CHAPTER 1

INTRODUCTION TO DFI’s AND BANKS

1.1 DEVELOPMENT FINANCIAL INSTITUTIONS

1.1.1 Introduction:

Development Financial Institutions or Development banks are the institutions

which supply capital, knowledge, and enterprise, the three major ingredients of
development for business enterprises. These Institutions provide long term finance
to agriculture, industries, trade, transport and basic infrastructure, so that in the
absence of financial resources the economic development of the country is not
adversely affected. These institutions have been taking interest in industrial finance
to industrial sectors as well as promotional development activities of the industrial
units in the country.

William Diamond defines Development Financial Institutions as “an institution to

promote and finance enterprises in the private sector.” It is important to stress that
the development banks apart from financing development projects provide
supporting services too. These institutions provide finance, promote industrial
units, and underwrite securities of the companies and directly invest in shares and
debentures of the company. Technical and managerial advice is also given by
them.
1.1.2 Objectives:

(i) To provide various types of assistance like technical, managerial, financial, and
marketing and so on. To provide medium and long-term credit at reasonable cost to
aspiring entrepreneurs.

(ii) To develop over a period of time efficient managerial resources, to help rapid
development of the country.

(iii) To sub-serve the social goals, planned objectives, priorities and targets at
national planning level.

(iv) To allocate resources to high priority areas.

(v) To accelerate the growth of the economy.

(vi) After the globalization process in the beginning of 90’s, development banks
diversified their services to almost each and every sector of the economy.

(vii) In countries like India, sheer vastness of size necessitates considerable

attention to be paid to the objective of regional development. In deployment of
credit, development banks pay adequate attention to the regional development
objectives.

1.1.3 DFI.s after post Financial Sector Reforms of 1990:

In India, the Development Financial Institutions were established and developed

by Government of India and Reserve Bank of India (RBI) to meet the specific
needs of the industry and 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. Off late, financial institutions were also permitted to combine their
traditional activities with investment banking activities with certain moderate
restrictions. Most of the Financial Institutions have floated banks, institutions and
mutual fund subsidiaries. Ownership changes took place, several institutions went
public, and organization structure itself got transformed.
1.2 COMMERCIAL BANKS

1.2.1 Introduction:

Commercial banks are the premier financial institutions as they play a pivotal role
in the country’s economy. Commercial banks two major functions are accepting
deposits and employing the funds thus mobilized in lending or investing in
securities. Banks being financial institutions, planning and management of funds
are essential elements of bank management.

It can be defined as an “institution that offers a broad range of deposit accounts,

including current, savings, and time deposits, and extends loans to individuals and
businesses -- in contrast to investment banking firms such as brokerage firms,
which generally are involved in arranging for the sale of corporate or municipal
securities.”

1.2.2 Objectives:

(i) To maintain higher profitability by maintaining circular and efficient flow of

amount deposited by the customers and the lenders.

(ii) To contribute to the economic cycle by keeping the money circulation among
households, government and corporate businesses

(iii) To design short term and long term loans and other products to cater to the
need of customers while enhancing their own returns.

(iv) To attract more customers and build profitable relationships with the new and
existing customers.
1.2.3 Commercial Banks after post Financial Sector Reforms of 1990:

Traditionally, the commercial banks in India were largely into the core banking
business of accepting deposits and providing working capital funds to agriculture
and allied, trade and industry sectors. In early 90’s the financial sector in India was
out for reforms. Ever since the process of liberalization there was a change in the
scenario. The banking sector saw the emergence of new-generation private sector
banks. Public sector banks which played useful role earlier on are facing
deterioration in their performance. For very long banks in India were not allowed
to have access to stock markets. So their dealing in other securities was minimal.
But the financial sector reforms changed it all.

Indian banks started to deal on the stock market but their bitter experiments with
scams; they became averse to deal in equities and debentures. Some banks have
even set up their own subsidiaries for their investment activities. Subsidiaries
include in the area of Merchant banking, factoring, Credit cards, housing finance
etc. Commercial banks offer a wide range of corporate financial services that
address the specific needs of private enterprise. They provide deposit, loan and
trading facilities but will not service investment activities in financial markets.

Commercial banks play a number of roles in the financial stability and cash flow of
a countries private sector. They process payments through a variety of means
including telegraphic transfer, internet banking and electronic funds transfers.
Commercial banks provide a number of import financial and trading documents
such as letters of credit, performance bonds, standby letters of credit, security
underwriting commitments and various other types of balance sheet guarantees.
They also take responsibility for safeguarding such documents and other valuables
by providing safe deposit boxes. At present, Indian banks are engaged in credit,
consumer finance, savings, money and capital, advisory services and recently
insurance market.
According to Saunders and Walters, India falls under Partially Integrated Financial

Conglomerates model of Universal Banking which is as follow:

(Source: Global Banking, Roy Smith and Ingo Walter)

An example of State Bank of India may be quoted here which has set up the
following subsidiaries:

(i) SBI funds Management.

(ii) SBI Capital Markets.

(iii) SBI Factors and Commercial Services.

(iv) SBI Home finance.

(v) SBI Life Insurance Company.

(vi) SBI Gilts.

Therefore Indian banks are already moving in the direction of Universal Banking,
undertaking all the financial services under one roof.
1.3 IMPORTANT ACTIVITIES OF BANKS AND DFI.s

Commercial Investment banking Other Financial

Banking or similar services
in nature
Banks
Accepting chequable Investments in Factoring, Leasing,
deposits, Granting Securities, Hire-purchase, Mutual
loans and advances. Underwriting of funds, Merchant
loans, banking, Housing
Loans Finance.
Syndication.

DFI’s
DFI’s granting Long- Underwriting and Commercial banking,
term Loans and Subscribing Credit rating,
Advances, Short-term directly to Brokerage, Housing
Loans and Advances, shares / bonds of Finance, Mutual funds,
Working capital corporate. Project Consultancy,
finance, Accepting Registrar Services etc.
term-deposits and
issuing Certificate of
Deposits.

(Source: Universal Banking, Dr. P.K. Bandgar and Aarthi Kalyanraman)

1.4 COMMERCIAL BANKS V/S DFI.s

DFI’s were set up either under The Companies Act 1956, or as statutory bodies
under the acts of parliament. These are prudential requirements as also entry
conditions for banks under Banking Regulation Act 1949, for undertaking banking
business.

Commercial Banks Development Financial Institutions

Commercial banks Short term finance. Commercial banks Short term finance.
They undertake the Planning and Management To promote growth and provide support they
of essential elements of banking. are going to underwrite securities, invest in
Shares and Debentures of other commercials.

Commercial banks accept deposits and lend
loans.
Banks are allowed to invest in shares of
private bodies and public sector undertakings
of their incremental deposits in the previous
year.
DFI’s provide capital, expertise and
knowledge.
They have been allowed to invest partially into
the deposit market subject to limit related to
their net worth.

Planning includes: DFI’s provide all kinds of assistance such as:

(i) Estimation of funds required.
(ii) Sources of finance and their proportion.
(iii) Utilization of fund.
(i) Medium to Long term credit at reasonable
cost.
(ii) Development of managerial resources to
priority areas.

(iv) Control and monitoring the Fund. (iii) Accelerating growth of the economy.

Sound planning helps banks in meeting its (iv) Adequate attention to regional
obligation of: development.

a) Statutory requirements. (v) Diversification to all fields after

globalization.
b) Assisting various sectors.

c) Fulfilling Social obligations.

d) Maintaining efficiency and profitability.

1.5 NEED FOR DFI.s CONVERTING INTO BANKS

1. High cost of funds, this is over 12 percent in case of a financial institution and
just over 6 percent in case of a commercial bank.

2. Increasing competition, due to increase in various new players like insurance

companies, mutual fund entities etc.

3. Low demands for long term funds, due to absence of heavy project investments
especially in the area of infrastructure.

4. High level of non-performing assets.

5. Increasing competition from commercial banks in retail financial market.

6. Lower spread due to extensive competition.

7. High competition in market to attract top rated borrowers at low.

8. The global financial services market is growing very fast and chains of foreign
banks are attacking traditional banks by offering new products of loans and
investment portfolios under one roof.

9. Liberalization and de-regulation of financial markets have led to fragmentation

of traditional branch services.

10. Information Technology development has paved the way for excellent
customer services by way of providing electronic distribution channels. New breed
of private sector banks and foreign banks are providing a wide range of services
under one roof.
11. Many foreign banks and new breed of private sector banks have started
outsourcing various products. For e.g. Credit cards, Insurance products, etc.

12. Customers have become very demanding now. They want various financial
services including expert advice on investment and portfolio management for
longer hours. (24 hours, 365 days) and sometime in their houses also.

13. Foreign banks and new private sector banks are integrating all its customer
information and making the information available across all different delivery
channels, i.e. their branches. Many other banks have also realized that the data
warehousing has the potential to play an immensely important role in the future,
especially in relation to how the banks use their information with their virtually
delivery channels.
 CHAPTER 2

HARMONISATION OF BANKS AND DFI’S

2.1 INTRODUCTION

The financial sector reforms ushered a significant change in the operating

environment of banking and development financial institution. The deregulation of
interest rates, disintermediation and increasing participation by banks in project
finance altered the operation environment of bank by, paving way for universal
banking. The development financial institution set up in the year 1948 with a view
to meet the long term financial needs of a project realized that to mitigate the
inherent risk arising from a care product dominant portfolio, they have to resort to
product diversification. With development financial institution making forays into
the realm of working capital or short term financing, the traditional operational
division between banks and development financial institutions became increasingly
blurred.

