RESEARCH PROJECT REPORT

ON

A STUDY ON INDIAN BANKING SECTOR

REFORMS
Submitted in partial fulfillment of the requirements
For the degree of
Bachelor of Commerce
Session 2023-24

IIMT COLLEGE OF MANAGEMENT

(Affiliated to CCS University, Meerut)
Under the guidance of Submitted By:
Manish singh
Assistance Professor B.COM – 6thsem.
Roll No. - 210613303067

1
 DECLARATION

I hereby declare that this project work entitled “INDIAN BANKING SYSTEM

REFORMS ” has been prepared by me during the year 2023 – 24 under the guidance

of Mr. Rajesh Kumar, Department of Management, IIMT Collage, NOIDA in the

partial fulfillment of B.COM degree prescribed by the college.

I also declare that this project is the outcome of my own effort, that it has not been

submitted to any other university for the award of any degree.

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 ACKNOWLEDGEMENT

I would like to express my sincere gratitude to Mrs Leena Bhati, HOD of B.COM
department for his contributions to the completion of my project report titled “A
STUDY ON REGIONAL RURAL BANKS IN INDIA”.
Further, I would like to express my special thanks to my mentor/guide Mrs. Diksha
mam for his continuous guidance and support throughout the project. His valuable
advice and suggestions added lots of value &were really helpful in completion of my
project with practical understanding of it.

Therefore, I am highly obliged to my college guide as well as the supervisor of the

organization/company under whose mentorship, I did this project work and the
overall learning was very enriching.

Also, I would like to declare that this internship project titled “A STUDY ON
INDIAN BANKING SYSTEM REFORMS” was exclusively done by me and not by
someone else.

MANISH SINGH
B.com – 6th Semester
Roll No. - 210613303067

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 PREFACE

As a part of the B.com Circulam and in order to gain practical Knowledge in the
field of management, we are required to make a report on "INDIAN BANKING
SECTOR REFORMS"The Basic Objective behind doing this project report is to
get knowledge.
In this project report we have included various concepts, effects and implications
regarding Indian Banking Sector
Doing this Project report helped us to enhance our knowledge regarding the
challenges and opportunity during Indian banking sector reforms.
experiences related with our topic concepts. Through this report we
come to know about importance of team work and role of devotion towards the
work.

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 TABLE OF CONTENTS

CH.NO. TITLE PAGE NO

CHAPTER - 1 REFORMS IN THE INDIAN BANKING SECTOR

1.1 Introduction 01 1.2 Reduction of SLR and CRR 04 1.3

Minimum Capital Adequacy Ratio 07 1.4 Prudential Norms 11 1.5
Disclosure Norms 17 1.6 Rationalisation of Foreign Operations in
India
19
1.7 Special Tribunals and Asset Reconstruction Fund 23 1.8
Restructuring of Weak Banks 26 1.9 Asset Liability
Management System

29
1.10 Reduction of Government Stake in PSBs
32
1.11 Deregulation of Interest Rate 39

CHAPTER - 2 DEVELOPMENTS IN THE INDIAN BANKING SECTOR

2.1 Introduction 42
2.2 Voluntary Retirement Scheme 43
2.3 Universal Banking 52
2.4 Mergers and Acquisition 56
2.5 Banking and Insurance 62
2.6 Rural Banking 65
2.7 Virtual Banking 71
2.8 Retail Banking 73

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 1.1 Introduction

As the real sector reforms began in 1992, the need was felt to restructure the Indian banking
industry. The reform measures necessitated the deregulation of the financial sector, particularly
the banking sector. The initiation of the financial sector reforms brought about a paradigm shift
in the banking industry. In 1991, the RBI had proposed to from the committee chaired by M.
Narasimham, former RBI Governor in order to review the Financial System viz. aspects
relating to the Structure, Organisations and Functioning of the financial system. The
Narasimham Committee report, submitted to the then finance minister, Manmohan
Singh, on the banking sector reforms highlighted the weaknesses in the Indian banking system
and suggested reform measures based on the Basle norms. The guidelines that were issued
subsequently laid the foundation for the reformation of Indian banking sector.

The main recommendations of the Committee were: -

i. Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years

ii. Progressive reduction in Cash Reserve Ratio (CRR)

iii. Phasing out of directed credit programmes and redefinition of the priority sector

iv. Deregulation of interest rates so as to reflect emerging market conditions

v. Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by
March 1993, 8 per cent by March 1996, and 8 per cent by those banks having
international operations by March
1994
vi. Adoption of uniform accounting practices in regard to income recognition, asset
classification and provisioning against bad and doubtful debts

vii. Imparting transparency to bank balance sheets and making more disclosures

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

ix. Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of
their bad and doubtful advances at a discount

x. Restructuring of the banking system, so as to have 3 or 4 large banks, which could

become international in character, 8 to 10 national banks and local banks confined to
specific regions. Rural banks, including RRBs, confined to rural areas

xi. Abolition of branch licensing

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xii. Liberalising the policy with regard to allowing foreign banks to open offices in India

xiii. Rationalisation of foreign operations of Indian banks xiv. Giving freedom to

individual banks to recruit officers xv. Inspection by supervisory authorities based
essentially on the internal audit and inspection reports

xvi. Ending duality of control over banking system by Banking Division and RBI

xvii. A separate authority for supervision of banks and financial institutions which would be
a semi-autonomous body under RBI

xviii. Revised procedure for selection of Chief Executives and Directors of Boards of public
sector banks

xix. Obtaining resources from the market on competitive terms by DFIs xx. Speedy
liberalisation of capital market
xxi. Supervision of merchant banks, mutual funds, leasing companies etc., by a separate
agency to be set up by RBI and enactment of a separate legislation providing
appropriate legal framework for mutual funds and laying down prudential norms for
such institutions, etc.

Several recommendations have been accepted and are being implemented in a phased manner.
Among these are the reductions in SLR/CRR, adoption of prudential norms for asset
classification and provisions, introduction of capital adequacy norms, and deregulation of most
of the interest rates, allowing entry to new entrants in private sector banking sector, etc.

Keeping in view the need of further liberalisation the Narasimham Committee II on

Banking Sector reform was set up in 1997. This committee’s terms of reference included
review of progress in reforms in the banking sector over the past six years, charting of a
programme of banking sector reforms required to make the Indian banking system more robust
and internationally competitive and framing of detailed recommendations in regard to make
the Indian banking system more robust and internationally competitive.

This committee constituted submitted its report in April 1998. The major recommendations
are :

i. Capital adequacy requirements should take into account market risks also
ii. In the next three years, entire portfolio of Govt. securities should be marked to market
iii.Risk weight for a Govt. guaranteed account must be 100 percent iv.CAR to be raised
to 10% from the present 8%; 9% by 2000 and 10% by 2002
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 v. An asset should be classified as doubtful if it is in the sub-standard category for 18
months instead of the present 24 months
vi.Banks should avoid ever greening of their advances vii.There should be no further re-
capitalization by the Govt. viii.NPA level should be brought down to 5% by 2000 and
3% by 2002.
ix.Banks having high NPA should transfer their doubtful and loss categories to ARCs
which would issue Govt. bonds representing the realisable value of the assets.
x. International practice of income recognition by introduction of the 90-day norm instead
of the present 180 days. xi. A provision of 1% on standard assets is required.
xii.Govt. guaranteed accounts must also be categorized as NPAs under the usual norms
xiii.There is need to institute an independent loan review mechanism especially for large
borrowal accounts to identify potential NPAs.
xiv.Recruitment of skilled manpower directly from the market be given urgent
consideration
xv.To rationalize staff strengths, an appropriate VRS must be introduced.
xvi.A weak bank should be one whose accumulated losses and net NPAs exceed its net
worth or one whose operating profits less its income on recap bonds is negative for 3
consecutive years.

To start with, it has assigned a 2.5 per cent risk-weightage on gilts by March 31, 2000 and laid
down rules for provisioning; shortened the life of sub-standard assets from 24 months to 18
months (by March 31, 2001); called for 0.25 per cent provisioning on standard assets (from
fiscal 2000); 100 per cent risk weightage on foreign exchange (March 31, 1999) and a
minimum capital adequacy ratio of 9 per cent as on March 31, 2000.

Only a few of these mainly constitute to the reforms in the banking sector.

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 1.2 Reduction of SLR and CRR

The South East Asian countries introduced banking reforms wherein bank CRR and SLR was
reduced, this increased the lending capacity of banks. The markets fell precipitously because
banks and corporates did not accurately measure the risk spread that should have been reflected
in their lending activities. Nor did they manage such risks or provide for them in their balance
sheets. And followed the South East Asian Crisis.

The monetary policy perspective essentially looks at SLR and CRR requirements (especially
CRR) in the light of several other roles they play in the economy. The CRR is considered an
effective instrument for monetary regulation and inflation control. The SLR is used to impose
financial discipline on the banks, provide protection to deposit-holders, allocate bank credit
between the government and the private sectors, and also help in monetary regulation.
However bankers strongly feel that these along with high non-performing assets (on which
banks do not earn any return) 10 percent CRR and 25 percent SLR (most banks have SLR
investments way above the stipulation) are affecting banks' bottomlines. With an effective
return of a mere 2.8 per cent, CRR is a major drag on banks' profitability.

The Narasimham Committee had argued for reductions in SLR on the grounds that the stated
government objective of reducing the fiscal deficits will obviate the need for a large portion of
the current SLR. Similarly, the need for the use of CRR to control secondary expansion of
credit would be lesser in a regime of smaller fiscal deficits. The committee offered the route
of Open Market Operations (OMO) to the Reserve Bank of India for further monetary control
beyond that provided by the (lowered) SLR and CRR reserves. Ultimately, the rule was
Reduction in the reserve requirements of banks, with the Statutory Liquidity Ratio (SLR) being
brought down to 25 per cent by 1996-97 in a period of 5 years.

The recent trend in several developed countries (US, Switzerland, Australia, Canada, and
Germany) towards drastic lowering of reserve requirements is often used to support the
argument for reduced reserve levels in India.

The arguments for higher or lower SLR and CRR ratios stem from two different perspectives
one which favours the banks, and the other which favours the bank reserves as a monetary
policy instrument. The bank perspective seeks to maximise "lendable" resources, the banks'
control over resource deployment, and returns to the banks from the
"preempted" funds. It is also claimed that the low returns from the forced investments in
government securities adversely affect the bank profitability - the cost of deposits for banks,
which averages at 15-16 per cent, was much greater than the (earlier) returns on the
government securities. This argument is sometimes carried further to state that RBI makes
profits on impounded money, at the cost of bank profitability. To some extent, this argument
has been weakened by the increase in interest on government securities to 13.5 per cent.

Some problems with the stated aim of reducing SLR and CRR are:

1. The supporting condition of smaller fiscal deficits is not happening in reality

9
 2. Open market operations have not been used to any significant extent in India for
monetary control. The time required for gaining experience with the use of such
operations would be much more than 5-6 years.
3. A commitment to a unidirectional movement of these vital controls irrespective of
the effects on, and the response of, other economic factors (such as inflation), would
be unwise.

This scenario thus indicates that despite the stated aim of reductions in SLR and CRR, RBI
may be forced to revert to higher reserve levels, if the economic indicators become
unfavourable, and RBI has already indicated as much. Bank investment are, therefore, not
likely to stabilize in the near future.

The RBI had announced an increase in interest rate on CRR balance to 6% from the present
4%. This will certainly boost the profits of banks, as they have to maintain a minimum balance
of 8% with the RBI.

10
 Trends in CRR and SLR 1993 – 2001

May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May-
93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01

SLR CRR
1.3 Minimum Capital AdequacyIllustration 1
Ratio

The committee recommended a Stipulation of minimum capital adequacy ratio of 4 per cent to
risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks
having international operations by March 1994. Later, all banks required attaining the capital
adequacy norm of 8 per cent, as per the Basle Committee Recommendations, by March 31,
1996.

Capital Adequacy

The growing concern of commercial banks regarding international competitiveness and capital
ratios led to the Basle Capital Accord 1988. The accord sets down the agreement to apply
common minimum capital standards to their banking industries, to be achieved by year-end
1992. Based on the Basle norms, the RBI also issued similar capital adequacy norms for the
Indian banks. According to these guidelines, the banks will have to identify their Tier-I and
Tier-II capital and assign risk weights to the assets. Having done this they will have to assess
the Capital to Risk Weighted Assets Ratio (CRAR). The minimum CAR that the Indian banks
are required to meet is set at 9 percent.
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 • Tier-I Capital, comprising of
Paid-up capital
Statutory Reserves
Disclosed free reserves
Capital reserves representing surplus arising out of sale proceeds of assets

• Tier-II Capital, comprising of

Undisclosed Reserves and Cumulative Perpetual Preference Shares Revaluation Reserves
General Provisions and Loss Reserves

The Narasimham Committee had recommended that the capital adequacy norms set by the
Bank of International Settlements (BIS) be followed by the Indian banks also. The BIS norm
for capital adequacy is 8 per cent of risk-weighted assets.

Inadequacy?

The structural inadequacy that is said to be responsible for the stock scam was the
compartmentalisation of the capital and money markets; and the availability of "illegal"
arbitrage opportunities. Such interconnections between various parts of the financial system
will continue to develop as the demands made by the rest of the economy on the financial
system increase in the next two decades. Also, a short-term danger of the new provisioning
and capital adequacy norms arises from the inefficiency of the Asset Reconstruction Fund
(ARF), or some alternative arrangement. The need to make massive provisions obviously
results in a depletion of capital. But the capital adequacy norm means the banks have to find
additional, costly money to refurbish the capital base. In this situation, the banks are being
forced to accept the minimum possible amounts from sub-standard and bad loans. Where time
and legal efforts might have forced them to pay more, errant loanees are now getting away
with token payments which the funds starved banks are only too willing to accept. Thus, the
need for ARF is now paramount.

