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With years, banks are also adding services to their customers. The Indian banking industry is passing through a phase of customers market. The customers have more choices in choosing their banks. A competition has been established within the banks operating in India. 2. TO STUDY ABOUT THE VARIOUS CHALLENGES FACED BY BANKING INDUSTRY IN INDIA The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. These multiple changes happening one after other has a ripple effect on a bank trying to graduate from completely regulated seller market to completed deregulated customers market.






Banking in India originated in the first decade of 18 century with The eneral Bank of India coming into existence in1786. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from1935. After India's independence 1947, the Reserve Bank was nationalized and given broader powers. A retrospect of the events clearly indicates that the Indian banking sector has come far away from the days of nationalization. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports , which laid significant thrust on enhancing the efficiency and viability of the banking sector. The deregulation process has resulted in delivery of innovative financial products at competitive rates; this has been proved by the increasing divergence of banks in retail banking for their development and survival. The Narasimham Committee has presented a detailed analysis of various problems and challenges facing the Indian banking system and made wide-ranging recommendations for improving and strengthening its functions. The recent international consensus on preserving the soundness of the banking system has veered around certain core themes. These are: effective risk management systems, adequate capital provision, sound practices of supervision and regulation, transparency of operation, conducive public policy intervention and maintenance of macroeconomic stability in the economy. Until recently, challenges like the lack of competitiveness vis-àvis global standards, low technological level in operations, over staffing, high NPAs and low levels of motivation had shackled the performance of the banking industry. The competitive environment created by financial sector reforms has nonetheless compelled the banks to gradually adopt modern technology to maintain their market share. The developments, in general have an emphasis on service and technology. The global challenges which banks face are not confined only to the global banks. These aspects are also highly relevant for banks which are part of a

globalised banking system. Further, overcoming these challenges by the other banks is expected to not only stand them in good stead during difficult times but also augurs well for the banking system to which they belong and will also equip them to launch themselves as a global bank. Today, the banking sector in India is fairly mature in terms of supply, product range and reach. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. With passing time, Indian economy is further expected to grow and be strong for quite some time-especially in its services sector. The significant change in the policy and attitude that is currently being seen is encouraging for the banking sector growth.


CHAPTER 1 EVOLUTION OF INDIAN BANKING SYSTEM Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below: ➢ Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991 To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III.

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority. During those day’s public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.  Phase II

Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi2

1955: Nationalization of State Bank of India. 1961: Insurance cover extended to deposits. Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven more banks.000%.urban areas. Indira Gandhi. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: ➢ 1949: Enactment of Banking Regulation Act. 1969. 1980: Nationalization of seven banks with deposits over 200crore. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Banking in the sunshine of Government ownership gave 2 . Mrs. 1971: Creation of credit guarantee corporation. It was the effort of the then Prime Minister of India. ➢ ➢ ➢ ➢ ➢ ➢ ➢ After the nationalization of banks. 1969: Nationalization of 14 major banks. 1959: Nationalization of SBI subsidiaries. 14 major commercial banks in the country were nationalized. Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July. the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11. 1975: Creation of regional rural banks. major process of nationalization was carried out. This step brought 80% of the banking segment in India under Government ownership.

2 . a committee was set up by his name which worked for the liberalization of banking practices. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. under the chairmanship of M Narasimham.the public implicit faith and immense confidence about the sustainability of these institutions  Phase III This phase has introduced many more products and facilities in the banking sector in its reforms measure. the foreign reserves are high. The financial system of India has shown a great deal of resilience. Phone banking and net banking is introduced. Efforts are being put to give a satisfactory service to customers. The entire system became more convenient and swift. In 1991. The country is flooded with foreign banks and their ATM stations. the capital account is not yet fully convertible. This is all due to a flexible exchange rate regime. and banks and their customers have limited foreign exchange exposure. Time is given more importance than money.

banks are also adding services to their customers. the service provided by banks has become more easy and convenient. A competition has been established within the banks operating in India. Strategic issues in banking services Strategic issues in banks services are known as or define by these ways. This section of banking deals with the latest discovery in the banking instruments along with the polished version of their old systems. With stiff competition and advancement of technology. 1 . The Indian banking industry is passing through a phase of customers market. which are known as.CHAPTER 2 BANKING SERVICES IN INDIA BANKING SERVICES With years. The customers have more choices in choosing their banks. • Non performing assets • Capital adequacy ratio • Total quality management • Management information system. The past days are witness to an hour wait before withdrawing cash from accounts or a cheque from north of the country being cleared in one month in the south.

different types of banks have been instituted to cater to the varying needs of the community. however. distinctive variety and large magnitude. Banks in the organized sector may.KINDS OF BANKS Financial requirements in a modern economy are of a diverse nature.CHAPTER 3 . Hence. be classified in to the following major forms: 1) 2) 3) 4) Commercial banks Co-operative banks Specialized banks Central bank COMMERCIAL BANKS 1 .

Industrial banks. They are based on the principle of self-reliance and mutual cooperation. however there is a mixed banking system. another six commercial banks of high standing were taken over by the government. 14 major commercial banks with deposits of over 50 Corers were nationalized. Development banks. 1. all the commercial banks-73 scheduled and 26 non-scheduled banks. 2. Co-operative banking system in India has the shape of a pyramid a three tier structure. 3. 2 . On July 19. The main objective of co-operative banks is to provide cheap credits to their members. CO-OPERATIVE BANKS Co-operative banks are a group of financial institutions organized under the provisions of the Co-operative societies Act of the states. except the state bank of India and its subsidiaries-were under the control of private sector. There are thus. Foreign exchange banks. however. At present. constituted by: SPECIALIZED BANKS There are specialized forms of banks catering to some special needs with this unique nature of activities. In April 1980.Commercial banks are joint stock companies dealing in money and credit. there are 20 nationalized banks plus the state bank of India and its 7 subsidiaries constituting public sector banking which controls over 90 per cent of the banking business in the country. 1969. In India. prior to July 1969.

