Index / Content

Particulars

Page No.

Executive Summary

02

Chapter 1: Introduction to the Study

04

Objective of the Project

06

Hypothesis

06

Research Methodology

06

Limitation of the study

07

Chapter 2: Introduction to Reforms in banking sector

History of Reforms in banking industries.

Chapter 3: Review of the Literature

Chapter 4: Analysis of the Project

08-66

67-69

70-80

Chapter 5: Findings

81

Chapter 6: Conclusion

82

Appendix
Brief background of Reforms in banking sector

84

Questionnaire

88

Bibliography

91

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EXECUTIVE SUMMARY

A retrospect of the events clearly indicates that the Indian banking sector has come
far away from the days of nationalization. The Narasimham Committee laid the
foundation
for
the
reformation
of
the
Indian
banking
Constituted in 1991, the Committee submitted two reports, in1992 and 1998,
which laid significant thrust on enhancing the efficiency and viability of the banking
sector. As the international standards became prevalent, banks had to unlearn their
traditional operational methods of directed credit, directed investments and fixed
interest rates, all of which held to deterioration in the quality of loan portfolios,
inadequacy of capital and the erosion of profitability. The recent international
banking system has veered around certain core themes. These are:
effective risk management systems, adequate capital provision, soundpracti
ces of supervision and regulation, transparency of operation , conductive
public policy intervention and maintenance of macroeconomic stability in the economy.
Until recently, the lack of competitiveness vis--vis global standards, low
technological level in operations, over staffing, high NPAs and low levels of motivation
had
shackled
the
performance
of
the
banking
industry.
However, the banking sector reforms have provided the necessaryplatform for the
Indian banks to operate on the basis of operationalflexibility and functional
autonomy, thereby enhancing efficiency, productivity and profitability.
The reforms also include increase in the number of banks due to the entry of new
private and foreign banks, increase in the transparency of the banks balance
sheets through the introduction of prudential norms and increase in the role of the
market forces due to the deregulated interest rates. These have significantly
affected the operational environment of the Indian banking sector. To encourage
speedy recovery of Non-performing assets, the Narasimham committee laid
directions to introduce Special Tribunals and also lead to the creation of an Asset
Reconstruction Fund. For revival of weak banks, the Verma Committee
recommendationsLastly,t o m a i n t a i n m a c r o e c o n o m i c s t a b i l i t y , R B I h a s i
n t r o d u c e d t h e A s s e t Liability Management System.
The East-Asian crisis has demonstrated the vital importance of financial institutions
in
sustaining
the
momentum
of
growth
and
development.
It
isn o l o n g e r p o s s i b l e f o r d e v e l o p i n g c o u n t r i e s l i k e I n d i a t o d e l a y t
h e introduction of these reforms of strong prudential and supervisory norms, in order
to make the financial system more competitive, more transparent and more
accountable. The competitive environment created by financial sector reforms
hasnonetheless compelled the banks to gradually adopt modern technology to
maintain their market share.

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The developments, in general, have an emphasis on service and technology; for

the first time that Indian public sector banks are being challenged by the foreign banks and
private sector banks.
The deregulation process has resulted in delivery of innovative financial products at
competitive rates; this has been proved by the increasing divergence of banks
in retail banking for their development and survival.
In order to survive and maintain strong presence, mergers andacquisitions has been
the most common development all around t h e world. In order to ensure healthy
competition, giving customer the best of the services, the banking sector reforms
have lead to the development of a diversifying portfolio in retail banking, and
insurance, trend of mergers for better stability and also the concept of virtual banking. The
Narasimham Committee has presented a detailed analysis of various problems and
challenges facing theIndian branging recommendations for improving.

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Meaning of Banking:A Bank is a financial institution that accepts deposits and channels those deposits
into lending activities. Banks primarily provide financial services to customers while
enriching investors. Government restrictions on financial activities by banks vary
over time and location. Banks are important players in financial markets and offer
services such as investment funds and loans. In some countries such as Germany
banks have historically owned major stakes in industrial corporations while in other
countries such as the United States banks are prohibited from owning non-financial
companies.

Chapter 1:- INTRODUCTION

Measured by share of deposits, 83 percent of the banking business in India is in the
hands of state or nationalized banks, which are banks that are owned by the
government, in some, increasingly less clear-cut way. Moreover, even the nonnationalized banks are subject to extensive regulations on who they can lend to, in
addition to the more standard prudential regulations.

Government control over banks has always had its fans, ranging from Lenin to
Ger schenkon. While there are those who have emphasized the political importance
of public control over banking, most arguments for nationalizing banks are based on
the premise that profit maximizing lenders do not necessarily deliver credit where the
social returns are the highest. The Indian government, when nationalizing all the
larger Indian banks in 1969, argued that banking was inspired by a larger social
purpose and must sub serve national priorities and objectives such as rapid growth
in agriculture, small industry and exports.

There is now a body of direct and indirect evidence showing that credit
markets in developing countries often fail to deliver credit where its social product
might be the highest, and both agriculture and small industry are often mentioned as
sectors that do not get their fair share of credit. If nationalization succeeds in pushing

4|Page

credit into these sectors, as the Indian government claimed it would, it could indeed
raise both equity and efficiency.

The cross-country evidence on the impact of bank nationalization is not very

encouraging. For example, La Porte find in a cross-country setting that government
ownership of banks is negatively correlated with both financial development and
economic growth. They interpret this as support for their view, which holds that the
potential benefits of public ownership of banks, and public control over banks more
generally, are swamped by the costs that come from the agency problems it creates:
cronyism, leading to the deliberate misallocation of
Capital, bureaucratic lethargy, leading to less deliberate, but perhaps equally costly
errors in the allocation of capital, as well as inefficiency in the process of mobilizing
savings and transforming them into credit.

Unfortunately the interpretation of this type of cross-country analysis is never

easy, and never more so than the case of something like bank nationalization, which
typically occurs as part of a package of other policies. For example, Bertrand study a
1985 banking deregulation in France, which gave banks much greater freedom to
compete for clients. They find that deregulated banks respond more to profitability
when making lending decisions. After the reform, firms that suffer a negative shock
are much more likely to undertake restructuring measures, and there is more entry
and exit in bank-dependent industries.

Micro studies of the effect of bank nationalization are rare: an important

exception is Main who examines the privatization of a large public bank in Pakistan
in 1991. He finds that the privatized bank does a better job both at choosing
profitable clients and monitoring existing clients, than the commercial banks that
remained public.
This paper builds on the previous work with the aim of using that evidence and
evidence from other research by ourselves and others, to come to an assessment of
the appropriate role of the Indian government vice versa the banking sector.

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1.1 Objectives

To study and analyze of various financial reforms in banking sector during

post liberalization period with respect to public and private sector banks.

To Study the legal and structural and financial status of banking sector prior to
financial reforms period.

To study the changes in banking sector during post financial reform period.

1.2 HYPOTHESIS

The reform measures brought a paradigm shift in the banking industry and
enhanced the overall performance of the banks.

Information technology in banking business has a visible impact on the quality

of customer service.

The performance of public sector banks is not as good as private sector

banks in spite of their age size and image.

The introduction of prudential norms improved the financial health and

credibility of banks.

1.3 Methodology
The study was conducted by the information given by them were directly
recorded on questionnaire. For the purpose of analyzing the data it is necessary to
collect the vital information. There are two types of data, this arePRIMARY DATA: - The data is collected from questionnaire. The questionnaire is
filled from customer through direct interviewing them.
SECONDARY DATA: - Secondary data is collected from magazines, newspaper,
etc. E.g. social networking sites, books, newspaper, etc.

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1.4 Limitations of the study

To understand the importance of banking sector.

To study the Indian bank scenario and its problem.

Long Term and Short Term Finances.

To study the role of bank in Indian Market.

Different types of services provided by the banks.

To study various bank, Corporate and Commercial.

To study the Indian bank scenario and its problem.

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CHAPTER 2
Reforms in Banking Sector

2.1 HISTORY OF BANKING IN INDIA

Banking in India has a very old origin. It started in the Vedic period where
literature shows the giving of loans to others on interest. The interest rates
ranged from two to five percent per month. The payment of debt was
made pious obligation on the heir of the dead person. Modern banking in India
began with the rise of power of the British. To raise the resources for the
attaining the power the East India Company on 2 nd June 1806 promoted the
Bank of Calcutta. In the mean while two other banks Bank of Bombay and
Bank of Madras were started on 15 April 1840and 1July, 1843 respectively. In 1862
the
right
to
issue
the
notes
was
taken
away from the presidency banks. The government also withdrew t
h e nominee directors from these banks. The bank of Bombay collapsed in 1867and
was put under the voluntary liquidation in 1868 and was finally wound up in 1872.
The bank was however able to meet the liability of public in full. A new bank called
new Bank of Bombay was started in 1867.On 27th January 1921 all the three
presidency banks were merged together to form the Imperial Bank by passing
the Imperial Bank of India Act, 1920.The bank did not have the right to issue the
notes but had the permission to manage the clearing house and hold Government
balances. In 1934, Reserve Bank of India came into being which was made the
Central Bank and had power to issue the notes and was also the banker to
the Government. The Imperial Bank was given right to act as the agent of the
Reserve Bank of India and represent the bank where it had no braches. In 1955
by passing the State Bank of India 1955, the Imperial Bank was taken
over and assets were vested in a new bank, the State Bank of India.

Bank Nationalization:
After the independence the major historical event in banking sector was the
nationalization of 14 major banks on 19th July 1969. The nationalization was
deemed as a major step in achieving the socialistic pattern of society.
In1980 six more banks were nationalized taking the total nationalized banks to
twenty.

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STRUTURE OF SCHEDULED COMMERCIAL BANKS

The composition of the board of directors of a scheduled commercial
bank s h a l l c o n s i s t o f w h o l e t i m e c h a i r m a n . S e c t i o n 1 0 A o f t h e
b a n k i n g Regulation Act, 1949 provides that not less than fifty-one per cent, of the
total number of members of the Board of directors of a banking
companyshall consist of persons, who shall have special knowledge or p
racticalexperience in respect of one or more of the matters including accountancy,
agriculture and rural economy, banking, co-operation, economics, finance, law,
small-scale industry, or any other matter the special knowledge of, and practical
experience in, which would, in the opinion of the Reserve Bank, be useful to the
banking
company.
Out
of the
aforesaid
number
ofdirectors, notless than two shall be persons having special knowledge or practicale
xperience in respect of agriculture and rural economy, cooperating or small-scale
industry. Besides the above the board of the scheduled bank shall
consist of the directors representing workmen and officer employees. The
Reserve Bank of India and the Central Government also has right to appoint their
nominees into the board of the banks.

PRESENT SCENARIO OF BANKS IN INDIA

Banks are extremely useful and indispensable in the modern community. The
banks create the purchasing power in the form of bank notes,
cheques b i l l s , d r a f t s e t c , t r a n s f e r s f u n d s b r i n g b o r r o w s a n d l e n d e r
s t o g e t h e r , encourage the habit of saving among people. The banks have
played substantial role in the growth of Indian economy. From the meagre start
in 1860 the banks have come to long way. At presenting India there are 19
nationalized banks, State bank of India and its seven Associate banks, 21 old
private
sector
banks
and
8
new
private
sector
banks.B e s i d e s t h e m t h e r e a r e m o r e t h a n 3 0 f o r e i g n b a n k s e i t h
e r o p e r a t i n g themselves or having their branches in India.

WAVE OF BANKING SECTOR REFORMS IN 1991

In 1991, the country was caught into a deep crisis. The government at
this j u n c t u r e d e c i d e d t o i n t r o d u c e c o m p r e h e n s i v e e c o n o m i c r e f o r m
s t h e banking sector reforms were part of this package. The main objective
of b a n k i n g s e c t o r r e f o r m s w a s t o p r o m o t e a d i v e r s i f i e d , e f f i c i
e n t a n d competitive financial system with the ultimate goal of imp
r o v i n g t h e allocative efficiency of resources through operational flexibility,
improved financial viability and institutional strengthening. Many of the regulatory
and supervisory norms were initiated f irst for the commercial banks
and were later extended to other types of financial intermediaries.
Whilenudgingthe Indian banking system to better health through the introduction of in
ternational best practices in prudential regulation and supervision early in the reform
process,
the
main
idea
was
to
increase
competition
in
the
systemgradually. The reforms have focused on removing financial repressionthroug
9|Page

h reductions in statutory pre-emption, while stepping up prudential regulations

at the same time. Furthermore, interest rates on both deposits and lending of banks
had been progressively deregulated.
In August 1991, the Government appointed a committee under the chairmanship of
M.Narasimham which worked for the liberalization of banking practices.
The aim of this Committee was to bring aboutoperational flexibility and functional a
utonomy so as to enhanceefficiency, productivity and profitability of banks.

CHARACTERISTICS OF BANKING REFORMS

1.Financial sector reform was undertaken early in the reform -cycle
in India.
2.The financial sector was not driven by any crisis and the reforms have
not been an outcome of multilateral aid.
3.The design
and
detail
of the reform were
evolved by
d o m e s t i c expertise, though international experience is always kept in view.

4.The Government preferred that public sector banks manage the

over-hang problems of the past rather than cleanup the balance sheets
with support of the Government.

10 | P a g e

2.2 The Committee submitted its report in November, 1991 and

recommended
1. Reduction in CRR to 8.5 percent and SLR to 25 percent over a period
of about five years.
2. Deregulation of interest rates structure and decreasing the emphasis laid
on directed credit and phasing out the concessional rates of interest to priority
sector.
3. To raise fresh capital through public issue by the profit making banks.
4. Transparency in Balance sheets.
5. Establishment of Special Tribunals to speed up the process of debts
recovery.
6. Establishment of an Assets Reconstruction Fund with special power
of recovery.
7.Bank restructuring through evolving a system of a broad pattern consisting
of 3 or 4 large banks including SBI, 8-10 national Banks engaged in Universal
Banking with a network of branches, local banks confined to a specific region and
RRBs confined to the rural areas engaged in financing of agriculture and allied
activities.
8. Abolishment of branch licensing and leaving the matter of opening and
closing of branches to the commercial judgment of individual banks.
9. Progressive reduction in pre-emptive reserves.
10.Introduction of prudential norms to ensure capital adequacy norms, proper
income recognition, more stringent recognition of NPAs, classification of assets
based on their quality and provisioning against bad and doubtful debts by
constituting the special debt recovery tribunals.
11. Introduction of greater competition by entry of private sector banks and foreign
banks and permitting them to access capital market.
12. Partial deviation from directed lending.
13. Strengthening the supervisory mechanism by creating a separate Board for
Banking and Financial supervision.
14. up gradation of technology through the introduction of computerized system in
banks.
15. Freedom to appoint chief executive and officers of the banks and changes in the
constitutions of the board.
16. Bringing NBFCS under the ambit of regulatory framework.
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The Government also appointed another committee on banking sector r

eforms under the Chairmanship of M. Narasimham which submitted its
report in April 1998. The committee focused on bringing about structural
changes so as to strengthen the foundations of the banking system to make it
more stable.
The major recommendations of Narasimham Committee II were1. In case of capital adequacy, strengthening the banking system through an
increase in the minimum capital adequacy ratio (CRAR) from 8 percent to 10 percent
by 2002, 100 percent of fixed income portfolio marked-to-market by 2001 (up from
70 percent), 5 percent market risk weight for fixed income securities and
open foreign exchange positions limits (no market risks weights previously) and 100
percent commercial risks weight to Government-Guaranteed advances (previously
treated as risk free).
2. To bring down net NPAs below 5 percent by 2000 and to 3 percent
by2002.
Reducing the minimum stipulated holding of the Government or RBI in the equity of
nationalized banks or SBI to 33 percent.
1. Merging financially strong institutions and giving a revival package
to the weak banks.
2. Strengthening the operation of rural financial institutions in terms of
appraisal, supervision and follow-up, loan recovery strategies and development of
bank-client relationships in view of higher NPAs in public sector banks due
to directed lending.
3. Amendment to RBI Act and Banking Regulation Act4.
The Government focused on competition enhancing measures by way of granting
operational autonomy to public sector banks, reduction of public ownership in public
sector banks by allowing them to raise capital from equity market up to 49 percent of
paid-up capital; setting of transparent norms for entry of Indian private sector, foreign
insurance companies, giving permission for foreign investment in thefinancial sector
as portfolio investment, giving permission to banks to diversify product portfolio and
business activities, to prepare a road map for presence of foreign banks and
guidelines for mergers and amalgamation of private sector banks, public sector
banks and NBFCs, and providing guidelines on ownership and governance in private
sectorbanks.Government focused through reform process on enhancing the role of
market forces by making sharp reduction in pre-emption through
reserverequirement, market determined pricing for government securities,disbanding
of administered interest rates with a few exceptions andenhanced transparency and
disclosure norms to facilitate market discipline; introduction of pure inter-bank call
money
market,
auction
basedrepos-reverse repos for shortterm liquidity management, facilitation of improved payments and settlement mechan
ism, and requirement of significant advancement in dematerialization and
markets for security zed assets are being developed.

