Meaning:

It is a multi purpose and multi-functional financial

supermarket providing both 'Banking and Financial Services'
through a single window. As per the World Bank," In
Universal Banking, large banks operate extensive network of
branches, provide many different services, hold several
claims on firms (including equity and debt) and participate
directly in the Corporate Governance of firms that rely on the
banks for funding or as insurance underwriters."

In a nutshell, a Universal Banking is a superstore for financial

products, under one roof. Corporates can get loans and avail
of other handy services, while individuals can bank and
borrow. It includes not only services related to savings and
loans but also investment. However in practice the term
'Universal Banking' refers to those banks that offer wide
range of financial services beyond the commercial banking
functions like Mutual Funds, Merchant Banking, Factoring,
Insurance, Credit Cards, Retail loans, Housing Finance, Auto
Loans, etc.

Empirical Background of Universal Banking:

The entry of banks into the realm of financial services was

followed very soon after Liberalization in the economy. Since
the early 1990s, structural changes of profound magnitude
came to be witnessed in global banking systems. Large scale
mergers, amalgamations and acquisitions among the banks
and financial institutions resulted in the growth in size and
competitive strengths of the merged entities. There thus
emerged new financial conglomerates that could maximize
Economies of Scale and Scope by building the production of
financial services organization called Universal Banking.
By the mid 1990s, all the restrictions on Project Financing
were removed and banks were allowed to undertake several
activities in house. Reforms in the insurance sector in the
late 1990s, and opening up of this field to private and foreign
players also resulted in permitting banks to undertake sale of
Insurance products. At present, only an 'arms length'
relationship between a bank and insurance entity has been
allowed by the regulatory authority, i.e.-IRDA (Insurance
Regulatory & Development Authority).

The phenomenon of Universal Banking as a distinct concept,

as different from Narrow Banking came to the forefront in the
Indian context with II Narsimham Committee (1998) and
later the Khan Committee (1998) reports recommending
consolidation of the banking industry through mergers and
integration of financial activities.

The need behind the Advent of Universal Banking

Liberalization and the banking reforms have given new

avenues to Development Finance Institutions (DFIs) to meet
the broader market. They can avail the options to involve in
deposit banking and short term lending as well. DFIs were
set up with the objective of taking care of the investment
needs of industries. They have build up expertise in
Merchant Banking and Project Evaluation.

So, saddled with obligations to fund long gestation projects,

the DFIs have been burdened with serious mismatches
between their assets and liabilities of the balance sheet. In
this context, the Narsimham Committee II had suggested
DFIs should convert into banks or Non-Banking Finance
Companies. Converting of these DFIs into Universal Banks
will grant them ready access to cheap retail deposits and
increase the coverage of the advances to include short term
working capital loans to corporates with greater operational
flexibility. At that time DFIs were in the need to acquire a lot
of mass in their volume of operations to solve the problem of
total asset base and net worth. So, the emergence of
Universal Banking was the solution for the problem of
banking sector.

A solution of Universal Banking coupled with SWOT

The solution of Universal Banking was having many factors

to deal with which further categorized under Strengths,
Weaknesses, Opportunities and Threats.

Strengths:

* Economies Of Scale

The main advantage of Universal Banking is that it results in

greater economic efficiency in the form of lower cost, higher
output and better products. Various Reserve Banks
Committees and reports in favor of Universal Banking, is that
it enables banks to exploit economies of scale and scope. It
means a bank can reduce average costs and thereby
improve spreads if it expands its scale of operations and
diversifying activities.

* Profitable Diversions
By diversifying the activities, the bank can use its existing
expertise in one type of financial service in providing other
types. So, it entails less cost in performing all the functions
by one entity instead of separate bodies.

* Resource Utilization

A bank possesses the information on the risk characteristics

of the clients, which it can use to pursue other activities with
the same client. A data collection about the market trends,
risk and returns associated with portfolios of Mutual Funds,
diversifiable and non diversifiable risk analysis, etc are
useful for other clients and information seekers.
Automatically, a bank will get the benefit of being involved in
Research.

* Easy marketing on the foundation a of Brand name

A bank has an existing network of branches, which can act

as shops for selling products like Insurance, Mutual Fund
without much efforts on marketing, as the branch will act
here as a parent company or source. In this way a bank can
reach the remotest client without having to take recourse
ton an agent.