The banking sector specialists have traditionally claimed that capital plays several roles in all
"depository institutions", such as banks. However, these roles can vary significantly between
the public sector banks and those in the private sector. The justification for capital adequacy
norms
for banks is brought out by the following arguments:

Capital lowers the probability of bank failure more capital means added ability to
withstand unexpected losses, and more time for the bank to work through
potentially fatal problems. At the same time, the Indian public sector banks may
attract more "punishments" in the form of politically motivated "loan waivers",
"loan melas", and non-performing assets.
Capital increases the disincentive for the bank management to take excessive risk: If
significant amount of their own funds are at stake, the equity-owners have a
powerful incentive to control the amount of risk the bank incurs. This may remain
12
 true for the public sector banks only if the government acts as a vigilant shareholder.
However, the government's ability to play such a role effectively is suspect. The
Indian banks have traditionally shown risk-aversion, but the recent stock scam
showed that the banks are perhaps being forced to take excessive risks to improve
the profitability. Since management control will remain with bureaucrats - banking
or government - the source of capital would not make much difference in the Indian
scenario.
Capital acts as a buffer between the bank and the deposit guarantee corporation
(funded by the tax-payer): while this is true for the private banks, the government-
owned capital in the public sector banks is itself taxpayer money.
Capital helps avoid "credit crunches": a well-capitalized bank can continue to lend in
the face of losses. Similar losses might force a poorly capitalized bank to restrict
credit (to increase capital ratios). In an economic downturn, well-capitalized banks
may provide a vital source of continuing credit.
Capital increases the long-term competitiveness: more capital allows a bank to build
long-term customer relationships, and respond to positive as well as negative
changes in the economic environment. New opportunities can be quickly made
use of by lending appropriately. If the bank is not constrained by capital, it can
give valuable time to customers with temporary repayment problems. It can
thereby recover more from the loans, which would otherwise have to be called in.

The Dilemma
The foregoing discussion clearly brings out two conclusions: (a) increasing the capital base of
the nationalised banks is necessary, especially in view of the large quantities of non-
performing assets; and (b) however, increase in capital owned directly by the government has
several attendant problems' The situation is complicated by the fact that " private management"
does not provide an answer in India, because of the size of the institutions involved. Also,
talent and expertise in bank management is available mainly in the existing nationalised banks.

One short-term fallout of the capital adequacy norms has been the massive increases in
investments by the banks in government securities. Since the risk-weight of government
securities is zero, investments in them do not add to the capital requirements. The banks are
therefore choosing to deploy funds mobilised through deposits in these long-term gilts.

In the first ten months of 1993-94, for example, the investments in government securities shot
up by 18.8 per cent while bank credit grew at only 6.6 per cent. Despite a strong growth in

13
 aggregate deposits of 13.8 per cent, credit grew by only 6.65 per cent, while investments surged
by 18.8 per cent. The problem with this practice of the banks is that it can upset the balance
of maturity patterns between deposits (many of ' which are short-term) and investments (which
have 10 year maturities). Now, banks would have to develop much better investment
management skills, especially when interest rates are deregulated, and significant open market
operations are started.

Growth In Investments In Government Securities by Banks

1991- 1992- 1992-93 1993-94
92 93 [Up to Jan [Up to Jan
93] 94]
36441
32364 37187
Aggregate deposits growth [19.6
[14.0 %] [13.8 %]
%]
26390
9291 20966 9999
Bank credit growth [21.0
[8.0 %] [16.7 %] [6.6 %]
%]
11042 19857
Investments 15131 15460
[12.2 %] [18.8 %]
Source: Reserve Bank of India Bulletin [1994]
Supplement - Report on Trends and Progress of Banking in India 1991-92 [July - June]; Jan
1993.
The Narasimham Committee II, 1998, suggested further revision i.e. CAR to be raised to 10%
from the present 8%(1998); 9% by 2000 and 10% by
2002
Illustration 2

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 1.4 Prudential Norms

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

Magnitude of the problem

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

What is ever greening or rescheduling of loans?

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

Asset Quality - Increased Transparency

Apart from the interest rate structure, the net interest income is also affected by the asset quality
of the bank. Asset quality is reflected by the quantum of non-performing assets (NPAs) – the
higher the level of NPAs, the lower will be the asset quality and vice versa. Courtesy the
nationalization agenda and the directed credit, most of the public sector banks were burdened
with huge NPAs. While the government did contribute to write-off these bad loans, the
problem still remains. NPAs expose the banks to not just credit risk but also to liquidity risk.
Considering the implications of the NPAs and also for imparting greater transparency and
accountability in banks operations and restoring the credibility of confidence in the Indian
financial system, the RBI introduced prudential norms and regulations. The prudential norms
which relate to income recognition, asset classification and provisioning for bad and doubtful
debts serve two primary purposes – firstly, they bring out the true position of a Bank’s loan
portfolio, and secondly, they help in arresting its deterioration.

The asset quality of the bank and its capital are closely associated. If the assets of the bank go
bad it is the capital that comes to its rescue. Implies that the bank should have adequate capital
to face the likely losses that may arise from its risky assets. In the changed business
environment, where banks are exposed to greater and different types of risk, it becomes
essential to have a good capital base, which can help it sustain unforeseen losses. As stated
earlier, the one major move in this direction was brought about by the Basle Committee, which
laid the capital standards that banks have to maintain. This became imperative, as banks began
to cross over their national boundaries and begin to operate in international markets. Following
15
the Basle Committee measures, RBI also issued the Capital Adequacy Norms for the Indian
banks also.

INCOME RECOGNITION

The regulation for income recognition states that the Income on NPAs cannot be booked.
Interest income should not be recognized until it is realized. An NPA is one where interest is
overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on
accrual basis, but is to be treated as income only when actually received. Income in respect of
accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As
regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic
system for income recognition based on the prospect of realisability of the security. On non-
performing accounts the banks should not charge or take into account the interest.

Income-recognition norms have been tightened for consortium banking too. Member banks
have to intimate the lead-bank to arrange for their share of recovery. They will no more have
the privilege of stating that the borrower has parked funds with the lead-bank or with a
member-bank and that their share is due for receipt. The new notifications emanated after
deliberations held between the RBI and a cross-section of banks after a working group headed
by chartered accountant, PR Khanna, submitted its report. The working group was set after the
RBI’s Board for Financial Supervision (BFS) wanted divergences in NPA accounting norms
by banks from central bank guidelines to be addressed. The working group had identified three
areas of divergence: non-compliance with RBI norms; subjectivity arising out of the flexibility
in norms; and differences in the valuation of securities by banks, auditors and RBI.

As of now, for income recognition norms, the RBI has suggested that the international norm of
90 days be implemented in a phased manner by 2002. The current norm is 180 days.

ASSET CLASSIFICATION
While new private banks are careful about their asset quality and consequently have low non-
performing assets (NPAs), public sector banks have large NPAs due to wrong lending policies
followed earlier and also due to government regulations that require them to lend to sectors
where potential of default is high. Allaying the fears that bulk of the NonPerforming Assets
(NPAs) was from priority sector, NPA from priority sector constituted was lower at 46 per
cent than that of the corporate sector at 48 per cent.

Loans and advances account for around 40 per cent of the assets of SCBs. However,
delay/default in payment of interest and/or repayment of principal has rendered a significant
proportion of the loan assets nonperforming. As per RBI’s prudential norms, a Non-
Performing Asset (NPA) is a credit facility in respect of which interest/installment has
remained unpaid for more than two quarters after it has become past due. “Past due” denotes
grace period of one month after it has become due for payment by the borrower. The Mid-
16
Term Review of Monetary and Credit Policy for 2000-01 has proposed to discontinue this
concept with effect from March 31, 2001.

Regulations for asset classification

Assets should be classified into four classes - Standard, Sub-standard, Doubtful, and Loss
assets. NPAs are loans on which the dues are not received for two quarters. NPAs consist of
assets under three categories: sub-standard, doubtful and loss. RBI for these classes of assets
should evolve clear, uniform, and consistent definitions. The health code system earlier in use
would have to be replaced. The banks should classify their assets based on weaknesses and
dependency on collateral securities into four categories:
Standard Assets: It carries not more than the normal risk attached to the business and is not an
NPA.

Sub-standard Asset: An asset which remains as NPA for a period exceeding 24 months, where
the current net worth of the borrower, guarantor or the current market value of the security
charged to the bank is not enough to ensure recovery of the debt due to the bank in full.

Doubtful Assets: An NPA which continued to be so for a period exceeding two years (18
months, with effect from March, 2001, as recommended by Narasimham Committee II, 1998).

Loss Assets: An asset identified by the bank or internal/ external auditors or RBI inspection
as loss asset, but the amount has not yet been written off wholly or partly.

The banking industry has significant market inefficiencies caused by the large amounts of Non
Performing Assets (NPAs) in bank portfolios, accumulated over several years. Discussions
on non-performing assets have been going on for several years now. One of the earliest
writings on NPAs defined them as "assets which cannot be recycled or disposed off
immediately, and which do not yield returns to the bank, examples of which are: Overdue and
stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and
bank balances with other banks, and amounts locked up in frauds".

The following Table shows the distribution of total loan assets of banks in the public private
sectors and foreign banks for 1997-98 through 19992000. It is worth noting that the ratio of
incremental standard assets of SCBs to their total loan assets increased from 83.1 per cent in
1998-99 to
97.2 percent in 1999-2000. In other words, the ratio of incremental NPAs of SCBs to their total
loan assets declined significantly from 16.9 per cent in 1998-99 to 2.8 percent in 1999-2000.

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 Classification of Loan Assets of SCBs
(Percentage distribution of total loan assets)
Assets Public Private Foreign SCBs

A. Standard

1997-98 84.0 91.3 93.6 85.6

1998-99 86.1 91.2 92.4 85.3

1999-2000 86.0 91.5 93.0 87.2

B. Sub-standard

1997-98 5.0 5.8 3.9 4.9

1998-99 4.9 6.2 4.0 5.0

1999-2000 4.3 3.7 2.9 5.1

C. Doubtful

1997-98 9.1 0.9 1.7 1.8

1998-99 4.0 0.9 2.0 1.9

1999-2000 1.7 0.8 1.9 1.6

D. Loss

1997-98 1.9 0.9 1.2 1.8

1998-99 2.0 0.9 2.0 1.9

1999-2000 1.7 0.8 1.9 1.6

E. Total Assets (Rs. Crore)

1997-98 284971 36753 30972 352696

1998-99 325328 43049 31059 399436

1999-2000 380077 58249 37432 475758

Note: Addition of percentages for B to D may not add up to 100 minus the percentage share of
standard assets (A) due to rounding. Illustration 3
The asset classification norms have resulted in a huge quantity of assets being classified into
the sub-standard, doubtful, and loss assets. As at 31 March 1993, the total of Non-Performing
Assets (NPAs) for the public sector banks (SBI, its seven associates, and 20 nationalised
banks) stood at Rs 36,588 crores. Of these, the sub-standard assets account for Rs 12,552
crores, doubtful assets Rs 20,106 crores, and loss assets Rs 3,930 crores (RBI Bulletin, 1994).
For the future, the banks will have to tighten their credit evaluation process to prevent this
18
scale of sub-standard and loss assets. The present evaluation process in several banks is
burdened with a bureaucratic exercise, sometimes involving up to 18 different officials, most
of whom do not add any value (information or judgment) to the evaluation.

PROVISIONING NORMS

Banks will be required to make provisions for bad and doubtful debts on a uniform and
consistent basis so that the balance sheets reflect a true picture of the financial status of the
bank. The Narasimham Committee has recommended the following provisioning norms

(i) 100 per cent of loss assets or 100 per cent of out standings for loss assets;
(ii) 100 per cent of security shortfall for doubtful assets and 20 per cent to
50 per cent of the secured portion; and
(iii) 10 per cent of the total out standings for substandard assets.
A provision of 1% on standard assets is required as suggested by Narasimham Committee II
1998. Banks need to have better credit appraisal systems so as to prevent NPAs from occurring.
The most important relaxation is that the banks have been allowed to make provisions for only
30 per cent of the "provisioning requirements" as calculated using the Narasimham Committee
recommendations on provisioning (but with the diluted asset classification). The nationalised
banks have been asked to provide for the remaining 70 per cent of the "provisioning
requirements" by 31 March 1994. The encouraging profits recently declared by several banks
have to be seen in the light of provisions made by them - Rs 10,390 crores pertaining to 1992-
93, and the additional provisions for 1993-94. To the extent that provisions have
not been made, the profits would be fictitious.1.5 Disclosure Norms

Banks should disclose in balance sheets maturity pattern of advances, deposits, investments
and borrowings. Apart from this, banks are also required to give details of their exposure to
foreign currency assets and liabilities and movement of bad loans. These disclosures were to
be made for the year ending March 2000

In fact, the banks must be forced to make public the nature of NPAs being written off. This
should be done to ensure that the taxpayer’s money given to the banks as capital is not used to
write off private loans without adequate efforts and punishment of defaulters.
# A Close look : For the future, the banks will have to tighten their credit evaluation process
to prevent this scale of sub-standard and loss assets. The present evaluation process in several
banks is burdened with a bureaucratic exercise, sometimes involving up to 18 different
officials, most of whom do not add any value (information or judgment) to the evaluation. But
whether this government and its successors will continue to play with bank funds remains to
be seen. Perhaps even the loan waivers and loan "melas" which are often decried by bankers
form only a small portion of the total NPAs. As mentioned above, much more stringent
disclosure norms are the only way to increase the accountability of bank management to the

19
taxpayers. A lot therefore depends upon the seriousness with which a new regime of
regulation is pursued by RBI and the newly formed Board for Financial Supervision.

RBI norms for consolidated PSU bank accounts

The Reserve Bank of India (RBI) has moved to get public sector banks to consolidate their
accounts with those of their subsidiaries and other outfits where they hold substantial stakes.
Towards this end, RBI has set up a working group recently under its Department of Banking
Operations and Development to come out with necessary guidelines on consolidated accounts
for banks. The move is aimed at providing the investor with a better insight into viewing a
bank's performance in totality, including all its branches and subsidiaries, and not as isolated
entities. According to a banker, earlier subsidiaries were floated as external independent
entities wherein the accounting details were not incorporated in the parent bank's balance sheet,
but at the same time it was assumed that the problems will be dealt with by the parent. This
will be a path-breaking change to the existing norms wherein each bank conducts its accounts
without taking into consideration the disclosures of its subsidiaries and other divisions for
disclosure. As per the proposed new policy guidelines, the banks will be required to
consolidate their accounts including all its subsidiaries and other holding companies for better
transparency.

# Result: This will require the banks to have a stricter monitoring system of not only their own
bank, but also the other subsidiaries in other sectors like mutual funds, merchant banking,
housing finance and others. This is all the more important in the context of the recent
announcements made by some major public sector banks where they have said they would
hive off or close down some of their under performing subsidiaries.