12 | P a g e

2.3 DISCLOSURE NORMS

Banks should disclose in balance sheets maturity pattern of advances,
deposits, investments and borrowings. Apart from this, banks are also required to
give details of their exposure to foreign currency assets and liabilities and
movement of bad loans. These disclosures were to be made for the year ending
March 2000.
In fact, the banks must be forced to make public the nature of
NPAs being written off. This should be done to ensure that the taxpayers
money given to the banks as capital is not used to write off private
loans without adequate efforts and punishment of defaulters.
# A Close look
For the future, the banks will have to tighten their credit evaluation
process to prevent this scale of sub-standard and loss assets. The present
evaluation process in several banks is burdened with a bureaucratic exercise,
sometimes involving up to 18 different officials, most of whom do not add any value
(information or judgment) to the evaluation. But whether this government and
its successors will continue to play with bank funds remains to be
seen. Perhaps even the
loan
waivers
and
loan
"melas" whichare oftend e c r i e d b y b a n k e r s f o r m o n l y a s m a l l p o r
tion of the total NPAs.
A lot therefore depends upon the seriousness with which a
newr e g i m e o f r e g u l a t i o n i s p u r s u e d b y R B I a n d t h e n e w l y f o r m e d
B o a r d f o r Financial Supervision.

13 | P a g e

2.4 RBI norms for consolidated PSU bank accounts

The Reserve Bank of India (RBI) has moved to get public sector banks to
consolidate their accounts with those of their subsidiaries and other
outf its Where they hold substantial stakes. Towards this end, RBI has set up a
working group recently under its Department of Banking Operations and
Development to come out with necessary guidelines on consolidated accounts for
banks. Those ova is aimed at providing the investor with a better insight into
viewinga bank's performance in totality,including all its branches and subsidi
aries, and not as isolated entities.
According to a banker, earlier subsidiaries were
floatedas external independent entities wherein the accounting details were notincor
porated in the parent bank's balance sheet, but at the same time it was assumed that
the problems will be dealt with by the parent. This will be a path-breaking change
to the existing norms wherein each bank conducts its accounts without taking into
consideration the disclosures of its subsidiaries and other divisions for
disclosure.

Result:
This will require the banks to have a stricter monitoring system of not only their own
bank, but also the other subsidiaries in other sectors like mutual funds, merchant
banking, housing f inance and others. This is all the more important in
the context of the recent announcements made by some major public
sector banks where they have said they would hive off or close down some of
their underperforming subsidiaries.

The Investors Advantage

Getting all these accounts consolidated with that of the parent bank will provide the
investor a better understanding of the banks' performances while deciding on
their exposures. More so, since a number of public sector banks are now
listed entities whose stocks are traded on the stock exchanges.
Some public sector banks are even preparing their accounts in line with US GAAP
norms in anticipation of a US listing. These norms will therefore be in
line with the future plans of these banks as well. The working group was set up
following the need to bring about transparency on the lines of international
norms through better disclosures. These new norms will necessitate not only that
the problems are handled by the parent, but investors are also aware of what exactly
the problems are and how they affect the bottom lines of the parent banks.
Now, under the new guidelines, this will no longer be an external disclosure
to the parent banks' books of accounts.

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2.5 RATIONALISATION OF FOREIGN OPERATIONSIN INDIA

Entry of New Banks in the Private Sector
As per the guidelines for licensing of new banks in the private sector issued in
January 1993, RBI had granted licenses to 10 banks. Based on are view of
experience
gained
on
the
functioning
of
new private
sector
provisions/requirements are listed below: Initial minimum paid-up capital shall be Rs. 200crore; this will be raised to Rs.
300crore within three years of commencement of business.
Promoters contribution shall be a minimum of 40 per cent of the paid -up
capital of the bank at any point of time; their contribution of 40 per cent s hall
be locked in for 5 yea rs f rom the date of licensing of the bank and
excess stake above 40 per cent shall be diluted after one year of
banks operations.
Initial capital other than promoters
through public issue or private placement.

contribution

could

be

raised

While augmenting capital to Rs. 300crore within three years, promoters

need to bring in at least 40 percent of the fresh capital, which will also be
locked in for 5 years. The remaining portion of fresh capital could be raised through
public issue or private placement.
NRI participation in the primary equity of the new bank shall be to the
maximum extent of 40 per cent. In the case of a foreign banking company
or f i n a n c e c o m p a n y ( i n c l u d i n g m u l t i l a t e r a l i n s t i t u t i o n s ) a s a t e c h n i
c a l collaborator or a co-promoter, equity participation shall be limited to 20 per cent
within the 40 per cent ceiling. Shortfall in NRI contribution to
foreigne q u i t y c a n b e m e t t h r o u g h c o n t r i b u t i o n b y d e s i g n a t e d m
u l t i l a t e r a l institutions.
No large industrial house can promote a new bank. Indi vidual companies
connected with large industrial houses can, however, contribute up to 10 per c e n t
of the equity of a new bank, which will maintain an arms
l e n g t h relationship with companies in the promoter group and the indivi
dualcompany/ies investing in equity. No credit facilities shall be extended to
them.
NBFCs with good track record can become banks, subject to specif ied
criteria
A minimum capital adequacy ratio of 10 per cent shall be maintained on a
continuous basis from commencement of operations.
15 | P a g e

Priority sector lending target is 40 per cent of net bank credit, as in the case of
other domestic banks; it is also necessary to open 25 per cent of
the branches in rural/semi-urban areas."Our industry did not oppose the entry of
private bankers because we knew they will not be able to reach out to
the rural markets states, G.M. Bhakey, president of the State Bank of India
Officers Association. "Even after privatisation not more than 10 per cent of the
Indian population can afford to open accounts in private banks."The new
generation
private
sector
banks
have
made
strong
presenceinthe most lucrative business areas i n t h e c o u n t r y b e c a u s e o f t e c h
n o l o g y upgradation. While, their operating expenses have been falling as compared
to the PSU banks, their efficiency ratios (employees productivity and profitability
ratios) have also improved significantly. The new private sector banks have
performed very well in the FY2000.Most of these banks have registered
an increase in net profits of over 50%.
They have been able to make significant inroads in the retail market of
the public sector and the old private sector banks. During the year, the two
leading banks in this sector had set a new trend in the Indian banking sector.
HDFC Bank, as a part of its expansion plans had taken over Times Bank. ICICI
Bank became the first bank in the country to list its shares on NYSE. The Reserve
Bank of India had advised the promoters of these banks to bring their stake to
40% over a time period. As a result, most of these banks hade foreign capital
infusion and some of the other banks have already initiated talks about a
strategic alliance with a foreign partner.
The main problems concerning the nationalized / state sector banks are as follows:
A. Large number of unprofitable branches.
B. Excess staffing of serious magnitude.
C.Non Performing Assets on account of politically directed lending and
industrial recession in last few years.
D. Lack of computerization leading to low service delivery levels, nonreconciliation of accounts, inability to control, misuse and fraud etc.
E.Inabilityto introduces profitable new consumer oriented products like
credit cards, ATMs etc.
The privates edge
TechnologyThe private banks have used technology to provide qu ality service through
lower cost delivery mechanisms. The implementation of new technology has
been going on at very rapid pace in the private sector, while PSU banks are lagging
behind in the race.

16 | P a g e

Declining interest ratesIn the present scenario of declining interest rates, some of the new private banks are
better able to manage the maturity mix.
PSU Banks by and large take relatively long-term deposits at fixed rates
tol e n d f o r w o r k i n g c a p i t a l p u r p o s e s a t v a r i a b l e r a t e s . I t t h e r e
f o r e i s negatively affected when interest rates decline as it takes time to
reduce interest rates on deposits when lending has to be done at lower
interest rates due to competitive pressures.
NPAsThe new banks are growing faster, are more profitable and have cleaner
loans. Reforms among public sector banks are slow, as politician sari reluctant to
surrender their grip over the deployment of huge amounts of public money.

17 | P a g e

2.6 ASSET LIABILITY MANAGEMENT SYSTEM

The critical role of managing risks has now come into the op
e n specially against the experience of the recent East Asian crisis, where markets
fell precipitously because banks and corporate did not accurately measure the risk
spread that should have been reflected in their lending activities. Nor did
they manage such risks or provide for them in their balance sheets.
In
India,
theReserve Bank has recently issued comprehensive guidelines to bank
s for putting in place an asset-liability management system. The emergence
of this concept can be traced to the mid 1970s in the US when
deregulation of the interest rates compelled the banks to undertake active
planning for the structure of the balance sheet. The uncertainty of interest rate
movements gave rise to interest rate risk thereby causing banks to look for
processes
to
manage
their risk. In the
wake of interest rate risk,
came liquidity risk and credit risk as inherent components of risk for
banks. The recognition of these risks brought Asset Liability Management to
the centre-stage of financial intermediation.
The Necessity
The asset-liability management in the Indian banks is still in its nascent
stage. With the freedom obtained through reform process, the Indian banks have
reached greater horizons by exploring new avenues. The government ownership of
most banks resulted in a carefree attitude towards risk management. This
complacent behaviour of banks forced the Reserve Bank to use regulatory
tacticsto ensure the implementation of the ALM. Also, the postreform bankingscenario is marked by interest rate deregulation, entry of new
private banks, and gamut of new products and greater use of information technology.
To cope with these pressures banks were required to evolve strategies rather than
ad hoc fire fighting solutions. Imprudent liquidity management can put banks'
earnings and
Reputation at great risk. These pressures call for structured and comprehensive
measures and not just action. The Management of banks has to base their
business decisions on a dynamic and integrated risk management system and
process, driven by corporate strategy. Banks are exposed to several major risks in
the course of their business - credit risk, interest rate risk, foreign
exchange risk, equity / commodity price risk, liquidity risk and operational
risk.It is, therefore, important that banks introduce effective risk manag
ementsystems that address the issues related to interest rate, currency and
liquidity risks.
Implementation of asset liability management (ALM) system
RBI has issued guidelines regarding ALM by which the banks have to ensure
coverage of at least 60% of their assets and liabilities by Apr 99. This will
provide information on banks position as to whether the bank is long
or short. The banks are expected to cover fully their assets and liabilities by
April2000.
18 | P a g e

ALM framework rests on three pillars.

ALM Organisation:
The ALCO consisting of the banks senior management including CEO should be
responsible for adhering to the limits set by the board as well as for deciding the
business strategy of the bank in line with the banks budget and decided
risk management objectives. ALCO is a decision making unit responsible for balance sheet planning from a risk return p
erspective including strategicm a n a g e m e n t o f i n t e r e s t a n d l i q u i d i t y r i
s k . C o n s i d e r t h e p r o c e d u r e f o r sanctioning a loan. The borrower, who
approaches the bank, is apprised by the credit department on various
parameters
like
industry
prospects,
operationalefficiency, f inancial efficiency, management evaluation and
others which influence the working of the client company. On the basis of this
appraisal the borrower is charged certain rate of interest to cover the credit risk. For
example, a client with credit appraisal AAA will be charged PLR. While somebody
with BBB rating will be charged PLR + 2.5 %, say. Naturally, there will
be certain cut-off for credit appraisal, below which the bank will not lend e.g.
Bank, will not like to lend to D rated client even at a higher rate of interest. The
guide lines for the loan sanctioning procedure are decided in the ALCO
meetings with targets set and goals established.

ALM Information System

ALM Information System is used for the collection of information accurately,
adequately and expeditiously. Information is the key to the ALM process. A
good information system gives the bank management a complete picture of
the bank's balance sheet.

ALM Process
The basic ALM process involves identification, measurement and management of
risk parameters. The RBI in its guidelines has asked Indian banks to
usetraditional techniques like Gap Analysis for monitoring interest rate
andl i q u i d i t y r i s k . H o w e v e r R B I i s e x p e c t i n g I n d i a n b a n k s t o m o v e
t o w a r d s sophisticated techniques like Duration, Simulation, and Vary in the future.
Keeping in view the level of computerisation and the current MIS
in banks, adoption of a uniform ALM System for all banks may not be
feasible. The final guidelines have been formulated to serve as a benchmark
for those banks which lack a formal ALM System.
Banks
that
have already
adopted
moresophisticated systems may continue their existing systems but the
y shouldensure to fine-tune their current information and reporting system so as to
be in line with the ALM System suggested in the Guidelines .

19 | P a g e

2.7 SPECIAL TRIBUNALS AND ASSETRECONSTRUCTION FUND

Setting up of special tribunals to speed up the process of recovery
of loans and setting up of Asset Reconstruction Funds (ARFs) to take over
from banks a portion of their bad and doubtful advances at a discount was one of
the crucial recommendations of the Narasimham Committee.
To expedite adjudication and recovery of debts due to banks andf
inancial institutions (FIs) at the instanc e of the Tiwari Committee
(1984),appointed by the Reserve Bank of India (RBI), the government
enacted the Debt Recovery Tribunal Act, 1993 (DRT). Accordingly, DRTs
and Appellate DRTs have been established at different places in the
country. The act was amended in January 2000 to tackle some problems with
the old act.
DRTs -- a compulsion
One of the main factors responsible for mounting non-performing assets(NPAs) in
the financial sector has been the inability of banks/FIs to enforce the security held by
them on loans gone sour. Prior to the passage of the DRT Act, the only recourse
available to banks/FIs to cover their dues from recalcitrant borrowers, when all
else failed, was to file a suit in a civil court. The result was that by the late 80s,
banks had a huge portfolio of accounts where cases were pending in civil
courts. It was quite common for cases to drag on interminably. In the interim,
borrowers, more often than not, stripped their premises of all assets so that
that by the time the final verdict came, there was nothing left of the security
that had been pledged to the bank.
DRTs, it was felt, would do away with the costly, time-consuming civil court
procedures
that
stymied
recovery
procedures
since
they
follow
a summary procedure that expedites disposal of suits filed by banks/FIs.
Following the passage of the Act in August 1993, DRTs were set up at
Calcutta,
Delhi,B a n g a l o r e , J a i p u r a n d A h m e d a b a d a l o n g w i t h a n A p p e l l a t e
T r i b u n a l a t Mumbai.However, DRTs soon ran into rough weather. The
constitutional validity of the Act itself was questioned. It was only in March
1996, that the Supreme Court modified its earlier order staying the
operation of the Delhi High Court order quashing the constitution of the
DRT for Delhi to allow the setting up of three more DRTs in Chennai,
Guwahati and Patna. Subsequently, many more DRTs and ADRTs have been
set up.
CURRENT STATUS
Unfortunately, as a consequence of the numerous lacunae in the act and the huge
backlog of past cases where suits had been filed, DRTs failed to make a significant
dent. For instance, the tribunals did not have powers of attachment before
judgment, for appointment of receivers or for ordering preservation
of property. Thus, legal infrastructure for the recovery of non-performing loans still
does not exist. The functioning of debt recovery tribunals has been
hampered considerably by litigation in various high courts. Complains Bank of
20 | P a g e

Baroda's Kannan: "Of the Rs 45,000-crore worth of gross NPAs, over Rs

12,000crore is locked up in the courts." So, the only solution to the problem of
high NPAs is ruthless provisioning. Till date, the banking system has provided for
about Rs20, 000crore, which means it is still stuck with net NPAs worth
Rs 25,000 crore. Even that is an under estimate as it does not include advances
covered
byg o v e r n m e n t g u a r a n t e e s , w h i c h h a v e t u r n e d s t i c k y . N o r d o e s i t i
nclude
Allowances for "ever greening"--the practice of extending fresh advances
todefaulting corporates so that the prospective defaulter can make inte
rest payments, thus enabling the asset to escape the non-performing loan tag.
Warns K.R. Maheshwari, 60, Managing Director, Inducing Bank: "NPA levels
are going to go up for all the banks." And so will provisions.
Recent Developments
The recent amendment (Jan 2000) to the DRT Act addresses many of the lacunae
in the original act. It empowers DRTs to attach the property on
the borrower filing a complaint of default. It also empowers the presiding officer to
execute the decree of the official receiver based on the certificate issued by the
DRT. Transfer of cases from one DRT to another has also been made
easier.M o r e r e c e n t l y , t h e S u p r e m e C o u r t h a s r u l e d t h a t t h e D R T A
c t w i l l t a k e precedence over the Companies Act in the recovery of debt, putting to
rest all doubts on that score.
Some More Issues
As things stand, the DRT Act supersedes all acts other than The
Sick Industrial Companies Act (SICA). This means that recovery procedures can
still be stalled by companies declaring themselves sick under SICA. Once the fact
of their sickness has prima facie been accepted by the Board for Industrial
and Financial Reconstruction (BIFR), there is nothing a DRT can do till such time as
the case is disposed of by the BIFR. This lacuna too must be addressed
if DRTs are to live up to their promise. The amendments would ensure speedy
recovery of dues, iron out delay sat the DRT end, as well as ensure that
promoters do not have the time and opportunity to bleed their companies
before they go into winding up.
Yet the number of cases pending before DRTs and courts make a telling
commentary on the inability of lenders to make good their threat. They also
reflect the ability of borrowers to dodge the lenders. The main culprit for all this is the
law. Existing recovery processes in the country are aimed at recovering lenders'
dues after a company has gone sick and not nipping sickness in the bud.
Since sickness is defined in law as the erosion of capital of a company
for three consecutive years, there is little to recover from a sick company after
it has been referred to the Board of Industrial and Financial Revival (BIFR).What's
hurting banks now is the fact that these new issues have cropped up even as they
have been (unsuccessfully) wrestling with their NPAs which, together, tot up
to a staggering Rs 60,000crore. The stratagem of using Debt Recovery
Tribunals has failed.

