INDEX

INTRODUCTION BANKING CONCEPTS INDIGENEOUS BANKERS NARASIMHAN COMMITTEE[1991) RECOMMENDATION OF NARASIMHAMCOMMITTEE NARASIMHAN COMMITTEE(1997-1998) RECOMMENDATION OF NARASIMHAMCOMMITTEE PRESENT STRUCTURE OF BANKING NON-BANKING FINANCIAL COMPANIES INNOVATIONS IN BANKING CONCLUSION BIBLIOGRAPHY

INTRODUCTION
India has presently entered a high-growth phase of 8-9 per cent per annum, from an intermediate phase of 6 per cent since the early 1990s. The growth rate of real GDP averaged 8.6 per cent for the four-year period ending 2006-07; if one considers the last two years, the growth rates are even higher at over 9 per cent. There are strong signs that the growth rates will remain at elevated levels for several years to come. This strengthening of economic activity has been supported by higher rates of savings and investment. While the financial sector reforms helped strengthening institutions, developing markets and promoting greater integration with the rest of the world, the recent growth phase suggests that if the present growth rates are to be sustained, the financial sector will have to intermediate larger and increasing volume of funds than is presently the case. It must acquire further sophistication to address the new dimensions of risks. It is widely recognised that financial intermediation is essential to the promotion of both extensive and intensive growth. Efficient intermediation of funds from savers to users enables the productive application of available resources. The greater the efficiency of the financial system in such resource generation and allocation, the higher is its likely contribution to economic growth. Improved allocated efficiency creates a virtuous cycle of higher real rates of return and increasing savings, resulting, in turn, in higher resource generation. Thus, development of the financial system is essential to sustaining higher economic growth.

Banking in the Pre-reform Period

It is useful to briefly recall the nature of the Indian banking sector at the time of initiation of financial sector reform in India in the early 1990s. This would facilitate a greater clarity of the rationale and basis of reforms. The Indian financial system in the pre-reform period, i.e., upto the end of 1980s, essentially catered to the needs of planned development in a mixed economy framework where the government sector had a domineering role in economic activity. The strategy of planned economic development required huge development expenditures, which was met thorough the dominance of government ownership of banks, automatic monetization of fiscal deficit and subjecting the banking sector to large pre-emptions both in terms of the statutory holding of Government securities (statutory liquidity ratio, or SLR) and administrative direction of credit to preferred sectors. Furthermore, a complex structure of administered interest rates prevailed, guided more by social priorities, necessitating crosssubsidization to sustain commercial viability of institutions. These not only distorted the interest rate mechanism but also adversely affected financial market development. All the signs of `financial repression were found in the system. There is perhaps an element of commonality in terms of such a repressed regime in the financial sector of many emerging market economies at that time. The decline of the Bretton Woods system in the 1970s provided a trigger for financial liberalization in both advanced and emerging markets. Several countries adopted a big bang approach to liberalization, while others pursued a more cautious or gradualist approach. The East Asian crises in the late 1990s provided graphic testimony as to how faulty sequencing and inadequate attention to institutional strengthening could significantly derail the growth process, even for countries with otherwise sound macroeconomic fundamentals. India, in this context, has pursued a relatively more gradualist approach to liberalization. The bar was gradually raised. Each year the Central Bank slowly, in a manner of speaking, tightened the screws. Nevertheless, the transition to a regime of prudential norms and free interest rates had its own traumatic effect. It must be said to the credit of our financial system that these changes were absorbed and the system has emerged stronger for this reason.

INTRODUCTION: Before the nationalization of banks, the Indian banking system was dominated by private ownership and quasi-government institutions. The important phase of banking sector began with the nationalization of the 14 major banks in 1969 and six more banks in 1980. This was an important step taken by the government in the process of public ownership and control of commanding height of national economy and its strategic sectors. The idea was that the bank network should cover the unbanked areas and the banking services. The number of offices of the commercial banks in the country increased from 8262 in June 1969 to 66436 in March 2003. Thus, the banking sector has witnessed phenomenal growth with shifting emphasis from social control to nationalization under various socioeconomic and political consideration and compulsions. Various commissions and committees were appointed to examine the operations, performance and malfunctioning of the banking sector, recommendations made and measures applied. But after the new economic policy, the contents, areas and priorities of the banking operation have undergone radical change.

Banining sector reforms

Measures for liberalization, like dismantling the complex system of interest rate controls, eliminating prior approval of the Reserve Bank of India for large loans, and reducing the statutory requirements to invest in government securities

o Measures designed to increase financial soundness, like introducing capital adequacy requirements and other prudential norms for banks and strengthening banking supervision o Measures for increasing competition like more liberal licensing of private banks and freer expansion by foreign banks.

BANKING CONCEPTS BANKING Banking has been defined as 'Accepting for the purpose of lending and investment, of deposits of money from the public, repayable on demand, order or otherwise and withdrawable by cheque, draft or otherwise. BANKER Banker is a person who accepts deposits, money on current accounts, issue and pay cheques and collects cheques for his customers. CUSTOMER A customer is a person who has an account with the bank, performs, at least a transaction of a banking activity nature. BANKING COMPANY Section 7, of the banking regulation act, provides that "No company other than a banking company shall use as part of its name any of the words 'Bank', 'Banker', or 'Banking'. Any no company shall carry on the business of banking in

India unless it uses as part of its name at least one of such words". It further provides that no firm, individual or group of individuals shall, for the purpose of carrying on any business, use as parts of its name, any of the words, bank, banking or banking company. INDIGENOUS BANKERS Though commercial banking of the western type was developed during the British rule, banking as such has not been unknown to India. From very ancient days indigenous banking as different from the modern western individual business. The indigenous bankers have been variously called as Shroffs, Seths, Sahukars, Mahajans, Chettis, and so on, in different parts of the country. They vary in their size from petty moneylenders to substantial shroffs who carry on large and specialized business which at times exceeds that of the scheduled banks. Operation of Indigenous Bankers:-(a)Those whose main business is banking. (b) Those who combine their banking business with trading and commission business, and (c) Those who are mainly traders and commission agents but who do a little banking business also.

