Chapter 2

Impact of Globalization and Liberalisation on banking in India

2.1 Introduction

Far reaching changes are taking place in the financial markets world over. There is

greater attention for improving efficiency strengthening the viability of financial

institutions. With the advent of globalization and rapid integration of financial markets,

our world is growing smaller in every aspect of life. From the global standpoint the size

of the banking system is not as important as the level of compliance with the

internationally accepted rules and standards and their functionality.

One of the focused area of macro economic reforms is the financial sector, its

soundness and efficiency. A well functioning banking sector is regarded as the bedrock

of a stable financial system. The growing universalization and internationalization

driven by the continuous deregulation has increased competition and technological

advancement. Banks have transformed themselves from of mere intermediator to one

providing quick efficient and consumer centric services. Secondly, there is a linkage

between economic reforms and banking sector reforms. The economic reforms brought

about large number of problems to be addressed by the financial sector.

The integration of financial markets has created a more complex financial environment.

Globalization is a more advanced form of internationalization that implies a degree of

functional integration between internationally dispersed economic activities. Banks

need to face the challenges on account of this process and they cannot afford to be

30

complacent in the face of large financial innovations taking place in the financial

markets. The Indian banking industry has to recognize these changes and adopt the

best principles of international banking.

2.2 Globalisation and World Trade Organisation:

The process of Globalization which began in 1970s and gained momentum in 1990s is

of considerable significance for the world economy in general and in India in particular.

Globalization of economy means expansion of production, trade, services and finance.

"Globalization constitutes integration of national economies into the international

economy through trade, direct foreign investment, short term capital flows,

international flow of workers, and flows oftechnology."13

IMF defines globalization as the growing economic interdependence of countries

worldwide through increasing volume and variety of cross border transactions inputs

and services and of international capital flows, and also through the more rapid and

widespread diffusion of technology. Globalization implies that the distinction between

domestic and international arena becomes blurred. It also means the free movement

across the national borders of the physical capital, financial capital, technology and

labour. "Globalization has brought new challenges for the Indian business particularly

the banking sector. Due to structural changes in the financial market, technological

advancements, deregulation, customer awareness and expectations." 14

n Bhagwati Jagdish, "In Defense Of Globalization," Oxford University Press, New Delhi .(2004) p-3. 14 Revathi K, (2006) "Impact of Globalization on the banking Sector," Facts for you, November, pp-40&41.

31

Under the General Agreement on Trade and Tariff (GAIT) free world trade has

become the engine of growth and countries are required to compete to gain strategic

advantage. With the passage oftime WTO has replaced GATT. In the process ofthe

WTO negotiations India had to give in to the demands of major trading partners. These

demands were to increase the number of licenses and provide gradual increase in the

market share on asset of foreign bank, subsidiaries and joint ventures should be allowed

in the banking sector, discrimination against foreign banks in terms of higher taxation

should be removed. The above commitment has led to the opening up of the banking

and financial sector to the foreign players.

2.2.1 Impact of globalisation and WTO on Indian banking industry:

Globalisation and liberalisation has created substantial impact on the banking services.

They are as follows:

A. Increase in global competition,

B. Reduction of distinction between universal and specialised financial institutions,

C. Blurring of separation between banks and other financial intermediaries/institutions,

D. Increase in complexities of banking activities and operations to the extent of

integration with international arena,

E. Increase in challenges to bank managers/owners/regulators in fulfilling their

respective responsibilities,

F. Increase in availability of arbitrage opportunities by undertaking operations at

favourable locations.

To establish global presence Indian banks will need to:

32

A. Update their technology and computerise their operations, improve payment,

delivery and settlement systems, as well as greater access to information about their

operations and customers,

B. Improve their work culture and remove rigidities in the labour practices that have

inhibited change,

C. Have an alert and assertive management to give directions to their operations,

D. Adopt new systems and procedures to enable them to cope in the changing milieu,

E. Improve their service orientation and update skill levels to match customers

requirements,

F. Restructure their operations at branch level and redefine role of branches with

greater emphasis on specialization. Create special skills to anticipate and handling

problems in specific areas and limit the role of the branch to specific market

segments, and

G. Become market driven and innovate new products and services to meet customer

requirements.15

Further, one of the impact is diversification and growth of ancillary banking activities.

Indian banks are allowed to undertake non traditional activities like mutual funds, hire

purchase, factoring, insurance etc. Banks can undertake such non traditional banking

activities through subsidiaries or in house or both. Banks are entering such services for

diversification of their earnings and maximization of economies of scale and scope and

for making profits.

The non traditional banking activities include the following:

A. Merchant banking :

15 Bhattachraya K M and Agarwal 0 P (2006), "Basics ofBanking and Finance," Himalaya Publishing House, Mumbai.

33

In includes services such as pre issue, management of public issue etc. these activities

primarily depend upon the conditions in the stock market.

