Universal banking final


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The entry of banks into the realm of financial services was followed very soon after the introduction of liberalization in the economy. Since the early 1990s structural changes of profound magnitude have been witnessed in global banking systems. Large scale mergers, amalgamations and acquisitions between the banks and financial institutions resulted in the growth in size and competitive strengths of the merged entities. Thus, emerged new financial conglomerates that could maximize economies of scale and scope by building the production of financial services organization called Universal Banking.

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Universal banking final

  1. 1. S.I.E.S. College of Commerce and Economics Universal Banking Chapter 1 Universal Banking Page 1 of 93
  2. 2. S.I.E.S. College of Commerce and Economics Universal Banking1.1Introduction The banking scenario in India has been changing at fast pace from beingjust the borrowers and lenders traditionally, the focus has shifted to moredifferentiated and customized product/service provider from regulation toliberalization in the year 1991, from planned economy to market. The Indian banking has come a long way from being a sleepy businessinstitution to a highly proactive and dynamic entity. This transformation hasbeen largely brought about by the large dose of liberalization and economicreforms that allowed banks to explore new business opportunities rather thangenerating revenues from conventional streams (i.e. borrowing and lending). The competition heated up with the entry of private and foreign banksderegulation and globalization resulted in increased competition that refined thetraditional way of doing business. They have realized the importance of acustomer centric approach, brand building and IT enabled solutions. Bankingtoday has transformed into a technology intensive and customer friendly modelwith a focus on convenience. The companies have redoubled their efforts to woothe customers and establish themselves firmly in the market. It is no longer anoption for a company to provide good customer service, it is expected. Reforms are continuing as part of the overall structural reforms aimed atimproving the productivity and efficiency of the economy. The sector is set to Page 2 of 93
  3. 3. S.I.E.S. College of Commerce and Economics Universal Bankingwitness the emergence of financial supermarkets in the form of universal banksproviding a suite of services from retail to corporate banking and industriallending to investment banking. The financial services market has become abattle ground with the marketers with the latest and the most sophisticatedweapons. The Indian banking industry is currently in a transition phase. On the onehand, the public sector banks, which are the mainstay of the Indian bankingsystem, are in the process of consolidating their position by capitalizing on thestrength of their huge networks and customer bases. On the other, the privatesector banks are venturing into a whole new game of mergers and acquisitionsto expand their bases. The use of technology has placed Indian banks at par withtheir global peers. It has also changed the way banking is done in India.‗Anywhere banking‘ and ‗Anytime banking‘ have become a reality. Thefinancial sector now operates in a more competitive environment than beforeand intermediates relatively large volume of international financial flows. The entry of banks into the realm of financial services was followed verysoon after the introduction of liberalization in the economy. Since the early1990s structural changes of profound magnitude have been witnessed in globalbanking systems. Large scale mergers, amalgamations and acquisitions betweenthe banks and financial institutions resulted in the growth in size andcompetitive strengths of the merged entities. Thus, emerged new financialconglomerates that could maximize economies of scale and scope by buildingthe production of financial services organization called Universal Banking. Page 3 of 93
  4. 4. S.I.E.S. College of Commerce and Economics Universal Banking1.2Meaning The financial and banking sector as it existed in the pre-reform days washighly regulated over-administered and subject to discretionary control anddirection. In this sense, financial sector reforms were designed to infuse, in thewords of the terms of reference of the Narsimham Committee, greatercompetitive vitality in the system. In the financial system, the players can be broadly classified into thefollowing groups: public sector banks, private sector banks, foreign banks, co -operative banks, all- India financial institutions and non-banks. A common element in all Development Financing Institution (DFI‘s) isthat they focus on investment rather than on conventional commercial bankingoperations, i.e., on deposit taking and short-term credit. On the other hand, thecommercial banks continue to concentrate on their traditional business ofaccepting deposits and advancing loans. With encouragement and sometimespressure, they have broaden their activities to include term credit and a broadrange of non-banking finance, including leasing, venture capital, housing andhousehold finance, mutual fund management, credit-card sponsorship, etc. The term Universal Banking in general refers to the combination ofcommercial banking and investment banking. The concept of universal bankingis spreading fast among various types of banks. Page 4 of 93
  5. 5. S.I.E.S. College of Commerce and Economics Universal Banking It is a multipurpose and multi-functional financial supermarket providingboth Banking and Financial Services through a single window. As per theWorld Bank," In Universal Banking, large banks operate extensive network ofbranches, provide many different services, hold several claims on firms(including equity and debt) and participate directly in the Corporate Governanceof firms that rely on the banks for funding or as insurance underwriters." In a nutshell, a Universal Banking is a superstore for financial products,under one roof. Corporates can get loans and avail of other handy services,while individuals can bank and borrow. It includes not only services related tosavings and loans but also investment. However in practice the term UniversalBanking refers to those banks that offer wide range of financial services beyondthe commercial banking functions like Mutual Funds, Merchant Banking,Factoring, Insurance, Credit Cards, Retail loans, Housing Finance, AutoLoans, etc. However, Universal Banking does not mean that every institutionconducts every type of business with every type of customer. In the spectrum ofbanking, specialized banking is on the one end and the Universal Banking onthe other. Page 5 of 93
  6. 6. S.I.E.S. College of Commerce and Economics Universal Banking1.3Empirical Background of Universal Banking: The entry of banks into the realm of financial services was followed verysoon after Liberalization in the economy. Since the early 1990s, structuralchanges of profound magnitude came to be witnessed in global bankingsystems. Large scale mergers, amalgamations and acquisitions among the banksand financial institutions resulted in the growth in size and competitivestrengths of the merged entities. There thus emerged new financialconglomerates that could maximize Economies of Scale and Scope by buildingthe production of financial services organization called Universal Banking. By the mid 1990s, all the restrictions on Project Financing were removedand banks were allowed to undertake several activities in house. Reforms in theinsurance sector in the late 1990s, and opening up of this field to private andforeign players also resulted in permitting banks to undertake sale of Insuranceproducts. At present, only an arms length relationship between a bank andinsurance entity has been allowed by the regulatory authority, i.e.-IRDA(Insurance Regulatory & Development Authority). The phenomenon of Universal Banking as a distinct concept, as differentfrom Narrow Banking came to the forefront in the Indian context with IINarsimham Committee (1998) and later the Khan Committee (1998) reportsrecommending consolidation of the banking industry through mergers andintegration of financial activities. Page 6 of 93
  7. 7. S.I.E.S. College of Commerce and Economics Universal Banking1.4Universal Banking in India In India Development financial institutions (DFIs) and refinancinginstitutions (RFIs) were meeting specific sectoral needs and also providing long-term resources at concessional terms, while the commercial banks in general, byand large, confined themselves to the core banking functions of acceptingdeposits and providing working capital finance to industry, trade andagriculture. Consequent to the liberalization and deregulation of financial sector,there has been blurring of distinction between the commercial banking andinvestment banking. Reserve Bank of India constituted on December 8, 1997, a WorkingGroup under the Chairmanship of Shri. S.H. Khan to bring about greater clarityin the respective roles of banks and financial institutions for greaterharmonization of facilities and obligations. Also report of the Committee onBanking Sector Reforms or Narsimham Committee (NC) has major bearing onthe issues considered by the Khan Working Group. The issue of universal banking resurfaced in Year 2000, when ICICI gavea presentation to RBI to discuss the time frame and possible options fortransforming itself into a universal bank. Reserve Bank of India also spelt out toParliamentary Standing Committee on Finance, its proposed policy for universalbanking, including a case-by case approach towards allowing domestic financialinstitutions to become universal banks. Page 7 of 93
