBI Chairman said, "We are converting ourselves into a universal bank, leveraging the
distribution network". To a question on associate banks of SBI, Mr. Purwar said they were all
loosely integrated through one technology platform and similar business process. "In the coming
days, there will be much more integration and co-ordination," he said. Questioned on the
possibility of swapping branches between SBI and its associates, he said, "we have not looked at
it now. We may perhaps do it at the right time as it comes along".

Earlier in his opening remark, Mr. Purwar said all the 590 branches had been fully computerised.
Chennai Circle was the third only to be fully automated besides Bangalore and Chandigarh.

He also launched two new products — State Bank Cash Plus and SBI Credit Khazana. State
Bank Cash Plus is a global ATM-cum-debit card, which allows customers to draw cash from
Maestro/Cirru branded ATMs across the globe. The card usage is, however, subject to forex
regulations.

SBI Credit Khazana is a scheme for customers who have availed themselves of housing loans
and regular in serving them. Under the scheme, customers can enjoy lower interest rates and
margins for other retail products of the bank.
India’s Universal banks : Size does
matter
I) ICICI -UNIVERSAL BANKING MODEL

India’s First Universal Bank

History of ICICI
1955: The Industrial Credit and Investment Corporation of India Limited (ICICI)
incorporated at the initiative of the World Bank, the Government of India and
representatives of Indian industry, with the objective of creating a development
financial institution for providing medium-term and long-term project financing to
Indian businesses. Mr. A. Ramaswami Mudaliar elected as the first Chairman of
ICICI Limited
ICICI emerges as the major source of foreign currency loans to Indian industry.
Besides funding from the World Bank and other multi-lateral agencies, ICICI also
among the first Indian companies to raise funds from International markets.
1956: ICICI declared its first Dividend at 3.5%.
1958: Mr.G.L.Mehta was appointed the 2nd Chairman of ICICI Ltd.
1960: ICICI building at 163, Back bay Reclamation was inaugurated.
1961: The first West German loan of DM 5 million from Kredianstalt was obtained by
ICICI.
1967: ICICI made its first debenture issue for Rs.6 crore, which was oversubscribed.
1969: First two regional offices in Calcutta and Madras were opened.
1972: Second entity in India to set-up merchant banking services.
Mr. H. T. Parekh appointed as the third Chairman of ICICI.
1977: ICICI sponsors the formation of Housing Development Finance Corporation.
Managed its first equity public issue
1978: Mr. James Raj appointed as the fourth Chairman of ICICI.
1979: Mr.Siddharth Mehta appointed as the fifth Chairman of ICICI.
1982: Becomes the first ever Indian borrower to raise European Currency Units.
ICICI commences leasing business.
1984: Mr. S. Nadkarni appointed as the sixth Chairman of ICICI.
1985: Mr.N.Vaghul appointed as the seventh Chairman and Managing Director of ICICI.
1986: ICICI first Indian Institution to receive ADB Loans. First public issue by an Indian
 entity in the Swiss Capital Markets.

ICICI along with UTI sets up Credit Rating Information Services of India Limited,
(CRISIL) India's first professional credit rating agency.
ICICI promotes Shipping Credit and Investment Company of India Limited. (SCICI)
The Corporation made a public issue of Swiss Franc 75 million in Switzerland, the
first public issue by any Indian equity in the Swiss Capital Market.
1987: ICICI signed a loan agreement for Sterling Pound 10 million with Commonwealth
Development Corporation (CDC), the first loan by CDC for financing projects in
India.
1988: ICICI promotes TDICI - India's first venture capital company.
1993: ICICI sets-up ICICI Securities and Finance Company Limited in joint venture with J.
P. Morgan.
ICICI sets up ICICI Asset Management Company.
1994: ICICI sets up ICICI Bank.
1996: ICICI becomes the first company in the Indian financial sector to raise GDR.

ICICI announces merger with SCICI.

Mr.K.V.Kamath appointed the Managing Director and CEO of ICICI Ltd

1997: ICICI was the first intermediary to move away from single prime rate to three-tier
prime rates structure and introduced yield-curve based pricing.
The name "The Industrial Credit and Investment Corporation of India Limited " was
changed to "ICICI Limited".
ICICI announces takeover of ITC Classic Finance.
1998: Introduced the new logo symbolizing a common corporate identity for the ICICI
Group.
ICICI announces takeover of Anagram Finance.
1999: ICICI launches retail finance - car loans, house loans and loans for consumer
durables.
ICICI becomes the first Indian Company to list on the NYSE through an issue of
American Depositary Shares.
2000: ICICI Bank becomes the first commercial bank from India to list its stock on NYSE.

ICICI Bank announces merger with Bank of Madura.

2001: The Boards of ICICI Ltd and ICICI Bank approved the merger of ICICI with ICICI
Bank.
2002: Moody assign higher than sovereign rating to ICICI.
Merger of ICICI Limited, ICICI Capital Sercvices Ltd and ICICI Personal Financial
Services Limited with ICICI Bank.

2003 The first Integrated Currency Management Centre launched in Pune.

:
: The first offshore banking unit (OBU) at Seepz Special Economic Zone, Mumbai,
launched.
: Representative office set up in China. : ICICI Bank’s UK subsidiary launched.

: India’s first ever "Visa Mini Credit Card", a 43% smaller credit card in dimensions
launched.

2004 : Max Money, a home loan product that offers the dual benefit of higher
eligibility and affordability to a customer, introduced.
: Mobile banking service in India launched in association with Reliance
Infocomm.
: India’s first multi-branded credit card with HPCL and Airtel launched.
: ICICI Bank introduced 8-8 Banking wherein all the branches of the Bank
would remain open from 8a.m. to 8 p.m. from Monday to Saturday.
2005: "Free for Life" credit cards launched wherein annual fees of all ICICI Bank
Credit Cards were waived off.
: ICICI Bank and Visa jointly launched mChq – a revolutionary credit card on
the mobile phone.
: ICICI Bank became the first private entity in India to offer a discount to retail
investors for its follow-up offer.
2006 : ICICI Bank became the first Indian bank to issue hybrid Tier-1 perpetual debt
in the international markets.
: Introduced a new product - ‘NRI smart save Deposits’ – a unique fixed deposit
scheme for nonresident Indians.
2007 : ICICI Bank‘s USD 2 billion 3-tranche international bond offering was the
largest bond offering by an Indian bank.
: Sangli Bank amalgamated with ICICI Bank.
: ICICI Bank raised Rs 20,000 crore (approx $5 billion) from both domestic and
international markets through a follow-on public offer.
: Launched India’s first ever jewellery card in association with jewelry major
Gitanjali Group.
 : Launched Bank@home services for all savings and current a/c customers
residing in India
2008 : ICICI Bank enters US, launches its first branch in New York
: ICICI Bank launched iMobile, a breakthrough innovation in banking where
practically all internet banking transactions can now be simply done on mobile
phones.
 ICICI As A Universal Bank

REVERSE MERGER OF ICICI & ICICI BANK

ICICI Bank is India's second-largest bank with total assets of Rs. 3,767.00 billion (US$ 96
billion) at December 31, 2007 and profit after tax of Rs. 30.08 billion for the nine months ended
December 31, 2007. ICICI Bank is second amongst all the companies listed on the Indian stock
exchanges in terms of free float market capitalization. The Bank has a network of about 955
branches and 3,687 ATMs in India and presence in 17 countries. ICICI Bank offers a wide range
of banking products and financial services to corporate and retail customers through a variety of
delivery channels and through its specialized subsidiaries and affiliates in the areas of investment
banking, life and non-life insurance, venture capital and asset management. The Bank currently
has subsidiaries in the United Kingdom, Russia and Canada, branches in Unites States,
Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre and
representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand,
Malaysia and Indonesia. Our UK subsidiary has established a branch in Belgium.

