MIS

                A Project Report

On

“PERFORMANCE OF BANKING SECTOR”

For the degree of

Master of Business Administration

Of

Punjab Technical University, Jalandhar

Submitted by:                        

RIMT-INSTITUTE OF MANAGEMENT AND TECHNOLOGY

MANDI GOBINDGARH. DISTT:FATHEGARH SAHIB

                          TABLE OF CONTENTS

                                                                                   PAGE NO.

CHAPTER 1

          INTRODUCTION TO BANK

The banking Companies Regulation Act of India 1949, defines banking as “The accepting for the purpose of lending or investment of deposits of money from public, repayable on demand or otherwise, withdrawal by cheques, draft or otherwise”. According to HORACE WHITE “The bank is manufacturer or credit and a machine for facilitating exchange”.

A bank is a commercial or state institution that provides financial services, including issuing money in form of coins, banknotes or debit cards, receiving deposits of money, lending money and processing transactions. A commercial bank accepts deposits from customers and in turn makes loans based on those deposits. Some banks (called Banks of issue) issue banknotes as legal tender. Many banks offer ancillary financial services to make additional profit; for example: selling insurance products, investment products or stock broking

Banks have a long history, and have influenced economies and politics for centuries. In history, the primary purpose of a bank was to provide liquidity to trading companies. Banks advanced funds to allow businesses to purchase inventory, and collected those funds back with interest when the goods were sold. For centuries, the banking industry only dealt with businesses, not consumers. Commercial lending today is a very intense activity, with banks carefully analysing the financial condition of its business clients to determine the level of risk in each loan transaction. Banking services have expanded to include services directed at individuals and risk in these much smaller transactions are pooled.

A bank generates a profit from the differential between what level of interest it pays for deposits and other sources of funds, and what level of interest it charges in its lending activities. This difference is referred to as the spread between the cost of funds and the loan interest rate. Historically, profitability from lending activities hasbeen cyclic and dependent on the needs and strengths of loan customers. In recenthistory, investors have demanded a more stable revenue stream and banks havetherefore placed more emphasis on transaction fees, primarily loan fees but alsoincluding service charges on array of deposit activities and ancillary services (international banking, foreign exchange, insurance, investments, wire transfers, etc.) However, lending activities still provide the bulk of a commercial bank's income. I

FUNCTIONS OF  BANKS

Banks are the guardians of the economy of the country. They regulate the credit and financial of the country. The two acid test functions of a bank are as follows.

1.ACCEPTING DEPOSITS

 The first main function of a bank is the acceptance of deposits. The public although the banks accept non-cehqueable also. It must accept chequeable deposits from the public. These are those deposits, which can be withdrawn by cheques distinguishing the banks from other financial institutes

This acceptance of chequeable deposits is a necessary function, but not a sufficient function. For example, post-office saving account accepts cheueable deposits but they do not perform other functions of a bank like lending of commercial loans as such distinguishing them from commercial banks. The various ways though which deposits are made in banks or types of deposits are made in banks or types of deposits are:

●Fixed deposit accounts

●Saving bank account

●Recurring deposits account

●Current account

  2. LENDING OR ADVANCING LOANS:

 Lending or advances of loans is another acid test function of commercial banks. A commercial bank must lend the deposits or  make advances to public directly or indirectly. Lending    must be on the basis of funds raised through acceptance of  deposits from the public. The usual modes adopts by banks to  make advances are:

 a). Overdraft                  

 b). Cash credit        

  c). Term loan

  d). Demand loans  

  3 .DEMAND LOANS

       Against existing securities

             Fixed deposits

             Indira vikas patras

             Kisan vikas patras

             Other Government securities

             Shares

              Life insurance policies

               Bonds and debentures

      4. OVERDRAFT:-

                 Against existing securities

                 Fixed deposits

                  Indira vikas patras

                      Kisan vikas patras

                      Other government securities

                       Shares

                        Life insurance policies

                       Bonds and debentures

5.CASH CREDIT

Cash credit facilities are a working capital facility granted for the purposes of meeting the working capital requirement of the borrower. It is granted against security of stocks, debts etc.Cash credit is a transaction account in which cheque book is issued and the borrower is able to withdraw up to the available drawing power /limit in the account.

6. TERM LOANS:-

Term loans are granted by the bank for several purposes, it can  be secured as well as unsecured Term loan may be granted under different segments as under :Agriculture Crop loans,Tractor,Impements,agri-Cultural machinery, Live stocks, Land devolement,     Horticulture, plantation etc.Industry: Plant and machinery, Vehicles, Contructions work, Furniture and Fitting, Equipments.Traders and Professionals: Office equipments, Vehicles, Furniture and Fitting etc.Transporters: Commercial Vehicles.Retail: Two Wheelers, Cars, Personal loans, Home loans, Consumer loans etc.

TYPES OF BANKS

CHAPTER 2

 INDIAN BANKING SECTOR — AN OVERVIEW

The Indian banking system is characterized by a large number of banks with mixed

 ownership.2 The commercial banking segment comprises 27 public sector banks in which

 theGovernment has majority ownership, 40 private sector banks, and 33 foreign banks

Totalbank assets constituted a little over 70 percent of GDP in 2003-04. Public sector banks

 had75 percent of the assets of the banking system in 2003-04, while private and foreign

banksheld 25 percent. In 1991, by comparison, public sector banks’ share of the total assets

of thebanking system was a little over 90 percent

.

BANKING SYSTEM IN INDIA:

Banking system occupies an important place in nation economy. In present day’s world, banking institutions have become indispensable. They play a pivotal role in the economic development of a country and upliftment of society. Banks are playing an important role in the nation’s economy. In India, though the Money market is still characterized by the existence of both the organized and unorganized segments, institution in the organized money market have grown significantly and are playing an increasingly important role. The unorganized sector compromising the money lender and indigenous bankers caters to the person’s economic needs especially in country side. Amongst the institutions in the organized sector money market, Commercial Banks and Cooperative Banks have been in existence for the past several decades and now they are being considered as the nerve center of the economy. Banking plays a very important role in the economic development of the people. Now-a-days we can not dream of any business without banking assistance. This is reason the banks are remarked as life-blood of modern economy. Centurion banks are a new concept in the banking system and these banks are playing their role for the development of the semi-urban and ruler areas. The Indian economy is characterized by the escalating trends towards the usage of banking products and services both the rural and urban markets.        

Banking in India originated in the first decade of 18th century with The General Bank of India coming into existence in 1786. This was followed by Bank of Hindustan. Both these banks are now defunct. The oldest bank in existence in India is the State Bank of India being established as "The Bank of Bengal" in Calcutta in June 1806. A couple of decades later, foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that point of time, Calcutta was the most active trading port, mainly due to the trade of the British Empire, and due to which banking activity took roots there and prospered. The first fully Indian owned bank was the Allahabad Bank, which was established in 1865.

By the 1900s, the market expanded with the establishment of banks such as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai - both of which were founded under private ownership. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from 1935. After India's independence in 1947, the Reserve Bank was nationalized and given broader powers.

Indian banking system, over the years has gone through various phases after establishment of Reserve Bank of India in 1935 during the British rule, to function as Central Bank of the country. Earlier to creation of RBI, the central bank functions were being looked after by the Imperial Bank of India. With the 5-year plan having acquired an important place after the independence, the Govt. felt that the private banks may not extend the kind of cooperation in providing credit support, the economy may need. In 1954 the All India Rural Credit Survey Committee submitted its report recommending creation of a strong, integrated, State-sponsored, State-partnered commercial banking institution with an effective machinery of branches spread all over the country. The recommendations of this committee led to establishment of first Public Sector Bank in the name of State Bank of India on July 01, 1955 by acquiring the substantial part of share capital by RBI, of the then Imperial Bank of India. Similarly during 1956-59, as a result of re-organisation of princely States, the associate banks came into fold of public sector banking.