The Investors Advantage

Getting all these accounts consolidated with that of the parent bank will provide the investor a
better understanding of the banks' performances while deciding on their exposures. More so,
since a number of public sector banks are now listed entities whose stocks are traded on the
stock exchanges. Some public sector banks are even preparing their accounts in line with US
GAAP norms in anticipation of a US listing. These norms will therefore be in line with the
future plans of these banks as well. The working group was set up following the need to bring
about transparency on the lines of international norms through better disclosures.

These new norms will necessitate not only that the problems are handled by the parent, but
investors are also aware of what exactly the problems are and how they affect the bottomlines
of the parent banks. Now, under the new guidelines, this will no longer be an external
disclosure to the parent banks' books of accounts.

Rather, point out bankers, this will very much form an integral part of the parent's balance
sheet.

20
For instance, if a subsidiary is not performing well or making losses, this will reflect in the
parent's balance sheet.
1.6 Rationalisation of Foreign Operations in India

Liberalising the policy with regard to allowing foreign banks to open offices in India or rather
Deregulation of the entry norms for private sector banks and foreign sector.

Entry of New Banks in the Private Sector

As per the guidelines for licensing of new banks in the private sector issued in January 1993,
RBI had granted licenses to 10 banks. Based on a review of experience gained on the
functioning of new private sector banks, revised guidelines were issued in January 2001. The
main provisions/requirements are listed below : -

• Initial minimum paid-up capital shall be Rs. 200 crore; this will be raised to Rs. 300 crore
within three years of commencement of business.
• Promoters’ contribution shall be a minimum of 40 per cent of the paidup capital of the bank
at any point of time; their contribution of 40 per cent shall be locked in for 5 years from
the date of licensing of the bank and excess stake above 40 per cent shall be diluted after
one year of bank’s operations.
• Initial capital other than promoters’ contribution could be raised through public issue or
private placement.
• While augmenting capital to Rs. 300 crore within three years, promoters need to bring in
at least 40 percent of the fresh capital, which will also be locked in for 5 years. The
remaining portion of fresh capital could be raised through public issue or private
placement.
• NRI participation in the primary equity of the new bank shall be to the maximum extent of
40 per cent. In the case of a foreign banking company or finance company (including
multilateral institutions) as a technical collaborator or a co-promoter, equity participation
shall be limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI contribution
to foreign equity can be met through contribution by designated multilateral institutions.
• No large industrial house can promote a new bank. Individual companies connected with
large industrial houses can, however, contribute up to 10 per cent of the equity of a new
bank, which will maintain an arms length relationship with companies in the promoter

21
 group and the individual company/ies investing in equity. No credit facilities shall be
extended to them.
• NBFCs with good track record can become banks, subject to specified criteria
• A minimum capital adequacy ratio of 10 per cent shall be maintained on a continuous basis
from commencement of operations.
• Priority sector lending target is 40 per cent of net bank credit, as in the case of other
domestic banks; it is also necessary to open 25 per cent of the branches in rural/semi-urban
areas.

"Our industry did not oppose the entry of private bankers because we knew they will not be
able to reach out to the rural markets” states, G.M. Bhakey, president of the State Bank of
India Officers Association. "Even after privatisation not more than 10 per cent of the Indian
population can afford to open accounts in private banks."

Can the keenly supported private and foreign banks cater to the banking needs of the people in
India fairly? Takeover and merger dramas are in progress in the world of private sector banks
now and time only can tell how many will live to render safe banking services in the days to
come. The bad debt figures even in the two to three year old new private sector banks have
crossed over 6% to the total advances, while the trends in the old private banks are still higher,
despite the fact that they have no social commitment lendings in their portfolios.

In any case, the private banks, in the Indian context, cannot be the alternative to our well-
developed public sector banks. They are there in the country to fill the private pockets with
their typical selectivity of business and costly operations. All those who beat their drums for
the privatisation parade, which is much on the move after globalisation, to denationalise our
public sector banks, do so with vested interests.

ICICI bank, HDFC bank, GTB, IndusInd, BOP and UTI Bank have come out with IPOs as per
licensing requirement. Their technological edge and product innovation has seen them gaining
market share from the slower, less efficient older banks. These banks have targeted non-fund
based income as major source of revenue, with their level of contingent liabilities being much
higher then their other counterparts viz. PSU and old private sector banks. The new private
banks have been consistently gaining market shares from the public sector banks. The major
beneficiary of this has been corporate clients who are most sought after now.

The new generation private sector banks have made a strong presence in the most lucrative
business areas in the country because of technology upgradation. While, their operating
expenses have been falling as compared to the PSU banks, their efficiency ratios (employee’s
productivity and profitability ratios) have also improved significantly.

The new private sector banks have performed very well in the FY2000.
Most of these banks have registered an increase in net profits of over
50%. They have been able to make significant inroads in the retail market of the public sector
and the old private sector banks. During the year, the two leading banks in this sector had set

22
a new trend in the Indian banking sector. HDFC Bank, as a part of its expansion plans had
taken over Times Bank. ICICI Bank became the first bank in the country to list its shares on
NYSE.

The Reserve Bank of India had advised the promoters of these banks to bring their stake to
40% over a time period. As a result, most of these banks had a foreign capital infusion and
some of the other banks have already initiated talks about a strategic alliance with a foreign
partner.

The main problems concerning the nationalized / state sector banks are as follows:

A. Large number of unprofitable branches

B. Excess staffing of serious magnitude
C. Non Performing Assets on account of politically directed lending and industrial
recession in last few years
D. Lack of computerization leading to low service delivery levels, nonreconciliation of
accounts, inability to control, misuse and fraud etc
E. Inability to introduce profitable new consumer oriented products like credit cards,
ATMs etc

The private’ edge

Technology- The private banks have used technology to provide quality service through
lower cost delivery mechanisms. The implementation of new technology has been going
on at very rapid pace in the private sector, while PSU banks are lagging behind in the
race.

Declining interest rates- in the present scenario of declining interest rates, some of the
new private banks are better able to manage the maturity mix. PSU Banks by and large
take relatively long-term deposits at fixed rates to lend for working capital purposes at
variable rates. It therefore is negatively affected when interest rates decline as it takes
time to reduce interest rates on deposits when lending has to be done at lower interest
rates due to competitive pressures.

NPAs- The new banks are growing faster, are more profitable and have cleaner loans.
Reforms among public sector banks are slow, as politicians are reluctant to surrender
their grip over the deployment of huge amounts of public money.

Convergence- The new private banks are able to provide a range of financial services
under one roof, thus increasing their fee based revenues.

23
 Illustration 4 Annexure 1
List of Banks operating in India.1.7 Special Tribunals and Asset
Reconstruction Fund

Setting up of special tribunals to speed up the process of recovery of loans and setting up of
Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful
advances at a discount was one of the crucial recommendations of the Narasimham Committee.

To expedite adjudication and recovery of debts due to banks and financial institutions (FIs) at
the instance of the Tiwari Committee (1984), appointed by the Reserve Bank of India (RBI),
the government enacted the Debt Recovery Tribunal Act, 1993 (DRT). Accordingly, DRTs
and Appellate DRTs have been established at different places in the country. The act was
amended in January 2000 to tackle some problems with the old act.

DRTs, a compulsion!
One of the main factors responsible for mounting non-performing assets (NPAs) in the
financial sector has been the inability of banks/FIs to enforce the security held by them on
loans gone sour. Prior to the passage of the DRT Act, the only recourse available to banks/FIs
to cover their dues from recalcitrant borrowers, when all else failed, was to file a suit in a civil
court. The result was that by the late ’80s, banks had a huge portfolio of accounts where cases
were pending in civil courts. It was quite common for cases to drag on interminably. In the
interim, borrowers, more often than not, stripped their premises of all assets so that that by the
time the final verdict came, there was nothing left of the security that had been pledged to the
bank.

24
 The Advantage
DRTs, it was felt, would do away with the costly, time-consuming civil court procedures that
stymied recovery procedures since they follow a summary procedure that expedites disposal
of suits filed by banks/FIs. Following the passage of the Act in August 1993, DRTs were set
up at
Calcutta, Delhi, Bangalore, Jaipur and Ahmedabad along with an Appellate Tribunal at
Mumbai.

However, DRTs soon ran into rough weather. The constitutional validity of the Act itself was
questioned. It was only in March 1996, that the Supreme court modified its earlier order —
staying the operation of the Delhi High Court order quashing the constitution of the DRT for
Delhi — to allow the setting up of three more DRTs in Chennai, Guwahati and Patna.
Subsequently, many more DRTs and ADRTs have been set up.

The truth undiscovered, CURRENT STATUS AND BANKERS COMPLAINS

!

Unfortunately, as a consequence of the numerous lacunae in the act and the huge backlog of
past cases where suits had been filed, DRTs failed to make a significant dent. For instance, the
tribunals did not have powers of attachment before judgment, for appointment of receivers or
for ordering preservation of property.

Thus, legal infrastructure for the recovery of non-performing loans still does not exist. The
functioning of debt recovery tribunals has been hampered considerably by litigation in various
high courts. Complains Bank of Baroda's Kannan: "Of the Rs 45,000-crore worth of gross
NPAs, over Rs 12,000 crore is locked up in the courts." So, the only solution to the problem
of high NPAs is ruthless provisioning. Till date, the banking system has provided for about Rs
20,000 crore, which means it is still stuck with net NPAs worth Rs 25,000 crore. Even that is
an under estimate as it does not include advances covered by government guarantees, which
have turned sticky. Nor does it include allowances for "ever greening"--the practice of
extending fresh advances to defaulting corporates so that the prospective defaulter can make
interest payments, thus enabling the asset to escape the non-performing loan tag. Warns K.R.
Maheshwari, 60, Managing Director, IndusInd Bank: "NPA levels are going to go up for all
the banks." And so too will provisions.
Recent Developments

The recent amendment (Jan 2000) to the DRT Act addresses many of the lacunae in the original
act. It empowers DRTs to attach the property on the borrower filing a complaint of default. It
also empowers the presiding officer to execute the decree of the official receiver based on the
certificate issued by the DRT. Transfer of cases from one DRT to another has also been made
easier. More recently, the Supreme Court has ruled that the DRT Act will take precedence over
the Companies Act in the recovery of debt, putting to rest all doubts on that score.

25
 SOME MORE ISSUES
As things stand, the DRT Act supersedes all acts other than The Sick Industrial Companies
Act (SICA). This means that recovery procedures can still be stalled by companies declaring
themselves sick under SICA. Once the fact of their sickness has prima facie been accepted by
the Board for Industrial and Financial Reconstruction (BIFR), there is nothing a DRT can do
till such time as the case is disposed of by the BIFR. This lacuna too must be addressed if
DRTs are to live up to their promise.
The amendments would ensure speedy recovery of dues, iron out delays at the DRT end, as
well as ensure that promoters do not have the time and opportunity to bleed their companies
before they go into winding up.

Yet the number of cases pending before DRTs and courts make a telling commentary on the
inability of lenders to make good their threat. They also reflect the ability of borrowers to
dodge the lenders.

The main culprit for all this is the law. Existing recovery processes in the country are aimed at
recovering lenders' dues after a company has gone sick and not nipping sickness in the bud.
Since sickness is defined in law as the erosion of capital of a company for three consecutive
years, there is little to recover from a sick company after it has been referred to the Board of
Industrial and Financial Revival (BIFR).

What's hurting banks now is the fact that these new issues have cropped up even as they have
been (unsuccessfully) wrestling with their NPAs which, together, tot up to a staggering Rs
60,000 crore. The stratagem of using Debt Recovery Tribunals has failed. Now these banks
have to explore the option of liquidating the assets of defaulting companies (a litigitinous
route), or writing off these debts altogether (which may not find favour with shareholders).
The solution could lie in better risk management
1.8 Restructuring of Weak Banks

How to deal with the weak Public Sector Banks is a major problem for the next stage of banking
sector reforms. It is particularly difficult because the poor financial position of many of these
banks is often blamed on the fact that the regulatory regime in earlier years did not place
sufficient emphasis on sound banking, and the weak Banks are, therefore, not responsible for
their current predicament. This perception often leads to an expectation that all weak Banks
must be helped to restructure after which they would be able to survive in the new environment.

26
Keeping in view the urgent need to revive the weak banks, the Reserve Bank of India set up a
Working Group in February, 1999 under the Chairmanship of Shri M.S. Verma to suggest
measures for the revival of weak public sector banks in India.

27
 THE VERMA PRESCRIPTION…a brief
Identification of weak banks by using benchmarks for 7 critical ratios

Recapitalisation of 3 weak banks conditional on their achieving specified

milestones

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

negotiated by the IBA

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

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

Transfer of non-performing assets to an Asset Reconstruction Fund

Reconstitution of bank boards to include professionals, industrialists and

financial experts

Independent Financial Restructuring Authority to monitor implementation of

revival package
The major recommendations/points of the Working Group, which
submitted its Report in October, 1999, are listed below:-

Seven parameters covering three areas have been identified; these are (i) Solvency
(capital adequacy ratio and coverage ratio), (ii) Earning Capacity (return on assets
and net interest margin) and (iii) Profitability (ratio of operating profit to average
working funds, ratio of cost to income and ratio of staff cost to net interest + income
all other income).

Restructuring of weak banks should be a two-stage operation; stage one involves

operational, organisational and financial restructuring aimed at restoring
competitive efficiency; stage two covers options of privatisation and/or merger.

Operational restructuring essentially involves building up capabilities to launch new

products, attract new customers, improve credit culture, secure higher fee-based
earnings, sell foreign branches (Indian Bank and UCO Bank) to prospective buyers
including other public sector banks, and pull out from the subsidiaries (Indian
Bank), establish a common networking and processing facility in the field of
technology, etc.

28
 The action programme for handling of NPAs should cover honouring of Government
guarantees, better use of compromises for reduction of NPAs based on
recommendations of the Settlement Advisory Committees, transfer of NPAs to
ARF managed by an independent AMC,etc.

To begin with, ARF may restrict itself to the NPAs of the three identified weak banks;
the fund needed for ARF is to be provided by the Government; ARF should focus
on relatively larger NPAs (Rs. 50 lakh and above).

A 30-35 percent reduction in staff cost required in the three identified weak banks to
enable them to reach the median level of ratio of staff cost to operating income.

