CHAPTER 1

INTRODUCTION TO DFI’s AND BANKS

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1.1 DEVELOPMENT FINANCIAL INSTITUTIONS

1.1.1 Introduction:

Development Financial Institutions or Development banks are the institutions which

supply capital, knowledge, and enterprise, the three major ingredients of development for
business enterprises. These Institutions provide long term finance to agriculture, industries, trade,
transport and basic infrastructure, so that in the absence of financial resources the economic
development of the country is not adversely affected. These institutions have been taking interest
in industrial finance to industrial sectors as well as promotional development activities of the
industrial units in the country .

William Diamond defines Development Financial Institutions as “an institution to

promote and finance enterprises in the private sector.” It is important to stress that the
development banks apart from financing development projects provide supporting services too.
These institutions provide finance, promote industrial units, and underwrite securities of the
companies and directly invest in shares and debentures of the company. Technical and
managerial advice is also given by them.

1.1.2 Objectives:

(i) To provide various types of assistance like technical, managerial, financial, and

marketing and so on. To provide medium and long-term credit at reasonable cost to
aspiring entrepreneurs.
(ii) To develop over a period of time efficient managerial resources, to help rapid

development of the country.

(iii) To sub-serve the social goals, planned objectives, priorities and targets at national

planning level.
(iv) To allocate resources to high priority areas.

(v) To accelerate the growth of the economy.

(vi) After the globalization process in the beginning of 90’s, development banks diversified

their services to almost each and every sector of the economy.

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 (vii) In countries like India, sheer vastness of size necessitates considerable attention to be

paid to the objective of regional development. In deployment of credit, development

banks pay adequate attention to the regional development objectives.

1.1.3 DFI‟s after post Financial Sector Reforms of 1990:

In India, the Development Financial Institutions were established and developed by

Government of India and Reserve Bank of India (RBI) to meet the specific needs of the industry
and were traditionally engaged in long term financing, as their main objective was to take care of
the investment needs of industries and to contribute to a better industrial climate. They had over
the time, built up expertise in merchant banking, project evaluation and also started giving
working capital finance. Recently, they were allowed to accept medium-term deposits within the
specified limits. Off late, financial institutions were also permitted to combine their traditional
activities with investment banking activities with certain moderate restrictions. Most of the
Financial Institutions have floated banks, institutions and mutual fund subsidiaries. Ownership
changes took place, several institutions went public, and organization structure itself got
transformed.

1.2 COMMERCIAL BANKS

1.2.1 Introduction:
Commercial banks are the premier financial institutions as they play a pivotal role in the
country’s economy. Commercial banks two major functions are accepting deposits and
employing the funds thus mobilized in lending or investing in securities. Banks being financial
institutions, planning and management of funds are essential elements of bank management.

It can be defined as an “institution that offers a broad range of deposit accounts, including
current, savings, and time deposits, and extends loans to individuals and businesses -- in contrast
to investment banking firms such as brokerage firms, which generally are involved in arranging
for the sale of corporate or municipal securities.”

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 1.2.2 Objectives:
(i) To maintain higher profitability by maintaining circular and efficient flow of amount
deposited by the customers and the lenders.
(ii) To contribute to the economic cycle by keeping the money circulation among
households, government and corporate businesses
(iii) To design short term and long term loans and other products to cater to the need of
customers while enhancing their own returns.
(iv) To attract more customers and build profitable relationships with the new and existing
customers.

1.2.3 Commercial Banks after post Financial Sector Reforms of 1990:

Traditionally, the commercial banks in India were largely into the core banking business of
accepting deposits and providing working capital funds to agriculture and allied, trade and
industry sectors. In early 90’s the financial sector in India was out for reforms. Ever since the
process of liberalization there was a change in the scenario. The banking sector saw the
emergence of new-generation private sector banks. Public sector banks which played useful role
earlier on are facing deterioration in their performance. For very long banks in India were not
allowed to have access to stock markets. So their dealing in other securities was minimal. But the
financial sector reforms changed it all.

Indian banks started to deal on the stock market but their bitter experiments with scams;
they became averse to deal in equities and debentures. Some banks have even set up their own
subsidiaries for their investment activities. Subsidiaries include in the area of Merchant banking,
factoring, Credit cards, housing finance etc. Commercial banks offer a wide range of corporate
financial services that address the specific needs of private enterprise. They provide deposit, loan
and trading facilities but will not service investment activities in financial markets.

Commercial banks play a number of roles in the financial stability and cash flow of a
countries private sector. They process payments through a variety of means including telegraphic
transfer, internet banking and electronic funds transfers. Commercial banks provide a number of
import financial and trading documents such as letters of credit, performance bonds, standby

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letters of credit, security underwriting commitments and various other types of balance sheet
guarantees. They also take responsibility for safeguarding such documents and other valuables
by providing safe deposit boxes. At present, Indian banks are engaged in credit, consumer
finance, savings, money and capital, advisory services and recently insurance market.
According to Saunders and Walters, India falls under Partially Integrated Financial
Conglomerates model of Universal Banking which is as follow:

(Source: Global Banking, Roy Smith and Ingo Walter)

An example of State Bank of India may be quoted here which has set up the following
subsidiaries:

(i) SBI funds Management.

(ii) SBI Capital Markets.

(iii) SBI Factors and Commercial Services.

(iv) SBI Home finance.

(v) SBI Life Insurance Company.

(vi) SBI Gilts.

Therefore Indian banks are already moving in the direction of Universal Banking,
undertaking all the financial services under one roof.

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1.3 IMPORTANT ACTIVITIES OF BANKS AND DFI‟s

Commercial Banking Investment Other Financial services

or similar in nature banking

Banks Accepting chequable Investments in Factoring, Leasing, Hire-

deposits, Granting loans Securities, purchase, Mutual funds,
and advances. Underwriting of Merchant banking,
loans, Housing Finance.
Loans Syndication.

DFI‟s DFI’s granting Long- Underwriting and Commercial banking,

term Loans and
Advances, Short-term
Loans and Advances,
Working capital finance,
Accepting term-deposits
and issuing Certificate of
Deposits.
Subscribing Credit rating, Brokerage,
directly to shares / Housing Finance, Mutual
bonds of corporate. funds, Project
Consultancy, Registrar
Services etc.

(Source: Universal Banking, Dr. P.K. Bandgar and Aarthi Kalyanraman)

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 1.4 COMMERCIAL BANKS V/S DFI‟s

DFI’s were set up either under The Companies Act 1956, or as statutory bodies under the
acts of parliament. These are prudential requirements as also entry conditions for banks under
Banking Regulation Act 1949, for undertaking banking business.

Commercial Banks Development Financial Institutions

Commercial banks Short term finance.
They undertake the Planning and
Management of essential elements of
banking.
Commercial banks accept deposits and
lend loans.
Banks are allowed to invest in shares of
private bodies and public sector
undertakings of their incremental
deposits in the previous year.
Planning includes:
(i) (i) Estimation of funds required.
(ii) (ii) Sources of finance and their
proportion.
(iii) (iii) Utilization of fund.
(iv) (iv) Control and monitoring the Fund.
Sound planning helps banks in meeting
its obligation of:
a) a) Statutory requirements.
b) b) Assisting various sectors.
c) c) Fulfilling Social obligations.
d) Maintaining efficiency and
profitability.
Commercial banks Short term finance.
To promote growth and provide support they
are going to underwrite securities, invest in
Shares and Debentures of other commercials.
DFI’s provide capital, expertise and knowledge.
They have been allowed to invest partially into
the deposit market subject to limit related to
their net worth.
DFI’s provide all kinds of assistance such as:
(i) Medium to Long term credit at reasonable
cost.
(ii) Development of managerial resources to
priority areas.
(iii) Accelerating growth of the economy.
(iv) Adequate attention to regional
development.
(v) Diversification to all fields after
globalization.

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1.5 NEED FOR DFI‟s CONVERTING INTO BANKS

1. High cost of funds, which is over 12 percent in case of a financial institution and just over
6 percent in case of a commercial bank.
2. Increasing competition, due to increase in various new players like insurance companies,
mutual fund entities etc.
3. Low demands for long term funds, due to absence of heavy project investments
especially in the area of infrastructure.
4. High level of non-performing assets.
5. Increasing competition from commercial banks in retail financial market.
6. Lower spread due to extensive competition.
7. High competition in market to attract top rated borrowers at low.
8. The global financial services market is growing very fast and chains of foreign banks are
attacking traditional banks by offering new products of loans and investment portfolios
under one roof.
9. Liberalization and de-regulation of financial markets have led to fragmentation of
traditional branch services.
10. Information Technology development has paved the way for excellent customer services

by way of providing electronic distribution channels. New breed of private sector banks
and foreign banks are providing a wide range of services under one roof.
11. Many foreign banks and new breed of private sector banks have started outsourcing

various products. For e.g. Credit cards, Insurance products, etc.

12. Customers have become very demanding now. They want various financial services

including expert advice on investment and portfolio management for longer hours. (24
hours, 365 days) and sometime in their houses also.
13. Foreign banks and new private sector banks are integrating all its customer information

and making the information available across all different delivery channels, i.e. their
branches. Many other banks have also realized that the data warehousing has the potential
to play an immensely important role in the future, especially in relation to how the banks
use their information with their virtually delivery channels.

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 CHAPTER 2

HARMONISATION OF BANKS AND DFI’S

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2.1 INTRODUCTION
The financial sector reforms ushered a significant change in the operating environment of
banking and development financial institution. The deregulation of interest rates,
disintermediation and increasing participation by banks in project finance altered the operation
environment of bank by, paving way for universal banking. The development financial
institution set up in the year 1948 with a view to meet the long term financial needs of a project
realized that to mitigate the inherent risk arising from a care product dominant portfolio, they
have to resort to product diversification. With development financial institution making forays
into the realm of working capital or short term financing, the traditional operational division
between banks and development financial institutions became increasingly blurred.

