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Central Bank and Monetary Authority

!eserve 'ank of India

Apex Banking Institutions

I1'I* 0A'A!18 /9I# 'A0: II'I ; 0ATIoreign 'anksroup 'anksubsidiary 6ompanies

'I ubsidiary

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Deelop!ent Banks

Industrial 1evelopment 'anks 3and 1evelopment'anks

All India tate 3eveltate 3evel 1evelopment

'anks

I>6I ? I6I6I@

>6s I16sB

2rimary 3and1evelopmentubsidiary 6ompanies 'anks

CHAPTER 2 GROWTH OF BANKING SECTOR

(DECADE WISE)

"re#$i%erali&ation' The growth of the 'anking ector in the pre liberali(ation period can be analy(ed asunder.

?Industrial >inance 6orporation of India@Industrial 6redit and Investment 6orporation of Indiatate >inancial 6orporationBtate Industrial 1evelopment 6orporation.

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1971-80:

This was the decade immediately following the 0ationali(ation of *? commercial banks.

Also the banking sector grew at the fastest pace in this decade.

() Assets'

The assets of the sector grew at 8*.@C D 6A!C. They increased from

!.C8.@8bn to !s.@C8.;;bn. This kind of growth was achieved due to massive

increase in the number of branches resulting in a spurt in deposit mobili(ation.

*) Deposits'

The deposits grew from !s.?.B+bn to !s.?;+.CBbn. at a 6A! 8*.** D. The

growth was higher in later part of the decade. This growth rate would have been

higher had the current accounts grown at a rate higher than *C D. This indicates

peopleEs preference for using bank as place to keep their savings. The bank was

not used as a place to keep money to be used for transaction motive. This is

further clarified by the poor ratio of average current deposits to total deposits at

8;.?@ D.

+) Adan,es'

The advances grew at *+.8 D 6A! from !s.?.C@bn to !s.8B8.Bbn. Also the

growth was higher in the later part of the decade. Thus the advances grew at a

pace slower than the deposits due to decreasing credit deposit ratio, which

reduced from B8.;F D in *+BF to *.++ D in *+CF.

-) Net .orth'

The 0et worth increased from !s.*.*bn to !s.@.;;bn at a 6A! of *.?C

D.

C6ompounded Annual rowth !ate.

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The 6apital of the banks remained flat throughout the decade growing at

just C.@? D and also the growth came in the later part of the decade. The

capital increased form !s.?BF.8mn to !s.*.FBbn.

=owever, the !eserves grew at a healthy pace of 8F D 6A! from

!s.+Fmn to !s.?.8Bbn. Thus the banks in this decade did not raise capital

and funded their growth from internal accruals. This resulted in a wide gap

between !eserves and 6apital indicating the banksE hunger for 6apital.

(/0(#/1'

() Assets'

The growth of the sector was significantly subdued since the last decade. The

assets grew at just *.;F D 6A! compared to 8*.@C D in the previous decade.

The total assets increased from !s.@C8.;;bn to !s.8;.+;bn.

*) Deposits'

1eposits increased from !s.?;+.Cbn to !s.*C8F.?bn at a 6A! of *@.8 D.

The current accounts remained the usual laggards in terms of growth growing at

just *8.B D 6A!. The term and saving deposits grew at a slightly faster pace

of *.*B D and *@.@ D 6A!.

+) Adan,es'

Advances grew at a 6A! of *.B+ D from !s.8B8.Bbn to !s.*8CB.C@bn. This

is due to the fact that the banks have stepped up their creditdeposit ratio from 8

D to BF.B? D. This indicates higher investment than saving in the economy.

-) Net .orth'

The 0et worth increased from !s.@.;;bn to !s.?B.*bn. Thus the net worth

grew at a whopping 8?.;; D 6A!.

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The capital hungry banks went on capital raising spree in the latter half of

the decade. Thus the capital grew at a 6A! of ;?.@; D. In absolute

terms, the capital soared from !s.*.Fbn at the beginning of the decade to

!s.8F.B;bn at the end of the decade.

The !eserves however grew at more or less constant pace of *+.+B D

6A! throughout the decade.

At the end of the decade the 6apital had kept pace with the !eserves and

the gap between them had significantly narrowed down.

"ost#$i%erali&ation' The growth of this sector after *++* can be represented as

under.

(//(#*111'

() Assets'

The rate of the sector further slowed down during this decade. The assets grew at

a 6A! of *@.8? D from !s.8;.+;bn to !s.***F;.Cbn. The growth rate

however, was greater in the later part of the decade indicating future prospects of

increase in growth.