  8. 8. S.I.E.S. College of Commerce and Economics Universal Banking Now RBI has asked FIs, which are interested to convert itself into auniversal bank, to submit their plans for transition to a universal bank forconsideration and further discussions. FIs need to formulate a road map for thetransition path and strategy for smooth conversion into a universal bank over aspecified time frame. The plan should specifically provide for full compliancewith prudential norms as applicable to banks over the proposed period. Page 8 of 93
  9. 9. S.I.E.S. College of Commerce and Economics Universal Banking1.5The need behind the Advent of Universal Banking Liberalization and the banking reforms have given new avenues toDevelopment Finance Institutions (DFIs) to meet the broader market. They canavail the options to involve in deposit banking and short term lending as well.DFIs were set up with the objective of taking care of the investment needs ofindustries. They have build up expertise in Merchant Banking and ProjectEvaluation. So, saddled with obligations to fund long gestation projects, the DFIshave been burdened with serious mismatches between their assets and liabilitiesof the balance sheet. In this context, the Narsimham Committee II had suggestedDFIs should convert into banks or Non-Banking Finance Companies.Converting of these DFIs into Universal Banks will grant them ready access tocheap retail deposits and increase the coverage of the advances to include shortterm working capital loans to Corporates with greater operational flexibility. Atthat time DFIs were in the need to acquire a lot of mass in their volume ofoperations to solve the problem of total asset base and net worth. So, theemergence of Universal Banking was the solution for the problem of thebanking sector. Page 9 of 93
  10. 10. S.I.E.S. College of Commerce and Economics Universal Banking Chapter 2 Products And Services Offered By Universal Banks coupled with SWOT Page 10 of 93
  11. 11. S.I.E.S. College of Commerce and Economics Universal Banking2.1Products And Services Offered By Universal BanksBroad Classification of Products in a Universal bank:The different products in an universal bank can be broadly classified into:  Retail Banking.  Trade Finance.  Treasury Operations. Retail Banking and Trade finance operations are conducted at the branchlevel while the wholesale banking operations, which cover treasury operations,are at the hand office or a designated branch.Retail Banking ―Retail banking is typical mass-market banking where individualcustomers use local branches of larger commercial banks. Services offeredinclude: savings and checking accounts, mortgages, personal loans, debit cards,credit cards, and so‖ Retail banking aims to be the one-stop shop for as many financial servicesas possible on behalf of retail clients. Some retail banks have even made a pushinto investment services such as wealth management, brokerage accounts,private banking and retirement planning. While some of these ancillary servicesare outsourced to third parties (often for regulatory reasons), they often Page 11 of 93
  12. 12. S.I.E.S. College of Commerce and Economics Universal Bankingintertwine with core retail banking accounts like checking and savings to allowfor easier transfers and maintenance.Services provided by Retail Banks:  Deposits  Loans, Cash Credit and Overdraft  Negotiating for Loans and advances  Remittances  Book-Keeping (maintaining all accounting records)  Receiving all kinds of bonds valuable for safe keepingTrade Finance Trade finance is related to international trade. While a seller (the exporter) can request the purchaser (an importer) toprepay for goods shipped, the purchaser (importer) may wish to reduce risk byrequiring the seller to document the goods that have been shipped. Banks mayassist by providing various forms of support. For example, the importers bankmay provide a letter of credit to the exporter (or the exporters bank) providingfor payment upon presentation of certain documents, such as a bill of lading.The exporters bank may make a loan (by advancing funds) to the exporter onthe basis of the export contract. Other forms of trade finance can include trade credit insurance, exportfactoring, forfaiting and others. In many countries, trade finance is oftensupported by quasi-government entities known as export credit agencies thatwork with commercial banks and other financial institutions. Page 12 of 93
  13. 13. S.I.E.S. College of Commerce and Economics Universal Banking In short, trade finance means money lent to exporters or importers.It includes the following services:  Issuing and confirming of letter of credit.  Drawing, accepting, discounting, buying, selling, collecting of bills of exchange, promissory notes, drafts, bill of lading and other securities.Treasury Operations Treasury management (or treasury operations) includes management of anenterprises holdings. It includes activities like trading in bonds, currencies,financial derivatives and also encompasses the associated financial riskmanagement.All banks have departments devoted to treasury management, as dolarger corporationsBank Treasuries may have the following departments: a) A Fixed Income or Money Market desk that is devoted to buying and selling interest bearing securities b) A Foreign exchange or "FX" desk that buys and sells currencies c) A Capital Markets or Equities desk that deals in shares listed on the stock market. In addition the Treasury function may also have a Proprietary Tradingdesk that conducts trading activities for the banks own account and capital, anAsset liability management or ALM desk that manages the risk of interest rate Page 13 of 93
  14. 14. S.I.E.S. College of Commerce and Economics Universal Bankingmismatch and liquidity; and a Transfer Pricing or Pooling function that pricesliquidity for business lines (the liability and asset sales teams) within the bank. Banks may or may not disclose the prices they charge for TreasuryManagement products.The operations include:  Buying and selling of bullion. Foreign exchange  Acquiring, holding, underwriting and dealing in shares, debentures, etc.  Purchasing and selling of bonds and securities on behalf of constituents. The banks can also act as an agent of the Government or local authority.They insure, guarantee, underwrite, participate in managing and carrying outissue of shares, debentures, etc. Apart from the above-mentioned functions of the bank, the bank providesa whole lot of other services like investment counseling for individuals, short-term funds management and portfolio management for individuals andcompanies. It undertakes the inward and outward remittances with reference toforeign exchange and collection of varied types for the Government. Page 14 of 93
  15. 15. S.I.E.S. College of Commerce and Economics Universal Banking2.2Common Banking Products Available Some of common available banking products which are in universal banksare explained below:Credit Card Credit Card is ―post paid‖ or ―pay later‖ card that draws from a creditline-money made available by the card issuer (bank) and gives one a graceperiod to pay. If the amount is not paid full by the end of the period, one ischarged interest. A credit card is nothing but a very small card containing a means ofidentification, such as a signature and a small photo. It authorizes the holder tochange goods or services to his account, on which he is billed. The bankreceives the bills from the merchants and pays on behalf of the card holder. These bills are assembled in the bank and the amount is paid to the bankby the card holder totally or by installments. The bank charges the customer asmall amount for these services. The card holder need not have to carrymoney/cash with him when he travels or goes for purchasing. Credit cards have found wide spread acceptance in the ‗metros‘ and bigcities. Credit cards are joining popularity for online payments. The majorplayers in the Credit Card market are the foreign banks and some big publicsector banks like SBI and Bank of Baroda. Page 15 of 93
  16. 16. S.I.E.S. College of Commerce and Economics Universal BankingDebit Cards A debit card (also known as a bank card or check card) is a plastic cardthat provides an alternative payment method to cash when making purchases.Functionally, it can be called an electronic check, as the funds are withdrawndirectly from either the bank account, or from the remaining balance on thecard. In some cases, the cards are designed exclusively for use on the Internet,and so there is no physical card. In many countries the use of debit cards has become so widespread thattheir volume of use has overtaken or entirely replaced the check and, in someinstances, cash transactions. Like credit cards, debit cards are used widely fortelephone and Internet purchases and, unlike credit cards, the funds aretransferred immediately from the bearers bank account instead of having thebearer pay back the money at a later date. Debit cards may also allow for instant withdrawal of cash, acting as theATM card for withdrawing cash and as a check guarantee card. Merchants mayalso offer cash back facilities to customers, where a customer can withdraw cashalong with their purchase. Debit Card holder need not carry a bulky checkbook or large sums of cashwhen he/she goes at for shopping. This is a fast and easy way of payment onecan get debit card facility as debit cards use one‘s own money at the time ofsale, so they are often easier than credit cards to obtain. Page 16 of 93