2.2 KHAN WORKING GROUP

2.2.1 Introduction:

In the light of number of reform measure adopted in the Indian financial system of reform
measures adopted in the Indian financial system since 1991 and keeping in view the need for
evolving an efficient and competitive financial system .the reserve bank constituted on
December 8th 1997, a working group for harmonising the role and operation of DFIs and banks ,
under the chairmanship of chairman and managing director of industrial development bank of
India, Shri S.H.Khan with following terms of reference:

(i) To review the role, structure and operation of DFI’s and Commercial banks in emerging
environment.
(ii) To suggest measures for bringing about harmonization in their roles and operations.
(iii) To suggest measures for strengthening of the organization, human resources, risk
management practices and other related issues in DFI’s and Commercial banks.
(iv) To examine whether DFI’s could be given increased access to short-term funding and the
regulatory framework needed for the purpose.
The working Group submitted its interim report in April and Final Report in May 1998.
After the submission of the Khan Working Group report, the Reserve Bank released a discussion
paper on the topic „Harmonizing the role and operations of Development Financial
Institution and Banks‟ in January 1999.

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 The discussion paper observed that the approach to universal banking in India should be
guided by the twin considerations of international experience and domestic requirements and
contended that the transformation of a Development Financial Institution should ideally be
considered after a reasonable period of time has elapsed. In the interim, Development Financial
Institutions could tailor their needs to become either a Non Banking Financial Company or a
bank, depending on institution-specific considerations and their comparative advantages. The
options to pursue banking activities could occur either through a process of mergers and
acquisitions, thus enabling Development Financial Institutions to reap the economies of a branch
network through a full fledged subsidiary as a part of the conglomerate. The Narasimham
committee II on Banking Sector Reforms (1998) suggested that DFI”s should convert ultimately
in to either commercial banks or Non-banking finance Companies. The transitory arrangements
in the process of evolution could be worked out, after a detailed examination by the RBI, on a
case-by-case basis, in view of the unique position of each financial position of each financial
institution as part of its progress towards universal banking practices.

In view of the special role of banks in the financial sector, and such conglomerate, in which
a bank is present, should be subject to a consolidated approach to supervision and regulation,
while ensuring consistency with monetary policy and prudential standards. The discussion paper,
however, recognized that till such time as the long term debt market improves in terms of depth
and liquidity, there would be a definitive role for the Development Financial Institutions in
providing long term development finance.

The Khan working group held the view that DFI’s should the allowed to become banks at
the earliest. The feed back on the Discussion Paper (DP) released in January 1999 by RBI,
indicated that while universal Banking is desirable from the point of view of efficiency of
resources, there is need for caution in moving towards such a system by banks and Development
Financial Institutions.

2.2.2 Khan Working Group Recommendations on Conversion of DFI‟s

The Khan Working Group (KWG) keeping in views the deregulation, securitization and the
diversification of business by banks into investment banking and beyond, made following
recommendations:

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 1. The approach to universal banking should be guided by international experience and
domestic requirements.
2. The DFIs should have the freedom to remain DFIs, specializing in their own activities.
However, if a DFI chooses to become a bank, venturing into commercial banking
activities, that option should also be available. In that case, the „Converted DFI‟ should
be prepared to fully conform to all prudential, regulatory and supervisory norms which
are applicable to banks.
3. The question of transformation of DFI into a bank should ideally be considered after a
period, say of five years from now. When a DFI chooses to transform itself into a bank,
the transitionary arrangements on a time bound basis could be worked out. This case by
case approach is essential because each DFI would be in a unique position in terms of its
capacity to transform into a bank.
4. If a DFI chooses to provide bank like services by itself through a wholly owned
subsidiary route, permission to set up a fully owned subsidiary could also be considered
by the RBI.
5. If a DFI, does not acquire a banking license within a stipulated period, it would be
categorized as a NBFC.
6. KWG has suggested that super regulations be established to supervise and coordinate the
activities of the multiple regulations in order to ensure uniformity in regulatory treatment.
7. The overall ceiling for DFIs mobilization of resources by term money borrowings,
certificate of deposits, term deposits and inter corporate deposits at 100 percent of NOF
(Net Owned Funds) of DFIs may be removed.
8. KWG recommend that a suitable level of Statutory Liquidity Ratio may be stipulated for
DFIs on incremental outstanding fixed deposits raised from the public (excluding inter
bank deposits).
9. KWG recommended:
a) The application of Cash Reserve Ratio (CRR) should be confined to cash and cash
like instruments.
b) CRR should be brought down progressively within a time bound frame to
international levels.
c) SLR should be placed in line with international practice.

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 10. To manage risks Khan Working Group recommended:

a) A prudent risk returns relationship strategy.

b) A clear strategy approved by the board of directors as to their risk management
policies and procedures.
c) An integrated treasury and proactive asset liability management and robust
operational controls.

2.3 NARASIMHAM COMMITTEE

2.3.1 Introduction:

The Narasimham committee II on Banking Sector Reforms (1998) suggested that DFI”s
should convert ultimately in to either commercial banks or Non-banking finance Companies.
Narasimhan Committee report made certain recommendations which have a bearing on the
issues considered by the Khan Working group.

2.3.2 Major Recommendations of the Committee on Banking sector

Reforms, 1998 (Narasimhan Committee-II) relating to DFI‟s:

The major recommendations of the Narasimhan Committee-II in so far as they relate to

DFI’s are set out below:

1. With convergence of activities between banks and DFI’s the DFI’s should over a
period of time/convert themselves into banks. There would then only be two forms of
intermediaries, viz., banking companies and non-banking finance companies. If a DFI
does not acquire a banking licence within a stipulated time, it would be categorized as
a non banking finance company.

2. A DFI which converts into a bank can be given sometime to phase its reserve
requirements in respect of its liabilities to bring it on par with the requirements
relating to commercial banks.

3. Mergers between banks and DFI’s and NBFC’s need to be based on synergies and
locational and business specific complementarities of the concerned institutions.

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4. Merger between strong banks/FI would make for greater economic and commercial
sense and would be cases were the whole is greater than the sum of nits parts and
have a “force multiplier effect.”

5. To provide the much needed flexibility in its operations, IDBI should be corporatized
and converted into a Joint stock company under the Companies act, 1956 on the lines
of ICICI, IFCI and IIBI. For providing focused attention to the work of State
Financial Corporations, IDBI shareholding in them should be transferred to SIDBI
which is currently providing refinance assistance to State Financial Corporations. To
give it greater operational autonomy, SIDBI should also be de-linked from IDBI

6. The Supervisory function over rural financial institutions has been entrusted to
NABARD. While this arrangement may continue for the present, over the longer-
term, the committee would suggest that all regulatory and supervisory functions over
rural credit institutions should vest with the Board for Financial Regulation and
Supervision (BFRS).

7. For effective supervision, there is need for formal accession to “Core principles”
announced by BASEL committee in September 1997.

8. An integrated system of regulations and supervision is put in place to regulate and

supervise the activities of banks, financial institutions and non-bank finance
companies (NBFC’s) and the agency (Board for Financial Supervision) be renamed
as the Board for Financial Regulation and Supervision (BFRS).

9. To have in place a place dedicated and effective machinery for debt recovery for
banks and financial institutions.

10. With the advent of computerization, there is need for clarity in the law regarding the

evidentiary value of computer generated documents. Also, issues regarding

authentication of payment instruments, etc. require to be clarified. A group should be
constituted by the Reserve bank to work out the detailed proposals in this regard and
implement them in a time-bound manner.

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2.4 SALIENT OPERATIONAL AND REGULATORY ISSUES OF RBI TO
BE ADDRESSED BY THE FIs FOR CONVERSION INTO A
UNIVERSAL BANK (RBI CIRCULAR).

1. Reserve requirements
Compliance with the cash reserve ratio and statutory liquidity ratio requirements (under
Section 42 of RBI Act, 1934, and Section 24 of the Banking Regulation Act, 1949,
respectively) would be mandatory for an FI after its conversion into a universal bank.
2. Permissible activities
Any activity of an FI currently undertaken but not permissible for a bank under Section
6(1) of the Banking Regulation Act, 1949, may have to be stopped or divested after its
conversion into a universal bank.
3. Disposal of non-banking assets
Any immovable property, howsoever acquired by an FI, would, after its conversion into
a universal bank, be required to be disposed of within the maximum period of 7 years
from the date of acquisition, in terms of Section 9 of the Banking Regulation Act.
4. Composition of the Board
Changing the composition of the Board of Directors might become necessary for some
of the FIs after their conversion into a universal bank, to ensure compliance with the
provisions of Section 10(A) of the Banking Regulation Act, which requires at least 51%
of the total number of directors to have special knowledge and experience.
5. Prohibition on floating charge of assets
The floating charge, if created by an FI, over its assets, would require, after its
conversion into a universal bank, ratification by the Reserve Bank of India under Section
14(A) of the Banking Regulation Act, since a banking company is not allowed to create
a floating charge on the undertaking or any property of the company unless duly
certified by RBI.
6. Licensing
A Financial Institution converting into a universal bank would be required to obtain a
banking licence from RBI for carrying on banking business in India.

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7. Nature of subsidiaries
If any of the existing subsidiaries of an FI is engaged in an activity not permitted under
Section 6(1) of the Banking Regulation Act, then on conversion of the FI into a
universal bank, delinking of such subsidiary / activity from the operations of the
universal bank would become necessary since Section 19 of the Act permits a bank to
have subsidiaries only for one or more of the activities permitted under Section 6(1) of
Banking Regulation Act, 1949.
8. Restriction on investments
An FI with equity investment in companies in excess of 30 per cent of the paid up share
capital of that company or 30 per cent of its own paid-up share capital and reserves,
whichever is less, on its conversion into a universal bank, would need to divest such
excess holdings to secure compliance with the provisions of Section 19(2) of the
Banking Regulation Act, which prohibits a bank from holding shares in a company in
excess of these limits.
9. Connected lending
Section 20 of the Banking Regulation Act prohibits grant of loans and advances by a
bank on security of its own shares or grant of loans or advances on behalf of any of its
directors or to any firm in which its director/manager or employee or guarantor is
interested. The compliance with these provisions would be mandatory after conversion
of an FI to a universal bank.
10. Branch network
An FI, after its conversion into a bank, would also be required to comply with extant
branch licensing policy of RBI under which the new banks are required to allot at least
25 per cent of their total number of branches in semi-urban and rural areas.
11. Assets in India
An FI after its conversion into a universal bank, will be required to ensure that at the
close of business on the last Friday of every quarter, its total assets held in India are not
less than 75 per cent of its total demand and time liabilities in India.