It is a service oriented financial institution. 5. Land development banks. was started as a shareholders’ organization in 1935. in 1949.a central bank is usually state owned but it may also be a private organization. It supervises.3. the reserve bank of India (RBI). 1 . control and regulates the activities of the commercial banks. it was nationalized after is free from parliamentary control. It acts as the leader of the money market. Exim bank. It is regarded as the highest monetary authority in the country. CENTRAL BANK A central bank is the apex financial institution in the banking and financial system of a country. For instance. however. India’s central bank is the reserve bank of India established in 1935 .

her move was swift and sudden. and a debate had ensued about the possibility to nationalize the banking industry. the nationalized banks grew at a pace of around 4%. At the same time. 1 . it had emerged as a large employer. the GOI controlled around 91% of the banking business of India. in the year 1993. the-then Prime Minister of India expressed the intention of the GOI in a paper entitled "Stray thoughts on Bank Nationalization. closer to the average growth rate of the Indian economy.CHAPTER 4 . A second dose of nationalization of 6 more commercial banks followed in 1980. With the second dose of nationalization. Chidambaram .NATIONALISATION By the 1960s. The nationalized banks were credited by some. and the GOI issued an ordinance and nationaliz ed the 14 largest commercial banks with effect from the midnight of July 19 ." Thereafter. After this. Later on. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalized banks from 20 to 19. including Home minister P. the Indian banking industry had become an important tool to facilitate the development of the Indian economy . the government merged New Bank of India with Punjab National Bank . until the 1990s. The stated reason for the nationalization was to give the government more control of credit delivery. 1969 . to have the Indian economy withstand the global financial crisis of 2007-2009 . Indira Gandhi .

along with the rapid growth in the economy of India . These came to be known as New Generation tech-savvy banks. namely. and included Global Trust Bank (the first of such new generation banks to be set up). Axis Bank (earlier as UTI Bank ). The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. strong and transparent balance sheets relative to other banks in comparable economies in its region. Lend at 6%. ICICI Bank and HDFC Bank . were used to the 4-6-4 method (Borrow at 4%. The Reserve Bank of India is an 1 . Indian banks are considered to have clean. government banks.LIBERALISATION In the early 1990s. which later amalgamated with Oriental Bank of Commerce. till this time. The next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment. the then Narsimha Rao government embarked on a policy of liberalization .Go home at 4) of functioning. revitalized the banking sector in India. The new policy shook the Banking sector in India completely. which has seen rapid growth with strong contribution from all the three sectors of banks. People not just demanded more from their banks but also received more. where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%. licensing a small number of private banks. In terms of quality of assets and capital adequacy. This move. banking in India is generally fairly mature in terms of supply. Currently (2007). private banks and foreign present it has gone up to 49% with some restrictions.CHAPTER 5 . Bankers. product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. All this led to the retail boom in India.

takeovers. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them.autonomous body. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services. especially retail banking . 2 . with minimal pressure from the government. and asset sales. In March 2006. In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing. vehicle and personal loans. mortgages and investment services are expected to be strong. the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. One may also expect M& As. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true.

RBI ROLE AS REGULATORY MONETORY AUTHORITY • RBI ROLE AS REGULATORY MONETORY AUTHORITY In past few months we saw RBI using 2 of its possible measures to tackle the inflation. But when money flows through series of players and layers very less money will be left with the institutions present at the bottom of pyramid. it ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system. So interest rates will move in upward direction sand opposite happens when CRR is reduced. So higher is the CRR less is the money available in the economy. 1 .CHAPTER 6 . RBI actually has four chief weapons in its arsenal to control the inflation. They are Reserve Requirements (CRR and SLR). CRR is the portion of deposits (as cash) which banks have to keep/maintain with the RBI. So due to CRR and SLR obligation towards RBI financial institutions will be able to lend only the part of money available with them although this effect is small when transaction is between just two entities and constitute one layer. This serves two purposes: firstly. Whereas SLR is the portion of their deposits banks are required to invest in government securities. We now discuss each one of them in detail and their effects as well: Reserve Requirements This mainly constitute of Cash to Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR). inflation. Bank Rate or Discount rate and Repo rate. and thereby.

With increase in repo rate banks tend to invest more in repo transactions. Considering Bank Rate which is untouched in current scenario RBI is left with only 2 major measures viz.000crore and out of that only Rs 45. the cooling price trend in them comes as a great relief to RBI and Indian economy as a whole and along with RBI measures has helped stabilize inflation. Thus. Open market operations have limitations due to amount of government securities with RBI is limited and close to Rs 60. Although the repo rate transactions are for very short duration the everyday quantum of operations is approximately Rs 40. 1 . So it makes more sense to banks to lend money to RBI at competitive rate with no risk at all. An increase in the discount rate means the RBI wants to slow the pace of growth to reduce inflation. After economic reforms RBI started borrowing at market prevailing rates. Indian bank rate is at 6 per cent down from 10 per cent in 1981 and 12 per cent in 1991 Repo rate It is the rate at which the RBI borrows short term money from the market.000crore everyday. Since large part of inflation is attributed to large increase in international oil and metal prices. Banks borrow from the RBI to meet any shortfall in their reserves.000crore is in form of marketable securities. A cut means that the RBI wants the economy to grow and take up new ventures. CRR and Repo Rate in its armory to guard against the onslaught of inflation.Bank Rate or Discount rate This is the rate at which the RBI makes very short term loans to banks. large amount of capital is not available for circulation.

