Understanding the Changing Customer Preference :EXPERIMENTAL MODELS

Volume V No. 7
July 2010 Rs. 50
Financial Regulation and
Financial Inclusion
Page 16
Understanding the Changing
Customer Preferences
Page 26
Sales on High Seas
Page 36
Financial Leasing
Page 48
Finance Minister
Addresses IBA AGM

The Indian Banker 3
E D I T O R ’ S N O T E
Editor’s Note
K Ramakrishnan
It was a unique honour to have the Union Finance Minister, Shri Pranab
Mukherjee address the Annual General Meeting of IBA. While commending
the role played by IBA and banks for their contribution to the economic
growth of the country and remaining resilient during financial crisis and its
aftershocks, the finance minister has spelt out his expectations from the
banking industry, especially in the areas of business growth, NPA control,
profitability, human resources and financial inclusion. Views expressed by him
form the major part of the cover story of this issue. Another major highlight
of this issue is based on the speech delivered by Smt Usha Thorat, deputy
governor, RBI at the Tenth Annual International Seminar on Policy Challenges
for the Financial Sector at Washington last month, which brings out the
convergence between financial regulation and financial inclusion, and explains
the rationale of various initiatives by RBI to ensure sustainable framework for
financial inclusion.
This issue carries further insights on how to deal with ‘Information Overload’,
the cover story of our previous issue. Marketing of products has assumed
critical importance in banking today. This issue carries a scholarly article on
how to estimate customer preferences to various attributes of a product such
as a home loan or a credit card using experimental design. On legal and
taxation issues, we carry one article which discusses ‘sale on high seas’ as a tax
saving mechanism; and the other one on service tax liability on financial leasing
services. The importance of post sanction monitoring in containing non-
performing assets and various tools of credit form the part of another article
of this issue, while the other discusses the future roadmap of central banking
in India.
Other features include a list of initiatives undertaken by IBA during last year,
and key takeaways from the meeting of bankers convened by the Secretary,
Department of Financial Services, Ministry of Finance, on the roadmap for
financial inclusion. Two book reviews, and the report of annual payment
summit organised last month also find place in this issue.
Vol V No. 7 - July 2010
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The Indian Banker
4
Vision
To work proactively for the growth of a
healthy, professional and forward looking,
banking and financial services industry, in a
manner consistent with public good.
COVER STORY
Finance Minister 12
Addresses
IBA AGM
INSIGHT
Financial Regulation and 16
Financial Inclusion
Working Together Or At Cross-purposes?
- Usha Thorat
Members
M V Nair
S A Bhat
Alok Kumar Misra
Allen C A Pereira
Albert Tauro
K R Kamath
J M Garg
D L Rawal
S Sridhar
G S Vedi
T Y Prabhu
J P Dua
Bhaskar Sen
Office Bearers
Chairman
O P Bhatt
Deputy Chairmen
Aditya Puri M D Mallya A C Mahajan
Honorary Secretary
Rana Kapoor
R Sridharan
Ms Renu Challu
Neeraj Swaroop
Gunit Chadha
Stuart Davis
Pramit Jhaveri
M Venugopalan
Ms Chanda Kochhar
N D Behere
D K Mulmule
Shrinivas D Joshi
Ms Shikha Sharma
Kevan Watts
C O V E R S T O R Y

The Indian Banker 5
NEWSROOM 8
INTERVIEW
Ashvin Parekh 24
- Partner, National industry leader for global financial services,
Ernst & Young
EXPERT VIEW
Understanding the Changing 26
Customer Preferences: Experimental Models
- Dr Dinabandhu Bag
ARTICLE
Central Banking in India: The Road Ahead 32
- Dr Ashish Srivastava
ARTICLE
Sales on High Seas 36
- Vinoy Mathew Thomas
ARTICLE
Post Sanction Monitoring 40
- Dr J P Joshipura
LEGAL OPINION
Financial Leasing: Service Tax Liability 48
- Dr Sanjiv Agarwal
BOOK REVIEWS 52
IBA NEWS 54
EVENT ROUNDUP 58
Contents

D A S H B O A R D
Dashboard
1. Banking and Money: All Scheduled Commercial Banks (INR Crores)
Outstanding on % Variation Over
May 28, May 22, Last Last End March
2010 2009 Month Year 27.03.2010
Aggregate Deposit 4562451 3967995 1.24 14.98 1.69
1. Demand 605387 509968 4.05 18.71 -5.28
2. Time 3957065 3458027 0.82 14.43 2.85
Bank Credit 3243775 2735750 0.90 18.57 0.10
1. Food 50592 57483 5.45 -11.99 4.34
2. Non-food 3193183 2678268 0.83 19.23 0.04
Cash in Hand 28202 25714 9.04 9.68 11.33
Balance with RBI 310326 214854 12.19 44.44 10.28
Investment 1437373 1258305 0.00 14.23 3.96
Money Supply 21.05.2010 22.05.2009
M3 (a+b+c+d) 5672224 4931213 0.89 15.03 1.59
a. Currency with Public 824692 694940 3.29 18.67 7.10
b. Demand Dep with Banks 638421 563107 -1.37 13.37 -10.60
c. Time Dep with Banks 4205291 3668459 0.77 14.63 2.73
d. Other Dep with RBI 3820 4707 7.39 -18.84 -30.96
2. Price % Variation Over
2010 2009 Month Year
WPI:1993-94=100 (May 2010) 258.1 234.3 1.73 10.16
CPI: 2001=100 (April 2010) 170 150 0.00 13.33
3. Major Stock Market Indices (as on 28.05.2010)
Close Net Change
Asia Pacific 114.93 2.09
Australia 4379.17 71.97
China 24004.08 373.76
Hong Kong 19431.37 234.92
India 16666.40 278.56
Indonesia 2713.923 17.143
Japan 9639.72 117.06
Malaysia 1269.16 20.22
Singapore 2739.70 43.68
4. Forex Reserves As on A year ago
(Including Gold & SDR) 28.05.2010 29.05.2009
INR Crore 1261852 1240441
US$ million 271970 262306
5. Bank Rate Percent Effective
i. Bank Rate 6.00 29-04-2003
ii. IDBI Minimum Term Lending Rate 10.25 30-01-2004
6. Deposit Rates
A. TERM DEPOSITS
7 days and above deregulated w.e.f .01.11.2004
B. SAVING 3.5% per annum w.e.f. 01.03.2003
7. Lending Rates per annum w.e.f. 01.07.2010
Amount Percent
i. Upto INR 2,00,000 Banks to fix
ii. Over INR 2,00,000 Banks to fix
8. Ratios Percent
1. CRR 6.00 w.e.f. 24.04.2010
2. SLR 25.00 w.e.f. 27.10.2009
3. Repo Rate 5.25 w.e.f. 20.04.2010
4. Reverse Repo Rate 3.75 w.e.f. 20.04.2010
5. Cash Dep Ratio 7.42 as on 28.05.2010
6. Investment Dep Ratio 31.50 as on 28.05.2010
7. Credit Dep Ratio 71.10 as on 28.05.2010
9. World Markets - Interest Rates (as on 28.05.2010) (Gov 10 yr)
US UK Germany Japan
Price 101.56 109.28 102.68 100.36
Yield 3.31 3.62 2.69 1.26
10. Capital Markets (INR Billion)
Feb-10 Mar-10 Apr-10 May-10
Capital Issue 302.2 455.5 270.6 123.8
Public Issue 130.9 115.1 41.5 0.0
Rights Issue 18.5 7.0 26.3 1.6
Private Placements 152.7 333.3 202.8 122.1
Call Money rates as on 28.05.2010 - 4.00 - 4.10 %
11. Prime Lending Rates as on 28.05.2010 (% p.a)
US CANADA ECB JAPAN SWISS BRITAIN HONG KONG
3.25 2.25 1.00 1.475 0.52 0.50 5.00
(As lending practices vary widely by location, these rates are not comparable)
Sources: 1, 4, 8 - RBI Weekly Supplement; 2-RBI Weekly Supplement, CMIE, Mumbai; 5, 6 - RBI, 10 - CMIE; 3 & 11- The Asian Wall Street Journal; 9 - Financial Times
Real GDP of Agriculture
5.2
3.7
4.7
1.6
0.2
5.8
0
1
2
3
4
5
6
7
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
Year
Percent
Source: CMIE
The Indian Banker
6 Vol V No. 7 - July 2010

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one capital, the basic measure of bank
capital. It also wants banks to hold
enough liquid assets to survive a short-
term market crisis and reduce their
reliance on short-term wholesale
funding. The IIF estimates that banks
will need to raise $700 billion of
common equity and issue $5,400
billion of new long-term wholesale
debt over the period 2010-15 to meet
the new requirements. Their study does
not attempt to measure the effect of
other potential reforms, such as forcing
banks to spin off proprietary trading
or capping total leverage.
The IIF has not yet calculated the
effect on the UK. It has found that the
impact of the new rules would ease
significantly over time, forecasting that
they would cut less than 0.1 percent
off the three areas' combined GDP
between 2015 and 2020. The figures
suggest that the annual impact could
be reduced by spreading out the
transition period, as some G20 finance
ministers proposed recently. The
bankers warned that the current failure
to harmonise accounting standards in
the US and Europe could hamper
regulatory reform. They also criticised
Basel's ‘net stable funding’ rule, which
would force banks to reduce their
reliance on wholesale funding.
Japan unveils ¥3,000 billion
lending package
The Bank of Japan (BoJ) unveiled the
framework of its new ¥3,000 billion
lending programme in its latest effort
to try to spur economic growth to help
end deflation. The new temporary
lending programme, to be introduced
by the end of August, will supply one-
year loans at the bank's overnight rate,
against eligible collateral, to financial
institutions, for lending to companies
with the objective of raising
productivity and creating consumer
demand. The initial plan was
announced in May. The loans will be
able to be rolled over a maximum of
three times, in effect extending the
funds for a maximum of four years at
the policy rate, which stands at 0.1
percent. The central bank kept interest
rates at 0.1 percent, as expected, after
the end of its two-day monetary policy
meeting. It is unusual for the BoJ to
introduce such a programme and the
move reflects its view that boosting
Japan's potential growth rate through
structural reform is the way to rid the
country of its entrenched deflation.
Structural reform lies within the
government's responsibility. The new
programme is likely to be seen as a
measure to appease Tokyo, which, with
the July upper house elections coming
near, has been putting pressure on the
central bank to do more to end falling
prices. The BoJ's plan also comes
ahead of a government announcement,
expected this month, outlining a new
economic growth strategy. Many
strategists remain skeptical as to the
extent to which the plan will stimulate
lending. Weak lending has left banks
with a huge gap between their loans
and deposits, the vast majority of
which has been invested in Japanese
government bonds. Banks will have to
submit a plan on how the funds they
borrow through the programme will be
used. The central bank has suggested
growth areas, including health,
agriculture and the environment, in
Basel rules and banking growth
Economic growth in the Eurozone, the
US and Japan will be cut by three
percentage points between now and
2015 if current proposals to force
banks to hold more capital and liquid
assets go forward unchanged, the
world's leading banking industry group,
Institute of International Finance (IIF)
stated recently. As a result, 9.7 million
fewer jobs would be created in those
areas over the period. The group is
pushing hard for the Basel Committee
on Banking Supervision (BCBS) to
rewrite or at least delay the
implementation of the proposals,
known as Basel III, which are slated to
be voted on later this year. According
to the IIF, the Eurozone would feel the
largest impact from the new Basel
proposals, with growth cut by 0.9
percentage points per year, resulting in
a cumulative reduction in gross
domestic product of $920 billion (€765
billion, £631 billion), or 4.3 percent, by
2015. The US would see a cumulative
reduction of 2.6 percent or $951
billion, and Japan would see a 1.9
percent or $130 billion cut. The BCBS,
which sets global standards
implemented by national regulators,
has proposed tightening the definition
of what can be counted as core tier
N E W S R O O M
Newsroom
The Indian Banker
8 Vol V No. 7 - July 2010