21 | P a g e

2.8 REDUCTION OF GOVERNMENT STAKE IN PSBS

This is what the finance minister said in his budget speech on February 29,
2000:
"In recent years, RBI has been prescribing prudential norms for banks broadly
consistent with international practice. To meet the minimum capital adequacy
norms
set
by
the
RBI
and
to
enable
thebanks to expand their operations, publicsector banks will need more capital. With the Government budget under sever
e strain, such capital has to be raised from the public which will result in
reduction in government shareholding. To facilitate this process the
Government
has
decided
to
accept
the
recommendations
of
the Narasimham Committee on Banking Sector Reforms for reducing the requi
rement of minimum shareholding by government innationalised banks to 33 pe
r cent. This will be done without changing the public-sector character of banks
and while ensuring that fresh issue of shares is widely held by the public."

Banking is a business and not an extension of government. Banks must be

self-reliant, lean and competitive. The best way to achieve this is to privatise
the banks and make the managements accountable to real shareholder
s. If "privatisation" is a still a dirty word, a good starting point for us is to
restrict government stake to 33 per cent.
During the winter session of the Parliament, on 16 November 2000,
theU n i o n C a b i n e t h a s t a k e n c e r t a i n d e c i s i o n s , w h i c h h a v e f a r
r e a c h i n g consequences for the future of the Indian banking sector cleared
amendment
of the Banking Compan ies (Acquisitions and Transfer of Undertakings)
Act970/1980 for facilitating the dilution of governments equity to 33 percent
Governments action programme has expressed clearly its programme for the
dilution of its stake in bank equity. The Cabinet had taken this de
c i s i o n , immediately on the next day after the bank employees went on strike, is a
clear indication of Government of Indias determination to amend the
concerned Acts, to pave the way for the reduction in its stake. The proposal
had
been
tor e d u c e t h e m i n i m u m s h a r e h o l d i n g f r o m 5 1 p e r c e n t t o 3 3 p e r c e
n t , w i t h adequate safeguards for ensuring its control on the operations of
the
banks.
However, it is not willing to give away the management control in
t h e nationalised banks. As a result public sector banks may find it very difficult to
attract strategic investors.
22 | P a g e

SALIENT FEATURES of the proposed amendments

Government would retain its control over the banks by stipulating that the
Voting rights of any investor would be restricted to one perce
n t , irrespective of the equity holdings.
T h e g o v e r n m e n t w o u l d c o n t i n u e t o h a v e t h e Prerogative of the
appointment of the chief executives and the directors of the
nationalised banks. There has been considerable delay in the past in filling
up the posts of the chairman and executive director of some banks. It is not clear
as to how this aspect would be taken care of in future. It is said that the proposed
amendment to the Act would also give the board of banks greater autonomy and
flexibility.
I t h a s b e e n d e c i d e d t o Discontinue the mandatory practice of
nominating the representatives of the government of India and the Reserve
Bank in the boards of nationalised banks. This decision is in tune with the
recommendation of Narasimham committee. However, the government would retain
the right to nominate its representative in the boards and strangely
nominee of the government can be in more than one bank
Af ter the amendment.
The number of whole time directors w ould be raised to four as
against the present position of two, the chairman and managing
director and the executive director.
While conceptually it is desirable to decentralise power, operationally it may be
difficult to share power at peer level. In quite a few cases, it was observed that inter
personal relations were not cordial among the two at the top. It has to be seen as to
how the four full time directors would function in unison.
It is proposed to amend the
provisions in the
Banking Companies
(Acquisition and Transfer of Undertakings) Act to enable the
bank shareholders to discuss, adopt and approve the annual accounts and
adopt the same at the annual general meetings. Paid-up capital of nationalised
banks can now fall below 25 per cent of the authorised capital.
Amendment will also enable the setting up of bank -specific Financial
Restructuring Authority (FRA). Authority will be empowered to take over the
management of the weak banks. Members of FRA will comprise of experts
from various fields & will be appointed by the government; on the advice
of Reserve Bank of India.
The measures seen in totality are clearly aimed at enabling banks to
access the capital markets and raise funds for their operations. The Government
seems to have no plans to reduce its control over these banks. The Act will
also permit it to transfer its stake if the need arises, apart from granting
banks the freedom to restructure their equity.
23 | P a g e

2.9 DEREGULATION ON INTEREST RATES

The interest rate regime has also undergone a significant change.
For long, an administered structure of interest rate has been in vogue in India.
The1998 Narasimham Reforms suggested deregulation of interest rates on
term deposits beyond a period of 15 days. At present, the Reserve Bank
prescribes only two lending rates for small borrowers. Banks are free to
determine the interest rate on deposits and lending rates on all landings above
Rs. 200,000.
In the last couple of years there has been a clear downward trend in
interest rates. Initially lending rates came down, leading to a decline in yield
son advances and investments.
Interest rates in the banking system have been liberalised v
e r y substantially compared to the situation prevailing before 1991, whe
n theReserve Bank of India controlled the rates payable on deposits of
different maturities. The rationale for liberalising interest rates in the banking
system was to allow banks greater flexibility and encourage competition. Banks were
able to vary rates charged to borrowers according to their cost of funds and
also to reflect the credit worthiness of different borrowers.
With effect from October 97 interest rates on all time deposits, including15-day
deposits, have been freed. Only the rate on savings deposits remains
controlled by RBI. Lending rates were similarly freed in a series of steps. The
Reserve Bank now directly controls only the interest rate charged for export
credit, which accounts for about 10% of commercial advances. Interest rates on time
deposits were decontrolled in a sequence of steps beginning with longer-term
deposits and the liberalisation was progressively extended to deposits
of shorter maturity.
Interest rates on loans up to Rs 2,00,000, which account for 25% of total
advances, is not f ixed at a level set by the RBI, but is now aligned with
the Prime Lending Rate (PLR) which is determined by the boards of
individual Banks.
Earlier interest rates on loans below Rs 2,00,000 were fixed at a highly
concessional level. The new arrangement sets a ceiling on these rates at the
PLR, which reduces the degree of concessionality but does not eliminate it. Co
operative Banks were freed from all controls on lending rates in 1996 and
this freedom was extended to Regional Rural Banks and private local
area banks in 1997. RBI also considers removal of existing controls on lending rates
in other Commercial Banks as the Indian economy gets used to higher interest rate
regime on shorter loan duration.
The line to control is the cost of funds, since the markets determine asset yields.
The opportunity to improve yields on the corporate side tends to be
limited if banks dont want to increase the risk profile of the portfolio. Banks income
24 | P a g e

will depend on the interest rate structure and the pricing policy for the deposits and
the credit. With the deregulation of the interest rates banks are given the
freedom to price their assets and liabilities effectively and also plan for a
proper maturity pattern to avoid asset-liability mismatches. Nevertheless, with the
increase in the number of players, competition for the funds and the other
banking services rose.
The consequential impact is being felt on the income profile of the banks
especially
due
to
the
fact
that
the
interest
incomecomponent of the total income is significantly larger than the no
n-interestincome component. As far as the interest costs are concerned, the
prevailing interest rate structure will be a major deciding factor for the rates.
But what influences both the interest costs and the intermediation costs is the time
factor as it is directly related to costs. The solution for these two influencing
factors lies predominantly on technology. In this regard, the new private banks and
the foreign banks, which are equipped with the latest technology, have a better edge
over the nationalized banks, which are yet to be automated at the branch level.

25 | P a g e

2.10 Income and Expenses Profile of Banks

Interest Income
Interest/discount on advances/bills
Interest on investments
Interest on balances with RBI and other interbank funds
Others
Interest Expenses
Interest on deposits
Interest on Refinance/interbank borrowings
Others

Other Income
Commission, Exchange and Brokerage
Profit on sale of investments
Profit on revaluation of investments
Profit on sale of land, building and other assets
Profit on exchange transactions
Income earned by way of dividends, etc.
Miscellaneous

Operating Expenses
Payments to and provisions for employees
Rent, taxes and lighting
Printing and stationery
Advertisement and publicity
Depreciation on Banks property
Director/Auditors fees and expenses
Law charges, Postage, etc.
Repairs and Maintenance,
Insurance.
Other expenses

26 | P a g e

2.11 VOLUNTARY RETIREMENT SCHEMES

Public Sector Banks which together (there are 27 of them) account for 77.34
per cent of the bank deposits in India. The most ambitious downsizing
exercise undertaken by the PSBs has set them back by close to Rs 7,490crore.
Voluntary Retirement Scheme in Banks was formally taken up by the
Government in November 1999. According to Finance Ministry on the basis
of business per employee (BPE) of Rs. 100 lakhs, there were 59,338 ex
cessemployees in 12 nationalised banks, while based on a BPE of Rs. 125lakhs,
the number shot up to 1, 77,405.
Government had cleared a uniform VRS for the banking sector, giving public
sector banks a seven-month time frame. The IBA has been allowed to
circulate the scheme among the public sector banks for adoption. The
scheme was to remain open till March 31, 2001. It would become
operational after adoption by the respective bank board of directors. No
concession had been made to weak banks under the scheme. The scheme is
envisaged to assist banks in their efforts to optimise use of human resource
and achieve a balanced age and skills profile in tune with their business
strategies.
As per estimates the average outgo per employee under the banking VRS s c h e m e
would range between Rs. 3lakhs and Rs. 4lakhs. However, the
aggregate burden on the banking industry is difficult to work out. To minimise the
immediate impact on banks, the scheme has allowed them the stagger
the payments in two instalments, with a minimum of 50 per cent of the amount to be
paid in cash immediately. The remaining payment can be paid within six
months either in cash or in the form of bonds. The total burden of the VRS on the
banking industry is about Rs 8,000crore, and union activists feel that it will adversely
affect the profitability and capital adequacy of the banks. In fact, out of this Rs8,
000crore, nearly Rs 2,200crore will be borne by State Bank of India, the
largest public sector bank.
Salient Features of Voluntary Retirement Scheme of Banks

Eligibility
All permanent employees with 15 years of service or 40 years of age are eligible.
Employees not eligible for this scheme include:
Specialists officers/employees, who have executed service bond sand have
not completed
it,
employees/officers
serving
abroad
under special
arrangements/bonds, will not be eligible for VRS. The Directors may however waive
this, subject to fulfilment of the bond & other requirements.

27 | P a g e

 Employees against whom Disciplinary Proceedings arecontemplated/pending

or are under suspension.
Employees appointed on contract basis.
Any other category of employees as may be specified by the Board.

Amount of Ex-gratia
60 days salary (pay plus stagnation increments plus special allowance plus
dearness relief) for each completed year of service or the salary for the number of
months service is left, whichever is less.

Other Benefits
Gratuity as per Gratuity Act/Service Gratuity, as the case maybe.
Pensions (including commuted value of pension)/bank
s contribution towards PF, as the case may be.
Leave encashment as per rules.

Other Features
It will be the prerogative of the banks management either to accept a request for
VRS or to reject the same depending upon the requirement of the bank.
Care will have to be taken to ensure that highly skilled and qualified workers and
staff are not given the option.
There will be no recruitment against vacancies arising due to VRS.
Before introducing VRS banks must complete their manpower planning and identify
the number of officers/employees who can be considered under the scheme.
Sanction of VRS and any new recruitment should only be in accordance with the
manpower plan.

Funding of the Scheme

Coinciding with their financial position and cash flow, banks may decide payment
partly in cash and partly in bonds or in instalments, but minimum 50 percent of the
cash instantly and in remaining 50 percent after a stipulated period. Funding of the
scheme will be made by the banks themselves either from their own funds or by
taking loans from other banks/financialinstitutions or any other source.

Periodicity
The scheme may be kept open up to 31.3.2001

28 | P a g e

Sabbatical
A n e m p l o y e e / o f f i c e r w h o m a y n o t b e i n t e r e s t e d t o t a k e voluntary
retirement immediately can avail the facility of sabbatical for five years, which can be
further extended by another term of five year. After the period of sabbatical is over
he may re-join the bank on the same post and at the same stage of pay where he
was at the time of taking sabbatical. The period of sabbatical will not be
considered for increments or qualifying service for person, leave, etc.
Current Status
The VRS, as on July 2001, which bankers rushed to grab, has become a drag on the
bottom line of the State-owned banking segment.
Heavy provisioning made towards VRS has pushed the combined net profit
of PSU banks down 16 per cent to Rs 4,315.70crore in 2000-01, from Rs
5,116crore in the previous year.
In the banking sector close to 1, 26,000 employees opted for the VRS in00-01.
The total benefits received by these employees has been close to
Rs15, 000crore

29 | P a g e

2.12Quality of Intermediation
Under-lending.
Identifying under-lending
A firm is getting too little credit if the marginal product of capital in the firm is higher
than the rate of interest the firm is paying on its marginal rupee of borrowing. Underlending therefore is a characteristic of the entire financial system: the firm has not
been able to raise enough capital from the market as a whole. In other words, while
we will focus on the clients of a public sector bank, if these firms are getting too little
credit from that bank, they should in theory have the option of going elsewhere for
more credit. If they do not or cannot exercise this option, the market cannot be doing
what, in its idealized form, we would have expected it to do. However, we know that
the Indian financial system does not function as the ideal credit market might. Most
small or medium firms have a relationship with one bank, which they have built up
over some timethey cannot expect to walk into another bank and get as much credit
as they want. For that reason, their ability to finance investments they need to make
does depend on the willingness of that one bank to finance them. In this sense the
results we report below might very well reflect the specificities of the public sector
banks, or even the one bank that was kind enough to share its data with us, though
given that it is seen as one of the best public sector banks, it seems unlikely that we
would find much better results in other banks in its category. On the other hand we
do not have comparable data from any private bank and therefore cannot tell
whether under-lending is as much of a problem for private banks. We will, however,
later report some results on the relative performance of public and private banks in
terms of overall credit delivery.

Our identification of credit constrained firms is based on the following simple

observation: if a firm that is not credit constrained is offered some extra credit at a
rate below what it is paying on the market, then the best way to make use of the new
loan must be to pay down the firms current market borrowing, rather than to invest
more. This is because, by the definition of not being credit constrained, any
additional investment will drive the marginal product of capital below what the firm is
30 | P a g e

paying on its market borrowing. It follows that a firm that is not facing any credit
constraint will expand its investment in response to additional subsidized credit
becoming available, only if it has no more market borrowing. By contrast, a firm that
is credit constrained will always expand its investment to some extent.
A corollary to this prediction is that for unconstrained firms, growth in revenue should
be slower than the growth in subsidized credit. This is a direct consequence of the
fact that firms are substituting subsidized credit for market borrowing. Therefore, if
we do not see a gap in these growth rates, the firm must be credit constrained. Of
course, revenue could increase slower than credit even for non-constrained firms, if
the technology has declining marginal return to capital.

The evidence for under-lending

Data: The data we use were obtained from one of the better-performing Indian public
sector banks. We use data from the loan folders maintained by the bank on profit,
sales, credit lines and utilization, and interest rates. The loan folders also report all
numbers that the banker was required to calculate (e.g. his projection of the banks
future turnover, his calculation of the banks credit needs, etc.) in order to determine
the amount to be lent. We also record these, and will make use of them in the
analysis described in the next section. We have data on 253 firms (including 93
newly eligible firms). The data is available for the entire 1997 to 1999 period for 175
of these firms.
Specification Through much of this section we will estimate an equation of the form
with y taking the role of the various outcomes of interest (credit, revenue, profits,
etc.) and the dummy POST representing the post January 1998 period. We are in
effect comparing how the outcomes change for the big firms after 1998, with how
they change for the small firms. Since y is always a growth rate, this is, in effect, a
triple differencewe can allow small firms and big firms to have different rates of
growth, and the rate of growth to differ from year to year, but we assume that there
would have been no differential changes in the rate of growth of small and large
firms in 1998, absent the change in the priority sector regulation.

