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Issues And Challenges in Banking

as compared to a 27 per cent growth in the market index during the same period. by themselves or through their subsidiaries. Indian banks have performed favorably on growth. pension fund regulation. Compared to other regional banks. The Reserve Bank of India (RBI). . In the current decade.7 per cent of GDP with over Rs.. The banking index has grown at a compounded annual rate of over 51% from April 2001 compared to the market index for the same period. life and general insurance. It is projected that the sector has the potential to account for over 7. and to provide over 1. banks have diversified their activities and are getting into new products and services that include opportunities in credit cards. stock broking services. this has emerged as a resurgent sector in the Indian economy. It is up to the banks to leverage the opportunities to meet the challenges to the best of their abilities. asset quality and profitability.Introduction The Banking sector in India has always been one of the most preferred avenues of employment. which registered a growth rate of 27%. etc. change in CRR and interest rate) to provide better options to potential and new customers. Adoption of new practices to cater to the demanding economy situation has enabled the banks to meet the changing customer requirements. wealth management.500 billion in market cap.5 million jobs. Today. Many big banks operating in the market have made use of the changed regulations (viz. investment banking. consumer finance. over the last few years. The past year witnessed a lot of turmoil in the Indian banking industry owing to the global financial crisis.7. private equity. mutual funds. Further. most of the leading Indian banks are going global. the banking sector index has grown at a compounded annual rate of over 51 per cent since the year 2001. As per the McKinsey report ‘India Banking 2010’. setting up offices in foreign countries. The Present Scenario The current economic situation provides a lot of opportunities as well as challenges to the existing banks. custodian services. Ministry of Finance and other regulatory authorities have made several notable efforts to improve regulation in the sector.

which forms 50% of banks' retail portfolio. Analysts and credit rating agencies in their reports showed marginal to moderate increases in NPLs in assets such as two-wheelers. this check also meant a clear pulling down of new/additional credit outflow. Globally. To ensure survival. owing to increased pressure on existing loan portfolios and the fear of anticipated mass job losses which would result in high NPAs. . restriction on collection practices and soaring real estate prices. commercial vehicles and unsecured loans. Over a short span of time. the solution to the systemic issues will require significant inputs and regulatory. in India. industry and infrastructural interventions. banks tried to quickly assess their liquidity reserves and capital position to check if they had any exposure to the failing global entities. these systemic issues are being tackled at the legislative and regulatory levels.The crisis that hit the financial services industry initially in the US and almost immediately in the entire world has moved our focus towards critical systemic issues—not only in the US banking business but also in India. the situation resulted in banks totally stopping the outflow of new credit. unless and until their positions were clear. Growth in mortgages. was also hit due to upward movement in interest rates. According to Indian Banks Association Data. Additionally. retail credit growth dropped drastically from 30% in 2007 to 10% in 2008.

outsourcing risks. and improvement in capital efficiency. enhancing corporate governance. alignment of regulatory and accounting requirements. Basel II implementation.Issues and Challenges in Banking Global challenges in banking An overview of the global challenges would include the following: Basel II implementation. banks are now beginning to focus on their inter-linkages with a view to achieve a more comprehensive risk management framework. and application of advanced technology. While it may be so for some banks.e. I would venture to mention that Basel II implementation has another dimension which offers considerable opportunities to banks. Enhancing corporate governance: The issues related to corporate .. It is true that Basel II implementation may be seen as a compliance challenge. therefore. In this transition. Basel II implementation Basel II implementation is widely acknowledged as a significant challenge faced by both banks and the regulators internationally.. a transition from capital adequacy to capital efficiency. is being increasingly seen as a medium through which banks constantly endeavour to upgrade the risk management systems to address the changing environment. viz. 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. how effectively capital is used will determine return on equity and a consequent enhancement of shareholder value. refinement of risk management systems. Besides the increase in the number of risks. I propose to cover these aspects now. I would like to highlight two opportunities that are offered to banks. Basel II has brought into focus a larger number of risks requiring banks to focus on a larger canvas. Comprehensive risk management: Under Basel I banks were focused on credit and market risks.

which is happening in the Indian banking system. the need to upgrade the accounting framework needs no emphasis. the absence of clear accounting guidelines in this area is matter of significant concern. A good “governance culture” is crucial for financial stability but since it is an ‘intangible’. Compliance with international accounting standards  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). It is widely accepted that as the volume of transactions increases. is an essential pre-requisite. While the risk management framework for derivative trading. sound corporate governance is not only relevant at the level of the individual bank.  Derivative activity in banks in India has been increasing at a brisk pace. In view of the importance of the banking system for financial stability.governance have continued to attract considerable national and international attention in light of a number of high-profile breakdowns in corporate governance. banks may have to cultivate a good governance culture building in appropriate checks and balances in their operations. rules may not be able to capture its essence effectively. but is also a critical ingredient at the system level. . 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. Therefore.