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12. Format of annual reports
After converting into a universal bank, an FI will be required to publish its annual
balance sheet and profit and loss account in the forms set out in the Third Schedule to
the Banking Regulation Act, as prescribed for a banking company under Section 29 and
Section 30 of the Banking Regulation Act.
13. Managerial remuneration of the Chief Executive Officers
On conversion into a universal bank, the appointment and remuneration of the existing
Chief Executive Officers may have to be reviewed with the approval of RBI in terms of
the provisions of Section 35 (B) of the Banking Regulation Act. The Section stipulates
fixation of remuneration of the Chairman and Managing Director of a bank by Reserve
Bank of India taking into account the profitability, net NPAs and other financial
parameters.
14. Deposit insurance
An FI, on conversion into a universal bank, would also be required to comply with the
requirement of compulsory deposit insurance from DICGC up to a maximum of Rs.1
lakh per account, as applicable to the banks.
15. Authorized Dealer's Licence
Some of the FIs at present hold restricted AD licence from RBI, Exchange Control
Department to enable them to undertake transactions necessary for or incidental to their
prescribed functions. On conversion into a universal bank, the new bank would normally
be eligible for full-fledged authorized dealer licence and would also attract the full
rigour of the Exchange Control Regulations applicable to the banks at present, including
prohibition on raising resources through external commercial borrowings.
16. Priority sector lending
On conversion, the obligation for lending to "priority sector" upto a prescribed
percentage of their 'net bank credit' would also become applicable to it.
17. Prudential norms
After conversion of an FI in to a bank, the extant prudential norms of RBI for the all-
India financial institutions would no longer be applicable but the norms as applicable to
banks would be attracted and will need to be fully complied with.

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2.5 BANCASSURANCE – AN IMPORTANT FACET OF CONVERSION OF
DFI‟s TO BANKS

a) Bancassurance is one of the important channels for mobilizing business for insurance

companies and it is one of the income sourcing activities of universal banks. The concept
of universal banks includes insurance in addition to commercial banking and investment
banking. The European countries and the US have already demonstrated the possibility of
combining banking with insurance. The European concept of Bancassurance in “Alfinaz”
has found acceptance in India of late, according to which banking and insurance services
can be allotted by a single organization.
b) RBI has recognized the importance of insurance and accordingly given guidelines for

entry of banks into insurance business.

i. Banks can undertake agency for insurance services i.e. they can sell insurance
products for certain fees.
ii. Banks can establish joint venture companies for insurance business.
iii. Banks can make an investment in insurance companies.
c) Banks don’t involve directly in insurance business because of risk involved in it. This

concept involves greater fee income and also helps in retaining the customers for a longer
period. It also contributes to the profitability of banks and insurance companies. It creates
competitive advantage through cross selling synergy. Banks should have a strategic
alliance with foreign counter parts. It should fulfill the requirements of Insurance
Regulatory Development Authority (IRDA), Securities and Exchange board of India
(SEBI), Reserve bank of India (RBI) and Government of India.
d) Banks and Insurance Companies have agreement with the objectives:

i. Improve competitive positioning.

ii. Gain entry into new markets.
iii. Supplement critical skills.
iv. Share the risk and cost.
e) The strategic alliance will improve brand image and reputation of the bank, reduce the

cost through economies of scale, create more customers, manage the relationships and
enhance long term prospects by achieving above stated objectives and ultimate
profitability.

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 f) The new private sector banks have become global players in the financial sector by

adapting to universal banking activities. Banks in the public sector like SBI, Corporation
bank have also made tie-ups with insurance companies in changing their trends to
universal banking.

Some of the strategic alliances of banks are listed below:

Strategic Alliances

Bank Partners for Life Partners for

Insurance General/Non-life
Insurance

ICICI Bank Prudential Life, England Lombard Insurance,

England

HDFC Bank Standard Life, USA CHUBB, USA

ING Vysya ING Life Insurance Royal Sundaram Bank,

Netherlands

Development Credit Bank Birla SunLife, (SunLife of Bajaj Allianz, Germany

Canada)

State Bank of India SBI Life

------------

Corporation Bank LIC of India

------------

CITI Bank Birla Sun Life

------------

Kotak Mahindra Old Mutual

-------------

Like wise some other banks have direct strategic alliances with the foreign partners. Other
banks have alliance with Indian companies who have a partnership with foreign insurance
companies. In order to exploit the opportunity of taking a good market share strategic alliances
are helpful. They create volume, manage relationships, and enhance long term prospects.

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2.6 ISSUES ARISING FROM CONVERSION OF DFI‟S TO BANKS

1. Conversion of DFI’s into banks and introduction of bancassurance scheme will no doubt

accelerate the move towards Universal banking but the development will create certain
problems.

2. Though the DFI’s can extend term loans even after their conversion into banks, the banks
are likely to lose interest in term lending since bank’s major source of funds are short and
medium term deposits which cannot be used foe extending long term loans.

3. In the absence of a well developed debt market and liberal inflow of foreign capital,
availability of long-term loans will be affected and which in turn will affect industrial
development. DFI”s will have to continue to provide long-term loans even after
converting themselves into banks.

4. After conversion into banks, the banks will have to meet Statutory Liquidity Ratio and
Cash Reserve Ratio requirement. To the extent they contribute to Statutory Liquidity
Ratio and Cash Reserve Ratio the funds available for their operations will get reduced.

5. The conversion with banks will not solve the problem of Non Performing assets of DFI’s
and it will only add to the problems of the huge institutions after merger takes place.

6. The acceptance of the bancassurance concept is welcome. For its success, the banks
taking up insurance will have to train their staff, since the nature of banking business for
which they are trained is very much different from the nature of insurance business.

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 CHAPTER 3
ICICI MERGER

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3.1 INTRODUCTION
ICICI (merged with ICICI Bank in March 30, 2002) established in 1995 facilitated the
economic objectives. Though ICICI played a highly significant role in assisting industrial
development through long term lending and a variety of other services to industry, it started
facing problems in 1990’s. Project like steel, textiles, basic chemicals in which heavy investment
had been made suffered losses and the default rate increased causing problems to all DFIs
including ICICI. In absolute terms, the NPAs outstanding in these sectors totaled to Rs 1333
crore – about 17 percent of ICICI’s total equity capital. The company began to look for safer
ways to deploy incremental resources. Two new investment avenues that stand out are the
massive deployment into medium-term corporate finance and retail lending.

Traditionally, ICICI had on-lent resources towards financing projects for duration of five to
seven years. The lending carried a relatively high degree of risk in the current environment. Over
the last three years or so, an increasing proportion of lending was directed towards medium-term
corporate finance. The implication of this is that the risks are lower, but so also the returns. So,
now about 40 percent of ICICI’s total portfolio today is deployed towards corporate financing.
To put that in perspective, around 60 percent of the incremental lending over the last four years
has been directed towards corporate finance.

The huge shift towards corporate financing has come at the expense of financing the projects
of traditional manufacturing sector. The implications of this major shift are that the risk
associated with the company’s current portfolio is, perhaps, lower than what the other DFI’s
have, and the returns on deployment are getting lower.

The two most important factors enabling the smooth and speedy implementation of the plan
of conversion by ICICI Ltd. were:

i. The ready banking platform available with it for launching itself into a universal bank,
by way of backward integration with its banking subsidiary.
ii. The private company character of the DFI, with resultant operational freedom and ability
to leverage, the superior managerial resources and skills available with it, in steering the
organization along the transition path.

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 Medium-term financing means that ICICI’s return on the money lent is done at a lower rate.
It is not just lower interest earned on losses that led to reduction in spread from around 3.46
percent in fiscal 1997 to 1.85 percent in fiscal 2000; ICICI also had to deal with higher cost
funds. Till the early 1990s, the DFIs were entitled to concessional long-term funds. Since then,
they have been forced to rely on a crowded market for funds, thereby raising the cost of their
funds.

3.2 UNIVERSAL BANKING

A higher proportion of corporate financing is not the only significant change in ICICI’s
operations. Over the last few years, the company’s top management has not missed an
opportunity to publicize the desire to move towards universal banking. Universal banking is
nothing but a presence in every dimension of financial service and given the disappearing
boundaries in the financial sector today, universal banking is a feasible option.

In last decade, ICICI has entered – subsidiaries and ventures – the areas of commercial
banking, investment banking, asset management, housing finance, personal finance and now life
insurance. It gradually diversified its activities and several new products evolved to meet the
changing needs of the corporate sector. ICICI provided a range of banking products and
including project finance, corporate finance, corporate finance, syndication service strategy
based financial products, and cash inflow based management tools as well as advisory services.
Subsequently it entered into commercial banking by establishing ICICI bank in 1994.
In the context of emerging competitive scenario in the financial sector the Board of Directors of
ICICI Ltd. and ICICI bank Ltd. in October 2001 approved the merger of ICICI Ltd. with
ICICI Bank Ltd.

Consequent upon the merger, the ICICI group’s financing and banking operations both
wholesale and retail have been integrated into a single full service banking company effective
May 2002. In fact ICICI has already harnessed some of the gains by transforming itself into a
virtual universal bank over past 5 rendering retail and corporate financial services though the
gamut of the following key building blocks present across the group of one hand and powered by
internet and technology platforms on the other hand:

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 Retail Financial Services Corporate Financial Services
ICICI ICICI
ICICI Bank ICICI Bank
ICICI Capital ICICI Securities
ICICI Prudential ICICI Brokerage
ICICI Web Trade ICICI Venture
ICICI PFS ICICI InfoTech
ICICI Home ICICI Lombard

(Source: Universal Banking, Dr. P.K. Bandgar and Aarthi Kalyanraman)

Throughout 90s, ICICI Group has nurtured the following building blocks that have in fact
have served as the Group’s strategy for success:

a) Organization Values.
b) Human Capital.
c) Seed Capital.
d) Brand Identity.
e) Knowledge Capital.
f) Technology Capital.

The above supplemented by organizational changes have created the right combination for
achieving leadership.

