The Universal Banking
Bigger is Better


Medha M. Katkar
Research Associate
ICFAI National College


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.


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.


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)


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.


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?


1) "Universal Banking by DFIs: Handy But no solution to NPAs"
     "Sanjiv Shankaran"                          "Business Line"
2) "Approach to Universal Banking"
3) "Banking in the New Millennium"
    "M. Guruprasad"     (Asst. Prof in Economics)
4) "Universal Banking: the Road Ahead"
    Kamal Sehgal (IIFT)
5) "A Financial Apartheid in informal sector: A Study"
    By Scientific Research Association for Economics, Chennai.
6) "Universal Banking The Indian Perspective"
    Chaitnya Krishna V.
7) "Consolidation of Indian Banks challenges"
    BNV Parthasarathi     "Professional Banker"
    (The ICFAI University Press)

Medha M. Katkar
Research Associate
ICFAI National College

Source: E-mail July 6, 2006


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