UNIVERSAL BANKING: A PARADIGM SHIFT IN INDIAN

BANKING SYSTEM
Dr. Savita
Assistant Professor,
Department of Commerce
Dev Samaj College for Women,
Ferozepur City (PB.)

Abstract:
The major challenge before Indian policy-makers has been to allow the development of
appropriate institutional structure that would respond to and open and liberalized regime.
Furthermore the ongoing liberalization process with its focus on international integration
necessitates the emergence of not just domestically strong players but also globally competitive
ones. Acquisition of a "Universal Banking" structure could be perceived as a strategic reaction of
certain players to these changed circumstances. In an emerging economy like India where
volatility is large, emergence of universal banks can contribute to faster economic growth as it
assist in strengthening the alliance between companies and banks. A movement into universality
is likely to promote consolidation in a healthy manner and hence should be encouraged.
Introduction:
The concept of universal Banking in the Indian context has somehow come to represent the
reverse merger of financial institution with its banking progeny. During the last few years, banks
in India have been increasingly expanding and diversifying beyond the boundaries of traditional
banking. Most of the Indian Banks have setup their subsidiaries through which they are
providing a wide range of specialized financial services like underwriting of equities and bonds,
venture capital financing, leasing etc. Earlier, Banking was considered to be business activity of
accepting and safeguarding money owed by other individual and entities, and then lending out
this money in order to earn a profit. Historically in the Indian set-up, it was commercial banks
that had largely met short-term working Capital requirements of business enterprises, while
national and state level financial institutions (FIs) took care of long term project finance
requirements. As, DFIs are set up with the main objectives of meeting the investment needs of
industries. They have build up expertise in Merchant Banking and Project evaluation, So, saddles
with obligations to fund long gestation projects, the DFIs have been burdened with serious
mismatches between their assets and liabilities of the balance sheet . In this context, the
Narsihman committee-II had suggested DFIs should convert into banks or Non- Banking Finance
companies (NBFCs). Converting of this DFIs into universal Banks will grant them ready access
to cheap retail deposits and increase the coverage of the advances to include short term working
capital loans to corporate with greater operational flexibility. At that time DFIs were in need to
acquire a lot of mass in their volume of operations to solve the problem of total asset base and
networth. In the year 2001, ICICI and ICICI Bank announced their merger to form a universal
Bank, and within a couple of day 'IDBI' decided to follow suit. Both have proposed reverse
merges i.e the smaller Commercial Bank taking over the larger DFIs indicating universal
Banking becoming a major event in the Indian Banking system and raised several important
issues.
Background of Transition of Indian Banks Towards Universal Banking:-
In the earlier Era, the three DFIs (IDBI, ICICI and IFCs) were mostly engaged in consortium
lending and there were uniformity in their services, pricing and quality of assets. This model of
uniformity has to undergo a change as:-
1. The license/permit/quota raj gave way to a more liberalized economy.
2. Corporate borrowers were forced to face global competition instead of operating in a
protected environment.
3. Interest rates were liberalized and the facility of issuing bonds eligible for SLR
investment was withdrawn.
4. Capital markets developed and top class corporate stopped needing the intermediation of
DFIs etc.
5. More stringent provisioning norms came into operation- IDBI also lost its tax-exempt
status.
In this changed context, the major challenge before Indian policy -makers has been to
allow the development of appropriate institutional structures that would respond to challenges
posed by an open and liberalized financial regime. Furthermore, the ongoing liberalization
process with its focus an international integration necessitates the emergence of not just
domestically strong players but also globally competitive ones. The institution which changed its
business model was ICICI, with entering into areas like consumer finance, shorter term debt etc
and expanding faster than the other two kundapur Vaman kamath, the CEO of ICICI Bank spoke
about his ambitious to make his Bank a universal Bank, selling every conceivable financial
products So, the issue of Universal Banking emerged in year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for transforming itself into an
Universal Bank. The RBI also spelt to the Parliamentary Standing Committee on Finance its
proposed policy to enable domestic financial institution (DFIs) to become Universal Banks. In
January 1999, RBI released a discussion paper on harmonizing the role and operation of
financial institution and banks in order to bring in a clear-cut clarity on the roles of banks and
financial institutions. Now RBI has asked FIs which are interested to convert itself into universal
bank to submit their plans for transition to universal banks for consideration and further
discussion.
Nowadays, Indian Banks in addition to normal banking provide other functions which are
non banking in character, such as Investment, Insurance, Mortgage, Securitization etc. These
types of Banks a define at universal banks. So, it is necessary to evaluate the actual performance
and suitability of a universal Banking model for India, given India's development and financial
priorities. In this paper we have made attempt to cover the following objective.
1. To Discuss the concept of Universal Banking and details its advantages and limitations.
2. To Expatiates upon the actual Indian experience in Universal Banking last Seven to Eight
years.
3. To discuss various regulatory challenges involved in the monitoring and financing
conglomerates.
4. To establish a link between Indians current financial challenges and efficacy of Universal
Banking Model.
Section-1
Concept of Universal Banking
"Universal Banking" may be defined as a banking system made up of large-scale banks
that operate extensive networks of branches provide many different services, hold several claims
on firms (including equity and debt), and participate directly in the corporate governance of
firms that rely on these banks as sources of funding or as securities underwriters [Calomiris
1995]. Universal banks conduct a range of financial services comprising deposit-taking and
lending, trading financial instruments and foreign exchange (and their derivatives), underwriting
of new debt and equity issues, brokerage, investment management, and insurance
As per the World Bank, "In Universal Banking, large banks operate extensive network of
branches, provide many different services, hold several claims on firms(including equity and
debt) and participate directly in the Corporate Governance of firms that rely on the banks for
funding or as insurance underwriters". Universal Banking generally takes one of the three
forms:
UNIVERSAL BANKING MODEL: AN INTERNATIONAL SCENARIO
The global experience of Universal banking can be segregated into broadly three models:

There is the Swedish or Hong Kong type model in which the banking corporate engages in In-
house activities associated with banking.
In Germany and the UK, certain types of activities are required to be carried out by separate
subsidiaries.
In the US type model, there is a holding company structure and separately capitalized
subsidiaries. The United States continues to block commercial banks from engaging in securities
transaction and underwriting.
UNIVERSAL BANKS IN DIFFERENT FORMS
Universal banks have played a leading role in Germany, Switzerland, and other Continental European
countries. The principal financial institutions in these countries typically are universal banks offering
the entire array of banking services. Germany today and before the second World War offers the best
example of universal banking (In practice, German universal banks conduct only securities and
merchant banking operations within the bank; insurance, mortgage banking, portfolio management and
investment funds are provided in affiliates, organized under an "Allfinanz" financial holding company).
Since European economic unification permits banks to operate in all European Community (EC)
countries as they are permitted to operate in their home country, it is likely that all countries in the EC
will be served by universal banks, subject to some restrictions on share ownership by banks, as well as
by specialized banks. In addition, banks in Switzerland and many non-European countries (with the
exception of Japan) permit universal banking. Most other countries (notably, Canada) allow banks to
offer any financial service through bank-owned subsidiaries. By contrast, the United States is served
only by specialized banking. Commercial banks are not permitted to offer full service securities
transactions and underwriting. Banks may not underwrite insurance and, in most states and cities, they
may not sell it either. Banks generally may not hold equities in nonfinancial companies and are
restrained from taking an active role in disciplining poor managers of these companies. The primary
laws that prohibit universal banking in the United States are the 1933 Glass-Steagall Act, which
separates commercial and investment banking, and the Bank Holding Company Act and the National
Banking Act, which generally prevent banks from offering insurance policies, real estate brokerage, and
other financial products.
Section II
INDIAN EXPERIENCE IN UNIVERSAL BANKING
In the early 1990s, firms requiring project finance approached one of three Development
Finance Institutions (DFIs) - IDBI, ICICI or IFCI; while individuals requiring home finance
approached HDFC. Players like Kotak Mahindra Finance focused on niche products like car
loans. Today, we find entities like ICICI, IDBI, SBI and Kotak Mahindra undertaking extensive
cross-selling of products resulting in significant expansion of their total business. Today, these
entities have all become one-stop departmental stores for mutual funds, loans, insurance, etc
[Financial Services, IBEF 2005]. These entitled shave realized that their newly acquired
universal banking structure has helped them immensely in diversify in business risks. To cite an
example, today the State Bank of India (SBI) offers the life insurance covers of its subsidiary,
"SBI Life", to all its saving account holders for a small fee. The SBI Life - an insurance arm of
SBI derives close to 70 per cent of its premium income through this route. In areas in which
foreign banks enjoyed comparative advantage for decades, Indian universal banks are making
serious inroads. Three Indian universal banks ICICI, SBI, HDFC have already stepped as leading
universal banks. These Indian universal banks have now crossed the two million card based with
ICICI leading the pack at four million cards (racing head of city bank which is at 2.8 million)
while HDFC bank has a card base for 2.2 million, SBI cards just crossed over 2 millions.
These banks deals with three key business segments - wholesale banking services, Retail
banking services and Treasury. They have entered the banking consortia many gaint cooperates
for providing working capital finance, trade services, corporate finance, merchant banking. They
are also providing sophisticated product services in area of foreign exchange and derivates,
money market and debt trading and equity. SBIs access to over 100 million accounts across the
country through 19000 branches (including associates banks and RRBs ) provide vibrant base for
insurance, penetration across every region and economic strata in the country ensuring true
financial inclusion Gross premium, the company crossed Rs. 12000 Crores by the year 2011
showing a growth of 28%. SBI-Life has emerged as the top private insurer in terms of number of
lives covered. SBI Life has a healthy mix of Bancassurance, Agency Channel coperate agents
indirect marketing. Bancassurance generated 33% of total business in 2009-10 Agency business
contributed 35% during the same period. SBI life has also bagged the distinction of having the
largest number of Million Dollar Round Table (MDRT) agents in 2010 among the global
insurance company. Ahead of the global heavy weights like New York life, Samsung Life
Insurance, North western mutual and Prudential Life Insurance. SBI Life's 2904 MDRT
members make it first Indian company to be included to the top 10 Global insurance company.
Overall , the channel productivity of the SBI Life is amongst the best in the industry with highest
average ticket size of approximately Rs. 30,000 contributing to its lower operating costs
1
.
At Present SBI has SBICAP (Securities Limited SSL) Which is wholly owned subsidiary
of capital market limited, besides offering equity broking services to retain and institutional
clients, this compnay also generated a profit of Rs. 4.59 crore for FY 2010-11.Similarly SBICAP
Trustee Co. which recently commenced security Trusty business w.e.f Ist Aug 2008 has on a
gross income of Rs. 8.3 crores and a net profit of 4.43 crore during 2010-11 as compared to Rs.
1.94 Crore during 2009-10. SBIFMPL, the Mutual Fund arm of SBI is also excelling with
average Assets Under Management (AUM) of the Company stood at Rs. 41,672 Crore as against
Rs 37417 Crore as on March 2010 achieving a Yoy growth of 11% as against the growth of 6%
for the mutual fund industry.
With more and more middle class customer wanting to spread their wealth across
banking products, leading banks like SBI see sense in adopting the universal banking model, so
that they can make their customer completely dependent on them. At the same time SBI
conversion into universal banks has not at all affected adversely the core lending operations as
SBI total advances have increased 17.52 Percent from 204573 crores in (2009-10) to 240423
Crores (10-11) showing an increase of 21.62 percent in above financial year.
In all ICICI is diversified financial service company that provide a range of banking and
financial services to customer, including retail baking , project and corporate finance, working
capital finance, insurance, venture capital and private equity, investment banking, broking and
treasury products and services. The company operates in india, U.K, Canada and Russia. It
operates in eight segments: treasury, wholesale banking, retail banking, life insurance, other
banking business, general insurance, venture and fund management and others.
Treasury includes the entire investment portfolio of the bank, ICICI Eco-net internet and
technology fund, ICICI equity fund, ICICI emerging sectors fund and ICICI strategic
investments fund. Wholesale banking includes all advances to trusts, partnership firms,
companies and statutory bodies which are not included under the retail banking. The investment
banking division provides treasury services including corporate advisory services, primary
dealership in government securities and equity underwriting and brokerage. Life Insurance is
provided trough subsidiary, ICICI Prudential Life insurance company. ICICI Venture funds
management company manages funds that provide venture capital funding to start-up companies
and private equity to a range of companies. As of March 31,2009, it had funds under
management of about INR97.87 billion.
1. Defined As Individual New Business Annualised Premium Equivalent (NBAPE) /Total
No. of Individual Policies
ICICI Bank, with two of its main subsidiaries ICICI Prudential Life Insurance and
Prudential ICICI Mutual fund have been performing well and have attained leadership positions
within the private player segment. ICICI Bank Reported its consolidated net profit for the quarter
ended 30th Sep 2011 surged 43 percent to Rs. 199 Crore, compared with Rs. 1395 Crore, The
rise was strongly aided by higher Earnings of Bank's Life Insurance Arm, ICICI Prudential Life
Insurance Company reported profit after tax of Rs. 350 Crore during the quarter, compared with
15 crore a year earlier. A part for income for core banking operation the fee income (from non
core banking operation) rose seven percent to Rs. 1700 Crores. The Bank's advances increased
20 percent year -on-year to Rs. 233952Crores driven mainly by growth in coporate loans. The
Bank has been successful to cut its provision by 50 percent, compared to a year ago to Rs. 319
crore during the quarter, due to improvement in quality of its assets. The Chanda Kohhar
Managing Director and Chief Executive officer ICICI Bank said that ICICI Banks aims to
increase its advances to 18 percent this financial year with much growth aimed at corporate and
in retail advances.The share of low cost current account and saving account deposits to total
deposits improved subsequently to 42.1 percent. Saving account stood at Rs. 70149 crore, while
current account deposit were Rs. 32,997 Crore. The Bank Capital adequacy ratio was 18.99
percent while its tier-1-adequacy rates was 13.14 percent
2