Another evaluation of the banking in India was undertaken during 1966 as the private banks were still not extending the required support in the form of credit disbursal, more particularly to the unorganised sector. Each leading industrial house in the country at that time was closely associated with the promotion and control of one or more banking companies. The bulk of the deposits collected, were being deployed in organised sectors of industry and trade, while the farmers, small entrepreneurs, transporters , professionals and self-employed had to depend on money lenders who used to exploit them by charging higher interest rates. In February 1966, a Scheme of Social Control was set-up whose main function was to periodically assess the demand for bank credit from various sectors of the economy to determine the priorities for grant of loans and advances so as to ensure optimum and efficient utilisation of resources. The scheme however, did not provide any remedy. Though a no. of branches were opened in rural area but the lending activities of the private banks were not oriented towards meeting the credit requirements of the priority/weaker sectors.

On July 19, 1969, the Govt. promulgated Banking Companies (Acquisition and Transfer of Undertakings) Ordinance 1969 to acquire 14 bigger commercial bank with paid up capital of Rs.28.50 cr, deposits of Rs.2629 cr, loans of Rs.1813 cr and with 4134 branches accounting for 80% of advances. Subsequently in 1980, 6 more banks were nationalised which brought 91% of the deposits and 84% of the advances in Public Sector Banking. During December 1969, RBI introduced the Lead Bank Scheme on the recommendations of FK Nariman Committee.

Meanwhile, during 1962 Deposit Insurance Corporation was established to provide insurance cover to the depositors.

In the post-nationalisation period, there was substantial increase in the no. of branches opened in rural/semi-urban centres bringing down the population per bank branch to 12000 appx. During 1976, RRBs were established (on the recommendations of M. Narasimham Committee report) under the sponsorship and support of public sector banks as the 3rd component of multi-agency credit system for agriculture and rural development. The Service Area Approach was introduced during 1989.

While the 1970s and 1980s saw the high growth rate of branch banking net-work, the consolidation phase started in late 80s and more particularly during early 90s, with the submission of report by the Narasimham Committee on Reforms in Financial Services Sector during 1991.

In these five decades since independence, banking in India has evolved through four distinct phases:

Foundation phase can be considered to cover 1950s and 1960s till the nationalisation of banks in 1969. The focus during this period was to lay the foundation for a sound banking system in the country. As a result the phase witnessed the development of neces sary legislative framework for facilitating re-organisation and consolidation of the banking system, for meeting the requirement of Indian economy. A major development was transformation of Imperial Bank of India into State Bank of India in 1955 and nationalisation of 14 major private banks during 1969.

Expansion phase had begun in mid-60s but gained momentum after nationalisation of banks and continued till 1984. A determined effort was made to make banking facilities available to the masses. Branch network of the banks was widened at a very fast pace covering the rural and semi-urban population, which had no access to banking hitherto. Most importantly, credit flows were guided towards the priority sectors. However this weakened the lines of supervision and affected the quality of assets of banks and pressurized their profitability and brought competitive efficiency of the system at low ebb.

Consolidation phase: The phase started in 1985 when a series of policy initiatives were taken by RBI which saw marked slowdown in the branch expansion. Attention was paid to improving house-keeping, customer service, credit management, staff productivity and profitability of banks. Measures were also taken to reduce the structural constraints that obstructed the growth of money market.

Reforms phase The macro-economic crisis faced by the country in 1991 paved the way for extensive financial sector reforms which brought deregulation of interest rates, more competition, technological changes, prudential guidelines on asset classification and income recognition, capital adequacy, autonomy packages etc.

BANK NATIONALISATION & PUBLIC SECTOR BANKING 

Organised banking in India is more than two centuries old. Till 1935 all the banks were in private sector and were set up by individuals and/or industrial houses which collected deposits from individuals and used them for their own purposes. In the absence of any regulatory framework, these private owners of banks were at liberty to use the funds in any manner, they deemed appropriate and resultantly, the bank failures were frequent.

Move towards State ownership of banks started with the nationalisation of RBI and passing of Banking Companies Act 1949. On the recommendations of All India Rural Credit Survey Committee, SBI Act was enacted in 1955 and Imperial Bank of India was transferred to SBI. Similarly, the conversion of 8 State-owned banks (State Bank of Bikaner and State Bank of Jaipur were two separate banks earlier and merged) into subsidiaries (now associates) of SBI during 1959 took place. During 1968 the scheme of ‘social control’ was introduced, which was closely followed by nationalisation of 14 major banks in 1969 and another six in 1980.

Keeping in view the objectives of nationalisation, PSBs undertook expansion of reach and services. Resultantly the number of branches increased 7 fold (from 8321 to more than 60000 out of which 58% in rural areas) and no. of people served per branch office came down from 65000 in 1969 to 10000. Much of this expansion has taken place in rural and semi-urban areas. The expansion is significant in terms of geographical distribution. States neglected by private banks before 1969 have a vast network of public sector banks. The PSBs including RRBs, acount for 93% of bank offices and 87% of banking system deposits.

1. Early history: The first fuuly indian owned bank was the ALLAHABAD Bank,established in 1865.At the end of late-18th century, there were hardly any bank in India in the modern sense of the term. At the time of the American Civil War, a void was created as the supply of cotton to Lancashire stopped from the Americas. Some banks were opened at that time which functioned as entities to finance industry, including speculative trades in cotton. With large exposure to speculative ventures, most of the banks opened in India during that period could not survive and failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century.

The Bank of Bengal, which later became the State Bank of India.

At the beginning of the 20th century, Indian economy was passing through a relative period of stability. Around five decades have elapsed since the India's First war of Independence, and the social, industrial and other infrastructure have developed. At that time there were very small banks operated by Indians, and most of them were owned and operated by particular communities. The banking in India was controlled and dominated by the presidency banks, namely, the Bank of Bombay, the Bank of Bengal, and the Bank of Madras - which later on merged to form the Imperial Bank of India, and Imperial Bank of India, upon India's independence, was renamed the State Bank of India. There were also some exchange banks, as also a number of Indian joint stock banks. All these banks operated in different segments of the economy. The presidency banks were like the central banks and discharged most of the functions of central banks. They were established under charters from the British East India Company. The exchange banks, mostly owned by the Europeans, concentrated on financing of foreign trade. Indian joint stock banks were generally under capitalized and lacked the experience and maturity to compete with the presidency banks, and the exchange banks. There was potential for many new banks as the economy was growing. Lord Curzon had observed then in the context of Indian banking: "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments."

Under these circumstances, many Indians came forward to set up banks, and many banks were set up at that time, and a number of them set up around that time continued to survive and prosper even now like Bank of India and Corporation Bank, Indian Bank, Bank of Baroda, and Canara Bank.By the 1900’s the market expanded with the establishment of banks such as Punjab National Bank in 1895 in lahore and in BANK OF INDIA in 1906,in mumbai which were founded under private ownership. PUNJAB NATIONAL BANK is the first SWADESHI bank founded by the leaders like Lala Lajpat Rai, Sardar Dyal Singh Majithia.The Swadeshi Movement in particular inspired local businessman and political figures to find banks of and for the Indian community.A number of banks established then have survived to the present such as BANKOF INDIA,CORPORATION BANK,INDIAN BANK,BANK OF BARODA,CANARA BANK AND CENTRAL BANK OF INDIA.

2. During the Wars : The period during the First World War (1914-1918) through the end of the Second World War (1939-1945), and two years thereafter until the independence of India were challenging for the Indian banking. The years of the First World War were turbulent, and it took toll of many banks which simply collapsed despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed during the years 1913 to 1918 as indicated in the following table:

3. Post-independence: The partition of India in 1947 had adversely impacted the economies of Punjab and West Bengal, and banking activities had remained paralyzed for months. India's independence marked the end of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included:

• In 1948, the Reserve Bank of India, India's central banking authority, was nationalized, and it became an institution owned by the Government of India.
• In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India."
• The Banking Regulation Act also provided that no new bank or branch of an existing bank may be opened without a licence from the RBI, and no two banks could have common directors.

However, despite these provisions, control and regulations, banks in India except the State Bank of India, continued to be owned and operated by private persons. This changed with the nationalization of major banks in India on 19th July, 1969.

4. Nationalisation: By the 1960s, the Indian banking industry has become an important tool to facilitate the development of the Indian economy. At the same time, it has emerged as a large employer, and a debate has ensued about the possibility to nationalize the banking industry. Indira Gandhi, the-then Prime Minister of India expressed the intention of the GOI in the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalisation." The paper was received with positive enthusiasm. Thereafter, her move was swift and sudden, and the GOI issued an ordinance and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies (Acquition and Transfer of Undertaking) Bill, and it received the presidential approval on 9th August, 1969.

