Krishna Chaitanya V.
Assistant Professor & Research Associate (Finance Area)
Dhruva College of Management
Kachiguda,Hydearabad - 500 027
Cell : 9849422731
Phone : 040 - 24655274 24600032
E-mail :


Ever since the financial sector reforms were introduced in early 90's the banking sector saw the emergence of new generation private sector banks. These banks gained at most popularity as they have technology edge and better business models when compared to public sector banks and the most important thing is they are able to attract more volumes simply because they meet their customers requirements under one roof.

If the newer players can do that then why cant the bigger players like the Development Financial Institutions (DFIs) try their hands on it? Here comes the concept of universal banking, its emergence, merits and related issues.

The paper focuses on understanding the concept of universal banking in India and attempts to explain the regulatory role, regulatory requirements, key duration and maturity distinction and lastly the optimal transition path. The paper also gives an overview of the international experience and argues in favour of developing a strong domestic financial system in order to compete in the global market.



The concept of Universal Banking

Universal Banking, means the financial entities the commercial banks, DFIs, NBFCs, - undertake multiple financial activities under one roof, thereby creating a financial supermarket.

The entities focus on leveraging their large branch network and offer wide range of services under single brand name.

Universal banking generally takes one of the three forms: -

    a. In-house Universal banking. Eg. Germany

    b. Through separately capitalized subsidiaries. Eg. England.

    c. Operations carried through a holding company. Eg. USA. (Nair, 1998)

Universal Banking includes not only services related to savings and loans but also investments. However in practice the term 'universal banks' refers to those banks that offer a wide range of financial services, beyond commercial banking and investment banking, insurance etc. It is a combination of commercial banking, investment banking and various other activities including insurance. If specialised banking is the one end universal banking is the other. This is most common in European countries.

A narrow view of Universal banking could be activities pertaining to lending plus investments in bonds and debentures. A broader view could include a basket of all the financial activities including insurance. Though the concept is prevalent in countries like France, Germany and USA but is yet to take-off, officially in India.

International Scenario

Federal Republic of Germany, Switzerland are generally known to be the home of universal banking. Factors like technological up gradation, wide spread of applications, increasing competition in financial sector etc., are the driving forces in these nations. In few other European countries, almost all other banking and non-banking services are carried out by financial institutions. For instances, in Germany, commercial and investment banking activities are performed by a single entity, but separate subsidiaries are required for other activities. In UK a separate subsidiaries of commercial banks involve in providing wide range of activities.

What the USA follows is an extreme model, where the commercial banks are prevented legally from combining their normal lending functions with investment operations, where they are separated by several legislative acts, including the Glass-Steagall Act of 1933 and the bank Holding company Act of 1956. However, at present USA is having a re-look at the position. Much of the international debate on universal banking has been centered around the restriction on diversification of the type.

Indian Scenario

1. Commercial banks

In early 90's the financial sector in India was crying out for reforms. Ever since the process of liberalization hit the Indian shores, the banking sector saw the emergence of new-generation private sector banks. Public sector banks which played a useful role earlier on are now facing deterioration in their performance. For very long, the banks in India were not allowed to have access to stock markets. So their dealing in other securities were minimal. But the financial sector reforms changed it all, Indian banks started to deal on the stock market but their bitter experience with scams, they became averse to deal in equities and debentures. Off late, commercial banks in India have been permitted to undertake a range of in-house financial services. Some banks have even setup their own subsidiaries for their investment activities. Subsidiaries include in the area of merchant banking, factoring, credit cards, housing finance etc.

2. Financial Institutions

DFIs were traditionally engaged in long term financing, as their main objective was to take care of the investment needs of industries and to contribute to a better industrial climate. They had, over the time, built up expertise in merchant banking, project evaluation and also started giving working capital finance. Recently, they were allowed to accept medium-term deposits within the specified limits. Lots of changes have taken place in DFIs in the recent past. Most of DFIs have floated banks, institutions and mutual fund subsidiaries. Ownership changes took place, several institutions went public, organization structure itself got transformed.

Indian Perspective on Universal Banking

Some argue that the approach is very slow, while some call for steady approach. The debate of universal banking is very much on. Should India have universal banking and if so when? Much has been written about it domestically, however the following are the issues which are key in Indian context.

      i. Regulatory burden

      ii. Regulatory requirements

      iii. Distinction between maturity and duration

      iv. Optimum Transition path

i. Regulatory burden:

One of the major problems associated with universal banking is the issue of regulation. DFIs in India are governed by separate Acts and banks are regulated by RBI and Banking Regulation Act. DFIs in India have commercial banks as their subsidiaries, but due to the separation of regulation, the DFIs cannot have direct access to the resource base of its subsidiary bank. Without any doubt, the net regulatory burden for all participants in the entire financial system should be equalized in order to ensure that no participant might end up having a disadvantage relative to any other. The importance of this point can be highlighted by citing the example of USA, Japan, West Germany and Britain where there was a tremendous decline in the share of banks in composition of household financial assets and its movement to mutual funds and insurance. The study reveled that the decline has been due to very high net regulatory burden being imposed upon the entire banking system relative to that on the mutual funds and insurance companies. In India there is an urgent need to reduce the regulatory burden, particularly for banks vis--vis mutual funds and insurance companies, if the banks are expected to compete in free market place. (Mor, 1999)

ii. Regulatory requirements

The reference of regulatory requirements here are on the following issues

a. Cash Reserve Ratio (CRR): From early 90's the monitory policy in India has been focusing on review of CRR. Off late RBI is concentrating more so on indirect instruments like Bank Rate and Open Market Operations, and felt that the CRR must be brought down to its minimum level of 3 percent at the earliest. It is also argued by some experts that instead of the complete Net Demand and Time Liabilities (NDTL) of banks, its application if restricted only to cash and cash like instruments, it would be more effective as an instrument of monetary policy and by applying the ratio, for the senior bonds that may be issued by banks to industry, is not in the interests of Monetary policy and this would further increase the cost of funds to the industry by almost at 1 percent.

