CHAPTER 1 INTRODUCTION

1.1 Financial Sector Reforms set in motion in 1991 have greatly changed the face of Indian Banking. The banking industry has moved gradually from a regulated environment to a deregulated market economy. The market developments kindled by liberali ation and globali ation have resulted in changes in the intermediation role of banks. The pace of transformation has been more significant in recent times !ith technology acting as a catalyst. "hile the banking system has done fairly !ell in ad#usting to the ne! market dynamics$ greater challenges lie ahead. Financial sector !ould be opened up for greater international competition under "T%. Banks !ill have to gear up to meet stringent prudential capital ade&uacy norms under Basel II. In addition to "T% and Basel II$ the Free Trade 'greements (FT's) such as !ith Singapore$ may have an impact on the shape of the banking industry. Banks !ill also have to cope !ith challenges posed by technological innovations in banking. Banks need to prepare for the changes. In this conte*t the need for dra!ing up a Road +ap to the future assumes relevance. The idea of setting up a ,ommittee to prepare a -ision for the Indian Banking industry came up in IB'$ in this background. 1.2 +anaging ,ommittee of Indian Banks. 'ssociation constituted a ,ommittee under the ,hairmanship of Shri S , /upta$ ,hairman 0 +anaging 1irector$ Indian %verseas Bank to prepare a -ision Report for the Indian Banking Industry. The composition of the ,ommittee is given at the end of the report. 1.3 The ,ommittee held its first meeting on 23 rd 4une 2553 at +umbai. 6rior to the meeting the members !ere re&uested to give their thoughts on the future landscape of the banking industry. ' discussion paper based on the responses received from members !as circulated along !ith a &uestionnaire eliciting vie!s of members on some of the specific issues concerning anticipated changes in the banking environment. In the meeting$ !hich served as a brainstorming session$ members gave their -ision of the future. ' second meeting of the ,ommittee !as held at ,hennai on 7 th 'ugust 2553 to have further discussions on the common vie!s$ !hich emerged in the first
1

meeting$ and also to e*amine fresh areas to be covered in the study.

1.4

The -ision Statement prepared by the ,ommittee is based on common thinking that crystalli ed at the meetings. In the ,hennai meeting it !as decided to form a smaller group from among the members to draft the report of the ,ommittee. The group met thrice to finali e the draft report. The report !as adopted in the final meeting of the ,ommittee held at +umbai.

1.5

"hen !e talk about the future$ it is necessary to have a time hori on in mind. The ,ommittee felt$ it !ould be rather difficult to visuali e the landscape of banking industry say$ 25 years hence due to the dynamic environment. "hile /overnment of India brought out India -ision 2525$ the ,ommittee is of the vie! that the pace of changes taking place in the banking industry and in the field of Information Technology !ould render any attempt to visuali e the banking scenario in 2525$ inconceivable. The entire financial services sector may undergo a dramatic transformation. It !as$ therefore$ felt that !e should set our goals for the near future say$ for 8915 years hence and appropriately call this e*ercise :Banking Industr !isi"n 2#1#;.

I am confident that India will become a Developed Nation by 2020. Come, let us strive together to turn this resolve into reality #a$payee !tal "ihari

CHAPTER $ 2
E%ER&IN& ECONO%IC 'CENE 2.1 The financial system is the lifeline of the economy. The changes in the economy get mirrored in the performance of the financial system$ more so of the banking industry. The ,ommittee$ therefore felt$ it !ould be desirable to look at the direction of gro!th of the economy !hile dra!ing the emerging contours of the financial system. The : India -ision 2525< prepared by the 6lanning ,ommission$ /overnment of India$ is an important document$ !hich is likely to guide the policy makers$ in the years to come. The ,ommittee has taken into consideration the economic profile dra!n in India -ision 2525 document !hile attempting to visualise the future landscape of banking Industry. 2.2 India -ision 2525 envisages improving the ranking of India from the present 11 th to =th among 257 countries given in the "orld 1evelopment Report in terms of the /ross 1omestic 6roduct (/16). It also envisages moving the country from a lo!9 income nation to an upper middle9income country. To achieve this ob#ective$ the India -ision aims to have an annual gro!th in the /16 of >.8 per cent to 9 per cent over the ne*t 25 years. ?conomic development of this magnitude !ould see &uadrupling of real per capita income. "hen compared !ith the average gro!th in /16 of =9@A in the recent past$ this is an ambitious target. This !ould call for considerable investments in the infrastructure and meeting the funding re&uirements of a high magnitude !ould be a challenge to the banking and financial system. 2.3 India -ision 2525 sees a nation of 1.3 billion people !ho are better educated$ healthier$ and more prosperous. Brban India !ould encompass =5A of the population as against 2> A no!. "ith more urban conglomerations coming up$ only =5A of population !ould be engaged in agricultural sector as against nearly t!o thirds of people depending on this sector for livelihood. Share of agriculture in the /16 !ill come do!n to @A (do!n from 2>A). Services sector !ould assume greater prominence in our economy. The shift in demographic profile and composition of /16 are significant for strategy planners in the banking sector.

2.4 Small and +edium ?nterprises (S+?) sector !ould emerge as a ma#or contributor to employment generation in the country. Small Scale sector had received policy support from the /overnment in the past considering the employment generation and favourable capital9output ratio. This segment had$ ho!ever$ remained vulnerable in many !ays. /lobali ation and opening up of the economy to international competition has added to the !oes of this sector making bankers !ary of supporting the sector. It is e*pected that the S+? sector !ill emerge as a vibrant sector$ contributing significantly to the /16 gro!th and e*ports. 2.5 India.s share in International trade has remained !ell belo! 1A. Being not an e*port led economy (e*ports remaining belo! 18A of the /16)$ !e have remained rather insulated from global economic shocks. This profile !ill undergo a change$ as !e plan for >99A gro!th in /16. 6lanning ,ommission report visuali es a more globalised economy. %ur international trade is e*pected to constitute 38A of the /16. 2.( In short$ the -ision of India in 2525 is of a nation bustling !ith energy$ entrepreneurship and innovation. In other !ords$ !e hope to see a market9driven$ productive and highly competitive economy. To reali e the above ob#ective$ !e need a financial system$ !hich is inherently strong$ functionally diverse and displays efficiency and fle*ibility. The banking system is$ by far$ the most dominant segment of the financial sector$ accounting for as it does$ over >5A of the funds flo!ing through the financial sector. It should$ therefore$ be our endeavor to develop a more resilient$ competitive and dynamic financial system !ith best practices that supports and contributes positively to the gro!th of the economy. 2.) The ability of the financial system in its present structure to make available investible resources to the potential investors in the forms and tenors that !ill be re&uired by them in the coming years$ that is$ as e&uity$ long term debt and medium and short9term debt !ould be critical to the achievement of plan ob#ectives. The gap in demand and supply of resources in different segments of the financial markets has to be met and for this$ smooth flo! of funds bet!een various types of financial institutions and instruments !ould need to be facilitated.

