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INTRODUCTION

Indian banking industry, the backbone of the countrys economy, has always played a key role in preventing the economic catastrophe from reaching terrible volume in the country. It has achieved enormous appreciation for its strength, particularly in the wake of the worldwide economic disasters, which pressed its worldwide counterparts to the edge of fall down. If we compare the business of top three banks in total assets and in terms of return on assets, the Indian banking system is among the healthier performers in the world. This sector is tremendously competitive and recorded as growing in the right trend. Indian banking industry has increased its total assets more than five times between March 2000 and March 2010, i.e., US$250 billion to more than US$1.3 trillion. This industry recorded CAGR growth of 18 percent as compared to countrys average GDP growth of 7.2 percent during the same period. The commercial banking assets to GDP ratio has increased to nearly 100 percent while the ratio of banks business to GDP has recorded nearly twofold, from 68 percent to 135 percent. The overall development has been lucrative with enhancement in banking industry efficiency and productivity. Indian banks have remained flexible even throughout the height of the sub-prime catastrophe and the subsequent financial turmoil. The Indian banking industry is measured as a flourishing and the secure in the banking world. The countrys economy growth rate by over 9 percent since last several years and that has made it regarded as the next economic power in the world. Our banking industry is a mixture of public, private and foreign ownerships. The major dominance of commercial banks can be easily found in Indian banking, although the co-operative and regional rural banks have little business segment. The Indian banking sector has two kinds of scheduled banks i.e. scheduled commercial banks and scheduled co-operative banks. Under the first category of scheduled banks, four types of entities have found based on their establishments and legal obligations. They are:

i) Public banks (28)3,

ii) Private Banks (25), iii) Foreign Banks working in India (29) and iv) Regional Rural Banks (91) The second category of scheduled cooperative banks consists of: i) Scheduled Urban Co-operative banks (55) and ii) Scheduled State Co-operative Banks (16) Under public & private sector, banks are more clearly defined according to nationalization and privatization. The banks under public banks are Nationalized Banks (20) and State Banks of India (with its associates, the number is come to 8). Under Private Bank category, banks are divided into two types i.e., Old private banks (17) and New-private banks (8).

EVOLUTION OF INDIAN BANKING SYSTEM

REFORMS AND BANKING SYSTEM In the post liberalization-era, Reserve Bank of India (RBI) has initiated quite a few to ensure safety and consistency of the banking system in the country and at the same point in time to support banks to play an effective role in accelerating the economic growth process. One of the major objectives of Indian banking sector reforms was to encourage operational self-sufficiency, flexibility and competition in the system and to increase the banking standards in India to the international best practices4. Although the Indian banks have contributed much in the Indian economy, certain weaknesses, i.e. turn down in efficiency and erosion in profitability had developed in the system, observance in view these conditions, the Committee on Financial System5 (CFS) was lay down. Reserve Bank of India has implemented banking sector reforms in two phases. The first reform focused on introduction of several prudential norms, major changes in the policy framework, and formation of competitive atmosphere. The second phase of reforms began in 1997 with aim to reorganization measures, human capital development, technological upgradation, structural development which helped them for achieving universal benchmarks in terms of prudential norms and pre-eminent practices. The Financial sector reforms were undertaken in 1992 based on the recommendations of the CFS. Later, The Narsimham Committee has provided the proposal for reforming the financial sector. The committee also argued that economic reforms in the real sector of economy will, however, fail to realize their full potential without a parallel reform of the financial sector. It focused on several issues like, releasing of more funds to banks, deregulation in interest rates, capital adequacy, income recognition, disclosures and transparency norms etc. However, financial sector reforms focused on improving the competitive efficiency of the banking system. The financial reform process has commenced since 1991 which was made the banking sector healthy, sound, well- capitalized and become competitive. This paper seeks to determine the impact of various market and regulatory initiatives on efficiency improvements of Indian banks. The reform process has shifted the focus of public sector dominated banking system from social banking to a more efficient and profit oriented industry. While the reform process has resulted in the private sector replacing the government as the source of resources for public sector banks (PSBs), the infusion of private equity capital has led to shareholders challenges to bureaucratic decision making. PSBs also face

increasing competition not only from private and foreign banks but also from growing nonbanking financial intermediaries like mutual funds and other capital market entities. The competitive pressures to improve efficiency in the banking sector has resulted in a switch from traditional paper based banking to electronic banking, use information technology and shift of emphasis from brick and mortar banking to use of ATMs.