31 | P a g e

Using, respectively, the log of the credit limit and the log of next years sales (or
profit) in place of y in equation 1, we obtain the first stage and the reduced form of a
regression of sales on credit, using the interaction BIG POST as an instrument for
credit. We will present the corresponding instrumental variable regressions.

Results: The change in the regulation certainly had an impact on who got priority
sector credit. The credit limit granted to firms below Rs. 6.5 million in plant and
machinery (henceforth, small firms) grew by 11.1 percent during 1999, while that
granted to firms between Rs.6.5 million and Rs. 30 million (henceforth, big firms),
grew by 5.4 percent. In 2002, after the change in rules, small firms had 7.6 percent
growth while the big firms had 11.3 percent growth. In 2005, both big and small firms
had about the same growth.

Bank Ownership and Sectoral Allocation of Credit

As mentioned above, an important rationale for the Indian bank nationalizations was
to direct credit towards sectors the government thought were underserved, including
small scale industry, as well as agriculture and backward areas. Ownership was not
the only means of directing credit: the Reserve Bank of India issued guidelines in
1974, indicating that both public and private sector banks must provide at least onethird of their aggregate advances to the priority sector by March 1979. In 1980, it was
announced that this quota would be increased to 40percent by March 1985. Subtargets were also specified for lending to agriculture and weaker sectors within the
priority sector. Since public and private banks faced the same regulation, in this
section we focus on how ownership affected credit allocation. The comparison of
nationalized and private banks is never easy: banks that fail are often merged with
32 | P a g e

healthy nationalized banks, which makes the comparison of nationalized banks and
non-nationalized banks close to meaningless. The Indian nationalization experience
of 1980 represents a unique chance to learn about the relationship between bank
ownership and bank lending behaviour. The 1980 nationalization took place
according to a strict policy rule: all private banks whose deposits were above certain
cut off were nationalized.18 After 1980, the nationalized banks remained corporate
entities, retaining most of their staff, though the board of directors was replaced by
nominees of the Government of India. Both the banks that got nationalized under this
rule and the banks that missed being nationalized, continued to operate in the same
environment, and face the same regulations and therefore ought to be directly
comparable.
Even this comparison between banks just nationalized and just not nationalized may
be invalid, because policy rule means that banks nationalized in 1980 are larger than
the banks that remained private. The differences between the nationalized and
private banks seem to have decreased over time: in the 2005 data, the point
estimate on agricultural lending drops from 8 to 5 points, on rural lending from 7 to 3
points, and on trade and transport and finance from -11 to -6 percentage points.

In sum, bank ownership does seem to have had a limited impact on the
governments ability to direct credit to specific sectors. Through the early 1990s, the
credit environment in India was very tightly regulated. The government set interest
rates, required both public and private banks to issue 40 percent of credit to the
priority sector, and to meet specific sub-targets within the priority sector.
Nevertheless, banks controlled by the government provided substantially more credit
to agriculture, rural areas, and the government, at the expense of credit to trade,
transport, and finance. Though, surprisingly, there was no effect on credit to small
scale industry. Lending differences shrunk over the 1990s, and in 2000 were about
half of what they were in the early 1990s. This might reflect the increasing dynamism
of the private sector banks in the liberalized environment of the 1990s or the
loosening grip of the government on the nationalized banks.

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Bank Ownership and Speed of Financial Development

To determine whether public ownership of banks inhibits financial intermediation, we
again compare banks just above and just below the 1980 nationalization cut-off,
using data from the Reserve Bank of India, for the period 1969 to 2000. We include
the six above, which were nationalized, and the nine largest below, which were not.
Since we have data from both the pre and post period, we adopt a difference-indifferences approach. Specifically, we regress the annual change in bank deposits,
credit, and number of bank branches on a dummy for post nationalization (Post=1 if
year (1980 1991)), and a dummy for post-nationalization in a liberalized
environment (Nineteen = 1 if year (1992 2000)). We break the post-nationalization
analysis up into two periods (1980-1991 and 1991-2000) because the former period
was characterized by continued financial repression, while substantial liberalization
measures were implemented in the beginning of the 1990s. Public and private banks
could well behave differently before and after liberalization.

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2.13Bank Ownership and the Quality of Intermediation

Limitations on Public Sector Banks

Official Lending Policies
While public sector banks in India are nominally independent entities, they are
subject to intense regulation by the Reserve Bank of India (RBI). This includes rules
about how much a bank should lend to individual borrowersthe so-called maximum
permissible bank finance. Until 1997, the rule was based on the working capital gap,
defined as the difference between the current assets of the firm and its total current
liabilities excluding bank finance (other current liabilities). The presumption is that the
current assets are illiquid in the very short run and therefore the firm needs to
finance them. Trade credit is one source of finance, and what the firm cannot finance
in this way constitutes the working capital gap. Firms were supposed to cover a part
of this financing need, corresponding to no less than 25 percent of the current
assets, from equity. The maximum permissible bank finance under this method was
thus:
CURRENT ASSETS OTHER CURRENT LIABILITIES

The sum of all loans from the banking system was supposed not to exceed this
amount. This definition of the maximum permissible bank finance applied to loans
above Rs. 20 million. For loans below Rs.20 million, banks were supposed to
calculate the limit based on the projected turnover of the firm. Projected turnover was
to be determined by a loan officer in consultation with the client. The firms financing
need was estimated to be 25 percent of the projected turnover and the bank was
allowed to finance up to 80 percent of what the firm needs, i.e. up to 20 percent of
the firms projected turnover. The rest, amounting to at least 5 percent of the
projected turnover has again to be financed by long term resources available to the
firm. In the middle of 1997, following the recommendation of the committee on
financing of the small scale industries (the Nyack committee), the RBI decided to
give each bank the flexibility to evolve its own lending policy, under the condition that
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it be made explicit. Moreover the Nyack committee recommended that the turnover
rule be used to calculate the lending limit for all loans under Rs. 40 millions.
Given the freedom to choose the rule, different banks went for slightly different
strategies. The bank we studied adopted a policy which was, in effect, a mix
between the now recommended turnover-based rule and the older rule based on the
firms asset position. First the limit on turnover basis was calculated as: min(0.20
Projected turnover, 0.25 Projected turnover available margin)
The available margin here is the financing available to the firm from long term
sources (such as equity), and is calculated as Current Assets Current Liabilities
from the current balance sheet. In other words the presumption is that the firm has
somehow managed to finance this gap in the current period and therefore should be
able to do so in the future. Therefore the bank only needs to finance the remaining
amount. Note that if the firm had previously managed to get the bank to follow the
turnover based rule exactly, its available margin would be precisely 5 percent of
turnover and the two amounts in 6 would be equal.
In India the venture capital industry is still nascent and it will be a while before it can
play the role that we expect of its US equivalent. Therefore banks may have to be
more pro-active in promoting promising firms. Following a rule that does not put any
weight on profits may not be the way to favour the most promising firms: while the
projected turnover calculation does favour faster growing firms, the loan officer is not
allowed to project a growth rate greater than 15 percent. This may be enough to
meet the needs of a mature firm, but a small firm that is growing fast clearly needs
much more than 15 percent. It is important that the rules encourage the loan officers
to lend more to companies on the basis of promise.

Actual Lending Policy

The lending policy statements give us the outside limits on what the banks can lend.
There is nothing in the policies that stops them from lending less, though bankers
are always enjoined to lend as much as possible in official documents.24 It is also
possible, given that it is not clear how these rules are enforced, that the banks
sometimes exceed the limitsit is, for example, often alleged that loan officers in
public sector banks give out irresponsibly large loans to their friends and business

36 | P a g e

associates. It is not even clear how one would necessarily know that banker had lent
too much given that he is given the task of estimating expected turnover.
Further, this is the case despite the fact that according to the banks own rules, the
limit could have gone up in 64 percent of the cases (note that getting a higher limit is
simply an option and does not cost the firm anything unless it uses the money).
Finally, this tendency seems to become more pronounced over time: in 1999, the
limit was equal to the previous granted limit 53 percent of the time. In 2001, it did not
change in 70 percent of the cases.

It is also conceivable that it is rational to ignore profit information in lending, if

the projected turnover calculated by the bank and included in the calculation of LTB,
already takes into account any useful information contained in the profits. To
examine this we looked at whether current profitability has any role in predicting
future profitability, delay in repayment and actual default, once we control for the
variables that seem to determine the level of lendingpast loans, LTB, LWC. As
reported in Bannered and Duffle, current profit is a good predictor of future profit, and
the variables that the bank uses (past loans, etc.) are not: the only good predictor of
future negative profit is current negative profit. Negative profits, in turn predict
default, while past loans, LTB and LWC do not.

This sub-section suggests an extremely simple prima facie explanation of why many
firms in India seem to be starved of credit. The nationalized banks, or at least the
one we study (but again, this is one of the best public banks) seem to be remarkably
reluctant to make fresh lending decisions: in two-thirds of the cases, there is no
change in the nominal loan amount from year to year. While the rules for lending are
indeed fairly rigid, this inertia seems to go substantially beyond what the rules
dictate. Moreover the deviations from the rules do not seem to reflect informed
judgments, but rather a desire to do as little as possible.
Moreover, when they do take a decision to make a fresh loan the beneficiaries tend
to be firms whose turnover is growing, irrespective of profitability. This indifference to
profitability is entirely consistent with the rules that bankers work with: none of the
many calculations that bankers are supposed to do before they decide on the loan
amount pay even lip service to the need to identify the most profitable borrowers. Yet
37 | P a g e

current profits do a much better job of predicting future losses and therefore future
defaults, than the variables that do seem to influence the lending decision. In other
words, it seems plausible that a banker who made better use of profit information
would do a better job at avoiding defaults. Moreover, he might do a better job of
identifying the firms where the marginal product of capital is the highest. Lending
based on turnover, by contrast, may skew the lending process towards firms that
have been able to finance growth out of internal resources and therefore do not need
the capital nearly as much.

Need of under-lending.
Given that the rules for lending are quite rigid and largely indifferent to profitability, it
is perhaps not surprising that there are opportunities for profitable investment that
have not yet been exploited. What is surprising is that to the extent that there are
deviations from the rules, they tend to be in the direction of lending less.

One plausible reason for why this happens is that the loan officers in these banks
have no particular incentive to lend. They are government employees on a more or
less fixed salary and promotion schedule and the rewards are at best weakly tied to
their success in making imaginative lending decisions. On the other hand, failed
loans, as discussed below, can lead to investigations by the Central Vigilance
Commission, which is the body entrusted to investigate potential cases of fraud in
the public sector. They therefore have a lot to lose and little to gain from being brave
in lending. Not taking any new decisions may dominate any other course of action
and moreover, this is especially likely to be true if there are attractive alternatives to
lending (such as putting your money in government bonds). The next sub-section
examines the role that the fear of prosecution plays in discouraging lending. The
following sub-section asks whether the reluctance to lend is exacerbated when the
rewards from putting money in government bonds become relatively more attractive.

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Inertia and the fear of prosecution

Since public sector banks are owned by the government, employees of the bank are
treated by law as public servants, and thus subject to government anti-corruption
legislation. There is an impression among bankers that it is very easy to be charged
with corruption, and that the law states that if any government functionary takes a
decision which results in direct financial gain to a third party, the individual is prima
facie guilty of corruption, and must prove her or his innocence.
The executive director of a large public sector bank was quoted saying Fear of
prosecution for corruption hangs over every loan officers head like the sword of
Damocles. The Economic Times of India has attributed slowdowns in lending
directly to vigilance activity working group on banking policy set up by the Reserve
Bank of India, and chaired by M.S.Verma, noted:
The [working group] observed that it has received representations from the
managements and the unions of the banks complaining about the diffidence in taking
credit decisions with which the banks are beset at present. This is due to
investigations by outside agencies on the accountability of staff in respect of some of
the Non Performing Assets. The group also noticed a marked reluctance at various
levels to take any credit decision.

In response to criticism from bankers, economists, and others, the Central Vigilance
Commission (henceforth CVC), which is the body entrusted to investigate potential
cases of fraud in the public sector, introduced in 1999 a special chapter of the
vigilance manual, on vigilance in public sector banks. While this new chapter was
meant to reassure bankers, the language would probably not reassure anyone with
experience working in a western bank. The manual reads, for example, that every
loss caused to the organization, either in pecuniary or non-pecuniary terms, need not
necessarily become the subject matter of a vigilance inquiry once a vigilance angle is
evident, it becomes necessary to determine through an impartial investigation as to
what went wrong and who is accountable for the same.

Interviews with public sector bankers revealed widespread concern: the legal
proceedings surrounding charges of corruption can drag on for years, leaving

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individuals charged with corruption in an uncertain state. Even if an individual is

exonerated, she may have been relieved of her duties, transferred, or passed over
for promotion during the time of investigation. In theory (as well as practice), even
one loan gone badly may be sufficient to start vigilance proceedings. The possible
penalties stand in stark contrast to rewards. While banks are constantly urged by the
Reserve Bank of India to lend as much as possible, there are no explicit incentives
for making good loans, or ways to penalize officers who make conservative
decisions. In effect, bankers are accountable to more than one authority the loan
officers boss is one of them but central vigilance may be another, and the press may
be yet another. In such circumstances, it may be very difficult to provide effective
incentives. If this were the case, loan officers would prefer not to take new decisions.
Simply renewing the loan without changing the amount is one easy way to avoid
responsibility, especially if the original decision was someone elses (loan officers
are frequently transferred) and when they do take a decision, making sure that they
did not deviate enormously from the precedent, is a way of covering themselves
against charges of wrong-doing or worse.

Lending to the government and the easy life

Lending to the government is the natural alternative to lending to firms and offers the
loan officers a secure vehicle for their money, with none of the legwork and
headaches associated with lending to firms. The ideal way to measure how
important high interest rates on government bonds might be in explaining underlending, would be to estimate the elasticity of bank lending to the private sector with
respect to the interest rate on government securities or the spread between the
interest rate on private loans and the interest rate on government securities. The
problem is that the part of the variation that comes from changes in the rate paid by
the government is the same for all banks and therefore is indistinguishable from any
other time varying effect on lending. The part that comes from the rates charged by
the banks does vary by bank, but cannot possibly be independent of demand
conditions in the bank and other unobserved time varying bank specific factors. One
cannot therefore hope to estimate the true elasticity of lending by regressing loans
on the spread.

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Our strategy is to focus on a more limited question which we may hope to answer
somewhat more convincingly: are banks more responsive to the central bank interest
rates in slow growing environments. We start by identifying the banks that are
particularly likely to be heavily invested in the easy life. These are banks that, for
historical reasons, have most of their branches in the states that are currently
growing slower than the rest. Our hypothesis is that it is these banks that have a
particularly strong reason to invest heavily in government securities, since in a slowgrowing environment it is harder to identify really promising clients. They also
probably have more marginal loans that they are willing to cut and reduce (or not
increase) when the interest rates paid to government bonds increases. It is therefore
these banks that should be particularly responsive to changes in the interest rate
paid by the government.

Data: The outcome we focus on is the in (Credit/Deposit Ratio), at the end of March
of each year, for 25 public sector and 20 private sector banks. Two minor public
sector banks were excluded due to lack of data, while the new private sector banks
were excluded for reasons of comparability. The data are from the Reserve Bank of
India.

Conclusion: The evidence seems to be consistent with the view that banks are
especially inclined towards the easy life in states where lending is hard. This
suggests that the opportunity for lending to the government tends to hurt the firms
that are relatively marginal from the point of view of the banks, such as firms in slow
growing states and smaller and less established firms.

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2.14 Commercial Bank Performances

Performance of commercial banks in India has been under policy and
academic spotlight for a while now with the public sector bank performance receiving
most attention. The performance of several public sector banks (PSBs) has been so
poor that many have called for a complete overhaul of these banks and privatization
as a solution.

Performance evaluation of banks, particularly in an economy that is

dominated by public sector banks that are not driven purely by profit motive, is not a
simple task. Profitability as the sole measure of performance is disputed by many
and several measures of efficiency, some with less than unequivocal support from
experts, have been used in the literature. This includes spread analysis and the Data
Envelopment Analysis (DEA) of banks. Here we take a look at a few of these
measures to evaluate the performance of banks in the post-reforms era.
DSouza (2005) provides an overview of the performance of the different groups of
banks during the decade of the 90s. We begin with Figure that focuses on
profitability as a proportion of working funds. It is evident from this figure that with the
exception of 1994-99, foreign banks are the most profitable bank category in India,
followed by private banks. Public banks are the worst, though their performance in
the second half of the decade with some of the reform measures becoming more
effective, appear to have improved and they seem to be closing the gap with their
smaller and more profitable competitors.