2.* /overnment.s policy documents list investment in infrastructure as a ma#or area !hich needs to be focused. Financing of infrastructure pro#ects is a speciali ed activity and !ould continue to be of critical importance in the future. 'fter all$ a sound and efficient infrastructure is a sine &ua non for sustainable economic development. Infrastructure services have generally been provided by the public sector all over the !orld in the past as these services have an element of public good in them. In the recent past$ this picture has changed and private financing of infrastructure has made substantial progress. This shift to!ards greater role of commercial funding in infrastructure pro#ects is e*pected to become more prominent in coming years. The role of the /overnment !ould become more and more of that of a facilitator and the development of infrastructure !ould really become an e*ercise in public9private partnership. CIndia Infrastructure Report. (Rakesh +ohan ,ommittee 9 199@) placed financing of infrastructure as a ma#or responsibility of banks and financial institutions in the years to come. The report estimated the funding re&uirements of various sectors in the infrastructure area at Rs 12$55$555 crore by the year 255895@. Since the estimated availability of financing from Indian financial institutions and banks !as e*pected at only Rs 1$25$555 crore$ a large gap is left !hich needs to be filled through bilateralDmultilateralDgovernment funding. 2.+ It has been observed globally that pro#ect finance to developing economies flo!s in !here there is relatively stable macro9economic environment. These include regulatory reforms and opening of market to competition and private investment. Eiberali ed financial markets$ promoting and deepening of domestic markets$ !ider use of risk management tools and other financial derivative products$ improved legal frame!ork$ accounting and disclosure standards etc are some of the other aspects !hich !ould impact commercial funding of infrastructure pro#ects.

2.1# The India -ision document of 6lanning ,ommission envisages Foreign 1irect Investments (F1I) to contribute 38A (21A no!) to gross capital formation of the country by 2525. /overnment has announced a policy to encourage greater flo! of F1I into the banking sector. The recent amendment bill introduced in 6arliament to remove the 15A ceiling on the voting rights of shareholders of banking companies is a move in this direction. The !orking group e*pects this to have an impact on the capital structure of the banks in India in the coming years. 2.11 ,onse&uent to opening up of the economy for greater trade and investment relations !ith the outside !orld$ !hich is imperative if the gro!th pro#ections of India -ision 2525 !ere to materiali e$ !e e*pect the banking Industry.s business also to be driven by forces of globali ation. This may be further accentuated !ith the realisation of full convertibility of the rupee on capital account and conse&uent free flo! of capital across the borders. 'n increase in the income levels of the people !ould naturally lead to changes in the spending pattern also. This could result in larger investments in the areas like entertainment and leisure$ education$ healthcare etc and naturally$ these !ould attract greater participation of the banking system. 2.12 %n the basis of the pro#ection made by the 1raft 15 th Five Fear 6lan on

relevant macro indicators such as /16 and e*tending the trend for a further period of three years$ it is estimated that /16 at current market prices during 2559915 !ould be Rs.@1$=5$555 crore. Taking into account the on9going reform measures$ e*pected Basel II needs$ and financial dis9intermediation$ the pace of e*pansion in the balance sheets of banks is likely to decelerate. Thus total assets of all scheduled commercial banks by end +arch 2515 may be taken as Rs.=5$95$555 crore as a !orking estimate. 't that level$ the annual composite rate of gro!th in total assets of Scheduled ,ommercial Banks !ould be about 13.= per cent to be over 2552953 as compared to 1@.7 per cent bet!een 199=998 and 2552953. It !ill form about @8 per cent of /16 at current market prices as compared to @7 per cent in 2552953. %n the liability side$ there may be large augmentation to capital base. Reserves are likely to increase substantially. Banks !ill relay more on borro!ed funds. Gence$ the pace of accretion to deposits may slo! do!n.
7

%n the asset side$ the pace of gro!th in both advances and investment may slacken. Go!ever$ under advances$ the share of bills may increase. Similarly$ under investment$ the share of Cothers. may increase. The +acro9magnitude of Indian banking sector visuali ed for the year 2515 is given in Ann,-ur, I.

CHAPTER 3 .UTURE /AND'CAPE O. INDIAN BAN0IN&

3.1 Eiberali ation and de9regulation process started in 1991992 has made a sea change in the banking system. From a totally regulated environment$ !e have gradually moved into a market driven competitive system. %ur move to!ards global benchmarks has been$ by and large$ calibrated and regulator driven. The pace of changes gained momentum in the last fe! years. /lobali ation !ould gain greater speed in the coming years particularly on account of e*pected opening up of financial services under "T%. Four trends change the banking industry !orld over$ vi . 1) ,onsolidation of players through mergers and ac&uisitions$ 2) /lobalisation of operations$ 3) 1evelopment of ne! technology and =) Bniversalisation of banking. "ith technology acting as a catalyst$ !e e*pect to see great changes in the banking scene in the coming years. The ,ommittee has attempted to visuali e the financial !orld 8915 years from no!. The picture that emerged is some!hat as discussed belo!. It entails emergence of an integrated and diversified financial system. The move to!ards universal banking has already begun. This !ill gather further momentum bringing non9banking financial institutions also$ into an integrated financial system. 3.2 The traditional banking functions !ould give !ay to a system geared to meet all the financial needs of the customer. "e could see emergence of highly varied financial products$ !hich are tailored to meet specific needs of the customers in the retail as !ell as corporate segments. The advent of ne! technologies could see the emergence of ne! financial players doing financial intermediation. For e*ample$ !e could see utility service providers offering say$ bill payment services or supermarkets or retailers doing basic lending operations. The conventional definition of banking might undergo changes. 3.3 The competitive environment in the banking sector is likely to result in individual players !orking out differentiated strategies based on their strengths and market niches. For e*ample$ some players might emerge as specialists in mortgage products$ credit cards etc. !hereas some could choose to concentrate on particular
9

segments of business system$ !hile outsourcing all other functions. Some other banks may concentrate on S+? segments or high net !orth individuals by providing specially tailored services beyond traditional banking offerings to satisfy the needs of customers they understand better than a more generalist competitor. 3.4 International trade is an area !here India.s presence is e*pected to sho!

