challenges before indian banking system
TRANSCRIPT
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
CHALLENGES BEFORE INDIAN BANKING SYSTEM
Summary:
A spell of severe credit crunch, salary cuts, rehiring and a lot of news on
loans going bad lead this paper to test the hypothesis that the IndianBanking Industry has been performing badly in contemporary times and
was adversely impacted due to the continuing Global Financial Crisis. he
methodology adapted to analyse the performance of all the !cheduled
Commercial Banks of the Indian Banking Industry was to study the trend of
the three most significant parameters"ratios applicable for Banking Industry.
Among the parameters of performance, the most significant ones comprise
#et #on $erforming Assets as a percentage of #et Advances, Capital
Ade%uacy &atio and &eturn on Assets. A single composite weightedaverage of all #ationali'ed banks, $rivate sector banks and Foreign banks
in India has been considered to
(iew the trend in the period )**+*- to )***/. he analysis shows that
the Indian Banking Industry is stable and still growing albeit at a slow pace.
he enhanced role of the banking sector in the Indian economy, the
increasing levels of deregulation along with the increasing levels of competition have facilitated globalisation of the India banking system and
placed numerous demands on banks. 0perating in this demanding
environment has e1posed banks to various challenges. he last decade
has witnessed ma2or changes in the financial sector new banks, new
financial institutions, new instruments, new windows, and new opportunities
and, along with all this, new challenges. 3hile deregulation has opened
up new vistas for banks to augment revenues, it has entailed greater
competition and conse%uently greater risks. 4emand for new products,particularly derivatives, has re%uired banks to diversify their product mi1
and also effect rapid changes in their processes and operations in order to
remain competitive in the globalised environment.
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
HISTORY:
he General Bank of India was set up in the year 5/-. #e1t came Bank of
6industan and Bengal Bank. he 7ast India Company established Bank of
Bengal 85/*9:, Bank of Bombay 85/;*: and Bank of <adras 85/;=: asindependent units and called it $residency Banks .
$6A!7 II > #ationali'ation of Imperial Bank of India with e1tensive
banking facilities on a large scale specially in rural and semiurban areas. It
formed !tate Bank of India to act as the principal agent of &BI and to
handle banking transactions of the ?nion and !tate Governments all over
the country. !even banks forming subsidiary of !tate Bank of India was
nationali'ed in 59-* on 59th @uly, 59-9, ma2or process of nationali'ation
was carried out. 5; ma2or commercial banks in the country wasnationali'ed .
$6A!7 III> his phase has introduced many more products and facilities
in the banking sector in its reforms measure. In 5995, under the
chairmanship of < #arasimhama, a committee was set up by his name
which worked for the liberali'ation of banking practices.
3ithout a sound and effective banking system in India it cannot have a
healthy economy. he banking system of India should not only be hasslefree but it should be able to meet new challenges posed by the technology
and any other e1ternal and internal factors.
For the past three decades Indias banking system has several outstanding
achievements to its credit. he most striking is its e1tensive reach. It is no
longer confined to only metropolitans or cosmopolitans in India. In fact,
Indian banking system has reached even to the remote corners of the
country. his is one of the main reasons of Indias growth process.
he governments regular policy for Indian bank since 59-9 has paid rich
divedend 3ith the nationali'ation of 5; ma2or private banks of India.
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
NEW PHASE OF INDIAN BANKING SYSTEM WITH THE ADENT OF
INDIAN FINANCIAL ! BANKING SECTOR REFORMS AFTER 1""1#
The Bank of Bengal which later became the State Bank of India
$haseI
the General Bank of India was set up in the year 5/-. #e1t came Bank of
6industan and Bengal Bank. he 7ast India Company established Bank of
Bengal 85/*9:, Bank of Bombay 85/;*: and Bank of <adras 85/;=: as
independent units and called it $residency Banks. hese three banks were
amalgamated in 59)* and Imperial Bank of India was established which
started as private shareholders banks, mostly 7uropeans shareholders
In 5/-+ Allahabad Bank was established and first time e1clusively by
Indians, $un2ab #ational Bank td. was set up in 5/9; with head%uarters at
ahore. Between 59*- and 595=, Bank of India, Central Bank of India,
Bank of Baroda, Canara Bank, Indian Bank, and Bank of <ysore were set
up. &eserve Bank of India came in 59=+.
4uring those days public has lesser confidence in the banks. As an
aftermath deposit mobili'ation was slow. Abreast of it the savings bank
facility provided by the $ostal department was comparatively safer.
<oreover, funds were largely given to traders.
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
P%a&e II
Government took ma2or steps in this Indian Banking !ector &eform after
independence. In 59++, it nationali'ed Imperial Bank of India with e1tensive
banking facilities on a large scale especially in rural and semiurban areas.
It formed !tate Bank of India to act as the principal agent of &BI and tohandle banking transactions of the ?nion and !tate Governments all over
the country.
!econd phase of nationali'ation Indian Banking !ector &eform was carried
out in 59/* with seven more banks. his step brought /*D of the banking
segment in India under Government ownership.
he following are the steps taken by the Government of India to &egulate
Banking Institutions in the Country>
59;9> 7nactment of Banking &egulation Act.
59++> #ationali'ation of !tate Bank of India.
59+9> #ationali'ation of !BI subsidiaries.
59-5> Insurance cover e1tended to deposits.
59-9> #ationali'ation of 5; ma2or banks.
595> Creation of credit guarantee corporation.
59+> Creation of regional rural banks.
59/*> #ationali'ation of seven banks with deposits over )** crore.
After the nationali'ation of banks, the branches of the public sector bank
India rose to appro1imately /**D in deposits and advances took a huge
2ump by 55,***D.
P%a&e 'III
his phase has introduced many more products and facilities in the banking
sector in its reforms measure. In 5995, under the chairmanship of <
#arasimham, a committee was set up by his name which worked for the
liberali'ation of banking practices.
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
INTROD)CTION:
THE MEANING OF BANK
From the Italian banca meaning bench, the table at which a dealer in
money worked. A bank is now a financial institution which offers savingsand che%ue accounts, makes loans and provides other financial services,
making profits mainly from the difference between interest paid on deposits
and charged for loans, plus fees for accepting bills and other services.
0ther relevant legislation includes the Banks 8!hareholdings: Act and the
&eserve Bank Act. he &eserve Bank Act gives the &eserve Bank of
Australia 8the central bank: a wide range of powers over the banking
sector.
E Bank is an institution which trades in money, an establishment for the
deposits, custody and issue of money, as also for making loans and
discounts and facilitating the transmission of remittances from one place to
another.
Sa*+,g& Ba,-> &unning account for saving with restriction in number of
withdrawal
Curre,. A//0u,.> &unning account without restriction on number of
withdrawals
Term De0&+.> 4eposit of an amount for a fi1ed period where interest is
paid monthly"uarterly.
Se/+a Term De0&+.> 4eposit of an amount for a fi1ed period where
interest is compounded 8Capitali'ed: and paid on maturity.
Re/urr+,g De0&+. > &egular 8<onthly: deposit of a fi1ed amount for a
fi1ed period
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
BANKING SYSTEM OF INDIA
<odern banking in India is said to be developed during the British era. In
the first half of the 59th century, the British 7ast India Company established
three banks H the Bank of Bengal in 5/*9, the Bank of Bombay in 5/;* andthe Bank of <adras in 5/;=. But in the course of time these three banks
were amalgamated to a new bank called Imperial Bank and later it was
taken over by the !tate Bank of India in 59++. Allahabad Bank was the first
fully Indian owned bank. he &eserve Bank of India was established in
59=+ followed by other banks like $un2ab #ational Bank, Bank of India,
Canara Bank and Indian Bank.
In 59-9, 5; ma2or banks were nationali'ed and in 59/*, - ma2or private
sector banks were taken over by the government. oday, commercialbanking system in India is divided into following categories.
Tye& 04 Ba,-&
Ce,.ra Ba,-
he &eserve Bank of India is the central Bank that is fully owned by the
Government. It is governed by a central board 8headed by a Governor:appointed by the Central Government. It issues guidelines for thefunctioning of all banks operating within the country.
Pu5+/ Se/.0r Ba,-& Among the $ublic !ector Banks in India, ?nited Bank of India is one of the
5; ma2or banks which were nationali'ed on @uly 59, 59-9. Its predecessor,
in the $ublic !ector Banks, the ?nited Bank of India td., was formed in
59+* with the amalgamation of four banks vi'. Comilla Banking Corporation
td. 8595;:, Bengal Central Bank td. 8595/:, Comilla ?nion Bank td.859)): and 6ooghly Bank td. 859=):.
!tate Bank of India and its associate banks called the !tate Bank Group )*
nationali'ed banks &egional rural banks mainly sponsored by public sector
banks
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
Pr+*a.e Se/.0r Ba,-&
$rivate banking in India was practiced since the beginning of banking
system in India. he first private bank in India to be set up in $rivate !ector
Banks in India was IndusInd Bank. It is one of the fastest growing Bank$rivate !ector Banks in India. I#G (ysya, yet another $rivate Bank of India
was incorporated in the year 59=*.
