1.

INTRODUCTION TO FINANCIAL SERVICES

Financial services can be defined as the products and services offered by institutions like
banks of various kinds for the facilitation of various financial transactions and other
related activities in the world of finance like loans, insurance, credit cards, investment
opportunities and money management as well as providing information on the stock
market and other issues like market trends.
The term “Financial Services” means “mobilizing and allocating savings”. In general, all
types of activities, which are of a financial nature, could be brought under the term
‘financial services’. Thus it includes all activities involved in the transformation of savings
into investment.

1.1 Types of Financial Services

Financial services could be fund based wherein the service provider will invest his own
fund and will bear some risk on his own balance sheet, to an extent. Most activities
however are non-fund based/fee based. These are intermediation activities. The service
provider here would act as a facilitator between the funding agency and the
corporate/firm. Fee based activities would also include assistance in investment
decisions.

Fund based activities Non-fund based activities

• Leasing • Issue Management

• Hire Purchase • Portfolio Management
• Bill Discounting • Capital Restructuring
• Loans • Loan Syndication
• Venture Capital • Mergers and
• Housing Finance Acquisitions
• Factoring & Forfaiting • Corporate Counseling
• Arranging foreign
collaboration

Points Fund Based Fee Based (Non-fund based)

Fund investment Service provider invests or Service provider does not invest
commits to invest, if necessary, his own funds.
his own funds.
Degree of risk Service provider is exposed to risk, Service provider’s risk is
to an extent. minimal.
Nature of role This is a participative role. This advisory, assistance and
role of intermediation
Includes Bill discounting, purchase of Management of IPO, Project
 commercial papers, underwriting, Feasibility Study, Custodian
etc. services, etc.

A] Fund Based services

 Own the fund by directly raising from the market
 Lend it to those who need them
 Firms raise equity, debts and deposits and invests in securities and lends to those
who are in need of capital
 Caters both short term and long term need
 E.g. commercial banking, term lending, bill discounting, leasing, factoring,
Forfeiting, Hire purchase, Venture Capital Financing, purchase of commercial
papers, etc.

1) Leasing
Leasing is an agreement under which a firm acquires a right to make use of a capital
asset like machinery, on payment prescribed fee called rental charges. Many financial
companies have started equipment leasing. A lease is an agreement under which a
company or a firm acquires a right to make use of capital asset like machinery, on
payment of prescribed fee called “rental charges”. The lease cannot acquire the ownership
to the asset, but he can use it and have full control over it. He is expected to pay all
maintenance charges and repairing and operating costs. In India, many financial
companies have started equipment leasing business. Commercial banks have also been
permitted to carry on this business by forming subsidiary companies. The lease
agreement can be classified as financial leasing, operational leasing, sale and leaseback,
leverage lease.

2) Hire purchase
Hire purchase is the legal terms for a contract, in these persons usually agree to pay for
goods in parts of a percentage at a time. Hire purchase is financial facilities which allow a
business to use an asset over a fixed period, in return for regular payments. The business
customer chooses the equipment it requires and the finance company buys it on behalf of
the business. With a hire purchase agreement, after all the payments have been made,
the business customer becomes the owner of the equipment. This ownership transfer
either automatically or on payment of an option to purchase fee. Under a hire purchase
agreement, the business customer is normally responsible for maintenance of the
equipment.

3) Discounting
Discounting is a financial mechanism in which a debtor obtains the right to delay
payments to a creditor, for a defined period of time, in exchange for a charge or fee.
 4) Loans
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of
financial asset over time, between the lender and the borrower. A loan is a type of debt.
The borrower initially does receive an amount of money from the lender, which they pay
back, usually but not always in regular installments, to the lender. This service is
generally provided at a cost, referred to as interest on the debt.

5) Venture Capital
A venture capital is another method of financing in the form of equity participation. It is in
contrast to the conventional security based financing. A venture capitalist finances a
project based on the potentialities of a new innovative project. It is in contrast to the
conventional “security based financing”. Much thrust is given to new ideas or
technological innovations. Finance is being provided not only for ‘development capital’ by
the financial intermediary.

6) Housing finance
In housing finance there are various schemes like purchase of new house, construction of
in home, home improvement, repairs, land purchase, bridge loans, etc. House financing is
a facility by which prospective buyer of any type of goods is provided required finance by
the seller. Thus, seller becomes financier too in case of in-house financing. There are
many type of advantages associated with this facility. First of all, a person is able to get
finance at lower costs as there are no middlemen involved. Middlemen here mean
financial institutions and other lenders that provide finance for buying goods. Second
advantage is getting finance at easy terms and conditions as seller of goods is making
profit out of sale also. Their advantage of in-house financing is that a person is not
required to approach different lenders and compare them for getting finance at lowest
cost. Similarly, in-house financing also involves less formalities pertaining to
documentation, etc. By way of in-house financing, a person is able to get finance quickly.

7) Factoring
It is an arrangement under which a financial intermediary assumes the credit risk in the
collection of book debts for its clients. The entire responsibility of collecting the book debts
passes on to the factor. His service can be compared to a De credre agent who undertakes
to collect debts. But a factor provides credit information, collects debt, monitors the sales
ledger and provides finance against debts. Thus, he provides a number of services apart
from financing.

8) Forfaiting
A forfaiter is a specialized service which offers non-recourse export financing through the
purchase of medium-term trade receivables. Similar to factoring, forfaiting virtually
eliminates the risk of nonpayment, once the goods have been delivered to the foreign
buyer in accordance with the terms of sale. However, unlike factors, forfaiters typically
work with the exporter who sells capital goods, commodities, or large projects and needs
to offer periods of credit from 180 days to up to seven years.

B] Non-fund/Fee Based services

 Enables the corporate sector and others to raise capital from the market of
exchange financial assets and risks with other participants of the market against
fee
 Help others raise funds
 Do not own the fund raised
 Provide advisory services for effective deployment of fund

1) Issue Management
It covers marketing of securities i.e. equity shares, preference shares, debentures or
bonds. It involves pre-issue and post-issue management. Pre-issue management can be
through prospectus offer for sale or provide placement. Post-issue management covers
collection of application forms, deciding allotment procedure, share certificate, refund
order, etc.

