Vivek College of CommerceCHAPTER :- 1INTRODUCTION UNIVERSAL BANKING1.1 INTRODUCTION In the early nineties the forces of globalization were unleashed on the hitherto protected Indian environment. The branch banking concept with which we were familiar and practiced since inception was basically on certain protected fundamentals. Theeconomytill theninetiesprovidedcomfort topublicsector banks in areas of liquidity management in an administered interest regime, direction of management was limited and the risk parameters in these spheres were hazy and not quantifiable.Globalization, liberalizationandderegulationoffinancial marketsinmany developed and developing countries have resulted in increased disintermediation and has made commercial banks vulnerable to interest rate risks. The position was further aggravated with the relaxation of exchange controls, adoption of uniform accounting practices, asset classification and provisioning norms and prescribing capital adequacy norms. The development of information technology and telecommunications are allowing international pooling of financial resources Universal Banking Page 1 Vivek College of Commercethereby spreading the risk across more than none market. As a result there is severe strain on interest spread and bottom line of banks. The banks in the developed countries started emphasizing on new sources for non-interest income to avert the pressure on their bottom line. The efforts of many foreignbankshaveyieldedgoodresults as their incomefromnon-fundbased business to total income has increased manifold. However, this process has led to the diversification in their existing activities. In many developed countries, besides traditional activities like accepting deposits and lending, the banks are undertaking the following activities :- Selling insurance products. Securitizing the debts. Holding equity of non-equity firms. Financing venture capital funds. Extending loans and advances on a longer term. Underwriting new debt and equity issues. Trading in financial instruments, foreign exchange and its derivatives. Providingcorporate advisory services including advice on mergers and acquisitions. Undertaking so many activities by commercial banks in various countries has changed the face of banking fromomni present banking to omni potent Universal Banking Page 2 Vivek College of Commercebanking having multifarious functions and selling/marketing their new products andmanymodernbankingservices. Thisdevelopment hasbrought toforethe concept of Universal Banking.1.2 OVERVIEW OF UNIVERSAL BANKING Universal banks are generally large banks with extensive network of branches that provide manydifferent financial services andare principallyengaged in commercial banking, investment banking, securities andeveninsurance. They invest in the equity and debt of the corporate and may even participate directly in the corporate governance of the firms that rely on the banks as sources of funding or securities underwriters. Universal banks with some variations in structure have been functioning in the United States, Europe and Japan. India can also boast of joining the band wagon as SBI, ICICI Bank and IDBI may now be termed as universal banks. This books deals with such universal banks. Set in two sections, the first one deals with global perspectives, while the second one contains some country specific cases.Universal Banking Page 3 Vivek College of CommerceUniversal banks, theonestopfinancial superstructuresareessentiallythe product of globalization of banking, deregulation of economies,liberalization of trade, capital and labor movements, the imperatives of competition, the concern for financial stability and more importantly, access to superior technology in financial services. Universal banks provide opportunities for cross selling, thereby enhancing revenue streams with diversity. In short, the consolidation, convergence and competition mantra, aided by superior technology is responsible for the birth, evolution and growth of these banks.In creating the mega universal banks, banks felt that there could be economies of scale andscope, efficiencyinriskmanagement, improvement inoperating efficiencies, improved financial stability through diversification of revenue streams etc. Universal Banking includes not only services related to savings and loans but also investments.However in practice the term universal banks refers to those banks that offer a wide range of financial services,beyond commercial banking andinvestment banking, insurance, etc. Universal bankingisacombinationof commercial banking, investment bankingandvariousother activitiesincluding insurance. If specialized banking is the one end then universal banking is the other. This is most common in European Countries.Universal Banking Page 4 Vivek College of Commerce1.3 DEFINITION OF UNIVERSAL BANKING The termUniversal Banking ingeneral refers tothe combinationof Commercial banking and Investment banking. In a broad sense however the term Universal Banks refers to those banks that offers a wide range of financial services suchas Commercial Banking, Investment Bankingandvariousother activities including Insurance under one roof. Universal banks apart fromdoing the traditional banking of accepting deposits and providing working capital finance to industry, tradeandagriculture, isasuper market for bothwholesaleandretail financial services/products.1.4 THE CONCEPT OF UNIVERSAL BANKING The entry of banks into the realm of financial services was followed very soon after theintroductionof liberalizationinthe economy. Sincetheearly1990s structural changes of profound magnitude have been witnessed in global banking systems. Large scale mergers, amalgamations and acquisitions between the banks and financial institutions resulted in the growth in size and competitive strengths of the merged entities. Thus, emerged newfinancial conglomerates that could maximize economies ofscaleandscopebybuildingtheproduction offinancial services organization called Universal Banking. By the mid 1990s, all the restrictions on project financing were removed and banks were allowed to undertake several in-house activities. Reforms in the Universal Banking Page 5 Vivek College of Commerceinsurancesector inthelate1990s, andopeningupof thisfieldtoprivateand foreign players also resulted in permitting banks to undertake the sale of insurance products. At present, only an arms length relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. IRDA (Insurance Regulatory and Development Authority).The phenomenon of Universal Banking as a distinct concept, as different from Narrow Banking came to the forefront in the Indian context with the Narasimhan Committee(1998)andlatertheKhanCommittee(1998)reportsrecommending consolidation of the banking industry of the banking industry through mergers and integration of financial activities.1.5 HISTORY OF UNIVERSAL BANKING GLOBAL SCENARIO There is no universally accepted definition of universal banking. An universal bank refers to a bank which offers a vide variety of financial services beyond the traditional boundaries of a commercial bank. According to the traditional description of a commercial bank, it confines itself to the core business of accepting deposits and providing working capital finance to industry, trade, commerce and agriculture. If this could be considered as one extreme, universal bankingistheother extreme. It couldnot beanexaggerationtostatethat an universal bank is a Financial Services Supermarket. Since Universal Banking is a combinationof commercial banking, Investment bankingandvarious other Universal Banking Page 6 Vivek College of Commerceactivities including insurance. An universal bank offers this entire range of financial services within the bank or through subsidiaries.Most countriespermit universal bankingalthoughit is most commonin Europeancountries. Universal bankingissaidtodominatetheworldfinancial scene. It is said to take of in a major way in the global market. It may be mentioned inthis connectionthat inU.S.A. theGLASSSTEAGALLACTwhichhad imposed severe restrictions on commercial banks in extending their activities and whichhadput upbarriers betweencommercial banks, Investment banks and Insurance companies has been scrapped. This led to mergers and acquisitions in the financial sector between banks, financial service companies and Insurance companies. Thus it resulted in the development and growth of universal banking. Universal banking has its own advantages while one cannot deny the fact that it hasitsowndisadvantagesalso. Themajoradvantageisincreasedineconomic efficiency in the form of lower cost, higher output and better products. At the same time a major disadvantage of universal banking is that as the banks carry out such a variety of services, failure in any one has a harmful effect on the entire economy. In many cases the different services provided have conflicting interest which may adversely affect economic growth. As a matter of fact, the GLASS STEAGALL ACTintheU.S.A. mainlyintendedtoprevent