0ld generation private banks
#ew generation private banks
Foreign banks operating in India
!cheduled cooperative banks
#onscheduled banks
C0'0era.+*e Se/.0r
he cooperative sector is very much useful for rural people. he co
operative banking sector is divided into the following categories.
S.a.e /0'0era.+*e Ba,-&
Central cooperative banks
$rimary Agriculture Credit !ocieties
4evelopment Banks"Financial Institutions
IFCI #ABA&4
I4BI 71portImport Bank of India
ICICI #ational 6ousing Bank
IIBI !mall Industries 4evelopment Bank of India
I4BI!CICI #orth 7astern 4evelopment Finance Corporation
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
Figure 5> N0# 04 5a,-& +, ea/% /a.eg0ry 04 I,8+a, Ba,-+,g I,8u&.ry
LOCAL AREA BANKS
he ocal Area Bank !cheme was introduced in August 599- aimed atbridging the gaps in credit availability and enhancing the institutional credit
framework in the rural and semi urban areas and providing efficient and
competitive services. !ince then, five ABs have been established.
he review group, which was appointed by &BI in @uly )**) to study and
make recommendations on the ABs scheme, has in its report, drawn
attention to the structural infirmities in the concept of the ABs and
recommended that there, should be no licensing of new ABs. It has
pointed out several weaknesses in the concept of the ocal Area Bankmodel, particularly in regards to si'e, capital base and inherent inability to
absorb the losses in the course of business etc.Four AB! were functional
at endmarch )**+. hey were Coastal area bank ltd, (i2ayawada, Andhra
$radesh,Capital local area bank ltd,phagwara,#avsari,Gu2rat, rishna
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
bhima samrudhdhi local area bank limited , <ehboob #agar,!ubhadra local
area bank limited, olhapur.
CO' OPERATIE BANKS
he Cooperative banks have a history of almost 5** years. he Cooperative banks are an important constituent of the Indian Financial
!ystem, 2udging by the role assigned to them, the e1pectations they are
supposed to fulfill, their number, and the number of offices they operate.
he cooperative movement originated in the 3est, but the importance that
such banks have assumed in India is rarely paralleled anywhere else in the
world. heir role in rural financing continues to be important even today,
and their business in the urban areas also has increased phenomenally in
recent years mainly due to the sharp increase in the number of primary cooperative banks.
3hile the cooperative banks in rural areas mainly finance agricultural
based activities including farming, cattle, milk, hatchery, personal finance
etc. along with some small scale industries and selfemployment driven
activities, the cooperative banks in urban areas mainly finance various
categories of people for selfemployment, industries, small scale units,
home finance, consumer finance, personal finance, etc.!ome of the cooperative banks are %uite forward looking and have
developed sufficient core competencies to challenge state and private
sector banks.
hough registered under the Cooperative !ocieties Act of the &espective
!tates 8where formed originally: the banking related activities of the co
operative banks are also regulated by the &eserve Bank of India. hey are
governed by the Banking &egulations Act 59;9 and Banking aws 8Co
operative !ocieties: Act, 59-+.
REGIONAL R)RAL BANKS IN INDIA
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CHALLENGES BEFORE INDIAN BANKING SYSTEM
&ural banking in India started since the establishment of banking sector in
India. &ural Banks in those days mainly focused upon the agro sector.
&egional rural banks in India penetrated every corner of the country and
e1tended a helping hand in the growth process of the country.
!BI has =* &egional &ural Banks in India known as &&Bs. he rural banks
of !BI are spread in 5= states e1tending from ashmir to arnataka and
6imachal $radesh to #orth 7ast. he total number of !BIs &egional &ural
Banks in India branches is )=;9 85-D:. ill date in rural banking in India,
there are 5;,;+ rural banks in the country of which )5)- 895D: are
located in remote rural areas.
INDIAN BANKS OPERATIONS ABROAD
As on 0ctober )*,)**+,fourteen Indian banksnine from the public sector
and five from the private sector had operation overseas spread across ;)
countries with a network of 5*5 branches,- 2oint ventures,5 subsidiaries
and representative offices.
64FC Bank
ICICI Bank!BI Bank
AJI! Bank
Kes Bank
Indian 0verseas Bank
otak <ahindra Bank
$un2ab #ational Bank
Andhra BankCorporation Bank
Allahabad Bank
arur (ysya Bank
Canara Bank
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RESERE BANK OF INDIA
he &eserve Bank of India was established on April 5, 59=+ in accordance
with the provisions of the &eserve Bank 0f India Act, 59=;.he Central
0ffice of the &eserve Bank was initially established in Calcutta but waspermanently moved to <umbai in 59=. he Central 0ffice is where the
Governors its and where policies are formulated. hough originally privately
owned, since nationali'ation in 59;9, the &eserve Bank is fully owned by
government of India.
he $reamble of the &eserve Bank of India describes the basic functions of
the &eserve Bank as>
<###.0 regua.e .%e +&&ue 04 Ba,- N0.e& a,8 -ee+,g 04 re&er*e&
=+.% a *+e= .0 &e/ur+,g m0,e.ary &.a5++.y +, I,8+a a,8
ge,eray .0 0era.e .%e /urre,/y a,8 /re8+. &y&.em 04 .%e /0u,.ry .0
+.& a8*a,.age#
Orga,+&a.+0, ! Fu,/.+0,&
&eserve Bank of India 8&BI: is the Central Bank and all Banks in India are
re%uired to follow the guidelines issued by &BI.
Financial !upervision
he &eserve Bank of India performs this function under the guidance of the
Board
for Financial !upervision 8BF!:. he Board was constituted in #ovember 5
99; as a committee of the Central Board of 4irectors of the &eserve Bank
of India.
C0,&.+.u.+0,he Board is constituted by coopting four 4irectors from the
Central Board as membersfor a term of two years and is chaired bythe Governor. he 4eputy Governors of the&eserve Bank are e1officio
members. 0ne 4eputy Governor, usually, the 4eputy Governor in charge of
banking regulation and supervision, is nominated as the (iceChairman of
the Board.
Curre,. F0/u&
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• supervision of financial institutions
• consolidated accounting
•legal issues in bank frauds
• divergence in assessments of nonperforming assets and
• supervisory rating model for banks.
• <ain Functions<onetary Authority>
• Formulates, implements and monitors the monetary policy.
• O5>e/.+*e: maintaining price stability and ensuring ade%uate flow of credit toproductive sectors.
• &egulator and supervisor of the financial system>
• $rescribes broad parameters of banking operations withinwhich the countrys banking and financial system functions.
• maintain public confidence in the system, protect depositors
interest and provide costeffective banking services to the public.• <anager of Foreign 71change
• <anages the Foreign 71change <anagement Act, 5999.
• 0b2ective> to facilitate e1ternal trade and payment and promote orderly development and maintenance of foreign e1change market in India.
• Issuer of currency>
• Issues and e1changes or destroys currency and coins not fit for
circulation.• 0b2ective> to give the public ade%uate %uantity of supplies of currency
notes andcoins and in good %uality.• 4evelopmental role
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• $erforms a wide range of promotional functions to support nationalob2ectives.
• &elated Functions
•Banker to the Government> performs merchant bankingfunction for the centraland the state governmentsL also acts astheir banker..
.
Da.e: 5*"*")*55
Ca&% Re&er*e Ra.+0 a,8 I,.ere&. Ra.e&
8per cent per annum:
I.em?Wee- E,8e8
2;1; 2;11
Se#2(
Aug#1"
Aug#26
Se# 2 Se# " Se# 16 Se# 2$
1 2 $ ( 3 6 7
Cash&eserve&atio 8per cent:85:
-.** -.** -.** -.** -.** -.** -.**
Bank&ate
-.** -.** -.** -.** -.** -.** -.**
Base&ate
.+*"/.**
5*.**"5*.+
5*.**"5*.+
5*.**"5*.+
5*.**"5*.+
5*.**"5*.+
5*.**"5*.+
4eposit -.+" /.+*"9. /.+*"9. /.+*"9. /.+*"9. /.+*"9. /.+*"9.)
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&ate .+ +* +* +* )+ )+ +
Call<oney&ate83eighted
Average:8;:
-.5* .9/ .9- /.*5 .9= /.*= /.)+
85: Cash &eserve &atio relates to !cheduled Commercial Banks8e1cluding &egional &ural Banks:.8): Base &ate relates to five ma2or banks since @uly 5, )*5*. 7arlier
figures relate to Benchmark $rime ending &ate 8B$&:.8=: 4eposit &ate relates to ma2or banks for term deposits of morethan one year maturity.8;: 4ata cover 9*9+ per cent of total transactions reported byparticipants. Call <oney &ate 83eighted Average: isvolumeHweighted average of daily call money rates for the week8!aturday to Friday:.
PRE'GLOBALI@ED SCENARIO OF BANKING IN INDIA
BANKS SERICE C)LT)RE WAS ETREMELY DEMOTIATED> the
services offered by banks were not so good and it was demotivated
because there was no competition and no improvement in banking services
previous to globali'ation
DISINTERESTED EMPLOYER ! EMPLOYEE:. 4uring preglobali'ed
period the employee were totally disinterested they dont have any target to
achieve and there main motive is 2ust to earn livelihood for them no feeling
of competition was there and even there senior e1ecutive dont motivate
them to achieve some target.
