Reforms in Banking Sector

REFORMS IN BANKING SECTOR
A. INTRODUCTION
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 in the banking industry.
In 1991, the RBI had proposed to from the committee chaired by M.
Narasimham, former RBI Governor in order to review the Financial System viz.
aspects relating to the Structure, 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 the Basle norms. The guidelines that were issued subsequently laid the
foundation 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 reflect 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 8 per cent
by those banks having international operations by March 1994
vi. Adoption of uniform accounting practices in regard to income
recognition, asset classification and provisioning against bad and
doubtful debts
vii.Imparting transparency to bank balance sheets and making more
disclosures
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viii.Setting up of special tribunals to speed up the process of recovery of

loans
ix. Setting up of Asset Reconstruction Funds (ARFs) to take over from
banks a portion of their bad and doubtful advances at a discount
x. Restructuring of the banking system, so as to have 3 or 4 large banks,
which could become international in character, 8 to 10 national banks and
local banks confined to specific regions. Rural banks, including RRBs,
confined to rural areas
xi. Abolition of branch licensing
xii.Liberalising the policy with regard to allowing foreign banks to open
offices in India
xiii.Rationalisation of foreign operations of Indian banks
xiv.Giving freedom to individual banks to recruit officers
xv.Inspection by supervisory authorities based essentially on the internal
audit and inspection reports
xvi.Ending duality of control over banking system by Banking Division and
RBI
xvii.A separate authority for supervision of banks and financial institutions
which would be a semi-autonomous body under RBI
xviii.Revised procedure for selection of Chief Executives and Directors of
Boards of public sector banks
xix.Obtaining resources from the market on competitive terms by DFIs
xx.Speedy liberalisation of capital market
xxi.Supervision of merchant banks, mutual funds, leasing companies etc.,
by a separate agency to be set up by RBI and enactment of a separate
legislation providing appropriate legal framework for mutual funds and
laying down prudential norms for such institutions, etc.
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Several recommendations have been accepted and are being implemented

in a phased manner. Among these are the reductions in SLR/CRR, adoption of
prudential norms for asset classification and provisions, introduction of capital
adequacy norms, and deregulation of most of the interest rates, allowing entry
to new entrants in private sector banking sector, etc.
Keeping in view the need of further liberalisation the Narasimham
Committee II on Banking Sector reform was set up in 1997. This committee’s
terms of reference included review of progress in reforms in the banking sector
over the past six years, charting of a programme of banking sector reforms
required to make the Indian banking system more robust and internationally
competitive and framing of detailed recommendations in regard to make the
Indian banking system more robust and internationally competitive.
This committee constituted submitted its report in April 1998. The major
recommendations are:
i. Capital adequacy requirements should take into account market risks also
ii. In the next three years, entire portfolio of Govt. securities should be
marked to market
iii. Risk weight for a Govt. guaranteed account must be 100 percent
iv. CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by
2002
v. An asset should be classified as doubtful if it is in the sub-standard
category for 18 months instead of the present 24 months
vi. Banks should avoid ever greening of their advances
vii.There should be no further re-capitalization by the Govt.
viii. NPA level should be brought down to 5% by 2000 and 3% by 2002.
ix. Banks having high NPA should transfer their doubtful and loss categories
to ARCs which would issue Govt. bonds representing the realisable value
of the assets.
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x. International practice of income recognition by introduction of the 90-

day norm instead of the present 180 days.
xi. A provision of 1% on standard assets is required.
xii.Govt. guaranteed accounts must also be categorized as NPAs under the
usual norms
xiii. There is need to institute an independent loan review mechanism
especially for large borrowal accounts to identify potential NPAs.
xiv. Recruitment of skilled manpower directly from the market be given
urgent consideration
xv. To rationalize staff strengths, an appropriate VRS must be introduced.
xvi. A weak bank should be one whose accumulated losses and net NPAs
exceed its net worth or one whose operating profits less its income on
recap bonds is negative for 3 consecutive years.
To start with, it has assigned a 2.5 per cent risk-weightage on gilts by

March 31, 2000 and laid down rules for provisioning; shortened the life of sub-
standard assets from 24 months to 18 months (by March 31, 2001); called for
0.25 per cent provisioning on standard assets (from fiscal 2000); 100 per cent
risk weightage on foreign exchange (March 31, 1999) and a minimum capital
adequacy ratio of 9 per cent as on March 31, 2000.
Only a few of these mainly constitute to the reforms in the banking
sector.
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1. REFORMS
1.1 REDUCTION OF SLR AND CRR

The South East Asian countries introduced banking reforms wherein
bank CRR and SLR was reduced; this increased the lending capacity of banks.
The markets fell precipitously because banks and corporates 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; and followed the South East Asian Crisis.
The monetary policy perspective essentially looks at SLR and CRR
requirements (especially CRR) in the light of several other roles they play in the
economy. The CRR is considered an effective instrument for monetary
regulation and inflation control. The SLR is used to impose financial discipline
on the banks, provide protection to deposit-holders, allocate bank credit
between the government and the private sectors, and also help in monetary
regulation. However bankers strongly feel that these along with high non-
performing assets (on which banks do not earn any return) 10 percent CRR and
25 percent SLR (most banks have SLR investments way above the stipulation)
are affecting banks' bottomlines. With an effective return of a mere 2.8 per cent,
CRR is a major drag on banks' profitability.
The Narasimham Committee had argued for reductions in SLR on the
grounds that the stated government objective of reducing the fiscal deficits will
obviate the need for a large portion of the current SLR. Similarly, the need for
the use of CRR to control secondary expansion of credit would be lesser in a
regime of smaller fiscal deficits. The committee offered the route of Open
Market Operations (OMO) to the Reserve Bank of India for further monetary
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control beyond that provided by the (lowered) SLR and CRR reserves.
Ultimately, the rule was Reduction in the reserve requirements of banks, with
the Statutory Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-
97 in a period of 5 years.
The recent trend in several developed countries (US, Switzerland,
Australia, Canada, and Germany) towards drastic lowering of reserve
requirements is often used to support the argument for reduced reserve levels in
India.
The arguments for higher or lower SLR and CRR ratios stem from two
different perspectives one which favours the banks, and the other which favours
the bank reserves as a monetary policy instrument. The bank perspective seeks
to maximise "lendable" resources, the banks' control over resource deployment,
and returns to the banks from the "preempted" funds. It is also claimed that the
low returns from the forced investments in government securities adversely
affect the bank profitability - the cost of deposits for banks, which averages at
15-16 per cent, was much greater than the (earlier) returns on the government
securities. This argument is sometimes carried further to state that RBI makes
profits on impounded money, at the cost of bank profitability. To some extent,
this argument has been weakened by the increase in interest on government
securities to 13.5 per cent.
Some problems with the stated aim of reducing SLR and CRR are:
1. The supporting condition of smaller fiscal deficits is not happening in
reality
2. Open market operations have not been used to any significant extent
in India for monetary control. The time required for gaining
experience with the use of such operations would be much more than
5-6 years.
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3. A commitment to a unidirectional movement of these vital controls

irrespective of the effects on, and the response of, other economic
factors (such as inflation), would be unwise.
This scenario thus indicates that despite the stated aim of reductions in
SLR and CRR, RBI may be forced to revert to higher reserve levels, if the
economic indicators become unfavourable, and RBI has already indicated as
much. Bank investment are, therefore, not likely to stabilize in the near future.
The RBI had announced an increase in interest rate on CRR balance to 6% from
the present 4%. This will certainly boost the profits of banks, as they have to
maintain a minimum balance of 8% with the RBI.
Trends in CRR and SLR 1993 – 2001
Illustration 1
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1.2 MINIMUM CAPITAL ADEQUACY RATIO