appreciable increase. 6resently$ Indian share in the global trade is #ust about 5.>A. The long term pro#ections for gro!th in international trade is placed at an average of @A per annum. "ith the gro!th in IT sector and other IT ?nabled Services$ there is tremendous potential for business opportunities. Heeping in vie! the /16 gro!th forecast under India -ision 2525$ Indian e*ports can be e*pected to gro! at a sustainable rate of 18A per annum in the period ending !ith 2515. This again !ill offer enormous scope to Banks in India to increase their fore* business and international presence. /lobali ation !ould provide opportunities for Indian Banks in India corporate entities to e*pand their business in other countries. follo! these corporates and other trade flo!s in and out of India. 3.5 Retail lending !ill receive greater focus. Banks !ould compete !ith one another to provide full range of financial services to this segment. Banks !ould use multiple delivery channels to suit the re&uirements and tastes of customers. "hile some customers might value relationship banking (conventional branch banking)$ others might prefer convenience banking (e9banking). 3.( %ne of the concerns is &uality of bank lending. +ost significant challenge

!anting to increase their international presence could naturally be e*pected to

before banks is the maintenance of rigorous credit standards$ especially in an environment of increased competition for ne! and e*isting clients. E-1,ri,n2, 3as s3"4n us t3at t3, 4"rst 5"ans ar, "6t,n 7ad, in t3, 8,st "6 ti7,s. ,ompensation through trading gains is not going to support the banks forever. Earge9scale efforts are needed to upgrade skills in credit risk measuring$ controlling and monitoring as also revamp operating procedures. ,redit evaluation may have to shift from cash flo! based analysis to :borro!er account behaviour;$ so that the state of readiness of Indian banks for Basle II regime improves. ,orporate lending is already undergoing changes. The emphasis in future !ould be to!ards more of
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fee based services rather than lending operations. Banks !ill compete !ith each other to provide value added services to their customers. 3.) Structure and o!nership pattern !ould undergo changes. There !ould be greater presence of international players in the Indian financial system. Similarly$ some of the Indian banks !ould become global players. /overnment is taking steps to reduce its holdings in 6ublic sector banks to 33A. Go!ever the indications are that their 6SB character may still be retained. 3.* +ergers and ac&uisitions !ould gather momentum as managements !ill strive to meet the e*pectations of stakeholders. This could see the emergence of =98 !orld class Indian Banks. 's Banks seek niche areas$ !e could see emergence of some national banks of global scale and a number of regional players. 3.+ ,orporate governance in banks and financial institutions !ould assume greater importance in the coming years and this !ill be reflected in the composition of the Boards of Banks. 3.1# ,oncept of social lending !ould undergo a change. Rather than being seen as directed lending such lending !ould be business driven. "ith S+? sector e*pected to play a greater role in the economy$ Banks !ill give greater overall focus in this area. ,hanges could be e*pected in the delivery channels used for lending to small borro!ers and agriculturalists and unorgani ed sectors (micro credit). Bse of intermediaries or franchise agents could emerge as means to reduce transaction costs. 3.11 Technology as an enabler is separately discussed in the report. It !ould not be out of place$ ho!ever$ to state that most of the changes in the landscape of financial sector discussed above !ould be technology driven. In the ultimate analysis$ successful institutions !ill be those !hich continue to leverage the advancements in technology in re9engineering processes and delivery modes and offering state9of9 the9art products and services providing complete financial solutions for different types of customers.
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3.12 Guman Resources 1evelopment !ould be another key factor defining the characteristics of a successful banking institution. ?mploying and retaining skilled !orkers and specialists$ re9training the e*isting !orkforce and promoting a culture of continuous learning !ould be a challenge for the banking institutions.

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CHAPTER $ 4 CHAN&E' IN THE 'TRUCTURE O. BAN0'

4.1 The financial sector reforms ushered in the year 1991 have been !ell calibrated and timed to ensure a smooth transition of the system from a highly regulated regime to a market economy. The first phase of reforms focused on modification in the policy frame!ork$ improvement in financial health through introduction of various prudential norms and creation of a competitive environment. The second phase of reforms started in the latter half of 95s$ targeted strengthening the foundation of banking system$ streamlining procedures$ upgrading technology and human resources development and further structural changes. The financial sector reforms carried out so far have made the balance sheets of banks look healthier and helped them move to!ards achieving global benchmarks in terms of prudential norms and best practices. 4.2 Bnder the e*isting Basel ,apital 'ccord$ allocation of capital follo!s a This !ould be replaced by a risk based approach to "hile regulatory minimum capital re&uirements !ould still

one9si e9fit9all approach. capital allocation.

continue to be relevant and an integral part of the three pillar approach under Basel II$ the emphasis is on risk based approach relying on e*ternal ratings as !ell as internal rating of each asset and capital charge accordingly. The internal risk based approach !ould need substantial investments in technology and development of +IS tools. For a rating tool for internal assessment to be effective$ past data for 3 to 8 years !ould be re&uired and as such$ Indian banking system !ill have to build up the capabilities for a smooth migration to the ne! method. 'nother aspect !hich is included in Basel II accord is a provision for capital allocation for operational risk. This is a ne! parameter and even internationally evaluation tools are not yet fully developed. This !ould be another area !here banking system !ill have to reckon additional capital needs and functioning of its processes. 4.3 The financial sector reforms have brought in the much needed competition in the market place. The competition to the e*isting banks came mainly from the techno9
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savvy private sector banks. In the coming years$ !e e*pect to see greater flo! of foreign capital to come into the Indian banking sector. %pening up of banking sector to global players !ould see banks facing global competition. 4.4 Technology is e*pected to be the main facilitator of change in the financial sector. Implementation of technology solutions involves huge capital outlay. Besides the heavy investment costs$ technology applications also have a high degree of obsolescence. Banks !ill need to look for !ays to optimi e resources for technology applications. skills sharing may help. 4.5 The pressure on capital structure is e*pected to trigger a phase of consolidation in the banking industry. Banks could achieve consolidation through different !ays. +ergers and ac&uisitions could be one !ay to achieve this. In the past$ mergers !ere initiated by regulators to protect the interests of depositors of !eak banks. In recent years$ market led mergers bet!een private banks have taken place. It is e*pected that this process !ould gain momentum in the coming years. +ergers bet!een public sector banks or public sector banks and private banks could be the ne*t logical thing D development to happen as market players tend to consolidate their position to remain in competition. 4.( ,onsolidation could take place through strategic alliances D partnerships. Besides helping banks to achieve economy of scale in operations and augment capital base$ consolidation could help market players in other !ays also to strengthen their competitiveness. The advantage could be in achieving better segmentation in the market. Strategic alliances and collaborative approach$ as an alternative to mergers and ac&uisitions$ could be attempted to reduce transaction costs through outsourcing$ leverage synergies in operations and avoid problems related to cultural integration. If consolidation is taken too far$ it could lead to misuse of dominant market positions. Rapid e*pansion in foreign markets !ithout sufficient kno!ledge of local economic conditions could increase vulnerability of individual banks. 4.) 6ublic Sector Banks had$ in the past$ relied on /overnment support for capital
14