ROLE OF BANKS IN DEVELOPING ECONOMY Banks play a very useful and dynamic role in the economic life of every modern state. Influence economic activity 4. Facilitator of monetary policy 5.CHAPTER 7 . The economic importance of commercial banks to the developing countries may be viewed thus: 1. Banks organization system in India 2 . the industrial revolution would not have taken place in Europe. Promoting capital formation 2. Encouraging innovation 3. A study of the economic history of western country shows that without the evolution of commercial banks in the 18th and 19th centuries.

GLOBAL MELTDOWN AND COLLAPSE OF AMERICAN BANKS When did the slide begin? A retrospect does help when the market is in a crisis. when the Federal Reserve (the central bank in the US) began a cycle of interest rate hikes that raised the cost of borrowing from the lowest levels registered since the 1950s. 1 .CHAPTER 8 . 2004. The countdown began on June 30.

25 per cent. The US housing market began sliding in August 2005 and that continued through 2006. Another US-based sub-prime firm Accredited Home Lenders Holding said it would pass on $2. several foreign institutional investors (FIIs) are reeling under the impact of non-performing or bad loans originating in the US sub-prime 2 . were suspended amid fears that the firm could be heading for bankruptcy. In July 2007. 2007. What has the US sub-prime market crisis got to do with stock markets going haywire in India? First. Merrill Lynch seized and sold $800 millions of bonds used as collateral for loans made to Bear Stearns’ hedge funds that were used to bet on the sub-prime mortgage market. Several sub-prime mortgage holders defaulted on their loans and the first sign of a “crisis” emerged in March 2007 when shares in New Century Financial.7 billions of its loans at a heavy discount. General Electric decided to sell the WMC Mortgage subprime lending business it bought in 2004. In June.It increased the interest rates seventeen times and paused only in June 2006 when the borrowing cost touched 5. Shares in Bear Stearns came under pressure in May 2007 because of the bank’s exposure to the US sub-prime market. Did this cause business failure? Yes. Building rates and housing prices tumbled. What do you think was the spillover effect of the slide? The sub-prime mortgage crisis went on to affect major global investment banks as well. On April 2. Goldman Sachs also announced financial support for one of its struggling hedge funds hit by the defaulting sub-prime mortgages. New Century Financial filed for bankruptcy protection after it was forced by its backers to repurchase billions of dollars worth of bad loans. one of the largest sub-prime lenders in the US.

investment management. LEHMAN BROTHERS Lehman Brothers Holdings Inc. Oil & Gas. FMCG ○ ○ ○ Case study on “THE SUB PRIME CRISIS ” . or even reverse. research and trading. will affect the long-term growth prospects of our economy. and private banking. banks and other lending institutions have recorded an increase in their non-performing assets. equity and fixed-income sales. It was a primary dealer in the U. Treasury securities market. ○ IT & IT enabled services. It is likely to slowdown. the flow of foreign direct investments in the Indian economy. 3 . eliminating 1. several aspects in the Indian housing sector eerily resemble the fundamentals of the US sub-prime mortgage crisis. Major sectors in India that would be affected out to a certain extent due to the current crisis are: ○ Banking Industry. and took an after-tax charge of $25 million and a $27 million reduction in as you know.200 positions in 23 locations. the firm closed its subprime lender. These points to a cognizable risk of collapse in the Indian credit markets. Second. private equity. was a global financial-service firm that did business in investment banking. Real Estate. In August 2007. This.S. BNC Mortgage. Property prices here have grown tremendously. borrowing and lending rates have seen gradual increases.

Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in assets. The next day. Lehman's loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages. It further announced that its subsidiaries will continue to operate as normal. In the first half of 2008 alone. Lehman announced a loss of $3. In the second fiscal quarter. which includes Neuberger Berman. On Saturday September 13. announced the possibility of an emergency liquidation of its assets.500 2 . both Barclays and Bank of America ultimately declined to purchase the entire company. In New York.In 2008. the next morning." It culminated on September 9. and assets worth $639 billion.m.9 billion and their intent to sell off a majority stake in their investment-management business. Most of those gains were quickly eroded as news came in that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal. shortly before 1 a. The stock slid seven percent that day. Lehman reported that it intended to release 6% of its work force. $155 billion in bond debt. people On August 22. However. A group of Wall Street firms agreed to provide capital and financial assistance for the bank's orderly liquidation and the In August 2008. when Lehman's shares plunged 45% to $7. 2008.79. 2008. Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale. Lehman faced an unprecedented loss to the continuing subprime mortgage crisis. Lehman stock lost 73% of its value as the credit market continued to tighten. after it was reported that the state-run South Korean firm had put talks on hold. 1. shares in Lehman closed up 5% on reports that the state-controlled Korea Development Bank was considering buying the bank. Lehman Brothers Holdings announced it would file for Chapter 11 bankruptcy protection citing bank debt of $613 billion.