The emerging structure of commercial banking

The years since the beginning of liberalization have brought about significant
changes in the structure and character of the Indian banking sector. The most visible
change is perhaps the emergence of new private sector banks as well as the entry of
several new foreign banks. The spirit of competition and the emphasis on profitability
are gradually but doubtlessly pushing the public sector banks towards a more profitoriented model departing from the socialistic approach followed for decades.

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A clear effect of these changes has been a reduction in the concentration in

the banking industry. Coeval (2003) points out that the findable indices for assets,
loans and deposits all show a notable decline during the period. Between 1991-1992
and 2000-2001 the findable index for advances dropped by over 28% while those for
assets fell by about 20%. Over the period, SBI, the largest Indian bank, witnessed a
decline in asset market share from 28% to 24% while its loan market share dropped
from 27% to 22%. The deposit share, on the other hand, stayed pretty much the
same at 23%. The asset, loan and deposit shares of the top 10 banks all fell from
close to 70% to below 60%. Clearly, the banking sector in India has become more
competitive since liberalization.

In general it seems that the emergence of the new private banks as well as the
increased participation of foreign banks has increased professionalism in the
banking sector. However the collapse of the Global Trust Bank in mid-2004 has
dented the public impression about the efficiency of these banks as well as the
monitoring abilities of the regulators.

Several foreign banks have entered the Indian market since liberalization. On March
2003, there were 36 foreign banks operating in India including 11 from Europe, 6
each from the Middle East, North America and East Asia (excluding Japan) and 4
from Japan. Foreign banks tend to perform better than domestic banks in most
emerging markets and add to operative efficiency of the banking sector as a whole.

Banks are different from other enterprises in that they directly affect thousands, if not
millions, of depositors and play a crucial role in economic growth. Privatization of
public sector banks has its own risks and it is not clear that the expected benefits
necessarily justify assuming those risks. Perhaps bringing more transparency in
public sector banking decisions and subjecting these banks to competitive pressures
will accomplish the improvements in their performance rather than selling them lock,
stock and barrel to private parties.

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2.15 Some Final Issues: Rural Branches, NPAs and Bailouts.

We conclude our study by examining two final arguments given in favour of public
ownership of banks: that public banks are more willing to expand into rural areas,
and that public banks are less likely to fail, and therefore cost the government (or
public) less than private banks.

Branch Expansion in Rural Areas

As mentioned in the introduction, in 1977 the government passed a regulation which
required both public and private banks to open four branches in unbanked locations
for every branch they opened in banked locations. This regulation was repealed in
1990, though the Reserve Bank of India still maintained some authority of bank
branch openings. Burgess and Paned study the impact of this regulation over the
period 1977-1990.38 They find that a 1 percent increase in the number of rural
banked locations, per capita, resulted in a .42 percent decline in poverty, and a .34
percent increase in total output. Cole uses the empirical strategy described in
Section 5 to study the impact of bank nationalization. On rural bank growth.39 He
shows that between 1980 and 2000 there was a substantial drop in the growth rate
of rural branches, of the order of twenty percent. The nationalized banks in our
sample experienced an even sharper decrease, with rural branch growth rates 6.6
percent and 8.6 percent slower their private counterparts in the 1980s and 1990s.

Non-Performing Assets and Bailouts

Mounting Non-Performing Assets (NPAs) and resulting questions about the ability of
the banks with high levels of NPA to honour their liabilities to their depositors has
been an important concern in the 1990s.

Recent RBI figures suggest that public sector banks have substantially higher levels
of nonperforming assets than private banks. For example, for the year ending in
March 2003, gross NPAs represented 4.6 percent of public sector banks total assets,
compared to 4.3 percent of old private sector banks, and 3.7 percent of new private
45 | P a g e

sector banks. However it is not clear how well these numbers represent the true
situation in these banks. There is some scepticism about the accuracy of reported
NPA numbers: banks may engage in creative accounting or ever greening, and the
current classification norms mapping loan repayment delay to NPL do not yet meet
international norms.
An informative check, conducted by Topalova, is to use data from corporate balance
sheets to estimate the ability of firms to repay their loans.40 Firms whose income
(defined as earnings before interest, taxes, depreciation, and amortization) is less
than their reported interest expense represent firms that are either defaulting, are
very close to default, or would be defaulting if their loans were not ever greened.
This share of potential NPAs has increased significantly in the past five years, while
banks reported level of NPAs have stayed fairly constant. To palova also finds that
banks are exposed to substantial interest rate risk: a 200 basis point increase in the
rate of interest could result in a four percentage point increase in the share of NPLs
in the banking system.
These high levels of NPAs raise obvious concerns about the stability of individual
banks. However the governments policy so far has been to allay these concerns by
simply taking over the uncovered liabilities of the failing banks, whether nationalized
or private. Therefore we will measure the cost of the NPAs in terms of resources that
have gone into bailing out these banks.
We are not aware of a systematic accounting of all bank failures in India since 1969.
To calculate the cost of bank failures, we use data collected from annual issues of
the Statistical Tables Relating to Banks in India, starting in 1969. Unfortunately, the
data were collected for purposes other than conducting this exercise, and are not
comprehensive. Nonetheless, we are optimistic that the data can provide at least the
correct order of magnitude.

In 1969, we have deposits data for 45 private sector banks. Between 1969 and 2000,
we are able to identify twenty-one cases of bank failure, which resulted either in the
liquidation of the bank, or merging of the bank with a public sector bank. (An
additional 20 banks were nationalized, 14 in 1969, and 6 in 1980. We do not count
these twenty nationalizations as failures). The value of the deposits at the time the
bank failed can be taken as an upper bound of the cost of a bank failure. Thus, we
calculate the value (in 2000 Rs.) of the deposits of these 21 banks. The largest
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single failure was Laxhmi Commercial Bank, which was merged with Canara bank in
1985, and represents 18.5 percent of the share of real deposits of failed banks. The
total value of deposits for banks that failed between 1969 and 2000 is approximately
45 Billion Rs., a substantial sum.

The total cost of recapitalization is also unknown. We also conduct a back-of-theenvelope exercise, using figures from the 1999-2000 issue of Trends and Progress
of Banking in India These figures give the capital contribution of the central
government to nationalized banks, as well as the amount of capital written down by
the central government. While interpretation of the write-off is straightforward, the
recapitalization funding requires a little work. Banks earned money from the
recapitalization bonds. The recapitalization subscription will, at least in theory, be
returned to the government (several public sector banks have already returned
capital): thus, the true cost of recapitalization is best measured by the interest
income forgone by the government.
The 2005-2006 issue of Trends and Progress of Banking in India reports the
income from nationalized banks both as recorded on their books, and after
subtracting the income from recapitalization bonds. We take the difference between
these two numbers as the implied subsidy from the government to the nationalized
banks. To calculate this number for other years, we assume that the ratio of
subsidized income (1797crores in 1998-1999) to cumulative capital contributed by
the central government (19,803crore in 1998-1999) was constant throughout the
nineties, at approximately 1757/19,403=9 percent. Taking the total reported capital
investment in each year from 1992 to 2000 (again from the 2000-2001 Trends and
Progress), and adjusting for inflation, gives an estimate of the subsidy from
recapitalization of approximately 13,607crore. Combined with 15,421crore of written
down capital, this amounts to a recapitalization cost to the government of
approximately 290 billion rupees.

This number requires three important adjustments. First, some of the weakness from
the nationalized banks balance sheets may come from the assets of the failed
private banks that were merged with the nationalized banks (this amount can be
bounded above by the figure derived above, 45 billion rupeesquite clearly, public
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sectors have many bad loans of their own). Second, and probably much more
importantly, this represents the cost up to the year 2000. It is an open question how
long it will take for the banks to return this capital to the government. Finally, it is also
possible that the public sector banks will be unable to return the entire amount of
capital subscribed by the government.
Thus, the most favourable accounting for public sector banks (in which they wean
themselves completely from recapitalization income starting in fiscal year 2004, and
are absolved of the entire value of the 45 billion rupees of the failed private banks)
gives a total cost of recapitalization of public banks of approximately 300 billion
rupees. A more realistic assessment might credit them for only one-half the value of
the losses, and assume that recapitalization bonds will be held for ten more years,
until 2014. This would give an approximate bail-out cost of 540billion rupees.
Thus, under the accounting that is most favourable to public sector banks, they
squeak by as less costly to the government than private sector banks (the ratio of
money spent bailing out public vs. private banks would be 6 2/3 to 1, less than the
deposits ratio). However, using the estimate of 540 billion rupees total cost gives a
12-1 ratio, which would imply that the public sector banks lost a greater portion of
their deposits to bad loans.

UNIVERSAL BANKING
The evolving scenario in the Indian banking system points to thee
mergence of universal banking. The traditional working capital financing is no longer
the banks major lending area while FIs are no longer dominant in term
lending. The motive of universal banking is to fulfil all the financial needs of the
customer under one roof. The leaders in the financial sector will be aiming to
become a one-stop financial shop. In recent times, ICICI group has expressed
their aim to function on the concept of the Universal Bank and was willing to
go for a reverse merger of ICICI ltd. with ICICI Bank. But due to some regulatory
constraints, the matter seems to have been delayed. Sooner or later, the
group would be working towards its aim . Even some of the other
groups in the f inancial sector like HDFC, IDBI have started functioning on
the same concept.
An Overview
Universal Banking includes not only services related to savings and
loans but also investments. However in practice the term 'universal banks'
refers to those banks that offer a wide range of financial services, beyond
commercial banking and investment banking, insurance etc. Universal banking is ac
ombination of commercial banking, investment banking and various
other activities including insurance. If specialised banking is the one end
universal banking is the other. This is most common in European countries.
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The main advantage

of universal
banking is that it results in greater economic efficiency in the form of lower co
st, higher output and better products. The spread of universal banking ideas will
bring to the fore issues such as mergers, capital adequacy and risk
management of banks. Universal banks may be comparatively better placed to
overcome such problems of asset-liability mismatches (for banks). However,
larger the banks the greater the effects of their failure on the system.
Also there is the fear that such institutions, by virtue of their sheer size, would gain
monopoly power in the market, which can have significant undesirable
consequences
for
economic
efficiency.
Alsocombining commercial and investment banking can give rise to con
f lict of interests.
In India
Now RBI has asked FIs, which a re interested to convert
itself into a universal bank, to submit their plans for transition to a
universal bank for consideration and further discussions. FIs need to formulate a
road map for the transition path and strategy for smooth conversion into an universal
bank over aSpecified time frame. The plan should specifically provide for full
compliance with prudential norms as applicable to banks over the proposed period.
The Narsimham Committee II suggested that DFIs should convert
ultimately into either commercial banks or non-bank finance companies. The
Khan Working Group held the view that DFIs should be allowed to
become banks at the earliest. The RBI released a 'Discussion Paper' (DP) in
January1999 for wider public debate. The feedback indicated that while the
universal banking is desirable from the point of view of efficiency of resource use,
there is need for caution in moving towards such a system. Major areas
requiring attention are the status of financial sector reforms, the state of
preparedness of the concerned institutions, the evolution of the regulatory regime
and above all a viable transition path for institutions which are desirous of
moving in the direction of universal banking.

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ICICI gearing to become a universal bank

ICICI
envisages
a
timeframe
of
12
to
18
months
in
converting itself into a Universal Bank. ICICI has
received
favourable response from Indian investors and FIIs on its move to merge with
ICICI Bank and become a universal bank. ICICI was the first one
to p r o p a g a t e u n i v e r s a l b a n k i n g a s a n i d e a l c o n c e p t f o r t h e D F I s t
o s u p p o r t industries with low cost funds.
In August, ICICI executive director Kalpana Morparia said that ICICI has to
obtain a separate banking licence from RBI for becoming a universal bank. I t
can avoid the stamp duty burden by first converting ICICI into bank, instead of going
for a direct merger of ICICI into ICICI Bank.
We have created fire walls and functioning as separate legal entities only
for complying with statutory obligations, she noted. There is clear demarcation in
the operation of ICICI and the bank. The bank takes care of liabilities of less
than one year by offering short-term loans to corporate and personal loans.
Medium to long-term products like home loans, auto loans are handled by
the parent; absolute coordination between them while marketing the products exists.
Crisis has reaffirmed its triple a rating for ICICI and FIIs also expects its profit
margins to improve after the merger due to the access to low cost deposits & the
scope to increase income from fee-based activities.
She said ICICI has started increasing its international presence and associating
closely with NRI community in various countries. ICICI InfoTech is based in US &
has an office in Singapore. ICICI Securities has been registered as a broking firm in
the US.
ICICI Bank is leveraging on strong network of 400 branches and extension counters
& 600 ATMs for offering products to NRIs; NRIs can transfer their money to
200 locations
in India by
internet. The
payment
will
be made
within72 hours. It also offers loan products for helping their relatives in India.Besides;
the Visa card helps them to withdraw cash through the ATM network.
Morparia said NPA of banks in India are < 10 per cent of GDP when
comparedto emerging economies like China, Korea & Thailand. It should not becom
pared with developed countries like Europe and US. ICICIs gross NPA comes to Rs
6,000crore. Asked about a approach to resolve the problem, she said if the units are
viable, it supported financial restructuring, mergers. If these options arent possible
and the units are not viable, it will go in for one time settlement.

50 | P a g e

Because of law, once the units are referred to BIFR, the lenders were unable to
enforce securities, she pointed out.

MERGERS AND ACQUISITIONS

For the irresistible compulsions of competitiveness have created
a situation where the only route for survival for many a bank in India may be to
merger with another. With the Union Finance Ministry thinking along the same lines,
it may not be long before mega -mergers between banks materialise.
World over banks have been merging at a furious pace, driven by an urge to
gain synergies in their operation, derive economies of scale and offer one stop
facilities to a more aware and demanding consumer. In the eighties and nineties
mergers were used as means to strengthen the banking sector. Small, weak and
inefficient non-scheduled banks were merged with scheduled banks when
the running of such banks becomes non-viable. However, mergers in the current era
will be driven by the motive of establishing a bigger market share
i n t h e industry and to improve the profitability. Mergers may prove to be an
effectiveremedial measure in a competitive environment where margins/sprea
ds areunder pressure for the banking sector. Though Indian systems were not keen
on the mergers and acquisitions in the banking sector, of late the systems
have started encouraging the global trends of M&A's.
Why the urge to merge?
The big question is why is there a sudden urge to merge? The answer
iss i m p l e a s i t i s o b v i o u s . T o b e a t c o m p e t i t i o n f o r w h i c h s u d d e n l y
s i z e h a s become an important matter. Mergers will help banks with added money
power,
extended geographical reach with diversif ied branch networks, improve
d product-mix, and economies of scale of operations. Mergers will also help
the banks to reduce their borrowing cost and to spread total risk associated with the
individual banks over the combined entity. Revenues of the combined entity are
likely to shoot up due to more effective allocation of bank funds. One such big
merger between banks globally was that of Industrial Bank of Japan, Fuji and
Dai-Ichi-Kangyo bank, all of which were merged to be nicknamed as Godzilla Bank,
implying the size of the post merged entity. Another instance that comes t o m i n d
is that of Bank of America's merger with that of Nation's Bank.
Financial consolidation was becoming necessary for the growth of the bank.