B. Retail banking:

Retail banking is typical mass-market banking where individual customers use local

branches of larger commercial banks. Services offered include savings and checking

accounts, mortgages, personal loans, debit cards, credit cards and other high street

banking services.

C. Universal Banking:

It is a multi-purpose and multi-functional financial supermarket providing both banking

and financial services through a single window. As per website of World Bank

(www.worldbank.org) the concept is explained as follows- "In universal banking, large

banks operate extensive networks 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."

To put in simple words, a universal bank is a superstore for financial products. Under

one roof, corporates can get loans and avail of other handy services, while individuals

can bank and borrow. To convert itself into a universal bank, an entity has to negotiate

several regulatory requirements. Therefore, universal banks in a nutshell have been in

the form of a group-concerns offering a variety of financial services like deposits, short

term and long term loans, insurance, investment banking etc, under an umbrella brand.

34

2.2.2 Entry of foreign banks in India:

Increasing globalization of trade under World Trade organisation has provided a new

perspective to Indian effort of refonns in financial sector. With an improved regulatory

and supervisory set up RBI is issuing licenses to a number of foreign banks. Recent

empirical studies across several countries have shown that the presence of foreign

banks is associated with improvement in banking sector efficiency through reduction in

cost, reduction in overhead expenses and interest margins for domestic banks. 16 The

emergence of foreign banks as a powerful force is shown in table 2.1. At present there

are 29 foreign banks operating in India. These banks are operating with the advanced

technology and internationally acclaimed practices and standards.

The total number of foreign banks operating in India is 29. The number of branches of

these bank stand at 25 8. If we consider representative offices and subsidiaries the total

number of foreign banks operating in India swell to 60. In the post refonn period India

has opened up her banking industry to foreign players.

These banks have not only brought in the foreign capital but also most advanced

banking technology and management practices into the banking scenario. Though the

number of branches are less and concentrated in urban and metropolitan cities their

importance and significance can not be overlooked.

16 Claessens, Stijin, Asli Demirguc-Kunt, and Harry Huizinga 'How Does Foreign Entry Affect the Domestic Banking Market?',

Journal of Banking and Finance 25 (5) (2001 ): 891-911.

35

Table 2.1: Foreign bank branches in India

Name of the Bank 2006

I. ABN-AMRO Bank N.V 24

2. Abu Dhabi Commercial Bank Ltd. 2

3. American Express Bank Ltd. 7

4. Antwerp Bank Ltd. 1 5. Arab Bangladesh Bank Ltd. 1 6. Bank International Indonesia 1 7. Bank of America NA 5 8. Bank of Bahrain and Kuwait B.S.C. 2

9. Bank of Ceylon 1

10. Bank of Nova Scotia 5

11. Bank ofTokyo-Mitsubishi UFJ Ltd. 3 12. Barclays Bank PLC 1 13. BNP Paribas 8 14. Calyon Bank 5 15. Chinatrust Commercial Bank 1 16. Citibank N.A. 39

17. DBS Bank Ltd. 2 18. Deutsche Bank AG 8

19. HSBC Ltd. 45 20. JPMorgan Chase Bank 1

21. Krung_ Thai Bank Public Co. Ltd. 1 22. Mashreqbankpsc 2

23. Mizuho Corporate Bank Ltd. 2 24. Oman International Bank S.A.O.G. 2

25. Shinhan Bank 1

26. Societe Generale 2 27. Sonali Bank 2

28. Standard Chartered Bank 81 29. State Bank of Mauritius Ltd. 3 Total 258

Source : Report on Trend and Progress of Banking in India, 2005-06.

These banks have made spectacular progress in the last one and half decades. Table 2.2

explains the relative position of these banks in terms of their assets. Due to fluctuation

in number of banks the share of foreign banks in the total assets declined from 7.6 per

cent in 2001 to 7.2 per cent in 2006.

36

Table: 2.2 - Percentage share in the total assets of banking sector

2001 2002 2003 2004 2005 2006 Public Sector Banks 76.6 72.6 75.7 74.5 75.3 72.3

Foreign Banks 7.6 7.0 6.9 6.9 6.5 7.2

Other SCBs 12.2 16.8 17.4 18.6 18.2 20.5

Source: Author's calculations based on the data from various issues of Reports on Trends and Progress ofBanks in India.

2.3 Liberalisation and deregulation:

With the signing of WTO by the Indian government it became imperative on the part of

the government to go for economic reforms. The process of economic reforms affected

all aspects ofthe economic life. The net result of economic reforms was the unleashing

of various sectors from the regime of controls. Therefore it was expected that the

economy would be liberalized on the basis ofthe functioning of market economy. The

philosophy driving globalisation and WTO norms brought about liberalization.

