Comparison between public sector & private sector

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  • 1. EXECUTIVE SUMMARY The project is about comparison between Public Sector & Private Sector Bank in India. Scheduled Commercial Banks in India are categorised into five different groups according to their ownership and / or nature of operation. Scheduled commercial banks consist of 28 public sector banks, 9 new private sector banks, 20 old private sector banks and 31 foreign banks1. Public sector banks are the ones in which the government has a major holding. They are divided into two groups i.e. Nationalized Bank of India and its associates. Private sector banks came into existence to supplement the performance of Public sector banks and serve the needs of the economy better. As the public sector banks were merely in the hands of the government, banks had no incentive to make profits and improve the financial health. Banks operated in regulatory environment with administered rate of interest structure, quantitative restrictions on credit, high reserve requirements and significant proportion of bendable resources going to the priority and government sectors. This resulted in low levels of investment and growth, decline in productivity and erosion of profitability of banking sector. Public Sector & Private Sector Banks are Performs multitude function and services. This Sector Banks are the financial institution that provides services such as accepting deposits and giving business loans. It raises funds by collecting deposits from businesses and consumers via checkable deposits, savings deposits, and time deposits. It makes loans to businesses 1
  • 2. and consumers. It also buys corporate bonds and government bonds. Its primary liabilities are deposits and primary assets are loans and bonds. There is a comprehensive policy framework for Ownership and governance in private sector banks. Which include minimum capital requirement, foreign investment in private sector banks, Foreign Direct Investment, Foreign Institutional Investors, Non Resident Indians, Due diligence process Transition arrangements & Continuous monitoring arrangements. The minimum capital requirement for private sector banks is Rs.200 crore. There has been a guideline on issue and pricing of shares had been prescribed. In terms of extant instructions, banks in private sector, whose shares are not listed on the stock exchanges, are required to obtain prior approval of Reserve Bank of India The performance and the roles of private and public sector banks are undergoing changes. The banks, both private as well as public have to now operate in an increasingly competitive environment. The customer-centric approach of private sector banks have thrown open many more challenges for the public sector banks private sector banks have thrown open many more challenges for the public sector banks. The project includes comparison between the Public Sector & Private Sector Bank which would help to understand various aspect of this of this two sector banks &how the private sector Bank creating competition for the Public sector Bank. And also we are overcome to know step which are taken by the Public sector Bank to face the challenges of the Private Sector Bank. 2
  • 3. Indian Banking System The Indian financial system comprises of four segments or components. These are financial institutions, financial markets, financial instruments and financial services. Banks come under the financial institutions segment. Financial institutions are intermediaries that mobilize savings and facilitate allocation of funds in an efficient manner. The Indian financial system was quite well developed even prior to India’s political independence in August 1947. Both foreign and domestic banks were present and so was a well- developed stock market. Until the 1990s, the Indian financial system was tightly regulated. Following the balance of payments crisis in 1991-92, a stabilization program was initiated with the help of International Monetary Fund, which specifically included a reform of the financial system. The foundation for the financial sector reforms was laid by recommendations of the Committee on Financial System 1991. The Committee again reviewed the financial system in 1998 and made further recommendations. The objectives of the financial sector reforms were to bring about greater efficiency and competitiveness in all the spheres of the economic activity. The reach of organized banking to rural areas and Banking in India has its origin in Vedic times, i.e. 2000 to 1400 BC. Indigenous India Company set up the first bank in Madras. Between 1770 and 1850 banks such as Bank of Hindustan, Commercial Bank, Calcutta Bank, Bank of Calcutta and Bank of Bombay. Later, Commercial Bank and Calcutta Bank merged to form Union Bank. 3
  • 4. Three Presidency Banks i.e. Bank of Bombay, Bank of Madras and Bank of Bengal which were set up between 1809 and 1843 were amalgamated to form the Imperial Bank of India in1921.The Imperial Bank of India later became the State Bank of India. The sudden boom of investment in the 1900s led to the emergence of leading joint stock banks such as the Punjab National (1895), Bank of India (1906), Indian Bank1907), Bank of Baroda (1909), Central bank of India (1911) and Union Bank of India(1919). The major functions of these banks were to finance foreign trade while domestic trade was largely handled by the Multani Shroffs and moneylenders. Between 1941 and1945, the number of banks increased from 473 to 737 but these banks suffered from certain limitations such as inadequate capital structure and unsound methods of operations and management. Thus, the government in consultation with Reserve Bank of India enacted the Banking Companies Act in 1949. Between 1947 and 1969 banks were under private ownership of maharaja’s, or king s of the princely states of India and these banks served the rich families and industrial houses which narrowed the industrial growth of the banking system. The Reserve Bank of India thus made it compulsory for reconstruction and / or merger of the weak units with the sound one’s as per the Banking Companies Act of 1960 and the number of banks declined from 548 in 1947 to 89 in 1969. Fourteen private banks were nationalized on July 19, 1969 and another six in 1980. One of the objectives of nationalization was to extend neglected sections of the society. 4
  • 5. Between 1969 and 1992, there was rapid expansion of bank network. The number of bank branches increased from 8262 to 60570. The banking system spread to rural areas. Small Scale, tiny and cottage industries benefited from the spread of banking system. The share priority sector in total banking grew up from14 percentage in 1969 to43% in 1990 and banking density improved from 64000 people per branch in 1969 to14000 people per branch in 1991. 5