*) Deposits'

The deposits grew from !s.*C8F.?Bbn to !s.+FF;.Fbn at a 6A! of *.+ D.

There was a spurt in the last ;? years of the decade indicating improving trend.

In this decade however, the savings accounts were the laggards in terms of growth

at *;.;? D 6A!. The term deposits grew at *C.;C D and current deposits grew

at *@.8; D. This reversal of trend in growth rates shows that the people are

increasingly using banks to deposit money to be used for transaction motive.

+) Adan,es'

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The advances increased from !s.*8CB.C@bn to !s.??;?.+bn at a 6A! of *8.?

D. The lower growth in advances is due to the decline in creditdeposit ratio from

BF.B? D in *++F to ?+.8 D. This shows there was a marked decline in

investment in this decade with savings e%ceeding investment.

-) Net .orth'

The 0et worth grew at a feverish pace of ;.F D 6A!, the highest in

last three decades. This was mainly because the !'I opened the 'anking

sector to 2rivate sector. As many as + 0ew 2rivate ector 'anks started

their operations in this period. They brought a lot of capital in the period

*++;+@. =owever in the later half of the decade, capital growth was

virtually nil.

The Reserves grew at !"#$ % CAGR &r'Rs"2"*+ Rs"$,"$*+" H'wever- .'+trar/ t'

Ca01ta the Reserves re.'r3e3 e4.e0t1'+agr'wth 1+ the ater ha& '& the 3e.a3e 35e t'10r'v1+g 0r'&1ts '& 0r1vate as we as 05*1.se.t'r *a+6s" H'wever the ga0 CHAPTER ,

7ERGERS AND AC8UISITIONS IN THE BANKINGSECTOR"

Mergers and A,2uisitions'

Throughout the world, banking industry has been transformed from a highly

protected and regulated to a competitive and deregulated one lobali(ation coupled with

technological development has shrinked the boundaries. >inancial services and products

are being provided to the customers across the length and breadth of the globe. 1ue to

this, domestic and foreign currency banking and nonbanking financial services are

getting closer. 6orrespondingly innovations and improvements are assuming greater

significance in institutional performance.

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;. /ffectively absorb the new technologies and the demand for sophisticated

products and services.

?. >und major development product in the realm of infrastructure,

telecommunication etc. which re$uire huge financial outlays.

@. treamline human resources, functions and skills in tune with the emerging

competitive environment.

Adantages o3 Merger 4 A,2uisition'

The overriding goal for merger or ac$uisition is the ma%imi(ation of the owners

wealth. pecific motives as discussed below should be pursued when they are believed to

be consistent with the motive of ownerEs wealth ma%imi(ation.

Reduction in Cost

'y proper utili(ation of resources and working at particular volume, cost

may be reduced.

Better Resource Utilization

#ergers H Ac$uisition help to achieve better productivity H profitability

by making best use of available material and human resources with both

the organi(ations.

Shrinking Profit Margin

!eduction in profit margin due to competition may be one of the reasons

to use merger and ac$uisition as an e%it route.

Diversification of Risk

preading of risk may also be a motive that may be achieved by activities

through merger and ac$uisition. Growth or Diversification

#erger or Ac$uisition can be used to fulfill the desired rapid growth in

si(e or market share or diversification in range of products and service.

Avoiding or Reducing Cometition

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6ompetition among the units providing same 2roduct)ervice in same area

of operation may be reduced through merger and ac$uisition.

!conom" of Scale

-hen larger volumes of operations are performed for a given level of

overhead of investment, average cost will be reduced. o by increasing the

volume of business, one can reduce cost.

Availing #a$ Concessions

7).B8 of Income Ta% Act *+* ta% benefits in the form of adjustment of

carry forward of loss and unabsorbed depreciation in the case of merger of

sick units with a healthy unit are available. o companies can go for

merger and ac$uisition for availing ta% benefits.

Disadantages o3 Merger 4 A,2uisition

A few disadvantages of merges and ac$uisition are also worth mentioning here

Monool"

The merger H ac$uisition may place the resultant firm in a monopolistic

position, which may dictate their prices and conditions in the market.

Reduction of StaffIn order to reduce costs strategies like, retrenchment of staff may be

adopted, which may create problems relating to unemployment etc.

Closure of %ffice&Branch

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#ergers and Ac$uisition may result in closure of few outlets which may

affect availability of services to the customers.

'ess Attention to Small Customers

#ergers and Ac$uisition may enlarge the si(e of organisation to such an

e%tent that it may concentrate its efforts towards big customers to gain

more business)profit this may reduce their attention towards small

customers.