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NON COMPETETIE ATTIT)DE.> preglobali'ation there were only
government banks who were ma2or players in the field of banking so there
is no way for competition so even staff attitude was completely non
competitive so no innovative service take place and even no innovation in
product line.
PROD)CT FOC)SED ! NOT C)STOMER SERICE FOC)SED: he
main focus of banks were selling of product not customers. like today bank
scenario customers are treated as lifeline of banking sector during pre
globali'ed time it was nothing so customers were given last priority.
CHALLENGES FACED BY BANK IN PRE'GLOBALI@ED SCENARIO
• 6A&4 0 &7AI# C?!0<7&>
• I##0(AI0# I# $&04?C I#7
• #73 7C6#00GI7!
• 47FF7&74 0KAK F&0< C?!0<7&!
• 7<7&GI#G 0F #73 BA#!
• $00& !I! 0F 7<$0K77!
• 6A&4 0 7!ABI!6I#G <A&7 F&I7#4K I<AG7
•
I#F&A!&?C?&7
THE PRESENT SCENARIO OF INDIAN BANKING SYSTEM
he current banking sector of India is Countrywide coverage even we can
found bank at small village level, district level and sate level also and
current Indian banking system involves arge number of players because
not only government banks take active participate in banking sector
whereas there are private banks also, his sector is going through ma2or
changes as a conse%uence of economic reforms. he changes affect the
ownership pattern of banks, availability of funds, the cost of funds as well
as opportunities to earn, range of services 8feebased and fundbased:,
and management of priority sector lending. As a conse%uence of
liberali'ation in interest rates, banks are operating on reduced spread.
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4evelopment financial institutions would have a lesser impact on the Indian
economy. Consumerism is here to stay..
SOME FOLLOWING FEAT)RES OF C)RRENT INDIAN BANKING
SYSTEM
• Increasing use of technology in operations
• $oised to e1pand and deepen technology usage
• 4iversification
• 7mergence of integrated players
• 4iversifying capital deployment
• everaging synergies
• &obust regulatory system aligned to international standards
• 7fficient monetary management he landscape of the bankingindustry underwent considerable changes during the last
decade. he industry witnessed>• 4eregulation of lending and deposit rates.
• 7ntry of new private sector banks.
• 71tensive use of technology for product innovation
• 7mergence of retail banking and new derivative products.
• !tricter provisioning and asset classification norms.
• &aising capital ade%uacy re%uirements.
• .he freedom from administered policies and government
regulation in matters of daytoday functioning has opened a
new era of selfgovernance and need for selfinitiative
C)RRENT CHALLENGES BEFORE INDIAN BANKING SYSTEM
G05a+&a.+0, a /%ae,ge a& =e a& a, 00r.u,+.y .
T%e0ry:
he enhanced role of the banking sector in the Indian economy, the
increasing levels of deregulation along with the increasing levels of
competition have facilitated globali'ation of the India banking system and
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placed numerous demands on banks. 0perating in this demanding
environment has e1posed banks to various challenges. he last decade
has witnessed ma2or changes in the financial sector new banks, new
financial institutions, new instruments, new windows, and new opportunities
and, along with all this, new challenges. 3hile deregulation has opened
up new vistas for banks to augment revenues, it has entailed greater
competition and conse%uently greater risks. 4emand for new products,
particularly derivatives, has re%uired banks to diversify their product mi1
and also effect rapid changes in their processes and operations in order to
remain competitive in the globalised environment.
G05a+a.+0, a /%ae,ge a& =e a& a, 00r.u,+.y he benefits of
globali'ation have been well documented and are being increasingly
recogni'ed. Globali'ation of domestic banks has also been facilitated by
tremendous advancement in information and communications technology.
Globali'ation has thrown up lot of opportunities but accompanied by
concomitant risks. here is a growing reali'ation that the ability of countriesto conduct business across national borders and the ability to cope with the
possible downside risks would depend, interalia, on the soundness of the
financial system and the strength of the individual participants
Ba&e ! Ca+.a A8eua/y:
Amidst globali'ation Banking !ystem in India has attained vital importance.
4ay by day there has been increasing banking comple1ities in bankingtransactions, capital re%uirements, li%uidity, credit and risks associated with
them.
he 3orld rade 0rganisation 830:, of which India is a member nation,
re%uires the countries like India to get their banking systems at par with the
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global standards in terms of financial health, safety and transparency, by
implementing the Basel II #orms by )**9.
BASEL COMMITTEE> he Basel Committee on Banking !upervision
provides a forum for regular cooperation on banking supervisory matters.Its ob2ective is to enhance understanding of key supervisory issues and
improve the %uality of banking supervision worldwide. It seeks to do so by
e1changing information on national supervisory issues, approaches and
techni%ues, with a view to promoting common understanding. he
Committees !ecretariat is located at the Bank for International !ettlements
8BI!: in Basel, !wit'erland.
NEED FOR S)CH NORMS:
he first accord by the name .Basel Accord I. was established in 59// and
was implemented by 599). It was the very first attempt to introduce the
concept of minimum standards of capital ade%uacy. hen the second
accord by the name Basel Accord II was established in 5999 with a final
directive in )**= for implementation by )**- as Basel II #orms. Basel II
#orms have been introduced to overcome the drawbacks of Basel I Accord.
For Indian Banks, its the need of the hour to buckleup and practice
banking business at par with global standards and make the banking
system in India more reliable, transparent and safe. hese #orms arenecessary since India is and will witness increased capital flows from
foreign countries and there is increasing crossborder economic M financial
transactions.
Ta5e 1:
Analysis of Capital Ade%uacy &atio for the period year )**- to */
S#N0# Ca.eg0ry 04 I,8+a, Ba,-&
N0 04 Ba,-& +, ;6;7;9
Ca+.a A8eua/y Ra.+0
As on <arch =5, In $er cent
2;;3';6 2;;6';7 2;;7';9
I #ationalised Banks 8)/,)/,)/: 5).) 5).) 5).*+
II $rivate !ector Banks 8),)+,)=: 55.5 5).9/ 5+.=
III Foreign Banks in India 8)9,)9,)/: ;5./; =9.)+ ;;.5
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We+g%.e8 A*erage 04 I II a,8 III 22#27 22#;$ 2(#$9
!ource> 4erived from data of Indian Bankers Association and &eserve
Bank of India
)> Ca/ua.e8 Tre,8 & A/.ua 04 Ca+.a A8eua/y Ra.+0 04 I,8+a,Ba,-&#
http>""en.wikipedia.org"wiki"CapitalNade%uacyNratio
Capital ade%uacy ratios 8OCA&O: are a measure of the amount of a
banks core capital e1pressed as a percentage of
its assets weightedcredit e1posures.
Capital ade%uacy ratio is defined as
I7& 5 CA$IA A: 7%uity Capital, B: 4isclosed &eservesI7& ) CA$IA A: ?ndisclosed &eserves, B: General oss reserves, C:
!ubordinate erm 4ebts
where &isk can either be weighted assets 8 : or the respective national
regulators minimum total capital re%uirement. If using risk weighted assets,
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P 5*D
he percent threshold varies from bank to bank 85*D in this case, a
common re%uirement for regulators conforming to the Basel Accords: is setby the national banking regulator of different countries.
wo types of capital are measured> tier one capital 8T 5 above:, which can
absorb losses without a bank being re%uired to cease trading, andtier two
capital 8T ) above:, which can absorb losses in the event of a windingup
and so provides a lesser degree of protection to depositors.
Capital ade%uacy ratio is the ratio which determines the banks capacity tomeet the time liabilities and other risks such as credit risk, operational risk,
etc. In the most simple formulation, a banks capital is the OcushionO for
potential losses, and protects the banks depositors and other
lenders. Banking regulators in most countries define and monitor CAR to
protect depositors, thereby maintaining confidence in the banking system.
CA& is similar to leverageL in the most basic formulation, it is comparable
to the inverse of debttoe%uity leverage formulations 8although CA& uses
e%uity over assets instead of debttoe%uityL since assets are by definition
e%ual to debt plus e%uity, a transformation is re%uired:. ?nlike
traditional leverage, however, CA& recogni'es that assets can have
different levels of risk.
!ince different types of assets have different risk profiles, CA& primarily
ad2usts for assets that are less risky by allowing banks to OdiscountO lower
risk assets. he specifics of CA& calculation vary from country to country,
but general approaches tend to be similar for countries that apply the Basel Accords. In the most basic application, government debt is allowed a *D
Orisk weightingO that is, they are subtracted from total assets for purposes
of calculating the CA&.
T+er 1 /a+.a is the core measure of a banks financial strength from
a regulator s point of view. It is composed of core capital, which consists
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primarily of common stock and disclosed reserves 8or retained
earnings: but may also include nonredeemable noncumulative preferred
stock. he Basel Committee also observed that banks have used
innovative instruments over the years to generate ier 5 capitalL these are
sub2ect to stringent conditions and are limited to a ma1imum of 5+D of totalier 5 capital.
