ion of Banking System of Us ,Europe,India

8/2/2019 ion of Banking System of Us ,Europe,India

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International Financial System

Comparision Of Banking System Of US,Europe

and India

Submitted To:Mrs. Payal Singh

Submitted by:

Aakriti Gupta

Sukriti Sharma

Rashmeet Kaur

Shobhana Saxena

Rishabh Mehta

Rhythm Pangotra


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INTRODUCTION:

Recent time has witnessed the world economy develop serious difficulties in terms of lapse ofbanking & financial institutions and plunging demand. Prospects became very uncertain causingrecession in major economies. However, amidst all this chaos Indias banking sector has been

amongst the few to maintain resilience. A progressively growing balance sheet, higher pace ofcredit expansion, expanding profitability and productivity akin to banks in developed markets,lower incidence of nonperforming assets and focus on financial inclusion have contributed tomaking Indian banking vibrant and strong. Indian banks have begun to revise their growthapproach and re-evaluate the prospects on hand to keep the economy rolling. The way forwardfor the Indian banks is to innovate to take advantage of the new business opportunities and at thesame time ensure continuous assessment of risks.

GENERAL BANKING SCENARIO

The predicament of the banks in the developed countries owing to excessive leverage and lax

regulatory system has time and again been compared with somewhat unscathed Indian BankingSector. An attempt has been made to understand the general sentiment with regards to theperformance, the challenges and the opportunities ahead for the Indian Banking Sector. Amajority of the respondents, almost 69% of them, felt that the Indian banking Industry was in avery good to excellent shape, with a further 25% feeling it was in good shape and only 6% of therespondents feeling that the performance of the industry was just average. In fact, anoverwhelming majority (93.33%) of the respondents felt that the banking industry comparedwith the best of the sectors of the economy, including pharmaceuticals, infrastructure, etc. Mostof the respondents were positive with regard to the growth rate attainable by the Indian bankingindustry for the year 2009-10 and 2014-15, with 53.33% of the view that growth would bebetween 15-20% for the year 2009-10 and greater than 20% for 2014-15.

Key effects of major International Banking Crisis

The banking crises have bought various losses. Private households that have sufferedconsiderable loss in wealth will raise their saving rates.

The many recapitalization of banks implemented by various governments in Euro zone the UKand the USA a will raise medium term debt GDP ratio and hence current and future tax rate.

There is also some probability that venture capital financing will become more difficult in manyOECD countries in the long run, since the risk premium have increased and since private equity

funds will become eager to finance.


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US Banking System

With nearly 90,000 branches and 371,000 automated teller machines (ATMs), US bankingsystem is the largest in the world. As of September 30th 2004, US banks had US$9.88 trillion inassets and US$5.98 trillion in total loans. US banking is more diverse than in most Westerncountries. Despite ongoing consolidation, vigorous competition exists within the vast bankingcommunity, which includes financial holding companies that operate nationwide, dominantregional banks and smaller independents. Large foreign banks also continue to expand in the USmarket.

Federal Reserve The Federal Reserve System is the central bank of the United States. It wasfounded by Congress in 1913 to provide the nation with a safer, more flexible, and more stablemonetary and financial system. Over the years, its role in banking and the economy hasexpanded. Today, the Federal Reserves duties fall into four general areas: - conducting thenations monetary policy by influencing the monetary and credit conditions in the economy inpursuit of maximum employment, stable prices, and moderate long-term interest rates; -supervising and regulating banking institutions to ensure the safety and soundness of the nationsbanking and financial system and to protect the credit rights of consumers; - maintaining the

stability of the financial system and containing systemic risk that may arise in financial markets;- providing financial services to depository institutions, the U.S. government, and foreign officialinstitutions, including playing a major role in operating the nations payments system. A networkof twelve Federal Reserve Banks and their Branches (twenty five as of 2004) carries out avariety of System functions, including operating a nationwide payments system, distributing thenations currency and coin, supervising and regulating member banks and bank holdingcompanies, and serving as banker for the U.S. Treasury. The twelve Reserve Banks are eachresponsible for a particular geographic area or district of the United States. Each Reserve Districtis identified by a number and a letter. Besides carrying out functions for the System as a whole,such as administering nationwide banking and credit policies, each Reserve Bank acts as adepository for the banks in its own District and fulfills other District responsibilities.

Member Banks The nations commercial banks can be divided into three types according towhich governmental body charters them and whether or not they are members of the FederalReserve System. Those chartered by the federal government (through the Office of the Controllerof the Currency in the Department of the Treasury) are national banks; by law, they are membersof the Federal Reserve System. Banks chartered by the states are divided into those that aremembers of the Federal Reserve System (state member banks) and those that are not (statenonmember banks). State banks are not required to join the Federal Reserve System, but theymay elect to become members if they meet the standards set by the Board of Governors. As of


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March 2004, of the nations approximately 7,700 commercial banks approximately 2,900 weremembers of the Federal Reserve System - approximately 2,000 national banks and 900 statebanks. Member banks must subscribe to stock in their regional Federal Reserve Bank in anamount equal to 6 percent of their capital and surplus, half of which must be paid in while theother half is subject to call by the Board of Governors. The holding of this stock, however, does

not carry with it the control and financial interest conveyed to holders of common stock in for-profit organizations. It is merely a legal obligation of Federal Reserve membership, and the stockmay not be sold or pledged as collateral for loans. Member banks receive a 6 percent dividendannually on their stock, as specified by law, and vote for the Class A and Class B directors of theReserve Bank. Stock in Federal Reserve Banks is not available for purchase by individuals orentities other than member banks.

Supervisory Function of the Federal Reserve The Federal Reserve has responsibility forsupervising and regulating the following segments of the banking industry to ensure safe andsound banking practices and compliance with banking laws: - bank holding companies, includingdiversified financial holding companies formed under the Gramm-Leach-Bliley Act of 1999 andforeign banks with U.S. operations; - state-chartered banks that are members of the Federal

Reserve System (state member banks); - foreign branches of member banks; - Edge andagreement corporations, through which U.S. banking organizations may conduct internationalbanking activities;- U.S. state-licensed branches, agencies, and representative offices of foreignbanks; - non- banking activities of foreign banks. Although the terms bank supervision and bankregulation are often used interchangeably, they actually refer to distinct, but complementary,activities. Bank supervision involves the monitoring, inspecting, and examining of bankingorganizations to assess their condition and their compliance with relevant laws and regulations.When a banking organization within the Federal Reserves supervisory jurisdiction is found to benoncompliant or to have other problems, the Federal Reserve may use its supervisory authorityto take formal or informal action to have the organization correct the problems. Bank regulationentails issuing specific regulations and guidelines governing the operations, activities, and

acquisitions of banking organizations.

Bretton Woods system

The Bretton Woods system of monetary management established the rules for commercial andfinancial relations among the world's major industrial states in the mid-20th century. The BrettonWoods system was the first example of a fully negotiated monetary order intended to governmonetary relations among independent nation-states.

Setting up a system of rules, institutions, and procedures to regulate the international monetarysystem, the planners at Bretton Woods established the International Monetary Fund (IMF) andthe International Bank for Reconstruction and Development (IBRD), which today is part of

the World Bank Group. The chief features of the Bretton Woods system were an obligation foreach country to adopt a monetary policy that maintained the exchange rate by tying its currencyto the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.


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U.S Banking Crises

The late-2000s financial crisis, also known as the Global Financial Crisis (GFC) orthe "Great Recession", is considered by many economists to be the worst financial crisis sincethe Great Depression of the 1930s. It resulted in the collapse of large financial institutions,

the bailout of banks by national governments and downturns in stock markets around the world.In many areas, the housing market also suffered, resulting innumerous evictions, foreclosures and prolonged unemployment. It contributed to the failure ofkey businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, and asignificant decline in economic activity, leading to a severe global economic recession in 2008.