3.3 EFFECTS OF MERGER

The merger was approved by the shareholders of both companies in January 2002, by the
High Court of Gujarat in March 2002, and by the High Court of Judicature at Mumbai and the
Reserve Bank of India (RBI) in April 2002. ICICI could successfully meet the statutory reserve
requirements applicable to banks within the target date of March30, 2002.

While the merger became effective on May 3, 2002, in accordance with the provision of the
Scheme of Amalgamation and the terms of approval of RBI, the appointed date for the merger
was March 30, 2002. The merger created India’s first universal bank and the second largest bank

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in country with total assets of about Rs 1 trillion and about 540 branches and offices and over
1000 ATMs.

The merged entity has now an access to low-cost deposits, higher income and participation in
the payment system, entry into new business segments, higher market share in various segments
especially in fee-based services and vast talent pool of ICICI and its subsidiaries which, in turn,
would enhance the value for ICICI Bank shareholders.

The merger has resulted in the integration of the retail finance operations of ICICI and its two
merging subsidiaries and ICICI Bank into one entity, creating an optimal structure for the retail
business. The share exchange ratio approved for the merger was one fully paid-up equity share of
ICICI Bank for two fully paid-up equity shares of ICICI. ICICI Bank’s equity shares are listed in
India on stock exchanges at Bombay Stock Exchange and National Stock Exchange.

The merger helped ICICI to increase its profits, stability and growth of the company. The
pre-merger profit of ICICI Limited before additional provision for tax was Rs 1,332 crore for the
year 2002 as compared to Rs 1,390 crore for the year 2001. The profit after additional provisions
and tax increased by 25% to Rs. 670 crore for the year 2002 from Rs. 537 crore for the year
2001. The ratio of net non-performing assets to net customer assets of the merger entity was
4.7% on March 31, 2002.

Consequent to the merger of ICICI with ICICI Bank, ICICI’s subsidiary companies of the
bank. On March 31, 2007, ICICI Bank had twelve subsidiaries:

(Source: www.icicibank.com)

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1. Principal Subsidiaries

i. ICICI Securities and Finance Company Ltd.

ii. ICICI Venture Funds Management Company Ltd.

iii. ICICI Prudential Life Insurance Company Ltd.

iv. ICICI Lombard General Insurance Company Ltd.

v. ICICI Securities primary Dealership Ltd.

vi. ICICI Prudential AMC and Trust.

2. Other Subsidiaries

i. ICICI Home Finance Company Ltd.

ii. ICICI Brokerage Services Ltd.

iii. ICICI Securities Holdings Inc.

iv. ICICI International Ltd.

v. ICICI Investment Management Company Ltd.

vi. ICICI Trusteeship Services Ltd.

3. Affiliate Companies

i. ICICI Infotech Services Ltd.

ii. ICICI Web Trade Ltd.

iii. ICICI One Source Ltd.

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ICICI Securities and Finance Company Ltd.

A subsidiary of ICICI Bank, ICICI Securities and Finance Company Ltd. was set up in
February 1993 to provide investment-banking services to investors in India. As on date ICICI
Securities is a strongly positioned investment bank in India and provides products and services in
Fixed Income, Equities and Corporate Finance. In the fixed income business ICICI Securities
is a leading market participant in the country. ICICI Securities fixed income activities include
interest rate trading, derivatives trading, research and issue management. The Corporate Finance
business focuses on industry consolidation. ICICI Securities has been involved in a number of
mergers, cross border acquisition, equity and bidding for a number of reputed companies.

The Company has one subsidiary in India namely; ICICI Brokerage Services Ltd. in order
to assist/provide corporate clients and institutional investors with investment banking services in
the United States of America, ICICI Securities has set up two subsidiaries namely, ICICI
Securities Holdings Inc and ICICI Securities Inc.

ICICI Securities Inc. has become the registered broker dealer with the National Association
of Securities Dealers Inc, empowering it to engage in a variety of securities transactions in the
U.S. market. ICICI Brokerage Services Limited, a member of the National Stock Exchange of
India Limited, is the domestic broking subsidiary of ICICI Securities.

ICICI Venture Funds Management Company Ltd.

ICICI Venture is one of the largest and most successful private equity firms in India with
funds under management in excess of USD 2 billion. ICICI Venture, over the years has built an
enviable portfolio of companies across sectors including pharmaceuticals, Information
Technology, media, manufacturing, logistics, textiles, real estate etc thereby building sustainable
value. ICICI Venture is a subsidiary of ICICI Bank, the largest private sector financial services
group in India.

ICICI Prudential Life Insurance Company Ltd.

ICICI Prudential Life Insurance Company is a joint venture between ICICI Bank - one of
India's foremost financial services companies-and Prudential plc - a leading international

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financial services group headquartered in the United Kingdom. Total capital infusion stands at
Rs. 47.80 billion, with ICICI Bank holding a stake of 74% and Prudential plc holding 26%.

It started its operations in December 2000 after receiving approval from Insurance
Regulatory Development Authority (IRDA). Today, our nation-wide team comprises of 2074
branches (inclusive of 1,116 micro-offices), over 225,000 advisors; and 7 bancassurance
partners.

ICICI Prudential is the first life insurer in India to receive a National Insurer Financial
Strength rating of AAA (Ind) from Fitch ratings. For three years in a row, ICICI Prudential has
been voted as India's Most Trusted Private Life Insurer, by The Economic Times - AC
Nielsen ORG Marg survey of 'Most Trusted Brands'. As the growth of the distribution of
ICICI Prudential Life Insurance, its product range and customer base, they continue to tirelessly
uphold their commitment to deliver world-class financial solutions to customers all over India.

ICICI Lombard General Insurance Company Ltd.

ICICI Lombard General Insurance Company Limited is a 74:26 joint venture between ICICI
Bank Limited and the Canada based $ 26 billion Fairfax Financial Holdings Limited. ICICI Bank
is India's second largest bank, while Fairfax Financial Holdings is a diversified financial
corporate engaged in general insurance, re-insurance, insurance claims management and
investment management.

Lombard Canada Ltd, a group company of Fairfax Financial Holdings Limited, is one of
Canada's oldest property and casualty insurers. ICICI Lombard General Insurance Company
received regulatory approvals to commence general insurance business in August 2001.

ICICI Securities primary Dealership Ltd.

ICICI Securities Primary Dealership Limited is an acknowledged leader in the Indian fixed
income and money markets, with a strong franchise across the spectrum of interest rate products
and services – institutional sales and trading, resource mobilization and research. One of the first
entities to be granted Primary Dealership license by RBI, ICICI-Securities Primary Dealership
has made pioneering contributions since inception to debt market development in India.

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ICICI Prudential Asset Management Company and Trust
ICICI Prudential Asset Management Company is a joint venture between Prudential plc and
ICICI Bank. Neither ICICI Prudential Asset Management Company nor Prudential plc are
affiliated in any manner with Prudential Financial, Inc., a company whose principal place of
business is in the United States of America.

ICICI Prudential Asset Management Company enjoys the strong parentage of Prudential plc, one
of UK's largest players in the insurance & fund management sectors and ICICI Bank, a well-
known and trusted name in financial services in India. ICICI Prudential Asset Management
Company, in a span of just over eight years, has forged a position of pre-eminence in the Indian
Mutual Fund industry as one of the largest asset management companies in the country.

ICICI Home Finance Company Ltd.

The company commenced its operations in 1999-2000. It provides home loans and other
related services. It was the first housing finance provider to introduce floating rate loans. It has
expanded into fee-based property services for both corporate and retail customers.

ICICI International Ltd.

This company was incorporated in the Republic of Mauritius on January 18, 1996, as an
investment and Fund Management Company

ICICI Investment Management Company Ltd.

This is an asset management company of ICICI securities Fund, a mutual fund registered
with SEBI.

ICICI Trusteeship Services Ltd

The company’s role is to serve a trustee for enterprises, transactions, or arrangements of
strategic or significant business importance to the ICICI group.

Thus to conclude, ICICI is India’s best managed financial institution, catering to the needs of
different customers. It has successfully transformed itself from a single product company to a
multi-group.

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 CHAPTER 4

IDBI MERGER

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4.1 INTRODUCTION

The Industrial Development Bank of India (IDBI) was established on July 1, 1964 under
an Act of Parliament as a wholly owned subsidiary of the Reserve Bank of India. In 16 February
1976, the ownership of IDBI was transferred to the Government of India and it was made the
principal financial institution for coordinating the activities of institutions engaged in financing,
promoting and developing industry in the country.

IDBI had played a pioneering role in fulfilling its mission of promoting industrial growth
through financing of medium and long-term projects, in consonance with national plans and
priorities. Over the years, IDBI has enlarged its basket of products and services, covering almost
the entire spectrum of industrial activities, including manufacturing and services. IDBI provided
financial assistance, both in rupee and foreign currencies, for green-field projects as also for
expansion, modernization and diversification purposes.

In the wake of financial sector reforms unveiled by the government since 1992, IDBI evolved
an array of fund and fee-based services with a view to providing an integrated solution to meet
the entire demand of financial and corporate advisory requirements of its clients. IDBI also
provided indirect financial assistance by way of refinancing of loans extended by State-level
financial institutions and banks and by way of rediscounting of bills of exchange. With the
changes in economic environment in the last decade, the flow of funds to FI’s from RBI’s
National Industrial Credit Long Term Operations (NIC-LTO) and allocation of Statutory
Liquidity ratio (SLR) bonds dried up and it became necessary for the FI’s to raise funds mainly
from the markets. Simultaneously, commercial banks also began to provide project finance and
these commercial banks had lower cost of funds than FI’s. With lower cost of funds for banks,
the business model of FI’s came under strain. In view of the changes in the operating
environment, following initiation of reforms since the early nineties, Government of India
decided to transform IDBI into a commercial bank.

The migration to the new business model of commercial banking with its gateway to low cost
current/savings bank deposits would help overcome most of the limitations of the current
business model of the development while simultaneously enabling it to diversify its client/asset
base. Towards this end, the IDBI (Transfer of Undertaking and Repeal) Act 2003 was passed by

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parliament in 2003. The act provides for repeal of IDBI Act, corporatisation of IDBI (with
majority Government holding current share 58.47%) and transformation into commercial
bank. The provisions of the act have come into force from July 2, 2004 in terms of a
Government Notification to this effect.