The committee recommended a Stipulation of minimum capital adequacy
ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March
1996, and 8 per cent by those banks having international operations by March
1994. Later, all banks required attaining the capital adequacy norm of 8 per
cent, as per the Basle Committee Recommendations, by March 31, 1996.
Capital Adequacy
The growing concern of commercial banks regarding international
competitiveness and capital ratios led to the Basle Capital Accord 1988. The
accord sets down the agreement to apply common minimum capital standards to
their banking industries, to be achieved by year-end 1992. Based on the Basle
norms, the RBI also issued similar capital adequacy norms for the Indian banks.
According to these guidelines, the banks will have to identify their Tier-I and
Tier-II capital and assign risk weights to the assets. Having done this they will
have to assess the Capital to Risk Weighted Assets Ratio (CRAR). The
minimum CAR that the Indian banks are required to meet is set at 9 percent.
• Tier-I Capital, comprising of
Paid-up capital
Statutory Reserves
Disclosed free reserves
Capital reserves representing surplus arising out of
sale proceeds of assets
• Tier-II Capital, comprising of
Undisclosed Reserves and Cumulative Perpetual Preference Shares
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Revaluation Reserves
General Provisions and Loss Reserves
The Narasimham Committee had recommended that the capital adequacy
norms set by the Bank of International Settlements (BIS) be followed by the
Indian banks also. The BIS norm for capital adequacy is 8 per cent of risk-
weighted assets.
One short-term fall-out of the capital adequacy norms has been the
massive increases in investments by the banks in government securities. Since
the risk-weight of government securities is zero, investments in them do not add
to the capital requirements. The banks are therefore choosing to deploy funds
mobilised through deposits in these long-term gilts.
In the first ten months of 1993-94, for example, the investments in
government securities shot up by 18.8 per cent while bank credit grew at only
6.6 per cent. Despite a strong growth in aggregate deposits of 13.8 per cent,
credit grew by only 6.65 per cent, while investments surged by 18.8 per cent.
The problem with this practice of the banks is that it can upset the balance of
maturity patterns between deposits (many of ' which are short-term) and
investments (which have 10 year maturities). Now, banks would have to
develop much better investment management skills, especially when interest
rates are deregulated, and significant open market operations are started.
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Growth In Investments In Government Securities by Banks
1991-92 1992-93 1992-93 1993-94

[Up to Jan 93] [Up to Jan 94]
36441 32364 37187
Aggregate deposits growth
[19.6 %] [14.0 %] [13.8 %]
9291 26390 20966 9999
Bank credit growth
[8.0 %] [21.0 %] [16.7 %] [6.6 %]
11042 19857
Investments 15131 15460
[12.2 %] [18.8 %]
Source: Reserve Bank of India Bulletin [1994]
Supplement - Report on Trends and Progress of Banking in India 1991-92 [July
- June]; Jan 1993.
The Narasimham Committee II, 1998, suggested further revision i.e. CAR to be
raised to 10% from the present 8% (1998); 9% by 2000 and 10% by 2002
Illustration 2
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1.3 PRUDENTIAL NORMS

To get a true picture of the profitability and efficiency of the Indian
Banks, a code stating adoption of uniform accounting practices in regard to
income recognition, asset classification and provisioning against bad and
doubtful debts has been laid down by the Central Bank. Close to 16% of loans
made by Indian banks were NPAs -- very high compared to almost 5% in
banking systems in advanced countries.
Magnitude of the problem

According to the latest RBI figures, gross NPAs in the banking sector
stands at Rs 45,563 crore which is about 16 per cent of the total loan assets of
the banks. The net NPAs (gross NPAs minus provisioning) stands at Rs 21,232
crore, which is about 7% of loans, advanced by the banking sector. Though in
percentage terms, the NPAs have come down over the last 5-6 years, in absolute
terms they have grown, signifying that while new NPAs are being added to
banks' operations every year, recovery of older dues is also taking too long.
What is ever greening or rescheduling of loans?

Sometimes, to avoid classifying problem assets as NPAs, banks give
another loan to the company with the help of which it can pay the due interest
on the original loan. While this allows the bank to project a healthy image, it
actually makes the problems worse, and creates more NPAs in the long run.
RBI discourages such practices.
Asset Quality - Increased Transparency

