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Indian Banking in the New Millenium -
Banking & Financial Services
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Banking & Financial Services

Module: 1 - Banking & Financial Services - Table of Contents

  1. Title Page - Banking & Financial Services

  2. Universal Banking -Introduction

  3. RBI Guidelines for Existing Banks/FIs for Conversion into Universal Banks

Other Modules under "Banking & Financial Services"

  1. Module: 2 - Digital Cash & Electronic Money

  1. Module: 3 - Credit Cards

  2. Module: 4 - Public Debit & How RBI Manages the same

  3. Module: 5 - National Dealing System & Clearing Corporation of India Ltd

  4. Module: 6 - Trading of G-sec through Stock Exchanges

Bankers enter the Realm of Financial Services

"Banking has traditionally remained a protected industry in many emerging economies. However, a combination of developments has compelled banks to change the old ways of doing business. These include, among others, technological advancements, disintermediation pressures arising from a liberalized marketplace, increased emphasis on shareholders' value and macroeconomic pressures and banking crises in 1990s. As a consequence of these developments, the dividing line between financial products, types of financial institutions and their geographical locations have become less relevant than in the past."

For several decades in the past banking continued to be viewed as a conservative business and was conducted with strict adherence to traditional prudence & principles, with predefined and listed DOs and DON'Ts. Profits and profitability were indeed looked for, but this goal was preceded by greater importance to norms of security and liquidity. Speculation was considered a sin. Traditional banking services included accepting deposits from the public, lending a part of the same on short term basis, and investing another portion in gilt-edged securities, while also holding a certain percentage in cash, as balance with the Central Bank of the country, and in the call money market. Thus the definition of "Banking" as per the Banking Regulation Act, 1949 says-

"banking" means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise".

The Act defined the functions that a commercial bank can undertake and restricted their sphere of activities. It prohibited banks from owning non-banking assets. No Company other than a commercial bank licensed by the RBI can include the words "Bank" or "Banking" as part of its name. Thus the boundary for banking and financial services was mutually demarcated and assigned separately between commercial banks and non-banking financial companies respectively. The one cannot encroach on the domain of the other.

By way of banking services, banks provided remittance service, collection of cheques and bills of exchange, Issue of Guarantees, Opening Letters of Credit, Leasing Safe Deposit Lockers, and accepting articles under safe custody. As distinguished from this financial services included long term lending for industrial and infrastructure projects, housing finance, financing hire-purchase and leasing transactions, providing insurance cover, selling mutual-fund products etc.

The initial move away from traditional concepts of banking took place after nationalisation of banks in 1969/70. Banks started lending on medium Term basis repayable between 3 to 7 years. After Nationalisation banks also diversified credit extension comprehensively to cater different sectors of the economy. Term Lending, lending extensively against hypothecation of securities, financing qualified and technical entrepreneurs, financing craftsmen and artisans, financing purchase of consumer durable, financing acquisition & constructions of houses, office premises, vehicles, financing agriculture & allied activities, small-scale industries and exports etc. came into vogue. It was still a mere diversification of credit-delivery functions, and a transition from commercial banking to development banking looking towards social objectives of employment generation and poverty alleviation under Government ownership covering the major segment of Indian Banking

While Indian banking was ardently pursuing social banking, since the Eighties of the last century International banking was undergoing rapid changes. These are discussed in an earlier article styled "Developments in International Financial Markets & Banking Arena". To quote the significant statement there-from-

Since the beginning of the Eighties, the International Financial Markets are witnessing revolutionary structural changes in terms of financial instruments and the nature of lenders and borrowers. On the one hand there is a declining role for the Banks in direct financial intermediation. On the other hand there is enormous increase in securitised lending, the growth of new financial facilities of raising funds directly from investors. There is also the growth of innovative techniques such as interest rate swaps, financial and foreign exchange futures and foreign exchange and interest rate options.