  • 6. Emerging Banks in India The Narasimham Committee on banking sector reforms suggested that 'merger should not be viewed as a means of bailing out weak banks. They could be a solution to the problem of weak banks but only after cleaning up their balance sheet.' The Government has tried to find a solution on similar lines, and passed an ordinance an September 4, 1993, and took the initiative to merge New Bank of India (NBI) with Punjab National Bank (PNB). Ultimately, this turned out to be an unhappy event. Following this, turned out to be an unhappy event. Following this, there was along silence in the market till HDFC Bank successfully took over Times Bank. Market gained confidence, and subsequently, we witnessed two more mega mergers. The merger of Bank of Madhura with ICICI Bank, and of Global Trust Bank with UTI Bank, emerging as a new bank, UTI-Global bank. While the private sector banks are on the threshold of improvement, the Public Sector Banks (PSB’s) are slowly contemplating automation to accelerate and cover the lost ground. To contend with new challenges posed by Private Sector Banks, PSBs are pumping huge amounts to update their IT. But still, it looks like, public sector banks need to shift the gears, accelerate their movements, in the right direction by automating their branches and providing, Internet banking services. Although large PSBs are slowly venturing into new areas, a few old big- sized banks are still encountering problems of unionized staff though in the milder way, and the employees are still finding their feet in new technologies. 6
  • 7. The private sector banks, in order to compete with large and well established public sector banks, are not only foraying into IT, but also shaking hands with peer banks to establish themselves in the market. While one of the first initiatives was taken in November. It is the first merger event in the history of Indian banking, signaling that Indian banking sector joined the M&A bandwagon. Prior to this private bank merger, there have been quite a few attempts made by the government to rescue weak banks and synergise the operations to achieve scale economics (but, unfortunately were futile). Presently, ‘Size’ of the bank is recognized as one of the major strengths in the industry. And, mergers amongst strong banks can be both a means to strengthen the base, and of course, to face the cut-throat competition. On the other hand, if the merger turns out to be mere arithmetical number crunching of two balance sheets without a proper strategic outlook and reorienting goals, it might result in disharmonious human resource problems. A few years ago any talk of bank mergers would have been something abnormal and any suggestion on bank mergers would have been regarded as nothing short of irreverence. For many years the Indian banking sector was monopolized by twenty public sector banks, and SBI group. With the removal of entry barriers, in 1995, the emergence of nine private sector banks has given a new glamorous outlook for the banking industry. The technological savvy, customer oriented service, innovative products have become the day’s meal. 7
  • 8. Introduction to Public Sector and Private Sector Banks Scheduled Commercial Banks in India are categorised into five different groups according to their ownership and / or nature of operation. These bank groups are i) State Bank of India and its associates (ii) other nationalised banks (iii) regional rural banks (iv) foreign banks and (v) other Indian SCBs (in the private sector). Scheduled commercial banks consist of 28 public sector banks (State Bank of India and its seven associates, nationalised banks and other public sector bank), 9 new private sector banks, 20 old private sector banks and 31 foreign banks1. Public sector banks are the ones in which the government has a major holding. They are divided into two groups i.e. Nationalized Bank of India and its associates. Private sector banks came into existence to supplement the performance of Public sector banks and serve the needs of the economy better. As the public sector banks were merely in the hands of the government, banks had no incentive to make profits and improve the financial health. Nationalization killed competition and stifled competition in banking. Banks operated in regulatory environment with administered rate of interest structure, quantitative restrictions on credit, high reserve requirements and significant proportion of bendable resources going to the priority and government sectors. This resulted in low levels of investment and growth, decline in productivity and erosion of profitability of banking sector. Thus, Narasimham Committee I (1991) which recommended the free entry of new banks in the financial market provided they confirm the minimum start up capital and other requirements by the permission of Reserve Bank of India. As on March 2006, the number of scheduled commercial banks in India stood at2182. As on June 2006, the number of banked centers served 8
  • 9. by scheduled commercial banks stood at 34,513. Of these centers, 29,039 were single office centers and 45 centers had 100 and more bank offices. The top hundred centers, out of 34,513 banked centers, arranged according to the size of deposits accounted for 67.7 per cent of the total deposits and the top hundred centers arranged according to the size of bank credit accounted for76.6 per cent of total bank credit. Aggregate deposits of top hundred centers grew at 27.7 per cent in June 2006 over June 2005 compared to 18.0 per cent growth recorded a year2006 over June 2005, compared to 32.9 per cent growth recorded in June 2005. Nationalised Banks, as a group, accounted for 48.5 per cent of the aggregate deposits, while State Bank of India and its Associates accounted for 22.9 per cent. The shares of Other Scheduled Commercial Banks, Foreign Banks and Regional Rural Banks in aggregate deposits were 20.0 per cent, 5.4 per cent and 3.2 per cent, respectively. As regards gross bank credit, Nationalised Banks held the maximum share of 47.6 per cent in the total bank credit followed by State Bank of India and its Associates at 22.6 per cent and Other Scheduled Commercial Banks at 20.3 per cent. Foreign Banks and Regional Rural Banks had relatively lower shares in the total bank credit at 6.9 per cent and 2.6 per cent, respectively3. With assets of around Rs 4, 93,000 crore, State Bank of India (SBI) is the country’s largest bank, yet it ranks 84th in the world, according to The Banker; the next biggest is ICICI Bank, which is half the size of SBI and ranked around 200 globally4. The top 25 banks — of which, 18 are owned by the government — account for about 85 per cent of banking assets. Thus there seems to be concentration as well as fragmentation in the Indian banking sector. 9
  • 10. FUNCTIONS OF PUBLIC AND PRIVATE SECTOR BANK A):- Primary functions 1):-Acceptance deposits a) Time Deposit:- These are deposit repayable after a certain fixed period. Deposits are not withdraw able by cheque, draft or by other means. It includes the following.  Fixed Deposit :- The deposit can be withdrawn only after expiry of certain period, say 3 years, 5 years or 10 years. The banker allows a higher rate of interest depending upon the amount and period of time. Previously the rates of interest payable on fixed deposit were determined by RBI. Presently banks are permitted to offer interest as determined by each bank. However, banks are not permitted to offer different interest rates to different customers for deposits of same maturity period, except in the case of deposit of RS. 15 lakhs and above. Fixed deposit receipt can not be transferred to other persons.  Recurring Deposit :- The customer opens an account & deposit a certain sum of money every month after a certain period say 1 year or 3 years or 5 years. The accumulated amount along with interest is paid to the customer. It is very helpful to the middle & poor sections of the people. This deposit system is useful mechanism for regulars savers of money. Interest paid on such deposits is generally on cumulative basic. 10