Apart from the interest rate structure, the net interest income is also
affected by the asset quality of the bank. Asset quality is reflected by the
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quantum of non-performing assets (NPAs) – the higher the level of NPAs, the
lower will be the asset quality and vice versa. Courtesy the nationalization
agenda and the directed credit, most of the public sector banks were burdened
with huge NPAs. While the government did contribute to write-off these bad
loans, the problem still remains. NPAs expose the banks to not just credit risk
but also to liquidity risk. Considering the implications of the NPAs and also
for imparting greater transparency and accountability in banks operations and
restoring the credibility of confidence in the Indian financial system, the RBI
introduced prudential norms and regulations. The prudential norms which
relate to income recognition, asset classification and provisioning for bad and
doubtful debts serve two primary purposes – firstly, they bring out the
true position of a Bank’s loan portfolio, and secondly, they help in
arresting its deterioration.
The asset quality of the bank and its capital are closely associated. If the
assets of the bank go bad it is the capital that comes to its rescue. This implies
that the bank should have adequate capital to face the likely losses that may
arise from its risky assets. In the changed business environment, where banks
are exposed to greater and different types of risk, it becomes essential to have a
good capital base, which can help it sustain unforeseen losses. As stated earlier,
the one major move in this direction was brought about by the Basle
Committee, which laid the capital standards that banks have to maintain. This
became imperative, as banks began to cross over their national boundaries and
begin to operate in international markets. Following the Basle Committee
measures, RBI also issued the Capital Adequacy Norms for the Indian banks
also.
INCOME RECOGNITION
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The regulation for income recognition states that the Income on NPAs
cannot be booked. Interest income should not be recognized until it is realized.
An NPA is one where interest is overdue for two quarters or more.
In respect of NPAs, interest is not to be recognized on accrual basis, but is to be
treated as income only when actually received. Income in respect of accounts
coming under Health Code 5 to 8 should not be recognized until it is realized.
As regards to accounts classified in Health Code 4, RBI has advised the banks
to evolve a realistic system for income recognition based on the prospect of
realisability of the security. On non-performing accounts the banks should not
charge or take into account the interest.
Income-recognition norms have been tightened for consortium banking
too. Member banks have to intimate the lead-bank to arrange for their share of
recovery. They will no more have the privilege of stating that the borrower has
parked funds with the lead-bank or with a member-bank and that their share is
due for receipt. The new notifications emanated after deliberations held
between the RBI and a cross-section of banks after a working group headed by
chartered accountant, PR Khanna, submitted its report. The working group was
set after the RBI’s Board for Financial Supervision (BFS) wanted divergences
in NPA accounting norms by banks from central bank guidelines to be
addressed. The working group had identified three areas of divergence: non-
compliance with RBI norms; subjectivity arising out of the flexibility in norms;
and differences in the valuation of securities by banks, auditors and RBI.
As of now, for income recognition norms, the RBI has suggested that the
international norm of 90 days be implemented in a phased manner by 2002. The
current norm is 180 days.
ASSET CLASSIFICATION
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While new private banks are careful about their asset quality and
consequently have low non-performing assets (NPAs), public sector banks have
large NPAs due to wrong lending policies followed earlier and also due to
government regulations that require them to lend to sectors where potential of
default is high. Allaying the fears that bulk of the Non-Performing Assets
(NPAs) was from priority sector, NPA from priority sector constituted was
lower at 46 per cent than that of the corporate sector at 48 per cent. Loans and
advances account for around 40 per cent of the assets of SCBs. However,
delay/default in payment of interest and/or repayment of principal has rendered
a significant proportion of the loan assets non-performing. As per RBI’s
prudential norms, a Non-Performing Asset (NPA) is a credit facility in respect
of which interest/installment has remained unpaid for more than two quarters
after it has become past due. “Past due” denotes grace period of one month after
it has become due for payment by the borrower. The Mid-Term Review of
Monetary and Credit Policy for 2000-01 have proposed to discontinue this
concept with effect from March 31, 2001.
Regulations for asset classification
Assets should be classified into four classes - Standard, Sub-standard,
Doubtful, and Loss assets. NPAs are loans on which the dues are not received
for two quarters. NPAs consist of assets under three categories: sub-standard,
doubtful and loss. RBI for these classes of assets should evolve clear, uniform,
and consistent definitions. The health code system earlier in use would have to
be replaced. The banks should classify their assets based on weaknesses and
dependency on collateral securities into four categories:
Standard Assets: It carries not more than the normal risk attached to the
business and is not an NPA.
Sub-standard Asset: An asset which remains as NPA for a period exceeding
24 months, where the current net worth of the borrower, guarantor or the
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current market value of the security charged to the bank is not enough to ensure
recovery of the debt due to the bank in full.
Doubtful Assets: An NPA which continued to be so for a period exceeding two
years (18 months, with effect from March, 2001, as recommended by
Narasimham Committee II, 1998).
Loss Assets: An asset identified by the bank or internal/ external auditors or
RBI inspection as loss asset, but the amount has not yet been written off wholly
or partly.
The banking industry has significant market inefficiencies caused by the

large amounts of Non Performing Assets (NPAs) in bank portfolios,
accumulated over several years. Discussions on non-performing assets have
been going on for several years now. One of the earliest writings on NPAs
defined them as "assets which cannot be recycled or disposed off immediately,
and which do not yield returns to the bank, examples of which are: Overdue and
stagnant accounts, suit filed accounts, suspense accounts and miscellaneous
assets, cash and bank balances with other banks, and amounts locked up in
frauds".
The following Table shows the distribution of total loan assets of banks
in the public private sectors and foreign banks for 1997-98 through 1999-2000.
It is worth noting that the ratio of incremental standard assets of SCBs to their
total loan assets increased from 83.1 per cent in 1998-99 to 97.2 percent in
1999-2000. In other words, the ratio of incremental NPAs of SCBs to their total
loan assets declined significantly from 16.9 per cent in 1998-99 to 2.8 percent
in 1999-2000.
Classification of Loan Assets of SCBs (Percentage distribution of total loan

assets)
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Assets Public Private Foreign SCBs

A. Standard
1997-98 84.0 91.3 93.6 85.6
1998-99 86.1 91.2 92.4 85.3
1999-2000 86.0 91.5 93.0 87.2
B. Sub-standard
1997-98 5.0 5.8 3.9 4.9
1998-99 4.9 6.2 4.0 5.0
1999-2000 4.3 3.7 2.9 5.1
C. Doubtful
1997-98 9.1 0.9 1.7 1.8
1998-99 4.0 0.9 2.0 1.9
1999-2000 1.7 0.8 1.9 1.6
D. Loss
1997-98 1.9 0.9 1.2 1.8
1998-99 2.0 0.9 2.0 1.9
1999-2000 1.7 0.8 1.9 1.6
E. Total Assets (Rs. Crore)
1997-98 284971 36753 30972 352696
1998-99 325328 43049 31059 399436
1999-2000 380077 58249 37432 475758
Note: Addition of percentages for B to D may not add up to 100 minus the
percentage share of standard assets (A) due to rounding.
Illustration 3
The asset classification norms have resulted in a huge quantity of assets

being classified into the sub-standard, doubtful, and loss assets. As at 31 March
1993, the total of Non-Performing Assets (NPAs) for the public sector banks
(SBI, its seven associates, and 20 nationalised banks) stood at Rs 36,588 crores.
Of these, the sub-standard assets account for Rs 12,552 crores, doubtful assets
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Rs 20,106 crores, and loss assets Rs 3,930 crores (RBI Bulletin, 1994). 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.
PROVISIONING NORMS
Banks will be required to make provisions for bad and doubtful debts on
a uniform and consistent basis so that the balance sheets reflect a true picture of
the financial status of the bank. The Narasimham Committee has recommended
the following provisioning norms:
(i) 100 per cent of loss assets or 100 per cent of out standings for loss assets;
(ii) 100 per cent of security shortfall for doubtful assets and 20 per cent to 50
per cent of the secured portion; and
(iii) 10 per cent of the total out standings for substandard assets.
A provision of 1% on standard assets is required as suggested by

Narasimham Committee II 1998. Banks need to have better credit appraisal
systems so as to prevent NPAs from occurring. The most important relaxation is
that the banks have been allowed to make provisions for only 30 per cent of the
"provisioning requirements" as calculated using the Narasimham Committee
recommendations on provisioning (but with the diluted asset classification).
The nationalised banks have been asked to provide for the remaining 70 per
cent of the "provisioning requirements" by 31 March 1994. The encouraging
profits recently declared by several banks have to be seen in the light of
provisions made by them - Rs 10,390 crores pertaining to 1992-93, and the
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additional provisions for 1993-94. To the extent that provisions have not been
made, the profits would be fictitious.
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1.4 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 taxpayer’s 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" which are often
decried by bankers form only a small portion of the total NPAs. As
mentioned above, much more stringent disclosure norms are the
only way to increase the accountability of bank management to the
taxpayers. A lot therefore depends upon the seriousness with which a new
regime of regulation is pursued by RBI and the newly formed Board for
Financial Supervision.
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 outfits
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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. The
move is aimed at providing the investor with a better insight into viewing a
bank's performance in totality, including all its branches and subsidiaries, and
not as isolated entities. According to a banker, earlier subsidiaries were floated
as external independent entities wherein the accounting details were not
incorporated 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. As per the proposed new
policy guidelines, the banks will be required to consolidate their accounts
including all its subsidiaries and other holding companies for better
transparency.
# 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 finance 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 under performing 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
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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.
Rather, point out bankers, this will very much form an integral part of the
parent's balance sheet. For instance, if a subsidiary is not performing well or
making losses, this will reflect in the parent's balance sheet.
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1.5 RATIONALISATION OF FOREIGN OPERATIONS

