Core banking is a general term used to describe the services

provided by a group of networked bank branches. Bank customers

may access their funds and other simple transactions from any of
the member branch offices.

Core Banking
Core Banking is normally defined as the business conducted by a
banking institution with its retail and small business customers.
Many banks treat the retail customers as their core banking
customers, and have a separate line of business to manage small
businesses. Larger businesses are managed via the Corporate
Banking division of the institution. Core banking basically is
depositing and lending of money.
Normal core banking functions will include deposit accounts,
loans, mortgages and payments. Banks make these services
available across multiple channels like ATMs, Internet banking,
and branches.
Core Banking Solutions
Core Banking Solutions is new jargon frequently used in banking
circles. The advancement in technology, especially internet and
information technology has led to new ways of doing business in
banking. These technologies have cut down time, working
simultaneously on different issues and increasing efficiency. The
platform where communication technology and information
technology are merged to suit core needs of banking is known as
Core Banking Solutions. Here computer software is developed to
perform core operations of banking like recording of transactions,
passbook maintenance, and interest calculations on loans and
deposits, customer records, balance of payments and withdrawal
are done. This software is installed at different branches of bank
and then interconnected by means of communication lines like

telephones, satellite, internet etc. It allows the user (customers)

to operate accounts from any branch if it has installed core
banking solutions. This new platform has changed the way banks
are working. Now many advanced features like regulatory
requirements and other specialized services like share (stock)
trading are being provided. Core banking solutions are very
helpful to SME industries.
Around the world
In countries such as India and Hong Kong that were a part of the
British empire, it is only recently that core banking has caught on.
This is mainly due to the restrictions by the UK government on
free movement of money throughout the region. Also, the IT
infrastructure necessary for such services did not exist in these
countries until recently. After Britain chose to give these countries
their freedom, the economies of these countries went through a
drastic change - thus the demand for such services increased and
the need to meet such demand were met with today's
technologies. Most of the nationalized banks in India for example:
Canara Bank, State Bank of India, Punjab National Bank and
Allahabad Bank today support core banking. As of 2007, many
Cooperative banks in India such as REPCO Bank, Jain Urban
Cooperative Bank, Kangra Central Cooperative Bank, Udaipur
Urban Cooperative Bank, Kollam District Cooperative Bank, Kerala
State Cooperative Bank and Panchsheel Mercantile Cooperative
Bank have started to use and offer centralized Core Banking too.
Oracle Flexcube from Oracle Financial Services, Intellect Suite
from POLARIS, Finacle from Infosys and B@ncs from TATA
Consultancy Services have a major market share. Other players in
this arena include Temenos, Tieto Enator and Misys
In the public sector banking has first evolved from automating the
accounting processes in a stand alone mode and subsequently
graduated into so called TBM's which in reality only integrated the
these stand alone accounting applications. Several registers,
legers scrolls and other forms of MIS continue to be generated
manually in the branch. Several application packages still function
in a stand alone mode even in a TBM branch like FDR, PPF etc.
Such disjointed view of the branches resulted in a complex

unmanageable IT infrastructure within these banks such

distributed data based / applications pose sever administrative
problems. Changing / modifying applications imply that these
changes need to be applied over vast geographically distributed
systems, resulting in slow and error prone updating.
With frequent interest rate changes, product launches regulatory
report MIS needs, it is indeed a night mare to carryout these
changes across 1500 odd branches and retrieve the information
and consolidate them to yield specific MIS reports. Added to this is
the quality of Data emanating from branches. Most data entry
operations are out sourced and validity of such massive data is
questionable. It is often said, albeit in a lighter vein, that if the
weekly return same week, then it would be different repeatability,
integrity and accuracy, became real issues.
In one panoramic / integrated view and develop that package. It is
beyond view of the branches view of the market and customers.
This holistic view is implemented in centralized software called
Core Banking.
Information Technology Idea:
If one sits down coolly and ponders over all these issues that
them would make any same mind to seek a strategy that will
solve. If not all, most of the problems Look around the world and
see what others are doing? A core part of that strategy is
deployment of a centralized core banking system. Today after
decades of existence outside India it is now been talked about
only now in our country. This is the only way to run a bank.
From business perspective Core Banking relates to the basic
business of a bank or financial institution. That in a nut shell is
taking deposits from customers and lending to customers. While
doing so, ensure that profits are generated for the bank. From a
technology perspective Core Banking is the short name for a
Centralized Banking system that a bank has to deploy in order to
perform its core banking business.
Core Banking:

