DEVELOPMENT FINANCIAL INSTITUTIONS

Introduction:

Development Financial Institutions or Development banks are the institutions which supply capital, knowledge, and enterprise, the three major ingredients of development for business enterprises. These Institutions provide long term finance to agriculture, industries, trade, transport and basic infrastructure, so that in the absence of financial resources the economic development of the country is not adversely affected. These institutions have been taking interest in industrial finance to industrial sectors as well as promotional development activities of the industrial units in the country .

Objectives:
To develop over a period of time efficient managerial resources, to help rapid development of the country. To sub-serve the social goals, planned objectives, priorities and targets at national planning level. To allocate resources to high priority areas. To accelerate the growth of the economy.

COMMERCIAL BANKS
Introduction:
Commercial banks are the premier financial institutions as they play a pivotal role in the countrys economy. Commercial banks two major functions are accepting deposits and employing the funds thus mobilized in lending or investing in securities. Banks being financial institutions, planning and management of funds are essential elements of bank management. It can be defined as an institution that offers a broad range of deposit accounts, including current, savings, and time deposits, and extends loans to individuals and businesses -- in contrast to investment banking firms such as brokerage firms, which generally are involved in arranging for the sale of corporate or municipal securities.

Objectives:
To maintain higher profitability by maintaining circular and efficient flow of amount deposited by the customers and the lenders. To contribute to the economic cycle by keeping the money circulation among households, government and corporate Businesses. To design short term and long term loans and other products to cater to the need of customers while enhancing their own returns. To attract more customers and build profitable relationships with the new and existing customers

NEED FOR DFIs CONVERTING INTO BANKS

High cost of funds, which is over 12 percent in case of a financial institution and just over6 percent in case of a commercial bank Increasing competition, due to increase in various new players like insurance companies, mutual fund entities etc. Low demands for long term funds, due to absence of heavy project investments especially in the area of infrastructure. High level of non-performing assets. Increasing competition from commercial banks in retail financial market. Lower spread due to extensive competition. High competition in market to attract top rated borrowers at low. The global financial services market is growing very fast and chains of foreign banks are attacking traditional banks by offering new products of loans and investment portfolios under one roof. Liberalization and de-regulation of financial markets have led to fragmentation of traditional branch services. Information Technology development has paved the way for excellent customer services by way of providing electronic distribution channels. New breed of private sector banks and foreign banks are providing a wide range of services under one roof. Foreign banks and new private sector banks are integrating all its customer information and making the information available across all different delivery channels, i.e. their branches. Many other banks have also realized

that the data warehousing has the potential to play an immensely important role in the future, especially in relation to how the banks use their information with their virtually delivery channels.

HARMONISATION OF BANKS AND DFIS

INTRODUCTION
The financial sector reforms ushered a significant change in the operating environment of banking and development financial institution. The deregulation of interest rates, disintermediation and increasing participation by banks in project finance altered the operation environment of bank by, paving way for universal banking. The development financial institution set up in the year 1948 with a view to meet the long term financial needs of a project realized that to mitigate the inherent risk arising from a care product dominant portfolio, they have to resort to product diversification. With development financial institution making forays into the realm of working capital or short term financing, the traditional operational division between banks and development financial institutions became increasingly blurred.

KHAN WORKING GROUP

Introduction:
In the light of number of reform measure adopted in the Indian financial system of reform measures adopted in the Indian financial system since 1991 and

keeping in view the need for evolving an efficient and competitive financial system .the reserve bank constituted on December 8th 1997, a working group for harmonising the role and operation of DFIs and banks ,under the chairmanship of chairman and managing director of industrial development bank of India, Shri S.H.Khan with following terms of reference: To review the role, structure and operation of DFIs and Commercial banks in emerging environment. To suggest measures for bringing about harmonization in their roles and operations. To suggest measures for strengthening of the organization, human resources, risk management practices and other related issues in DFIs and Commercial banks. To examine whether DFIs could be given increased access to short-term funding and the regulatory framework needed for the purpose.