In this regard$ global partnerships on technology and

augmentation. Go!ever$ !ith the /overnment making a conscious decision to reduce its holding in Banks$ most Banks have approached the capital market for raising resources. This process could gain further momentum !hen the government holding gets reduced to 33A or belo!. banks. It is e*pected that pressures of market forces !ould be the determining factor for the consolidation in the structure of these If the process of consolidation through mergers and ac&uisitions gains momentum$ !e could see the emergence of a fe! large Indian banks !ith international character. There could be some large national banks and several local level banks. 4.* %pening up of the financial sector from 2558$ under "T%$ !ould see a number of /lobal banks taking large stakes and control over banking entities in the country. They !ould bring !ith them capital$ technology and management skills. This !ill increase the competitive spirit in the system leading to greater efficiencies. /overnment policy to allo! greater F1I in banking and the move to amend Banking Regulation 'ct to remove the e*isting 15A cap on voting rights of shareholders are pointers to these developments. 4.+ The cooperative banks have played a crucial part in the development of the economy. The primary agricultural societies !hich concentrate on short9term credit and rural investment credit institutions supported by 1istrict D State level cooperative banks have played a crucial role in the credit delivery in rural areas. The Brban ,ooperative Banks have found their o!n niche in urban centres. These institutions in the cooperative sector need urgent capital infusion to remain as sound financial entities. ,ooperative sector comes under State #urisdiction !hile commercial banking operations are regulated by the Reserve Bank of India. The duality in control had !eakened the supervisory set up for these institutions. It is e*pected that certain amendments to the Banking Regulation 'ct introduced recently in the 6arliament !ith the ob#ective of strengthening the regulatory po!ers of the Reserve Bank of India !ould pave the !ay for strengthening of cooperative D financial institutions. It is e*pected that these banks !ould upgrade skills of their staff and improve the systems and procedures to compete !ith commercial bank entities. 4.1# ,onsolidation !ould take place not only in the structure of the banks$ but also
15

in the case of services. For instance$ some banks !ould like to shed their non9core business portfolios to others. This could see the emergence of niche players in different functional areas and business segments such as housing$ cards$ mutual funds$ insurance$ sharing of their infrastructure including 'T+ Iet!ork$ etc. 4.11 Rationali ation of a very large net!ork of branches$ !hich at present has rendered the system cost ineffective and deficient in service !ould take place. +ost of the banks !ould have adopted core9banking solutions in a fully net!orked environment. Back office functions !ould be taken a!ay from branches to a centrali ed place. "hile brick and mortar branches !ould continue to be relevant in the Indian scenario$ the real gro!th driver for cost cutting !ould be virtual branches vi .$ 'T+s$ Internet Banking$ mobile banking$ kiosks etc.$ !hich can be manned by a fe! persons and run on 2= * 7 basis to harness the real potential of these technological utilities$ there !ill be strategic alliances D partnership amongst banks and this phenomenon has already set in. 4.12 's !e move along$ the concept of branch banking !ill undergo changes. Banks !ill find that many of the functions could be outsourced more profitably !ithout compromising on the &uality of service. Speciali ed agencies could come for!ard to undertake +arketing and delivery functions on behalf of banks. This could see banking products being sold outside the four !alls of a branch. Banks !ould then concentrate on developing ne! products and earning fee based income. 4.13 The composition of bank staff !ill change. 's total computeri ation !ill render a part of the !orkforce surplus$ banks !ill go for a rightsi ing e*ercise. Some may resort to another round of -RS to shed e*cess flab !hile some other may go for re9 deployment to strengthen marketing arms. "ith greater use of technology and outsourcing of services in different areas$ the manpo!er recruitment !ill mostly be in speciali ed areas and technology applications. "ith commitment shifting from the organi ation to the profession$ !e could see greater lateral movement of banking personnel. Training and skill development !ill$ ho!ever$ continue to be key GR functions. "ith the age profile of staff undergoing changes$ banks !ill have to focus on leadership development and succession planning. Hno!ledge management !ill become a critical issue.
16

4.14 +anagement structure of banks !ill also undergo drastic changes in the coming years. Instead of the present pyramid structure$ the banks !ill move 6roduct9!ise to!ards reduction in tiers to ultimately settle for a flat structure. segmentation !ill facilitate speedier decision9making. (The e*isting structure of banks in India$ their balance sheet composition and !orking results as on 31st +arch$ 2553 are given in 'nne*ures II$ III and I-.)