ICICI Bank offers a wide range of banking products and financial services to corporate and
retail customers through a variety of delivery channels and through its specialized subsidiaries
and affiliates in the areas of investment banking, life and non-life insurance, venture capital,
asset management and information technology. ICICI Bank's equity shares are listed in India on
stock exchanges at Chennai, Delhi, Kolkata and Vadodara, the Stock Exchange, Mumbai and the
National Stock Exchange of India Limited and its American Depositary Receipts (ADRs) are
listed on the New York Stock Exchange (NYSE).

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution,
and was its wholly owned subsidiary. ICICI's shareholding in ICICI Bank was reduced to 46%
through a public offering of shares in India in fiscal 1998, an equity offering in the form of ADRs
listed on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of Madura Limited in an all-
stock amalgamation in fiscal 2001, and secondary market sales by ICICI to institutional investors
in fiscal 2001 and fiscal 2002. ICICI was formed in 1955 at the initiative of the World Bank, the
Government of India and representatives of Indian industry. The principal objective was to create
a development financial institution for providing medium-term and long-term project financing
to Indian businesses.
In 2001, After consideration of various corporate structuring alternatives in the context of
the emerging competitive scenario in the Indian banking industry, and the move towards
universal banking, the managements of ICICI and ICICI Bank formed the view that the
merger of ICICI with ICICI Bank would be the optimal strategic alternative for both
entities, and would create the optimal legal structure for the ICICI group's universal
banking strategy.
The merger would enhance value for ICICI shareholders through the merged entity's
access to low-cost deposits, greater opportunities for earning fee-based income and the
ability to participate in the payments system and provide transaction-banking services. The
merger would enhance value for ICICI Bank shareholders through a large capital base and scale
of operations, seamless access to ICICI's strong corporate relationships built up over five
decades, entry into new business segments, higher market share in various business segments,
particularly fee-based services, and access to the vast talent pool of ICICI and its subsidiaries. In
October 2001, the Boards of Directors of ICICI and ICICI Bank approved the merger of ICICI
and two of its wholly owned retail finance subsidiaries, ICICI Personal Financial Services
Limited and ICICI Capital Services Limited, with ICICI Bank. The merger was approved by
shareholders of ICICI and ICICI Bank in January 2002, by the High Court of Gujarat at
Ahmedabad in March 2002, and by the High Court of Judicature at Mumbai and the
Reserve Bank of India in April 2002. Consequent to the merger, the ICICI group's
financing and banking operations, both wholesale and retail, have been integrated in a
single entity.
ICICI has transformed itself from the role of a FI to a Universal Bank. The company is making
constant efforts to take first mover advantage in the technology-related businesses. In the past,
there has considerable amount of influence and direction from the government in ICICI’s
policiesICICI became the first Indian Company to get listed on the NYSE on September 22,
1999. ICICI, the only FI having private participation since its inception, is the second largest in
the sector with an asset base of Rs734.14bn as at FY2001 end.

Indian financial system comprises financial institutions, which were set up with the objective of
providing long term finance, commercial banks fulfilling working capital and general banking
needs, specialized investment institutions like LIC, GIC, UTI and private sector Non-Banking
Finance Companies (NBFCs). This demarcation no longer exists. Historically, the sector has
been dominated by State owned institutions. The twin forces of deregulation and technology
have increased the degree of competition in the Indian financial sector to unprecedented levels.

Concessional funding is no longer available. Government guaranteed SLR and other bonds,
which used to be the pre-dominant source of funding till 1993, has been phased out in
accordance with the reform process. These account for less than 10% of asset base of FIs and are
due for repayment within 3-4 years. On the other hand interest rates have fallen sharply and
disintermediation has grown rapidly. Banks are competing in each area (banks have a much
wider access to deposits, especially low cost demand deposits) spreads are under pressure, long-
term outlook looks unfavourable.

ICICI has transformed itself from the role of a FI to a Universal Bank. The company is making
constant efforts to take first mover advantage in the technology-related businesses. In the past,
there has considerable amount of influence and direction from the government in ICICI’s
policies. However, of late, under the direction of Mr.K.V.Kamath, ICICI has quite successfully
broken away from direct government interference. Private participation in equity since inception
and its image of a professionally managed company has enabled ICICI to recruit professional
managers and fresh MBAs from premier institutes consistently. Key rest with professional
managers.
ICICI is undoubtedly one of India’s best-managed financial institutions. ICICI’s project loans’
team has considerable depth and wide experience in project and loan appraisals. With excellent
quality manpower, ICICI is forging ahead very strongly on its mission to transform itself from a
project-finance /development banking institution to a universal bank catering to all kinds of
needs of both retail and corporate customers. The company has placed itself in a perfect position
to take any benefit accruing in the Indian Financial sector because of further technological
changes. Its diversification of business portfolio will also help it to leverage its strength from one
segment to another.

Universal Banking, ICICI Style

ICICI: Bonds, loans, ICICI Web Trade: Online
corporate finance, and stock trading
infrastructure finance
ICICI Bank: Retail and ICICI Home: Housing
corporate banking, and finance
cash management
ICICI Capital: ICICI Securities: I-Banking,
Financial products corporate finance, and
marketing and advisory
distribution
ICICI Prudential: Life ICICI Brokerage: Broking
Insurance joint venture and equity research
ICICI Lombard: ICICI Venture: Private
General Insurance joint equity investments
venture
ICICI Infotech: ICICI Kinfra: Infrastructure
Software solutions and financing in Kerala
IT-enabled services
ICICI Personal ICICI Winfra: Infrastructure
Financial Services: financing in West Bengal
Retail loan distribution
ICICI International: ICICI Knowledge Park:
Offshore investment Infrastructure and support
and fund management facilities
Reasons Behind Merger

The reasons that compelled ICICI Ltd. to become a ‘Universal bank’ had much to do with the
change in global banking environment rather than its internal dynamics. The reasons for the
merger merely reflect the dilemma faced by the entire Indian banking community in general and
the development banking sector in particular.
1.) Commercial banks have access to low cost funds in the form of savings and current account
deposits. But development banks can access public money only through bonds of at least five
years’ maturity and at a fairly high rate of return. So the attraction of cheap source of funds lured
ICICI Ltd. to reverse merge itself with its commercial offspring.