The financial crisis was triggered by a complex interplay of valuation and liquidity problems inthe United States banking system in 2008.The bursting of the U.S. housing bubble, which peakedin 2007, caused the values of securities tied to U.S. real estate pricing to plummet, damagingfinancial institutions globally. Questions regarding bank solvency, declines in credit availabilityand damaged investor confidence had an impact on global stock markets, where securitiessuffered large losses during 2008 and early 2009. Economies worldwide slowed during this

period, as credit tightened and international trade declined. Governments and centralbanks responded with unprecedented fiscal stimulus, monetary policy expansion and institutionalbailouts. Although there have been aftershocks, the financial crisis itself ended sometimebetween late-2008 and mid-2009.

Many causes for the financial crisis have been suggested, with varying weight assigned byexperts. The United States Senate issued theLevinCoburn Report, which found "that the crisiswas not a natural disaster, but the result of high risk, complex financial products; undisclosedconflicts of interest; and the failure of regulators, the credit rating agencies, and the market itselfto rein in the excesses of Wall Street."

Critics argued that credit rating agencies and investors failed to accurately price the risk involved

with mortgage-related financial products, and that governments did not adjust their regulatorypractices to address 21st-century financial markets. The 1999 repeal of the GlassSteagall Act of1933 effectively removed the separation that previously existed between Wall Street investmentbanks and depository banks. In response to the financial crisis, both market-based and regulatorysolutions have been implemented or are under consideration.

European Banking System

The European System of Central Banks (ESCB) is composed of the European Central Bank(ECB) and the national central banks (NCBs) of all 27 European Union (EU) Member States.

FunctionsSince not all the EU states have joined the euro, the ESCB could not be used as the monetaryauthority of the euro zone. For this reason the Euro system (which excludes all the NCBs whichhave not adopted the euro) became the institution in charge of those tasks which in principle hadto be managed by the ESCB. In accordance with the treaty establishing the EuropeanCommunity and the Statute of the European System of Central Banks and of the EuropeanCentral Bank, the primary objective of the Euro system is to maintain price stability (in other


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words control inflation). Without prejudice to this objective, the Euro system shall support thegeneral economic policies in the Community and act in accordance with the principles of anopen market economy.

The basic tasks to be carried out by the Euro system are:

to define and implement the monetary policy of the euro zone;to conduct foreign exchange operations;to hold and manage the official foreign reserves of the Member States; andto promote the smooth operation of payment systems.

In addition, the Euro system contributes to the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of credit institutions and the stabilityof the financial system. The ECB has an advisory role vis--vis the Community and nationalauthorities on matters which fall within its field of competence, particularly where Communityor national legislation is concerned. Finally, in order to undertake the tasks of the ESCB, theECB, assisted by the NCBs, has the task of collecting the necessary statistical information either

from the competent national authorities or directly from economic agents.

Organization

The process of decision-making in the Eurosystem is centralized through the decision-making

bodies of the ECB, namely the Governing Council and the Executive Board. As long as there are

Member States which have not adopted the euro, a third decision-making body, the General

Council, shall also exist. The NCBs of the Member States that do not participate in the euro area

are members of the ESCB with a special status while they are allowed to conduct their

respective national monetary policies, they do not take part in the decision-making with regard to

the single monetary policy for the euro area and the implementation of such decisions.

The Governing Council comprises all the members of the Executive Board and the governors of

the NCBs of the Member States without a derogation, i.e. those countries which have adopted the

euro. The main responsibilities of the Governing Council are:

to adopt the guidelines and take the decisions necessary to ensure the performance of the tasks

entrusted to the Eurosystem; to formulate the monetary policy of the euro area, including, as

appropriate, decisions relating to intermediate monetary objectives, key interest rates and the

supply of reserves in the Eurosystem, and to establish the necessary guidelines for their

implementation.

The Executive Board comprises the President, the Vice-President and four other members, all

chosen from among persons of recognized standing and professional experience in monetary or

banking matters. They are appointed by common accord of the governments of the Member

States at the level of the Heads of State or Government, on a recommendation from the Council

of Ministers after it has consulted the European Parliament and the Governing Council of the


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ECB (i.e. the Council of the European Monetary Institute (EMI) for the first appointments). The

main responsibilities of the Executive Board are:

to implement monetary policy in accordance with the guidelines and decisions laid down by the

Governing Council of the ECB and, in doing so, to give the necessary instructions to the NCBs;

and to execute those powers which have been delegated to it by the Governing Council of theECB.

The General Council comprises the President and the Vice-President and the governors of the

NCBs of all 27 Member States. The General Council performs the tasks which the ECB took

over from the EMI and which, owing to the derogation of one or more Member States, still have

to be performed in Stage Three of Economic and Monetary Union (EMU). The General Council

also contributes to: the ECB's advisory functions; the collection of statistical information; the

preparation of the ECB's annual reports; the establishment of the necessary rules for

standardizing the accounting and reporting of operations undertaken by the NCBs; the taking of

measures relating to the establishment of the key for the ECB's capital subscription other thanthose already laid down in the Treaty; the laying-down of the conditions of employment of the

members of staff of the ECB; and the necessary preparations for irrevocably fixing the exchange

rates of the currencies of the Member States with a derogation against the euro.

The Euro system is independent. When performing Euro system-related tasks, neither the ECB,

nor an NCB, nor any member of their decision-making bodies may seek or take instructions from

any external body. The Community institutions and bodies and the governments of the Member

States may not seek to influence the members of the decision-making bodies of the ECB or of

the NCBs in the performance of their tasks. The Statute of the ESCB makes provision for the

following measures to ensure security of tenure for NCB governors and members of theExecutive Board:

a minimum renewable term of office for national central bank governors of five years;

a minimum non-renewable term of office for members of the Executive Board of eight years (a

system of staggered appointments was used for the first Executive Board for members other than

the President in order to ensure continuity); and

removal from office is only possible in the event of incapacity or serious misconduct; in this

respect the Court of Justice of the European Communities is competent to settle any disputes.

The ECB's capital amounts to 5 billion. The NCBs are the sole subscribers to and holders of the

capital of the ECB. The subscription of capital is based on a key established on the basis of the

EU Member States' respective shares in the GDP and population of the Community. It has, thus

far, been paid up to an amount just over 4 billion. The euro area NCBs have paid up their

respective subscriptions to the ECB's capital in full. The NCBs of the non-participating countries

have to pay up 7% of their respective subscriptions to the ECB's capital as a contribution to the


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operational costs of the ECB. As a result, the ECB was endowed with an initial capital of just

under 4 billion.

In addition, the NCBs of the Member States participating in the euro area have provided the ECB

with foreign reserve assets of up to an amount equivalent to around 40 billion. The

contributions of each NCB were fixed in proportion to its share in the ECB's subscribed capital,while in return each NCB was credited by the ECB with a claim in euro equivalent to its

contribution. 15% of the contributions were made in gold, and the remaining 85% in US dollars

and Japanese yen.

Euro Debt and Banking Crisis

Introduction

Europe has been beset by two interrelated crises: (i) a banking crisis, stemming from losses in capitalmarket securities (including US subprime and other structured products), as well as home-grown, boom-

bust problems in the property markets of some EU countries; and (ii) a sovereign debt crisis exacerbatedby recession, transfers to help banks, and in some cases very poor fiscal management over a number ofyears that was inconsistent with the principles laid down in the Stability and Growth Pact and theMaastricht Treaty. In late 2010, the sovereign debt crisis worsened on market concerns about thedifficulty of budget consolidation; for the first time, the European Summit in October 2010 pondered thenotion that private creditors might have to bear some of the pain via mechanisms being put together todeal with future sovereign-debt crises.

Greece and Ireland have faced very significant adverse movements in their yield spreads relative to euro-area benchmark bonds, and to a lesser extent this is also the case for Portugal, and Spain. The market haseven begun to ponder whether the crisis could spread further, and whether the euro system in its currentform is sustainable. Markets are concerned that the prospect of very weak growth and high unemployment

resulting from fiscal consolidation, and years of painful structural adjustment, will make the temptation torestructure sovereign debt too great to be ignored. Such concerns add to the crisis countries problems,making it difficult for them to borrow, while the prevailing high interest rates increase their debt servicecosts. Where the marginal borrowing rate exceeds the average rate on the outstanding stock of debt, thedebt-service burden will rise, making consolidation efforts even more difficult to achieve. Similarly, asgrowth weakens, tax revenues fall.