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CHAPTER 5 PRODUCT INNO!ATION AND PROCE'' RE$EN&INEERIN& 5.1 "ith increased competition in the banking Industry$ the net interest margin of banks has come do!n over the last one decade. Eiberali ation !ith /lobali ation !ill see the spreads narro!ing further to 191.8A as in the case of banks operating in developed countries. Banks !ill look for fee9based income to fill the gap in interest income. 6roduct innovations and process re9engineering !ill be the order of the day. The changes !ill be motivated by the desire to meet the customer re&uirements and to reduce the cost and improve the efficiency of service. 'll banks !ill therefore go for re#uvenating their costing and pricing to segregate profitable and non9 profitable business. Service charges !ill be decided taking into account the costing and !hat the traffic can bear. From the earlier r,9,nu, : 2"st ; 1r"6it e&uation i.e.$ customers are charged to cover the costs incurred and the profits e*pected$ most banks have already moved into the 1r"6it :r,9,nu, $ 2"st e&uation. This has been reflected in the fact that !ith cost of services staying nearly e&ual across banks$ the banks !ith better cost control are able to achieve higher profits !hereas the banks !ith high overheads due to under9utilisation of resources$ un9remunerative branch net!ork etc.$ either incurred losses or made profits not commensurate !ith the capital employed. The ne! paradigm in the coming years !ill be 2"st : r,9,nu, $ 1r"6it. 5.2 's banks strive to provide value added services to customers$ the market !ill see the emergence of strong investment and merchant banking entities. 6roduct innovation and creating brand e&uity for speciali ed products !ill decide the market share and volumes. Ie! products on the liabilities side such as fore* linked deposits$ investment9linked deposits$ etc. are likely to be introduced$ as investors !ith varied risk profiles !ill look for better yields. There !ill be more and more of tie9ups bet!een banks$ corporate clients and their retail outlets to share a common platform to shore up revenue through increased volumes.

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5.3 Banks !ill increasingly act as risk managers to corporate and other entities by offering a variety of risk management products like options$ s!aps and other aspects of financial management in a multi currency scenario. Banks !ill play an active role in the development of derivative products and !ill offer a variety of hedge products to the corporate sector and other investors. For e*ample$ 1erivatives in emerging futures market for commodities !ould be an area offering opportunities for banks. 's the integration of markets takes place internationally$ sophistication in trading and speciali ed e*changes for commodities !ill e*pand. 's these changes take place$ banking !ill play a ma#or role in providing financial support to such e*changes$ facilitating settlement systems and enabling !ider participation.

5.4 Bancassurance is catching up and Banks D Financial Institutions have started entering insurance business. From mere offering of insurance products through net!ork of bank branches$ the business is likely to e*pand through self9designed insurance products after necessary legislative changes. This could lead to a spurt in fee9based income of the banks. 5.5 Similarly$ Banks !ill look analytically into various processes and practices as these e*ist today and may make appropriate changes therein to cut costs and delays. %utsourcing and adoption of B6%s !ill become more and more relevant$ especially !hen Banks go in for larger volumes of retail business. Go!ever$ by increasing outsourcing of operations through service providers$ banks are making themselves vulnerable to problems faced by these providers. Banks should therefore outsource only those functions that are not strategic to banks. business. For instance$ in the !ake of implementation of 95 days. delin&uency norms for classification of assets$ some banks may think of engaging e*ternal agencies for recovery of their dues and in I6' management. 5.( Banks !ill take on competition in the front end and seek co9operation in the back end$ as in the case of net!orking of 'T+s. This type of 2"$"1,titi"n !ill become the order of the day as Banks seek to enlarge their customer base and at the same time to reali e cost reduction and greater efficiency. CHAPTER ( TECHNO/O&< IN BAN0IN&
19

(.1 Technology !ill bring fundamental shift in the functioning of banks. It !ould not only help them bring improvements in their internal functioning but also enable them to provide better customer service. Technology !ill break all boundaries and encourage cross border banking business. Banks !ould have to undertake e*tensive Business 6rocess Re9?ngineering and tackle issues like a) ho! best to deliver products and services to customers b) designing an appropriate organi ational model to fully capture the benefits of technology and business process changes brought about. c) ho! to e*ploit technology for deriving economies of scale and ho! to create cost efficiencies$ and d) ho! to create a customer 9 centric operation model. 6.2 ?ntry of 'T+s has changed the profile of front offices in bank branches. ,ustomers no longer need to visit branches for their day to day banking transactions like cash deposits$ !ithdra!als$ che&ue collection$ balance en&uiry etc. ?9banking and Internet banking have opened ne! avenues in :convenience banking;. Internet banking has also led to reduction in transaction costs for banks to about a tenth of branch banking. (.3 Technology solutions !ould make flo! of information much faster$ more accurate and enable &uicker analysis of data received. This !ould make the decision making process faster and more efficient. For the Banks$ this !ould also enable development of appraisal and monitoring tools !hich !ould make credit management much more effective. customers. (.4 "hile application of technology !ould help banks reduce their operating costs in the long run$ the initial investments !ould be si eable. IT spent by banking and financial services industry in BS' is appro*imately 7A of the revenue as against around 1A by Indian Banks. "ith greater use of technology solutions$ !e e*pect IT spending of Indian banking system to go up significantly. (.5 %ne area !here the banking system can reduce the investment costs in
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The result !ould be a definite reduction in

transaction costs$ the benefits of !hich !ould be shared bet!een banks and

technology applications is by sharing of facilities. "e are already seeing banks coming together to share 'T+ Iet!orks. Similarly$ in the coming years$ !e e*pect to see banks and FIs coming together to share facilities in the area of payment and settlement$ back office processing$ data !arehousing$ etc. "hile dealing !ith technology$ banks !ill have to deal !ith attendant operational risks. This !ould be a critical area the Bank management !ill have to deal !ith in future. (.( 6ayment and Settlement system is the backbone of any financial market place. The present 6ayment and Settlement systems such as Structured Financial +essaging System (SF+S)$ ,entralised Funds +anagement System (,F+S)$ ,entralised Funds Transfer System (,FTS) and Real Time /ross Settlement System (RT/S) !ill undergo further fine9tuning to meet international standards. Ieedless to add$ necessary security checks and controls !ill have to be in place. In this regard$ Institutions such as I1RBT !ill have a greater role to play.