The working Group submitted its interim report in April and Final Report in May 1998.After the submission of the Khan Working Group report, the Reserve Bank released a discussion paper on the topic Harmonizing the role and operations of Development Financial Institution and Banks in January 1999.

Khan Working Group Recommendations on Conversion of DFIs

The Khan Working Group (KWG) keeping in views the deregulation, securitization and the diversification of business by banks into investment banking and beyond, made following recommendations.

The approach to universal banking should be guided by international experience and domestic requirements.

The DFIs should have the freedom to remain DFIs, specializing in their own activities. However, if a DFI chooses to become a bank, venturing into commercial banking activities, that option should also be available. In that case, the Converted DFI should be prepared to fully conform to all prudential, regulatory and supervisory norms which are applicable to banks.

The question of transformation of DFI into a bank should ideally be considered after a period, say of five years from now. When a DFI chooses to transform itself into a bank, the transitionary arrangements on a time bound basis could be worked out. This case by case approach is essential because each DFI would be in a unique position in terms of its capacity to transform into a bank.

BANCASSURANCE AN IMPORTANT FACET OF CONVERSION OF DFIs TO BANKS

RBI has recognized the importance of insurance and accordingly given guidelines for entry of banks into insurance business.

Banks can undertake agency for insurance services i.e. they can sell insurance products for certain fees. Banks can establish joint venture companies for insurance business. a) Banks dont involve directly in insurance business because of risk involved in it. This concept involves greater fee income and also helps in retaining the customers for a longerperiod. It also contributes to the profitability of banks and insurance companies. It createscompetitive advantage through cross selling synergy. Banks should have a strategicalliance with foreign counter parts. It should fulfill the requirements of Insurance Regulatory

Development Authority (IRDA), Securities and Exchange board of India(SEBI), Reserve bank of India (RBI) and Government of India.

b) Banks and Insurance Companies have agreement with the objectives:

i. ii. iii. iv.

Improve competitive positioning. Gain entry into new markets. Supplement critical skills. Share the risk and cost.

c) The strategic alliance will improve brand image and reputation of the bank, reduce the cost through economies of scale, create more customers, manage the relationships and enhance long term prospects by achieving above stated objectives and ultimate profitability.

d) The new private sector banks have become global players in the financial sector byadapting to universal banking activities. Banks in the public sector

like SBI, Corporationbank have also made tie-ups with insurance companies in changing their trends touniversal banking.

ICICI MERGER
INTRODUCTION
ICICI (merged with ICICI Bank in March 30, 2002) established in 1995 facilitated the economic objectives. Though ICICI played a highly significant role in assisting industrial development through long term lending and a variety of other services to industry, it started facing problems in 1990s. Project like steel, textiles, basic chemicals in which heavy investment had been made suffered losses and the default rate increased causing problems to all DFIs including ICICI. In absolute terms, the NPAs outstanding in these sectors totaled to Rs 1333crore about 17 percent of ICICIs total equity capital. The company began to look for safer ways to deploy incremental resources. Two new investment avenues that stand out are the massive deployment into medium-term corporate finance and retail lending. The two most important factors enabling the smooth and speedy implementation of the plan of conversion by ICICI Ltd. were: The ready banking platform available with it for launching itself into a universal bank, by way of backward integration with its banking subsidiary.

The private company character of the DFI, with resultant operational freedom and ability to leverage, the superior managerial resources and skills available with it, in steering the organization along the transition path. Medium- term financing means that ICICIs return on the money lent is done at a lower rate. It is not just lower interest earned on losses that led to reduction in spread from around 3.46percent in fiscal 1997 to 1.85 percent in fiscal 2000; ICICI also had to deal with higher cost funds. Till the early 1990s, the DFIs were entitled to concessional long-term funds. Since then, they have been forced to rely on a crowded market for funds, thereby raising.