it spread geographically from the 3 . agreed to buy the Asian division of Lehman Brothers for $225 million and parts of the European division for a nominal fee of $2. Massive deleveraging drove down asset prices setting off a vicious cycle. Suddenly. Several venerable financial institutions came to the brink of collapse. agreed to a swap of lower-quality assets in exchange for loans and other assistance from the government. Credit. Nomura Holdings. investment. Anatomy of Financial Instabilit y It was the abrupt breakdown of trust following the collapse of Lehman Brothers in mid-September 2008 that caused financial markets in advanced economies to go into seizure. Japan's top brokerage firm. in the advanced economies. it spread from the financial sector to the real sector severely hurting consumption. but it soon spread in two directions. in turn.Federal Reserve. Trust totally dried up. Nomura negotiated such a low price because it will acquire only Lehman's employees in the regions. What resulted was what many have called the “perfect storm” of economic distress factors. This uncertainty triggered unprecedented panic and almost totally paralyzed the entire chain of financial intermediation. 2008. bond and equity markets nearly froze.It would not take on any trading assets or liabilities in the European units. and not its stocks. but about the extent of risk in the system. On September 17. The last Lehman Brothers Annual Report identified that these non-US subsidiaries of Lehman Brothers were responsible for over 50% of global revenue produced immediately following the bankruptcy filing. Second. bonds or other assets. the New York Stock Exchange delisted Lehman Brothers. Banks hoarded liquidity. an already unstable market began an uncontrollable tailspin. The epic centre of the crisis lay in the advanced economies. where it lay and how it might explode. First. there was a great deal of uncertainty not only about the extent of losses and the ability of banks to withstand those losses. export and import.

2 . In short. financial stability that we had grown to take for granted got impaired. finance and confidence channels.advanced economies to the emerging market economies and soon engulfed almost the entire world through trade.

CHAPTER 9 CHA LLENGES FACING BANKING INDUSTRY IN INDIA CHALLENGES FACING BANKING INDUSTRY IN INDIA The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. ➢ DEREGULATION: 3 . These multiple changes happening one after other has a ripple effect on a bank trying to graduate from completely regulated seller market to completed deregulated customers market.

the market place has been redefined with new rules of the game. Customers have become demanding and the loyalties are diffused. Banks need to access low cost funds and simultaneously improve the efficiency. There are multiple choices. specifically retail credit. Given the relatively low switching costs. as they are bound to react to the value added offerings. flawless service delivery. Banks are transforming to universal banking. ➢ NEW RULES: As a result. 4 . The deregulation of the industry coupled with decontrol in interest rates has led to entry of a number of players in the banking industry. The banks are facing pricing pressure. the wallet share is reduced per bank with demand on flexibility and customization. customer retention calls for customized service and hassle free. ➢ DIFFUSED CUSTOMER LOYALTY: This will definitely impact Customer preferences. Natural fall out of this has led to a series of innovative product offerings catering to various customer segments. adding new channels with lucrative pricing and freebees to offer. operational flexibility and decontrolled interest rate and liberalized norms for foreign exchange. ➢ EFFICIENCY: This in turn has made it necessary to look for efficiencies in the business.This continuous deregulation has made the Banking market extremely competitive with greater autonomy. squeeze on spread and have to give thrust on retail assets. At the same time reduced corporate credit off take thanks to sluggish economy has resulted in large number of competitors batting for the same pie.

GLOBALISATION – A CHALLENGE The benefits of globalization have been well documented and are being increasingly recognized. as employees are made to adapt to changing conditions. ➢ COMPETENCY GAP: Placing the right skill at the right place will determine success. Globalization of domestic banks has also been facilitated by tremendous advancement in information and communications 5 .➢ MISALIGNED MINDSET: These changes are creating challenges. There is resistance to change from employees and the Seller market mindset is yet to be changed coupled with Fear of uncertainty and Control orientation. The competency gap needs to be addressed simultaneously otherwise there will be missed opportunities. on escalating problems rather than solving them and on disposing customers instead of using the opportunity to cross sell. Acceptance of technology is slowly creeping in but the utilization is not maximized. The focus of people will be on doing work but not providing solutions.

implementation of Basel II. If we were to identify a few global challenges which banks face today. It is true that Basel 6 . alignment of regulatory and accounting requirements. enhancement of transparency & disclosures. viz. I had identified a few broad challenges faced by the Indian banks in the following areas. outsourcing risks. improvement of risk management systems. and compliance with KYC aspects. Adoption of appropriate prudential. enhancement of customer application of technology. and technological framework on par with international best practices enables strengthening of the domestic banking system. Global challenges in banking Recently I was afforded an opportunity to speak on the challenges faced by the Indian banking industry. enhancing corporate governance. and application of advanced technology. which would help in fortifying it against the risks that might arise out of globalization. Globalization has thrown up lot of opportunities but accompanied by concomitant risks. which followed the twin governing principles of non-disruptive progress and consultative process. To recapitulate. An overview of the global challenges would include the following: Basel II implementation. There is a growing realization that the ability of countries to conduct business across national borders and the ability to cope with the possible downside risks would depend. In India.. on the soundness of the financial system and the strength of the individual participants. we had strengthened the banking sector to face the pressures that may arise out of globalization by adopting the banking sector reforms in a calibrated manner. inter-alia. BASEL II IMPLEMENTATION. implementation of new accounting standards. supervisory. regulatory.A CHALLENGE Basel II implementation is widely acknowledged as a significant challenge faced by both banks and the regulators internationally. I propose to cover these aspects now. I am sure we would cover some common ground.