IN 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 a
review of experience gained on the functioning of new private sector banks,
revised guidelines were issued in January 2001. The main
provisions/requirements are listed below: -
• Initial minimum paid-up capital shall be Rs. 200 crore; this will be raised to
Rs. 300 crore 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
shall be locked in for 5 years from the date of licensing of the bank and
excess stake above 40 per cent shall be diluted after one year of bank’s
operations.
• Initial capital other than promoters’ contribution could be raised through
public issue or private placement.
• While augmenting capital to Rs. 300 crore 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
finance company (including multilateral institutions) as a technical
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 foreign
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equity can be met through contribution by designated multilateral

institutions.
• No large industrial house can promote a new bank. Individual companies
connected with large industrial houses can, however, contribute up to 10 per
cent of the equity of a new bank, which will maintain an arms length
relationship with companies in the promoter group and the individual
company/ies investing in equity. No credit facilities shall be extended to
them.
• NBFCs with good track record can become banks, subject to specified
criteria
• A minimum capital adequacy ratio of 10 per cent shall be maintained on a
continuous basis from commencement of operations.
• 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 a strong presence in
the most lucrative business areas in the country because of technology
upgradation. While, their operating expenses have been falling as compared to
the PSU banks, their efficiency ratios (employee’s 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%.
Page | 23
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 had
a 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, non-
reconciliation of accounts, inability to control, misuse and fraud etc
E. Inability to introduce profitable new consumer oriented products like
credit cards, ATMs etc
The private’s edge

☑ Technology- The private banks have used technology to provide quality
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.
☑ Declining interest rates- in the present scenario of declining interest rates,

some of the new private banks are better able to manage the maturity mix.
Page | 24
PSU Banks by and large take relatively long-term deposits at fixed rates to
lend for working capital purposes at variable rates. It therefore is
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.
☑ NPAs- The new banks are growing faster, are more profitable and have
cleaner loans. Reforms among public sector banks are slow, as politicians
are reluctant to surrender their grip over the deployment of huge amounts
of public money.
☑ Convergence- The new private banks are able to provide a range of

financial services
under one roof, thus
increasing their fee
based revenues.
List of Banks operating in

India
Illustration 4
Page | 25
1.6 SPECIAL TRIBUNALS AND ASSET

RECONSTRUCTION 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 and
financial institutions (FIs) at the instance 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.
The Advantage
Page | 26
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,
Bangalore, Jaipur and Ahmedabad along with an Appellate Tribunal at
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 Baroda's
Kannan: "Of the Rs 45,000-crore worth of gross NPAs, over Rs 12,000 crore 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 Rs
20,000 crore, 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 by
government guarantees, which have turned sticky. Nor does it include
Page | 27
allowances for "ever greening"--the practice of extending fresh advances to

defaulting corporates so that the prospective defaulter can make interest
payments, thus enabling the asset to escape the non-performing loan tag. Warns
K.R. Maheshwari, 60, Managing Director, IndusInd 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.
More recently, the Supreme Court has ruled that the DRT Act will take
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 delays
at 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.
Page | 28
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 60,000 crore. The stratagem of using Debt
Recovery Tribunals has failed. Now these banks have to explore the option of
liquidating the assets of defaulting companies (a litigitinous route), or writing
off these debts altogether (which may not find favour with shareholders). The
solution could lie in better risk management.
Page | 29
1.7 RESTRUCTURING OF WEAK BANKS

How to deal with the weak Public Sector Banks is a major problem for
the next stage of banking sector reforms. It is particularly difficult because the
poor financial position of many of these banks is often blamed on the fact that
the regulatory regime in earlier years did not place sufficient emphasis on sound
banking, and the weak Banks are, therefore, not responsible for their current
predicament. This perception often leads to an expectation that all weak Banks
must be helped to restructure after which they would be able to survive in the
new environment.
Keeping in view the urgent need to revive the weak banks, the Reserve
Bank of India set up a Working Group in February, 1999 under the
Chairmanship of Shri M.S. Verma to suggest measures for the revival of weak
public sector banks in India.
Page | 30
THE VERMA PRESCRIPTION…a brief

 Identification of weak banks by using benchmarks for 7 critical ratios
 Recapitalisation of 3 weak banks conditional on their achieving

specified milestones
 Five-year freeze on all wage-increases, including the 12.25% increase

negotiated by the IBA
 A 25% reduction in staff-strength, either through VRSs or through

wage-cuts
 Branch rationalisation, including the closure of loss-making foreign

branches
 Transfer of non-performing assets to an Asset Reconstruction Fund
 Reconstitution of bank boards to include professionals, industrialists

and financial experts
 Independent Financial Restructuring Authority to monitor

implementation of revival package
The three identified banks on committee recommendations were UCO

bank, United Bank of India and Indian Bank.
In August 2001, the government of India directed UCO Bank to shut
down 800 branches and also 4 international operations in line with the Verma
Page | 31
committee recommendation on sick banks. Three more PSBs declared sick are
Dena Bank, Allahabad Bank and Punjab and Sindh Bank. UCO bank had been
posting losses for the past eleven years.
Page | 32
1.8 ASSET LIABILITY MANAGEMENT SYSTEM

The critical role of managing risks has now come into the open,
especially against the experience of the recent East Asian crisis, where markets
fell precipitously because banks and corporates 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, the
Reserve Bank has recently issued comprehensive guidelines to banks 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 behavior of banks forced the Reserve Bank to use regulatory tactics
to ensure the implementation of the ALM. Also, the post-reform banking
scenario 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
Page | 33
reputation at great risk. These pressures call for structured and comprehensive
measures and not just ad hoc 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 management
systems 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 bank’s position as to whether the bank is long or
short. The banks are expected to cover fully their assets and liabilities by April
2000.
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 perspective including strategic
management of interest and liquidity risk. Consider the procedure for
sanctioning a loan. The borrower, who approaches the bank, is appraised by the
credit department on various parameters like industry prospects, operational
efficiency, financial efficiency, management evaluation and others which
Page | 34
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 guidelines
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 use
traditional techniques like Gap Analysis for monitoring interest rate and
liquidity risk. However RBI is expecting Indian banks to move towards
sophisticated techniques like Duration, Simulation, VaR in the future.
Is it possible?
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 more
sophisticated systems may continue their existing systems but they should
ensure to fine-tune their current information and reporting system so as to be in
line with the ALM System suggested in the Guidelines. Other banks should
Page | 35
examine their existing MIS and arrange to have an information system to meet
the prescriptions of the new ALM System. In the normal course, banks are
exposed to credit and market risks in view of the asset-liability transformation.
Banks need to address these risks in a structured manner by upgrading their risk
management and adopting more comprehensive Asset-Liability Management
(ALM) practices than has been done hitherto
But, ultimately risk management is a culture that has to develop from

within the internal management systems of the banks. Its critical importance
will come into sharp focus once current restrictions on banks’ portfolios are
further liberalised and are subjected to the pressure of macro economic
fluctuations.
Page | 36
1.9 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 the
banks to expand their operations, public-sector banks will need
more capital. With the Government budget under severe 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 requirement of minimum shareholding by government in
nationalised banks to 33 per 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 shareholders. 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, the
Union Cabinet has taken certain decisions, which have far reaching
consequences for the future of the Indian banking sector cleared amendment of
the Banking Companies (Acquisitions and Transfer of Undertakings) Act
Page | 37
1970/1980 for facilitating the dilution of government’s equity to 33 per cent