IDBI MERGER

INTRODUCTION

The Industrial Development Bank of India (IDBI) was established on July 1, 1964 under an Act of Parliament as a wholly owned subsidiary of the Reserve Bank of India. In 16 February1976, the ownership of IDBI was transferred to the Government of India and it was made the principal financial institution for coordinating the activities of institutions engaged in financing, promoting and developing industry in the country.

In the wake of financial sector reforms unveiled by the government since 1992, IDBI evolved an array of fund and fee-based services with a view to

providing an integrated solution to meet the entire demand of financial and corporate advisory requirements of its clients. IDBI also provided indirect financial assistance by way of refinancing of loans extended by State-level financial institutions and banks and by way of rediscounting of bills of exchange. With the changes in economic environment in the last decade, the flow of funds to FIs from RBIs National Industrial Credit Long Term Operations (NIC-LTO) and allocation of Statutory Liquidity ratio (SLR) bonds dried up and it became necessary for the FIs to raise funds mainly from the markets.

ROLE OF CONVERSION OF DFIs TO BANKS IN INDIA In India, though there has been no legislative distinction between Commercial banking and Investment banking or any explicit legislative restriction for the banks to operate in investment banking activities, the banks have traditionally been maintaining the arms length distance from investment banking. The plausible reason could be that, as we followed the British style of banking, which could on the Anglo-Saxon style wherein strict separation was maintained between commercial banking activity and investment activity, the same pattern has been adopted in India. With the financial sector reforms, beginning 1990s ,bank were however, given abundant freedom to go much beyond traditional conservative banking related to working capital finance. But the more tangible momentum for the universal banking in India seem to have set in only after the second Narasihmam committees report [1998] recommendation for development inancial institution [DFIs], over a period of time, to convert themselves into banks

[implicitly universal banks] and that there should eventually be only two form of intermediaries, viz. Banking companies and Non Banking finance company. This was followed by a working group chaired by S.H. Khan on Harmonizing the Role and Operations of Development Financial Institutions and Banks (1998) which made it more explicit by recommending for a progressive movement towards universal banking for the DFIs. Reserve bank of India as a regulator and supervisor of the banking system, laid the formal roadmap, especially for the DFI.s, by way of giving a set of guidelines. Banks were permitted to enter into term finance infrastructure finance, insurance business, (i.e. similar to bancassurance prevailing in European countries), underwriting of shares, etc. It is beneficial for the bank as well as its customers

7.1 CONCLUSION 1. Finally, when arrived at the conclusion of the project one question that arises is How close we are to the vision of a sound and well-functioning banking system in India?

2. It is fair to say that despite turbulent years and many challenges, we have made some progress towards 8/.this goal. There has been progressive intensification of financial sectorhj ,nb21re forms, and the financial sector as a whole is more sensitized than before to the need for internal strength and effective management as well as to the overall concerns for financial stability. At the same time, in view of greater disclosure and tougher prudential norms, the weaknesses in our financial system are more apparent than before.

3. There is greater awareness now of the need to prepare the banking system for the technical and capital requirements of the emerging prudential regime and a greater focus on core strengths and niche strategies. We have also made some progress in assessing our financial system against international best practices and in benchmarking the future directions of progress. Several contemplated changes in the surrounding legal and institutional environment have been proposed for legislation. 7.2 SUGGESTIONS The following suggestions can be taken into consideration by the DFIs converting themselves into bank: 1. More and more DFIs should try to convert themselves into Universal Banks i.e. all services under one roof which will be beneficial to both i.e. for banks and the customers. For banks it will be beneficial as it will help them to maximize their profits and from the point of view of customers it will be a solution for all their financial services under one roof. It will help the banks to expand their business on national and international level and will help to create their image in International banking sector.

2. As India is moving ahead in the field of technology, more and more banks should try to improve the use of technology in their services provided to the customers and should provide Core Banking Solutions in all their branches. 3. As NPAs are the greatest challenge for the banks these days, it is suggested that these banks should focus on reducing their NPA levels as it will indirectly help in increasing their profits