Banking and Insurance

Assignment

Topic:
1. Role of RBI in developing Financial System
2. Banking in 2020

Vinay Sharma
Division / Roll No.: D / 432
Contact number: 7208604876
 1.Role of RBI in developing Financial System

In every country there is one organization which works as the central

bank. The function of the central bank of a country is to control and
monitor the banking and financial system of the country. In India, the
Reserve Bank of India (RBI) is the Central Bank.
The RBI was established in 1935. It was nationalised in 1949. The RBI
plays role of regulator of the banking system in India. The Banking
Regulation Act 1949 and the RBI Act 1953 has given the RBI the power
to regulate the banking system.
The RBI has different functions in different roles.
(A) RBI is the Regulator of Financial System
The RBI regulates the Indian banking and financial system by issuing
broad guidelines and instructions. The objectives of these regulations
include:
Controlling money supply in the system,
Monitoring different key indicators like GDP and inflation,
Maintaining peoples confidence in the banking and financial
system, and
Providing different tools for customers help, such as acting as
the Banking Ombudsman.

(B) RBI is the Issuer of Monetary Policy

The RBI formulates monetary policy twice a year. It reviews the policy
every quarter as well. The main objectives of monitoring monetary
policy are:
Inflation control
Control on bank credit
Interest rate control

The tools used for implementation of the objectives of monetary policy

are:
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR),
Open market operations,
 Different Rates such as repo rate, reverse repo rate, and bank
rate.

(C) RBI is the Issuer of Currency

Section 22 of the RBI Act gives authority to the RBI to issue currency
notes. The RBI also takes action to control circulation of fake currency.

(D) RBI is the Controller and Supervisor of Banking

Systems
The RBI has been assigned the role of controlling and supervising the
bank system in India. The RBI is responsible for controlling the overall
operations of all banks in India. These banks may be:
Public sector banks
Private sector banks
Foreign banks
Co-operative banks, or
Regional rural banks
The control and supervisory roles of the Reserve Bank of India is done
through the following:
Issue Of Licence: Under the Banking Regulation Act 1949,
the RBI has been given powers to grant licenses to commence
new banking operations. The RBI also grants licenses to open
new branches for existing banks. Under the licensing policy,
the RBI provides banking services in areas that do not have
this facility.
Prudential Norms: The RBI issues guidelines for credit
control and management. The RBI is a member of the Banking
Committee on Banking Supervision (BCBS). As such, they are
responsible for implementation of international standards of
capital adequacy norms and asset classification.
Corporate Governance: The RBI has power to control the
appointment of the chairman and directors of banks in India.
The RBI has powers to appoint additional directors in banks as
well.
 KYC Norms: To curb money laundering and prevent the use
of the banking system for financial crimes, The RBI has Know
Your Customer guidelines. Every bank has to ensure KYC
norms are applied before allowing someone to open an
account.
Transparency Norms: This means that every bank has to
disclose their charges for providing services and customers
have the right to know these charges.
Risk Management: The RBI provides guidelines to banks for
taking the steps that are necessary to mitigate risk. They do
this through risk management in basel norms.
Audit and Inspection: The procedure of audit and
inspection is controlled by the RBI through off-site and on-site
monitoring system. On-site inspection is done by the RBI on
the basis of CAMELS. Capital adequacy; Asset quality;
Management; Earning; Liquidity; System and control.
Foreign Exchange Control: The RBI plays a crucial role in
foreign exchange transactions. It does due diligence on every
foreign transaction, including the inflow and outflow of foreign
exchange. It takes steps to stop the fall in value of the Indian
Rupee. The RBI also takes necessary steps to control the
current account deficit. They also give support to promote
export and the RBI provides a variety of options for NRIs.
Development: Being the banker of the Government of India,
the RBI is responsible for implementation of the governments
policies related to agriculture and rural development. The RBI
also ensures the flow of credit to other priority sectors as well.