  17. 17. S.I.E.S. College of Commerce and Economics Universal BankingAutomatic Teller Machine An automated teller machine (ATM), also known as a automated bankingmachine (ABM) or Cash Machine and by several other names, is a computerizedtelecommunications device that provides the clients of a financial institutionwith access to financial transactions in a public space without the need for acashier, human clerk or bank teller. On most modern ATMs, the customer is identified by inserting a plasticATM card with a magnetic stripe or a plastic smart card with a chip thatcontains a unique card number and some security information such as anexpiration date or CVVC (CVV). Authentication is provided by the customerentering a personal identification number (PIN). Using an ATM, customers can access their bank accounts in order tomake cash withdrawals, credit card cash advances, and check their accountbalances as well as purchase prepaid cell phone credit. If the currency beingwithdrawn from the ATM is different from that which the bank account isdenominated in (e.g.: Withdrawing Japanese Yen from a bank accountcontaining US Dollars), the money will be converted at a wholesale exchangerate. Thus, ATMs often provide the best possible exchange rate for foreigntravelers and are heavily used for this purpose as well. ATMs are known by various other names including automatic bankingmachine (or automated banking machine particularly in the United States)(ABM), automated transaction machine, cash point (particularly in the UnitedKingdom), money machine, bank machine, cash machine, hole-in-the-wall, Page 17 of 93
  18. 18. S.I.E.S. College of Commerce and Economics Universal Bankingautoteller (after the Bank of Scotlands usage), cashline machine (after the RoyalBank of Scotlands usage), MAC Machine (in the Philadelphia area), Bankomat(in various countries particularly in Europe and including Russia), Multibanco(after a registered trade mark, in Portugal), Minibank in Norway, GeldAutomaat in Belgium and the Netherlands, and All Time Money in India.Advantages of ATM’s:To the Customers  ATM‘s provide 24 hrs, 7 days and 365 days a year service.  Service is quick and efficient  Privacy in transaction  Wider flexibility in place and time of withdrawals.  The transaction is completely secure – you need to key in Personal Identification Number (Unique number for every customer).To Banks  Alternative to extend banking hours.  Crowding at bank counters considerably reduced.  Alternative to new branches and to reduce operating expenses.  Relieves bank employees to focus an more analytical and innovative work.  Increased market penetration. Page 18 of 93
  19. 19. S.I.E.S. College of Commerce and Economics Universal Banking ATM‘s can be installed anywhere like Airports, Railway Stations, PetrolPumps, Big Business arcades, markets, etc. Hence, it gives easy access to thecustomers, for obtaining cash. The ATM services provided first by the foreign banks like Citibank,Grind lays bank and now by many private and public sector banks in India likeICICI Bank, HDFC Bank, SBI, UTI Bank etc. The ICICI has launched ATMServices to its customers in all the Metropolitan Cities in India. By the end of1990 Indian Private Banks and public sector banks have come up with their ownATM Network in the form of ―SWADHAN‖. Over the past year upto 44 banksin Mumbai, Vashi and Thane, have became a part of ―SWADHAN‖ a system ofshared payments networks, introduced by the Indian Bank Association (IBA).E-Cheques E-cheques are a mode of electronic payments. E-cheques work the sameway as paper cheques and are a legally binding promise to pay. This technologywas developed couple of years ago by a consortium of Silicon Valley ITresearchers and merchant bankers and since then has been promoted by many ofthe financial bodies. E-cheques work the same way as paper cheques and are alegally binding promise to pay. The payment system uses digitally signed XMLdocuments that provide mechanism to authenticate parties to a transaction. E-cheques are defined using FSML (financial services markup language) whichallows for addition and deletion of document blocks, signing, co-signing,endorsing, etc. Page 19 of 93
  20. 20. S.I.E.S. College of Commerce and Economics Universal Banking Signatures are accompanied by bank-issued certificates which tie thesigners key to a bank account. It seems that consumers would gain from havingE-cheques available to make payments for online purchases. The onlinemerchants on the other hand could receive payments instantly and since thecustomer‘s bank will be involved in the transaction. It would be impossible forE-cheques to bounce. Banks can do paperless, efficient transactions.A typical electronic cheque transaction takes place in the following manner: The customer accesses the merchant server and the merchant server presents its goods to the customer. The consumer selects the goods and purchases them by sending an e- cheque to the merchant. The merchant validates the e-cheque with its bank for payment authorisation. The merchant electronically forwards the e-cheque to its bank. The merchant‘s bank forwards the e-cheque to the clearing house for cashing. The clearing house jointly works with the consumer‘s bank clears the cheque and transfers the money to the merchant‘s banks. The merchant‘s bank updates the merchant‘s account. The consumer‘s bank updates the consumer‘s account with the withdrawal information. The e-chequing is a great boon to big corporate as well as small retailers.Most major banks accept e-cheques. Thus this system offers secure means ofcollecting payments, transferring value and managing cash flows. Page 20 of 93
  21. 21. S.I.E.S. College of Commerce and Economics Universal BankingElectronic Funds Transfer (EFT) Many modern banks have computerised their cheque handling processwith computer networks and other electronic equipments. These banks aredispensing with the use of paper cheques. The system called electronic fundtransfer (EFT) automatically transfers money from one account to another. Thissystem facilitates speedier transfer of funds electronically from any branch toany other branch. In this system the sender and the receiver of funds may belocated in different cities and may even bank with different banks. Fundstransfer within the same city is also permitted. The scheme has been inoperation since February 7, 1996, in India. The other important type of facility in the EFT system is automatedclearing houses. These are the computer centers that handle the bills meant fordeposits and the bills meant for payment. In big companies pay is not disbursedby issued cheques or issuing cash. The payment office directs the computer tocredit an employee‘s account with the person‘s pay.Telebanking Telebanking refers to banking on phone services a customer can accessinformation about his/her account through a telephone call and by giving thecoded Personal Identification Number (PIN) to the bank. Telebanking isextensively user friendly and effective in nature. Page 21 of 93
  22. 22. S.I.E.S. College of Commerce and Economics Universal Banking  To get a particular work done through the bank, the users may leave his instructions in the form of message with bank.  Facility to stop payment on request. One can easily know about the cheque status.  Information on the current interest rates.  Information with regard to foreign exchange rates.  Request for a DD or pay order.  D-Mat Account related services.  And other similar services.Mobile Banking A new revolution in the realm of e-banking is the emergence of mobilebanking. On-line banking is now moving to the mobile world, giving everybodywith a mobile phone access to real-time banking services, regardless of theirlocation. But there is much more to mobile banking from just on-line banking. Itprovides a new way to pick up information and interact with the banks to carryout the relevant banking business. The potential of mobile banking is limitlessand is expected to be a big success. Booking and paying for travel and eventickets is also expected to be a growth area. According to this system, customer can access account details on mobileusing the Short Messaging System (SMS) technology where select data ispushed to the mobile device. The wireless application protocol (WAP)technology, which will allow user to surf the net on their mobiles to access Page 22 of 93
  23. 23. S.I.E.S. College of Commerce and Economics Universal Bankinganything and everything. This is a very flexible way of transacting bankingbusiness. Already ICICI and HDFC banks have tied up cellular service providessuch as Airtel, Orange, Sky Cell, etc. in Delhi and Mumbai to offer these mobilebanking services to their customers.Internet Banking Internet banking involves use of internet for delivery of banking productsand services. With internet banking is now no longer confirmed to the brancheswhere one has to approach the branch in person, to withdraw cash or deposits acheque or requests a statement of accounts. In internet banking, any inquiry ortransaction is processed online without any reference to the branch (anywherebanking) at any time. The Internet Banking now is more of a normal rather than anexception due to the fact that it is the cheapest way of providing bankingservices. As indicated by McKinsey Quarterly research, presently traditionalbanking costs the banks, more than a dollar per person, ATM banking costs 27cents and internet banking costs below 4 cents approximately. ICICI bank wasthe first one to offer Internet Banking in India. Page 23 of 93
  24. 24. S.I.E.S. College of Commerce and Economics Universal BankingBenefits of Internet Banking:  Reduce the transaction costs of offering several banking services and diminishes the need for longer numbers of expensive brick and mortar branches and staff.  Increase convenience for customers, since they can conduct many banking transaction 24 hours a day.  Increase customer loyalty.  Improve customer access.  Attract new customers.  Easy online application for all accounts, including personal loans and mortgagesFinancial Transaction on the Internet:Electronic Cash: Companies are developing electronic replicas of all existingpayment system: cash, cheque, credit cards and coins.Automatic Payments: Utility companies, loans payments, and other businessesuse on automatic payment system with bills paid through direct withdrawal froma bank account.Direct Deposits: Earnings (or Government payments) automatically depositedinto bank accounts, saving time, effort and money. Page 24 of 93