N E W S R O O M
which borrowing companies could use
funds, but stressed it would not be
involved in their allocation. The BoJ
also stated faster growth in emerging
economies provided an ‘upside risk’ for
economic activity, but that attention
needed to be paid ‘to the effects of
developments in fiscal conditions in
some European economies on
international finance and the global
economy’.
Price rise fuel food crises fears
Food commodity prices will increase
more than previously expected in the
next decade because of rising energy
prices and developing countries’ rapid
growth, according to the annual
agricultural outlook of United Nations’
Food and Agriculture Organisation
(FAO) and the Organisation for
Economic Cooperation and
Development (OECD). Higher crude
oil prices would add force to rising
agricultural commodities prices,
particularly in those regions – including
Europe and the US – where energy
inputs such as fertilisers were used
intensively. For the next 10 years the
FAO and OECD forecast that
significant food prices, with the
exception of pork, would remain
above the 1996-2007 average, in both
nominal and real terms – adjusted for
inflation. The forecast of high prices is
likely to exacerbate concerns about
global food security. Since the food
crisis and the number of chronically
hungry people surging above the 1
billion mark last year, agriculture has
drawn more attention from
policymakers – particularly in the US.
The OECD earlier this year organised
its first ministerial meeting on
agriculture for 12 years. The prospect
of higher prices could prompt those
nations dependent on food imports –
such as Saudi Arabia and South Korea
– to try to secure long-term food
supplies by accelerating their
investment in overseas agriculture in
so-called farmland grabs. Developing
countries would provide the main
source of growth for world agricultural
production, consumption and trade,
said the report. As incomes rise, diets
are expected to slowly diversify away
from staple foods towards increased
meats and processed foods. In turn,
with increasing affluence and an
expanding middleclass, food
consumption in developing countries
would become less responsive to price
and income changes. In real terms, the
report projected cereal prices to rise
around 15-40 percent relative to the
1997-2006 average, up from last year’s
forecast of 10-20 percent. Vegetable
oils are expected to be more than 40
percent higher, against last year’s
forecast of a 30 percent increase. Meat
and dairy products will also be more
expensive in the next decade, reversing
last year’s forecast that pointed to
lower prices.
China acts to head off currency
showdown
China tried to preempt a potential
showdown at the upcoming G20
Summit when it warned the other large
economies not to use the Toronto
meeting as a platform to criticise its
currency policy. In other words, it does
not want to encourage other countries
to point a finger towards it on currency
matters at the G-20 meet. China feels
that the G20 Summit should be about
coordinating policy, not criticising
individual countries. In addition to the
US and Brazil, India has also recently
voiced criticism towards China’s
currency policy. It is generally believed
that a stronger Chinese currency would
benefit both China and the rest of the
G20 and at the same time G20 needs
to be careful not to put too much
direct pressure on China.
EU leaders give go-ahead for
publication of bank stress tests
Europe's leaders made a fresh attempt
to restore confidence in its financial
system with a decision to publish
detailed results of tests on the health
of 25 big European banks. The so-
called ‘stress tests’ initiative was
approved at a European Union (EU)
summit in Brussels where the leaders
united behind a call for a general levy
on European banks to ensure they
contributed to the cost of overcoming
the financial crisis. The leaders of the
27-nation bloc also set out plans for
stronger economic governance of the
Eurozone, involving stricter mutual
surveillance of national budgets, closer
attention to debt levels and the
development of a scoreboard for
assessing competitiveness. The decision
to publish the results of stress tests
follows weeks of turmoil in financial
markets. Fears about banking stability
have kept European government bond
yields high, in spite of the EU-led
€110 billion (£92 billion) emergency
rescue of Greece and creation of a
€500 billion back-up facility.
The stress test results would be
published in the second half of July.
Of the 25 banks, five will be British,
and the UK officials feel that it was
important that the tests were
conducted simultaneously and with
support immediately available for any
bank that failed the test. Before the
summit, the most vocal opposition to
publication of results came from
Germany's public sector regional banks
as well as from Austria. However, the
German government indicated its
support for publication afterwards.
Banks and financial inclusion
Usually financial exclusion is seen as a
purely developing world problem. But
it is not correct. In some developing
countries, almost three quarters of the
population is unbanked and the access
to financial services is confined to the
urban middleclasses. But the number
of people in mature economies who
remain outside the financial system is
also shocking. In the US, 7.8 percent of
The Indian Banker 9

N E W S R O O M
the adult population (17 million) does
not have a bank account. In the UK,
this applies to 4 percent of the
population (1.75 million adults). Other
developed economies are also having
similar statistics on financial exclusion.
In the developing world, the need is
dramatic. A recent survey by CGAP,
the independent policy and research
organisation that aims to improve
financial access to the world’s poor,
indicates that about 70 percent of
adults in developing countries are
excluded from the regulated financial
system, despite years of growth in the
financial sector and multiple
programmes championed by the World
Bank and regional development banks.
The banking system’s failure to
enfranchise the low waged begins in
the remittance sector. The World Bank
estimates that remittances totaled $44.3
billion in 2008, of which $33 billion
were sent to developing countries,
involving about 192 million migrants
that make up a staggering 3 percent of
the world’s population. According to
remittance experts, as much as 40
percent of this traffic bypasses the
regulated banking sector’s remittance
operations. Many are critical about the
failure of the banking world to capture
a greater percentage of the remittance
market, as well as the failure to convert
those remittance customers who do
use banks into account holders. Now
banks do seem to be finally waking up
to the potential of remittances as the
first step in establishing a banking
relationship. Many are undertaking
research to develop a product suitable
to the requirements of new class of
customers who are doing only
remittances. The failure to bank the
poor has historically been driven by the
perceived lack of profitability in this
client segment. But evidence from the
UK proves that this need not be the
case. The Santander, a growing force in
UK retail banking, has been successful
in offering basic bank account to the
low waged. It has also seen migration
of these accounts into intermediate
products. The bank says that 40
percent of basic bank account
customers have moved to accounts
with some access to credit and other
services. The bank also underlines the
importance of government and
regulatory efforts in encouraging banks
and ensuring that those who increase
financial inclusion do not end up
paying a disproportionate cost. For
financial inclusion, microfinance also
plays a critical role. The success of
Bangladesh is one such example which
is quoted everywhere. Technology also
plays an effective role in helping the
microfinance institutions reach masses.
Financial inclusion has come a long
way, but as the figures of the unbanked
reveal, it still has a long way to go.
Banking the poor and making a profit
remains an emotive subject. However,
the attitude that financial inclusion is
charity or philanthropy needs to exit
first.
Discussion paper on Direct
Taxes Code
The draft Direct Taxes Code (DTC)
released in August 2009 has been
revised and a discussion paper has
been released by the government on
June 16, 2010 with the last date for
reaction set at June 30. While the
discussion paper along with the draft
Direct Taxes Code has listed 24
subjects with each subject covering a
number of proposals chosen for
discussion, the revised paper deals with
only 11 subjects. The only major
change is the dropping of the proposal
for tax on gross assets but that too
only because of ‘practical difficulties’
and ‘unintended consequences
particularly in the case of loss making
companies and companies having long
gestation period’. It is for this reason it
is stated that Minimum Alternate Tax
(MAT) will be computed on the basis
of book profits with no other better
reason for its continuance. The revised
discussion paper stands committed to
the Exempt Exempt Tax (EET)
scheme, which was generally
unwelcome. But the clarification that
the proposed EET scheme will be only
prospective and that the contributions
can happen only after the Direct Taxes
Code comes into force is welcomed by
the public.
In respect of salary taxation, there is
hardly any change from the code,
except for the assurance that the
annual value of rent-free
accommodation need not be on the
basis of market value for the reason
that it will create ‘high tax burden in
the case of government employees, if
market rent is adopted’. In the
computation of property income, there
is assurance of continuation of
deduction of interest, subject to a
ceiling of INR 1.50 lacs against nil
income from one self-occupied
property. The changes that are
proposed for capital gains, especially in
respect of transactions in listed
securities through a stock exchange
now exempt, but for securities
transaction tax, sends alarming signal
for long-term investors in listed shares.
For non-profit organisations, there is
hardly any material change from the
treatment in the draft code. Loss of
exemption for income of those trusts
and institutions with income from
source, which is construed as business,
even where it is incidental to the
objects of general public utility in the
present law from assessment year
2009-10, will continue. For other trusts
and institutions, capital expenditure
will be treated as utilised only if it is
for acquiring a business capital asset
incidental to its charitable objects.
Amount applied for charities through
any other institutions will not be
treated as utilised. Unutilised income
subject to 15 percent tolerance limit
will be taxed at 15 percent.
Wealth tax will remain but the
threshold limit will be suitably
calibrated. The General Anti-
The Indian Banker
10 Vol V No. 7 - July 2010