POST LIBERALIZATION The liberalization of the Indian banking system dates back to the 1990s when the government began to implement the recommendations of the Narasimham Committee (1992, 1997). The principal features of the steps taken to liberalize and reform the system include: 1. Increase in competition via more liberal rules for the entry of new domestic and foreign banks, raising the number of banks from 70 to over 90 by March 2004. Recent consolidation in the industry has reduced the number of total number of banks to 80 with number of foreign banks declining from a peak of 40 to 29 and private banks shrinking to 27 by end March 2007. Since 1993, twelve new private sector banks were set up but some of them have already either merged with other PSBs or private banks or have gone out of business. Foreign direct investment in private sector banks is allowed up to 74%.

2. Infusion of Government capital in PSBs followed by Injection of private equity. PSBs are allowed to increase the share of private capital upto 49% of which 20% can be foreign equity. As a result, the share of wholly Government-owned public sector banks in total system assets fell from 90% in 1991 to 10% in 20041.

3. Deregulation on interest rates except for certain specific classes such as savings deposit accounts, NRI deposits, small loans up to Rs. 2 lakh, and exports credits.

4. Cuts in Statutory Liquidity Requirements (SLR) and Cash Reserve Requirements (CRR) to reduce pre-emption of bank lending and lower financial repression.

5. Reduction in credit controls to 40% from 80% of total credit.

6. Introduction of a broader definition of priority sector lending.

BANKING SYSTEM IN INDIA


The banking system in India is significantly different from that of other Asian nations because of the countrys unique geographic, social, and economic characteristics. India has a large population and land size, a diverse culture, and extreme disparities in income, which are marked among its regions. There are high levels of illiteracy among a large percentage of its population but, at the same time, the country has a large reservoir of managerial and technologically advanced talents. Between about 30 and 35 percent of the population resides in metro and urban cities and the rest is spread in several semi-urban and rural centers. The countrys economic policy framework combines socialistic and capitalistic features with a heavy bias towards public sector investment. India has followed the path of growth-led exports rather than the exportled growth of other Asian economies, with emphasis on self-reliance through import substitution. These features are reflected in the structure, size, and diversity of the countrys banking and financial sector. The banking system has had to serve the goals of economic policies enunciated in successive five year development plans, particularly concerning equitable income distribution, balanced regional economic growth, and the reduction and elimination of private sector monopolies in trade and industry. In order for the banking industry to serve as an instrument of state policy, it was subjected to various nationalization schemes in different phases (1955, 1969, and 1980). As a result, banking remained internationally isolated (few Indian banks had presence abroad in international financial centers) because of preoccupations with domestic priorities, especially massive branch expansion and attracting more people to the system. Moreover, the sector has been assigned the role of providing support to other economic sectors such as agriculture, small-scale industries, exports, and banking activities in the developed commercial centers (i.e., metro, urban, and a limited number of semi-urban centers). The banking systems international isolation was also due to strict branch licensing controls on foreign banks already operating in the country as well as entry restrictions facing new foreign banks. A criterion of reciprocity is required for any Indian bank to open an office abroad. A big challenge facing Indian banks is how, under the current ownership structure, to attain operational efficiency suitable for modern financial intermediation. On the other hand, it has been relatively easy for the public sector banks to recapitalize, given the increases in nonperforming assets

(NPAs), as their Government dominated ownership structure has reduced the conflicts of interest that private banks would face.

BUSINESS SEGMENTATION OF BANKING INDUSTRY The entire range of banking operations are segmented into four broad heads- retail banking businesses, wholesale banking businesses, treasury operations and other banking activities. Banks have dedicated business units and branches for retail banking, wholesale banking (divided again into large corporate, mid corporate) etc.

RETAIL BANKING It includes exposures to individuals or small businesses. Retail banking activities are identified based on four criteria of orientation, granularity, product criterion and low value of individual exposures. In essence, these qualifiers imply that retail exposures should be to individuals or small businesses (whose annual turnover is limited to Rs. 0.50 billion) and could take any form of credit like cash credit, overdrafts etc. Retail banking exposures to one entity is limited to the extent of 0.2% of the total retail portfolio of the bank or the absolute limit of Rs. 50 million. Retail banking products on the liability side includes all types of deposit accounts and mortgages and loans (personal, housing, educational etc) on the assets side of banks. It also includes other ancillary products and services like credit cards, demat accounts etc.