2.) It became quite clear after 1992 that concentrating was a very risky strategy. ICICI Ltd.
needed to spread its risks. And the only way for it was to become a financial conglomerate – a
financial superstore that provides banking, insurance, fund management, mutual funds and
securities trading under the same umbrella. This was reflected in the words of ICICI chief when
he said, “I see the process of becoming a financial conglomerate as a de-risking exercise”.

3.) Development banks provide long-term project finance. So they need cheap source of long-
term funds. The lowering of the Bank Rate and the cash reserve ratio (CRR) by RBI has led to a
fall in the Prime Lending Rate (PLR) leading to erosion in bank’s income.This falling interest
rate regime, as mirrored by the following chart, has led to serious asset-liability mismatch for the
banks. This is another reason for development banks like ICICI Ltd. to convert themselves into
universal banks.

4.) One of the prime reasons for the merger was to derive operational synergies as both the
entities were in the same line of business with slightly different specialisation. While ICICI Ltd.
was expert in long-term management of finance and dealing with large institutional (both
domestic and foreign) clients, ICICI Bank focused on the domestic consumer and small to
medium sized corporates. Moreover, the merger was also expected to lead to greater tax
efficiencies and consolidation of holdings.

5.) Indians are now following the global trend of ‘spending tomorrow’s money today’, i.e., the
practice of using credit to finance purchases of all kinds of goods – from houses to mixer
grinders. Banks from both the public and private domain are now providing consumer loans at
cheap rates of interest But again development banks cannot provide consumer loans until they
get converted into commercial ones.

6.) India is slowly becoming a global economy. So inevitably every industry has to reach global
scale to survive. But out of 95 scheduled commercial banks, only State Bank of India ranks
among top 200 banks in the world. So all types of banks are frantically trying to grow in size in
any way possible. And the shortest way to achieve it is through the way of merger. During the
last 35 years, about 36 banks and non-banking finance companies have merged. But the great
wave is yet to come. ICICI Ltd. has shown the way.
II) IDBI
History Of IDBI
July 1964: Set up under an Act of Parliament as a wholly owned subsidiary of Reserve Bank
of India.
February 1976: Ownership transferred to Government of India. Designated Principal
Financial Institution for coordinating the working of institutions at national and State levels
engaged in financing, promoting and developing industry.
March 1982: International Finance Division of IDBI transferred to Export-Import Bank of
India, established as a wholly owned corporation of Government of India, under an Act of
Parliament.
 April 1990: Set up Small Industries Development Bank of India (SIDBI) under SIDBI Act as
a wholly owned subsidiary to cater to specific needs of small-scale sector. In terms of an
amendment to SIDBI Act in September 2000, IDBI divested 51% of its shareholding in
SIDBI in favour of banks and other institutions in the first phase. IDBI has subsequently
divested 79.13% of its stake in its erstwhile subsidiary to date.
January 1992: Accessed domestic retail debt market for the first time with innovative Deep
Discount Bonds; registered path-breaking success.
December 1993: Set up IDBI Capital Market Services Ltd. as a wholly owned subsidiary to
offer a broad range of financial services, including Bond Trading, Equity Broking, Client Asset
Management and Depository Services. IDBI Capital is currently a leading Primary Dealer in the
country.
September 1994: Set up IDBI Bank Ltd. in association with SIDBI as a private sector
commercial bank subsidiary, a sequel to RBI's policy of opening up domestic banking sector to
private participation as part of overall financial sector reforms.
October 1994: IDBI Act amended to permit public ownership up to 49%.
July 1995: Made Initial Public Offer of Equity and raised over Rs.2000 crore, thereby reducing
Government stake to 72.14%.
March 2000: Entered into a JV agreement with Principal Financial Group, USA for
participation in equity and management of IDBI Investment Management Company Ltd.,
erstwhile a 100% subsidiary. IDBI divested its entire shareholding in its asset management
venture in March 2003 as part of overall corporate strategy.
March 2000: Set up IDBI Intech Ltd. as a wholly owned subsidiary to undertake IT-related
activities.
June 2000: A part of Government shareholding converted to preference capital, since
redeemed in March 2001; Government stake currently 58.47%.
August 2000: Became the first All-India Financial Institution to obtain ISO 9002:1994
Certification for its treasury operations. Also became the first organization in Indian financial
sector to obtain ISO 9001:2000 Certification for its forex services.
March 2001: Set up IDBI Trusteeship Services Ltd. to provide technology-driven information
and professional services to subscribers and issuers of debentures.
February 2002: Associated with select banks/institutions in setting up Asset Reconstruction
Company (India) Limited (ARCIL), which will be involved with the strategic management of
non-performing and stressed assets of Financial Institutions and Banks.
September 2003: IDBI acquired the entire shareholding of Tata Finance Limited in Tata
Home finance Ltd, signaling IDBI's foray into the retail finance sector. The housing finance
subsidiary has since been renamed 'IDBI Home finance Limited'.
December 2003: On December 16, 2003, the Parliament approved The Industrial
Development Bank (Transfer of Undertaking and Repeal Bill) 2002 to repeal IDBI Act 1964. The
President's assent for the same was obtained on December 30, 2003. The Repeal Act is aimed at
bringing IDBI under the Companies Act for investing it with the requisite operational flexibility
to undertake commercial banking business under the Banking Regulation Act 1949 in addition to
the business carried on and transacted by it under the IDBI Act, 1964.
July 2004: The Industrial Development Bank (Transfer of Undertaking and Repeal) Act 2003
came into force from July 2, 2004.
July 2004: The Boards of IDBI and IDBI Bank Ltd. take in-principle decision regarding
merger of IDBI Bank Ltd. with proposed Industrial Development Bank of India Ltd. in their
respective meetings on July 29, 2004.
September 2004: The Trust Deed for Stressed Assets Stabilization Fund (SASF) executed by
its Trustees on September 24, 2004 and the first meeting of the Trustees was held on September
27, 2004.
September 2004: The new entity "Industrial Development Bank of India" was incorporated on
September 27, 2004 and the Registrar of Companies issued Certificate of commencement of
business on September 28, 2004.
September 2004:Notification issued by Ministry of Finance specifying SASF as a financial
institution under Section 2(h)(ii) of Recovery of Debts due to Banks & Financial Institutions Act,
1993.
September 2004:Notification issued by Ministry of Finance on September 29, 2004 for issue
of non-interest bearing GOI IDBI Special Security, 2024, aggregating Rs.9000 crore, of 20-year
tenure.
September 2004: Notification for appointed day as October 1, 2004, issued by Ministry of
Finance on September 29, 2004.
September 2004: RBI issues notification for inclusion of Industrial Development Bank of
India Ltd. in Schedule II of RBI Act, 1934 on September 30, 2004.
October 2004: Appointed day - October 01, 2004 - Transfer of undertaking of IDBI to IDBI
Ltd. IDBI Ltd. commences operations as a banking company. IDBI Act, 1964 stands repealed.
January 2005: The Board of Directors of IDBI Ltd., at its meeting held on January 20, 2005,
approved the Scheme of Amalgamation, envisaging merging of IDBI Bank Ltd. with IDBI Ltd.
Pursuant to the scheme approved by the Boards of both the banks, IDBI Ltd. will issue 100
equity shares for 142 equity shares held by shareholders in IDBI Bank Ltd. EGM has been
convened on February 23, 2005 for seeking shareholder approval for the scheme.
 IDBI As A Universal Bank

Merger of IDBI Bank Ltd. with IDBI Ltd.