The Indian Banker 11
Avoidance Rule (GAAR) is sought to
be justified with promised remedy
against its indiscriminate application by
way of guidelines, prior approval,
minimum exemptions limit and hearing
before Dispute Resolution Panel
(DRP).
The preamble to the revised discussion
paper clearly states that there could be
reduction of tax base as a result of
revision of the proposals apparently
because of dropping of the proposal
of gross assets tax so that it would be
necessary that tax slabs, tax rates and
monetary limits for exemption would
all require to be ‘calibrated accordingly
while finalising the legislation’.
Government, RBI take measures
to infuse INR 20,000 crores to
ease liquidity
The government of India in
consultation with the Reserve Bank of
India (RBI) has announced measures
to infuse INR 20,000 crores into the
system to manage the ongoing tight
liquidity situation. The notification
issued by the government would
repurchase 12.25 percent government
stock in 2010 and 6.57 percent
government stock in 2011 for their
cash management operations. The
repurchase of government stocks to
the amount of INR 20,000 crores is to
be undertaken in one or multiple
tranches. The repurchase operations
are purely ad-hoc in nature and will be
funded through the current surplus
cash balances of the government.
Recently, in a bid to ensure enough
liquidity in the banking system, the
central bank had allowed banks to
maintain a lower statutory liquidity
ratio (SLR), by 0.50 percent for a short
period till July 2, 2010. The RBI now
conducts two liquidity adjustment
facility (LAF) operations daily, allowing
banks access to funds. The central
bank has also reduced the size of the
treasury bill auction for June to INR
15,000 crores from INR 22,000 crores.
The tightness of liquidity in the system
was largely due to advance tax
collection and 3G licence payments.
Telecom companies have paid the
government INR 67,719 crores for 3G
spectrum and another INR 38,500
crores for broadband wireless access
spectrum auctions. Most of these
payments have been funded by banks.
Similarly, the advance tax outflows
have drained out close to INR 35,000
crores from the system.
TRAI, RBI agree on roles in
rollout of m-banking
In an attempt to ensure a smooth
rollout of mobile banking in the
country, the Telecom Regulatory
Authority of India (TRAI) and the
Reserve Bank of India (RBI) have
reached an understanding on its
regulation. Early rollout of mobile
banking will speed up the
government’s plans towards financial
inclusion. TRAI will deal with all
interconnection issues while RBI will
look into banking aspects like the
maximum amount of transactions per
day, know-your-customer guidelines
and verification criteria etc. The
development comes as a relief for
telecom operators who feared getting
caught in a possible regulatory crossfire
despite their excitement about the
prospects for mobile banking. Such
fears had gained currency following the
recent controversy between capital
market regulator, Securities and
Exchange Board of India (SEBI) and
the Insurance Regulatory and
Development Authority (IRDA) over
regulating unit-linked insurance
products.
Interconnection is an important aspect
in mobile banking since telecom
networks would need to connect with
bank networks. Charges payable on
these counts and the number of points
of interconnection need to be worked
out in a manner which leaves no room
for dispute. TRAI has been mandated
with this exercise since it has the
required expertise in the area. TRAI
will also be in charge of setting tariffs
which consumers would pay for mobile
banking access. Mobile banking
promises new revenue streams for
telecom operators, at the same time
expanding banks’ reach in rural areas
where mobile telephony has made
giant strides. Today, there are more
mobile users in rural areas than bank
account holders, leading to a situation
where people have better access to
telecommunications and less to
financial services.
The scope of mobile banking can be
gauged from the fact that every year,
around INR 25,000 crores is transacted
on the network of the country’s largest
mobile operator Bharti Airtel alone, by
way of recharge coupons. Once mobile
banking takes off, people will be able
to withdraw cash and transfer funds
using their mobile phones. The
government has already approved the
framework for introduction of such
facilities by the banks. In fact, banks
have been advised to start mobile
banking services in rural areas by July
31, 2010 and complete the rollout by
the end of next year. This happened
after the government accepted the
report of an inter-ministerial group led
by a committee of secretaries.
The mobile banking model envisioned
for rural areas will enable mobile
phone users to deposit and draw cash
instantly into or from their mobile-
linked no-frills bank accounts through
a business correspondent having a
mobile phone in the village. A
significant feature of the proposed
framework is that funds remain within
the banking system throughout and the
intermediary does not have custody of
the funds even momentarily.
Jayasree Menon
Vice President
Department of Research & Statistics
Indian Banks’ Association
N E W S R O O M

Finance Minister Addresses IBA AGM
year to discuss operational issues in payment systems, last
year also we had set up ‘India Pavilion’ at Hong Kong on
the theme ‘Vibrant India-Promising Future’.
We are happy to note that National Payment Corporation
of India (NPCI), the umbrella organisation for retail
payment system, set up by IBA during last year, is fully
functional now. Now IBA is fully focused on the formation
of Credit and Operational Risk Data Exchange
(CORDEx). This company is expected to provide a
common data exchange for pooling of risk data and
operational loss data among the banks, which in turn would
help them to fine-tune their risk management practices and
also to meet the requirements for Basel II compliance.
Similarly, we are engaged in setting up of Central
Electronic Registry as per the provisions of the SARFAESI
Act, 2002. We are grateful to our FM for entrusting this
responsibility to IBA and for allocating INR 25 crores for
this purpose in the Union Budget. Banks in India are fine-
tuning their risk management capabilities in their run-up to
adopt Basel II Advanced Measurement Approach (AMA)
towards risk management. IBA with the support of Ernst
& Young completed a survey on the preparedness of
Indian banks for migrating to AMA.
Financial inclusion has been a critical issue not only for the
government and the RBI, but for our member banks also.
Welcoming the hon’ble union finance minister (FM) Pranab
Mukherjee, M V Nair, chairman, IBA and chairman and
managing director, Union Bank of India said that ‘the FM
has been taking interest in understanding the concerns of
the banking industry and possesses a knack of dealing with
any issue in his inimitable style. We are privileged to have
him in our midst today.’ Nair also welcomed Shri Gopalan
acknowledging his keen interest in interacting with IBA on
policy and operational matters. ‘Successful implementation
of financial inclusion, HR challenges in public sector banks
are issues close to his heart,’ said Nair. Here are the edited
excerpts of the talks delivered in this meeting..
M V Nair
During the economic downturn, IBA was actively involved
with banks in implementing the various policy prescriptions
arising out of the stimulus package announced by the
government related to export sector, SME sector, housing
etc and providing a lifeline to mutual fund industry. We had
quite a few delegations visiting us from Italy, Germany and
Australia with a view to explore various means to foster
mutual cooperation and coordination. During the year, we
also had the opportunity to organise India-China Financial
Conference aimed to strengthen trade ties with China.
Encouraged by the good response received for ‘India
Pavilion’ at SIBOS, where over 8,000 bankers meet every
The Indian Banker
12 Vol V No. 7 - July 2010
M V Nair welcomes Hon’ble Finance Minister Pranab Mukherjee
C O V E R S T O R Y
The 63rd Annual General Meeting of IBA held on June 8, 2010 at Hotel Trident, Bandra Kurla Complex,
Mumbai was addressed by hon’ble finance minister, Pranab Mukherjee, who was the chief guest.
R Gopalan, secretary, financial services, government of India also graced the occasion.

that he grappled with during his tenure and the most
important one was the recently concluded industry-wide
wage settlement. The IBA has a solution-centric approach.
So, even as members compete with each other in the
marketplace, they collaborate with each other in finding
solutions to issues of common interest. Often many of
these issues are flagged to the IBA by the RBI or by the
government. Today the leaders of this country have been
saying that the growth which the economy is having this
year, 8 percent plus, is only the beginning. It could clock 9
or 10 percent or even greater. For any modern economy to
continue to grow at such a rate would require a very
healthy, smart and in sync banking system.
While I will continue with all the current projects such as
risk management, Basel II, IFRS, financial inclusion,
education, agriculture etc in which IBA is involved, I am
also keen on exploring new areas, which are very critical to
the banking industry. One such area is of human resources.
In the next 3 to 5 years lacs of people are going to retire
from the Indian banking industry collectively. So, not only
we need to recruit lacs of people as replacement but I
believe we need to recruit lacs of more people to serve the
growing financial and banking needs of this major
economy growing at 9 to 10 percent. There are issues with
regard to skills, recruitment, training, and more importantly
with regard to leadership pipeline.
Also, Indian banking industry is heterogeneous - we have
got large banks, medium banks and small banks. Some
banks by virtue of their size are in a better position to
invest in technologies, utilities and procedures which make
for greater efficiency and greater cost containment whereas
others are not able to do that. Is it possible to develop
common utilities or common infrastructure for smaller
banks or medium sized banks which they could share? This
could be in the area of pensions, cheque collection, cheque
truncation, storage, archival, retrieval of documents, and a
host of other such areas which will improve efficiency and
reduce cost. I propose to engage the IBA in many of these
areas.
IBA is coordinating with the Unique Identification
Authority of India (UIDAI) on financial inclusion, as the
project would be mutually beneficial to UIDAI and banks.
We have brought out a report on Micro ATM Standards
for facilitating financial inclusion. This document is hosted
on the website of IBA and UIDAI. Another IBA
committee had earlier stipulated standards for use of
smartcards for financial inclusion.
Banks are also playing a crucial role in the field of
infrastructure financing. IBA has lobbied with the
government and RBI to obtain some relaxation to enable
banks to lend more to infrastructure. From IBA’s side, we
have worked along with India Infrastructure Finance
Company Limited (IIFCL) to develop an appropriate
scheme for take-out financing to help banks to have more
resources to finance infrastructure.
We could conclude the 9th bipartite settlement with the
unions in this year, after two and half years of negotiations.
We considered the demands of the unions for the second
option of pension for the state–owned bank employees.
Another important highlight of the settlement was the
introduction of New Pension Scheme (NPS) for the new
recruits and this would certainly remove the uncertainty
about pension cost in future. We are also contemplating the
idea of introduction of variable pay to the bank employees
as a means of improving the motivational aspect of the
state-owned bank employees. Government has set up a
committee to study HR issues of public sector banks and
IBA is closely associated with this committee.
I have a very pleasant announcement to make today. Mr O
P Bhatt, chairman, State Bank of India, will be the new
chairman of IBA. He has been elected to this post in the
management committee meeting held this evening.
O P Bhatt
I am happy and honoured to have been elected as the new
chairman of IBA. My predecessor has handled this position
with great aplomb and grace. Numerous were the issues
C O V E R S T O R Y