In order to control staff cost, the three identified weak banks should adopt a VRS
covering at least 25 percent of the staff strength; for the three banks taken together,
the estimated cost of VRS ranges from Rs. 1100 to Rs. 1200 crore.

The organisational restructuring includes delayering of the decision making process

relating to credit, rationalisation of branch network, etc.

Experts have also suggested the concept of narrow banking, where only strong and
efficient banks will be allowed to give commercial loans, while the weak banks will
take positions in less risky assets such as government securities and inter-bank
lending.

The three identified banks on committee recommendations were UCO bank, United Bank of
India and Indian Bank.

In August 2001, the government of India directed UCO Bank to shut down 800 branches and
also 4 international operations in line with the Verma committee recommendation on sick
banks. Three more PSBs declared sick are Dena Bank, Allahabad Bank and Punjab and Sindh
Bank. UCO bank had been posting losses for the past eleven years.
1.9 Asset Liability Management System

The critical role of managing risks has now come into the open, especially against the
experience of the recent East Asian crisis, where markets fell precipitously because banks and
corporates did not accurately measure the risk spread that should have been reflected in their
lending activities. Nor did they manage such risks or provide for them in their balance sheets.
In India, the Reserve Bank has recently issued comprehensive guidelines to banks for putting
in place an asset-liability management system. The emergence of this concept can be traced to
the mid 1970s in the US when deregulation of the interest rates compelled the banks to
undertake active planning for the structure of the balance sheet. The uncertainty of interest rate
movements gave rise to interest rate risk thereby causing banks to look for processes to manage

29
their risk. In the wake of interest rate risk came liquidity risk and credit risk as inherent
components of risk for banks. The recognition of these risks brought Asset Liability
Management to the centre-stage of financial intermediation.

The necessity
The asset-liability management in the Indian banks is still in its nascent stage. With the
freedom obtained through reform process, the Indian banks have reached greater horizons by
exploring new avenues. The government ownership of most banks resulted in a carefree
attitude towards risk management. This complacent behavior of banks forced the Reserve Bank
to use regulatory tactics to ensure the implementation of the ALM. Also, the post-reform
banking scenario is marked by interest rate deregulation, entry of new private banks, gamut of
new products and greater use of information technology. To cope with these pressures banks
were required to evolve strategies rather than ad hoc fire fighting solutions. Imprudent liquidity
management can put banks' earnings and reputation at great risk. These pressures call for
structured and comprehensive measures and not just ad hoc action. The Management of banks
has to base their business decisions on a dynamic and integrated risk management system and
process, driven by corporate strategy. Banks are exposed to several major risks in the course
of their business - credit risk, interest rate risk, foreign exchange risk, equity / commodity price
risk, liquidity risk and operational risk. It is, therefore, important that banks introduce effective
risk management systems that address the issues related to interest rate, currency and liquidity
risks.

Implementation of asset liability management (ALM) system RBI has issued

guidelines regarding ALM by which the banks have to ensure coverage of at least 60% of their
assets and liabilities by Apr ’99. This will provide information on bank’s position as to whether
the bank is long or short. The banks are expected to cover fully their assets and liabilities by
April 2000.

ALM framework rests on three pillars

ALM Organisation:
The ALCO consisting of the banks senior management including CEO should be responsible
for adhering to the limits set by the board as well as for deciding the business strategy of the
bank in line with the banks budget and decided risk management objectives. ALCO is a
decisionmaking unit responsible for balance sheet planning from a risk return perspective
including strategic management of interest and liquidity risk. Consider the procedure for
sanctioning a loan. The borrower who approaches the bank, is appraised by the credit
department on various parameters like industry prospects, operational efficiency, financial
efficiency, management evaluation and others which influence the working of the client
company. On the basis of this appraisal the borrower is charged certain rate of interest to cover
the credit risk. For example, a client with credit appraisal AAA will be charged PLR. While
somebody with BBB rating will be charged PLR + 2.5 %, say. Naturally, there will be certain
cut-off for credit appraisal, below which the bank will not lend e.g. Bank will not like to lend
30
to D rated client even at a higher rate of interest. The guidelines for the loan sanctioning
procedure are decided in the ALCO meetings with targets set and goals established
ALM Information System
ALM Information System for the collection of information accurately, adequately and
expeditiously. Information is the key to the ALM process. A good information system gives
the bank management a complete picture of the bank's balance sheet.
ALM Process
The basic ALM process involves identification, measurement and management of risk
parameters. The RBI in its guidelines has asked Indian banks to use traditional techniques like
Gap Analysis for monitoring interest rate and liquidity risk. However RBI is expecting Indian
banks to move towards sophisticated techniques like Duration, Simulation, VaR in the future.
Is it possible ?

Keeping in view the level of computerisation and the current MIS in banks, adoption of a
uniform ALM System for all banks may not be feasible. The final guidelines have been
formulated to serve as a benchmark for those banks which lack a formal ALM System. Banks
that have already adopted more sophisticated systems may continue their existing systems but
they should ensure to fine-tune their current information and reporting system so as to be in
line with the ALM System suggested in the Guidelines. Other banks should examine their
existing MIS and arrange to have an information system to meet the prescriptions of the new
ALM System. In the normal course, banks are exposed to credit and market risks in view of
the asset-liability transformation. Banks need to address these risks in a structured manner by
upgrading their risk management and adopting more comprehensive Asset-Liability
Management (ALM) practices than has been done hitherto

But, ultimately risk management is a culture that has to develop from within the internal
management systems of the banks. Its critical importance will come into sharp focus once
current restrictions on banks’ portfolios are further liberalised and are subjected to the pressure
of macro economic fluctuations.

31
 1.10 Reduction of Government Stake in PSBs

This is what the finance minister said in his budget speech on February
29, 2000;

"In recent years, RBI has been prescribing prudential norms for banks broadly consistent with
international practice. To meet the minimum capital adequacy norms set by the RBI and to
enable the banks to expand their operations, public-sector
banks will need more capital. With the Government budget under severe strain, such
capital has to be raised from the public which will result in reduction in government
shareholding. To facilitate this process, the Government has
decided to accept the recommendations of the Narasimham
Committee on Banking Sector Reforms for reducing the requirement of minimum
shareholding by government in
nationalised banks to 33 per cent. This will be done without changing the public-sector
character of banks and while ensuring that fresh issue of shares is widely held by the
public."

Banking is a business and not an extension of government. Banks must be self-reliant, lean
and competitive. The best way to achieve this is to privatise the banks and make the
managements accountable to real shareholders. If "privatisation" is a still a dirty word, a good
starting point for us is to restrict government stake to 33 per cent.

During the winter session of the Parliament, on 16 November 2000, the Union Cabinet has
taken certain decisions, which have far reaching consequences for the future of the Indian
banking sector cleared amendment of the Banking Companies (Acquisitions and Transfer of
Undertakings) Act 1970/1980 for facilitating the dilution of government’s equity
to 33 per cent
Government’s action programme has expressed clearly its programme for the dilution of its
stake in bank equity. The Cabinet had taken this decision, immediately on the next day after
the bank employees went on strike, is a clear indication of Government of India’s
determination to amend the concerned Acts, to pave the way for the reduction in its stake. The
proposal had been to reduce the minimum shareholding from 51 per cent to 33 per cent, with
adequate safeguards for ensuring its control on the operations of the banks. However, it is not
willing to give away the management control in the nationalised banks. As a result public
sector banks may find it very difficult to attract strategic investors.

32
 SALIENT FEATURES of the proposed amendments

Government would retain its control over the banks by stipulating that the voting
rights of any investor would be restricted to one per cent, irrespective of the equity
holdings.
The government would continue to have the prerogative of the appointment of the
chief executives and the directors of the nationalised banks. There has been
considerable delay in the past in filling up the posts of the chairman and executive
director of some banks. It is not clear as to how this aspect would be taken care of in
future. It is said that the proposed amendment to the Act would also give the board
of banks greater autonomy and flexibility.
It has been decided to discontinue the mandatory practice of nominating the
representatives of the government of India and the Reserve Bank in the boards of
nationalised banks. This decision is in tune with the recommendation of
Narasimham committee. However, the government would retain the right to nominate
its representative in the boards and strangely a nominee of the government can be
in more than one bank after the amendment.
The number of whole time directors would be raised to four as against the present
position of two, the chairman and managing director and the executive director.
While conceptually it is desirable to decentralise power, operationally it may be
difficult to share power at peer level. In quite a few cases, it was observed that inter
personal relations were not cordial among the two at the top. It has to be seen as to
how the four full time directors would function in unison.
It is proposed to amend the provisions in the Banking Companies (Acquisition and
Transfer of Undertakings) Act to enable the bank shareholders to discuss, adopt
and approve the annual accounts and adopt the same at the annual general
meetings.
Paid-up capital of nationalised banks can now fall below 25 per cent of the authorised capital.
Amendment will also enable the setting up of bank-specific Financial Restructuring
Authority (FRA). Authority will be empowered to take over the management of the
weak banks. Members of FRA will comprise of experts from various fields & will be
appointed by the government, on the advice of Reserve Bank of India.
The government has been maintaining that the nationalised banks would continue to retain
public sector character even after the reduction in equity.

33
This is the reason why the banks would continue to be statutory bodies even after the reduction
in government equity below 51 per cent and the banks would not become companies. This
implies that they would continue to be subject to parliamentary and other scrutiny
despite proposed relaxations.

The measures seen in totality are clearly aimed at enabling banks to access the capital markets
and raise funds for their operations. The Government seems to have no plans to reduce its
control over these banks. The Act will also permit it to transfer its stake if the need arises, apart
from granting banks the freedom to restructure their equity.

Reserve Bank’s perception; the Reserve Bank has been emphatic in its views on lowering the
stake of the government in the equity of nationalized banks:

The panel wants government stake to be diluted to less than 50 per cent in order to make
banks' decision-making more autonomous. It has said, “in view of the severe budgetary strain
of the government, the capital has to be raised from the public, which leads to a reduction in
government shareholding.” The process of the transition from public sector to the joint sector
has already been initiated with 7 of the public sector banks accessing the capital market for
expanding their capital base. Since total privatization is not contemplated, the banks in the
joint sector are expected to control the commanding heights of the banking business in the
years to come.
In the domestic context, the idea behind a reduction in government stake is to free bank
employees from being treated as "public servants." Instead, by directly reducing the
government stake below 50 per cent, the banks will be free from the shackles of the central
vigilance commission.
Official sources explained that this has been done to enable banks to clean up their
balance sheets so that they can access the capital market easily. In terms of transferring
equity, the government is arming itself with powers to sell its stake if it so desires at a later
date.

A LOOK AT PAST

The Indira Gandhi government had nationalised 14 commercial banks through the Banking
Companies (Acquisitions and Transfer of Undertakings) Ordinance in 1969. The 1970 and
1980 Acts brought about after the nationalisation of 14 and 6 banks respectively were first
amended in 1994 to allow government to reduce its equity in them to up to 49 per cent. The
20 nationalised banks became 19 subsequently after New Bank of India merged with Punjab
National Bank. Only six of these 19 banks have so far accessed the market and to gone for
public issues meet its additional capital needs. The government holds majority or entire equity
of 19 nationalised banks currently.

34
Till now, banks could reduce equity only up to 25 per cent of the paid up capital on the date of
nationalisation. Some banks like the Bank of Baroda have returned equity to the government
in the past, but that has been within the prescribed 25 per cent cap.
The Nationalisation Act provides that the PSU banks cannot sell a single share. This is the
reason why banks have been tapping the market to fund their expansion plans. Also the Act
originally provided that the government must mandatorily hold 100 per cent stake in banks.
The 1994 amendments brought it down to 51 per cent, to help induction of public as
shareholders.
At this stage, the government provided that all shares, excluding government shares could be
transferred. This was necessary to permit the transfer of shares when public shareholders sold
their stake in banks. The amendments remove restrictions on the transfer of government
shareholding.

What did they have to say ?

Union parliamentary affairs minister Pramod Mahajan said:
“The amendment is an enabling provision. We are only making it easier for banks to access
funds from the market...It is not the
intention of the government to privatise these banks or enter
Who is afraid of into strategic alliances
with private sector.”

Why should the taxpayers’ money be used repeatedly for improving the capital base of the
public sector banks?
The Indian Banks' Association had, in its memo to the committee, called for 100 per cent
divestment of the government stake. “Banks should be allowed to access 100 per cent capital
from public, either from the domestic or international capital markets. This will increase the
accountability of banks to shareholders”.

Employees of the public sector banks went on a token strike on 15 November, protesting
against the government’s policy of privatisation of public sector banks. It was as usual,
reported that the strike was total and successful. The inconveniences caused to millions of
customers, unconnected with the issues involved, went unnoticed, though one or two TV
channels interviewed a couple of people, who could not articulate their views properly.

This is an expedient decision contributing to the process of liberalisation of the economy.

As for current status, Union bank will issue an IPO next year, in order to reduce the 100 percent
government stake to 70 percent and then gradually to 33 percent.

35
 From 1992-93 to 1998-99, the government has injected into the 19 public sector banks, an
amount of Rs.20,446 crore as additional capital. Of this, three banks-UCO Bank, Indian Bank
and United Bank of India, have received Rs.5729 crore

Capital Contributed by Government

Capital Added [Rs in
Bank
Crores]
Allahabad Bank 90
Andhra Bank 150
Bank of Baroda 400
Bank of India 635
Bank of Maharashtra 150
Canara Bank 365
Central Bank of India 490
Corporation Bank 45
Dena Bank 130
Indian Bank 220
Indian Overseas Bank 705
Oriental Bank of
50
Commerce
Punjab National Bank 415
Punjab & Sind Bank 160
Syndicate Bank 680
UCO Bank 535
Union Bank of India 200
United Bank of India 215
Vijaya Bank 65
Total 5700

Source: Reserve Bank of India Bulletin [1994].

Illustration 5

36
The demand for funds by the SBI is even more acute than even the
Corporation Bank since the SBI Act provides for a minimum 55 per cent RBI holding in SBI,
and the bank is already close to breaching this threshold. The immediate beneficiary of this
move would be Corporation Bank where government equity is down to 66 per cent. The bank
would be able to access funds from the market without being hampered by the 51 per cent
minimum government holding threshold, which currently limits the ability of banks to expand
beyond a certain level. Since a decision on the new threshold has been taken in the case of the
nationalised banks, the government is expected to follow suit by moving an ordinance to
reduce the RBI stake in the SBI to 33 %

The issue of reducing government stake in the nationalised banks has come about on account
of demand from the SBI which had demanded that either RBI as the stakeholder pump in funds
for the SBI’s massive expansion plans or permit it to issue shares to the public to raise the
necessary funds.