Section 54 of the RBI gives stress on specialized support for rural

development. Priority sector lending is also in key focus area of the
RBI.
Apart from the above, the RBI publishes periodical review and data
related to banking. The RBI plays a very important role in every aspect
related to banking and finance. Finally the control of NBFCs and others
in the financial world is also assigned with RBI.

Performance of the Financial Sector and the Impact of Reforms:

The reforms have ushered in extensive improvements in the terms of
various parameters, like capital adequacy and asset quality. There have
also been considerable improvements in the efficiency of the financial
intermediation process and profitability of banks. Closer to our hearts in
the RBI, there has been a significant advancement in terms of systemic
stability of the Indian financial sector. While my deliberations shortly
would elaborate this point further, I would, however, emphasise that
the impact of reforms across the financial sector has not been even. It
is the commercial banking sector, which has fared the best under
reform. The full and positive impact of reforms is yet to be realised in
some other segments of financial sector. I have already stated that
enhancing stability and efficiency were the two main planks of the
financial sector reforms in India and there has been visible
improvement on both fronts. Capital position of any company is a good
indicator of its viability and stability. This is more so for financial
companies like banks since most of their resources are borrowed funds.
In terms of capital requirement for banks, India has set norms, which
are even stringent than the international benchmarks. As opposed to
international norm of 8 per cent capital to risk-weighted asset ratio (or
CRAR in short) in India banks need to maintain 9 per cent CRAR. It is
heartening to see that as on March 31, 2002 among the 97 commercial
banks operating in India, all but 5 had fulfilled this criterion. Among the
DFIs, all but one fulfilled the minimum CRAR norm. Keeping the higher
risk associated with the operations of 10 certain category of NBFCs, the
minimum CRAR has been kept higher for them than commercial banks.
In spite of this, an overwhelming proportion of NBFCs satisfy this
requirement. The only segment of the financial sector where
capitalisation level is a matter of concern is co-operative banks. Even in
this segment a time frame has been fixed and by March 31, 2005 all co-
operative banks are required to achieve minimum CRAR compatible
with that for commercial banks. Another way to measure the stability
and soundness of a company is to examine the quality of its assets. In
financial parlance, lower the level of non-performing assets or NPAs, for
short, higher is the stability of the institution. An asset is defined as NPA
if the interest or repayment due on that loan remains overdue even
after a specified time period. Under the reform process, in line with
international best practices, the asset classification norms in India have
been made stringent. In spite of that, there has been a considerable
reduction in the NPA levels of commercial banks. In early 1990s, gross
NPA of commercial banks were close to one fourth of the total loans and
advances extended by them. In ten years since then, this has come
down to slightly above 10 per cent of the total advances. Though there
has been considerable reduction in the NPA position of most of the DFIs,
for some of them, the level remains high. There has, however, not been
much reduction in the NPA position of NBFCs or co-operative banks.
Various measures have been initiated to alleviate the NPA situation of
all financial institutions. As in case of stability, since the initiation of
reforms, improvement in efficiency has taken place in almost all
segments of the financial sector but it has been most marked for
commercial banks. One measure of efficiency is competitiveness. The
liberalisation of entry norms for private and foreign banks as well as
private and foreign investment in the existing banks has enhanced the
competitiveness of the commercial banking sector. This is reflected in
the declining share of top five banks in the total deposit as well as
assets of the total commercial banking sector. Another indication of
larger competition and efficiency of the commercial banks in the post-
reform period is the decline in the gap between the interest rates at
which banks lend their fund and rates at which they themselves borrow
such funds. In a simple sense this indicates that faced with competition,
banks are selling their products at lower margins. But the important
point is that even with this fall in margin, banks remained profitable
and in fact many increased their 11 profitability. This signals an
increase in efficiency of the banks. The lowering of interest margin has
been observed for DFIs and cooperative banks as well. Due to increased
competition between different segments of the financial sector, the
interest rates charged by different types of institutions have moved
closer. Not only that, there has also been a better alignment in the
interest rates charged in India and those prevailing in the international
market.