NARSIMHAM COMMITTEE (1991) : There is been a phenomenal expansion in the geographical coverage and functional spread in the banking and financial system since bank nationalization in 1969. Government of the India set up a high level committee with Mr. M. narasimham, a former governor of RBI as chairman to examine all aspects relating to the structure organization function organizations, operation of the financial system .the committee on the financial system submitted its report in November 1, 1991. The narasimham committee [1991] was primarily interested in improving the financial health of the public sector banksthemviable and efficient a meet fully the emerging needs of the real economy. The basic approach of the committee was that greater market orientation would strengthen the system and improve its efficiency. The narasimham committee (1991) acknowledgment the spectacular success of the public sector banks since the top banks were nationalized in 1969. (a)Massive branch expansion, particularly in rural areas. (b)Expansion in the volume of deposits. Bank deposited constituted two fifths of financial assets of the household sector in 1991. (c)Rural penetration go three banking system. Rural deposited as a proportion go the total deposite had increased from percent to 15 percent.

(d) Diversion of an increasing portion of the bank credit to priority sector i.e. agriculture small scale industry, transport etc. the priority sector credit had gone up from 14 percent veto 41 percent between 1969 to 1991. (e) Increase In deposited and borrower account over 300 million borrower deposited accents in the country and over 35 million borrower accounts as compared to 4 kHz boreal accounts in 1969. (f)More involvement in the relative under banked state.

The expansion of the priority sector lending and emphasis on area approach has almost evened-out regional disparities and the concentration of banking business easy relatively less in 1991 The banking system in India recorded spectacular progress since nationalization. However, it had also suffered serious decline in productivity and consequent erosion in profitability. Narasimham committee (1991) pointed out that two major causes for the state of the state of affairs are:1) Directed investment 2) Directed credit programme

11 Directed investment Maintenance of liquid assets is a basis principle of sound banking system in any country. As per banking regulation act, 1969 (under section 24) commercial banks in India are required to maintain liquid assets in the from of cash gold, and unencumbered approved securities equal to not less than 25 % of their total demand and time deposited abilities. This requirement is known as statutory liquidity ratio. The RBI has power to change the minimum ratio. Accordingly, RBI raised the statutory liquidity ratio from 25% to 30% in November 1972 and further gradually to 38.5% in 1991. RBI stopped up the SLR for two reasons: (i) A high SLR forced commercial banks to maintain larger proportion of their funds in government securities and government guaranteed securities and thus reduced the capacity of the commercial banks to grant loans and advances to business and industry. (ii)A higher SLR diverted banks funds from loans and advances to investment in government securities and other securities which had an anti inflationary effect Under the RBI Act, every commercial banks is required to keep certain minimum cash reserves with the RBI. initially it was 5% against demand deposit and 2% against time deposit .RBI was empowered to vary the

CRR between 3% to 15% of the total demand and time deposit, the CRR was raised by RBI to the statutory maximum of 15 % on the average. Thus banks had to keep as much as 53.5 percent of their aggregate deposits as cash balances with RBI or in government securities and securities of public sector financial institutions. The RBI paid interest at the rate of 10.5% on the cash reserves kept by commercial banks with it under car and at 5% on incremental cash balances. Narasimham Committee (1991) found the rates of interest received by the commercial banks from RBI for their eligible cash balances were below the rate which scheduled commercial banks had to pay for one year deposits. Similarly, the interest on government securities was also much lower than the market rate of interest

KEY RATES
CRR REPO RATE REVERSE REPO BANK RATE SLR

APRIL 2010
6.00 5.25 3.75 6.00

JULY 3rd 2010

6.00 5.50 4.00 6.00 25.00

JULY 27th 2010

6.00 5.75 4.50 6.00

23.50

25.00

2} Directed Credit Programmed:

The banks were also directed to shift from security-oriented credit to purpose-oriented credit. However, this system was hailed by the government as a great success at the cost of deterioration of quality of loans. There was no adequate attention towards qualitative aspects of lending. It resulted into growth of overdoes and consequent erosion of profitability. There was no proper loan appraisal of credit applications. No collateral requirements and no post-credit supervision and monitoring. According to Narasimham Committee (1991) there was a serious damage to the public sector banks due to the following: (i) Political and administrative interference in credit decision making. (ii)Loan melas organized by political parties. (iii) Government direction to banks o extend credit to sick industrial units. (iv)There were phenomenal cresses in branch banking without any relation to demonstrated and potential viability. (v)There was rapid growth in staff in number and in accelerated promotions.

Recommendation of Narasimham committee (1991): The narasimham committee recommendation were based on the fundamental assumption that the recourses are held by the bank in trust and that they are to deployed for maximum benefit of the depositor Thus the recommendation of narasimham committee (1991) was as follows: (1) The government should give up the precision using SLR as a major instrument f mobilizing funds for the government and public sector financial institution. The committee further recommended that the SLR should be reduced from 38.5%to 25% over a period of 5 years. The committee father recommended that the government borrowing rates should be progressively market related. (2) RBI should permit the setting up of new banks in the private sector, provided they confirm to the maximum startup capital and other requirement there should between pubic sector banks and private sector banks. (3)The committee recommended that the government should allow foreign banks to open offices in India either as branches or as subsidiaries they should confirm to or fulfill the same social obligation as the India banks. Foreign banks and Indian banks should be permitted to set up join venture in regard to merchant and investment banking, leasing and other new forms of financial services. (4]The committee also recommended the setting up of the Assets Reconstruction Fund (ARF] thought a special resolution to take over from the nationalized banks and financial institution a portion of their bad of doubtful debts at a discount All bad and doubtful debts of banks and financial institution were to be transferred in a phased manner to ensure smooth and effective function of the assets reconstruction fund. (5)The narasimham committee 1991 recommended that the present system of dual control over the banking system between RBI and the banking division of the ministry of finance should end immediately and that the RBI should be primary agency for the regulation of the banking system in the country. (6) The committee further recommended that the public sector banks should be free and autonomous. Every bank should go for radical changes in work technology and culture so as to become competitive internally and to be

step with wide ranging innovation taking place abroad. (7) The appointment of the chief executive of a bank should not be based on political consideration but on professionalism and integrity &should be made by an independent panel of experts and not by the government.

