A paper

on

Financial Services Management in the global

context - Indications for Indian Banking Industry

By
Prof.Shikha Jain (09325070148, shikhasalil@yahoo.com)
Prof.Anthony Rose (09881477920,anthonyrose8@yahoo.co.in)
Institute of Management and Entrepreneurship Development
Bharati Vidyapeeth Deemed University
 ABSTRACT

At the dawn of the new millennium, the world around us is changing fast. Sustaining and
accelerating economic growth is possible only on the backdrop of an ever-increasing
integration of economies.

Indian economy, too, opened its doors to welcome foreign equity, technology, products,
and people in 1991. Along came an unprecedented challenge that of managing this new
developmental thrust. For this structural reforms were introduced in all the sectors. In this
process a great emphasis was laid on the banking sector, which after all is a candid mirror
of any economy.

This paper is an attempt to study the pace of banking industry in India with,
• A deepening market economy
• Emerging opportunities coming along with the trinity of globalization,
liberalization and privatization.

The economic perestroika of Indian banks has generated a spate of efforts. Here is an
attempt to unravel the causes and effects of this episode.
FINANCIAL SERVICES MANAGEMENT IN THE GLOBAL CONTEXT…
Indications for Indian banking industry

No managers in banking services require to be enlightened that their world is changing

rapidly. No managers in banking services require being enlightened that managing this is
going to be difficult. No managers in banking services require to be informed that success
in the short-term does not warranty long-term success or even survival, or that short-term
failure is not a warranty of demise. The truth is that all managers in banking services
have to understand that balancing change for tomorrow and for the day after tomorrow is
probably the best ruse that they can pull off — for their personal careers, for their
shareholders or stakeholders, and for their customers.

This paper focuses on following issues,

• Trends that have a bearing on the Indian banking industry’s evolution,
domestically and globally.
• Trends those are highly likely to continue and perhaps increase in velocity.
• Challenges and opportunities for the industry in the future.

PRELUDE – An overview of the evolution of Indian banking industry

Indian Banking system consists of a vast network of Banks and Financial Institutions
offering a wide range of products and services. It accounts for about two-thirds of the
assets of the organized sector. While building this sound system, a major developmental
objective has been to provide a financial infrastructure that is geographically wide and
functionally diverse. We can identify three distinct phases in the evolution of Indian
Banking.

• Early phase from 1786 to 1969

• Nationalization of Banks in 1969 and up to 1991, prior to Banking Sector
Reforms
• New phase of Indian banking with the advent of Financial & Banking Sector
Reforms post 1991

The first phase from 1786 to 1969, the early phase up to the nationalization of banks,
portrays the traditional and conservative face of Indian Banking. The banks were largely
confined to urban areas and banking services were not available at rural and semi-urban
areas. Loan extension was, principally, to the trading sector dealing with agricultural
produce while such segments of the economy like small industries, professionals and
self-employed entrepreneurs, artisans, retail traders etc., were largely isolated from
banking exposure. These institutions, hence, did not play their due role in the planned
development of the country.

In order to ensure extension of banking facilities on a large scale, with greater focus on
the rural and semi-urban areas, for diverse public purposes and economic objectives,
nationalization of banks was carried out with 14 large banks in 1969 followed by another
6 banks in 1980. This period saw enormous growth in the number of branches and the
banks’ branch network became wide enough to reach the weakest sections of the society
in a country that is vast and geographical varied. Such a growth, both in terms of sectoral
coverage as well as geographical extension, has indeed been unmatched in the world. But
like everything else, this growth has also not been without a cost.

An impressive growth on the social front exacted a heavy toll, over the years, on the
productivity and efficiency of the system. A consequence was serious erosion of the
profitability of the entire banking system, to the point of raising doubts about the viability
of some of its constituents. Hence, a need for change in policies which ushered in with
economic perestroika post 1991.

Liberalization brought about sweeping economic changes on the Indian shores, opening
up of the economy and its integration with the world market. To survive in the global
competition it required a quantum leap in performance by all. For banks, which after all,
best reflect a pick-up in economic activity, it has implied radical transformation. Banks,
which were born and bred in an atmosphere of protection, realized the importance of
changing as otherwise their existence was itself under threat.

LIBERALIZATION AND GLOBALIZATION OF INDIAN ECONOMY…Onset of

Banking Sector Reforms

Liberalization or deregulation, essentially, engages a greater role of market forces to

improve the operation of institutions and is brought about by the reduction of policy
induced and other constraints. The diverse aspects of deregulation include price
deregulation, access deregulation, product/activity deregulation and easing controls on
lending and investments regulations.