A second dose of nationalisation of 6 more commercial banks followed in 1980. The stated reason for the nationalisation was to give the government more control of credit delivery. With the second dose of nationalisation, the GOI controlled around 91% of the banking business of India.

After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy.

5.  Liberalisation: In the early 1990s the then Narasimha Rao government embarked on a policy of liberalisation and gave licences to a small number of private banks, which came to be known as New Generation tech-savvy banks, which included banks such as UTI Bank (the first of such new generation banks to be set up), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, kickstarted the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks.

The next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%,at present it has gone up to 49% with some restrictions.

The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks.All this led to the retail boom in India. People not just demanded more from their banks but also received more.

6. Current scenario: (2007), overall, banking in India is considered as fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. Even in terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets-as compared to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility-without any stated exchange rate-and this has mostly been true.

With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector, the demand for banking services-especially retail banking, mortgages and investment services are expected to be strong. M&As, takeovers, asset sales and much more action (as it is unravelling in China) will happen on this front in India.

In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them.

Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

CHAPTER 3

Banking Sector Developments in Indi:1980-2005:

.

Banking sector in India is currently passing through an exciting and challenging

phase. The reform measures have brought about sweeping changes in this vital sector

of the country's economy. This paper is an attempt to study the trends in important

banking indicators for the 25-year period from 1980 to 2005. Analysing the data from

balance sheets of banks, the paper draws some important conclusions for the banking

sector as a whole as well as for different bank groups.

Introduction

The banking system is central to a nation’s economy. Banks are special as they not only

accept and deploy large amounts of uncollateralized public funds in a fiduciary capacity,

but also leverage such funds through credit creation. In India, prior to nationalization,

banking was restricted mainly to the urban areas and neglected in the rural and semi-urban

 areas. Large industries and big business houses enjoyed major portion of the credit facilities

 Agriculture, small-scale industries and exports did not receive the deserved attention.

Therefore, inspired by a larger social purpose, 14 major banks were nationalised in 1969 and

 six more in 1980. Since then the banking system in India has played a pivotal role in the Indian

  economy, acting as an instrument of social and economic change.The rationale behind  bank

 nationalisation has been succinctly put forth by eminent bankers:

“Many bank failures and crises over two centuries, and the damage they did under laissez faire

conditions; the needs of planned growth and equitable distribution of credit, which in privately

owned banks was concentrated mainly on the controlling industrial houses and influential

borrowers; the needs of growing small scale industry and farming regarding finance, equipment

and inputs; from all these there emerged an inexorable demand for banking legislation, some

government control and a central banking authority, adding up, in the final analysis, to social

 control and nationalisation” (Tandon,1989).Post nationalisation, the Indian banking system

registered tremendous growth in volume. Despite the undeniable and multifold gains of bank

 nationalization, it may be noted that the important financial institutions were all state owned and

were subject to central direction and control. Banks enjoyed little autonomy as both lending

and deposit rates were controlled until the end of the 1980s. Although nationalisation of banks

helped in the spread of banking to the rural and hitherto uncovered areas, the monopoly granted to

the public sector and lack of competition led to overall inefficiency and low productivity. By 1991,

 the country’s financial system was saddled with an inefficient and financially unsound banking

sector. Some of the reasons for this were

1. high reserve requirements,

2. administered interest rates,

3.  directed credit and

4.   lack of competition

5.   political interference and corruption

.

 As recommended by the Narasimham Committee Report (1991) several reform measures were

introduced which included reduction of reserve requirements, de-regulation of interest rates,

introduction of prudential norms, strengthening of bank supervision and improving the

 competitiveness of the system, particularly by allowing entry of private sector banks. With a

 view to adopting the Basel Committee (1988) framework on capital adequacy norms, the

 Reserve Bank introduced a risk-weighted asset ratio system for banks in India as a capital

 adequacy measure in 1992. Banks were asked to maintain risk-weighted capital adequacy ratio

 initially at the lower level of 4 per cent, which was gradually increased to 9 per cent. Banks were

  also directed to identify problem loans on their balance sheets and make provisions for bad loans

   and bring down the burgeoning problem

BANKING SECTOR DEVELOPMENTS IN INDIA WITH RESPECT TO BASEL II

Globalisation and financial innovation have over the last two decades or more multiplied and

diversified the risks carried by the banking system. In response, the regulation of banking in

the developed industrial countries has increasingly focused on ensuring financial stability, at

the expense of regulation geared to realising growth and equity objectives. The appropriateness

of this move is being debated even in the developed countries, which in any case are at a

completely different level of development of their economies and of the extent of financial

deepening and intermediation as compared to the developing world.

Despite this and the fact that in principle the adoption of the core principles for effective

banking supervision issued by the Basel Committee on Banking Supervision is voluntary, India

like many other emerging market countries adopted the Basel I guidelines and has now decided

to implement Basel II.

India had adopted Basel I guidelines in 1999. Subsequently, based on the recommendations of

a Steering Committee established in February 2005 for the purpose, the Reserve Bank of India

had issued draft guidelines for implementing a New Capital Adequacy Framework, in line with

Basel II.

At the centre of these guidelines is an effort to estimate how much of capital assets of specified

kinds should banks hold to absorb losses. This requires some assessment of likely losses that

may be incurred and deciding on a proportion of liquid assets that banks must have at hand to

meet those losses in case they are incurred. This required regulatory capital is defined in terms

"tiers" of capital that are characterised by differing degrees of liquidity and capacity to absorb

losses. The highest, Tier I, consists principally of the equity and recorded reserves of the bank.

Three pillars

Under Basel I, risk-weights for different kinds of assets were pre-decided by the regulator and

the regulatory capital required, measured on this basis, 8 per cent of the risk-weighted value of

assets. In the transition to Basel II, risk-weights were linked to the external ratings by

accredited rating agencies of some of these assets. Finally, banks were to be allowed to develop

their own internal ratings of different assets and risk-weight them based on those ratings. This

gives greater freedom to individual banks to assess their own economic capital after taking

account of risks, resulting in a degree of regulatory forbearance.

This is the first pillar of Basel II. The second pillar is concerned with the supervisory review

process by national regulators for ensuring comprehensive assessment of the risks and capital

adequacy of their banking institutions. The third pillar provides norms for disclosure by banks

of key information regarding their risk exposures and capital positions and aims at improving

market discipline. In India, the RBI had initially specified that the migration to Basel II will be

effective March 31, 2007, though it expected banks to adopt only the rudimentary Standardised

Approach for the measurement of credit risk and the Basic Indicator Approach for the

assessment of operational risk. The Standardised Approach fixes risk-weights linked to

external credit assessments, and then weights them using these fixed weights. The Basic

Indicator Approach prescribes a capital charge of 15 per cent of the average gross income for

the preceding three years to cover operational risk. Over time, as risk management skills

improve, some banks were to be allowed to migrate to the Internal Ratings Based approach for

credit risk measurement.

Deadline extended

The deadline for implementing Basel II, originally set for March 31, 2007, has now been

extended. Foreign banks in India and Indian banks operating abroad are to meet those norms

by March 31, 2008, while all other scheduled commercial banks will have to adhere to the

guidelines by March 31, 2009. But the decision to implement the guidelines remains

unchanged. This is true even though the international exposure of even the major Indian banks

is still limited. As far back as 2003, the then chairman of the State Bank of India, the country's

largest commercial bank, had declared that his institution has committed itself to becoming a

Basel-II compliant bank, even though the RBI had taken a view that only Indian banks that get

20 per cent of their business from abroad need to follow the Basel-II norms. At that time SBI's

international operations contributed just about 6 per cent of its business.

Effect of implementation

This raises the question as to what effects the implementation would have on the structure of

banking in India. It needs to be noted, however, that Basel II allows national regulators to

specify risk weights different from the internationally recommended ones for retail exposures.