The Indian Banker
14
C O V E R S T O R Y
Hon’ble FM Pranab Mukherjee
First of all, I would like to congratulate M V Nair for very
successfully leading IBA in a very critical hour and I would
like to congratulate O P Bhatt who has assumed the
responsibility of presiding over this organisation for the
coming year. One thing, which appeals my mind about
IBA, is its adaptability to the ever-changing banking
landscape. Recently, IBA has performed actively in the
settlement of critical HR issues like wage revision and
second pension option for bank employees. I congratulate
Nair for his apt handling of these sensitive and critical
issues. The Indian banking system has been relatively in
good health, and I believe that changes in policy and
regulation have helped strengthen the Indian banking
sector. As a result significant financial deepening has taken
place in Indian economy over the years as seen from the
credit-GDP, M3-GDP ratios as well as flow of funds
indicators.
Despite developments in the global scenario, contribution
of the banking sector to the economy in India has grown
and Indian banks have outperformed in share indices.
However, challenges still remain. For instance, the cost of
intermediation remains high and bank penetration is low.
Financial deepening has to be accelerated else it could
constrain the full potential of the Indian economy. This is
essential if we are to maintain India's high GDP growth
trajectory.
My first area of concern is that despite a higher than
anticipated GDP and manufacturing sector growth during
2009-10 compared to the previous year, both credit and
deposit growth were much lower at around 17 percent.
Credit growth for the current year is projected at 20
percent by the RBI and banks will have to step up their
performance to ensure that this is achieved. Furthermore,
the sectoral flow of credit should be such that the
productive requirements of growing sectors of the
economy are adequately taken care of while maintaining
the quality of assets.
Secondly, it is imperative that banks maintain profitability.
Many banks have posted good balance sheet results during
2009-10 and I congratulate them for this. However, in
order to meet the needs of one of the fastest growing
economies of the world, banks will have to constantly
augment their capital base. The challenges before banks
during the current year include an uncertain pace of global
recovery, exit policy, containment of NPA levels, higher
provisioning norms and reduction in operational costs and
cost of funds. Furthermore, banks may no longer enjoy
windfall treasury gains that the decade-long secular decline
in interest rates had earlier provided. This may expose the
weaker banks.
An issue that demands immediate attention by Indian
banks is containment of NPA levels. The recent balance
sheet results show that the NPAs of some banks have risen
notably. The increase in the level of NPAs has a number of
negative consequences. From the banking system's point of
view, high loan loss provisions reduce net profits and tend
to put pressure on the lending rates. High real lending rates
discourage new and creditworthy borrowers from seeking
loans from banks, with negative consequences for real
economic activity. From a macroeconomic policy point of
view, rigidities in lending rates that result from the large
stock of NPAs dampen the effectiveness of monetary
policy. In addition, to the extent that the public sector
banks have to be recapitalised by the government because
of the credit losses, the NPAs represent a source of quasi-
fiscal liabilities. I am hopeful that banks will focus on this
aspect while expanding future business.
However, perhaps the most daunting task for banks in my
opinion is going to be the management of human
resources in the coming years. The market is seeing growth
driven by new products and services that include
opportunities in credit cards, consumer finance and wealth
management on the retail side, and in fee-based income
and investment banking on the wholesale banking side.
These require new skills in sales and marketing, credit and
operations.
Public sector banks need to fundamentally strengthen
institutional skill levels especially in sales and marketing,
service operations, risk management and the overall
organisational performance ethic. There is a need for a
large number of recruitments of the right quality in the
next few years to bridge the gap likely to be caused by a
large number of retirements as has been pointed out by the
new chairman of IBA. The skills of the existing manpower
need to be urgently upgraded in view of the changed job
roles in the technology driven environment. Employees
need training in risk management, foreign exchange
management, treasury management, branches/credit
appraisal, infrastructure project appraisal and a host of
things. The performance appraisal system also needs to be
made more effective and systematic and initiatives for
employee retention need to be worked out.
I would now like to turn to a subject close to my heart, ie,
financial inclusion. This is an important priority of the
government as only 37.2 percent of bank branches of
scheduled commercial banks are in rural areas and only 40
percent of the country’s population has bank accounts. As
you are aware financial inclusion provides an avenue to the
poor for bringing their savings into the formal financial
system, an avenue to remit money to their families in
villages besides weaning away the poor from the clutches of
the usurious moneylenders. It is thus essential to extend

forward. Financial services offered with the help of ICT
should ideally be standardised, interoperable and cost
effective. One of the major reasons for the slow progress
in providing banking services in the hinterland is the high
transaction costs associated with the low value large volume
transactions. Technology can to a great extent reduce the
cost of transactions.
I am happy to note that for any policies of the
government, whether it be financial inclusion or adoption
of technology or ways to tackle HR issues, banks are open
to new ideas.
M D Mallya
On behalf of IBA, I take this opportunity to express my
sincere gratitude to our chief guest, hon’ble union finance
minister Pranab Mukherjee, for making available his time to
grace this occasion. I also thank Shri R Gopalan, secretary,
financial services, for the cooperation extended by him on
various occasions. On this occasion, I would also like to
acknowledge the cooperation extended by the RBI
governor, Dr D Subbarao, all deputy governors and the
senior officials of RBI to IBA.
Our sincere thanks also go to member banks that are ever
willing to support us in all our activities and also for
deputing their senior executives to participate in various
working groups and committees constituted by IBA.
banking services to the rural hinterland at the earliest in
order to include these regions in India’s growth story.
You would recall that I had in my budget speech for this
year announced that appropriate banking facilities would be
provided to habitations having population in excess of
2,000 by March 2012. I had also proposed to extend
insurance and other services to the targeted beneficiaries.
These services would be provided using the business
correspondent and other models with appropriate
technology backup. By this arrangement, it is proposed to
cover around 60,000 habitations. In this regard the banks
were directed to make their financial inclusion plans for
covering those villages with a population over 2,000 as per
2001 census by March 31, 2010.
I have written to the chief ministers of all states informing
them of these financial inclusion plans for their states and
requesting them to support the banks’ efforts in reaching
banking services to these villages. I exhort the IBA and its
member banks to come forward and take on this
challenging task wholeheartedly so that this objective is
achieved by March 2012. Your efforts to reach banking to
the 'aam aadmi', if successfully implemented will become a
model for financial access for the global banking
community.
Even as the achievements of IT in the banking sector in
India are impressive, there is a big agenda on the way
C O V E R S T O R Y

The case for financial inclusion is not based on the
principle of equity alone – access to affordable banking
services is required for inclusive growth with stability.
Achieving financial inclusion in a country like India with a
large and diverse population with significant segments in
rural and unorganised sectors requires a high level of
penetration by the formal financial system. Even in areas
that are well covered by banks, there are sections of society
excluded from the banking system. Political and social
stability also drive financial inclusion. In the recent period,
the Indian government has been encouraging opening of
bank accounts by providing government benefits through
such accounts. Information and Communication
Technology (ICT) solutions have made such initiatives
possible at relatively low cost.
Defining financial inclusion
Financial inclusion is not merely providing reliable access
to an efficient payments system. Many discussions -
especially in the context of mobile phone-led retail
payments system - seem to focus on this aspect of financial
inclusion. Financial inclusion is also not just microfinance.
Financial inclusion represents reliable access to affordable
savings, loans, remittances and insurance services. It
primarily implies access to a bank account backed by
deposit insurance, access to affordable credit and the
payments system.
The key question is what kind of regulatory and
supervisory mechanism will ensure that the formal financial
system delivers affordable financial services to the excluded
population with greater efficiency without compromising
on acceptable levels of safety and reliability?
Financial regulation and financial inclusion – Is
there a trade off?
During several outreach activities by the RBI at remote
unbanked areas last year, cases of people having been
Financial Regulation and Financial Inclusion
Working Together Or At Cross-purposes?
Usha Thorat
The Indian Banker
16 Vol V No. 7 - July 2010
This is an abridged version of the speech delivered by Smt Usha Thorat, deputy governor, Reserve Bank of
India at the Tenth Annual International Seminar on Policy Challenges for the Financial Sector co-hosted by
the Board of Governors of the Federal Reserve System, the International Monetary Fund, and the World
Bank at Washington, in June 2010, reproduced with permission from the Reserve Bank of India.
For full text, please visit www.rbi.org.in - Ed.

