Universal Banking in India


By

Abdul Nasir Jamal
Anuj Kumar Rathi
PGDBA 3rd Semester
Graduate School of Business & Administration
Greater Noida
 


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.

REFERENCES

*
www.banknetindia.com/banking/ubfeature.htm: Universal Banking: introduction, RBI rules and regulations, Universal Banking in India

* www.answers.com/topic/universal-banking: Universal Banking: definition

* www.investopedia.com/terms/u/universalbanking.asp Universal Banking: definition

* www.cato.org/pubs/journal/cj13n2/cj13n2-8.pdf Universal Banking: Future

* 'The Universal Banking': introduction, concept, pros and cons.  Journal of Professional Banker, October 2006 pg 24-27
 


Abdul Nasir Jamal
Anuj Kumar Rathi
PGDBA 3rd Semester
Graduate School of Business & Administration
Greater Noida
 

Source: E-mail September 24, 2007

 

       

 

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