In this context the major forces entailing change for Indian Banks have been the
following,

1. Consistent and strong Regulatory and Supervisory framework with a commitment

to adopt, refine, and standardize them at par with international best practices.
2. Structural reforms in the real and financial sectors
3. Competition from foreign banks and new generation private banks.

Consider the following table that highlights the implication of these changes for the
Indian banking industry,

S.No. Triggers of Change Implication for the banking industry

1. Interest rate deregulation Banks enjoy greater freedom to determine
their own rates of interest.
2. Adoption of Global Standards Prudential norms in terms of capital
adequacy, asset classification, income
recognition, provisioning, exposure limits,
investment fluctuation reserve etc. are now
close to global standards. Best
 international practices in accounting
systems, corporate governance, payment
and settlement systems etc. are
increasingly desired of individual banks.
3. Reduction in pre-emption Lower reserve requirements (SLR and
CRR) enable more lendable resources,
which banks can deploy profitably.

4. Access to capital markets Government equity in banks has been

reduced and they have been allowed to
access the capital market for raising
additional capital.
5. Operational freedom Banks enjoy greater operational freedom
in terms of opening and swapping of
branches, and if have a good track record
of profitability, greater flexibility in
recruitment.
6. Competition from new banks New private sector banks have been set up
and foreign banks permitted to expand
their operations in India including through
subsidiaries. Banks have also been
allowed to set up Offshore banking Units
in Special Economic Zones.
7. New areas for bank financing New areas have been opened for bank
financing such as insurance, credit cards,
infrastructure financing, leasing, and gold
banking etc. indicating emerging
opportunities.
8. Introduction of new financial New instruments have been introduced for
instruments greater flexibility and better risk
management such as interest rate swaps,
forward rate agreements, cross currency
forward contracts, forward cover to hedge
inflows under foreign direct investment,
liquidity adjustment facility for meeting
day-to-day liquidity mismatch.
9. Investment in overseas market Limits for investment in overseas market
by banks has been liberalized marking true
globalization of the banking industry.
10. Universal banking Banks are permitted to diversify into long-
term finance and DFIs into working
capital; guidelines have been put in place
for the evolution of universal banks in an
orderly fashion.
11. Technology infrastructure Technology infrastructure for the
payments and settlement system in the
 country has been strengthened with
electronic funds transfer, Centralized
Funds Management System, Structured
Financial Messaging Solution, Negotiated
Dealing system, and move towards Real
Time Gross Settlement

All this has offered individual banks a wealth of opportunities as well as challenges.
Modern day banks are not mere suppliers of money. They have become providers of a
wide range of services.

CURRENT SCENARIO - issues of relevance…

Banks in India have shown remarkable progress in adjusting to the new operational
environment. The response to the reforms has been positive. The impact and the
experiences with the reforms, though varying in various groups of banks, the style and
content of operation with which they have been brought, however, have a similar chord.
• For public sector banks, the changing economic environment entailed that
profitability and productivity assume center stage.
• For older private sector banks the changing economic environment provided an
opportunity to unleash their latent talents and potentialities
• For foreign banks the changing economic environment facilitated a big foray into
personal banking, trade, and project finance.

In a bid to survive and grow, therefore, banks have changed their shell through strategic
and operational changes. Overall the major challenge has been to adopt a customer-
centric business focus, instead of the administratively coordinated planned actions for
development. But reforms are really a continuous process, which imply that banks
continuously search for viable options and strategies in meeting the challenges emerging
from an increasingly competitive and market driven economic environment. How
individual banks gear up can be summed up in terms of their response to the compulsions
of competition, consolidation, and systematic stability.

Competition
The Indian banking sector is a level playing field for public sector banks, private players,
and foreign banks, and this is the biggest reflection of a committed move towards a
market economy, infact, a ‘ tipping point’ for transformation, for all current and potential
players. Core banking efforts to meet the challenges posed by the demands of a market
economy revolve around the following,

• Cost reduction using technology and other means

• Product differentiation
• Customer-centric services
New methods of accessing financial services, developing new products and services, and
using new delivery channels are widely worked upon by banks to reduce costs, maximize
return on existing clients, acquire more customers and build the customer/product ratio to
effectively retain those customers who might otherwise defect to competitors. The
philosophy for banks is very clear: to provide a whole new range of financial products
and services at minimal costs. And technology has made this possible.

For instance, while customers access retail banks by walking into their local branch and
talking with members of staff and continue to use traditional ATMs to access a relatively
simple range of banking services, automated methods of access are on the increase, and
the Internet is undoubtedly becoming a strong growth story in the Indian retail banking
industry, with millions of customers already choosing to bank this way. The new mobile
channel is another field, which is very exciting, providing plenty of potential for
customers and retail banking organizations alike. For example, Karur Vysya bank ltd.
enables its clients account information, balance status, transaction status, cheque status,
issue of stop payment, requests for cheque book and a plethora of information through its
mobile banking services.