The notification facilitated for formation, incorporation and registration of Industrial

Development Bank of India Ltd. Under the Companies Act 1956 and a deemed banking
company under the Banking Regulation Act 1949 and helped in obtaining requisite regulatory
and statutory clearances, including those from RBI. IDBI commenced banking business in
accordance within the provisions of the new Act in addition to the business being transacted
under IDBI Act 1964 from October 1, 2004. IDBI has firmed up the infrastructure technology
platform and reorientation of its human capital to achieve a smooth transition.

4.2 THE MERGER DEAL OF IDBI

1. The merger created the seventh largest bank in India in terms of assets. The merger was a

win-win situation for both the institutions besides using the brand name of IDBI; IDBI
bank would get access to a wide distribution network of branches of IDBI. It also got the
necessary capital to expand its horizon. On the other hand, IDBI would function as a full
fledged deposit taking bank without incurring heavy expenditure on setting up branches
introducing new technology or inducting new people.
2. IDBI also benefited immensely from the consumer banking knowledge of IDBI bank
along with a private sector culture that was totally different from that of IDBI’s. The
merger helped IDBI to reduce its overall cost of funds from 5.6% to 4.9% with access to
savings account, current account and call money market.
3. To facilitate the merger, Rs. 900 crore Non-Performing assets (NPA’s) in IDBI’s
portfolio accounting for almost6 15% of its net loans were transferred to Stressed Assets
Stabilization Fund (SASF) in the form of Zero coupon bands held till maturity.
4. Stressed Assets Stabilization Fund was given the status of a “financial institution” to
enable; it to access Debt recovery tribunals (DRT). This financial restructuring enabled
IDBI to bring down its NPA’s to below 1%.

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5. The assets transferred to Stressed Assets Stabilization Fund were without recourse to
IDBI Ltd. For a period of 20 years the tenure of the bonds. At the time of the settlement
of any of these loans, the money would be received by IDBI Ltd. And simultaneously an
equivalent amount of bonds would be relinquished. The bank would take back assets
remaining unrecovered by Stressed Assets Stabilization Fund for 20 years.
6. IDBI Ltd. Was granted a 5 year relief period by RBI from maintaining the Statutory
Liquidity ratio (SLR) against a requirement of Rs. 3500 crore towards Cash Reserve
Ratio (CRR) liabilities, the bank deposited Rs. 2400 crore immediately after the merger.
7. In a competitive sense the merger created a strong foundation for IDBI Ltd. To compete
with the other banks. It had a clean and strong balance sheet free from NPA’s to a large
extent, a better organization rating that was translated into more cost effective borrowing
and most importantly enormous government support.
8. IDBI also planned to reduce its high cost liabilities priced at almost 9.5% by nearly 100
basis point within 12 months of the merger. This would lead to a saving of Rs. 500 crore
for the bank. IDBI also lowered its prime lending rate from 12.5% to 10.5% and with the
corporate sector expanding with new business opportunities the bank was expected to
grow its asset value by 10-12% a year.
9. There was also a large disparity in the Capital Adequacy Ratio (CAR) of IDBI and IDBI
bank. As compared to 18.3% for IDBI the Capital Adequacy Ratio of IDBI bank was just
over 9%. However the merger entity was expected to have a Capital Adequacy Ratio
much better than the RBI stipulated 9%.
10. The merger also led to a rationalization of the workforce to a great extent. The institution

followed a Shape up or Ship out strategy to the hilt, in order to do away with non-
performing employees and also reduce the cut-of age of retirement of employees from 60
to 58 years.
11. IDBI Ltd. Sanctioned Rs. 75 crore to fund its voluntary retirement scheme (VRS)

which would be written off over a period of 5 years.

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 Consequent to the merger of IDBI with IDBI bank, IDBI’s subsidiary companies have
become subsidiaries of the bank. On March 31, 2007 IDBI Bank had four subsidiaries.

IDBI Capital Market Services Limited

IDBI Capital Market Services Ltd. (head quartered in Mumbai), is a leading provider of
financial services and is a 100% subsidiary of IDBI Bank Ltd. The company was set up in 1993
with the objective of catering to specific financial requirements of financial institutions, banks,
mutual funds and corporate houses. The company provides a complete range of financial
products and services that includes:

a) Stock Broking-Institutional and Retail.

b) Derivatives Trading.
c) Distribution of Mutual Funds.
d) Investment Banking.
e) PF/Pension Fund Management.
f) Retail Marketing of Bonds and IPOs.
g) Depository Services.
h) Research Services.

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 Over the last 5 years, the company has been ranked amongst the leading players in each of
these businesses. It has a strong agent network which caters to the investment needs of retail
investors in instruments like IPOs, Bonds, etc.

The company is a major player in the Equity and Derivatives market and a leading manager
of Pension & Provident Funds in the country. The company has executed several mandates on
the Issue Management and Corporate Advisory Services.

The company offers an online investment portal with advanced features and tools for an easy
and informed investing experience in Equities, Mutual Funds and IPOs.

IDBI Home Finance Limited

IDBI Home finance Ltd. is 100% subsidiary of IDBI Bank Ltd. acquired the entire
shareholding of Tata Finance Ltd. in Tata Home finance Ltd. in September 2003. The name of
the company was changed to IDBI Home finance Ltd. Over the years, the company has taken
steps to enhance its retail reach, strengthen brand image, improve asset quality, thereby
achieving business growth.

IDBI Intech Limited

IDBI Intech Ltd. is a wholly owned subsidiary of IDBI Bank Ltd. IDBI has set up IDBI
Intech Ltd. (INTECH) in March 2000 to tap the opportunities arising from the IT sector.

Intech capitalizes on the banking business knowledge acquired over the years supplemented
with experience in Implementation & Management of state-of-the-art IT Infrastructure,
Technology applications and Systems for one of the largest universal bank in India and uniquely
positions itself, in the Information Technology Service Provider Space, to offer the IT-related
products and services to the IDBI Group companies.

Intech operates in a multi-dimensional framework and provides IT related services in the area
of Consultancy, System Integration, System implementation & support, Applications & Server
hosting and other IT related managed services and specialized training.

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IDBI Gilts Limited
IDBI Gilts Ltd. was set up as a wholly owned subsidiary of IDBI Bank Ltd. to undertake
Primary Dealership [PD] Business. In accordance with RBI guidelines, the Primary Dealership
business of IDBI Capital Market Services Ltd. [ICMS] has been de-linked and transferred to
IDBI Gilts Ltd. The company was incorporated in December 2006 and became operational from
July 24, 2007. The company's business ambit includes Bond trading, underwriting in auctions of
primary issuance of Government dated securities and treasury bills. In addition, IDBI Gilts also
plans to be a major player in the interest rate and credit derivative market.

Thus IDBI Ltd. goal is to be the most preferred bank for total financial and banking solutions
for corporate and individuals and becoming a major force to reckon within the financial sector.

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 CHAPTER 5

CONVERSION OF DFI’s INTO BANK:

A BOON OR BANE FOR INDIA!

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5.1 CONVERSION OF DFI‟S INTO BANKS COUPLED WITH SWOT

I. Strengths:

a) Economies of Scale

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. Many
Committees and reports by Reserve Bank of India are in favour of Universal banking as
it enables banks to exploit economies of scale and scope.
b) Profitable Diversions

By diversifying the activities, the bank can use its existing expertise in one type of
financial service in providing other types. So, it entails less cost in performing all the
functions by one entity instead of separate bodies.
c) Resource Utilization

A bank possesses the information on the risk characteristics of the clients, which can be
used to pursue other activities with the same clients. A data collection about the market
trends, risk and returns associated with portfolios of Mutual Funds, diversifiable and non
diversifiable risk analysis, etc, is useful for other clients and information seekers.
d) Easy Marketing on the Foundation of a Brand Name

A bank's existing branches can act as shops of selling for selling financial products like
Insurance, Mutual Funds without spending much efforts on marketing, as the branch will
act here as a parent company or source.
e) One-stop shopping

The idea of 'one-stop shopping' saves a lot of transaction costs and increases the speed of
economic activities. It is beneficial for the bank as well as its customers.

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 f) Investor Friendly Activities

Another manifestation of Universal Banking is bank holding stakes in a form a bank's

equity holding in a borrower firm, acts as a signal for other investor on to the health of
the firm since the lending bank is in a better position to monitor the firm's activities.

II. Weaknesses:

a) Grey Area

The path of universal banking for DFIs is strewn with obstacles. The biggest one is
overcoming the differences in regulatory requirement for a bank and DFI. Unlike banks,
DFIs are not required to keep a portion of their deposits as cash reserves.
b) No Expertise in Long term lending

In the case of traditional project finance, an area where DFIs tread carefully, becoming a
bank may not make a big difference to a DFI. Project finance and Infrastructure finance
are generally long- gestation projects and would require DFIs to borrow long- term.
Therefore, the transformation into a bank may not be of great assistance in lending long-
term.
c) NPA Problem Remained Intact

The most serious problem of DFIs has had to encounter is bad loans or Non Performing
Assets (NPA). For the DFIs and Universal Banking or installation of cutting-edge-
technology in operations are unlikely to improve the situation concerning NPAs. So,
instead of improving the situation Universal Banking may worsen the situation, due to
the expansion in activities banks will fail to make thorough study of the actual need of
the party concerned, the prospect of the business, in which it is engaged, its track record,
the quality of the management, etc.
d) Two big structures like universal banks will not be able to draw quality oriented

professionals.
e) There can be conflicts of interest the way commercial banking and investment banking

operates.
f) It is argued that universal banks are more difficult to regulate because their ties to the

business world are more complex. In case of government/supervisory agencies it could

effectively monitor them because their functions are limited.