Capital in this sense is related to, but different from, the accounting
concept of shareholders e%uity. Both ier 5 and ier ) capital were first
defined in the Basel I capital accord and remained substantially the same in
the replacement Basel II accord. ier ) capital represents Osupplementary
capitalO such as undisclosed reserves, revaluation reserves, general loan
loss reserves, hybrid 8debt"e%uity: capital instruments, and subordinated
debt.
7ach countrys banking regulator, however, has some discretion over how
differing financial instruments may count in a capital calculation. his is
appropriate, as the legal framework varies in different legal systems.
he theoretical reason for holding capital is that it should provide protection
against une1pected losses. #ote that this is not the same as e1pected
losses, which are covered by provisions, reserves and current year profits.
In Basel I agreement, ier 5 capital is a minimum of ;Downershipe%uity but investors generally re%uire a ratio of 5*D. ier 5 capital should
be greater than +*D of the minimum re%uirement.
1#2 OPERATIONAL RISK
An 0era.+0,a r+&- is, as the name suggests, a risk arising from e1ecution
of a companys business functions. It is a very broad concept which
focuses on the risks arising from the people, systems and processes
through which a company operates. It also includes other categories such
as fraud risks, legal risks, physical or environmental risks.
A widely used definition of 0era.+0,a r+&- is the one contained in
the Basel II regulations. his definition states that operational risk is the
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risk of loss resulting from inade%uate or failed internal processes, people
and systems, or from e1ternal events.
he approach to managing operational risk differs from that applied to other
types of risk, because it is not used to generate profit. In contrast, creditrisk is e1ploited by lending institutions to create profit, market risk is
e1ploited by traders and fund managers, and insurance risk is e1ploited by
insurers. hey all however manage operational risk to keep losses within
their risk appetite the amount of risk they are prepared to accept in pursuit
of their ob2ectives. 3hat this means in practical terms is that organisations
accept that their people, processes and systems are imperfect, and that
losses will arise from errors and ineffective operations. he si'e of the loss
they are prepared to accept, because the cost of correcting the errors or
improving the systems is disproportionate to the benefit they will receive,
determines their appetite for operational risk.
4etermining appetite for operational risk is a discipline which is still in its
infancy. !ome of the issues and considerations around this process are
outlined in this !ound $ractice paper published by the Institute for
0perational &isk in 4ecember )**9Q
Ba/-gr0u,8
!ince the mid599*s, the topics of market risk and credit risk have been the
sub2ect of much debate and research, with the result that financial
institutions have made significant progress in the identification,
measurement and management of both these forms of risk. 6owever, it is
worth mentioning that the near collapse of the ?.!. financial system in
!eptember )**/ is a clear indication that our ability to measure market and
credit risk is far from perfect.
Globali'ation and deregulation in financial markets, combined with
increased sophistication in financial technology, have introduced more
comple1ities into the activities of banks and therefore their risk profiles.
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hese reasons underscore banks and supervisors growing focus upon the
identification and measurement of operational risk.
7vents such as the !eptember 55 terrorist attacks, rogue trading losses
at !ociRtR GRnRrale, Barings, AIB and #ational Australia Bank serve tohighlight the fact that the scope of risk management e1tends beyond
merely market and credit risk.
he list of risks 8and, more importantly, the scale of these risks: faced by
banks today includes fraud, system failures, terrorism and employee
compensation claims. hese types of risk are generally classified under the
term operational risk.
De4+,+.+0,
he Basel Committee defines operational risk as>
Ohe risk of loss resulting from inade%uate or failed internal processes,
people and systems or from e1ternal events.O
6owever, the Basel Committee recogni'es that operational risk is a term
that has a variety of meanings and therefore, for internal purposes, banks
are permitted to adopt their own definitions of operational risk, provided that
the minimum elements in the Committees definition are included.
S/0e e/u&+0,&
he Basel II definition of operational risk e1cludes, for e1ample, strategic
risk the risk of a loss arising from a poor strategic business decision.
0ther risk terms are seen as potential conse%uences of operational risk
events. For e1ample, reputational risk 8damage to an organi'ation through
loss of its reputation or standing: can arise as a conse%uence 8or impact: of operational failures as well as from other events.
Ba&e II e*e,. .ye /a.eg0r+e&
he following lists the official Basel II defined event types with some
e1amples for each category>
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I,.er,a Frau8 misappropriation of assets, ta1 evasion, intentional
mismarking of positions, bribery
E.er,a Frau8 theft of information, hacking damage, thirdparty theft and
forgeryEm0yme,. Pra/.+/e& a,8 W0r-a/e Sa4e.y discrimination, workers
compensation, employee health and safety
C+e,.& Pr08u/.& ! Bu&+,e&& Pra/.+/e market manipulation, antitrust,
improper trade, product defects, fiduciary breaches, account churning
Damage .0 P%y&+/a A&&e.& natural disasters, terrorism, vandalism
Bu&+,e&& D+&ru.+0, ! Sy&.em& Fa+ure& utility disruptions, software
failures, hardware failures
Ee/u.+0, De+*ery ! Pr0/e&& Ma,ageme,. data entry errors,
accounting errors, failed mandatory reporting, negligent loss of client
assets
D+44+/u.+e&JIt is relatively straightforward for an organi'ation to set and
observe specific, measurable levels of market risk and credit risk because
models e1ist which attempt to predict the potential impact of market
movements, or changes in the cost of credit. It should be noted however
that these models are only as good as the underlying assumptions, and a
large part of the recent financial crisis arose because the valuations
generated by these models for particular types of investments were based
on incorrect assumptions.
By contrast it is relatively difficult to identify or assess levels of operational
risk and its many sources. 6istorically organi'ations have accepted
operational risk as an unavoidable cost of doing business. <any nowthough collect data on operational losses for e1ample through system
failure or fraud and are using this data to model operational risk and to
calculate a capital reserve against future operational losses. In addition to
the Basel II re%uirement for banks, this is now a re%uirement for 7uropean
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insurance firms who are in the process of implementing !olvency II ,the
e%uivalent of Basel II for the banking sector
Me.%08& 04 0era.+0,a r+&- ma,ageme,.
Basel II and various !upervisory bodies of the countries have prescribedvarious soundness standards for 0perational &isk <anagement for Banks
and similar Financial Institutions. o complement these standards, Basel II
has given guidance to = broad methods of Capital calculation for
0perational &isk
Basic Indicator Approach based on annual revenue of the Financial
Institution
!tandardi'ed Approach based on annual revenue of each of the broadbusiness lines of the Financial Institution
Advanced <easurement Approaches based on the internally developed
risk measurement framework of the bank adhering to the standards
prescribed 8methods include I<A, 4A, !cenariobased, !corecard etc.:
he 0perational &isk <anagement framework should include identification,
measurement, monitoring, reporting, control and mitigation frameworks for
0perational &isk.
1#$ Re/a+.a+&a.+0, 04 Pu5+/ Se/.0r Ba,-&
$ublic sector banks performance is important. $ublic banks still dominate
the banking systems serving the ma2ority of people in developing countries,
despite the rash of privati'ations of the last 5* years. In )**), public sector
banks represented -* percent or more of the banking systems assets in
Algeria, Bangladesh, China, 7gypt, 7thiopia, India, Iran, and (ietnam. InIndonesia, public banks, including those under control of the Indonesian
Bank &estructuring Agency, held over -* percent of the banking systems
assets, up from about ;+ percent before the 7ast Asian crisis. In Bra'il,
despite closure, conversion into agencies or privati'ation of most provincial
banks, including the massive !tate Bank of !ao $aulo in )**5, federal
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banks, including the federal development bank 8B#47!:, held about 5"= of
bank assets and dominate lending for agriculture, housing and longer term
pro2ects
5.;: Fre&% Ca+.a 40r Pr+*a.e Ba,-& he standardi'ed re%uirements in place for banks and other depository
institutions, which determines how much capital is re%uired to be held for a
certain level of assets through regulatory agencies such as the Bank for
International !ettlements,Federal 4eposit Insurance Corporation or Federal
&eserve Board. hese re%uirements are put into place to ensure that these
institutions are not participating or holding investments that increase the
risk of default and that they have enough capital to sustain operating losses
while still honoring withdrawals. Also known as Oregulatory capitalO.
he Basel Accords, published by the Basel Committee on Banking
!upervision housed at the Bank for International !ettlements, sets a
framework on how banks and depository institutions must calculate
their capital. In 59//, the Committee decided to introduce a capital
measurement system commonly referred to as Basel I. his framework has
been replaced by a significantly more comple1 capital ade%uacy framework
commonly known as Basel II. After )*5) it will be replaced by Basel
III Another term commonly used in the conte1t of the frameworksis E/0,0m+/ Ca+.a, which can be thought of as the capital level bank
shareholders would choose in absence of capital regulation. For a detailed
study on the differences between these two definitions of capital, refer to
he /a+.a ra.+0 is the percentage of a banks capital to its risk
weighted assets. 3eights are defined by risksensitivity ratios whose
calculation is dictated under the relevant Accord. Basel II re%uires that the
total capital ratio must be no lower than /D.
he + Cs of Credit Character, Cash Flow, Collateral, Conditions and
Capital have been replaced by one single criterion. 3hile the international
standards of bank capital were laid down in the 59// Basel I accord, Basel
II makes significant alterations to the interpretation, if not the calculation, of
the capital re%uirement.