CUSTOMER
May also want from a bank efficient cash management, advisory services and
market research on his product. Thus the importance of fee based is increasing in
comparison with the fund-based income.
The once RIGID DISTINCTION Between the providers of term-finance and the
providers of working-capital finance is blurring, leading to an increasing
convergence in the asset-liability structure of the banks and the FIs. Mergers
would position the combined entity for rapid growth not only in the working
capital and term-lending segments, but also in the growing fee-income business.
51 | P a g e

And that would be in conso nance with the global trend towards
universal banking.
GLOBALISATION: Competition from abroad is also set to intensif y. The
foreign banks are looking to expand beyond their narrow niches to acquire retail
reach. Restrictions on branch expansion of the foreign banks are being relaxed in
line with the commitments made to the World Trade Organisation, under the
Financial Services Agreement, by India. The archaic restriction on the number of
Automated Teller Machines has gone.
CAPITAL ACCOUNT CONVERTABILTY
W ill grant Indian corporate access to capital markets abroad as well as
provide
f oreign
banks
access
toI n d i a n f i r m s a n d i n v e s t o r s . G i v e n t h e i r u n d o u b t e d f i n a n c i a l m u s
c l e a n d technical expertise, the foreign banks are likely to dominate the
new markets.
DISINTERMEDIATION : As capital markets deepen and widen, the
core banking functions--deposit
taking and lending--come
under attack; and the number of alternative savings vehicles multiply, limiting bank
deposits
growth.M u t u a l f u n d s , i n p a r t i c u l a r , a r e a p o t e n t l o n g t e r m t h r e a t b e c a u s e t h e y appropriate what was once the USP of bank
deposits.
VOLATILITY: A l a r g e c a p i t a l b a s e p r o v i d e s t h e n e c e s s a r y c u s h i o n t o
withstand nasty shocks. The classic illustration of the absorptive capacity
of capital is, of course, the deeply divergent fates of Barings Bank and Daiwa
Bank. Both banks chalked up huge derivatives-trading losses. But while losses of
$1.20 billion were enough to topple a 233-year-old British institution, Daiwa Bank
managed to survive losses of a similar magnitude simply because of its
abundant capital reserves.
THE SCENARIO TODAY
It began with HDFC Bank and Times Bank last year, which took everyone by
surprise. However, the latest merger of ICICI Bank with Bank of Madura is
even more astonishing as well as surprising, though a welcome changes.
ICICIB a n k h a d a l s o i n i t i a t e d m e r g e r t a l k s w i t h C e n t u r i o n B a n
k , b u t d u e t o differences arising over swap ratio the merger didn't materialize.
INTERNATIONALLY
The merger of the Citibank with Travellers Group and the merger of
Bank of America with NationsBank have triggered the mergers and acqu
isitionmarket in the banking sector worldwide. Europe and Japan are also on their
way to restructure their financial sector through M&A's. The merger of Malaysia's
58 domestic banks into six anchor groups is part of a global trend that will
strengthen the financial sector and enable it to compete internationally, Second
Finance
Minister
Mustapa
Mohamed
says.
Inas e m i n a r o n M a l a y s i a ' s r e c o v e r y e f f o r t s , o r g a n i z e d b y t h e W o r l d
52 | P a g e

B a n k i n W ashington, Mustapa said it was important for the governmen

t to ''moveaggressively'' in strengthening the banking system because ''the
WTO (World Trade Organization) is knocking on our doors and asking us to
liberalize our financial sector. When asked why the government intervened in bank
mergers rather than letting the markets decide for themselves, Mustapa said the
banks were urged to merge in the 1980s, ''but our advice fell on deaf ears. We
spent no less thanRM60 billion ($15.78 billion) in those days to bail them out and
frankly
we'ref e d u p a n d t i r e d o f b a i l i n g t h e m o u t . ' ' A f t e r t h e m e r g e r s , h e a
d d e d , t h e government hoped to divert those resources to building schools and
hospitals. At the height of the crisis, depositors of the ''smaller banks''
themselves felt unsafe and moved their savings to the bigger banks. Witness the
alliance between Chase Manhattan and Chemical Bank in the US, the fusion of
two Japanese monoliths, Bank of Tokyo and Mitsubishi Bank, and, more
recently, the mega -merger of the Swiss giants, United Bank
of Switzerland and Switzerland Banking Corporation. In Europe, the prospect of a
single currency system has sparked off a merger mania among banks.

53 | P a g e

2.16 BANKING AND INSURANCE

What will the future of Indian banking and insurance look like? Will there form in
these sectors face the same fate as in power? It is increasingly evident that the
economy offers opportunities but no security. The future will belong to those who
develop good internal controls, checks and balances and a sound market
strategy. The latest to be opened up for private investment, including foreign direct
investment, is the insurance sector. On a rough reckoning, commercial
bank deposits account for 25 per cent of GDP and credit extended by banks may
be15 per cent of GDP. Thus, regular bank credit transactions alone
asubstantial percentage of GDP by way of servicing econom ic activitie
s. Agradual convergence is taking place in the banking and insurance
sectors.Several major banks are floating subsidiaries to enter both life and
non-lifeinsurance businesses. Some of them are
looking at niche markets such as corporate insurance. Reform of the
insurance sector began with the decision to open up this sector for private
participation
with
foreign
insurance
companies
being
allowede n t r y w i t h a m a x i m u m o f 2 6 p e r c e n t c a p i t a l i n v e s t m e n t ? T h
e I n s u r a n c e Regulatory and Development Authority (IRDA), in its guidelines
for the new private sector insurance companies, have stipulated that at least 20 per
cent of the total premium revenue of these companies should come from rural
India. The government permits banks to distribute or market insurance products. It
is amending the Banking Regulation Act to this effect. Only banks with a
three
year track record of positive growth as well as with a strong
f i n a n c i a l background will be entitled to do insurance business. In
anticipation of the government move, some banks have begun talking of
alliances with foreign insurance players.
Keeping in view the limited actuarial and technical expertise of
Indian banks in undertaking insurance business; RBI has found it necessary to
restrictentry into insurance to f inancially sound banks. Permission to un
dertakeinsurance business through joint ventures on risk participation
basis willtherefore
be
restricted
to
those
banks
which
(i) Have a minimum net worth of Rs. 500crore and
(ii) Satisfy other criteria in regard to capital adequacy, profitability, etc. Banks which
do not satisfy these criteria will be allowed as strategic investors (without r i s k
participation) up
to 10 per cent
of their net worth or Rs. 50
crore,w h i c h e v e r i s l o w e r . H o w e v e r , a n y b a n k o r i t s s u b s i d i a r
y c a n t a k e u p distribution of insurance products on fee basis as
a n a g e n t of insurancecompany. In all cases, banks need prior approval
of RBI for undertaking insurance business. Quite a few banks are desirous of
undertaking life insurance or general insurance business. State Bank of
54 | P a g e

India,
Bank
of
Baroda,
Bank
of
India,G l o b a l T r u s t B a n k , V y s y a B a n k , C e n t u r i o n B a n k , O r i e n t a l
B a n k o f Commerce, ICICI Bank and HDFC Bank have or are intending
to
enter insurance business after various procedural formalities have bee
n clearlydefined in Insurance Regulatory Authority Bill. From the NBFC sector
Alpha Finance and Kotak Mahindra will be entering this sector. Also a few industrial
houses like Bombay Dyeing, Aditya Birla, Tata Group, Godrej Group are in
the picture. It is felt that volume of new business in the insurance
sector could touch $25 billion.

RURAL BANKING
ECONOMICALLY empowering, i.e. access to inexpensive credit and other microfinance services, including savings and insurance, India's rural p o p u l a t i o n
w i l l h a v e a s i g n i f i c a n t i m p a c t o n I n d i a ' s e c o n o m i c g r o w t h . Economi
c empowerment is defined here as. The modern banking system has failed to
deliver inexpensive credit to Indias 600,000 villages - despite several expensive
attempts
to
do
so.
Do
we
need
to
rethink
the
appropriate
institutionalstructure for rural banking in India? The problems of widespr
ead poverty, growing inequality, rapid population growth and rising unemployment
all find their origins in the stagnation of economic life in rural areas. Since the days
of the Rural Credit Survey Committee (1954), India has come a long way in its
search
for
an
appropriate
rural
banking
set-up.
Thought h e r e h a s b e e n s o m e i m p r o v e m e n t , t h e p r o b l e m r e m a i n s . T
h e r e h a s b e e n tremendous progress in quantitative terms but quality has
suffered, progress has been slow and halting and significant regional disparities
persist. Stagnation in rural banking is noticed in the north and north eastern regions.
The focus should be on assisting and guiding small farmers. It is in this
context that the role of rural banking institutions has to be reconsidered. The
Development
strategy
adopted
and
the
increasing
diversificationa n d c o m m e r c i a l i s a t i o n o f a g r i c u l t u r e u n d e r l i n e t h e n e
e d f o r t h e r a p i d development of rural infrastructure and a larger flow of credit.
Activities allied to agriculture livestock breeding, dairy farming,
sericulture etc are beingtaken up on commercial lines. Further, hitech agriculture with an exportorientation has brought about higher productivity
in cotton, oilseeds, etc.
E x p e r i e n c e o f R R B s t h a t h a v e locally
recruited employees; the employees are unhappy in view of the lack of
adequate career prospects. A part from having a basic knowledge of agriculture
and rural development, a rural banker is required to handle credit extension
work, scheme appraisal work in connection with farm and non-farm investments
and the production of different crops, the monitoring/supervision and recovery
of loans spread over villages which are not even connected by all -weather
roads and in an environment in which vested interests are quite powerful. A
person who says he has been in bank service for more than 25 years
55 | P a g e

writes: That rural credit has become unfashionable is evident from the fact
that the subject is accorded only residual focus in the various congregations
of our bankers. The placement policy in vogue in our banks is such
that exposures in rural credit or agro-financing rarely count for promotions.
Unfortunately A uniform standardized approach to lending has led to rigidities
as a result of which a farmer-borrower becomes a defaulter for no fault of his.
Also, the agricultural sector is beset with considerable uncertainties the weather
and rainfall problem, the pest problem and the market and price problem.
Government interference that leaves no scope for these apex bodies to show
initiative and work out action plans for development on their own is partly
responsible for this situation. Another reason for such a state of affairs is
that the apex bodies have expanded and prospered at the cost of primary bodies by
taking over functions like deposit mobilisation even at the rural level. By way of
liberalisation of the federal structures working, societies that want to
work independently of the federal system should be allowed to exit.

VIRTUAL BANKING
The practice of banking has undergone a significant transformation in the nineties.
While banks are striving to strengthen customer relationship and move towards
'relationship banking', customers are increasingly moving away from the
confines of traditional branch-banking and are seeking the convenience of remote
electronic banking services. And even within the broad spectrum
of electronic banking, the aspect of banking that has gained currency is
virtual banking. Increase in the functional and geographical spread of b
anks hasnecessitated the switchover from hard cash to paper based instruments
and
nowto electronic instruments. Broadly speaking, virtual banking denote
s the provision of banking and related services through extensive use of information
technology without direct recourse to the bank by the customer. The origin
of virtual banking in the developed countries can be traced back to the
seventies with the installation of Automated Teller Machines (ATMs). It is
possible to delineate the principal types of virtual banking services. These include
Shared ATM networks, Electronic Funds Transfer at Point of Sale (EFTPOS),
Smart Cards, Stored-Value Cards, phone banking, and more recently,
internet and intranet banking. The salient features of these services a re the
over whelming reliance on information technology and the absence of physical
bank branches to deliver these services to the customers. The financial benefits of
virtual banking services are manifold.
Lower cost of handling a transaction and of operating branch
network along with reduced staff costs via the virtual resource compared to
the cost of handling the transaction via the branch.
The increased Speed of response to customer requirements ; enhance
customer satisfaction and, ceteris paribus, can lead to higher profits via
handling a larger number of customer accounts.
56 | P a g e

It also implies the possibility of access to a greater number of potential

customers.
Manipulation of books by unscrupulous staff, frauds relating to local clearing
operations will be prevented if computerisation in banks takes place.
On the flip side of the coin, however, it needs to be recognized that such high-cost
technological
initiatives
need
to
be
undertaken
only
after
the
viabilityand feasibility of the technology and its associated applications
have been thoroughly examined.
Virtual banking has made some beginning in the Indian banking
system. ATMs have been installed by almost all the major banks in major metro
Politian cities, the Shared Payment Network System (SPNS) has already been
installed in Mumbai and the Electronic Funds Transfer (EFT) mechanism
by major banks has also been initiated. The operationalisation of the Very Small
Aperture Terminal (VSAT) is expected to provide a significant thrust to the
developmentof Indian Financial Network (INFINET)
This will f urther facilitate connectivity within the financial sector.
T h e p o p u l a r i t y w h i c h v i r t u a l b a n k i n g s e r v i c e s h a v e w o n a m o n g cus
tomers, owing to the speed, convenience and round -the clock access they
offer, is likely to increase in the future? However, several issues of concern
would need to be pro-actively attended. While most of electronic banking
have b u i l t in security features such as encryption. Prescriptions of maximu
m monetary limits and authorizations, the system operators have to be extremely
vigilant and provide clear-cut guidelines for operations. On the large issue
of electronically initiated funds transfer, issues like authentication of
paymentsinstructions, the responsibility of the customer for secrecy of t
he security procedure would also need to be addressed.
The INFINET is a Closed User Group (CUG) Network for the
exclusiveu s e o f M e m b e r B a n k s a n d F i n a n c i a l I n s t i t u t i o n s . I t
u s e s a b l e n d o f communication technologies such as VSATs and
Terrestrial Leased Lines.Presently, the network consists of over 689 VSATs
located in 127 cities of the country and utilises one full transponder on INSAT 3B.
Inaugurated
on
June
19,1999, various inter-bank and intra
bank applications ranging f rom simple messaging, MIS, EFT (Retail, RTGS),
ECS,
Electronic
Debit,
online processingand trading in Government securities, dematerialis ation,
centralized fundsq u e r y i n g f o r B a n k s a n d F I s , A n y w h e r e / A n y t i m e B
a n k i n g , I n t e r - B r a n c h Reconciliation are being implemented using the INFINET.
The INFINET will be the communication backbone for the National Payments
System,
which
willcater mainly to interbank applications like RTGS, Delivery Vs Payment (DVP), Government
Transactions, and Automatic Clearing House (ACH) etc. Major issues plaguing the
banking industry are the Lack of standardisation of operating systems, systems
software and application software throughout the banking industry.

57 | P a g e

2.17 RECENT STATUS OF THE INDIAN BANKING SECTOR

The following states recent status of the Indian Banking sector.
Foreign allies can hold up to 49% in private banks.
The RBI-SEBI panel has decided that a foreign collaborator can hold up to49
per cent in a private bank as against 20 per cent allowed earlier. As per
earlier norms, a foreign bank or financial institution stepping in as a technical
collaborator can pick up a maximum 20 per cent stake directly, while another 20 per
cent can come as direct investments by NRIs.

Life after VRS: Nationalised banks facing shortage of staff

A voluntary retirement scheme, leaner, smarter, and manageable
workforce, lower overheads may all have been relevant reasons to get onto
best
business
practices.
But
what
many
of
these
nationalised
banksdid not consider was acute shortage of manpower (read officers) f
orsupervisory banking functions. Outsourcing administrative services has
arrived in the banks. But this is not proving to be a catch -all-solution
either. Most banks are rushing in officers to branches where senior officers have left.
Reducing workforce is fine. But post-VRS manning structures had obviously not been
clearly forecast.

IDBI to focus more on retail banking

IDBI is to focus more on retail banking as part of its revised
functional strategy for future growth, bank's managing director Gunit Chadha said.
He said the rolling out of the bank's RPU underlined the increased focus the bank
had placed on retail banking. The RPU has armed the bank with the necessary
systems and structure to roll out new products in retail banking and will
greatly reduce time to market the new products," he said.

A sharp rise
A study of the performance of banking sector stocks over the past
one year has shown that while several public sector banks have shown
a sharp rise in prices, many of their private counterparts are high on the
losers list. Leading the gainers list is Corporation bank whose scrip has
nearly doubled in the last one year. It is followed by Bank of India with a gain of
75 per
cent,
and
Jammu
& Kashmir
Bank
which,
despitea majorityh o l d i n g b y t h e J & K g o v e r n m e n t i s c l a s s i f i e d
a s a p r i v a t e b a n k . "Corporation bank takes only select clients and a lot
of effort goes into this selection," says a merchant banker explaining the low NPA
levels in the bank.

Bankers jittery over proposed laws

Rattled by scams, bankers are now jittery that new laws could push them
further towards the edge. The financial regulators are now pitching for
ac h a n g e i n t h e s t a t u t e s t h a t w o u l d p u t t h e r e s p o n s i b i l i t y o n b a n k s
, financial institutions and other intermediaries to first prove themselves it
58 | P a g e

didnt come as a surprise when bankers were visibly upset and later voiced their
protest last week after the committee on fraud made a final presentation before
submitting its report to the government. In its final recommendations the panel
headed by Prof N L Mitra has said that when a fraud over Rs 10crore is committed,
the
onus
will
be
on
banks
and
FIsto prove themselves innocent, failing which the law will take its own
course.
The recommendations, which assume a special significance after thestr
ing of scams that have rocked the Indian markets and institutions, will be submitted
to the finance ministry in the first week of September. The committee
on fraud has further recommended a special investigative

agency

for

the

purpose. This will require professionals from different fields and could be in line with the
Serious Fraud Office, UK, which has teams comprising lawyers, accountants,
bankers,

software

experts

etc

all

of w h o m g i v e t h e i r i n p u t s s o t h a t t h e c a s e c a n b e p r e s e n t
e d i n a comprehensive way before the court of law.