The reason for calling it Core Banking System, after deployment,

is the hart or the Core of the Bank / financial institution. All
entities that form part of the eco-system of the bank / financial
institution interact with. The entities are;
* Bank employees head office, regional offices, branches etc
* Bank Management: executives / managers at respective
locations head office, regional offices branches etc
* Bank customers: Personal banking, corporate banking
international banking etc.
* Bank Auditors, internal and external auditors who need to verify
systems and procedures.
* Bank Regulators: mandatory reporting to central bank and other
financial bodies.
* Bank share holders: providing the desired return to shareholders
from banking operations.
For a bank / financial institutions the Core Banking system must
address the Core Business of deposits and loans and the same
time, address the work place needs of all above entitles at their
respective locations.
Ingredients:
There are 5 ingredients that form part of the Core Banking
system. These are the essential building blocks for the entire bank
/ institution.
(1) General Ledger:
The absolute Core is the General Ledger of the bank accordingly,
the absolute core of the banking system is the General Ledger
system, every single financial activity that happens at any
location within entire bank has to be reflected in the G.L. system
that generates the financial statements for the entire bank which
provides any entity to monitor the financial health of the bank.
Throughout the world, almost all banks have all their financial
activity reflected in G.L. every night and next morning the G.L.
system provides the bank with enterprise wide balance sheet and

trial balance report In short for those who have successfully

implemented Core Banking Systems, the concerned entities in the
bank know the financial condition of the bank at the beginning of
each business day. If one is looking at the financial statements of
the whole bank the G.L. System must provide that. If one is in
regional office, the G.L. System must provide the financial
statements for the region. If one is the branch the G.L. System
must provide the financial statements at the branch. Each
morning all these entities, at the respective workplaces, see these
financial statements reflecting the condition as of close of
business yesterday.
In a Core Banking System, this is achieved by deploying a
centralized G.L. System which provides for thousands of sub
legers with. Level's start with individual branch G.L. rolled up to
regional G.L. with further rollup of all regional G.L's to bank G.L.
financial transactions from various sources throughout the bank
update these subsidiary ledgers and the G.L. system then
performs rollups to report at branch, region, zone, country wise
head office and any other level that is required by the bank /
financial institution.
(2) Customer Information System:
The next major ingredient of a Core Banking system is the
Customer Information System or CIS. Accordingly in the CIS, a
customer is identified by uniquely by his / her CIS number and all
information related to that customer (name, address, phones,
employment, credit history, relatives, family members, and
demographic data) is stored along with this unique number. All
this is stored in a centralized CIS system allowing the customer to
visit any branch to do business with the bank.
In addition, CIS stores Customer to account relationships. A single
unique customer could have a current account a joint saving
account with his wife a time deposit, a car loan and a house loan.
The CIS links all these five account to this single unique customer
I.D. whenever the customer visits any branch of the bank, all that
he does is give his name (and / or address or phone or CIS
number) and the CIS system shows the branch staff the

information about this customer as well as all the accounts linked

to this customer and the latest balance in each of these account.
(3) Deposit System:
The third major ingredient is the deposit system. The ability to
process various types of deposits is a must. These include current,
savings, time deposit and hundreds of variations in each of these.
e.g. Simple current accounts, current accounts with overdraft,
cash credit accounts, variable rate overdrafts, simple savings,
multi-currency savings, time deposits, CDS, variable rate time
deposit, recurring deposits, multi-currency, time deposits, and so
on. This is required to handle the liability side of the bank /
financial institution's business.
This all is achieved by having deposits system that are heavily
deposit system that are heavily parameterized i.e. by simply
setting a parameter "Fixed Rate" or "Variable Rate" the deposit
account will be processed by the deposit system using the
appropriate rate from the applicable rates.
Around the world banks do not open a new deposit account for a
customer directly in the deposit system. When the customer
wants to open a new deposit account, the branch staff to go the
CIS screen verifies the customer details and opens the account.
This way, the existing CIS data of the customer remains infect and
the CIS information shows that this customer has now increased
his relationship with the bank / financial institution. As a result
banks who have implemented such systems do not need to have
an inter branch reconciliation organization / system.
(4) Loan System:
The fourth major ingredient is the loan system. This system
handles the asset side of this business. In most banks / financial
institutions around the world loans are separated by those to
retail customer and those to commercial customers processing
requirement of loans to corporate customers is different form
retail customers and hence there are loan systems that cater to