banks are also aware of the desirability of risk aggregation across the group both in the specific risk areas as also across the risks. therefore.e. Besides the increase in the number of risks. It is no longer adequate to manage each risk independently. a transition from capital adequacy to capital efficiency. Banks in India are also moving from the individual silo system to an enterprise wide risk management system. now putting in place an integrated framework for risk management which is proactive.. In effect. therefore. Enterprises worldwide are. and improvement in capital efficiency Comprehensive risk management: Under Basel I banks were focused on credit and market risks. I would venture to mention that Basel II implementation has another dimension which offers considerable opportunities to banks. how effectively capital is used will determine return on equity and a consequent enhancement of shareholder value. banks are now beginning to focus on their inter-linkages with a view to achieve a more comprehensive risk management framework. Basel II has brought into focus a larger number of risks requiring banks to focus on a larger canvas. While it may be so for some banks. In this transition. in which capital will flow quickly to its most efficient use.II implementation may be seen as a compliance challenge. therefore. systematic and spans across the entire organization. viz. banks may adopt a more dynamic approach to use of capital.. be required to allocate significant resources towards this endeavor. I would like to highlight two opportunities that are offered to banks. This revised efficiency approach is 7 . banks were managing each risk in isolation. is being increasingly seen as a medium through which banks constantly endeavour to upgrade the risk management systems to address the changing environment. Capital efficiency: Basel II prescriptions have ushered in a transition from the traditional regulatory measure of capital adequacy to an evaluation of whether a bank has found the most efficient use of its capital to support its business i. While the first milestone would be risk integration across the entity. refinement of risk management systems. Banks would. in the initial stages. Further. Basel II implementation.

legal prescriptions for ownership and governance of banks in Banking Regulation Act. and poor Board oversight of the 8 . but also leverage such funds through credit creation. Effective risk management systems determine the health of the financial system and its ability to survive economic shocks. In view of the above. A notable feature of these instruments is that these are designed to help banks in not only managing their capital effectively but also efficiently.A CHALLENGE The issues related to corporate governance have continued to attract considerable national and international attention in light of a number of high-profile breakdowns in corporate governance. including perpetual instruments. banks would need to shore up the capital levels not only for complying with these requirements but also for supporting the balance sheet growth. In view of the importance of the banking system for financial stability. sound corporate governance is not only relevant at the level of the individual bank. 1949 have been supplemented by regulatory prescriptions issued by RBI from time to time. With a view to enhancing the options available to banks for augmenting their capital levels. the Reserve Bank has recently permitted banks to issue new capital instruments. Banks are also important participants in the payment and settlement systems. To a large extent. many risk management failures reflect a breakdown in corporate governance which arise due to poor management of conflicts of interest.expected to guide the return-on-equity strategy and influence banks’ business plans. This becomes all the more relevant for banks since they not only accept and deploy large amount of uncollateralized public funds in fiduciary capacity. With the extension of capital charge for market risks to the AFS portfolio this year and the coming into force of Basel II norms in March 2007. ENHANCING CORPORATE GOVERNANCE. but is also a critical ingredient at the system level. inadequate understanding of key banking risks.

compliance and audit functions. Consequently. (2) Oversight by individuals not involved in the day-to-day running the various business areas. therefore. COMPLIANCE WITH INTERNATIONAL ACCOUNTING of STANDARDS – A CHALLENGE 9 . Although some ownership structures might have the potential to alter the strategies and objectives of a bank. the foundation for effective risk managements in banks and thus the foundation for a sound financial system. A good "governance culture" is crucial for financial stability but since it is an ‘intangible’. In addition. Therefore. the choices which banks make when they establish their risk management and corporate governance systems have important ramifications for financial stability. the general principles of sound corporate governance should also be applied to all banks irrespective of their unique ownership structures. There are four important forms of oversight that should be included in the organizational structure of any bank in order to ensure appropriate checks and balances: (1) Oversight by the board of directors or supervisory board. and (4) Independent risk management. These systems can affect how the institution functions and how others perceive it in the marketplace .mechanisms for risk management and internal audit. these banks will also face many of the same risks associated with weak corporate governance. rules may not be able to capture its essence effectively. (3) Direct line supervision of different business areas. banks may have to cultivate a good governance culture building in appropriate checks and balances in their operations. it is important that key personnel are fit and proper for their jobs. Therefore. Corporate governance is.

the need to upgrade the accounting framework needs no emphasis. The World Bank’s ROSC on Accounting and Auditing in India has commented on the absence of an accounting standard which deals with recognition. Financial reporting and prudential supervision have slightly different perspectives. While the risk management framework for derivative trading. The proposed Accounting Standards will be of considerable significance for 10 . It is widely accepted that as the volume of transactions increases. While the former is oriented towards capturing the historical position. presentation and disclosures pertaining to financial instruments. the absence of clear accounting guidelines in this area is matter of significant concern. Derivative activity in banks in India has been increasing at a brisk pace. measurement. it is essential for the regulators to be in a position to address any implications that the changes in accounting standards may have for the safety and soundness of banks. therefore. An important challenge. These will be the Indian parallel to International Financial Reporting Standard 7. which is happening in the Indian banking system. is an essential pre-requisite. is to ensure that accounting standards and prudential frameworks are mutually consistent. While working towards achieving this consistency between the two sets of standards. the latter has a forward looking element particularly with reference to measurement of impairment and capital. The Accounting Standards Board of the Institute of Chartered Accountants of India (ICAI) is considering issue of Accounting Standards on the above aspects pertaining to financial Instruments. Accounting standards are now a part of the set of twelve standards that have been identified by the Financial Stability Forum as conducive to a robust financial infrastructure. International Accounting Standards 32 and 39.One of the prime international standards considered relevant for ensuring a safe and sound banking system is the ‘Core Principles for Effective Banking Supervision’ issued by the Basel Committee on Banking Supervision (BCBS). which is a relatively new area for Indian banks (particularly more in respect of structured products).