Liberalisation means freeing of economy from the controlled regime and bringing in

the market forces. "Financial liberalization in the Indian context refers to -

rehabilitation of banks, freedom of pricing, freedom to choose ones clients, freedom of

entry and exit, encouragement for greater competition and the autonomy ofbanks."17 In

general, liberalization refers to a relaxation of government restrictions, usually in areas

of social or economic policy. It is the gradual removal of government intervention in

markets.

17 Patel! G, (1998) '"Economic Reforms and Global Change," Macmillan India Ltd, Delhi,, p-171.

37

Liberalisation and deregulation are creating more competitive environment conducive

to innovation and growth. The lowering of trade barriers and growing cross border

flows, markets are becoming global where efficiency and productivity have become

cornerstones. Financial liberalization is a part of the economic liberalization. "Changes

have been prominent in the banking industry world over, viz. (1) Consolidation of

players through mergers and acquisitions, (2) Globalization of operations, (3)

Development of new technology and (4) Universalization ofbanking." 18

The forces of liberalization and globalization have transformed the structure of

financial industry. It has changed the Indian banking services in the same fashion as it

has done in the rest of the developed world. Liberalization has provided greater scope

for markets. It has also de-regularized the banking operations. The final result is

ushering in of competition and the creation of a number of new financial products. The

banking sector is facing competition on the intermediation business from other players

in the financial market such as financial institutions, mutual funds, non-banking

financial companies, investment and leasing companies, chit fund companies and the

capital market.

2.3.1 Banking Sector Reforms:

At the time independence Indian banking system had a total of 2876 branches catering

to an average population of 82,000 with Rs. 860 Crore deposit and Rs 470 Crore

advances. In the history of Indian banking two years are of great significance namely

1969 and 1980 for nationalization of commercial banks. Indian banking system has

made unparallel growth and diversification. The total deposit of banks has crossed Rs

18 Gupta S.C., (2004) "Banking industry vision 2010," in "Economic Developments in India," 73,

academic foundation, New Delhi, , pp 232- 268.

38

18,00,000 Crores and advances have reached Rs 12,00,000 Crores. Though the growth

in number of banks branches and the volumes have been impressive, the Indian banking

sector has faced the problems of low productivity, poor efficiency and financial

weakness.

The Narsimham Committee 1991 examined the financial system and made

recommendations to remove and rectify the weaknesses of the financial sector and also

to initiate the reforms. Recommendations of Narsimham Committee 1991 focused on

operational flexibility and functional autonomy for enhancing the efficiency,

productivity and profitability ofthe financial system.

The financial sector reforms have been initiated for the purpose of enhancing

operational flexibility and functional autonomy. The following steps were taken to

initiate the first phase of reforms:

./ Reduction in the entry barriers,

./ Definition of priority sector phased out,

./ Deregulation of interest rates,

./ Reduction of S LR to 25 per cent and CRR to 19 per cent,

./ Introduction of prudential norms in relation to income recognition, asset

classification and capital adequacy norms to strengthen the banks balance .

./ Increased transparency in the balance sheet and profit and loss account of the

banks, and

./ Major thrust for the creation of Debt Recovery Tribunals .

./ Introduction of advance technology.

39

The second phase of banking reforms were based on the recommendations of

Narsimham Committee 1998. At that time Indian banking system was suffering from

mounting NP A, over staffing, lack of legal infrastructure for recovery of bank dues,

absence of autonomy, and completely outdated systems needing technological support.

The major recommendations were :

./ Greater specialization for the banks in different niches like retail, export, SSI,

Corporate sector and agriculture .

./ Reduction ofCRR to 5.5 per cent,

./ Reduction of average level of net NPAs for all banks below 5 per cent by the

year 200 and 3 per cent by 2002 .

./ Greater attention to be paid to ALM to avoid mismatch and to cover liquidity

and interest rate risks,

./ Introduction ofVoluntary Retirement Scheme.19

Hence this phase focused more on the structural measures and improvement in

disclosure standards with the internationally recognized best practices. The number of

scheduled commercial banks excluding the RRBs the branch offices in India has

increased from 76 an 41811 in 19992 to 90 and 54905 in 2004 respectively.20

In league with the ongoing reforms in the structural aspects of the macro economy RBI

has rationalized interest rates, reduced the reserve requirements and indirect monetary

control instruments are used to regulate the financial sector. "An important constituent

19 Kapoor Reetu and Pyare Lal (2007), "Productivity and Profitability of Public Sector Banks," Professional Banker, May 2007, pp 46-51. 20 Rama Sastri, A S and Jayaraman A R,(2005), "Is there excess capacity of Indian banking? An empirical study during post reform period," The Asian Economic Review, Vol, 47 (2), August pp-185-196.