2.2 KHAN WORKING GROUP

2.2.1 Introduction:

In the light of number of reform measure adopted in the Indian financial system of
reform measures adopted in the Indian financial system since 1991 and keeping in
view the need for evolving an efficient and competitive financial system .the
reserve bank constituted on December 8th 1997, a working group for harmonising
the role and operation of DFIs and banks , under the chairmanship of chairman and
managing director of industrial development bank of India, Shri S.H.Khan with
following terms of reference:

(i) To review the role, structure and operation of DFI’s and Commercial banks in
emerging environment.

(ii) To suggest measures for bringing about harmonization in their roles and
operations.
(iii) To suggest measures for strengthening of the organization, human resources,
risk management practices and other related issues in DFI’s and Commercial
banks.

(iv)To examine whether DFI’s could be given increased access to short-term

funding and the regulatory framework needed for the purpose.

The working Group submitted its interim report in April and Final Report in May
1998. After the submission of the Khan Working Group report, the Reserve Bank
released a discussion paper on the topic “Harmonizing the role and operations of
Development Financial Institution and Banks” in January 1999.

The discussion paper observed that the approach to universal banking in India
should be guided by the twin considerations of international experience and
domestic requirements and contended that the transformation of a Development
Financial Institution should ideally be considered after a reasonable period of time
has elapsed. In the interim, Development Financial Institutions could tailor their
needs to become either a Non Banking Financial Company or a bank, depending
on institution-specific considerations and their comparative advantages. The
options to pursue banking activities could occur either through a process of
mergers and acquisitions, thus enabling Development Financial Institutions to reap
the economies of a branch network through a fully fledged subsidiary as a part of
the conglomerate. The Narasimham committee II on Banking Sector Reforms
(1998) suggested that DFI”s should convert ultimately in to either commercial
banks or Non-banking finance Companies. The transitory arrangements in the
process of evolution could be worked out, after a detailed examination by the RBI,
on a case-by-case basis, in view of the unique position of each financial position of
each financial institution as part of its progress towards universal banking
practices.
 In view of the special role of banks in the financial sector, and such conglomerate,
in which a bank is present, should be subject to a consolidated approach to
supervision and regulation, while ensuring consistency with monetary policy and
prudential standards. The discussion paper, however, recognized that till such time
as the long term debt market improves in terms of depth and liquidity, there would
be a definitive role for the Development Financial Institutions in providing long
term development finance.

The Khan working group held the view that DFI’s should the allowed to become
banks at the earliest. The feedback on the Discussion Paper (DP) released in
January 1999 by RBI, indicated that while universal Banking is desirable from the
point of view of efficiency of resources, there is need for caution in moving
towards such a system by banks and Development Financial Institutions.

2.2.2 Khan Working Group Recommendations on Conversion of DFI.s

The Khan Working Group (KWG) keeping in views the deregulation,

securitization and the diversification of business by banks into investment banking
and beyond, made following recommendations:

1. The approach to universal banking should be guided by international experience

and domestic requirements.

2. The DFIs should have the freedom to remain DFIs, specializing in their own
activities. However, if a DFI chooses to become a bank, venturing into commercial
banking activities, that option should also be available. In that case, the
“Converted DFI” should be prepared to fully conform to all prudential, regulatory
and supervisory norms which are applicable to banks.

3. The question of transformation of DFI into a bank should ideally be considered

after a period, say of five years from now. When a DFI chooses to transform itself
into a bank, the transitionary arrangements on a time bound basis could be worked
out. This case by case approach is essential because each DFI would be in a unique
position in terms of its capacity to transform into a bank.
4. If a DFI chooses to provide bank like services by itself through a wholly owned
subsidiary route, permission to set up a fully owned subsidiary could also be
considered by the RBI.

5. If a DFI, does not acquire a banking license within a stipulated period, it would
be categorized as a NBFC.

6. KWG has suggested that super regulations be established to supervise and

coordinate the activities of the multiple regulations in order to ensure uniformity in
regulatory treatment.

7. The overall ceiling for DFIs mobilization of resources by term money

borrowings, certificate of deposits, term deposits and inter corporate deposits at
100 percent of NOF (Net Owned Funds) of DFIs may be removed.

8. KWG recommends that a suitable level of Statutory Liquidity Ratio may be

stipulated for DFIs on incremental outstanding fixed deposits raised from the
public (excluding interbank deposits).

9. KWG recommended:

a) The application of Cash Reserve Ratio (CRR) should be confined to cash and
cash like instruments.

b) CRR should be brought down progressively within a time bound frame to

international levels.

c) SLR should be placed in line with international practice.

10. To manage risks Khan Working Group recommended:

a) A prudent risk returns relationship strategy.

b) A clear strategy approved by the board of directors as to their risk management

policies and procedures.

c) An integrated treasury and proactive asset liability management and robust

operational controls.
2.3 NARASIMHAM COMMITTEE

2.3.1 Introduction:

The Narasimham committee II on Banking Sector Reforms (1998) suggested that

DFI”s should convert ultimately in to either commercial banks or Non-banking
finance Companies. Narasimhan Committee report made certain recommendations
which have a bearing on the issues considered by the Khan Working group.

2.3.2 Major Recommendations of the Committee on Banking sector Reforms,

1998 (Narasimhan Committee-II) relating to DFI.s:

The major recommendations of the Narasimhan Committee-II in so far as they

relate to DFI’s are set out below:

1. with convergence of activities between banks and DFI’s the DFI’s should over a
period of time/convert themselves into banks. There would then only be two forms
of intermediaries, viz., banking companies and non-banking finance companies. If
a DFI does not acquire a banking license within a stipulated time, it would be
categorized as a non banking finance company.

2. A DFI which converts into a bank can be given sometime to phase its reserve
requirements in respect of its liabilities to bring it on par with the requirements
relating to commercial banks.

3. Mergers between banks and DFI’s and NBFC’s need to be based on synergies
and locational and business specific complementarities of the concerned
institutions.

4. Merger between strong banks/FI would make for greater economic and
commercial sense and would be cases were the whole is greater than the sum of its
parts and have a “force multiplier effect.”
5. To provide the much needed flexibility in its operations, IDBI should be
corporatized and converted into a Joint stock company under the Companies act,
1956 on the lines of ICICI, IFCI and IIBI. For providing focused attention to the
work of State Financial Corporations, IDBI shareholding in them should be
transferred to SIDBI which is currently providing refinance assistance to State
Financial Corporations. To give it greater operational autonomy, SIDBI should
also be de-linked from IDBI.

6. The Supervisory function over rural financial institutions has been entrusted to
NABARD. While this arrangement may continue for the present, over the longer-
term, the committee would suggest that all regulatory and supervisory functions
over rural credit institutions should vest with the Board for Financial Regulation
and Supervision (BFRS).

7. For effective supervision, there is need for formal accession to “Core principles”
announced by BASEL committee in September 1997.

8. An integrated system of regulations and supervision is put in place to regulate

and supervise the activities of banks, financial institutions and non-bank finance
companies (NBFC’s) and the agency (Board for Financial Supervision) be
renamed as the Board for Financial Regulation and Supervision (BFRS).

9. To have in place a place dedicated and effective machinery for debt recovery for
banks and financial institutions.

10. With the advent of computerization, there is need for clarity in the law
regarding the evidentiary value of computer generated documents. Also, issues
regarding authentication of payment instruments, etc. require to be clarified. A
group should be constituted by the Reserve bank to work out the detailed proposals
in this regard and implement them in a time-bound manner.
2.4 SALIENT OPERATIONAL AND REGULATORY ISSUES OF RBI TO
BE ADDRESSED BY THE FIs FOR CONVERSION INTO A UNIVERSAL
BANK (RBI CIRCULAR).

1. 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.

2. Permissible activities

Any activity of an FI currently undertaken but not permissible for a bank under
Section 6(1) of the Banking Regulation Act, 1949, may have to be stopped or
divested after its conversion into a universal bank.

3. 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.

4. 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 Banking Regulation Act, which
requires at least 51% of the total number of directors to have special knowledge
and experience.
5. 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.

6. Licensing

A Financial Institution converting into a universal bank would be required to

obtain a banking license from RBI for carrying on banking business in India.

7. 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 Banking Regulation 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, 1949.

8. 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.
9. 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.

10. 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.

11. 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.

12. 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 Banking Regulation Act, as prescribed for a banking company under Section
29 and Section 30 of the Banking Regulation Act.

13. 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.
14. 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.

15. Authorized Dealer's Licence

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 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.

16. Priority sector lending

On conversion, the obligation for lending to "priority sector" upto a prescribed

percentage of their 'net bank credit' would also become applicable to it.

