Indian Banking Industry : Prepared By Sawan Malik

Introduction

The Indian financial sector today comprises an impressive network of financial

institutions and a wide range of financial instruments. Provision of short term credit is
entrusted primarily to commercial and cooperative banks. Of late , commercial banks
have diversified into several new areas of business such as merchant banking, mutual
funds, leasing, venture capital, factoring and other financial services. In addition, there is
a wide network of cooperative banks and cooperative land development banks at state,
district and subdistrtict levels. Together, commercial and cooperative banks hold around
two thirds of the total assets of the Indian financial system. The structure of the Indian
financial system is shown in Exhibit 1.

In March 1996, there were 293 commercial banks in India, of which 196 were regional
rural banks (RRBs), with 14459 branches. The banking sector spanned 63026 offices, of
which 32995 offices were located in the rural areas. There were 16400 offices in the
metropolitan and urban areas. The total deposits of the scheduled commercial banks
stood at Rs. 577, 959 crores as on 27th February, 1998. (Investment in Govt. and other
approved securities is Rs. 214,073 crores)

The range of products offered by the Indian banking industry can be classified under two
broad headings essentially targetted at two different customers:
• Consumer Banking: This includes savings and checking accounts, fixed deposits and
various loans like e.g. auto, housing, education etc. ATM’s, credit cards are the
value added services.
• Corporate Banking: This includes working capital loans to corporates, trade financing,
opening of Letters of Credit, issuing guarantees, cash management, project financing
and treasury operations for foreign exchange marketing and trading activities.

Over the last 4 years, most of the PSU banks have painfully pulled themselves upto RBI
mandated international accounting standards, writing off losses, recapitalising
themselves through government and capital issues, and tightening lending quality.
Some, like Bank of Baroda, Bank of India and Union Bank have emerged as strong banks.
Others like Uco Bank, United Bank of India and Indian Bank are still struggling towards
recovery.

Indian bankers today have innumerable challenges : worrying levels of Non Performing
Assets ( NPA’s), stricter prudential norms, new and expanded risks and whether to merge
or not to form a bigger stronger bank. These questions are hard to answer.
Simultaneously, the banks face a task that is less tangible but no less dificult. In search
of that elusive competitive edge thay have to reinvent themselves. Indian banking is in
for an tumultous but exciting time.

Evolution Of The Banking Sector In India

The evolution of the banking sector in India can be broken down into the following five
phases :
• Initial Years ( Prior to 1950)
• Foundation Phase ( 1950-69)
• Expansionary Phase ( 1969- 85)
• Consolidation and Diversification Phase ( 1985-91)
• Financial reform phase ( Post liberalization)

Initial Years

Banking has been known to India for ages. India evolved and worked the principles of
banking prior to Western countries. The coinage and currency system has its deep roots
in the Indian history. At the beginning of the 19th century, although no uniform
standard coins appear to have existed, a silver standard existed with gold coins in
concurrent circulation. Throughout India two standard coins of both gold and silver were
in circulation side by side without any relation between them. The exchange value was
determined by weight and fineness of coins.

Indian Joint Stock Banks: These were formed by traders who took money from the
public and lent it out. A number of joint stock banks came into being on the crest of the
Swadeshi movement which began in India in 1905. Since that year there was an outburst
of banking activity in India. The rapid stride made by the Indian joint stock banks is
shown in the table below:
Number Of Deposits
Banks ( Rs. Lacs)
 1905 1910 1905 1910
The Presidency Banks 3 3 2538 3658
Indian Joint Stock 9 16 1199 2566
Banks
The Exchange Banks 10 11 1704 2479

The Imperial Bank of India: The expansion of internal and foreign trade, increase in
public debt, a substantial rise in bank deposits and other war time and post war financial
developments brought the question of the amalgamation of the Presidency banks to the
forefront. It was also feared that if they did not combine their resources , a time might
come when any of the foreign banking concerns might succeed in obtaining a strong
footing in India, thus acquiring undue influence over the Indian money market. The
Imperial bank of India act provided an agreement between the bank and the secretary of
state which was signed on January 27, 1921. By this agreement the bank was required to
act as bankers to the government for a period of ten years and to open 100 new
branches within five years. Complaints, were however made that most of the new
branches of the bank were opened at places where one or other of the Indian joint stock
banks were already working, thus providing no additional facilities to the country. The
imperial bank, Exchange bank and the Joint- Stock bank formed the crux of Indian
banking from 1920-30.
Formation of RBI: The Banking Inquiry committee completed its exhaustive survey of
Indian banking conditions in 1930. The principal recommendations of this committee may
be summarized as follows: Establishment of Reserve bank, removal of restrictions of the
foreign exchange business of the Imperial bank, formation of All India Bankers
Association, promulgation of the special bank act and amendment of the Indian
Companies Act.

The Reserve bank bill was introduced in the legislative assembly in September, 1933. In
April 1935, the bank began to function. This marked the close of the period of
uncoordinated banking. The general superintendence and direction of the reserve bank is
entrusted to a Central board of Directors of 20 members, consisting of the governor and 4
deputy Governors, 1 Government official from the Ministry of Finance, 10 Directors
nominated by the Central Government to represent the 4 local boards at Bombay, New
Delhi, Madras and Calcutta. These local boards consist of 5 members each appointed by the
Central Government for a term of 4 years to represent territorial and economic interests
and the interests of co-operative and indigenous banks.
As the supreme banking authority in the country, the RBI had the following powers:
• It held the cash reserves of all the scheduled banks.
• It controlled the credit operations of banks through qualitative and quantitative controls
• It controlled the banking system through the system of licensing, inspection and calling
for information
• It acted as the lender of last resort by providing rediscount facilities to scheduled banks

During the decade that followed , several attempts were made to pass a banking
legislation. But, it was only in 1949 that the Banking companies bill was passed. With the
coming of the Banking Companies act into force on March 10, 1949 the country was
equipped with a very modern and a very comprehensive banking legislation.

Foundation Phase (Before Nationalization)

During the foundation phase, covering the period from 1950 till nationalization, the accent
was on the development of the necessary legislative framework for facilitating
reorganization and consolidation of the banking system. During this phase, the co-operative
credit structure was strengthened and the institutional framework for providing long term
finance to agriculture was set up.

Bank deposits, in this phase, began to increase much faster than national income. The ratio
of bank deposits to national income rose from 14.7 in 1960 to 16.6 in 1969.
This faster growth of deposits was due to three main factors, namely,
• Spread of the banking habit ;
• Expansion of the branch network which provided a service in many centers which were
earlier unbanked ; and
• Increase in interest on bank deposits which made them more attractive than other
forms of investment.

Emergence of Development Banks: During this period, due to the peculiar

characteristics inherent in the Indian economy ( viz. , underdeveloped capital market,
shyness of capital market, lack of entrapreneurship etc.) gaps existed in the field of
industrial finance between the demand for and supply of financial resources required by the
Indian industries. The existing banks, with their resources were unable to make advances to
industries on a long term basis. This led to the necessity of setting up special financial
institutions also known as “ Development Banks” for industry to fill the gap in the
machinery for financing industrial development and to ensure adequate flow of assistance
to industrial projects.

The idea of development banks has its origins in the urge in backward and underdeveloped
countries to achieve quick economic growth. Under this urge a development bank was
conceived as an instrument for promoting all-round development. They undertake both
banking functions as well as development functions. On the development front these
institutions are under obligation to play a promotional role in setting up new industrial
projects, expansion, diversification and for modernisation and renovation of existing units.
Financial assistance is the primary task of these institutions. Assistance can be in different
forms like equity participation, loans, guaranteeing the deferred payments etc. Managerial
and technical know-how is also provided according to the requirements of the industrial
units. A development bank must create for itself the image of an activist institution ,
interested in development and unafraid of hazards of change and fully aware that there can
be no development without new ideas whereas a commercial banker is concerned more
particularly with security and interest margin. The philosophy of development banking
demands judicious blending of banking and development policies and operations.

The structure of development banks in India is given in EXHIBIT 2

Emergence of Co-operative banks: Co-operatives were the first credit agencies for
disbursing credit to the rural poor. The formal foundation of these institutions was laid with
the introduction of the Cooperative Credit Societies Act. Till the early 1960’s the thrust in
the policy and approach to rural credit was to build up the cooperative credit system as
specialized agency for rural credit disbursement. This was because of the impression that
only cooperative institutions could serve the twin objectives of providing a credit delivery
system operating at the doorstep of the farmers and providing this credit at relatively
cheaper rates.