duped by ‘fly by night’ operators who had vanished with
their life savings came to light. The distress to people and
the damage to public confidence caused by such
unscrupulous operators are something that no regulator
can ignore. Sound and reliable deposit-taking entities,
backed by deposit insurance for small deposits, accessible
to all are, therefore, essential for financial inclusion. It is
not possible to have sound and reliable deposit-taking
entities and a deposit insurance system without financial
regulation. Hence, in my mind, there is no doubt that
financial regulation and financial inclusion work together -
the former is a must for the latter.
Another reason why there is convergence between financial
regulation and financial inclusion is that if financial
intermediaries have to deliver affordable services they need
to take advantage of technology and economies of scale.
This requires them to grow to some optimal size. Such
growth is not possible without capital. Investors and
lenders are comfortable with providing more funds only if
such entities are regulated. This has been our experience
with microfinance institutions (MFIs) wanting to be
registered as non-banking financial companies (NBFCs)
with RBI, but wanted RBI to reduce the minimum capital
requirement below what had been prescribed for NBFCs in
general. The RBI allowed them to register, on fulfilling the
prescribed norms, without lowering the minimum capital
requirement. The dramatic growth of MFIs in the recent
period on account of support by lenders and investors
owes in no small measure to their being registered with
RBI as NBFCs.
More recently, in the context of the global crisis, it is
observed that undue reliance on borrowed funds can be a
source of risk and a more stable retail base of deposits is
good for both the bottom-line and resilience. Similarly, a
diversified asset portfolio leads to less volatility in earnings.
Thus financial inclusion which can promote such a retail
and diversified portfolio - in assets and liabilities - also
promotes financial stability.
Regulatory interventions for facilitating financial
inclusion
I would like to highlight here the various regulatory
measures taken by the RBI to facilitate financial inclusion.
The key message here is that the regulatory approach has
not compromised with prudential norms for deposit-taking
entities. We are of the firm view that only sound and
strong institutions can deliver financial inclusion. Within
the overall traditional prudential framework, what we have
tried to do is to have a system of incentives and
disincentives that further the financial inclusion objective
and while doing so, we have tried to balance the degree of
the risk with the ability to achieve greater penetration.
Is small beautiful?
Looking at the success of credit unions and community
banks worldwide in providing financial services to local
communities, it could be argued that smaller regional banks
could be the answer for financial inclusion. However, our
experience with local entities such as cooperative banks,
deposit-taking NBFCs and regional rural banks highlighted
the risks of poor governance, connected lending,
geographic concentration leading to vulnerability to natural
calamities and downturns. Small entities also tend to absorb
disproportionate share of supervisory resources. Besides,
the adoption of ICT solutions that are essential for
accessing mainstream payments system requires larger
investments and these often prove to be too onerous for
small entities and render them uncompetitive.
We have encouraged merger of non-viable entities and
growth of banks that meet regulatory requirements. We
have also followed a three tiered regulatory approach –
‘non-Basel’ approach for regional rural banks and rural
cooperatives with the objective of ensuring positive net
worth, ‘Basel-I’ for urban cooperative banks and ‘Basel II’
for commercial banks. For non-banking deposit taking
entities, that do not enjoy deposit insurance or offer
savings/checking accounts, we have adopted a simpler
regulatory framework albeit with higher capital ratios.
I N S I G H T
Smt Usha Thorat

Allowing banks to open accounts for Self Help
Groups
An important regulatory dispensation that facilitated
financial inclusion was given in the early 90s, when banks
were allowed to open savings accounts for Self Help
Groups (SHGs), which were neither registered nor
regulated. National Bank for Agriculture and Rural
Development (NABARD) launched the SHG–Bank
Linkage programme in 1992 to forge the synergies between
formal financial system and informal sectors. Under this
programme, banks provide loans to the SHGs against
group guarantee and the quantum of
loan could be several times the
deposits placed by such SHGs with
the banks.
The recovery rates of such loans
have been good and banks have
found that the transaction cost of
reaching the poor through SHGs is
considerably lower as such cost is
borne by the SHG rather than the
bank. Interest earned from group
members is retained in the group.
The penetration achieved through
SHGs has been very significant. As
per NABARD’s report on status of
microfinance (2008-09), about 86
million poor households are covered
under the SHG-Bank Linkage
programme with over 6.1 million
saving-linked SHGs and 4.2 million
credit-linked SHGs as on March 31,
2009.
The initial phase of SHG movement
saw concentration of SHGs in the
southern parts of the country, but
now the SHGs have spread more to
the eastern and north-eastern
regions where the extent of financial
exclusion is greater. The government of India has also
been using the SHGs for subsidy linked credit schemes for
the poor. NABARD offers grant assistance to NGOs that
promote SHGs and link them to banks.
Mandated priority sector lending
Priority sectors broadly include agriculture and allied
activities, micro and small enterprises, education, housing
and micro-credit. All domestic commercial banks are
required to allocate 40 percent of their lending to the
priority sectors. For foreign banks, the requirement is 32
percent and export credit is also included in their case.
Credit extended by banks to SHGs, MFIs, NBFCs for on-
lending to priority sector and to regional rural banks for
agriculture and allied activities have been included in the
definition of priority sector. Investments made by banks in
securitised assets, representing loans to various categories
of priority sector which are originated by banks and
financial institutions, are also included in priority sector. A
bank can also purchase priority sector lending from another
bank through participatory notes. Any shortfall in priority
sector lending is required to be deposited in special funds
maintained by NABARD or Small Industries Development
Bank of India (SIDBI) or National Housing Bank (NHB),
which are used for funding rural
infrastructure/micro-
enterprises/housing sectors. As on
March 31, 2009, the coverage under
priority sector was to the tune of 51
million loan accounts.
It could be argued that mandated
credit distorts allocative efficiency of
the banking system, but I would like
to emphasise that no subvention is
involved as interest rates are
deregulated and all the usual
prudential norms for income
recognition, asset classification and
provisioning, as also standard risk
weights are applicable, which ensures
that such loans do not add undue
risk to the bank’s balance sheet.
Linking branch licensing
approvals to penetration in
under-banked areas
Banks in India are required to obtain
a licence from RBI for opening a
branch. This requirement has been
used as a regulatory tool for
furthering financial inclusion.
Statutory approvals for branch
licences in more lucrative centres are linked to the number
of branches opened in under-banked districts and states, as
also other factors such as fulfilling priority sector
obligations, offering no-frills accounts and other
parameters to gauge achievements in financial inclusion and
in customer service.
Opening of no-frills accounts by banks
Taking the view that access to a bank account can be
considered a public good, in 2005 RBI directed all banks to
offer at all branches the facility of ‘no frills’ account to any
person desirous of opening such an account. These
The Indian Banker
18
I N S I G H T
THE PENETRATION
ACHIEVED THROUGH SHGS
HAS BEEN VERY
SIGNIFICANT. AS PER
NABARD’S REPORT ON
STATUS OF MICROFINANCE
(2008-09), ABOUT 86 MILLION
POOR HOUSEHOLDS ARE
COVERED UNDER THE SHG-
BANK LINKAGE PROGRAMME
WITH OVER 6.1 MILLION
SAVING-LINKED SHGS AND
4.2 MILLION CREDIT-LINKED
SHGS AS ON MARCH 31, 2009.

The Indian Banker
20 Vol V No. 7 - July 2010
a boost to financial inclusion while ensuring the integrity of
financial transactions.
Branchless banking
With 6,00,000 villages in the country, it is impossible to
provide access to a bank account for every household
through branch banking. At the same time, electronic
banking for such a populace where cash forms the
dominant payment mechanism, is unlikely to become a
reality for quite some time. Keeping
in view these ground realities, the
RBI issued the business
correspondent guidelines in 2006,
which paved the way for branchless
banking through agents. The
guidelines allowed, for the first time,
commercial banks to offer simple
savings loan and remittance products
through agents, who were allowed to
undertake banking transactions,
including ‘cash in cash out’
transactions at locations close to the
customer. Banks were advised as part
of risk management to adopt ICT
solutions including biometric
identification of the customer. The
agents are required to deposit bank’s
cash balances beyond certain limits
with the bank’s branches by end of
day or the next day. Initially, the
regulations restricted the entities that
could act as business correspondents
to ‘not for profit’ entities such as
NGOs/cooperatives/post offices etc.
This was because we were concerned
about the risk of reckless pushing of
products by agents whose sole
incentive was earning commission,
and we also felt that local community
based organisations and NGOs had
the trust and confidence of the local
population.
Over the last few years, the list of persons who can be
appointed as business correspondents has been relaxed to
include individuals such as retired government officials,
school teachers, defence personnel as also ‘for profit’ local
‘mom and pop’ shops, petrol pumps/public call offices
operators etc that usually deal in cash in the villages.
Another regulatory requirement was that the business
correspondents appointed for direct contact with the
customers should be within 30 km from a designated base
branch of the bank to ensure proper oversight of such
agents and minimise agency risk. The distance criteria can
accounts have nil or low minimum balances and charges,
and have limited facilities. Since 2005, over 39 million no-
frills accounts have been opened. However, there are
certain barriers that inhibit the active operation of such
accounts like the time and cost involved in reaching the
nearest branch where the accounts have been opened.
Hence, we have allowed branchless banking to ensure that
these accounts are more accessible to their holders.
KYC regulations for small value clients and
transactions
One significant area, where we
found that regulation could be a
challenge in achieving greater
financial inclusion is in regard to
Know Your Customer (KYC)
norms. In a country where most of
the low income and poor people do
not have any document of identity
or proof of address it is very
difficult to have KYC norms that
insist on such documents. At the
same time, to ensure integrity of
financial transactions, it is necessary
that each customer is properly
identified before accounts are
opened. In rural areas, this is
addressed by asking for
identification by local officials and
requiring a photograph of the
account holder. In big towns and
cities where there are a large number
of migrants who do not have any
documents, fulfilling KYC norms
and opening a bank account
continue to be a challenge. As a
proportional regulatory dispensation
having regard to the degree of risk,
RBI has simpler KYC norms for
small value accounts where the
balances in the account and the
annual credits are below respective
specified prudent limits.
The Unique Identification Authority of India (UIDAI) will
be issuing a Unique Identification Number (UID) with
biometric recognition to every resident of the country. It is
expected that by latter part of this year, the UIDAI will
begin issuing UIDs and roll out 600 million UIDs in a
phased manner by 2014. UID enrolment would be done
with the help of state government machinery and other
registrars. Using UID for fulfilling KYC for small value
accounts will facilitate financial inclusion. In a country with
deep penetration of mobile phones, this is expected to give
IN A COUNTRY WHERE MOST
OF THE LOW INCOME AND
POOR PEOPLE DO NOT HAVE
ANY DOCUMENT OF
IDENTITY OR PROOF OF
ADDRESS IT IS VERY
DIFFICULT TO HAVE KYC
NORMS THAT INSIST ON SUCH
DOCUMENTS. AT THE SAME
TIME, TO ENSURE INTEGRITY
OF FINANCIAL
TRANSACTIONS, IT IS
NECESSARY THAT EACH
CUSTOMER IS PROPERLY
IDENTIFIED BEFORE
ACCOUNTS ARE OPENED.
I N S I G H T