retail customers and those that cater to commercial or corporate

customers.
The loan process in a bank involves multiple stems. The loan
appraisal and sanction step, the disbursement and monitoring
step, the non-performance tracking step the recovery step and
the closure. Owing to the fact that a multitude of entities and
processes are involved in the appraisal and sanction step, most
banks around the world separate the appraisal and sanction step
and implement a system called a loan organization system. The
other remaining steps of the loan process are handling by the
loan system.
With authorized access, any staff working in any branch around
the country should be able to retrieve the customer loan
information on his terminal and help the customer do a financial
transaction. These financial transactions are automatically sent to
the bank / financial institution's General Ledger and they update
the appropriate credits and debits in the subsidiary ledgers in the
General Ledger.
(5) Management Information System (MIS):
Once the core deposit and loan business transaction for all
customers of the bank are captured and appropriate General
Ledger accounts are updated, various users of the Core Banking
System throughout the bank need to know what is happening
within the entire financial institution. As a result, the fifth major
ingredient is the management information system. This enables
everybody in the bank to obtain the relevant information from the
system in order to carry out their business effectively.
MIS is simple terms takes information from the General Ledger,
CIS Deposit, Loan Systems and present them to the bank /
financial institution. The staff all employees including
management.
Around the world, typical examples of information that bank staff
(each with access rights) retrieves include.

* Branch transaction activity for today ( list of all branch

transactions )
* Loan activity for a single customer or a group of customer.
* Branch General Ledger report printed at the branch.
* N P A report for the entire bank for all transactions as of
yesterday.
New Components:
Besides the 5 major ingredients, there are optional components
(like a car with options like leather seats, flashing light etc) that
can be added on to the Core Banking Systems to help the bank
staff uses them in a more efficient manner, these include:
Delivery Channels:
All the 5 major ingredients of a Core Banking system can be
operated by a bank staff from any location in the country simple
by using their terminal at their workplace. Around the world as
banks started focusing on customer relationship management,
they realized that customers interact with the entire bank for
banking transactions in many ways. Customer can go to the
branch, go to an ATM, call on the phone, and log on to the
Internet to do their banking transactions. They can use one or
more of these delivery channels (Called customer touch paints) to
conduct segment and decide on further investment design
specific products and services to promote such delivery channels.
The Core Banking Systems are production factories creating
products and services and tracking them and the delivery
channels are distributors and retailers who ensure these products
and services are available to the customers whenever they are in
the country. Hence, the add-on systems for Core Banking System
include;
*
*
*
*

Branch Automation system

ATM Switch and connected ATM
Call center system
Internet Banking System

Any transaction done by the customers in any of the above

systems goes and updates the Core Banking System like deposit
or loan at that in turn updates the Bank's G.L. in the Core.
What ingredients are not included in Core Banking?
Typically these systems are confined to a specific business
department within the bank. They are not Core because they do
not affect all areas and entities of the bank.
* Trade finance
* Treasure
* Credit Card
* Mutual Funds
* Stocks, Bonds
* External System
* Payment gateways
* SWIFT
* Shared ATM network
* World Wide credit card networks, maestro, electron etc
* World wide ATM networks plus, Cirrus etc and possibly other
systems that the bank may want to deploy in specific
departments
Impact of Core Banking:
The Core Banking Systems have to satisfy the requirements of all
the entities that form part of the eco-system of the Bank.
[1] Bank Employee: Head office, regional offices, branches etc:
Using Core banking System. With appropriate authority employee
as given above can help customers do their financial transaction.
[2] Bank management: Executives / managers at respective
locations, head office, regional offices, branches etc. can obtain
the financial position from Core Banking Systems related the
respective sphere of banking operations and thus help pinpoint
potential problems so as to avoid crises.