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III. Opportunities:

a) To increase efficiency and productivity

Liberalization offers opportunities to banks. Now, the focus will be on profits rather than
on the size of balance sheet. Fee based incomes will be more attractive than mobilizing
deposits, which lead to lower cost funds. To face the increased competition, banks will
need to improve their efficiency and productivity, which will lead to new products and
better services.
b) To get more exposure in the global market

In terms of total asset base and net worth the Indian banks have a very long road to
travel when compared to top 10 banks in the world. (SBI is the only Indian bank to
appear in the top 100 banks list of 'Fortune 500' based on sales, profits, assets and
market value. It also ranks II in the list of Forbes 2000 among all Indian companies) as
the asset base sans capital of most of the top 10 banks in the world are much more than
the asset base and capital of the entire Indian banking sector.Pure routine banking
operations alone cannot take the Indian banks into the league of the Top 100 banks in
the world. Here is the real need of universal banking, as the wide range of financial
services in addition to the Commercial banking functions like Mutual Funds, Merchant
banking, Factoring, Insurance, credit cards, retail, personal loans, etc. will help in
enhancing overall profitability.
c) To eradicate the 'Financial Apartheid'

A recent study on the informal sector conducted by Scientific Research Association for
Economics (SRA), a Chennai based association, has found out that, 'Though having a
large number of branch network in rural areas and urban areas, the lowest strata of the
society is still out of the purview of banking services. Because the small businesses in
the city, 34% of that goes to money lenders for funds. Another 6.5% goes to pawn
brokers, etc. The respondents were businesses engaged in activities such as fruits and
vegetables vendors, laundry services, provision stores, petty shops and tea stalls. 97% of
them do not depend the banking system for funds. Not because they do not want credit
from banking sources, but because banks do not want to lend these entrepreneurs. It is a
situation of Financial Apartheid in the informal sector. It means with the help of retail
and personal banking services Universal Banking can reach this stratum easily.

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 IV. Threats:

Big Empires
Universal Banking is an outcome of the mergers and acquisitions in the banking sector.
The Finance Ministry is also empathetic towards it. But there will be big empires which
may put the economy in a problem. Universal Banks will be the largest banks, by their
asset base, income level and profitability there is a danger of 'Price Distortion'. It might
take place by manipulating interests of the bank for the self interest motive instead of
social interest. There is a threat to the overall quality of the products of the bank,
because of the possibility of turning all the strengths of the Universal Banking into
weaknesses. (e.g. - the strength of economies of scale may turn into the degradation
of qualities of bank products, due to over expansion). If the banks are not prudent
enough, deposit rates could shoot up and thus affect profits. To increase profits quickly
banks may go in for riskier business, which could lead to a full in asset quality.
Disintermediation and securitization could further affect the business of banks.

5.2 ROLE OF CONVERSION OF DFI‟s TO BANKS IN INDIA

In India, though there has been no legislative distinction between Commercial banking and
Investment banking or any explicit legislative restriction for the banks to operate in investment
banking activities, the banks have traditionally been maintaining the “arms length” distance
from investment banking. The plausible reason could be that, as we followed the British style of
banking, which could on the Anglo-Saxon style wherein strict separation was maintained
between commercial banking activity and investment activity, the same pattern has been adopted
in India.

With the financial sector reforms, beginning 1990s ,bank were however, given abundant
freedom to go much beyond traditional conservative banking related to working capital finance.
But the more tangible momentum for the universal banking in India seem to have set in only
after the second Narasihmam committees report [1998] recommendation for development
financial institution [DFIs], over a period of time, to convert themselves into banks [implicitly
universal banks] and that there should eventually be only two form of intermediaries, viz.
Banking companies and Non Banking finance company.

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 This was followed by a working group chaired by S.H.Khan on “Harmonizing the Role and
Operations of Development Financial Institutions and Banks” (1998) which made it more
explicit by recommending for a progressive movement towards universal banking for the DFI’s.
Reserve bank of India as a regulator and supervisor of the banking system, laid the formal road
map, especially for the DFI.s, by way of giving a set of guidelines. Banks were permitted to enter
into term finance infrastructure finance, insurance business, (i.e. similar to bancassurance
prevailing in European countries), underwriting of shares, etc.

Taking a cue, ICICI an erstwhile DFI took the lead and became a universal bank by merging
itself with its own subsidiary ICICI bank Ltd. in 2002. Falling in line with this, more recently,
IDBI has already been corporatized under the companies act, 1956 and became universal bank
by merging itself with its own subsidiary, viz., IDBI Bank Ltd. Even other banks extending term
loans, entered in the area of insurance, merchant banking activities, viz., funding for buying
primary issue of equities, etc. These were some of the indications that the commercial banks in
India have been moving away from their traditional banking and moving towards universal
banking.

Simultaneously, either voluntarily or due to compulsion, there has also been a number of
bank mergers in recent years, banks with DFI’s or possibly among the DFI’s themselves also
could not be ruled out. These developments also automatically lead to not only Universal
banking milieu but even beyond that and ultimately to the emergence of “Financial
Conglomerates”. As banks have been permitted to take part in Insurance business either with or
without risk participation or as sub-agents, i.e., referral models, a number of banks in both public
and private sector have already commenced exploiting the vast business potential of
bancassurance. All these developments are a pointer to the fact that conversion of DFI’s into
Banks has become real in India both in letter and spirit .

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5.3 CHALLENGES IN CONVERSION OF DFI‟s INTO BANKS

There are certain challenges, which need to be effectively met by the Universal Banks:
1. The establishment of new private sector banks and foreign banks have rapidly changed

the competitive landscape in the Indian consumer banking industry and placed greater
demands on banks to gear themselves upto meet the increasing needs of customers. For
discerning current day bank customers, it is not only relevant to offer a wide menu of
services but also provide these in an increasingly efficient manner in terms of cost, time
and convenience.

2. Development Financial Institutions (DFIs) opting for conversion into Universal Banks by
merger/reverse merger routes may also face certain difficult situations on account of
Asset Liability Mismatches, burden of mounting NPAs and differences in regulatory
prescriptions applicable to FIs and banks such as CRR and SLR requirements and priority
sector lending. The asset profile of DFIs in India is predominantly of long term nature,
which also includes a very high level of non-performing assets. Further, the regulation of
DFIs in India has been historically less as compared with the banking system, partly
because DFIs do not form part of the monetary system and partly because they do not
have deposits like liabilities.

3. In case DFIs are converted into banks they would also be subject to the reserve
requirements like banks. This would mean that all liabilities issued by the DFIs in the
past would also be subject to the reserve requirements and since the assets structure of
DFIs are largely of long term nature it would be very difficult for them to maintain the
required level of SLR/CRR.

4. Further, the cost at which DFIs have been raising resources in the past has generally

remained high as compared to banks and maintenance of CRR/SLR for such liabilities,
which may earn lower returns, would adversely affect the profitability of such universal
banks. Compliance of priority sector lending norms, which earn lower returns, may also
create difficult situations for such bank Risk Management is one of the major challenges,
where in the financial activity carries with it various risks, which would need to be
identified, measured, monitored and controlled by Universal banks.

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 5. The nature of risks and mitigating techniques for different financial products/services will

be different and therefore, Universal Banks will be required to develop comprehensive

system for each product/service and each kind of risk.

6. Another aspect is related to building up of supervisory infrastructure. The regulatory

framework would need to be strengthened so as to cover all aspects of Universal Banking
either under control of one regulator or a co-coordinating mechanism would have to be
developed among different regulators like the Reserve Bank of India, SEBI, Insurance
Regulatory, Authority etc. The regulators will have to frame sound mechanism to protect
the interests of all concerned including the customer, the Universal Banking Institution
and the financial system of the country.

7. It is likely that Universal Banks of roughly the same size and providing roughly the same
range of services may have very different cost levels per unit of output on account of
efficiency differences in the use of labour and capital, effectiveness in the sourcing and
application of available technology, and perhaps effectiveness in the acquisition of
productive inputs, organizational designs, compensation and incentive systems and just
plain better management.

8. Larger the banks, the greater will be 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 undesirable consequences for economic efficiency. Further
combining commercial and investment banking can give rise to conflict of interest.

9. Supervision of Financial Conglomerates

In view of increased focus on empowering supervisors to undertake consolidated
supervision of bank groups and since the Core Principles for Effective Banking
Supervision issued by the BASEL Committee on Banking Supervision have
underscored consolidated supervision as an independent principle, the Reserve Bank has
introduced, as an initial step, consolidated accounting and other quantitative methods The
components of consolidated supervision include, consolidated financial statements
intended for public disclosure, consolidated prudential reports intended for supervisory
assessment of risk and application of certain prudential regulations on group basis.

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 10. Improving Risk Management Systems

With the increasing degree of deregulation and exposure of banks to various types of risk,
efficient risk management systems have become essential. For enhancing the risk
management systems in banks, Reserve Bank has issued guidelines on asset liability
management and risk management systems in banks in 1999 and Guidance Notes on
Credit Risk Management and Market Risk Management in October 2002 and the
Guidance Note on Operational Risk Management in 2005.

11. Sharpening Skills

The far-reaching changes in banking and financial sector entail a fundamental shift in the
set of the skills required in banking. To meet increased competition and manage risks, the
demand for specialized banking functions, using IT as a competitive tool has to go up.
Special skills in retail banking, treasury, risk management, foreign exchange,
development banking, etc. will need to be carefully nurtured and built. Thus, the twin
pillars of the banking sector i.e. human resources and IT will have to be strengthened.

5.4 ISSUES INVOLVED IN PRACTICING CONVERSION BY DFI‟s IN

INDIA

Worldwide there are a few examples of conversation of DFIs into banks. The Korea Long
term Credit Bank established in 1967, became a full fledged bank in early 1980s. Japanese
Development Bank named Industrial Bank of Japan (IBJ) is regarded as a transnational DFI
with a global network providing comprehensive financial services to cross border of clientele.
However, before converting DFIs into banks, in India, the following issues have to be addressed:

1. As per existing regulations, DFI’s are allowed only to raise deposits worth one time their
net worth. DFI’s are allowed to raise deposits for a maximum maturity profile of one year
and interest rate offered by them has to be inline with the rates offered by banks. On these
deposits, DFI’s are not allowed to make premature payments or provide loans on deposits
unlike banks.

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2. As DFI’s will be increasing their short term loan exposure, the matching short term
deposits are also required hence the above said regulations in regard to raising deposits
will have to be amended.

3. One question arises in the mind is that after conversion of DFIs into banks who will make
the specialized project finance. All banks do not have the required expertise with them
and it cannot be created overnight.