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Policies to deal with unsustainable debt

dynamics There are a number of ways to deal

with the problem of explosive debt scenarios

The debt dynamics equation suggests a numberof ways to deal with the problem of explosivedebt scenarios: Cutting spending and raising taxes to bring thebudget balance to the point where it offsets thedebt-service burden, after allowing for the

growth of the economy. Thus setting:

Causing inflation to rise a great deal, notingthat here g refers to the nominal growth of GDP(i.e. the sum of real growth and inflation).Inflation surprises essentially reduces the realburden of the debt. Carrying out structural reforms to improve thereal component of the rate of nominal growth(g). Labour market, pension and competitionreforms will improve growth over the longer run.

Restructuring the level of outstanding debt(dt-1). By applying a haircut to the outstanding stockof debt, the debt service burden is reduced.Alternatively, the effective interest rate can bereduced by renegotiating the terms andconditions of the outstanding debt with theholders.6The economic costs of doing this,however, can be to increase the likelihood offuture exclusion from global capital markets, aswell as credit rating downgrades that result in thebond issuer having to pay higher spreads. Themain benefit is the ability to cut the debt-serviceburden to credible levels overnight, thereby

making it easier for countries to achieve macrogoals, including consistency with currency-unionconstraints on fiscal policy and debt such asthose embedded in the Maastricht Treaty.

Inflation is not a policy tool for the countries

concerned

As EU monetary policy is in the hands of theECB, the possibility of initiating an inflationarypolicy is not an option for the countriesconcerned. Were the ECB to carry outquantitative easing to the point where EU-wideinflation accelerated, this would benefit allEuropean debt-service burdens; but it is not an

immediate option for the crisis countries withinEurope now.

The OECD favours labour market, pension and

regulatory reforms that will not have animmediate effect

With respect to structural reform, the OECDcertainly favours: (a) policies to improve thefunctioning of labour markets, and therequirement in a currency union that labourmobility play a key competitiveness adjustmentrole; (b) the reform of EU pension systems, toensure they are fully funded, which is essential to


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reduce the fiscal burden on future generations;and (c) addressing the structure of competitionwithin Europe and the consistency of regulationsand governance for improving efficiency.7However, structural reform is likely to be aprocess the success of which will be measured in

decades. The market tolerance for sovereign debtis unlikely to be improved by promises, of whichthere have been plenty, as the above market-implied probability-of-default calculationssuggest.

Bank vulnerabilities and potential feedback on fiscal deficits

The EU stress tests of June 2010 did not fully allay concerns about bank losses and fiscal interplay. Thestress-tested sovereign shock, for example, left out the bulk of holdings in the banking book.9 Blundell-Wignall and Atkinson (2010) point out that, excluding the sovereign shock, many of the 91 banksincluded did not generate enough write-offs or other adverse pressures to lead to actual losses. Most of the

losses (i.e. impairments to the banking book and losses to the trading book) were covered by income. Inother cases, net losses were small (the main exceptions being the Spanish cajas, small Spanish banks,Royal Bank of Scotland, ABN/Fortis, Hypo Real Estate, Dexia and two large Irish banks). Only 7 of the91 banks failed the test (falling below 6% Tier 1 capital). However, the test shed virtually no light on theadequacy of capital to serve as a buffer to absorb losses, since this was not actually tested. For the systemas a whole, and individually for most of the banks, Tier 1 capital actually rises in the adverse scenario.Since the scenario is designed with a constant balance sheet assumption, it is unclear what is being testedbesides the sensitivity of regulatory constructs. If capital rises as income exceeds losses, while the balancesheet is otherwise unchanged, a sensible capital ratio should rise. But the Tier 1 ratio actually falls by0.7% for the system as a whole, entirely due to the rise in risk weights. This largely reflects the pro-cyclical features introduced in Basel II, which raise risk-weighted assets by EUR 824bn. This inability tosubject the system to a reasonable amount of stress that would require new capital has already been

surpassed by actual events.European banks are less-well capitalised than US banks. This is in part due to the absence of a leverageratio requirement in Europe, where authorities instead rely on the Basel system, which applies capitalrequirements only to Risk-Weighted Assets (RWA) without any reference to the ratio of RWA to totalassets (TA) in banks. EU banks systematically reduced the share of RWA to TA by a variety oftechniques prior to the crisis and raised leverage commensurately to very high levels. RWA of the 91stress-tested banks amounts to only 40% of TA (and much less than this in some large systemicallyimportant EU financial institutions)More transparency about the real situation at EU banks would help allay concerns in the financialmarkets. Just as the financial markets are factoring in the risk of restructuring for sovereign bonds, theprices of bank-debt certificates in the secondary market have again begun falling, particularly in Irelandand Spain, where the housing crises may have exacerbated pressures on banks.11This is especially the case

for the Bank of Ireland and Allied Irish, and (though to a much lesser extent) for the cajas and smallSpanish/Portuguese banksThe market has become increasingly concerned that banks in Ireland and Spain may require furtherinjections of capital to offset housing-related losses that were not picked up by the stress test. At the sametime, the exposure of some banks in all four countries to market fears regarding a restructuring ofsovereign debt would likewise require an increase in capital to act as a shock absorber. Both sets of fearsmay have some potential to impact fiscal policy (as has already been the case recently in Ireland)


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Market arithmetic for Spain

At the start of 2010, the Spanish banking system had minimum required capital of around 168bn, andactual capital of 195bn. This suggests a capital buffer of 27bn. Moodys loss estimate (in November2010) was 176bn, of which they suggest that about half has been recognised. This suggests that Spanish

banks would need to raise more capital. Markets are concerned about the possibility that losses could belarger than these estimates due to weakening property prices, including commercial property an issuethat reduces transparency about the true position of banks. At the same time the situation is veryheterogeneous, with two large Spanish banks having a large share of the profits and less legacy non-performing loans to deal with, while some of the smaller players may face greater difficulties. At thesame time, there is a quite substantial exposure to sovereign debt a 30% haircut on sovereign debtwould add another 63bn to banks capital needs. According to the fifth criterion concerning thelikelihood of sovereign-debt haircuts, discussed above, this would substantially reduce the chance of debtrestructuring. This may be one of the reasons that the markets give this possibility a relatively lowprobability at present.

Market arithmetic for Ireland

The Irish banking sector had minimum required capital of 51bn and actual capital of 63bn at the start of2010, suggesting a buffer of 12bn. The official estimate for losses (in November 2010) was 85bn.12Thisamount is large relative to GDP, and the banks operating profits arent large enough to cover this overany reasonable period. At the same time, the banks exposure to sovereign debt is fairly small. In terms ofcriterion 5 mentioned earlier, this increases the likelihood of a sovereign-debt restructuring, according tomarket reasoning.The government has raised the capital requirements of the Bank of Ireland (BOI), Allied Irish (AIB), EBSBuilding Society and Irish Life and Permanent (ILP) to a new minimum of 10.5% core Tier 1 capital, andover-capitalisation of at least 12% by the end of February 2011, in order to cover further potential losses.This compares to the 9.8% on which the required capital is based in Table 3. This suggests on-going risk

to the budget with respect to support for the banking system affecting the market assessments ofrestructuring via the first and second criteria above (the size of the primary deficit and debt as a share ofGDP). The market probably believes that, ultimately, the bank debt instruments will need to bear some ofthe burden of relieving government budget pressures. This may be one of the reasons why some banksbond prices, too, have begun to fall.

Market arithmetic for Greece

The Greek bank sector had required capital of 23bn at the start of 2010 and actual capital of 31 bn,suggesting a buffer for absorbing losses of 8bn. Estimates of bank losses for 2010 are not taken intoaccount, but the exposure to sovereign debt of 61bn means that a 30% haircut would be difficult for

banks to absorb. On the fifth criterion, this argues against such a haircut. On the other hand, Greek debt isat the highest level of the four countries considered, and the market gives Greece the highest probabilityof a restructuring.