[3] Bank Customers: Can operate any of their accounts from

any branch or preferred delivery channel and have access to his
funds any time 24 hours a day.
[4] Bank Auditors : Ones accounts audited, they operate the
same year on year thus enabling auditors to focus more on
systems and procedures at delivery channels like branches, call
center etc.
[5] Bank regulators: Core Banking Systems produce the
required reports for regulatory bodies like the central bank,
financial statement, asset and liability reports, NPA reports, large
currency transaction reports etc. are all produced by either the
deposits, or the loan or a combination of deposit, loan and G.L.
System.
[6] Bank Share Holders: C.B. providing the desired return to
shareholders from banking operations Trends overtime on such
data informs S.H. about how the banks is doing and help take
timely action to accelerate or improve performance.

Retail banking
It refers to banking in which banking institutions execute
transactions directly with consumers, rather than corporations or
other banks. Services offered include: savings and checking
accounts, mortgages, personal loans, debit cards, credit cards,
and so forth.Typical mass-market banking in which individual
customers use local branches of larger commercial banks.
Services offered include savings and checking accounts,
mortgages, personal loans, debit/credit cards and certificates of
deposit (CDs).
Retail banking aims to be the one-stop shop for as many financial
services as possible on behalf of retail clients. Some retail banks
have even made a push into investment services such as wealth

management, brokerage accounts, private banking and

retirement planning. While some of these ancillary services are
outsourced to third parties (often for regulatory reasons), they
often intertwine with core retail banking accounts like checking
and savings to allow for easier transfers and maintenance.
Banking in India-Banking on Retail
With a jump in the Indian economy from a manufacturing
sector, that never really took off, to a nascent service sector,
Banking as a whole is undergoing a
change. A larger option for the consumer is getting translated into
a larger demand for financial
products and customisation of services is fast becoming the norm
than a competitive advantage.
With the Retail banking sector expected to grow at a rate of 30%
[Chanda Kochhar, ED, ICICI
Bank] players are focussing more and more on the Retail and are
waking up to the potential of
this sector of banking. At the same time, the banking sector as a
whole is seeing structural
changes in regulatory frameworks and securitisation and stringent
NPA norms expected to be in
place by 2004 means the faster one adapts to these changing
dynamics, the faster is one
expected to gain the advantage. In this article, we try to study the
reasons behind the euphemism
regarding the Retail-focus of the Indian banks and try to assess
how much of it is worth the
attention that it is attracting.
Potential for Retail in India: Is sky the limit?
The Indian players are bullish on the Retail business and this is
not totally unfounded. There are
two main reasons behind this. Firstly, it is now undeniable that the
face of the Indian consumer is
changing. This is reflected in a change in the urban household
income pattern. The direct fallout

of such a change will be the consumption patterns and hence the

banking habits of Indians,
which will now be skewed towards Retail products. At the same
time, India compares pretty
poorly with the other economies of the world that are now
becoming comparable in terms of
spending patterns with the opening up of our economy. For
instance, while the total outstanding
Retail loans in Taiwan is around 41% of GDP, the figure in India
stands at less than 5%. The
comparison with the West is even more staggering. Another
comparison that is natural when
comparing Retail sectors is the use of credit cards. Here also, the
potential lies in the fact that of
all the consumer expenditure in India in 2001, less than 1% was
through plastic, the
corresponding US figure standing at 18%.
But how competitive are the players?
The fact that the statistics reveal a huge potential also brings with
it a threat that is true for any
sector of a country that is opening up. Just how competitive are
our banks? Is the threat of getting
drubbed by foreign competition real? To analyze this, one needs
to get into the shoes of the
foreign banks. In other words, how do they see us? Are we good
takeover targets?
Going by international standards, a large portion of the Indian
population is simply not bankable
taking profitability into consideration. On the other hand, the
financial services market is highly
over-leveraged in India. Competition is fierce, particularly from
local private banks such as HDFC
and ICICI, in the business of home, car and consumer loans.
There, precisely lie the pitfalls of
such explosive growth. All banks are targeting the fluffiest
segment i.e. the upwardly mobile urban
salaried class. Although the players are spreading their operations
into segments like selfemployed