Government’s action programme has expressed clearly its programme for the
dilution of its stake in bank equity. The Cabinet had taken this decision,
immediately on the next day after the bank employees went on strike, is a clear
indication of Government of India’s determination to amend the concerned
Acts, to pave the way for the reduction in its stake. The proposal had been to
reduce the minimum shareholding from 51 per cent to 33 per cent, with
adequate safeguards for ensuring its control on the operations of the banks.
However, it is not willing to give away the management control in the
nationalised banks. As a result public sector banks may find it very difficult to
attract strategic investors.
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 per cent,
irrespective of the equity holdings.
 The government would continue to have the 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.
 It has been decided to 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 a
Page | 38
nominee of the government can be in more than one bank after the
amendment.
 The number of whole time directors would 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 government has been maintaining that the nationalised
banks would continue to retain public sector character even after
the reduction in equity.
This is the reason why the banks would continue to be statutory bodies
even after the reduction in government equity below 51 per cent and the banks
would not become companies. This implies that they would continue to
subject to parliamentary and other scrutiny despite proposed relaxations.
Page | 39
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.
Page | 40
1.10 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. The
1998 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 lendings 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 yields
on advances and investments.
Interest rates in the banking system have been liberalised very
substantially compared to the situation prevailing before 1991, when the
Reserve 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, including
15-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 upto Rs 2,00,000, which account for 25% of total
advances, is not fixed at a level set by the RBI, but is now aligned with the
Page | 41
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.
Cooperative 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 don’t want to increase the risk profile of the portfolio. Banks’
income 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 income
component of the total income is significantly larger than the non-interest
income 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.
Page | 42
Income and Expenses Profile of Banks

Interest Income Interest Expenses
•Interest/discount on •Interest on deposits
advances/bills • Interest on Refinance/interbank
• Interest on investments borrowings
• Interest on balances with RBI • Others
and other interbank funds
• Others
Other Income Operating Expenses
• Commission, Exchange and  Payments to and
Brokerage provisions for employees
• Profit on sale of investments • Rent, taxes and lighting
• Profit on revaluation of • Printing and stationery
investments • Advertisement and publicity
• Profit on sale of land, building • Depreciation on Bank’s property
and other assets • Director’/Auditor’s fees and
• Profit on exchange expenses
transactions • Law charges, Postage, etc.
• Income earned by way of • Repairs and Maintenance,
dividends, etc.  Insurance.
• Miscellaneous • Other expenses
Illustration 5
Page | 43
1. DEVELOPMENTS
The following will state the development in Indian banking sector.
2.1 INTRODUCTION
The financial sector reforms have brought about significant
improvements in the financial strength and the competitiveness of the Indian
banking system. The efforts on the part of the Reserve Bank of India to adopt
and refine regulatory and supervisory standards on a par with international best
practices, competition from new players, gradual disinvestments of government
equity in state banks coupled with functional autonomy, adoption of modern
technology, etc are expected to serve as the major forces for change. New
businesses, new customers, and new products beckon, but bring increased risks
and competition. How might that change banks? To attract and retain
customers, the banks need to optimise their networks, speed up decision-
making, cut down on bureaucratic layers, and sharpen response times.
The reform has lead to new trends of being ahead and being with, by and
for the customer. While the private sector banks are on the threshold of
improvement, the Public Sector Banks (PSBs) are slowly contemplating
automation to accelerate and cover the lost ground. VRS introduced to bring up
the productivity, the concept of universal competition set in just to ensure
customer convenience all the time.
Also, the strength factor has lead to mergers and Indian banks will
explore this opportunity.
Page | 44
2.2 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 7,490 crore.
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 excess
employees in 12 nationalised banks, while based on a BPE of Rs. 125 lakhs, 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
scheme would range between Rs. 3 lakhs and Rs. 4 lakhs. 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 installments, 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 8,000 crore, and union activists feel that it will
adversely affect the profitability and capital adequacy of the banks. In fact, out
Page | 45
of this Rs 8,000 crore, nearly Rs 2,200 crore 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 bonds
and 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 fulfillment of the
bond & other requirements.
• Employees against whom Disciplinary Proceedings are
contemplated/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 bank’s management either to accept
a request for VRS or to reject the same depending upon the
requirement of the bank.
Page | 46
• 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 installments,
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/financial
institutions or any other source.
Periodicity – The scheme may be kept open up to 31.3.2001
Sabbatical – An employee/officer who may not be interested to take
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.
While the right of refusal to give voluntary retirement has been granted to
the bank management, recruitment against vacancies arising through the
VRS route has been disallowed.
Page | 47
Current Status
The VRS, as on July 2001, which bankers rushed to grab, has become a
drag on the bottomline 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 4,315.70 crore in 2000-01,
from Rs 5,116 crore in the previous year.
➢ In the banking sector close to 1,26,000 employees opted for the VRS in
‘00-01.
➢ The total benefits received by these employees has been close to Rs
15,000 crore.
Page | 48
Illustration 7
2.3 UNIVERSAL BANKING
RBI states: "The emerging scenario in the Indian banking

system points to the likelihood of the provision of multifarious
financial services under one roof. This will present opportunities to
banks to explore territories in the field of credit/debit cards,
mortgage financing, infrastructure lending, asset securitisation,
leasing and factoring. At the same time it will throw challenges in
the form of increased competition and place strain on the profit
margins of banks"
The evolving scenario in the Indian banking system points to the