The RBI had, therefore, announced an indicative set of weights for domestic corporate long-

term loans and bonds subject to different ratings by international rating agencies such as

Moody's Investor Services which are slightly different from that specified by the Basel

Committee  

Since the loans and advances portfolios of India banks largely covers un-rated entities that are

assigned a risk weight of 100 per cent, the impact of the lower risk weights assigned to higher

rated corporates would not be significant. However, given the investments into higher rated

corporates in the bonds and debentures portfolio of the banks, the risk weighted corporate

assets measured using the standardised approach may be subject to marginally lower risk

weights as compared with the 100 per cent risk weights assigned under Basel I (ICRA 2005).

In the case of retail exposure, which is the growth segment in the asset structure of most Indian

banks post-liberalisation, the RBI has gone with the lower 75 per cent risk weight prescribed

under Basel II norms, as against the currently applicable risk weights of 125 per cent and 100

per cent for personal/credit card loans and other retail loans respectively. This is likely to

accentuate the current tendency to diversify out of productive lending characterising Indian

banks The other benefit that Indian banks can exploit is the fact that they have a large short-

term portfolio in the form of cash credit, overdraft and working capital demand loans, which

are currently un-rated, and carry a risk weight of 100 per cent. They also have short-term

investments in commercial papers in their investment portfolio, which also currently carry a

100 per cent risk weight.

Lower Risk Weights

The RBI's draft capital adequacy guidelines provide for lower risk weights for short-tem

exposures, if these are rated (Table 2). This would allow banks to benefit from their

investments in commercial paper (which are typically rated in A1+/A1 category) and give them

the potential to exploit the proposed short-term credit risk weights by obtaining short-term

ratings for exposures in the form of cash credit, overdraft and working capital loans.

The net result is that the implementation of Basel II does provide Indian banks the opportunity

to significantly reduce their credit risk weights and reduce their required regulatory capital, if

they suitably adjust their portfolio by lending to rated but strong corporates, increase their retail

lending and provide mortgage under loans with higher margins. This would, of course, change

the proportion of lending in their portfolio and the direction of their lending. But, even if they

do not resort to that change, ICRA estimates that the implementation of Basel II would result in

marginally lower credit risk weights and a marginal release in regulatory capital needed for

credit risk.

However, the same does not hold for operational risk. The Basic Indicator approach specifies

that banks should hold capital charge for operational risk equal to the average of the 15 per

cent of annual positive gross income over the past three years, excluding any year when the

gross income was negative. Gross income is defined as net interest income and non-interest

income, grossed for any provisions, unpaid interest and operating expenses (such as fees paid

for outsourced services). It should only exclude treasury gains/losses from banking book and

other extraordinary and irregular income (such as income from insurance).

Dealing with bad debt

Besides this, the exact amount of capital that banks would need would depend on the legacy of

bad debt or non-performing assets they carry. Much of the discussion on Basel II is based on

the presumption that the problem of bad debt has been substantially dealt with. In the recent

past, banks have been able to reduce their provisioning needs by adjusting their non-

performing assets. The proportion of total NPAs to total advances declined from 23.2 per cent

in March 1993 to 7.8 per cent in March, 2004.

Among the many routes that were pursued to deal with the accumulating bad debt legacy, there

were some that received special attention. The first and most obvious route was to set aside

potential profits as provisions for bad assets. Banks have gone part of the way in this direction.

The cumulative provisions against loan losses of public sector banks (PSBs) worked out to

42.5 per cent of the gross NPAs for the year that ended on 31 March 2002 while international

norms are as high as 140 per cent. Subsequently, scheduled commercial banks (SCBs) raised

provisions towards NPAs by as much as 40 per cent in 2003-04. By the end of 2003-04,

cumulative provisions of SCBs accounted for 56.6 per cent of gross NPAs.

The second was infusion of capital by the government into PSBs. It is estimated that the

government had injected a massive Rs 20,446 crore towards recapitalisation of PSBs till end-

March 1999 to help them fulfil the new capital adequacy norms.

Subsequently, the S. P. Talwar and Verma committees set up by the Finance Ministry had

recommended a two-stage capitalisation for three weak banks (Indian Bank, United Bank of

India and United Commercial Bank) involving infusion of a total of Rs 2,300 crore for shoring

up their capital adequacy ratios. Similar infusion arrangements have been under way in the

case of financial institutions such as the IDBI and IFCI and in the bailing out of UTI, involving

large sums of taxpayers' money.

Finally, there are efforts to retrieve as much of these assets as possible from defaulting clients,

either by directly attaching the borrowers' assets and liquidating them to recover dues or by

transferring NPAs to specialised asset reconstruction or asset management companies. The

government tried to facilitate recovery through the ordinance issued in June 2002, which was

subsequently replaced by the Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Bill passed in November 2002.

It should be obvious that of the above ways to deal with the legacy of NPAs, the first two are

means that involves putting good money in to adjust for bad money, pre-empting the additional

resources that the banks and the government can put into the system. It was only the third,

involving a change in the legal framework governing the relations between lenders and

borrowers, which involved penalties on the defaulting borrowers. However, it is here that the

progress has been slow.

Requirement of additional capital

Thus, there is reason to believe that the improvement in terms of NPAs has been largely the

result of provisioning or infusion of capital. This meant that if the banks required more capital,

as they would to implement Basel II norms, they would have to find capital outside of

their own or the government's resources.

In ICRA's estimates, Indian banks would need additional capital of up to Rs 120 billion

(12,000 crore) to meet the capital charge requirement for operational risk under Basel II. Most

of this capital would be required by PSBs (Rs 90 billion, or Rs 9,000 crore), followed by the

new generation private sector banks (Rs 11 billion, or Rs 1,100 crore), and the old generation

private sector bank (Rs 7.5 billion, or Rs 750 crore).

In ICRA's view, given the asset growth witnessed in the past and the expected growth trends,

the capital charge requirement for operational risk would grow 15-20 per cent annually over

three years, which implies that the banks would need to raise Rs 180-200 billion (Rs 18,000-

20,000 crore) over the medium term.

In practice, to deal with this, a large number of banks have been forced to turn to the capital

market to meet their additional regulatory capital requirements. ICICI Bank, for example, has

raised around Rs 35 billion (Rs 3,500 crore), thus improving its Tier I capital significantly.

Many of the PSBs, namely, Punjab National Bank, Bank of India, Bank of Baroda and Dena

Bank, besides private sector banks such as UTI Bank have either already tapped the market or

have announced plans to raise equity capital in order to boost their Tier I capital.

The need to go public and raise capital has begun to challenge the current structure of

government policy aimed at restricting concentration of share ownership, maintaining public

dominance and limiting foreign influence in the banking sector. One immediate fallout was

that PSBs are being permitted to dilute the government's stake to 51 per cent, and the pressure

to reduce this to 33 per cent is increasing. Secondly, the government has allowed private banks

to expand equity by accessing capital from foreign investors.

There have been two consequences of this decision. First, it is putting pressure on the RBI to

rethink its policy on the ownership structure of domestic banks. In the past the Reserve Bank

has emphasised the risks of concentrated foreign ownership of banking assets in India.

Subsequent to the March 5, 2004, notification issued by the Ministry of Commerce and

Industry, which had raised the FDI limit in private sector banks to 74 per cent under the

automatic route, a comprehensive set of policy guidelines on ownership of private banks was

issued by the RBI on July 2, 2004. These guidelines stated, among other things, that no single

entity or group of related entities would be allowed to hold shares or exercise control, directly

or indirectly, in any private sector bank in excess of 10 per cent of its paid-up capital.

Recognising that the March 5 notification by the Union Government had hiked foreign

investment limits in private banking to 74 per cent, the guidelines sought to define the ceiling

as applicable on aggregate foreign investment in private banks from all sources (FDI, Foreign

Institutional Investors, Non-Resident Indians), and in the interest of diversified ownership, the

percentage of FDI by a single entity or group of related entities was restricted to 10 per cent.

This made the norms with regard to FDI correspond to the 10 per cent cap on voting rights.

The RBI's position was based on its view regarding the advantages of diversified ownership of

banks. Despite these strong views the RBI is under pressure to permit appropriate amending

legislation to the Banking Regulation Act, 1949, in order to provide that the economic

ownership of investors is reflected in the voting rights. On February 28, 2005, the Reserve

Bank released a roadmap for the presence of foreign banks in India. The RBI notification

formally adopted the guidelines issued by the Ministry of Commerce and Industry on March 5,

2004, which had raised the FDI limit in private sector banks to 74 per cent under the automatic

route, and went on to spell out the steps that would operationalise these guidelines. According

to those steps, starting April 2009 the RBI would allow much greater freedom to foreign banks.