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71amples of national regulators implementing Basel II include the F!A in
the ?, BaFin in Germany, 0!FI in Canada, Banca dItalia in Italy.
perceived credit risk associated with balance sheet assets, as well as
certain offbalance sheet e1posures such as unfunded loancommitments, letters of credit, andderivatives and foreign e1change
contracts. he riskbased capital guidelines are supplemented by
a leverage ratio re%uirement. o be ade%uately capitali'ed under federal
bank regulatory agency definitions, a bank holding company must have
a ier 5 capital ratio of at least ;D, a combined ier 5 and ier )
capital ratio of at least /D, and a leverage ratio of at least ;D, and not be
sub2ect to a directive, order, or written agreement to meet and maintain
specific capital levels. o be well-capitalized under federal bank regulatory
agency definitions, a bank holding company must have a ier 5 capital ratio
of at least -D, a combined ier 5 and ier ) capital ratio of at least 5*D,
and a leverage ratio of at least +D, and not be sub2ect to a directive, order,
or written agreement to meet and maintain specific capital levels.
T+er 1 /a+.a
ier 5 capital, the more important of the two, consists largely of
shareholders e%uity and disclosed reserves. his is the amount paid up to
originally purchase the stock 8or shares: of the Bank 8not the amount thoseshares are currently trading for on the stock e1change:, retained profits
subtracting accumulated losses, and other %ualifiable ier 5 capital
securities 8see below:. In simple terms, if the original stockholders
contributed S5** to buy their stock and the Bank has made S5* in retained
earnings each year since, paid out no dividends, had no other forms of
capital and made no losses, after 5* years the Banks tier one capital would
be S)**. !hareholders e%uity and retained earnings are now commonly
referred to as OCoreO ier 5 capital, whereas ier 5 is core ier 5 together with other %ualifying ier 5 capital securities.
T+er 2 &ueme,.ary /a+.a
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ier ) capital, or supplementary capital, comprises undisclosed reserves,
revaluation reserves, general provisions, hybrid instruments and
subordinated term debt.
?ndisclosed reserves are not common, but are accepted by someregulators where a Bank has made a profit but this has not appeared in
normal retained profits or in general reserves. <ost of the regulators do not
allow this type of reserve because it does not reflect a true and fair picture
of the results.
Re*aua.+0, re&er*e&
A revaluation reserve is a reserve created when a company has an asset
revalued and an increase in value is brought to account. A simple e1ample
may be where a bank owns the land and building of its head%uarters and
bought them for S5** a century ago. A current revaluation is very likely to
show a large increase in value. he increase would be added to a
revaluation reserve.
Ge,era r0*+&+0,&
A general provision is created when a company is aware that a loss may
have occurred but is not sure of the e1act nature of that loss. ?nder pre
IF&! accounting standards, general provisions were commonly created toprovide for losses that were e1pected in the future. As these did not
represent incurred losses, regulators tended to allow them to be counted as
capital.
Hy5r+8 8e5. /a+.a +,&.rume,.&
hey consist of instruments which combine certain characteristics of e%uity
as well as debt. hey can be included in supplementary capital if they are
able to support losses on an ongoing basis without triggering li%uidation.
Su50r8+,a.e8'.erm 8e5.
!ubordinated debt is classed as ower ier ) debt, usually has a maturity
of a minimum of 5* years and ranks senior to ier 5 debt, but subordinate
to senior debt. o ensure that the amount of capital outstanding doesnt fall
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sharply once a ower ier ) issue matures and, for e1ample, not be
replaced, the regulator demands that the amount that is %ualifiable as ier
) capital amortises 8i.e. reduces: on a straight line basis from maturity
minus + years 8e.g. a 5bn issue would only count as worth /**m in capital
;years before maturity:. he remainder %ualifies as senior issuance. For this reason many ower ier ) instruments were issued as 5*yr noncall +
year issues 8i.e. final maturity after 5*yrs but callable after +yrs:. If not
called, issue has a large step similar to ier 5 thereby making the call
more likely.
D+44ere,. I,.er,a.+0,a Imeme,.a.+0,&
&egulators in each country have some discretion on how they implement
capital re%uirements in their 2urisdiction.
For e1ample, it has been reportedQ-T that Australias Commonwealth Bank is
measured as having .-D ier 5 capital under the rules of the Australian
$rudential &egulation Authority, but this would be measured as 5*.5D if the
bank was under the 2urisdiction of the ?s Financial !ervices Authority.
his demonstrates that international differences in implementation of the
rule can vary considerably in their level of strictness.
1#3 CREDIT RISK
Cre8+. r+&- is an investors risk of loss arising from a borrower who does
not make payments as promised!uch an event is called a default. 0ther
terms for credit risk are default risk and counterparty risk.
Investor losses include lost principal and interest, decreased cash flow, andincreased collection costs, which arise in a number of circumstances
A consumer does not make a payment due on a mortgage loan, credit
card, line of credit, or other loan
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A business does not make a payment due on a mortgage, credit card, line
of credit, or other loan
A business or consumer does not pay a trade invoice when due
A business does not pay an employees earned wages when due
A business or government bond issuer does not make a payment on
a coupon or principal payment when due
Tye& 04 /re8+. r+&-
here are three primary types of credit risk4efault risk when the borrower
fails to make contractual payments
Credit spread risk risk due to volatility in the difference between interestrates on investments and the riskfree rate of return
Cre8+. a,ay&+& a,8 /0,&umer /re8+. r+&-
!ignificant resources and sophisticated programs are used to analy'e and
manage risk!ome companies run a credit risk department whose 2ob is to
assess the financial health of their customers, and e1tend credit 8or not:
accordingly. hey may use in house programs to advise on avoiding,
reducing and transferring risk. hey also use third party providedintelligence. Companies like !tandard M $oors, <oodys Analytics, Fitch
&atings, and 4un and Bradstreet provide such information for a fee.
<ost lenders employ their own models 8credit scorecards: to rank potential
and e1isting customers according to risk, and then apply appropriate
strategies. 3ith products such as unsecured personal loans or mortgages,
lenders charge a higher price for higher risk customers and vice versa.
3ith revolving products such as credit cards and overdrafts, risk is
controlled through the setting of credit limits. !ome products alsore%uire security, most commonly in the form of property.
Credit scoring models also form part of the framework used by banks or
lending institutions grant credit to clients. For corporate and commercial
borrowers, these models generally have %ualitative and %uantitative
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sections outlining various aspects of the risk including, but not limited to,
operating e1perience, management e1pertise, asset %uality, and leverage
and li%uidity ratios, respectively. 0nce this information has been fully
reviewed by credit officers and credit committees, the lender provides the
funds sub2ect to the terms and conditions presented within the contract 8asoutlined above:.
Credit risk has been shown to be particularly large and particularly
damaging for very large investment pro2ects, socalled megapro2ects. his
is because such pro2ects are especially prone to end up in what has been
called the Odebt trap,O i.e., a situation where H due to cost overruns,
schedule delays, etc. H the costs of servicing debt becomes larger than the
revenues available to pay interest on and bring down the debt.
S0*ere+g, r+&-
!overeign risk is the risk of a government becoming unwilling or unable to
meet its loan obligations, or reneging on loans it guarantees. Q9T he
e1istence of sovereign risk means that creditors should take a twostage
decision process when deciding to lend to a firm based in a foreign country.
Firstly one should consider the sovereign risk %uality of the country and
then consider the firms credit %uality.Q5*T
Five macroeconomic variables that affect the probability of sovereign
debt rescheduling are> De5. &er*+/e ra.+0
• Import ratio
• Investment ratio
• (ariance of e1port revenue
• 4omestic money supply growth
he probability of rescheduling is an increasing function of debt serviceratio, import ratio, variance of e1port revenue and domestic money supply
growth. Frenkel, arman and !choltens also argue that the likelihood of
rescheduling is a decreasing function of investment ratio due to future
economic productivity gains. !aunders argues that rescheduling can
become more likely if the investment ratio rises as the foreign country could
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become less dependent on its e1ternal creditors and so be less concerned
about receiving credit from these countries"investors.Q5)T
C0u,.erar.y r+&-
Counterparty risk, known as default risk, is the risk that an organi'ationdoes not pay out on a bond, credit derivative, credit insurance contract, or
other trade or transaction when it is supposed to. Q5=T 7ven organi'ations
who think that they have hedged their bets by buying credit insurance of
some sort still face the risk that the insurer will be unable to pay, either due
to temporary li%uidity issues or longer term systemic issues.Q5;T
arge insurers are counterparties to many transactions, and thus this is the
kind of risk that prompts financial regulators to act, e.g., the bailout of
insurer AIG.