2) Portfolio management
Portfolio means combination of various securities and investment. Here merchant bankers
assist in maintaining the proper portfolio by having good qualification of shares,
debentures, bonds, government securities, equities, etc.

3) Loan Syndication
It refers to assistance to get term loan for project; it may be obtain from single institution.
The decision of which financial institutions to be approach and it is given by merchant
banking. This is more or less similar to consortium financing. But, this work is taken up
by the merchant banker as a lead manager. It also enables the members of the syndicate
to share the credit risk associated with a particular loan among them.

4) Advisory relating to Mergers and Takeovers

A merger is a combination of two or more companies into a single company where one
survives and other lose their corporate existence. A takeover is the purchase by one
company acquiring controlling interest in the share capital of another existing company.
Merger means that the two merging companies become history and a new firm is
established while acquisition means only one company become history which is the
acquired company while acquiring company remains.
 5) Corporate Counseling
It covers activities related to companies such as project counseling, capital restructuring,
project management, loan syndication, fixed deposits, working capital, lease finance,
public issue management. It is provide to every business unit to ensure better
performance, stay growth and better image among investor.

6) Credit rating
A credit rating is an evaluation of the credit worthiness of a debtor, especially a business
(company) or a government, but not individual consumers. Many credit rating agencies
have been established to help investors to make a decision of their investment in various
instruments and to protect them from risky ventures.

7) Mutual funds
It collects savings from small investors, invest them in Government and other corporate
securities and earn income through interest and dividends, besides capital gains.

8) Underwriting of securities
It is a guarantee given by underwriters to take up whole part of the issue of securities and
subscribed by the public. The underwriter works for a commission.

2. EVOLUTION OF UNIVERSAL BANKING

2.1 Meaning of Universal Banking
Universal Bank can be defined as a financial super market offering multifarious products
under one roof.

A Universal Bank normally has three distinguishable services which include:

 Commercial Banking – This is the routine operations of the bank which comprise
mostly of deposit taking and lending as well as the associated functions that go
with these tasks. Commercial banking was implemented to provide individuals with
a secure place to store their funds.
 Investment Banking – This section of the Universal Banking model deals with the
securities, which including issuing, underwriting and distributing them.
Investment banking was introduced in North America through the United States
shortly after the Revolution. The main reason for the introduction of Investment
banking was for the governments to issue bonds to finance wars, banks and
internal improvements.
 Insurance – The final division of a Universal Bank is the insurance sector. This is
basically the division where the bank offers products for individuals to transfer risk
from one party to another for a premium. It can be seen as taking a small loss to
 prevent a catastrophic loss. There are many different types of insurance products
for all cases, these ranges from auto insurance to life insurance to credit insurance.

In general, Universal Bank is a name given to banks engaged in diverse kind of banking
business which includes not only services related to savings and loans but also
investments, offering wide range of financial services, beyond commercial banking and
investment banking, insurance etc. If specialized banking is the one end universal
banking is the other. This is most common in European countries and this concept is
widely popular in countries like USA but is about to take-off officially in India, as the
definition of Universal Banking is yet to be established clearly and conclusively.
A narrow view of Universal banking could be activities pertaining to lending plus
investments in bonds and debentures. A broader view could include a basket of all the
financial activities including insurance.

The characteristics of Universal Banking heavily depend of two most important factors,
namely:
- The specific country’s diversification rules and regulations.
- The strengths of individual banks in enlarging the scope of the activities in the various
segments of financial services industry

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.

2.2 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". 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.
This is most common in European countries.

As mentioned in the Discussion Paper by Reserve Bank of India, the term Universal
banking in general refers to the combination of commercial banking and Investment
banking i.e., issuing underwriting, investing and trading in securities.

2.3 Rise of Universal Banking

Giving the relationship between money supply and inflation, the financial section in
most of the countries in the world, up to the 1970 and early ‘80s presented a picture of
highly structured and stratified industry.
 Clear demarcation lines used to exist between the functions of different institutions
within the financial system. This situation existed on account of two reasons:
 Restrictions in the regularly framework and
 Technical and economic barriers to entry like ownership and minimum equity
restrictions.
The combination of these factors had by and large a positive impact on the
performance of banks. But with the introduction of deregulation in most of the developed
countries in 1980s and the increasing disintermediation in both the domestic as well as
international capital markets, the banks became, very vulnerable to interest income i.e.
intermediation income.
This was further aggravated by three important developments in the governing
environment.
1. Regulatory prescription of capital cover (capital adequacy); irrespective of the
financial standing;
2. Globalization of local markets marked by interest rate competition and relaxation of
exchange controls
3. Developments in information technology and telecommunications allowing
international pooling of financial resources and the spreading of risk across more
than one market.
Amidst, all these developments, banks started placing more emphasis on new
sources of non-interest income. This led to the diversification in activities in financial
sector undertaken by the existing as well as new players. Some of these players later came
to be known as universal banks and their activities included activities like:
 Practice of making loans and advances on a longer term for example financing or
fixed investment in industrial enterprises;
 Intermediation in domestic and international financial markets through new
financial innovations in loan and liability products induced by the customer
derivatives;
 Underwriting new debt and equity issues;
 Venture capital
 Brokerage
 Corporate advisory services, including mergers and acquisition advice;
 Insurance
 Holding equity of nonfinancial firms in the bank’s portfolio

2.4 Classification of Universal Banks

http://w4.stern.nyu.edu/finance/docs/WP/1996/pdf/wpa96040.pdf
Creating Value in Financial Services: Strategies, Operations and Technologies - edited by Edward L. Melnick
According to one school of thought there are four different types of universal banks in the
world.
2.4.1 Fully Integrated Universal Bank
It is one institutional entity offering the complete range of services. It provides a
broad range of financial services (banking, securities, insurance) under a single
corporate structure supported by a single capital base. There are at present no
good examples of this particular model.

2.4.2 Partly Integrated Universal Bank

It conducts both commercial and investment banking within the same entity, but
undertakes insurance, underwriting and distribution, mortgage banking, assets
management, lease financing, factoring, management consulting, and other
specialized activities through separately capitalized subsidiaries, either because
such activities are separately regulated, or because they involve significant
potential for exploitation of conflicts of interest, or a combination of such factors.
Deutsche Bank is a good example of this type of universal banking structure.