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Market arithmetic for Portugal

Required and actual capital positions suggest Portuguese banks have no buffer to absorb losses, but bankexposure to periphery sovereign debt is small in aggregate. According to the fifth market criterion, thisshould increase the likelihood of restructuring in market calculations, on fiscal grounds.

Bank exposure to known holdings of sovereign debt

As noted in Blundell-Wignall and Slovik (2010), bank exposures to sovereign debt are notevenly distributed:13Buiter and Rahbari (2010) have recently pointed out that averageexposures to sovereign debt dont matter: Averages give little information about specific banks capital needs, housing related losses, pre-tax income and holdings of governmentdebt, which all differ widely. It is the outlier cases that are important in assessing the risk offinancial crises. If the issue is to be properly managed by policy makers it is critical to focuson individual banks. A major lesson of the crisis was that failures of systemically important

financial institutions led to counterparty and contagion effects that had widespread cross-border implications.

The markets and bank solvency and debt options

A second major concern in financial markets addressed in this paper is the uncertainty thereis about how bank insolvency issues are to be dealt with and the risk that they might pose tofiscal consolidation in some countries, particularly where bank liabilities are subject togovernment guarantees. Bank bond prices have been subject to significant moves following

official discussion of these issues. A run on deposits or failure to roll-over debt in thewholesale markets requires emergency liquidity lending in order to keep banks operating,which has been working well enough via ECB operations. But this does not deal withsolvency issues resulting from losses on the assets side. Once existing equity holders arewiped out, the full resolution of a financial institution would involve the unsecuredbondholders bearing the losses and the economy experiencing the deadweight lossesassociated with failures, inconsistent with principle 2 above (de-leveraging and activityeffects). If government guarantees are in place, the pain is borne directly by the taxpayerinstead.


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INDIAN BANKING SYSTEM

Financial StructureThe Indian financial system comprises the following Institutions:Reserve bank of India at apex1. Scheduled banks

State co-operative banks Commercial banks

Commercial banks further divided into two categoriesa)Indian(public (state bank and its subsidiaries, other nationalized bank & RRBs)and privateb)foreign

2. Non-scheduled bank

Central co-operative bank and primary credit societiesCommercial banks

Reserve bank of IndiaRBI is the banker to bankswhether commercial, cooperative, or rural. The relationship isestablished once the name of a bank is included in the Second Schedule to the Reserve Bankof India Act, 1934.Such bank, called a scheduled bank, is entitled to facilities of refinance from RBI, subject tofulfillment of the following conditions laid down in Section 42(6) of the Act, as follows:

It must have paid-up capital and reserve of not less than Rs. 5 lakhs. It must satisfy RBI that its affairs are not being conducted in a manner detrimental to

the interests of its depositors.

Scheduled banks are require to maintain a certain amount of reserves with the RBI.They in return, enjoy the facility of financial accommodation and remittance facility

at concessional from the RBIThe classification of commercial banks into scheduled and non-scheduled categories

that was introduced at the time of establishment of RBI in 1935 has been extendedduring the last two or three decades to include state cooperative banks, primary urbancooperativebanks, and RRBs. RBI is authorized to excludethe name of any bank from theSecond Scheduleif the bank, having been given suitable opportunityto increase the value ofpaid-up capital and improvedeficiencies, goes into liquidation or ceases tocarry on bankingactivities.A system of local area banks announced by the


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Government in power until 1997 has not yet taken root. RBI has given in principle clearanceto five applicants. Specialized development financial institutions (DFIs) were established toresolve market failures in developing economies and shortage of long-term investments. Thefirst DFI to be established was the Industrial Finance Corporation of India (IFCI) in 1948,and was followed by SFCs at state level set up under a special statute. In 1955, Industrial

Credit and Investment Corporation of India (ICICI) was set up in the private sector withforeign equity participation. This was followed in 1964 by Industrial Development Bank ofIndia (IDBI) set up as a subsidiary of RBI. The same year saw the founding of the firstmutual fund in the country, the Unit Trust of India (UTI). A wide variety of financialinstitutions (FIs) has been established. Examples include the National Bank for Agricultureand Rural Development(NABARD), Export Import Bank of India (Exim Bank), National Housing Bank (NHB), andSmall Industries Development Bank of India (SIDBI), which serve as apex banks in theirspecified areas of responsibility and concern. The three institutions that dominate the term-lending market in providing Financial assistance to the corporate sector are IDBI, IFCI, andICICI. The Government owns insurance Companies, including Life Insurance Corporation

of India (LIC) and General Insurance Corporation (GIC). Subsidiaries of GIC also providesubstantial equity and loan assistance to the industrial sector, while UTI, though a mutualfund, conducts similar operations. RBI also set up in April 1988 the Discount and FinanceHouse of India Ltd. (DFHI) in partnership with SBI and other banks to deal with moneymarket instruments and to provide liquidity to money markets by creating a secondarymarket for each instrument. Major shares of DFHI are held by SBI. Liberalization ofeconomic policy since 1991 has highlighted the urgent need to improve infrastructure inorder to provide services of international standards. Infrastructure is woefully inadequate forthe efficient handling of the foreign trade sector, power generation, communication, etc. Formeeting specialized financing needs, the Infrastructure Development Finance Company Ltd.(IDFC) was set up in 1997. To nurture growth of private capital flows, IDFC will seek tounbundle and mitigate the risks that investors face in infrastructure and to create an efficientfinancial structure at institutional and project levels. IDFC will work on commercialorientation, innovations in financial products, rationalizing the legal and regular framework,creation of a Long-term debt market and best global practices on governance and riskmanagement in infrastructure Projects NBFCs undertake a wide spectrum of activitiesranging from hire purchase and leasing to pure investments. More than 10,000 reportingNBFCs (out of more than 40,000 NBFCs operating) had deposits of Rs1, 539 billion in1995/96. RBI initially limited their powers, aiming to moderate deposit mobilization inorder to provide depositors with indirect protection. It regulated the NBFCs under theprovisions of Chapter IIIB of the RBI Act of 1963, which were confined solely to depositacceptance activities of NBFCs and did not cover their functional diversity and expandingintermediation. This rendered the regulatory framework inadequate to control NBFCs. TheRBI Working Group on Financial Companies recommended vesting RBI with more powersfor more effective regulation of NBFCs. A system of registration was introduced in April1993 for NBFCs with net owned funds (NOF) of Rs5 million or above.

RBI regulations

In India, banks lending to individual is based on their income. The banks do religiously


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verify an individuals income and expenditure before sanctioning any loans.

Mortgage loan still insists on down payment (15% to 30%) and this prevented manywho dreamt of having properties completely at banks expense.

70% of the banks in India are still nationalized. RBI issued market stabilization schemes and bonds and absorbed dollars; now if

overseas investors suck out dollars after selling shares, there is no shortage of dollars tosell to them; and, there will be no domestic liquidity crisis because the RBI can buyback those bonds and pump rupees into the market.

RBI has made banks keep 7.5 per cent of their deposits in cash, and another 25 per centof their deposits in government bonds. So even if there were to be a run on a bank theystill would have the liquidity to tackle the situation.

RBI insists the bank to keep the capital ratios within the range of 11% to 13%(Regulation is 9 %)

Indian banks are not focusing on the business structure like securitization andcollateralized debt obligation (CDO)Again thanks to RBI regulations.

Another crucial factor RBI had the right person in the right job at right time. He was YV Reddy, the former RBI governor (6th Sept 2003 to 5th Sept 2008). He made sure thatIndian banks did not get too caught up in the bubble mentality.

Last but not the least -Culture Indians are not very comfortable with credit. Indiansgenerally think, if you spend more than you earn, you will get in trouble. In India,joint families still exist and family members help each other in times of economic crisisso they dont go to banks to borrow money.