International Finance has to deal with and cater to the complex financial needs relating to the global economic activities. It has to satisfy to diverse customers like individuals, commercial organizations and government owned corporations spread over various countries. By nature these requirements could not be uniform. A stream of financial products have therefore come into usage to meet specific needs of both investors and borrowers. The range of product covers fund raising, underwriting, hedging or arbitrage instruments. The dynamism, in terms of variety and packages provided, as exhibited by the International Financial & Banking market has led to the equating of Euro-banking operations, the nerve centre of global financial and banking services as "financial engineering".

In this context it is apt to quote portions of a speech of the Governor of RBI, Dr.Bimal Jalan at 22nd Bank Economists Conference, New Delhi,15th February, 2001 as under:-

"The institution of banks continues to have a unique place within the financial system. This is due to their 'franchise' i.e., their unique ability to issue monetary liabilities by leveraging non-collateralised deposits. Over the last three decades, however, the role of banking in the process of financial intermediation has been undergoing a profound transformation, owing to changes in the global financial system. It is now clear that a thriving and vibrant banking system requires a well developed financial structure with multiple intermediaries operating in markets with different risk profiles.

"What are the compulsions underlying this interdependence? Firstly, the proliferation of financial innovations has led to a blurring of the boundaries between traditional banking and other types of financial intermediation. Today, banks operate with a wide variety of financial assets and liabilities, some of which are created by the non-bank constituents of the financial system. Secondly, specialised markets have come into being for each class of financial instruments and banks have to transact business in various segments of the financial market spectrum in the process of their routine day-to-day business. Thirdly, banks undertake leveraging transformations as part of their intermediation - asset-liability, debt-equity, collateralised/ non-collateralised, maturity, size and risk. This necessarily involves other types of financial intermediaries as counterparties, in syndications and co-financing strategies, as also in the sharing of risk. Fourthly, active global capital movements and the growing volume of cross-border trade in financial services have exerted external pressures for reorientation and refocusing of activities for all players in financial markets.

"Competitive pressures in the financial sector are thus building up, both within and from outside the banking system. Other financial intermediaries are increasingly refocusing on core competencies and niche strategies. Banks as well as other financial intermediaries are undergoing radical organisational change with an objective of synergising strength and shedding activities with comparative disadvantage. Specialisation in financial intermediation provides competitive efficiency, depth and resilience to the financial system. Together, the spectrum of financial institutions can bring about further financial deepening and encourage financial saving in the community.

The following is also a quotation from the speech of Dr.Bimal Jalan, Governor, RBI titled "Indian Banking and Finance: Managing New Challenges" at the Twenty-third Bank Economists' Conference at Kolkata, on January 14, 2002.

"Since the early 1990s, banking systems worldwide have been going through a rapid transformation. Mergers, amalgamations and acquisitions have been undertaken on a large scale in order to gain size and to focus more sharply on competitive strengths. This consolidation has produced financial conglomerates that are expected to maximise economies of scale and scope by 'bundling' the production of financial services. The general trend has been towards downstream universal banking where banks have undertaken traditionally non-banking activities such as investment banking, insurance, mortgage financing, securitisation, and particularly, insurance. Upstream linkages, where non-banks undertake banking business, are also on the increase. The global experience can be segregated into broadly three models. There is the Swedish or Hong Kong type model in which the banking corporate engages in in-house activities associated with banking. In Germany and the UK, certain types of activities are required to be carried out by separate subsidiaries. In the US type model, there is a holding company structure and separately capitalised subsidiaries.

In India, the first impulses for a more diversified financial intermediation were witnessed in the 1980s and 1990s when banks were allowed to undertake leasing, investment banking, mutual funds, factoring, hire-purchase activities through separate subsidiaries. By the mid-1990s, all restrictions on project financing were removed and banks were allowed to undertake several activities in-house. In the recent period, the focus is on Development Financial Institutions (DFIs), which have been allowed to set up banking subsidiaries and to enter the insurance business along with banks. DFIs were also allowed to undertake working capital financing and to raise short-term funds within limits. It was the Narasimham Committee II Report (1998) which suggested that the DFIs should convert themselves into banks or non-bank financial companies, and this conversion was endorsed by the Khan Working Group (1998). The Reserve Bank's Discussion Paper (1999) and the feedback thereon indicated the desirability of universal banking from the point of view of efficiency of resource use, but it also emphasised the need to take into account factors such as the status of reforms, the state of preparedness of the institutions, and a viable transition path while moving in the desired direction."