Role of RBI in the Management of Financial Sector:

Let us now turn our attention to what exact role RBI is playing for the
financial sector in general and the financial reform process in particular.
As all of you know, RBI is the central bank of the country. Central banks
are very old institutions. The Bank of England was set up way back in
1694, the Bank of France is more than 200 years old and the Federal
Reserve Bank was set up in 1913. As aptly stated by our Governor, Dr.
Bimal Jalan, although RBI, set up in 1935, may appear a toddler or at
most a young adult, it is one of the oldest central banks among the
developing world. Traditionally, central banks have performed roles of
currency authority, banker to the Government and banks, lender of last
resort, supervisor of banks and exchange control (now it would be more
appropriate to call it exchange management) authority. Generally,
central banks in developed economies have price or financial stability
as their prime objective.

The RBI has the twin objectives of maintaining price stability and
promoting growth.
The objectives are the following:
 - Provision of adequate liquidity to meet credit growth and support
investment demand in the economy while continuing a vigil on
movements in the price level.
- In line with the above to continue the present stance on interest
rates including preference for soft interest rates.
- To impart greater flexibility to the interest rate structure in the
medium-term In developing economies, however, the growth
objective assumes greater importance.
Recently it is seen that during recessionary or deflationary conditions
achievement of 12 higher growths becomes the dominant objective of
central banks, both in developing and developed economies.
Let us now look at the evolution of RBI and its changing role and
strategy over time.
RBI was set up to regulate the issue of currency and keep reserves with
a view to securing monetary stability in India and generally to operate
the currency and credit system of the country to its advantage (RBI Act,
1934).
Within these overall objectives, RBI performs a wide range of
promotional functions, which are designed to support the countrys
efforts to accelerate the pace of economic development with social
justice. In keeping with the overall logic of reforms that market based
allocation rather than directed allocation of resources led to greater
efficiency, the functions of the RBI have undergone a strategic shift
under the current reforms. The strategy shifted from controlling
institutions and markets to facilitation of efficient functioning of
markets and strengthening of the supporting institutional infrastructure.

The pre-emptions in the form of CRR and SLR have been progressively
reduced. The scope of priority sector has been expanded. The interest
rate has been deregulated both on deposits and advances.

Allowing DFIs and banks to lend in the short as well as the long end of
the market has reduced segmentation of credit market.
From conservation of foreign exchange through control of transactions,
the focus has shifted to facilitation of foreign exchange transactions.
Intervention in the foreign exchange market has shifted from fixing of
exchange rate to merely curbing speculative volatility.
Stability issues came to the fore especially after the crises in South East
Asian countries in late 1990s.
The RBI progressively strengthened prudential regulation relating to
capital adequacy, income recognition, asset classification, provisioning,
disclosures and transparency. Sequencing of reforms among various
segments of the financial sector (banks, DFIs, co-operative banks,
NBFCs, money market, debt market and Forex market) was determined
by the importance of each segment, extent of regulatory powers
enjoyed by the RBI and the evolving situation. Furthermore, institutional
strengthening was undertaken to ensure the progressive development
and integration of the securities, money and Forex markets. The RBI
has made significant improvements in the quality of performance of
regulatory and supervisory functions. Our standards 13 are comparable
to the best in the world. Attention is being paid to several
contemporary issues such as, relative roles of onsite and off-site
supervision, functional versus institutional regulation, relative stress on
internal management, market discipline and regulatory prescriptions,
consolidated approach to supervision, etc. Several legislative initiatives
have also been taken up with Government, covering procedural law,
debt recovery systems, Credit Information Bureau, Deposit Insurance,
etc. Progress in these is critical for effectiveness of RBI in the regulatory
sphere. A recent important legislative development, which will improve
the momentum of recovery of dues, is the enactment of Securitisation
and Reconstruction of Financial Assets and Enforcement of Security
Interest (SRFAESI) Act. Under this Act RBI has been entrusted with the
role of stipulating suitable norms for registration of securitisation or
reconstruction companies, prescribing prudential norms, recommending
proper and transparent accounting and disclosure standards and
framing appropriate guidelines for the conduct of asset reconstruction
and securitisation.
 2.Banking in 2020