and the semi-urban rich, it is an open secret that the big city
Indian yuppies form the
most profitable segment. Over-dependence on this segment is
bound to bring in inflexibility in the
business.
What about the foreign giants?
The foreign banks have identified this problem but there are
certain systematic risks involved in
operating in the Retail market for them. These include
regulatory restrictions that prevent them
from expanding their branch network. So these banks often take
the Direct Selling Agent (DSA)
route whereby low-end jobs like sourcing or transaction
processing are outsourced to small
regional layers. So now on, when you see a loan mela or a road
show showcasing the retail
bouquet of an elite MNC giant, you know that a significant
commission earned out of any such
booking gets ploughed back to our own economy. Perhaps, one of
the biggest impediments in
foreign players leveraging the Indian markets is the absence of
positive credit bureaus. In the
west the risk profile can be easily mapped to things like SSNs and
this information can be publicly
traded. PAN is a step in this direction but lot more work need to
be done. What has been a
positive step towards this is a negative file sharing started by a
consortium of 11 banks. However,
as a McKinsey study points out actual write-offs on NPAs show a
strong negative correlation with
sharing of positive information. On top of this, the spend-now-paylater credit culture in India is
just not picking up. A swift legal procedure against consumers
creating bad debt is virtually nonexistent.
Finally, the vast geographical and cultural diversity of the country
makes credit policy
formulation a tough job and it simply cannot be dictated from a
Wall Street or a Singapore

boardroom! All these add up to the unattractiveness of the Indian

retail market to the foreign
players.
So over the past few years, in spite of the entry of MNCs in many
industries, Retail Banking has
seen a flurry of panicky exits. Fewer than 40 remain in India and
their share of total bank assets
currently 7.2% is falling. Those that remain might be thought to
be likely buyers of Indian banks.
Yet Citibank, HSBC and Standard Charteredall in India for more
than a century, and with
relatively large retail networksseem to have no pressing need to
acquire a local bank.
Established foreign banks have preferred to take over customers
or businesses from other
foreign banks that want to leave. Thus HSBC, in recent years, has
acquired customers from
France's BNP, Germany's Deutsche Bank and Japan's Bank of
Tokyo-Mitsubishi. ABN Amro took
over Bank of America's retail business.
So all for the keeping then?
This will perhaps be the most wrongful inference that can be
drawn from the above. We just
cannot afford to look inwards and repeat the mistakes that were
the side effects of the
Nationalization of the Banking System. A growing market can
never be an alibi for lack of
innovation. Indian banks have shown little or no interest in
innovative tailor-made products. They
have often tried to copy process designs that have been tested,
albeit successfully, in the West.
Each economic culture has its own traits and one who successfully
adapts those to the business
is the eventual winner. A case in point is the successful
implementation of micro-credit networks
in Bangladesh. Positioning a bank as a tech-savvy financial vendor
in a country where Internet

penetration is an abysmal 1.65% can only add to the overleveraging as pointed out earlier. The
focus of the sector should remain in macroeconomic wealth
creation and not increasing the per
capita indebtedness that will do little but add to the NPA burden.
Retail Banking in India has to be
developed in the Indian way, notwithstanding the long queues in
front of the teller counter in the
SBI Joka branch!

UNIVERSAL BANKING THE INDIAN PERSPECTIVE

Universal Banking, means the financial entities the commercial

banks, DFIs, NBFCs, - undertake multiple financial activities under
one roof, thereby creating a financial supermarket. The entities
focus on leveraging their large branch network and offer wide
range of services under single brand name.
Universal banking generally takes one of the three forms: a. In-house Universal banking. Eg. Germany
b. Through separately capitalized subsidiaries. Eg. England.
c. Operations carried through a holding company. Eg. USA. (Nair,
1998)
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. It is a combination 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.
A narrow view of Universal banking could be activities pertaining
to lending plus investments in bonds and debentures. A broader
view could include a basket of all the financial activities including
insurance. Though the concept is prevalent in countries like
France, Germany and USA but is yet to take-off, officially in India.
International Scenario
Federal Republic of Germany, Switzerland are generally known to
be the home of universal banking. Factors like technological up
gradation, wide spread of applications, increasing competition in
financial sector etc., are the driving forces in these nations. In few
other European countries, almost all other banking and nonbanking services are carried out by financial institutions. For
instances, in Germany, commercial and investment banking
activities are performed by a single entity, but separate
subsidiaries are required for other activities. In UK a separate
subsidiaries of commercial banks involve in providing wide range
of activities.
What the USA follows is an extreme model, where the commercial
banks are prevented legally from combining their normal lending
functions with investment operations, where they are separated
by several legislative acts, including the Glass-Steagall Act of
1933 and the bank Holding company Act of 1956. However, at
present USA is having a re-look at the position. Much of the
international debate on universal banking has been centered
around the restriction on diversification of the type.
Indian Scenario