0n the methodological side, counterparty risk can be affected by wrong
way risk, namely the risk that different risk factors be correlated in the most
harmful direction. Including correlation between the portfolio risk factors
and the counterparty default into the methodology is not trivial, see for
e1ample Brigo and $allavicini
M+.+ga.+,g /re8+. r+&-
enders mitigate credit risk using several methods>
R+&-'5a&e8 r+/+,g> enders generally charge a higher interest rate to
borrowers who are more likely to default, a practice called riskbasedpricing. enders consider factors relating to the loan such as loan
purpose, credit rating, and loantovalue ratio and estimates the effect on
yield 8credit spread:.
C0*e,a,.&> enders may write stipulations on the borrower,
called /0*e,a,.&, into loan agreements>
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$eriodically report its financial condition
&efrain from paying dividends, repurchasing shares, borrowing further, or
other specific, voluntary actions that negatively affect the companys
financial position&epay the loan in full, at the lenders re%uest, in certain events such as
changes in the borrowers debttoe%uity ratio or interest coverage ratio
.T+g%.e,+,g> enders can reduce credit risk by reducing the amount of
credit e1tended, either in total or to certain borrowers. For e1ample,
a distributor selling its products to a troubled retailer may attempt to lessen
credit risk by reducing payment terms from net 30 to net 1 .
D+*er&+4+/a.+0,> enders to a small number of borrowers 8or kinds of borrower: face a high degree of unsystematic credit risk, called
/0,/e,.ra.+0, r+&-. enders reduce this risk by diversifying the borrower
pool.
De0&+. +,&ura,/e> <any governments establish 8e0&+. +,&ura,/e to
guarantee bank deposits of insolvent banks. !uch protection discourages
consumers from withdrawing money when a bank is becoming insolvent, to
avoid a bank run, and encourages consumers to hold their savings in the
banking system instead of in cash.
Cre8+. r+&- rea.e8 a/r0,ym&
ACPM Active credit portfolio management
EAD 71posure at default
EL 71pected lossERM 7nterprise risk management
LGD oss given default
PD $robability of default
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INCREASING ROLE OF INS)RANCE COMPANIES
he Insurance sector in India governed by Insurance Act, 59=/, the ife
Insurance Corporation Act, 59+- and General Insurance Business
8#ationalisation: Act, 59), Insurance &egulatory and 4evelopment Authority 8I&4A: Act, 5999 and other related Acts. 3ith such a large
population and the untapped market area of this population Insurance
happens to be a very big opportunity in India. oday it stands as a business
growing at the rate of 5+)* per cent annually. ogether with banking
services, it adds about per cent to the countrys G4$ .In spite of all this
growth the statistics of the penetration of the insurance in the country is
very poor. #early /*D of Indian populations are without ife insurance
cover and the 6ealth insurance.
his is an indicator that growth potential for the insurance sector is
immense in India. It was due to this immense growth that the regulations
were introduced in the insurance sector and in continuation
EMa%0.ra C0mm+..ee was constituted by the government in 599= to
e1amine the various aspects of the industry. he key element of
the reform process was $articipation of overseas insurance companies with
)-D capital. !ince then the insurance industry has gone through many
sea changes .he competition IC started facing from these companieswere threatening to the e1istence of IC .since the liberali'ation of the
industry the insurance industry has never looked back and today stand as
the one of the most competitive and e1ploring industry in India.
$#1 RISE OF INS)RANCE SECTOR
he business of life insurance in India in its e1isting form started in India in
the year 5/5/ with the establishment of the 0riental ife Insurance
Company in Calcutta. !ome of the important milestones in the lifeinsurance business in India are given in the table
Ta5e 1: m+e&.0,e& +, .%e +4e +,&ura,/e 5u&+,e&& +, I,8+a
Year M+e&.0,e& +, .%e +4e +,&ura,/e 5u&+,e&& +, I,8+a
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595) he Indian ife Assurance Companies Act enacted as
the first statute to regulate the life insurance business
59)/ he Indian Insurance Companies Act enacted to enablethe government to collect statistical information about
both life and nonlife insurance businesses
59=/ 7arlier legislation consolidated and amended to by the
Insurance Act with the ob2ective of protecting the
interests of the insuring public.
59+- );+ Indian and foreign insurers and provident societies
taken over by the central government and nationalised.IC formed by an Act of $arliament, vi'. IC Act, 59+-,
with a capital contribution of &s. + crore from the
Government of India.
$#$ +,&ura,/e &e/.0r gr0=.
he General insurance business in India, on the other hand, can trace its
roots to the riton Insurance Company td., the first general insurance
company established in the year 5/+* in Calcutta by the British. !ome of
the important milestones in the general insurance business in India are
given in the table ).
Ta5e 2: m+e&.0,e& +, .%e ge,era +,&ura,/e 5u&+,e&& +, I,8+a
Year M+e&.0,e& +, .%e ge,era +,&ura,/e 5u&+,e&&
+, I,8+a
59* he Indian <ercantile Insurance td. set up, the first
company to transact all classes of general insurance
business
59+ General Insurance Council, a wing of the Insurance
Association of India, frames a code of conduct for
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ensuring fair conduct and sound business practices
59-/ he Insurance Act amended to regulate investments and
set minimum solvency margins and the ariff Advisory
Committee set up.59) he General Insurance Business 8#ationalisation: Act,
59) nationalised the general insurance business
in India with effect from 5st @anuary 59=.
5* insurers amalgamated and grouped into four
companies vi'. the #ational Insurance Company td.,
the #ew India Assurance Company td., the 0riental
Insurance Company td. and the ?nited India Insurance
Company td. GIC incorporated as a company.
(#Tra+,+,g .%e HR
6uman resource training and development 86& M4: in manufacturing
firms is a
critical aspect of the development of a knowledgeworkforce in <alaysia.
he ob2ective of this study is to e1amine challenges to the effective
management of 6& M4 activities in manufacturing firms in <alaysia. In
order to achieve this ob2ective, indepth interviews were conducted with +/
6& managers managing employees training and development, employing
a purposive or 2udgmental sampling techni%ue. he study revealed three
ma2or challenges to the effective management of 6& M4. hese include a
shortage of intellectual 6&4 professionals to manage 6& M4 ctivities,
coping with the demand for knowledge workers and fostering learning and
development in the workplace. It is hoped that the findings of this study will
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provide 6& professionals with a clear understanding and awareness of the
various challenges in managing effective 6& training and development.
6ence, relevant and appropriate policies and procedures can be developed
and implemented for an effective management of 6& M4.
(#1Te/%,00gy A+e, HR:
Ac%uiring the technical e1pertise should be the focus of future human
resource management given the changing paradigm of banking sector
regulations. For instance, the implementation of the new Capital Accord
8Basel II: whereby capital ade%uacy re%uirements have been made more
riskoriented by linking capital to operational risk and changing the risk
measurement approaches for credit and market risks. 6owever, its
implementation is not going to be an easy task especially in countries
8including $akistan: where risk management systems are at nascent stage.
his is because of one of the prere%uisite for Basel II implementation which
re%uires that the banking institutions should have a robust risk
management setup which is capable of effectively managing all ma2or risks
that an institution is e1posed to.
!imilarly, the banking institutions are also re%uired to carry out stress
testing, a techni%ue used around the globe by financial institutions toassess risk e1posures across the institution and to estimate the changes in
the value of the portfolio, if e1posed to various risk factors. Initially,
although, !B$ has advised banks to carry out the simple Usensitivity
analysis keeping in the view the varying levels of skill and available
resources among banksL however, going forward more sophisticated
techni%ues will be adopted. Certainly, this process would re%uire technical
e1pertise at least in three areas> identifying, analy'ing and proper recording
of the assumptions used for stress testingL ad2usting the situation or shocks
applied to the data and interpreting the resultsL and an effective
management information system that ensures flow of information to the
senior management to take proper measures to avoid certain e1treme
conditions. herefore, going forward, the focus of human resource
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management should be to ac%uire technical e1pertise if the institutions
intend to go along with the changing regulatory environment.
EMERGING CHALLENGES BEFORE INDIAN BANKING SYSTEM
CONS)MER>he biggest challenge for the Indian banking system today is
the Indian consumer. 4emographic shifts in terms of income levels and
cultural shifts in terms of lifestyle aspirations are changing the profile of the
Indian consumer
CHANGES IN BEHAIOR>In the post(&! scenario, banks have beenable to bring down their operating costs without upsetting their
business .6owever, the average age profile andt he skill sets of employees
continue to remain unfavourable to meet the challenges of change. he
ne1t five years would see the average profile of staff worsening particularly
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with banks going slow on fresh recruitment. <anpower planning would be a
ma2or challenge before banks
Targe. mar-e.e a/e> he challenge before the Indian retail banking
industry is twofold> focus and e1ecution. 7ach bank must sharply focus onits target marketplace and rapidly e1ecute its services
A+/a.+0, 04 a8*a,/e8 .e/%,00gy>echnology is a key driver in the
banking industry, which creates new business models and processes, and
also revolutionises distribution channels. Banks which have made
inade%uate investment in technology have conse%uently faced an erosion
of their market shares. he beneficiaries are those banks which have
invested in technology. Adoption of technology also enhances the %uality of
risk management systems in banks. A further challenge which banks facein this regard is to ensure that they derive ma1imum advantage from their
investments in technology and avoid wasteful e1penditure which might
arise on account of uncoordinated and piecemeal adoption of technologyL
adoption of inappropriate" inconsistent technology and adoption of obsolete
technology.