conflictsbetweenthedifferent services provided under universal banking. This law is no longer applicable but it is important toremember that conflicts shouldbeavoidedas it will leaveto increase in all types of risks (market risk and credit risk).Universal Banking Page 7 Vivek College of CommerceCHAPTER :- 2SIGNIFICANCE OF UNIVERSAL BANKING2.1 THE ROLE OF UNIVERSAL BANKING IN INDIA In India, though there has been no legislative distinction between commercial banking and investment banking or any explicit legislative restriction for the banks tooperate ininvestment bankingactivities, the banks have traditionallybeen maintainingthearmslength distancefrominvestment banking. Theplausible reason could be that, as we followed the British Style of banking, which was based ontheAnglo-Saxonstylewhereinstrictseparationwasmaintainedbetweenthe commercial banking activity and investment banking activity, the same pattern has been adopted in India. With the financial sector reforms, beginning 1990s, banks were, however, given abundant freedomtogomuchbeyondtheirtraditionalconservativecommercial banking related to working capital finance. But the more tangible momentum for the universal banking in India seems to have set in only after the Second Narasimhan Committees Report (1998)s recommendations for Development Financial institutions(DFIs), over aperiodof time, toconvert themselvesinto banks (implicitly universal banks) and that there should eventually two forms of Universal Banking Page 8 Vivek College of Commerceintermediaries, viz, banking companies and non-banking finance companies.This was followed by a Working Group chaired by S.H.KHANon Harmonising the Role and Operations of Development Financial Institutions and Banks (1998)which made it moreexplicit byrecommendingfora progressive movement towardsuniversal bankingfortheDFIs. ReserveBankofIndiaasa regulator and supervisor of the banking system, laid the formal road map, especially for the DFIs, by way of giving a set of guidelines. Banks were permitted to enter into term finance, infrastructure finance, insurance business, (i.e., similar to bancassurance prevailing in European Countries), underwriting of shares, etc. Taking a cue, ICICI an erstwhile DFI took the lead and became a universal bank by merging itself with its own subsidiary ICICI Bank Ltd. in 2002. Falling in line with this, more recently, IDBI has already been corporatized under the Companies Act, 1956 and became a universal bank by merging itself with its own subsidiary, viz IDBI Bank Ltd. Even other banks extending term loans, entered in the area of insurance, merchant banking activities, viz., funding for buying primary issueof equities, etc. Theseweresomeof theindicationsthat thecommercial banks in India have been moving away from their traditional banking and moving towards universal banking.Simultaneously, either voluntarily or due to compulsion, there has also been a number of bank mergers in recent years, banks with DFIs or possibly among the Universal Banking Page 9 Vivek College of CommerceDFIs themselves, also could not be ruled out. These developments also automatically lead to not only universal banking but even beyond that and ultimatelytotheemergenceof financial conglomerates. Asbankshavebeen permitted to take part in insurance business either with or without risk participation or as sub-agents, i.e. referral models, a number of banks in both public and private sector have already commenced exploiting the vast business potential of bancassurance. All thesedevelopments areapointer tothefact that universal banking system has become real in India both in letter and spirit.2.2 THE NEED FOR UNIVERSAL BANKING+ The global retail financial services market is growing very fast and chains of foreign banks are attacking traditional banks by offering new products of loans and investments portfolios under one roof.E.g. ICICI Bank provides services like Mutual Fund, Demat account services to its customers.+ Information technology development has paved the way for excellent customer services by way of providing electronic distribution channels. New breed of private sector banks and foreign banks are providing a wide range of services under one roof.Universal Banking Page 10 Vivek College of CommerceE.g. ICICI Bank provides Electronic Clearing System service through which thebanksendsthebill tothecustomersandthecustomerspaysthebill electronically through Internet.+ Liberalization and de-regulation of financial market have led to fragmentation of traditional branch services.+ Manyforeignbanksandnewbreedof privatesector bankshavestarted outsourcing their various products.E.g. Credit Cards, Insurance Products, etc. ICICI Bank offers Credit Cards of VISA Company.+ Customers have alsobecome verydemanding now. Theywant various financial services including expert advice on investment and portfolio management forlongerhours. (24hoursand365days)andsometimein their houses also.E.g. ICICIBankprovidespersonalizedservicestoitscustomersevenin case of portfolios investments.+ Foreign banks and new private sector banks are integrating all its customer information and making the information available across all different delivery channels, i.e. their branches. Many other banks have also realized that the data warehousing has the potential to play an immensely important Universal Banking Page 11 Vivek College of Commercerole in the future, especially in relation to howthe banks use their information with their virtual delivery channels.E.g. ICICI Bank maintains all information of its customers which it can use it for selling Insurance and other products to its customers.CHAPTER :- 3ACTS RELATING TO UNIVERSAL BANKING3.1 GLASS STEAGALL ACT 1933 INTRODUCTION This act has been passed in the US with a view to fight the great depression and asset deflation of the 1930s. Around this period, US has witnessed colossal failures ofbanks, morethan8000innumber. Thesefailures, essentiallycausedbythe depression, have been partly attributed to the irregular activities of major banks in underwriting and dealing in corporate stock and bonds. Many critics believed that banks engaged in inappropriate securities activities that harmed investors. In particular, critics charged that if a bank had a bad loan to a failing company, it had sold securities of the company to recover the loan and leave the investors with poor quality paper.Universal Banking Page 12 Vivek College of Commerce With the enactment of the GLASS STEAGALL ACT, banks and bank holding companies were prohibited from expanding geographically and from moving into the insurance business and large areas of securities business. Hence, all banking functions have been conducted distinctly by different players.ARGUMENTS FOR RETAINING GLASS STEAGALL ACT * Conflicts of Interests characterize the acts of credit lendingandcredit investingbythesameentitywhichcouldleadtoabuses. Thiswasthe primary reason for the passage of the Act.* Depository Institutions possess enormous financial power by virtue of their controloverother peoplesmoney.Hence thismustbe limitedtoensure soundness and competition in the market for funds, whether loans or investments.* Securities activities can be risky, lending to enormous losses. Such losses could threaten the integrity of deposits. In case, the depository institutions were to collapse as a result of securities losses, the Government could be required to pay large sums as the Government insures the deposits.* DepositoryInstitutionsaresupposedtobemanagedtolimit risk. Their managers thus may not be conditioned to operate prudently in more Universal Banking Page 13 Vivek College of Commercespeculativesecurities businesses. For example, thecrashof Real Estate Investment Trust sponsored by bank holding companies in the 1970s and 1980s reveals that the depository institutions cannot operate in speculative businesses.ARGUMENTS FOR REPEALING THE GLASS STEAGALL ACT Depository Institutions usually operate in Deregulated financial markets in which distinctions between loans, securities and deposits are not well drawn. Hence these institutions may lose their market share to securities firms that are not strictly regulated and also to foreign financial institutions operating without much restrictions from the Act. Conflicts of Interest can be prevented by enforcing legislation against them andbyseparatingthelendingandcredit functionsbyformingdistinctly separate subsidiaries of financial firms. The securities activities that are being sought by the depository institutions are less risky by their very nature and would also help to reduce the total risk of organizations due to diversifications.Universal Banking Page 14 Vivek College of Commerce In much of the rest of the world, depository institutions operate simultaneouslyandsuccessfullyinbothbankingandsecurities markets. Lessons learnt from their experiences can be applied to the U.S.A. National Financial Structure and Regulation.3.2 GRAMM LEACH BLILEY ACT 1999Glass-Steagall regime lasted for 66 years and analysts, at hindsight say that it was a mistake. In the