17. 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.
2.5 BANCASSURANCE – AN IMPORTANT FACET OF CONVERSION OF
DFI.s TO BANKS

a) Bancassurance is one of the important channels for mobilizing business for

insurance companies and it is one of the income sourcing activities of universal
banks. The concept of universal banks includes insurance in addition to
commercial banking and investment banking. The European countries and the US
have already demonstrated the possibility of combining banking with insurance.
The European concept of Bancassurance in “Alfinaz” has found acceptance in
India of late, according to which banking and insurance services can be allotted by
a single organization.

b) RBI has recognized the importance of insurance and accordingly given

guidelines for entry of banks into insurance business.

i. Banks can undertake agency for insurance services i.e. they can sell insurance
products for certain fees.

ii. Banks can establish joint venture companies for insurance business.

iii. Banks can make an investment in insurance companies.

c) Banks don’t involve directly in insurance business because of risk involved in it.
This concept involves greater fee income and also helps in retaining the customers
for a longer period. It also contributes to the profitability of banks and insurance
companies. It creates competitive advantage through cross selling synergy. Banks
should have a strategic alliance with foreign counter parts. It should fulfill the
requirements of Insurance Regulatory Development Authority (IRDA), Securities
and Exchange board of India (SEBI), Reserve bank of India (RBI) and
Government of India.

d) Banks and Insurance Companies have agreement with the objectives:

i. Improve competitive positioning.

ii. Gain entry into new markets.

iii. Supplement critical skills.

iv. Share the risk and cost.

e) The strategic alliance will improve brand image and reputation of the bank,
reduce the cost through economies of scale, create more customers, manage the
relationships and enhance long term prospects by achieving above stated objectives
and ultimate profitability.

f) The new private sector banks have become global players in the financial sector
by adapting to universal banking activities. Banks in the public sector like SBI,
Corporation bank have also made tie-ups with insurance companies in changing
their trends to universal banking.

Some of the strategic alliances of banks are listed below:

Strategic Alliances

Bank Partners for Life Partners for

Insurance General/Non-life
Insurance
ICICI Bank Prudential Life, England Lombard Insurance,
England
HDFC Bank Standard Life, USA CHUBB, USA
ING Vysya ING Life Insurance Royal Sundaram Bank,
Netherlands
Development Credit Bank Birla SunLife, (SunLife of Bajaj Allianz, Germany
Canada)
State Bank of India SBI Life ------------
Corporation Bank LIC of India ------------
CITI Bank Birla Sun Life ------------
Kotak Mahindra Old Mutual -------------

Likewise some other banks have direct strategic alliances with the foreign partners.
Other banks have alliance with Indian companies who have a partnership with
foreign insurance companies. In order to exploit the opportunity of taking a good
market share strategic alliances are helpful. They create volume, manage
relationships, and enhance long term prospects.

2.6 ISSUES ARISING FROM CONVERSION OF DFI.S TO BANKS

1. Conversion of DFI’s into banks and introduction of bancassurance scheme will
no doubt accelerate the move towards Universal banking but the development will
create certain problems.

2. Though the DFI’s can extend term loans even after their conversion into banks,
the banks are likely to lose interest in term lending since bank’s major source of
funds are short and medium term deposits which cannot be used for extending long
term loans.

3. In the absence of a well developed debt market and liberal inflow of foreign
capital, availability of long-term loans will be affected and which in turn will affect
industrial development. DFI”s will have to continue to provide long-term loans
even after converting themselves into banks.

4. After conversion into banks, the banks will have to meet Statutory Liquidity
Ratio and Cash Reserve Ratio requirement. To the extent they contribute to
Statutory Liquidity Ratio and Cash Reserve Ratio the funds available for their
operations will get reduced.

5. The conversion with banks will not solve the problem of Non Performing assets
of DFI’s and it will only add to the problems of the huge institutions after merger
takes place.

6. The acceptance of the bancassurance concept is welcome. For its success, the
banks taking up insurance will have to train their staff, since the nature of banking
business for which they are trained is very much different from the nature of
insurance business.

CHAPTER 3
 ICICI MERGER

3.1 INTRODUCTION

ICICI (merged with ICICI Bank in March 30, 2002) established in 1995 facilitated
the economic objectives. Though ICICI played a highly significant role in assisting
industrial development through long term lending and a variety of other services to
industry, it started facing problems in 1990’s. Project like steel, textiles, basic
chemicals in which heavy investment had been made suffered losses and the
default rate increased causing problems to all DFIs including ICICI. In absolute
terms, the NPAs outstanding in these sectors totaled to Rs 1333 crore – about 17
percent of ICICI’s total equity capital. The company began to look for safer ways
to deploy incremental resources. Two new investment avenues that stand out are
the massive deployment into medium-term corporate finance and retail lending.

Traditionally, ICICI had on-lent resources towards financing projects for duration
of five to seven years. The lending carried a relatively high degree of risk in the
current environment. Over the last three years or so, an increasing proportion of
lending was directed towards medium-term corporate finance. The implication of
this is that the risks are lower, but so also the returns. So, now about 40 percent of
ICICI’s total portfolio today is deployed towards corporate financing.

To put that in perspective, around 60 percent of the incremental lending over the
last four years has been directed towards corporate finance.

The huge shift towards corporate financing has come at the expense of financing
the projects of traditional manufacturing sector. The implications of this major
shift are that the risk associated with the company’s current portfolio is, perhaps,
lower than what the other DFI’s have, and the returns on deployment are getting
lower.

The two most important factors enabling the smooth and speedy implementation of
the plan of conversion by ICICI Ltd. were:
i. The ready banking platform available with it for launching itself into a universal
bank, by way of backward integration with its banking subsidiary.

ii. The private company character of the DFI, with resultant operational freedom
and ability to leverage, the superior managerial resources and skills available with
it, in steering the organization along the transition path.

Medium-term financing means that ICICI’s return on the money lent is done at a
lower rate. It is not just lower interest earned on losses that led to reduction in
spread from around 3.46 percent in fiscal 1997 to 1.85 percent in fiscal 2000;
ICICI also had to deal with higher cost funds. Till the early 1990s, the DFIs were
entitled to concessional long-term funds. Since then, they have been forced to rely
on a crowded market for funds, thereby raising the cost of their funds.

3.2 UNIVERSAL BANKING

A higher proportion of corporate financing is not the only significant change in

ICICI’s operations. Over the last few years, the company’s top management has
not missed an opportunity to publicize the desire to move towards universal
banking. Universal banking is nothing but a presence in every dimension of
financial service and given the disappearing boundaries in the financial sector
today, universal banking is a feasible option.

In last decade, ICICI has entered – subsidiaries and ventures – the areas of
commercial banking, investment banking, asset management, housing finance,
personal finance and now life insurance. It gradually diversified its activities and
several new products evolved to meet the changing needs of the corporate sector.
ICICI provided a range of banking products and including project finance,
corporate finance, corporate finance, syndication service strategy based financial
products, and cash inflow based management tools as well as advisory services.

Subsequently it entered into commercial banking by establishing ICICI bank in

1994.
In the context of emerging competitive scenario in the financial sector the Board of
Directors of ICICI Ltd. and ICICI bank Ltd. in October 2001 approved the merger
of ICICI Ltd. with ICICI Bank Ltd. Consequent upon the merger, the ICICI
group’s financing and banking operations both wholesale and retail have been
integrated into a single full service banking company effective May 2002. In fact
ICICI has already harnessed some of the gains by transforming itself into a virtual
universal bank over past 5 rendering retail and corporate financial services though
the gamut of the following key building blocks present across the group of one
hand and powered by internet and technology platforms on the other hand:

Retail Financial Services Corporate Financial Services

ICICI ICICI
ICICI Bank ICICI Bank
ICICI Capital ICICI Securities
ICICI Prudential ICICI Brokerage
ICICI Web Trade ICICI Venture
ICICI PFS ICICI InfoTech
ICICI Home ICICI Lombard

(Source: Universal Banking, Dr. P.K. Bandgar and Aarthi Kalyanraman)

Throughout 90s, ICICI Group has nurtured the following building blocks that have
in fact have served as the Group’s strategy for success:

a) Organization Values.

b) Human Capital.

c) Seed Capital.

d) Brand Identity.

e) Knowledge Capital.

f) Technology Capital.

The above supplemented by organizational changes have created the right

combination for achieving leadership.

3.3 EFFECTS OF MERGER

The merger was approved by the shareholders of both companies in January 2002,
by the High Court of Gujarat in March 2002, and by the High Court of Judicature
at Mumbai and the Reserve Bank of India (RBI) in April 2002. ICICI could
successfully meet the statutory reserve requirements applicable to banks within the
target date of March30, 2002.

While the merger became effective on May 3, 2002, in accordance with the
provision of the Scheme of Amalgamation and the terms of approval of RBI, the
appointed date for the merger was March 30, 2002. The merger created India’s first
universal bank and the second largest bank in country with total assets of about Rs
1 trillion and about 540 branches and offices and over 1000 ATMs.

The merged entity has now an access to low-cost deposits, higher income and
participation in the payment system, entry into new business segments, higher
market share in various segments especially in fee-based services and vast talent
pool of ICICI and its subsidiaries which, in turn, would enhance the value for
ICICI Bank shareholders.