Cooperatives are of two different types; those providing short and medium term loans and
those providing long term loans. Short and medium term cooperatives bear a three tiered
credit structure and is constituted by the state cooperative bank at the apex level, central
cooperative bank at district level and primary cooperative credit societies at the base level.
Each lower entity is federated into the higher one. In this federated structure money flows
from the apex bank to the central banks and from the central banks to the rural societies
and from them to the individual borrowers. Sources of capital for each entity consist of own
capital ( share capital and reserves), deposits and borrowings. Borrowings are made from
the from the government , RBI and higher cooperative institutions and others. Most of the
resources of each institution is utilized in granting loans to the constituting members.
Higher institutions not only provides refinance to the lower institutions but also supervises
and advises them.

The long term cooperative credit institutions, like the land development banks (LDB’s),
have not evolved a uniform organisational pattern for the country as a whole. In some
states like ( Tamil Nadu and Punjab) structure consists of two tiers , while in some
states( as in U.P. and Maharashtra) it is unitary with branches, and in other states ( West
Bengal, Himachal) it is mixed i.e. it operates in certain areas through a federal structure
and in others through unitary structure. Another point of difference is that the LDB’s are not
banks like short term cooperative credit institutions since they cannot accept deposits from
the public withdrawable by cheque or otherwise on demand. Their own resources comprise
share capital and reserves. Their borrowings include debentures which are guaranteed by
the state governments. Infact long term credit is required for the purposes of permanent
improvement of land, construction of wells and tanks, installation of pumping sets and
other water lifting appliances, purchasing of tractors and redemption of prior debts etc.

Coperatives served their purpose very well till the start of the green revolution when a
need was felt for increasing credit. The cooperatives both organisationally and
operationally found it difficult to meet with the then created challenges of credit
requirements. Around this time the cooperative system started developing certain signs
of weakness largely due to mounting overdues and various other problems like weak
staff structure and lack of the effective contact with agriculture and rural development
programs. Given this scenario a change in policy was made through which entrance of
other agencies in the was made possible. As a result commercial banks entered the field
in 1969 and Regional Rural Banks ( RRB’s) were set up in 1975. Governments thrust in
the policy to institutionalize the rural credit and the adherence to multi- agency approach
to the rural cruder is clear from the following table:

Percentage Distribution of Rural Credit According to Agency

 1961 1971 1981
Institutional Credit 17.2 31.7 63.2
Cooperatives 10.4 22 29.8
Commercial Banks 0.3 2.4 8.8
(Including RRB’s)

Expansionary Phase (Nationalization of Banking in 1969)

Government intervention in the banking sector had its origin in nationalist thinking. Colonial
banking was perceived to be biased in favor of working- capital loans to trade and large
capitalist enterprises and against rural areas and “the common man”. This legacy
combined with socialist ideology culminated in nationalization. On 19 July 1969, fourteen
major commercial banks (each with deposits of Rs. 50 crores and more) were nationalized.
This step changed, almost overnight, the very complexion of the financial structure of the
economy. The banking sector was brought under considerable Government supervision
through what was described as "social control". The main objectives of bank nationalization
were to make the administrative set-up of the banks conform to the norms specified by the
Government, to make easy credit available to neglected sectors like agriculture, small scale
industry, export oriented sectors etc., to have greater mobilization of savings through bank
deposits and to widen the branch network of banks, especially in the rural and semi-urban
areas.

A series of policy measures were taken to achieve the objectives mentioned above. These
include:
• Setting priority sector targets
• Special schemes for the weaker sections, such as the Differential Rate of Interest (DRI)
scheme in 1972 and Integrated Rural Development Program (IRDP) in 1980.
• Setting up specialized institutions like Regional Rural Banks (RRBs) in 1975, National
Bank for Agriculture and Rural Development (NABARD) and Export Import Bank of
India (EXIM) in 1982.
• Normalization of policies regarding Bank credit or Cash credit systems based on the
recommendations of the Tandon Committee (1975) and Chore Committee (1979)
respectively.

With the nationalization of banks, the Government came into control of 83 percent of bank
deposits. This put the government in a dominant position in the field of finance. In 1980, six
more banks (each with deposits of Rs. 200 crores and above) were nationalized. Thus, the
Government further extended the area of public control over the country’s banking system.
With this, the number of public sector banks has increased to 28 and the share of public
sector banking has increased to 90.7% in terms of deposits and 90.6% in terms of
advances. The decade and a half following the nationalization in 1969 was marked by a
rapid expansion of the banking system.

Consolidation and Diversification Phase

The banking sector entered the next phase - the phase of consolidation and diversification,
beginning in the mid - 1980s. A series of policy initiatives were taken in this phase aimed
mainly at consolidation and diversification and to an extent, at deregulation.

Some of the important banking variables during this period (1980) are as given in the
Exhibit 3.

There was a series of structural reforms which provided banks with different avenues of
investing their surplus money or borrowing for their immediate emergency requirements, or
providing services to the clients. Among these measures, the prominent one is the policy to
pursue the development of the money market - widening its scope, introducing new
instruments and strengthening the existing ones. New instruments included 182 - day
Treasury bills, Certificates of deposit (CD), Commercial Paper (CP), and inter-bank
participation certificates (IBPC).

New institutions, such as Discount and Finance House of India (DFHI) and Small Industries
Development Bank of India (SIDBI) were also established. DFHI paved the way for
development of active money market.

This phase was dominated to an extent by the Chakravarty Committee recommendations

(1985). It paved the way for the latest phase - the financial liberalization phase in the wake
of the macroeconomic crises of 1991 and especially with the Narasimhan Committee Report
submitted in 1991.

Before, moving on to the next phase it is important to realize how government policy which
had been evolving since nationalization affected the banks and caused a mismatch in their
assets and liabilities. The distortions that crept into the banking system over the years
have been summed up as follows:
• A big chunk of bank resources has been statutorily pre-empted for investments in
Government and related securities. These securities are safe assets and so the yield
is less. This has eroded the profit earning capability of the banks.
• Banks have been required to lend a substantial amount of their credit to designated
priority sectors at subsidized rates of interest. In addition, administrative and default
costs associated with such lending have been very high.
• Banks have to maintain large amount of cash reserves. As the cash earns nothing, the
profitability of the bank reduces proportionately with the increase in the amount of
cash reserves.
• The banks have to expand their branch network to areas or regions in which it is not
viable economically to operate a branch.
• Deterioration in the quality of the loan portfolio, mainly due to the reason mentioned in
above, resulted in accumulation of a large proportion of non-performing assets
(NPAs). The proportion of NPAs to total assets is alarmingly high when compared to
the banks abroad.
• Extensive degree of central direction of their operations in terms of investment, credit
allocation, branch expansion and internal management aspects of business
• Political interference has resulted in the failure of the system to operate on the basis of
commercial judgement and in the framework of internal autonomy.
Due to the above reasons, bank management cannot manage the assets (which are
investments in securities and loans) properly in line with the liabilities (mainly the deposit
base). Funds supply , which is a liability is as it is regarded as a factor beyond control and
since a significant percentage of the assets are under obligations because of above
mentioned facets of the government policy the Asset- Liability matching becomes very
difficult for a bank.

Financial Liberalization Phase

Though considerable progress was achieved in the earlier phases in terms of geographical
reach of the banking sector , profitability and efficiency levels have been very low especially
in the case of the public sector banks, not to speak of quality of service. The banking
system was burdened with NPA’s ( non performing assets) of around 17% ( in actual terms
it could have been even more considering the loose asset classification system which
existed then).Regulation had a stranglehold on all aspects of the banking sector including
entry of players, interest rates and credit allocation. The loan melas, priority sector lending,
and a host of such schemes contributed to the low profitability of the banking sector.

At the beginning of 1990’s many public sector banks became unprofitable and
undercapitalized.The root cause of this was the excess emphasis given to social banking
goals like widening the reach of banking services. The crucial elements like capital
adequacy, profitability and low NPA’s which are sine qua non for sound and efficient
banking were given a backseat. Above all government protection acted as a disincentive
leading to lethargy in banking management’s. Things had reached such a pass that it could
have an adverse impact on depositor and investor confidence.

Against this backdrop Narsimhan committee was constituted to examine all relevant
aspects of the structure , organization, functions and procedures of the financial system
and make recommendations thereon. The priority areas to be tackled were:
• Removing the external constraints operating on the profitability of banks.
• Improving the financial health of banks and introducing greater transparency in the
balance sheet of banks.
• Injecting a greater element of competitiveness in the system.

A brief summary of these recommendations (insofar as they relate to the banking sector),
along with the rationale for the same, and subsequent implementation follows.