40

of financial reforms strategy adopted in the 1990s has been the opening up of the

economy to foreign investment both direct and indirect."21

Hence the financial sector reforms covered deregulation of policies, prescription of

prudential norms based on internationally accepted practices in respect of capital

adequacy, income recognition, asset classification and provisioning for impaired assets

and introduction of competition in the banking sector. The major elements of banking

sector reforms can be enumerated as follows:

• Pre emption and interest rate structure

• Prudential norms

• Competition

• Efficiency- widening of banking services, increase in profit

• Technology

2.3.1.1 Pre emption and interest rate structure

Progressive deregulation of interest rates, competitive market place, market determined

exchange rate mechanism and technology are the factors which are changing the way in

which banking sector is operating in our country. The statutory pre-emptions have

gradually been lowered. The combined pre-emptions under CRR and SLR, amounting

to 63.5 per cent of net demand and time liabilities in 1991 (ofwhich CRR was 25 per

cent), has since been reduced and presently the combined ratio stands lowered at 31 per

cent (of which, the SLR is at its statutory minimum of 25 per cent) This has enabled

banks to commit a greater quantum of resources for commercial purposes. The Reserve

21 Joseph M and Nitsura R R, "WTO and Indian Banking Sector: The Road Ahead,'' Economic and Political Weekly, Vol XXXVII, No-24, PP-2315-2322.

41

bank of India has rationalised progressively administered interest rate structure of

banks, both on the deposit and lending side

2.3.1.2 Prudential norms

Indian banks have to acquire global perspective. Globalisation and financial sector

reforms have opened up new vistas for Indian banking sector. Indian banks have to

adhere to international standards and practices to compete in the domestic market as

well as in the international market. Therefore, Indian banks are forces to adopt global

strategy even in their domestic operations.

A set of micro-prudential measures have been stipulated, aimed at imparting strength to

the banking system as well as ensuring safety and soundness on a prospective basis in

order to fix the true position of bank's balance sheet and to arrest its deterioration.

The banking system has attained greater transparency in the post reform era. Infact the

Central Vigilance Commission (CVC) has made it mandatory for all the banks to

follow open policy and make the banking business more transparent and accountable.

This applies both with regard to prudential norms (disclosure of capital adequacy ratios

separately, net non-performing assets (NPAs) ratios, provisions and more recently, the

maturity profile of loans and advances, investments, movements in NP As and lending

to sensitive sectors, such as capital market, real estate and commodities) as well as

securities portfolio. Public sector banks (PSBs) are attaching the balance sheet of the

subsidiaries to their balance sheets beginning from 2000-01, in order to bring greater

transparency in operations and move towards consolidated supervision. This move will

increase the degree of trust that the customers have on bank. Further, the Reserve

Bank of India has made it compulsory for all the banks to make it public the terms and

42

conditions of credit card transactions, interest rates and other financial charges on the

use of different cards .

In 1988 Basel Committee on Banking supervision (BCBS) under the auspices of the

Bank for International Settlement brought forward the first Basle committee accord

popularly know as Basle I. It became a world wide standard for banks to follow and set

the bench mark for all the banksP

Due to the implementation of Basle I a number of banks have developed sophisticated

system to measure the multiple dimensions of credit, risks and portfolio management.

However, with the advancement in technology, computation techniques, innovation in

banking products and services, and the increasing globalisation of financial markets,

banks have started to measure risks very differently from what Baste I required them to

do. In a way Basel I has become outdated. To get over the above short coming the

Basel II accord was evolved by the BCBS.

Basel II is mutually reinforcing three pillar approach. This can be explained with the

help of the chart 2.1. The Basel Committee has estimated that the aggregate daily

turnover in the foreign exchange market is between $ 900 billion to $ 1 trillion.23 If

Indian banks have to face this challenge to compete with international banks within the

country as well as in the foreign market they have to following steps.

22 Rao R R (2005), "Credit Scoring Models and the Basel Accord," Bank Quest, Vol 76(3), July-Sept, pp5-13. 23 Source : BIS estimate.

43

Chart 2.1 Basel II Framework

Basel II Framework

Capital for credit Risk

Capital for operational Risk

Capital for Market Risk

Source: Bank of International Settlements.

Standardized Approach

IRB approach

Basic Indicator

Standardized Approach

Advanced Measurement

Standardized Approach

Modified Approach

• Update their technology and computerize their operations,

• Improve payment , delivery and settlement system,

• Improve their work culture,

• Improve the service orientation,

• Restructure the operations,

• Become market driven and innovate new products and service to meet the

customer requirements.

2.3.1.3 Competition

Reduction in entry barriers have increased the competition in the banking sector. As a

result several new private sector banks and foreign bank have started their operations in

the India. Moreover Indian banks have also got an opportunity to compete in the

44

foreign land. Government of India has initiated a number of steps to strengthen PSBs

and infuse competition into the banking system. Towards strengthening PSBs, the

Government initiated steps to improve their autonomy and increase their capital base

through explicit recapitalisation through the fiscal as well as changing legislation to

enable PSBs to raise resources from the market. Many banks have gone for public issue

to raise funds for the banks. Recently Indian banks have gone for raising foreign capital

with help of ADR and GDR. The functional autonomy to PSBs is seen as a sure step to

revive the sector and bring it to the standards of international level.