  25. 25. S.I.E.S. College of Commerce and Economics Universal BankingStored Value Cards: Prepaid cards for telephone service, transit fares, highwaytolls, laundry service, library fees and school lunches.Point of Sale transactions: Acceptance of ATM/Cheque at retail stores andrestaurants for payment of goods and services. This system has madefunctioning of the stock Market very smooth and efficient.Cyber Banking: It refers to banking through online services. Banks with website ―Cyber‖ branches allowed customers to check balances, pay bills, transferfunds, and apply for loans on the Internet.Demat: Demat is short for de-materialisation of shares. In short, Demat is aprocess where at the customer‘s request the physical stock is converted intoelectronic entries in the depository system. In January 1998 SEBI (Securities and Exchange Board of India) initiatedDEMAT ACCOUNTANCY System to regulate and to improve stock investing.As on date, to trade on shares it has become compulsory to have a share demataccount and all trades take place through demat. One needs to open a Demat Account with any of the branches of the bank.After opening an account with any bank, by filling the demat request form onecan handover the securities. The rest will be taken care by the bank and the Page 25 of 93
  26. 26. S.I.E.S. College of Commerce and Economics Universal Bankingcustomer will receive credit of shares as soon as it is confirmed by theCompany/Register and Transfer Agent. There is no physical movement of sharecertification any more. Any buying or selling of shares is done via electronictransfers. 1. If the investor wants to sell his shares, he has to place an order with his broker and give a ―Delivery Instruction‖ to his DP (Depository Participant). The DP will debit hi s account with the number of shares sold by him. 2. If one wants to buy shares, he has to inform his broker about his Depository Account Number so that the shares bought by him are credited in to his account. 3. Payment for the electronic shares bought or sold is to be made in the same way as in the case of physical securities. Page 26 of 93
  27. 27. S.I.E.S. College of Commerce and Economics Universal Banking2.3UNIVERSAL BANKING SERVICES Banking covers so many services that it is difficult to defineit. However, these basic services have always been recognized as the hallmarkof the genuine banker. These are:  The receipt of the customer‘s deposits  The collection of his cheques drawn on other banks  The payment of the customer‘s cheques drawn on himselfThere are other various types of banking services like:  Advances – Overdraft, Cash Credit, etc.  Deposits – Saving Account, Current Account, etc.  Financial Services – Bill discounting etc.  Foreign Services – Providing foreign currency, travelers cheques, etc.  Money Transmission – Funds transfer etc.  Savings – Fixed deposits, etc.  Services of place or time – ATM Services.  Status – Debit Cards, Credit Cards, etc. Page 27 of 93
  28. 28. S.I.E.S. College of Commerce and Economics Universal Banking2.4Universal Banking coupled with SWOT The solution of Universal Banking was having many factors to deal withwhich further categorized under Strengths, Weaknesses, Opportunities andThreats:Strengths:Economies Of Scale The main advantage of Universal Banking is that it results in greatereconomic efficiency in the form of lower cost, higher output and betterproducts. Various Reserve Banks Committees and reports in favor of UniversalBanking, is that it enables banks to exploit economies of scale and scope. Itmeans a bank can reduce average costs and thereby improve spreads if itexpands its scale of operations and diversifying activities.Profitable Diversions By diversifying the activities, the bank can use its existing expertise inone type of financial service in providing other types. So, it entails less cost inperforming all the functions by one entity instead of separate bodies. Page 28 of 93
  29. 29. S.I.E.S. College of Commerce and Economics Universal BankingResource Utilization A bank possesses the information on the risk characteristics of the clients,which it can use to pursue other activities with the same client. A data collectionabout the market trends, risk and returns associated with portfolios of MutualFunds, diversifiable and non diversifiable risk analysis, etc are useful for otherclients and information seekers. Automatically, a bank will get the benefit ofbeing involved in Research.Easy marketing on the foundation a of Brand name A bank has an existing network of branches, which can act as shops forselling products like Insurance, Mutual Fund without much efforts onmarketing, as the branch will act here as a parent company or source. In thisway a bank can reach the remotest client without having to take recourse to anagent.One stops shopping The idea of one stop shopping saves a lot of transaction costs andincreases the speed of economic activities. It is beneficial for the bank as well ascustomers.Investor friendly activities Another manifestation of Universal Banking is bank holding stakes in afirm. A banks equity holding in a borrower firm, acts as a signal for otherinvestors on to the health of the firm, since the lending bank is in a betterposition to monitor the firms activities. Page 29 of 93
  30. 30. S.I.E.S. College of Commerce and Economics Universal BankingEasy handling of business cycles Due to various shifts in business cycles, the demand for productsalso varies at different points of time. It is generally held that universal bankscould easily handle such situations by shifting the resources within theorganization as compared to specialized banks. Specialized firms are alsosubject to substantial risks of failure. Because their operations are not well diversified. By offering a broaderset of financial products than what a specialized bank provides, it has beenargued that a universal bank is able to establish long-term relationship with thecustomers and provide them with a package of financial services through asingle window. Page 30 of 93
  31. 31. S.I.E.S. College of Commerce and Economics Universal BankingWeaknesses:Grey area of Universal Bank The path of Universal Banking for DFIs is strewn with obstacles. Thebiggest one is overcoming the differences in regulatory requirements for a bankand DFI. Unlike banks, DFIs are not required to keep a portion of their depositsas cash reserves.No expertise in long term lending In the case of traditional project finance an area where DFIs treadcarefully, becoming a bank may not make a big difference. Project finance andInfrastructure Finance are generally long gestation projects and would requireDFIs to borrow long term. Therefore, the transformation into a bank may not beof great assistance in lending long-term.NPA problem remained intact The most serious problem of DFIs have had to encounter is bad loans orNon Performing Assets (NPA). For the DFIs and Universal Banking orinstallation of cutting edge technology in operations are unlikely to improve thesituation concerning NPAs. Most of the NPAs came out of loans to commoditysectors, such as steel, chemicals, textiles, etc. the improper use of DFI funds byproject promoters, a sharp change in operating environment and poor appraisalsby DFIs combined to destroy the viability of some projects. So, instead of Page 31 of 93
  32. 32. S.I.E.S. College of Commerce and Economics Universal Bankingimproving the situation Universal Banking may worsen the situation, due to theexpansion in activities banks will fail to make thorough study of the actual needof the party concerned, the prospect of the business, in which it is engaged, itstrack record, the quality of the management, etc.ICICI suffered the least in this section, but the IDBI has got worst hit of NPAs,considering the negative developments at Dabhol Power Company (DPC). Page 32 of 93
  33. 33. S.I.E.S. College of Commerce and Economics Universal BankingThreats:Big Empires Universal Banking is an outcome of the mergers and acquisitions in thebanking sector. The Finance Ministry is also empathetic towards it. But therewill be big empires which may put the economy in a problem. Universal Bankswill be the largest banks, by their asset base, income level and profitability thereis a danger of Price Distortion. It might take place by manipulating interests ofthe bank for the self interest motive instead of social interest. There is a threat tothe overall quality of the products of the bank, because of the possibility ofturning all the strengths of the Universal Banking into weaknesses. (e.g. - thestrength of economies of scale may turn into the degradation of qualities of bankproducts, due to over expansion. If the banks are not prudent enough, depositrates could shoot up and thus affect profits. To increase profits quickly banksmay go in for riskier business, which could lead to a full in asset quality.Disintermediation and securitization could further affect the business of banks . Page 33 of 93
  34. 34. S.I.E.S. College of Commerce and Economics Universal BankingOpportunities:To increase efficiency and productivity Liberalization offers opportunities to banks. Now, the focus will be onprofits rather than on the size of balance sheet. Fee based incomes will be moreattractive than mobilizing deposits, which lead to lower cost funds. To face theincreased competition, banks will need to improve their efficiency andproductivity, which will lead to new products and better services.To get more exposure in the global market In terms of total asset base and net worth the Indian banks have a verylong road to travel when compared to top 10 banks in the world. (SBI is the onlyIndian 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 amongall Indian companies) as the asset base sans capital of most of the top 10 banksin the world are much more than the asset base and capital of the entire Indianbanking sector. In order to enter at least the top 100 segment in the world, theIndian banks need to acquire a lot of mass in their volume of operations. Pure routine banking operations alone cannot take the Indian banks intothe league of the Top 100 banks in the world. Here is the real need of universalbanking, as the wide range of financial services in addition to the Commercialbanking functions like Mutual Funds, Merchant banking, Factoring, Insurance,credit cards, retail, personal loans, etc. will help in enhancing overallprofitability. Page 34 of 93