The predicament of Indian banks is the consequence of factors, both internal and external
to the banking system, and the financial sector reforms seek to address both these issues.
The reforms are mainly based on the recommendations of the special committee set up to
address the issues which can lead to improvement in the performance of the Indian
financial sector.

External Constraints

In the course of the reform process, a number of steps have been taken to relax, reduce or
even abolish the external constraints which have been operating on the viability of the
banking institutions. These relate mainly to the following points :-
1. The high levels of cash reserve requirements (CRR) and statutory liquidity ratio (SLR)
2. The administered structure of the interest rates.
Cash Reserve Ratio (CRR)

Banks are required to maintain a certain percentage of their time and demand deposits as
cash. This percentage is the Cash Reserve Ratio (CRR). The RBI pays a nominal interest rate
on the cash reserves maintained by the banks with it. Needless to say, this rate is much
less than the market rate.

Increased CRR levels result in an increased proportion of the banks' resources being
impounded as idle cash. The recommendations of the Committee to reduce the CRR to 10
percent will lower the amount of idle cash balances kept by the banks with the RBI and
release the amount for more productive and remunerative purposes. The CRR over the past
years have been reduced gradually to the current level of around 10%.

Statutory liquidity Ratio (SLR)

Banks are required to maintain a certain proportion of their demand and time deposits in
the form of gold or unencumbered approved securities. The RBI is empowered to impose an
SLR of upto 40 percent. RBI raised the SLR ratio to acquire funds to help the Government to
finance its consumption/non-developmental expenditure. It was almost a fraud of the
Finance ministry on a captive banking system.

A higher SLR forces commercial banks to maintain a larger proportion of their funds in
Government securities and Government guaranteed securities (of public sector financial
institutions) and reduces the capacity of commercial banks to grant loans and advances to
business and industry. It affects the profitability of banks due to the unremunerative yields
on SLR investments. Due to this, the Committee favoured a decrease in the SLR, which it
characterized as a "tax on the banking system". As part of the reform process, the
Narasimham Committee has recommended the reduction of the SLR to 25 percent over a
five year period.

Regulation of Interest Rates

The interest rates on both loans extended and on deposits booked had always been
controlled by the RBI to varying degrees. The rationale behind this had been to ensure that
small borrowers receive a preferential rate of interest on their loans and also that the
average cost of the funds to the bank remain under control. Interest rates were set by the
RBI on loans as a function of the size and on the deposits as a function of the term.
With the onset of the reform process, the administered structure of the interest rates has
also been deregulated. This is one of the significant moves toward a free market
environment. Some of the major recommendations of the Committee are as follows:
• Level and structure of interest rates should be broadly determined by market forces
• All controls on deposit and lending rates should be removed
• Subsidies on IRDP loans should be withdrawn
• RBI should be the authority to simplify the interest rate structure
• All interest rates should be closely connected with the bank rate
• Government borrowing rates should be progressively market related, in order to
increase the rates on Government borrowing, which, in turn, would help the banks to
increase income from SLR investment.

Directed credit Program

The recommendations in this area are:

• Gradual phase-out of directed credit
• Dispense with concessional interest rates
• Redefine priority sector and fix directed credit to 10% of aggregate bank credit

Agriculture and small industry have already grown to a mature stage and do not require
any support. Decades of interest subsidy are enough and concessional rates can therefore
be done away with.

Capital adequacy norms

Indian banks are also required to achieve capital adequacy norms of 10% risk-weighted
assets to be achieved by 2000. This is higher than the 8% which is prescribed by the Basle
committee .

The Government has done its part by injecting more capital into the banks; enabling them
to conform to capital adequacy standards. A sum of Rs. 11,300 crores has been provided by
the Government in the union budgets towards the recapitalisation of public sector banks.

Banks have also been permitted to access the capital market for funds in order to augment
their capital. With the amendment of the Banking companies Act, w.e.f. July 15, 1994,
nationalised banks can strengthen their capital base by tapping the capital market for
public contribution to their capital upto 49%.
Regulation and supervision

With regard to the supervision of Indian banks, the Committee has recommended that an
autonomous Department of Supervision be set up under the RBI for this purpose. The
Narasimham Committee had recommended that the supervision over banks be separated
from the traditional central banking functions of the RBI.A major breakthrough in the
supervisory mechanism of the financial system was the constitution of the Board of
Financial Supervision (BFS) in November 1994 under the aegis of the RBI. The first step
towards a new strategy for strengthening the supervision of banks under the direction of
the BFS has been the introduction in February 1995 of an off-site monitoring system by the
Dept. of Supervision. The system is based on a package of prudential supervisory reports to
be filed by banks on a quarterly basis and is to be introduced in 2 stages.

Banks have also been advised to introduce a system of concurrent audit at all branches so
as to ensure adherence to the prescribed systems and procedures by the branches and also
help in the prevention and timely detection of lapses and irregularities.

Uniform accounting practices

There had been increasing pressure on the Indian Government to catch up with
international accounting standards, as many Indian banks had been actively following what
could only be called “Creative Accounting”. A generous attitude towards unpaid loans
had covered their balance sheets in red and increased their NPAs. Banks however did not
worry about this, as they were mainly concerned with growth in deposits and advances,
and not with recovery of loans. In order to ensure that Indian banks followed accounting
practices that were in line with global standards, the Committee made the following
recommendations:
• Adopt uniform accounting practices w.r.t. income recognition and provisioning norms.
• Adopt sound practices w.r.t. valuation of investments in keeping with the Ghosh
committee recommendations.
Banks have also been forced to follow prudential norms w.r.t. income recognition, asset
classification and provisioning as part of the changes in accounting practices.

Branch licensing

One of the major recommendations of the Committee was the abolition of branch licensing,
in order to increase the level of competition in the sector. It was also recommended that
the opening/closing of branches should be left to the commercial judgment of banks, and
that the policy relating to opening of branches/subsidiaries of foreign banks should be
liberalized.As a result of these recommendations, the branch licensing policy was
liberalized.

Internal constraints

A series of steps have been taken in this area also to improve the financial health of the
banks. The steps include:

The prudential norms - relating to income recognition and asset classification and capital
adequacy have been finalized. These norms satisfy basically two purposes :
• Ensure that the balance sheets and income and expenditure statements provide a true
reflection of the health of the banks. This has thus helped in identifying the root
causes of ill health or poor efficiency in the banking sector.
• These prudential norms act as a tool of financial discipline and compel banks to look
more carefully at the quality of loan assets and the risks attached to lending. These
norms also conform to the international accounting standards. This will help the
Indian banks getting their due place and recognition in the Global banking scene.

Recommendations of the Narasimham Committee w.r.t. asset classification and

provisioning norms
ASSET PROVISIONING PROVISIONING
CLASSIFICATION REQUIREMENT FY94 REQUIREMENT FY95

Standard No provision No provision

10% of total loan 10% of total loan

Sub-standard No provision No provision

10% of total loan 10% of total loan

Bad and doubtful

(NPL < 2 years)

Basic provisioning 100% of loan less 100% of loan less

security security
• Upto 1 year as Nil 20% of security
doubtful
• 1-3 years as 20% of security 30% of security
doubtful

• >3 years as 50% of security

doubtful

• 3-5 years as 30% of security N.A.

doubtful

• >5 years as 50% of security N.A.

doubtful

Loss assets 100% of security 100% of security

(NPL defined) Interest not received for Interest not received for
Provisions for small 3 quarters 2 quarters during the
loans upto Rs. 25,000 Flat rate of 5% year
Flat rate of 7.5% of
outstanding amount in
FY95

There has also been a directed effort towards reducing the percentage of the Non
performing assets of the banks. This is particularly important as an increasing proportion of
NPAs decreases the profitability of banks. The fall in NPA’s is shown in Exhibit 4.