A. Entry of new private sector banks:

The entry barriers of new private sector banks have been relaxed. Due to this many

Indian financial institutions are setting up banks. There are 8 new private sector banks

with total 1950 branches of which 92 branches are rural, 322 semi urban, 674 urban and

857 metropolitan branches.

The figure 2.1 shows that more than 75 per cent of the branches of these new private

sector banks are in the metropolitan and urban area. Thus their mechanised operations

are giving higher results to them. The urban bend of these banks has made them

technology savvy and customer centric.

45

43.9

Figure 2.1 Area wise Branches of New Private Banks 4. 7 (per cent)

• rural DSemi Urban

II Urban

I!J Metropolitian

These banks are new generation banks with different philosophy. In the course of the

interview the researcher came across a statement 'this is a technology organisation

doing banking business.'

Table 2.3: Branches of New Private Sector Banks as on 31st March 2006

Name of the Bank No. OfBranches 1. Centurion Bank ofPunjab Ltd. 237 2. Development Credit Bank Ltd. 68 3. HDFC Bank Ltd. 515 4. ICICI Bank Ltd. 557 5. Induslnd Bank Ltd. 137 6. Kotak Mahindra Ltd. 78 7. UTI Bank Ltd. 349 8. Yes Bank Ltd. 09 Total 1950

Source: Report on Trend and Progress of Banking in India, 2005-06.

Competition among commercial banks has increased with the entry of new private

sector banks and the permission to foreign banks to increase their number of branches

in the nineties. The threat of new entrants and substitute products as well as the rivalry

amongst existing banks are becoming increasingly apparent in the Indian banking

industry. After the guidelines issued in January 1993, 8 new private sector banks are

presently in operation. These banks use state-of-the-art technology.

46

Further, following India's commitment to the WTO agreement in respect of the

services sector, foreign banks including both new and the existing ones, have been

permitted to open up to 12 branches a year with effect from 1998-99 as against the

earlier stipulation of 8 branches. Also competition among public sector banks has

increased with relaxation of many guidelines, allowing for portfolio shifts for

optimizing the ultimate objectives. With the amendment to the Banking Companies Act

197011980, public sector banks are now allowed to access the capital market to raise

funds. Local Area Banks (LABs) are also being set up to induce competition in urban,

semi urban and rural areas.

The liberalization process has lasting impact on Indian public sector banks. With a huge

Indian population settled down in various comers of the globe the Indian PSBs

visualize a large business potential by starting new branches in various countries. As a

result a number of Indian banks have opened up new branches in foreign countries. The

presence of Indian banks in the middle East, North America and in the far East is an

indicator of Indian banks becoming global players.

B. Indian banks going global:

Many Indian banks are positioning themselves to seize the new opportunities nationally

and internationally. Several PSBs are opening up new branches in foreign countries.

India's capacity to attract and manage foreign investment and capital is increasingly

felt.

47

From the table 2.4 it can be seen that 17 Indian banks had overseas operations by 2006.

Today Indian banks have their branches in 4 7 countries. This operation in foreign

countries are in the forms of branches, subsidiaries, representative offices and joint

ventures. Apart form this, Indian banks are setting up their operations in special

economic zones by the name Offshore Banking Units (OBUs).

Table 2.4: Number of Foreign Branches oflndian banks

Number No. Name ofthe Bank of

Branches I. Punjab National Bank 6 2. Sate Bank of India 45 3. Bank of India 26 4. Bank of Baroda 51 5. Indian Bank 3 6. Indian Overseas Bank 8 7. UCOBank 5 8. CanaraBank 3 9. Syndicate Bank 1 IO. Bharat Overseas Bank 1 11. ICICI Bank 14 12. Indusind Bank Ltd. 2 13. Centurian Bank Ltd. 2 14. HDFC Bank Ltd. 1 15. UTI Bank Ltd. I 16. Andhara Bank 1 17. Allahabad Bank 1

Total 173 Source: Report on Trend and Progress of Banking in India, 2005-06.

These OBUs are located in India but they function like foreign branches ofthe Indian

banks. These OBUs are exempt from CRR and SLR requirements. Under this scheme

ofOBUs 14 approvals are issues to 10 banks for opening up such units.