+ =
During the four decades of its existence, IDBI has been instrumental not only in establishing a
well developed, diversified and efficient industrial and institutional structure but also adding a
qualitative dimension to the process of industrial development in the country. Cumulative
assistance sanctioned and disbursed by IDBI since inception up to end-September 2004
aggregated around Rs.2, 23,000 crore and Rs 1,78,000 crore respectively. IDBI's asset base stood
in the vicinity of Rs.63850 crores at end- September 2004.

As a considered response to changes in its operating environment following initiation of

reforms since the early nineties and the resultant concerns of IDBI's sustained viability
therein in its current avatar, IDBI, in consultation with the Government of India, decided
to transform into a commercial bank without eschewing its secular development finance
obligations. The migration to the new business model of commercial banking, with its gateway
to low-cost current/savings bank deposits, it was felt, would help overcome most of the
limitations of the current business model of development finance while simultaneously enabling
it to diversify its client/asset base.
Towards this end, the IDBI (Transfer of Undertaking and Repeal) Act 2003 was passed by
Parliament on December 16, 2003 and received the President's assent on December 30, 2003.
The provisions of the Act came into force from July 2, 2004 in terms of a Government
Notification to this effect. The Notification enabled IDBI to obtain the requisite statutory and
regulatory approvals, including those from RBI, for conversion into a banking company. The
new company viz. "Industrial Development Bank of India Limited" (IDBIL) was
incorporated on September 27, 2004 and the Registrar of Companies, Mumbai, issued the
certificate for commencement of business to IDBI Ltd. on September 28, 2004.
Subsequently, the Central Government notified October 1, 2004 as the 'Appointed Date'
and RBI issued the requisite notification on September 30, 2004 incorporating IDBI Ltd. as a
'scheduled bank' under the RBI Act, 1934. Consequently, IDBI, the erstwhile Development
Financial Institution of the country, formally entered the portals of banking business as IDBIL
from October 1, 2004, over and above the business currently being transacted.

On July 29, 2004, the Board of Directors of IDBI and IDBI Bank accorded in principle
approval to the merger of IDBI Bank with the Industrial Development Bank of India Ltd.
to be formed incorporated under the Companies Act, 1956 pursuant to the IDB (Transfer
of Undertaking and Repeal) Act, 2003 (53 of 2003), subject to the approval of shareholders
and other regulatory and statutory approvals. A mutually gainful proposition with positive
implications for all stakeholders and clients, the merger process is expected to be completed
during the current financial year ending March 31, 2005.

The merger of IDBI Bank with IDBI Ltd. seeks to consolidate businesses across the value
chain. The merger will provide a win-win situation for both the institutions and also enable
the merged entity to provide an array of customer-friendly services to its existing and
prospective clients. In a physical sense, this would enable IDBI to complete the integration
across the board.

The board of directors of the two financial intermediaries, decided that IDBI Bank, the 57 per
cent subsidiary of IDBI, will merge with its parent. The merger of IDBI Bank with IDBI will
see the resultant entity occupy a key slot in the Indian banking sweepstakes after State
Bank of India and ICICI Bank. Further, the long-cherished dream of IDBI to metamorphose
into a universal bank appears ready to be fulfilled. While the IDBI stock finally settled at Rs
66.75, up from Rs 63.15, the IDBI Bank stock hit the upper circuit of 20 per cent, closing at Rs
50.55, from the previous close of Rs 42.15 after the merger.The merged entity had a minimum
government shareholding of 51%. IDBI had a 55.5% stake in IDBI Bank while the Small
Industries Development Bank of India (Sidbi) holded 13.9%. LIC also has a 6.4% in IDBI Bank.
The government's stake in IDBI was 58.5%, while the other majority stakeholders are LIC with
4.4%, followed by SBI with 2.6% and UTI with 1.5%.

IDBI would continue to provide the extant products and services as part of its development
finance role even after its conversion into a banking company. In addition, the new entity would
also provide an array of wholesale and retail banking products, designed to suit the specific
needs cash flow requirements of corporates and individuals. In particular, IDBI would leverage
the strong corporate relationships built up over the years to offer customised and total financial
solutions for all corporate business needs, single-window appraisal for term loans and working
capital finance, strategic advisory and “hand-holding” support at the implementation phase of
projects, among others.

IDBI’s transformation into a commercial bank would provide a gateway to low-cost deposits like
Current and Savings Bank Deposits. This would have a positive impact on the Bank’s overall
cost of funds and facilitate lending at more competitive rates to its clients. The new entity would
offer various retail products, leveraging upon its existing relationship with retail investors under
its existing Suvidha Flexi-bond schemes. In the emerging scenario, the new IDBI hopes to
realize its mission of positioning itself as a one stop super-shop and most preferred brand for
providing total financial and banking solutions to corporates and individuals, capitalising on its
intimate knowledge of the Indian industry and client requirements and large retail base on the
liability side.
 III) State Bank Of India (SBI)

The State Bank of India, the country’s oldest Bank and a premier in terms of balance sheet
size, number of branches, market capitalization and profits is today going through a
momentous phase of Change and Transformation – the two hundred year old Public sector
behemoth is today stirring out of its Public Sector legacy and moving with an agility to give
the Private and Foreign Banks a run for their money.
The bank is entering into many new businesses with strategic tie ups – Pension Funds, General
Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant
Acquisition, Advisory Services, structured products etc – each one of these initiatives having a
huge potential for growth.
The Bank is forging ahead with cutting edge technology and innovative new banking models, to
expand its Rural Banking base, looking at the vast untapped potential in the hinterland and
proposes to cover 100,000 villages in the next two years.
It is also focusing at the top end of the market, on whole sale banking capabilities to provide
India’s growing mid / large Corporate with a complete array of products and services. It is
consolidating its global treasury operations and entering into structured products and derivative
instruments. Today, the Bank is the largest provider of infrastructure debt and the largest arranger
of external commercial borrowings in the country. It is the only Indian bank to feature in the
Fortune 500 list.

The Bank is changing outdated front and back end processes to modern customer friendly
processes to help improve the total customer experience. With about 8500 of its own 10000
branches and another 5100 branches of its Associate Banks already networked, today it offers the
largest banking network to the Indian customer. The Bank is also in the process of providing
complete payment solution to its clientele with its over 8500 ATMs, and other electronic
channels such as Internet banking, debit cards, mobile banking, etc.
The bank is also looking at opportunities to grow in size in India as well as Internationally. It
presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in
India – SBI Capital Markets, SBICAP Securities, SBI DFHI, SBI Factors, SBI Life and SBI
Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising
capital for its growth and also consolidating its various holdings.

Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and
take all employees together on this exciting road to Transformation. In a recently concluded mass
internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two day
workshops across the country and covered over 130,000 employees in a period of 100 days using
about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops
fired the imagination of the employees with some other banks in India as well as other Public
Sector Organizations seeking to emulate the programme.The elephant has indeed started to
dance.
 STATE BANK OF INDIA
BANKING: Largest bank in the country, 9,043
branches, Rs 19,680.3 crore in deposits.