21

CHAPTER ) RI'0 %ANA&E%ENT ).1 Risk is inherent in any commercial activity and banking is no e*ception to this rule. Rising global competition$ increasing deregulation$ introduction of innovative products and delivery channels have pushed risk management to the forefront of today.s financial landscape. A8i5it t" gaug, t3, risks and tak, a11r"1riat, 1"siti"n 4i55 8, t3, k, t" su22,ss. It 2an 8, said t3at ris% ta%ers will survive, effective ris% managers will prosper and ris% averse are li%ely to perish . In the regulated banking environment$ banks had to primarily deal !ith credit or default risk. 's !e move into a perfect market economy$ !e have to deal !ith a !hole range of market related risks like e*change risks$ interest rate risk$ etc. %perational risk$ !hich had al!ays e*isted in the system$ !ould become more pronounced in the coming days as !e have technology as a ne! factor in today.s banking. Traditional risk management techni&ues become obsolete !ith the gro!th of derivatives and off9balance sheet operations$ coupled !ith diversifications. The e*pansion in ?9 banking !ill lead to continuous vigilance and revisions of regulations. ).2 Building up a proper risk management structure !ould be crucial for the banks in the future. Banks !ould find the need to develop technology based risk management tools. The comple* mathematical models programmed into risk engines !ould provide the foundation of limit management$ risk analysis$ computation of risk9ad#usted return on capital and active management of banks. risk portfolio. strategies. ).3 Bnder Basel II accord$ capital allocation !ill be based on the risk inherent in the asset. The implementation of Basel II accord !ill also strengthen the regulatory revie! process and$ !ith passage of time$ the revie! process !ill be more and more sophisticated. Besides regulatory re&uirements$ capital allocation !ould also be ?*ternal users of financial information !ill +ore detailed and more determined by the market forces. +easurement of risk e*posure is essential for implementing hedging

demand better inputs to make investment decisions.

fre&uent reporting of risk positions to banks. shareholders !ill be the order of the day. There !ill be an increase in the gro!th of consulting services such as data
22

providers$ risk advisory bureaus and risk revie!ers. These revie!s !ill be intended to provide comfort to the bank managements and regulators as to the soundness of internal risk management systems. ).4 Risk management functions !ill be fully centrali ed and independent from the business profit centres. The risk management process !ill be fully integrated into the business process. Risk return !ill be assessed for ne! business opportunities and incorporated into the designs of the ne! products. 'll risks J credit$ market and operational and so on !ill be combined$ reported and managed on an integrated basis. The demand for Risk 'd#usted Returns on ,apital (R'R%,) based R'R%, !ill be used to drive pricing$ performance measures !ill increase.

performance measurement$ portfolio management and capital management. ).5 Risk management has to trickle do!n from the ,orporate %ffice to branches or operating units. 's the audit and supervision shifts to a risk based approach rather than transaction orientation$ the risk a!areness levels of line functionaries also !ill have to increase. Technology related risks !ill be another area !here the operating staff !ill have to be more vigilant in the coming days. ).( Banks !ill also have to deal !ith issues relating to Reputational Risk as they !ill need to maintain a high degree of public confidence for raising capital and other resources. Risks to reputation could arise on account of operational lapses$ opa&ueness in operations and shortcomings in services. Systems and internal controls !ould be crucial to ensure that this risk is managed !ell. ).) The legal environment is likely to be more comple* in the years to come. Innovative financial products implemented on computers$ ne! risk management soft!are$ user interfaces etc.$ may become patentable. For some banks$ this could offer the potential for reali ing commercial gains through licensing.

23

).* 'dvances in risk management (risk measurement) !ill lead to transformation in capital and balance sheet management. 1ynamic economic capital management !ill be a po!erful competitive !eapon. The challenge !ill be to put all these capabilities together to create$ sustain and ma*imise shareholders. !ealth. The bank of the future has to be a total9risk9enabled enterprise$ !hich addresses the concerns of various stakeholders. effectively.

).+ Risk management is an area the banks can gain by cooperation and sharing of e*perience among themselves. ,ommon facilities could be considered for development of risk measurement and mitigation tools and also for training of staff at various levels. Ieedless to add$ !ith the establishment of best risk management systems and implementation of prudential norms of accounting and asset classification$ the &uality of assets in commercial banks !ill improve on the one hand and at the same time$ there !ill be ade&uate cover through provisioning for impaired loans. significantly. 's a result$ the I6' levels are e*pected to come do!n

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CHAPTER $ * RE&U/ATOR< AND /E&A/ EN!IRON%ENT

*.1 The advent of liberali ation and globali ation has seen a lot of changes in the focus of Reserve Bank of India as a regulator of the banking industry. 1e9 regulation of interest rates and moving a!ay from issuing operational prescriptions have been important changes. The focus has clearly shifted from micro monitoring to macro management. Supervisory role is also shifting more to!ards off9site surveillance rather than on9site inspections. The focus of inspection is also shifting from transaction9based e*ercise to risk9based supervision. In a totally de9regulated and globalised banking scenario$ a strong regulatory frame!ork !ould be needed. The role of regulator !ould be critical forK a) b) c) d) e) ensuring soundness of the system by fi*ing benchmark standards for capital ade&uacy and prudential norms for key performance parameters. adoption of best practices especially in areas like risk9management$ provisioning$ disclosures$ credit delivery$ etc. adoption of good corporate governance practices. creation of an institutional frame!ork to protect the interest of depositors. regulating the entry and e*it of banks including cross9border institutions.

Further$ the e*pected integration of various intermediaries in the financial system !ould add a ne! dimension to the role of regulators. 'lso as the co9operative banks are e*pected to come under the direct regulatory control of RBI as against the dual control system in vogue$ regulation and supervision of these institutions !ill get a ne! direction. Some of these issues are addressed in the recent amendment Bill to the Banking Regulation 'ct introduced in the 6arliament. *.2 The integration of various financial services !ould need a number of legislative changes to be brought about for the system to remain contemporary and competitive. The need for changes in the legislative frame!ork has been felt in several areas and steps have been taken in respect of many of these issues$ such as$ i) abolition of SI,' D BIFR setup and formation of a Iational ,ompany Ea!
25

Tribunal to take up industrial re9construction. Ii) enabling legislation for sharing of credit information about borro!ers among lending institutions. Integration of the financial system !ould change the !ay !e look at banking functions. The present definition of banking under Banking Regulation 'ct !ould re&uire changes$ if banking institutions and non9banking entities are to merge into a unified financial system *.3 "hile the recent enactments like amendments to 1ebt Recovery Tribunal (1RT) procedures and passage of Securitisation and Reconstruction of Financial 'ssets and ?nforcement of Security Interest 'ct$ 2552 (S'RF'?SI 'ct) have helped to improve the climate for recovery of bank dues$ their impact is yet to be felt at the ground level. It !ould be necessary to give further teeth to the legislations$ to ensure that recovery of dues by creditors is possible !ithin a reasonable time. The procedure for !inding up of companies and sale of assets !ill also have to be streamlined. *.4 In the recent past$ ,orporate 1ebt Restructuring has evolved as an effective voluntary mechanism. This has helped the banking system to take timely "ith the corrective actions !hen borro!ing corporates face difficulties.

borro!ers gaining confidence in the mechanism$ it is e*pected that ,1R setup !ould gain more prominence making I6' management some!hat easier. It is e*pected that the issue of giving statutory backing for ,1R system !ill be debated in times to come. *.5 In the emerging banking and financial environment there !ould be an increased need for self9regulation. This is all the more relevant in the conte*t of the stated policy of RBI to move a!ay from micro9management issues. 1evelopment of best practices in various areas of banks. !orking !ould evolve through self9regulation rather than based on regulatory prescriptions.