2.4.3 Bank Subsidiary Structure

It is one which focuses essentially on commercial banking and other functions,
including investment banking and insurance, which are carried out through legally
separate subsidiaries of the bank. E.g. Barclays Banks, ICICI Bank, SBI

2.4.4 Bank Holding Company Structure

It involves creation of holding company which controls affiliates engaged in
commercial banking, investment banking, insurance and possibly other types of
financial and non-financial business. E.g. J. P. Morgan, CS Holding
 2.5 Global Scenario
Universal banking has played greater role in the continental Europe in general and
specifically in countries such as Germany and Switzerland since the end of world war II,
besides gaining importance from the perspective of stability of banking in these two
countries. However, experience of universal banking across countries revealed almost no
conclusive evidence either in favor of or against it anywhere including that of the main
practitioners, viz., Germany, Swiss and other European countries. There was substantial
debate in the literature, both for and against the system of universal banks. There who
were in favor of universal banking argued that as universal banks were by and large
bigger in size, there had been clear link between size and scope deriving scale economics,
by spreading their overhead costs over many clients and assets and could expand into the
full range of products and services while minimizing their risk of failures. Eugine White
(1986), also came out with a very similar conclusion that universal banks though involved
in securities trading had lesser chances of failure. Benston (1990) who explored if banking
crises during the pre Glass-Steagall era was mainly due to the then prevailing system of
universal banking concluded saying these were mainly due to the flaw in the internal
control system and inadequate supervision in general and had nothing to do with the
universal banking. In fact, it has been prominently pointed out that universal banks had
played crucial role to rebuild the Germany economy from the devastation of world war II.
Universal banks could be very useful especially in countries where capital markets play
limited role, while the economy demands large scale investment. Furthermore, as
universal banks were better placed to understand and appreciate the activities and fund
requirements of the borrowing units and accordingly offer ’tailor made’ products and
services, the banks could not only develop strong relationship with the borrowing firms,
but also ensure proper end use of funds. Rajan Raghuram (1996), added one more
dimension stating that the universal banks could use the reputation gained in
product/service to sell the other easily. There was also a view that though the ‘too big to
fail’ theory did not always hold good, the relative chances of failures for smaller
institutions were greater that the universal banks and thereby secure systematic stability.
Customers have the advantage of obtaining all possible financial services/ products at a
single point and it relieves them from the hassle of searching different service providers
for different services.
However the flip side of the arguments was also equally strong. As universal
banking combines both the commercial banking and investment banking under one roof,
it does raise certain issues which, inter alia were conflict of interests and impact on
systems stability.

2.5.1 Conflicts of Interests

Conflicts of interest arise mainly because of the multiple roles performed by the
universal banks. Being both lender and underwriter of a particular instrument of the
same company, banks have privileged access to the insider information of the company
and such access is feared to be misused by the banks for their own advantage at the
expense of depositors or the investors. In fact, this was the main premise on which the
Glass Steagall Act was enacted way back in 1933, resulting in separate of investment
banking from the traditional banking business and which continued as the hallmark of
banking practice in United States for almost seven decades till the enactment of Gramm
Leach Billey Act, 1999 which rolled back many of the earlier restrictions. Conflicts of
interest could take the following forms which however, are not entirely mutually exclusive,
viz.
 1. To promote the issue which it underwrites though the bank was well aware of the
company’s actual weakness;
2. As a fund manager sell all the unsold securities to the account holders merely to
shift the risks;
3. Transfer the ‘risk of default by its borrower firm’ to outside investors by issuing
securities to repay its own loans and
4. Access to insider information of the borrowing unit for bank’s own convenience.
In this context, it would be worth pointed that Santos had, stated that the vital
issue regarding any potential conflict of interests’ as outlined above rests not
merely on their existence, but whether there were sufficient incentives and
opportunities to the banks to exploit them to their favour and at the cost of the
customers.

2.5.2 Stability of the System

Soundness and stability always remain to be the uppermost concern of banking
and financial system. For banks are more ‘fragile’ than the non-banking organizations for
several reasons; of which the most important being that failure of an individual bank
would be detrimental to the entire banking system and which in turn has serious
macroeconomic implications. Banks are highly leveraged institutions in the sense that
their entire business is based on the borrowed funds which are disproportionate to the
owned funds or capital, further, their structure of assets and liabilities inherently make
them highly vulnerable for the liquidity crises due to duration or maturity mismatches.
Moreover, any failure of an individual bank will have cascading effect over the entire
systems. Because of inter institutional exposures and being part of the payment system.
This was precisely the reason why banking system world over were highly regulated, even
in the case of open economy. Therefore, banking system’s stability became an
overwhelming reason for the regulation and supervision of their assets and liability
structure which became the deciding factor to choose between universal banking and
traditional banking. As universal banks have exposure to equity market it was often
pointed out to be highly risky, besides, such risks arise at relatively a very short spell of
time compared with the risks arising out of the traditional lending business, sparing little
time to repair the system. Moreover as universal banks in general are larger in size any
failure of one bank could have a ‘know on’ effect on the entire system through ‘contagion’
as the theory of ‘too big to fail’ has lost its relevance. However, Santos (1998) who studies
surveyed gave mixed results disproving that banks conducting securities trading were
highly risky. Thus, experience world over did not yield a conclusive evidence on adverse
impact of universal banking on systematic stability.
 2.6 Universal Banks in India
Economists classify the financial developments of market broadly into three stages.
1. Bank Oriented Stage
In the first stage, the banks and development financial institutions contribute to
the significant part of financing capital formation and development. This stage is
normally characterized by low growth rate, low rate of savings as well as capital
formation. The Government and the regulator play a very active role in diverting
the idle resources for growth and controlling the financial markets.

2. Early Capital market oriented stage

In the second stage, the capital market development in the form of issue of equity
and debentures starts playing a role meeting a part of the financing needs. The
establishment and growth of basic infrastructure, steady growth in income level
and rate of savings and change in the investors’ approach are the characteristics of
the stage.

3. Highly capital market oriented stage

In the third stage capital market becomes a major source of financing long term
funds requirements. The financial markets are largely developed with plenty of
modern instruments with varied maturity and complexity meeting the needs of the
investors both in the local and global markets.