Powerful forces are reshaping the banking industry. Customer

expectations, technological capabilities, regulatory requirements,
demographics and economics are creating an imperative to change.
Banks and credit unions need to get ahead of these challenges and
retool if they are to find success in the upcoming decade.
Growth remains elusive, costs are proving hard to contain and ROE
remains stubbornly low. Regulation is impacting business models and
economics. Technology is rapidly morphing from an expensive
challenge into a potent enabler of both customer experience and
effective operations. Non-traditional players are challenging the
established order, leading with customer-centric innovation. New
service providers are emerging. Customers are demanding ever higher
levels of service and value. Trust in financial institutions hovers near
historic lows.

Seven Macro-Trends Impacting the Future of Retail

Banking:

1. Technology will change everything becoming a potent

enabler of increased service and reduced cost.

Innovation is imperative. In the last few years technology has

rapidly evolved big data, cloud computing, smartphones and
high bandwidth are all now commonplace. PwC says weve
reached a tipping point thats analogous with what has already
occurred in other industries (e.g. music, video, and print media),
where the digital channel will compress revenues, enable new
attackers, redefining service and crippling the laggards. The pace
of innovation will continue to increase, and financial institutions
will need to enable or leverage this innovation if they want to
keep up.

2. Every bank will be a direct bank, and branch banking will

experience a significant transformation.

Experts say that as technology shifts more and more activities

online and as cashusage drops, traditional brancheswill no longer
be necessary. Given their high-fixed cost, branches will need to
 become dramatically more productive, or significantly less costly
(e.g., smaller). Banks and credit unions have already reduced
staff levels, closed less viable locations, and are experimenting
with new retail concepts. PwC predicts branches will remain
relevant, but will adopt many different forms from flagship
engagement hubs to compact smart kiosks.

3. Competitive reach will no longer be determined by branch

networks, but rather by banking licenses, technology and
marketing budgets.

When every aspect of banking can be done digitally, a banks

target market and competitive arena is no longer defined by its
physical footprint, but rather by its technology, its regulatory
boundaries and the sheer limitations of its marketing budget. In
the US, for example, top regional banks could become viable
national playersand ambitious foreign entrants with resources but
without any brick-and-mortar footprint could suddenly find
themselves compete on a new, larger field. New entrants could
sprout up rapidly, potentially spawning dozens of new
competitors and refragmenting the landscape further than it
already has.

4. Banks will organize themselves around customers instead

of products or channels.

The winners of tomorrow will offer a seamless customer

experience, integrating sales and service across all channels.
They will develop the ability to view customers as a segment of
one, recognizing their uniqueness, and tailoring their offerings so
that customers view banks as meeting their needs not pushing
products.

5. Banks (in most countries) will evolve their customer

experience to be more female-friendly.

In one US survey, 73% of women said they were dissatisfied with

the financial services industry. Complaints range from a lack of
respect, to being given contradictory advice and worse terms
than men. Smart institutions will address this through a
 combination of branding, products, and service solutions.
Furthermore, PwC forecasts that significantly more bankers
working in the industry will be women by 2020; many banks
publicly state this as an ambition.

6. Social media will be the media. Today, most financial

marketers view social media as co-existing alongside
traditional channel.

By 2020, PwC says social media will be the primary medium with
which financial institutions connect, engage, inform and
understand consumers everything from the mass collective
social mindset, to the minutiae of each and every individual.
Information and opinions both good and bad will be
amplified. Mastery of social media will be a core competency,
according to PwC.

7. Cyber security is paramount to rebuilding trust.

Winners will invest significantly in this area. Recent high-profile

security breaches and media commentary surrounding cyber-
attacks have sparked fear and uncertainty, further eroding
consumer trust. There are now higher expectations about security
of information and privacy among clients, employees, suppliers
and regulators. A proactive response is vital.