  35. 35. S.I.E.S. College of Commerce and Economics Universal BankingTo eradicate the Financial Apartheid A recent study on the informal sector conducted by Scientific ResearchAssociation for Economics (SRA), a Chennai based association, has found outthat, Though having a large number of branch network in rural areas and urbanareas, the lowest strata of the society is still out of the purview of bankingservices. Because the small businesses in the city, 34% of that goes to moneylenders for funds. Another 6.5% goes to pawn brokers, etc. The respondents were businesses engaged in activities such as fruits andvegetables vendors, laundry services, provision stores, petty shops and tea stalls.97% of them do not depend the banking system for funds. Not because they donot want credit from banking sources, but because banks do not want to lendthese entrepreneurs. It is a situation of Financial Apartheid in the informalsector. It means with the help of retail and personal banking services UniversalBanking can reach this stratum easily. Page 35 of 93
  36. 36. S.I.E.S. College of Commerce and Economics Universal Banking Chapter 3 Committee Reports, Guidelines & its Impact Page 36 of 93
  37. 37. S.I.E.S. College of Commerce and Economics Universal Banking3.1Khan Committee On Universal Banking The khan committee on harmonizing the role and operations ofdevelopment financial institutions and banks submitted its report on April 24,1998 with following recommendations: -  Give banking license to DFIs  Merge banks with banks, DFIs  Bring down CRR progressively  Phase out SLR  Redefine priority sector  Set up a super regulator to coordinate regulators‘ activities  Develop risk-based supervisory framework  Usher in legal reforms in debt recovery  State level FIs be allowed to go public and come under RBI  DFIs be permitted to have wholly-owned banking subsidiaries  Remove cap on FIs‘ resources mobilization  Grant authorized dealers‘ license to DFIs  Set up a standing committee to coordinate lending policies Page 37 of 93
  38. 38. S.I.E.S. College of Commerce and Economics Universal BankingRecommendations:  About Universal Banking Universal banking refers to elimination of the distinction betweenthe development financial institutions and the banks and market segmentationthat presently exists between them.  About Harmonization Of Role Of Banks And DFIs Harmonization means the introduction of universal banking in alimited sense, wherein the DFIs could become banks and intermediate in theshort-term end of the financial market (say finance for working capital) andcommercial banks could enter the long-term end of the financial market (sayproject financing). In other words, the harmonization allows the DFIs and banksto move freely to the other end than where they are presently placed.  About The Main Areas Of Operations Of DFIs And Banks Presently And How: Universalisation Will Change That Role In Future. DFIs are specialist institutions catering to different sectors, appraisingprojects from technical and financial parameters and finance long-terminvestment requirements. This specialization has given edge to DFIs in terms ofproject appraisal. On the other hand, the banks meet the short term investmentand production requirements and they have developed expertise in providingworking capital finance to industry, exports, imports, small industry, agriculture Page 38 of 93
  39. 39. S.I.E.S. College of Commerce and Economics Universal Bankingetc. They can take as intermediates in a big way at the other end of their marketswhere they are less dominant presently. Some of them may even diversify intoinsurance and other related areas.  About Requirement Of Cost Considerations In Universalisation Cost of funds differentiates the DFIs from banks, as DFIs incur highercosts for mobilizing long-term finance. Banks do not normally mobilizesubstantial deposit resources with maturities in excess of 5 years, which limitstheir capacity to extend long-term loans. This has resulted in participation typeof relationship in financing by banks and DFIs.  About The Areas Of Conflict arising Between Banks And DFIs There are conflicts relating to securities for the loans sanctioned by thebanks and DFIs. While the DFIs have first charge over block assets, the bankshave first charge on current assets, which place both the banks and DFIs indifferent positions. Another area of conflict is extension of refinance by DFIs to banks tosupplement banks‘ long-term resources. But due to higher cost of their funds,the DFIs find it a losing proposition. Page 39 of 93
  40. 40. S.I.E.S. College of Commerce and Economics Universal Banking  About The Committee Which Recommended Universal Banking & What It Suggested The S H Khan Committee suggested the concept of Universal Banking. Italso suggested to give banking license to DFIs, merging banks with banks orDFIs, bring down CRR progressively, phase out SLR, redefine priority sector,set up a super regulator to coordinate regulators‘ activities, develop risk-basedsupervisory framework, usher in legal reforms in debt recovery, allow Statelevel FIs to go public and come under RBI, permit DFIs to have wholly-ownedbanking subsidiaries, remove cap on FIs‘ resources mobilization, grantauthorized dealers‘ license to DFIs, set up a standing committee to coordinatelending policies etc.  About The Likely Gains From Universalisation The universalisation is expected to result in expansion of banks anddiversification into new financial and Para-banking services. The business focusof the banks would emerge on profit lines. This may at the same time result inreluctance on their part to enter the smaller end of retail banking particularly,the small borrowers in rural areas, who may find it difficult to access thebanking services, since they do not contribute substantially to Banks‘ BusinessVolumes or Profits. Page 40 of 93
  41. 41. S.I.E.S. College of Commerce and Economics Universal Banking  About The Apprehensions Of Universalisation The financial services may not become the privilege of elitist. If the reformswith a human face are what we want, the universal banking has to makeadjustments and ensure that financial services are available to all at affordablecosts. Page 41 of 93
  42. 42. S.I.E.S. College of Commerce and Economics Universal Banking3.2Need Of Universal Banking In India 1. The phenomenon of universal banking—as different from narrow banking is suddenly in the news. With the second Narsimham Committee (1998) and the Khan Committee (1998) reports recommending consolidation of the banking industry through mergers and integration of financial activities, the stage seems to be set for a debate on the entire issue. 2. A universal bank is a ‗one-stop‘ supplier for all financial products and activities, like deposits, short-term and long-term loans, insurance, investment etc. 3. The benefits to banks from universal banking are the standard argument given everywhere also by the various Reserve Bank committees and reports—in favour of universal banking is that it enables banks to exploit economies of scale and scope. 4. So that a bank can reduce average costs and thereby improves spreads if it expands its scale of operations and diversifies its activities. Page 42 of 93
  43. 43. S.I.E.S. College of Commerce and Economics Universal Banking 5. The bank can diversify its existing expertise in one type of financial service in providing the other types. So, it entails less cost in performing all the functions by one entity instead of separate specialized bodies. 6. A bank has an existing network of branches, which can act as shops for selling products like insurance. This way a big bank can reach the remotest client without having to take recourse to any agent. 7. Many financial services are inter-linked activities, e.g. insurance and lending. A bank can use its instruments in one activity to exploit the other, e.g., in the case of project lending to the same firm, which has purchased insurance from banking 8. The idea of ‗one-stop-shopping‘ saves a lot of transaction costs and increases the speed of economic activity. Another manifestation of universal banking is a bank holding stakes in a firm. 9. In India, too, a lot of opportunities are there to be exploited. Banks, especially the financial institutions, are aware of it. And most of the groups have plans to diversify in a big way. 10. At present, only an‘ arms-length‘ relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. the Page 43 of 93
  44. 44. S.I.E.S. College of Commerce and Economics Universal Banking Insurance Regulatory and Development Authority (IRDA). This means that commercial banks can enter insurance business either by acting as agents or by setting up joint ventures with insurance companies. 11. Development financial institutions (DFIs) can turn themselves into banks, but have to adhere to the statutory liquidity ratio and cash reserve requirements meant for banks, which they are lobbying to avoid. All these can be seen as steps towards an ultimate culmination of financialintermediation in India into universal banking. Page 44 of 93
  45. 45. S.I.E.S. College of Commerce and Economics Universal Banking3.3Approach To Universal Banking The Narsimham Committee II suggested that Development FinancialInstitutions (DFIs) should convert ultimately into either commercial banks ornon-bank finance companies. The Khan Working Group held the view thatDFIS should be allowed to become banks at the earliest. The RBI released aDiscussion Paper (DP) in January 1999 for wider public debate. The feedbackon the discussion paper indicated that while the universal banking is desirablefrom the point of view of efficiency of resource use, there is need for caution inmoving towards such a system by banks and DFIs. The principle of "Universal Banking" is a desirable goal and someprogress has already been made by permitting banks to diversify intoinvestments and long-term financing and the DFIs to lend for working capital,etc. However, banks have certain special characteristics and as such any dilutionof RBIs prudential and supervisory norms for conduct of banking businesswould be inadvisable. Though the DFIs would continue to have a special role in the Indianfinancial System, until the debt market demonstrates substantial improvementsin terms of liquidity and depth, any DFI, which wishes to do so, should have theoption to transform into bank (which it can exercise), provided the prudential Page 45 of 93