An insight into the Bank oriented stage takes us to the Theory of Financial
Intermediation. Banks and development financial institutions (Development Banks) are
the prominent institutions functioning as financial intermediaries in the economy. The
primary task of these institutions is to transform one capital asset into another with an
objective to make the transformed capital asset more productive. The very definition of
banking as per the Banking Regulation Act 1949 highlights the functions of banks being
Financial intermediaries and facilitators of payment mechanism. The other permissible
activities for banking companies in India are listed in section 6 of the Act.
The financial disintermediation or diversified financial intermediation is the next
stage in the financial market development. This is the result of financial deregulation
where the regulator gradually assumes the role of directing the influential forces rather
than exercising strict controls. This leaves the participants in the markets to respond to
these policy changes suitable. The diversified financial intermediation is also the corollary
of technology and globalization of markets.
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. The banks which were hitherto working under the most regulated
environmental could expand their product menu by incorporating several financial
services which also resulted in augmenting their non interest income.
By the mid 1990s, all restrictions on project financing were removed and banks
were allowed to undertake several activities in-house. The role of DFIs as the sole source
of long term project or infrastructure financing started dwindling in this era as other
cheaper sources of finance like primary capital market, infusion of foreign capital and
availability of foreign debt at cheaper rate came to the rescue as the result of pragmatic
liberalization and deregulation strategies. A clear shift in delivery channels from bank
branches to ATMs, internet and telephone owing to technological revolution increased
banks’ reach and penetration. The three pronged penetration approach of modern day
banking is to expand the customer base – individuals/ families, corporate, SMEs, to
enlarge the market scope – domestic, regional, global and to develop and extensive
product menu from narrow/conventional to large/ varied.
In the late nineties, the focus is on 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 RBI 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. The working group submitted its report in May
1998. The Reserve Bank’s Discussion Paper (January 1999) and the feedback thereon
indicated the desirability of universal banking from the point of view of efficiency of
resource use.
Both the Committees draw upon the factors like: smooth transfer of resources from
savers to investors across the globe, exchange of financial assets at minimum transaction
cost, risk control etc. However, RBI vision of universal banking is influenced by the
absence/lack of breadth and depth in different segments of the financial markets,
particularly debt market which is yet to go a long way in terms of offering a market
determined MIBOR (Mumbai Inter Bank Offered Rate) which can facilitate evolution of a
liquid and stable market for debt instruments of different maturities in integrating all the
sub-segments of the financial market by removing arbitrage opportunities.

Presently, it is observed that in India including the insurance segment, banks are
present in all the segments. For example,
1. Credit market
Almost all the banks have their presence in the three main areas of activity in the
credit market: wholesale credit, retail credit and mortgage credit. Though presence
 of commercial banks in long term credit activities like project finance and housing
finance is not as much as DFIs like NABARD, IDBI, etc., encourage the banks in
this activity.

2. Consumer Finance market

Consumers’ higher standard of living and growing financial literacy, which led to
the development of most popular form of consumer credit instrumentalised by the
credit cards, attracted number of banks on account of certain distinct advantages
like size of revenue and relationship with potential customer like retail
establishment.

3. Saving market
To compete with private mutual funds and NBFCs number of banks have
established subsidiaries like mutual funds and insurance activity.

4. Money market and capital market

To improve the quality of asset liability management and to cover maladjustment in
the ratios (CRR, SLR) required by the monetary authorities most of the banks
actively participate in the money market and capital market.

5. Advisory service market (merchant banking)

To help the corporate in their financial restructuring efforts, number of commercial
banks has established merchant banking subsidiaries which are effectively
competing with merchant banks established in private sector.

2.7 Advantages of Universal Banking

2.7.1 Greater Economic efficiency
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 optimize the use of their resources and circumstances.

2.7.2 Economies of scale

It means lower average costs which arise when larger volumes of operations are performed
for a given level of overhead on investment. When fixed costs are shared by the higher
output the average costs tend to reduce which widens the gap between the cost and sales
price favourably. In reality, however these economies are countered by diseconomies. The
countering forces may not allow the firm to reach its capacity utilization to its fullest
extent and also put a cap at a level then optimum capacity.

2.7.3 Economies of scope

They arise in multi product firms because costs of offering various activities by different
units are greater than the cost when they are offered together. Economies of scale and
scope have been given as the rationale for combining the activities. Large scale could also
avoid wasteful duplication of marketing, research and development and information
gathering efforts.

2.7.4 Optimum resource utilisation

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.

2.7.5 Diversification of risks

Specialised firms are also subject to substantial risk of failure, because their operations
are not well diversified. Proponents of universal banking thus argue that specialized
banking system can present considerable risks and costs to the economy.

2.7.6 Customer Relationship Building

By offering a broader set of financial products than what a specialized 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.

2.7.7 One-stop Shopping

Universal banking offers all financial products and services under one roof. One-stop
shopping saves a lot of time and transaction costs. It also increases the speed or flow of
work. So, one-stop shopping gives benefits to both banks and their clients.

2.8 Disadvantages of Universal Banking

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

2.8.2 Risky exposure

Universal bankers may also have a feeling 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.

2.8.3 Fear of monopoly creation

Historically, an important reason for limiting combination of activities has been the fear
that such institutions, by virtue of their sheet size, would gain monopoly power in the
market, which can have significant undesirable consequences for economic efficiency. Two
kinds of concentration should be distinguished i.e. 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.

2.8.4 Structural
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 specialized
banks from serving the market.

2.8.5 Conflict of interests

Combining commercial and investment banking give 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.

3. COMMERCIAL BANKING VS DEVELOPMENT BANKING

3.1 Commercial Banking
3.1.1 Meaning of Commercial Banking
Commercial banks are an organisation which normally performs certain financial
transactions. It performs the twin task of accepting deposits from members of public and
make advances to needy and worthy people from the society. When banks accept deposits
its liabilities increase and it becomes a debtor, but when it makes advances its assets
increases and it becomes a creditor. Banking transactions are socially and legally
approved. It is responsible in maintaining the deposits of its account holders.

3.1.2 Definitions of Commercial Banks

According to Prof. Sayers, "A bank is an institution whose debts are widely accepted in
settlement of other people's debts to each other." In this definition Sayers has emphasized
the transactions from debts which are raised by a financial institution.