As part of the integration of financial services world over, new opportunities have emerged for banks to enter into the area of insurance. Banks' entry into insurance sector has opened up viable opportunities to enhance their non-interest income and improve their performance. With the passage of the Insurance Regulatory and Development Authority (IRDA) Act, 1999, the Insurance Regulatory and Development Authority has been set up with statutory powers to function as the sector regulator for insurance in India. The Act, while allowing private participation including foreign equity participation up to 26% of the paid-up capital, has come out with regulations on various aspects of insurance business such as, licensing of agents, solvency margin for insurers, accounting norms, investment norms and registration of Indian insurance companies. The Act has also simultaneously stipulated prudential norms for investments and service obligations in the less lucrative rural sector. With the issuance of notification specifying insurance as a permissible form of business under Section 6(1)(o) of the Banking Regulation Act, 1949, RBI has issued guidelines for entry of banks into insurance business. Accordingly, those banks which satisfy the vital parameters set therein - minimum net worth of Rs.500 crore, eligibility criteria in regard to net worth, capital adequacy, profitability, reasonable level of non-performing advances - would be allowed to set up insurance joint ventures on risk participation basis. Banks which are not eligible as joint venture participants, would be allowed to take up strategic investment up to a certain limit for providing infrastructure and services support without taking on any contingent liability provided these banks satisfy some of the criteria specified therein. With a view to providing the banks with another avenue for generating fee based income, any scheduled commercial bank or its subsidiary would be permitted to undertake insurance business as agent of an insurance company and distribute insurance products without any risk participation. Banks are required to maintain an 'arms length' relationship with insurance outfit and adopt a risk management framework where the risks of insurance business do not get transferred to the banking business.


In terms of Section 19(1)(a) of the B.R.Act, 1949, banks can form subsidiaries to undertake activities which banks themselves are allowed to engage in under Section 6(1)(a) to (o) of the Act. Section 6(1)(a) to (n) of the Act cover traditional banking activities. Under Section 6(1)(o) of the B.R.Act, 1949, Govt. of India has notified certain para-banking activities as eligible activities for banks to undertake either departmentally or by setting up subsidiaries. Further, in terms of Section 19(1)(c) of the Act, Reserve Bank may allow a bank to adopt only its subsidiary route for any activity which is considered to be in the interest of banking or in the public interest, with the approval of Govt. of India.

So far, subsidiaries have been formed by banks to undertake activities such as equipment leasing, merchant banking, hire-purchase finance, factoring venture capital, housing finance, mutual funds (asset management companies), stock broking, credit card services, primary dealership in Government securities market [under Section 19(1)(a) of the B.R.Act], assaying and hallmarking of gold, computer related services [under Section 19(1)(c) of the B.R.Act]. With the issuance of notification specifying insurance as a permissible form of business under Section 6(1)(o) of the B.R.Act, 1949, SBI has been allowed to set up a subsidiary for doing insurance business.

Banks, therefore, have now as a global development come to diversify their approach and extend many services that blur the difference between "banking service" and "financial service". They sell products like insurance cover, mutual fund investments, trading on the stock exchange on behalf of its customers etc. In short the thinking now is to develop as "Universal Banking Organizations", described as "supermarket for financial products".

The new innovative developments in information technology and telecommunication has enabled banks to successfully carry out this product diversification and enter into financial services at a rapid spree. This module carries out an analysis of this trend and describes the reforms that have taken place in the Insurance, & Mutual Fund sectors and the capital markets. Initially we start with more information on Universal Banking

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