C)STOMER ORIENTED SERICES >In India, currently, there are two
types of customers one who is a multichannel user and the other who still
relies on a branch as the anchor channel. he primary challenge is to giveconsistent service to customers irrespective of the kind of channel they
choose to use. he channels broadly cover the primary channels of branch
8i.e., teller, platform, A<: phone banking, 8i.e., call centre, interactive voice
response unit:, and internet channel 8i.e., personal computer, browser,
wireless:. A retail customer selects a bank based on two criteria H
convenience and relationship and would continue with a bank if it provides
good service.
Regua.0ry a,8 Suer*+&0ry C%ae,ge& +, Ba,-+,g
As the financial landscape in the last few years has changed significantly,there has been rethinking on several aspects of regulatory and supervisorypractices" framework"structure among the regulators and supervisors allover the world. In some countries such as ?, supervision has been hived
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off from the central bank to avoid perceived conflict of interest withmonetary policy. In response to blurring of distinctions among providers of financial services and emergence of financial conglomerates, a singleregulator approach has been adopted in some countries. he fast evolvingfinancial sector and the ever e1panding rule books of the regulatory bodieshave made some countries such as ? to adopt principlesbasedsupervision.
he Indian banking sector is faced with multiple and concurrent challenges
such as increased competition, rising customer e1pectations, and
diminishing customer loyalty. he banking industry is also changing at a
phenomenal speed. 3hile at the one end, we have millions of savers and
investors who still do not use a bank, another segment continues to bank
with a physical branch and at the other end of the spectrum,
F)T)RE SCENARIO OF INDIAN BANKING SYSTEM
iberali'ation and deregulation process started in 59959) has made a
sea change in the banking system. From a totally regulated environment,
we have gradually moved into a market driven competitive system. 0ur
move towards global benchmarks has been, by and large, calibrated and
regulator driven. he pace of changes gained momentum in the last few
years. Globali'ation would gain greater speed in the coming years
particularly on account of e1pected opening up of financial services under
30. Four trends change the banking industry world over, vi'
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Consolidation of players through mergers and ac%uisitions, Globalisation
of operations, 4evelopment of new technology and ?niversalisation of
banking. 3ith technology acting as a catalyst, we e1pect to see great
changes in the banking scene in the coming years. he Committee has
attempted to visuali'e the financial world +5* years from now. he picture
that emerged is somewhat as discussed below. It entails emergence of
an integrated and diversified financial system. he move towards universal
banking has already begun. his will gather further momentum bringing
nonbanking financial institutions also, into an integrated financial system.
he competitive environment in the banking sector is likely to result in
individual players working out differentiated strategies based on their
strengths and market niches. For e1ample, some players might emerge as
specialists in mortgage products, credit cards etc. whereas some could
choose to concentrate on particular segments of business system, while
outsourcing all other functions. !ome other banks may concentrate on
!<7 segments or high net worth individuals by providing specially tailoredservices beyond traditional banking offerings to satisfy the needs of
customers they understand better than a more generalist competitor.
&etail lending will receive greater focus. Banks would compete with one
another to provide full range of financial services to this segment. Banks
would use multiple delivery channels to suit the re%uirements and tastes of
customers. 3hile some customers might value relationship banking
8conventional branch banking:, others might prefer convenience banking8ebanking:.
0ne of the concerns is %uality of bank lending. <ost significant challenge
before banks is the maintenance of rigorous credit standards, especially in
an environment of increased competition for new and e1isting clients.
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Eer+e,/e %a& &%0=, u& .%a. .%e =0r&. 0a,& are 04.e, ma8e +, .%e
5e&. 04 .+me&# Compensation through trading gains is not going to support
the banks forever. argescale efforts are needed to upgrade skills in credit
risk measuring, controlling and monitoring as also revamp operating
procedures. Credit evaluation may have to shift from cash flow based
analysis to Eborrower account behaviour, so that the state of readiness of
Indian banks for Basle II regime improves.
F)T)RE CHALLENGES :
THE FOLLOWING ARE MAOR CHALLENGES THAT ARE LIKELY TOBE FACED BY INDIAN BANKING IND)STRY IN COMING FEW YEARS:'
Ma,ag+,g Re&0ur/e M05++a.+0, :
Gr0=.% 04 De0&+.& T+ ,0=: he deposit growth of !CBs in the post
nationali'ation period could be analysed broadly in four phases. In the first
phase 859-9/;: beginning immediately after nationali'ation of banks in@uly 59-9, deposit growth accelerated sharply as the rapid branch
e1pansion. enabled banks to tap savings from the rural areas. In the
second phase 859/+9+:, deposit growth decelerated as banks faced
increased competition from alternative savings instruments, especially
capital market instruments 8shares"debentures"units of mutual funds: and
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nonbanking financial companies. his was the phase of disintermediation
as savings instead of being deployed in bank deposits, were increasingly
deployed in alternative financial instruments. 4eposit growth decelerated
further during the third phase 8599+)**;: in the wake of competition from
post office deposits and other small saving instruments, which carriedsignificantly higher ta1ad2usted returns than bank deposits. efforts by
banks to meet the increased demand for credit. As a result, the share of
bank deposits in the financial savings of the household sector increased
sharply.
Fu.ure /%ae,ge& 40r re&0ur/e m05++a.+0, : Banks have a ma2or role
to play in meeting the resource re%uirements of Indias fast growing
economy. Although bank deposits have all along been the mainstay of thesaving process in the Indian economy and banks have played an
increasingly important role in stepping up the financial savings rate,
physical savings, nevertheless, have tended to grow in tandem with the
financial savings. A ma2or challenge, thus, is to convert unproductive
physical savings into financial savings. Also, in view of the shrinking share
of household sector deposits in total deposits, banks need to e1plore ways
of broadening the depositor base, especially in rural and semiurban areas
by offering customised products and features suitable to individual risk
return re%uirements.
T%u& =e /a, &um u &ay+,g .%a. 8espite India having a reasonably high
and growing savings rate, there is a need to increase financial savings.
Ehe substitution of unproductive physical savings in favour of financial
savings can generate large resources for investment. here is an
enormous untapped saving potential in rural and semiurban areas. For
this purpose banks are in a better position to develop innovative and cost
effective products due to their Eoutreach as also special features of deposits, vi', safety and li%uidity.
Ma,ag+,g Ca+.a a,8 R+&- ? Imeme,.a.+0, 04 Ba&e II ,0rm& >
W%y .%ere +& ,ee8 40r Ma,ag+,g Ca+.a a,8 R+&- > he importance of
maintaining bank capital in line with the risks involved in the banking
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business has assumed greater significance in view of the need for
maintaining the safety and soundness of the financial system. he Basel I
framework was adopted in over 5** countries. 6owever, over the years,
several deficiencies of Basel I surfaced partly due to its inherent features
and partly due to rapid financial innovations. he ma2or limitation of BaselIwas its onesi'efitsall approach. he inade%uacies of Basel I also
became evident following the recent financial turmoil as it failed to capture
offbalance sheet e1posures. he Basel II framework, finali'ed in @uly
)**-, attempts to align regulatory capital more closely with the inherent
risks in banking by using enhanced risk measurement techni%ues and a
more disciplined approach to risk management. In addition, Basel II has in
place a variety of safeguards, which also have the benefit of reinforcing
supervisors ob2ective of strengthening risk management and marketdiscipline.
C%ae,ge& +, Imeme,.a.+0, 04 Ba&e II ? Ma,ag+,g Ca+.a a,8 R+&- >
In keeping with the international best practices, India also decided to
implement Basel II. Foreign banks operating in India and Indian banks
having operational presence outside India have already adopted the
standardised approach 8!A: for credit risk and the basic indicator approach
8BIA: for operational risk for computing their capital re%uirements with effect
from <arch =5, )**/. All other commercial banks 8e1cluding local area
banks and regional rural banks: are e1pected to adopt Basel II not later
than <arch =5, )**9. he parallel runs for these banks are in progress. A
significant improvement in risk management practices, assetliability
management and corporate governance in Indian banks under regulatory
pressure to adopt Basel II framework has been observed.
.
3hile the Basel II framework, by making the capital re%uirements risk
sensitive, would enhance the stability of the financial system, its
implementation also raises several issues"challenges. India follows a three
track approach with commercial banks, cooperative banks and regional
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rural banks having been placed at different levels of capital ade%uacy
norms.
Le,8+,g a,8 I,*e&.me,. Oera.+0,& 04 Ba,-&
GROWTH OF CREDIT TILL NOW> Credit e1tended by scheduled
commercial banks from the early 599*s witnessed three distinct phases.
Bank credit growth was erratic in the first phase 8from 599*95 to 599+9-:.