  46. 46. S.I.E.S. College of Commerce and Economics Universal Bankingnorms as applicable to banks are fully satisfied. To this end, a DFI would needto prepare a transition path in order to fully comply with the regulatoryrequirement of a bank. The DFI concerned may consult RBI for such transitionarrangements. Reserve Bank will consider such requests on a case-by-casebasis. Financing requirements, which is necessary. In due course, and in thelight of evolution of the financial system, Narsimham Committeesrecommendation that, ultimately there should be only banks and RestructuredNBFCs can be operationalised. Page 46 of 93
  47. 47. S.I.E.S. College of Commerce and Economics Universal Banking3.4RBI Guidelines for Existing Banks/FIs for Conversion intoUniversal Banks:Salient operational and regulatory issues to be addressed by the FIs For theconversion into Universal bank are: -  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  Permissible activities Any activity of an FI currently undertaken but not permissible for a bank under Section 6(1) of the B. R. Act, 1949, may have to be stopped or divested after its conversion into a universal bank.  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 B. R. Act. Page 47 of 93
  48. 48. S.I.E.S. College of Commerce and Economics Universal Banking  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 B. R. Act, which requires at least 51% of the total number of directors to have special knowledge and experience  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 B. R. 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 as required under the Section.  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 B R 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 B. R. Act. Page 48 of 93
  49. 49. S.I.E.S. College of Commerce and Economics Universal Banking  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 B. R. Act, which prohibits a bank from holding shares in a company in excess of these limits.  Connected lending Section 20 of the B. R. 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.  Licensing An FI converting into a universal bank would be required to obtain a banking license from RBI under Section 22 of the B. R. Act, for carrying on banking business in India, after complying with the applicable conditions. Page 49 of 93
  50. 50. S.I.E.S. College of Commerce and Economics Universal Banking  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.  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, as required of a bank under Section 25 of the B R Act.  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 in the forms set out in the Third Schedule to the B R Act, as prescribed for a banking company under Section 29 and Section 30 of the B. R. Act.  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 B. R. Act. The Section stipulates fixation of remuneration of Page 50 of 93
  51. 51. S.I.E.S. College of Commerce and Economics Universal Banking the Chairman and Managing Director of a bank by Reserve Bank of India taking into account the profitability, net NPAs and other financial parameters. Under the Section, prior approval of RBI would also be required for appointment of Chairman and Managing Director.  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.  Authorized Dealers License Some of the FIs at present hold restricted AD license 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 license and would also attract the full rigor of the Exchange Control Regulations applicable to the banks at present, including prohibition on raising resources through external commercial borrowings.  Priority sector lending On conversion of an FI to a universal bank, the obligation for lending to "priority sector" up to a prescribed percentage of their net bank credit would also become applicable to it . Page 51 of 93
  52. 52. S.I.E.S. College of Commerce and Economics Universal Banking  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. Page 52 of 93
  53. 53. S.I.E.S. College of Commerce and Economics Universal Banking3.5Impact Of Universal Banking Since the early 1990s, banking systems worldwide have been goingthrough a rapid transformation. Mergers, amalgamations and acquisitions havebeen undertaken on a large scale in order to gain size and to focus more sharplyon competitive strengths. This consolidation has produced financialconglomerates that are expected to maximize economies of scale and scope by‗bundling‘ the production of financial services. The general trend has beentowards downstream universal banking where banks have undertakentraditionally non-banking activities such as investment banking, insurance,mortgage financing, securitization, and particularly, insurance. Upstreamlinkages, where non-banks undertake banking business, are also on the increase. The global experience can be segregated into broadly three models. Thereis the Swedish or Hong Kong type model in which the banking corporateengages in in-house activities associated with banking. In Germany and the UK,certain types of activities are required to be carried out by separate subsidiaries.In the US type model, there is a holding company structure and separatelycapitalized subsidiaries. In India, the first impulses for a more diversified financial intermediationwere witnessed in the 1980s and 1990s when banks were allowed to undertake Page 53 of 93
  54. 54. S.I.E.S. College of Commerce and Economics Universal Bankingleasing, investment banking, mutual funds, factoring, hire-purchase activitiesthrough separate subsidiaries. By the mid-1990s, all restrictions on projectfinancing were removed and banks were allowed to undertake several activitiesin-house. In the recent period, the focus is on Development FinancialInstitutions (DFIs), which have been allowed to setup banking subsidiaries andto enter the insurance business along with banks. DFIs were also allowed toundertake working capital financing and to raise short-term funds within limits. It was the Narsimham Committee II Report (1998) which suggested thatthe DFIs should convert themselves into banks or non-bank financialcompanies, and this conversion was endorsed by the Khan Working Group(1998). The Reserve Bank‘s Discussion Paper (1999) and the feedback thereonindicated the desirability of universal banking from the point of view ofefficiency of resource use, but it also emphasized the need to take into accountfactors such as the status of reforms, the state of preparedness of the institutions,and a viable transition path while moving in the desired direction. Accordingly, the mid-term review of monetary and credit policy, October1999 and the annual policy statements of April 2000 and April 2001 enunciatedthe broad approach to universal banking and the Reserve Bank‘s circular ofApril 2001 set out the operational and regulatory aspects of conversion of DFIsinto universal banks. The need to proceed with planning and foresight isnecessary for several reasons. The move towards universal banking would notprovide a panacea for the endemic weaknesses of a DFI or its liquidity and Page 54 of 93
  55. 55. S.I.E.S. College of Commerce and Economics Universal Bankingsolvency problems and/or operational difficulties arising fromundercapitalization, non-performing assets, and asset liability mismatches, etc. The overriding consideration should be the objectives and strategicinterests of the financial institution concerned in the context of meeting thevaried needs of customers, subject to normal prudential norms applicable tobanks. From the point of view of the regulatory framework, the movementtowards universal banking should entrench stability of the financial system,preserve the safety of public deposits, improve efficiency in financialintermediation, ensure healthy competition, and impart transparent and equitableregulation. Page 55 of 93
  56. 56. S.I.E.S. College of Commerce and Economics Universal Banking3.6Universal Banking – Pros And Cons The solution of Universal Banking was having many factors to deal with,which can be further analyzed by the pros and cons.Advantages of Universal Banking  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.  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.  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 Page 56 of 93
  57. 57. S.I.E.S. College of Commerce and Economics Universal Banking diversifiable risk analysis, etc, is useful for other clients and information seekers. Automatically, a bank will get the benefit of being involved in the researching  Easy Marketing on the Foundation of a Brand Name: A banks 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. In this way, a bank can reach the client even in the remotest area without having to take resource to an agent.  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.  Investor Friendly Activities: Another manifestation of Universal Banking is bank holding stakes in a form : a banks 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 firms activities. Page 57 of 93
  58. 58. S.I.E.S. College of Commerce and Economics Universal BankingDisadvantages of Universal Banking  Grey Area of Universal Bank. 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.  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.  NPA Problem Remained Intact. The most serious problem that the DFIs have had to encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Universal Banking or installation of cutting-edge-technology in operations are unlikely to improve the situation concerning NPAs. Page 58 of 93