Expectations are that if and when this transition occurs there would be a rapid increase in the

presence of foreign capital in the banking sector. This is because, using the benefit of an

`aggregate ownership' ceiling well in excess of 50 per cent in private banks and the relaxation

of rules governing FIIs meant foreign firms have been acquiring substantial stakes in Indian

banks.

The process of liberalisation keeps alive expectations that the caps on FDI in different sectors

would be relaxed over time, providing the basis for foreign control. Thus, acquisition of shares

through the FII route today paves the way for the sale of those shares to foreign players

interested in acquiring companies as and when the demand arises and/or FDI norms are

relaxed. This creates the ground for speculative forays into the Indian market. Figures relating

to end-December 2005 indicate that the shareholding of FIIs varied between 49 per cent in the

case of ICICI Bank to as much as 66 per cent in the case of the Housing Development Finance

Corporation.

Growing Pressure

A concomitant of this tendency has been growing pressure to consolidate domestic banks to

make them capable of facing international competition. Indian banks are pigmies compared

with the global majors. India's biggest bank, the State Bank of India, which accounts for one-

fifth of the total banking assets in the country, has an asset base (end-2006) of $84 billion

(Bandyopadhyay, Business Standard Banking Annual 2006). It is roughly one-fifth as large as

the world's biggest bank - Citigroup - on the basis of Tier I capital. Citigroup's consolidated

Tier I capital in 2006 was $79 billion compared to SBI's $7.9 billion. Given this difference,

even after consolidation of domestic banks, the threat of foreign takeover remains if FDI policy

with respect to the banking sector is relaxed.

Not surprisingly, a number of foreign banks have already evinced an interest in acquiring a

stake in Indian banks. Thus, it appears that foreign bank presence and consolidation of banking

are inevitable post Basel II. They are, in fact, part and parcel of a two-track approach for

`further enhancing efficiency and stability to the best global standards.' To quote the RBI: "One

track is consolidation of the domestic banking system in both public and private sectors. The

second track is gradual enhancement of the presence of foreign banks in a synchronised

manner."

OTHER DEVELOPMENTS

The period 1992-97 laid the foundations for reform in the banking system (Rangarajan, 1998). The

second Narasimham Committee Report (1998) focussed on issues like strengthening of the

banking system, upgrading of technology and human resource development.. They are expected to

adopt the standardised approach for credit risk and the basic indicator approach for operational risk

 After adequate skills are developed, both at the banks and at the supervisory levels, some banks

 may be allowed to migrate to the internal rating based (IRB) approach (Reddy 2005).At present,

 banks in India are venturing into non-traditional areas and generating income through diversified

 activities other than the core banking activities. Strategic mergers and acquisitions are being

 explored and implemented. With this, the banking sector is currently on the threshold of an

exciting phase.Against this backdrop, this paper endeavours to study the important banking

 indicators for the last 25-year period from 1981 to 2005. These indicators have been broadly

grouped into different categories, viz., (i) number of banks and offices (ii) deposits and credit

(iii) investments (iv) capital to risk-weighted assets ratio (CRAR) (v) non performing assets

 (NPAs) (vi) Income composition (vii)Expenditure composition (viii) return on assets (ROAs) and

 (ix) some select ratios. Accordingly, the paper discusses these banking indicators in nine sections

 in the same order as listed above. The paper concludes in section X by drawing important

inferences from the trends of these different banking parameters.

Section I

Number of Banks and Offices

The number of offices of all scheduled commercial banks almost doubled from 29,677 in 1980 to

 55,537 in 2005. This rapid increase in the number of bank offices is observed in the case of all the

 bank groups. However, the number of banks in the case of foreign bank group and domestic

 private sector bank group decreased from 42 in 2000 to 31 in 2005 and from 33 in 2000 to 29 in

2005, respectively.This fall in the number of banks is reflective of the consolidation process and,

in particular, the mergers and acquisitions that are the order of the banking system at present

.

Section II

Deposits and Credit

II.1 Credit Deposit Ratio

The credit-deposit ratio (C-D ratio) provides an indication of the extent of credit deployment for

every unit of resource raised in the form of deposits. The C-D ratios of all scheduled commercial

banks decreased gradually from 63.3 per cent in 1980 to 49.3 per cent in 2000. This declining

trend has been reversed in the recent years, with the ratio increasing to 62.7 per cent in 2005. The

foreign bank group recorded the highest C-D ratio (87.1 per cent) and State Bank Group the lowest

(56.3 per cent) in 2005)

II.2 Per Office Deposits and Credit

The overall business of foreign banks per office is higher than the per office business of other bank

 groups. Across the board, the per office deposits are more than the per office credit as expected.

With respect to all scheduled commercial banks, deposits per office increased from Rs.1.4 crore

 1980 to Rs. 33 crore in 2005 and credit per office also increased from Rs. 0.9 crore to Rs. 20.7

 crore during the same period

II.3 Type-wise Deposits

Over the years, there has been a shift in the composition of deposits. While the savings bank

deposits of all scheduled commercial banks remained more or less constant at around one

fourth of the total deposits, term deposits increased from 55.1 per cent in 1980 to 63.0 per cent in

2005. On the other hand, demand deposits fell from 19.7 per cent in 1980 to 12.8 per cent in 2005.

More or less similar trend is observed for both State Bank Group and also for the nationalised bank

group. In the case of foreign banks and domestic private sector bank groups, the pattern in the

composition of deposits differs from that of the public sector banks.In the case of foreign banks,

demand deposits, which formed 25.7 per cent in 1980, increased to 30.1 per cent in 2005. The

share of savings bank deposits in total deposits of foreign banks, decreased from 21.5 per cent in

1980 to 9.9 per cent in 2000. This share was 17.9 per cent in 2005. The analysis shows that more

funds of shortterm nature are parked with the foreign banks group. This may be an indication that

the business class is attracted towards better service offered by foreign banks. In the case of

domestic private sector bank group, while the composition of demand deposits did

not vary much over the 25-year period, the share of savings deposits fell from 26.8 per cent in

1980 to 16.0 percent in 2005, whereas term deposits increased from 56.7 per cent to 69.5 per cent

over the same period. Even though bank deposit rates are low, people prefer to park major portion

of their funds in the form of term deposits because of the risk free returns and assured returns it

provides. We can infer that the interest rate structure has definitely influenced the maturity

structure of bank deposits. For example, since the year 2000, the share of term deposits to total

deposits declined across bank groups except for State Bank group. The deposit rates of 1 to

3 yrs maturity show that there is a clear fall in the rates since 2000.

II.4 Bank Group-wise Share in Deposits

The bank group-wise share in deposits of scheduled commercial banks depicts that nationalised

bank group contributed more than 50 per cent in the total deposits mobilised by all scheduled

commercial banks in the year 2005. This share dropped from 64.4 per cent in 1980 to 50.7 per cent

in 2005. The share of deposits of State Bank group remained more or less constant during the 25-

year period constituting a little more than one fourth of the total deposits by all scheduled

commercial banks. State Bank group is successful in holding on to its percentage share of deposits

in total deposits of all scheduled commercial banks. However, nationalised bank group is seen to

be slipping in this area. The share of foreign bank group in total deposits is showing increasing

trend. The share of foreign banks increased from 2.9 per cent to 4.7 per cent and in the case of

domestic private sector banks, it increased from 5.3 per cent in 1980 to 17.0 per cent in 2005. This

shows that banks in the private sector have taken a head start in the deposit mobilisation after the

liberalization measures adopted with regard to entry of new private sector banks in 1995.

.

II.5 Security-wise Advances

The advances secured by tangible assets in the case of all scheduled commercial banks increased

from 73.2 per cent in 1992 to 76.4 percent in 2005. For all the bank groups, with the exception of

foreign bank group, advances secured by tangible assets were more than 70 per cent for the period

1992 to 2005. In the case of foreign banks, such secured loans increased from 54 per cent in 1992

to 57.9 per cent in 2005. Advances covered by government / bank guarantees with respect to all

scheduled commercial banks decreased from 15.1 per cent to 5.9 per cent during the same period.