Phase II of Narsimhan Recommendations : Some of the recommendations of Phase I

were implemented. This helped in the development of the Indian financial system and
has contributed significantly to the increase in savings rate as can be seen from Exhibit
5. The second report of the committee has reiterated many of its previous
recommendations. It has also suggested some new ones in light of seven years of post
reform experience. More than anything else the second phase of banking reforms is a
precursor to full convertibility on the capital account which is expected to be
operational from 2000 in a phased manner. CAC would open the Indian banks to
greater competition from international players. The major recommendations in this
phase are:
• Reducing government stake in banks to 33%: This is a very significant proposal as the
commitee has, instead of saying anywhere less than 50% prescribed a threshold of
33%. This is good as the current limits of holding restrict the ability of banks to tap
the capital market . As a logical fallout of this the appointment of chairmen and
managing directors shall be left to the board of the banks. This will remove a
major inconsistency in the Indian Banking regulatory framework where the owner
and the regulator was the same party(RBI). This anomaly is sought to be rectified
through the Narsimham reccomendations to withdraw all RBI nominees from the
boards of public sector banks.
• Employee stock options to be introduced: This will help motivate the employees of the
banks to perform better as now they would have a personal stake.
• Increasing capital adequacy norm to 10% by 2002: The limit of 10%is more than the
Basle committee requirements of 8%. This has been done because the Indian
experience shows that a little more of capital adequacy is desirable in the interest
of the financial strength of the banking system. Also, Indian banks are being
exposed to more off balance sheet risks than before which is another reason for
the review of capital adequacy norms.
• Conversion of weak banks into narrow banks: The concept of narrow banking implies
that a bank will only lend to a very specific sector which is very credit worthy. This
will help the weak banks in reducing their level of NPA’s.
• Asset reconstruction companies to issue NPA swap bonds: The assets which have been
identified as doubtful or or loss making can be transfered to an Asset
reconstruction Company which in turn issues NPA swap bonds to banks. The ARC
will be allowed to file suits in debt recovery tribunals for recovery.
• Depoliticisation of appointments in boards: This will help improve the flexibility and
autonomy of banks. It will also encourage professionalism in the bank management
and board appointments.

Role of the RBI

Over the years, the RBI has established a system of regulating banks within the overall
macroeconomics and developmental objectives laid down by the Government in the 5 year
plans.

The policy goals of regulating banks in India can be summarized as follows:

Monetary Stability: The statutory basis for the regulation of the credit system by the RBI
is laid down in the RBI act and the Banking Regulation Act. The former confers on the RBI
the usual powers available to Central banks:
• Bank rate
• Open market operations
• Variable reserve requirements

The latter provides special powers of direct regulation of bank operations. The objective of
pursuing this policy goal is that the rate of increase in money supply is kept at a judicious
level above the projected rate of growth of real national income, thus acting as a check on
inflation.

Social and Economic Development :With the help of nationalization , the Government
expected to satisfy the legitimate needs of the hitherto neglected sectors of the economy.
Since then, the RBI's regulatory machinery has been fine-tuned to ensure that banks
comply with the allocative and quantitative goals set from time to time.

Prudential functioning of banks :Prudential regulation helps prevent, limit or stop the
damage caused by inefficient or dishonest management. The following areas have been
specified by the banking Regulation act as the elements of a prudential, regulatory
framework for banks:

• Capital adequacy
• Liquidity
• Appointment of Directors and Chairman
• Control over management
• Branch network
• Treatment of problem and failed banks
• Audit program
• Loans to insiders and other connected parties
• Acquisition of the bank, in the public interest, by the Central Government

Supervisory Functions of the RBI: In addition to its traditional central banking

functions, the RBI has certain non-monetary functions of the nature of supervision of banks
and promotion of sound banking in India. The Reserve bank of India Act, 1934 and the
Banking regulation Act, 1949 have given the RBI wide powers of supervision over
commercial and co-operative banks, relating to the following aspects:
• licensing and establishments
• branch expansion
• asset liquidity
• management and methods of working
• amalgamation, reconstruction and liquidation

In addition, the RBI is authorized to carry out periodical inspection of banks and to call for
returns and necessary information from them. The nationalization of 14 major Indian banks
in 1969 has imposed new responsibilities on the RBI for directing the growth of banking and
credit policies towards more rapid development of the economy and realization of creation
desired social objectives. The supervisory functions of the RBI have helped a great deal in
improving the standard of banking in India to develop on sound lines and to improve the
methods of operation.

The Features of the Banking Industry

The banking sector in India has high growth potential and is expected to grow at around
20-30% in contrast to the stagnant developed economies. Deregulation is also taking
place and the sector is being bought at par with international norms and standards. With
the backing of their strong parent banks abroad many Foreign banks are finding it very
attractive to set up shop in India.

Private players have also been allowed to set up banks in India under the new policy
guidelines in the deregulated environment. This is further going to increase the number
of players in the market and thus the competition is going to further hot up for attracting
customers.

As per RBI norms any bank has to have a minimum required equity base of Rs. 100
crores. This has been done so as to restrict the entry of small players who might be
there in the market just to make a quick profit. At the same time, for other private
players who have got the backing of big institutions behind them this is not really an
entry barrier as the strong parent can easily support this equity base. Moreover, the
private banks have recently been exempted from the SEBI guidelines relating to the
public issue of equity. This implies that the new players can go to the capital market to
raise the required equity to meet the statutory minimum equity base.

Any new player would also be wary of the vast branch network of the existing monolith
nationalised banks. To reduce its cost of funds and hence improve profitability any bank
has to have a large % of its deposits as retail deposits, which can only be possible if the
bank has a large number of branches. This disadvantage due to poor distribution
network can be overcome to an extent by the superior technology, skills and systems
which these new banks would start with. Since depositor switching costs are negligible,
by their better service levels these banks can attract customers from the nationalised
banks. These banks will also be starting from clean balance sheets and no NPA’s which
will make it easier for them to access funs at cheaper rates than the existing players.

The banking industry broadly serves two types of customers: corporates and individuals.
Both of these have their own motivations to park their funds at the banks. With
competition emerging from lot of sources which are also vying for these funds the banks
have to fight hard to retain their ground.
Corporate Banking : Corporates esssentially go to banks for meeting their working
capital needs. But if they could get access to cheaper funds from other sources they
would not hesitate from going to them . The availability of financial instruments like
commercial paper, fixed deposits and also the development of capital markets corporates
are getting access to other easy sources of funds. At the same time it must be kept in
mind that only blue chip corporates are able to raise funds by these instruments.

For other activities of corporates like cash management, forex services, opening letters
of credit etc. it is still the banks which are holding a dominant position, essentially
because of the operational efficiency with which they are able to provide these services.
Substitutes for such services are not likely to come up in the near future. This is also
substantiated by the fact that in recent times, more and more of the income of banks is
coming from fee based activites rather than from interest income.

Retail Banking: The main reason behind customers making deposits in the banks is the
liquidity and safety that is offered to the individual. The customer can go to the bank
anytime and get the money withdrawn. Therefore, the banks charge liquidity premium
and thus offer lesser returns in comparison to the other financial instruments which
cannot be encashed on tap. But now with the availability of a wide variety of financial
instruments a customer can choose the level of liquidity he desires and thus get a higher
return. Exhibit 6 shows the yields on different types of securities available in the market.

Securities like debentures-on-tap, debentures-on-shelf, MMMFs and other open-ended

mutual fund schemes provide the easy liquidity and also benefits of high yield securities.

The suppliers of the sources of funds for the banks are the clients of banks who deposit
money with them. It is a difficult task for a bank for attracting these deposits as clients
can always keep their money with other banks if they think that service levels of other
banks are better. Switching costs for a savings bank account are virtually negligible.
However in savings accounts the product offered is standard and also governed by
regulations, thus making it more or less indistinguishable. In case of bank deposits, the
guiding factors thus are the service level and the accessibility of the customer to the
branch.

In case of time deposits banks have stiff competition from companies offering fixed
deposits and from Non-Banking Finance Companies (NBFCs) which offer higher rates of
return. Therefore banks cannot keep their time deposits way below the deposit rates
offered by NBFCs. At the same time banks are much more safer than NBFC’s as banks
offer deposit insurance and the regulations governing banks are much more stringent
than those covering the NBFC’s.

The growing sophistication on the financial markets and the increased number of
financial instruments has led to a shift in the asset portfolio for the personal sector as
shown in the table below:

Item 1970- 1980- 1990-

71 81 91
Physical assets as a % to total 48.8% 39% 33%
assets
Financial asset as a % of total 51.2% 61% 67%
assets
The above table implies that people are becoming more and more aware of the financial
instruments. This implies that they will be expecting higher service level from the banks
in terms of quick response in clearing of accounts. Also, this implies that people can
easily switch from one financial asset to another.

Further, a trend is evident that while the year-on year increase in term deposits was
17.26%, that of demand deposits was 34.81%. Thus, a fundamental shift in the deposit
structure towards short-term deposits seems to be emerging.

Banks have to always compete with each other to get the accounts of “ blue chip” and
other financially strong corporates. These corporates have a strong cash position and
negligible risk of default. Banks often reduce their lending rates to such clients so that
they can get their accounts. Hence, such clients have high bargaining power.

Corporates which have low credit ratings have little or no bargaining power with banks
keeping in mind their low credit ratings. This translates into more stringent terms and
higher interest rates for these clients as compared to the blue chip clients. In this case,
the bargaining power of banks is quite high.

The competition amongst existing banks is quite fierce but it is so only for lending to
blue-chip companies and established companies with stable cash flows, which banks
perceive as having the least risk. The competition is further intensified because of low
product differentiation and easy copiability of most services.

