Sparshy And Satbir_35 & 46

Impact of Globalization on Indian Banking System

Sparshy Saxena and Satbir Samra

The Indian Banking scene in under a constant cycle of change. The number of banks and their customerorientation, technology, diversification, competition and the resultant factors have changed the take on the perception of a bank as merely being a financial institution. Through its take on globalization, the Indian Banking sector has undergone varied changes in terms of reforms and nationalization. The reforms that have been brought into force have changed the market of Indian banking, increasing the players (both foreign as well as private) and, most importantly, supporting the banking framework with financial stability and risk absorption capacity. The paper maps the trend of the banking sector across an expanse stretching from 1985 to 2008, the change in the working of the sector pre- and post events like nationalization and globalization. It also analyses the impact of reform implementation on the sector as well as the challenges faced by the Indian banks. 1|I mp a ct o f Gl ob alisa ti o n o n The In di an B an king Se cto r

INTRODUCTION A bank is a financial institution which engages in the business of keeping money for savings and checking accounts or for

its sleeve. One of them is its extensive reach. Not

confining

itself

to

only

the

metropolitans, it has shown a reach to even the remote areas of the country.

exchange or for issuing loans and credit etc.

The first conservative bank was set up in

(http://wordnet.princeton.edu/perl/webwn,

1786.

retrieved Jan 20, 2009). The banking section

differentiated under various categories with

is vital to any nation’s economy. It is of

each section comprising of branches. The

prime importance as it has a multiplier effect

entire history of the banking industry can be

on the economy. It also leverages on the

classified under three phases.

funds by issuing credit creation. The banking institution in India can be broadly divided into Scheduled and Non-Scheduled Banks. (For the hierarchical display of the banking structure, refer Exhibit 1.1)

The banking system has been

Phase I extends from the earlier time period till 1969. Phase II covers the period from the nationalization of the banks till before the implication of economic reforms. The Phase III covers the period from after the implication

till

present

date.(for

data

regarding the number of banks under various A bank is a financial institution which engages in the business of keeping money for savings and checking accounts or for exchange or for issuing loans and credit.

categories on a scale from 1985 to 2005, refer Exhibit 1.2). The banking sector before the economic reforms assumed a very traditional method of working. Phase III paved way for the advent of globalization, thereby changing the Indian banking scene.

THE PAST TREND OF THE INDIAN BANKING INDUSTRY For the past three decades, the Indian banking sector has had many credits under 2|I mp a ct o f Gl ob alisa ti o n o n The In di an B an king Se cto r

GLOBALISATION and THE INDIAN BANKING SYSTEM REFORM IMPLEMENTATION Prior to the nationalization of banks, the services were enjoyed by only the industrial urban

group.

14

banks

saw

the

nationalization in the year 1969 and six in 1980. Thus this led to a monopoly of government owned banks till the start of the 1990s. The banks faced a risk form factors like;

banking sector, in the year 1991. The reforms reviewed the system conforming to the expanding and emerging need of the

Indian

economy.

The

capital

adequacy norms, which required banks to have a risk-adjusted capital adequacy ratio to absorb risks, as per Basel I accord was also implemented at this

Need to maintain reserve,

time. The regulations that were brought

Interest rates

into effect are represented in Exhibit 1.3.

Lack of Competition

A second committee was appointed to

Political influence

suggest remedial measures for the sector

(Ramasastri

A.S

Samuel (2006),

&

Achamma

in the year 1998. The resultant reforms

RBI

Occasional

are shown in Exhibit 1.4. Accordingly, Basel II was also implemented in effect

papers)

from March 31, 2007. During the early 1990s, the government, under Narasimha Rao, adopted a policy of

The reforms have the reduced the

liberalization which paved the way for

amount of equity holdings in banks, but

private

in turn allowing them to access the

participation

(mergers

and

acquisitions) and foreign investors. The

capital

market

to

raise

phase of Indian banking from 1991 onwards

Recruitment policies have become more

was essentially a period of prudential

flexible with time allowing banks to

banking. The union government appointed a

access a talent pool of staff. In terms of

committee headed by Mr. Narasimha Rao to

operations, opening of branches has

study and formulate reforms within the

3| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

funds.

become much more feasible. The reforms

compared to the traditional security-based

have increased the participation of private as

lending.