b. Statutory Liquid Ratio (SLR): Though, the SLR has already reached its statutory minimum of 25 percent, some experts feel there is need to re-examine the present minimum limit, which is very high as per the international practices and could be brought down further by amending the Banking Regulation Act. Few banking experts extended to specific infrastructure projects as a part of SLR, since these facilities have directly replaced similar financing by Government of India.

c. Priority Sector: The whole issue of priority sector needs a closer look. The S.H Khan panel called for modifications in defining the priority sector by excluding all infrastructure loans from the net bank credit for the priority sector. It has also suggested the creation of an alternative mechanism to finance the priority sector.

Even the international experience of banks in Asia-Pacific region had a 'must serve' obligation towards priority sector and the result was discriminatory and inefficient performance without the support of commercial mindset.

iii. Distinction between Maturity and Duration

This is the another issue of debate between long term and short term. Somehow DFIs are the suppliers of term finance, where the maturity is clearly specified which could be between 3 years to 7 years, where as banks are providers of short-term finance where in reality bank finance in a way amounts to financing in perpetuity since there are in general no definite maturity dates. Usually the deposit base of the banks have are short duration but with a variably high interest rates but its not the case with DFIs. Their funds have a longer duration with less interest rates. (Mor, 1999)

The interim report of S H Khan committee has argued that the distinction between commercial and investment banking have become increasingly blurred with banks providing both working capital and term loans to corporates but DFIs can provide only term loans as they cannot accept short term deposits. The committee further argued that DFIs should be given banking licenses eventually and until then they should be allowed to establish 100 percent banking subsidiaries while they continue to play their present role.

iv. Optimal Transition path

Viable transition path is one of the major areas of concern for institutions which are desirous of moving in the direction of universal banking. The transition path contains several operational and regulatory issues for information and guidance of DFIs. The S H Khan working group and the discussion paper on the subject prepared by RBI eventually felt that DFIs should transform themselves into commercial banks but in a phased manner. The committee also recommended that DFIs can have 100 percent owned banking subsidiaries which would be extremely beneficial to them. If this happens, then it would allow DFIs to gain expertise in the area of commercial banking which would in turn help the DFIs if they are seriously looking at the prospect of converting into a commercial bank. Also the 100 percent subsidarisation allows banks to have a full access to capital base of DFIs and gain substantial knowledge in the area of project financing.

The 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.


Caution must be applied on Universal banking because of the following considerations:

1. Dis-intermediation (i.e replacement of traditional bank intermediation between savers and borrowers by a capital market process) is only a decade old in India and has badly slowed down due to loss of investors' confidence.

2. There is an ample room for financial deepening (by banks & DFIs) since loan market will continue to grow.

3. DFIs as a folder of equity in most of the projects promoted in the past have never used the tool advantageously.

4. DFIs are now only moving into working capital finance, an area in which they need to gain lot of expertise and this involves creation of network of services (including branches) in all fields like remittances, collections etc.

5. Reforms in the Indian capital market is still in the half way stage. The priority will be to ensure branch expansions, financial deepening of credit markets, and creation of an efficient credit delivery mechanism that can compete with the capital market. 

Salient operational and regulatory issues to be addressed by the FIs for conversion into a Universal Bank [RBI circular]

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 Banking Regulation 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 Banking Regulation 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 Banking Regulation 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 Banking Regulation Act, which prohibits a bank from holding shares in a company in excess of these limits.

h) Connected lending

Section 20 of the Banking Regulation 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 license from RBI under Section 22 of the Banking Regulation 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 east 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 Banking Regulation 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 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 Banking Regulation 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 Banking Regulation 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 license 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 authorized dealer license 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. 

Concluding Remarks

The following are the steps suggested:

a. Equalise the net regulatory burden across the financial system (including banks, DFIs, mutual funds, NBFCs and Insurance companies).

b. Lower the regulatory burden on the over regulated entities.

c. Promote and encourage strong competition.

d. Do not allow the merger of a weak bank with a viably strong DFI or vice-versa.

e. DFIs should be permitted to set up a 100 percent owned banking subsidiaries.

f. Need is felt to re-examine the minimum level of SLR requirement in order to meet the best of international standards.


1.Dr. KRS Nair, Universal Banking, Indian Management, (May 1999) pp. 48-51.

2. Dr. Nachiket Mor, An Indian Perspective on Universal Banking, paper presented at 'National Seminar on Financial Markets & Institution' at Mumbai, (Jan 1999).

3. Dr. Nachiket Mor & Rupa Rege Nitsure, Universal Banking Issues & concerns, paper presented at national seminar by RBI at ASCI, Hyderabad, (June 1999).

4. Anurag Khanna, Universal banking an overview, Bank net India.com.

5. Approach to universal banking, Mid-term Review of the Monetary and Credit Policy of Reserve Bank of India for 1999-2000.

6. RBI Circular paper on 'Salient operational and regulatory issues to be addressed by the FIs for conversion into a Universal Bank.'


Krishna Chaitanya V.
Assistant Professor & Research Associate (Finance Area)
Dhruva College of Management
Kachiguda,Hydearabad - 500 027
Cell : 9849422731
Phone : 040 - 24655274 24600032
E-mail :

Source : E-mail February 4, 2004




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