Influenced with the performance and working and these two trend setters of universal
banks, many banks both in private and public sector are now meeting diversify needs of
customer to name of few: Punjab National Bank, UTI ( AXIS Bank), Hong Kong and Shaghai
Banking (HSBC), Kotak Mahindra Bank, Sundram Bank, Oriental Bank of commerce etc.
In a recent move, India's largest insurance company- Life Insurance Company (LIC) has
entered into the home loans and mutual funds business in a big way. Though it is not into
banking yet, it has made a foray by picking up a substantial stake in a state-run bank -
Corporation Bank. Cooperation bank itself has been planned to setup and insurance subsidiary
since a long time.
Going forward, however, there is an apprehension that these full-fledged universal banks
in India will gain more market share from other players because of their potential to exploit scale
and scope economies, technological edge and risk diversification. Influenced by the actual
performance of universal banks in India, policy-makers are increasingly favoring strategic
alliances between public sector banks (PSBs) and other financial sector players such as insurance
companies, mutual funds, etc. which would help PSBs enhance their product range, leverage on
economies of scale and reduce costs.
In fact, relatively stronger PSBs have already started moving into universality following a
well-drawn transition path with a time-bound programme. As a first step most of them are
moving towards centralized databases and core banking solutions. They have put in place
comprehensives technology plans encompassing computerization, branch networking and
aggressive expansion of ATMs.