year 1999, Gramm-Leach-Bliley Act (GLB Act) was passed, which removed the line of business barriers and allowed banks to acquire securities firms as well as insurancefirms andvice-versa. GLBAct, therefore, maybe termed asonethatbrought into being universalbanks like Citi Group,Bankof America, JP Morgan Chase, etc, in the U.S. However, this act has erected new barriers toalliance acquisitions betweenor commonownershipof banks and commercial firms. GLB Act did not result in the creation of a large number of universal banks as expected. While some banks have entered insurance brokerage (not underwriting) through GLBA route, only two non-banking organizations have become financial holding companies to acquire banks.Universal Banking Page 15 Vivek College of Commerce There are multiple regulators in the US, for various financial services. While SecuritiesandExchangeCommissionregulatesstockmarkets, FederalReserves takes care of the holding company structures. However, analysts admit that the US financial markets have, by and large, an effective market driven discipline.CHAPTER :- 4SERVICES OFFERED BY UNIVERSAL BANKSUniversal Banking Page 16 Vivek College of CommerceCHAPTER :- 5RECOMMENDATIONS OF UNIVERSAL BANKINGUniversal Banking Page 17PRIVATEBANKINGBANC ASSURANCE(INSURANCE)INVESTMENTMANAGEMENTEQUITYCORPORATEBANKINGINVESTMENTBANKINGCOMMERCIAL BANKINGRETAIL BANKINGUNIVERSALBANKING Vivek College of Commerce5.1 KHAN WORKING GROUPS RECOMMENDATION ON UNIVERSAL BANKING The Khan Working Group (KWG) keeping in viewthe deregulation, securitization and the diversification of business by banks into investment banking and beyond, made the following recommendations :-+The approach to universal banking should be guided by international experience and domestic requirements.+The DFIs should have the freedom to remain DFIs, specializing in their own activities. However, if aDFI chooses tobecomeabank, venturinginto commercial banking activities, that option should be available. In that case, the Converted DFI should be prepared to fully conform to all prudential, regulatory and supervisory norms which are applicable to banks.+The question of transformation of DFI into a bank should ideally be considered after a period, say of five years from the establishment of this committee. When a DFI chooses to transformitself into a bank, the transitionary arrangements on a time bound basis, could be worked out, after a detailed examination by the RBI, on a case by case basis. This case by case approachisessential becauseeachDFIwouldbeinauniquepositionin Universal Banking Page 18 Vivek College of Commerceterms of its capacity to transform into a bank, necessitating a transition path which need to be worked out.+If a DFI chooses to provide bank like services by itself through a wholly owned subsidiary route, permission to set up a fully owned subsidiary could also be considered by the RBI.+If a DFI, does not acquire a banking license within a stipulated period, it would be categorized as a NBFC.+KWG has suggested that super regulations be established to supervise and coordinate the activities of the multiple regulations in order to ensure uniformity in regulatory treatment.+The overall ceilingfor DFIs mobilizationof resources bytermmoney borrowings, certificate of deposits, term deposits and inter corporate deposits at 100 percent of NOF (Net Owned Funds) of DFIs may be removed.+KWG recommended that a suitable level of Statutory Liquidity Ratio (SLR) may be stipulated for DFIs on incremental outstanding fixed deposits raised from public (excluding inter bank deposits).Universal Banking Page 19 Vivek College of Commerce+KWG recommended :- The application of Cash Reserve Ratio (CRR) should be confined to cash and cash like instruments. CRRshouldbe brought downprogressivelywithina timebound frame to international levels. SLR should be placed in line with international projects.+To manage risks, KWG recommended :- A prudent risk return relationship strategy. Aclearstrategyapprovedbytheboardofdirectorsastotheirrisk management policies and procedures. An integrated treasury and proactive asset liability management and robust operational controls.Universal Banking Page 20 Vivek College of Commerce5.2 NARASIMHAN COMMITTEE II RECOMMENDATIONS ON DFIS Narasimhan Committee report made certain recommendations which have a bearing on the issues considered by the Khan Working Group. The main recommendationsoftheNarasimhanCommitteeIIinsofarastheyrelateto DFIs are set out below :-* Withthe Convergence of activities betweenbanks andDFIs, the DFIs should over a period of time, convert themselves into banks. There would then be only two forms of intermediaries, viz, banking companies and non-bankingfinancecompanies. IfaDFI doesnot acquireabankinglicense within a stipulated time, it would be categorized as a non-banking finance company.* ADFI whichconvertsintoabankcanbegivensometimetophaseits reserve requirements in respect of its liabilities to bring it on par with the requirements relating to commercial banks.* Mergers between banks and DFIs and NBFCs need to be based on synergies andlocational andbusinessspecificcomplementaritiesoftheconcerned institutions andmust obviously make sound commercial sense. Merger between strong bank/FIs would make for greater economic and commercial Universal Banking Page 21 Vivek College of Commercesense and would be a case where the whole is greater than the sum of its parts and have a force multiplier effect.* The supervisory function over rural financial institutions has been entrusted to NABARD. While this arrangement may continue for the present, over the longer-term, the Committee would suggest that all regulatory and supervisoryfunctions over rural credit institutions shouldvest withthe Board for Financial Regulation and Supervision (BFRS).* For effectivesupervision, thereis aneedfor formal accessiontocore principles.* Anintegratedsystemof regulation and supervision be put inplace to regulate and supervise the activities of banks, financial institutions and non-bankfinance companies (NBFCs) andthe agency(Boardfor Financial Supervision) be renamed as the Board for Financial Regulation and Supervision (BFRS).* To have in place a dedicated and effective machinery for debt recovery for banks and financial institutions.Universal Banking Page 22 Vivek College of Commerce* With the adventof computerization,thereis a needforclarityinthelaw regardingtheevidentiaryvalueof computer generateddocuments. Also, issuesregardingauthenticationofpayment instruments, etc, requiretobe clarified.CHAPTER :- 6Universal Banking Page 23 Vivek College of CommerceSWOT ANALYSIS OF UNIVERSAL BANKINGUniversal Banking Page 24INVESTOR FRIENDLY ACTIVITIESONE STOP SHOPPINGEASY MARKETING BRAND NAMERESOURCE UTILIZATIONPROFITABLE DIVERSIONSECONOMIESOF SCALESTRENGTH OF UNIVERSAL BANKING Vivek College of CommerceUniversal Banking Page 25NPA PROBLEM REMAINED INTACTNO EXPERTISE IN LONG TERM LENDINGGREY AREA OF UNIVERSAL BANKINGWEAKNESS OF UNIVERSAL BANKING Vivek College of CommerceUniversal Banking Page 26ERADICATE THE FINANCIAL APARTHEIDERADICATE THE FINANCIAL APARTHEIDGET MORE EXPOSURE IN THE GLOBAL MARKETGET MORE EXPOSURE IN THE GLOBAL MARKETINCREASE THE EFFICIENCY AND PRODUCTIVITYINCREASE THE EFFICIENCY AND PRODUCTIVITYOPPORTUNITIES OF UNIVERSAL BANKINGOPPORTUNITIES OF UNIVERSAL BANKING Vivek College of CommerceADVANTAGES OF UNIVERSAL BANKING ProfitableDiversions:-Byundertakingdifferentfinancialactivities, bank can make multiple uses of its existing skills. Thus, multitasking and multiple skills sets of a single entity would result in saving of cost which is essential to increase profitability in service sector.E.g. An existing employee of ICICI bank itself is engaged in marketing of Insurance product, there is no need to appoint new personnel. Thus, it results in multiple uses of its existing skills. Easy Marketing on the Foundation of a Brand Name :- A Banks physical branches can be turned as shops selling financial products related to Universal Banking Page 27THREATS BIG EMPIRES Vivek College of CommerceInsurance and Mutual Funds without expending additional effort on marketingtheseproducts. Inthisway, abankcanreachtheprospective clients even in the most distant place without taking the help of agents.E.g. SincethepeoplehaveconfidenceinICICI Banktheywill buythe products which is marketed by ICICI Bank. One StopShopping:- The idea of one stopshoppingsaves a lot of transaction Costs and increases the speed of economic activities. It is beneficial for the bank as well as its customers.E.g. TheCustomerswill behappysincetheyreceivealmost all financial services under one bank of roof. Investor Friendly Activities :- Another clear sign of universal banking is a bank holding say equity stake in a borrower firm. This would send a positive signal for other Investors with regard to the financial health and stability of the firm because of the lending bank is in a better position for monitoring the firms functions. Thebankcanuseitsinstrument inoneactivitytoexploit theother. For example, In the