  • 11.  Cash certificates:- Cash certificates are issued to the public for a longer period of time. It attracts the people because it’s maturity value is in multiples of the sum invested. it is an attractive and high yielding investment for those who can keep the funds for a long time . It is very useful account for meeting future financial requirement at the occasion of marriage, education of children etc. cash certificates are generally issued at discount to face value. It means a cash certificate of RS.1 00 000 payable after 10 years can be purchased now, say for RS. 20000. b):-Demand deposit:- These are the deposit which may be withdrawn by the depositor at any time without previous notice. it is withdraw able by cheque and draft.  Saving deposits :- Saving deposit can only be held by individuals and non profit institutions. The rate of interest paid on saving deposit is lower than that of time deposits. These account holders gets the advantage of liquidity and small income in the form of interest but there are some restrictions on withdrawals presently interest on saving bank account is determined by RBI.  Current account deposits :- These accounts are maintained by the people who need to have a liquid balance. Current account offers high liquidity. No interest is paid on current deposits and these is no restrictions on withdrawals from the current 11
  • 12. account.Thease account are generally in the case of business firms, institutions and cooperative bodies. These schemes vary from bank to bank. 2):-Advancing of loans:- The commercial banks provide loans and advances in various forms. They are given below,  Overdraft facility:- This facility is given to holder of current account only. This is an arrangement with the bankers thereby the customer is allowed to draw money over and above the balance in his/ her account. This facility of overdrawing his/her account is generally pre arranged with the bank up to a certain limit. It is a short term temporary fund facility from bank and the bank will charge interest over the amount overdrawn. This facility is generally available to business firms and companies.  Cash credit :- Cash credit is a form of working capital firms. The customer can operate that account within the sanctioned limit as and when required. It is made against security of goods personal security etc.on the basis of operation .The period of credit facility may be extended further one advantage under this method is that bank charges interest only an account utilized and not an total amount sanctioned or credited to the account.  Discounting of bills :- It may be another form of bank credit. The bank may purchase inland and foreign bills before are due for payment by the drawee. Debtors at 12
  • 13. discounted value. The bankers discount is generally the interest on the full amount for the unexpired period of the bill, the account of the customer in case the bill are ultimately not paid i.e. dishonoured.The bill passes to the banker after endorsement. Banks will not dis-accomodation bills.  Loans and advances :- It includes both demand and term loans, direct loans and given to all type of customers mainly to businessmen and investors against personal security or goods of movable in nature. The loan amount is paid in cash or by credit to the customer account which the customer can draw at any time.  Educational loan scheme :- The RBI from August 1999 introduced a new educational loan scheme for students of full time graduate / post graduate /professional courses in private professional colleges. Under the scheme all public sector banks have been directed to provide educational loan up to RS. 15,000 for free seat and RS. 50,000 for payment seat student at interest not more than 12% p.a. This loan is available only for students whose annual family income does not exceed RS. 1, 00,000. The loan has to be repaid together with interest within five years from the date of completion of course. Students in respect of the following subjects/ areas are covered Medical or dental course, Engineering or law studies, Chemical technology or, Management course like MBA, Computer Science  Housing Finance :- 13
  • 14. Nowadays the commercial banks are competing among themselves in providing housing finance facilities to their customers. It is mainly to increase the housing facilities in the country. State bank of India, Indian bank, Canara bank, Punjab national bank have formed housing subsidiaries to provide housing finance. The others bank are also providing housing finance. Housing finance up to RS. 5 lakhs is treated as priority sector advances for banks. The limit has been raised to RS. 10 lakhs per borrower in cities.  Loans against saving certificates:- Banks are also providing loans up to certain value of savings certificates like National Savings Certificate, Fixed Deposit Receipt, Indira Vikas Patra, etc. the loan may be obtained for personal or business purposes.  Consumer loans and advances:- One of the important areas for bank financing in recent years is towards purchase of consumer durables like TV sets, Washing Machines, Micro Oven ,etc. Banks also provide liberal Car finance. These days banks are competing with one another to lend money for these purposes as default of payment is not high in these areas as the borrowers are usually salaried persons having regular income. Bank rate is also higher.  Loans against shares / securities :- Commercial banks provide loans against the security of shares / debentures of reputed companies. Loans are usually given only up to 50 % value (market value) of the shares subject to a maximum amount permissible as 14
  • 15. per RBI directives. Presently one can obtain a loan up to Rs. 20 lakhs against the physical shares and up to RS. 20 lakhs against dematerialized shares.  Securitization of loans :- Banks are recently trying to securities a part of their part of loan portfolio and sell it to another investor. Under this method, banks will convert their business loans into a security or a document and sell it to some investment or fund Manager for cash to enhance their liquidity position. It is a process of transferring the credit risk from the banker to the buyer of securitised loans. It involves a cost to the bankers but it helps the bank to insure proper recovery of loan.  Others :- Commercial banks provide other type of advances such as venture capital advances, jewel loans, etc 3):- Credit Creation Credit Creation is one of the primary function of commercial banking when a bank sanction a loan to the customer, it does not give cash to him, but a deposit account is opened in his name and the amount is credited to his account he can withdraw the money whenever he needs. A bank sanction loan it creates a deposit. In this way the bank increase the money supply of the economy such functions is known as credit creation. 15