Allahabad Bank gets a sock for hiking CAR

The Government on Wednesday pulled up the CMD of Allahabad Bank, B Samal,
and his management team for falsely reporting the banks capital adequacy at 11.51
per cent against the actual 8.61 per cent. At a review presided by finance secretary Ajit
Kumar here, the bank was asked to turnaround or close down 136 loss-making
branches. The ministry team also criticised the management for letting standard assets
turn NPAs again. On Tuesday, the government had asked UCO Bank to shut
down
800
of
itslossmaking domestic branches besides four international ones. Theg o v e r n
m e n t i s m e e t i n g a l l t h e w e a k b a n k s t o t a k e s t o c k o f t h e i r oper
ations, indicating a change in the mindset and a resolve to chide shoddy
performers. Indian Bank, however, was the odd man out.

ATMs in India
The BOI is planning to install 225 ATMs in nine major cities. The growth of ATMs in
India has been exponential; currently there are over one lakhs ATMs in India
and the growth rate is 40 %. As far as cost is concerned, Mr. Loney Antony, NCR
Corporation India, Country Manager, states that cost of branch transaction is Rs 50
to Rs 100 whereas cost on an ATM is not more than Rs 25.

59 | P a g e

2.18 The Future of Banking Reform

When we take this evidence together, where does it leave us? There are obvious
problems with the Indian banking sector, ranging from under-lending to unsecured
lending, which we have discussed at some length. There is now a greater awareness
of these problems in the Indian government and a willingness to do something about
them.
One policy option that is being discussed is privatization. The evidence from Cole,
discussed above, suggests that privatization would lead to an infusion of dynamism
in to the banking sector: private banks have been growing faster than comparable
public banks in terms of credit, deposits and number of branches, including rural
branches, though it should be noted that in our empirical analysis, the comparison
group of private banks were the relatively small old private banks.48 It is not clear
that we can extrapolate from this to what we could expect when the State Bank of
India, which is more than an order of magnitude greater in size than the largest old
private sector banks. The new private banks are bigger and in some ways would
have been a better group to compare with. However while this group is also growing
very fast, they have been favoured by regulators in some specific ways, which,
combined with their relatively short track record, makes the comparison difficult.
Privatization will also free the loan officers from the fear of the CVC and make them
somewhat more willing to lend aggressively where the prospects are good, though,
as will be discussed later, better regulation of public banks may also achieve similar
goals.

Historically, a crucial difference between public and private sector banks has been
their willingness to lend to the priority sector. The recent broadening of the definition
of priority sector has mechanically increased the share of credit from both public and
private sector banks that qualify as priority sector. The share of priority sector
lending from public sector banks was 42.5 percent in 2003, up from 36.6 percent in
1995. Private sector lending has shown a similar increase from its 1995 level of 30
percent. In 2003 it may have surpassed for the first time ever public sector banks,
with a share of net bank credit to the priority sector at 44.4 percent to the priority
sector.

60 | P a g e

Still, there are substantial differences between the public and private sector banks.
Most notable is the consistent failure of private sector banks to meet the agricultural
lending sub target, though they also lend substantially less in rural areas. Our
evidence suggests that privatization will make it harder for the government to get the
private banks to comply with what it wants them to do. However it is not clear that
this reflects the greater sensitivity of the public banks to this particular social goal. It
could also be that credit to agriculture, being particularly politically salient, is the one
place where the nationalized banks are subject to political pressures to make
imprudent loans.

Finally, one potential disadvantage of privatization comes from the risk of bank
failure. In the past there have been cases where the owner of the private bank
stripped its assets, and declared that it cannot honour its deposit liabilities. The
government is, understandably, reluctant to let banks fail, since one of the
achievements of the last forty years has been to persuade people that their money is
safe in the banks. Therefore, it has tended to take over the failed bank, with the
resultant pressure on the fiscal deficit. Of course, this is in part a result of poor
regulationthe regulator should be able to spot a private bank that is stripping its
assets. Better enforced prudential regulations would considerably strengthen the
case for privatization.
On the other hand, public banks have also been failingthe problem seems to be
part corruption and part inertia/laziness on the part of the lenders. As we saw above,
the cost of bailing out the public banks may well be larger (appropriately scaled) than
the total losses incurred from every bank failure since 1969.
Once again the fact that thenew private banks pose a problem: So far none of them
have defaulted, but they are also new, and as a result, have not yet had to deal with
the slow decline of once successful companies, which is one of the main sources of
the accumulation of bad debtor the books of the public banks.

On balance, we feel the evidence argues, albeit quite tentatively, for privatizing the
nationalized banks combined with tighter prudential regulations. On the other hand
we see no obvious case for abandoning the social aspect of banking. Indeed there
61 | P a g e

is a natural complementarily between reinforcing the priority sector regulations (for

example, by insisting that private banks lend more to agriculture) and privatization,
since with a privatized banking sector it is less likely that the directed loans will get
redirected based on political expediency.
However there is no reason to expect miracles from the privatized banks. For a
variety of reasons including financial stability, the natural tendency of banks, public
or private, the world over, is towards consolidation and the formation of fewer, bigger
banks. As banks become larger, they almost inevitably become more bureaucratic,
because most lending decisions in big banks, by the very fact of the bank being big,
must be taken by people who have no direct financial stake in the loan. Being
bureaucratic means limiting the amount of discretion the loan officers can exercise
and using rules, rather human judgment wherever possible, much as is currently
done in Indian nationalized banks. Berger et al. have argued in the context of the US
that this leads bigger banks to shy away from lending to the smaller firms. Our
presumption is that this process of consolidation and an increased focus on lending
to corporate and other larger firms is what will happen in India, with or without
privatization, though in the short run, the entry of a number of newly privatized banks
should increase competition for clients, which ought to help the smaller firms.

In the end the key to banking reform may lie in the internal bureaucratic reform of
banks, both private and public. In part this is already happening as many of the
newer private banks (like HDFC, ICICI) try to reach beyond their traditional clients in
the housing, consumer finance and blue-chip sectors.

This will require a set of smaller step reforms, designed to affect the incentives of
bankers in private and public banks. A first step would be to make lending rules more
responsive to current profits and projections of future profits. This may be a way to
both targets better and guard against potential NPAs, largely because poor
profitability seems to be a good predictor of future default. It is clear however that
choosing the right way to include profits in the lending decision will not be easy. On
one side there is the danger that unprofitable companies default. On the other side,
there is the danger of pushing a company into default by cutting its access to credit
exactly when it needs it the most, i.e. right after a shock to demand or costs has

62 | P a g e

pushed it into the red. Perhaps one way to balance these objectives would be to
create three categories of firms:
(1) Profitable to highly profitable firms. Within this category lending should respond
to profitability, with more profitable firms getting a higher limit, even if they look
similar on the other measures.

(2) Marginally profitable to loss-making firms that used to be highly profitable in the
recent past but have been hit by a temporary shock (e.g. an increase in the price of
cotton because of crop failures, etc.). For these firms the existing rules for lending
might work well.

(3) Marginally profitable to loss-making firms that have been that way for a long time
or have just been hit by a permanent shock (e.g., the removal of tariffs protecting
firms producing in an industry in which the Chinese have a huge cost advantage).
For these firms, there should be an attempt to discontinue lending, based on some
clearly worked out exit strategy (it is important that the borrowers be offered enough
of the pie that they feel that they will be better off by exiting without defaulting on the
loans).Of course it is not always going to be easy to distinguish permanent shocks
from the temporary. In particular, what should we make of the firm that claims that it
has put in place strategies that help it survive the shock of Chinese competition, but
that they will only work in a couple of years. The best rule may be to use the
information in profits and costs over several years, and the experience of the
industry as a whole. One constraint on moving to a rule of this type is that it puts
more weight on the judgment of the loan officer. The loan officer would now have to
also judge whether the profitability of a company (or the lack of it) is permanent or
temporary. This increased discretion will obviously increase both the scope for
corruption and the risk of being falsely accused of corruption. As we saw above, the
data is consistent with the view that the loan officers worry about the possibility of
being falsely accused of corruption and that this pushes them in the direction of
avoiding taking any decisions if they can help it. It is clear that it would be difficult to
achieve better targeting of loans without reforming the incentives of the loan officers.
There are probably a number of steps that can go some distance towards this goal,
even within public banks. First, to avoid a climate of fear, there should be a clear
separation between investigation of loans and investigations of loan officers. The
63 | P a g e

loan should be investigated first (could the original sanction amount have made
sense at the time it was given, were there obvious warning signs, etc.) and a prima
facie case that the failure of the loan could have been predicted, must be made
before the authorization to start investigating the officer is given. Ideally, until that
point the loan officer should not know that there is an investigation.

The authorization to investigate a loan officer should also be based on the most
objective available measures of the life-time performance of the loan officer across
all the loans where he made decisions and weight should be given both to
successes and failures. A loan officer with a good track record should be allowed a
number of mistakes (and even suspicious looking mistakes) before he is open to
investigation.
Banks should also create a division, staffed by bankers with high reputations, which
is allowed to make a certain amount of high risk loans. Officers posted to this division
should be explicitly protected from investigation for loans made while in this division.
This may not be enough, and some extra effort to reach out more effectively to the
smaller and less well established firms will probably be needed, not just on equity
grounds, but also because these firms may have the highest returns on capital. A
possible step in this direction would be to encourage established reputable firms in
the corporate sector as well as multinationals to set up small specialized companies
whose only job is to lend to smaller firms in a particular sector (and possibly in
particular location). In other words these would be the equivalents of the many
finance companies that do extensive lending all over India, but with links to a much
bigger corporate entity and therefore creditworthiness. The banks would then lend to
these entities at some rate that would be somewhat below the cost of capital (instead
of doing priority sector lending) and these finance companies would then make loans
to the firms in their domain, at a rate that is at most x per cent higher than their
borrowing rates. By being small and connected to a particular industry, these finance
companies would have the ability to acquire detailed knowledge of the firms in the
industry and the incentive to make loans that would appear adventurous to outsiders.

Finally we feel that giving banks a stronger incentive to lend by cutting the interest
rate on government borrowing will also help. The evidence reported above is only
suggestive but it does suggest that where lending is difficult, making lending to the
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government less lucrative can have a strong effect on the willingness of bankers to
make loans to the private sector. Thus it is the less obviously creditworthy firms that
suffer most from the high rates of government borrowing.

The Indian Banks even after a decade full of reforms for the sector have a long way
to go. Product innovations, better information technology and operating
mechanisms not only enhance the income and reduce expenses but also act as a
catalyst
to
retain
customers.
The
question
is
will
this
suffice for the future? W ith the continued integration of the India
n markets with the global markets, the volatility is rising. To survive this
dynamism and the
risks arising from the same, banks need to have
resources in place to understand and manage them on a regular basis.
Markets, which have so far witnessed a deluge in the number of banks, will
now witness consolidation.
With the onset of globalisation in each and every sector, Indian Banks need
to be much more sustainable, efficient, transparent in working and also competitive.
Now the bank mergers will not be a new phenomenon since synergies are
derived from the alliances in the recent mergers. The following seem to be what the
Indian Banking sector is heading for:

As the economy revives fee based activities and asset quality of banks could
improve.

After adjusting for Non Performing Loans some public sector banks may have
to go in for fresh capital infusion.

Banks will have to compete with mutual funds as an alternative to bank deposits.

As public sector banks find their margins squeezed, they may become more
active in trading to make up for the margin squeeze. The risk profile of these public
sector banks may increase as their trading in money and forex markets
increase. Thus, a sound risk management i.e. the ALMs need to be in
place.

As competition compress spreads earned on lending business, banks

will have to focus on fee income. Private Banks are likely to
generate better fee income due to their focus on having adequate
technology and having skilled personnel to generate such business.

RBI is examining the feasibility of introduction of half yearly audit

of accounts by external auditors towards improving the quality of auditing
standards further.

New arenas for advancing may be surveyed, the housing loan sector
hasgained a considerable boosts as per the recent budgeta ry mea

65 | P a g e

sures;banks are allowed to lend 3 per cent of their advances to this sector,
also infrastructure and film financing remain untapped.

W ith the opening of the insurance sector and recent relaxation of

regulation by RBI for entry of banks in this area of business, some of the big
banks are expected to enter this business in a big way. Public sector banks
with their wide reach and higher confidence levels can take the lead.

All banks will have to adapt to new emerging technologies in order to exploit the new
business opportunities it offers. It will be a new challenge and will require investment
in technology and new systems.

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CHAPTER 3
REVIEW OF LITERATURE
The RBI governors recent observation about GOIs liquidity problems for allowing
further expansion of public sector banks adds to the confusion. If the financial sector
has to rise to the expectations in regard to credit delivery, especially to agriculture
and service sectors, the banking infrastructure will need structural reforms, skill
development and a change in outlook on HRD-related issues.
Public sector banks continue to shoulder more than their real share of the burden of
lending to traditional priority sector which includes agriculture and small borrowers.
Even if they come into being, the proposed additional private sector banks may not
be immediately in a position to support the critical areas which are neglected by
private sector banks to a large extent, as of now.
In this context, any further delay in comprehensive financial sector reforms, for
political reasons (compulsions of coalition politics, government not having adequate
dependable numbers in both the Houses), may have long-term adverse impact on
the countrys economic development. Perhaps, this is the right time for the finance
minister to open a debate for a consensus in the matter.
Here one has to admit that it is quite natural that as a regulatory body responsible for
the health of the financial sector, RBIs concerns go farther from just the net worth of
the promoter or his professional capability to run a bank. RBIs intention to regularize
and ratify the parallel banks which can conform to regulatory norms
and rehabilitate some RRBs (regional rural banks) which may have manpower and
infrastructure in place but may be finding it difficult to perform for want of leadership
as also the central banks desire to keep the business of banking trustworthy is
evident from the cautious approach of RBI in regard to new bank licenses despite
perceivable pressure from industry and to some extent from GOI.
Even when the RBI came out with the discussion paper on the issue of new
bank licenses, it was known that the idea of setting up some more private sector
banks was loaded with compulsions much beyond the governments stated intention
to give a greater role for private sector in banking to promote financial inclusion and
reduce governments financial commitments for running banks. The role so far
played by the private sector banks which came into being post-LPG (LiberalisationPrivatisation-Globalisation), which are driven by profit-motive, in lending to traditional
priority sector, penetration to semi-urban and rural areas and financial inclusion has
not been very impressive.

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It has to be said to the credit of RBI that the central bank effectively brought to the
fore the real issues and concerns of all stakeholders in the financial sector, about
new banking licenses. In the present scenario, the central bank should take initiative
to reopen the banking reforms agenda which was kept in the backburner after
allowing some banks in the private sector during the introductory years of financial
sector reforms.
In 1991, the Committee on Financial System (Narasimham Committee) visualized a
structure for Indian banking system with three or four large banks that could become
international in character; eight-10 banks with a network of branches throughout the
country engaged in universal banking; local banks whose operations would be
generally confined to a specific region and rural banks (including RRBs) whose
operations would be confined to the rural areas and whose business would be
predominantly engaged in financing of agriculture and allied activities. As more than
two decades have passed, though there may be reason to re-evaluate a suitable
model in the present context, the relevance of structural reforms has not lost validity.
Although the recommendations of the Narasimham Committee were realistic and
had kept in view the long-term credit needs and the inability of large banks to reach
out to un-banked and under-banked rural India, for various reasons including
compulsions of coalition politics, RBI and the Centre did not take a serious look at
reorganization of banking infrastructure. Banking services, in India evolved through a
multi-agency system and through different limbs, supported the credit needs of small
borrowers to a great extent.
The need of the hour is to ensure that all players in the business of banking in the
formal sector, namely, commercial banks, cooperatives and RRBs remain healthy
and perform their assigned roles effectively and the informal sector, through which
banks and NBFCs support microfinance needs, is also brought under financial
discipline through regulatory arms such as RBI, NABARD and state governments.
The present scenario is partly the result of GOI and RBI keeping the residual
banking sector reforms in the backburner after allowing some banks in the private
sector in the initial days of reforms. The debate in the media during the last couple of
years about new private sector bank licenses shows that a bank or a financial
institution is a different animal to different persons, depending on the persons
financial status and banking needs.
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At this delayed hour at least, a total view of banking needs of agriculture, industries
and service/export sectors and institutional infrastructure for meeting them may have
to be taken by the central bank. If this is not done, corporate at the national level and
small borrowers at the ground level will continue to bypass the banking system.
The RBI has been consistently playing a proactive role in institution-building in the
financial sector, since early 1950s. SBI, IDBI, NABARD and new private sector
banks are some examples of the central banks success stories in institutionbuilding. Despite its efforts, along with GOI, to improve the health of the rural
financial infrastructure by rehabilitation of existing cooperatives, trying experiments
like Regional Rural Banks and Local Area Banks and promoting financial inclusion,
adequate and cost-effective institutional credit is yet to arrive in rural India. The
proposed new private banks will initially be able to focus on large investors and
borrowers only, which will definitely have an impact on the sources and uses of
funds available to banks and financial institutions. In the circumstances, the central
bank should, while going ahead with the processes and procedures for allowing new
banks, simultaneously, reopen the banking reforms agenda.
The diversions so far provided for bigger banks to dilute their priority sector and rural
lending responsibilities should be reviewed with a view to ensure that depositmobilization gets tied up to the social responsibility of meeting the genuine credit
needs of all sectors considered relevant for overall economic development. If this is
not done corporate at the national level and small borrowers at the ground level will
continue to disbelieve the banking system and find out escape roots for deploying
their surpluses and meeting their financial needs.
The public sector-private sector divide in meeting social responsibilities also needs a
closer look. If this is not done corporate at the national level and small borrowers at
the ground level will continue to bypass the banking system.
Overlap of functions, large-scale outsourcing of activities and challenges from
business houses who are telling that if you will object to owning a bank, the same
objective will be achieved through an NBFC or some other arm or instrument which
can achieve desired objectives and reluctance of banks in the private sector to
directly penetrate below the creamy layer of the large majority which is waiting for
financial inclusion are all major areas of concern needing immediate response from
RBI.