Adoption of technology also enhances the quality of risk management systems in banks. marketing and research. The beneficiaries are those banks which have invested in technology. supervision of loans. 'Outsourcing' may be defined as a bank's use of a third party.Outsourcing risks Banks are increasingly using outsourcing for achieving strategic aims leading to either rationalisation of operational costs or tapping specialist expertise which is not available internally. to perform activities on a continuing basis that would normally be undertaken by the bank itself. Typically outsourced financial services include applications processing (loan origination. Application of advanced technology Technology is a key driver in the banking industry. credit card). 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. data processing and back office related activities etc. Capacity building As dictated by the changing environment. investment management. document processing. and also revolutionises distribution channels. Banks which have made inadequate investment in technology have consequently faced an erosion of their market shares. Recognising the benefits of modernising their technology infrastructure banks are taking the right initiatives. banks need to focus on motivating their skilled staff and retaining them. In the likelihood of a high level of attrition in the system. which creates new business models and processes. including an affiliated entity within a corporate group. Conclusion .

The high liquidity with banks forced them to invest in the liquid funds of mutual funds. the Indian banking industry emerged as a strong performer owing to the coordinated efforts of policy makers and the banks in bringing these policies to action for the best of the economy. The alarm will start ringing if the regulator decides to continue with the stimulus package for long.4%. which is consistently on a growth path. According to a report by Tata Securities. an increase in domestic liquidity has had a cascading effect on the asset price inflation.related companies—power. leading to fiscal deficit eventually. banking in India involves the cooperation and participation of many stakeholders for the desired changes to be made in the existing system. and a demand in the economy for physical asset creation. resulting in the banks' looking for other investment opportunities. However. the economy witnessed perhaps the biggest and positive impact of higher credit growth in infrastructure. which in turn invested in commercial papers of corporates at a lower coupon— corporates would have otherwise borrowed at a higher cost from the banks for their working capital requirements. the YTD growth in deposits is 9%. it was partially compensated by the reduction in other funding sources such as private equity and foreign institutional investors. These factors enabled the Indian banking sector to become stronger on the capitalization front and also ensure lower level NPAs and better spreads in the past one-and-a-half decade. The strength provided through timely measures has helped the industry and the economy in many ways. central bank's proactive measures to steadily improve banks' balance sheet strength. However. The downturn which the economy witnessed has discouraged the banks .Thus. the banking system will continue to invest excessively in government securities. The Indian banking industry gathered the strength to sustain during such times through its huge deposit base. Last year. With dried-up liquidity and no borrowers (given the low credit growth). while the credit growth is only 5. during the economic slowdown. when the banking system globally went for a toss. Last year. telecom and others.

The banks need to have higher incremental CD ratio. the only other Indian bank in the top 100 club has improved its position with a brand value of US$ 2. housing loans grew by 20% CAGR during the same period and consisted ~10% of the total bank credit. The brand value of SBI has enhanced to US$ 1. Thus.501 million. have emerged stronger. In fact. the State Bank of India (SBI) which is the first Indian bank to be ranked among the Top 50 banks in the world. ICICI Bank. it is expected that the Net Interest Margin (NIM) will not expand much. According to a research report from Tata Securities. Indian banks continue to build on their strengths under the regulator's watchful eye and hence. has improved its position from 36th to 34th. it is up to the banks as to how well they leverage the opportunities to meet the challenges to the best of their capacities. as always. 18 Indian banks have been included in the Brand Finance Global Banking 500.from having any exposure to unsecured consumer credit. we can very well say that the current situation has provided a lot of opportunities and challenges to the existing banks. . fee income has been the major contributor of revenue for private sector banks. Indian banks contributed 1. Within the retail segment.741 million and grew by 19 per cent in 2011.7 per cent to the total global brand value at US$ 14. According to the study. The banking system remains. In the annual international ranking conducted by UK-based Brand Finance Plc. Besides the favorable condition for liquidity and high bond yield.119 million. In the past few years. as per the Brand Finance study released on February 1. Banks are expected to have a low cost of deposits owing to a stable interest rate scenario and ample liquidity in the system. 2011. improvement in spreads and stable yield on investments to improve NIMs. the most dominant segment of the financial sector. and a revival in this segment is not expected to happen soon. Another important area which requires critical attention is fee income. Now. retail loans showed a CAGR of 22% during FY05-FY09.