For other clients, it is mainly a sellers market for banks. Banks are very cautious and
choosy while lending to small or medium companies which are lesser known or to new
ventures which they view as more risky.

For the retail client also the competition is extremely fierce as banks are outdoing each
other to attract these clients by superior technology and much better service levels.

India being a capital starved country the demand for loans will always be immense and
new entrants will thus have enough business on hands as long as they lend judiciously.
Lending is also influenced by macro-economic factors like interest rates for government
securities. If yields on government securities increase as is currently happening, then
banks will prefer to invest in such securities rather than lend to riskier clients. Nationwide
and increasingly world wide recessionary cycles can also affect competition amongst
banks as in boom periods there will be great demand for funds, assuring business for all
and vice-versa.

Players in the Market

The players have been classified on the basis of three main constituents, viz. the Public
Sector banks , the Foreign Banks and the Private Sector banks, as is evident from the
industry structure.

Public Sector Banks

The Public Sector Banks have dominated the Indian banking scene for over three decades
since nationalisation of the banks in 1969. The major players are State bank of India,
Canara Bank and Corporation bank. Public sector banks are those banks in which the
government has a major stake. This control by the government makes these banks put
more importance on social objectives than profitability per se. The cost per rupee of
public secctor banksis given in Exhibit 7.

State Bank of India: The mission statement of SBI is “To become the largest bank in
the Asian banking scene, outside Japan”

The State Bank of India is the largest bank in India. Established in 1921, SBI was formed
by the amalgamation of the Presidency Banks of Mumbai, Bengal and Madras. The Bank
was reconstituted under the SBI Act of 1955. In 1959, the State Banks of Bikaner &
Jaipur, Hyderabad, Indore, Mysore, Patiala, Saurashtra and Tarvancore joined the SBI as
subsidiaries. In 1996, it had 8835 branches, and employed 2.32 lacs people. Its net profit
for the same year stood at Rs. 1329.30 crores (RONW = 16.66%). SBI’s gross NPAs
touched 17% in 1996-97, while the capital adequacy ratio was 12.17%.

SBI also has the largest number of overseas branches, numbering 48 in 34 countries. At
present, 750 branches, accounting for 35% of total business and profits are completely
computerized. Over the next two years, about 2200 branches, covering 75% of total
business are expected to be computerized.
SBI was set up with the objectives of social commitment to promoting agriculture, small
industry and easy access to small investors and for taking banking to the masses by
spreading its branching network to all parts of the country. This objective clearly lacks a
profit focus which any commercial organisation should have for self sustenance. Lately ,
with the market forces gaining prominence the profit perspective is also being taken care
of.

Products & Services Offered : SBI offers a wide range of products and services. Retail
clients would prefer the bank because of its large branch network, ATM facilities, credit
cards and loans. Over the years the bank has established the following subsidiaries:
• SBI Capital Markets : SBI's merchant (investment) banking subsidiary. Engages in
leasing, hire purchase and renders corporate finance advisory services
• SBI Funds Management’s Ltd.: SBI's asset management subsidiary. Offers mutual
funds and other retail products
• SBI Gilts Ltd.: Incorporated as a subsidiary in March 1996 to act as primary dealer in
the govt securities . Asian Development Bank contributed 15% of its equity
• SBI Factors Ltd.: Offers domestic factoring services to industrial and commercial
enterprises
• SBI Securities Ltd.: Incorporated as the stock-broking arm of the SBI Group in
March 1997 . Asian Development Bank has agreed to invest Rs. 150 Million in its
equity

The strengths of SBI are its unparalleled branch network , large deposit mobilisation
capability, wide spectrum of products and services through its associate subsidiaries and
a huge reservoir of skilled manpower. Its credit rating is also AAA. The bank has also
recently gone in for computerisation. This will allow the bank to compete in terms of
quality of services offered with the foreign banks.

The bank also has certain weaknesses. It is based more on geographical and functional
structure rather than business focus with significant centralization leading to procedural
delays. There is also inertia due to huge manpower which also leads to low productivity
standards. Moreover, the Bank Employees Association is a powerful association and the
union usually resists any change which might result in manpower reduction and hence
increase in productivity.
The performance of the bank over the past three years is given in Exhibit 8.
In the recent competitive environment the bank is under increasing pressure in the
following areas :
• Declining New Deposits : The growth rate in deposits has decelerated as borne out
by the fact that it was 11.41 percent in 1994-95 compared to 15.21 percent in
1993-94. This is alarming as the deposits are the cheapest source of funds for any
bank. This, when compared to the overall growth in deposits of the banking sector
as a whole (18.86 percent in 1994-95) shows that the economy wide factors are
not responsible for this decline in growth.

• Commission and Fee Growth rate : This has gone down from 23.41 percent in
1993-94 to 15.47 percent in 1994-95. This income is critical for the bank as in this,
bank does not have to part with the funds, which are the critical resource for any
bank.

• Serious decline in Metros : The foreign banks have concentrated all their efforts in
the metropolitan areas which they have identified as their focus area. The
metropolitan areas are the high profit areas as the concentration of profit
generating customers is high in these areas. The foreign banks have been able to
capitalise in these areas on the basis of their superior service levels and
operational efficiencies as compared to the public sector banks.

• Net interest margin. The margins of the bank are increasingly coming under
pressure due to developments within the banking industry and the financial sector as
a whole.

Corporation Bank : Corporation Bank was founded in 1906 by a group of

philanthropists in the temple town of Udupi and Dakshina Kannada District which is
hailed as the cradle of banking. The bank was nationalized in 1980 and since then has
emerged as an innovative and dyanamic bank. In October 1997, the Bank came out
with an Initial Public Offer of 38 million Equity Shares of Rs.10/- each at a premium of
Rs.70/- and it was a stunning success with a whopping 10.8 times oversubscription.

The Bank has a 3-tier set up, consisting of Corporate Office, 18 Regional Offices and
631 outfits (582 branches and 49 Extension Counters) as on date, spread over 17 States
and 2 Union Territories, with a total workforce of over 9,600. The bank has also done well
in imformation technology implementation with fully computerized branches constituting
36% of the bank’s total branches, covering about 75% of the Bank’s aggregate business.

Exhibit 9 gives the performance of the bank over the past three years.

The bank offers a wide range of products and services , both for the individual as well as
the corporate customer. These are highlighted below:
• Deposit Services: Corporation Bank has structured a wide range of innovative
schemes for its depositors which are tailored to the depostiors liquidity and return
requirements.
• Loan Products: Loans for cars, education , consumer durables, housing, farm
machinery and medical equipment are easily available. Corporates are also given
loans for projects and for trade financing.
• Corporate Services: Corporation Bank has several unique services tailor-made for the
requirement of Corporate and large business houses. Apart from the borrowing
products, two unique products have been developed by Corporation Bank for
speedy collection and payment across a network of locations in India. These
products help corporates to realise their receivables faster or remit funds to
various centres across India.
• Forex Services : Corporation Bank has a wide range of forex services for both
business and non business needs. The Bank undertakes
Collection/Negotiation/discount of Export Bills, it offers to advise Export Letters of
Credit and also add confirmation thereof,it arranges for external commercial
Borrowings, it offers all types of credit facilities to exporters and importers,
including foreign exchange denominated finance to resident entities, it offers
inward and outward foreign exchange remittance services for travel,medical
and other personal requirements. Finally Bank also issues travellers cheques, in
foreign exchange and deals in foreign currency.

Foreign Banks

After the liberalisation process started, lot of foreign banks have proliferated into India,
attracted by the large Indian market. The major foreign banks existing in India are
Citibank, Bank of America, Standard Chartered, ANZ Grindlays, American Express Bank,
Hongkong Bank. These banks have realised the potentially big market in the retail
banking sector. The cost per rupee of operating income for foreign banks is given in Exhibit
10

Citibank : Citibank is a subsidiary of Citicorp, one of the largest banks with assets of more
than 4 250 billion and record earnings in 1995 of approximately 4 3.4 billion. The bank
employs over 85,000 people in 96 countries around the world.

Citibank’s Indian operations started in 1902 in Calcutta. The entry of Citibank (then known
as International Banking Corporation) was part of the “ Asian thrust “ with branches
operating in Hongkong, China, Singapore and Japan. Citibank then opened the second
branch in India, at Bombay, in 1904 and then spread to Delhi (1963) and Madras (1965).

Presently Citibank operates six branches in the country, but its presence is limited to the
four metros. It is the largest private sector financial institution in the country in terms of
operating profits.