NARASIMHAM COMMITTEE f1997-981: The committee on banking sector reforms under the chairmanship of Mr. narasimham was constituted on December 26 1997 to review the record of financial sector reforms recommended by the committee on financial system in 1991 and to suggest remedial measures for strengthening the banking system, legislative and technological changes. The Report of this Committee was submitted to the government on April 23,1998. The report sets the pace for the second phase of banking sector reforms. The major recommendations of the Committee are as follows:(i)Merge strong banks and close weak unviable banks (ii)Strengthen legal framework to accelerate the credit recovery. (iii)Increase capital adequacy to match enhanced banking risk. (iv)Budgetary support non variable for recapitalization. (vJDepoliticize Bank Boards under RBIsupervision. (vi)No alternative to asset reconstruction fund. (vii)Review major banking laws. (viii)Rationalize Branches and start, review recruitment and renumeration.

l)Mergers and Acquisitions: Mergers between Bank and NBFCs need to be based on synergies and locational and business specific complementaries of the concerned institutions. Mergers between Banks and Financial Institutions would make for greater economic and commercial sense and would be a case where the whole is greater than the sum of its parts ane have a force multiplier effect. Joint Parliamentary Committee also recommended for such mergers and acquisitions:(a) Laying down the guidelines to process a merger proposal in terms of ability of investing bankers. (b) The key parameters that form a basis for determining swap ratios (c)Disclosures. (d)The involvement of Board at meaningful board level deliberations. (d)Many mergers will become a subject of public debate which is not all time necvessarily be conducive without these norms. Mergers and Acquisitions are considered to be the fast track for increasing the size. It has been preferred choice for banks to grow and become big. In the present stage of globalization banks are expected to have the expertise, products and presence to serve them anywhere. Merger aims at the task of achiving cost reduction simultaneously improving and increasing competitiveness. Mergers provide services at lower cost. It improves efficiency and achive synergies.

2) PRUDENTIAL NORM Banks and other financial institution were required to be effective so that can meet the challenges and needs of commercial banks in terms of branch expansion. Banks were investing more than 50 % of their depositewhih could not cover the cost of funds. The statutory liquidity ratio was 38.5% which means that the major chunks of deposit were retained by the RBI and the government. With this deteriorating scenario of the banking sector, the naraimham committee recommended the prudential norms. By following and implementing the recommendation of the narasimham committee report, it was possible for the bank to know their strength and weakness particularly about the Non- Performing Assets (NPA). Non -performing assets is the loan amount which is not- recovered from the borrower income i.e. the principle and interest or both are overdue to bank for a certain period of the time.

(3) Capital Adequacy: The committee on banking sector reforms (1998) suggested tightening of the capital adequacy norms, it was expected that the Indian banks should try to develop internal models for measuring capital adequacy .Capital adequacy norms were fixed at 8% by the reserve bank of India in April 1992. The prudential and the new capital adequacy norm expect scheduled commercial bank to make large provision amounting to over Rs.14000/- crores for bad and doubtful advances in their portfolio. As the resulting losses would erode the already inadequate capital of the bank the viability and financial health of the banking system was sought to be protected by capital contribution of Rs. 5700/-crores by the central government in the budget for 1993-94. (A) Tier I, or core capital considered the most permanent and readily available support against unexpected losses, includes paid up capital, statutory reserves, share premium and capital reserve. (B)Tier II, capital consisting of undisclosed reserves fully paid up cumulative perpetual preference shares revaluation reserves general provision and loss -reserves.
Rank Name of the bank Tier capital ($ mn) 6,323 1,469 1,184 846 782 676 514 509 459 436 392 280 270 261 254 246 237 210 206 192 World Total rank in assets ($mn.) tier 82 268 313 405 425 474 559 566 604 619 655 793 809 824 837 850 860 915 924 960 1,26,930 28,261 24,127 17,282 19,615 15,593 9,750 6,719 9,451 10,344 12,009 5,956 8,672 3,532 7,343 5,899 7,242 4,240 5,241 5,190 World rank in assets 83 242 267 343 316 317 495 612 506 476 431 659 524 814 578 665 586 765 706 710

1 2 3 4 5 6 7
00

9 10 11 12 13 14 15 16 17 18 19 20

State bank of India ICICIbank Punjab national bank Canara bank bank of Baroda Bank of India HDFC bank Corporation bank OBC Union bank of India central bank of India United bank of India Indian overseas bank Jammu and Kashmir bk United commercial bk Allahabad bank Syndicate bank Dena bank Bank of Maharashtra Andhra bank