T56 76ASONS B65IND T56 76C6NT T76ND O8 M67G67 IN BANKING S6CTO7

The $uestion on everybodys mind is

QG Are banks and bankers on the road to redundancyJ

AG Kes.

Today a customer can invest in mutual funds or bonds and obtain higher returns .

An Indian customer can open an account anywhere in the world.

o what is the need for numerous banksJ There certainly is a need for 9:uality treat!ent9)

This leads to;oining hands

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STANDA7D C5A7T676D BANK # AN= G7IND$A>S BANK

It had been a hectic year at 3ondonbased tandard 6hartered 'ank, going by its

ac$uisition spree across the Asia2acific region. At the helm of affairs, globally, was

!ana Talwar, group 6/

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CHAPTER 9 RECENT TRENDS

I) Uniersal Banking

7niversal banking refers to >inancial Institution offering all types of

financial services under one roof. Thus, for e%ample, besides borrowing

and lending for the long term, the 1evelopment >inancial Institutions will

be able to borrow)lend for the shortterm as well.

This fle%ibility brings about a sea change in the bottom line of theInstitution.

I!pa,t on 8DI'

Two key aspects of the business are affected. The institution can have

access to cheap retail deposits and the breadth of its advances increase to

include shortterm working capital loans to corporates. The Institution has

greater operational fle%ibility. Also they can now effectively compete with

the commercial banks.

Indian S,enario'

In India the five >1Is that are frontrunners in the race to

convert to 7niversal 'ank areG

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*. Industrial 6redit and Investment 6orporation of

India 4I6I6I5

8. Industrial 1evelopment 'ank of India 4I1'I5

;. /%port Import 'ank 4/9I# 'ank5

?. Industrial >inance 6orporation of India 4I>6I5

@. Industrial Investment 'ank of India 4II'I5

I6I6I is already a virtual bank with subsidiaries like I6I6I

'ank engaged in banking business. Thus with clearing of

legal hurdles it just has to work out the modalities to

formally call itself a universal bank.

imilarly other >1Is are charting out aggressive plans to

stay ahead in this race.

Also recently 'ank of 'aroda, a commercial bank has

indicated its intention to convert to a 7niversal 'ank.

II) 7BI Nor!s'

The norms stipulated by !'I treat >1Is at par with the e%isting commercial

banks. Thus all 7niversal banks have to maintain the 6!! and the 3!

re$uirement on the same lines as the commercial banks. Also they have to fulfill

the priority sector lending norms applicable to the commercial banks. These are

the major hurdles as perceived by the institutions, as it is very difficult to fulfill

such norms without hurting the bottomline

633e,t on the Banking Se,tor'

=owever, with large Term lenders converting into 6ommercial banks, the e%isting

players in the industry are likely to face stiff competition, lower bottom line

ultimately leading to a shakeout in the industry with only the operationally

efficient banks will stay into the business, irrespective to the si(e.

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III) Mergers 4 A,2uisition

The Indian 'anking ector is more overcrowded then ever. There are +

commercial banks reporting to the !'I. /ver since the !'I opened up the sector

to private players, there have been nine new entrants. All of them are growing at a

scorching pace and redefining the rules of the business. =owever they are

dwarfed by many large public and old private sector banks with a large network

of branches spread over a diverse geographical area. Thus they are unable to make

a significant dent in the market share of the old players. Also it is impossible to

e%ponentially increase the number of branches. The only route available for these

banks is to grow inorganically via the # H A route. =ence the new banks are

under a tremendous pressure to ac$uire older banks and thus increase their

business.

6urrently most of the institutionally promoted banks have already gobbled

smaller banks. I6I6I 'ank has ac$uired IT6 6lassic, Anagram >inance and 'ank

of #adura within a period of two years. =1>6 'ank has merged Times 'ank

with itself. 7TI bank had almost completed its merger with lobal Trust 'ank

before it ran into rough weather. Also 0ationalised 'anks like 'ank of 2unjab,

Oyasa 'ank are wooing I1'I 'ank for a merger. Among foreign banks, tandard

H 6hartered 'ank has ac$uired A0M rindlays 'ankEs Asian and #iddle /ast

operations

The above happenings clearly indicate that the # H A scenario in the Indian

banking sector is far from over. trong banks will continue to takeover weak and

inefficient banks to increase their si(e.

I?) Multiple Deliery Channels

Today the technology driven banks are finding various means to reduce

costs and reach out to as many customers as possible spread over a diverse

area. This has led to using multiple channels of delivery of their products.