Such type of advances declined for each of the bank groups. It is interesting to note here that

unsecured loans granted by foreign banks group was more than a third of the total advances for all

the years from 1992 to 2005. For all other bank groups, unsecured loans were less than 21 per cent.

It is also noteworthy that unsecured advances granted by State Bank of India and its Associates

increased sharply from 15.4 per cent in 2004 to 20.9 percent in 2005 .

.

II.6 Bank Group-wise Share in Advances

The bank group-wise share of advances of scheduled commercial banks depicts that nationalised

bank group contributed  about 50 per cent of the total credit advanced by all scheduled commercial

banks followed by State Bank Group with a share of about 25 per cent, domestic private sector

banks with a share of 19 per cent and foreign banks about 7 per cent in the year 2005. This

indicates that banks in the public sector even after the implementation of reforms since 1991,

contribute about 75 per cent of the total credit advanced by all scheduled commercial banks.

This trend may not continue in future as the data reveals that the share of the public sector banks

declined from 92.1 per cent in 1980 to 74.3 per cent in 2005. On the other hand, the advances

made by foreign banks increased from 3.3 per cent in 1980 to 6.5 per cent in 2005 and that made

by private banks in the domestic sector increased from 4.5 per cent in 1980 to 19.2 per cent in

2005.Data supports that in the post reform period, public sector banks are facing increasing

competition from the private sector banksboth foreign and domestic.

II.7 Priority Sector Advances

Priority sector advances of scheduled commercial banks showed some marginal decline from 35

per cent in 1992 to 34 per cent in2005. This declining trend is observed in the case of all bank

groups except for foreign banks. In the case of foreign banks, priority sector advances increased

over the years since the banking sector reforms started. Of the total advances, nationalised banks

advanced loans to priority sectors to the extent of 37.4 per cent and State Bank group to the extent

of 35.3 per cent in 2005. Such loans were low with respect to domestic private sector banks group

at 26.5 per cent and foreign banks at 25.8 per cent. A target of 40 per cent of net bank credit has

been stipulated for lending to the priority sector by domestic scheduled commercial banks both in

the public and private sectors and a target of 32 per cent has been stipulated for lending to the

priority sector by foreign bank groups at present. However, the data presented in this section are

percentages of priority sector lending to gross bank credit.

Section III

Investments

Bank group-wise investments show that all scheduled commercial banks invested 92.6 per cent of

their total investments in government and other approved securities in the year 1980, which

declined to 82.4 per cent in 2005; whereas other investments increased from 7.4 per cent

to 17.6 per cent during the same period. This could be due to the reduction in SLR requirements.

Even though the SLR requirements have been reduced from a high of 38.5 per cent in 1992 to the

statutory minimum of 25 per cent, banks still prefer to invest large portion of their investments

in approved securities, because of the risk-free and assured returns they get through such

investments. In the case of public sector banks and foreign banks, there was a reduction in

investment in government securities and a preference for other investments like shares, bonds and

debentures, which are not counted for SLR requirements. However, in 2005, a major reduction was

noticed with respect to investments in other securities and a clear preference for government and

other approved securities. As against this, in the case of domestic private sector banks, there is a

clear preference for investments in other securities after the year 1995 and a reduction of

investments in government and other approved securities. Since the year 2000, with the entry of

more private sector banks, this group invested more than one third of their total investments in

non-SLR securities, which indicates that the private banks of late are currently venturing into more

riskier, nonetheless challenging business

Section IV

Capital To Risk-weighted Assets Ratio (CRAR)

The capital to risk weighted assets ratio (CRAR) is an indicator  for assessing soundness and

solvency of banks. Out of 92 scheduled commercial banks, 75 banks could maintain the CRAR of

more than 8 per cent during the year 1995-96, when the prescribed CRAR was 8 per cent. During

1999-2000, 96 banks maintained CRAR of 9 to 10 per cent and above when the prescribed rate

was 9 per cent. In 2004-05, out of 88 scheduled commercial banks, 78 banks could maintain

CRAR of above 10 per cent and 8 banks between 9 and 10 per cent All banks in the State Bank

group maintained capital to risk weighted assets ratio of more than 10 per cent in 2004-05. In the

nationalized bank group, 17 banks reached more than 10 per cent CRAR level except two banks

whose CRAR during 2004-05 was between 9-10 per cent. During 2004-05, there were 2 banks in

the old private sector category whose CRAR was less than 9 per cent.

Section V

Non-performing Assets (NPAs)

The measure of non-performing assets helps us to assess the efficiency in allocation of resources

made by banks to productive sectors. The problem of NPAs arise either due to bad management

by banks or due to external factors like unanticipated shocks, business cycle and natural calamities

(Caprio and Klingebiel, 1996). Several studies have underscored the role of banks’ lending policy

and terms of credit, which include cost, maturity and collateral in influencing the movement of

non-performing assets of banks (Reddy, 2004,Mohan 2003, 2004).The ratio of gross non-

performing assets (NPAs) to gross advances of all scheduled commercial banks decreased from

14.4 per cent in 1998 to 5.1 per cent in 2005. Bank group-wise analysis shows that across the bank

groups there has been a significant reduction in the gross non-performing assets. With respect to

public sector banks (State Bank group and nationalised bank group together), NPAs have

decreased from 16.0 per cent in 1998 to 5.4 per cent in 2005. In the case of foreign banks group,

gross NPAs as a percentage to gross advances, which was the lowest among all the groups at 6.4

per cent in 1998, decreased to 2.9 per cent in 2005. With regard to domestic private sector banks

group, gross NPAs decreased from 8.7 per cent to 3.9 per cent during the same period. The ratio of

net NPAs to net advances of different bank groups also exhibited similar declining trends during

the period from 1998 to 2005. The net NPAs of all scheduled commercial banks declined from 7.3

per cent in 1998 to 2.0 per cent in 2005 .The decline in NPAs is more evidenced across bank

groups especially since 2003. This reflects on the positive impact of the measures taken by the

Reserve Bank towards NPA reduction and specifically due to the enactment of the Securitisation

And Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act,

ensuring speedier recovery without intervention of courts or tribunal. The composition of NPAs of

public sector banks brings to light certain interesting aspects. It is observed that in 1995 for State

Bank group, the share of NPAs was 52.5 per cent for the priority sector,41.4 per cent for the non-

priority sector, and 6.1 per cent for the public sector. These percentages were 47.4 per cent, 51.5

per cent and 1.1 per cent, respectively in 2005. Similarly in the case of nationalised banks also, the

NPA composition for non-priority sector has increased, whereas, that for priority sector and public

sector, there is a marginal reduction. This shows that not only advances to the priority sector are

going non-performing, but more than that, nonpriority sector lending is the area where the bankers

need to cautiously examine the possibilities of loans becoming non-performing. Here the question

of moral hazard, adverse selection and credit rationing comes to the fore. These issues are to be

addressed face on. This also goes to explode the commonly held myth that the problem of NPAs is

caused mainly due to the credit allocation to priority sectors.

Section VI

Income Composition

Income composition of scheduled commercial banks shows that across the different bank groups,

interest income viz., income from advances and investments are falling and the percentage of other

income is increasing. Other income inter alia includes income earned in the form of commission,

exchange and brokerage and income from profit on sale of investments. In 1980, the share of

interest income of all scheduled commercial banks was 89.0 per cent, which decreased to 82.0 per

cent in 2005. Other income on the other hand, increased from 11.0 per cent to 18.0 per cent during

the same period. This reflects upon the increasing reliance on non-interest income vis-à-vis interest

income of commercial banks. This is a welcome trend as it may reduce the risks arising out of the

sole dependency on interest as the source of income (Ramasastri, Samuel & Gangadaran, 2004)

Bank group-wise interest and non-interest income shows that in the case of SBI and its Associates,

interest income declined from 84.5 per cent in 1980 to 82.3 percent in 2005 and in the case of

nationalised banks group, the same declined from 91.4 per cent to 84.0 per cent. In the case of

domestic private sector banks also, interest income declined from 90.3 per cent in 1990 to 80.5 per

cent in 2005.It is evident from these figures that more than 80 per cent of the income still comes

from interest income in the case of public sector banks and domestic private sector banks, which

indicates that these banks are seen to be dependent mainly on the traditional way of earning

income even though there is a reduction in such dependence.In contrast, foreign banks are seen to

be increasingly dependent upon non-interest sources of income. Non-interest income of foreign

banks formed about 29.6 per cent of their total income, followed by domestic private sector banks

19.5 per cent, State Bank of India and its Associates 17.7 percent and nationalised banks 16.0 per

cent .A comparison of the break-up of interest income viz., interest on advances and interest on

investments shows that with respect to all scheduled commercial banks, interest income on

advances has fallen from 60.7 per cent in 1992 to 52.3 per cent in 2005. Whereas, interest income

on investments increased from 25.6 per cent in 1992 to 42.2 per cent in 2005. This is true for all

the bank groups.