Six Priorities for 2020:

1. Developing a customer-centric business model
 2. Optimizing retail delivery
3. Simplifying business and operating models
4. Obtaining an information advantage
5. Enabling innovation, and the capabilities required to foster it
6. Proactively managing regulations, risk and capital

Financial institutions seem to universally agree that they are hindered

from addressing these priorities by financial, talent, technology and
organizational constraints. Banks and credit unions needto take
aggressive action to ease these constraints, and manage themselves in
a more agile manner to enable innovation and transformation they so
desperately need.

1. Developing a customer-centric business model

Financial marketers today have a simplistic understanding of their

customers and a vastly complex product set. They typically do not
know their customers very well. Many still send customers multiple
product offers in the hope that something will stick. They struggle to
join the dots internally and prepare bank-wide views of a customer
relationship, let alone integrate external sources of data. For instance,
few can analyze a customers deposit account, recognize that their
salary increased, and send a note congratulating the customer on their
promotion together with an offer of a premium card and a higher credit
limit.

2. Optimizing retail delivery

Historically, banks with the best and/or biggest branch footprint have
dominated, gaining a disproportionate share in their markets. By 2020,
much of todays infrastructure will not be a competitive advantage.
Leading institutions will offer an anytime/anywhere service, fully
utilizing all banking channels in an integrated fashion. The shakeup in
branch-based banking and the need to optimize distribution networksis
clearly top of mind for banking executives. Respondents globally view
the largest banks as benefitting most from these changes, and smaller
regional and community banks being the most threatened.

3. Simplifying business and operating models

Banks have developed staggeringly complex and costly business

models. Now they must simplify. Rising customer expectations,
increasingly active regulators and stagnant shareholder returns
demand it. Efforts thus far have not been enough. Many financial
institutions have been built over decades of acquisitions, and new
product and channel development, typically with each development
adding additional systems, layers, processes and costs. Few have
tackled the difficult and expensive work of integrating, optimizing and
simplifying their platforms.

PwC says you should start with the customer and work backwards.
Simplifying the experience requires that products, channels,
organization and operations all must change. The most successful
banks will learn from other industries. Many consumer products
companies (Adidas, Apple) do not ownthe entire value chain. They
focus on what makes them distinctive product design, marketing,
distribution and contract out much of the rest to third-party
specialists. Granted, all this sounds like a major undertaking, but PwC
says the rewards for those who get it right will be huge.

4. Obtaining an information advantage

Getting this right will be a game-changer. Fast movers will create

competitive advantage in every area of the bank from customer
experience and brand management to underwriting and pricing.

The banking industry and the consumers they serve now generate
exponentially more information than ever before. Few banks are
positioned to integrate, analyze and act on the insights from the
massive data streams available today; imagine how the volume of data
will have ballooned even further by 2020.

In the future, PwC say leading players will exploit both structured and
unstructured information from traditional sources (such as credit
scores and customer surveys) and from non-traditional sources (such as
social media, and cross-channel bank customer interaction data). They
will collect and purchase other behavioral data (such as mobile location
and purchase data) particularly as customers grow accustomed to
surrendering privacy in a voluntary value exchange.

5. Enabling innovation, and the capabilities required to foster it

Innovation is the single most important factor driving sustainable top-

and bottom-line growth in banking. But PwC points out that financial
institutions today are not known as places where innovation thrives, nor
are they the first choice for top software engineers. Banks and credit
unions need to organize and manage themselves differently, PwC says
protecting and enabling talent, becoming agile in their development
processes and being open to partnerships with outside institutions.
Successful executives in the future will need to be fluid and savvy
mentally nimble, with an innovative mindset.

6. Proactively managing regulations, risk and capital

The post-crisis flood of regulations signals a major mindset change for

regulators. In the past, regulation was just one of many considerations.
Capital was plentiful and not a significant business constraint. Conduct
issues were thought to be few and far between. Today, not only are the
rules much more complex, but regulators are more suspicious, and less
flexible with their demands to improve compliance, reporting, and the
underlying business processes and data. Leading banks are taking a
different and more comprehensive approach to managing their
regulatory obligations. This approach is pragmatic, proactive and
increasingly integrated into business as usual.