I N S I G H T
be increased in consultation with the district consultative
committee, a forum for bankers and government officials
that meets each quarter. Initially there was a restriction on
the bank in recovering any charge from the customer for
such doorstep service as it was expected that the savings in
cost of setting up a branch would be sufficient incentive.
Subsequently, following a comprehensive review of the
business correspondent guidelines, we have relaxed this
condition and banks are now allowed to recover reasonable
charges from the customer for providing the service.
Approach towards non-banking entities involved
in financial inclusion
Non-banking entities can be either
non-banking non-financial entities or
non-banking financial entities. In
case of non-banking financial
entities, we have had to deal with
two issues. The first is the question
of allowing non-deposit taking
financial companies registered with
the RBI, especially microfinance
companies, to provide savings
facilities and deposit products for
their clients. The argument put forth
is that these entities are innovative
and nimble footed and have shown
their ability to provide loan products
to the poor.
Considering the difficulties in
ensuring effective supervision of
large number of small deposit-taking
entities and the constraints in
extending deposit insurance to such
entities, the regulatory approach in
India has been to restrict deposit-
taking activity to banks while
promoting the branchless banking
model for areas not served by bank branches. Hence fresh
approvals to NBFCs for accepting deposits are not
considered, while capital, liquidity and leverage
requirements have been tightened for those already
permitted to do so.
The second issue is that of allowing NBFCs especially
microfinance companies to act as business correspondents
of banks for branchless banking. The argument put
forward is that this would enable their clients to access
insured deposits, national payments system and remittance
services. There have also been demands that large ‘for
profit’ companies having a wide network of outlets
especially in rural areas could be allowed to act as business
correspondents of banks as there could be significant
synergies if such networks are leveraged upon. This issue is
currently under examination and in doing so the possible
risks such as conflicts of interest, co-mingling of funds,
misrepresentation and other agency related risks would
need to be weighed against possible safeguards for
consumer protection.
Non-banking non-financial entities have emerged as active
players in financial inclusion in that they have helped banks
in offering customised payments and remittance services to
their customers based on innovative ICT solutions. Any
role enhancement of non-banks to become principals in
provision of financial services implies that these non-
banking entities would have to be brought under financial
regulation and this could inhibit their
other activities. Combining financial
and non-financial business is also
something the regulator may not be
comfortable with as there could be
conflicts of interest. Our concerns
have also been on the access to and
the use of float funds by such non-
banking entities in the process of
providing such payments services.
Many jurisdictions have dealt with
this issue by asking the service
provider to maintain 100 percent
liquidity against float funds held by
them and restricting the value of
transactions. Whether the escrowed
funds/investments will be protected
in the event of bankruptcy of the
service provider depends on the legal
provisions and there could be risks in
such arrangements. In addition, there
has to be clear regulatory authority
over such companies. Hence, our
preference is to have a bank-led
system with non-banking players as
partners and service providers, so that regulatory resources
are focused on banks. Banks in turn take responsibility for
their partners and agents as part of their risk management
processes.
Subsequent to the notification of Payment and Settlement
Systems Act, 2007, the payment services have been opened
up for non-banking service providers also. The broad
regulatory approach of RBI towards non-banks has been to
permit these entities to provide payment services which are
fee-based without access to funds of the customers.
Keeping in view the penetration of mobile telephony in the
country, telecom operators have been permitted to enable
‘m-wallet’ facilities up to INR 5,000 in the interest of small
retail payments.
OUR PREFERENCE IS TO
HAVE A BANK-LED SYSTEM
WITH NON-BANKING
PLAYERS AS PARTNERS AND
SERVICE PROVIDERS, SO THAT
REGULATORY RESOURCES
ARE FOCUSED ON BANKS.
BANKS IN TURN TAKE
RESPONSIBILITY FOR THEIR
PARTNERS AND AGENTS AS
PART OF THEIR RISK
MANAGEMENT PROCESSES.

Ombudsman for the region and the major controlling
offices of banks attend such meetings and perhaps even
hold on-the-spot conciliation meetings for complaint
redressal. Ultimately, responsible borrowing facilitated by
financial literacy and responsible lending by financial
institutions are essential for consumer protection and
financial stability.
Summing up
Financial inclusion primarily represents access to a bank
account backed by deposit insurance, access to affordable
credit and the payments system. The Indian experience
demonstrates that financial inclusion can work within the
framework of mainstream banking within a sound
regulatory framework. Regulations have been used to
facilitate financial inclusion without subventions or
compromising on prudential and financial integrity norms.
Regulations have been proportional to the risks. Innovative
solutions like SHG-Bank Linkage, branchless banking have
been adopted after careful assessment of risks to the banks
as also to customers. The preference has been to restrict
deposit-taking to banks and NBFCs are encouraged to
focus on innovative approaches to lending under a lighter
regulatory framework, with additional regulations for
systemically important NBFC entities. Non-banking non-
financial players are encouraged to be partners and agents
of banks rather than principal providers of financial
services. Fair and transparent code of conduct enforced
through an effective grievance redressal system and
facilitated by financial literacy and education are the
cornerstones for ensuring consumer protection which is an
overarching objective of financial regulation in the context
of financial inclusion.
Consumer protection issues
Amongst the various objectives of regulation, consumer
protection should take priority in the context of financial
inclusion. In 2005, RBI took the initiative of setting up the
Banking Codes and Standards Board of India (BCSBI) in
order to ensure that comprehensive code of conduct for
fair treatment of customers was evolved and adhered to.
The BCSBI is registered as a separate society and functions
as an independent and autonomous body. The BCSBI has
evolved two voluntary codes - one which is a code of
commitment setting out minimum standards of banking
practices in dealing with individual customers. The other is
a code of commitment to micro and small enterprises.
Individual complaints about non-adherence to the code fall
within the jurisdiction of the Banking Ombudsman who
also investigate individual complaints of non-adherence to
the various RBI guidelines on customer service.
Other areas of consumer protection are related to excessive
interest rates and harsh recovery practices. In particular the
high rates of interest charged by non-banking microfinance
companies have attracted attention. Views have been
expressed that with the lending to MFIs included in the
priority sector, there should be a cap on the interest rates
charged to the ultimate borrower. Efforts at financial
inclusion can be sustained only if the delivery models are
viable and interest rate caps can be a deterrent. From a
regulatory perspective, we emphasise transparency, creating
better awareness, customer education and effective
grievance redressal systems.
Financial literacy has to be an integral part of financial
inclusion and consumer protection. In fact, it should
accompany and even precede the provision of financial
services. Several countries have a very clearly articulated
vision and programmes for financial literacy with initiative
from the central banks and regulators. We too have a
comprehensive financial literacy programme. At the
grassroots level, financial literacy and grievance redressal is
best delivered by arranging regular meetings of
communities with people’s representatives, local officials
and bankers, NGOs and other stakeholders. The Banking
The Indian Banker
22
I N S I G H T
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TIB (The Indian Banker): Do you agree that
‘information overload’ has become an issue which needs to
be addressed?
Parekh (Ashvin Parekh): ‘Information overload’ has
often been identified as the culprit, which takes away most
of the office time. The issue to be addressed is not so
much the incessant information bombardment, but the
necessity to determine the relevance of the information to
each person/organisation in a faster way. Each of the new
information might bring something of relevance to you. If
the information’s meaning was clearer, it would have been
easier to deal with incessant information bombardment.
Another issue that needs to be addressed is overshooting –
the movement in a given direction continues even when
need is satisfied.
TIB: What are the major causes of information overload?
Parekh: The major causes according to me are:
• Difficulty in finding the relevance of the information in
a faster way
• Contradictions and inaccuracies in available information
lead to overshooting
The Indian Banker
24 Vol V No. 7 - July 2010
• The ease of duplication of data
• The increase in the number of incoming channels –
email, phone, instant message – have caused the
incessant information flow and also lead to overshooting
• Increasing rate of new information production
TIB: What are the effects of information overload on
efficiency?
Parekh: As mentioned before, each of the new
information might be of relevance to you. Some could
provide you the breakthrough, while most would take away
your precious work time. If the relevance is not found
faster it will impact the efficiency negatively.
Also, the overshooting inertia would delay other tasks and
impact efficiency.
TIB: Is this overload a result of inappropriate, incomplete
and at times not-of-any-use information?
Parekh: Yes and also because of contradictory
information.
TIB: How does your bank (organisation) cope or deal with
information overload?
Parekh: We have created standard data
repositories/database across the organisation to manage
any overload issues.
TIB: What actions or steps do you consider necessary for
the Indian banking industry to undertake to avoid this
problem?
Parekh: The Indian banking industry after core banking
solution (CBS) implementation is now trying to swim
through data cleansing and mining activities. Hence we see
lot of clients implementing tools for data intelligence and
warehousing.
TIB: Despite the fact that there is information overload,
do you think there is certain element of information
illiteracy?
I N T E R V I E W
Information Overload
More Insights
We publish here the responses received from Ashvin Parekh, partner-national industry leader for global
financial services, Ernst & Young in an email interview with The Indian Banker. We could not incorporate
these responses in our cover story on the topic in June 2010 issue-Ed.