The merger has resulted in the integration of the retail finance operations of ICICI
and its two merging subsidiaries and ICICI Bank into one entity, creating an
optimal structure for the retail business. The share exchange ratio approved for the
merger was one fully paid-up equity share of ICICI Bank for two fully paid-up
equity shares of ICICI. ICICI Bank’s equity shares are listed in India on stock
exchanges at Bombay Stock Exchange and National Stock Exchange.

The merger helped ICICI to increase its profits, stability and growth of the
company. The pre-merger profit of ICICI Limited before additional provision for
tax was Rs 1,332 crore for the year 2002 as compared to Rs 1,390 crore for the
year 2001. The profit after additional provisions and tax increased by 25% to Rs.
670 crore for the year 2002 from Rs. 537 crore for the year 2001. The ratio of net
non-performing assets to net customer assets of the merger entity was 4.7% on
March 31, 2002.

Consequent to the merger of ICICI with ICICI Bank, ICICI’s subsidiary companies
of the bank. On March 31, 2007, ICICI Bank had twelve subsidiaries:
(Source: www.icicibank.com) chart

1. Principal Subsidiaries

i. ICICI Securities and Finance Company Ltd.

ii. ICICI Venture Funds Management Company Ltd.

iii. ICICI Prudential Life Insurance Company Ltd.

iv. ICICI Lombard General Insurance Company Ltd.

v. ICICI Securities primary Dealership Ltd.

vi. ICICI Prudential AMC and Trust.

2. Other Subsidiaries

i. ICICI Home Finance Company Ltd.

ii. ICICI Brokerage Services Ltd.

iii. ICICI Securities Holdings Inc.

iv. ICICI International Ltd.

v. ICICI Investment Management Company Ltd.

vi. ICICI Trusteeship Services Ltd.

3. Affiliate Companies

i. ICICI Infotech Services Ltd.

ii. ICICI Web Trade Ltd.

iii. ICICI One Source Ltd.

ICICI Securities and Finance Company Ltd.

A subsidiary of ICICI Bank, ICICI Securities and Finance Company Ltd. was set
up in February 1993 to provide investment-banking services to investors in India.
As on date ICICI Securities is a strongly positioned investment bank in India and
provides products and services in Fixed Income, Equities and Corporate Finance.
In the fixed income business ICICI Securities is a leading market participant in the
country. ICICI Securities fixed income activities include interest rate trading,
derivatives trading, research and issue management. The Corporate Finance
business focuses on industry consolidation. ICICI Securities has been involved in a
number of mergers, cross border acquisition, equity and bidding for a number of
reputed companies.

The Company has one subsidiary in India namely; ICICI Brokerage Services Ltd.
in order to assist/provide corporate clients and institutional investors with
investment banking services in the United States of America, ICICI Securities has
set up two subsidiaries namely, ICICI Securities Holdings Inc and ICICI Securities
Inc.

ICICI Securities Inc. has become the registered broker dealer with the National
Association of Securities Dealers Inc, empowering it to engage in a variety of
securities transactions in the U.S. market. ICICI Brokerage Services Limited, a
member of the National Stock Exchange of India Limited, is the domestic broking
subsidiary of ICICI Securities.

ICICI Venture Funds Management Company Ltd.

ICICI Venture is one of the largest and most successful private equity firms in
India with funds under management in excess of USD 2 billion. ICICI Venture,
over the years has built an enviable portfolio of companies across sectors including
pharmaceuticals, Information Technology, media, manufacturing, logistics,
textiles, real estate etc thereby building sustainable value. ICICI Venture is a
subsidiary of ICICI Bank, the largest private sector financial services group in
India.

ICICI Prudential Life Insurance Company Ltd.

 ICICI Prudential Life Insurance Company is a joint venture between ICICI Bank -
one of India's foremost financial services companies-and Prudential plc - a leading
international financial services group headquartered in the United Kingdom. Total
capital infusion stands at Rs. 47.80 billion, with ICICI Bank holding a stake of
74% and Prudential plc holding 26%. It started its operations in December 2000
after receiving approval from Insurance Regulatory Development Authority
(IRDA). Today, our nation-wide team comprises of 2074 branches (inclusive of
1,116 micro-offices), over 225,000 advisors; and 7 bancassurance partners.

ICICI Prudential is the first life insurer in India to receive a National Insurer
Financial Strength rating of AAA (Ind) from Fitch ratings. For three years in a
row, ICICI Prudential has been voted as India's Most Trusted Private Life Insurer,
by The Economic Times - AC Nielsen ORG Marg survey of 'Most Trusted
Brands'. As the growth of the distribution of ICICI Prudential Life Insurance, its
product range and customer base, they continue to tirelessly uphold their
commitment to deliver world-class financial solutions to customers all over India.

ICICI Lombard General Insurance Company Ltd.

ICICI Lombard General Insurance Company Limited is a 74:26 joint venture

between ICICI Bank Limited and the Canada based $ 26 billion Fairfax Financial
Holdings Limited. ICICI Bank is India's second largest bank, while Fairfax
Financial Holdings is a diversified financial corporate engaged in general
insurance, re-insurance, insurance claims management and investment
management. Lombard Canada Ltd, a group company of Fairfax Financial
Holdings Limited, is one of Canada's oldest property and casualty insurers. ICICI
Lombard General Insurance Company received regulatory approvals to commence
general insurance business in August 2001.

ICICI Securities primary Dealership Ltd.

ICICI Securities Primary Dealership Limited is an acknowledged leader in the
Indian fixed income and money markets, with a strong franchise across the
spectrum of interest rate products and services – institutional sales and trading,
resource mobilization and research. One of the first entities to be granted Primary
Dealership license by RBI, ICICI-Securities Primary Dealership has made
pioneering contributions since inception to debt market development in India.

ICICI Prudential Asset Management Company and Trust

ICICI Prudential Asset Management Company is a joint venture between

Prudential plc and ICICI Bank. Neither ICICI Prudential Asset Management
Company nor Prudential plc are affiliated in any manner with Prudential Financial,
Inc., a company whose principal place of business is in the United States of
America. ICICI Prudential Asset Management Company enjoys the strong
parentage of Prudential plc, one of UK's largest players in the insurance & fund
management sectors and ICICI Bank, a well-known and trusted name in financial
services in India. ICICI Prudential Asset Management Company, in a span of just
over eight years, has forged a position of pre-eminence in the Indian Mutual Fund
industry as one of the largest asset management companies in the country.

ICICI Home Finance Company Ltd.

The company commenced its operations in 1999-2000. It provides home loans and
other related services. It was the first housing finance provider to introduce floating
rate loans. It has expanded into fee-based property services for both corporate and
retail customers.

ICICI International Ltd.

This company was incorporated in the Republic of Mauritius on January 18, 1996,
as an investment and Fund Management Company

ICICI Investment Management Company Ltd.

This is an asset management company of ICICI securities Fund, a mutual fund

registered with SEBI.

ICICI Trusteeship Services Ltd

The company’s role is to serve a trustee for enterprises, transactions, or

arrangements of strategic or significant business importance to the ICICI group.
Thus to conclude, ICICI is India’s best managed financial institution, catering to
the needs of different customers. It has successfully transformed itself from a
single product company to a multi-group.

CHAPTER 4
 IDBI MERGER

4.1 INTRODUCTION

The Industrial Development Bank of India (IDBI) was established on July 1, 1964
under an Act of Parliament as a wholly owned subsidiary of the Reserve Bank of
India. In 16 February 1976, the ownership of IDBI was transferred to the
Government of India and it was made the principal financial institution for
coordinating the activities of institutions engaged in financing, promoting and
developing industry in the country.

IDBI had played a pioneering role in fulfilling its mission of promoting industrial
growth through financing of medium and long-term projects, in consonance with
national plans and priorities. Over the years, IDBI has enlarged its basket of
products and services, covering almost the entire spectrum of industrial activities,
including manufacturing and services. IDBI provided financial assistance, both in
rupee and foreign currencies, for green-field projects as also for expansion,
modernization and diversification purposes.

In the wake of financial sector reforms unveiled by the government since 1992,
IDBI evolved an array of fund and fee-based services with a view to providing an
integrated solution to meet the entire demand of financial and corporate advisory
requirements of its clients. IDBI also provided indirect financial assistance by way
of refinancing of loans extended by State-level financial institutions and banks and
by way of rediscounting of bills of exchange. With the changes in economic
environment in the last decade, the flow of funds to FI’s from RBI’s National
Industrial Credit Long Term Operations (NIC-LTO) and allocation of Statutory
Liquidity ratio (SLR) bonds dried up and it became necessary for the FI’s to raise
funds mainly from the markets. Simultaneously, commercial banks also began to
provide project finance and these commercial banks had lower cost of funds than
FI’s.

With lower cost of funds for banks, the business model of FI’s came under strain.
In view of the changes in the operating environment, following initiation of
reforms since the early nineties, Government of India decided to transform IDBI
into a commercial bank.