According to the Indian Banking Company Act 1949, "A banking company means any
company which transacts the business of banking. Banking means accepting for the
purpose of lending of investment of deposits of money from the public, payable on
demand or other wise and withdraw able by cheque, draft or otherwise.”

3.1.3 Features of Commercial Banks

  Acceptance of deposits from public constitute a large proportion of narrow money
M-1 (consisting currency with public, demand deposits and deposits with RBI). The
total bank deposits for the year ended March 2013 stood at Rs 10.27 lakh crore,
recording a rise of 17.4 per cent year-on-year.
 Advancing of credit to needy borrowers, individual corporate or institutions is
another function of commercial banks. As at 2012-13, total bank credit stood at Rs
7.8 lakh crore, a rise of 17 per cent.
 Banks deal in a wide variety of assets and accommodate different types of
borrowers, to facilitate the spread of the impact on non-bank lenders and other
sections.
 Banks change cash for bank-deposits and bank deposits for a cash.
 To transfer bank deposits to borrowers between individuals an d corporate and
government institutions.
 To exchange deposits for bills of exchange, various government and local
authorities, bonds and industrial units
 To underwrite capital issues and to invest small portion of incremental deposits in
shares/debentures in the primary/secondary market offering services of portfolio
management, executor and trustee services, etc.
 They provide securities related services by setting up subsidiaries to provide capital
market related services and investment counseling.

3.1.4 Functions of Commercial Banks

3.1.4.1 Primary Functions of Commercial Banks

Commercial Banks performs various primary functions some of them are given below
 Accepting Deposits : Commercial bank accepts various types of deposits from
public especially from its clients. It includes saving account deposits, recurring
account deposits, fixed deposits, etc. These deposits are payable after a certain
time period.
  Making Advances : The commercial banks provide loans and advances of various
forms. It includes an over draft facility, cash credit, bill discounting, etc. They also
give demand and demand and term loans to all types of clients against proper
security.
 Credit creation : It is most significant function of the commercial banks. While
sanctioning a loan to a customer, a bank does not provide cash to the borrower
Instead it opens a deposit account from where the borrower can withdraw. In other
words while sanctioning a loan a bank automatically creates deposits. This is
known as a credit creation from commercial bank.

3.1.4.2 Secondary Functions of Commercial Banks

Along with the primary functions each commercial bank has to perform several secondary
functions too. It includes many agency functions or general utility functions. The
secondary functions of commercial banks can be divided into agency functions and utility
functions.
 Agency Functions : Various agency functions of commercial banks are
o To collect and clear cheque, dividends and interest warrant.
o To make payment of rent, insurance premium, etc.
o To deal in foreign exchange transactions.
o To purchase and sell securities.
o To act as trusty, attorney, correspondent and executor.
o To accept tax proceeds and tax returns.
 General Utility Functions : The general utility functions of the commercial banks
include
o To provide safety locker facility to customers.
o To provide money transfer facility.
o To issue traveller's cheque.
o To act as referees.
o To accept various bills for payment e.g phone bills, gas bills, water bills, etc.
o To provide merchant banking facility.
o To provide various cards such as credit cards, debit cards, Smart cards, etc.

3.2 Development Banking

3.2.1 Meaning of Development Banks
Development banks are specialized financial institutions. They provide medium and long-
term finance to the industrial and agricultural sector. These banks are mostly set up after
World War II in both developed and underdeveloped countries. Every country felt the need
to accelerate the rate of development in post world war era. There was a need for
reconstruction of economics at a faster speed. A need to set up such institutions which
could take up promotional activities besides financing was felt necessary to achieve the
twin goals of nation- growth and social welfare.
The following points were considered to be the reasons for the establishment of
development banks:
 Lay foundation for industrialization
 Meet capital needs
 Need for promotional activities
 Help small and medium sectors
At the same time, there was also a great need for the modernization and replacement of
obsolete machinery in already established industries.

They provide finance to both private and public sector. Development banks are
multipurpose financial institutions. They do term lending, investment in securities and
other activities. They even promote saving and investment habit in the public.
Developments banks are the institutions engaged in the promotion and development of
industry, agriculture and other key sectors.

D.M. Mithani states that “A development bank may be defined as a financial institution
concerned with providing all types of financial assistance, medium as well as long-term to
business units, in the form of loans, underwriting, investment and guarantee operations
and promotional activities- economic development in general and industrial development
in particular.”

Development Banks do not mobilize savings like other banks but invest the resources in a
productive manner. These banks make significant contribution to the industrial
development while conventional institutions serve mainly to provide liquidity to the
investments made earlier. The development banks are mainly meant to further the cause
of development.

3.2.2 Definition of Development Banks

The definition of the term 'development banks' can be stated as follows,
1. In General sense,
"Development banks are those financial institutions whose prime goal (motive) is to
finance the primary (basic) needs of the society. Such funding results in the growth and
development of social and economic sectors of the nation. However, needs of the society
vary from region to region due to differences seen in its communal structure, economy
and other aspects."
2. As per Banking subject (mainly in Indian context),
"Development banks are financial institutions established to lend (loan) finance (money)
on subsidized interest rate. Such lending is sanctioned to promote and develop important
sectors like agriculture, industry, import-export, housing and allied activities."

3.2.3 Features of Development Banks

 It is a specialized financial institution which provides medium and long term
lending facilities.
 A development bank does not accept deposits from the public like commercial
banks and other financial institutions.
 It is a multipurpose financial institution. Besides providing financial help, it
undertakes promotional activities also. It helps an enterprise from planning to
operational level.
 The role of development bank is gap filler.
 It aims at promoting the saving and investment habit in the business society.
 It provides spectrum of financial assistance to the public and private sector.
 It aims to serve public interest rather than making profits.
 Its motive is to encourage new and small entrepreneurs.
 Its aim is to promote economic development of the nation.
 Development banks react to the socio-economic needs of development.

3.2.4 Functions of Development Banks

The nine important functions of development banks in India are as follows:
 To promote and develop small-scale industries (SSI) in India.
 To finance the development of the housing sector in India.
 To facilitate the development of large-scale industries (LSI) in India.
 To help the development of agricultural sector and rural India.
 To enhance the foreign trade of India.
 To help to review (cure) sick industrial units.
 To encourage the development of Indian entrepreneurs.
 To promote economic activities in backward regions of the country.
 To contribute in the growth of capital markets.