MUTUAL FUNDS: 100 per cent subsidiary

SBI Mutual Fund manages 20 schemes, Rs 3,500
crore in assets.

MERCHANT BANKING: SBI Capital, a 100

per cent subsidiary, is one of the oldest merchant
banks in India.

CREDIT CARDS: SBI-GE, a 60:40 joint

venture with GE Capital has 700,000 card
members.

CONSUMER FINANCE: SBI markets

consumer finance through its personal loan
schemes and has a loan portfolio of Rs 233 crore.

GOVERNMENT SECURITIES TRADING:

SBI Gilts, a 100 per cent subsidiary, trades in
gilts.

INSURANCE: SBI-Life, a JV with Cardiff SA, is entering

the bancassurance business
 SBI: Charging Ahead

SBI dominates the Indian banking sector with a market share of around 20% in terms of total
banking sector deposits. The increasing focus on upgrading the technology back-bone of the bank
will enable it to leverage its reach better, improve service levels, provide new delivery platforms,
and improve operating efficiency to counter the threat of competition effectively. Once the core
banking solution (CBS) is fully implemented, it will cover over 10,000 branches and ATMs of the
State Bank group, and emerge as the strongest technology enabled distribution network in
India.The increasing integration of SBI with its associate banks (associates) and subsidiaries will
further strengthen its dominant position in the banking sector and position it as the country’s
largest universal bank.

Resource-raising capabilities

SBI’s funding profile is strong, underpinned by its strong retail deposit base. The bank is facing
increasing competition in its metropolitan and urban franchise. SBI’s strong franchise gives it
access to a steady source of stable retail funds, which constitute around 59% of the total resources
as on March 31, 2005 (56% as at March 31, 2004).

Savings deposits have shown a strong three-year growth of 19%. Thus, despite a reduction in the
proportion of current account deposits, low-cost deposits have continued to constitute over 40% of
total deposits as at March 31, 2005. The bank’s cost of deposits (excluding IMD) has significantly
reduced to 4.70% for the 2004-05 (refers to financial year from April 1 to March 31), compared
with 5.48% in 2003-04. The bank’s liquidity position is very strong due to healthy accretion to
deposits, large limits in the call market, and significant surplus SLR investments. SBI will maintain
its strong funding profile and a low cost resource position in view of its strong retail base and wide
geographical reach.
Management strategies

In retail finance, the bank has leveraged its corporate relationships, pursued business growth
selectively, and has not competed based on interest rate. The bank has taken initiatives like on-line
tax returns filing and faster transfer of funds to protect its dominant position in the government
business. The bank also has a clear technology strategy that will enable it to compete with the new
generation private sector banks in customer service and operational efficiency.

Business description

SBI along with its associate banks offer a wide range of banking products and services across its
different client markets. The bank has entered the market of term lending to corporates and
infrastructure financing, traditionally the domain of the financial institutions. It has increased its
thrust in retail assets in the last two years, and has built a strong market position in housing loans.

SBI, through its non-banking subsidiaries, offers a host of financial services, viz., merchant
banking, fund management, factoring, primary dealership, broking, investment banking and credit
cards. SBI has commenced its life insurance business by setting up a subsidiary, SBI Life
Insurance Company Limited, which is a joint venture with Cardiff S.A., one of the largest
insurance companies in France. SBI currently holds 74% equity in the joint venture.

Industry prospects

To leverage benefits such as access to low cost resources and the facility to provide a larger gamut
of services, a number of finance companies such as Kotak Mahindra Finance Limited and HDFC
Limited have promoted banks. Simultaneously, yet another emerging trend is that of foreign banks
promoting NBFCs to benefit from regulatory flexibility available to such entities in areas like
absence of statutory liquidity ratio and cash reserve ratio requirements, priority sector
requirements, and corporate exposure limits.
I)---ICICI After Reverse Merger And Conversion
As A Universal Bank

MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF

OPERATIONS AND FINANCIAL CONDITION

The Board of Directors of ICICI Limited and ICICI Bank Limited, approved the merger of ICICI
with ICICI Bank on October 25, 2001. The merger of two wholly-owned subsidiaries of ICICI,
ICICI Personal Financial Services Limited and ICICI Capital services Limited, with ICICI Bank
was also approved by the respective Boards. The proposal has been submitted to the Reserve
Bank of India for its consideration and approval, and shall be subject to various other approvals,
including the approval of the shareholders of the respective companies, the High Courts of
Mumbai and Gujarat, and the Government of India as may be required. Consequently, the
Appointed Date of merger is proposed to be March 31, 2002, or the date from which RBI’s
approval becomes effective, whichever is later. The Scheme of Amalgamation (“the Scheme”)
approved by the respective Boards envisages a share exchange ratio of one equity share of ICICI
Bank for two equity shares of ICICI.

As on September 30, 2001, the equity share capital of ICICI Bank was Rs. 220.36 crore
consisting of 22.036 crore shares of Rs. 10 each and Reserves and Surplus of Rs. 1223.66 crore.
ICICI Bank has emerged as the leading private sector bank in India. Deposits grew 80 per cent to
Rs. 17,515 crore at September 30, 2001 as against Rs. 9,728 crore at september 30, 2000 and Rs.
16,378 crore at March 31, 2001. The share of ICICI Bank in total deposits of the banking system
increased to 1.52 per cent as on September 30, 2001 from 0.97 per cent at September 30, 2000.
Retail deposits constituted 67 per cent of total deposits as on September 30, 2001, compared to
48 per cent at September 30, 2000, reflecting ICICI Bank’s retail thrust and benefits arising from
Bank of Madura merger. Savings deposits registered a growth of 159 per cent to Rs. 2,186 crore
as on September 30, 2001 from Rs. 843 crore at September 30, 2000. ICICI Bank’s customer
assets (including credit substitutes) increased 80 percent to Rs. 11,409 crore at September 30,
2001 from Rs. 6,324 crore at September 30, 2000. ICICI Bank’s market share in customer assets
increased to 2.01 per cent at September 30, 2001 from 1.26 per cent at September 30, 2000. As
per its audited accounts, ICICI Bank recorded profit after tax (PAT) of Rs. 66.15 crore in Q2-
2002, an increase of 120% from Rs. 30.06 crore in Q2-2001.

On the merger being effective, the merged entity would be the second largest bank in India in
terms of assets with total assets of about Rs. 95,000 crore (pro forma at September 30, 2001),
396 existing branches/ extension counters of ICICI Bank, 140 existing retail finance offices and
centres of ICICI, and 8,275 employees. The merged entity would leverage on its large capital
base, comprehensive suite of products and services, extensive corporate and retail customer
relationships, technology-enabled distribution architecture, strong brand franchise and vast talent
pool. The merged entity would benefit from the access to low-cost deposits, greater opportunities
for earning fee-based income and the ability to participate in the payments system and provide
transaction-banking services. The retail segment will be a key driver of growth for the merged
entity, with respect to both assets and liabilities. The merged entity will have a combined cost-to-
income ratio of 27 per cent (pro forma for the half-year ended September 30, 2001).