Parekh: Yes, to a certain extent because information does
not always reach the right person/decision maker at the
right time. Information illiteracy is the main reason why
information overload is so stressful and impacts the
efficiency.
TIB: Some people say that ‘We are drowning in
information but starved for knowledge’. Do you concur
with this statement? And how can this be remedied?
Parekh: Yes, because of the lack of information literacy
we are not able to handle information overload. The
uncontrolled, unorganised and contradictory information is
more harmful than useful. Distraction because of non-
relevant information takes the focus away from gaining
knowledge about relevant things. Information literacy is the
remedy for this.
TIB: Do you think that technological development and
deployment of technology in the Indian banking industry
have kept pace with information to effectively handle
information overload?
Parekh: No, the adoption of information literacy has been
lagging behind as compared to the adoption of new
technology in the Indian banking industry.
TIB: Do you think there is a need for a focused
information audit?
Parekh: Yes, focused information audit would result into
effective management of information and let information
achieve its true purpose of increasing productivity.
TIB: Does your bank (organisation) measure the ‘value of
information’ or assign an economic value to information. If
so, could you briefly explain the methodology followed for
such valuation?
Parekh: We measure knowledge sharing and hence
information contribution by each individual during the
performance development process every year.
I N T E R V I E W

customer or customer segments. The
entire process of determining product
attributes and mapping them to the
behavioural needs of a customer can
be called value building.
Thus, there exists a need to test for an
expected customer response rather
than simply designing a product offer
in the hope that someone would buy
it. This could improve efficiency and
provide rollout opportunities for
greater benefits within the bank. For
example, the rapid rollout demand for
banking products within the customer
base of current accounts and savings
accounts (CASA) or credit cards would
also require testing to understand the
value of both the bank and its
customer accurately. This article
intends to highlight the issue of
customer preferences in credit markets
and proposes to adopt a test based
approach to credit markets using
experimental design.
How does a bank go about testing its
products to understand customer
preferences? Traditional testing by
direct marketer has involved split
groups (solicitations) to compare
customers’ reaction to different offers.
For example, for one attribute of two
levels, say home loan fixed rate 12
percent versus fixed rate 14 percent,
we need two test groups when a base
group is given a 12 percent offer
versus the other a 14 percent offer to
conclusively say that 14 percent gives
how much lower value to customers as
compared to 12 percent. Thus, split
groups are simple to understand and
implement. There could be 3 split
groups where one group is offered
floating 8.25 percent, another 9.25
percent and the third one 10.25
percent. As the levels of an attribute
increase the bank needs a much larger
number of test groups to establish the
value preferences due to change in
rates. Banks have the flexibility to offer
their products through multiple
channels such as branch, web and
direct selling agents (DSAs) or direct
mail which are the customer touch-
points.
There exist few gaps in the existing
practice of understanding customer
preferences from the manner in which
these are used to derive customer
expectations. The banks’ market
testing involves randomly making
product offers to customers through a
branch or through the DSAs. The
bank has little control over what to
offer to which customer and so on.
Such testing methods could be
impractical and may not result in
robust value proposition for the bank.
The test and control method which is
the basis of banks’ market testing
today starts with a control cell for a
base offer and test cells for higher and
lower prices. To test five price points
and six promotions, one needs a
Introduction
Credit marketing has come a long way
in today’s economy of hard-hitting
competition and diminishing customer
loyalty. With the increasing level of
cut-throat competition, decreasing
customer loyalty and the increasing
commoditisation of banking products,
it has become essential for banks to
proactively understand the changing
customer preferences to build a value
proposition since banks are flexible
enough to align their products towards
the value needs of their customers.
This would need some effort from the
bank’s marketer in terms of
understanding the response behaviour
of their customers against the features
of a given product offer. A bank
typically offers a variety of products
and each of these individual products
can have multiple features. Such offers
could vary by maturity, interest rate or
other conditional rewards etc.
Behavioural psychologists explain that
human beings are highly influenced by
the external competitive offers which
are available in the market. Human
behaviour is to make rational
economic decisions based on how
much value is sought to be derived
from a bank’s product terms as
compared to the outside world.
Therefore the bank needs to
determine what to offer to its
Understanding the Changing
Customer Preferences
Experimental Models
Dr Dinabandhu Bag
The Indian Banker
26 Vol V No. 7 - July 2010
E X P E R T V I E W

applications to direct mail, Internet,
retail, and other market testing
programs. Factorial and fractional-
factorial designs are well-known and
have been widely used in behavioural
marketing experiments. Green, Krieger
and Wind (2001) describe a credit card
study that illustrates how fractional-
factorial designs may be used in
conjoint analysis.
Banks have access at relatively low cost
to experimental design techniques,
long applied in other fields such as
agriculture and biology. Experimental
design, which quantifies the effects of
independent stimuli on behavioural
responses, can help marketing
executives analyse how the various
components of a marketing campaign
influence consumer behaviour.
Therefore, such approach is much
more precise and cost effective than
traditional market testing. The science
of experimental design lets people
project the impact of many stimuli by
testing just a few of them. By selecting
a subset of combinations of variables
that represent the complexity of all the
original variables, marketers can model
hundreds or even thousands of stimuli
accurately and efficiently. It may be
mentioned here that data mining
methods are also used in banks to
identify target populations or sub-
populations, which are most suited for
a given product offer.
However, there exists a difference in
the purpose for which both data
mining and experimental design is
used. The difference in data mining
and experimental design is that data
mining is a post facto analysis whereas
experimental design is a priori control.
In other words, experimental design
reveals whether variables caused a
certain behaviour as opposed to simply
being correlated with the behaviour.
Therefore, it is a true cause and effect
analysis instead of a correlation
analysis. However, it is not to
undermine the investigative power of
data mining models for banks. We
describe two simple models to set the
testing of a home loan offer and a
credit card offer for a Bank.
The model
We describe two processes of testing
for a typical home loan offer and a
credit card offer for a bank here.
Table 1 explains the offer types and
the value propositions that exist for a
bank. For simplicity let us consider a
control cell and 30 test cells. In credit
card marketing the possible
combinations of brands, co-brands,
annual prices and teaser rates,
marketing messages and mail messages
can quickly add up to hundreds of
possible bundles of attributes. Clearly
it will be impractical for a banker to
test all of them. Further there exist
important questions on how to read
(analyse) them since a combination of
attributes is tested simultaneously. Is it
the lower price that prompts the
higher response or is it the lower fees?
It would be difficult to analyse them
and deduce recommendations.
This problem has actually
compounded manifold recently. For a
product with ‘m’ attributes having ‘n’
levels each, we actually need more than
‘m x n’ test groups and also many
control groups to objectively establish
the incremental lifts in response rates
for each of those levels. This could
turn out to be a gigantic task for the
bank and there must exist a scientific
method to reduce the test size while
gaining the same amount of
information. As mentioned earlier, it is
impossible to test for all possible
incremental levels of the factors to be
able to understand the response
behaviour of consumers. Therefore,
we propose an objective method of
testing using an experimental design
approach.
Experimental design and
customer preferences
In the recent years marketing leaders
have begun to embrace advanced
techniques for real-world testing. The
financial industry—including
insurance, investment, credit card, and
banking firms—was among the first to
use experimental design techniques for
marketing testing. Although factorial,
fractional factorial, and related
methods of experimental design have
been widely applied to manufacturing
problems, there have been few
Table 1: Response against home loan offers across DSAs (2x2x2)
Source: Test data from DSAs on home loans (2009)
E X P E R T V I E W

estimation is given in Appendix at the
end of this article. The model
specification provides answers to the
preference of fixed rate and floating
rate and which one gives higher
incremental lift to the response rate
against home loans. It also provides
answers to questions such as,
1. What is the incremental lift for a
100 basis points drop in fixed rate?
2. What is the incremental lift for a
100 basis points drop in floating
rate?
3. What is the incremental lift for a 50
basis points drop in processing
fees?
The results of the analysis are
provided in the latter part of the
article.
Let us consider another example of a
credit card offer for a leading Indian
bank. The base of credit card
customers is considered a good
channel to acquire customers and
manage them during their lifecycle
through a variety of product offers as
the credit card customers mature to
become home loan, auto loan, CASA,
investment and wealth management
products, etc.
For simplicity let us consider a
3-way 2-level design such as 2x2x2
such as:
• Purchase interest rate with 2 levels
(2.5 percent, 3.0 percent)
• Late fees/renewal fees with 2 levels
(INR 300, INR 600)
3-way 2-level design such as 2x2x2
such as:
• Floating interest rate with 2 levels
(8.25 percent and 9.25 percent)
• Fixed interest rate with 2 levels (12
percent and 14 percent)
• Processing fees with 2 levels (0.5
percent and 1 percent)
The total number of DSAs from
where the bank has collected the
response information is 4. Thus, Table
1 provides a brief description of the
design to the bank’s marketer that
gives the opportunity to interpret the
customer’s changing preferences
towards home loan offers. Table 2
summarises the meaning of the factors
of the home loan. As shown in Table
1 there exist 8 combinations of the
offers and all of these are solicited to
the customers by 4 DSAs. The
acceptance column provides the
number of customers who have
accepted the solicitations.
A structure of both the above models
in equation form and also a detailed
explanation of the factors and their
use to explain response level in
Analysis of Variance (ANOVA)
Table 2: Summarising the explanation of 3 factors
Source: Handbook of Statistics (www.itl.nist.gov)
The Indian Banker
28 Vol V No. 7 - July 2010
Table 3: Response against credit card offers across DSAs (2x2x2)
Source: Test data on DSAs on credit cards on Indian banks (2009)
E X P E R T V I E W

It is obvious from the above that the
model specification intends to obtain
maximum information about the
sensitivities of the offer attributes
from minimum offer combinations.
We estimate these models using the
main effects alone, ignoring the
presence of any interactions for
simplification in understanding.
Model results
The results of fitting the ANOVA
models on the response level test data
for both the home loan and credit
cards are interesting to note. We
describe the results of the application
of our test data in Chart 1 and Chart 2
for the first model on home loan. The
first ANOVA model on home loan
offers’ response provides critical
insights into the value of home loan
products. It captures factors such as
fixed rate and floating rate as the most
significant attributes of the model. A
customer prefers floating rate over
fixed rate and also lower price points
over a higher price points. We also find
that processing fees is insignificant
here which could be because of a
sample issue. The results show an
incremental lift of 24 percent over a
200 basis point drop in the fixed rate.
Further, it shows a lift of 30 percent
over a 100 basis points drop in the
floating rate.
The next ANOVA model on the
response level against the attributes of
credit cards reveals significant
marketing insight. Both the APR and
late fees amount are significant as both
purchase APR and late fees jointly
determine the decision to accept a
credit card offer. A 50 basis point
increase in APR results in over 26
percent drop in the response rate and
similarly an INR 300 increase in late
fees results in 19 percent drop in
response rate. As mentioned earlier,
both the case studies depict stronger
value statements on the incremental
benefits in response rates by reading
only the data from 8 test cells, which
are very easy to collect and compile
for a bank.
These results are in line with
theoretical findings in consumer
finance and utility theory on the shape
of a consumer utility function. The
quantum of incremental lift for a given
100 basis points rise or fall in the price
point is important information to the
marketer. Therefore, these results have
significant implications in
understanding the preference of a
bank’s customers. This would mean
the bank has an opportunity to adjust
the design of its home loan offer to
raise the acceptance level of their
offers.
A financial analysis of the net income
impact due to unit drop in price points
is mandatory to take a final call, which
has not been discussed here on
account of data limitations. A lower
price point could hit the bottom-line
of the bank since the increase in
business income due to the increased
number of converted accounts say at a
rate (below 8.25 percent) of 7.25
percent would not justify the reduced
interest income. However there exists
a benefit of lowered net credit losses
at floating 7.25 percent versus floating
• Grace period days with 2 levels (48
days, 50 days)
The total number of DSAs from
where the bank has collected the
response information is 4. Table 3
provides a brief description of the
design and Table 4 summarises the
meaning of the factors of the credit
card. There exist 8 runs and the
customers are randomly offered all
combinations by the 4 DSAs. The
acceptance column provides the
number of customers who have
accepted the offer. Therefore, a simple
(2x2x2) design gives the unique benefit
of conducting an experiment to
understand the preference of
customers willing to buy the credit
cards. The specific questions which are
examined include:
1. What is the incremental lift of
purchase brought about by annual
percentage rate (APR) 2 percent
over 2.5 percent?
2. What is the incremental lift brought
about by INR 600 late fees over
INR 300?
3. What is the comparision between a
grace period of 48 days versus a
grace period of 50 days?
Table 4: Summarising the explanation of 3 factors in 2x2x2 design
Source: Handbook of Statistics (www.itl.nist.gov)
E X P E R T V I E W