Citibank is structured into the following main divisions :

• Private Banking : This is a new unit relying heavily on relationships. This offers a
complete range of financial services and specialises in helping individuals and
families with significant means to pursue their business and aspirations. Citibank
realised that it could offer the personal banking products on the strength of
Relationships that it is competent at building.

• Global Consumer Banking is the globally-integrated retail banking division for

domestic and worldwide financial needs of customers in all the countries of the
world. Beginning in 1985 Global Consumer Business has changed the very concept of
consumer banking in India by pioneering several schemes for the individual
customer. The services include transaction products such as checking accounts,
cards, saving and investment products, credit and insurance. Globally this consumer
segment has been a leader in the development of the automated cash machine, in
the automation of the process shop and credit card transactions.
• Global Finance is the wholesale banking division catering to local and world-wide
financial needs of corporates and other FI's in the Emerging Markets. Today Global
Finance clients include established Indian corporates, multinationals, financial
institutions, major Government enterprises and foreign institutional investors (FIIs)
 looking for portfolio opportunities. The operations of this division include cash/trade
services, Custodial services, treasury operations, CP s etc.
• Global Relationships Banking is the wholesale banking division catering to
corporates.
The performance of the bank over the past three years is given in Exhibit 11.

Bank Of America : BofA is the second best performer among US commercial banks,
coming a close second to Citicorp in terms of assets (US$ 200 billion) and net income (US
$ 2.17 billion). The bank currently has branches in 37 countries and employs over
100,000 people worldwide. Its important services include retail banking, corporate
banking, trade finance, forex advisory and risk management. The bank has been
constantly improving its performance in terms of deposit growth (compounded annual
growth rate of 9.2% over ‘92-’95) and net income (compounded annual growth rate of
21% over ‘92-’95).

BofA’s Indian operations began 30 years ago and the bank currently has branches in the
four metropolitan cities of Bombay, Madras, Calcutta and New Delhi. In 1995, deposits in
India totaled Rs. 21.95 billion and net profits were Rs. 545 million. The Indian operations
have been concentrating largely on corporate customers: the top 100 companies in India
and non-resident Indians (NRI) depositors until recently. In late 1994, the bank expanded
into retail banking and has decided to aggressively target this segment. In Mar. ‘96 BofA
also applied to the RBI for six licenses to allow it to expand its services to non-metro
towns.

Areas of activity in India include:

Commercial Banking - Letters of Credit, Working capital and term loans,
Cash management - Treasury workstations, funds transfers
Treasury management - Forex and securities trading, derivative products, forex
advisory
Consumer banking - Deposits, Car loans, loans against securities
Corporate Finance - Capital market operations, corporate advisory, Mergers and
acquisitions, business advisory

The performance of the bank over the past three years is given in Exhibit 12.
Private Banks

In the first phase of financial reforms in 1991 a major recommendation was to allow the
entry of private players in the banking sector. This was done so as to compete with the
foreign banks on a near equal footing as the public sector banks were in bad shape and
were also under the burden of fulfilling social objectives. Many of these private banks
were promoted by financial institution like IDBI, ICICI, HDFC etc. In a way the government
policy of allowing the entry of private players into the banking sector was also because
these financial instituitons could then mobilise deposits at a lower cost through the retail
sector. Earlier the government used to provide these institutions loans at a subsidised
rate, so that they could match their medium and long term assets. This subsidised loans
had stopped and therefore the government had to give these instituions some kind of
sops as compensation. This they gave by allowing them to set up private banks.

Private sector entities and banking professionals have also been permitted to set up
their own banks, though getting licenses is very difficult.

In the early years the private sector banks raised money through short term sources of
funding like CD’s etc. which had high interset rates. These were then sold to large
institutions and banks. Recently these banks have started expanding rapidly so that they
can tap a major portion of their deposits through retail depositors , which will lower their
cost of funds.

Though the regulations and policies for this sector are not very concrete till now, the
players that have entered the scene are UTI, Indusind, ICICI, HDFC and Centurion. The
cost per rupee of operating income for private sector banks is given in Exhibit 13.

Indusind : Indusind bank,the first private sector bank to be opened in the country has
made rapid strides since its inception in April, 1994. Within a short span of just four years
, the bank has not only emerged as the fastest growing new generation private bank but
also has been rated as the best bank by various surveys.

Indusind , the brainchild of S.P. Hinduja, a leading NRI businessman belonging to the
house of Hindujas, has been set up with the clear aim to be a “ model amongst the
similar new generation banks, setting its eyes on globalisation”. The thrust areas of the
bank are international banking, treasury services, corporate banking, priority sector
banking , investment banking and retail banking.

Indusind is also one of the most modern hi-tech banks. All operations are fully
computerised with a single window concept and fast turnaround time resulting in a high
level of customer satisfaction. All offices of the bank are linked via satellite allowing the
customer instant access to all branches and permitting the bank to offer innovative
products like Indusreach ( anywhere banking for individual), Indusconnect ( for
corporates to efficiently manage their cash flows), Indusinstant( online electronic transfer
of funds), Indusfloat ( one year deposit with floating interest rates ), Induscal
( telebanking services) and internet banking.

IndusInd plans to be an international bank and in lieu of this is planning to set up

overseas offices in New York, London, Dubai and Hongkong after completing its domestic
network of a mere 20 branches by 1996-97.

The performance of the bank over the past three years is given in Exhibit 14.

HDFC bank: When HDFC bank was set up in 1994 its parent’s goal was to create a
“world class indian bank”. Currenly the bank is doing quite well as is shown in the table
below.

HDFC bank follows an interesting strategy. On the lending side the bank is very
conservative . It only lends to the Triple A and Double A clients. In contrast the treasury
desk is the most aggressive in the business and trades actively in debt and foreign
exchange.

Inspite of having a high prime lending rate of 15.25% the bank has been able to attract
top clients like Reliance, Godrej, IPCL etc. One of the reasons for this is that HDFC bank
has recruited the best professionals in the business . All of them have excellent contacts
and they have persuaded blue chip companies to shift some of their business to it.
Another reason for this is that the brand equity of the parent is very high and corporates
thus have confidence in the bank.
The bank is also agressively increasing its deposit base by opening branches. This has
reduced the bank’s dependence on wholesale deposits , which are costlier and more
volatile. Certificates of Deposits( CD’s) have reduced from 28% of total deposits to 2.8 %
of total deposits. They have also kept the minimum balance low so as to attract the
middle class. Moreover, the bank has an equity tie-up with a foreign commercial bank,
National Westminster (NatWest) of the UK and some capital has also come from
overseas corporate bodies with a presence in Singapore and the Gulf. This has not only
helped the bank in building a network and technology sharing arrangement but has also
helped it to attract NRI funds and lower its cost of funds. Another way the bank has
reduced its cost of funds is by building a franchise of products which will give it float
money. The bank has also been appointed as a clearing bank by the National Securities
Clearing Corp. for cash settlements on the NSE. This activity provides the bank with
money at zero interst rate for a short period of time.

Similarly, the corporate finance department has introduced a product called cash
management for its clients - it makes statutory payments like customs and excise duties
on thir behalf. The bank gets a substantial amount of float money becaus of the
differnece between the pay-in and pay-out days .
Some of HDFC’s future plans include:
• Introduce phone banking.
• Widen the scope of cash mangement service.
• Provide equity advice to high networth individuals.
• Offer loans aginst shares.
• Float a money market mutual fund.

The performance of the bank over the past three years is given in Exhibit 15
The RBI data for the banking sector as a whole is given in Exhibit 16.
A summary performance of Indian banks is given in Exhibit 17.

Dimensions Of Competition
To be successful in the competitive Indian market the banks have to compete on the
following dimensions.
• Number of branches : This is a major driving factor in deciding whether a bank
should go for high volume or for low volume. It also decides the banks capability to
mobilise deposits at cheaper rates.
• Quality of customer service : Service differentiation is an important factor which
decides a customer’s choice of bank. It also helps in distinguishing between the
various players.
• Range of products and services offered : In addition to the usual portfolio of
products a bank will have to innovate and take the lead in offering more value
added service and products like ATMs, credit cards etc. so that it can maximise its
business per client by being a one-stop shop.
• Size of the fund base : This again determines what the customer profile for a bank
should be which is an important factor influencing the strategy for a bank. This
factor also decides the bargaining power of banks with its loan clients.
• Technology : A bank needs to have the latest networking technology and
information systems which will result in quicker service levels, maintain internal
controls of banks and reduce manpower costs.Technology is thus being used by
banks as a competitive advantage.
• Niche marketing versus mass marketing : To compete successfully a bank will
have to decide whether it wants to concentrate on getting blue chip clients thus
catering to only a particular market segment or to expand its branches and get the
masses. This is to an extent determined by the variety of products and services
offered by the bank.
• Overall skill level of personnel : Type of people, their attitudes, skills and
motivation levels can make a lot of difference to the performance of the bank.
Professionals with sound knowledge of banking and marketing and with a flair for
innovation can form a banks competitive edge. Productivity levels for the banks
should be high and continuously improving for it to survive.