4)REVIEW OF MAJOR BANKING LAWS The Banking Companies Act, 1962 raised the minimum amount of the value of the paid up capital to Rs.5 lakhs for any Indian bank commencing businesses after that act. In case of a banking company incorporated outside India, the aggregate value of its paid up capital and reserves shall not be less than Rs.15 lakhs, and if it has a place of business ion the city of Bombay or Calcutta, or both, Rs.201akhs. The banking company incorporated outside India is also required to deposit with the Reserve Bank either in cash or in the form of unencumbered approved securities, or in both, an amount equal to the minimum amount specified above. Section 22, provides that it is essential for every banking company to hold a license issued by the Reserve Bank. The license is issued by the Reserve Bank after conducting the inspection of the books of accounts of the banking company Section 23, provides that every banking company should take Reserve Bank's prior permission for opening a new place of business in India, or to change the location of an existing place of business in India. Section 24, of the banking regulations act, 1983 provides that every banking company is required to maintain in India, in cash, gold or unencumbered approved securities an amount which shall not at the close of business on any day be less than 25 percent of the total of its demand and time liabilities in India. This is also known as statutory liquidity ratio. (SLR) Section 35 of the Act, provides that the reserve bank, may either at its own initiative or at the instance of the central government cause an inspection to be made by one or more of its officers, of any banking company and its book of accounts. Section 20, of the Act lays down certain restrictions on the loans granted by the banks to the persons interested in the management of the banks. Section 21, of the Act confers wide powers on the Reserve Bank to issue directives to the banking companies to determine the policy in relation to advances to be followed by the banking companies either generally or by any of them in particular. Section 10 of the Act, provides that every

banking company is required to constitute its board of directors in such a way that not less than 51 per cent of the total number of members of the board. Section 16 of the Act, prohibits a common director of a banking company. Accordingly a person having as a director of a banking company in India cannot become a director of any other banking company in India. Section 12 A, confers on the reserve bank the power to require any banking company to call a general meeting of the shareholders of the company within the prescribed time limit to elect fresh directors in accordance with the voting rights permissible under the Act.

41 ASSETS RECONSTRUCTION FUND

Narasimham committee recommended the setting up of the Assets Reconstruction Fund (ARF) even through a special legislation to take over from the nationalized banks and financial institutions a portion of their bad and doubtful debts at a discount. The committee also recommended that all bad and doubtful debts of banks and financial institutions should be transferred in a phased manner to ensure smooth and effective functioning of the Asset Reconstruction Fund. This will help the banks and financial institutions to take off bad and doubtful debts from their balance sheets and recycle the funds realised through this process into more productive use. 5) RATIONALISATION OF BRANCHES AND STAFF The Narasimhan Committee (1998) had recommended that there should be rationalization of branches, staff, review recruitment and remuneration. Accordingly, scheduled commercial banks had been given freedom to open new branches and upgrade extension counter, after obtaining capital adequacy norms and prudential accounting standards. The recommendations of the second Narasimhan Committee could provide useful guidance to banks particularly in recruiting skilled manpower from the open market including lateral induction of experts and redeployment of existing staff in new businesses and activities after appropriate training. The human resource management policy for rural banking may need to be flexible in respect of

recruitment to technical staff, their placement, training, promotion, transfer and provision of incentives. Performance appraisal and reward system should be designed to meet the demands and industry is monitored on appropriate indicators in conformity with its objectives. 61 DEREGULATION OF INTEREST RATES The Chakravarty committee had recommended that controlled competition among banks should be allowed implying that banks should have some freedom to vary their lending rates of interest subject to some minimum rate fixed by RBI and not the maximum. The administered interest rate system had become unduly complex and it had acquired features which reduced its ability to promote effective use of credit. A system of concessional interest rates was developed on account of social concerns. The Narasimhan Committee had argued that the interest rates should increasingly be allowed to perform their main function of allocating scarce lonable funds among alternative users. Therefore, interest rates should be allowed broadly to be determined by market forces. The government accepted this approach with respect to the role of interest rates in the Indian economy and adopted the necessary measures to regulate them. EVALUATION OF NARASIMHAN COMMITTEE RECOMMENDATIONS On the basis of narasimhan committee reportl998 RBI announced a number of decisions as a part of its midterm review of the monitory and credit policy realize on October 30,1998. They related to phased introduction of risk weight for government approach securities, guaranteed advances, general provision for standard assets and higher capital to risk assets ratio for banks. These decisions have prospective affect. However, they are relevance is in view of growing exposure of Indian banks to market risk which impact significantly on the financial performance of the banks. The committee clearly recommends the closing down of the banking divisions of the finance ministry and stated

that all matters pertaining to the banking system should be the responsibility of the RBI.

PRESENT STRUCTURE OF INDIAN BANKING SECTOR The Indian banking can be broadly categorized into nationalized, private banks, co-operative banks and specialized banking institutions. The RBI acts as a centralized body monitoring any discrepancies and shortcomings in the system. The structure of Indian banking is given in the chart below: Structure of Indian banking Reserve bank of India Scheduled banks Commercial banks Public sector banks Private sector banks Co-operative banks Foreigivbanks urban cooperative Banks Regional banks rural bank s co-operative banks state co-operative Banks

NON-BANKING FINANCIAL COMPANIES (NBFCs) INTRODUCTION A non-bank finance company can be defined as an institution, which mobilizes the savings of the community and diverts them for financing different activities. Investment Companies, Investment Trusts, Nidhis, Hire purchase and leasing Companies, and Housing Finance Companies specialize in giving loans for consumption, commerce and trading purposes. They have close links and they constitute small-scale decentralized sector of the financial system in India. In order to identify a non-banking finance company, Reserve Bank considers both the assets and the income pattern of the company as evidenced from the last audited balance sheet A company is treated as NBFC, if its financial assets are more than 50% of its total assets and income from financial assets should be more than 50% of the gross income. DEFINITION Non Banking Finance Company is defined as a company which is a financial institution and has its business of receiving the deposits or pending under any scheme or arrangement. INNOVATIONS IN BANKING MERCHANT BANKS:Merchant banking is an organization which underwriters securities for companies, advises in various activities, any person who is engaged in the business of issue management either by making arrangements regarding selling, buying, or subscribing to securities or acting as manager, consultant, advisor or rendering corporate advisory services in relation to issue management is known as merchant banker. Thus, merchant banks are financial institutions which provide specialized services including acceptance of bills of exchange, corporate finance, portfolio management and other services. LEASING: Banks have started funding the fixed assets through leasing, it refers to the renting out of immovable property by the bank to the businessmen on a specified rent for a specific period on terms which may be mutually agreed upon. A written agreement is made in this agreement is made in this respect. The banks have started subsidiaries to transact equipment leasing business with the permission of RBI.