State bank group: This consists of the State Bank of India (SBI) and Associate Banks ofSBI. The Reserve Bank of India (RBI) owns the majority share of SBI and some AssociateBanks ofSBI.SBI has 13 head offices governed each by a board of directors under the supervision ofa central Board. The boards of directors and their committees hold monthly meetings whilethe executive committee of each central board meets every week.Nationalized banks: In 1969, the Government arranged the nationalization of 14 scheduledcommercial banks in order to expand the branch network, followed by six more in 1980. Amerger reduced the number from 20 to 19. Nationalized banks are wholly owned by theGovernment, although some of them have made public issues. In contrast to the state bankgroup, nationalized banks are centrally governed, i.e., by their respective head offices. Thus,there is only one board for each nationalized bank and meetings are less frequent (generally,once a month). The state bank group and nationalized banks are together referred to as thepublic sector banks (PSBs).Regional Rural Banks (RRBs): In 1975, the state bank group and nationalized banks wererequired to sponsor and set up RRBs in partnership with individual states to provide low-cost financing and credit facilities to the rural masses.Co-operative banks: The cooperative banks also perform basic functions of banking butdiffer from commercial banks in the following respects: Commercial banks are joint-stock companies under the Companies Act of 1956, or public


16/36

sector banks under a separate Act of the Parliament Co-operative banks were establishedunder the Co-operative Societies Acts of different states; co-operative banks have a three-tier setup, with state cooperative bank at the apex,central/district co-operative banks at district level, and primary cooperative societies at rurallevel;

Only some of the sections of the Banking Regulation Act of 1949 (fully applicable tocommercial banks), are applicable to cooperative banks, resulting in only partial control byRBI of cooperativeBanks; and Cooperative banks function on the principle of cooperation and not entirely on commercialparameters.

Comparison Of Banking Systems

India could become the third largest banking sector by 2050 after China and US, leaving Japan,

UK and Germany behind.

India is an emerging economy and comparison of Indian economy with other countries such asthe US, European Union , Canada, Japan and China is needed to study international economyand business. People want to compare economies to make strategies. This article will help youunderstand better Indian markets, consumers, industries and overall growth picture of India inComparison with US, EU, Canada, Japan, China and rest of the world.

India is a large country having population of more than a billion, second highest in the world. Itis also the largest democracy in the globe. GDP India is fourth highest in the world in PPP terms.Here is a comparison of Indian economy vs. the US, EU, Canada, Japan, China and rest of theworld.

Indian GDP ranks to No.12 in nominal term of world GDP after US, Japan, UK, Germany,China, France, Italy, Spain, Canada, Brazil and Russia. However, India ($3000B) comes to No.4after US (America) (($13800B), China ($7000B) and Japan ($4300B) in PPP terms .

India is a large economy. It has GDP of $1100 B (2007) or RS.55000 B. It is approximately twopercent of the GDP of the world i.e. $55000 B. It does not tell the real story because world GDPis calculated based on US dollars. However, Indians have to buy, sell and spend in Indian rupee.Price parity parameter shows comparatively better picture. In PPP method, Indian GDP iscalculated to $3000B that is approximately 4.7 percent of world GDP of $64000B in PPP.

India has particularly strong long-term growth potential.Indian banking sector in general and the

Reserve Bank of India were applauded post financial crisis for fiscal prudence. Post downturn,Indian banks have become more efficient due to tighter credit assessment and disbursals, cost

efficient model, weeded out non profitable and highly risky portfolios and increased the CASA

substantially resulting in lower cost of funds for the bank.

Indian banks have improved their cost to income ratio by 6 per cent on an average, he added.


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Indias largest private sector bank, ICICI Bank improved its cost to income ratio from 53 per

cent in 2007 to 38 per cent in 2010, owing to shift in strategy from aggressive growth to cost

rationalization.

China could overtake US in 2023 and India could overtake Japan in 2033. Indias domestic

banking assets are expected to grow to $38,484 in 2050 from $945.

India is an emerging economy and comparison of Indian economy with other countries such as

the US, European Union, Canada, Japan and China is needed to study international economy

and business.

Indiais a large country having population of more than a billion, second highest in the world. It

is also the largest democracy in the globe. GDP India is fourth highest in the world in PPP terms.

Indian GDP ranks to No.12 in nominal term of world GDP afterUS, Japan,UK,

Germany,China, France, Italy, Spain, Canada, Brazil and Russia. However, India ($3000B)

comes to No.4 after US (America) (($13800B), China ($7000B) and Japan ($4300B) in PPP

terms.

India is a largeeconomy. It has GDP of $1100 B (2007) or RS.55000 B. It is approximately two

percent of the GDP of the world i.e. $55000 B. It does not tell the real story because world GDP

is calculated based on US dollars. However, Indians have to buy, sell and spend in Indian rupee.

Price parity parameter shows comparatively better picture. In PPP method,IndianGDP is

calculated to $3000B that is approximately 4.7 percent of world GDP of $64000B in PPP.

More overIndiais growing at the rate of eight to nine percent per annum whereas most of the

developed countries includingUS, Canada, Japanand countries ofEU and UK are growing at

a very slow speed until last year. OnlyChina has shown greater growthrate than India.

Picture is little different this year. Most of the developed countries have started showingtendency of negative growth. This will surelyaffect Indiaand China but they can manage their

growth in a positive range. It is expected that China will manage a growth rate of eight to nine

percent where as India will anywhere between seven to eight percent.

India has achieved highest growth rate instock marketin the world. If we compare the stock

markets of India and America since 9/11

Highest growth in stock market

More over India is growing at the rate of eight to nine percent per annum where as most of the

developed countries including US, Canada, Japan and countries of EU and UK are growing at a

very slow speed until last year. Only China has shown greater growth rate than India.
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18/36

Picture is little different this year. Most of the developed countries have started showing

tendency of negative growth. This will surely affect India and China but they can manage their

growth in a positive range. It is expected that China will manage a growth rate of eight to nine

percent where as India will anywhere between seven to eight percent.

India has achieved highest growth rate in stock market in the world. If we compare the stock

markets of India and America since 9/11, we find fascinating facts. Dow Jones fell after 9/11 to

8235 on 21st September 2001. The BSE (India) also fell during those days to reach a low of

2595. Particular data for Shanghai (China) and Hangseng (Hong Kong) are not available to me

(If anyone has the data, please inform me) but those were around 1400 and 11000 respectively.

Dow Jones is trading at 8787 (While writing this hub Dec. 09, 2008). If we compare it with the

previous Dow Jones data (21st sept.2001), it has gained mere 550 points over the period of more

than seven years. Where as BSE India has traded at (on eighth Dec.2008, 9th market closed)

9162 level. It has jumped from 2595 to 9162, that is a gain of 6567 points or approximately 250

percent! Hangseng is 14753 and Shanghai is 2037 today. As I do not have actual data of 21stSept. of both these indexes it is not justified to calculate the gain but it is some thing around

thirty to fifty percent.

Dow has increased mere six percent in more than seven years and China and Hong Kong index

has raised by thirty to fifty percent (roughly estimated) but Indian stock exchange index BSE has

shown an amazing growth of more than two hundred fifty percent.

Fifth highest foreign currency reserve in the world

India has fifth highest foreign currency reserve in the world.Foreign currency reserves ofChina, Japan, Russia, Taiwanand India were $ 1905, $997B,

$485B, $282 B and $247 B respectively in 2007. This shows that Foreign currency reserve

ofIndiawas the fifth highest in the world after that of China, Japan, Taiwan and Russia. The

most interesting fact is that Indian foreign currency reserve had been increased 64 percent in

comparison to 32 percent ofChina and 57 of Russia, 9 ofJapan and below 3 percent

ofTaiwan on year-to-year basis.

It is worth mention that so called rich countries likes of the US, Canada, France and the UK are

not in this list.

Composite economic scenario of India:GDP Indiais twelfth largest economy in the world in nominal parameter but that does not show

the real picture.

GDP India represents thefourth largest economyin the world in price parity parameter (PPP).