Future Banking

In the future the following changes are likely to happen to this industry :

NBFC’s becoming prominent : The last decade saw the financial services industry
finally take off. The regulatory structure witnessed quite a shake up and the conditions
were conducive for the financial services sector to find a lucrative foothold in India's capital
markets. The principal advantage which these units have is the lesser degree of regulation
that they are subjected to. Also given the relatively recent origin of these entities, they do
not have any excess baggage to carry with them and they start with clean balance sheets.
The banks have a larger capital base due to government rules and this leads to a larger
capital cost. Priority sector lending is another bane of the banking sector not shared by
the other players in the financial services industry.
Shift towards Fee based business : The banking industry is witnessing a sea change in
its basic structure with a distinct shift in the nature of income. The share of fee based
income has seen a rapid rise in the recent past. The rise of fee based income in the
banking sector's revenue pie can be attributed to the following reasons :
• The last decade has witnessed a deregulation of the financial services sector and
consequently a sharp rise in the proliferation of non banking financial entities in the
country. This is one of the prominent reasons behind the squeeze in interest rate
margins resulting in the banks being forced to look for alternative avenues for
profits.
• The service requirements of the customer has also undergone quite a change. This is a
reflection of the growing consumerist attitude of the customers. The awareness level of
the customer has increased due to exposure to the quality of service offered by the
financial industry. The customer is willing to pay a premium for these high quality and
reliable services.

The share of non interest income is 10 % of the total income for Indian banks compared
to 49 % in Switzerland, 38 % in USA, 41 % in UK and 36.5 % in Germany. The Indian
banking industry is bound to follow in the footsteps of its foreign counterparts in the
shift towards fee based activities, given the rapid globalisation that is taking place.

The Indian Capital Markets offer tremendous scope for fee based activities like custodial
services, electronic transfer, Money market Mutual Funds, portfolio advisory services
etc. Another area which the banks can look to enter are bank funds which are quite
popular in the US. These essentially are mutual funds run by banks and have a lot in
similar with a traditional bank account. Custodial Services would require extremely
sophisticated systems backup support and a good organisational set up.

Formation of larger banks: The banking industry is getting polarised between the
large players and the small players with the smaller players establishing themselves in
lucrative niches. Big banks across the globe are merging with each other and forming huge
entities.
Universal Banking: The boundaries between commercial banks and DFI’s is gradually
diminishing. In a few years time we might have one financial services industry with the
current distinctions between banks and other financial services areas being no longer
valid.
Other Booming Areas : Venture Capital , Housing finance, Consumer durables finance
and credit cards are areas with huge potential and demand in these areas is expected to
rise exponentially in the future.
 Exhibit 1

Structure of the Indian Financial Sector

Indian Financial Sector

Development Banking Non Banking

Banking Institutions Financial
Institutions Intermediaries

Cooperative Commercial Regional Rural

Banks Banks Banks

Nationalized Private Banks Foreign Banks

Banks e.g. Indus Ind e.g. ANZ
e.g. SBI, Indian Bank Grindlays
Bank
 Exhibit 2
Structure of Development Banks in India

Development Banks

All India Development Banks Regional Development Banks

State Financial State Industrial

Corporation Development
Corporation

Industrial Industrial Finance The Industrial Credit Industrial

Development Corporation of and Investment
Reconstruction
Bank of India India Corporation of Bank of India
India
 Exhibit 3

Banking Variables in the 1980’s

Banking Variables Proportion of

total deposits
Demand deposits 18.1

Time deposits 16

Bank credit 18.6

Food credit 16.8

`
Non-food credit 14.9

Investments in 17.8
Gov.Sec

Aggregate deposits 19.4

Exhibit 4

Non-performing loans of Indian banks (as % of total loans)

BANK FY19 FY199 FY199 FY199
94 5 6 7

SBI 17.5 11 7.5 6.07

Bank of Baroda 16.5 15.1 8 6.6

Corporation 7.7 5.8 2.26 2.94

Bank

Canara Bank 18.3 12.5 7.45 7.52

Oriental Bank 8 4 3.3 4.5

PNB 22.3 N.A. N.A. 9.57

Vysya Bank 4.9 4.8 4.2 N.A

 Exhibit 5

Savings Rate Over the Years

Variables 1994- 1993- 1992- 1991-

95 94 93 92

Aggregate deposits 22.8 17.3 16.4 19.8

demand deposits 35.9 21.8 3 35.8
Time deposits 19.9 16.4 19.6 16.5
Bank credit 28.7 8.2 21 8
Food credit 12.5 61.8 44.4 3.6
Non-food credit 29.8 5.7 20.1 8.2
Investments in Govt 16.3 33.3 21.1 25.5
Securities

Exhibit 6

Yields on Securities

Security Yield (% p.a.)

Bank Deposit (Savings 4-6
A/c)
Corporate Debentures 16 - 19
(AAA)
Corporate Fixed 13 - 16
Deposits
Bank Fixed Deposits 9 -13
 Exhibit 7

Cost Per Rupee of Operating Income For Public Sector Banks

1993 1994 1995 1996 1997

Interest/Financial cost 66.68 60.37 56.31 58.35 59.58
On Deposits 58.87 54.89 50.23 49.57 53.96
On RBI loans 3.85 2.72 2.57 4.41 1.94
Others 3.96 2.75 3.52 4.36 3.68
Personnel Cost 13.16 17.49 20.18 20.36 18.39
Loss on exchange 0 0 0 0.03 0.03
transactions
Loss on security transactions 0 0.04 0.04 0.24 0.08
Provision for diminution in 0 0 1.25 2.57 0.41
investment
Other operating Costs 1.06 1.51 1.67 1.24 1
Interest tax 0 0 0 0 0.18
Provision for contingencies 12.93 18.81 10.95 11.69 6.67
Other rent 1.71 2.2 2.04 1.85 1.82
Other expenses 4.39 4.44 3.96 3.86 3.87
Depreciation 0.73 0.67 0.69 0.72 0.81
Tax 0 0 0 0.08 3.67
PAT -0.66 -5.53 2.9 -0.98 3.49
 Exhibit 8
Summary Performance of State bank Of India

Mar 96 Mar 97 Mar 98

Interest income 298.50 453.30 541.22

Dividend income 92.03 121.32 184.19

PAT 52.90 94.45 177.00

Cash & bank balance 485.98 405.55 530.99

Advances 2167.19 2934.94 3467.48

Short term advances 1346.78 1259.68 1642.24
Term advances 661.20 1675.26 1825.24

Deposits 1927.08 2975.83 3860.30

Demand deposits 372.68 561.46 617.37
Savings deposits 99.49 148.08 256.24
Term deposits 1454.91 2266.29 2986.69

Growth (%) :

PAT -2.67 78.54 87.40

Deposits -12.23 54.42 29.72
Advances 57.23 35.43 18.14

Returns ratios (%) :

ROE 17.25 24.95 34.42
ROA 1.61 2.09 2.95

Avg return on advances 15.80 16.82 16.17

Avg cost on deposits 7.84 11.14 10.61
Interest spread 7.95 5.68 5.56

Credit deposit ratio (times) 1.12 0.99 0.90

 Exhibit 9

Summary Performance of Corporation Bank

Mar 96 Mar 97 Mar 98

Interest income 379.08 462.56 505.34

Dividend income 286.52 365.54 522.19

PAT 104.74 125.13 188.34

Cash & bank balance 1965.00 1404.26 2159.84

Advances 2103.12 2736.15 3755.84

Short term advances 1324.75 1620.70 2187.10
Term advances 778.37 1115.45 1568.74

Deposits 5733.96 6673.30 9351.56

Demand deposits 1191.38 1471.75 1443.19
Savings deposits 912.24 1096.75 1315.68
Term deposits 3630.34 4104.80 6592.69

Growth (%) :

PAT 46.41 19.47 50.52

Deposits -6.56 16.38 40.13
Advances 19.97 30.10 37.27

Returns ratios (%) :