  • 16. B):- Secondary functions 1):- Agency functions  Collection of cheques dividends interest :- As an agent the banks collects cheque, draft, promissory notes, interest, dividend etc. on behalf of its customer and credit the amounts to their account. Customer may furnish their bank details to corporate where investment is made in shares; debentures etc. as and when dividend, interest is due the companies directly send the warrants / cheques to the bank for credit to customer account.  Payment of rent ,insurance premiums :- The bank makes the payments such as rent, insurance premiums, subscription on standing instructions until further notice till the order is revoked the bank will continue to make such payment regularly by debiting the customer account.  Dealing in foreign exchange :- As an agent the commercial bank purchase and sell foreign exchange as well for customers as per RBI exchange control regulations.  Purchase and sale of securities:- 16
  • 17. Commercial banks undertake the purchase and sale of different securities such as shares, debentures, bonds etc. on behalf of their customers. They run a separate “Portfolio management scheme” for their big customers.  Act as correspondent :- Commercial banks act as a correspondent of their customer. Small banks even get travel tickets, book vehicles; receive letters etc. on behalf of the customers.  Preparation of income tax returns :- They provide income tax returns and provide advice on tax matters for their customers. For those purposes they employ tax experts and make their services available to their customers. 2) General utility services:-  Safety Locker Facility:- Safe keeping of important document valuables like jewels is one of the oldest services provided by commercial banks. Lockers are small receptacles which are fitted in steel racks and kept inside strong rooms known as “vaults”. These lockers are available on half yearly or annual rental basis. The bank merely provided lockers and the key but the valuable are always under the control of its users. Any customer of safety lockers after entering into a register his name account number and time can enter into the vault.  Issue “Traveler’s cheques’’ :- 17
  • 18. Banks issue travelers cheque to help carry money safely while traveling within India or Abroad. Thus, the customer can travel without fear,theft or loss of money.  Payment Mechanism or Money transfer :- Transfer of funds is one of the important functions performed by commercial banks. Cheques and credit cards are two important payment mechanisms through banks. Despite an increase in financial transactions, banks are managing the transfer of funds process very efficiently. Cheques are also cleared through the banking sustem.correspondent banking is another method of transferring funds over long distance, usually from one country to another. Banks, these days employ computers to speed up money transfer and to reduce cost of transferring funds. Electronic transfer of funds is also known as’ Chequeless banking’ where funds are transferred through computers and sophisticated electronic system by using code words. They offer Mail Transfer, Telegraphic Transfer Facility also.  Acting as referees :- The banks act as referees and supply information about the business transactions and financial standing of their customers on enquiries made by third parties. This is done on the acceptance of the customers and help to increase the business activity in general.  Letters of credit :- 18
  • 19. It is payment document provided by the buyer’s bankers in favour of seller. This document guarantees payment to the seller upon production of document mentioned in the letter of credit evidencing dispatch of goods to the buyer. The letter of credit is an assurance of payment upon fulfilling conditions mentioned in the letter of credit. The letter of credit is an important method of payment in international trade. There are primarily 4 parties to letter of credit. The buyer or importer, the bank which issues the letter of credit ,known as opening bank, the person in whose favour the letter of credit is issued or opened, and the credit receiving/advising bank. The letter of credit is generally advised / sent through the seller’s bank known as Negotiating or advising bank.  Provide trade information :- The commercial banks collect information on business and financial conditions etc. and make it available to their customers to help plan their strategy. Trade information service is very useful for those customers going for cross – border business. it will help traders to know the exact business conditions , payment rules and buyers financial status in other countries.  ATM facilities :- The banks .today has ATM facilities. Under this system the customers can withdrawn their money easily and quickly and 24 hours a day. This is also known as Any Time Money .Customers under this system can withdraw funds i.e. Currency notes with a help of certain magnetic card issued by the bank and similarly deposit cash / cheque for credit to account. 19
  • 20.  Gift cheques :- The commercial banks offer gift cheque facilities to the general public .these cheques received a wider acceptance in India. Under this system by paying equivalent amount one can buy gift cheque for presentation on occasions like wedding birthday.  Accepting bills :- On behalf of their customers the banks accept bills drawn by third parties on its customers. This resembles the letter of credit. While banks accept bills, they provide a better security for payment to seller of goods or drawer of bills  Traveler’s cheques: These are used by domestic travelers as well as by international travelers. However the use of traveler’s cheque is more common by international travelers. However the use of traveler’s cheques is more common by international travelers because of their safety and convenience. These can be also termed as a modified of travelers letter of credit. A bank issuing travelers cheque usually have banking arrangement with many of the foreign banks abroad, known as correspondent banks.travellers cheque are not drawn on specific bank abroad. The cheques are issued in foreign currency.  Merchant banking :- 20
  • 21. The commercial banks provide valuables services through their merchant banking divisions or through their subsidiaries to the traders. This is the function of underwriting of securities. They underwrite a portion of the public issue of shares, debentures and bonds of joint stock companies. Such underwriting ensures the expected minimum subscription and also convey to the investing public about the quality of the company issuing the securities. Currently this type of services can be provided only by separate subsidiaries known as ‘Merchant Bankers’ as per SEBI regulation.  Advice on financial matters :- The commercial banks also give advice to their customers on financial matters particularly on investment decision such as expansion, diversification, new ventures, rising of funds etc.  Factoring service :- Today, the commercial banks provide factoring service to their customers. It is very much helpful in the development of industry as immediate cash flow and administration of debtors accounts are taken care of by factors.  Credit cards:- Banks have introduced credit card system. Credit cards enables a customers to purchase goods and services from certain specified retail and service establishments up to a limit without making immediate payment ,in others words purchases can be made on credit basic on the strength of the credit card. 21