case of project lending to the same firmwhich has purchased insurance from the same bank.Universal Banking Page 28 Vivek College of Commerce Under the universal banking system, the risk of banking failure and therefore the cost thereof is reasonably hedged when bank is performing the diversified activities.E.g. Since ICICI Bank offers such variety of service, failure in one service will not be harmful for the entire bank. Too Big to Fail :- Universal banking is promoted in this theory. It is said that the banking industry will be able to provide better financial services. As the banks providemoreservices inuniversal banking, it will increase their profitability and also their customer base.DISADVANTAGES OF UNIVERSAL BANKING Universal banking result in greater economic efficiency in the form of lower cost, higher output and better product mix, on the other side if one universal bank collapses it leads to a systemic financial risk. Too Big to Fail Leading to Monopoly :- Universal banks are generally very big. Their failurescouldbedisasters for theeconomy. Hence, thereare always attempts on the part of the regulators and exchequers to bail them out, oftenat a huge cost. The recent bailout packages inthe U.S. for Investmentbanks, CommercialbanksandInsurancecompaniesreinforced this point. Apart from that, there is a fear that these financial establishments, Universal Banking Page 29 Vivek College of Commercebyvirtueoftheirsizeandfinancial clout, maybecomemonopolyinthe market, resulting in unfavorable consequences for the economic well being. Under the universal banking system the organizational structures are big and becomeoverlybureaucratic, whichmaycreateproblemsinattractingtop quality employees. The systemof providing all services under one roof may prevent the universal bank from developing the highly specialized expertise needed to compete in todays financial market.E.g. The employee of bank may only have the expertise knowledge about banking, hewill not haveknowledgerelatingtoInsurance, Mutual Fund, Stock, etc which will create problem in providing the correct advise to its clients. DifficultiesinSupervision:-Thesebanks, whicharebigwithdiversified activities, pose difficulties in supervision and also problems of regulation, as the skill sets needed for this purpose are different.E.g. Since the employee of banks do not have knowledge in any field other than banking, they will be facing difficulties in supervision and regulation of those activities.Universal Banking Page 30 Vivek College of Commerce Conflicts of Interests was one of the major reasons for introduction of Glass-Steagall Act. Three well-defined evils were found to flowfromthe combination of investment and commercial banking as detailed below :- Banks were deploying their own assets in securities with consequent risk to commercial and savings deposit. Unsound loans were made in order to shore up the price of securities or the financial position of companies in which a bank had invested its own assets. Acommercial banks financial interest intheownership, priceor distributionof securitiesinevitablytemptedbankofficialstopress their banking customers to invest in securities which the bank itself was under pressure to sell because of its own pecuniary stake in the transaction. TooBig and Falls :- This theory discourages the growth of universal banking. The supporters of this theory state that banks have a tendency to incur losses when large number of various services are provided by them. Loss ineconomies of specialization:- Thereis a problemof thebank indulging in too many risk activities. To account for this, appropriate regulation can be devised, which will ultimately benefit all the participants Universal Banking Page 31 Vivek College of Commerceinthemarket, includingthebanksthemselves. Inspiteof theassociated problems, there seems to be a lot of interest expressed by banks and financial institutions in universal banking.E.g. Banksmayberequiredtoemployeenewpersonsspecializedinthe fields other than banking in order to face the competition and to market other products. Thus for banks to become universal banks will cost more by way of appointing new employees and to provide proper infrastructure, etc. Thus it results in lesser profit for the banks.CHAPTER :- 7IMPORTANCE & IMPROVEMENTS OF UNIVERSAL BANKINGIMPORTANCE OF UNIVERSAL BANKINGUniversal Banking Page 32 Vivek College of Commerce Improving Profitability :- The most direct result of the above changes is that ofincreasing competition and narrowingof spreads and itsimpactonthe profitabilityof banks. The challenge for banks is howtomanage with thinningmargins whileat thesame timeworkingto improve productivity whichremains lowinrelation to global standards. This is particularly important because with dilution in banks equity, analysts and shareholders nowclosely tracktheir performance. Thus, with falling spreads, rising provision for NPAs and falling interest rates, greater attention will need to be paid to reducing transaction costs. This will require tremendous efforts in theareaof technologyandfor bankstobuildcapabilitiestohandleand bigger volumes. Reinforcing technology :- Technology has become a strategic and integral part of Banking. Driving banks to acquire and implement world class systems that enable them to provide products and services in large volumes at a competitive cost with better risk management practices. The pressure to undertakeextensivecomputerizationisveryreal asbanksthat adopt the latest in technology have a edge over others. Customers have become very demanding and banks have to deliver customized products through multiple channels, allowing customers access to the bank round the clock.E.g. ICICI Bank which is famous among customers has adopted computerized technology to deal with its customers.Universal Banking Page 33 Vivek College of Commerce Risk Management :- The deregulated environment brings in its wake risks along with profitable opportunities, and technology plays a crucial role in managing these risks. In addition to being exposed to credit risk, market risk and operational risk, which will be heightened as controls on the movement of capital are eased. In this context, banks are upgrading their credit assessment andriskmanagement skillsandretrainingstaff, developinga cadre of specialists and introducting technology driven management information systems. Sharpening Skills :- The far-reaching changes in the banking and financial sector entail a fundamental shift in the set of skills required in banking. To meetincreasedcompetitionandmanagerisks, thedemandforspecialized bankingfunctions, usingITasacompetitivetoolissettogoup.Special skills in retail banking, treasury, risk management, foreign exchange, development banking, etc, will need to be carefully nurtured and built. Thus, the twin pillars of the banking sector, i.e. human resources and IT will have to be strengthened. Greater Customer Orientation :- In todays competitive environment, banks will have to strive to attract and retain customers by introducing innovative products, enhancing the quality of customer service and marketing a variety of products through diverse channels targeted at specific customer groups.Universal Banking Page 34 Vivek College of Commerce Corporate Governance :- Besides using their strengths and strategic initiativesfor Creatingshareholder value, bankshavetobeconsciousof their responsibilities towards corporate governance. Following financial liberalization, as the ownership of banks get broadbased, the importance of institutional andindividual shareholderswillincrease. Insuchascenario, banks will need to put in place a code of corporate governance for benefiting all stakeholders of a corporate entity. International Standards :- Introducing internationally followed best practices andobservinguniversally acceptablestandardsandcodesisnecessaryfor strengthening the domestic financial architecture. This includes best practices in the areas of corporate governance along with full transparency in disclosures. Intodays globalisedworld, focusingonthe observance of standards will help smooth integration with world financial markets.UNIVERSAL BANKING :- IMPORTANCEPortfolio Risk :- Permitting banks to acquire more substantial equity holdings thentheycannowcoulddiminishtherisktakenbybanks or increase it. Economists and regulators have long understood that the rikiness of returns on common stock exceeds that of debt, other things being equal. For many years, a principal reason for separating banking from commerce hasbeenthebelief that someactivities, includingequityandreal estate Universal Banking Page 35 Vivek College of Commerceinvestment, were toorisky. It is nowwell understoodthat riskcanbe reduced by diversification. Equity and other types of assets might, in themselves, be relatively risky, but if they have a diversifying effect on other investments, theycanreduceriskinaportfolioof assets bysmoothing revenue streams over time.Global CompetitionandBank Viability :-Ifnarrowing oreliminatingthe Separationbetweenbankingandcommerce