The migration to the new business model of commercial banking with its gateway
to low cost current/savings bank deposits would help overcome most of the
limitations of the current business model of the development while simultaneously
enabling it to diversify its client/asset base. Towards this end, the IDBI (Transfer
of Undertaking and Repeal) Act 2003 was passed by parliament in 2003. The act
provides for repeal of IDBI Act, corporatisation of IDBI (with majority
Government holding current share 58.47%) and transformation into commercial
bank. The provisions of the act have come into force from July 2, 2004 in terms of
a Government Notification to this effect.

The notification facilitated for formation, incorporation and registration of

Industrial Development Bank of India Ltd. Under the Companies Act 1956 and a
deemed banking company under the Banking Regulation Act 1949 and helped in
obtaining requisite regulatory and statutory clearances, including those from RBI.
IDBI commenced banking business in accordance within the provisions of the new
Act in addition to the business being transacted under IDBI Act 1964 from October
1, 2004. IDBI has firmed up the infrastructure technology platform and
reorientation of its human capital to achieve a smooth transition.

4.2 THE MERGER DEAL OF IDBI

1. The merger created the seventh largest bank in India in terms of assets. The
merger was a win-win situation for both the institutions besides using the brand
name of IDBI; IDBI bank would get access to a wide distribution network of
branches of IDBI. It also got the necessary capital to expand its horizon. On the
other hand, IDBI would function as a fully fledged deposit taking bank without
incurring heavy expenditure on setting up branches introducing new technology or
inducting new people.

2. IDBI also benefited immensely from the consumer banking knowledge of IDBI
bank along with a private sector culture that was totally different from that of
IDBI’s. The merger helped IDBI to reduce its overall cost of funds from 5.6% to
4.9% with access to savings account, current account and call money market.

3. To facilitate the merger, Rs. 900 crore Non-Performing assets (NPA’s) in IDBI’s
portfolio accounting for almost6 15% of its net loans were transferred to Stressed
Assets Stabilization Fund (SASF) in the form of Zero coupon bonds held till
maturity.

4. Stressed Assets Stabilization Fund was given the status of a “financial

institution” to enable; it to access Debt recovery tribunals (DRT). This financial
restructuring enabled IDBI to bring down its NPA’s to below 1%.

5. The assets transferred to Stressed Assets Stabilization Fund were without

recourse to IDBI Ltd. For a period of 20 years the tenure of the bonds. At the time
of the settlement of any of these loans, the money would be received by IDBI Ltd.
And simultaneously an equivalent amount of bonds would be relinquished. The
bank would take back assets remaining unrecovered by Stressed Assets
Stabilization Fund for 20 years.

6. IDBI Ltd. Was granted a 5 year relief period by RBI from maintaining the
Statutory Liquidity ratio (SLR) against a requirement of Rs. 3500 crore towards
Cash Reserve Ratio (CRR) liabilities, the bank deposited Rs. 2400 crore
immediately after the merger.

7. In a competitive sense the merger created a strong foundation for IDBI Ltd. To
compete with the other banks. It had a clean and strong balance sheet free from
NPA’s to a large extent, a better organization rating that was translated into more
cost effective borrowing and most importantly enormous government support.

8. IDBI also planned to reduce its high cost liabilities priced at almost 9.5% by
nearly 100 basis point within 12 months of the merger. This would lead to a saving
of Rs. 500 crore for the bank. IDBI also lowered its prime lending rate from 12.5%
to 10.5% and with the corporate sector expanding with new business opportunities
the bank was expected to grow its asset value by 10-12% a year.

9. There was also a large disparity in the Capital Adequacy Ratio (CAR) of IDBI
and IDBI bank. As compared to 18.3% for IDBI the Capital Adequacy Ratio of
IDBI bank was just over 9%. However the merger entity was expected to have a
Capital Adequacy Ratio much better than the RBI stipulated 9%.

10. The merger also led to a rationalization of the workforce to a great extent. The
institution followed a Shape up or Ship out strategy to the hilt, in order to do away
with non-performing employees and also reduce the cut-of age of retirement of
employees from 60 to 58 years.

11. IDBI Ltd. Sanctioned Rs. 75 crore to fund its voluntary retirement scheme
(VRS) which would be written off over a period of 5 years.

Consequent to the merger of IDBI with IDBI bank, IDBI’s subsidiary companies
have become subsidiaries of the bank. On March 31, 2007 IDBI Bank had four
subsidiaries.

IDBI Capital Market Services Limited

IDBI Capital Market Services Ltd. (head quartered in Mumbai), is a leading
provider of financial services and is a 100% subsidiary of IDBI Bank Ltd. The
company was set up in 1993 with the objective of catering to specific financial
requirements of financial institutions, banks, mutual funds and corporate houses.
The company provides a complete range of financial products and services that
includes:

a) Stock Broking-Institutional and Retail.

b) Derivatives Trading.

c) Distribution of Mutual Funds.

d) Investment Banking.

e) PF/Pension Fund Management.

f) Retail Marketing of Bonds and IPOs.

g) Depository Services.

h) Research Services.

Over the last 5 years, the company has been ranked amongst the leading players in
each of these businesses. It has a strong agent network which caters to the
investment needs of retail investors in instruments like IPOs, Bonds, etc.

The company is a major player in the Equity and Derivatives market and a leading
manager of Pension & Provident Funds in the country. The company has executed
several mandates on the Issue Management and Corporate Advisory Services.

The company offers an online investment portal with advanced features and tools
for an easy and informed investing experience in Equities, Mutual Funds and IPOs.

IDBI Home Finance Limited

IDBI Home finance Ltd. is 100% subsidiary of IDBI Bank Ltd. acquired the entire
shareholding of Tata Finance Ltd. in Tata Home finance Ltd. in September 2003.
The name of the company was changed to IDBI Home finance Ltd. Over the years,
the company has taken steps to enhance its retail reach, strengthen brand image,
improve asset quality, thereby achieving business growth.

IDBI Intech Limited

IDBI Intech Ltd. is a wholly owned subsidiary of IDBI Bank Ltd. IDBI has set up
IDBI Intech Ltd. (INTECH) in March 2000 to tap the opportunities arising from
the IT sector.

Intech capitalizes on the banking business knowledge acquired over the years
supplemented with experience in Implementation & Management of state-of-the-
art IT Infrastructure, Technology applications and Systems for one of the largest
universal bank in India and uniquely positions itself, in the Information
Technology Service Provider Space, to offer the IT-related products and services
to the IDBI Group companies.

Intech operates in a multi-dimensional framework and provides IT related services

in the area of Consultancy, System Integration, System implementation & support,
Applications & Server hosting and other IT related managed services and
specialized training.

IDBI Gilts Limited

IDBI Gilts Ltd. was set up as a wholly owned subsidiary of IDBI Bank Ltd. to
undertake Primary Dealership [PD] Business. In accordance with RBI guidelines,
the Primary Dealership business of IDBI Capital Market Services Ltd. [ICMS] has
been de-linked and transferred to IDBI Gilts Ltd. The company was incorporated
in December 2006 and became operational from July 24, 2007. The company's
business ambit includes Bond trading, underwriting in auctions of primary issuance
of Government dated securities and treasury bills. In addition, IDBI Gilts also
plans to be a major player in the interest rate and credit derivative market.

Thus IDBI Ltd. goal is to be the most preferred bank for total financial and
banking solutions for corporate and individuals and becoming a major force to
reckon within the financial sector.

CHAPTER 5
 CONVERSION OF DFI’s INTO BANK:

A BOON OR BANE FOR INDIA!

5.1 CONVERSION OF DFI.S INTO BANKS COUPLED WITH SWOT

I. Strengths:

a) 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 exploit economies of scale and scope.

b) 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.

c) 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.

d) 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.

e) 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.

f) 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.

II. Weaknesses:

a) Grey Area

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.

b) 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.

c) NPA Problem Remained Intact

The most serious problem of DFIs has 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. 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.

d) Two big structures like universal banks will not be able to draw quality oriented
professionals.

e) There can be conflicts of interest the way commercial banking and investment
banking operates.

f) It is argued that universal banks are more difficult to regulate because their ties
to the business world are more complex. In case of government/supervisory
agencies it could effectively monitor them because their functions are limited.

III. Opportunities:
a) 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.

b) 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.
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.

c) 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.

IV. 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.

5.2 ROLE OF CONVERSION OF DFI.s TO BANKS IN INDIA

In India, though there has been no legislative distinction between Commercial

banking and Investment banking or any explicit legislative restriction for the banks
to operate in investment banking activities, the banks have traditionally been
maintaining the “arms length” distance from investment banking. The plausible
reason could be that, as we followed the British style of banking, which could on
the Anglo-Saxon style wherein strict separation was maintained between
commercial banking activity and investment activity, the same pattern has been
adopted in India.
With the financial sector reforms, beginning 1990s ,bank were however, given
abundant freedom to go much beyond traditional conservative banking related to
working capital finance. But the more tangible momentum for the universal
banking in India seem to have set in only after the second Narasihmam committees
report [1998] recommendation for development financial institution [DFIs], over a
period of time, to convert themselves into banks [implicitly universal banks] and
that there should eventually be only two form of intermediaries, viz. Banking
companies and Non Banking finance company.