* One stop shopping

The idea of 'one stop shopping' saves a lot of transaction

costs and increases the speed of economic activities. It is
beneficial for the bank as well as customers.
* Investor friendly activities

Another manifestation of Universal Banking is bank holding

stakes in a firm. A bank's equity holding in a borrower firm,
acts as a signal for other investors on to the health of the
firm, since the lending bank is in a better position to monitor
the firm's activities.

Weaknesses:

* Grey area of Universal Bank

The path of Universal Banking for DFIs is strewn with

obstacles. The biggest one is overcoming the differences in
regulatory requirements for a bank and DFI. Unlike banks,
DFIs are not required to keep a portion of their deposits as
cash reserves.

* No expertise in long term lending

In the case of traditional project finance an area where DFIs

tread carefully, becoming a bank may not make a big
difference. Project finance and Infrastructure Finance are
generally long gestation projects and would require DFIs to
borrow long term. Therefore, the transformation into a bank
may not be of great assistance in lending long-term.

* NPA problem remained intact

The most serious problem of DFIs have had to encounter is
bad loans or Non Performing Assets (NPA). For the DFIs and
Universal Banking or installation of cutting-edge-technology
in operations are unlikely to improve the situation
concerning NPAs.

Most of the NPAs came out of loans to commodity sectors,

such as steel, chemicals, textiles, etc. the improper use of
DFI funds by project promoters, a sharp change in operating
environment and poor appraisals by DFIs combined to
destroy the viability of some projects. So, instead of
improving the situation Universal Banking may worsen the
situation, due to the expansion in activities banks will fail to
make thorough study of the actual need of the party
concerned, the prospect of the business, in which it is
engaged, its track record, the quality of the management,
etc.

ICICI suffered the least in this section, but the IDBI has got
worst hit of NPAs, considering the negative developments at
Dabhol Power Company (DPC)

Threats:

* Big Empires

Universal Banking is an outcome of the mergers and

acquisitions in the banking sector. The Finance Ministry is
also empathetic towards it. But there will be big empires
which may put the economy in a problem. Universal Banks
will be the largest banks, by their asset base, income level
and profitability there is a danger of 'Price Distortion'. It
might take place by manipulating interests of the bank for
the self interest motive instead of social interest. There is a
threat to the overall quality of the products of the bank,
because of the possibility of turning all the strengths of the
Universal Banking into weaknesses. (e.g. - the strength of
economies of scale may turn into the degradation of
qualities of bank products, due to over expansion.

If the banks are not prudent enough, deposit rates could

shoot up and thus affect profits. To increase profits quickly
banks may go in for riskier business, which could lead to a
full in asset quality. Disintermediation and securitization
could further affect the business of banks.

Opportunities:

* To increase efficiency and productivity

Liberalization offers opportunities to banks. Now, the focus

will be on profits rather than on the size of balance sheet.
Fee based incomes will be more attractive than mobilizing
deposits, which lead to lower cost funds. To face the
increased competition, banks will need to improve their
efficiency and productivity, which will lead to new products
and better services.

* To get more exposure in the global market

In terms of total asset base and net worth the Indian banks
have a very long road to travel when compared to top 10
banks in the world. (SBI is the only Indian bank to appear in
the top 100 banks list of 'Fortune 500' based on sales,
profits, assets and market value. It also ranks II in the list of
Forbes 2000 among all Indian companies) as the asset base
sans capital of most of the top 10 banks in the world are
much more than the asset base and capital of the entire
Indian banking sector. In order to enter at least the top 100
segment in the world, the Indian banks need to acquire a lot
of mass in their volume of operations.

Pure routine banking operations alone cannot take the Indian

banks into the league of the Top 100 banks in the world.
Here is the real need of universal banking, as the wide range
of financial services in addition to the Commercial banking
functions like Mutual Funds, Merchant banking, Factoring,
Insurance, credit cards, retail, personal loans, etc. will help in
enhancing overall profitability.