Almost all of them have entered bank assurance tie -up sand have also taken up mutual
fund distribution. To cite a few examples, Punjab National Bank has started marketing mutual
fund products of Principal PNB-AMC from lastly ear with an aim to retain large custom e/base
and enhance fee-based income of the bank. A joint venture insurance broking company, PNB-
Principal Insurance Advisory Company (IAC) has also been set up, which has already
commenced its activities with effect from April 18, 2005. A tie up with IFFCO-TOKIO General
Insurance has been done so as to provide insurance to housing loan borrowers. It has also entered
into a tie-up arrangement with New India Assurance for providing personal accident insurance
cover to its retail-lending customers. Further, a tie-up arrangement has been made recently with
MetLife India for providing insurance cover to all savings and individual current account holders
in the age group of 18 to 64. On payment of nominal premium. Bank of Baroda has an alliance
with -National Insurance Company for selling general insurance products.
Canara Bank has been retailing Aviva Life Insurance products since February 2003 and
has also tied up with a non-life insurer United India's Insurance Company (UIICL) as a part of its
bank assurance arrangements in February 2005.




Section -III
Regulatory challenges in Universal Banking

Universal banks are more complex to supervise than narrow commercial banks. Large
universal banks are generally not allowed to fail due to the social cost' dimension of such failures
and this acts an advantage for them in competing with smaller institutions, This also encourages
some "moral hazard" or excessive risk taking on their part In any process of competition size is
always seed as a weapon, and since the road to universal banking is confirmed by the need of a
large scale. Universal banking model ultimately gives rise to local monopolies.
2. www.business-standard.com/India/news/life-insurance-arm-pushes-icici-bank92-
profit/43/454152/-