well as foreign entities in terms of expansion

oriented rather than being commercially

of their operations

oriented

They

However,

as

are

an

more

development

implication

of

the

implementation of the reforms, the banks Risk Management along with the Capital Adequacy requirement has been one of the major effects of the Globalization which has lead to financial stability within the Indian banking Sector

experience a think spread as compared to an earlier healthy spread. Globalization created the ground for the creation

of

institutions

like

Credit

Information Bureau India Ltd., National Securities Corporation

Depositaries of

India

Ltd., Ltd.,

Clearing Central

Depositaries Services Ltd. The extent of within the country. This has increased the

investment within banks by foreign entities

level of competition faced by the public

and NRI deposits has been relaxed. The

banks, thereby pushing them to become

overseas investment limit for corporate has

more customer-oriented and thus offer

been extended to up to 100% of the net

services comparable to those of the private

profit. Maintenance of foreign currency

and foreign players. The post-globalisation

accounts is possible under the implication of

banking

the new reforms.

sector

has

diversified

their

businesses into various fields like insurance, credit cards, infrastructure financing, gold banking and leasing of assets. This product mix is offered on a customized basis to the consumers of the bank. The introduction of hi-tech technology has further enhanced the operations and made the whole process more accurate and faster. The banking sector is now more purpose and viability based as

Risk management in terms of capital adequacy has been of the most vital effects of globalization and reform implementation on the Indian banking sector. The capital adequacy ratio has been increased to 9% of risked assets. This has insured the fiscal stability within the banking system as it has increased the ability to face risks with liquidity.

4| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

Overall, the deregulation has thrown open

provided incentives for going international.

the banking sector to face not only internal

Foreign ventures are invited alongwith they

competition but also competition from other

getting a substantial investor’s share in the

financial market entities like mutual funds,

Indian banks. Mergers and acquisitions and

NBFCs and post office.

mergers face a favorable environment.

There would be a greater presence of international players in the Indian financial system and some of the Indian banks would become global players in the coming years (Indian

Banks’

Association,

“Banking

(Necessary reforms mentioned in Exhibits 1.4 and 1.5). The existing market has been thrown open for competition and has become more of a buyers’ market rather than being a sellers’ market.

Industry Vision 2010,” n.d). With the advent

A supportive regulatory framework provides

of the globalization, the banks not only face

aids for the banks to tap the global market.

competition from the external market but

V Leeladhar (2005) states certain steps

also from the internal environment, on

which have been undertaken to improve the

account of increased private players.

global opportunities. Prudential accounting

Even with the prospects of a bright global future, the present stance of the Indian banks is not very rosy amidst the top banks of the world. This weakens the proposition that the home banks can compete on an international level.

norms in relation to the asset classification, income

recognition

provisioning implemented. Effective

and

have The

Banking

loan

loss

already core

been

principles

Supervision,

of

Basel

Committee have been complied with by India. Accounts are being presented as per

As compared to the old 4-6-4 (Borrow at

the U.S GAAP. The government stake in

4%- Lend a 6%- Go Home at 4) ideology

certain public sector banks has been

(http://en.wikipedia.org/wiki/Bank,

reduced, thereby enhancing public equity..

Retrieved January 20, 2009), a globalised

These implementations have increased the

working has improved the way Indian banks

scope of overseas operations by the Indian

used

Banks.

to

encouraged

work.

The

Private

government and

has

Foreign

participation. Private banks have been

5| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

Universal Banking with Mergers and

Institution, IDBI has also adopted the same

Acquisitions

strategy, and has already transformed itself into a universal bank.

Banking industry is developing slowly and

Now the process of its progeny IDBI Bank

steadily and development of “large number

merging itself with the parent IDBI is

of small banks” to “small number of large

underway, and is likely to be completed

banks .” proves it. This new era is going to

soon. All these mergers and acquisitions

be one of consolidation around identified

may lead to promote the concept of financial

core competencies. Mergers and acquisitions

super market chain, making available all

in the banking sector are going to be the

types of credit and non fund facilities under

order of the day.

under one roof, i.e.under same organization.

Three years ago we saw the successful

Consolidated accounting and supervisory

merger of HDFC Bank and Times Bank and

techniques would have to evolve as there are

Stanchart

many risks in mergers and acquisition as

and

demonstrated

ANZ that

Grindlays. trend

It

towards

good will is also calculated

consolidation is almost an accepted fact. We can see such signs in respect of a number of old private sector banks, many of banks are unable to manage non performing assets which is main hindrance for development Coming times may usher in large banking institutions, if the development financial institutions commercial

go

for

banking

conversion by

into

following

recommendation of Narasimhan (II). In India, one of the largest financial institutions, ICICI, took the lead towards universal banking with its reverse merger with ICICI Bank coming through a couple of years ago. Another mega financial

6| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

FUTURE

CHALLENGES

OF

THE

INDIAN BANKING SECTOR (i) Improving profitability:

(iv) Sharpening skills:

In order to increase profitability, banks are required to take many decisions like strategy to compete with international players. The challenge for banks is management of thinning margins while, at the same time working to improve productivity which remains low in relation to global standards. (ii) Reinforcing technology :