The retail portfolio of banks accounted for around 21.3% of the total loans and advances of SCBs as at end-March 2009. The major component of the retail portfolio of banks is housing loans, followed by auto loans. Retail banking segment is a well diversified business segment. Most banks have a significant portion of their business contributed by retail banking activities. The largest players in retail banking in India are ICICI Bank, SBI, PNB, BOI, HDFC and Canara Bank. Among the large banks, ICICI bank is a major player in the retail banking space which has had definitive strategies in place to boost its retail portfolio. It has a strong focus on movement towards cheaper channels of distribution, which is vital for the transaction intensive retail business. SBIs retail business is also fast growing and a strategic business unit for the bank. Among the smaller banks, many have a visible presence especially in the auto loans business. Among these banks the reliance on their respective retail portfolio is high, as many of these banks have advance portfolios that are concentrated in certain usages, such as auto or consumer durables. Foreign banks have had a somewhat restricted retail portfolio till recently. However, they are fast expanding in this business segment. The retail banking industry is likely to see a high competition scenario in the near future. WHOLESALE BANKING Wholesale banking includes high ticket exposures primarily to corporates. Internal processes of most banks classify wholesale banking into mid corporates and large corporates according to the size of exposure to the clients. A large portion of wholesale banking clients also account for off balance sheet businesses. Hedging solutions form a significant portion of exposures coming from corporates. Hence, wholesale banking clients are strategic for the banks with the view to gain other business from them. Various forms of financing, like project finance, leasing finance, finance for working capital, term finance etc form part of wholesale banking transactions. Syndication services and merchant banking services are also provided to wholesale clients in addition to the variety of products and services offered. Wholesale banking is also a well diversified banking vertical. Most banks have a presence in wholesale banking. But this vertical is largely dominated by large Indian banks. While a large

portion of the business of foreign banks comes from wholesale banking, their market share is still smaller than that of the larger Indian banks. A number of large private players among Indian banks are also very active in this segment. Among the players with the largest footprint in the wholesale banking space are SBI, ICICI Bank, IDBI Bank, Canara Bank, Bank of India, Punjab National Bank and Central Bank of India. Bank of Baroda has also been exhibiting quite robust results from its wholesale banking operations.

TREASURY OPERATIONS Treasury operations include investments in debt market (sovereign and corporate), equity market, mutual funds, derivatives, and trading and forex operations. These functions can be proprietary activities, or can be undertaken on customers account. Treasury operations are important for managing the funding of the bank. Apart from core banking activities, which comprises primarily of lending, deposit taking functions and services; treasury income is a significant component of the earnings of banks. Treasury deals with the entire investment portfolio of banks (categories of HTM, AFS and HFT) and provides a range of products and services that deal primarily with foreign exchange, derivatives and securities. Treasury involves the front office (dealing room), mid office (risk management including independent reporting to the asset liability committee) and back office (settlement of deals executed, statutory funds management etc). OTHER BANKING BUSINESSES This is considered as a residual category which includes all those businesses of banks that do not fall under any of the aforesaid categories. This category includes para banking activities like hire purchase activities, leasing business, merchant banking, factoring activities etc.

PRODUCTS OF THE BANKING INDUSTRY The products of the banking industry broadly include deposit products, credit products and customized banking services. Most banks offer the same kind of products with minor variations. The basic differentiation is attained through quality of service and the delivery channels that are adopted. Apart from the generic products like deposits (demand deposits current, savings and term deposits), loans and advances (short term and long term loans) and services, there have been innovations in terms and products such as the flexible term deposit, convertible savings deposit (wherein idle cash in savings account can be transferred to a fixed deposit), etc. Innovations have been increasingly directed towards the delivery channels used, with the focus shifting towards ATM transactions, phone and internet banking. Product differentiating services have been attached to most products, such as debit/ATM cards, credit cards, nomination and demat services.

Other banking products include fee-based services that provide non-interest income to the banks. Corporate fee-based services offered by banks include treasury products; cash management services; letter of credit and bank guarantee; bill discounting; factoring and forfeiting services; foreign exchange services; merchant banking; leasing; credit rating; underwriting and custodial services. Retail fee-based services include remittances and payment facilities, wealth management, trading facilities and other value added services.