The forces of deregulation, technology and growing customer sophistication has

changed the Indian banking industry. The successful banks in India will be those that

48

have a rigorously defined strategic focus, technology, a stringent attention to cost and

risk and quality customer service. In the words of Shri C K Prahalad, "Creating market

abroad is not different from defending markets in India."24 Therefore, PSBs in India

have two challenges in their hand - one is to defend the Indian market from foreign and

new private sector banks and second they have to become internally strong to become

internationally competitive. Table 2.4 brings out the fact that many of the PSBs in India

have become truly international banks.

The competition in the banking sector has so evolved in the recent years that the market

structure of the banking sector has tended to be oligopolist. While the number ofbanks

is reasonably large, the dominance of the public sector banks and especially of a few

large banks continues. Such banks accounting for large share of deposits and advances

as market leaders are able to influence decisions about liquidity and rate variables the

system. But, even such banks may face challenges in the future and face tougher

competition, given the gradual upgradation of skills and technologies in competing

banks and the restructuring and reengineering processes being attempted by both

foreign and private sector banks.

In the wake of deregulation of the banking sector and liberalization and globalization of

the economy the role of bankers is gradually becoming different from the traditional

banking role performed by the banks. Banking system has to face more and more

competition from the non banking sector within the country and also from foreign

institutions.

24 Ramamoorthy K R, ( 1996), "Giobalisation and Competitiveness: Emerging Challenges," Challenges to

Indian Banking, Jadhav N (Ed), Macmillan India, Delhi.

49

2.3.1.4 Efficiency- widening of banking services, increase in profit

The credit deposit ratio which is an important indicator of banks efficiency has

increased from 55.4 pr cent in 1992 to 56.1 per cent in 2004.25 The visible impact of

reforms is evident in both a widening (as reflected in the financial interrelations ratio)

as well as the deepening (as evidenced by the intermediation ratio) of the

intermediation process as well as its positive influence on growth. (as reflected by the

finance ratio) In addition to banks, various other intermediaries, including financial

institutions, mutual funds and non-banking financial companies, are also engaged in the

process of intermediation.

All banks have to give more attention to the organizational setup and administrative

machinery in order to increase productivity and profitability. Banks have tore-engineer

strategies so that there is efficiency in the delivery of financial products and increased

customer satisfaction. Banks in the 21st century have to pay attention in the area of

profitability and it has to integrate its business with globalized economy. It has to

increase the effectiveness of delivering bank products and ensure the optimum use of

the vast banking infrastructure.

The widespread deregulation accompanied by technological development has changed

the way in which banks carry out their intermediating functions. Traditionally a lions

share of income of banks had its origin in net interest income. However, in the new era

there is increased importance given to incomes other than interest income. All the

banks have been mandated to increase the other incomes. As a result of computerisation

and use of high degree of technology the cost of financial intermediation has come

25 Rama Sastri, A S and Jayaraman A R,(2005), "Is there excess capacity oflndian banking? An empirical study during post reform period," The Asian Economic Review, Vol, 47 (2), August pp-185-196.

50

--- -- -------------------~

down. With the increase in other incomes and with reduction in the intermediation cost

banks profitability and efficiency have increased.

2.3.1.5 Technology

Technology plays an important role creating new business models and processes, in

maintaining competitive advantage, in enhancing quality of risk management systems

in banks, and in revolutionising distribution channels. Banks are taking initiatives

towards building their technology infrastructure. While doing so, banks have four

options to choose from: they can build a new system themselves, or buy best of the

modules, or buy a comprehensive solution, or outsource. 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; adoption of

inappropriate/ inconsistent technology and adoption of obsolete technology. A case in

point is the implementation of core banking solution by some banks without assessing

its scalability or adaptability to meet Basel II requirements.26

The changing scenario in the financial field indicates that banks' role in the payment

transmission services will gain more importance because the payment mechanism for

all investments works through banking instrument like cheques and drafts. As the

present trend shows, the banking is going to be quite different in the future. With the

changes in the economy the banking sector is re-orienting itself. Banks are taking steps

to retain their existing customer base and creating new customers. Some of the areas

26 Leeladhar V (2007}, "Indian financial sector reforms," at the Annual Washington Conference of the Institute of

International Bankers, Washington, DC.

51

where changes are taking place are - customer service, Mechanization, advertising,

interest rates, working hours, service charges, deposits and advances.

The use of computers and communication technologies is increasing in PSBs. In the

initial years of reforms stress has been placed on branch level computerisation. Later on

the emphasis shifted to providing Core Banking Solutions (CBS). Computerization has

brought about a new culture of discipline, knowledge management and innovations in

the Indian banking industry. Initially computerization has received a very lukewarm

response from management as well as from the employees. The Indian Bank

Association stepped-in in 1993 to provide a major thrust in computerization. In the

initial phase most of the PSBs were faced with a number of problems such as lack of

direct involvement of senior management, paucity of trained personnel's, absence of

coordination and resistance from employees.

However, with passage of time in the computerized branches computers are replacing

ledgers. The additional manpower created in the organization due to computerization

can be alternatively used for marketing, surveys, extended services, creation of MIS

and recovery.