reduces risk, moderates the asymmetric information problem, and, for these and other reasons,lowers average costs, foreign banks with broader powers should have an advantage in competition with local banks. If nothing more, foreign banks should have an advantage in maintaining loan customers in whomthey have an ownership interest.Financial Markets :- On banking developments in other countries, comparisons Suggest that financial markets are less developed in countries in which banks have played a larger role in providing equity and long-term credit as well as short-term credit.ProductionSector:-Prospectivebanking/commercechangesmaydirectly affectnotonlythefinancialsectorbutalso thecommercial or production sector of the economy. Potential impacts can be considered in a number of areas, including economic growth and stability, competition, concentration, Universal Banking Page 36 Vivek College of Commerceand small business lending. There are, moreover, a variety of other allocational efficiency considerations that also merit attention.GrowthandStability:- Therelativecontributions of banking-commerce relationshipstoeconomicgrowthandstabilityhasbeenafocal point of comparisonbetweenGermanyandUnitedStates. Thecost of capital to commercial firms, thepaceof innovationandtechnological change, and susceptibility of the different economies to systematic events all have potentially differential effects oneconomic growth and stability.Technological Changeand Innovation:- Technological improvements and Innovation accounts, through improved productivity, for a substantial share of economic growth in the economy. It is conceivable that larger and better diversified banks would contribute to more rapid technological innovation. The combination of banking with commercial firms will result in larger and more diversifiedorganizations. Improved efficiency and lower costs of capital, if theyarematerialized, might better support innovationbothin banking and in industry. There has, however, been little or no investigation into the effects of bank size and diversification on innovation. In other areas, empirical studies have not provided consistent results.SystematicRisk:-Concernabout systematicrisktranscendsthefinancial and commercial sectors.To the extent a systematic event develops in any Universal Banking Page 37 Vivek College of Commercesector, it is likelytoaffect theentireeconomy. Theabilityof banking organizations to diversify could provide some protection against distress that might otherwise lead to systematic problems. Whatever the extent of geographic and/or product diversification, systematic problems maystill occur, forexample, fromoil crises, stockmarket crashes, andreal estate busts; that is, from the kind of risk that cannot be reduced by diversification. The timing and specific nature of such shocks are not predictable. Less bank aversiontoriskat theendof alongexpansionhasbeenidentifiedasa contributing cause of systematic problems.Risk-SharingandIntertemporal Smoothing:-Theexistenceofsystematic riskraises theissueof risk-sharing. It is awell-establishedprincipal of modernfinancial analysis that well-functioningfinancial markets permit portfolio diversification and reduction or elimination of the risk associated with variability in the return to individual securities. Diversification, portfolioadjustment, and hedging involve the exchange of risk among marketparticipants. Theycanbetermedascross-sectional risk-sharing, since different individuals are exchanging risks at a given point of time.CHAPTER :- 8CRITICISMS OF UNIVERSAL BANKINGUniversal Banking Page 38 Vivek College of CommerceISSUES ARISING FROM THE EMERGENCE OF UNIVERSAL BANKINGC Conversion of DFIs into banks and introduction of bancassurance (bank + insurance) schemewill nodoubt acceleratethemovetowardsUniversal Banking but the development will create certain problems.C ThoughtheDFIscanextendtermloansevenafter their conversioninto banks, thebanksarelikelytoloseinterest intermlendingsincebanks major source of funds are short and medium term deposits which cannot be used for extending long term loans.C In the absence of a well-developed debt market and liberal inflow of foreign capital, availability of long-term loans will be affected and which in turn will affect industrial development. DFIs will have to continue to provide long-termloansevenafterconvertingthemselvesintobanksandalsohaveto meet Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements.CHAPTER :- 9CHALLENGES OF UNIVERSAL BANKINGUniversal Banking Page 39 Vivek College of Commerce There are certain challenges, which need to be effectively met by the Universal Banks :-The establishment of newprivate sector banks andforeignbanks have rapidly changed the competitive landscape in the Indian consumer banking industry and placed greater demands on banks to gear themselves upto meet theincreasingneeds of customers. For thediscerningcurrent daybank customers, it is not only relevant to offer a wide menu of services but also provide these in an increasingly efficient manner in terms of cost, time and convenience.Development Financial Institutions (DFIs) opting for conversion into Universal Banks bymerger/reversemerger routes mayalsofacecertain difficult situations onaccount of Asset LiabilityMismatches, burdenof mounting NPAs and differences in regulatory prescriptions applicable to FIs and banks such as CRR and SLR requirements and priority sector lending. Theasset profileof DFIsinIndiaispredominantlyof long-termnature, which also includes a very high level of non-performing assets. Further, the regulation of DFIs in India has been historically less as compared with the bankingsystem, partlybecause DFIs donot formpart of themonetary system and partly because they do not have deposits like liabilities.Universal Banking Page 40 Vivek College of CommerceIncaseDFIsareconvertedintobankstheywouldalsobesubject tothe reserve requirements like banks. This would mean that all liabilities issued by the DFIs in the past would also be subject to the reserve requirements and since the assets structure of DFIs are largely of long-term nature it would be very difficult for them to maintain the required level of SLR/CRR.Further, the cost at which DFIs have been raising resources in the past has generally remained high as compared to banks and maintenance of CRR/SLR for such liabilities, which may earn lower returns, would adverselyaffecttheprofitabilityofsuchUniversal Banks. Complianceof prioritysector lendingnorms, whichearnlower returns, mayalsocreate difficult situationsfor suchbank. RiskManagement isoneof themajor challenges, wherein the financial activity carries with it various risks, which would need to be identified, measured, monitored and controlled by Universal Banks. The nature of risks and mitigating techniques for different financial products/services will be different and therefore, Universal Banks will be required to develop comprehensive system for each product/service and each kind of risk.ImprovingRiskManagement Systems :- Withthe increasingdegree of deregulation and exposure of banks to various types of risks, efficient risk management systems have become essential. For enhancing the risk management systems in banks, Reserve Bank has issued guidelines on asset-liabilitymanagementandriskmanagementsystemsinbanksin1999and Universal Banking Page 41 Vivek College of CommerceGuidance Notes on Credit Risk Management and Market Risk Management in October 2002 and the Guidance Note on Operational Risk Management in 2005.Another aspect is related to building up of supervisory infrastructure. The regulatoryframeworkwouldneedtobestrengthenedsoas tocover all aspects of Universal Banking either under control of one regulator or a co-ordinating mechanism would have to be developed among different regulators like the Reserve Bank of India, SEBI, Insurance Regulatory Authority, etc. The regulators will have toframe sound mechanismto protect the interests of all concerned including the customer, the Universal Banking Institution and the financial system of the country.SupervisionofFinancial Conglomerates:-Inviewofincreasedfocuson empowering supervisors to undertake consolidated supervision of bank groups andsincetheCorePrinciples for EffectiveBankingSupervision issuedbytheBasel committeeonBankingSupervisionhaveunderscored consolidated supervision as an independent principle, the Reserve Bank had introduced, as an initial step, consolidated accounting and other quantitative methods to facilitate consolidated supervision. The components of consolidated supervision include, consolidated financial statements intended for public disclosure, consolidated prudential reports intended for supervisory assessment of risks and application of certain prudential Universal Banking Page 42 Vivek College of Commerceregulations on group basis. In due course, consolidated supervision as introduced above would evolve to cover.It islikelythat Universal Banksofroughlythesamesizeandproviding roughly the same range of services may have very difficult cost