India has the second highest growth rate in the world after China.
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19/36

BSE stock index of India has grown at the fastest pace beating all stock indexes in the world

including America, Canada, China, Japan and of course, all stock markets in European

Union. India has no.1 growth rate amongstock markets in the world.

Compared to America, Indian Bank system is in a better position and more stable. Indian banksare in a strong position as the ratio between lending and deposit is vast in India. On the otherhand, American banks, till the recession, gave loan to the people even with zero income. Butnow, there are changes in bank regulations along with restructuring in lending. American banksused to believe that real estate sector never goes down and thus, lent on it without any hesitation,but they were wrong. Now banks have understood this and made some changes.

India continues to be an attractive place for investment. The growth rates of the country willabout five percent which is higher than America. Agriculture is one of the factors, which willhelp survive during slow down. While for American economy, this year will be quite disturbing,but next year onwards, it will be a good time.

The Indian financial system has been witnessing an exciting era of transformation. The banking

sector has seen major changes with deregulation of interest rates and the emergence of strong

domestic private players as well as foreign banks. At the same time, there is some evidence of

credit constraints for Indias SME firms that rely heavily on trade credit. Corporate governance

norms in India have strengthened rapidly in the past few years. Family businesses, however, still

dominate the landscape and investor protection, while excellent on paper, appears to be less

effective owing to an overburdened legal system and corruption. In the last few years

microfinance has contributed in a big way to financial inclusion and is now attracting venture

capital and for-profit companiesboth domestic and foreign.

The Impact of Inflation on Bank Lending

By now, everybody knows inflation is bad. Hyperinflationswhen inflation rates are extremely

highare the horror

stories, but few doubt the harmful effects of inflation rates in the teens either. Over the past

several decades, central banks around the world have been pretty successful at dramatically

lowering inflation rates. Can we now stop worrying about inflation? Probably not. There is

good reason to believe that inflation is harmful even at what one

Might consider relatively moderate ratesannual rates of perhaps 5 to 10 percent.

Effect on Banking sectorBecause of high inflation, RBI has increased the CRR rates, which means withdrawal of more

free flow of funds from the banking sector and their lending source of funds come down, there

by price rice can be controlled. Naturally the banks liquidity will be affected and they have to

make money only with the limited source available with them. Now after this Financial Tsunami

RBI has reduced the CRR hike and there by more funds into the market and asked the bankers to


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21/36

the time period we looked at is not one of particularly high world-wide inflation: The median

inflation rate was around 8 percent across all our sam-ples. Prior studies looked at episodes in

which average inflation was consider-ably higher, but they yielded similar results to ours.

The Impact of Inflation on Bank Lending

Several economists have found that countries with high inflation rates have inefficiently smallbanking sectors and equity markets. This effect suggests that inflation reduces bank lending tothe private sector, which is consistent with he view that a sufficiently high rate of inflationinduces banks to ration credit.

This finding also holds for the data we examined. Figure 1 shows one measure of bank lending inan economytotal bank lending to the private sector as a ratio to GDP. For this analysis, thesample period is 198095. The median inflation rate is 8.5 percent, with inflation rates rangingfrom 0.8 percent to 85.9 percent.

We break the cross-country data into quartiles. The first quartile includes those countries withaverage inflation in the lowest 25 percent of the sample. The fourth quartile includes thosecountries with the highest inflation averages. In figure 1, we present the median and mean valuesof the banking sector size measure for each of the inflation quartiles. Below each quartile group,

the range of the inflation rate for each of the quartiles is listed. For example, the lowest inflationquartile covers inflation rates less than 5.4 percent, and the highest inflation quartile containscountries with inflation rates in excess of 17.4 percent.

We see that the amount of bank lending declines with inflation. Moreover, inflation affects banklending even at relatively low inflation ratesthe median ratio of bank lending to GDP in thesecond quartile is 10 percent smaller than in the first quartile, and the median inflation rate in thesecond quartile is only 6.6 percent. Many people might be surprised that such a small rate of


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inflation could cause such a fall in credit. At the highest inflation quartile, the effect is dramatic,with the ratio of bank lending to GDP only 15 percent

Although suggestive, such a simple graph does not take into account other factors that can affectthe size of the banking sector. However, after controlling for other variables (in a multivariate

statistical analysis), we still find a statistically significant negative relationship between inflationand banking sector size. In fact, at the median inflation rate, a one percentage point increase ininflation is associated with a one percentage point decline in the ratio of bank lending to GDP.Other studies have found similar effects of inflation on alternative measures of banking sectorsize, such as the ratio of total bank assets to GDP or the ratio of the liquid liabilities of thefinancial sector to GDP.

The Impact of Inflation on Asset Returns and Bank Profitability

inflation in sufficiently high doses kicks off a chain of events that ultimately leads to stuntedeconomic growth. The chain begins when high inflation lowers the real return on assets. We

uncover substantial evidence for this effect in the data, but not complete support. We find thatinflation is negatively associated with real money market rates, real treasury bill rates, and realtime-deposit rates; that is, as inflation increases, the real rate of return on these instruments falls.The one example where we dont find what we might expect is with nominal interest rates onbank loans. We would expect banks to adjust their nominal rates to account for inflation. (Onemight not expect nominal rates to rise one for one with inflation over a short period of time,since banks might not be immediately aware that inflation has stepped up, but over longerperiods, it should be evident.) We find no significant statistical relationship between inflationand the real bank loan rate. However, as we detail later, inflation does appear to have a negativeimpact on bank profitability measures.

The impact of inflation on real rates is most evident at the extreme. The economies in ourhighest-inflation quartile experienced real money market rates and real treasury bill rates ofaround zero percent on average during the time period studied. The real time deposit rate for thehigh-inflation countries was approximately 3 percent. Negative real interest rates provide littleincentive for saving, as savers actually lose purchasing power.

Perhaps most importantly, we find that inflation has a dramatic negative impact on theprofitability of banks. Various measures of bank profitabilitynet interest margins, net profits,rate of return on equity, and value added by the banking sectorall decline in real terms asinflation rises, after controlling for other variables. Figure 2 plots banks real net interest marginsagainst the inflation quartiles to give one example. (The real net interest margin is a measure ofthe inflation-adjusted spread between a banks lending rate and its cost of obtaining funds.) Wesee that even at fairly modest inflation rates of between 5.1 percent and 9.1 percent, the real netinterest margin turns negative. Such low real rates of return suggest that the incentives to expandbank operations simply are not as strong as inflation rises.


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RESERVE RATIOThe portion (expressed as a percent) of depositors' balances banks must have on hand as cash.

This is a requirement determined by the country's central bank, which in the U.S. is the Federal

Reserve, in India by Central Bank. The reserve ratio affects the money supply in a country.

In the United Kingdom and in certain European countries, there is no compulsory ratio, although

banks will have their own internal measures and targets to be able to repay customer deposits as

they forecast they will be required.

In Europe, the reserve requirement of an institution is calculated by multiplying the reserve ratio

for each category of items in the reserve base, set by the European Central Bank, with the

amount of those items in the institution's balance sheets. These figures vary according to theinstitution.

In the United States, specified percentages of depositsestablished by the Federal Reserve

Boardmust be kept by banks in a non-interest-bearing account at one of the twelve Federal

Reserve Banks located throughout the country.

The required reserve ratio in the United States is set by federal law, and depends on the amount

of checkable deposits a bank holds.

Reserve Requirements


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Liability TypeRequirement

% of liabilities Effective date

Net transaction accounts 1

$0 to $11.5 million2 0 12-29-11

More than $11.5 million to $71.0 million3 3 12-29-11

More than $71.0 million 10 12-29-11

Nonpersonal time deposits 0 12-27-90

Eurocurrency liabilities 0 12-27-90

These breakpoints are reviewed annually in accordance with money supply growth. No reserves

are required against certificates of deposit or savings accounts.

The reserve ratio requirement limits a bank's lending to a certain fraction of its demand deposits.

The current rule allows a bank to issue loans in an amount equal to 90% of such deposits,

holding 10% in reserve. The reserves can be held in any combination of till money and deposit at

a Federal Reserve Bank.