Both the Banking Regulation Act and the SBI Act provide that government shares cannot be
divested and since the government has decided that it would no longer support banks through
budgetary support, they have no option but to go to the market to meet their fund requirements.
Though there is no special significance attached to the 33 per cent threshold in the Company
Law — which recognised only 26 per cent and 74 per cent as two major thresholds for
management and ownership control — the government has opted for 33 per cent on the basis
of the recommendations of the Narasimham Committee. The committee had felt that this
threshold would provide comfort to the employees. The banks, like insurance companies, have
strong unions and, hence, a phased reduction in government equity was recommended.

The State would continue to be the single largest shareholder in banks even after its stake had
been brought down to 33 per cent.
The government is also proposing to move an ordinance for demerger of four subsidiaries of
GIC. The law ministry has already cleared both proposals of the finance ministry. In the case
of GIC, the ordinance would amend the GIC Act, 1972, and demerge its four subsidiaries -
National Insurance Corp, Oriental Insurance, United Insurance and New India
1.11 Deregulation on Interest
Assurance. Rates

The interest rate regime has also undergone a significant change. For long, an administered
structure of interest rate has been in vogue in India. The 1998 Narasimham Reforms suggested
deregulation of interest rates on term deposits beyond a period of 15 days. At present, the
Reserve Bank prescribes only two lending rates for small borrowers. Banks are free to
determine the interest rate on deposits and lending rates on all lendings above Rs. 200,000.

In the last couple of years there has been a clear downward trend in interest rates. Initially
lending rates came down, leading to a decline in yields on advances and investments.
37
Interest rates in the banking system have been liberalised very substantially compared to the
situation prevailing before 1991, when the Reserve Bank of India controlled the rates payable
on deposits of different maturities. The rationale for liberalising interest rates in the banking
system was to allow banks greater flexibility and encourage competition. Banks were able to
vary rates charged to borrowers according to their cost of funds and also to reflect the credit
worthiness of different borrowers.

With effect from October 97 interest rates on all time deposits, including 15-day deposits, have
been freed. Only the rate on savings deposits remains controlled by RBI. Lending rates were
similarly freed in a series of steps. The Reserve Bank now directly controls only the interest
rate charged for export credit, which accounts for about 10% of commercial advances. Interest
rates on time deposits were decontrolled in a sequence of steps beginning with longer-term
deposits and the liberalisation was progressively extended to deposits of shorter maturity.

Interest rates on loans upto Rs 2,00,000, which account for 25% of total advances, is not fixed
at a level set by the RBI, but is now aligned with the Prime Lending Rate (PLR) which is
determined by the boards of individual Banks.

Earlier interest rates on loans below Rs 2,00,000 were fixed at a highly concessional level. The
new arrangement sets a ceiling on these rates at the PLR, which reduces the degree of
concessionality but does not eliminate it.

Cooperative Banks were freed from all controls on lending rates in 1996 and this freedom was
extended to Regional Rural Banks and private local area banks in 1997. RBI also considers
removal of existing controls on lending rates in other Commercial Banks as the Indian
economy gets used to higher interest rate regime on shorter loan duration.

The line to control is the cost of funds, since the markets determine asset yields. The
opportunity to improve yields on the corporate side tends to be limited if banks don’t want to
increase the risk profile of the portfolio. Banks’ income will depend on the interest rate
structure and the pricing policy for the deposits and the credit. With the deregulation of the
interest rates banks are given the freedom to price their assets and liabilities effectively and
also plan for a proper maturity pattern to avoid assetliability mismatches. Nevertheless, with
the increase in the number of players, competition for the funds and the other banking services
rose. The consequential impact is being felt on the income profile of the banks especially due
to the fact that the interest income component of the total income is significantly larger than
the non-interest income component. As far as the interest costs are concerned, the prevailing
interest rate structure will be a major deciding factor for the rates. But what influence both the
interest costs and the intermediation costs is the time factor as it is directly related to costs.
The solution for these two influencing factors lies predominantly on technology. In this regard,
the new private banks and the foreign banks, which are equipped with the latest technology,
have a better edge over the nationalized banks, which are yet to be automated at the branch
level.

38
 Income and Expenses Profile of Banks
Interest Income Interest Expenses
• Interest/discount on • Interest on deposits
advances/bills • Interest on
• Interest on investments Refinance/interbank borrowings
• Interest on balances with RBI • Others
and other interbank funds • Others

Other Income Operating Expenses

• Commission, Exchange and
Brokerage
• Profit on sale of investments Payments to and provisions for
• Profit on revaluation of employees
investments • Rent, taxes and lighting
• Profit on sale of land, • Printing and stationery•
building and other assets • Profit on Advertisement and publicity
exchange transactions • Depreciation on Bank’s property
• Income earned by way of • Director’/Auditor’s fees and
dividends, etc. • Miscellaneous expenses
• Law charges, Postage, etc.
• Repairs and Maintenance,
Insurance.
• Other expenses

Illustration 6

39
 2.1 Introduction

The financial sector reforms have brought about significant improvements in the financial
strength and the competitiveness of the Indian banking system. The efforts on the part of the
Reserve Bank of India to adopt and refine regulatory and supervisory standards on a par with
international best practices, competition from new players, gradual disinvestments of
government equity in state banks coupled with functional autonomy, adoption of modern
technology, etc are expected to serve as the major forces for change. New businesses, new
customers, and new products beckon, but bring increased risks and competition. How might
that change banks? To attract and retain customers, the banks need to optimise their networks,
speed up decision-making, cut down on bureaucratic layers, and sharpen response times.

The reform has lead to new trends of being ahead and being with, by and for the customer.
While the private sector banks are on the threshold of improvement, the Public Sector Banks
(PSBs) are slowly contemplating automation to accelerate and cover the lost ground. VRS
introduced to bring up the productivity, the concept of universal competition set in just to
ensure customer convenience all the time.

Also, the strength factor has lead to mergers and Indian banks will explore this opportunity.

The following will state the development in Indian banking sector.

2.2 Voluntary Retirement Schemes … Please leave ?

Public Sector Banks which together (there are 27 of them) account for 77.34 per cent of the
bank deposits in India. The most ambitious downsizing exercise undertaken by the PSBs has
set them back by close to Rs 7,490 crore.

Voluntary Retirement Scheme in Banks was formally taken up by the Government in

November 1999. According to Finance Ministry on the basis of business per employee (BPE)
of Rs. 100 lakhs, there were 59,338 excess employees in 12 nationalised banks, while based
on a BPE of Rs.
125 lakhs, the number shot up to 1,77,405.
40
Government had cleared a uniform VRS for the banking sector, giving public sector banks a
seven-month time frame. The IBA has been allowed to circulate the scheme among the public
sector banks for adoption. The scheme was to remain open till March 31, 2001. It would
become operational after adoption by the respective bank board of directors. No concession
had been made to weak banks under the scheme. The scheme is envisaged to assist banks in
their efforts to optimise use of human resource and achieve a balanced age and skills profile
in tune with their business strategies.
As per estimates the average outgo per employee under the banking VRS scheme would range
between Rs. 3 lakhs and Rs. 4 lakhs. However, the aggregate burden
on the banking industry is difficult to work out. To minimise the
immediate impact on banks, the scheme has allowed them the stagger
the payments in two installments, with a minimum of 50 per cent of
the amount to be paid in cash immediately. The remaining payment
can be paid within six months either in cash or in the form of bonds.
The total burden of the VRS on the banking industry is about Rs 8,000
crore, and union activists feel that it will adversely affect the
profitability and capital adequacy of the banks. In fact, out of this Rs
8,000 crore, nearly Rs 2,200 crore will be borne by State Bank of
India, the largest public sector bank.

41
Salient Features of Voluntary Retirement Scheme of Banks
Eligibility – All permanent employees with 15 years of service or 40 years of age are
eligible. Employees not eligible for this scheme include:
• Specialists officers/employees, who have executed service bonds and have not
completed it, employees/officers serving abroad under special
arrangements/bonds, will not be eligible for VRS. The Directors may however
waive this, subject to fulfillment of the bond & other requirements.
• Employees against whom Disciplinary Proceedings are contemplated/pending or
are under suspension.
• Employees appointed on contract basis.
• Any other category of employees as may be specified by the Board.

Amount of Ex-gratia – 60 days salary (pay plus stagnation increments plus special
allowance plus dearness relief) for each completed year of service or the salary for the
number of months service is left, whichever is less.

Other Benefits
• Gratuity as per Gratuity Act/Service Gratuity, as the case maybe.
• Pensions (including commuted value of pension)/bank’s contribution towards PF,
as the case may be.
• Leave encashment as per rules.Other Features
• It will be the prerogative of the bank’s management either to accept a request for
VRS or to reject the same depending upon the requirement of the bank.
• Care will have to be taken to ensure that highly skilled and qualified workers and
staff are not given the option.

• There will be no recruitment against vacancies arising due to VRS.

• Before introducing VRS banks must complete their manpower planning and
identify the number of officers/employees who can be considered under the scheme.
• Sanction of VRS and any new recruitment should only be in accordance with the
manpower plan.

42
 Funding of the Scheme
• Coinciding with their financial position and cash flow, banks may decide
payment partly in cash and partly in bonds or in installments, but minimum 50
percent of the cash instantly and in remaining 50 percent after a stipulated period.
• Funding of the scheme will be made by the banks themselves either from their
own funds or by taking loans from other banks/financial institutions or any other
source.
Periodicity – The scheme may be kept open up to 31.3.2001 Sabbatical – An
employee/officer who may not be interested to take voluntary retirement immediately
can avail the facility of sabbatical for five years, which can be further extended by
another term of five year. After the period of sabbatical is over he may re-join the bank
on the same post and at the same stage of pay where he was at the time of taking
sabbatical. The period of sabbatical will not be considered for increments or qualifying
service for person, leave, etc.

While the right of refusal to give voluntary retirement has been granted to the bank
management, recruitment against vacancies arising through the VRS route has been
disallowed.

Nearly half the VRS benefits are by way of an ex-gratia ‘golden handshake’ payment to the
employees to encourage them to leave.
Banks have been allowed to amortise half the retirement benefits provided to those opting for
VRS over a period of five years.

VRS and its effect on Capital Adequacy norms There are immediate concerns
for PSBs. The weaker among them may not be able to maintain the Reserve Bank of India
stipulated capital adequacy ratio of 9 per cent, primarily because of the huge outflow of funds
for the VRS. UCO Bank, for instance, ended up with a bill for Rs 360 crore; Union Bank, Rs
292 crore, and United Bank, Rs 150 crore. The obvious way out is to tap the capital market,
but PSBs are constrained as they cannot reduce their stake below 50 per cent. The result? ''If
these banks cannot meet the capital adequacy norms, their ability to do incremental business
will be curtailed,'' explains Rohit Sarkar, a Consultant with the Planning Commission. ''...
irrespective of their deposits.'' The Finance Ministry, with one VRS bullet, aims to achieve, at
least, three objectives immediately viz. the privatisation of banks at any cost, bailing out of the
favoured willful defaulters, and shielding of the corrupt bureaucrats. These are the measures
what exactly the IMF and World Bank have been urging upon the government, without which
the support of U.S. is not certain.

43
 VRS now best walk out too!
There's the issue of the VRS weeding out non-targets like investment bankers and treasury
managers, leaving most PSBs short of the very people they'll need to implement any services-
initiative. ''Recruiting the right kind of people will be difficult for these banks, given the poor
work culture and uncompetitive salaries,'' says Ravi Trivedy, a Partner at Pricewaterhouse
Coopers. A mid-level treasury manager, for instance, comes with a tag of between Rs 15 lakh
and Rs 20 lakh; few PSBs can pay that kind of money.

Why did he opt for VRS?

"It is because opportunities outside the banking sector are more in the western zone," says a
union activist. Apart from the lure of money, bad working conditions also contributed to this
deluge," says Bhakey. "They are transferred anywhere, are held accountable in case of
problems in rural areas and don't get residential accommodation. "Apart from all the VRS
benefits, they will be entitled to pension as well. So they have a continuous source of income
even if they don't work," said a director of Bank of Maharashtra.

What did they say last !

V. V. Phatak, 55, is special assistant in Punjab National Bank who opted for VRS after 32
years' service. With the Rs 16 lakh severance package that he received, he sees deliverance
from the dreary chawl-life in Mumbai. He has spent all his earnings on a flat in Vile Parle.

On Sabbatical.......S.Balachandran
Sabbatical as a measure for reducing surplus staff will not be cost effective in the long run for
the following reasons: Even though the banks can save on the salaries & allowances during
the leave period, but once the employee returns, he will have to be absorbed and as such
redundancy or surplus cannot be cut totally. Retraining cost for the returning staff that are 45
plus, in a totally changed banking environment will be much higher than the cost bank saves
during their leave. Hence it would be better to offer the sabbatical to junior level employees
for whom the retraining cost will be much lower.

R. Krishnamurthy
An employee should be free to exercise Sabbatical option at any point of time in his career,
rather than a specific period. It should be an open option and should normally be granted by
the Bank Management provided the employee does not have any disciplinary proceedings
against him.
The option may also be a one-time option during his/her (employees) service. Banks should
not insist that the employees should close the loan accounts, but can take an undertaking that
the employees should service their loans during the sabbatical period. This will help employees
to search for a suitable job and then exercise the Sabbatical option. He can service the loans
from his new employment.

ARE EMPLOYEES A PROBLEM OR NPAs ?

44
 They are in the fools' paradise. The policy-makers, RBI, IBA and the bankers, who schemed
unilaterally the VRS, think that by removing massively thousands of able and experienced
bankmen from services in their middle age, they could boost profits in the nationalised banks.

Is it the 10 to 12 percent wage factor that affects adversely the profitability in the
nationalised banks? Certainly not. Then what is the truth? At least the apex bank in the country
has all the latest figures of the banks and as such, would agree honestly that it is the
unrecovered and unchecked cancerous growth of over Rs.100000 crore of the bad debts, called
as NPA in the international terms, piled up in the PSBs with the blessings of the new regime,
that eroded profits and made one or two banks less profitable. Added to this, when large
numbers of employees of all stages are shunted away, a number of branches of these banks
will come to a grinding halt.