This was followed by a working group chaired by S.H.Khan on “Harmonizing the

Role and Operations of Development Financial Institutions and Banks” (1998)
which made it more explicit by recommending for a progressive movement
towards universal banking for the DFI’s. Reserve bank of India as a regulator and
supervisor of the banking system, laid the formal road map, especially for the
DFI.s, by way of giving a set of guidelines. Banks were permitted to enter into
term finance infrastructure finance, insurance business, (i.e. similar to
bancassurance prevailing in European countries), underwriting of shares, etc.

Taking a cue, ICICI an erstwhile DFI took the lead and became a universal bank
by merging itself with its own subsidiary ICICI bank Ltd. in 2002. Falling in line
with this, more recently, IDBI has already been corporatized under the companies
act, 1956 and became universal bank by merging itself with its own subsidiary,
viz., IDBI Bank Ltd.

Even other banks extending term loans, entered in the area of insurance, merchant
banking activities, viz., funding for buying primary issue of equities, etc. These
were some of the indications that the commercial banks in India have been moving
away from their traditional banking and moving towards universal banking.

Simultaneously, either voluntarily or due to compulsion, there has also been a

number of bank mergers in recent years, banks with DFI’s or possibly among the
DFI’s they also could not be ruled out. These developments also automatically lead
to not only Universal banking milieu but even beyond that and ultimately to the
emergence of “Financial Conglomerates”.
As banks have been permitted to take part in Insurance business either with or
without risk participation or as sub-agents, i.e., referral models, a number of banks
in both public and private sector have already commenced exploiting the vast
business potential of bancassurance. All these developments are a pointer to the
fact that conversion of DFI’s into Banks has become real in India both in letter and
spirit.

5.3 CHALLENGES IN CONVERSION OF DFI.s INTO BANKS

There are certain challenges, which need to be effectively met by the Universal
Banks:

1. The establishment of new private sector banks and foreign banks have rapidly
changed the competitive landscape in the Indian consumer banking industry and
placed greater demands on banks to gear themselves upto meet the increasing
needs of customers. For discerning current day bank customers, it is not only
relevant to offer a wide menu of services but also provide these in an increasingly
efficient manner in terms of cost, time and convenience.

2. Development Financial Institutions (DFIs) opting for conversion into Universal

Banks by merger/reverse merger routes may also face certain difficult situations on
account of Asset Liability Mismatches, burden of mounting NPAs and differences
in regulatory prescriptions applicable to FIs and banks such as CRR and SLR
requirements and priority sector lending.

The asset profile of DFIs in India is predominantly of long term nature, which also
includes a very high level of non-performing assets. Further, the regulation of DFIs
in India has been historically less as compared with the banking system, partly
because DFIs do not form part of the monetary system and partly because they do
not have deposits like liabilities.

3. In case DFIs are converted into banks they would also be subject to the reserve
requirements like banks. This would mean that all liabilities issued by the DFIs in
the past would also be subject to the reserve requirements and since the assets
structure of DFIs are largely of long term nature it would be very difficult for them
to maintain the required level of SLR/CRR.
4. Further, the cost at which DFIs have been raising resources in the past has
generally remained high as compared to banks and maintenance of CRR/SLR for
such liabilities, which may earn lower returns, would adversely affect the
profitability of such universal banks. Compliance of priority sector lending norms,
which earn lower returns, may also create difficult situations for such bank Risk
Management is one of the major challenges, where in the financial activity carries
with it various risks, which would need to be identified, measured, monitored and
controlled by Universal banks.

5. The nature of risks and mitigating techniques for different financial

products/services will be different and therefore, Universal Banks will be required
to develop comprehensive system for each product/service and each kind of risk.

6. Another aspect is related to building up of supervisory infrastructure. The

regulatory framework would need to be strengthened so as to cover all aspects of
Universal Banking either under control of one regulator or a co-coordinating
mechanism would have to be developed among different regulators like the
Reserve Bank of India, SEBI, Insurance Regulatory, Authority etc. The regulators
will have to frame sound mechanism to protect the interests of all concerned
including the customer, the Universal Banking Institution and the financial system
of the country.

7. It is likely that Universal Banks of roughly the same size and providing roughly
the same range of services may have very different cost levels per unit of output on
account of efficiency differences in the use of labour and capital, effectiveness in
the sourcing and application of available technology, and perhaps effectiveness in
the acquisition of productive inputs, organizational designs, compensation and
incentive systems and just plain better management.

8. Larger the banks, the greater will be effects of their failure on the system. Also
there is the fear that such institutions, by virtue of their sheer size would gain
monopoly power in the market, which can have undesirable consequences for
economic efficiency. Further combining commercial and investment banking can
give rise to conflict of interest.
9. Supervision of Financial Conglomerates

In view of increased focus on empowering supervisors to undertake consolidated

supervision of bank groups and since the Core Principles for Effective Banking
Supervision issued by the BASEL Committee on Banking Supervision have
underscored consolidated supervision as an independent principle, the Reserve
Bank has introduced, as an initial step, consolidated accounting and other
quantitative methods The components of consolidated supervision include,
consolidated financial statements intended for public disclosure, consolidated
prudential reports intended for supervisory assessment of risk and application of
certain prudential regulations on group basis.

10. Improving Risk Management Systems

With the increasing degree of deregulation and exposure of banks to various types
of risk, efficient risk management systems have become essential. For enhancing
the risk management systems in banks, Reserve Bank has issued guidelines on
asset liability management and risk management systems in banks in 1999 and
Guidance Notes on Credit Risk Management and Market Risk Management in
October 2002 and the Guidance Note on Operational Risk Management in 2005.

11. Sharpening Skills

The far-reaching changes in banking and financial sector entail a fundamental shift
in the set of the skills required in banking. To meet increased competition and
manage risks, the demand for specialized banking functions, using IT as a
competitive tool has to go up. Special skills in retail banking, treasury, risk
management, foreign exchange, development banking, etc. will need to be
carefully nurtured and built. Thus, the twin pillars of the banking sector i.e. human
resources and IT will have to be strengthened.
5.4 ISSUES INVOLVED IN PRACTICING CONVERSION BY DFI.s IN
INDIA

Worldwide there are a few examples of conversation of DFIs into banks. The
Korea Long term Credit Bank established in 1967, became a full fledged bank in
early 1980s. Japanese Development Bank named Industrial Bank of Japan (IBJ) is
regarded as a transnational DFI with a global network providing comprehensive
financial services to cross border of clientele. However, before converting DFIs
into banks, in India, the following issues have to be addressed:

1. As per existing regulations, DFI’s are allowed only to raise deposits worth one
time their net worth. DFI’s are allowed to raise deposits for a maximum maturity
profile of one year and interest rate offered by them has to be inline with the rates
offered by banks. On these deposits, DFI’s are not allowed to make premature
payments or provide loans on deposits unlike banks.

2. As DFI’s will be increasing their short term loan exposure, the matching short
termdeposits are also required hence the above said regulations in regard to raising
deposits will have to be amended.

3. One question arises in the mind is that after conversion of DFIs into banks who
will make the specialized project finance. All banks do not have the required
expertise with them and it cannot be created overnight.

4. The issue of regulation has to be addressed, as in India DFIs are regulated by

separate acts while banks are regulated by the RBI and merchant banks are
regulated by SEBI etc. Regulation is one single most important reason responsible
for practicing Financial Conglomerate model by many banks in India. A common
regulatory framework should be considered as the most fundamental prerequisite
for a universal banking regime. The system should also include uniform statutory
reserve requirements, capital adequacy, asset classification, income recognition
and provisioning norms.
5. Commercial banks, since the onset of social banking , have been subjected to
stipulations in lending areas for which compliance is mandatory, like directed
lending to the priority sector. In order to create a level playing field in universal
banking, it is imperative that similar guidelines should be prescribed for DFIs as
well.

6. DFIs conversion into banks may pose a threat to the commercial banks as he
inter-institutional functional specifications will no longer be in vogue, as all
institutions will be in a position to undertake all kinds of financing activities,
wholesale to retail and from project financing to working capital finance. This will
further increase the competition for commercial banks.

7. If DFIs and commercial banks start practicing German model of universal

banking, the following issues will also have to be addressed:

8. In the regime of universal banking, the spread will come under further strain, as
interest rate structure will no more be administered. The emphasis, therefore, will
have to be put on more off balance sheet activities so that the non-interest income
generated can make good the loss in interest income.

5.5 RECENT TRENDS IN CONVERSION OF DFI.s TO BANKS IN INDIA

1. Financial reforms were central to India’s economic liberalization program

initiated in the early 1990s. After more than a decade of reforms since 1991,
India’s financial sector- including markets, institutions and products- has changed,
in some respects, beyond recognition. While the banking sector continues to
dominate the financial system and remains overwhelmingly government owned,
competition has increased. Private entry has also been progressively allowed into
mutual funds and, more recently, insurance.

2. These reforms have led to financial integration at two levels. At, one level, the
trends towards universal banking and mergers between two financial institutions
have led to integration between different segments of the domestic financial
system. Traditional frontiers between banking, capital markets and insurance have
become less distinct.
3. The effect of the recommendations of the Khan Working Group and Narasimhan
Committee-II reports regarding harmonization of role of banks and DFIs were seen
when major banking organizations like ICICI, IDBI, and SBI etc. started proposing
plans for taking up the coveted status of a universal bank. ICICI merged with the
ICICI bank in 2001 and IDBI merged with IDBI bank in 2004. Many public sector
banks set up subsidiaries for providing various financial services.