In india, Reserve ratio is decided by RBI and revised gradually.

Cash Reserve Ratio (CRR 5.50% (wef 28/01/2012) -announced on 24/01/2012 Decreased

from 6.00% to 5.50% which was continuing since 24/04/2010

Statutory Liquidity Ratio (SLR) 24%(w.e.f. 18/12/2010) Decreased from 25% which was

continuing since 07/11/2009

Challenges and Opportunities for Indian Banking Industry


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Indian Banking industry was deregulated since 1994, private players were allowed to enter and

this step transformed the structure of Indian banking system. Since 1994 world has seen two

major financial crises including the subprime crisis due to which giant like Lehman Brothers,

Washington Mutual etc collapsed. The structure of Indian Banking industry is different than

USA. We are having instrument like SLR which is not being used in USA. Perhaps this extra

security feature makes our system strong, we follow Bessel 2 norms and all the Indian banks

maintain all the CAMELS ratios better than the benchmark Bessel 2 norms. The Indian Banking

system has successfully managed the financial tornado due to sound policies of our central bank

and fiscal stimulus packages implemented by the Government. Due to strict regulations, tighter

norms on capital adequacy and close watch by the Reserve Bank of India (RBI) prevented the

severe impact of the global financial crisis to the Indian banking system. During the recessionary

phase between October 2008 to March 2009, the RBI reduced the policy rates, both repo and

reverse repo and provide liquidity to the economy by reducing the reserve ratios and offering

adequate support to the banking system.he Indian banking market is growing at an astonishingrate, with Assets expected to reach US$1 trillion by 2010. An expanding economy, middle class,and technological innovations are all contributing to this growth. The countrys middle class

accounts for over 32 crore people. In correlation with the growth of the economy, rising income

levels, increased standard of living, and affordability of banking products are promising factors

for continued expansion. The banking system is reorienting its approach to rural lending. Going

Rural could be the new market mantra. Rural market comprises 74% of the population, 41% of

Middle class and 58% of disposable income.

The banking sector is seeing constant growth driven by new products and services that include

opportunities in credit cards, consumer finance and wealth management on the retail side, and in

fee-based income and investment banking on the wholesale banking side. These require newskills in sales & marketing, credit and operations. Second, given the demographic shifts resulting

from changes in age profile and household income, consumers will increasingly demand

enhanced institutional capabilities and service levels from banks. This segment of customers

prefer to do banking from their workplace or home only, as a banks point of view it is good

because the operational costs is going down. Banks are now offering new technologically

sophisticated products like Mobile Banking, internet banking, E-Remit, to attract technically

sophisticated customer segment. Now the point of contact is reducing and Banks are taking this

challenge as an opportunity, through its innovative products.

Banks are targeting to open new branches in Tier 2 & 3 cities along with opening new branchesin rural areas to penetrate this market. Their aim is to offer products to each and every segment

of customers. Specialised branches are being opened to target the niche like overseas branches

or Corporate branches. The manpower shortage is really a big worry for the banking industry and

to retain existing employees is also a big challenge. But better HR policies and chances of better

growth in Banking industry are attracting the youths.


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Although due to competition created by Private and Foreign banks government banks initially

faced tough competition but their core competency is trust of our customers which make us

different than others ,as a government banks they have some corporate social responsibility so

unlike private players they not only think about the profitability but also our responsibility. So

their brand equity is RELATIONSHIP with their customers and now with prompt and efficient

services these government banks are making long lasting relationship with their customers. After

the deregulation in banking industry the level of service has been improved and in long run the

future of Indian banking industry is good.

NEWS ARTICLES

1 ) U.S. Banks Face Contagion Risk From Europe Debt

U.S. banks face a serious risk that their creditworthiness will deteriorate if Europes debt crisis

deepens and spreads beyond the five most-troubled nations, Fitch Ratings said.

Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit

outlook for the U.S. banking industry could worsen, the New York-based rating company said

yesterday in a statement. Even as U.S. banks have manageable exposure to stressed European

markets, further contagion poses a serious risk, Fitch said, without explaining what it meant by

contagion.

The exposures of U.S. lenders to major European banks and the stressed nations of Greece,

Ireland, Italy, Portugal and Spain, known as the GIIPS, are smaller than those to some of the

continents larger countries, Fitch said.

The six biggest U.S. banks -- JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC),

Citigroup Inc. (C), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. and Morgan Stanley


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(MS) -- had $50 billion in risk tied to the GIIPS on Sept. 30, Fitch said. So-called cross-border

outstandings to France for all except Wells Fargo were $188 billion, including $114 billion to

French banks. Risk to Britain and its banks was $225 billion and $51 billion, respectively.

Europes debt crisis has toppled four elected governments, with the last two, in Greece and Italy,

falling last week. Italian bond yields remained at about 7 percent -- the threshold that led Greece,Portugal and Ireland to seek bailouts -- and shares of French banks, including BNP Paribas

(BNP) SA and Societe Generale (GLE) SA, dropped amid concern theyll need more capital.

Stocks Slump

U.S. stocks slumped yesterday after the Fitch report was released. The Standard & Poors 500

Index slid 1.7 percent and the 24-company KBW Bank Index fell 1.9 percent. U.S. stock declines

continued today, with the S&P benchmark dropping 1.8 percent at 12:41 p.m. in New York.

The Fitch report is a worst-case scenario and is oddly out of step with the rating firms

previous reports, analysts at HSBC Holdings Plc said today. U.S. banks may even benefit as

investors shift money from Europe, HSBC said.

Ratings on the U.S. banking industry are stable and take into account lenders improved capital

and liquidity position, Fitch said. The rating companys assumption is that euro zone sovereign

debt concerns will be dealt with in an orderly fashion and that a disorderly restructuring of

sovereign debt or the forced exit of a nation from the euro will not occur, according to the

report.

Relative Safety

Investor demand for the relative safety of Treasuries during the European debt crisis has sent the

difference between U.S. short-term yields and bank rates surging to levels not seen in more than

two years.

The gap between the London interbank offered rate and the overnight index swap, or what

traders expect the Federal Reserves benchmark to be over the term of the contract, widened to

38 basis points today, the highest level since June 2009.

U.S. five-year swap spreads climbed to 45 basis points, the most since August 2009. Investorsuse swaps to exchange fixed and floating interest rates. The spread, the gap between the fixed

component and the yield on similar-maturity Treasuries, is a measure of bank creditworthiness.

TED Spread

The TED spread, the difference between what lenders and the U.S. government pay to borrow

for three months, widened to 47 basis points today, or 0.47 percentage point, the most since June


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2010. The TED spread was as wide as 4.64 percentage points in October 2008 when credit

markets froze and the U.S. economy was in a recession.

While U.S. banks have hedged some of their risk with credit-default swaps, those may not be

effective if voluntary debt forgiveness becomes more prevalent and the insurance provisions of

the instruments arent triggered, Fitch said in the report. The top five U.S. banks had $22 billionin hedges tied to stressed markets, according to Fitch.

Disclosure practices also make it difficult to gauge U.S. banks risk, Fitch said. Firms including

Goldman Sachs and JPMorgan dont provide a full picture of potential losses and gains in the

event of a European default, giving only net numbers or excluding some derivatives altogether.

Guarantees provided by U.S. lenders on government, bank and corporate debt in Greece, Italy,

Ireland, Portugal and Spain rose by $80.7 billion to $518 billion in the first half of 2011,

according to the Bank for International Settlements.

U.S. banks that run money-market funds may face additional risk if the funds suffer losses on

European debt and the lenders are forced to offer support, Fitch said.

Also yesterday, Moodys Investors Service downgraded the senior debt and deposit ratings of 10

German public-sector banks, citing its assumption that there is now a lower likelihood that the

lenders would get external support.

2) The euro zone: the central bankers' latest view on the crisis

When Central Bankers talk, people listen. Or maybe they don't. In any case, two of Europe's

most important central bankers spoke to the press today and they had some very interestingthings to say.