Amidst the disastrous Asian contagion, the Indian economy survived, mainly because of the
strength and stability of our public sector banks. The correct remedial measure is not
demolishing them by sending home several thousand employees enmass, but change the policy
to preserve and develop them, said a member of IBA.
THE EFFECTS
Negatives
Banks had approached the government and warned that only efficient people will leave by way
of VRS. It will take away most of the staff from more than 22,000 rural branches of public
sector banks. "They will have to be merged or closed down in favour of a satellite branch
which will operate just once a week", says G.M. Bhakey, president of the State Bank of India
Officers Association. If these fears come true, rural India may be the biggest victim of VRS.
In fact the United Federation of Bank Unions has decided to oppose the whimsical closure of
branches in the post-VRS scenario. "The management will have to discuss the post VRS
merger of branches with the unions first," says P Jayaraman, the general secretary of the State
Bank's union. "It is true that more than 90,000 employees will be relieved, but what about the
remaining 8.1 lakh?" asks a union activist. The unions will still have to fight for them. The
way the VRS contagion is spreading at the instance of the government, it is imminent that a
chaotic situation with grave consequences will emerge soon, causing irreparable losses to the
clients of all types and great hardships to the remaining work force. Also, large number of staff
might be transferred and more and more branches might be closed.

Positives
As part of the banking sector reforms, public sector banks are trimming the staff strength by
launching VRS. This is likely to bring not only higher cash flows to banks in future but also
long term benefits like improvement in efficiency level.
Bank of Maharashtra will be accepting applications of 2,000 VRS optees 800 officers and
1,200 class III and IV employees. Reduce the annual wage bill by about Rs 56 crore.

Andhra Bank Substantial reduction in overheads and significant improvement in per employee
productivity.

45
 Bank of India (BoI) has embarked on a major organisational recast exercise. After the launch
of the voluntary retirement scheme (VRS) which was opted by 7,780 employees , the bank is
set to abolish one tier (zonal offices) from its four-tier organisational structure. The bank will
now have
three tiers -- branch offices, regional offices and head office.
Newly-formed association of VRS optees of Punjab National Bank (PNB) -- the PNB
Voluntarily Retired Staff Association (PNBVRSA) -- has filed
a case against the bank for settling outstanding issues arising out of the

T h e h u m a n s i d e…
He still went by the same train, he sat on the same place, he admired the same table, that’s all he
did there and came back home in the evening. VRS has disturbed the comfort zone of many,
when he is back at home, children are to be disciplined the whole day, as they come back home,
they are told to be studying, not playing much, etc; wife cant visit her neighbour at the afternoon,
her TV serials alls is gone; clashes and arguments arise, families breaking, the comfort zone is
shaken up. A dissatisfied issue arises out of VRS, a person working for 15 to 20 years, is now to
do nothing? All are seeking physiatrists’ help now. What about this? Social activities for these
people, some kind of work, tie up with service organisation, keeping them busy may be the only
way out!

Close on the heels of public sector banks implementing Voluntary Retirement Scheme,
public sector giant, SAIL has launched VRS. SAIL aims to cut down its personnel by 60,000
over the next 3 years.

ANOTHER OPTION could have been!!!

“They could have developed business by expanding into sectors like insurance which relies
heavily on the expertise of the banking industry.” Mr. Sanghavi, senior manager of Canara
Bank states, “It would have been much sensible to invest and divert these funds in Tech
banking and installation of new systems. These firstly, retain the existing functions, also in the
long run there would be a good payback, after this if the VRS was declared then may be it
would have been a wise decision”.

And the numbers say . . .

The VRS, as on July 2001, which bankers rushed to grab, has become a drag on the bottomline
of the State-owned banking segment.

46
Heavy provisioning made towards VRS has pushed the combined net profit of PSU
banks down 16 per cent to Rs 4,315.70 crore in 2000-01, from Rs 5,116 crore in the
previous year.
In the banking sector close to 1,26,000 employees opted for the VRS in ‘00-01.
The total benefits received by these employees has been close to Rs 15,000 crore.

47
Gone for GOOD !

48
 VRS – The SBI Way
State Bank of India's VRS, which closed on January 31, has attracted 35,380 applications.
I.e.15 per cent of the bank's employee base of 233,000. Of the 35,380 applications, 54 per cent
are from officers, 36 per cent from clerical staffs, and 3,137 are from the sub-staff category.

STATE Bank of India has kick started its post-VRS restructuring programme, with plans to
merge 440 loss making branches and virtually eliminate its network of regional offices across
the country. The bank is also working to redeploy additional administrative manpower to
frontline banking jobs. This is in line with practices followed by private sector banks and is
meant to enhance the overall productivity. One of the major tasks for SBI in its restructuring
programme is merger of loss making branches. SBI has identified 440 branches out of 8,000
as weak branches. The bank management has asked all its 13 circle offices to initiate the
process and start merger of loss making branches in their respective areas. SBI has also decided
to reduce its regional office network as a part of its downsizing programme. The bank is
planning to reduce its regional offices from 10 to 1/2 in each circle.

The unions had earlier expressed the view that the bank management should not merge loss
making branches but should shift them to other areas with profit potential, in order to retain
branch license.

For example, in the Gujarat circle, SBI has four regional offices in Gandhinagar and three each
in Ahmedabad and Baroda. Plans are to shut all these down and have a single regional office
in Ahmedabad. The excess administrative manpower will be utilised at branch level. Post VRS,
in some branches of the bank, important posts are lying vacant and at some places shortage of
staff is also being felt. SBI has appointed National Institute of Bank Management as consultant
for manpower planning. The final decisions on redeployment of administrative staff and
reduction in regional offices will be taken only after NIBM report.

49
 2.3 Universal Banking … just one stop ahead !

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

The evolving scenario in the Indian banking system points to the emergence of universal
banking. The traditional working capital financing is no longer the banks major lending area
while FIs are no longer dominant in term lending. The motive of universal banking is to fulfill
all the financial needs of the customer under one roof. The leaders in the financial sector will
be aiming to become a one-stop financial shop.

In recent times, ICICI group has expressed their aim to function on the concept of the Universal
Bank and was willing to go for a reverse merger of ICICI ltd. with ICICI Bank. But due to
some regulatory constraints, the matter seems to have been delayed. Sooner or later, the group
would be working towards its aim. Even some of the other groups in the financial sector like
HDFC, IDBI have started functioning on the same concept.

An Overview
Universal Banking includes not only services related to savings and loans but also investments.
However in practice the term 'universal banks' refers to those banks that offer a wide range of
financial services, beyond commercial banking and investment banking, insurance etc.
Universal banking is a combination of commercial banking, investment banking and various
other activities including insurance. If specialised banking is the one end universal banking is
the other. This is most common in European countries.

The main advantage of universal banking is that it results in greater economic efficiency
in the form of lower cost, higher output and better products. The spread of universal
banking ideas will bring to the fore issues such as mergers, capital adequacy and risk
management of banks. Universal banks may be comparatively better placed to overcome
such problems of asset-liability mismatches (for banks). However, larger the banks, the
greater the effects of their failure on the system. Also there is the fear that such institutions,
by virtue of their sheer size, would gain monopoly power in the market, which can have
significant undesirable consequences for economic efficiency. Also combining
commercial and investment banking can gives rise to conflict of interests.

50
 Banks v/s DFIs

India Development financial institutions (DFIs) and refinancing institutions (RFIs) were
meeting specific sectoral needs and also providing long-term resources at concessional terms,
while the commercial banks in general, by and large, confined themselves to the core banking
functions of accepting deposits and providing working capital finance to industry, trade and
agriculture. Consequent to the liberalisation and deregulation of financial sector, there has been
blurring of distinction between the commercial banking and investment banking.

The comparative advantage or disadvantage of DFIs vis-a-vis banks in this regard depends to
a large extent on the quality of their portfolios, the accounting policies that are practiced and
personnel management. The banks, on the other hand, have a competitive edge in resource
mobilisation through the route of retail deposits. The RBI has identified certain regulatory
issues that need to be addressed to make harmonisation of the needs of commercial banking
with institutional banking successful.

First, banks are subject to CRR stipulations on their liabilities. DFIs face no such
pre-emptions on their funds.

Secondly, DFIs do not enjoy the advantage of branch network for resource
mobilisation. This in effect curtails DFIs' ability to raise lowcost deposits.

Thirdly, with the larger part of new loans going to capital-intensive projects like
power, telecom, etc., the DFIs would need to extend loans with longer maturities. On the
other hand, due to interest rate uncertainties, DFIs are finding it attractive to raise more of
short-term resources. Due to their past borrowings of long-term nature, the mismatch is
still in their favour. This, however, raises a challenge for the DFIs to manage the maturity
match of their assets and liabilities on an ongoing basis.

In India
The issue of universal banking resurfaced in Year 2000, when ICICI gave a presentation to
RBI to discuss the time frame and possible options for transforming itself into an universal
bank. Reserve Bank of India also spelt out to Parliamentary Standing Committee on Finance,
its proposed policy for universal banking, including a case-by-case approach towards allowing
domestic financial institutions to become universal banks.
Now RBI has asked FIs, which are interested to convert itself into a universal bank, to submit
their plans for transition to a universal bank for consideration and further discussions. FIs need
to formulate a road map for the transition path and strategy for smooth conversion into an

51
 universal bank over a specified time frame. The plan should specifically provide for full
compliance with prudential norms as applicable to banks over the proposed period.

The Narsimham Committee II suggested that DFIs should convert ultimately into either
commercial banks or non-bank finance companies. The Khan Working Group held the view
that DFIs should be allowed to become banks at the earliest. The RBI released a 'Discussion
Paper' (DP) in January 1999 for wider public debate. The feedback indicated that while the
universal banking is desirable from the point of view of efficiency of resource use, there is
need for caution in moving towards such a system. Major areas requiring attention are the
status of financial sector reforms, the state of preparedness of the concerned institutions, the
evolution of the regulatory regime and above all a viable transition path for institutions which
are desirous of moving in the direction of universal banking.
ICICI gearing to become a universal bank
ICICI envisages a timeframe of 12 to 18 months in converting itself into an universal bank.
ICICI has received favourable response from Indian investors and FIIs on its move to merge
with ICICI Bank and become a universal bank. ICICI was the first one to propagate universal
banking as an ideal concept for the DFIs to support industries with low cost funds.
In August, ICICI executive director Kalpana Morparia said that ICICI has to obtain a
separate banking licence from RBI for becoming a universal bank. It can avoid the
stamp duty burden by first converting ICICI into bank, instead of going for a direct
merger of ICICI into ICICI Bank.
“We have created fire walls and functioning as separate legal entities only for complying
with statutory obligations,” she noted. There is clear demarcation in the operation of ICICI and
the bank. The bank takes care of liabilities of less than one year by offering shortterm loans to
corporates and personal loans. Medium to long-term products like home loans, auto loans are
handled by the parent; absolute coordination between them while marketing the products exist.

Crisil has reaffirmed its triple A rating for ICICI and FIIs also expects its profit margins to
improve after the merger due to the access to low cost deposits & the scope to increase income
from fee-based activities.

She said ICICI has started increasing its international presence and associating closely with
NRI community in various countries. ICICI InfoTech is based in US & has an office in
Singapore. ICICI Securities has been registered as a broking firm in the US.
ICICI Bank is leveraging on strong network of 400 branches and extension counters & 600
ATMs for offering products to NRIs; NRIs can transfer their money to 200 locations in India
by internet. The payment will be made within 72 hours. It also offers loan products for helping
their relatives in India. Besides, the Visa card helps them to withdraw cash through the ATM
network.
Morparia said NPA of banks in India are < 10 per cent of GDP when compared to emerging
economies like China, Korea & Thailand. It should not be compared with developed countries
like Europe and US. ICICI’s gross NPA comes to Rs 6,000 crore. Asked about a approach to
resolve the problem, she said if the units are viable, it supported financial

52
Because of law, once the units are referred to BIFR, the lenders wererestructuring, mergers. If
these options arent possible and the units are unable to enforce securities, she pointed outnot
viable, it will go in for one time settlement.

2.4 Mergers & Acquisitions…

Divided they fall, united they may strive !

For the irresistible compulsions of competitiveness have created a situation where the only
route for survival for many a bank in India may be to merger with another. With the Union
Finance Ministry thinking along the same lines, it may not be long before mega-mergers
between banks materialise. World over banks have been merging at a furious pace, driven by
an urge to gain synergies in their operation, derive economies of scale and offer one stop
facilities to a more aware and demanding consumer. In the eighties and nineties mergers were
used as means to strengthen the banking sector. Small, weak and inefficient non-scheduled
banks were merged with scheduled banks when the running of such banks becomes non-viable.
However, mergers in the current era will be driven by the motive of establishing a bigger
market share in the industry and to improve the profitability. Mergers may prove to be an
effective remedial measure in a competitive environment where margins/spreads are under
pressure for the banking sector. Though Indian systems were not keen on the mergers and
acquisitions in the banking sector, of late the systems have started encouraging the global
trends of M&A's.
53
 Why the urge to merge?

The big question is why is there a sudden urge to merge? The answer is simple as it is obvious.
To beat competition for which suddenly size has become an important matter. Mergers will
help banks with added money power, extended geographical reach with diversified branch
networks, improved product-mix, and economies of scale of operations. Mergers will also help
the banks to reduce their borrowing cost and to spread total risk associated with the individual
banks over the combined entity. Revenues of the combined entity are likely to shoot up due to
more effective allocation of bank funds. One such big merger between banks globally

54
was that of Industrial Bank of Japan, Fuji and Dai-Ichi-Kangyo bank, all of which were merged
to be nicknamed as Godzilla Bank, implying the size of the post merged entity. Another
instance that comes to mind is that of Bank of America's merger with that of Nation's Bank.
Financial consolidation was becoming necessary for the growth of the bank.

Do you consider the reasons why one does not need banks in large numbers any
more ?