Today, technology has reached a level of sophistication that supports as well as drives– it
is now possible to offer and access simple as well as relatively complicated banking
products in an automated fashion. For example, customers can now complete the initial
stages of a mortgage application without direct human contact, and can obtain insurance
products and term deposits. Automated access gives the considerable benefits of greater
speed and accuracy, which can result in an all-important reduction in overall costs. Much
is being achieved through automated access using existing technology and
infrastructures, which therefore enables banks to optimize return on the investments they
have already made. Hence while individual banks use technology to automate
accounting/back office functions and enable customer interfacing/interaction massively,
the benefits can be summed up in following ways,

• Greater reach to customers

• Quicker time to market
• Greater ability to introduce new products and services and that too quickly and
successfully
• More proficiency in better understanding customer needs
• Customers are enabled access to information easily across any location
• Greater customer loyalty

ICICI, IDBI, HDFC banks are few examples who are matured performers in this arena.
Certainly, the banking industry will work closely with information and
telecommunications industry in years to come, as the opportunities are vast on both sides.

It is clear that retail banking is in an exciting developmental phase, with new products
and services arriving on the market almost every week. Many of these new products and
services build on the back of existing mainstream investments, so their development costs
are relatively low and the return on investment is high. Typically in the industry, we are
seeing the replacement of broad-based generic products and services with solutions
targeted at specific segments. To do this successfully, a far more sophisticated view of
the customer is required. No wonder we are witnessing such unprecedented levels of
retail banking investment in strategies and technologies supporting improved Customer
Relationship Management (CRM). Traditional banking services are being linked in
innovative ways with non-banking services. For example, a shopping mall can now offer
card-processing services as part of their unit rental service, while the bank can link its
credit card service delivery schemes with the product and service delivery of the retailer.
ICICI bank’s collaboration with HPCL, HDFC bank’s with IDEA, Citibank with Indian
Oil and Jet Airways are some cases in point. New products and services have a key role
to play in customer retention. Clearly banks are realizing that when they increase the
number of products held by each customer (customer/product ratio); they are less likely
to see customers deflecting to competitors.

“We have everything -- experience, network, products, and facility. All it takes is to
package it and sell it well”, says an expert banker.

Consolidation
It is generally accepted that consolidation of firms in any industry promotes synergies.
For banks also the basic idea is that a combined bank will create more value than the
individual bank operating independently. Economists refer to the phenomenon of the
“2+2 = 5” effect brought about by synergy. The resulting combined entity gains from
operational and financial synergies. Operational synergies generally refer to gains in
economies of scale and economies of scope.

Economies of scale are generated as a result of lower operating costs arising from
spreading the fixed costs over a wider scale of production and economies of scope are
generated as a result of greater utilization of skill assets employed in production to
produce similar products or services. In a combined entity, the skill used to produce
separate and limited results will be used to produce results on a wider scale. Additionally,
financial synergies refer to the effect of a merger on the financial activities of the
resulting company. The cash flows arising from the merger are expected to present
opportunities in respect of the cost of financing and investment. The argument is that
combining two banks gives rise to savings in costs, maximization in the use of resources
and increase in revenues.

Similarly consolidation exercises also play a crucial role in efficient allocation of

resources. When a bank is not performing as expected, others in the industry will notice
that the assets of the bank are not being put to their most efficient use. This bank will
then become a potential target for a takeover for a bank, which believes that under its
management the assets can be fully-utilized to produce better results. To that extent
mergers and takeovers play a crucial economic role of moving resources from zones of
under-utilization to zones of better utilization. Poorly run companies are more prone to
being taken over by the powerful and managers have an incentive to ensure that their
company is governed properly and resources are used to produce maximum value.
Takeovers in the banking sector ensure that the boards and management of institutions
will improve corporate governance to avoid being targets in future.

When asked how he became the world's richest man, Bill Gates replied, “First, I was in
the right place at the right time. Second, I saw the vision. Third, and most important, I
took action.” Perhaps, the Oriental Bank of Commerce (OBC) had the vision of instant
geographical advantage with the Global Trust Bank (GTB) takeover and therefore, they
took the action. With the amalgamation, OBC, a north India-based bank, gains not just in
terms of a geographical network of 103 branches, 265 ATMs and 8.3 lakhs customer base
in southern and western India. It also gains GTB's technological infrastructure and focus
area. Clearly, it was a sinking GTB that strengthened OBC.