1. Small Scale Industries (SSI)

Development banks play an important role in the promotion and development of the
small-scale sector. Government of India (GOI) started Small industries Development Bank
of India (SIDBI) to provide medium and long-term loans to Small Scale Industries (SSI)
units. SIDBI provides direct project finance, and equipment finance to SSI units. It also
refinances banks and financial institutions that provide seed capital, equipment finance,
etc., to SSI units.

2. Development of Housing Sector

Development banks provide finance for the development of the housing sector. GOI
started the National Housing Bank (NHB) in 1988.
NHB promotes the housing sector in the following ways:
 It promotes and develops housing and financial institutions.
 It refinances banks and financial institutions that provide credit to the housing
sector.

3. Large Scale Industries (LSI)

Development banks promote and develop large-scale industries (LSI). Development
financial institutions like IDBI, IFCI, etc., provide medium and long-term finance to the
corporate sector. They provide merchant banking services, such as preparing project
reports, doing feasibility studies, advising on location of a project, and so on.

4. Agriculture and Rural Development

Development banks like National Bank for Agriculture & Rural Development (NABARD)
helps in the development of agriculture. NABARD started in 1982 to provide refinance to
banks, which provide credit to the agriculture sector and also for rural development
activities. It coordinates the working of all financial institutions that provide credit to
agriculture and rural development. It also provides training to agricultural banks and
helps to conduct agricultural research.

5. Enhance Foreign Trade

Development banks help to promote foreign trade. Government of India started Export-
Import Bank of India (EXIM Bank) in 1982 to provide medium and long-term loans to
exporters and importers from India. It provides Overseas Buyers Credit to buy Indian
capital goods. It also encourages abroad banks to provide finance to the buyers in their
country to buy capital goods from India.

6. Review of Sick Units

Development banks help to revive (cure) sick-units. Government of India (GOI) started
Industrial investment Bank of India (IIBI) to help sick units.
IIBI is the main credit and reconstruction institution for revival of sick units. It facilitates
modernization, restructuring and diversification of sick-units by providing credit and
other services.

7. Entrepreneurship Development
Many development banks facilitate entrepreneurship development. NABARD, State
Industrial Development Banks and State Finance Corporations provide training to
entrepreneurs in developing leadership and business management skills. They conduct
seminars and workshops for the benefit of entrepreneurs.

8. Regional Development
Development banks facilitate rural and regional development. They provide finance for
starting companies in backward areas. They also help the companies in project
management in such less-developed areas.

9. Contribution to Capital Markets

Development banks contribute the growth of capital markets. They invest in equity shares
and debentures of various companies listed in India. They also invest in mutual funds
and facilitate the growth of capital markets in India.

3.2.5 Development Banks in India

Development banking was started after the World War II. It provided finance to
reconstruct the buildings and industries which were destroyed in the war.
In India, development banking was started immediately after independence.
The arrangement of development banks in India is depicted below.

Development banks in India are classified into following four groups:

 Industrial Development Banks : It includes, for example, Industrial Finance
Corporation of India (IFCI), Industrial Development Bank of India (IDBI), and Small
Industries Development Bank of India (SIDBI).
 Agricultural Development Banks : It includes, for example, National Bank for
Agriculture & Rural Development (NABARD).
 Export-Import Development Banks : It includes, for example, Export-Import
Bank of India (EXIM Bank).
 Housing Development Banks : It includes, for example, National Housing Bank
(NHB).
Industrial Finance Corporation of India (IFCI) is the first development bank in India. It
started in 1948 to provide finance to medium and large-scale industries in India. The
“recommendation for setting up industrial financing institutions was made in 1931 by
Central Banking Enquiry Committee but no concrete steps were taken. In 1949, Reserve
Bank had undertaken a detailed study to find out the need for specialized institutions. It
was in 1948 that the first development bank i.e. Industrial Finance Corporation of India
(IFCI) was established. IFCI was assigned the role of a gap-filler which implied that it was
not expected to compete with the existing channels of industrial finance. It was expected
to provide medium and long-term credit to industrial concerns only when they could not
raise sufficient finances by raising capital or normal banking accommodation. In view of
the vast size of the country and needs of the economy it was decided 10 set up regional
development banks to cater to the needs of the small and medium enterprises. In 1951,
Parliament passed State Financial Corporation Act. Under this Act state governments
could establish financial corporations for their respective regions. At present there are 18
State Financial Corporations (SFC’s) in India.

The IFCI and state financial corporations served only a limited purpose. There was a need
for dynamic institutions which could operate as true development agencies. National
Industrial Development Corporation (NIDC) was established in 1954 with the objective of
promoting industries which could not serve the ambitious role assigned to it and soon
turned to be a financing agency restricting itself to modernization and rehabilitation of
and jute textile industries.

The Industrial Credit and Investment Corporation of India (ICICI) were established in
1955 as a Joint Stock Company. ICICI was supported by Government of India, World
Bank, Common wealth Development Finance Corporation and other, foreign institutions.
It provides term loans and takes an active part in the underwriting of and direct
investments in the shares of industrial units. Though ICICI was established in private
sector but its pattern of shareholding and methods of raising funds gives it the
characteristic of a public sector financial institution.

Another institution, Refinance Corporation for Industry Ltd. (RCI) was set up in 1958 by
Reserve Bank of India, LIC and Commercial Banks. The purpose of RCI was to provide
refinance to commercial banks and SFC’s against term loans granted by them to
industrial concerns in private sector. In 1964, Industrial Development Bank of India
(IOBI) was set up as an apex institution in the area of industrial finance, RCI was merged
with IDBI. IDBI was a wholly owned subsidiary of RBI and was expected to co-ordinate the
activities of the institutions engaged in financing, promoting or developing industry.
However, it is no longer a wholly owned subsidiary of the Reserve Bank of India. Recently,
it made a public issue of shares to increase its capital. In order to promote industries in
the slate another type of institutions, namely, the State Industrial Development
Corporations (SIDC’s) were established in the sixties to promote medium scale industrial
units. The state owned corporations have promoted a number of projects in the joint
sector and assisted sector. At present there are 28 SIDC’s in the country. The State Small
Industries Development Corporations (SSIDC’s) were also set up to cater to the needs of
industry at state level. These corporations manage industrial estates, supply raw
materials, run common service facilities and supply machinery on hire purchase basis.
Some states have established their own institutions.