  • 22. The establishments like hotels, shops, airline companies, and railways etc. which sell the goods or services on credit forward monthly of fortnightly statements to the bank. The amount is paid to these establishments by the bank. The bank subsequently collects the dues from the customers by debit to their accounts. Usually the bank receives certain service charges for every credit card issued. Visa card, BOB card are example of credit cards. A comprehensive policy framework for Ownership and governance in private sector banks Introduction Banks are "special" as they not only accept and deploy large amount of uncollateralized public funds in fiduciary capacity, but also they leverage such funds through credit creation. They are also important for smooth functioning of the payment system. In view of the above, legal prescriptions for ownership and governance of banks laid down in Banking Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI from time to time. The existing legal framework and significant current practices in particular cover the following aspects 1. Minimum capital The capital requirement of existing private sector banks should be on par with the entry capital requirement for new private sector banks prescribed in RBI guidelines of January 3, 2002, which is initially Rs.200 crore, with a 22
  • 23. commitment to increase to Rs.300 crore within three years. In order to meet with this requirement, all banks in private sector should have a net worth of Rs 300 crore at all times. Where the net worth declines to level below Rs 300 crore, it should be restored within reasonable time. 2. Foreign investment in private sector banks In terms of the recent GOI press note of March 5, 2004, the aggregate foreign investment in private banks from all sources (FDI, FII, and NRI) cannot exceed 74 per cent. The limit of 74 will be reckoned by taking the direct and indirect holding. At all times, at least 26 per cent of the paid up capital of the private sector bank will have to be held by residents. 3. Foreign Direct Investment (FDI) The policy already articulated in the February 3, 2004 guidelines for determining fit and proper status of shareholding of 5 per cent and above will be equally applicable for FDI. Hence any FDI in private banks where shareholding reaches and exceeds 5 percent either individually or as a group will have to comply with the criteria indicated in the aforesaid guidelines. In the interest of diversified ownership, the percentage of FDI by single entity or group of related entities may not exceed 10 percent agencies as considered appropriate. 4. Foreign Institutional Investors (FIIs) Currently there is a limit of 10 per cent for individual FII investment with the aggregate limit for all FIIs restricted to 24 per cent which can be raised to 49 per cent with the approval of Board / General Body. This 23
  • 24. dispensation will continue. The present policy of RBI’s acknowledgement for acquisition/ transfer of shares of 5 percent and more of a private sector bank by FIIs will continue and will now be based upon the policy guidelines on acknowledgement of acquisition/transfer for shares issued on February 3, 2004. For this purpose RBI may seek certification from the concerned FII of all beneficial interest. 5. Non Resident Indians (NRIs) Currently there is a limit of 5 per cent for individual NRI portfolio investment with the aggregate limit for all NRIs restricted to 10 per cent but can be raised to 24 per cent with the approval of Board / General Body. This dispensation will continue. But, the policy guidelines of February 3, 2004 on acknowledgement for acquisition/transfer will be applied. 6. Due diligence process The process of due diligence in all cases of shareholders and directors as above, will involve reference to the relevant regulator, revenue authorities, investigation agencies and independent credit reference 7. Transition arrangements The current minimum capital requirements for entry of new banks is Rs. 200 crore to be increased to Rs. 300 crore within three years of commencement of business. A few private sector banks which have been in existence before these capital requirements are prescribed are having less than Rs.200 crore 24
  • 25. net worth. In the interest of having sufficient minimum size for financial stability, all the existing private banks should also be able to fulfill the minimum net worth requirement of Rs. 300 crore required for new entry. Hence any bank falling below this level will be required to submit a time bound programme for capital augmentation to RBI for approval. 8. Continuous monitoring arrangements Where RBI acknowledgment has already been obtained for transfer of shares of 5 per cent and above, it will be the bank’s responsibility to ensure continuing compliance of the fit and proper criteria and provide an annual certificate to the RBI of having undertaken such continuing due diligence, Similar continuing due diligence on compliance with the fit and proper criteria for directors/CEO of the bank will have to be undertaken by the bank and certified to RBI annually, RBI may, when considered necessary, undertake independent verification of fit and proper test conducted by banks through a process of due diligence. 25
  • 26. Issue and pricing of shares by private sector banks In terms of which guidelines on issue and pricing of shares had been prescribed. In terms of extant instructions, banks in private sector, whose shares are not listed on the stock exchanges, are required to obtain prior approval of Reserve Bank of India (RBI) for issue of all types of shares, viz., public, preferential, rights / special allotment to employees and bonus shares. However, banks whose shares are listed on the stock exchanges need not seek prior approval of RBI for issue of shares except bonus shares, which is to be linked with rights / public issues by all the banks in private sector. The matter has since been reviewed and issue and pricing of shares by private sector banks would be governed by the following guidelines: 1. Initial Public Offers (IPOs): 26
  • 27. All banks should obtain RBI approval for IPOs. After listing on the stock exchanges, banks are free to price their subsequent issues. Issue price should be based on merchant banker's recommendation. There need be no reference to the CCI formula for deciding on the pricing of such issues. 2. Rights issues: RBI approval would not be required for rights issues by both listed and unlisted banks. 3. Bonus issues: Private sector banks, both listed and unlisted, need not seek RBI's approval for bonus issues. The issues would, however, be subject to SEBI's requirements on issue of bonus shares, viz. bonus issues (a) should be made from free reserves built out of genuine profits or share premium, (b) should not dilute the value or rights of partly or fully convertible debentures, (c) should not be in lieu of dividend and (d) should not be made unless all partly paid-up shares are fully paid-up. Further, bonus issues may be issued without linkage to rights issues. 27