First, Mario Draghi, new head of the European Central Bank, making his maiden speech before

the European Parliament. Forgive me for quoting at length:

"What I believe our economic and monetary union needs is a new fiscal compact ... Just as we

effectively have a compact that describes the essence of monetary policy an independent

central bank with a single objective of maintaining price stability so a fiscal compact would

enshrine the essence of fiscal rules and the government commitments taken so far, and ensure

that the latter become fully credible, individually and collectively."

This is as close as Draghi could get to stating the obvious, if the euro is to survive, tax policies

will have to be set at euro zone level, not at national level. That much was clear by a point the

ECB chief added a minute later.

"Other elements might follow ... " What are those other elements? Euro zone wide political

institutions that have the ability to set fiscal policy.


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Draghi concluded, "A new fiscal compact would be the most important signal from euro area

governments for embarking on a path of comprehensive deepening of economic integration. It

would also present a clear trajectory for the future evolution of the euro area, thus framing

expectations."

Okay, it's not up there with, "We the People of the United States, in order to form a more perfectunion," or any of Alexander Hamilton's more forceful contributions to the Federalist Papers. But

clearly Draghi sees where the solution to the euro zone crisis lies. The question is whether the

currency can survive the short term assault by the bond markets on its individual members

sovereign debt.

According to Sir Mervyn King, Governor of the Bank of England, the answer to that question is,

nobody knows. King was speaking at a press conference to present the latest analysis of the

bank's Financial Stability Board.

Describing the situation, King came up with the sound bite of the week: "It is not a liquiditycrisis, it is a solvency crisis." He was referring to yesterday's coordinated intervention by central

banks around the world to prop up Europe's beleaguered retail banks. These institutions are

holding an awful lot of iffy sovereign national debt.

King acknowledged that the bank was making contingency plans for the breakup of the euro

zone. "Maybe it (the euro zone) won't breakup, maybe it will continue in various forms but

maybe there will still be questions of default. None of us really know."

He also urged the country's private banks to begin making contingency plans to build up cash

reserves - including not paying out massive bonuses to its top executives!

Who is listening to all this? As I write markets seem to be doing better ... but that is probably

because the central banks - including the Federal Reserve - showed yesterday they were willing

to provide a backstop for the banking system. Money talks, as they say, and something else

walks.

CASE STUDY

The intensifying American banking crisis threatens the stability of its economy and the

worlds. Where is it leading?

Global financial stability has been shaken and America is facing a growing economic crisis thatcould make the 1930s look like good times. The U.S. banking system is on the verge of

disaster, as banks have recorded over $100 billion in losses, with hundreds of billions more

forecasted. Simply put, Americas banks are staring into a financial abyss.

What started with subprime mortgage losses in 2007 is now growing into a full-blown financial

crisis. Consider just one example. As of January 2008, Stockton, Calif. (pop. 280,000), had 4,200


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homes in default or foreclosure, with bad loans totaling a staggering $1.4 billion. According

to CBS News, Stockton has gone from being one of the hottest real estate markets to the

foreclosure capital of America. Prices of homes in the city have dropped as much as 70%.

In many of the nations cities, towns and smaller communities, Stockton-like scenarios are

playing out. Banks are busy auctioning off houses at fire sale prices.

And the news keeps growing worse. Once proud banking titans Merrill Lynch and Citigroup had

to look to investments from Asian and Middle Eastern governments (through Sovereign-Wealth

Funds) to shore up their balance sheets. They were rescued by life-saving injections of $6.6

billion and $14.5 billion, respectively. European banks have also been affected, as Swiss,

German, French and British banks have suffered billions of dollars in losses.

The losses are not confined to banks alone. One of the worlds largest insurance companies,

American International Group, recently reported losses from the mortgage crisis of up to $5

billionup from a previous estimate of $2 billion. This may be a sign of coming reassessmentsby others as the crisis intensifies.

At a meeting of the G7 finance leaders, German Finance Minister Peer Steinbrueck stated that

the G7 feared losses from the subprime mortgages could reach as high as $400 billion (nearly as

large as the entire economy of Holland, ranked 16th worldwide). Highlighting the gravity of the

economic situation, U.S. Treasury Secretary Hank Paulson described it as challenging and

uncertain.

A deadly combination of the credit crunch, the collapsing housing market, increasing energy

prices, and the threat of rising inflation are rapidly weakening Americas economy.

The crisis threatens to engulf banks and other financial institutions, affecting pension funds,

mutual funds and insurance companies. The situation is so grave that President George W. Bush

and the Federal Reserve (the Fed) have implemented unprecedented emergency measures,

including stimulus plans, tax rebates and interest rate freezes, in an effort to prevent total

collapse. The stability of the global economy is at stake.

Traditional vs. Modern Banking

Banks traditionally operated by taking deposits from their customers and lending money to those

seeking loans. The difference between the interest rate paid on deposits and the higher one

charged on loans (the spread) was their profit. If customers defaulted on their loans, banks

were liable to depositors for payment the banks held the risk on the books, 100% their

responsibility. It was therefore in a banks best interest to carefully screen customers ability to

repay before providing loans. The customer needed to have a good job, adequate assets, and was

required to make a sizable down-payment. This conservative approach to lending enabled banks

to make tidy profits for decades, while staying financially sound. However, the 1990s saw banks


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change their traditional way of operating. Seeking higher and higher profits to satisfy

shareholders and to secure executive performance-pay bonuses, banks decided they could make

even higher profits if they loaned out more money. To do this, they used other peoples money

through securitization, a process that allows banks to convert hundreds, even thousands, of

mortgages into bonds and then sell the bonds to investors, such as pension funds, mutual funds,

insurance companies and other banks. Banks did not make a profit through the spread

anymore, but instead made a fee for having put together (originated) the loan, now owned by

other investors.

Further, the bonds were insured by specialized insurance companies (so-called monoline

insurers), and were rated as safe investments by the rating agencies (i.e., Standard & Poors,

Moodys, and Fitch).

Since the loans were now off the books and insured, the banks felt comfortable about

originating even more loans. Through their new fee-based income, banks made much higher

profits than ever before.

Reckless Lending

In their quest for higher profits, banks no longer felt the need to carefully screen loan applicants,

as they once did. Customers who did not qualify for loans under the banks standard lending

procedures (i.e., subprime customers) were now targeted as a lucrative source of income, and

marketed aggressively to. Loans were provided to people with no income, no job and no assets

(so-called NINJA loans).Additional sweetener incentives were also provided, such as no down

payment required and interest-only payments. Those who initiated the loans and approved them

were no longer attached to the risk, and were paid handsomely for their efforts.The subprimemortgage market became a ticking bomb, ready to explode at any time.

Enter the Fed: Expand Image

Thinking ahead: Federal Reserve Chairman Ben Bernanke discusses Savings during an

Economics Club of Washington luncheon (Oct. 4, 2006). Mr. Bernanke called for an urgent

reform of Social Security and Medicare, warning that failure to do so soon could lead to dire

economic consequences for future generations.

Two developments have played a significant role in the development of modern banking and the

current crisis.

The first was deregulation of the U.S. financial services industry with the 1999 repeal of the

Glass-Steagall Act, after years of lobbying by the banks. Carefully crafted during the Great

Depression to control speculation in the stock market, Glass-Steagall prevented retail banks,

insurance companies and investment banks from owning each other. With the repeal of Glass-

Steagall, massive financial services conglomerates were suddenly formed, combining these three


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types of financial institutions. Industry behemoths such as Citigroup and JP Morgan quickly

came into being. This meant that retail banks seeking higher and higher profits could now dive

headlong into high-risk speculative ventures through ownership of (or being owned by)

investment banks, which led to disastrous consequences during the Stock Market Crash of 1929.

The second was the low interest rate policy pursued by the Federal Reserve. Low interest ratesencouraged banks to target subprime customers with variable rate mortgages. Banks offered

initially low interest rates (teaser rates), to be increased two or three years later. Because of

rising house prices, customers took the bait believing they could refinance their homes at an

affordable rate when the time for the reset arrived.

A Culture of Greed

ion of Banking System of Us ,Europe,India

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