* To eradicate the 'Financial Apartheid'

A recent study on the informal sector conducted by Scientific

Research Association for Economics (SRA), a Chennai based
association, has found out that, 'Though having a large
number of branch network in rural areas and urban areas,
the lowest strata of the society is still out of the purview of
banking services. Because the small businesses in the city,
34% of that goes to money lenders for funds. Another 6.5%
goes to pawn brokers, etc.

The respondents were businesses engaged in activities such

as fruits and vegetables vendors, laundry services, provision
stores, petty shops and tea stalls. 97% of them do not
depend the banking system for funds. Not because they do
not want credit from banking sources, but because banks do
not want to lend these entrepreneurs. It is a situation of
Financial Apartheid in the informal sector. It means with the
help of retail and personal banking services Universal
Banking can reach this stratum easily.

The Need of Universal Banking

To make pace with the present need of corporates.

Now a day, there is a large market of General Insurance and

Project Financing. As only a bank is not able to fund it
properly, due to insufficient asset base and net worth. So, to
overcome this, they form a consortium of lenders, for
funding the Greenfield and Brownfield projects. (In the
month June a consortium of 20 lenders led by SBI has
committed a 14 year project finance term loan for a special
purpose company promoted BPCL, which is starting a
Greenfield project in Madhya Pradesh) The point of
consideration here is the consortium partner – Bank of
Baroda, Bank of Maharashtra, Central Bank of India, LIC,
Indian Overseas Bank. Most of the partners are nationalized
banks.

It means there is a need of developing a strong domestic

financial system to cater the need of the corporate sector. It
is possible if banks have strong capital/asset base. It fortifies
the importance of Universal Banking. Along with that, the
ongoing clamor of Mergers and Acquisitions in the corporate
sector, this needs financial assistance as well as consulting.
More financial institutional investors entering in India and
several Joint Ventures are being started between domestic
companies and global firms. A number of issues may crop up
between from the signing up of the sale purchase document
and the deal actually coming up. Near about 4% could be
getting aborted (e.g.-the failure of Jet Airways and Air Sahara
is one of that. So, the corporates are in need of takers to
insure the associated transactions of Mergers and
Acquisitions)

Now International insurers are offering cover in India against

the loss arising out of Mergers and Acquisitions and
Breakups. (E.g.-Howden India leading International brokers,
which has introduced transactional insurance of M & A, is
now finding takers for their insurance cover) Indian banking,
with the help of Universal Banking has technology edge and
better business models, compared to pre-liberalizations era,
today they are able to attract and gain more volumes simply
because they meet their customers' requirements better
than anyone else. If the newer and foreign players can do
that, then why can't bigger DFIs try their hands on it?

Universal Banking is a multi-purpose and multi-functional

financial supermarket (a company offering a wide range of
financial services e.g. stock, insurance and real-estate
brokerage) providing both banking and financial services
through a single window.
Definition of Universal Banking: As per the World Bank, "In
Universal Banking, large banks operate extensive network of
branches, provide many different services, hold several
claims on firms(including equity and debt) and participate
directly in the Corporate Governance of firms that rely on the
banks for funding or as insurance underwriters".

In a nutshell, a Universal Banking is a superstore for financial

products under one roof. Corporate can get loans and avail
of other handy services, while can deposit and borrow. It
includes not only services related to savings and loans but
also investments.

However in practice the term 'universal banking' refers to

those banks that offer a wide range of financial services,
beyond the commercial banking functions like Mutual Funds,
Merchant Banking, Factoring, Credit Cards, Retail loans,
Housing Finance, Auto loans, Investment banking, Insurance
etc. This is most common in European countries.

For example, in Germany commercial banks accept time

deposits, lend money, underwrite corporate stocks, and act
as investment advisors to large corporations. In Germany,
there has never been any separation between commercial
banks and investment banks, as there is in the United
States.

THE CONCEPT OF UNIVERSAL BANKING

The entry of banks into the realm of financial services was

followed very soon after the introduction of liberalization in
the economy. Since the early 1990s structural changes of
profound magnitude have been witnessed in global banking
systems. Large scale mergers, amalgamations and
acquisitions between the banks and financial institutions
resulted in the growth in size and competitive strengths of
the merged entities. Thus, emerged new financial
conglomerates that could maximize economies of scale and
scope by building the production of financial services
organization called Universal Banking.