emergence 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 fulfill 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 financial 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
Page | 49
those banks that offer a wide range of financial services, beyond commercial
banking and investment banking, insurance etc. Universal banking 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.
The main advantage of universal banking is that it results in greater
economic efficiency in the form of lower cost, 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. Also
combining commercial and investment banking can give rise to conflict of
interests.
In India
The issue of universal banking resurfaced in Year 2000, when ICICI gave
a presentation to RBI to discuss the time frame and possible options for
transforming itself into an universal bank. Reserve Bank of India also spelt out
to Parliamentary Standing Committee on Finance, its proposed policy for
universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.
Now 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 an universal bank over a
Page | 50
specified 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 January
1999 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.
Page | 51
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
propagate universal banking as an ideal concept for the DFIs to support
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. It
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 corporates 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 exist.
Crisil 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.
Page | 52
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 within
72 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 compared
to emerging economies like China, Korea & Thailand. It should not be
compared with developed countries like Europe and US. ICICI’s gross NPA
comes to Rs 6,000 crore. Asked about a approach to resolve the problem, she
said if the units are viable, it supported financial restructuring, mergers. If these
options aren’t possible and the units are not viable, it will go in for one time
settlement.
“Because of law, once the units are referred to BIFR, the lenders were unable to
enforce securities,” she pointed out.
Page | 53
2.4 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 in the
industry and to improve the profitability. Mergers may prove to be an effective
remedial measure in a competitive environment where margins/spreads are
under 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 is
simple as it is obvious. To beat competition for which suddenly size has
become an important matter. Mergers will help banks with added money power,
extended geographical reach with diversified branch networks, improved
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
Page | 54
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
to mind 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.
Page | 55
Disintermediation
Rigid
That’s
Volatability
Capital
Customer
Globalisation
Distinction
why!
A/c
Convertibility
Page | 56
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.
And that would be in consonance with the global trend towards universal
banking.
GLOBALISATION: Competition from abroad is also set to intensify. 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. Already, the number of foreign banks
Page | 57
operating in the country has jumped to 41, and 28 more have set up
representative offices.
CAPITAL ACCOUNT CONVERTABILTY will grant Indian corporates

access to capital markets abroad as well as provide foreign banks access to
Indian firms and investors. Given their undoubted financial muscle and
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.
Mutual funds, in particular, are a potent long-term threat because they
appropriate what was once the USP of bank deposits.
VOLATILITY: A large capital-base provides the necessary cushion to

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 change. ICICI
Bank had also initiated merger talks with Centurion Bank, but due to
differences arising over swap ratio the merger didn't materialized.
Page | 58
INTERNATIONALLY
The merger of the Citibank with Travelers Group and the merger of Bank
of America with NationsBank have triggered the mergers and acquisition
market 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. In a
seminar on Malaysia's recovery efforts, organized by the World Bank in
Washington, Mustapa said it was important for the government to ''move
aggressively'' 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 then
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 than
RM60 billion ($15.78 billion) in those days to bail them out and frankly we're
fed up and tired of bailing them out.'' After the mergers, he added, the
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.
Page | 59
The post merger scenario at ICICI

Elements Pre-merger Post-merger %
Change
Assets 12063 crores 16051 crores 33.06
No of 106 360 239.62
branches 9728 13123 34.90
Deposits 15 lakhs 27 lakhs 80
Customers 1700 4300 152.94
Employees 197 crores 220 crores 10.5
Equity Rs 7.10 / Rs 8.70 / 23
EPS share share
Illustration 6
The following table shows a General Comparison of three main classes of

banks:
Particulars PSU Banks Pvt. Banks Pvt.

(Old) Banks(New)
Cost of funds Low Moderate High
Branch network Wide Regional Low
Spread
Level of Automation Low Moderate High
NPAs High Low Low
Capital Adequacy Moderate Low High
Employee Productivity Low Moderate High
Focus on Non- interest Low High High
Page | 60
Income
Illustration 7
Page | 61
2.5 BANKING AND INSURANCE
What will the future of Indian banking and insurance look like? Will the
reform 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 be
15 per cent of GDP. Thus, regular bank credit transactions alone account for a
substantial percentage of GDP by way of servicing economic activities. A
gradual convergence is taking place in the banking and insurance sectors.
Several major banks are floating subsidiaries to enter both life and non-life
insurance 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 allowed
entry with a maximum of 26 per cent capital investment? The Insurance
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 financial
background will be entitled to do insurance business. In anticipation of the
Page | 62
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 restrict
entry into insurance to financially sound banks. Permission to undertake
insurance business through joint ventures on risk participation basis will
therefore be restricted to those banks which
(i) Have a minimum net worth of Rs. 500 crore 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
risk participation) up to 10 per cent of their net worth or Rs. 50 crore,
whichever is lower. However, any bank or its subsidiary can take up
distribution of insurance products on fee basis as an agent of insurance
company. 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 India, Bank of Baroda, Bank of India,
Global Trust Bank, Vysya Bank, Centurion Bank, Oriental Bank of
Commerce, ICICI Bank and HDFC Bank have or are intending to enter
insurance business after various procedural formalities have been clearly
defined in Insurance Regulatory Authority Bill. From the NBFC sector Alphic
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.
Page | 63
2.6 RURAL BANKING

ECONOMICALLY empowering, i.e. access to inexpensive credit and
other micro-finance services, including savings and insurance, India's rural
population will have a significant impact on India's economic growth.
Economic empowerment is defined here as. The modern banking system has
failed to deliver inexpensive credit to India’s 600,000 villages - despite several
expensive attempts to do so. Do we need to rethink the appropriate institutional
structure for rural banking in India? The problems of widespread 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. Though
there has been some improvement, the problem remains. There has been
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 northeastern 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 diversification
and commercialisation of agriculture underline the need for the rapid
development of rural infrastructure and a larger flow of credit. Activities allied
to agriculture – livestock breeding, dairy farming, sericulture etc are being
taken up on commercial lines. Further, hi-tech agriculture with an export
orientation has brought about higher productivity in cotton, oilseeds, etc.
Page | 64
Progressive and not-so-small farmers have no difficulty in obtaining

credit from the commercial banks. Credit for the poorer households is the real
problem.
The Narasimham Committee observed that the manning of rural

branches “has posed problems for banks owing to the reluctance of
urban-oriented staff to work in the rural branches and the lack of
motivation to do so. More local recruitment and improved working
conditions in rural areas should help to meet this problem.”
Experience of RRBs that have locally-recruited employees; the

employees are unhappy in view of the lack of adequate career prospects. Apart
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 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.
Page | 65
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 structure’s working, societies that want to work
independently of the federal system should be allowed to exit.
Page | 66
2.7 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 banks has
necessitated the switchover from hard cash to paper based instruments and now
to electronic instruments. Broadly speaking, virtual banking denotes 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 are the overwhelming
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.
Page | 67
➢ 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 viability
and 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 metropolitan
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 development
of INdian FInancial NETwork (INFINET) which will further facilitate
connectivity within the financial sector.
The popularity which virtual banking services have won among
customers, 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
built-in security features such as encryption. Prescriptions of maximum
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 payments
instructions, the responsibility of the customer for secrecy of the security
procedure would also need to be addressed.
Page | 68
The INFINET is a Closed User Group (CUG) Network for the exclusive
use of Member Banks and Financial Institutions. It uses a blend of
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 from simple
messaging, MIS, EFT (Retail, RTGS), ECS, Electronic Debit, online processing
and trading in Government securities, dematerialisation, centralized funds
querying for Banks and FIs, Anywhere/Anytime Banking, Inter-Branch
Reconciliation are being implemented using the INFINET. The INFINET will
be the communication backbone for the National Payments System, which will
cater mainly to inter-bank applications like RTGS, Delivery Vs Payment
(DVP), Government Transactions, 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. In a tight competitive environment where banks are
making a thrust towards technology to provide superior services to its
customers, customers stand to gain the most.
With increased competition, spreads in corporate lending have decreased
significantly. Banks are thus moving into the retail mode to tide over the global
slowdown and boost the bottomline.
The Customer is now in an enviable position where he can demand