*.( Role of Indian Banks. 'ssociation !ould become more pronounced as a self
26

regulatory body. 1evelopment of benchmarks on risk management$ corporate governance$ disclosures$ accounting practices$ valuation of assets$ customer charter$ Eenders. Eiability$ etc. !ould be areas !here IB' !ould be re&uired to play a more proactive role. The 'ssociation !ould also be re&uired to act as a lobbyist for getting necessary legislative enactments and changes in regulatory guidelines. *.) GR practices and training needs of the banking personnel !ould assume greater importance in the coming days. Gere again$ common benchmarks could be evolved. Talking about shared services$ creation of common database and conducting research on contemporary issues to assess anticipated changes in the business profile and market conditions !ould be areas !here organi ations like Indian Banks. 'ssociation are e*pected to play a greater role. *.* ?volution of ,orporate /overnance being adopted by banks$ particularly those !ho have gone public$ !ill have to meet global standards over a period of time. In future$ ,orporate /overnance !ill guide the !ay Banks are to be run. /ood ,orporate /overnance is not a straight #acketed formula or processL there are many !ays of achieving it as international comparisons demonstrate$ provided the follo!ing three basic principles are follo!edK9 a) +anagement should be free to drive the enterprise for!ard !ith the minimum interference and ma*imum motivation. b) +anagement should be accountable for the effective and efficient use of this freedom. There are t!o levels of accountability J of management to the Board and of the Board to the Shareholders. The main task is to ensure the continued competence of management$ for !ithout ade&uate and effective drive$ any business is doomed to decline. 's stated by 4."olfensohn$ 6resident$ "orld Bank J =C"r1"rat, g"9,rnan2, is a8"ut 1r"7"ting 2"r1"rat, 6airn,ss> trans1ar,n2 and a22"unta8i5it ?.

27

c) In order to enlist the confidence of the global investors and international market players$ the banks !ill have to adopt the best global practices of financial accounting and reporting. This !ould essentially involve adoption of #udgmental factors in the classification of assets$ based on Banks. estimation of the future cash flo!s and e*isting environmental factors$ besides strengthening the capital base accordingly.

*.+

"hen !e talk about adoption of International accounting practices and

reporting formats it is relevant to look at !here !e stand and the !ay ahead. 'ccounting practices being follo!ed in India are as per 'ccounting Standards set by the Institute of ,hartered 'ccountants of India (I,'I). ,ompanies are re&uired to follo! disclosure norms set under the ,ompanies 'ct and S?BI guidelines relating to listed entities. Both in respect of 'ccounting 6ractices and disclosures$ banks in India are guided by the Reserve bank of India guidelines issued from time to time. Io! these are$ by and large$ in line !ith the 'ccounting Standards of I,'I and other regulatory bodies. It is pertinent to note that 'ccounting Standards of I,'I are based on International 'ccounting Standards (I'S) being follo!ed in a large number of countries. ,onsidering that BS forms =5A of the financial markets in the !orld compliance !ith BS/''6 has assumed greater importance in recent times. +any Indian banks desirous of raising resources in the BS market have adopted accounting practices under BS/''6 and !e e*pect more and more Indian Financial entities to move in this direction in the coming years. There are certain areas of differences in the approach under the t!o main international accounting standards being follo!ed globally. %f late$ there have been moves for convergence of accounting standards under I'S and BS/''6 and this re&uires the standard setters to agree on a single$ high9&uality ans!er. 1iscussions in the accounting circles indicate that convergence of various international accounting standards into a single global standard !ould take place by 2557.

In the Indian conte*t$ one issue !hich is likely to be discussed in the coming years
28

is the need for a common accounting standard for financial entities.

"hile a

separate standard is available for financial entities under I'S$ I,'I has not so far come out !ith an Indian version in vie! of the fact that banks$ etc. are governed by RBI guidelines. It is understood that I,'I is sei ed of the matter. It is e*pected that banks !ould migrate to global accounting standards smoothly in the light of these developments$ although it !ould mean greater disclosure and tighter norms.

29

CHAPTER +
RURA/ AND 'OCIA/ BAN0IN& I''UE'

+.1 Since the second half of 19@5s$ commercial banks have been playing an important role in the socio9economic transformation of rural India. Besides actively implementing /overnment sponsored lending schemes$ Banks have been providing direct and indirect finance to support economic activities. +andatory lending to the priority sectors has been an important feature of Indian banking. The Iarasimham committee had recommended for doing a!ay !ith the present system of directed lending to priority sectors in line !ith liberali ation in the financial system. The recommendations !ere$ ho!ever$ not accepted by the /overnment. In the prevailing political climate in the country any drastic change in the policy in this regard appears unlikely. +.2 The banking system is e*pected to reorient its approach to rural lending. :/oing Rural; could be the ne! market mantra. Rural market comprises 7=A of the population$ =1A of +iddle class and 8>A of disposable income. ,onsumer gro!th is taking place at a fast pace in 17113 villages !ith a population of more than 8555. %f these$ 99>9 villages are in 7 States$ namely 'ndhra 6radesh$ Bihar$ Herala$ +aharashtra$ Tamilnadu$ Bttar 6radesh and "est Bengal. Banks. approach to the rural lending !ill be guided mainly by commercial considerations in future. +.3 ,ommercial Banks$ ,o9operatives and Regional Rural Banks are the three ma#or segments of rural financial sector in India. Rural financial system$ in future has a challenging task of facing the drastic changes taking place in the banking sector$ especially in the !ake of economic liberali ation. There is an urgent need for rural financial system to enlarge their role functions and range of services offered so as to emerge as <one stop destination for all types of credit re&uirements of people in ruralDsemi9urban centres.