1. Commercial banks
In early 90's the financial sector in India was crying out for
reforms. Ever since the process of liberalization hit the Indian
shores, the banking sector saw the emergence of new-generation
private sector banks. Public sector banks which played a useful
role earlier on are now facing deterioration in their performance.
For very long, the banks in India were not allowed to have access
to stock markets. So their dealing in other securities were
minimal. But the financial sector reforms changed it all, Indian
banks started to deal on the stock market but their bitter
experience with scams, they became averse to deal in equities
and debentures. Off late, commercial banks in India have been
permitted to undertake a range of in-house financial services.
Some banks have even setup their own subsidiaries for their
investment activities. Subsidiaries include in the area of merchant
banking, factoring, credit cards, housing finance etc.
2. Financial Institutions
DFIs were traditionally engaged in long term financing, as their
main objective was to take care of the investment needs of
industries and to contribute to a better industrial climate. They
had, over the time, built up expertise in merchant banking,
project evaluation and also started giving working capital finance.
Recently, they were allowed to accept medium-term deposits
within the specified limits. Lots of changes have taken place in
DFIs in the recent past. Most of DFIs have floated banks,
institutions and mutual fund subsidiaries. Ownership changes
took place, several institutions went public, organization structure
itself got transformed.
Indian Perspective on Universal Banking

Some argue that the approach is very slow, while some call for
steady approach. The debate of universal banking is very much
on. Should India have universal banking and if so when? Much has
been written about it domestically, however the following are the
issues which are key in Indian context.
i. Regulatory burden
ii. Regulatory requirements
iii. Distinction between maturity and duration
iv. Optimum Transition path
i. Regulatory burden:
One of the major problems associated with universal banking is
the issue of regulation. DFIs in India are governed by separate
Acts and banks are regulated by RBI and Banking Regulation Act.
DFIs in India have commercial banks as their subsidiaries, but due
to the separation of regulation, the DFIs cannot have direct
access to the resource base of its subsidiary bank. Without any
doubt, the net regulatory burden for all participants in the entire
financial system should be equalized in order to ensure that no
participant might end up having a disadvantage relative to any
other. The importance of this point can be highlighted by citing
the example of USA, Japan, West Germany and Britain where
there was a tremendous decline in the share of banks in
composition of household financial assets and its movement to
mutual funds and insurance. The study reveled that the decline
has been due to very high net regulatory burden being imposed
upon the entire banking system relative to that on the mutual
funds and insurance companies. In India there is an urgent need
to reduce the regulatory burden, particularly for banks vis--vis

mutual funds and insurance companies, if the banks are expected

to compete in free market place. (Mor, 1999)
ii. Regulatory requirements
The reference of regulatory requirements here are on the
following issues
a. Cash Reserve Ratio (CRR): From early 90's the monitory policy
in India has been focusing on review of CRR. Off late RBI is
concentrating more so on indirect instruments like Bank Rate and
Open Market Operations, and felt that the CRR must be brought
down to its minimum level of 3 percent at the earliest. It is also
argued by some experts that instead of the complete Net Demand
and Time Liabilities (NDTL) of banks, its application if restricted
only to cash and cash like instruments, it would be more effective
as an instrument of monetary policy and by applying the ratio, for
the senior bonds that may be issued by banks to industry, is not
in the interests of Monetary policy and this would further increase
the cost of funds to the industry by almost at 1 percent.
b. Statutory Liquid Ratio (SLR): Though, the SLR has already
reached its statutory minimum of 25 percent, some experts feel
there is need to re-examine the present minimum limit, which is
very high as per the international practices and could be brought
down further by amending the Banking Regulation Act. Few
banking experts extended to specific infrastructure projects as a
part of SLR, since these facilities have directly replaced similar
financing by Government of India.
c. Priority Sector: The whole issue of priority sector needs a closer
look. The S.H Khan panel called for modifications in defining the
priority sector by excluding all infrastructure loans from the net
bank credit for the priority sector. It has also suggested the