() ATM @Auto!ati, Teller Ma,hine'

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An AT# is basically a machine that can deliver cash to the

customers on demand after authentication. =owever, nowadays we

have AT#s that are used to vend different >#6 products also.

An AT# does the basic function of a bankEs branch, i.e.,

delivering money on demand. =ence setting of newer branches is

not re$uired thereby significantly lowering infrastructure costs.

6ost reduction is however possible only when these machines are

used. In India, the average cash withdrawal per AT# per day has

fallen from *FF last year to BF this year. Though the number of

AT#s has increased since last year, it is not in sync with the

number of cards issued. Also, there are many dormant cardholders

who do not use the AT#s and prefer the teller counters. Inspite of

these odds, Indian banks are increasing the number of AT#s at a

feverish pace. These machines also hold the keys to future

operational efficiency.

*) Net Banking'

0et banking means carrying out banking transactions via the

Internet. Thus the need for a branch is completely eliminated by

technology. Also this helps in serving the customer better and

tailoring products better suited for the customer

A customer can view his account details, transaction history, order

drafts, electronically make payments, transfer funds, check his

account position and electronically communicate with the bank

through the Internet for which he may have wanted to visit the

bank branch.

0et banking helps a bank spread its reach to the entire world at a

fraction of the cost.

+) "hone Banking'

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This means carrying out of banking transaction through the

telephone. A customer can call up the banks helpline or phone

banking number to conduct transactions like transfer of funds,

making payments, checking of account balance, ordering che$ues,

etc,. This also eliminates the customer of the need to visit the

bankEs branch.

-) Mo%ile Banking'

'anks can now help a customer conduct certain

transactions through the #obile 2hone with the help of

technologies like -A2, #, etc,. This helps a bank to

combine the Internet and telephone and leverage it to cut

costs and at the same time provide its customer the

convenience.

Thus it can be seen that tech savvy banks are tapping all the

above alternative channels to cut costs improve customer

satisfaction.

?) ?7S @?oluntary 7etire!ent S,he!e'

O! or the Polden =andshakeE is picking up very fast in the recent times

due to the serious attention of the government towards overstaffing in the

banks, especially among the public sector banks. The government had also

cleared a uniform O! framework for the sector giving the banks a seven

months time frame to cut flab. The scheme was open till ;*stmarch, 8FF*.

Though many banks had announced different O! schemes it involved an

outflow of huge sums of money. This could have had an adverse impact

on the 6apital Ade$uacy !atio 46A!5. =ence the !'I allowed the banks

to write off the O! e%penses over a period of @ years.

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CHAPTER 9: 7ACRO;ECONO7IC

DE

3/01I0A6TIOITK

>A33 I06!! I0O/T#/0T

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Chapter I

Banking Deelop!ents and "erspe,ties

irst, the growing universalisation and internationalisation ofbanking operations, driven by a combination of factors, such as, thecontinuingderegulation, heightened competition and technological advancements, have altered theface of banks from one of mere intermediator to one of provider of $uick, efficient andconsumercentric services. In the process, the potential for risks has also increased.econdly, the widespread banking problems that have plagued large areas of the globehave raised a gamut of $uestions relating to the linkages between banking reforms andreforms of other segments of the financial sector, the e%tent of e%posures to sectors whichare characterised by asymmetric information problems, and the PcontagionE effect. It has,therefore, become necessary to promote robust financial practices and policies, especiallyin respect of banks, in order to sustain financial stability. This is all the more true indeveloping economies where assets of the banking system constitute a substantialproportion of financial sector assets. In this conte%t, a number of policy measures havebeen taken in recent years to improve the health and efficiency of Indian commercialbanks. This chapter provides an overall view of the policy initiatives undertaken since*+++8FFF, the financial performance of scheduled commercial banks during *+++8FFFand a perspective towards developing a more stable, efficient, resilient and vibrantbanking system.

Box I)0' Insuran,e and Banking Issues o3 Oerlap

Insurance may be defined as a Psocial device whereby a large group of individuals, through a system ofcontributions, may reduce or eliminate certain measurable risks of economic loss common to all membersof the groupE. Insurance involves the transfer ofotentiallosses to an insurance pool. The pool combinesall the potential losses and then transfers the cost of the redicted losses back to the e%posures. Thus,insurance involves the transfer of loss e%posures of several entities into a common pool, and theredistribution of the cost of actual losses among the members of the pool. The intermediary in the process,which collects premia 4payment for the purchase of insurance5 from individual entities with risk e%posuresand pays compensation to the ones that actually suffer the loss insured against, is the insurer. The insureris a risk taker who accepts the risks of others and earns a profit given by the difference between the totalpremium collected from the buyers of insurance and the total payment made on account of compensationfor losses.