In the second phase 8from 599-9 to )**5*):, credit growth decelerated
sharply and remained range bound due to the industrial slowdown, high
level of #$As and introduction of prudential norms, which made banks risk
averse. he third phase 8from )**)*= to )**-*: was generally markedby high credit growth attributable to several factors, including pickup in
economic growth, sharp improvement in asset %uality, moderation in
inflation and inflation e1pectations, decline in real interest rates, increase in
the income levels of households and increased competition with the entry
of new private sector banks.
Although the share of credit to industry in total bank credit declined in the
current decade, the credit intensity of industry increased sharply. A cross
country survey suggests that the reliance of industry on the banking sector
in India was far greater than that in many other countries. Credit growth to
the !<7 sector, which slowed down significantly between 599-9 and
)**=*;, picked up sharply from )**;*+. 6owever, the share of the !<7
sector in the total nonfood bank credit declined almost consistently from
5+.5 per cent in 599*95 to -.+ per cent in )**-*. his suggests that it is
the large corporates that have increased their dependence on the banking
sector. he share of retail credit comprising housing loans, credit to
individuals, credit cards receivables and lending for consumer durables, intotal bank credit increased sharply from -.; per cent in 599* to )+.; per
cent in )**.
CHALLENGES FOR INCREASING CREDIT> #otwithstanding some pick
up in credit growth to the agriculture and !<7 sectors in recent years,
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there is need for more concerted efforts to increase the flow of credit to
these sectors given their significance to the economy. Creating enabling
conditions, i!e!" providing irrigation facilities, rural roads and other
infrastructure in rural areas, is necessary to augment the credit absorptive
capacity. 4evising products to suit the specific needs of the farmers iscritical. here is also a need for comprehensive public policy on risk
management in agriculture. Computerisation of land records can go a long
way in smoothening the flow of credit to agriculture. !imilarly the credit
assessment capabilities of banks need improvement to ensure flow of
credit to !<7s. here is need to increase the use of cluster based lending
and credit scoring, which has proved %uite effective in many countries as
also in India. In view of the increased e1posure of banks to infrastructure
and retail credit segments, banks need to guard against e1posures toattendant risks. he corporate sector needs to gradually reduce its
dependence on the banking sector and move towards tapping the capital
market so as to enable the banking sector to meet the growing
re%uirements of agriculture, !<7s and other small and tiny enterprises,
which are unable to tap funds from other sources
CHALLENGES FOR FINANCIAL INCL)SION> 3hile there has been a
significant improvement in financial inclusion in recent years, moving ahead
several challenges remain to be addressed. A proper assessment of the
problem of financial e1clusion is necessary. here is, therefore, a need to
conduct specific survey for gathering information relating to financial
inclusion"e1clusion. here is need to reduce the transaction cost for which
technology can be very helpful. &&Bs and cooperative banks, are
e1pected to play a greater role in financial inclusion in future. here would
be need to design appropriate products tailor made to suit the re%uirements
of the people with low income supported by financial literacy and credit
counselling. here is also a need to improve the absorptive capacity of financial services by providing the basic infrastructure. Investment in
human development such as health, water sanitation, and education, in
particular, would be very helpful.
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C0me.+.+0, a,8 C0,&0+8a.+0, +, Re/e,. Year& : here has been a
significant increase in the number of bank amalgamations in India in the
postreform period. 3hile amalgamations of banks in the pre5999 period
were primarily triggered by the weak financials of the bank being merged,
in the post5999 period, mergers occurred between healthy banks, drivenby the business strategy and commercial considerations. !ignificantly,
despite increase in the number of bank mergers and ac%uisitions, the
Indian banking system has become less concentrated during the post
reform period. In fact, the degree of concentration in the Indian banking
system, based on the concentration ratio and 6irschman6erfindhal Inde1,
was one of the lowest among the select countries studied for the year
)**-. he level of competition declined somewhat in the initial years of
reforms, but improved significantly thereafter. Based on the empiricalevidence, the Indian banking industry could be characterised as a
monopolistic competitive structure, as is the case with most other advanced
countries and 7<7s
he empirical analysis also suggests that mergers andamalgamation had a
positive impact on efficiency both in terms of increase in return on assets
and reduction in cost, when the transferees were public sector banks
CHALLENGES OF COMPETITION AND CONSOLIDATION> heownership of public sector banks is not an issue from the efficiency
viewpoint as public sector banks in India now are as efficient as new
private and foreign banks, as revealed by the various measures.
6owever, the operating environment for banks has been changing rapidly
and banks in the changed operating environment need fle1ibility to respond
to the evolving situation. Another issue that needs to be considered is the
funding of capital re%uirements of public sector banks given the present
floor of minimum +5 per cent on Government e%uity in public sector banks.In the medium term, this can become an issue hampering the growth of
public sector banks if Government is not able to provide ade%uate capital
for their e1pansion.
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he roadmap of foreign banks is due for review in )**9. his would involve
several issues. he increased presence of foreign banks, by intensifying
competition, may accelerate the consolidation process that is underway.
6owever, at the same time, this may also raise the risk of concentration if
mergers"amalgamations involve large banks. he e1perience of some other countries also suggests that the emergence of large banks due to
consolidation has resulted in reduced lending to small enterprises
significantly. All these issues would need to be carefully weighed at the time
of review. he policy relating to ownership of banks by commercial interests
may have to take full account of international practices, given the issues
relating to potential conflict of interests, increased potential of contagion
effects and increased concentration.
EFFICIENCY PROD)CTIITY AND SO)NDNESS OF THE BANKINGSECTOR IN INDIA:9#1 PAST TRENDS : he efficiency and productivity of scheduled commercial banks 8!CBs: in India was analysed empirically,using both the accounting and economic measures.. he most significantimprovement has occurred in the performance of public sector banks andhas converged with those of the foreign banks and new private sector banks. Intermediation cost as also the net interest margin declined acrossthe bank groups. 4espite this, however, profitability of the banking sector improved. Business per employee and per branch also increased
significantly across the bank groups.
he improvement of various accounting measures, however, varied acrossthe bank groups. In terms of cost ratios 8operating cost to income: foreignbanks, and with regard to labour productivity, foreign and new privatebanks were ahead of their peer groups. In terms of net interest margins andintermediation cost, new private sector banks and public sector banks,respectively, were more efficient than the other bank groups. he cost of deposits of foreign banks was the lowest in the industry. 6owever, this was
not passed on to the borrowers, leading to higher net interest spread. heempirical e1ercise suggested that the operating cost was the main factor affecting the net interest margin. #oninterest income and the asset %ualitywere the other determinants of net interest margin.
CHALLENGES: . !imilarly, there is a need for increased absorption of
enhanced technological capability 8innovation: by several banks to further
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augment productivity of the banking sector through changes in processes
and improvement in human resource skills.
he recent events in global financial markets in the aftermath of ?!
subprime crisis have evoked rethinking on several regulatory andsupervisory aspects of the banking industry, #iz ., how to cope with li%uidity
stresses under unusual circumstancesL whether Uprocyclicality of capital
re%uirements is one of the factors with inherent tendency that escalate the
impact of booms and busts. &egulation of comple1 products and monitoring
of derivatives is becoming an important issue. Further, a %uestion has been
raised whether institutions should be allowed to become so big and so
comple1 that their problems can have systemwide repercussions.
OERALL ASSESSMENT :
he &eport has attempted an indepth analysis of various aspects of the
banking sector in India against the backdrop of the evolution of the Indian
banking sector beginning the 5/th century with a focus on the post
independence period. he analysis suggests that the Indian banking sector
has witnessed several structural changes from time to time. India now has
a welldeveloped banking infrastructure, conducive regulatory environment
and sound supervisory system. Banks have become efficient and soundand compare well with banks around the world. Banks in India have
benefitted from the robust growth in the last few years, which enabled them
to produce strong financial performance
An important lesson emerging from the recent financial market
developments is that the focus should not be on how the turmoil should be
managed, but on what policies could be put in place to strengthen the
financial system on a longerterm basis regardless of specific sources of
disturbances. hese issues point towards the challenges that lie ahead topreserve the safety and soundness of the financial
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CONCL)SION
A robust banking and financial sector is critical for facilitating higher
economic growth ainth 8)**/:. he analysis of the Indian Banking
Industry shows stability and growth.
he Government of India and the &BI have attempted to implement a
proactive and responsive monetary policy and fiscal policy with timely,
targeted, and temporary measures. 3hile the &BI has reversed its earlier
stance of a tight monetary policy, the government recently announced a
fiscal stimulus package to push overall economic activity. Indian Banks
have put in place a constellation of measures both on interest rates and
li%uidity to ward off the impending crisis.
As a result Indian Banks have been able to perform well globally. Certainaspects and learnings from the Indian Banking Industry can be adopted as
best practices by other financial crisis affected countries.
he global challenges which banks face are not confined only to the global
banks. hese aspects are also highly relevant for banks which are part of a
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globalised banking system. Further, overcoming these challenges by the
other banks is e1pected to not only stand them in good stead during difficult
times but also augurs well for the banking system to which they belong and
will also e%uip them to launch themselves.
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