creation of an alternative mechanism to finance the priority

sector.
Even the international experience of banks in Asia-Pacific region
had a 'must serve' obligation towards priority sector and the
result was discriminatory and inefficient performance without the
support of commercial mindset.
iii. Distinction between Maturity and Duration
This is the another issue of debate between long term and short
term. Somehow DFIs are the suppliers of term finance, where the
maturity is clearly specified which could be between 3 years to 7
years, where as banks are providers of short-term finance where
in reality bank finance in a way amounts to financing in perpetuity
since there are in general no definite maturity dates. Usually the
deposit base of the banks have are short duration but with a
variably high interest rates but its not the case with DFIs. Their
funds have a longer duration with less interest rates. (Mor, 1999)
The interim report of S H Khan committee has argued that the
distinction between commercial and investment banking have
become increasingly blurred with banks providing both working
capital and term loans to corporates but DFIs can provide only
term loans as they cannot accept short term deposits. The
committee further argued that DFIs should be given banking
licenses eventually and until then they should be allowed to
establish 100 percent banking subsidiaries while they continue to
play their present role.
iv. Optimal Transition path
Viable transition path is one of the major areas of concern for
institutions which are desirous of moving in the direction of

universal banking. The transition path contains several

operational and regulatory issues for information and guidance of
DFIs. The S H Khan working group and the discussion paper on
the subject prepared by RBI eventually felt that DFIs should
transform themselves into commercial banks but in a phased
manner. The committee also recommended that DFIs can have
100 percent owned banking subsidiaries which would be
extremely beneficial to them. If this happens, then it would allow
DFIs to gain expertise in the area of commercial banking which
would in turn help the DFIs if they are seriously looking at the
prospect of converting into a commercial bank. Also the 100
percent subsidarisation allows banks to have a full access to
capital base of DFIs and gain substantial knowledge in the area of
project financing.
The RBI has asked FIs, which are 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 a universal bank over a specified time
frame. The plan should specifically provide for full compliance
with prudential norms as applicable to banks over the proposed
period.
Considerations
Caution must be applied on Universal banking because of the
following considerations:
1. Dis-intermediation (i.e replacement of traditional bank
intermediation between savers and borrowers by a capital market
process) is only a decade old in India and has badly slowed down
due to loss of investors' confidence.

2. There is an ample room for financial deepening (by banks &

DFIs) since loan market will continue to grow.
3. DFIs as a folder of equity in most of the projects promoted in
the past have never used the tool advantageously.
4. DFIs are now only moving into working capital finance, an area
in which they need to gain lot of expertise and this involves
creation of network of services (including branches) in all fields
like remittances, collections etc.
5. Reforms in the Indian capital market is still in the half way
stage. The priority will be to ensure branch expansions, financial
deepening of credit markets, and creation of an efficient credit
delivery mechanism that can compete with the capital market.
Salient operational and regulatory issues to be addressed by the
FIs for conversion into a Universal Bank [RBI circular]
a) Reserve requirements
Compliance with the cash reserve ratio and statutory liquidity
ratio requirements (under Section 42 of RBI Act, 1934, and
Section 24 of the Banking Regulation Act, 1949, respectively)
would be mandatory for an FI after its conversion into a universal
bank.
b) Permissible activities
Any activity of an FI currently undertaken but not permissible for a
bank under Section 6(1) of the B. R. Act, 1949, may have to be
stopped or divested after its conversion into a universal bank.
c) Disposal of non-banking assets -

Any immovable property, howsoever acquired by an FI, would,

after its conversion into a universal bank, be required to be
disposed of within the maximum period of 7 years from the date
of acquisition, in terms of Section 9 of the Banking Regulation Act.