By the mid-1990s, all the restrictions on project financing

were removed and banks were allowed to undertake several
in-house activities. Reforms in the insurance sector in the
late 1990s, and opening up of this field to private and foreign
players also resulted in permitting banks to undertake the
sale of insurance products. At present, only an 'arm's length
relationship between a bank and an insurance entity has
been allowed by the regulatory authority, i.e. IRDA
(Insurance Regulatory and Development Authority).

The phenomenon of Universal Banking as a distinct concept,

as different from Narrow Banking came to the forefront in the
Indian context with the Narsimham Committee (1998) and
later the Khan Committee (1998) reports recommending
consolidation of the banking industry through mergers and
integration of financial activities.

UNIVERSAL BANKING – PROS AND CONS

The solution of Universal Banking was having many factors

to deal with, which can be further analyzed by the pros and
cons.

Advantages of Universal Banking

 * Economies of Scale. The main advantage of Universal
Banking is that it results in greater economic efficiency in
the form of lower cost, higher output and better products.
Many Committees and reports by Reserve Bank of India are
in favour of Universal banking as it enables banks to explit
economies of scale and scope.
* Profitable Diversions. By diversifying the activities, the
bank can use its existing expertise in one type of financial
service in providing other types. So, it entails less cost in
performing all the functions by one entity instead of
separate bodies.
* Resource Utilization. A bank possesses the information
on the risk characteristics of the clients, which can be used
to pursue other activities with the same clients. A data
collection about the market trends, risk and returns
associated with portfolios of Mutual Funds, diversifiable and
non diversifiable risk analysis, etc, is useful for other clients
and information seekers. Automatically, a bank will get the
benefit of being involved in the researching
* Easy Marketing on the Foundation of a Brand Name. A
bank's existing branches can act as shops of selling for
selling financial products like Insurance, Mutual Funds
without spending much efforts on marketing, as the branch
will act here as a parent company or source. In this way, a
bank can reach the client even in the remotest area without
having to take resource to an agent.
* One-stop shopping. The idea of 'one-stop shopping'
saves a lot of transaction costs and increases the speed of
economic activities. It is beneficial for the bank as well as its
customers.
* Investor Friendly Activities. Another manifestation of
Universal Banking is bank holding stakes in a form : a bank's
equity holding in a borrower firm, acts as a signal for other
investor on to the health of the firm since the lending bank is
in a better position to monitor the firm's activities.
Disadvantages of Universal Banking

* Grey Area of Universal Bank. The path of universal

banking for DFIs is strewn with obstacles. The biggest one is
overcoming the differences in regulatory requirement for a
bank and DFI. Unlike banks, DFIs are not required to keep a
portion of their deposits as cash reserves.
* No Expertise in Long term lending. In the case of
traditional project finance, an area where DFIs tread
carefully, becoming a bank may not make a big difference to
a DFI. Project finance and Infrastructure finance are
generally long- gestation projects and would require DFIs to
borrow long- term. Therefore, the transformation into a bank
may not be of great assistance in lending long-term.
* NPA Problem Remained Intact. The most serious problem
that the DFIs have had to encounter is bad loans or Non-
Performing Assets (NPAs). For the DFIs and Universal Banking
or installation of cutting-edge-technology in operations are
unlikely to improve the situation concerning NPAs.

UNIVERSAL BANKING IN INDIA

In India Development financial institutions (DFIs) and

refinancing institutions (RFIs) were meeting specific sect oral
needs and also providing long-term resources at
concessional terms, while the commercial banks in general,
by and large, confined themselves to the core banking
functions of accepting deposits and providing working capital
finance to industry, trade and agriculture. Consequent to the
liberalisation and deregulation of financial sector, there has
been blurring of distinction between the commercial banking
and investment banking.
Reserve Bank of India constituted on December 8, 1997, a
Working Group under the Chairmanship of Shri S.H. Khan to
bring about greater clarity in the respective roles of banks
and financial institutions for greater harmonization of
facilities and obligations . Also report of the Committee on
Banking Sector Reforms or Narasimham Committee (NC) has
major bearing on the issues considered by the Khan Working
Group.