ICICI currently holds 46% of the paid-up equity share capital of ICICI Bank. This holding would
not be cancelled under the scheme of amalgamation. It is proposed to be held in trust for the
benefit of the merged entity, and divested through appropriate placement by fiscal 2003, subject
to the provisions of the Scheme. The proceeds from the divestment will accrue to the merged
entity.
At the time of the merger, ICICI Bank would align the Indian GAAP accounting policies of
ICICI to those of ICICI Bank, including a higher general provision against standard assets.
Further, ICICI Bank has decided to adopt the “purchase method” of accounting, which is
mandatory under US GAAP, to account for the merger under Indian GAAP as well. ICICI’s
assets and liabilities will therefore be fair valued for the purpose of incorporation in the accounts
of ICICI Bank on the Appointed Date.
The higher proportion of deposits in the sources of funding of the merged entity, as compared to
long-term wholesale borrowings, may result in an excess of maturing liabilities over maturing
assets. However, the merged entity’s focus on raising resources through retail deposits, which is
recognised as a stable source of funding for banks, will impart greater stability to the liability
base. Further, the merged entity will maintain cash reserves and liquid investments in
Government securities, in compliance with statutory norms applicable to banks, which will
ensure adequate liquidity at all times. The merged entity will continue to manage its asset-
liability position carefully and adopt appropriate strategies to mitigate any risks arising
therefrom. Consequent to the merger, the businesses presently being carried on by ICICI would
become subject for the first time to various regulations applicable to banks. These include the
prudential reserve and liquidity requirements, namely Statutory Liquidity Ratio (SLR) under
Section 24 of the Banking Regulation Act, 1949, and Cash Reserve ratio (CRR) under Section 42
of the Reserve Bank of India Act, 1934. At present, the stipulated SLR is 25% of a bank’s net
demand and time liabilities in India and the stipulated CRR is 5.5% of the net demand and time
liabilities in India. SLR is required to be maintained in the form of Government securities and
other approved securities, while CRR is required to be maintained in the form of cash balances
with RBI. In addition to the above, the directed lending norms of RBI require that every bank
should extend 40% of net bank credit to certain eligible sectors, which are categorised as
“priority sector”. ICICI and ICICI Bank have submitted to RBI the proposal for compliance with
regulatory norms applicable to banks, and would adhere to RBI’s decision in the matter. Full
compliance with the prudential norms applicable to banks on all of ICICI’s existing liabilities is
likely to have an adverse impact on the overall profitability of both ICICI and ICICI Bank in
fiscal 2002, which cannot be quantified at this stage.

The top management of ICICI `enbloc' will form the top corporate management of the ICICI
Bank; among banks ICICI Bank may be the first to be headed by a non-executive Chairman and
except for him, all others in the top management, after the merger might be non-bankers. Also
the proposed merger is the first of its kind that a non-bank of a larger balance sheet size (Rs.
74,371 crores as on March 31, 2001) is proposed with a commercial bank (Rs. 203,809 crores);
post-merger again, the larger complement of ICICI staff will be non-bankers again, having
exposure to `credit' only and would probably require a refresher course on diverse banking
activities, the several enactments as well as the peculiar banking practices.
 Financial Position After Merger
ICICI posts Rs 285-cr consolidated net profit for the second quarter of 2002-
2003.

Financial Position After Merger

 Year Ending 2002(Rs Billion) Year Ending 2003(Rs
Billion)

Net interest 11.76 6.25

income and other
incomes

5.45 2.90
Operating Profits

1.29
Provisions and
2.87
Contingencies
Profit after tax 2.58 1.61

Financial Performance of ICICI Bank

 Particulars 00- 2001- 02-03 03-04 04-05 05-06 06-07
001 02
Total Income 1,462 2,726 12,526 11,958 12,826 18,767.6 28923
(Rs. cr.)

Operating 290 545 2,571 2,372 2,956 4,690.67 5874

Profit (Rs. cr.)

Net Profit (Rs. 161 258 1,206 1,637 2,005 2,540.07 3110
cr.)
Equity Capital 220 613 613 616 737 889.83 899
(Rs. Cr )

E.P.S. (diluted) 8.13 11.61 19.65 26.44 27.33 32.15 34.84

(Rs)

Deposits(Rs. 16,378 32,085 48,169 68,109 99,819 165,0 230510

cr.)
83
C.R.A.R. (%) 11.57 11.44 11.10 10.36 11.78 13.35% 11.69%

The Year of Reverse Merger

II)---IDBI As A Universal Bank

 Conversion into a Banking Company

Oct 1, 2004, converted into a banking company

 Mandated to continue playing the Development Financing role, with expansion into
commercial banking space.
 April 2, 2005, merged its Banking arm (IDBI Bank) with itself; effective date of merger
October 1, ’04.

Post-merger –

 GoI holding at around 53%.

 Wider branch network and access to low-cost funds
 Proven technology platform (Finacle from Infosys)
 Broader range of products; cross selling opportunities
 Large pool of professionally qualified employees to cater to both wholesale as well as
retail segment
 Oct 3,2006, amalgamated the erstwhile United Western Bank (UWB) with itself

Strong Capital Position (IDBI)

 20%

18%

16%

14%

12%

10%

8%

6%

4%

2%

0%
Tier I Capital Tier II Capital Total CAR
30-Sep-04 14.9% 3.3% 18.2%
31-Mar-05 11.9% 3.6% 15.5%
31-Mar-06 11.7% 3.1% 14.8%
31-Mar-07 9.1% 4.6% 13.7%

 Capital considerably higher than the current RBI requirement of 9%.

 Scope for raising further capital by way of Perpetual Tier I and Upper Tier II capital of

around Rs.1200 crore (USD 277 mln) and Rs.2766 crore (USD 636 mln) respectively .

Growth in Business

(Rs.crore)

As on: 31-03-05 31-03-06 31-03-07

Deposits 15103 26001 43354
Advances 45414 52739 62471
 Deposits at Rs.43,354 Cr; growth of 67%

 Retail Deposits grow by 27%

 CASA at 25.4% of total deposits

 Advances at Rs.62,471 Cr; growth of 18.5%

 Retail Advances constitute 15.7% of total advances (Previous Year 16.2%)

Strong Retail Growth

 Financials of The Merged Entity

IDBI IDBI Bank

C FY 04 FY 04 FY 04

ROA 0.60% 1.30% 0.95%

Investments (Rs in m) 98,800 39,100 137,900

Advances (Rs in m) 451,100 74,000 525,100

Deposits (Rs in m) 49,800 100,500 150,300

Net NPAs (Rs m) 11,244 623 11,867

Net NPA to advances 2% 0.80% 2.26%

Credit / Deposit Ratio 85% 73.60% 349%

No. of Branches 101 92 193

ATMs NA 298 298

No. of Employees 1,400 1,700 3,100

Business/employee (Rs m) - 108.0 108

Business / branch (Rs m) - 1,517 1,517

Profits/employee (Rs m) 2.7 0.8 3.5

Profit after Tax (Rs m) 3,789 1,326 5,115

No. of shares outstanding (m) 652.8 214.2

No of shares held by IDBI in IDBI Bank 120.0

(m)