  • 28. 4. Preferential issue: All preferential issues would require prior approval of RBI. Pricing of preferential issues by listed banks may be as per SEBI formula, while for unlisted banks the fair value may be determined by a chartered accountant or a merchant banker. 5. In case of pricing of issues where RBI approval is not required, pricing of issues should be as per SEBI guidelines; in cases where prior approval of RBI is required, pricing should take into account both SEBI and RBI guidelines. 6. These instructions come into force with immediate effect. 28
  • 29. MPORTANCE OF PRIVATE SECTOR BANK IN INDIA The private sector bank plays a vital role in the Indian economy. They indirectly motivate the public sector banks by offering a healthy competition to them. The following are their importance: 1. Offering high degree of professional management : The private sector bank helps in introducing a high degree of professional management and marketing concept into banking. It helps the public sector banks as well to develop similar skill and technology. 2. Creates healthy competition : The private sector banks provide a healthy competition on general efficiency levels in the banking system. 3. Encourage Foreign Investment : 29
  • 30. The private sector banks especially the foreign banks have much influence on the foreign investment in the country. 4. Helps to access foreign capital markets : The foreign bank in the private sector helps the Indian companies and the government agencies to meet out their financial requirements from international capital markets. This service becomes easier for them because of the presence of their head offices / other branches in important foreign centers. In this way they help a large extent in the promotion of trade and industry in the country. 5. Helps to develop innovation and achieve experts : The private sector banks are always trying to innovate new products avenues (new schemes, services) and make the industries to achieve experts in their respective fields by offering quality service and guidance. They introduce Thus; they lead the other banks in various new fields. For example, introduction of computerized operations, credit cards business, ATM service, etc. 30
  • 31. Performance of Public and Private Sector Banks: A Comparison The performance and the roles of private and public sector banks are undergoing changes. The banks, both private as well as public have to now operate in an increasingly competitive environment. The competition for public sector banks is coming from the private sector banks. Despite having the advantage of a substantial presence and penetration in the rural areas, the public sector banks are under tremendous pressure to maintain their margins and to survive the competition. The customer-centric approach of private sector banks have thrown open many more challenges for the public sector banks private sector banks have thrown open many more challenges for the public sector banks especially in retaining customers and expanding customer base. Especially in retaining customers and expanding customer base. 31
  • 32. We have compared Public and Private sector banks based on this parameters, which are critical while evaluating their performance. These criteria are as follows: 1. Assets and Liabilities 2. Priority Sector Lending 3. Sensitive Sector Lending 4. Credit Deposit Ratio 5. Capital Adequacy 6. Distribution Network 7. Operating Expenses 8. Return on Assets 9. Deposit & advances 10. Market Share 11. Non Interest Income/Total Income 12. Advances 13. Operating Net Profit The analysis and statistics for the above is depicted below. 1. Liabilities and Assets of Banks As can be seen below the percentage of total assets and liabilities of New Private sector banks is higher than the Public sector Banks. Supported by robust economic growth and industrial recovery, loans and advances witnessed strong growth, investments, in a rising interest rate scenario Deposits showed a lackluster performance in the wake of increased competition from other saving instruments. Borrowings and net owned funds (capital and reserves and surplus), however, increased sharply underscoring 32
  • 33. the growing importance of non-deposit resources of SCBs. Bank group- wise, assets of new private sector banks grew at the highest rate, followed by public sector banks and old private sector banks. As their base is small, private sector banks show a very high percentage increase in assets. They also are competing for increasing market share, acquisition of clients has been their main agenda and technology has enabled them to scale their operations hugely. Seven associates, nationalized banks and other public sector bank (one)), 9 new private sector banks, 20 old private sector banks and 31 foreign banks. Table1 GROWTH OF SCHEDULE COMMERCIAL BANKS: BANKGROUP- WISE 33
  • 34. 2. Priority Sector Lending The performance of private sector banks in the area of priority sector lending remained less satisfactory with 12 out of 30 private sector banks failing to achieve the overall priority sector targets. Only one private sector bank could achieve the sub-targets within the priority sector. Advances to weaker sections for the private sector banks of net bank credit was much lower than the Stipulated 34
  • 35. target for the sector. Public sector banks are enforced by government to undertake lending mostly in the priority sector (40%) at subsidized rates to encourage and support the rural sectors. Private sector banks aims at profitability and marginal returns, so they concentrate more on the sensitive sector. Agricultural sector gets less importance in priority sector as compared to other sectors because private sector banks concentrate less on this sector as compared to PSB’s. Item Public Sector Bank Private Sector Bank 2003-04 2004-05 2003-04 2004-05 Priority Sector Of which: 2,44,456 (43.6) 3,10,093 (43.2) 48,920 (47.3) 69,384 (43.3) Agriculture 84,435 (15.1) 1,12,475 (15.7) 14,730 (14.2) 21,475 (12.1) Small Scale Industries 58,311 (10.4) 67,634 (9.4) 7,590 (7.3) 8,668 (5.4) Other Priority Sector 1,01,710 (18.1) 1,29,984 (18.1) 26,600 (25.7) 39,241 (24.5) Table: Priority Sector Lending by Public Sector & Private Sector Bank 3. Sensitive Sector lending 35
  • 36. Sensitive Sector comprises of Capital Market, Real Estate Market, Commodities, and Venture Capital. Among bank groups, old private sector banks had the highest exposure to the sensitive (measured as percentage to total loans and advances of banks), followed by new private sector banks, foreign banks and public sector banks. Private sector banks focuses more on sensitive sectors as these markets are Private sector banks focuses more on sensitive sectors as these markets are highly volatile involving high returns and higher risk. Since Public sector banks require high expertise and high risk is, involved they refrain from lending to sensitive sector. Lending to Public Sector Bank Old Private Sector Bank New Private Sector Bank FY05 FY06 FY05 FY06 FY05 FY06 Capital Market 1.1 1.2 1.1 1.3 2.2 2.3 Real Estate Market 9.1 14.2 12.7 14.5 28.4 28.8 Commodities 0.1 0.1 0.1 0.2 0.7 1.3 Total advances to Sensitive sector 10.3 15.5 14.0 16.0 31.3 32.4 Table: Sensitive Sector lending 4. Credit Deposit Ratio 36