The issue of universal banking resurfaced in Year 2000, when

ICICI gave a presentation to RBI to discuss the time frame
and possible options for transforming itself into an universal
bank. Reserve Bank of India also spelt out to Parliamentary
Standing Committee on Finance, its proposed policy for
universal banking, including a case-by-case approach
towards allowing domestic financial institutions to become
universal banks.

Now RBI has asked FIs, which are interested to convert itself
into a universal bank, to submit their plans for transition to a
universal bank for consideration and further discussions. FIs
need to formulate a road map for the transition path and
strategy for smooth conversion into a universal bank over a
specified time frame. The plan should specifically provide for
full compliance with prudential norms as applicable to banks
over the proposed period.

SALIENT OPERATIONAL AND REGULATORY ISSUES OF RBI TO

BE ADDRESSED BY THE FIs FOR CONVERSION INTO A
UNIVERSAL BANK

a) Reserve requirements. Compliance with the cash reserve

ratio and statutory liquidity ratio requirements (under
Section 42 of RBI Act, 1934, and Section 24 of the Banking
Regulation Act, 1949, respectively) would be mandatory for
an FI after its conversion into a universal bank.

b) Permissible activities. Any activity of an FI currently

undertaken but not permissible for a bank under Section 6(1)
of the B. R. Act, 1949, may have to be stopped or divested
after its conversion into a universal bank..

c) Disposal of non-banking assets. Any immovable property,

howsoever acquired by an FI, would, after its conversion into
a universal bank, be required to be disposed of within the
maximum period of 7 years from the date of acquisition, in
terms of Section 9 of the B. R. Act.

d) Composition of the Board. Changing the composition of

the Board of Directors might become necessary for some of
the FIs after their conversion into a universal bank, to ensure
compliance with the provisions of Section 10(A) of the B. R.
Act, which requires at least 51% of the total number of
directors to have special knowledge and experience.

e) Prohibition on floating charge of assets. The floating

charge, if created by an FI, over its assets, would require,
after its conversion into a universal bank, ratification by the
Reserve Bank of India under Section 14(A) of the B. R. Act,
since a banking company is not allowed to create a floating
charge on the undertaking or any property of the company
unless duly certified by RBI as required under the Section.

f) Nature of subsidiaries. If any of the existing subsidiaries of

an FI is engaged in an activity not permitted under Section
6(1) of the B R Act ,then on conversion of the FI into a
universal bank, delinking of such subsidiary / activity from
the operations of the universal bank would become
necessary since Section 19 of the Act permits a bank to
have subsidiaries only for one or more of the activities
permitted under Section 6(1) of B. R. Act.

g) Restriction on investments. An FI with equity investment

in companies in excess of 30 per cent of the paid up share
capital of that company or 30 per cent of its own paid-up
share capital and reserves, whichever is less, on its
conversion into a universal bank, would need to divest such
excess holdings to secure compliance with the provisions of
Section 19(2) of the B. R. Act, which prohibits a bank from
holding shares in a company in excess of these limits.

h) Connected lending .Section 20 of the B. R. Act prohibits

grant of loans and advances by a bank on security of its own
shares or grant of loans or advances on behalf of any of its
directors or to any firm in which its director/manager or
employee or guarantor is interested. The compliance with
these provisions would be mandatory after conversion of an
FI to a universal bank.

i) Licensing. An FI converting into a universal bank would be

required to obtain a banking licence from RBI under Section
22 of the B. R. Act, for carrying on banking business in India,
after complying with the applicable conditions.

j) Branch network An FI, after its conversion into a bank,

would also be required to comply with extant branch
licensing policy of RBI under which the new banks are
required to allot at least 25 per cent of their total number of
branches in semi-urban and rural areas.
k) Assets in India. An FI after its conversion into a universal
bank, will be required to ensure that at the close of business
on the last Friday of every quarter, its total assets held in
India are not less than 75 per cent of its total demand and
time liabilities in India, as required of a bank under Section
25 of the B R Act.

l) Format of annual reports. After converting into a universal

bank, an FI will be required to publish its annual balance
sheet and profit and loss account in the forms set out in the
Third Schedule to the B R Act, as prescribed for a banking
company under Section 29 and Section 30 of the B. R. Act.

m) Managerial remuneration of the Chief Executive Officers.