superior services at competitive prices.
Page | 69
2.8 RETAIL BANKING

Retail banking had been a neglected segment accounting to 10.5 percent
of all banks loans of India. The main advantages of retail banking are assured
spread, widely distributed risks and lower NPAs due to limited risk associated
with the salaried class. However, transactions cost is higher as compared to of
corporate lendings. Thus, the target clientele is consumers and mid size
companies.
The product offerings include home loans, car loans, credit cards,
personal loans and also customized loans like equipment loan for doctors.
In India, out of 100 houses sold, 30 are bought by housing loans and out
of 100 cars sold, 28 are brought by car loans.
In India today
Among PSBs, SBI, Bank of Baroda, Union Bank of India and Bank of
India have diverged into the retail segment, whereas in the private sector,
opportunity seekers like ICICI and HDFC have focused on retail lendings.
Banks have a stronger influence on profits due to individual customers.
This is best proved by the success of HDFC which has achieved breakeven on
its operations in the fiscal year 2001. Even though retail loans account for 18
percent of total loans, these account for 40 percent of bank revenues.
“In retail banking, you need a higher physical presence, in the form of
ATMs as well as branches. State-of-art technology has to be used to enable
convenient customer transactions.” States, Mr.Swaroop of HDFC Bank.
Page | 70
Canara Bank – Interview of Mr. Sanghavi–Senior Manager–Andheri (W)
On VRS
In the long run, it will be fruitful, salary expenditure will drop, and also cost of
related perks would reduce. But they lay an immediate disadvantage; the VRS
was introduced in a much disorganized manner, there was no provision made
for the payment of VRS dues earlier. The cost at Canara Bank is around Rs 139
Crores; if these funds were used to make public sector banks technology savvy
then VRS could have been introduced after a period of 5 years. The banks
would also have the power to retain clients, currently, the clients who can pay
more for better services are moving away.
On diversifying portfolio
The private players have limited clients to cater; hence they can manage a
varied portfolio easily. Canara Bank had introduced single window system for
their clients; when you have a large database of customers, service quality
deproves.
On ECS – tech banking

UTI is the largest user of ECS credit, and BSES and MTNL are one of the
greatest beneficiaries, a problem here is when a cheque is bounced on account
of inadequate cash. The government needs to make clear laws on use of ECS.
Page | 71
Debt Recovery Tribunals

Interview of Mrs Rama Pendharkar – Advocate and Mr R S
Chehel – Advocate
CHURCHGATE
In Maharashtra, there are around 5 DRT, 3 in Mumbai. These have a specific
area of jurisdiction. DRT are authorised to handle DRT, the profile amount
exceeding Rs 10 Crores, all below Rs 10 crores need to approach the civil
courts.
The procedure
Banks send a notice to their client and if they don’t give a reply; the bank
i.e. applicant files a suit in the DRT. Section 19 of DRT Act states the banks
permitted to be an applicant, only scheduled banks and nationalised banks are
permitted. DRTs have their own procedure distinct from the civil courts; and
are headed by the Presiding Officer who is said to be equivalent to the District
Judge.
Within a month of filing a suit, the defaulted borrower i.e. the defendant
requires to reply back. No oral evidence is permitted, the defendant has to file
an affidavit. The issue is resolved only by affidavits. Within 6 month, the
presiding officer resolves to the issue.
Issues Resolved
The number of issues resolved is not disclosed on account of disclosure
regulations with respect to the same.
Page | 72
2.9 RECENT STATUS OF THE INDIAN BANKING SECTOR

The RBI-SEBI panel has decided that a foreign collaborator can hold up
to 49 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 banks did not consider
was acute shortage of manpower (read officers) for supervisory 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.
As a fall-out, daily operations that are being affected, will have to be outsourced
in the long run,” the sources said.
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.
Page | 73
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, despite a majority holding by the J&K government, is
classified as a private bank. "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 a change
in the statutes that would put the responsibility on banks, financial institutions
and other intermediaries to first prove themselves innocent when a `serious
fraud’ hits the system.
So it didn’t 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 10 crore is committed, the onus will be on banks and FIs to prove
themselves innocent, failing which the law will take its own course.
Understandably, it didn’t go down well among the bankers who fear that the
proposed law could terrorise bank officials to such an extent that business
would suffer.
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The central bank, which took the initiative to form the committee, is
understood to be supportive of the different changes that the panel has
prescribed. For instance, the committee has asked for changes in the Indian
Penal Code to enable the legal system handle `financial fraud’. Currently,
Indian laws with provisions for crimes like cheating, forgery and criminal
breach of trust, are vague about financial frauds. The committee aims to make it
more difficult for scamsters to take refuge in legal loopholes by making
financial frauds a crime.
The recommendations, which assume a special significance after the
string 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 whom give their inputs so
that the case can be presented in a comprehensive way before the court of law.
Allahabad Bank gets a sock for hiking CAR

The Governement on Wednesday pulled up the CMD of Allahabad Bank,
B Samal, and his management team for falsely reporting the bank’s 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 turn around 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 its loss-making
domestic branches besides four international ones. The government is meeting
all the weak banks to take stock of their operations, indicating a change in the
mindset and a resolve to chide shoddy performers. Indian Bank, however, was
Page | 75
the odd man out. Although the government did not promise capital, it
complimented the bank for its improved performance in recent months.
On sabbatical
The scheme launched by PSBs along with VRS, sabbatical has got
around 200 optees as of August 2001, comparing this to the VRS response of
11% of the employees in the industry; an observation was that only highly
qualified employees opted for this scheme.
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 lakh ATMs
in India and the growth rate is 40 %. As far as cost are 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.
Page | 76
2.10 THE FUTURE
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. With the continued integration of the
Indian 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
Page | 77
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 has
gained a considerable boosts as per the recent budgetary measures; banks are
allowed to lend 3 per cent of their advances to this sector, also infrastructure
and film financing remain untapped.
With 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. Some value-added services
may also need to be provided, which will call for innovation standardisation.
Virtual Banking will set in as a trend successfully.
Today, the banks have to compete with their peers as well as with other
financial companies; but tomorrow, competitors might zoom in from
completely unexpected industries, as deregulation and new technology blur old
boundaries, these rewrites the conventional definition of a bank. Those forces
offer as many opportunities as threats.
A reinvention or a renewal or a rediscovery, the way you term it,
shall root the structural changes in the Indian Banking Sector.
Page | 78
B. 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 CRAR requirements are necessary for financial soundness of Indian
banks; also; a need to assign risk weightage to government securities seems to
be coming up due to increasing investments of banks portfolios.
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 deprove the circumstances in the long
run; the asset quality is the determinance of banks profitability today. The
present evaluation process of banks states requires around 18 officials for
quality inspection; the bureaucracy involved can reduce only by way of better
bank supervision. The Disclosure norms shall avoid situations 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 Banking
sector; like the other sectors opened up, today, the Indian banks need to learn
much more from competition; customers and not advances and customer
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. It’s a fact in our country
Page | 79
that for every law made there is one more to escape from it. However, the
conceptualization of this structure needs to be acknowledged.
Increasing risks and imprudent liability management constitute to asset
liability mismatch. Complacent behaviour of Indian banks with this 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.
The corporates can now have a good deal with loans and advances; the
interest rate deregulation has been in line with the international standards. The
current trend of falling rates shall indeed give the corporate 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. I think a better plan would have been of
investments in technology partially and then a VRS. Currently, lots of banks are
facing problems of inadequate staffing; a good manpower planning in advance
would not have lead to the current problem.
About universal banking, due to increasing competition banks need to
strive for customers, thus, offering all at the same desks for corporates 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.
Page | 80
The opening of insurance has given banks a new opportunity to make the
best out of their resources; how much advantage do our PSBs make is yet to
see.
As far as rural banks are concerned, GOI has to give personnel better
career prospects in order to get them working, better products and convenience
and safety has to be guaranteed by the bank. Personalized service in a crude
form will help.
Lastly, technological upgradation will be what will lead to customer
retention on the grounds of accessibility and convenience.
Page | 81
C. QUESTIONNAIRE
The personnel in public sector and the private sector bank were
interviewed on basis of the following questionnaire (this is customized for
ICICI Bank):
About REFORMS in the Indian banking sector
What is the procedure being a private player (ICICI) in this industry, is it