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Chapter 4
DATA COLLECTION AND ANALYSIS
1) Do you have bank account?
Categories
Consumer Response

Yes
45

No
05

No
5%

Yes
45%

Interpretation:- In this pie chart we are calculating bank account of the customers. Have 45
customers are saying yes for this refer red color and 05 customers are saying no for this refer
blue color.

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2) Which type of account do you have?

Categories
Fixed deposit
Recurring deposit
Current deposit
Saving deposit

Consumer response
12
05
03
30

12
30

Fixed Deposit
5
3

Recurring Deposit
Current Deposit
Saving Deposit

Interpretation:- In this pie chart we are calculating types of account of the customers. Have
30 customers are saying savings deposits for this refer purple color, 03 customers are saying
current deposit refer green color, 05 customers saying recurring deposit refer red color and 12
customers are saying fixed deposit refer blue color.

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3) Which recent innovations came in banking industries do you like most?

Categories
RTGS
Online banking
SWIFT
Other

Consumer response
15
25
03
07

15
RTGS
Online Banking

25

SWIFT
Other

Interpretation:- In this pie chart we are calculating innovations came in banking sector. Have
15 customers are saying RTGS for this refer blue color, 25 customers are saying online
banking for this refer red color, 03 customers saying SWIFT for this refer green color and 07
customers are others for this purple color.

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4) Do you know that banking industries is growing up to mark as compared to other

countries?

Categories
Yes
No

Customer response
18
32

18

32
Yes
No

Interpretation:- In this pie chart we are calculating banking industries is growing up to mark
with customers. Have 18 customers are saying yes for this refer blue color and 32 customers
are saying no for this refer red color.

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5) Do you think that reformation bought in Indian banking system have increased
customer satisfaction?

Categories
Yes
No

Customer response
46
04

46

Yes

No

Interpretation:- In this pie chart we are calculating reformation bought in banking system
have increased customers satisfaction. Have 46 customers are saying yes for this refer blue
color and 04 customers are saying no for this refer red color.

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6) Which financial services you use mostly?

Categories
Mutual fund
Loan
Deposits
Others

Customer response
11
33
06
00

11
Mutual Fund
Loan
Deposit

33

Others

Interpretation:- In this pie chart we are calculating financial services of the customers. Have
11 customers are saying mutual fund for this refer blue color, 33 customers are saying loan
for this refer red color, 06 customers are saying deposits for this refer green color and 0
customers are saying others for this refer purple color.

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7) Where do you see the future of Indian banking industry?

Categories

Customer response

Growth
Same as it is now
Growing rapidly

08
0
41

0
growth
same as it is now
growing rapidly

41

growing continusly

Interpretation:- In this pie chart we are calculating future of Indian banking system with
customers. Have 08 customers are saying growth for this refer blue color, 0 customers are
saying same as it is now for this refer red color, 41 customers saying growing rapidly for this
refer purple color.

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8) What do you think privatisation helped the development in Indian banking industries?

Categories
Yes
No

Customer response
30
20

20

30
Yes
No

Interpretation:- In this pie chart we are calculating privatization helps the development in
banking system. Have 30 customers are saying yes for this refer blue color and 20 customers
are saying no for this refer red color.

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9) What do you think more beneficial to Indian banking industries?

Categories
Nationalisation
Privatisation

Customer response
15
35

15

35

Nationalisation
Privatisation

Interpretation:- In this pie chart we are calculating more beneficial to banking system. Have
15 customers are saying nationalization for this refer blue color and 35 customers are saying
privatization for this refer red color.

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10) Do you think FDI in Indian sector can help in development of Indian banking
industries?

Categories
Agree
Strongly agree
Disagree
Strongly disagree

Customer response
11
19
05
15

15

11
Agree
Strongly Agree
Disagree

19

Strongly Disagree

Interpretation:- In this pie chart we are calculating FDI in Indian banking system. Have 11
customers are saying agree with that for this refer blue color, 19 customers are saying
strongly agree for this refer red color, 05 customers are saying disagree for this refer green
color and 15 customers are saying strongly disagree for this refer purple color.

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11) What do you think Indian youth are getting motivated to use banking services?

Categories
Yes
No

Customer response
39
11

11

39

Yes
No

Interpretation:- In this pie chart we are calculating Indian youth are getting motivated to use
banking services. Have 39 customers are saying yes for this refer blue color and 11 customers
are saying no for this refer red color.

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CHAPTER 5
FINDINGS

Maximum employees have account in saving deposits as compared to fixed, current

account etc.

Many customers are using online banking to fast and easy ways.

More customers are thinking our banking industries is not growing up to mark as
compared to others countries.

Employees also think that if there is more reformation in banking sector than there will
be increased in customer satisfaction.

Loans financial services are mostly uses by the customers.

More customers want to growth rapidly in banking industries.

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CHAPTER 6

CONCLUSION
A personal view on reforms and developments in the Indian Banking Sector is stated below.

The reduction in SLR and CRR has been effective in the sense that the
lendable resources of banks have increased. The anticlimax is about the current
recession in the economy and decreasing need of investments by the corporate
sector.
The NPA trend has been fortunately declining in the recent years, initially the NPAs
were amounting to total of 16 %, and however banks should note that ever
greening of loans would deprave the circumstances in the long run; the asset quality is
today. The present evaluation process of banks states requires around
18officials for quality inspection, the bureaucracy involved can reduced
onlyby way of better bank supervision. The Disclosure norms shall avoi
dsituations like in case of South East Asian Crisis; with this respect, RBI
proves to be a quite proactive institution.
Globalisation has but lead to the liberalisation of the Indian Bankingsec
tor; like the other sectors opened up, today, the Indian banks need
tolearn much more from competition; customers and not advances andcustom
er service is the call for the day.
The DRT Act supersedes all acts but the SICA which clearly states that
companies can very easily stall recovery procedures. Its a fact in our
country that for every law made there is one more to escape f rom it.
However, the conceptualization of this structure needs to be acknowledged.
Increasing
risks
and
imprudent
liability
management
constitute
to
assetl i a b i l i t y m i s m a t c h . C o m p l a c e n t b e h a v i o u r o f I n d i a n b a n k s w i t
h t h i s context has lead to ALM reforms. This shall positively improve and get
bankers alert. The ALM framework if correctly implemented shall prove
useful.
Reduction of government stake seems to be a good decision of RBI, but on deeper analysis,
the control strongly remains with the government and it is a truth that bureaucracy
has become a side business. We still need to see what happens next! The corporate
can
now
have
a
good
deal
with
loans
and
advances;
theinterest rate deregulation has been in line with the internationalstandards. The cur
rent trend of falling rates shall indeed give thecorporate customers fair access with
better services.VRS was a government decision and about 11 % of the employees
retired. It was no form of a structural change but is a very effective tool to improve
efficiency of the Indian PSBs.

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I think a better plan would have been of investments in technology partially and then
aVRS.Currently,lots of banks are facing problems of inadequate staffing; a goodman
power planning in advance would not have lead to the currentproblem.About univers
al banking, due to increasing competition banks need to strive for customers, thus,
offering all at the same desks for corporate as well as individuals i.e. retail banking is
required; public sector needs to have a pace in this arena.
A merger to improve the overall health, reach and customer base has given a rise to
the trend of mergers globally. The recent merger of ICICI and BOM proves that
customer base has to develop for sustainability. Mergers constitute as a cheaper and
a quicker form of expansion and Indian banks should explore such an opportunity. The
opening of insurance has given banks a new opportunity to make the best out
of their resources; how much advantage does our PSBs make is yet to see. As far
as rural banks are concerned, GOI has to give personnel
bettercareer prospects in order to get them working, better products an
dconvenience and safety has to be guaranteed by the bank. Personalized service in a
crude form will help. Lastly, technological up gradation will be what will lead to customer
retention on the grounds of accessibility and convenience.

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APPENDIX

Brief background:India has a long history of both public and private banking. Modern banking in India
began in the 18th century, with the founding of the English Agency House in Calcutta
and Bombay. In the first half of the 19th century, three Presidency banks were
founded. After the 1860 introduction of limited liability, private banks began to
appear, and foreign banks entered the market. The beginning of the 20th century
saw the introduction of joint stock banks. In 1935, the presidency banks were
merged together to form the Imperial Bank of India, which was subsequently
renamed the State Bank of India. Also that year, Indias central bank, the Reserve
Bank of India (RBI), began operation. Following independence, the RBI was given
broad regulatory authority over commercial banks in India. In 1959, the State Bank of
India acquired the state-owned banks of eight former princely states. Thus, by July
1969, approximately 31 percent of scheduled bank branches throughout India were
government controlled, as part of the State Bank of India.
The post-war development strategy was in many ways a
socialist one, and the Indian government felt that banks in private hands did not lend
enough to those who needed it most. In July 1969, the government nationalized all
banks whose nationwide deposits were greater than Rs. 500 million, resulting in the
nationalization of 54 percent more of the branches in India, and bringing the total
number of branches under government control to 84 percent. Prakash Tandon, a
former chairman of the Punjab National Bank (nationalized in 1969) describes the
rationale for nationalization as follows: Many bank failures and crises over two
centuries, and the damage they did under laissez faire conditions; the needs of
planned growth and equitable distribution of credit, which in privately owned banks
was concentrated mainly on the controlling industrial houses and influential
borrowers; the needs of growing small scale industry and farming regarding finance,
equipment and inputs; from all these there emerged an inexorable demand for
banking legislation, some government control and a central banking authority, adding
up, in the final analysis, to social control and nationalization.

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After nationalization, the breadth and scope of the Indian banking sector expanded
at a rate perhaps unmatched by any other country. Indian banking has been
remarkably successful at achieving mass participation. Between the time of the 1969
nationalizations and the present, over 58,000 bank branches were opened in India;
these new branches, as of March 2008, had mobilized over 9 trillion Rupees in
deposits, which represent the overwhelming majority of deposits in Indian banks.
This rapid expansion is attributable to a policy which required banks to open four
branches in unbanked locations for every branch opened in banked locations.
Between 1969 and 1980, the number of private branches grew more quickly than
public banks, and on April 1, 1980, they accounted for approximately 17.5 percent of
bank branches in India.
Nationalized banks remained corporate entities, retaining most of their staff, with the
exception of the board of directors, who were replaced by appointees of the central
government.
The political appointments included representatives from the government, industry,
agriculture, as well as the public. (Equity holders in the national bank were
reimbursed at approximately par).
Since 1980, has been no further nationalization, and indeed the trend
appears to be reversing itself, as nationalized banks are issuing shares to the public,
in what amounts to a step towards privatization. The considerable accomplishments
of the Indian banking sector notwithstanding, advocates for privatization argue that
privatization will lead to several substantial improvements. Recently, the Indian
banking sector has witnessed the introduction of several new private banks, either
newly founded, or created by previously extant financial institutions. The new private
banks have grown quickly in the past few years, and one has grown to be the
second largest bank in India. India has also seen the entry of over two dozen foreign
banks since the commencement of financial reforms. While we believe both of these
types of banks deserve study, our focus here is on the older private sector, and
nationalized banks, since they represent the overwhelming majority of banking
activity in India.
Financial liberalization has, however, had a predictable effect in the distribution of
scheduled commercial banking in India. The reforms era growth in banking have
focused on the more profitable urban and metro areas of the country. Between 1969
85 | P a g e

and 1995 for instance, the share of the rural branches increased from about 22% to
over 58%. In 2004, the corresponding figure stood at a much lower 46%. The
number of rural bank branches actually declined from the 1991 figure of over 35,000
branches by about 3000 branches. Between 1969 and 1991 the share of urban and
metro branches fell from over 37% to less than 23%. In the years since it has
crawled back up to over 31%. Figure provides a snapshot of this changing facet of
Indian banking.
As the real sector reforms began in 1992, the need was felt to restructure the
Indian banking industry.
The reform measures
necessitated the
deregulation of the financial sector, particularly the banking sector. The initiation of
the
financial
sector
reforms
brought
about
a
paradigm
shift
int h e b a n k i n g i n d u s t r y . I n 1 9 9 1 , t h e R B I h a d p r o p o s e d t o f r o
m t h e committee chaired by M. narasimham, former RBI Governor in order
to
review t h e F i n a n c i a l S y s t e m v i z . a s p e c t s r e l a t i n g t o t h e S t r u c t u r e ,
Organisations and Functioning of the financial system. The Narasimham
Committee report, submitted to the then finance minister, Manmohan Singh,
on the banking sector reforms highlighted the weaknesses in the
Indian banking system and suggested reform measures based on theB
asle norms. The guidelines that were issued subsequently laid thefound
ation for the reformation of Indian banking sector. The main recommendations of the
Committee were:-

i.

Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of

five years.

ii.

Progressive reduction in Cash Reserve Ratio (CRR).

iii.

Phasing out of directed credit programmes and redefinition of the priority

sector.

iv.

Deregulation of interest rates so as to ref lect emerging market

conditions.

v.

Stipulation of minimum capital adequacy ratio of 4 per cent to risk

weighted assets by March 1993, 8 per cent by March 1996, and
8percent by those banks having international operations by March1994.
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vi.

vii.

Adoption of uniform accounting practices in regard to incomer

ecognition, asset classification and provisioning against bad and
doubtful debts.
Setting up of special tribunals to speed up the process of recovery of loans
revised procedure for selection of Chief Executives and Directors of Boards of
public sector banks.

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Questionnaires
VIDYALANKAR SCHOOL OF INFORMATION TECHNOLOGY

Name
:_______________________________________
Email address
:_______________________________________
Age
:_______________________________________
Contact no (if interested) :_______________________________________

I am the student of Vidyalankar Collage, department of banking studies and

presently doing a project on Reforms in Banking Sector. I requested you to kindly
fill the questioners below and assure you that the data generated shall be kept
confidential.

1) Do you have bank account?

a. Yes
b. No
2) Which type of account do you have?
a.
b.
c.
d.

Fixed Deposit
Recurring Deposit
Current Deposits
Saving Deposits

3) Which recent innovations came in banking industries do you like most?

a.
b.
c.
d.

RTGS
Online banking
SWIFT
Other

4) Do you know that banking industries is growing up to mark as compared to

other countries?
a. Yes
b. No
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5) Do you think that reformation bought in Indian banking system have increased
customer satisfaction?
a. Yes
b. No
6) Which financial services you use mostly?
a.
b.
c.
d.

Mutual fund
Loan
Deposit
Other

7) Where do you see the future of Indian banking industry?

a.
b.
c.
d.

Growth
Same as it is now
Growing continuously
Growing rapidly

8) What do you think privatisation helped the development in Indian banking

industries?
a. Yes
b. No
9) What do you think more beneficial to Indian banking industries?
a. Nationalisation
b. Privatisation
10) Do you think FDI in Indian sector can help in development of Indian banking
industries?
a.
b.
c.
d.

Agree
Strongly agree
Disagree
Strongly agree

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11) What do you think Indian youth are getting motivated to use banking
services?
a. Yes
b. No

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Bibliography

Reference books.
1. Ed. Peelon, Reform in Banking sector, publisher Dorling Kindersley, 2009.
2. Dr.KF Sen, Banking, publisher tech mark 2011.

NEWSPAPERS
BUSINESS ECONOMICS.
HINDUSTAN TIMES.

Webliography
www.rbi.co.in
www.indianbank.com

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