? A depositor today can open an account with a money market mutual fund and obtain both
higher returns and greater flexibility. Indian MF is queuing up to offer this facility.
? A draft can be drawn or a telephone bill paid easily through credit cards. ? Even if a bank is
just a safe place to put away your savings, you need not go to it. There is always an ATM you
can do business with.
? If you are solvent and want to borrow money, you can do so on your credit card- with far
fewer hassles.
? An 'AAA' corporate can directly borrow from the market through commercial papers and get
better rates in the bargain. Infact the banks may indeed be left with bad credit risk or those that
cannot access the capital market. This once again makes a shift to non-fund based activities all
the more important.

Of course, one would still need a bank to open letters of credit, offer guarantees, handle
documentation, and maintain current account facilities etc. So banks will not suddenly become
superfluous. But nobody needs so many of them any more !
CUSTOMER may also want from a bank efficient cash management, advisory services and
market research on his product. Thus the importance of fee based is increasing in comparison
with the fund-based income.

The once RIGID DISTINCTION between the providers of term-finance and the providers of
working-capital finance is blurring, leading to an increasing convergence in the asset-liability
structure of the banks and the FIs. Mergers would position the combined entity for rapid growth
not only in the working capital and term-lending segments, but also in the growing fee-income
business. And that would be in consonance with the global trend towards universal banking.

GLOBALISATION. Competition from abroad is also set to intensify. The foreign banks are
looking to expand beyond their narrow niches to acquire retail reach. Restrictions on branch
expansion of the foreign banks are being relaxed in line with the commitments made to the
World Trade Organisation, under the Financial Services Agreement, by India. The archaic
restriction on the number of Automated Teller Machines has gone. Already, the number of
foreign banks operating in the country has jumped to 41, and 28 more have set up
representative offices.

CAPITAL ACCOUNT CONVERTABILTY will grant Indian corporates access to capital markets
abroad as well as provide foreign banks access to Indian firms and investors. Given their
undoubted financial muscle and technical expertise, the foreign banks are likely to dominate
the new markets.

DISINTERMEDIATION As capital markets deepen and widen, the core banking functions--
deposit taking and lending--come under attack. And the number of alternative savings vehicles
multiply, limiting bank deposits growth. Mutual funds, in particular, are a potent long-term
threat because they appropriate what was once the USP of bank deposits.

VOLATILITY A large capital-base provides the necessary cushion to withstand nasty shocks.
The classic illustration of the absorptive capacity of capital is, of course, the deeply divergent
fates of Barings Bank and Daiwa Bank. Both banks chalked up huge derivatives-trading losses.
But while losses of $1.20 billion were enough to topple a 233-year-old British institution,
Daiwa Bank managed to survive losses of a similar magnitude simply because of its abundant
capital reserves.

THE SCENARIO TODAY

It began with HDFC Bank and Times Bank last year, which took everyone by surprise.
However, the latest merger of ICICI Bank with Bank of Madura is even more
astonishing as well as surprising, though a welcome change. ICICI Bank had also
initiated merger talks with Centurion Bank, but due to differences arising over swap
ratio the merger didn't materialized.

And INTERNATIONALLY
The merger of the Citibank with Travelers Group and the merger of Bank of America with
NationsBank have triggered the mergers and acquisition market in the banking sector
worldwide. Europe and Japan are also on their way to restructure their financial sector through
M&A's.

The merger of Malaysia's 58 domestic banks into six anchor groups is part of a global trend
that will strengthen the financial sector and enable it to compete internationally, Second
Finance Minister Mustapa Mohamed says. In a seminar on Malaysia's recovery efforts,

56
organized by the World Bank in Washington, Mustapa said it was important for the
government to ''move aggressively'' in strengthening the banking system because ''the WTO
(World Trade Organization) is knocking on our doors and asking us to liberalize our financial
sector.

When asked why the government intervened in bank mergers rather then letting the markets
decide for themselves, Mustapa said the banks were urged to merge in the 1980s, ''but our
advice fell on deaf ears. We spent no less than RM60 billion ($15.78 billion) in those days to
bail them out and frankly we're fed up and tired of bailing them out.'' After the mergers, he
added, the government hoped to divert those resources to building schools and hospitals.
At the height of the crisis, depositors of the ''smaller banks'' themselves felt unsafe and moved
their savings to the bigger banks.
Witness the alliance between Chase Manhattan and Chemical Bank in the
US, the fusion of two Japanese monoliths, Bank of Tokyo and Mitsubishi
Bank, and, more recently, the mega-merger of the Swiss giants, United Bank of Switzerland
and Switzerland Banking Corporation.
In Europe, the prospect of a single currency system has sparked off a merger mania among
banks.

The post merger scenario at ICICI

Take a look at what happens post merger to ICICI Bank. The bank will have shot up to the
number one position among new private sector banks.

Elements Pre-merger Postmerger %

Change
Assets No of 12063 crores 16051 crores 33.06
branches 106 360 239.62
Deposits 9728 13123 34.90
15 lakhs 27 lakhs 80
Customers 1700 4300 152.94
Employees 197 crores Rs 220 crores Rs 10.5
Equity 7.10 / share 8.70 / share 23
EPS
Illustration 8
Will mergers be the norm in the industry?

57
What about the future? Will THE STRATEGY MERGER UNIVERSAL BANKS
mergers stop here or will they speed
up? Analysts and bank observers The Assets
feel that merger acquisition activity Enables rapid growth in new markets and new
products
will speed up in times ahead. It is a
Combats the trend towards disintermediation
fact that growth through
acquisitions and mergers is cheaper The Liabilities
and Increases risks of mismatch between assets and
quicker in comparison to setting up liabilities
new units. What will acquiring Multiple focus could lead to conflicts of interest
banks look for while choosing their targets? One, financial viability and two strong
geographical reach and large asset base. However staffing/employee costs and technological
infrastructure will also play an important role in acquiring target banks. For example,
Karnataka Bank has employee strength of over 4,200 and business per employee of just Rs
1.80 crore. Compare this with Indusind Bank, which, with only 510 employees commands a
business per employee of Rs 20 crore. Banks which boast of high business per employee
include names such as Bank of Punjab Rs 7.10 crore, Centurion Bank Rs 6.90 crore and Global
Trust Bank Rs 8.60 crore.

The following table shows a general comparison of three main classes of banks.
Particulars PSU Banks Pvt. Banks Pvt. (Old) Banks(New)

Cost of funds Low Moderate High

Branch network Wide Regional Low
Spread
Level of Automation Low Moderate High
NPAs High Low Low
Capital Adequacy Moderate Low High
Employee Productivity Low Moderate High
Focus on Non- interest Low High High
Income
Illustration 9

Mergers for private banks will be much smoother and easier as against that of PSBs. To
survive, banks need to diversify into non-fund-based activities (investment banking) and new
fund-based activities (mutual funds, leasing, housing finance, infrastructure finance, or,
maybe, even insurance). M&As offer a cheaper and, certainly, quicker diversification option
than organic growth. Indeed, for activities like infrastructure finance, which require a huge

58
critical mass, mergers may well be the only option. Only a large, strong entity with deep
reservoirs of capital will be able to provide funds without bumping against prudential exposure
limits, and have the requisite skills to evaluate mega-projects

THE RESCUE MERGER BANK BAILOUTS

The Assets
Provides the stronger bank with a relatively cheap deposit
network
Minimises the likelihood of systemic failure

The Liabilities
Saddles the stronger bank with huge NPAs
Erodes the profitability of the stronger bank

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 8
9
2.5 Banking and Insurance … much more to service !

What will the future of Indian banking and insurance look like? Will the reform in these
sectors face the same fate as in power? It is increasingly evident that the economy offers
opportunities but no security. The future will belong to those who develop good internal
controls, checks and balances and a sound market strategy.

The latest to be opened up for private investment, including foreign direct investment, is the
insurance sector. On a rough reckoning, commercial bank deposits account for 25 per cent
of GDP and credit extended by banks may be 15 per cent of GDP. Thus, regular bank credit
transactions alone account for a substantial percentage of GDP by way of servicing economic
activities. A gradual convergence is taking place in the banking and insurance sectors.
Several major banks are floating subsidiaries to enter both life and non-life insurance
businesses. Some of them are looking at niche markets such as corporate insurance.

Reform of the insurance sector began with the decision to open up this sector for private
participation with foreign insurance companies being allowed entry with a maximum of 26
per cent capital investment? The Insurance Regulatory and Development Authority (IRDA),
in its guidelines for the new private sector insurance companies, has stipulated that at least
20 per cent of the total premium revenue of these companies should come from rural India.
The government permits banks to distribute or market insurance products. It is amending
the Banking Regulation Act to this effect. Only banks with a three-year track record of
positive growth as well as with a strong financial background will be entitled to do insurance
business. In anticipation of the government move, some banks have begun talking of
alliances with foreign insurance players.
Keeping in view the limited actuarial and technical expertise of Indian banks in undertaking
insurance business. RBI has found it necessary to restrict entry into insurance to financially
sound banks. Permission to undertake insurance business through joint ventures on risk
participation basis will therefore be restricted to those banks which
(I) have a minimum net worth of Rs. 500 crore and
(ii) satisfy other criteria in regard to capital adequacy, profitability, etc. Banks which do not
satisfy these criteria will be allowed as strategic investors (without risk participation) up to
10 per cent of their net worth or Rs. 50 crore, whichever is lower. However, any bank or its
subsidiary can take up distribution of insurance products on fee basis as an agent of insurance
company. In all cases, banks need prior approval of RBI for undertaking insurance business.

Insuring the SBI way !

State Bank of India (SBI) has identified Cardif, a wholly owned subsidiary of BNP Paribas,
to enter into a joint venture for life insurance with an equity stake of 26 per cent. SBI has

60
 incorporated a wholly owned subsidiary SBI Life Insurance Company Ltd with an authorised
capital of
Rs 250 crore.

Cardif SA and its sister company Natio-Vie together rank as the thirdlargest French insurers
with a premium income of $9 billion and assets under management of over $59 billion.
Although Cardif is a lesser known name in the life insurance business, compared to some of
the global giants present in India, the French insurer has expertise in bancassurance. The
company has pioneered the concept of bancassurance in France by selling insurance products
through branches of commercial banks and non-banking finance companies. The joint
venture plans to bring into India a number of products, which would suit different segments
of the market.
SBI intends to fully integrate the insurance business into its banking activities with
appropriate sales support and marketing.

SBI will become the largest insurance outfit in terms of distribution with its network of
around 13,000 branches. The key to success will be the ability to integrate the savings
products of the bank, insurance product line of the Joint Venture Company & network of
branches.

Insuring it the Private way !

Explains Sugata Gupta, vice-president-marketing, ICICI Prudential: "We have unit managers
and agents to cater to the rural market. These field staffs are linked to the city offices and
keep on visiting the rural areas." ICICI Prudential keeps on sending regular vans with doctors
to underwrite the policies. Additionally, the company has tied up with NGOs to sell social
sector policies, like SEWA in Gujarat. ICICI Prudential Life Insurance, also, has tied up with
two Chennai-based corporate houses, Madras Cements Ltd and Lucas TVS, to serve
underprivileged children. ICICI Prudential has also come out with its social sector policy,
Salam Zindagi, which is aimed at the economically weaker sections.

HDFC Standard Life is customising its approach to cater to the rural markets so as to address
the special needs of these areas. The life insurance company has tied up with NGOs and self
help groups. One such NGO is LEAD (League for Education and Development) and the
insurance company covers the members of the SHGs associated with the NGO.
All this is being done to cater to the IRDA norms. As per norms, two per cent of insurance
premia of the new age insurance companies have to come from rural areas. In addition, the
insurance watchdog has put in some policy stipulation on insurance companies to cover life
in the social sector for the under-privileged.
Dabur CGU Life Insurance - in which Dabur holds the majority 74 percent stake while the
remaining 26 percent is owned by CGU - has recently forged a marketing alliance with the
Lakshmi Vilas Bank. Lakshmi Vilas Bank -- with 208 branches and 800,000 customers --
has a strong regional presence in the southern part of the country.

61
 "Typically we are looking to tie up with banks with strong regional presence and
knowledge of both rural and urban
segments of their markets. We feel that banks have got the expertise to give
financial advice to its customers, helping them make right decision," he said.

"For selling specialised financial products such as life insurance policies a lot depends on
the distributor's relationship with its customer and in India, customers share a strong and
long-term relationship with banking institutions," he added.

Quite a few banks are desirous of undertaking life insurance or general insurance business.
State Bank of India, Bank of Baroda, Bank of India, Global Trust Bank, Vysya Bank,
Centurion Bank, Oriental Bank of Commerce, ICICI Bank and HDFC Bank have or are
intending to enter insurance business after various procedural formalities have been clearly
defined in Insurance Regulatory Authority Bill. From the NBFC sector Alphic Finance and
Kotak Mahindra will be entering this sector. Also a few industrial house like Bombay
Dyeing, Aditya Birla, Tata Group,It is felt that volume of new business in the insurance
sector could touch
$25 billion.
Godrej Group are in the picture. 2.6 Rural Banking … Indigenous Route
to
Convenient Credit ?

ECONOMICALLY empowering, i.e. access to inexpensive credit and other micro-finance

services, including savings and insurance, India's rural population will have a significant
impact on India's economic growth. Economic empowerment is defined here as. The modern
banking system has failed to deliver inexpensive credit to India’s 600,000 villages - despite
several expensive attempts to do so. Do we need to rethink the appropriate institutional
structure for rural banking in India? The problems of widespread poverty, growing
inequality, rapid population growth and rising unemployment all find their origins in the
stagnation of economic life in rural areas.

Since the days of the Rural Credit Survey Committee (1954), India has come a long way in
its search for an appropriate rural banking set-up. Though there has been some improvement,
the problem remains. There has been tremendous progress in quantitative terms but quality
has suffered, progress has been slow and halting and significant regional disparities persist.
Stagnation in rural banking is noticed in the north and northeastern regions. The focus should
be on assisting and guiding small farmers. It is in this context that the role of rural banking
institutions has to be reconsidered.

The development strategy adopted and the increasing diversification and commercialisation
of agriculture underline the need for the rapid development of rural infrastructure and a larger
flow of credit. Activities allied to agriculture – livestock breeding, dairy farming, sericulture
etc are being taken up on commercial lines. Further, hi-tech agriculture with an export
orientation has brought about higher productivity in cotton, oilseeds, etc.

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Progressive and not-so-small farmers have no difficulty in obtaining credit from the
commercial banks. Credit for the poorer households is the real problem.