MUTUAL FUNDS:Banks have floated new subsidiaries to undertake the business of mutual funds. These subsidiaries collect funds from the people and invest this money in the capital market and other securities and market in order to earn income and distribute the surplus to the unit holders. This service is very useful to the Indian investors. The main function of mutual fund is to mobilize the savings of the general public and invest them in stock market and money markets. Unit Trust of India is the first mutual fund in India in 1964. There are more than 63 mutual funds in public sector, private sector and even foreign mutual funds. Each mutual fund has different schemes for investment by interested investors and suitability to specific category of investors. There are open-ended schemes in which investors can enter or exit at any point of time and close ended schemes in which there is a lock-in period of 3years or 5 years. Therefore, mutual funds act as a boon to investors in general and small investors in particular. MONEY TRANSFER:Banks are helping business and society for transfer of money from place to place or person to person. For this purpose, demand draft, pay orders, telegraphic transfer, mail transfer, credit cards etc. Type methods are used. FACTORING Factoring is an arrangement in which receivables arising out of goods/services are sold by a firm to the factor as a result of which the title to the goods represented by the said receivables passes on to the factor. The factor becomes responsible for all credit control, sales accounting and debt collection from the buyers. In a full service factoring, if any of the debtors fails to pay the dues as a result of his financial ability or insolvency the factor has to absorb the losses. The factor provides the services of (i) finance (ii) maintenance of accounts (hi] collection of debts (iv] protection against credit risk. HOUSING FINANCE There are a variety of housing finance schemes started by banks. Such as purchase of a new house, home improvement, repairs, extension, land purchase, bridge loans, and balance transfer loans. Commercial banks through their subsidiaries undertake housing finance as a specialized business. Nowadays, all the banks are permitted to provide housing finance to the people. They provide housing finance and other related services to the needy people at reasonable rate of interest.

CREDIT CARDS Credit card is a small plastic card that allows its hold to buy goods and services on credit and to pay at fixed intervals through the card issuing bank. It may also be used for the purpose of obtaining cash from the branches of issuing bank or branches of certain other banks with which arrangements have been made. Banks make a specific annual charge to their cardholders. The customer applies to the bank and gets the credit card. Each credit card bears a specimen signature of its holder and is embossed by the issuing bank with the holder's name and number. There is no need to have an account with the bank and to pay money in advance. The bank gives credit to the cardholder up to a certain amount and period. Commercial banks in India have been offering credit cards to their customers. They have a link-up with international banking network. The credit card holders are given 30to 40 days credit at a certain rate of interest. PORTFOLIO MANAGEMENT Portfolio management is a process of investment in securities. It involves a proper investment decisionmaking and proper money management. The objective of this service is to help investors with the expertise of professionals. It involves construction of a portfolio based upon the fact sheet of the investor giving out his objectives; constraints, preferences and tax liability. The portfolio should be reviewed and adjusted from time to time with the market conditions. The portfolio manager is an important person who holds the financial dreams of millions of the investors. As per SEBI guidelines, the portfolio manager should get a certificate from the SEBI for rendering the portfolio management services to the services to the clients. Banks usually extend services for managing surplus funds of their corporate customers either directly or through merchant bankers. It involves helping their clients in investing their funds in a manner that balances the liquidity, safety and maximum yield. ATM One of the channels of banking service delivery is vide Automated Teller Machine (ATM) whose traditional and primary use is to dispense cash upon insertion of a plastic card and its unique Personal Identification Number(PIN) ATM card is a plastic card with a magnetic strip with the account number of the individual. The bank issues ATM cards to its current and savings accountholders. The amount withdrawn is immediately debited to the concerned account through accounting entries preprogrammed on the ATM. Cash or cheques can be deposited through the ATM for the credit to an account. ATMs can be accessed any time. The

scope of frauds, robberies and misappropriation are reduced considerably if the PIN is maintained diligently. TELE-BANKING Tele-banking is a banking service offered by banks to enable customers to access their accounts for information or transactions, a telephone PIN (TPIN) is provided to each account holder. The customer can all the exclusive tele-banking numbers and provide the details to identify himself to the automatted voice. Upon the perspective numbers matching the computerized systems, the customer is given access to his account to query or transact on his account. Cash withdrawal and deposit are not enabled through this service but many

banks offer a cash delivery or collection service to certain classes of customers. INTERNET BANKING Internet is one of the channels of service delivery to a banking customer. The access to account information as well as transaction is offered through the world-wide network of computers on the internet. Every bank has special firewalls and its own security measure to protect the accounts from non-authentic use from unauthorised users. Each accountholder is provided a PIN similar to that of the ATM. The access to the account is allowed upon the match of the account details and PIN entered on the computer system, a higher level of security may be reached by an electronic finger-print. Account querying as well as transaction are possible on the internet banking Platform. The accounting is instantaneous and funds transfers can be affected immediately. Financial services companies are using the Internet as the new distribution channel