No. of shares outdg post merger (m) 684.2

EPS (Rs) 5.8 6.3 7.48

Consolidated Entity
III)--- State Bank Of India
STATE BANK OF INDIA -FINANCIAL HIGHLIGHTS-2002-2007
Rs. in Billion FY2002 FY2003 FY2004 FY2005 FY 2006 FY2007
Deposits 2705.6 2961.24 3186.19 3670.48 3800.46 4355.21

Advances 1208.06 1377.58 1579.34 2023.74 2618.01 3373.36

Investments 1451.42 1723.48 1856.76 1970.98 1625.34 1491.49

Total Assets 3482.28 3758.76 4078.15 4598.83 4940.29 5665.65

Interest Income 298.10 310.87 304.60 324.28 359.80 394.91

Interest Expenses 207.29 211.09 192.74 184.83 203.90 234.37

Net Interest Income 90.81 99.78 111.86 139.45 155.89 160.54

Non-Interest Income 41.74 57.40 76.12 71.20 74.35 57.69

Total Operating Income 132.55 157.18 187.98 210.65 230.24 218.23

Staff Expenses 51.53 56.89 64.48 69.07 81.23 79.33

Overhead Expenses 20.58 22.53 27.97 31.67 36.02 38.91

Total Operating Expenses 72.11 79.42 92.45 100.74 117.25 118.24

Operating Profit 60.44 77.76 95.53 109.91 112.99 100.00

Total Provisions 36.14 46.70 58.72 66.86 68.93 54.59

Net Profit 24.30 31.06 36.81 43.05 44.07 45.41

 STATE BANK OF INDIA
KEY FINANCIAL INDICATORS(%) FY2002 FY2003 FY2004 FY2005 FY2006 FY2007
ROA 0.73 0.86 0.94 0.99 0.89 0.84
ROE 15.97 18.05 18.19 18.10 15.47 14.24
EPS(Rs.) 46.20 59.00 69.94 81.79 83.73 86.29
BVS(Rs.) 289 327 384 450 525 606
Dividend Pay out Ratio 12.98 14.40 15.73 15.29 16.72 16.22
Cost/Income Ratio 54.40 50.53 49.18 47.83 58.70 54.18
Capital Adequacy Ratio 13.35 13.50 13.53 12.45 11.88 12.34
Cost of Deposits 7.60 7.11 6.02 5.11 4.77 4.79
Yield on Advances 9.66 8.97 8.17 7.68 7.78 8.67
Yield on Resources Deployed 10.06 9.53 8.62 7.94 7.10 6.88
Net Interest Margin 2.91 2.95 3.04 3.39 3.40 3.31
Gross NPA Ratio 11.95 9.33 7.75 5.96 3.61 2.92
Net NPA Ratio 5.63 4.50 3.48 2.65 1.88 1.56
Provision Coverage 56 54 57 57 49 47

Balance Sheet Of SBI

MARCH MARCH
MARCH MARCH MARCH
(Rs. in billion) MARCH
2002 2005 2007
2003 2004 2006
CAPITAL & LIABILITIES
Capital 5.26 5.26 5.26 5.26 5.26 5.26
Reserves & Surplus 146.98 166.77 197.05 235.46 271.18 307.72
Deposits 2705.60 2961.23 3186.19 3670.48 3800.46 4355.21
Borrowings 93.24 93.04 134.31 191.84 306.41 397.03
Other Liabilities & Provisions 531.20 532.46 555.34 495.79 556.98 600.42
Total 3482.28 3758.76 4078.15 4598.83 4940.29 5665.65
ASSETS
Cash & balances with
218.73 127.38 190.41 168.10 216.53 290.76
Reserve Bank of India
Balances with banks and
430.58 324.43 245.25 225.12 229.07 228.92
money at call & short notice
Investments 1451.42 1723.48 1856.76 1970.98 1625.34 1491.49
Advances 1208.06 1377.58 1579.34 2023.74 2618.01 3373.36
Fixed Assets 24.15 23.89 26.45 26.98 27.53 28.19
Other Assets 149.34 182.01 179.94 183.91 223.81 252.92
Total 3482.28 3758.77 4078.15 4598.83 4940.29 5665.65
Contingent Liabilities 1022.13 1061.06 1118.92 1593.97 2288.51 3065.90
Bills for Collection 101.77 75.71 101.94 167.77 205.93 233.68

Limitations of the Study

1. All the information’s were not included as most of the information were confidential
and was not approachable.

2. The project is mainly confined to only three organizations.

3. Staff although were very helpful but were not able to give much of their time due to
their own job constraints.

4. Study was not very exhaustive and many concepts were not studied due to time and
other constraints.

5. The scope of the topic chosen was very wide.

6. The data collected by secondary sources sometimes comes out to be wrong

Challenges Ahead Of Universal Banking

(i) Improving profitability: The most direct result of the above changes is increasing
competition and narrowing of spreads and its impact on the profitability of banks. The challenge
for banks is how to manage with thinning margins while at the same time working to improve
productivity which remains low in relation to global standards. This is particularly important
because with dilution in banks’ equity, analysts and shareholders now closely track their
performance. Thus, with falling spreads, rising provision for NPAs and falling interest rates,
greater attention will need to be paid to reducing transaction costs. This will require tremendous
efforts in the area of technology and for banks to build capabilities to handle much bigger
volumes.

(ii) Reinforcing technology: Technology has thus become a strategic and integral part of
banking, driving banks to acquire and implement world class systems that enable them to
provide products and services in large volumes at a competitive cost with better risk management
practices. The pressure to undertake extensive computerisation is very real as banks that adopt
the latest in technology have an edge over others. Customers have become very demanding and
banks have to deliver customised products through multiple channels, allowing customers access
to the bank round the clock.

(iii) Risk management: The deregulated environment brings in its wake risks along with
profitable opportunities, and technology plays a crucial role in managing these risks. In addition
to being exposed to credit risk, market risk and operational risk, the business of banks would be
susceptible to country risk, which will be heightened as controls on the movement of capital are
eased. In this context, banks are upgrading their credit assessment and risk management skills
and retraining staff, developing a cadre of specialists and introducing technology driven
management information systems.

(iv) Sharpening skills: The far-reaching changes in the banking and financial sector entail a
fundamental shift in the set of skills required in banking. To meet increased competition and
manage risks, the demand for specialised banking functions, using IT as a competitive tool is set
to go up. Special skills in retail banking, treasury, risk management, foreign exchange,
development banking, etc., will need to be carefully nurtured and built. Thus, the twin pillars of
the banking sector i.e. human resources and IT will have to be strengthened.

(v) Greater customer orientation: In today’s competitive environment, banks will have to
strive to attract and retain customers by introducing innovative products, enhancing the quality of
customer service and marketing a variety of products through diverse channels targeted at
specific customer groups.