Executives in all regions unsurprisinglygiven whats transpired in this

area over the last few years consider this the biggest priority they
need to address, with 64% citing this as very important. Again,
however, very few (only 22%) consider themselves very prepared.
Respondents say the biggest obstacles to addressing these issues are
the level of financial investments required and technology constraints.

Two Challenges of the Decade:

There are two areas in which the Indian banking industry will be
severely challenged to find a solution over the next decade. First
pertains to the rising expectation from banks to find an economically
viable solution for financial exclusion. The second pertains to human
resources challenge in the public sector. While the first challenge
demands unusual innovation and experimentation, the second
threatens to cripple the ability of the largest segment of the banking
industry from being able innovate and stay competitive. It is unclear
that the solutions to these two challenges will be identified unless the
banks were to accord highest priorities to these and work in concert.

1. Financial inclusion:
The issue of financial inclusion is at the center stage of the agenda of
the government. While the expectation from banks is high, the
government is also starting to look at non-banking industries to come
forward with a solution. Needless to say, if the answer does not come
from banking industry, non-banks will be welcome to nibble at its
revenue pool. It is a strategic priority given that the customer segment
in question will be the largest in number over the next decade and
banks stand to lose this relationship.

2. The HR challenge in the public sector:

The public sector banks enter the next decade with the same
expectations as their private sector peers but with a severe
disadvantage in human resources. The HR challenge of public sector
banks has reached a tipping point. Due to a legacy of several decades,
the public sector banks will witness unprecedented loss of skills and
competencies in form of retiring senior and middle management
executives over the next few years. That coupled with the need for
large scale reskilling, attracting and retaining fresh talent, controlling
the growing employee costs, and introduction of performance discipline
are significant challenges.

Crucial Role for NBFC and DFI:

Encourage NBFC in specialized segments: Banks may not be able

to live up to all expectations. There are many opportunities that are
easy to capture but there are also many that require significant
innovation or specialized skills that conventionally not banks strengths.
The latter opportunities are at the extremes of spectrum. Very large
ticket, long term infrastructure lending requires risk management
expertise that goes beyond traditional credit appraisals at banks. There
will be significant space for specialized entities in risk assessment and
structuring of infrastructure finance. Very low ticket unsecured credit
requires sophisticated risk management and cost control that is not
easy in business model of conventional banks. Gaps in SME finance can
be filled with asset based lending, operating leases, and factoring.
Specialized NBFCs can play a major role in all of these. These are
niches. But each one of them is individually large to sustain significant
balance sheets. Importance of NBFC needs to be recognized to make
the decades promise come true for India. Positive regulatory
environment to support NBFC will be crucial.

Rural infrastructure needs a government backed DFI to address

market failures: Financial inclusion is being pursued as a crucial
driver of inclusive growth. However, financial inclusion is necessary but
not sufficient. Sustainable inclusive growth requires financial inclusion
to be supplemented (if not preceded) by rural infrastructure
development and stimulation of rural economy through livelihood
generation interventions. While commercially viable models are being
encouraged for financial inclusion, the same is not possible in the case
of rural infrastructure development and livelihood generation. Market
failures abound. Currently rural infrastructure is supported by
government through myriad agencies and departments NABARD
(through RIDF funding to states), MoRD (through PURA and PPP
initiatives), REC, various state government agencies, etc. India needs a
pivotal agency with appropriate government backing to finance rural
infrastructure. No DFI across the world survives without access to cheap
source of funds supported by the government.

In the current institutional landscape of India, NABARD is most suited to

play this role. It already channelizes RIDF funds to states for rural
infrastructure development. However, RIDF funds are hardly sufficient
for the purpose and need to be augmented. NABARD supported rural
infrastructure development is credited to be higher quality compared to
initiatives of state government due to higher standards of quality
control and emphasis on livelihood generation and citizen participation.
Explicit government financial support to NABARD has to be
strengthened. NABARD has to be restructured to expand the breadth of
its product portfolio from simple loans to state governments to
structured finance options that meet needs of not only different state
governments and but also private sector which will participate in select
segments of rural infrastructure through PPP route.