-henever the contract period of an insurance contract covers a long time, as is the case with life insurance,premium payments have two components. The first is the payment for risk coverage and the second goestowards savings. The saving component of life insurance results in enhanced competition between theinsurer and other financial intermediaries like banks offering different savings instruments. It may be notedhere that the combination of risk coverage and savings is peculiar to life insurance, especially in developingcountries.

The progressive e%pansion of the insurance sector in India has certain implications for the banking

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industry. The overlaps between banking and insurance business implies that, on the one hand, the two canbe competitors and hence substitutes of each other, and on the other hand, they can complement each otheras well.

'anks are the chief purveyors of financial services to a very large number of individuals and smallborrowers. or instance, financial services companies offer a whole gamut of financialproducts that include banking services, motor insurance, home finance, life insurance and pensions.

#any /uropean markets have put bankassurance into practice. In >rance more than @F per cent of lifeinsurance is sold through banks. In the 7nited :ingdom a large number of banks deal with insurers asproviders of products. In the 7A, banks lease space to insurers and retail products of multiple insurers. InIndia too, banks have been offering personal accident and baggage insurance directly to their credit cardholders as value addition to their products.

In developed economies, the collaboration between banking and insurance is brought about by severalmeans. 'anks like the 1eutsche 'ank and the 6redit Agricole have entered the insurance market by startingtheir own insurance companies.

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The issue of regulatory overlap also comes to the fore when banks enter insurance business through settingup of joint venture companies. The guidelines, however, seek to eliminate any concern on this account.-hereas the holding of e$uity by a promoter bank in an insurance company or participation in any form inthe insurance business is subject to compliance with the overnment)I!1A regulations, the authority togrant casebycase permission to banks to enter insurance business is vested with the !eserve 'ank.

References6anals, ordi 4*++B5, PUniversal Banking) *nternational Comarisons and #heoretical PersectivesE,

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transferor5 to a special purpose vehicle 42O5 as the asset purchaser. The 2O may be a corporation, trustor other independent legal entity. The 2O issues securities to public or private investors in the capitalmarkets, which are backed 4i.e. secured5 by the cash payment streams generated by the assets securitisedand by the assets themselves. The net proceeds received from the issuance of the securities are used to paythe transferor for the assets ac$uired by the 2O.The principal advantage of securitisation is the separation of the transferorEs credit risk from that of the2O. 'y segregating its credit risk in securitisation, a transferor can access the capital market at a lowercost of financing because 4a5 significant differential e%ists between the stream of cash payments that can begenerated by the assets segregated and the cost of securitisation, and 4b5 the credit of securitisation is basedprimarily on the credit of the source of the cash payment streams generated by the assets segregated and oncredit enhancement, if any. In securitisation, investors focus mainly on the credit and li$uidity of the assetssecuritised and on the structure of the financing not on the transferorEs credit risk.

Assets that have been securitised in structured financings in the 7 include, among others, mortgages,automobiles, aircraft, e$uipment and municipal leases, credit card receivables, hospital, retail and tradereceivables, real estate, purchase contract for natural resource assets such as oil, gas and timber, student andhome e$uity loans.

The principal disadvantage of securitisation is its comple%ity. ecuritisation, typically being PtransactionspecificE, is more costly to structure and implement than other more traditional forms of secured financing.

Therefore, securitisation is an appropriate alternative to traditional secured financings only if thesecuritisation costs are lower than the cost of funds accessed in the public or private capital markets or ifother material benefits are realised from the securitisation deal.

#ost securitisation deals in India have been related to transport sector financing, while there have beensome towards housing receivables. In India, securitisation dates back to *++* when 6itibank securitisedauto loans and placed a paper with I6 #utual >und. ince then, a variety of deals have been undertaken.According to some estimates, ;@ per cent of all securitisation deals between *++8 and *++C were related tohire purchase receivables of trucks and the rest towards other auto) transport segment receivables. Theseapart, 'I 6aps structured an innovative deal in *++?+@, where a pool of future cash flows of high valuecustomers of !ajasthan tate Industrial and 1evelopment 6orporation was securitised. The recentsecuritisation deal of 3arsen and Toubro has opened a new vista for financing power projects. 0ational=ousing 'ank 40='5 has also been making efforts to structure the pilot issue of mortgage backedsecurities 4#'5 within the e%isting legal, fiscal and regulatory framework.

In

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