STRUCTURE OF INDIAN BANKING SYSTEM Reserve bank of India

Commercial Banks

Regional rural banks

Co operative banks

Public Sector banks

Private Sector banks

State Cooperative Banks

Indian

Foreign

Central/District Cooperative banks

Old Banks

New Banks

Local Area banks

Primary Credit Societies

State Bank group State Bank of India Subsidiary Banks

Nationalized Banks

RESERVE BANK OF INDIA The Reserve bank of India, the central bank of our country, was established in 1935 under the aegis of Reserve Bank of India Act, 1934. It was a private shareholders institution till January 1949, after which it became a state owned institution under the Reserve Bank of India Act , 1948. It is the oldest central bank among the developing countries. As the apex bank , it has been guiding, monitoring, regulating and promoting the destiny of the Indian financial system. COMMERCIAL BANKS A commercial bank is run on commercial line that is to earn profits unlike a cooperative bank which is run for the benefit of a group of members of the cooperative body. The commercial banks are spread across the length and breadth of the country, and cater to the short term needs of the industry ,trade and commerce and agriculture unlike the developmental banks which focus on long term needs. These days the commercial banks also looks after other needs of their customers including long term credit requirements. Commercial banks operating in India may be categorized into public sector , private sector , and Indian or foreign banks depending upon the ownership ,management and control. They may also be differentiated as scheduled or non scheduled , licensed or unlicensed. SCHEDULED BANKS A scheduled bank means a bank included in the second schedule of the Reserve bank of India Act, 1934. It is carrying on the business of banking in India. Its paid-up capital and reserves are not less than Rs. 5 Lakhs. All nationalized banks and almost all the private sector banks are commercial scheduled banks in India. Foreign banks are also scheduled banks in India. At present , scheduled commercial banks (SCBs) consist of 28 public sector banks , 9 new private sector banks, 20 old private sector banks and 31 foreign banks. A scheduled bank enjoys certain privileges like becoming eligible for availing the facilities of accommodation from the Reserve bank, dealing the foreign exchanges etc. It also has certain obligations like maintaining statutory reserves with the Reserve bank of India.

NON-SCHEDULED BANK Those banks which are not included in the second schedule of the Reserve bank of India Act are termed as non scheduled banks. Usually they are small sized institutions which restrict their activities to local areas. Their paid up capital and reserves do not aggregate up to more than Rs.5 lakhs. Their banking activities are also limited. E.g. they cannot deal in foreign exchange. LICENSED BANKS No bank can carry on the business of banking unless it holds a license granted by the Reserve Bank of India. Provisions regarding licensing are contained in section 22 of the banking regulation Act, 1949. A license is usually granted if the RBI is satisfied that the bank has the capacity to pay its depositors as and when their claims accrue, and that its operations are not detrimental to the interests of the depositors. Licensing is done to ensure that the working of individual banks improves , and that the weaker and unsound ones can be weeded out. Licenses can be cancelled at any time if the RBI feels that the affairs of a bank are not being carried on in a satisfactory manner. PUBLIC SECTOR BANKS The public sector banks comprise 19 nationalized banks, the State Bank of India and its 7 associates . Till 1955 they were used to be only private commercial bank whether scheduled or non-scheduled ,licensed or un- licensed , foreign or Indian, they were all owned and controlled by private entrepreneurs and shareholders. There were three phases of bank nationalization . First was in july1955 , when government of India nationalized the imperial Bank of India to create the State Bank of India. It was a pioneering attempt in introducing public sector banking in the country. In 1959, eight state banks of erstwhile princely states were also nationalized to form the subsidiaries of the state bank of India. But now only seven of them are in existence since the state banks of Bikaner and Jaipur were merged. The second phase of public sector banking came into existence when 14 major commercial banks were nationalized on july19,1969. This was done with the view to serve the needs of development of the economy in conformity with national priorities and objectives. On April 15,1980,six more private sector banks were

nationalized. This led to the dominance of public sector banks as nearly 90 percent of the banking activity in the country was brought into the public sector. Most people generally rely on nationalized banks backed by the government. The public sector banks were socially controlled and publicly owned. It was done with the objective of giving a professional bent to bank management and provision of adequate credit for agricultural and rural sector, small industries, exports and a new class of entrepreneurs. It also aimed to professionalize bank management through adequate training of bank staff. PRIVATE SECTOR BANKS Private sector banks have existed for over a century in India. Prior to the first major nationalization in 1969,private capital called the shots in commercial banking. The Tatas owned the Central Bank of India, the Birlas the united Commercial Bank(UCO Bank) and so on. The recommendations of the Narasimham Committee on financial sector (1991), the Reserve Bank of India issued guidelines for the setting up of new private sector banks in India in January 1993. It was hoped that these financially viable, technologically sound and professionally managed banks will infuse greater competition and propel the entire banking sector to much higher levels of productivity and efficiency. At present . there are 21 old private sector banks and 9 new private sector banks . LOCAL AREA BANKS To meet the long standing need of developing a decentralized banking system, the union budget 1996-97 announced a very important policy measure regarding the development of commercial banking in India, namely the setting up of local area banks(LABNKs) as commercial banks in the private sector. It is hoped that the large number of problems faced by RRBs and other commercial and cooperative banks would be addressed by the local area banks especially in the rural areas. These banks were thus set up with the twin objectives of i)Providing an institutional mechanism for promoting rural and semi-urban savings, and ii)For providing credit for viable economic activities in the local areas. The local area banks are governed by the provisions of the RBI Act, 1934, the Banking Regulation Act,1949 and other relevant statutes.