different and more effective as far as recoveries are concerned?
The 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. This ultimately leads to one
solution i.e. ruthless provisioning, any better ways; it is a major drawback of
this ruling.
Are the transfers on NPAs to state owned ARF, just about shifting the
responsibility to the ARF? What’s the whole point of having something like
that, it’s like a better way of declaring losses and turning away from
efficiencies?
The need to make massive provisions obviously results in a depletion of
capital. But the capital adequacy norm means the banks have to find additional,
costly money to refurbish the capital base. In this situation, the banks are being
forced to accept the minimum possible amounts from sub-standard and bad
loans. Thus, the need for ARF is now paramount.
Page | 82
As a private player what are the problems that you face while communicating
with the government?
Reforms among public sector banks are slow, as politicians are reluctant
to surrender their grip over the deployment of huge amounts of public money.
Please comment on this reform, its positive and negative effects on private
players.
Government intends to reduce its stake to 33% in nationalized banks.
Any other recommendations as a private bank?

Introduction of prudential norms, Income Recognition & Asset
Classification and compulsory disclosure of accounts has lead to transparency
in the working of banks.
Please state your views on the overall development of India with this major
development in the financial system.
Consolidation of the Banking industry by merging strong banks is the
latest development in the Indian Banking Sector. ICICI has had a recent merger
with BoM, ANZ and Stanchart, etc.
About DEVELOPMENTS in the Indian Banking Sector
ICICI, as a company holds a diversified portfolio, is the main aim to increase

the non-fund based revenue due the trend of falling interest rates?
The 1992 reforms gave scope for diversified product profile. New
products and new operating styles exposed the banks to newer and greater risks.
Page | 83
Can you please state the benefits of universal banking, may be in terms of
revenue or utilisation of resources or others?
The issue of universal banking resurfaced in Year 2000, when ICICI gave
a presentation to RBI to discuss the time frame and possible options for
transforming itself into a Universal Bank.
What is the viability of “Insurance & Banking” in India, how would you rate
the success of ICICI Prudential – Joy Hope Freedom Life, on a scale of 1 to 10
(10 being highest), do you think PSBs should also go for insurance and why?
SBI Insurance – just confusing customers by lot of Insurance companies.
Your comments on distinguishing factor from a public sector bank which has a
low reputation as compared to private sector.
Especially ICICI, it is known for its network in rural areas, please comment on
the potentials in the rural area.
Due to increasing competition all banks are now heading towards
developing areas or rather towns in the country.
***************************
Page | 84

Reforms in Banking Sector

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REFORMS IN BANKING SECTOR

viii.Setting up of special tribunals to speed up the process of recovery of

Several recommendations have been accepted and are being implemented

x. International practice of income recognition by introduction of the 90-

To start with, it has assigned a 2.5 per cent risk-weightage on gilts by

1.1 REDUCTION OF SLR AND CRR

3. A commitment to a unidirectional movement of these vital controls

1.2 MINIMUM CAPITAL ADEQUACY RATIO

Growth In Investments In Government Securities by Banks

1991-92 1992-93 1992-93 1993-94

1.3 PRUDENTIAL NORMS

Magnitude of the problem

What is ever greening or rescheduling of loans?

Asset Quality - Increased Transparency

The banking industry has significant market inefficiencies caused by the

Classification of Loan Assets of SCBs (Percentage distribution of total loan

Assets Public Private Foreign SCBs

The asset classification norms have resulted in a huge quantity of assets

A provision of 1% on standard assets is required as suggested by

1.4 DISCLOSURE NORMS

RBI norms for consolidated PSU bank accounts

The Investors Advantage

anticipation of a US listing. These norms will therefore be in line with the

1.5 RATIONALISATION OF FOREIGN OPERATIONS

Entry of New Banks in the Private Sector

equity can be met through contribution by designated multilateral

The private’s edge

☑ Declining interest rates- in the present scenario of declining interest rates,

☑ Convergence- The new private banks are able to provide a range of

List of Banks operating in

1.6 SPECIAL TRIBUNALS AND ASSET

allowances for "ever greening"--the practice of extending fresh advances to

Some More Issues

1.7 RESTRUCTURING OF WEAK BANKS

THE VERMA PRESCRIPTION…a brief

 Recapitalisation of 3 weak banks conditional on their achieving

 Five-year freeze on all wage-increases, including the 12.25% increase

 A 25% reduction in staff-strength, either through VRSs or through

 Branch rationalisation, including the closure of loss-making foreign

 Transfer of non-performing assets to an Asset Reconstruction Fund

 Reconstitution of bank boards to include professionals, industrialists

 Independent Financial Restructuring Authority to monitor

The three identified banks on committee recommendations were UCO

1.8 ASSET LIABILITY MANAGEMENT SYSTEM

Implementation of asset liability management (ALM) system

ALM framework rests on three pillars

But, ultimately risk management is a culture that has to develop from

1.9 REDUCTION OF GOVERNMENT STAKE IN PSBS

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

1970/1980 for facilitating the dilution of government’s equity to 33 per cent

SALIENT FEATURES of the proposed amendments

The measures seen in totality are clearly aimed at enabling banks to

1.10 DEREGULATION ON INTEREST RATES

Prime Lending Rate (PLR) which is determined by the boards of individual

Income and Expenses Profile of Banks

The following will state the development in Indian banking sector.

2.2 VOLUNTARY RETIREMENT SCHEMES

Salient Features of Voluntary Retirement Scheme of Banks

2.3 UNIVERSAL BANKING

RBI states: "The emerging scenario in the Indian banking

The evolving scenario in the Indian banking system points to the

ICICI gearing to become a universal bank