ROE 37.39 34.49 30.17
ROA 1.51 1.69 1.98

Avg return on advances 15.95 16.62 13.16

Avg cost on deposits 6.37 7.95 7.77
Interest spread 9.58 8.68 5.39

Credit deposit ratio (times) 0.37 0 .41 0.40

 Exhibit 10

Cost Per Rupee of Operating Income For Foreign Banks

199 199 1997

5 6
Interest/Financial cost 44.0 50.9 50.7
2 4 6
On Deposits 34.4 30.6 42.0
8 7 9
On RBI loans 8.6 10.8 6.26
5
Others 0.94 4.41 2.41
Personnel Cost 7.01 7.77 7.99
Loss on exchange transactions 0.01 0.87 0.55
Loss on security transactions 0.16 0.59 0.28
Provision for diminution in investment 0 1.54 0.52
Other operating Costs 0.41 0.38 0.38
Interest tax 0 0.38 0.55
Provision for contingencies 24.0 3.24 3.72
8
Other rent 1.22 1.73 1.8
Other expenses 10.6 9.99 10.3
9 7
Depreciation 3.47 1.61 1.58
Tax 0 10.1 12.3
1
PAT 8.93 10.8 9.12
6
 Exhibit 11

Summary Performance of Citibank

Mar 96 Mar 97 Mar 98

Interest income 605.62 838.56 888.77

Dividend income 273.43 281.16 298.63

PAT 174.89 54.72 119.22

Cash & bank balance 2048.70 2386.84 2446.58

Advances 3287.00 3788.40 4566.36

Short term advances 1433.34 580.60 711.69
Term advances 1853.66 3207.80 3854.67

Deposits 6775.19 7203.52 7550.72

Demand deposits 858.89 1461.86 1262.02
Savings deposits 214.06 236.28 231.13
Term deposits 5702.24 5505.38 6057.57

Growth (%) :

PAT 33.60 -68.71 117.87

Deposits 11.24 6.32 4.82
Advances 26.68 15.25 20.54

Returns ratios (%) :

ROE 26.85 7.02 13.76
ROA 2.19 0.60 1.17

Avg return on advances 18.91 20.60 18.83

Avg cost on deposits 6.22 7.64 7.49
Interest spread 12.69 12.95 11.34

Credit deposit ratio (times) 0.49 0.53 0.60

 Exhibit 12

Summary Performance of Bank Of America

Mar 96 Mar 97 Mar 98

Interest income 298.50 453.30 541.22

Dividend income 92.03 121.32 184.19

PAT 52.90 94.45 177.00

Cash & bank balance 485.98 405.55 530.99

Advances 2167.19 2934.94 3467.48

Short term advances 1346.78 1259.68 1642.24
Term advances 661.20 1675.26 1825.24

Deposits 1927.08 2975.83 3860.30

Demand deposits 372.68 561.46 617.37
Savings deposits 99.49 148.08 256.24
Term deposits 1454.91 2266.29 2986.69

Growth (%) :

PAT -2.67 78.54 87.40

Deposits -12.23 54.42 29.72
Advances 57.23 35.43 18.14

Returns ratios (%) :

ROE 17.25 24.95 34.42
ROA 1.61 2.09 2.95

Avg return on advances 15.80 16.82 16.17

Avg cost on deposits 7.84 11.14 10.61
Interest spread 7.95 5.68 5.56

Credit deposit ratio (times) 1.12 0.99 0.90

 Exhibit 13

Cost Per Rupee of Operating Income For Private Sector Banks

1993 1994 1995 1996 1997

Interest/Financial cost 64.05 60.65 57.24 61.41 64.77
On Deposits 58.66 55.65 51.14 52.33 58.92
On RBI loans 3.27 2.68 4 6.37 2.88
Others 2.11 2.32 2.1 2.71 2.96
Personnel Cost 18.06 16.31 14.14 12.8 9.87
Loss on exchange 0.2 0.03 0 0 0.02
transactions
Loss on security transactions 0.05 0.02 0 0.31 0.08
Provision for diminution in 0 0 0 0 0.43
investment
Other operating Costs 0.34 0.57 0.45 0.35 0.33
Interest tax 0 0 0.03 0.1 0.35
Provision for contingencies 7.05 11.25 8.74 7.42 5.94
Other rent 1.92 1.85 1.69 1.65 1.75
Other expenses 5.09 5.66 4.81 4.69 4.26
Depreciation 0.63 0.77 1.12 2.32 2.88
Tax 0 0 0 0.27 1.92
PAT 2.62 2.88 10.99 8.54 7.28
 Exhibit 14

Summary Performance of Indusind Bank

Mar 96 Mar 97 Mar 98

Interest income 149.16 308.61 359.77

Dividend income 42.06 100.69 191.27

PAT 45.62 73.32 91.13

Cash & bank balance 307.02 376.55 587.16

Advances 997.92 1825.39 2139.96

Short term advances 925.87 1661.07 1809.58
Term advances 72.05 164.32 330.38

Deposits 1412.23 3093.11 4273.33

Demand deposits 126.33 211.72 342.03
Savings deposits 10.45 26.77 43.84
Term deposits 1275.45 2854.62 3887.46

Growth (%) :
PAT 108.98 60.72 24.29
Deposits 103.23 119.02 38.16
Advances 114.08 82.92 17.23

Returns ratios (%) :

ROE 26.98 28.71 23.01
ROA 3.26 2.69 2.12

Avg return on advances 19.17 21.39 17.32

Avg cost on deposits 7.73 10.23 10.06
Interest spread 11.43 11.16 7.26

Credit deposit ratio (times) 0.71 0.59 0.50

 Exhibit 15

Summary Performance of HDFC Bank

Mar 96 Mar 97 Mar 98

Interest income 114.56 99.79 136.89

Dividend income 0.00 61.95 103.91

PAT 20.28 40.50 63.15

Cash & bank balance 170.08 263.24 541.09

Advances 353.37 531.00 567.03

Short term advances 111.96 225.82 235.02
Term advances 241.41 305.18 332.01

Deposits 685.70 1279.07 2191.74

Demand deposits 226.89 408.86 673.21
Savings deposits 17.31 68.67 177.35
Term deposits 441.50 801.54 1341.18

Growth (%) :

PAT 2435.00 99.70 55.93

Deposits 6.82 86.53 71.35
Advances 260.58 50.27 6.79

Returns ratios (%) :

ROE 12.22 17.42 23.87
ROA 0.92 2.89 2.72

Avg return on advances 17.72 20.83 21.43

Avg cost on deposits 8.92 7.24 5.99
Interest spread 8.80 13.59 15.44

Credit deposit ratio (times) 0.52 0.42 0.26

 Exhibit 16

Aggregate RBI Data on the Banking Sector in India

1990-91 1995-96 1996-97 1998

Aggregate Deposits ( Rs. 192541 433819 505599 557816
Cr.)
33192 80614 90610 90152
Demand............................ 159349 353205 414989 467655
Time..................................
Cash Deposit 13.3 12.4 10.5 10.6
Investment- Deposit 39 38 37.7 39.2
Credit Deposit 60.4 58.6 55.1 51.6

Exhibit 17

Summary Performance of Indian Banks

Parameters Public Private Foreig

Sector Sector n
Banks Banks Banks
Staff expenses/operating 57.59 65.65 60.08
expenses(%)
Average costs of deposits(%) 7.76 6.85 7.23
Average yield on advances(%) 12.36 13.63 17.17
Average yield on 10.65 11.77 11.44
investments(%)
Advance Growth rate(%) 2.11 24.89 21.9
Investment growth rate(%) 38.54 41.44 75.27
Return on Equity(%) 6.29 27.29 -
Bank Interest Interest Interest Operating
Income/ expenses/ spread/ expenses/
(All figures in
Working Working Working Working
%)
funds funds funds funds
State Bank of 9.92 6.88 3.04 2.63
India
Bank of Baroda 10.54 7.60 2.94 2.40
Bank of India 9.00 7.18 1.82 2.35
Punjab 10.60 7.69 2.99 2.55
National Bank
Canara Bank 11.56 7.73 3.82 2.80
Central Bank 10.11 8.18 1.93 3.21
Indian Bank 11.61 9.58 2.02 2.26
UCO Bank 8.01 7.48 0.53 2.65
IOB 8.60 7.94 0.66 2.88
Union Bank 10.66 7.91 2.74 3.17
Citibank 12.80 7.71 5.09 4.40
ANZ Grindlays 11.91 9.30 2.61 2.48
Stanchart Bank 11.08 12.21 -1.14 2.18
Hongkong 12.62 8.71 3.91 2.95
Bank
American 13.95 7.43 6.53 4.28
Express
Bank of 15.97 9.36 6.61 3.11
America
Tokyo Bank 14.12 7.56 6.56 1.34
Deutsche Bank 16.31 9.65 6.65 2.87
ABN Amro 14.85 8.97 5.88 3.08