A number of other institutions also participate in industrial financing. The Unit Trust of
India (UTI) established in 1964, Life Insurance Corporation of India (1956) and General
Insurance Corporation of India (GIC) set up in 1973 also finance industrial activities at all
India level. Some more units have been set up to provide help in specific areas such as
rehabilitation of sick units, export finance, agriculture and rural development. Industrial
Reconstruction Corporation of India Ltd. (IRCI)’was set up in 1971 for the rehabilitation of
sick units. In 1982 the Export-Import Bank of India (Exim Bank) was established to
provide financial assistance to exporters and importers. In order to meet credit needs of
agriculture and rural sector, National Bank for Agriculture and Rural Development
(NABARD) was set up in 1982. It is responsible for short term, medium term and long-
term financing of agriculture and allied activities. The institutions such as Film Finance
Corporation, Tea Plantation Finance Scheme, Shipping Development Fund, Newspaper
Finance Corporation, Handloom Finance Corporation, Housing Development Finance
Corporation also provide financial various areas.
 3.3 COMMERCIAL BANK VS DEVELOPMENT BANKS
Area Commercial bank Development bank

Focus Profitability , Market Serve public interest rather

Share, All segment of than earning profits
customer

Risk Tolerance Less tolerant of risk Higher risk tolerance due

to their business model
and the relative weakness
of government regulation in
the industry

Deposit from Accepts deposits from Does not accept deposits

public public

Source of Funds Combination of owned and

Borrowed Capital

Ownership Banks in India ‘owned’ by It is owned by government.

government (as
shareholder and policy
maker), regulator and
private investor.

Products A number of products to Micro-loans, agriculture

market in a day to day loans and other such
routine development products

Area coverage Targeting the masses Focused on the developing

sector only

Nature of Financial institution Service institution

Institution

Financial Goal Profit maximization Surplus to sustain

3.4 SOURCES AND USES OF FUNDS OF COMMERCIAL BANK

3.4.1 Sources of fund of commercial bank
The total liabilities of commercial banks are the sources of funds.
3.4.1.1 Paid up Capital and Reserves
All commercial banks have to maintain a minimum capital as per RBI directions. Present
rate of minimum capital is 9% of risk weighted advances of the bank. This is in line with
the international banks, requirement of Basel-I. However, any private sector bank has to
have in minimum paid up capital of Rs. 300 crores and promotor’s contribution should
not be less that 40% of capital at any point of time with capital adequacy ratio 10% and
NBFC desiring conversion should have capital adequacy ratio of 12% with NPAs not more
than 5%.
Bank capital provides a cushion against temporary losses and signals that the bank has a
basis of continuity and that its constituents have reason to look at banks’ difficulties in a
long term prospective. Capital funds of scheduled commercial banks include Tier I (Core
capital) and Tier II (Supplemental capital). Tier I capital includes paid up capital, statutory
reserves and other disclosed free reserves and capital reserves representing surplus
arising out of the sale proceeds of assets. In computing Tier I capital, equity investment in
subsidiaries, intangible assets and losses are deducted. Tier 1 capital consists of
permanent and readily available support to a bank against expected losses. Tier I capital
should not be less that 50% of total capital. While in Tier II, Capital includes undisclosed
reserves, preference shares, revaluation reserves, general provisions and loss reserves,
hybrid debt, capital instruments and subordinated debt. The total of Tier II capital should
not be more that Tier I capital. From 31st March 2009 all commercial banks have to
maintain capital adequacy in terms of Basel II. Existing RBI norms for banks in India (as
of September 2010): Common equity (incl of buffer): 3.6% (Buffer Basel 2 requirement
requirements are zero.); Tier 1 requirement: 6%. Total Capital: 9% of risk weighted assets.

3.4.1.2 Deposits from Public

There are various types of deposits which are accepted by banks. There are various types
of nomenclature by individual bank, but all deposits are classified as demand/savings
and term deposits. There deposits vary in terms of maturity, interest rate payments,
withdrawal system and deposit insurance covered or not covered.
Demand deposits are transaction accounts, that are payable to the depositor on demand
and carry no interest. While time deposits consist of savings account and fixed deposits
with maturity varying from 7 days to 10 years at the varying interest.
Deposit also includes Certificate of Deposits issued by banks for maturity less than one
year at the discount rate to meet their emergent demand of funds.

3.4.1.3 Inter Bank Borrowings

This indebtedness arises out of transfer of deposits from one bank to another. The
interbank call money market is the most sensitive part of the Indian Money Market and is
also an important indicator of interest rates. The feature of this lending is that loans are
given without security. This enables banks to replenish their resources with disturbing
their assets.

3.4.1.4 Borrowings from RBI

Liquidity adjustment facility is operative by way of Repo and Reverse Repo rates, providing
a reasonable corridor to banks. The present Repo rate is 7.75% and Reverse repo rate is
6.75% (w.e.f.29/10/2013)

3.4.1.5 Bills Payable

These are the bills or cheques issued by the bank for payment on behalf of the customers
as a measure of firm commitment. Such liabilities are local in nature i.e. for payments to
be made on demand by bank to other banks for credit of their accounts. Such liabilities
are for a very short period say between 3 days to 30 days and bears no interest. Such is
also a source of funds for banks.

3.4.1.6 Profit and Loss A/c

This is the amount of excess of income over expenditure during the financial year of the
bank and it is also a source of funds for utilization. The balance sheet shows this amount
as net amount after appropriation of reserves/dividends/statutory liabilities.

3.4.2 Uses of fund of commercial bank

3.4.2.1 Cash and Bank Balance with RBI
The liquidity requirements are met by cash and investment securities. Every fortnightly
the banks have to inform RBI their position which includes cash and balances with RBI,
which are required for CRR purpose.

3.4.2.2 Balance with other banks

It forms the part of liquidity, which the bank has kept with other banks as deposits/call
money or accounts opened for the purposes of payments to other banks, for clearance of
cheques.