30

+.4 Barring commercial banks$ the other rural financial institutions have a !eak structural base and the issue of their strengthening re&uires to be taken up on priority. ,o9operatives !ill have to be made viable by infusion of capital. Bringing all cooperative institutions under the regulatory control of RBI !ould help in better control and supervision over the functioning of these institutions. Similarly Regional Rural banks (RRBs) as a group need to be made structurally stronger. It !ould be desirable if I'B'R1 takes the initiative to consolidate all the RRBs into a strong rural development entity. +.5 Small Scale Industries have$ over the last five decades$ emerged as a ma#or contributor to the economy$ both in terms of employment generation and share in manufactured output and e*ports. SSIs account for 98A of the industrial units and contribute about =5A of the value addition in the manufacturing sector. There are more than 32 lac units spread all over the country producing over 7855 items and providing employment to more than 17> lac persons. The employment generation potential and favourable capital9output ratio !ould make small scale sector remain important for policy planners. +.( Removal of &uantitative restrictions on a large number of items under the "T% and opening up of Indian market to greater international competition have thro!n both challenges and opportunities for the SSI sector. Eo! capital base and !eak management structure make these units vulnerable to e*ternal shocks$ more easily. Go!ever the units !hich can adopt to the changing environment and sho! imagination in their business strategy !ill thrive in the ne! environment. +.) Instead of follo!ing the narro! definition of SSI$ based on the investment in fi*ed assets$ there is a move to look at Small and +edium ?nterprises (S+?) as a group for policy thrust and encouragement. For S+?s$ banks should e*plore the option of ?9banking channels to develop !eb9based relationship banking models$ !hich are customer9driven and more cost9effective. gro!th. /overnment is already considering a legislation for the development of S+? sector to facilitate its orderly

31

+.* In the ne*t ten years$ S+? sector !ill emerge more competitive and efficient and kno!ledge9based industries are likely to ac&uire greater prominence. S+?s !ill be dominating in industry segments such as 6harmaceuticals$ Information Technology and Biotechnology. "ith S+? sector emerging as a vibrant sector of the Indian economy$ flo! of credit to this sector !ould go up significantly. Banks !ill have to sharpen their skills for meeting the financial needs of this segment. Some of the Banks may emerge as niche players in handling S+? finance. Flo! of credit to this Sector !ill be guided purely by commercial considerations as Banks !ill find S+?s as an attractive business proposition.

32

CHAPTER 1#
HU%AN RE'OURCE' %ANA&E%ENT

15.1

The key to the success of any organi ation lies in ho! efficiently the organi ation manages its. human resources. The principle applies e&ually and perhaps more aptly to service institutions like banks. The issue is all the more relevant to the public sector banks !ho are striving hard to keep pace !ith the technological changes and meet the challenges of globali ation.

15.2

In order to meet the global standards and to remain competitive$ banks !ill have to recruit specialists in various fields such as Treasury +anagement$ ,redit$ Risk +anagement$ IT related services$ GR+$ etc. in keeping !ith the segmentation and product innovation. 's a complementary measure$ fast track merit and performance based promotion from !ithin !ould have to be institutionali ed to in#ect dynamism and youthfulness in the !orkforce.

15.3

To institutionali e talent management$ the first priority for the banking industry !ould be to spot$ recogni e and nurture the talent from !ithin. Secondly$ the industry has to attract the best talent from the market to maintain the re&uired competitive edge vis9a9vis global players. Go!ever$ the issue of critical importance is ho! talent is integrated and sustained in the banks. Therefore$ a proper system of talent management has to be put in place by all the banks.

15.=

's the entire Indian banking industry is !itnessing a paradigm shift in systems$ processes$ strategies$ it !ould !arrant creation of ne! competencies and capabilities on an on9going basis for !hich an environment of continuous learning !ould have to be created so as to enhance kno!ledge and skills.

15.8

'nother important ingredient of GR management is re!ard and compensation !hich at present do not have any linkage to skills and performance. ' system of re!ard and compensation that attracts$ recogni es and retains the
33

talent$ and !hich is commensurate !ith performance is an urgent need of the industry. 15.@ 'n e&ually important issue relevant to GR+ is to create a conducive !orking environment in !hich the bankers can take commercial decisions #udiciously and$ at the same time$ !ithout fear. This calls for a re9look into the vigilance system as it e*ists today$ and perhaps there is a need to keep the banking industry out of the ,-,. The Banks. Boards may be allo!ed to have their o!n system of appropriate checks and balances as !ell as accountability.

34

!C&I'N ('IN&) !*I)IN+ ',& '- #I)I'N *.('*&

1.

Banks !ill have to adopt global standards in capital ade&uacy$ income recognition and provisioning norms.

2.

Risk management setup in Banks !ill need to be strengthened. Benchmark standards could be evolved.

3.

6ayment and settlement system !ill have to be strengthened to ensure transfer of funds on real time basis eliminating risks associated !ith transactions and settlement process.

=.

Regulatory set9up !ill have to be strengthened$ in line !ith the re&uirements of a market9led integrated financial system

8. @.

Banks !ill have to adopt best global practices$ systems and procedures. Banks may have to evaluate on an ongoing basis$ internally$ the need to effect structural changes in the organisation. This !ill include capital restructuring through mergers D ac&uisitions and other measures in the best business interests. IB' and I'B'R1 may have to play a suitable role in this regard.

7.

There should be constant and continual upgradation of technology in the Banks$ benefiting both the customer and the bank. Banks may enter into partnership among themselves for reaping ma*imum benefits$ through consultations and coordination !ith reputed IT companies.

>.

The skills of bank staff should be upgraded continuously through training. In this regard$ the banks may have to relook at the e*isting training modules and effect necessary changes$ !herever re&uired. encouraged.
35

Seminars

and conferences on all relevant and emerging issues should be

9.

Banks !ill have to set up Research and +arket Intelligence units !ithin the organi ation$ so as to remain innovative$ to ensure customer satisfaction and to keep abreast of market developments. Banks !ill have to interact constantly !ith the industry bodies$ trade associations$ farming community$ academic D research institutions and initiate studies$ pilot pro#ects$ etc. for evolving better financial models.

15.

Industry level initiatives !ill have to be taken$ may be at IB' level$ to speed up reform measures in legal and regulatory environment.

36