To meet the increased competition and to manage risks, the demand for specialised banking functions, using IT as a competitive tool, is set to go up. Special skills in retail banking, treasury, risk management, foreign exchange, development banking, etc., will need to be carefully nurtured and built. (v) Greater customer orientation: In

Now a days technology has become an

today’s competitive environment, banks will

integral part of banking. So, advancement in

have to strive to attract and retain customers

technology

by

is

mandatory

for

the

introducing

innovative

products,

development of banking sector. Customers

enhancing the quality of customer service

have become very demanding and banks

and marketing a variety of products through

have to deliver customised products through

diverse

multiple

customer groups.

channels,

allowing

customers

access to the bank round the clock. (iii) Risk management:

channels

targeted

at

specific

(vi) Corporate governance: Besides using their strengths and strategic

In banking, extensive business gives rise to

initiatives for creating shareholder value,

more risk and to avoid all risks like credit

banks are required to be conscious of their

risk, market risk, and operational risk, banks

responsibilities

need

governance.

to

adopt

technology-driven

towards

management and information system.

7| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

corporate

(vii) International standards: Introduction of

internationally followed

best practices and observing universally acceptable standards and codes is necessary for strengthening the domestic financial architecture. In today’s globalised world, focusing on the observance of standards will help

smoother

integration with world

financial markets.

capabilities and products, but yet with this back-up, banks need to review their working and basic principles in order to reach a global

or

an

international

platform

sucessfully. In times of economic instability, factors like dollar volatility, lowering of reserve limits, flattening of a consumer boom, it would indeed be a challenge to the Indian

banking

sector

to

co-manage

profitability and achieving a global standard.

CONCLUSION With the entry of foreign players and increased competition, the banks have been pushed into a phase of self-realisation in order to improve profitability as well as their position in the market. This has lead to a diversification of the services to activities that are not traditionally institutional in nature. In light of the necessary need for the banks to go global, the possibility of their extension is difficult. Some of the potential banks do have the required human resource

8| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

EXHIBITS Exhibit 1.1

Source : www.wikipedia.org

Exhibit 1.2

Source : Ramasastri A.S & Achamma Samuel (2006), RBI Occasional papers

9| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

Exhibit 1.3

Exhibit 1.4

The Narsimha Committee Report (1991)

The Narsimha Committee Report (1998)

Reforms Listed

Reforms Listed

Lowering of SLR to 25% over a period of 5 years. CRR operational flexibility by RBI Phasing out of Directed credit program. Regulation of Interest rate. Minimum Capital Adequacy Ratio for banks. Asset valuation at realizable value. Uniform following of the accounting principles. No income recognition in terms of Non-Performing Assets. Asset classification to be followed as prescribed. Pre-Payment of the balance sheet according to the International Accounting standards. Tribunals for speedy recovery of debts. Establishing of Asset Reconstruction Funds. Encouragement of Mergers and Acquisitions. No further Nationalisation of Banks. Abolishment of licensing. Rationalizing of foreign operations of the Indian banks Organizational control over the internal management Encouragement of foreign banks Computerization of activities Provision of internal autonomy Avoidance of over-regulation

Source: RBI (1991): Narasimha Committee Report

Consideration of the Market and credit ratio Increase in Capital to Risk assets to 10% from 8%. Tapping of capital markets or Central government for bank funding. No further recapitalization of banks from Government budget. Target level of NPA for 2003 as below 3.1%. International recognition of 96 days for Income recognition Public availability to full disclosure Adaptation of risk management techniques Inception of new technology Close scrutiny of computer credit. Appointment of statutory auditor by the bank auditor. Conversion of financial institutions into banks over a period of time. Scope definition in terms of external and regional possibilities. Allowing the set-up of subsidiary joint ventures by foreign banks in India. Reform of the deposit insurance scheme. Review of the financial institutions.

Source: RBI (1998): Narasimha Committee Report

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BIBLIOGRAPHY Ramasastri A.S & Samuel Achamma (2006) : “Banking sector Developments In India, 19802005:What the Annual Accounts Speak?”, Reserve Bank of India Occasional Papers, Summer and Monsoon 2006 V Leeladhar (2005) : “Contemporary and Future Issues in Indian banking”, Speech in Kanara Chamber of Commerce and Industry, March 11 Reddy Y.V. (2005) : “Banking sector reforms in India : An Overview”, Reserve Bank of India Bulletin,June Reserve Bank of India (1991) : Report on the Financial System (Narasimha Committee report) Dr. K Sabrinath & Mrs. Sethu Ravi (n.d) : “Challenges and Opportunities Surging in the Recent Banking Scenario” Kapila Raj & Kapila Uma (1992) Banking, Financial Sector Reforms in India, Delhi Academic Foundation http://wordnetweb.princeton.edu/perl/webwn?s=banking, Retrieved January 20, 2009

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