3.4.2.3 Investment in Government and other securities

A part from the CRR, (which is at present 4.00% w.e.f. 09-02-2013) every commercial
bank has to maintain under Section 24 of Banking Regulation Act, 1949 these liquidity
requirements of min. 25% and max. 40%. At present SLR is 23.0% w.e.f. 11-08-2012.
Banks have to classify their investment portfolio under 3 categories. Viz
 Held to Maturity (HTM)
 Available for Sale (AFS)
 Held for Trading (HFT)
The investments under AFS and HFT categories are marked to market. Banks decide the
category of investment at the time of acquisition. The investment included under HTM
should not exceed 25% of the banks total investment. Securities in the HFT category are
to be sold within 90 days or else shifted to the AFS category.

3.4.2.4 Investment in shares and debentures

Banks are allowed to subscribe to shares and debentures in the primary market, inclusive
of underwriting development and investment in mutual funds. Further they are allowed to
trade in shares and debentures in the secondary market. Investments in venture capital
by banks are allowed and such investment is treated as priority sector lending.

3.4.2.5 Loans and advances

This includes advances made by banks under three categories viz.
 Bills Purchased and Discounted
 Cash Credit and Overdrafts
 Term Loans
Banks earn their income by advances to public under above categories of advances.

3.4.2.6 Fixed Assets

Utilization of resources are made after loans and advances in fixed assets for its own use.
Such fixed assets are branch premises, residential quarters for its employees, guest
houses for employees use, furniture and fixtures, computer machine etc.

3.4.2.7 Other Assets

Such assets are formation and organisation expenses, development expenditure, interest
accrued on investment but not collected, investment in shares of subsidiaries and any
other assets.

3.5 UNIVERSAL BANKING IN AN OPEN ECONOMY

Developments in Information Technology, New Economic Policies, Globalization,
Liberalization of Financial Sectors, Competition and opportunities for rapid Economic
growth in the emerging markets, altered the basic paradigms of banks. These changes
and developments necessitated banks to extend various services resulting in banks
adopting a new AVTAR, “Universal Bank”.
In a broader sense, the term Universal Banking refers to providing a wide range of
financial services even beyond commercial banking and investment banking. These banks
do carry on the insurance business, which at present in India is being done by separate
institutions, separately floated for the purpose of carrying on insurance business. In the
light of above, and changing scenario at both national and international levels, it aims at
analyzing various issues involved concerning, acceptability of concept of Universal
Banking.
Prior to the 1980s, the focus of banking services in India was on traditional lines of
mobilizing deposits and lending as per the extant guidelines of RBI. With liberalization in
the mid 1980s, the banks were permitted to undertake a range of financial services
subject to certain restrictions and banks had the option of conducting investment activity
etc., through subsidiaries. Briefly, both banks and DFIs are permitted in a limited way to
undertake a range of financial services either in-house or through subsidiaries. The
concept of with the introduction of New Economic Policy in early 90s, though there have
been attempts on the part of banks in a small way in diversification of their portfolios for
increasing their business activity. Historically, the banks in India and other parts of the
globe, excepting in Switzerland and Germany where both short and long term finance was
extended by banks, are mainly engaged in short term financing keeping in view the nature
of liabilities mobilized as they were for short medium duration, generally for a period of
maximum five years and long term financing for industrial projects, etc. is left for
specialized institutions viz. DFIs.

3.5.1 Consolidation of Banking System

The most important issue that is fast emerging now is the question of consolidation of
banking system in India. ICICI by process of reverse merger with its subsidiary evolved
into universal bank. Subsequently, it had also acquired Bank of Madura by means of
voluntary merger. IDBI has converted itself into a bank by an Act of Parliament and got its
subsidiary merged with itself. There were proposals to merge IFCI with Punjab National
Bank or thirty other financial institutions including LIC, to convert zero coupon
convertible debentures issued in 2002-03 into equity to the extent of 50% these
debentures are payable in the year 2022 were part of revival package worked out by the
government to rescue the IFCI. Apart from these major initiatives, Oriental Bank of
Commerce, a PSU, had taken over the assets and liabilities of GTB. Thus there are
instances of voluntary, compulsory and directed mergers in India in the recent past
because of changing scenario and Regulatory and Supervisory compulsions.

3.5.2 Evolution of Regulatory Regime

Issues concerning regulatory regime have been taken care of to a great extent, by
RBI for a smooth transition from traditional to universal banking. However, in the wake of
the withdrawal of Government support for DFIs, the flow of funds for long term finance to
some extent slowed down in the recent past. Slowing down was attributed to issues
relating to exemption of banks from Section 19(2) of BR Act, 1949 regarding holding of
equities and shares, and 5 per cent ceiling on investment in equities by banks. As long
term financing is beset with high risks and uncertainties, there is a need to have separate
regulatory guidelines within the overall regulatory structure.
At present the Income Recognition and Asset Classification norms are uniform and
there is also a need to have industry/sector specific norms in the emerging markets in
order to enable the Universal banks to play an effective role. Risk weights for project
loans may also be reduced in order to encourage term financing.
The vital need for attaining global competitiveness has resulted in wide spread
restructuring across corporate India. Increasing consolidation in search of globally scales
capacities, technology upgrading and focus on core competencies are the cornerstones of
this restructuring process. The Government too has recognised the significance of
corporate restructuring in a competitive environment and accordingly several fiscal and
legal changes are envisaged to facilitate the process of merger and de-mergers.
Globalisation has been a two way process and in the context, globally competitive
players have been actively seeking opportunities for wealth creation. Global financial
services industry has become desegmented in the closing decade of 20 th century on
account of the transformation of traditional banking institutions into new financial firms
taking on new business lines such as securities trading, insurance and asset
management and assuming concomitant risks. Banks had to diversify by taking on
related activities in different markets since their lending business suffered on account of
competition from security markets and institutional asset managers.
The global economy, despite continued high oil prices and natural disasters,
exhibited resilience during 2005 after a robust expansion during the previous year.
Accordingly to the IMFs World Economic Outlook, April 2006, global GDP registered a
growth of 4.8% during 2005, as compared to the 5.3% growth registered during the
previous year, with the momentum in economic activity driven mainly by the US and
Developing Asia.