  • 37. The Credit-Deposit ratio (C-D ratio) is the proportion of loan-assets created by the bank from the deposits received. Among the 82 banks profiled, the aggregate C-D ratio stood at 70.1% in FY06 as compared to 62.7% in FY05. Where in private banks, their C-D ratio stood at 73.4% in FY06, higher than 70.9% for FY05. Public sector banks too showed a growth in their C-D ratio at 68.2% as compared to 59.5% in FY05. As seen earlier, the high rate of bank credit growth during the last two years has resulted in this unique behavior of credit-deposit (C-D) ratio. Groups Credit Deposit Ratio (%) FY05 FY06 Public Sector Bank 59.5 68.2 Private Sector Bank 70.9 73.4 Table: Credit Deposit Ratio (%) 5. Capital Adequacy Ratio Among bank groups, the CRAR of new private sector banks improved significantly, which brought them closer to other bank groups. Within the public sector banks, the CRAR of nationalized banks registered a marginal improvement during the year2005but during the year 2006 CAR of the nationalized banks has declined. A banks CAR is ratio of qualifying capital to risk adjusted assets. The RBI has set the minimum CAR at 10%, a rate below the minimum indicates that the bank is not adequately capitalized to expand its operations. However banks CAR can be a little higher than the 37
  • 38. minimum. Overall, Public Sector Banks have shown satisfactory performance as compared to Private sector banks as they are more cautious while lending. In case of PSB’s CAR has decreased as compared to previous year. Decreasing ratio could affect the business expansion and result in low level of income. Higher CAR shows that bank can expand its business more and is less vulnerable to external shocks. FY01 FY02 FY03 FY04 FY05 FY06 Public Sector Bank 11.2 11.8 12.6 13.2 12.9 12.2 Old Private Sector Bank 11.9 12.5 12.8 13.7 12.5 11.7 New Private Sector Bank 11.5 12.3 11.3 10.2 12.1 12.6 Table: Capital Adequacy Ratio (%) 6. Distribution of Network The expansion in the distribution network of the banks is increasingly evident from the growth of the automated teller machines. There is a surge in the growth of off-site ATMs with their share in the total ATMs rising to 32% in respect of Public Sector Banks, 32% in Old Private Sector Bank, 63%in New Private Sector Bank.Computarisation of public sector bank branches is also moving at rapid pace. In 2007 the pace of computerization progressed much further. Public Sector Bank have 93 branches operating abroad in 26 countries. 38
  • 39. Table: Branches /ATMs /Staff in Banks (Number) 7. Operating Expenses The operating expenses are those expenses that cover the day-to-day functioning of the bank like employee costs and charges for normal running of business. Among the profiled 82 banks, the ratio of operating expense to total expense for the Public Sector Banks was 26.5%, Private Sector Banks was 28.4%, while for Foreign Banks the ratio was nearly one-third of their total expenses and stands a little higher compared to their peers Intermediation cost is the ratio of operating expense to total assets, and when seen in conjunction with non-interest income explains how much is 39 Particulars Public Sector Banks Old Private Sector Banks New Private Sector Banks Branches Rural 18219 936 97 Semi-Urban 11146 1447 322 Urban 9439 1236 674 Metropolitan 9039 947 857 Total 47843 456 1950 ATMs 12608 1547 6112 On Site 6587 1054 2255 Off Site 6021 493 3857 Employees 738110 49657 59249 Officers 248270 21308 44519 Clerks 330985 29301 4469 Subordinate 158855 9048 261 Foreign Offices 93 9 4
  • 40. the non-interest income able to cover up the operating expenses of the banks. This gap (the excess of operating expenditure over non-interest income as a percentage to total assets) has been narrowing considerably over the past few years. Among the profiled banks, for Public Sector Banks this gap was 0.9%, for private banks 0.4% and for Foreign Banks it stood at 0.2% for the year ending Mar 06. 8. Return on Assets In the list of 82 banks profiled, the return on assets for Foreign Banks was highest at 1.5%, followed by Private Sector Banks at 0.9%; and Public Sector Banks at 0.6%. The graph depicts that the return on assets bounced back smartly for Foreign Banks after the slight decline it witnessed in FY05. The return on assets for the Private Sector Banks has more or less remained the same with just a slight decline in it. While the return on assets for a Public Sector Banks shows a very sharp decline. 40
  • 41. 9. Deposits and Advances Deposits of SCBs grew by 17.8 % in FY06 as against 16.6% in FY05, but the advances growth outstripped this pace with a rise of 31.8% in FY06, over a 33.2% growth in FY05. As per a recent RBI report, FY06 was the second consecutive year, when increase in credit in absolute terms was more than the absolute increase in aggregate deposits. Group Year Deposits Advances Investment Total Assets State Bank Group FY05 5056500 2847540 267050 6271150 FY06 5424100 3715190 2249450 69184710 Nationalised Banks FY05 9308910 56944610 4255090 11468660 FY06 1080072 0 7346090 4087950 1320260 Private FY05 3146290 2213030 14087950 4278960 41
  • 42. Sector Banks FY06 4282520 3128730 1804890 5714060 Foreign Banks FY05 863900 753190 428580 1536380 FY06 1137460 975550 535620 2015830 All SCB’s FY05 1837557 0 11508340 8697330 23554940 FY06 2164476 0 15165550 867780 27878760 10. Market Share The share of Public Sector Banks showed deceleration in respect of major areas of business, where as that of the new private sector and Foreign Banks earned higher share of business. The market share of the Old Private Sector Banks too came under pressure. Public Sector Banks hold 75% market share in major areas of business. Bank Group Assets Deposits Advances Investment 2005 2006 2005 2006 2005 2006 2005 2006 Public Sector Bank 75.3 72.3 78.2 75.0 74.2 72.9 78.9 73.1 Old Private Sector Banks 5.7 5.4 6.4 6.0 5.9 5.5 5.1 5.2 New Private Sector Banks 12.5 15.1 10.8 13.8 13.3 15.5 11.0 15.6 Foreign Banks 6.5 7.2 4.7 5.3 6.5 6.4 4.9 6.2 42
  • 43. Table: Major Components of Business, Bank GroupWise (in %) 11. Non-Interest Income/Total Income The non-interest income for all the 82 banks profiled in this publication on an average stood at 22.1% of the total income. Among the bank groups, non-interest income was the highest for Foreign Banks at 31%, followed by Private Sector Banks at 19.8%; indicative of the value-added services these banks offer. For Public Sector Banks, non-interest income was just 15.3% while interest income was a high 84.7%. Non-interest income includes fee income components such as commission, brokerage and exchange transactions, sale of investments, corporate finance transactions, M&A deals; and any other income other than the interest income generated by the bank. 12. Advances 43