4. Deregulations opened up new opportunities for banks to increase revenues by

diversifying into investment banking, insurance, credit cards, depository services,
mortgage financing, securitization, etc. Interest rates have been deregulated over a
period of time, branch-licensing procedures have been liberalized and Statutory
Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) have been reduced. The
entry barriers for foreign banks and new private sector banks have been lowered as
part of the medium term strategy to improve the financial and operational health of
the banking system by introducing an element of competition into it.

5. There has been a paradigm shift in Indian banking with the absorption of the
latest technology and the need to meet the client’s expectations in a customized
manner. Corporate governance in banks and financial institutions assumed great
importance in India.

6. The benefits of a liberalized financial system are well-known. At the same time,
a series of financial crises-in East Asia in 1997, Turkey in 2000 and, more recently,
in Argentina- have alerted policy makers and regulators to the potential fragility of
financial intermediaries in a deregulated environment.

7. These crises resulted from the integration of a variety of mutually reinforcing,

macroeconomic, structural, and political events. Whatever the trigger, the weaker
the financial system, the greater have been the fireworks of the collapse and the
depth and duration of post crisis distress.
8. So, if there is one lesson above all others from the recent financial crisis, it is the
importance of a sound and well regulated financial sector. This means better
disclosure, better supervisory norms and their proper enforcement. And it means
having a financial regulatory structure that makes the regulatory properly
accountable, and ensures that regulators are properly equipped to anticipate
problems in complex and integrated financial systems, detect fragilities, take
prompt corrective action to deal with distressed institutions, and minimize
opportunities for regulatory arbitrage by financial intermediaries.

9. India’s financial system has shown a great deal of resilience. India appears to be
sheltered from a crisis triggered by an external macroeconomic shock of the type
suffered by the East Asian countries, because India’s exchange rate regime is
flexible, foreign exchange reserves are high, the capital account is not yet fully
convertible, and banks and their customers have limited foreign exchange
exposures. It should also be noted that, in recent years, India has gone a
considerable way in improving financial sector regulation. Prudential norms have
been tightened, bank capital bolstered, and the supervisory systems strengthened.

10. But important weaknesses remain, and need to be addressed. Stock market
scams, the UTI story and problems with cooperative banks, underline the
importance of enhancing supervision and governance. Moreover, as the financial
sector becomes more open, the challenge facing India’s regulators will become
ever greater.

5.6 FUTURE OF CONVERSION OF DFI.s INTO BANKS

1. In view of changes in economic and national environment in India leading to

liberalization and deregulation, integration of Indian financial markets, entry of
new players both domestic and overseas in the market disintermediation.

2. High degree of product innovation and effacing of operating boundaries among

suppliers of financial products and services, and growing customer’s preferences
for wide variety of efficient products under one shop, existing development
financial institutions are left with no choice but to assume the role of universal
banking and not remain confined to engaging in terms of lending and participating
in equity.
3. In their new avtar, DFIs will be providing working capital finance to big
corporate groups as DFIs have their own creamy layers of clients with whom their
business transactions are quite voluminous. The time is ripe that commercial banks
give a deep thinking on the issue of switching over to the German model of
universal banking from the financial Conglomerate model of UK/USA. If
commercial banks start practicing German model of universal banking, it will get
more success as one distinct advantage for these banks is their impressive branch
network.

4. Commercial banks should also make a foray into the insurance business as these
banks can use their distribution network to sell all types of insurance particularly
life insurance, to their traditional customers. Many banks are providing insurance
in European countries as this has resulted in good growth in their non-fund based
business.

5. There is also a need for commercial banks to synergize the operations of their
various subsidiaries. Commercial banks, their subsidiaries and associates should
work in a cohesive manner. A system of cross selling and marketing the products
of the subsidiaries, associates banks should be evolved and foreign subsidiaries of
commercial banks should canvas India related business/NRI business for various
branches of these banks in India.

6. Commercial banks, over the years, have developed expertise in many areas like
Asset-Liability Management, Risk Management and Computerization etc. Now
these banks may develop their own packages to be sold to other banks/co-operative
banks/ NBFCs etc

7. Universal Banking system will come to stay in India in the near future. There is,
therefore, need to prepare ourselves right now.
5.7 LESSONS LEARNT FROM THE CONVERSION OF ICICI AND IDBI
FROM DFI TO BANK

The Working Group has reviewed the experience of both the DFI’s, i.e. ICICI Ltd.
and IDBI Ltd., which has so far successfully converted into a bank. The
organizational dynamics of ICICI Ltd. and IDBI Ltd. is therefore, the exact
replication of its experience by others may not be possible. However, some
tentative conclusions can be drawn from the experience of ICICI Ltd. and IDBI
Ltd., which can serve as reference points and the underlying hypothesis can be
further tested by applying these principles to future attempts at conversion by any
of the DFIs.

The conclusions are as under:

1. Existing Banking Platform for Conversion

A ready banking platform would greatly facilitate the conversion of a DFI into a
bank. A DFI by forward or backward integration into a bank would land at a higher
point on a learning curve in terms of banking experience and operational readiness.
A ready infrastructure of branch network, operating procedures, technology
platform, skilled manpower, etc., will make the transformation much smoother and
efficient than conversion of a DFI on a standalone basis and attempting to build the
entire banking infrastructure from the scratch. The process of transformation on a
standalone basis would require higher degree of change management skills and
may have adverse effect on the operations, unless sufficient and long preparations
are made for conversion. The asset liability management could cause serious
concern in case of conversion on standalone basis. The assets liability mismatch
could arise since the deposit base of the converted entity would build up only
gradually. The teething problem would be manageable in case of a DFI merging
with a bank of a size commensurate with the balance sheet of DFI.
2. De-risking and diversification of loan portfolio

Long term project finance is a risky proposition for any financial intermediary and
more so for a DFI whose loan portfolio is almost exclusively comprised of project
financing. Therefore, in preparation for conversion to a bank the DFI should
consciously scale down the proportion of project financing by resorting to
diversified products. e.g. structured finance and innovative financial techniques.

3. Flexibility of organizational structure

A flexible and agile organizational structure is a pre-requisite for meeting the

challenges in a competitive environment. A company structure possesses the
attributes of operational flexibility and is best suited for the role of a financial
intermediary. Therefore, any DFI seeking transformation to a bank should
necessarily migrate to the structure of a company, preferably with a large and
diversified share holding.

4. Correct positioning and business strategy

The choice of the target clientele, appropriate business and product mix to be
offered, in face of the acute competition in the banking sector and mechanism for
delivery of banking services and compliance with statutory and regulatory
requirements, over a self determined time horizon despite relaxations given for a
specified time period, should be formulated well before embarking on conversion
to bank and there should be ongoing monitoring of the business and strategic plan
till the entity is fully integrated into the banking system.
5. Availability of management skills

In an organization transforming to a new role, there would be a significant need for

skilful change management, by retraining and equipping the managerial personnel
with new set of skills and facilitating their adaptation to a new working style and
environment. An organization undergoing a transformation must give top priority
to this aspect.

6. Brand Equity

The brand image of an organization would determine its success or failure in any
role. A good image has to be assiduously built over a long time span and a poor
image which cannot be shaken off easily would be a hindrance in the
transformation process. DFI Possessing brand equity can in very a short time
establish itself in the market after conversion into a bank.
 CHAPTER 6

CORPORATE VIEWS ON CONVERSION OF

DFI’s INTO BANKS

6.1 Universal banking no panacea for ill DFI.s, says former RBI Governor,

Bimal Jalan

(Monday, Oct 26, 2009)

The Reserve Bank of India governor Bimal Jalan added a new dimension to an
ongoing debate by saying that the move towards universal banking will not solve
the problems of the Development financial institutions (FIs).

“Universal banking will not provide a panacea for the weaknesses of an FI or its
liquidity and solvency problems,” Jalan said. He was addressing bank chiefs at the
Bank Economists Conference 2008, organised by Allahabad Bank. He also said
that universal banking cannot be the escape route for FIs which have been
suffering from operational difficulties arising from under capitalisation, non-
performing assets and asset-liability mismatches.

Later, participating in a question-answer session, Jalan categorically said universal

banking is not the central bank’s prescription and neither has it fixed any
timeframe for the transition to the “so-called universal banking’. “The overriding
consideration should be the objectives and strategic interests of the institutions
concerned in the context of meeting the varied needs of customers, subject to
normal prudential norms applicable to banks,” he said. From the regulatory point
of view, the movement towards universal banking should firmly entrench the
stability of the financial system and preserve the safety of public deposits, he
added.
Jalan’s views on universal banking are significant in the context of both, the ICICI
and the Industrial Development Bank of India (IDBI) proposing to become
universal banks. ICICI has already merged itself with ICICI Bank and the
integration process is expected to be wrapped up by March 31. The IDBI, however,
is yet to formalise its game plan. Both the institutions suffer from asset-liability
mismatches and IDBI’s non-performing assets are still rising. Both the institutions
have been projecting that Universal banking is the only way to survive as far as
they are concerned.
6.2 Extinction of DFI.s will affect Development of the Country

(Tuesday, June 16, 2009)

ICICI was the first to change colours followed by IDBI and now it is the turn of
IFCI. There is also talk of merging Industrial Investment Bank of India (IIBI) with
IDBI once the latter is converted into a bank. Anyway, Industrial Investment Bank
of India is a marginal player in development financing. With the concept of
universal banking catching up, the DFIs have decided to convert into banks. One of
the main complaints of these DFIs is that as they are not banks since they did not
have access to cheap finance by way of deposits from the public. But this was to an
extent made good by allowing them to issue tax-saving bonds.