INDIAN BANKS Banks in India may be commercial banks incorporated as joint stock companies, public sector banks or cooperative banks or regional rural banks or foreign banks . Indian banks operate nationally through a colossal network of branches. Since . they have a large and varied clientele with a diverse spectrum of needs, the Indian banks specialize in different geographical regionsurban and rural, different sectors-industry both large and small, agriculture , trade, housing , exports , etc. However , all of them in the organized sector come under the purview of the RBI Act and the Banking Regulation Act. The main strength of the Indian banks is their vast number of employees who are well conversant with the social and cultural fabric of their customers. The Indian banks by and large focus on core banking operations. They also comply with the RBI guidelines as to liquidity requirements, interest rates and priority sector lending amongst other provisions. FOREIGN BANKS Till the 1950s they were called Exchange Banks because they alone transacted most of the import and export financing business of India. The foreign banks are branches of joint stock companies incorporated abroad, but operating in India. They are foreign in origin, and have their head office located in their parent country. Many foreign banks opened their offices and expanded branches after the opening up of the Indian economy I the 1990s. These banks created an entirely new playing field in the banking sector through their range of products and services including ATMs, electronic services, credit cards and portfolio management. They provide foreign currencies for bona fide purposes like Travel, trade or for study abroad. Most foreign banks have a strong parent bank commitment, superior technology and provide a very high level of customer service. This has resulted in very strong performance of the banks both in the retail sector as well as the corporate sector .

REGIONAL RURAL BANKS 19 regional rural banks (RRBs) were set up by the government of India under the Regional Rural Banks Act of 1976 with the specific purpose of providing credit and other facilities to the small and marginal farmers, agricultural labourers, artisans and small entrepreneurs in rural areas. The then existing credit agencies namely the cooperative and commercial banks, were unable to meet the requirements of the rural people in general and the rural poor in particular. At present there are 196 RRBs in India, 29 of which have a negative net worth of about Rs.1800 crore. They have a network of 14,519 branches with an average credit deposit ratio of less than 60 per cent. RRBs are operating across 518 districts in 26 states. COOPERATIVE BANKS Cooperative banks are a part of the set of institutions, which are engaged in financing rural and agricultural development. The other institutions in this set include the RBI, NABARD, commercial banks and regional rural banks. Cooperative banking is small scale banking carried on a no profit , no loss basis for mutual cooperation and help. Cooperative banks were assigned the important role of delivering of fruits of economic planning at the grass roots level. Cooperative banking structure is viewed as a vehicle for democratization of the Indian financial system. They were conceived to supplant moneylenders and indigenous bankers by providing adequate short-term and long-term institutional credit at reasonable rates of interest.

CURRENT PERFORMANCE OF INDIAN BANKING SECTOR The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. The sector now compares favorably with banking sectors in the region on metrics like growth, profitability and non-performing assets (NPAs). A few banks have established an outstanding track record of innovation, growth and value creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in the sector remain limited to a small part of it. The cost of banking

intermediation in India is higher and bank penetration is far lower than in other markets. Indias banking industry must strengthen itself significantly if it has to support the modern and vibrant economy which India aspires to be. While the onus for this change lies mainly with bank managements, an enabling policy and regulatory framework will also be critical to their success.

KEY PLAYERS IN BANKING SECTOR

State bank of India Bank of Baroda Bank of India HDFC bank Axis bank

Punjab national bank ICICI bank Canara bank IDBI bank Central bank of India

RECENT DEVELOPMENTS IN INDIAN BANKING SYSTEM The key developments during the last 15 months, which could have an impact on the credit profile of the banks going forward, are highlighted below: Sizeable Capital infusion into PSU banks by the Government; more capital likely to be infused in FY12. Increase in provision coverage on NPAs by majority of the banks to 70%1 leading to improvement in Solvency profile. Steady rise in interest rates in the economy as the Reserve Bank takes steps to tackle inflationary pressures. Introduction of Base Rate from Jul-10; rise in yield on advances for the banking system albeit with some lag

Interest on savings account balances increased to 4.00% from 3.50%; interest to be paid on daily balance; ICRA estimates adverse impact on cost of funds at 8-15 basis points. Reopening of pension option to employees of PSU banks and enhancement of gratuity limit to Rs. 1 million per employee from Rs. 0.35 million likely to impact Tier I capital; option to amortize over 5 years cushions immediate adverse impact on reported Tier I capital.

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