In the entities and could therefore have implications for the financial sector. Adoption and implementation of these principles are likely to pose a great challenge to both the banks and the Reserve Bank. 11 . investment management. Since this is likely to give rise to some regulatory prudential issues all relevant aspects are being comprehensively examined. marketing and research. to perform activities on a continuing basis that would normally be undertaken by the bank itself. the Reserve Bank is considering the need for banks and financial entities adopting the broad underlying principles of IAS 39. as is normal. OUTSOURCING RISKS-A CHALLENGE Banks are increasingly using outsourcing for achieving strategic aims leading to either rationalization of operational costs or tapping specialist expertise which is not available internally. be discussed with the market participants before introduction. supervision of loans. document processing. The formal introduction of these Accounting Standards by the ICAI is likely to take some time in view of the processes involved. credit card). 'Outsourcing' may be defined as a bank's use of a third party. Typically outsourced financial services include applications processing (loan origination. data processing and back office related activities etc. including an affiliated entity within a corporate group. The proposals in this regard would.

compliance risk. Banks which have made inadequate investment in technology have consequently faced an erosion of their market shares. Recognizing the benefits of modernizing their technology infrastructure banks are taking the right initiatives.Outsourcing might give rise to several risks including. The beneficiaries are those banks which have invested in technology. or buy best of the modules. ensure security/ confidentiality. strategic risk. comply with legal and regulatory requirements can lead to financial losses/ reputational risk for the bank and could also lead to systemic risks for the entire banking system in a country. It is in this background that RBI has issued draft guidelines on outsourcing. It would therefore be imperative for the bank outsourcing its activities to ensure effective management of these risks. banks have four options to choose from: they can build a new system themselves. or outsource. banks are not expected to outsource any activity that would result in their internal control. exit strategy risk. or buy a comprehensive solution. country risk. operational risk. which creates new business models and processes. counterparty risk. Adoption of technology also enhances the quality of risk management systems in banks. Outsourcing banks. or reputation being compromised or weakened. concentration risk and systemic risk. access risk. therefore. In this 12 . should take steps to ensure that the service provider employs the same high standard of care in performing the services as would be employed by the banks if the activities were conducted within the banks and not outsourced. The failure of a service provider to provide a specified service. While doing so. which is intended to provide direction and guidance to banks to effectively manage risks arising from such outsourcing activities. business conduct. reputation risk. Accordingly. APPLICATION OF ADVANCED TECHNOLOGY-A CHALLENGE Technology is a key driver in the banking industry. and also revolutionizes distribution channels.

so as to equip themselves to take advantage of the incentives offered under the advanced approaches. and give them a competitive advantage. The demand for better skills can be met either from within or from outside. A further challenge which banks face in this regard is to ensure that they derive maximum advantage from their investments in technology and avoid wasteful expenditure which might arise on account of uncoordinated and piecemeal adoption of technology. CAPACITY BUILDING. banks need to focus on appropriate capacity building measures to equip their staff to handle advanced risk management systems and supervisors also need to equally equip themselves with appropriate skills to have effective supervision of banks adopting those systems. but is only intended to prioritize the process INTEREST RATE RISK – A CHALLENGE 13 . Skill requirements would be significantly higher for banks planning to migrate to the advanced approaches under Basel II. A relevant point in this regard is that capacity building should be across the institution and not confined to any particular level or any particular area. It would perhaps be worthwhile to first glean through the existing resources to identify misplaced or hidden or forgotten resources and re-position them to boost the bank’s efforts to capitalize on available skills.context banks need to clearly define their core competencies to be sure that they are investing in areas that will distinguish them from other market players. Capacity building gains greater relevance in these banks. adoption of inappropriate/ inconsistent technology and adoption of obsolete technology. In the likelihood of a high level of attrition in the system. This does not undermine the benefits that a bank may derive by meeting their requirements from the market. banks need to focus on motivating their skilled staff and retaining them 7 .A CHALLENGE As dictated by the changing environment.

from 13 per cent to 4. Any movement in domestic interest rate is the main source of interest rate risk. ⇒ Now as yields go up (with the rise in inflation. ⇒ Over the last few years the treasury departments of banks have been responsible for a substantial part of profits made by banks. bond yields go up and bond prices fall as the debt market starts factoring a possible interest rate hike). Between July 1997 and Oct 2003. This concern becomes much stronger because a substantial percentage of bank deposits remain invested in government bonds. Recent months have shown a rise in the bond yields has led to the profit from treasury operations falling.⇒ Interest rate risk can be defined as exposure of bank's net interest income to adverse movements in interest rates. A bank's balance sheet consists mainly of rupee assets and liabilities. With yields falling the banks made huge profits on their bond portfolios. If the rise in yields continues the banks might end up posting huge losses on their trading books. banks will have to look at alternative sources of investment. ⇒ This will make it difficult to show huge profits from treasury operations. the yield on 10-year government bonds (a barometer for domestic interest rates) fell.9 per cent. the banks will have to set aside funds to mark to market their investment. ⇒ Banking in the recent years had been reduced to a trading operation in government securities. as interest rates fell. Given these facts. The latest quarterly reports of banks clearly show several banks making losses on their treasury operations. 14 .

Reduced NPAs generally gives the impression that banks have strengthened their credit appraisal processes over the years. A lot of foreign banks have already burnt their fingers in the retail game and have now decided to get out of a few retail segments completely. with the banks undercutting one another. OBC was a zero NPA bank). is now the most important of the lot. treasury income will come down and if the banks wish to make large provisions. which was earlier ignored. COMPETITION IN RETAIL BANKING – A CHALLENGE The entry of new generation private sector banks has changed the entire scenario. A few banks have even managed to reduce their net NPAs to less than one percent (before the merger of Global Trust Bank into Oriental Bank of Commerce. Indian banks seem to be better placed than they were in the past. shall bring down the profitability of banks. The retail segment. with the banks jumping over one another to give out loans. Now they need to sell banking. Given this fact. and this in turn. But as the bond yields start to rise the chances are the net NPAs will also start to go up. 15 . With increasing bond yields. This will happen because the banks have been making huge provisions against the money they made on their bond portfolios in a scenario where bond yields were falling. The consumer has never been so lucky with so many banks offering so many products to choose from. This does not seem to be the case. the money will have to come from their interest income.INTEREST RATES AND NON-PERFORMING ASSETS – A CHALLENGE The best indicator of the health of the banking industry in a country is its level of NPAs. Earlier the household savings went into banks and the banks then lent out money to corporate. With supply far exceeding demand it has been a race to the bottom.