4. The issue of regulation has to be addressed, as in India DFIs are regulated by separate
acts while banks are regulated by the RBI and merchant banks are regulated by SEBI etc.
Regulation is one single most important reason responsible for practicing Financial
Conglomerate model by many banks in India. A common regulatory framework should
be considered as the most fundamental prerequisite for a universal banking regime. The
system should also include uniform statutory reserve requirements, capital adequacy,
asset classification, income recognition and provisioning norms.

5. Commercial banks, since the onset of social banking , have been subjected to stipulations
in lending areas for which compliance is mandatory, like directed lending to the priority
sector. In order to create a level playing field in universal banking, it is imperative that
similar guidelines should be prescribed for DFIs as well.

6. DFIs conversion into banks may pose a threat to the commercial banks as he inter-
institutional functional specifications will no longer be in vogue, as all institutions will be
in a position to undertake all kinds of financing activities, wholesale to retail and from
project financing to working capital finance. This will further increase the competition
for commercial banks.

7. If DFIs and commercial banks start practicing German model of universal banking, the
following issues will also have to be addressed:

8. In the regime of universal banking, the spread will come under further strain, as interest
rate structure will no more be administered. The emphasis, therefore, will have to be put
on more off balance sheet activities so that the non-interest income generated can make
good the loss in interest income.

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5.5 RECENT TRENDS IN CONVERSION OF DFI‟s TO BANKS IN INDIA

1. Financial reforms were central to India’s economic liberalization program initiated in the
early 1990s. After more than a decade of reforms since 1991, India’s financial sector-
including markets, institutions and products- has changed, in some respects, beyond
recognition. While the banking sector continues to dominate the financial system and
remains overwhelmingly government owned, competition has increased. Private entry
has also been progressively allowed into mutual funds and, more recently, insurance.

2. These reforms have led to financial integration at two levels. At, one level, the trends
towards universal banking and mergers between two financial institutions have led to
integration between different segments of the domestic financial system. Traditional
frontiers between banking, capital markets and insurance have become less distinct.

3. The effect of the recommendations of the Khan Working Group and Narasimhan
Committee-II reports regarding harmonization of role of banks and DFIs were seen when
major banking organizations like ICICI, IDBI, and SBI etc. started proposing plans for
taking up the coveted status of a universal bank. ICICI merged with the ICICI bank in
2001 and IDBI merged with IDBI bank in 2004. Many public sector banks set up
subsidiaries for providing various financial services.

4. Deregulations opened up new opportunities for banks to increase revenues by

diversifying into investment banking, insurance, credit cards, depository services,
mortgage financing, securitization, etc. Interest rates have been deregulated over a period
of time, branch-licensing procedures have been liberalized and Statutory Liquidity Ratio
(SLR) and Cash Reserve Ratio (CRR) have been reduced. The entry barriers for foreign
banks and new private sector banks have been lowered as part of the medium term
strategy to improve the financial and operational health of the baking system by
introducing an element of competition into it.

5. There has been a paradigm shift in Indian banking with the absorption of the latest
technology and the need to meet the client’s expectations in a customized manner.
Corporate governance in banks and financial institutions assumed great importance in
India.

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6. The benefits of a liberalized financial system are well-known. At the same time, a series
of financial crises-in East Asia in 1997, Turkey in 2000 and, more recently, in Argentina-
have alerted policy makers and regulators to the potential fragility of financial
intermediaries in a deregulated environment.

7. These crises resulted from the integration of a variety of mutually reinforcing,

macroeconomic, structural, and political events. Whatever the trigger, the weaker the
financial system, the greater have been the fireworks of the collapse and the depth and
duration of post crisis distress.

8. So, if there is one lesson above all others from the recent financial crisis, it is the
importance of a sound and well regulated financial sector. This means better disclosure,
better supervisory norms and their proper enforcement. And it means having a financial
regulatory structure that makes the regulatory properly accountable, and ensures that
regulators are properly equipped to anticipate problems in complex and integrated
financial systems, detect fragilities, take prompt corrective action to deal with distressed
institutions, and minimize opportunities for regulatory arbitrage by financial
intermediaries.

9. India’s financial system has shown a great deal of resilience. India appears to be sheltered
from a crisis triggered by an external macroeconomic shock of the type suffered by the
East Asian countries, because India’s exchange rate regime is flexible, foreign exchange
reserves are high, the capital account is not yet fully convertible, and banks and their
customers have limited foreign exchange exposures. It should also be noted that, in recent
years, India has gone a considerable way in improving financial sector regulation.
Prudential norms have been tightened, bank capital bolstered, and the supervisory
systems strengthened.

10. But important weaknesses remain, and need to be addressed. Stock market scams, the

UTI story and problems with cooperative banks, underline the importance of enhancing
supervision and governance. Moreover, as the financial sector becomes more open, the
challenge facing India’s regulators will become ever greater.

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5.6 FUTURE OF CONVERSION OF DFI‟s INTO BANKS
1. In view of changes in economic and national environment in India leading to
liberalization and deregulation, integration of Indian financial markets, entry of new
players both domestic and overseas in the market disintermediation.
2. High degree of product innovation and effacing of operating boundaries among suppliers
of financial products and services, and growing customer’s preferences for wide variety
of efficient products under one shop, existing development financial institutions are left
with no choice but to assume the role of universal banking and not remain confined to
engaging in terms of lending and participating in equity.
3. In their new avtar, DFIs will be providing working capital finance to big corporate groups
as DFIs have their own creamy layers of clients with whom their business transactions
are quite voluminous. The time is ripe that commercial banks give a deep thinking on the
issue of switching over to the German model of universal banking from the financial
Conglomerate model of UK/USA. If commercial banks start practicing German model
of universal banking, it will get more success as one distinct advantage for these banks is
their impressive branch network.
4. Commercial banks should also make a foray into the insurance business as these banks
can use their distribution network to sell all types of insurance particularly life insurance,
to their traditional customers. Many banks are providing insurance in European countries
as this has resulted in good growth in their non-fund based business.
5. There is also a need for commercial banks to synergize the operations of their various
subsidiaries. Commercial banks, their subsidiaries and associates should work in a
cohesive manner. A system of cross selling and marketing the products of the
subsidiaries, associates banks should be evolved and foreign subsidiaries of commercial
banks should canvas India related business/NRI business for various branches of these
banks in India.
6. Commercial banks, over the years, have developed expertise in many areas like Asset-
Liability Management, Risk Management and Computerization etc. Now these banks
may develop their own packages to be sold to other banks/co-operative banks/ NBFCs etc
7. Universal Banking system will come to stay in India in the near future. There is,
therefore, need to prepare ourselves right now.

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5.7 LESSONS LEARNT FROM THE CONVERSION OF ICICI AND IDBI
FROM DFI TO BANK

The Working Group has reviewed the experience of both the DFI’s, i.e. ICICI Ltd. and IDBI
Ltd., which has so far successfully converted into a bank. The organizational dynamics of ICICI
Ltd. and IDBI Ltd. is therefore, the exact replication of its experience by others may not be
possible. However, some tentative conclusions can be drawn from the experience of ICICI Ltd.
and IDBI Ltd., which can serve as reference points and the underlying hypothesis can be further
tested by applying these principles to future attempts at conversion by any of the DFIs.
The conclusions are as under:

1. Existing Banking Platform for Conversion

A ready banking platform would greatly facilitate the conversion of a DFI into a bank. A
DFI by forward or backward integration into a bank would land at a higher point on a
learning curve in terms of banking experience and operational readiness. A ready
infrastructure of branch network, operating procedures, technology platform, skilled
manpower, etc., will make the transformation much smoother and efficient than
conversion of a DFI on a stand alone basis and attempting to build the entire banking
infrastructure from the scratch. The process of transformation on a stand alone basis
would require higher degree of change management skills and may have adverse effect
on the operations, unless sufficient and long preparations are made for conversion. The
asset liability management could cause serious concern in case of conversion on stand
alone basis. The assets liability mismatch could arise since the deposit base of the
converted entity would build up only gradually. The teething problem would be
manageable in case of a DFI merging with a bank of a size commensurate with the
balance sheet of DFI.
2. De-risking and diversification of loan portfolio
Long term project finance is a risky proposition for any financial intermediary and more
so for a DFI whose loan portfolio is almost exclusively comprised of project financing.
Therefore, in preparation for conversion to a bank the DFI should consciously scale down
the proportion of project financing by resorting to diversified products. e.g. structured
finance and innovative financial techniques.

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3. Flexibility of organizational structure
A flexible and agile organizational structure is a pre-requisite for meeting the challenges
in a competitive environment. A company structure possesses the attributes of operational
flexibility and is best suited for the role of a financial intermediary. Therefore, any DFI
seeking transformation to a bank should necessarily migrate to the structure of a
company, preferably with a large and diversified share holding.
4. Correct positioning and business strategy
The choice of the target clientele, appropriate business and product mix to be offered, in
face of the acute competition in the banking sector and mechanism for delivery of
banking services and compliance with statutory and regulatory requirements, over a self
determined time horizon despite relaxations given for a specified time period, should be
formulated well before embarking on conversion to bank and there should be ongoing
monitoring of the business and strategic plan till the entity is fully integrated into the
banking system.
5. Availability of management skills
In an organization transforming to a new role, there would be a significant need for
skilful change management, by retraining and equipping the managerial personnel with
new set of skills and facilitating their adaptation to a new working style and environment.
An organization undergoing a transformation must give top priority to this aspect.
6. Brand Equity
The brand image of an organization would determine its success or failure in any role. A
good image has to be assiduously built over a long time span and a poor image which can
not be shaken off easily would be a hindrance in the transformation process. A DFI
Possessing brand equity can in very a short time establish itself in the market after
conversion into a bank.

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 CHAPTER 6
CORPORATE VIEWS ON CONVERSION OF
DFI’s INTO BANKS

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 6.1 Universal banking no panacea for ill DFI‟s, says former RBI Governor,
Bimal Jalan

(Monday, Oct 26, 2009)

The Reserve Bank of India governor Bimal Jalan added a new dimension to an ongoing
debate by saying that the move towards universal banking will not solve the problems of the
Development financial institutions (FIs).