  • 44. Advances for all the profiled banks have grown at about 32% and that made by Private Sector Banks grew at the highest rate of 44% for FY06 followed by a growth of 30.7% for Public Sector Banks and 30% for Foreign Banks. Among the major components of total advances, there was no relative change in the percentage share of Bills Purchased and Discounted, over the last three years. Cash Credits, Overdrafts and Loans have shown a yearly decline of 4% in FY05 as a part of total advances. Correspondingly, Term Loans have been growing and constitute a large component of advances. In FY04, Term Loans constituted 49.4% of Total Advances, which increased to 54.2% in FY05, and further to 55.7% in FY06. Group-wise Average Growth in Term Loans Groups FYO5 FYO6 Public Sector Banks 59.8 32.2 Private Sector Banks 38.7 48.9 Foreign Banks 37.2 30.2 Table: Group-wise Average Growth in Term Loans 44
  • 45. In FY06, Term Loans across the profiled banks grew on an average of 35.9%. Term Loans provided by the public sector banks showed robust growth of 59.8% in FY05 which almost reduced to half and stood at 32.2% in FY06. The growth shown by Private Sector Banks has varied too, with 38.7% growth in FY05 and 48.9% in FY06. Foreign Banks, however, have shown a lower growth in term loans in FY06 as compared to FY05, which grew by 30.2% in FY06 as against a growth of 37.2% in FY05. This growth in all three bank-groups can largely be attributed to the growth in retail credit and the overall economy, among other factors. 13. Operating and Net Profit Net profits declined by 7.0 per cent (excluding the conversion impact i.e. conversion of non-banking entity to banking entity) during 2004-05 as against an increase of 30.4 per cent in the last year. While net profits of nationalized banks, old private sector banks and foreign banks declined, those of SBI group and new private sector banks increased. Sharp increase in the net profits of new private sector banks was because of a Banks operating profit is calculated after which mainly includes salary cost and network expansion cost. Operating margins are profits earned by banks on its total interest income. Net Profit is calculated after deducting various cost of funds, since the cost of funds i.e. the borrowing costs are higher as compared to the lending rates offered, the PSB’s net profit is lesser compared to the private bank. 45
  • 46. Strategies and Challenges Public Sector Banks The public sector banks are turning the spotlight on the customer and offering quicker, better service. That includes everything from ATM machines and computerized branches to never before seen marketing initiatives. Clearly, public sector banks have woken up to competition. Post- liberalization, several new generation private sector banks changed the face of the industry, with a distinct customer focus. These changes are now taking place in many public sector banks. Private sector banks brought in concepts like customer relations officers focused marketing teams and single window banking. Moreover, with new technology, private sector banks like ICICI and HDFC Bank could offer customer services like ATMs, phone 46
  • 47. banking, internet banking, automatic money transfer, mobile banking, core banking solutions and computerized monthly statements. The two important challenges for public sector banks are: • To maintain their profitability despite government norms and regulations, as also to maintain their PLR. • Put in place appropriate technology of excellent standards that will make them be seen more as virtual banks rather than brick and mortar banks. This will lead to consolidation of their respective network. It is essential that they be given autonomy- operational and administrative- and be completely board driven, including in the selection of the chief executive officer. Finally, they must be taken out of the purview of the Central Vigilance Commission, even if it entails bringing them under the Companies Act. Public sector banks, which account for 75 per cent of banking assets, also should be prepared for such mergers and acquisitions which would further strengthen our banking sector. Since any merger moves are likely to face opposition, the best public sector banks are forming loose alliances of the kind struck by Corporation Bank, Indian Bank and Oriental Bank of Commerce, which agreed to, among other things, rationalise branch network, and share IT and treasury resources5. Private Sector Banks There are two types of private sector banks, the old and the new. As far as the old mostly regional banks are concerned, inadequacy of capital will lead to their inevitable mergers sooner rather than later. Private sector banks have good technology for handling governance and risk management 47
  • 48. are far superior to that of the Public Sector Banks. Some of the most important challenges for private sector banks are: • Priority sector credit Generally, private sector banks lend money to individuals and corporate sector whereas sectors like agriculture, small-scale industries and retail trade small business is neglected. • Consolidation and Convergence The extent of fragmentation in the Indian banking sector today is a matter of concern, especially given the fact that in 2009 RBI would relax operational norms for entry of foreign banks into India. The exact nature and extent of those changes haven’t been articulated yet, but as and when foreign banks are allowed unrestricted access, they could pose a major threat to the smaller undercapitalized banks with their large capital base. For instance, total assets of HSBC Holdings, the biggest global bank with a presence in India, are about thrice the assets of all Indian banks put together. Some private banks are also confronted with survival issues6. Another issue is the ownership pattern of banks which is considered crucial to protecting the interests of depositors. As some of the private sector banks are community-based or promoter-driven, their shareholding pattern is concentrated in the hands of a few, which raises the possibility of misappropriation of funds. If their stakes are to be reduced, some of the smaller banks will necessarily have to merge among themselves. Compared to public sector banks, there’s less overlap between private banks, as they have different business models and cater to different segments, but that also creates its own shortcomings. 48
  • 49. Conclusion In any banking system, no bank -- public or private -- can survive unless it continuously strives to transform its organization into a self-governing, self- correcting and self-adjusting entity. For banks to grapple with these problems and manage the future, structural and institutional rigidities need to be eased in two critical areas: comprehensive legal support for recovery of bad debts and a fundamental change in the pattern of governance for the Public Sector Banks. While public sector banks are in the process of restructuring, private sector banks are busy consolidating through mergers and acquisitions (the sector has been recently opened up for foreign investments). 49
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