On conversion into a universal bank, the appointment and
remuneration of the existing Chief Executive Officers may
have to be reviewed with the approval of RBI in terms of the
provisions of Section 35 B of the B. R. Act. The Section
stipulates fixation of remuneration of the Chairman and
Managing Director of a bank by Reserve Bank of India taking
into account the profitability, net NPAs and other financial
parameters. Under the Section, prior approval of RBI would
also be required for appointment of Chairman and Managing
Director.

n) Deposit insurance . An FI, on conversion into a universal

bank, would also be required to comply with the requirement
of compulsory deposit insurance from DICGC up to a
maximum of Rs.1 lakh per account, as applicable to the
banks.

o) Authorized Dealer's License. Some of the FIs at present

hold restricted AD licence from RBI, Exchange Control
Department to enable them to undertake transactions
necessary for or incidental to their prescribed functions. On
conversion into a universal bank, the new bank would
normally be eligible for full-fledged authorised dealer licence
and would also attract the full rigour of the Exchange Control
Regulations applicable to the banks at present, including
prohibition on raising resources through external commercial
borrowings.

p) Priority sector lending. On conversion of an FI to a

universal bank, the obligation for lending to "priority sector"
up to a prescribed percentage of their 'net bank credit' would
also become applicable to it.

q) Prudential norms. After conversion of an FI in to a bank,

the extant prudential norms of RBI for the all-India financial
institutions would no longer be applicable but the norms as
applicable to banks would be attracted and will need to be
fully complied with.

(This list of regulatory and operational issues is only

illustrative and not exhaustive).

THE FUTURE TREND OF UNIVERSAL BANKING IN DIFFERENT

COUNTRIES

Universal banks have long played a leading role in Germany,

Switzerland, and other Continental European countries. The
principal Financial institutions in these countries typically are
universal banks offering the entire array of banking services.
Continental European banks are engaged in deposit, real
estate and other forms of lending, foreign exchange trading,
as well as underwriting, securities trading, and portfolio
management. In the Anglo-Saxon countries and in Japan, by
contrast, commercial and investment banking tend to be
separated. In recent years, though, most of these countries
have lowered the barriers between commercial and
investment banking, but they have refrained from adopting
the Continental European system of universal banking. In the
United States, in particular, the resistance to softening the
separation of banking activities, as enshrined in the Glass-
Steagall Act, continues to be stiff.

In Germany and Switzerland the importance of universal

banking has grown since the end of World War II. Will this
trend continue so that universal banks could completely
overwhelm the specialized institutions in the future? Are the
specialized banks doomed to disappear? This question
cannot be answered with a simple "yes" or "no". The German
and Swiss experiences suggest that three factors will
determine future growth of universal banking.

First, universal banks no doubt will continue to play an

important role. They possess a number of advantages over
specialized institutions. In particular, they are able to exploit
economies of scale and scope in banking. These economies
are especially important for banks operating on a global
scale and catering to customers with a need for highly
sophisticated financial services. As we saw in the preceding
section, universal banks may also suffer from various
shortcomings. However, in an increasingly competitive
environment, these defects will likely carry far less weight
than in the past.

Second, although universal banks have expanded their

sphere of influence, the smaller specialized institutions have
not disappeared. In both Germany and Switzerland, they are
successfully coexisting and competing with the big banks. In
Switzerland, for example, the specialized institutions are
firmly entrenched in such areas as real estate lending,
securities trading, and portfolio management. The continued
strong performance of many specialized institutions suggests
that universal banks do not enjoy a comparative advantage
in all areas of banking.

Third, universality of banking may be achieved in various

ways. No single type of universal banking system exists. The
German and Swiss universal banking systems differ
substantially in this regard. In Germany, universality has
been strengthened without significantly increasing the
market shares of the big banks. Instead, the smaller
institutions have acquired universality through cooperation.
It remains to be seen whether the cooperative approach will
survive in an environment of highly competitive and
globalized banking.

What universal banking can do for you

Banking will never be the same again. With official
committees recommending a move towards universal
banking, DFIs, led by ICICI, are getting set to storm the
banking arena.