The PSBs have been losing business to the private sector banks in this segment. The central government also seems to be game about the issue and is seen to be encouraging PSBs to merge or acquire other banks. PSBs need to figure out the means to generate profitable business from this segment in the days to come THE URGE TO MERGE – A CHALLENGE In the recent past there has been a lot of talk about Indian Banks lacking in scale and size. Before a merger is carried out cultural issues should be looked into. A bank based primarily out of North India 16 . Most of the PSBs are either looking to pick up a smaller bank or waiting to be picked up by a larger bank. Global evidence seems to suggest that even though there is great enthusiasm when companies merge or get acquired. majority of the mergers/acquisitions do not really work. So in the zeal to merge with or acquire another bank the PSBs should not let their common sense take a back seat. globally. The State Bank of India is the only bank from India to make it to the list of Top 100 banks.The nimble footed new generation private sector banks have taken a lead on this front and the public sector banks are trying to play catch up.

As Keynes wrote. Technological compatibility is another issue that needs to be looked into in details before any merger or acquisition is carried out. So the integration process might become very difficult. "Worldly wisdom teaches us that it's better for reputation to fail conventionally than succeed unconventionally". time and convenience. it is not only relevant to offer a wide menu of services but also provide these in an increasingly efficient manner in terms of cost.might want to acquire a bank based primarily out of South India to increase its geographical presence but their cultures might be very different. The establishment of new private sector banks and foreign banks has rapidly changed the competitive landscape in the Indian consumer banking industry and placed greater demands on banks to gear themselves up to meet the increasing needs of customers. banks have begun offering a bouquet of financial services to their clients. The banks must not just merge because everybody around them is merging. For the discerning current day bank customers. Some banks have begun employing customer relationship management systems to not only retain the existing customers but also to attract new customers. While banks are focusing on the methodologies of meeting the increasing demands placed on them. The ultimate aim is to offer a one-stop-shop for meeting varied customers' financial needs. Banks should avoid falling into this trap. there are legitimate concerns in regard 17 . Apart from providing the conventional banking services. CUSTOMER SERVICE – A CHALLENGE It is no longer adequate for banks to provide only traditional banking services. including cross selling of financial products.

to the banking practices that tend to exclude rather than attract vast sections of population. self-employed and those employed in unorganized sector. While proceeding in this direction banks ought not to lose sight of the new risks that they might be assuming and hence put in place appropriate strategies and systems for managing these new risks. BRANCH BANKING – A CHALLENGE Traditionally banks have been looking to expansion of their branch network to increase their business. Banks are. therefore. examining the potential benefits that may accrue by tapping the agency arrangement route and the outsourcing route. Feedback received reveals recent trends of levying unreasonably high service/user charges and enhancement of user charges without proper and prior intimation. Reserve Bank of India had mentioned in the Annual Policy Statement 2007-08 that RBI will take initiatives to encourage • • • greater degree of financial inclusion in the country. Effective redressal of customer grievances. It is in this context that the Governor. 18 . be reasonable to expect banks to focus on the above aspects while designing their products for customers. in particular pensioners. setting up of a mechanism for ensuring fair treatment of consumers. It would. Further. therefore. experience has shown that consumers’ interests are at times not accorded full protection and their grievances are not properly attended to. It has been realized that it might not be necessary to establish a wider brick and mortar network to reach a wider population. Against this background it is interesting to observe that the new private sector banks as well as the foreign banks have been able to achieve business expansion through other means.

This will make it imperative for banks to enhance their systems and procedures to international standards and also simultaneously fortify their financial positions. banks need to equip themselves to operate in the increasingly competitive environment. TRANSPARENCY AND DISCLOSURES – A CHALLENGE In pursuance of the Financial Sector Reforms introduced since 1991 and in order to bring about meaningful disclosure of the true financial position of banks to enable the users of financial statements to study and have a meaningful comparison of their positions.COMPETITION – A CHALLENGE With the ever increasing pace and extent of globalization of the Indian economy and the systematic opening up of the Indian banking system to global competition. Reserve Bank has proposed enhanced disclosures which lay a greater emphasis on disclosure of certain qualitative 19 . a series of measures were initiated. The disclosure requirements broadly covered the following aspects: • • • • • • • Capital adequacy Asset quality Maturity distribution of select items of assets and liabilities Profitability Country risk exposure Risk exposures in derivatives Related party disclosure With a view to moving closer towards international best practices including International Accounting Standards (IAS) and the disclosure requirements under Pillar 3 of Basel II.

process and technology to reduce the fixed costs and cost per transaction. (e. banks should implement a process for assessing the appropriateness of their disclosures.  Leveraging the branch network and sales structure to mobilize low cost current and savings deposits.  Making aggressive forays in the retail advances segment of home and personal loans. including validation and frequency.aspects. OPTIONS WITH BANKS TO COPE WITH THE 20 .  Implementing organization wide initiatives involving people. CHAPTER 10 STRATEGIC CHALLENGES Leading players in the industry have embarked on a series of strategic and tactical initiatives to sustain leadership. The major initiatives include:  Investing in state of the art technology as the back bone to ensure reliable service delivery. In addition.  Focusing on fee based income to compensate for squeezed spread. Transparency and disclosure standards are also recognized as important constituents of a sound corporate governance mechanism. trade services). Banks are required to formulate a formal disclosure policy approved by the Board of directors that addresses the bank’s approach for determining what disclosures it will make and the internal controls over the disclosure process.g. CMS.