 .

Section VII

Expenditure Composition

The expenditure composition of scheduled commercial banks indicates that the percentage of

interest expenses to total expenses of all scheduled commercial banks declined by 2.1 per cent

from 66.3 per cent in 1980 to 64.2 per cent in 2005. Percentage of operating expenses to total

expenses has increased from 33.7 per cent in 1980 to 35.8 per cent in 2005. In the case of all bank

groups similar trend is noticed except for foreign banks where the interest expenses has decreased

from 64.6 per cent in 1990 to 47.9 per cent in 2005. Whereas, percentage of operating expenses to

the total expenses of foreign banks increased from 35.4 per cent to 52.1 percent A further break-up

of operating expenses reveals that wages as percentage of operating expenses of public sector

banks is more than 60 per cent. These are symptoms of under employment. This situation calls for

more apt and pragmatic human resource policies and proper man power planning for the future.

The wages of foreign banks increased from 25.9 per cent in 1990 to 30.6 per cent of their operating

expenses in 2005. In the case of domestic private sector banks group, wages as percentage of

operating expenses was 73.5 per cent in 1990 and the same decreased drastically to 33.7 percent.

This goes to indicate that banks in the private sector both foreign and domestic are spending for

other business boosting measures like image building, software development etc.

Section VI

Return on Assets

Return on assets (ROA) is an important performance indicator of banks. Return on assets has been

worked out by taking the ratio of net profit or loss to average advances and investments. For all

scheduled commercial banks, the ROA increased from 0.1 per cent in 1980 to 1.1 per cent in 2005.

Amongst the bank groups, the ROA of foreign banks group is the highest at 1.8 per cent in 2005.

All other bank groups recorded a return on assets of 1.1 per cent showing that all banks are making 

profits and their performances are good. Foreign banks group is on a higher plane with respect to

its performance in comparison with other bank groups. Compared to the pre-reform period, the

ROA of public sector banks improved significantly after the initiation of reforms. In the case of

foreign banks and domestic private sector banks, data are available only from 1995 .The

distribution of scheduled commercial banks by ROA reveals that in 1995, with respect to State

Bank group, all 8 banks were in the ROA range of up to 1 per cent. This position improved slightly

as one bank was in the ROA category of more than 1.5 per cent in 2000 and 2005. This goes to

indicate that State Bank group has much potential to enhance their performance. Similarly,

majority of the banks in the nationalised group were in the ROA range of less than 1 per cent

in1995, which exhibited some improvement since 2000. In the case of domestic private sector

banks also, there seems to be more scope for improvement as many banks reported negative ROA

in 2005. In contrast to all other bank groups, majority of the foreign banks were placed in the

category of high ROA of more than 1.5 per cent

Section IX

Some Select Ratios

The data reveals that the ratio of interest on advances to average advances of all scheduled

commercial banks, which is reflective of the lending rates, decreased from 14.0 per cent in 1992 to

7.1 percent in 2005. The prime lending rate was 19.0 per cent in 1992 and in the range of 10.25 to

10.75 per cent in 2005. From this, it is evidenced that banks are lending at the sub prime lending

Rates.The gap between the PLR and lending rates of all scheduled commercial banks was very less

for the years 2000 to 2002.However, this gap widened since 2003. This is true for all the

bankgroups, which is indicative of the fact that during the recent years, banks are lending at sub

PLR rates with wider gaps between PLR and lending rates..The ratio of interest on investments to

average investments which is reflective of the return on investments, shows that for all scheduled

commercial banks, the rates have declined from 10.1 per cent in 1992 to 7.6 percent in 2005. In

comparison, the interest rates on central government dated securities (weighted average) declined

from 11.8 per cent in 1992 to 6.1 per cent in 2005. Overall trends indicate that the return on

investments made by the public sector banks is higher than that of all scheduled commercial banks.

An interesting point to note here is that even though private sector banks invested more of their

funds in non-SLR securities, still their interest on investments as a percentage to average

investments is lower than that obtained by the public sector banks. Between State Bank group and

nationalised bank group, the former was successful in getting higher yields on their investments

than the latter group. The ratio of interest on deposits to average deposits of scheduled commercial

banks, which is reflective of the deposit rate, declined from 7.5 per cent in 1992 to 4.2 per cent in

2005. These rates are lower than the rates of deposits with 1 to 3 year maturity for all the bank

groups. This indicates that banks are able to mobilise deposits at a lower rate than that of the rates

for deposits of 1 to 3 years maturityThe spread between the lending and deposit rates have

 reduced over the years from 1992 to 2005. The general fall in interest rates in the recent period is

in consonance with the monetary policy stance of a soft and flexible interest rate regime

.

Table 1. Summary of the Banking Industry: 1990-91 to 2003-04 (in Rs. billion)

*SOB-STATE OWNED BANKS;Pvt:PRIVATE SECTOR BANKS;Frgn-Foreign banks

                        CHAPTER 4

                CHANGES DURING 2008

The public sector banks continue to be a dominant part of the banking system. As on March 31,

2008, the PSBs accounted for 69.9 per cent of the aggregate assets and 72.7 per cent of the

aggregate advances of the Scheduled commercial banking system. A unique feature of the

reform of the public sector banks was the process of their financial restructuring.

The banks were recapitalised by the government to meet prudential norms through

Recapitalization bonds.

Consequently, all the public sector banks, which issued shares to private shareholders, have

been listed on the exchanges and are subject to the same disclosure and market discipline

standards as other listed entities. To address the problem of distressed assets, a mechanism has

been developed to allow sale of these assets to Asset Reconstruction Companies which operate

as independent commercial entities.

. As regard the prudential regulatory framework for the banking system, we have come a long

way from the administered interest rate regime to deregulated interest rates, from the system of

Health Codes for an eight-fold, judgmental loan classification to the prudential asset

classification based on objective criteria, from the concept of simple statutory minimum capital

and capital-deposit ratio to the risk-sensitive capital adequacy norms – initially under Basel I

framework and now under the Basel II regime.

There is much greater focus now on improving the corporate governance set up through “fit

and proper” criteria, on encouraging integrated risk management systems in the banks and on

promoting market discipline through more transparent disclosure standards. The policy

endeavor has all along been to benchmark our regulatory norms with the international best

practices, of course, keeping in view the domestic imperatives and the country context.

The average capital adequacy ratio for the scheduled commercial banks, which was around two

per cent in 1997, had increased to 13.08 per cent as on March 31, 2008. The improvement in

the capital adequacy ratio has come about despite significant growth in the aggregate asset of

the banking system. This level of capital ratio in the Indian banking system compares quite

well with the banking system in many other countries – though the capital adequacy of some of

the banks in the developed countries has remained under considerable strain in the recent past

in the aftermath of the sub-prime crisis.

In regard to the asset quality also, the gross NPAs of the scheduled commercial banks, which

were as high as 15.7 per cent at end-March 1997, declined significantly to 2.4 per cent as at

end-March 2008. The net NPAs of these banks during the same period declined from 8.1 per

cent to 1.08 per cent. These figures too compare favourably with the international trends and

have been driven by the improvements in loan loss provisioning by the banks as also by the

improved recovery climate enabled by the legislative environment. What is noteworthy is that

the NPA ratios have recorded remarkable improvements despite progressive tightening of the

asset classification norms by the RBI over the years.