Unless the state-of- the-art IT was introduced as early as possible, winning new

business and even holding on to the old one will become increasingly difficult. Services

and products like "Anywhere Banking" "Tete-Banking" "Internet banking" "Web

Banking" , e-banking, e-commerce, e-business etc. have become the buzzwords of the

day and the Banks are trying to cope with the competition by offering innovative and

attractively packaged technology-based services to their customers.

52

1.

2.

3.

4.

5.

Table 2.5: Computerisation in Public Sector

Banks as on 31st March 2006

Branches Fully Computerized #48.5

Branches Under Core Banking Solutions 28.9

Fully Computerized Branches (1+2) 77.5

Partially Computerized Branches 18.2

Non Computerized Branches 4.3

Note (#)means other than branches under Core Banking Solutions.

Source : Reserve Bank of India

Based on the norms worked out by Rangarajan Committee (II), 7827 branches of the

Public Sector banks were identified for full branch computerisation upto March 2000 of

which around 4620 were computerized as on March 99. Meanwhile, the networking of

the already-computerized branches also assumed urgency and some of the Banks have

started inter-connecting their computerized branches using leased telephone lines or

Very Small Aperture Terminals (VSATs). This is meant to provide a more

comprehensive service to customers and at the same time give banks better centralized

control over the branch operations. As of now, New Private Sector and Foreign Banks

have an edge over Public Sector Banks as far as implementation of technological

solutions is concerned. However, the latter are in the process of making huge

investments.

As part of restructuring of the banking sector, special emphasis has been accorded to

improvements in payment and settlement systems. Prominent among the measures

initiated in these areas include introduction of Electronic Funds Transfer (EFT), Real

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Time Gross Settlement System (RTGS), Centralised Funds Management System

(CFMS), the NOS and the Structured Financial Messaging Solution (SFMS). The

SFMS would be the backbone for all message-based communication over the Indian

Financial Network (INFINET).

Simultaneously, the importance of effective MIS for control of operations and of

maintaining customer and business/industry data bases for strategic planning has also

surfaced; while Banks are looking at Data warehousing, Data mining, Business

Restructuring etc. as most essential things to have as early as possible, they are taking

urgent steps to computerize the operations in their administrative and controlling

offices (viz. head /zonal/regional offices) as well as the data collection machinery, so as

to evolve an effective MIS. In this phase, the new communication revolution sweeping

the nation and the world has come in extremely handy, as the communication

infrastructure has improved significantly and the Internet technologies are available to

network branches at a relatively low and affordable cost with a high degree of

reliability.

The present level of MIS covers, basically, information needed for control,

performance monitoring, decision making etc. and encompasses most activities in

administrative offices like processing of statutory returns under Reserve Bank of India

Act, monthly/quarterly performance reports from branches, credit information!BSR,

inter-branch transactions, personnel inventory, provident fund accounting, profit and

loss accounts, cash and investment management, stationery stock accounting, and

branch house keeping etc.

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During 1999-2000 the RBI focused on two major areas in the field of computers and

information technology. The RBI encouraged commercial banks to go for faster

computerisation and technical upgradation. The RBI setup a committee to study the

technological upgradation in the banking sector. With this in view a National Payments

Council (NPC) was constituted. The NPC made the following policy decision in the

year 2000:

• Introduction of Real time Gross Settlement (RTGS)

• Payment and settlement system

• Issue of plastic cards

• Standardization ofiNFINET.

Reforms also led to diversification of banking operations. The insurance Regulatory

and Development authority (IRDA) Act 1999 was passed in the Parliament. The Act is

major milestone in liberalization as it opened new entry into the insurance business.

Based on the Act the RBI issued fresh guidelines to commercial banks for entry into

insurance sector. As a result Commercial banks would be permitted to undertake

insurance business as an agent of insurance, set up joint ventures with insurance

companies, and take part in the capital markets with a ceiling of 5 per cent of the total

outsourcing advances.

In order to strengthen the banking sector, prudential regulations and norms have been

put in place. For increasing the competition new institutions have been permitted to

enter in the market. As a result a number of new generation private sector banks have

been allowed to operate in the Indian banking scenario.