The Narasimham Committee observed that the manning of rural branches “has posed
problems for banks owing to the
reluctance of urban-oriented staff to work in the rural branches and the lack of motivation
to do so. More local recruitment and improved working conditions in rural areas should
help to meet this problem.”

Experience of RRBs that have locally-recruited employees; the employees are unhappy in
view of the lack of adequate career prospects. Apart from having a basic knowledge of
agriculture and rural development, a rural banker is required to handle credit extension work,
scheme appraisal work in connection with farm and non-farm investments and the production
of different crops, the monitoring/supervision and recovery of loans spread over villages
which are not even connected by all-weather roads and in an environment in which vested
interests are quite powerful. A person who says he has been in bank service for more than 25
years writes: “That rural credit has become unfashionable is evident from the fact that the
subject is accorded only residual focus in the various congregations of our bankers. The
placement policy in vogue in our banks is such that exposures in rural credit or agro-financing
rarely count for promotions.

Unfortunately a uniform standardized approach to lending has led to rigidities as a result

of which a farmer-borrower becomes a defaulter for no fault of his. Also, the agricultural
sector is beset with considerable uncertainties – the weather and rainfall problem, the pest
problem and the market and price problem.

Government interference that leaves no scope for these apex bodies to show initiative and
work out action plans for development on their own is partly responsible for this situation.
Another reason for such a state of affairs is that the apex bodies have expanded and prospered
at the cost of primary bodies by taking over functions like deposit mobilisation even at the
rural level. By way of liberalisation of the federal structure’s working, societies that want to
work independently of the federal system should be allowed to exit.

WORKING OF RRBs and Rural Cadre

It is the view that rural banking is simple that has landed the RRBs in a mess. The poor
performance of the RRB personnel is largely due to the fact that the personnel hurriedly
recruited and trained in a routine way have been given the difficult task of dealing with a
large number of smallterm/composite loans advanced to small farmers and other poor rural
families who, not knowing how to deal with banks, require assistance and guidance at each
stage – from loan application to loan recovery.

63
Neither the cooperative channel nor public sector one is able to meet local needs in regard to
savings and loans due to a rigid all-India approach and lack of flexibility in their operations.
This in fact is one of the reasons for informal banking surviving and for the emergence of
non-banking financial companies (NBFCs) in rural districts. Though there is a multiagency
set-up for rural banking, nearly 45 per cent of rural credit is from cooperatives. But the
commercial banks are a more important source of credit as can be seen from Table 1.

What did the RBI do?

Reserve Bank appointed the R V Gupta Committee in 1997. The committee was asked to
identify the constraints faced by banks in augmenting the flow of credit and simplifying the
procedures for agricultural credit. New institutions were over-administered, and bureaucratic
regimentation was the result. It is along such lines that the rural credit co-operatives came up
followed by the commercial banks’ diversification into rural banking after the nationalisation
of 14 big banks. Since the commercial banks, too, did not perform as expected, the regional
rural banks (RRBs) were formed. At the national level NABARD was established. Even then,
banking progress in the rural sector was not able to take care of the growing credit needs of
agriculture.

Think about it !

There should be credit societies at the village level. Such societies, however, tend to
become weak. A strong society at the tehsil level would serve the farmers in a better,
more effective and efficient manner. After all, a farmer has to deal with a credit
society only a few times in a year; he can go up to the tehsil headquarters for the
purpose.

Advance a tailor-made package of credit with a consumption component and closely

supervise its disbursement to a large number of farmers in far-flung villages and
provide technical guidance and marketing links. Such an approach would ensure that
scarce resources have properly utilised and that small producers can reach a higher
plane of technology and earn enough extra income to improve their standard of living
after repaying the loan.

Since the merger of the RRBs in their respective sponsor banks has been ruled out,
the RRBs should atleast be made fully owned subsidiaries of the sponsor banks so
that the banks can develop for both their rural branches and their RRBs in a unified
way. Besides placing all the RRB employees in the rural banking cadre, the sponsor
bank should throw this cadre open and give its own staff, including those not working
in the rural branches, the option of joining the cadre. The best option seems to be to
have managerial cadre at the district level and at the same time, each primary should
have the choice to choose its manager from the panel of managers given by the district
union district central cooperation bank (DCCB). At the district and state levels,

64
 managerial cadres can be created as a collaborative effort of DCCBs, state
cooperative banks (SCBs) and state and all-India cooperative Unions.

Decentralised banking and giving branch managers sufficient powers are a must.
The Gupta Committee’s recommendation that at least 90 per cent of loan applications
“should be decided at the branch level”, though desirable in itself, does not go far
enough. It does not take care of the need for giving the branch manager the power to
reschedule loan installments on the merits of each case. Without such empowerment
the spectre of non-performing assets (NPAs) would harass the farmers.

Recent Developments

The second Narasimham Committee (Committee on Banking Sector Reforms) has suggested
de-layering of the cooperative credit system with a view to reducing the costs of
intermediation and making NABARD credit cheaper for ultimate borrowers [Government of
India 1998:61].

One recent development under the leadership of NABARD and nongovernment

organisations (NGOs) is the formation of informal, self-help groups (SHGs) broadly on the
model of the ‘grameen banks’ of Bangladesh. The mutual trust reflected in the SHGs working
is in tune with the true spirit of cooperation. The creditworthiness of an SHG is linked to the
amount of saving brought about by the group. The SHG promotes thrift and savings,
howsoever temporary and small they are, thereby to a great extent weaning the poor away
from moneylenders. The number of SHGs linked to banks is now around 33,000.
The makers of banking policy are now focusing on technology-led banking in the rural sector.
This requires a restructuring of cooperatives to enable them to meet the challenges of
competition. It also requires a change in mindset. While the government should promote the
restructuring and modernisation of cooperatives through an incentive/disincentive package
and by providing adequate infrastructure in the rural areas, the actual task should be left to
the cooperative leadership and the apex bodies of cooperatives.

If and when rural banking becomes a separate entity in each bank, that would ensure full
attention for the rural sector and motivate personnel who opt for this cadre, besides providing
them with career prospects. The staff requirement of the rural banking cadre (RBC) will be
on a big scale.

One objective of policy-makers is to subject the banking system to greater competition and
for this purpose introduce new players in the market. This objective is expected to be
achieved by permitting the establishment of large private banks and by encouraging the
setting up of small private local area banks (LABs) in the rural areas. LABs are envisaged as
private enterprises in rural localities for mobilizing rural savings and making them available
for investment locally. The LAB policy gives agriculturists an opportunity to form self-help
groups in the form of LABs for their banking needs and to look after the development of
their respective areas. This is in line with the multi-agency approach to rural credit. Each

65
banking channel has to meet competition, and together they are to meet the growing banking
needs of rural India.

What did they have to say?

According to bank unions the aim of local area banks will be to snatch a share of the savings
and divert them into profitable investment in cities. The weaker sections of society living in
rural areas will be starved of bank credit in consequence” Another argument against LABs
is that “any smalltime trader can come into banking”.

If this were true, the Reserve Bank would by now have been flooded with applications for
starting LABs. The fact is that the mobilisation of even Rs 5 crore by way of promoters’
contribution is very difficult for a small trader or even for large farmers. The bank employees’
unions refuse to appreciate the logic behind the establishment of LABs. The logical followup
of the new economic policy is to encourage private enterprise in all fields, including banking.
In the rural sector, such private banking really means self-help efforts.

Yet another point raised is that as there are already a large number of branches of banks and
RRBs, and cooperative credit institutions too, there is no need for LABs. The trade unions
did not object when the public sector banks started competing with the cooperative credit
institutions, including urban banks. They do not even mind the banks competing with the
RRBs, which they have sponsored. They only fear that when the LABs come up they will
compete with the public sector banks and take away their deposit business.

Commercial Bank v/s RRB

There are 28 PSB with 19423 branches and 196 RRBs with 12311 branches. This means that
there is a public sector bank branch for every 20 villages. In addition, there are 12,357 semi
urban branches (10,535 of public sector banks and 1,822 of RRBs), which also mainly serve
the rural hinterland. This spectacular spread in the villages is a significant achievement of
banks in India. The banks’ achievement in respect of mobilisation of rural deposits and
advancement of loans to rural families is equally commendable.
Lendings in Rural India, 1999 2000
Source Direct Indirect Total
Amount Percen Amount Percen Amount
(Rs Crore) t (Rs Crore) t (Rs
Crore)
Primary cooperative 8,218 15.9 NA 12.9 8,218
credit society

66
Land development banks 12,940 25.2 NA 20.3 12,940

Commercial banks 26,327 51.1 4,986 49.2 31,313

RRBs 4,044 7.8 NA 8.3 4,044
Total 51,529 100.0 12,137 100.0 63,666
Illustration 10
The new context compels us to think on new lines and, instead of approaching the issue in a
routine way, to work out the restructuring of selected branches to suit the needs of specialised
banking for agriculture, bank managements being left free to work out programmes for this
task. As regards co-operative rural banking, the primary credit societies hold the key to
success. Banking policy should aim at encouraging the viable ones through incentives,
including direct access to NABARD finance, and
letting them function without government interference.

2.7 Virtual Banking … the

transformation !

The practice of banking has undergone a significant transformation in the nineties. While
banks are striving to strengthen customer relationship and move towards 'relationship
banking', customers are increasingly moving away from the confines of traditional branch-
banking and are seeking the convenience of remote electronic banking services. And even
within the broad spectrum of electronic banking, the aspect of banking that has gained
currency is virtual banking. Increase in the functional and geographical spread of banks has
necessitated the switchover from hard cash to paper based instruments and now to electronic
instruments. Broadly speaking, virtual banking denotes the provision of banking and related
services through extensive use of information technology without direct recourse to the bank
by the customer. The origin of virtual banking in the developed countries can be traced back
to the seventies with the installation of Automated Teller Machines (ATMs). It is possible to
delineate the principal types of virtual banking services. These include Shared ATM
networks, Electronic Funds Transfer at Point of Sale (EFTPoS), Smart Cards, Stored-Value
Cards, phone banking, and more recently, internet and intranet banking. The salient features
of these services are the overwhelming reliance on information technology and the absence
of physical bank branches to deliver these services to the customers.

The financial benefits of virtual banking services are manifold.

Lower cost of handling a transaction and of operating branch network along with
reduced staff costs via the virtual resource compared to the cost of handling the
transaction via the branch.

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 The increased speed of response to customer requirements; enhance customer
satisfaction and, ceteris paribus, can lead to higher profits via handling a larger
number of customer accounts.

It also implies the possibility of access to a greater number of potential customers

Manipulation of books by unscrupulous staff, frauds relating to local clearing

operations will be prevented if computerisation in banks takes place.

On the flip side of the coin, however, it needs to be recognized that such high-cost
technological initiatives need to be undertaken only after the viability and feasibility of
the technology and its associated applications have been thoroughly examined.
Virtual banking has made some beginning in the Indian banking system. ATMs have been
installed by almost all the major banks in major metropolitan cities, the Shared Payment
Network System (SPNS) has already been installed in Mumbai and the Electronic Funds
Transfer (EFT) mechanism by major banks has also been initiated. The operationalisation of
the Very Small Aperture Terminal (VSAT) is expected to provide a significant thrust to the
development of INdian FInancial NETwork (INFINET) which will further facilitate
connectivity within the financial sector.

The popularity which virtual banking services have won among customers, owing to the
speed, convenience and round-the clock access they offer, is likely to increase in the future.
However, several issues of concern would need to be pro-actively attended. While most of
electronic banking have built-in security features such as encryption. Prescriptions of
maximum monetary limits and authorizations, the system operators have to be extremely
vigilant and provide clear-cut guidelines for operations. On the large issue of electronically
initiated funds transfer, issues like authentication of payments instructions, the responsibility
of the customer for secrecy of the security procedure would also need to be addressed.

# The INFINET is a Closed User Group (CUG) Network for the exclusive use of Member
Banks and Financial Institutions. It uses a blend of communication technologies such as
VSATs and Terrestrial Leased Lines. Presently, the network consists of over 689 VSATs
located in 127 cities of the country and utilises one full transponder on INSAT 3B.
Inaugurated on June 19, 1999, various inter-bank and intra-bank applications ranging from
simple messaging, MIS, EFT (Retail, RTGS), ECS, Electronic Debit, online processing and
trading in Government securities, dematerialisation, centralized funds querying for Banks
and FIs, Anywhere/Anytime Banking, Inter-Branch Reconciliation are being implemented
using the INFINET. The INFINET will be the communication backbone for the National
Payments System, which will cater mainly to inter-bank applications like RTGS, Delivery
Vs Payment (DVP), Government Transactions, Automatic Clearing House (ACH) etc.

Major issues plaguing the banking industry are the lack of standardisation of operating
systems, systems software and application software throughout the banking industry. In
a tight competitive environment where banks are making a thrust towards technology to
provide superior services to its customers, customers stand to gain the most.

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 2.8 Retail Banking …the ‘in’ thing !
The Customer is now in an enviable position where he can demand
With increased competition, spreads in corporate lending have decreasedsuperior services
at competitive prices. significantly. Banks are thus moving into the retail mode to tide over
the global slowdown and boost the bottomline.

Retail banking had been a neglected segment accounting to 10.5 percent of all banks loans
of India. The main advantages of retail banking are assured spread, widely distributed risks
and lower NPAs due to limited risk associated with the salaried class. However, transactions
cost are higher as compared to of corporate lendings. Thus. The target clientele is consumers
and mid size companies.

The product offerings include home loans, car loans, credit cards, personal loans and also
customized loans like equipment loan for doctors.

In India, out of 100 houses sold, 30 are bought by housing loans and out of 100 cars sold, 28
are brought by car loans.

In India today …
Among PSBs, SBI, Bank of Baroda, Union Bank of India and Bank of India have diverged
into the retail segment, whereas in the private sector, opportunity seekers like ICICI and
HDFC have focused on retail lendings.

Banks have a stronger influence on profits due to individual customers. This is best proved
by the success of HDFC which has achieved breakeven on its operations in the fiscal year
2001. Even though retail loans account for 18 percent of total loans, these account for 40
percent of bank revenues.

“In retail banking, you need a higher physical presence, in the form of ATMs as well as
branches. State-of-art technology has to be used to enable convenient customer transactions.”
States, Mr.Swaroop of HDFC Bank.

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