Sagar Patel
THE DOMESTIC banking sector is going through some
interesting times -- not just economically, but on the policy
front as well. And the major policy shift was heralded by the
Narasimham committee's recommendation that
development finance institutions (DFIs) ultimately convert
into either commercial banks or non-banking finance
companies. This, in a way, spelt the beginning of the end of
specialised services from DFIs, and the introduction of
universal banks.

With universal banking, banks will offer a wide range of

financial services, beyond solely commercial banking or
investment banking. The main advantage of universal
banking is that it results in greater economic efficiency and
enables asset diversification, not only in the nature of
ventures financed but also in the age profile of assets.
Additionally, it offers reasonable protection from economic
cycles. For FIs, moving towards universal banking will mean
the ability to raise short-term, low-cost funds.

In India, banks have traditionally been prime lenders for

working capital loans and DFIs financed term loans. Now,
with DFIs told to move towards universal banking, banks
have been allowed to diversify into investments and long-
term financing, and DFIs will lend for working capital.

Starting trouble. In spite of the Narasimham committee's

recommendations -- later endorsed by the Khan working
group -- the road to universal banking is proving far from
smooth. One major impediment for FIs is the fact that they
have past liabilities on which reserve requirements -- SLR,
CRR and priority sector advances -- have not been met.
Meeting this requirement in its current form and level would
require FIs to raise huge resources from the capital market,
which could give rise to liquidity concerns. Now, depending
on the fiscal and monetary situation, RBI is slated to reduce
the CRR requirement to a minimum of 3 per cent.

It has been suggested that reserve requirements apply only

to the incremental liabilities, but this may not be a prudent
move when the huge backlog of liabilities is not covered. The
most plausible solution would be to adhere to the reserve
requirements over a period of time to be specified by the FI.
In fact, RBI has mentioned that DFIs would need to prepare a
transition path in order to fully comply with the regulatory
requirement of a bank and such requests will be considered
on ‘case by case’ basis.
Services on offer

ICICI

IDBI

SBI

HDFC
LIC
Insurance

Yes

No

Yes

Yes

Yes
MF

Yes

Yes
Yes

Yes

Yes
Banking

Yes

Yes

Yes

Yes

Yes
Merchant banking

Yes
Yes

Yes

No

No
Broking

Yes

Yes

Yes

Yes
No
Retail finance
Housing

Yes

No

Yes

Yes

Yes
Credit/debit cards

Yes

No
Yes

Yes

No

Moving to universal banking may also create some pressure

on the asset and liability side of balance sheets. On the
liability side -- sources of funds (at least for banks) -- there
will be increasing competition from investment alternatives
such as MFs where schemes with similar liquidity but a
better return are available. On the asset side -- deployment
of funds -- the growth of capital markets, new players and
efficient investment banking have enabled corporates to
raise funds directly from the market.

The new bankers. The shift from specialised to universal

banks is not restricted to FIs -- SBI and LIC can be considered
universal banks. SBI deals with MFs and investment banking,
and its insurance initiative with Cardiff SA brings it closer to
the universal bank objective. And LIC's move to acquire a
stake in Corporation Bank makes it a serious candidate.

ICICI, which will have to raise something like Rs 20,000 crore

for reserve compliance, has decided to join the few universal
banks. It has begun reducing the number of its subsidiaries,
and is planning to merge with ICICI Bank, in a bid to turn into
a universal bank in 12-18 months.
ICICI will benefit

ICICI

ICICI Bank
CAR (%)

14.6

11.57
Net NPAs (%)

5.2

2.19
Cost of funds (%)

11.71
7.77
ROA (%)

0.79

0.82
Spread (%)

1.83

2.00

While this may be good news for customers, shareholders

have reason to be wary. ICICI is seen to benefit more from
the deal (see table above) as ICICI Bank is the better placed
company on most counts. The better financials from ICICI
Bank will aid in reducing the cost of funds. And the bank's
lower NPA, in view of the higher NPA provisioning by ICICI,
augurs well for the merged entity. The possibility of the swap
ratio being skewed in favour of ICICI in view of its 47 per cent
holding in ICICI Bank cannot be ruled out. Investors should,
therefore, wait for clarity on the merger proposal before
taking any decision to buy or sell.