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A large number of foreign banks have also opened their branches in India. These banks

have started off with modernization and technology in operation. All of them use the

latest state of art technology which includes wide scale use of computers. Use of such

technology cuts down lot of time spent in maintaining information on customers. It is

also true that these new generation banks offer services at a lower cost. The above

developments have forced the PSBs to go in for modem banking practices. Several

new initiatives on the technological front, including among others, the setting up of the

Indian Financial Network (INFINET), a Wide Area Satellite based Network using

VSAT technology, Shared Payment Network System, initiatives for Electronic Fund

Transfer have already been undertaken. A Real Time Gross Settlement (RTGS) system,

with system requirement specifications to take into account international best practices

and the specific requirements of Indian banking is being developed. Banks have been

directed by the Reserve Bank of India to go for Core banking Solutions so as to

increase the efficiency and quality of products and services offered.27

2.3.2 Impact of liberalisation on Public Sector Banks:

The liberalisation measures have permitted a refocusing of supervisory strategy from

one of micro-management to one of macro-governance with the establishment of a

quasi-autonomous Board for Financial Supervision (BFS) in 1994. The supervisory

strategy of the BFS consists of a four-pronged approach, including (1) restructuring

system of inspection, (2) setting up of off-site surveillance, (3) enhancing the role of

external auditors, and (4) strengthening corporate governance, internal controls and

27 Bhide M G, Prasad A. and Ghosh S, "Emerging Challenges in Indian Banking," Working PaperNo. 103, (2001) MPRA Paper

No. 1711, posted 08. February 2007

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audit procedures. Detailed off-site surveillance of banks, financial institutions and

NBFCs is based on a quarterly reporting framework covering mandated aspects of

liquidity, solvency and asset quality.

Many of the banks have been subjected to on line surveillance by the RBI. It has been

combined with on-site inspection, based on the evaluation of total operations and

performance of banks under the supervisory rating framework based on the CAMELS

(Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Systems)

methodology for Indian commercial banks and CACS (Capital Adequacy, Asset

Quality, Compliance and Systems) for foreign banks. The role of external auditors has

been enlarged: besides auditing of annual accounts, they are required to verify and

certify financial ratios to be disclosed in the balance sheet.

Another important development in the Indian banking sector is the sharp reduction in

the NPAs. It has decreased in the post reform era to less than 3 per cent from the earlier

15 per cent. The reduction in the NPA has improved the quality of assets. Due to the

knowledge base available to the banks regarding the quality of customers and their

credit worthiness banks are in a position to control credits.

Another positive effect of the reform measures have been the building up of the

institutional architecture in terms of markets, technological and legal infrastructure and

improving the managerial competence and the quality of human resources, which are

pre-requisites for the efficient functioning of markets. Since 1997, there has been an

intensification of efforts to develop and fortify the domestic financial architecture,

albeit with a distinct country-specific approach.

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As a result of changing banking sector operations PSBs have increased the functional

areas. They include equipment leasing, housing finance, merchant banking, venture

capital, securitization of debts etc. as for the product diversification banks have gone in

for consumer credit cards, farm credit cards, traveler cheques, investors club, home

loan account scheme, industrial finance branch, automated teller system, oversea

branches, loan against equity, consumer loans, educational loans, quick cheque

collection schemes , internet banking, mobile banking, etc. banks have also made

extensions of various financial products such as funs based and fee based business. The

fund based products include cash credit, over draft, demand loans, import credit, export

credit and bill financing.

With the changing economic environment banks are shifting into non fund based

business. The non fund based business includes letter of credit, guarantees, bid bonds,

loan syndication, counseling, investment management, portfolio management, credit

cards, treasury products, currency switch etc. Originally banks concentrated on asset

management treating themselves purely as deposit takers. Today the very concept of

asset management has changed. Banks have been forced to adopt a more

comprehensive approach which necessitates continues planning, organizing, controlling

assets and liability volumes.

Further, the technological changes are forcing Indian banks to become high tech and to

become a world entity. Revolutionary changes in computerisation information and

communication technology are enabling banks to strengthen internal control, minimize

credit risk, improve the quality of inputs, and enhance employee productivity and to

facilitate introduction of new products and services.

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2.4 Summary and Conclusion:

Globalisation and liberalization have provided challenges as well as opportunities to

Indian banking system. The progressive liberalization process has freed the sector from

excessive government control and restrictive regime. The banks in India are

experiencing changes brought about by Basel norms, deregulation and entry of new

banks. The foreign banks brought in a fine blend of international practices and

technology. The public sector banks have adopted many of the good practices. Banks

have started reorienting their operations with a view to increase their profitability and

operational efficiency. A number of Indian banks have become global players. As a

result they are adopting the practices like merchant banking; retail banking, and

universal banking. Operational flexibility, deregulation of interest rates, reduction in

SLR and CRR, has provided enormous opportunities to the PSBs.

Computerization and use of technology have further increased the technical efficiencies

of the banks. There has been a sea change in the attitude of the banks employees.

Management information systems, customer centric approach, product re-engineering

etc have become the buzz words in baking industry. Banks have set up specialized

branches catering to specialized products and services. Finally it can be said that

globalisation and liberalization has breathed in fresh ideas, management practices,

global standards and high level of competition. The net impact of globalisation and

liberalisation is the birth of new generation banks and the transformation of old banks

into new banks having the inner strength to fight the competition domestically as well

as internationally.

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