“Universal banking will not provide a panacea for the weaknesses of an FI or its liquidity and
solvency problems,” Jalan said. He was addressing bank chiefs at the Bank Economists
Conference 2008, organised by Allahabad Bank. He also said that universal banking cannot be
the escape route for FIs which have been suffering from operational difficulties arising from
under capitalisation, non-performing assets and asset-liability mismatches.

Later, participating in a question-answer session, Jalan categorically said universal banking is

not the central bank’s prescription and neither has it fixed any timeframe for the transition to the
“so-called universal banking’. “The overriding consideration should be the objectives and
strategic interests of the institutions concerned in the context of meeting the varied needs of
customers, subject to normal prudential norms applicable to banks,” he said. From the regulatory
point of view, the movement towards universal banking should firmly entrench the stability of
the financial system and preserve the safety of public deposits, he added.

Jalan’s views on universal banking are significant in the context of both, the ICICI and the
Industrial Development Bank of India (IDBI) proposing to become universal banks. ICICI has
already merged itself with ICICI Bank and the integration process is expected to be wrapped up
by March 31. The IDBI, however, is yet to formalise its game plan. Both the institutions suffer
from asset-liability mismatches and IDBI’s non-performing assets are still rising. Both the
institutions have been projecting that Universal banking is the only way to survive as far as they
are concerned.

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 6.2 Extinction of DFI‟s will affect Development of the Country

(Tuesday, June 16, 2009)

ICICI was the first to change colours followed by IDBI and now it is the turn of IFCI. There
is also talk of merging Industrial Investment Bank of India (IIBI) with IDBI once the latter is
converted into a bank. Anyway, Industrial Investment Bank of India is a marginal player in
development financing.

With the concept of universal banking catching up, the DFIs have decided to convert into
banks. One of the main complaints of these DFIs is that as they are not banks since they did not
have access to cheap finance by way of deposits from the public. But this was to an extent made
good by allowing them to issue tax-saving bonds.

If the DFI’s were burdened with huge NPAs it would be wrong to blame the concept of
development finance. It is more to do with wrong selection of projects (usually due to political
interference) than anything else.

In India, the debt market is not fully developed nor is there any attempt to develop one.
Therefore, those who want to set up new projects have to approach financial institutions for part-
financing the projects.

Now the banks are more interested in retail banking as also home loan financing. Though this
mania has started only recently no one knows where it will end. There is no guarantee that retail
banking is the safest way of employing banks funds. One will come to know its validity only
after the recovery process begins. Short duration of the borrowing period is one reason for banks'
craze for retail banking.

DFI’s have seen a premature end though their continuance was a necessity, at least till India
reached the growth levels of the South-East Asian countries. The absence of DFIs will, therefore,
hamper development of the countries growth in the coming years.

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 6.3 “Universal banking by DFIs: Handy, but no Solution to NPAs”

(Thursday, Feb 12, 2009)

In the last few years, the most serious problem DFI’s had to encounter is bad loans or Non-
performing assets (NPAs). For DFIs, universal banking or the installation of cutting-edge
technology in operations are unlikely to improve the situation concerning NPAs.

The improper use of DFI funds by project promoters, a sharp change in operating
environment and poor appraisals by DFIs combined to destroy the viability of some projects. The
NPAs of these projects have dented, in varying degrees, the balance-sheets of the three DFIs.

ICICI seems to have suffered the least, mainly because size of its balance-sheet size, which
has grown by a compound annual growth rate of 19.25 per cent over the last four years. At the
same time, the company's gross NPAs have grown by 21 per cent. Though the gross NPAs grew
faster than the balance-sheet, the combined effect of the growth in the absolute size of the
balance-sheet and accelerated provisioning has brought down ICICI's net NPAs to 5.2 per cent of
total loan assets in 2000-01 from 6.8 per cent in 2006-07.

As the former RBI Governor, Mr. Bimal Jalan, suggested, universal banking will not solve
the NPA problem. Keeping aside the grey areas that accompany the move to universal banks,
DFIs seeking a merger with a commercial bank makes sense. While the move may not solve the
NPA problem, it may mitigate the problem of competing in a market that has players with a
significantly lower cost of funds.

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.

CHAPTER 7

CONCLUSION AND SUGGESTIONS

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7.1 CONCLUSION

1. Finally, when arrived at the conclusion of the project one question that arises is
How close we are to the vision of a sound and well-functioning banking system in
India?

2. It is fair to say that despite turbulent years and many challenges, we have made some
progress towards this goal. There has been progressive intensification of financial sector
reforms, and the financial sector as a whole is more sensitized than before to the need for
internal strength and effective management as well as to the overall concerns for financial
stability. At the same time, in view of greater disclosure and tougher prudential norms,
the weaknesses in our financial system are more apparent than before.

3. There is greater awareness now of the need to prepare the banking system for the
technical and capital requirements of the emerging prudential regime and a greater focus
on core strengths and niche strategies. We have also made some progress in assessing our
financial system against international best practices and in benchmarking the future
directions of progress. Several contemplated changes in the surrounding legal and
institutional environment have been proposed for legislation.

4. Nevertheless, several sources of vulnerability persist. The NPA levels remain too large by
international standards and concerns relating to management and supervision within the
ambit of corporate governance are being tested during the period of downturn of
economic activity. There is also a sense that we have a lot to acquire and adapt in terms
of the technical expertise necessary to measure and manage risks better. The structure of
the financial system is changing and supervisory and regulatory regimes are experiencing
the strains of accommodating these changes. In a fundamental sense, regulators and
supervisors are under the greatest pressures of change and bear the larger responsibility
for the future.

5. We should strive to move towards realizing our vision of an efficient and sound banking
system of international standards with redoubled vigour. Our greatest asset in this
endeavour is the fund of human capital formation available in the country but however
we need to focus on scientific and technical formation.

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7.2 SUGGESTIONS

The following suggestions can be taken into consideration by the DFI’s converting
themselves into bank:

1. More and more DFI’s should try to convert themselves into Universal Banks i.e. all

services under one roof which will be beneficial to both i.e. for banks and the customers.
For banks it will be beneficial as it will help them to maximize their profits and from the
point of view of customers it will be a solution for all their financial services under one
roof. It will help the banks to expand their business on national and international level
and will help to create their image in International banking sector.

2. As India is moving ahead in the field of technology, more and more banks should try to

improve the use of technology in their services provided to the customers and should
provide Core Banking Solutions in all their branches.

3. As NPA’s are the greatest challenge for the banks these days, it is suggested that these

banks should focus on reducing their NPA levels as it will indirectly help in increasing
their profits.

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ANNEXURE – I

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BIBLIOGRAPHY

I. Books

a) Dr. Bandgar P.K, Kalyanraman.A, Universal Banking, Vipul Prakashan.

b) Smith R, Walter I, Global Banking.

c) Reddy C.N., Banking and Its Credit creation.

d) B.S.Sreekantaradhya, Banking and Finance.

II. Newspapers

a) Oct 26, 2009, Universal banking no panacea for ill DFI’s, Bimal Jalan, Business Standard.

b) June 16, 2009, Extinction of DFI’s will affect Development, The Economic Times.

c) Feb 12, 2009, Universal banking by DFI’s: Handy, but no solution to NPA’s, The Hindu.

III. WebPages

a) www.banknetindia.com/banking/universalbankingfeature.

b) www.managementor.com.

c) www.investopedia.com/terms/universalbanking.

d) www.indianmba.com.

e) www.researchandmarkets.com.

f) www.reportbuyer.com.

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ANNEXURE II

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REPORT ON RESPONSE COLLECTED FROM MR. PENDARKAR,
BRANCH MANAGER, IDBI BANK, DOMBIVLI

While having face to face interview with Mr. Dhananjay Pendarkar, Branch Manager,
IDBI Bank, Dombivli, on October 30, 2009 his views were asked regarding conversion of DFI’s
into Banks for which the following answers were given:

Q1) How different is the Universal Banking model from the existing (Development
Financial Institution) model?

Ans: The current banking model is in terms of intermediation between households and
industries at the short end of the spectrum. The DFI’s used to get Government funds at
subsidized rates to be lent for long. In the case of new model the entity is expected to be a
one-stop shop. The mobilization of funds could be focused on both long side and short side.
The short end and long term is combined in an institution, which needs to develop internal
safe guards for asset liability, mismatches. From the borrower side it is providing funds for
fixed assets as well as current assets and to do that extent safe guards can be built in rating.

Q2) DFIs are moving towards Universal Banking on the pretext to hide NPA’s and meet
the regulatory requirements. Could you comment?

Ans: At present, the DFI’s are permitted an overdue period of 365 days for the principal and
180 days for the interest. But once these are placed on par with those of Banks then, an asset
will be treated as nonperforming if interest or installment remains overdue for more than 180
days. Hence the level of NPA’s and erosion of capital could be larger in these FI’s than what
is presented. To that extent the surmise that DFI’s move towards Universal Banking may be
to overcome their NPA problems.

Q3) Should it be “Banks v/s DFIs” or “Banks and DFIs”?

Ans: As per the views of Mr. Dhananjay Pendarkar the services provided by banks and DFIs,
are more or less the same and so in this modern complex competitive banking sector the
banks are getting a cutting edge competition from DFIs. So as per Mr. Pendarkar it should be
“Banks v/s DFIs”.

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Q4) What are your views regarding the transformation of DFI’s to Universal Banking?

Ans: One of the reasons for the decision to convert DFI’s to Universal Banks is because the
Government is not in a position to infuse additional capital to these entities. In a sense the
burden of bailing out these DFI’s will have to carry the burden of NPA’s of the DFI’s in
addition to their own. In other words the decision by the Government is not out of love for
Universal Banking but out of concern about the situation of DFI’s. The capital markets are
sluggish on the whole and the position of Banks is also no better.

Q5) Is Universal Banking Suited to India’s Needs?

Ans: Yes, Universal banking is definitely suited to Indian needs because universal banking
provides a one stop shop solution for all the financial needs of the Indian customers. Public
financial institutions (FIs) should return to the culture of development banking and long-term
lending instead of adopting the model of ``universal banking' which is unsuited to the needs
of India, according to the Branch Manager he said that the adoption of provisioning and other
norms, evolved by the Bank of International Settlements (BIS), Basel, and based on the
demands of global speculative finance capital by the Reserve Bank of India (RBI) was
proving ruinous to Indian banks and financial institutions.

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