levels per unit of output an account of efficiency differences in the use of labour and capital, effectiveness in the sourcing and application of available technology and perhaps effectiveness in the acquisition of productive inputs, organizational designs,compensation and incentive systems and just plain better management.Larger the banks, the greater will be effects of their failure on the system. Alsothereisthefearthat suchinstitutions, byvirtueoftheir sheersize wouldgainmonopolypower inthemarket, whichcanhaveundesirable consequences for economic efficiency. Further combining commercial and investment banking can give rise to conflict of interest. Sharpening Skills :- The far-reaching changes in the banking and financial sector entail a fundamental shift in the set of skills required in banking. To meetincreasedcompetitionandmanagerisks, thedemandforspecialized banking functions, using IT as a competitive tool has to go up. Special skill in retail banking, treasury, risk management, foreign exchange, development banking, etc., will need to be carefully nurtured and built.Universal Banking Page 43 Vivek College of CommerceCHAPTER :- 10CASE STUDIES10.1 INDIAS UNIVERSAL BANKS :- ICICI BANK ICICI Bank is the second largest bank in India and the largest private sector bank in terms of assets size. It has a leadership in retail credit. As a universal bank, it offersarangeofbankingandfinancial products. Throughitssubsidiaries, it offers life insurance, general insurance, investment banking, venture capital funding and asset management services. During the pre-economic reforms period, commercial banks and development financial institutionsfunctioneddistinctly. Theformer specializedinshort and medium-term financing, while the latter in long-term lending and project financing. Commercial bankswereaccessingshort-termlowcost fundsthrough savings investments like current accounts, savings bank accounts and short duration fixed deposits, besides collection float. Development Financial Institutions (DFIs) on the other hand, were essentially depending on budget allocations for long-term lending at a concessionary rate of interest.Universal Banking Page 44 Vivek College of Commerce The scenario has radically changed during the post-reforms period, with the government resolving not to fund DFIs through budget allocations. DFIs, therefore, have been accessing long-term funds from the markets in the form of bonds, which are not all that inexpensive, resulting in a hike in lending rates. Further, globalizationandliberalizationofeconomyhasresultedinamassive pile-up of NPAs, as many Indian industrial borrowers could not simply become competitive in a global market for a variety of reasons. This way, DFIs like IDBI, IFCI and ICICIhavebeenpostingdismal financial results. Infact, theirveryviabilityis being questioned. Will universal banking offer any solace to them? By converting themselves into commercial banks, they may only access short-term funds at a lower cost but the problemof maturitymismatchwill not be addressed. Inthe absence of vast network of branches, they may not be even in good competition with the commercial banks. It is in this context, that the reverse merger of ICICI with ICICI Bank assumes significance. Following the merger during March 2002, ICICI Bank has become the largest private sector bank and the second largest bank in India. The merger has indeed ushered in an era of universal banking in India. As a universal bank, ICICI Bank has transformed itself from the role of a mere financial intermediary into a providerofawiderangeofservices, inadditiontoanoriginatorofcredit.The product range is impressive :- home loans, car loans, consumer loans, credit cards, Universal Banking Page 45 Vivek College of Commercedebit cards, smart cards, e-cheques, private banking, Demat services, NRI Service, all these in retail banking, driven by branches, ATMs, Internet and call centres.No less formidable is its corporate banking wing consisting of project finance, structuredproducts, capital market services, international banking, government enterprises, corporate solutions besides the recently initiated agribusiness. Always a techsavvybank, it has takenfull advantage of a liberalizedeconomyand availabilityof superior technology. Itsretail distributionandservicesaretruly technology driven.INNOVATIVE BUSINESS MODEL Indian banking is not known to change its business models to stay afloat when conditions are adverse. Consequently, it clings to outdated models with no hopes of growth and prosperity.ICICI Bank has shown the way to others in changing business models, in line with the changes in the external environment. Thanks to growing consumerism and the failure of NBFCs, the bank has entered retail finance with a big bang and truly claims market leadership in many retail products now. It has been leveraging its strong corporate relationships to expand the range of business that it did with its corporate clients, focusing on delivering customized solutions with the objective of addingvaluetoitsclientsbusinesses. Perhapsit isthefirst banktoenterinto structured finance deals. Its technology driven distribution and operations models Universal Banking Page 46 Vivek College of Commerceresulted in rapid growth of customer base, besides securing operational efficiency and economies of scale.It is rapidly moving its transaction volumes away from branchestochannelsthat offergreatercustomerconvenience, whilealsobeing more cost effective.THE SAGA OF MERGERSBankmergershavebecomeaglobal phenomenon. Theobjectiveofthese mergersistocut costsbesidessecuringother synergies. DuringJanuary2001, Bankof Madura, aSouth-based, oldgenerationprivatebankhasmergedwith ICICI Bank, bringing cheer to the shareholders and employees of Bank of Madura but discomfort and anxiety to those of ICICI Bank. As the consequence of the merger, ICICI Bank has gained a larger balance sheet size, enhanced branch network, increased customer base with cross selling opportunities andpotential toaugment prioritysector credit inSMEsegment, particularly agriculture and microcredit. With 260 branches of Bank of Madura, the networkofICICIBankhasrisento360. Theclient basehasshot upfrom0.5 million to 2.7 million. March 2002 witnessed yet another merger. This time it was ICICIs merger with the ICICI Bank, which paved the way for ICICI bank to become Indias first Universal Banking Page 47 Vivek College of Commerceprivate sector universal bank. Two of ICICIs wholly owned retail finance subsidiaries, namelyICICI Personal Financial Services Ltd. (ICICI PLS) and ICICI Capital Services Ltd (ICICI Capital) were also merged with ICICI Bank.To begin the story, ICICI, the first development bank, set up in the year 1955, inprivatesectorat theinitiativeoftheWorldBank, Government ofIndiaand Indian Industry. Over a period of time, ICICI has diversified into merchant bankingandleasingoperations, venturecapital, investment bankingandasset management. It has promoted ICICI Bank in the year 1994, making its first foray into retail banking. ICICI was the first Indian entity to get listed on the New York Stock Exchange (NYSE). Later, ICICIBankbecamethefirst IndianBanktoget NYSElisting. Consequent to a host of factors like Industrial slowdown, pile up of Non-PerformingAssets(NPAs)(asdomesticindustrialborrowerscouldnotcompete with global players in a deregulated, globalized economic environment), high cost of funds, due to the stoppage of government funding, ICICI was forced to embark on the reverse merger with the ICICI Bank. The merger itself has posed many challenges to ICICI Bank. Raising substantial resources to meet the enhanced statutory preemptions is one such challenge. The bankhas facedthese challenges rather comfortably, aided principally by the abundanceofliquidityinthesystem. Formeetingthereserverequirementsand managing the interest rate risk arising fromthe acquisition of government Universal Banking Page 48 Vivek College of Commercesecuritiesaggregatingtoabout Rs.18,000Cr. inanenvironmentoflowinterest rates, the bank has adopted a strategy of acquiring securities of a lower duration. There were two more challenges namely meeting the 40% priority sector norm in lending and bringing down in the higher NPA level of the merged entity. The bank has met with significant success with regard to these two challenges.INCREASED PRESENCE IN RURAL AREAS The bank depends on rural branches (essentially a legacy of the erstwhile Bank of Madura), franchisees, Kiosks and tie ups with Micro Finance Institutions (MFIs) and cooperative banks, to augment rural sector credit. It has 3500 such points of presence. The bank has an agriculture finance portfolio of Rs. 6373 cr. The bank is lookingintoinvestmentavenuesinsupplychainandlendingagainstwarehouse receipts toimprovetherural credit. It is developingspecializedproducts like financing against commodities, index-based products, wealth insurance at a micro level and weather insurance. ICICI Bank has now become Indias second largest bank with an asset base of Rs.167,700Cr as onMarch31, 2005. It