Contours of reforms
Financial sector reforms encompassed broadly institutions especially banking, development of financial markets, monetary fiscal and external sector management and legal and institutional infrastructure. Reform measures in India were sequenced to create an enabling environment for banks to overcome the external constraints and operate with greater flexibility. Such measures related to dismantling of administered structure of interest rates, removal of several preemptions in the form of reserve requirements and credit allocation to certain sectors. Interest rate deregulation was in stages and allowed build up of sufficient resilience in the system. This is an important component of the reform process which has imparted greater efficiency in resource allocation. Parallel strengthening of prudential regulation, improved market behaviour, gradual financial opening and, above all, the underlying improvements in macroeconomic management helped the liberalisation process to run smooth. The interest rates have now been largely deregulated except for certain specific classes, these are: savings deposit accounts, non-resident Indian (NRI) deposits, small loans up to Rs.2 lakh and export credit. Without the dismantling of the administered interest rate structure, the rest of the financial sector reforms could not have meant much. As regards the policy environment on public ownership, the major share of financial intermediation has been on account of public sector during the pre-reform period. As a part of the reforms programme, initially there was infusion of capital by Government in public sector banks, which was subsequently followed by expanding the capital base with equity participation by private investors up to a limit of 49 per cent. The share of the public sector banks in total banking assets has come down from 90 per cent in 1991 to around 75 per cent in 2006: a decline of about one percentage point every year over a fifteen-year period. Diversification of ownership, while retaining public sector character of these banks has led to greater market accountability and improved efficiency without loss of public confidence and safety. It is significant that the infusion of funds by government since the initiation of reforms into the public sector banks amounted to less than 1 per cent of Indias GDP, a figure much lower than that for many other countries.

Another major objective of banking sector reforms has been to enhance efficiency and productivity through increased competition. Establishment of new banks was allowed in the private sector and foreign banks were also permitted more liberal entry. Nine new private banks are in operation at present, accounting for around 10-12 per cent of commercial banking assets. Yet another step towards enhancing competition was allowing foreign direct investment in private sector banks up to 74 per cent from all sources. Beginning 2009, foreign banks would be allowed banking presence in India either through establishment of subsidiaries incorporated in India or through branches. Impressive institutional reforms have also helped in reshaping the financial marketplace. A high-powered Board for Financial Supervision (BFS), constituted in 1994, exercise the powers of supervision and inspection in relation to the banking companies, financial institutions and non-banking companies, creating an arms-length relationship between regulation and supervision. On similar lines, a Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) prescribes policies relating to the regulation and supervision of all types of payment and settlement systems, set standards for existing and future systems, authorise the payment and settlement systems and determine criteria for membership to these systems. The system has also progressed with the transparency and disclosure standards as prescribed under international best practices in a phased manner. Disclosure requirements on capital adequacy, NPLs, profitability ratios and details of provisions and contingencies have been expanded to include several areas such as foreign currency assets and liabilities, movements in NPLs and lending to sensitive sectors. The range of disclosures has gradually been increased. In view of the increased focus on undertaking consolidated supervision of bank groups, preparation of consolidated financial statements (CFS) has been mandated by the Reserve Bank for all groups where the controlling entity is a bank. The legal environment for conducting banking business has also been strengthened. Debt recovery tribunals were part of the early reforms process for adjudication of delinquent loans. More recently, the Securitisation Act was enacted in 2003 to enhance protection of creditor rights. To combat the abuse of financial system for crime-related activities, the Prevention of Money Laundering Act was enacted in 2003 to provide

the enabling legal framework. The Negotiable Instruments (Amendments and Miscellaneous Provisions) Act 2002 expands the erstwhile definition of 'cheque' by introducing the concept of 'electronic money' and 'cheque truncation'. The Credit Information Companies (Regulation) Bill 2004 has been enacted by the Parliament which is expected to enhance the quality of credit decisions and facilitate faster credit delivery. Improvements in the regulatory and supervisory framework encompassed a greater degree of compliance with Basel Core Principles. Some recent initiatives in this regard include consolidated accounting for banks along with a system of Risk-Based Supervision (RBS) for intensified monitoring of vulnerabilities. The structural break in the wake of financial sector reforms and opening up of the economy necessitated changes in the monetary policy framework. The relationship between the central bank and the Government witnessed a salutary development in September 1994 in terms of supplemental agreements limiting initially the net issuance of ad hoc treasury Bills. This initiative culminated in the abolition of the ad hoc Treasury Bills effective April 1997 replaced by a limited ways and means advances. The phasing out of automatic monetization of budget deficit has, thus, strengthened monetary authority by imparting flexibility and operational autonomy. With the passage of the Fiscal Responsibility and Budget Management Act in 2003, from April 1, 2006 the Reserve Bank has withdrawn from participating in the primary issues of Central Government securities Reforms in the Government securities market were aimed at imparting liquidity and depth by broadening the investor base and ensuring marketrelated interest rate mechanism. The important initiatives introduced included a market-related government borrowing and consequently, a phased elimination of automatic monetisation of Central Government budget deficits. This, in turn, provided a fillip to switch from direct to indirect tools of monetary regulation, activating open market operations and enabled the development of an active secondary market. The gamut of changes in market development included introduction of newer instruments, establishment of new institutions and technological developments, along with concomitant improvements in transparency and the legal framework.

What has been the impact? These reform measures have had major impact on the overall efficiency and stability of the banking system in India. The present capital adequacy of Indian banks is comparable to those at international level. There has been a marked improvement in the asset quality with the percentage of gross non-performing assets (NPAs) to gross advances for the banking system reduced from 14.4 per cent in 1998 to 7.2 per cent in 2004. The reform measures have also resulted in an improvement in the profitability of banks. The Return on Assets (RoA) of the banks rose from 0.4 per cent in the year 1991-92 to 1.2 per cent in 2003-04. Considering that, globally, the RoA has been in the range 0.9 to 1.5 per cent for 2004, Indian banks are well placed. The banking sector reforms also emphasized the need to review the manpower resources and rationalize the requirements by drawing a realistic plan so as to reduce the operating cost and improve the profitability. During the last five years, the business per employee for public sector banks more than doubled to around Rs.25 million in 2004.