could cause an interpolated lift of 12
percent in response rate and so on.
This means that the bank need not test
for a fixed rate home loan offer of 13
percent.
Similarly, a 50 basis point rise in
purchase APR causes a drop of 26
percent in response rate. This means a
100 basis points rise in purchase APR
could be extrapolated to drop to 52
percent in response rate and so on.
The bank obtains these insights
without necessarily testing for a 3.5
percent purchase APR offer. All of
these discussions point to the fact that
there exists an opportunity of cost
savings in the usage of an
experimental design approach for
understanding customer preferences.
Many a times bank’s marketing team
assumes that a particular product
attribute such as renewal fees or
processing fees is important for a
product. However, such analysis will
help the bank understand the fact that
the critical and important attributes are
pricing and late fees as compared to
others.
Conclusion
The article presented a simple and
easily implementable credit testing
strategy which could be used to
understand the changing customer
preferences of a bank. These results
can have critical business implications.
The bank finally has an objective and
informed decision-making process to
devising customer value proposition.
This study also provides significant
business insights to the bank. The
bank has the flexibility to compare the
8.25 percent (or higher). Such
customer behaviour is consistent with
the concave value properties of
customer behaviour, which are
understood otherwise.
In the second analysis, it is easier to
attract credit card customers at lower
APR say (purchase APR below 2
percent) at 1.75 percent. However,
similar to the above argument the
increased number of credit card
accounts may not set forth the
reduction in interest income even if it
is true that lower APR means lower
net credit losses. Therefore, these
conclusions are not easy to make and
these results need to be substantiated
with richer financials to be able to take
a comprehensive decision.
A critical discussion on these specific
findings on incremental lifts in
response rates against a product
attribute level change is necessary to
be able to obtain innovations in
product offers. Implementation of the
model could result in forecast
response rates which are critical to the
design of offers. For example, a 200
basis point drop in fixed rate results in
a lift of 24 percent over response rate.
This means a 100 basis point drop
The Indian Banker
30 Vol V No. 7 - July 2010
Chart 1: ANOVA Model for response rate on home loans
Chart 2: Effects plot for ANOVA model for Table 1
E X P E R T V I E W

Kuhfeld W F, Tobias R D, and Garratt M (1994);
‘Efficient Experimental Design with Marketing Research
Applications’; Journal of Marketing Research, 31(4),
545-557
Ledolter J and Swersey A J (2007); ‘Testing 1–2–3:
Experimental Design for Marketing and Service
Operations’; Stanford, Stanford University Press
Stone B and Jacobs R (2001); ‘Successful Direct
Marketing Methods’, New York, McGraw-Hill.
Appendix
The structural model is given as
follows:
Yijk = MODEL + ERROR (1)
Yijk = µ + α + β + γ +є (2)
Mean model components
µ the overall mean of the sample
response rate
Main effect model components
α The effect of being in level j of
Factor A (floating rate)
β The effect of being in level j of
Factor B (fixed rate)
γ The effect of being in level j of
Factor C (processing fees)
є Unexplained errors
and learn the implementation of such
tests over a period of time to conclude
on its impact.
References
Art Weinstein et al (1993); Handbook of Market
Segmentation; McGraw Hill
Bag Dinabandhu, Mohanty Asit (2009); ‘Retail Assets
Management in Indian Banking: Credit Marketing
Model Using Data Mining Approach’; XIMB,
Vilakhan No 2
Bella H Gordon, et al (2006); ‘Experimental Design on
the Front Lines of Marketing: Testing New Ideas to
Increase Direct Mail Sales’; International Journal of
Research in Marketing, Vol 23, No 3
Barclay W D (1969); ‘Factorial Design in a Pricing
Experiment’; Journal of Marketing Research, 6(4), 427
Brook Richard, Arnold Gregory (1985); ‘Applied
Regression Analysis & Regression Design’, Marcel
Dekker Inc
Berger P D, Maurer R E (2002); ‘Experimental Design
with Applications in Management, Engineering and the
Sciences’, Belmont, CA; Duxbury Press
Carmone F J, Green P E (1981); ‘Model
Misspecification in Multi Attribute Parameter
Estimation’; Journal of Marketing Research, 18(1), 87
Ennew Christine (1996): ‘Marketing of Financial
Services’, Butterworth Heinemann
Handbook of Statistics (2005); www.itl.nist.gov
expected customer preferences across
various product offers, which actually
leads to a value statement. The specific
findings of these experiments can lead
to immediate and substantial
improvements, increased response
rates, lower costs, and higher profits.
When the bank knows how customers
will respond to what it has to offer, it
can target marketing programmes
directly to their needs and boost the
bottom-line in the process. Therefore
experimental design can go a long way
in identifying, developing and
managing industry leading products
and propositions to enable banks to
further penetrate the consumer
markets.
With the advent of information
technology, test and learn framework
is easy to adopt and implement in a
bank. To a bank’s marketer, there
always exists very limited opportunity
to pick and choose across a variety of
offers while targeting. Thus the
method to test more offers around
competition and build efficient tools
to identify and match customer needs
better will be useful. All of this can
actually go a long way in building a
better product for the bank.
The experimental design is particularly
helpful in product markets where a
large number of customers face rapid
and constant change, such as retail
banking markets. Banks spend
enormous amount on attracting
customers and then converting them.
Getting it right the first time is
difficult and therefore experimentation
is critical. Thus, whether it is a test for
an absolute price or a test around the
lead offer is a question which is left to
the marketer.
There are a few gaps in this study. One
needs to encompass optimisation on
other decision parameters such as
market acceptance, etc. More than a
fractional factorial test design
implementation, the bank needs to test
About the Author
Dr Dinabandhu Bag is an associate professor at the School of
Business Management, the National Institute of Technology,
Rourkela, Orissa. He teaches finance and economics and
specialises in advanced financial modelling. Dr Bag has over 13
years of industry experience in the implementation of enterprise
analytic applications for banks and financial institutions.
He has worked with Oracle Financial Services Software Ltd,
Citibank NA, Genpact Ltd and the Reserve Bank of India, Mumbai. He has contributed
to several journals and presented at conferences. Dr Bag holds an MPhil in research in
economics from IGIDR, Mumbai and PhD in finance from the University of Mysore.
E X P E R T V I E W

The Indian Banker
32
A R T I C L E
Since the inception of the Reserve Bank of India (RBI) in
1935, central banking has been evolving in India. The
functions of the RBI have emerged out of a diversity of
roles entrusted to it and its key functions have evolved with
the changing socioeconomic and political conditions of the
country, a phenomenon similar to most of the central
banks. The changing contours of regulation and
supervision, financial markets, the monetary-fiscal interface
and dynamics of the balance sheet have reflected the
changing paradigm of economic and financial landscape in
the country. Further, in view of the recent unprecedented
happenings and volatilities in the global financial markets
and heightened threats to the financial stability, the critical
role and responsibilities of central banking have come to
the fore.
In the following paragraphs, an attempt has been made to
present a futuristic view about the likely shape as also the
issues and challenges for central banking in India. For the
purpose of clarity and easy understanding, these have been
grouped on functional lines.
Conduct of monetary policy
The biggest challenge in the emerging market economies in
terms of central banking functions is the tough task of
monetary management. The monetary policy function of
maintaining price stability in order to maintain the value of
the currency over a period has been a crucial task for the
central banks, as it touches the lives of the people. The
maintenance of internal value of currency is intricately
linked with the issues involved in managing its external
value. This is particularly challenging in emerging market
economies, as their central banks have to keep on grappling
with the inflow of foreign capital in excess of the
absorption capacity in the economy and the consequent
expansion of domestic liquidity, due to market
interventions, affecting internal valuation of the currency.
Over the years, there is an increasing realisation that stable
price levels are a prerequisite of growth and trade.
Accordingly, the maintenance of price stability through the
conduct of monetary policy has become the prime
objective of central banks. In countries like India, which
are supply constrained and monsoon dependent, while
inflation may not be under the direct control of the central
bank, they have the option of using market-based
instruments for the conduct of monetary policy.
Since the early 1990s, the objectives of monetary policy
have become increasingly focused and more precisely
defined, consistent with the central banks’ goals of price
and financial stability and moved from direct instruments
to the greater use of indirect instruments. In developing
economies, understanding and coordinating with the
priorities of the fiscal policy is also equally important for a
successful monetary management. Further, it is being
increasingly accepted that financial stability in long-term is
a much more important goal for the central banks than the
short-term exchange rate or inflation targeting. In future,
monetary policy functions in India are likely to be oriented
towards managing the trade-off between stability and
growth, while keeping an unwavering focus on attaining
financial stability.
Issue and management of currency
Issue and management of currency continue to be one of
the traditional functions of the RBI since its inception.
However, the challenges of managing currency have
increased over time. Given the expansion of the economy
and the growing needs for banknotes, the task of currency
management has become increasingly complex.
Distribution of fresh notes as well as withdrawal and
destruction of soiled notes constitute the core of the
Central Banking in
India
The Road Ahead
Dr Ashish Srivastava

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