has anetworkof 560branches and extensioncounters andover 1,900ATMs. Apart fromthetraditional banking services and products offered to corporate and retail customers, it also provides an arrayof financial serviceslikeinvestment banking, lifeandnon-lifeinsurance, venturecapital andasset management. Its international bankinggroup, set up during2002, caters tothe cross border needs of clients andleverages onits Universal Banking Page 49 Vivek College of Commercedomestic banking strengths to offer products internationally. The bank has subsidiaries in the UKandCanada, branches in Singapore and Bahrain and representativeofficesintheUS, China, UnitedArabEmirates, Bangladeshand South Africa. The banks capital adequacy as on March 31, 2005 was 11.78% and net non-performing assets constitute 2%. Its profit after tax is Rs.2005 Cr. ICICI Lombard General Insurance Company (ICICI Lombard) maintained its leadership position among private sector general insurance companies. It achieved a profit after tax of Rs.48 Cr in FY 2005, compared to profit after tax of Rs.32 Cr inFY2004. The companys returnon equityfor FY2005 was 20%ICICI Prudential Life Insurance Company (ICICI Prudential Life) continued to maintain its market leadership among private sector life insurance companies. ICICI Securities Limited (ICICI Securities) achieved a profit after tax of Rs.64 Cr in FY 2005 despite a sharp decline in fixed income gains due to the prevailing interest rateenvironment. ICICIVentureFundsManagement CompanyLimited (ICICI Venture) strengtheneditsleadershippositioninprivateequityinIndia, investing its India Advantage Fund and entering into a joint venture with Tishman Speyer Properties for investment in real estate.Universal Banking Page 50 Vivek College of Commerce10.2 INDIAS UNIVERSAL BANKS :- THE STATE BANK GROUPSBIgroup, thelargest ownedbytheGovernment ofIndia, isIndiasfirst universalbank.It offerscommercialbanking,investment banking and securities trading. Of late, it has also started providing insurance and credit card facilities. It has over 13,600 branches, 5000 ATMs and balance sheet footage of Rs.5 lakh Cr.State Bank of India (SBI), the government owned largest Indian Bank may be termed as the first universal bank of India.THE ASSOCIATE BANKS OF SBI The SBI has seven associate banks, namely, State Bank of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of Indore, State Bank of Mysore, State Bank of Patiala, State Bank of Saurashtra and State Bank of Travancore. These seven associate banks have over 4,600 branches, over 1,100 ATMs networked with the SBI ATMs. These seven associate banks account for combined asset base of over Rs.1,70,000 Cr as on 31-3-2005.SBI COMMERCIAL AND INTERNATIONAL BANKING LTD. (SBICIBL)Universal Banking Page 51 Vivek College of CommerceSBI Commercial and International Bank Ltd, with a modest asset base of over Rs.500 Cr, is a banking subsidiary, fully owned by SBI. The bank, operating out of Mumbai, has a network of 48 overseas offices spread over 28 countries.SBI undertakes various financial services through its non-banking subsidiaries or joint ventures.SBI Capital Market Ltd. (SBI Cap) is into debt placements, and public issues. Discount and Finance House of India Ltd, (DFHI) is a subsidiary of SBI dealing in moneymarket instruments, whileSBI GiltsLtd, actsasaprimarydealer. SBI CardsandPaymentsServicesLtd, issuescreditcards. SBIhasenteredintolife insurance as well. The bank has a mutual funds arm called SBI Funds Management Ltd. Factoring services are performed through SBI Factors and Commercial services Ltd. The State Bank group with 13,600 branches, 5000 ATMs, balance sheet footage of Rs.5 lakh Cr and net profit above Rs. 5000 Cr (2004-05) is Indias number one bank, offering various financial services as a universal bank.10.3INDIAS UNIVERSAL BANK :- IDBI-IDBI MERGER Universal Banking Page 52 Vivek College of Commerce The IDBI-IDBI Bank merger has created a bank-IDBI Ltd, which has assets worth Rs.80,000 Cr. The major benefits to IDBI is that it can access low-cost funds besides theready-madeavailabilityof branchnetwork, technologyandATMs across 72 cities. RBI has relaxed SLR norms for the new bank. The transfer of the Rs.9,000 Cr NPAs of IDBI to a newly created Stressed Assets Stabilization Fund (SASF) has helped the new bank to reduce its net NPA ratio to less than 1% and capital adequacy ratio to just over 9%. The new bank has many opportunities in the infrastructure area to increase its asset base in the future. The Indian banking sector underwent a series of merges and acquisitions in a needfor consolidationof Indianbankstocreateworld-classbanksinsizeand scale. As a response tochanges inthe operatingenvironment, followingthe initiationofreformssincetheearly1990stheGovernment ofIndiadecidedto transformIDBI into a commercial bank without avoiding its developmental finance obligations. IDBIs merger with its private banking arm, IDBI Bank, was one of the biggest mergers in the history of the Indian banking sector. The first such merger took place in March 2002, when ICICI was reverse merged with its banking arm ICICI Bank. The IDBI-IDBI Bank merger created a bank with assets worth Rs.8000 Cr. The newentitypost-merger, renamedIDBILimiteda company within the meaning of companies act, 1956 and a banking company as defined under Banking Regulation Act, 1949, formed in accordance with the provisions of IDBI (Transfer of Universal Banking Page 53 Vivek College of CommerceUndertaking and Repeal) Act 2003 (Repeal Act) passed by Parliament,primarily focused on project finance and retail lending. In the new market dominated economy, IDBIs development banking model had largely become irrelevant. The present focus of the financial sector is primarily on the vast untapped retail segment. IDBI believed that moving on to the new business model of commercial banking, with access to low-cost current and savings bank deposit would help it to diversify its client and asset base. Formed in 1964 by an Act of Parliament, IDBI functioned as a premier financial institution of the country, entrusted with the responsibility of providing credit and financial assistance to corporate India. Initially, IDBI was set up a wholly-owned subsidiary of the RBI. But in 1976 the ownership of IDBI was transferred to the Government of India. However, thegovernment stakeinIDBI wasreducedto 58.47%followingIDBIspublicissueinJuly1995. IDBI wasinstrumental in settingupfinancial institutionslikeEXIMBank, SIDBI, ARCIL, andNEDFI. IDBI alsoparticipatedactivelyinthesettingupvariouscapital market related institutions such as SEBI, NSE, and CARE. IDBI Bank came into existence after RBI sanctioned the entry of new private sector banksintheIndianeconomyinJanuary1993. Thebankbeganwithan equity capital base of Rs.100 Cr by SIDBI. The bank increased its paid-up share capital toRs.140Cr. throughapublicissueinFebruary1999. Thepromoters holding, consequent to this public issue, was reduced to 70% with IDBI holding 56%and SIDBI14% stake. Gradually,frombeinga corporate-orientedbank,it Universal Banking Page 54 Vivek College of Commerceturnedintoabankwithapredominantlyretailfocus. Inanunusual positioning strategy, IDBI Bank targeted non-metro, second-line urban cities in order to cater to the retail segment.THE MERGER DEAL The merger created the seventh-largest bank in India in terms of assets. The mergerwaswin-winsituationforboththeinstitutions. Besidesusingthe brandnameofIDBI, IDBIBankwouldget accesstoawidedistribution network of 100 odd branches of IDBI. It also got the necessary capital to expand its horizon. On the other hand, IDBI would function as a full-fledged deposit-taking bank without incurring heavy expenditure on setting up branches, introducingnewtechnologyorinducingnewpeople. IDBIwas provided with a readymade technology platform with access to IDBI Banks 95 branches and 302 ATMs across 72 cities with a nearly a million customer base. IDBI alsobenefitedimmenselyfromthe consumerbankingknowledge of IDBI Bank along with a private sector culture that was totally different from that of IDBIs. The merger helped IDBI to reduce its overall cost of funds from 5.6% to around 4.9% with access to savings account, current account and call money market.Universal Banking Page 55 Vivek College of Commerce To facilitate the merger, the Rs.9000 Cr Non-Performing Assets (NPAs) in IDBIs portfolio, accounting for almost 15% of its net loans, was transferred to Stressed Assets Stabilization Fund (SASF) in the form of Zero-Coupon Bonds held till maturity, SASF was given the status of a financial institution bythe Central Government toenable it toaccess the Debt Recovery Tribunals (DRT).ThisfinancialrestructuringenabledIDBItobringdownitsNPAsto below 1%. The assets transferred to SASF were without recourse to IDBI Ltd, for a period of 20 years the tenure of the bonds. At the time of the settlement of any of these loans, the money would be received by IDBI Ltd, and simultaneously an equivalent amount of bonds would be relinquished. Thebank would take backassets remaining unrecoveredbySASFfor20 