we were able to contain the 21 .  We managed the capital account actively. When the flows reversed during the last quarter of 2008. In the face of large capital inflows during 2006-08. Innovating Products to capture customer ‘mind share’ to begin with and later the wallet share.IMPORTANT MEASURES TOWARDS FINANCIAL STABILITY It may be relevant to highlight some of the specific features of our system that have contributed to financial stability:  Banks are required to hold a minimum percentage of their liabilities in risk free government securities under the statutory liquidity ratio (SLR) system.  Improving the asset quality as per Base II norms INDIA . we reversed the measures too. This stipulation ensures that banks are buffered by liquidity in times of stress. We cut the CRR and bought back the MSS securities to inject liquidity into the banking system.  Through pre-emptive countercyclical provisioning and a differentiated risk weight stipulation for ‘sensitive sectors’. we sterilised the resultant excess liquidity through calibrated hikes in the cash reserve ratio (CRR) and issue of market stabilisation scheme (MSS) securities.

adverse impact of high credit growth in some sectors and asset price fluctuations on banks’ balance sheets. We also require profit from sale of assets to SPVs to be amortised over the life of the securities issued. CCP guaranteed arrangements for forex forwards and OTC rupee interest rate swaps are underway.  To ensure that securitization is value adding. Our expertise 22 . and credit enhancements and liquidity support are subject to capital regulations. Other entities can access the overnight market only through collateralised instruments which are cleared and settled on a guaranteed basis through a central counterparty.  Regulation and oversight have been extended to systemically important non-deposit taking.  Central counterparty (CCP) clearing and guaranteed settlement is currently to non-bank finance companies within the prudential operative for government securities transactions and inter-bank rupee-USD forex transactions. non-banking finance companies.  Access to overnight unsecured call market is restricted to banks and primary dealers. and this has limited leverage and space for regulatory arbitrage. TRANSFORMATION INITIATIVES NEEDED FOR BANKS The ECS value proposition for helping banks in their transformation agenda. we insist on ‘true sale’.  Systemic interconnectedness has been addressed by bringing banks’ exposures framework. We at ECS have vast experience in partnering with leading players in banking for addressing these challenges in a holistic manner.

KRA ○ Assessing competencies of people across levels and match the position with the skill set ○ Designing and implementing a new PMS for restructured organization 23 .is reflected in our product offerings for addressing the key challenges. A select few are outlined below: • Strategy ○ Sales & Marketing strategy for both retail & wholesale banking ○ Expanding geographies • Brand ○ Understanding the values of the brand ○ Repositioning the brand to communicate the values • Organization restructuring ○ Re organization of the bank in line with the strategic thrust • Re engineering of the key business processes ○ Redesign of Sales processes to increase conversion ratio ○ Six Sigma process improvements for branch channel. Call Centre & back office processes ○ Centralization of branch operations and deferred processes to free up resources • Cost efficiency ○ Reduction in Total cost of acquisition ○ Reduction in transaction costs ○ Reduction in fixed and overheads cost • Creating a high performing organization ○ Define new roles & responsibilities.

it has effected. 2. financial innovation has changed . by adopting or following bank rules & norms.• Change management & creating a new mind set ○ Developing critical mass of champions and drive ‘Change’ across the organisation to move from conventional banking to new age bank ANALYSIS 1. under one roof – function of universal banking. b)due to globalisation. Yes. Manpower has controlled & costing has decreased. basel II implementation is being following such as capital adequacy. they should follow the same 3. non performing assets etc. This bank has not caused any effect because of nice monitoring activity done by RBI. a) All reports & documents are being getted or collected from one branch. e)yes. The Indian banks which have their foreign bank a/c they have to follow that.this does not cause any effect on federal resrve after subprime 4.flow of money has increased that has not caused any effect. d)yes. i. c)capital requirement.e.yes. 24 .CBS – core banking solution because pof that one bank connect to the other.

CONCLUSION After the study. The past days are witness to an hour wait before withdrawing cash from accounts or a cheque from north of the country being cleared in one month in the south. And due to globalization. 25 . With stiff competition and advancement of technology. the service provided by banks has become more easy and convenient.many banks got relief against working activities done by them by adopting new foreign rules& norms & also technological infrastructure has increased. I have found that Indian Banking System is growing tremendously Because it has a strong base for development of an economy.

with the borrowing and lending rates extremely low which helped boost the demand for and supply of new and existing houses. Many institutions offered home loans to borrowers with poor or no credit histories by requiring higher than normal repayment levels — creating what is now referred to as “sub-prime mortgages” —attracting investment banks and hedge fund owners to bet big on this emerging aspect of the US economy. home loans. crisis began at home. 26 .CASE STUDIES SUBPRIME CRISIS How and when did the sub-prime mortgage crisis begin? Here. or more exactly. Housing prices began spiraling upwards in the US in the early years of this decade and continued through mid-2006.

e. 27 . flow of money d) Whether the globalisation has affected in reduction of cost for bank? e) Basel II implementation in your bank. 4) Effect of globalisation on Indian banking system.APPENDIX 1) What could be the lesson which India can learn from sub-prime crisis. a) Do you think whether globalisation has helped Indian banks to improve their technological infrastructure? b) Financial innovation c) Capital requirement i. 2) Do you think whether the foreign banks should follow the prudent norms which Indian banks are following? 3) Your comments on loose monetary policy followed by US Federal Reserve after sub- prime issue.


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