(vi) Corporate governance: Besides using their strengths and strategic initiatives for creating
shareholder value, banks have to be conscious of their responsibilities towards corporate
governance. Following financial liberalisation, as the ownership of banks gets broadbased, the
importance of institutional and individual shareholders will increase. In such a scenario, banks
will need to put in place a code for corporate governance for benefiting all stakeholders of a
corporate entity.
(vii) International standards: Introducing internationally followed best practices and observing
universally acceptable standards and codes is necessary for strengthening the domestic financial
architecture. This includes best practices in the area of corporate governance along with full
transparency in disclosures. In today’s globalised world, focusing on the observance of standards
will help smooth integration with world financial markets.

CONCLUSION

Universal Banking, means the financial entities – the commercial banks, DFIs, NBFCs, -
undertake multiple financial activities under one roof, thereby creating a financial supermarket.
The entities focus on leveraging their large branch network and offer wide range of services
under single brand name. . Ever since the process of liberalization hit the Indian shores, the
banking sector saw the emergence of new-generation private sector banks. Public sector banks
which played a useful role earlier on are now facing deterioration in their performance. For very
long, the banks in India were not allowed to have access to stock markets. So their dealing in
other securities were minimal. But the financial sector reforms changed it all, Indian banks
started to deal on the stock market but their bitter experience with scams, they became averse to
deal in equities and debentures. Off late, commercial banks in India have been permitted to
undertake a range of in-house financial services. Some banks have even setup their own
subsidiaries for their investment activities. Subsidiaries include in the area of merchant banking,
factoring, credit cards, housing finance etc.
Merger and acquisition is nothing new in the Indian banking industry. But there has been with
the banks firmly under the control of RBI, mergers were forced upon to save weak banks from
collapsing. The gradual privatization and globalization of the banking industry has now forced
banks themselves to go in for merger. Increase in profitability, synergies in operation, global
scale and other such reasons have replaced the social and political motives of yesteryears.
Successful mergers can lead to prosperity both for the shareholders of the merged company and
for the economy as a whole. The true catalyst of a successful merger is the top executive whose
pragmatic and dynamic leadership and a clear foresight can help a merger click. The trick is to
neutralize the expected pitfalls while bringing the best out of operational synergies. The making
of ICICI Bank, IDBI and others into a ‘Universal bank’ has shown the way. The reverse merger
of ICICI has thus opened up a challenge to the banks and financial institutions in India to merge
and become ‘financial conglomerate(s)’ by exploiting the present favourable business
environment and also to de-risk their operating environment.
The face of banking is changing rapidly. Competition is going to be tough and with financial
liberalisation under the WTO, banks in India will have to benchmark themselves against the best
in the world. For a strong and resilient banking and financial system, therefore, banks need to go
beyond peripheral issues and tackle significant issues like improvements in profitability,
efficiency and technology, while achieving economies of scale through consolidation and
exploring available cost-effective solutions. These are some of the issues that need to be
addressed if banks are to succeed, not just survive, in the changing millenium.

Due to globalization and liberalization our economy is opening its door for reforms. The onset
of universal banking will undoubtedly accelerate the pace of structural change within the Indian
banking system. The financial institutions as a segment will essentially convert into banks. This
can potentially impose a better corporate control structure on the firms, they can be sources of
long-term finance, and they can contribute to real sector restructuring. Thus Universal banking,
in fact, provides for a cafeteria approach or, if one were to vary the metaphor, it would take on
the role of a one-stop financial supermarket.

Caution must be applied on Universal banking because of the following considerations:

 . Dis-intermediation (i.e replacement of traditional bank intermediation between savers
and borrowers by a capital market process) is only a decade old in India and has badly
slowed down due to loss of investor’s confidence.

There is an ample room for financial deepening (by banks & DFIs) since loan market will
continue to grow.

DFIs as a folder of equity in most of the projects promoted in the past have never used
the tool advantageously. DFIs are now only moving into working capital finance, an area in
which they need to gain lot of expertise and this involves creation of network of services
(including branches) in all fields .

Reforms in the Indian capital market is still in the half way stage. The priority will be to
ensure branch expansions, financial deepening of credit markets, and creation of an efficient
credit delivery mechanism that can compete with the capital market.

The following are the steps suggested :

 Equalise the net regulatory burden across the financial system (including banks, DFIs,
mutual funds, NBFCs and Insurance companies.
 Lower the regulatory burden on the over regulated entities.

 Promote and encourage strong competition.

 Do not allow the merger of a weak bank with a viably strong DFI or vice-versa.

 DFIs should be permitted to set up a 100 percent owned banking subsidiaries.

 Need is felt to re-examine the minimum level of SLR requirement in to meet the
international standards.
 References

 Books

 Khan M Y, “Indian Financial System”, Tata McGraw Hill,2000.

 Francis J C, “Investment analysis and Management”, Tata McGraw Hill, 1991.

 Committee on Banking Reforms (Narasimham Committee II) Report, 1998.

  Development Research and Policy division, Financial Sector Reforms In Selected Asian
Countries (1999a).

 Sengupta A., “Financial Sector And Economic Reforms In India”, Economic and
political weekly, 1995.

 Soesastro, H, and M.C. Basri, “ Survey of Recent Economic Developments “ Bulletin of

Indonesian Economic Studies, 1998.

 Reserve Bank Of India, Report of the Narasimham Committee on Financial System,

1991.

 Reserve Bank Of India, RBI Annual Report (Various issues).

 SITES

 www.rbi.org.in
 www.indiainfoline.com
 www.icici.com
 www.idbi.com
 www.ifci.com
 www.economictimes.com
 www.businessindia.com
 www.domain-b.com
 www.businessstandard.com

 MAGAZINES
Annual Report of ICICI bank,IDBI,SBI.
 Indian Institute Journal

Appendix
IDBI mandated BCG for universal banking strategy in 2003

Industrial Development Bank of India has mandated the Boston Consulting Group(BCG) for
drawing a detailed strategy for the term-lending institution's metamorphosis into a universal
bank.

The strategy was aimed at reviewing the entire business perspective of the institution and giving
it the sharper competitive edge required to take on future competition.
The US-based consulting group devised a strategy that equipped IDBI's existing businesses to
meet future challenges, the official said.
Also, BCG spotted new business areas and new products for IDBI that hold promising future
business potential. The fundamental changes expected in IDBI's business perspective may in turn
require alterations in the regulatory framework for the institution itself, according to the official.
At 2003, the IDBI fall under a special regulatory act called the IDBI Act, and was not
accountable to either Banking Regulations Act or the Companies Act.
"Fundamental changes are likely because we can't go on competing in the marketplace and at the
same time be a development financial institution, without feeling the impact on our balance
sheet," the official said. "Our cost of funds is too high, when compared to bank which are
allowed to take deposits."
In 2003 "The choices are two, basically," the official said. "IDBI can either become a full-
fledged commercial bank, or it can become a non-banking finance company."
This mandate to BCG was seen as a significant fresh initiative on the part of the development
financial institution, after a yearlong spell of lethargy. The IDBI Board had taken up a report by
M B Athreya, but subsequently decided "the resources of a globally experienced consultant were
required to prepare the roadmap to universal banking."