d) Composition of the Board

Changing the composition of the Board of Directors might become
necessary for some of the FIs after their conversion into a
universal bank, to ensure compliance with the provisions of
Section 10(A) of the B. R. Act, which requires at least 51% of the
total number of directors to have special knowledge and
experience.
e) Prohibition on floating charge of assets
The floating charge, if created by an FI, over its assets, would
require, after its conversion into a universal bank, ratification by
the Reserve Bank of India under Section 14(A) of the Banking
Regulation Act, since a banking company is not allowed to create
a floating charge on the undertaking or any property of the
company unless duly certified by RBI as required under the
Section.
f) Nature of subsidiaries
If any of the existing subsidiaries of an FI is engaged in an activity
not permitted under Section 6(1) of the B R Act, then on
conversion of the FI into a universal bank, delinking of such
subsidiary / activity from the operations of the universal bank
would become necessary since Section 19 of the Act permits a
bank to have subsidiaries only for one or more of the activities

permitted under Section 6(1) of Banking Regulation Act.

g) Restriction on investments
An FI with equity investment in companies in excess of 30 per
cent of the paid up share capital of that company or 30 per cent
of its own paid-up share capital and reserves, whichever is less,
on its conversion into a universal bank, would need to divest such
excess holdings to secure compliance with the provisions of
Section 19(2) of the Banking Regulation Act, which prohibits a
bank from holding shares in a company in excess of these limits.
h) Connected lending
Section 20 of the Banking Regulation Act prohibits grant of loans
and advances by a bank on security of its own shares or grant of
loans or advances on behalf of any of its directors or to any firm in
which its director/manager or employee or guarantor is
interested. The compliance with these provisions would be
mandatory after conversion of an FI to a universal bank.
i) Licensing
An FI converting into a universal bank would be required to obtain
a banking license from RBI under Section 22 of the Banking
Regulation Act, for carrying on banking business in India, after
complying with the applicable conditions.
j) Branch network
An FI, after its conversion into a bank, would also be required to
comply with extant branch licensing policy of RBI under which the
new banks are required to allot at east 25 per cent of their total
number of branches in semi-urban and rural areas.

k) Assets in India
An FI after its conversion into a universal bank, will be required to
ensure that at the close of business on the last Friday of every
quarter, its total assets held in India are not less than 75 per cent
of its total demand and time liabilities in India, as required of a
bank under Section 25 of the Banking Regulation Act.
l) Format of annual reports
After converting into a universal bank, an FI will be required to
publish its annual balance sheet and profit and loss account in the
in the forms set out in the Third Schedule to the B R Act, as
prescribed for a banking company under Section 29 and Section
30 of the Banking Regulation Act.
m) Managerial remuneration of the Chief Executive Officers
On conversion into a universal bank, the appointment and
remuneration of the existing Chief Executive Officers may have to
be reviewed with the approval of RBI in terms of the provisions of
Section 35 B of the Banking Regulation Act.
The Section stipulates fixation of remuneration of the Chairman
and Managing Director of a bank by Reserve Bank of India taking
into account the profitability, net NPAs and other financial
parameters. Under the Section, prior approval of RBI would also
be required for appointment of Chairman and Managing Director.
n) Deposit insurance
An FI, on conversion into a universal bank, would also be required
to comply with the requirement of compulsory deposit insurance

from DICGC up to a maximum of Rs.1 lakh per account, as

applicable to the banks.
o) Authorized Dealer's License
Some of the FIs at present hold restricted AD license from RBI,
Exchange Control Department to enable them to undertake
transactions necessary for or incidental to their prescribed
functions. On conversion into a universal bank, the new bank
would normally be eligible for full-fledged authorized dealer
license and would also attract the full rigour of the Exchange
Control Regulations applicable to the banks at present, including
prohibition on raising resources through external commercial
borrowings.
p) Priority sector lending
On conversion of an FI to a universal bank, the obligation for
lending to "priority sector" up to a prescribed percentage of their
'net bank credit' would also become applicable to it.
q) Prudential norms
After conversion of an FI in to a bank, the extant prudential norms
of RBI for the all-India financial institutions would no longer be
applicable but the norms as applicable to banks would be
attracted and will need to be fully complied with.
Concluding Remarks
The following are the steps suggested:
a. Equalise the net regulatory burden across the financial system
(including banks, DFIs, mutual funds, NBFCs and Insurance

companies).
b. Lower the regulatory burden on the over regulated entities.
c. Promote and encourage strong competition.
d. Do not allow the merger of a weak bank with a viably strong
DFI or vice-versa.
e. DFIs should be permitted to set up a 100 percent owned
banking subsidiaries.
f. Need is felt to re-examine the minimum level of SLR
requirement in order to meet the best of international standards.