years. With the resurgence of the steel and textiles industry, it is expected that the NPAstatus of the bank would improve considerably and the incremental NPAs would be reduced to less than Rs.250 Cr a year. IDBI Ltd, was granted a five-year relief period by RBI, from maintaining the required Statutory Liquidity Ratio (SLR). Against a requirement of Rs.3500 Cr towards Cash Reserve Ratio(CRR) liabilities, the bank deposited Rs.2,400 Cr immediately after the merger.Universal Banking Page 56 Vivek College of Commerce In a competitive sense, the merger created a strong foundation for IDBI Ltd. to compete with the other banks. It had a clean and strong balance sheet, free from NPAs to a large extent, a better organization rating that was translated into more cost-effective borrowing and most importantly, enormous government support.Themergeralsohadapositiveimpact intheareaofdevelopmental finance. Previously the borrowers could get away with numerous reliefs and concessionsduetothepresenceofmultiplelenderswhodidnot want to makehighprovisionsfortheirassets. Withtheassetsconcentratedinthe hands of averyfewinstitutions, theconcessions werefar less andthe borrowers simply had to perform or else face disciplinary action. The Union Budget2004-05 emphasized infrastructural developmentthrough a pooled investment of Rs.40,000 Cr by the proposed Inter-Institutional Group (IIG), comprisingIDBILtd, andsomeoftheselectedfinancial institutionsand banksofthecountry.BeingamemberofIIG,IDBILtd,wouldhavethe opportunity to speed-up loan agreements and implementation of infrastructure projects, with special emphasis on airports, seaports and tourism development. IDBI also planned to reduce its high-cost liabilities priced at almost 9.5% by nearly 100 basis points within 12 months of the merger. This would lead to savings of Rs.500 Cr for the bank. IDBI also lowered its Prime Lending Rate (PLR) from 12.5% to 10.5%, and with the corporate sector expanding Universal Banking Page 57 Vivek College of Commercewithnewbusinessopportunities, thebankwasexpectedtogrowitsasset value by 10% to 12% a year. There was also a large disparity in the Capital Adequacy Ratio (CAR) of IDBI and IDBI Bank. As compared to 18.3% for IDBI, the CAR of IDBI Bank was just over 9%. However, the merged entity was expected to have a CAR much better than the RBI stipulated 9%. Prior to the merger in August 2003, several top-level executives of the bank resigned, including the head of cash management services operations, head of Internet banking, head of call center and head of product and sales. The main reasons for the exodus of employees were the looming uncertainties about the changes in the banks management structure and also the challenge of integratingthe private andpublic sector cultures. The contrasting workculture and atmosphere in IDBI and IDBI Bank were perceived as stumbling blocks.According to a renowned credit agency. It would be counterproductive for anIDBI employeetoheadabankbranchandlikewise, for abank personneltosanction a long-term project plan. The mergeralso led to a rationalization of the workforce to a great extent. The institution followed a shape up or ship out strategy to the hilt, in order to do away with the non-performingemployeesandalsoreducedthecut-off ageof retirement of employees from 60 to 58 years. IDBI Ltd sanctioned Rs.75 Cr to fund its VoluntaryRetirement Scheme(VRS), whichwouldbewrittenoffovera Universal Banking Page 58 Vivek College of Commerceperiod of 5 years. Under this scheme 425 employees, accounting for almost 15% of the total workforce, opted for voluntary retirement. IDBI Ltd, aggressively leveraged the combined strengths of both IDBI and IDBI Bank to improve the quality of its portfolio, relative standing in thefinancial infrastructuresectorandoverall financial performance. Such strengths included quick decision-making abilities, lending out at a competitive rate, enormous customer base, customized services for the clientsandanexhaustiveknowledgeof theIndianIndustry. Thus, IDBI Limiteds goal is tobethemost preferredbrandfor total financial and banking solutions for corporate and individuals and becoming a major force to reckon within the financial sector. CHAPTER :- 11FUTURE ASPECTSUniversal Banking Page 59 Vivek College of CommerceTHE FUTURE TREND OF UNIVERSAL BANKINGINDIFFERENT COUNTRIESUniversal banks have long played a leading role in Germany, Switzerland and other Continental European Countries. The principal Financial Institutions in these countries typically are universal banks offering the entire array of banking services. Continental European banks are engaged in deposit, real estate and other formsof lending, foreignexchangetrading, aswell asunderwriting, securities trading and portfolio manangement. In the Anglo-Saxon countries and in Japan, by contrast, commercial and investment banking tend to be separated. In recent years, though, most of these countries have lowered the barriers between commercial and investment banking, but they have refrained fromadopting the Continental EuropeanSystemof universal banking. IntheUnitedStates, inparticular, the resistancetosofteningtheseparationof bankingactivities, asenshrinedinthe Glass-steagall Act, continues to stiff. In Germany and Switzerland the importance of universal banking has grown since the end of world war II. Will this trend continue so that universal banks could completely overwhelmthe specialized institutions in the future ? Are the specialized banks doomed to disappear ? This question cannot be answered with a simple yes or no. The German and Swiss experiences suggest that three factors will determine the future growth of universal banking.Universal Banking Page 60 Vivek College of Commerce First, Universal banks no doubt will continue to play an important role. They possess a number of advantages over specialized institutions. In particular, they are abletoexploit economiesofscaleandscopeinbanking. Theseeconomiesare especially important for banks operating on a global scale and catering to customers with a need for a highly sophisticated financial services. As we saw in the preceding section, universal banks may also suffer from various shortcomings. However, inanincreasinglycompetitiveenvironment, thesedefectswill likely carry far less weight than in the past.Second, although universal banks have expanded their sphere of influence, the smaller specialized institutions have not disappeared. In both Germany and Switzerland, they are successfully coexisting and competing with the big banks. The continued strong performance of many specialized institutions suggests that universal banks do not enjoy a comparative advantage in all areas of banking. Third, universality of banking may be achieved in various ways. No single type of universal bankingsystemexists. TheGermanandSwiss universal banking systems differ substantiallyinthis regard. InGermany, universalityhas been strengthened without significantly increasing the market shares of the big banks. Instead, the smaller institutions have acquired universality through cooperation.CHAPTER :- 12Universal Banking Page 61 Vivek College of CommerceCONCLUSION The face of banking is changing rapidly. Competition is going to be tough and with financial liberalization under the World Trade Organization (WTO), banks in India will have to benchmark themselves against the best in the world. For a strong and resilient banking and financial system, therefore, the banks need to go beyond peripheral issues and tackle significant issues like improvements in profitability, efficiency and technology, while achieving economies of scale through consolidation and exploring available cost-effective solutions. Universal banking is evolving and numerous examples such as Citigroup, ICICI Bank and HDFC Bank are rapidly moving to integrate and automate their diverse operations and processes. Development financial institutions (DFIs) can turnthemselves into banks, but havetoadheretothestatutoryliquidityratioandcashreserveratio requirements meant for banks. Even then, some groups like the HDFC (commercial banking and insurance joint venture with Standard Assurance), ICICI (commercial banking), SBI (investment banking), etc, have already started diversifyingfromtheir traditional activitiesthroughsettingupsubsidiariesand joint ventures. Inarecent move, theLifeInsuranceCorporationincreasedits stakes in Corporation Bank and is planning to sell insurance to the customers of the Bank. Corporation Bank itself has been planning to set up an insurance subsidiary since a long time. All these can be seen as steps towards an ultimate culmination of financial intermediation in India into Universal Banking.BIBLIOGRAPHYUniversal Banking Page 62 Vivek College of CommerceBOOKS+ UNIVERSAL BANKING GLOBAL PERSPECTIVESAUTHOR KATURI NAGESWARA RAO+ EMERGING SCENARIO OF INDIAN BANKING INDUSTRY AUTHOR NALINI PRAVA TRIPATHYINTERNET WEBSITES+ UNIVERSAL BANKING.COM+ ECONOMYWATCH.COM+ BANKNET.COM+ WWW.RBIORG.INUniversal Banking Page 63 Vivek College of CommerceUniversal Banking Page 64