Close on its heels, was the IDBI merger with IDBI bank at the end of FY 2005. The
merger created an entity with assets worth over Rs.80, 000 cr. and the size and strength
comparable to the big players. The merged entity has operations in retail, commercial and
development banking.

The quick succession of mergers wakes us up to the realization that bank consolidations
are no longer pipe dreams. HDFC Bank’s merger with Times Bank, ICICI Bank’s
acquisition of ITC Classic, Anagram Finance and Bank of Madura are some other
examples. Centurion Bank, IndusInd Bank, Bank of Punjab, Vysya Bank are said to be on
the lookout. The towering plans of IDBI are just a case in point. In terms of asset base,
post merger, IDBI ranks seventh. Smitten by the merger benefits of size, strength and
asset worth, IDBI has plans for more mergers up its sleeves. And the plans are nothing
short of ambitious. It aims to displace ICICI from its current number two position in the
short term and SBI from its dominance of the banking sector in the medium term.

Systematic Stability
Evidently Indian economy is on a high growth trajectory, propelled by industrial
restructuring, burgeoning consumer demand and growth of knowledge economy. It is
absolutely imperative that there is sustained an economic environment that is conducive
to this growth, at the same time which also ensures stability in the constituent economic
units and strengthens their innate ability to withstand any shocks that may come in future.
In this context, the issue of financial stability of banks is of great significance and
enormous complexity for Central Banks, particularly in Emerging Market Economies like
India. The necessary transformation required of banks by contemporary economic
situation in such economies, poses threat of several potential sources of instability, such
as financial bubbles, bouts of market volatility and changes in the allocation of risk
between participants. The efficiency properties of these systems can be evaluated on
policies of risk sharing, information provision, funding new ventures, corporate
governance, legal framework, monetary policy of the central bank, and conduciveness of
politics.

The initiatives taken by RBI, in India, to ensure, while also contribute, to systematic
stability broadly aim at building such a regulatory and supervisory framework that
affirms existence of banks which are well-capitalized and well-diversified. Here’s a
check on some of them,

• Renewed emphasis on financial stability as an objective of monetary policy and

lengthening the monetary policy horizon beyond the usual two-year framework.
• Encouraging more transparency in accounting and disclosure practices.
• Bringing prudential norms at par with international standards and best practices,
with suitable India specific adaptations
• Significant initiatives towards graduating towards Basel II, keeping in view India-
specific requirements.
• Ensuring that the banks have suitable risk management framework oriented
towards their requirements dictated by the size and complexity of business, risk
philosophy, market perceptions and the expected level of capital. The framework
adopted by banks would need to be adaptable to changes in business size, market
dynamics and introduction of innovative products by banks in future.
• Improving the level of corporate governance standards in banks. A good
“governance culture” is crucial for financial stability because many risk
management failures reflect a breakdown in corporate governance which arise due
to poor management of conflicts of interest, inadequate understanding of key
banking risks, and poor oversight of the mechanisms for risk management and
internal audit.

Such an approach from RBI has served the banking sector well, in terms of aiding
growth, avoiding crisis, enhancing efficiency, and imparting resilience to the system.
Infact, since the initiation of reforms, financial health as well as efficiency of the banking
sector has improved. From the vantage point of a post-liberalization era and the resultant
challenges, one of the successes of the Indian financial sector reform has been the
maintenance of financial stability and avoidance of any major financial crisis during the
reform period - a period that has been turbulent for the financial sector in most emerging
market countries. This is why the efforts of Indian banking continue to integrate them
with the global markets, while also sequencing and timing these measures in the context
of the imperatives of domestic growth.

IN RETROSPECT…

An efficient financial sector is an engine for economic growth. It converts the fuel of
savings into kinetic energy for the economy. The banking industry, which is at the core of
the financial sector, has to take the lead. The reform process commenced in the 90's has
given the industry a great opportunity. The last decade has, as a result, witnessed major
changes - new banks, new financial institutions, new instruments, new windows, and new
opportunities - and, along with all this, new challenges. While deregulation has opened
up new vistas for banks to augment revenues, it has entailed greater competition and
consequently greater risks. Not only must the sector become more efficient it must also
identify sectors having growth opportunities and devise strategies to move savings into
these sectors. To survive and thrive in the long run, banks need to pursue these strategies
that enable them to develop resources that are inimitable, rare, durable and superior to
competitors. In an era, where businesses thrive beyond geographies and wealth creation
progresses quickly, achieving global benchmarks is central for global players. But
underlying this is the need to have sound fundamentals. There is no doubt that only banks
and financial institutions that are alert on effectiveness, yield and profitability have
abilities to survive in the vastly competitive environment and therefore need to equip
themselves thoroughly.