  59. 59. S.I.E.S. College of Commerce and Economics Universal Banking Chapter 4 Page 59 of 93
  60. 60. S.I.E.S. College of Commerce and Economics Universal Banking4.1Introduction To ICICI Bank The Industrial Credit and Investment Corporation of India limited (ICICI)was formed in 1955 at the initiative of the World Bank, the government of Indiaand representatives of Indian industry. The principal objective was to create adevelopment financial institution for providing medium-term and long-termproject financing to Indian businesses. Until the late 1980s, ICICI primarilyfocused its activities on project finance, providing long-term funds to a varietyof industrial projects. ICICI typically obtained funds for these activities througha variety of government-sponsored and government-assisted programs designedto facilitate industrial development in India. Today ICICI is one of the largestfinancial institutions in India. It provides a wide range of products and servicesaimed at fulfilling the banking and financial needs of Indias corporate and retailsectors. ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indianfinancial institution, and was its wholly-owned subsidiary. ICICIs shareholdingin ICICI Bank was reduced to 46% through a public offering of shares in Indiain fiscal 1998, an equity offering in the form of ADRs listed on the NYSE infiscal 2000, ICICI Banks acquisition of Bank of Madura Limited in an all-stockamalgamation in fiscal 2001, and secondary market sales by ICICI toinstitutional investors in fiscal 2001 and fiscal 2002. In the 1990s, ICICItransformed its business from a development financial institution offering onlyproject finance to a diversified financial services group offering a wide variety Page 60 of 93
  61. 61. S.I.E.S. College of Commerce and Economics Universal Bankingof products and services, both directly and through a number of subsidiaries andaffiliates like ICICI Bank. After consideration of various corporate structuring alternatives in thecontext of the emerging competitive scenario in the Indian banking industry,and the move towards universal banking, the managements of ICICI and ICICIBank formed the view that the merger of ICICI with ICICI Bank would be theoptimal strategic alternative for both entities, and would create the optimal legalstructure for the ICICI groups universal banking strategy. The merger would enhance value for ICICI shareholders through themerged entitys access to low-cost deposits, greater opportunities for earningfee-based income and the ability to participate in the payments system andprovide transaction-banking services. The merger would enhance value forICICI Bank shareholders through a large capital base and scale of operations,seamless access to ICICIs strong corporate relationships built up over fivedecades, entry into new business segments, higher market share in variousbusiness segments, particularly fee-based services, and access to the vast talentpool of ICICI and its subsidiaries. In October 2001, the Boards of Directors ofICICI and ICICI Bank approved the merger of ICICI and two of its wholly-owned retail finance subsidiaries, ICICI Personal Financial Services Limitedand ICICI Capital Services Limited, with ICICI Bank. The merger wasapproved by shareholders of ICICI and ICICI Bank in January 2002, by theHigh Court of Gujarat at Ahmadabad in March 2002, and by the High Court ofJudicature at Mumbai and the Reserve Bank of India in April 2002. Consequentto the merger, the ICICI groups financing and banking operations, bothwholesale and retail, have been integrated in a single entity. Page 61 of 93
  62. 62. S.I.E.S. College of Commerce and Economics Universal Banking4.2History Of ICICI Bank1955: The Industrial Credit and Investment Corporation of India Limited (ICICI) incorporated at the initiative of the World Bank, the Government of India and representatives of Indian industry, with the objective of creating a development financial institution for providing medium-term and long-term project financing to Indian businesses. Mr. A. Ramaswami Mudaliar elected as the first Chairman of ICICI Limited ICICI emerges as the major source of foreign currency loans to Indian industry. Besides funding from the World Bank and other multi-lateral agencies, ICICI also among the first Indian companies to raise funds from International markets.1956: ICICI declared its first Dividend at 3.5%.1958: Mr. G. L. Mehta was appointed the 2nd Chairman of ICICI Ltd.1960: ICICI building at 163, Backbay Reclamation was inaugurated.1961: The first West German loan of DM 5 million from Kredianstalt was obtained by ICICI.1967: ICICI made its first debenture issue for Rs.6 crores, which was oversubscribed. Page 62 of 93
  63. 63. S.I.E.S. College of Commerce and Economics Universal Banking1969: First two regional offices in Calcutta and Madras were opened.1972: Second entity in India to set-up merchant banking services. Mr. H. T. Parekh appointed as the third Chairman of ICICI.1977: ICICI sponsors the formation of Housing Development Finance Corporation. Managed its first equity public issue.1978: Mr. James Raj appointed as the fourth Chairman of ICICI.1979: Mr. Siddharth Mehta appointed as the fifth Chairman of ICICI.1982: Becomes the first ever Indian borrower to raise European Currency Units. ICICI commences leasing business.1984: Mr. S. Nadkarni appointed as the sixth Chairman of ICICI.1985: Mr. N. Vaghul appointed as the seventh Chairman and Managing Director of ICICI. Page 63 of 93
  64. 64. S.I.E.S. College of Commerce and Economics Universal Banking1986: ICICI first Indian Institution to receive ADB Loans. First public issue by an Indian entity in the Swiss Capital Markets. ICICI along with UTI sets up Credit Rating Information Services of India Limited, (CRISIL) Indias first professional credit rating agency. ICICI promotes Shipping Credit and Investment Company of India Limited. (SCIC) .The Corporation made a public issue of Swiss Franc 75 million in Switzerland, the first public issue by any Indian equity in the Swiss Capital Market.1987: ICICI signed a loan agreement for Sterling Pound 10 million with Commonwealth Development Corporation (CDC), the first loan by CDC for financing projects in India.1988: ICICI promotes TDICI - Indias first venture capital company.1993: ICICI sets-up ICICI Securities and Finance Company Limited in joint venture with J. P. Morgan. ICICI sets up ICICI Asset Management Company.1994: ICICI sets up ICICI Bank.1996: ICICI becomes the first company in the Indian financial sector to rise GDR. ICICI announces merger with SCICI. Mr. K. V. Kamath appointed the Managing Director and CEO of ICICI Ltd. Page 64 of 93
  65. 65. S.I.E.S. College of Commerce and Economics Universal Banking1997: ICICI was the first intermediary to move away from single prime rate to three-tier prime rates structure and introduced yield-curve based pricing. The name "The Industrial Credit and Investment Corporation of India Limited "was changed to "ICICI Limited". ICICI announces takeover of ITC Classic Finance.1998: Introduced the new logo symbolizing a common corporate identity for the ICICI Group. ICICI announces takeover of Anagram Finance.1999: ICICI launches retail finance - car loans, house loans and loans for consumer Durables. ICICI becomes the first Indian Company to list on the NYSE through an Issue of American Depositary Shares.2000: ICICI Bank becomes the first commercial bank from India to list its stock on NYSE. ICICI Bank announces merger with Bank of Madura.2001: The Boards of ICICI Ltd and ICICI Bank approved the merger of ICICI with ICICI Bank.2002: Moodys assign higher than sovereign rating to ICICI. Merger of ICICI Limited, ICICI Capital Services Ltd and ICICI Personal Financial Services Limited with ICICI Bank. Page 65 of 93
  66. 66. S.I.E.S. College of Commerce and Economics Universal Banking4.3SWOT Analysis Of ICICI Bank  STRENGTHS: ICICIs distribution network is a major strength of the company. It has physical presence across 42 cities. It also has a strong network of marketing agents, ATMs and call centers. ICICI offers a wide range of products and services to its corporate and retail customers. This has increased its market share and enabled it to move a step ahead to achieve its vision of being a Universal Bank.  WEAKNESSES: The company has a large amount of non-performing loans.  OPPORTUNITIES: The signs of Indian economy reviving have created a lot of opportunities for the company. The industrial production has gone up by 8% and this is expected to favor the company. The revival in the economy will reduce the NPAs and could result in growth of credit.  THREATS: Increased competition from foreign banks which have begun to foray into financial services segment will pose a threat to the companys market share and hence its bottom line. Page 66 of 93
  67. 67. S.I.E.S. College of Commerce and Economics Universal Banking4.4Merger Of ICICI & ICICI Bank The merger is a culmination of a dream, which began five years ago. Thisprocess was initiated in 1996. The time when SCICI merged with ICICI, in 1997-98 ICICI acquired ITC classic and Anagram finance by way of acquisition, in2000, ICICI bank gobbled up Bank of Madura. Reverse merger of ICICI‘s MD &CEO K.V. Kamath started articulating on it in 1996. At first, it seemedimpossibility latter, it looked imperative. On 25the of October India‘s first true-blue universal bank was born, as ICICIreverse merged into its sibling ICICI Bank to create a Rs. 95,000 crores asset basemonolith, only second after SBI that has the asset base of 3,16,000 crores. HDFCBank is left at third place with asset size of Rs. 19000 crores. Earlier the reversemerger looked like a bailout strategy for Non Performing Assets (NPA) riddenICICI, but later the merger seemed justified because of possibility of numerousbenefits through size and diverse portfolio of products of two entities. Swap rationfor merger is decided to be two shares of ICICI for one share of ICICI Bank. stMerged entity became fully operational from 31 March, 2002. ICICI requires thisfive-month to meet all regulatory requirements. The other interesting aspect of reverse merger is its methodology. ICICI Bankhas adopted the ―purchase method‖ of accounting principles (GAAP) for themerger, unique in India. ICICI‘s assets and liabilities will be ―fair valued‖ for thepurpose of incorporation in the accounts of ICICI Bank on the appointed date. Thisaccounting practice is opportunity for ICICI to bring down its level of NPA. Page 67 of 93