If the DFI’s were burdened with huge NPAs it would be wrong to blame the
concept of development finance. It is more to do with wrong selection of projects
(usually due to political interference) than anything else.

In India, the debt market is not fully developed nor is there any attempt to develop
one. Therefore, those who want to set up new projects have to approach financial
institutions for part-financing the projects. Now the banks are more interested in
retail banking as also home loan financing.

Though this mania has started only recently no one knows where it will end. There
is no guarantee that retail banking is the safest way of employing banks funds. One
will come to know its validity only after the recovery process begins. Short
duration of the borrowing period is one reason for banks' craze for retail banking.
DFI’s have seen a premature end though their continuance was a necessity, at least
till India reached the growth levels of the South-East Asian countries. The absence
of DFIs will, therefore, hamper development of the countries growth in the coming
years.
6.3 “Universal banking by DFIs: Handy, but no Solution to NPAs”

(Thursday, Feb 12, 2009)

In the last few years, the most serious problem DFI’s had to encounter is bad loans
or Non-performing assets (NPAs). For DFIs, universal banking or the installation
of cutting-edge technology in operations are unlikely to improve the situation
concerning NPAs.

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. The NPAs of these projects have dented, in varying degrees, the
balance-sheets of the three DFIs.

ICICI seems to have suffered the least, mainly because size of its balance-sheet
size, which has grown by a compound annual growth rate of 19.25 per cent over
the last four years. At the same time, the company's gross NPAs have grown by 21
per cent.
Though the gross NPAs grew faster than the balance-sheet, the combined effect of
the growth in the absolute size of the balance-sheet and accelerated provisioning
has brought down ICICI's net NPAs to 5.2 per cent of total loan assets in 2000-01
from 6.8 per cent in 2006-07.

As the former RBI Governor, Mr. Bimal Jalan, suggested, universal banking will
not solve the NPA problem. Keeping aside the grey areas that accompany the
move to universal banks, DFIs seeking a merger with a commercial bank makes
sense. While the move may not solve the NPA problem, it may mitigate the
problem of competing in a market that has players with a significantly lower cost
of funds.
 CHAPTER 7

CONCLUSION AND SUGGESTIONS

7.1 CONCLUSION

1. Finally, when arrived at the conclusion of the project one question that arises is
How close we are to the vision of a sound and well-functioning banking system in
India?

It is fair to say that despite turbulent years and many challenges, we have made
some progress towards this goal. There has been progressive intensification of
financial sector reforms, and the financial sector as a whole is more sensitized than
before to the need for internal strength and effective management as well as to the
overall concerns for financial stability. At the same time, in view of greater
disclosure and tougher prudential norms, the weaknesses in our financial system
are more apparent than before.

3. There is greater awareness now of the need to prepare the banking system for
the technical and capital requirements of the emerging prudential regime and a
greater focus on core strengths and niche strategies. We have also made some
progress in assessing our financial system against international best practices and
in benchmarking the future directions of progress. Several contemplated changes in
the surrounding legal and institutional environment have been proposed for
legislation.
4. Nevertheless, several sources of vulnerability persist. The NPA levels remain
too large by international standards and concerns relating to management and
supervision within the ambit of corporate governance are being tested during the
period of downturn of economic activity. There is also a sense that we have a lot to
acquire and adapt in terms of the technical expertise necessary to measure and
manage risks better. The structure of the financial system is changing and
supervisory and regulatory regimes are experiencing the strains of accommodating
these changes. In a fundamental sense, regulators and supervisors are under the
greatest pressures of change and bear the larger responsibility for the future.

5. We should strive to move towards realizing our vision of an efficient and sound
banking system of international standards with redoubled vigor. Our greatest asset
in this endeavor is the fund of human capital formation available in the country but
however we need to focus on scientific and technical formation.
7.2 SUGGESTIONS

The following suggestions can be taken into consideration by the DFI’s converting
themselves into bank:

1. More and more DFI’s should try to convert themselves into Universal Banks i.e.
all services under one roof which will be beneficial to both i.e. for banks and the
customers.

For banks it will be beneficial as it will help them to maximize their profits and
from the point of view of customers it will be a solution for all their financial
services under one roof. It will help the banks to expand their business on national
and international level and will help to create their image in International banking
sector.

2. As India is moving ahead in the field of technology, more and more banks
should try to improve the use of technology in their services provided to the
customers and should provide Core Banking Solutions in all their branches.

3. As NPA’s are the greatest challenge for the banks these days, it is suggested that
these banks should focus on reducing their NPA levels as it will indirectly help in
increasing their profits.
ANNEXURE – I

BIBLIOGRAPHY

I. Books

a) Dr. Bandgar P.K, Kalyanraman.A, Universal Banking, Vipul Prakashan.

b) Smith R, Walter I, Global Banking.

c) Reddy C.N., Banking and Its Credit creation.

d) B.S.Sreekantaradhya, Banking and Finance.

II. Newspapers

a) Oct 26, 2009, Universal banking no panacea for ill DFI’s, Bimal Jalan, Business
Standard.

b) June 16, 2009, Extinction of DFI’s will affect Development, The Economic
Times.

c) Feb 12, 2009, Universal banking by DFI’s: Handy, but no solution to NPA’s,
The Hindu.

III. WebPages

a) www.banknetindia.com/banking/universalbankingfeature.

b) www.managementor.com.

c) www.investopedia.com/terms/universalbanking.

d) www.indianmba.com.

e) www.researchandmarkets.com.

f) www.reportbuyer.com.
ANNEXURE II

REPORT ON RESPONSE COLLECTED FROM MR. PENDARKAR, BRANCH

MANAGER, IDBI BANK, DOMBIVLI

While having face to face interview with Mr. Dhananjay Pendarkar, Branch
Manager, IDBI Bank, Dombivli, on October 30, 2009 his views were asked
regarding conversion of DFI’s into Banks for which the following answers were
given:

Q1) How different is the Universal Banking model from the existing (Development
Financial Institution) model?

Ans: The current banking model is in terms of intermediation between households

and industries at the short end of the spectrum. The DFI’s used to get Government
funds at subsidized rates to be lent for long. In the case of new model the entity is
expected to be a one-stop shop. The mobilization of funds could be focused on
both long side and short side.

The short end and long term is combined in an institution, which needs to develop
internal safe guards for asset liability, mismatches. From the borrower side it is
providing funds for fixed assets as well as current assets and to do that extent safe
guards can be built in rating.

Q2) DFIs are moving towards Universal Banking on the pretext to hide NPA’s and
meet the regulatory requirements. Could you comment?

Ans: At present, the DFI’s are permitted an overdue period of 365 days for the
principal and 180 days for the interest. But once these are placed on par with those
of Banks then, an asset will be treated as nonperforming if interest or installment
remains overdue for more than 180 days. Hence the level of NPA’s and erosion of
capital could be larger in these FI’s than what is presented. To that extent the
surmise that DFI’s move towards Universal Banking may be to overcome their
NPA problems.
Q3) Should it be “Banks v/s DFIs” or “Banks and DFIs”?

Ans: As per the views of Mr. Dhananjay Pendarkar the services provided by banks
and DFIs, are more or less the same and so in this modern complex competitive
banking sector the banks are getting a cutting edge competition from DFIs. So as
per Mr. Pendarkar it should be “Banks v/s DFIs”.

Q4) what are your views regarding the transformation of DFI’s to Universal
Banking?

Ans: One of the reasons for the decision to convert DFI’s to Universal Banks is
because the Government is not in a position to infuse additional capital to these
entities. In a sense the burden of bailing out these DFI’s will have to carry the
burden of NPA’s of the DFI’s in addition to their own. In other words the decision
by the Government is not out of love for Universal Banking but out of concern
about the situation of DFI’s. The capital markets are sluggish on the whole and the
position of Banks is also no better.

Q5) Is Universal Banking Suited to India’s Needs?

Ans: Yes, Universal banking is definitely suited to Indian needs because universal
banking provides a one stop shop solution for all the financial needs of the Indian
customers. Public financial institutions (FIs) should return to the culture of
development banking and long-term lending instead of adopting the model of
``universal banking' which is unsuited to the needs of India, according to the
Branch Manager he said that the adoption of provisioning and other norms,
evolved by the Bank of International Settlements (BIS), Basel, and based on the
demands of global speculative finance capital by the Reserve Bank of India (RBI)
was proving ruinous to Indian banks and financial institutions.