The reform measures have also resulted in an improvement in the profitability of banks. The

Return on Assets (RoA) of scheduled commercial banks increased from 0.4 per cent in the year

1991-92 to 0.99 per cent in 2007-08. The Business per Employee (BPE), as a measure of

productivity, for the public sector banks has registered considerable improvement. The BPE for

the public sector banks, which was Rs. 95 lakh in 1998-99, almost doubled to Rs. 188 lakh in

2002 and more than re-doubled to Rs. 496 lakh in 2007.

. It needs to be noted that the turnaround in the financial performance of the public sector

banks, pursuant to the banking sector reforms, has resulted in the market valuation of

government holdings in these banks far exceeding the initial recapitalisation cost – which is

something unique to the Indian banking system. Thus, the recapitalisation of banks by the

government has not been merely a “holding out” operation by the majority owner of the banks.

The Indian experience has shown that a strong, pragmatic and non-discriminatory regulatory

framework coupled with the market discipline effected through the listing of the equity shares

and operational autonomy provided to the banks, can have a significant positive impact on the

functioning of the public sector banks. The global financial crisis is changing the banking

landscape. As bankers and regulators struggle with the crisisIn a way the solution lies in two

domains, one is solution by regulators and second by banks themselves Banks themselves have

to cut cost, thats going to be critical if markets have stopped grow, keep the confidence of retail

customers, stay close to the customer, be very good at managing the customers experience and

relook at their risk management practisesBanks would need to adjust quickly to this new

landscape including the recessionary environment and regulators to act with speed to

build retail investor confidence

                 EFFECT OF STOCK MARKET CRISIS

. “The banking sector through overseas branches has some exposure to distressed financial

  instruments and troubled financial institutions. But this exposure is part of the normal course of

their business and is quite small relative to the size of their overall business.” Maintaining that

Indian banks do not have any direct exposure to the sub-prime mortgages,  the Indian banking

system and the foreign exchange market were sound and well regulatedBanking stocks were

particularly hit, with ICICI Bank, the country’s largest in the private sector, crashing 26 percent on

the Bombay Stock Exchange, while Axis Bank and HDFC Bank lost 15.64 percent and 5.93

percent, respectively Banking circles says the Lehman-Lynch effect will be minimal for the

banking sector in India. “India’s banking system is largely robust and secure compared to

the US banking industry. Mainly, it is because public sector banks continue to be a

dominant part of the banking system in India,” says Lokesh Sharma, a banking sector

consultant based in Mumbai.

As on March 31, 2008, public sector banks accounted for 69.9 per cent of the aggregate

assets and 72.7 per cent of the aggregate advances of commercial banking system in

India. A unique feature of the reform of the public sector banks was the process of their

financial restructuring.

Banking sector reforms in India were initiated in the beginning of the 1990s. The reforms

have brought about a sea change in the profile of the banking sector over the years.

According to a document from the Reserve Bank of India: “India’s implementation of the

reforms process in banking has had several unique features. Our financial sector reforms

were undertaken early in the reform cycle. Notably, the reforms process was not driven by

any banking crisis, nor was it the outcome of any external support package.”

”Besides, the design of the reforms was crafted through domestic expertise, taking on

board the international experiences in this respect. The reforms were carefully sequenced

with respect to the instruments to be used and the objectives to be achieved. Thus,

prudential norms and supervisory strengthening were introduced early in the reform cycle,

followed by interest-rate deregulation and a gradual lowering of statutory pre-emptions.

The more complex aspects of legal and accounting measures were ushered in

subsequently when the basic tenets of the reforms were already in place.”.

.

Chapter 5

 _                                BANKING SECTOR AHEAD

While we have made a significant progress. The first is the issue of

consolidation. The emergence of titans has been one of the noticeable trends in the

banking industry at the global level. These banking entities are expected to drive the

growth and volume of business in the global segment. In the Indian banking sector

also, consolidation is likely to gain prominence in the near future. Despite the

liberalization process, state-owned banks dominate the industry, accounting for three-

quarter of bank assets. The consolidation process in recent years has primarily been

confined to a few mergers in the private sector segment, although some recent

consolidation in the state-owned segment is evident as well. These mergers have been

based on the need to attain a meaningful balance sheet size and market share in the

face of increased competition, driven largely by synergies and locational and

business-specific complementarities. Efforts have been initiated to iron out the legal

impediments inherent in the consolidation process. As the bottom lines of domestic

banks come under increasing pressure and the options for organic growth exhaust

themselves, banks in India will need to explore ways for inorganic expansion. This, in

turn, is likely to unleash the forces of consolidation in Indian banking.  However,

there are two caveats.  First, any process of consolidation must come out of a felt

need for merger rather than as an imposition from outside.  The synergic benefits

must be felt by the entities themselves.  The process of consolidation that is driven by

fiat is much less likely to be successful, particularly if the decision by fiat is

accompanied by restrictions on the normal avenues for reducing costs in the merged

entity.  Thus, any meaningful consolidation among the public sector banks must be

driven by commercial motivation by individual banks, with the government and the

regulator playing at best a facilitating role. Second, the process of consolidation does

not mean that small or medium sized banks will have no future.  Many of the Indian

banks are of appropriate size in relation to the Indian situation. Actual experience

shows that small and medium sized banks even in advanced countries have been able

to survive and remain profitable. These banks have survived along with very large

financial conglomerates.  Small banks may be the more natural lenders to small

businesses.

The second issue is related to capital adequacy.  Basel I standards have been

successfully implemented in India and the authorities are presently moving towards

adoption of Basel II tailored to country’s specific considerations. Adoption of Base II

norms will enhance the required capital.  Besides, banks’ assets will grow or will

have to grow in tandem with the growth of the real sectors of the economy.  The

public sector banks’ ability to meet the growing needs will be inhibited, unless the

government is willing to bring in more capital.  At present, the share of the

government in the public sector banks cannot go below 51 per cent.  While there is

some scope for expanding capital through various modalities, tier-I capital, that is

equity, is still critical.  While this constraint may not be binding immediately, sooner

or later it will be.  If growth is modest, retained earnings may form an adequate

source of supply.  However, when growth is rapid which is likely to be the case, there

is need for injection of equity, enlarging the shareholding.  In this situation, the

government will have to make up its mind either to bring in additional capital or

move towards reducing its share from 51 per cent through appropriate statutory

changes.  A third alternative could, however, be to include in the definition of

government such entities as the Life Insurance Corporation that are quasi-government

in nature and are likely to remain to be fully owned or an integral part of the

government system in the future.  However, even to do this an amendment is needed

in the statute.

The third aspect concerns risk management.  The most important facet of risk in India

or for that matter in most developing countries markets remains the credit risk.  

Management of credit risks is an area which has received considerable attention in

recent years.  The new Basle accord  rests on the assumption that an internal

assessment of risks by a financial institution will be a better measure than an

externally imposed formula.  The economic structure is undergoing a change.  The

service sector has emerged as major sector.  Assessing credit risk in lending to service

sectors needs a methodology different from assessing risks while lending to

manufacturing.  There are other areas of lending such as housing and consumer credit

which will need new approaches.  Equally important will be the area of management

of exchange risk.  Besides enabling customers to adopt appropriate exchange cover,

banks themselves will have to ensure that their exposure is within acceptable limits

and is properly hedged.  The entire area of risk management encompassing all aspects

of risk including credit risk, market risk and operational risk will have to receive

prime attention.

The fourth and final concern  is improvement in customer service.  

Banks exist to provide service to customers.  With the introduction of technology,

there has been a significant change in the way banks operate.  This is a far cry from

the situation that existed even 15 years ago.  The induction of technology has enabled

several transactions to be processed in a shorter period of time.  Transmission of

funds to customers takes less time now.  ATMs provide easy access to cash.  

Nevertheless, it is not very clear whether the customers as depositors and users of

other banking services are fully satisfied with the services provided when they come

to a bank.  This is an area, which must receive continuous attention.  The interface

with the customers needs to improves

BIBLIOGRAPHY

 http://www.bis.org

http://www.banking.indiaupdate.com

http://www.livemint.com

http://www.linkedwords.com

http://www.thehindubusinessline.com

http://www.rbidocs.rbi.org.in

http://www.imf.org

http://www.wikipedia.com

http://www.thaindian.com

BUSINESS WORLD