  68. 68. S.I.E.S. College of Commerce and Economics Universal Banking The new entity will have the capital adequacy ratio of 11.25 per cent with TierI capital contributing 7.5 per cent and Tier II 3.75 per cent.Merged entity will have following features: - a) Strong retail franchise will be able to access low- cost savings bank and current account. b) Funding cost will be reduced. c) Leverage on its large capital base, products suite, extensive corporate and retail customer relationship, technology enabled distribution system & vast talent pool. d) Retail segment will be a key driver for growth. e) Reduction in the cost to income ratio due to scale of operations will provide competitive age. f) It will reduce the pressure on the capital adequacy front. g) Long term of the merger would offset the temporary hiccups. h) The benefits of leveraging and cross selling will set off the cost of carrying the reserves. i) Creation of an asset reconstruction companies (ARC) to manage NPAs. j) Merger has been completed without seeking concessions on the reserve requirements; this is an important aspect of reverse merger. Page 68 of 93
  69. 69. S.I.E.S. College of Commerce and Economics Universal Banking4.5Benefits From Merger 1) Biggest benefit that would accrue to the merged entity is operational and economic efficiency. Both ICICI and ICICI Bank operate through different premises in a city. Merger would facilitate use of common infrastructure and computer network to carry out their operations. It would drastically reduce duplication of functions and operational costs and improve efficiency. ICICI, being a financial institution, takes care of long term fund requirement of corporate while ICICI Bank gives short term loan for financing the working capital requirement of corporate and individuals. Now under one roof ICICI will be able to do project finance investment banking, housing finance and consumer loans. 2) Merged entity would have a network of 396 existing branches and extension counter, 140 existing retail finance offices and centers of ICICI. Such a huge distribution network would help it to reach a large number of corporate and retail customers. With cross-selling ICICI would be able to increase its revenues. Profits are expected to improve by at least 3% because of better utilization of funds and economies of scales in operation. With merger ICICI will become a single shop for all type of finances and can leverage better its credit appraisal skills and infrastructure. 3) Indian commercial banks, like ICICI Bank, have access to cheaper deposits from general public. As they have idle funds they invest these funds into government securities over the required Statutory Liquidity Ratio (SLR). SLR investments earn average return of 8.5% only. These banks can earn Page 69 of 93
  70. 70. S.I.E.S. College of Commerce and Economics Universal Banking higher return if they finance long term requirements of corporate with these funds. On the other hand financial institutions like ICICI have shortage of funds and are saddled by poor asset quality. So weakness of both ICICI and ICICI Bank has become the strength for both the entities after merger. 4) Problem with financial institutions these days is that due to slack capital market and high level of poor assets, they cannot raise funds. Merger with banks would provide them with access to cheaper funds and retail deposits. It is not possible for government to recapitalize sick financial institutions all the times. Merger is the right move towards improving the financial health of them. ICICI has the NPA of 5.1%, achieved after accelerated provisioning of Rs. 813 crores in addition to a normal provisioning of Rs. 276 crores. On the other hand ICICI Bank has the NPA as low as 1.41%. With merger total NPA level of merged entity would come down substantially. 5) Asset based of Rs. 95000 crores. 6) Talent pool of 8275 employees. Page 70 of 93
  71. 71. S.I.E.S. College of Commerce and Economics Universal Banking4.6Issues Behind The Merger Undoubtedly the most significant event of the past few months was themerger of ICICI with its progeny, ICICI Bank. It is easily the largest merger seenin corporate India and has the potential to seriously shake up India‘s bankingindustry. The merger has been on the cards of a while, and it was more a question of―when‖ rather than ―if‖. Investors have been prepared for this, a fact what isprobably a major but not the only reason for ICICI Bank‘s relatively lowervaluation compared to HDFC Bank. The rationale for the union goes something like this. ICICI was a leftover of anera when the government provided financial institution low-cost funds and ensuredthe monopoly over big-ticket lending. This allowed them to fix interest rates atvery high levels. But this changed in the nineties and ICICI along with otherfinancial institutions faced competition from bank and other financial entities.Banks have access to cheap funds and can lend at cheaper rates. So a major reasonfor the merger is to allow ICICI access to these low cost deposits. Page 71 of 93
  72. 72. S.I.E.S. College of Commerce and Economics Universal Banking From the point of view of ICICI Bank, the management feels that they willgain due to increased size and scale. In fact, a lot is being made of the fact that themerged entity is now second only to State Bank of India. Further, the management believes they will be able to better utilize synergiesbetween the two companies. Earlier, ICICI‘s presence in areas such as consumerlending meant that ICICI Bank could not offer similar products. Moreover, ICICIBank will also gain due to ICICI‘s strong corporate relationships and access to thevast talent pool of ICICI and its subsidiaries. The reverse merger between ICICI and ICICI Bank will be smooth becauseICICI is in the strange position of being both, a government organization and notone at the same time. It is still recognized as a ―specified financial institutions‖under Section 4A of the Companies Act. This entitles it to several privileges suchas being recognized as a ―permitted security‖ for investment by trusts and others,preferential treatment in terms of risk weightage attached to its bonds, andprotection from disclosure norms. At the same time, there are no checks on itsinvestment decisions and no control on salaries. This is why ICICI can pay Rs. 1crore to CEO K.V. Kamath while the Industrial Development Bank of India (IDBI)chief has to settle for a small fraction of that amount. The anomaly arises becausethough government shareholding in ICICI has fallen much below 51 percent(which allows it to claim to be a non-government concern when it suits itspurpose), it is yet to be denotified under Section 4A. Page 72 of 93
  73. 73. S.I.E.S. College of Commerce and Economics Universal Banking But the same is not true of other Financial Institutions (FIS) that will alsohave to go the ICICI way into universal banking. All FIS will have to do that astheir access to cheap funds has been cut off. Their spreads have narrowed; they canonly survive by accessing the cheap deposit bases of banks. But the merger of anIDBI or an IFCI with a bank is not going to be easy. If one were to look at a newprivate sector bank, the salaries there would want an IDBI, loaded with more thanits fair share of NPAS. An older, nationalized bank would bring to the table itsquota of NPAS too, not to talk about a slothful staff and union problems. One can never accuse the ICICI management of not being aggressiveenough. But while its belligerent expansion has kept it in the headlines, it has oftenfailed to carry other stakeholders along. This time round its ―Agenda for the newmillennium‖- the much-hyped conversion to universal bank seems to have run intorough weather. It is obvious that ICICI‘s investors are unhappy about the mergerratio and intend to fight for their rights. Several cases have already been filed in theBombay High Court and the Investor Grievances Forum is also lobbying hard withinstitutions and bureaucrats against the merger ratio. Ignoring the interests of other stakeholders is typical of ICICI‘s managementand has frequently landed it is trouble. It has been sued several times for trying toram through restructuring proposals which protects its own lending at the cost ofothers. A recent example is that of Arvind Mills, where a group of secured foreignlenders, led by Commerz Bank have filed civil and criminal charges against ICICI.The merger of ICICI with ICICI Bank seems to be following a similar trajectory.Although it is clear that ICICI has no future as a development financial institution, Page 73 of 93
  74. 74. S.I.E.S. College of Commerce and Economics Universal Bankingit will only succeed as a universal bank it is controls costs and reduces non-performing assets. Let us examine the merger of ICICI with ICICI bank. Firstly, it is curiousthat of the three valuation methods recognized by SEBI, ICICI has chosen one thathurts its own shareholders the most. ICICI is indeed saddled with large NPAs, butthat did not stop the management from collecting fat pay packets every year.Moreover, the goodwill it commands as a development financial institution, whichis reorganized under section 4A of the Companies Act, has been ignored, as alsothe fact that it has frequently been able to raise large sums of money through whatare dangerously termed ‗ safety bonds‘. Had there been factored in, it may havechanged the merger ratio and also benefited ICICI‘s other institutionalshareholders. Page 74 of 93