In universal banks, the probability of conflicts of interest the arise from serving various
clients increases substantially given the breadth of their activities. Moreover Universal banks by
holding large blocks of stocks in industrial companies may be able to influence the structure of
the national economy in ways that run counter to national interest. Also, such concentration of
economic power in their hands may give them an additional ability to influence political
decisions and shift the balance of risks and returns in their favour.
Luckily in India financial regulators have carefully designed the regulatory framework
with much improved coordination among the Reserve Bank of India, the Securities Exchange
Commission of India (SEBI-the capital markets regulator) and the Insurance Regulatory
Authority of India (IRDA. the insurance regulator).
Only an "arms-length" relationship between a bank and an insurance entity has been
allowed by India's insurance regulator. This means that commercial banks' can enter insurance
business either by acting as agents or by setting up joint ventures with insurance companies.
Also, the RBI allows banks to only marginally invest in equity (5 per cent of their outstanding
credit) thus restricting their exposure to this sensitive sector.
Similarly, once a FI gets converted into a bank it is subjected to the same resource pre-
emption norms as commercial banks so that it will not have opportunities for regulatory
arbitrage. But it is necessary to remember that broader range of activities by universal banks
increases their inherent stability and. therefore decreases the probability of a serious failure. Also
an answer to the problem of moral hazard lies not in prohibiting universal banking but in
designing a safety net in order to punish and not to protect excessive risk-taking behavior.
The emergence of monopolies due to universal banking could be countered by promoting
competition both in the domestic and global marketplace. In India, it is healthy competition,
which has eventually brought down the corporate financing costs for the clients of major
universal banks in last three years.
So, the adversities of conflicts of interests can be easily checked by creating reputational
risks and legal sanctions. Similarly, the problems of concentration of economic and political
power can be controlled through the vigorous application of sophisticated regulatory regime.

Section-VI
Conclusion
As revealed by the rich cross-country experience (including that of India for last few
years) universal banking model enables financial players to offer different products and services
- more or less interrelated depending on the internal resources available and the competitive
dynamics in each financial market. A universal banking character would offer them more options
for penetrating more quickly, new segments within the financial services sector. As guided by
the customer demands and for generating revenue synergies through the provision of multiple
services.
The concerns relating to regulatory issues could be effectively tackled through improved
coordination among multiple regulators. In an emerging economy like India where volatility is
large, emergence of universal banks can contribute to faster economic growth. This is because
universal banking aids in strengthening the alliance between companies and banks. As the
companies can access both capital market services and credit facilities from the same institutions.
Also Universal banks have an advantage of accessing more information about the companies that
could offset higher volatility. Due to this advantage today many banks have begun to migrate to
the universal Banking model, which has opened up new avenues of growth for them. Several
banks are now foraying into areas such as credit cards, insurance, DEMAT services, mortgage
financing, investment banking, securitization, mutual funds, insurance, etc. , thereby offering
different services to their customers under one roof. This is also fueling the growth of these
banks. As the competition increases, it will make consolidation in the sector inevitable. With the
highly fragmented nature of the sector, it is not unlikely that many banks especially PSBs will
find some of their branches unproductive and unsustainable. The greater cost competitiveness of
private banks will also force PSBs with inefficient operations and high costs to either close those
branches of merge with other banks to bring down the costs. In the case of Indians PSB's which
has rich experience in social banking and cash flow analysis, have long term contractual
relationships with both urban and rural entireness and also have made investment in upgrading
technology into universal banks seems to be the appropriate strategic response to heightened
competition.
The experience of ICICI and SBI with universal model banking model have proved
beyond doubt that "size" matters. There is a tremendous scope for small sized Indian banks to
consolidate with in the domestic economy and increase the "size" through merger and
acquisition. Signs of consolidation have already begun to emerge. The high profile merger of
Times Bank with HDFC Bank five years ago marked the arrival of Mergers and Acquisitions
(M&A) in the banking sector in the country. A couple of (recent mergers clearly send a signal
that consolidation is inevitable. The merger between ICICI Bank and Bank of Madura,
Nidungadi Bank's merger with Punjab National Bank, and more recently, the merger of the
beleaguered Global Trust Bank with the government-owned Oriental Bank of Commerce
vindicate the argument. Industry experts opine that there may be many more mergers on the
cards. The Union Finance Minister has also hinted that he is favorable to mergers between banks,
especially government-owned ones. He recently quoted saying, "Consolidation alone will give
banks the muscle, size and scale to act local and seek new markets. New classes of borrowers."
This gives enough indication as to what lies in store for the banks, particularly the PSBs, as far as
consolidation is concerned. Further as banks in India look forward to expanding their presence
outside the country and have a global reach they will be competing with global behemoths like
the Citigroup, HSBC Bank, etc. in terms of strong balance sheet, and economies of scale and
size. Thus in all measures the spread of universal banking in India likely to promote
consolidation in healthier manner - a major prerequisite for the banking system stability.

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