Continuity, change and context We lay considerable emphasis on appropriate mix between the elements of continuity and change in the process of reform, but the dynamic elements in the mix are determined by the context. While there is usually a consensus on the broad direction, relative emphasis on various elements of the process of reform keeps changing, depending on the evolving circumstances. Perhaps it will be useful to illustrate this approach to contextualizing the mix of continuity and change. The mid-term review in November 2003, reviewed the progress of implementation of various developmental as well as regulatory measures in the banking sector but emphasized facilitating the ease of transactions by the common person and strengthening the credit delivery systems, as a response to the pressing needs of the society and economy. The annual policy statement of May 2004 carried forward this focus but flagged major areas requiring urgent attention especially in the areas of ownership, governance, conflicts of interest and customer-protection. Some extracts of the policy statement may be in order: "First, it is necessary to articulate in a comprehensive and transparent manner the policy in regard to ownership and governance of both public and private sector banks keeping in view the special nature of banks. This will also facilitate the ongoing shift from external regulation to internal systems of controls and risk assessments. Second, from a systemic point of view, inter-relationships between activities of financial intermediaries and areas of conflict of interests need to be considered. Third, in order to protect the integrity of the financial system by reducing the likelihood of their becoming conduits for money laundering, terrorist financing and other unlawful activities and also to ensure audit trail, greater accent needs to be laid on the adoption of an effective consolidated know your customer (KYC) system, on both assets and liabilities, in all financial intermediaries regulated by RBI. At the same time, it is essential that banks do not seek intrusive details from their customers and do not resort to sharing of information regarding the customer except with the written consent of the customer. Fourth, while the stability and efficiency imparted to the large

commercial banking system is universally recognized, there are some segments which warrant restructuring." The annual policy statement for the current year reiterates the concern for common person, while enunciating a medium term framework, for development of money, forex and government securities markets; for enhancing credit flow to agriculture and small industry; for action points in technology and payments systems; for institutional reform in co-operative banking, non-banking financial companies and regional rural banks; and, for ensuring availability of quality services to all sections of the population. The most distinguishing feature of the policy statement relates to the availability of banking services to the common person, especially depositors. The statement reiterates that depositors interests form the focal point of the regulatory framework for banking in India, and elaborates the theme as follows: A license to do banking business provides the entity, the ability to accept deposits and access to deposit insurance for small depositors. Similarly, regulation and supervision by RBI enables these entities to access funds from a wider investor base and the payment and settlement systems provides efficient payments and funds transfer services. All these services, which are in the nature of public good, involve significant costs and are being made available only to ensure availability of banking and payment services to the entire population without discrimination. The policy draws attention to the divergence in treatment of depositors compared to borrowers as: while policies relating to credit allocation, credit pricing and credit restructuring should continue to receive attention, it is inappropriate to ignore the mandate relating to depositors interests. Further, in our country, the socio-economic profile for a typical depositor who seeks safe avenues for his savings deserves special attention relative to other stakeholders in the banks.

Another significant area of concern has been the possible exclusion of a large section of population from the provision of services and the Statement pleads for financial inclusion. It states: There has been expansion, greater competition and diversification of ownership of banks leading to both enhanced efficiency and systemic resilience in the banking Sector. However, there are legitimate concerns in regard to the banking practices that tend to exclude rather than attract vast sections of population, in particular pensioners, self-employed and those employed in unorganized sector. While commercial considerations are no doubt important, the banks have been bestowed with several privileges, especially of seeking public deposits on a highly leveraged basis, and consequently they should be obliged to provide banking services to all segments of the population, on equitable basis. Operationally, it has been made clear that RBI will implement policies to encourage banks which provide extensive services while disincentivising those which are not responsive to the banking needs of the community, including the underprivileged. The quality of services rendered has also invited attention in the current policy. I quote further, Liberalization and enhanced competition accord immense benefits, but experience has shown that consumers interests are not necessarily accorded full protection and their grievances are not properly attended to. Several representations are being received in regard to recent trends of levying unreasonably high service/user charges and enhancement of user charges without proper and prior intimation. Taking account of all these considerations, it has been decided by RBI to set up an independent Banking Codes and Standards Board of India on the model of the mechanism in the UK in order to ensure that comprehensive code of conduct for fair treatment of customers are evolved and adhered to.

It is essential to recognize that, while these constitute contextual nuanced responses to changing circumstances within the country, the overwhelming compulsion to be in harmony with global developments must be respected and that essentially relates to Basel II.

Basel II and India

RBIs association with the Basel Committee on Banking Supervision dates back to 1997 as India was among the 16 non-member countries that were consulted in the drafting of the Basel Core Principles. Reserve Bank of India became a member of the Core Principles Liaison Group in 1998 and subsequently became a member of the Core Principles Working Group on Capital. Within the Working Group, RBI has been actively participating in the deliberations on the New Accord and had the privilege to lead a group of six major non-G-10 supervisors which presented a proposal on a simplified approach for Basel II to the Committee. Commercial banks in India will start implementing Basel II with effect from March 31, 2007. They will adopt Standardized Approach for credit risk and Basic Indicator Approach for operational risk, initially. After adequate skills are developed, both at the banks and also at supervisory levels, some banks may be allowed to migrate to the Internal Rating Based (IRB) Approach. Let me briefly review the steps taken for implementation of Basel II and the emerging issues. The RBI had announced in its annual policy statement in May 2004 that banks in India should examine in depth the options available under Basel II and draw a roadmap by end-December 2004 for migration to Basel II and review the progress made at quarterly intervals. The Reserve Bank organized a two-day seminar in July 2004 mainly to sensitize the Chief Executive Officers of banks to the opportunities and challenges emerging from the Basel II norms. Soon thereafter all banks were advised in August 2004 to undertake a self-assessment of the various risk management systems in place,

with specific reference to the three major risks covered under the Basel II and initiate necessary remedial measures to update the systems to match up to the minimum standards prescribed under the New Framework. Banks have also been advised to formulate and operationalize the Capital Adequacy Assessment Process (CAAP) within the banks as required under Pillar II of the New Framework. It is appropriate to list some of the other regulatory initiatives taken by the Reserve Bank of India, relevant for Basel II. First, we have tried to ensure that the banks have suitable risk management framework oriented towards their requirements dictated by the size and complexity of business, risk philosophy, market perceptions and the expected level of capital. Second, Risk Based Supervision (RBS) in 23 banks has been introduced on a pilot basis. Third, we have been encouraging banks to formalize their capital adequacy assessment process (CAAP) in alignment with their business plan and performance budgeting system. This, together with the adoption of RBS would aid in factoring the Pillar II requirements under Basel II. Fourth, we have been expanding the area of disclosures (Pillar III), so as to have greater transparency in the financial position and risk profile of banks. Finally, we have tried to build capacity for ensuring the regulators ability for identifying and permitting eligible banks to adopt IRB / Advanced Measurement approaches. As per normal practice, and with a view to ensuring migration to Basel II in a nondisruptive manner, a consultative and participative approach has been adopted for both designing and implementing Basel II. A Steering Committee comprising senior officials from 14 banks (public, private and foreign) has been constituted wherein representation from the Indian Banks Association and the RBI has also been ensured. The Steering Committee had formed sub-groups to address specific issues. On the basis of recommendations of the Steering Committee, draft guidelines to the banks on implementation of the New Capital Adequacy Framework have been issued. Implementation of Basel II will require more capital for banks in India due to the fact that operational risk is not captured under Basel I, and the capital charge for market risk was not prescribed until recently. Though last year has not been a very good year for banks, they are exploring all avenues for meeting the capital requirements under Basel II. The cushion available in the system, which has a CRAR of over 12 per cent now, is, however, comforting. India has four rating agencies of which three are owned partly/wholly by international rating agencies. Compared to developing countries, the extent of rating penetration has been increasing every year and a large number of capital issues of companies has been rated. However, since rating is of issues and not of issuers, it is likely to result, in effect, in application of only Basel I standards for credit risks in respect of non-retail exposures.

While Basel II provides some scope to extend the rating of issues to issuers, this would only be an approximation and it would be necessary for the system to move to rating of issuers. Encouraging rating of issuers would be essential in this regard. In this context, current non-availability of acceptable and qualitative historical data relevant to ratings, along with the related costs involved in building up and maintaining the requisite database, does influence the pace of migration to the advanced approaches available under Basel II. Above all, capacity building, both in banks and the regulatory bodies is a serious challenge, especially with regard to adoption of the advanced approaches. We in India have initiated supervisory capacity-building measures to identify the gaps and to assess as well as quantify the extent of additional capital which may be required to be maintained by such banks. The magnitude of this task, which is scheduled to be completed by December 2006, appears daunting since we have as many as 90 scheduled commercial banks in India.

Processes of Reform
What are the unique features of our reform process? First, financial sector reform was undertaken early in the reform cycle in India. Second, the banking sector reforms were not driven by any immediate crisis as has often been the case in several emerging economies. Third, the design and detail of the reform were evolved by domestic expertise, while taking on board the international experience in this regard. Fourth, enough space was created for the growth and healthy competition among public and private sectors as well as foreign and domestic sectors. How useful has been the financial liberalization process in India towards improving the functioning of institutions and markets? Prudential regulation and supervision has improved; the combination of regulation, supervision

and safety nets has limited the impact of unforeseen shocks on the financial system. In addition, the role of market forces in enabling price discovery has enhanced. The dismantling of the erstwhile administered interest rate structure has permitted financial intermediaries to pursue lending and deposit taking based on commercial considerations and their asset-liability profiles. The financial liberalisation process has also enabled to reduce the overhang of non-performing loans: this entailed both a stock (restoration of net worth) solution as well as a flow (improving future profitability) solution. Financial entities have become increasingly conscious about risk management practices and have instituted risk management models based on their product profiles, business philosophy and customer orientation. Additionally, access to credit has improved, through newly established domestic banks, foreign banks and bank-like intermediaries. Government debt markets have developed, enabling greater operational independence in monetary policy making. The growth of government debt markets has also provided a benchmark for private debt markets to develop. There have also been significant improvements in the information infrastructure. The accounting and auditing of intermediaries has improved. Information on small borrowers has improved and information sharing through operationalization of credit information bureaus has helped to reduce information asymmetry. The technological infrastructure has developed in tandem with modern-day requirements in information technology and communications networking. The improvements in the performance of the financial system over the decade-and-a-half of reforms are also reflected in the improvement in a number of indicators. Capital adequacy of the banking sector recorded a marked improvement and stood at 12.3 per cent at end-March 2006. This is a far cry from the situation that prevailed in early 1990s. On the asset quality front, notwithstanding the gradual tightening of prudential norms, non-performing loans (NPL) to total loans of commercial banks which was at a high of 15.7 per cent at end-March 1997 declined to 3.3 per cent at end-March 2006. Net NPLs also witnessed a significant decline and stood at 1.2 per cent of net advances at end-March 2006, driven by the improvements in loan loss provisioning, which comprises over half of the total provisions and contingencies. The proportion of net NPA to

net worth, sometimes called the solvency ratio of public sector banks has dropped from 57.9 per cent in 1998-99 to 11.7 per cent in 2006-07. Operating expenses of banks in India are also much more aligned to those prevailing internationally, hovering around 2.1 per cent during 2004-05 and 2005-06. These numbers are comparable to those obtaining for leading developed countries which were range-bound between 1.4-3.3 per cent in 2005. Bank profitability levels in India have also trended upwards and gross profits stood at 2.0 per cent during 2005-06 (2.2 per cent during 2004-05) and net profits trending at around 1 per cent of assets. Available information suggests that for developed countries, at end-2005, gross profit ratios were of the order of 2.1 per cent for the US and 0.6 per cent for France. The extent of penetration of our banking system in our country as measured by the proportion of bank assets to GDP has increased from 50 per cent in the second half of nineties to over 80 per cent a decade later.