Banking & Financial Services

Bankers enter the Realm of Financial Services

1. Speculation was considered a sin.
2. It prohibited banks from owning non-banking
assets.
3. No Company other than a commercial bank
licensed by the RBI can include the words "Bank"
or "Banking" as part of its name.
4. Banking services, banks provided remittance
service, collection of cheques and bills of
exchange, Issue of Guarantees, Opening Letters
of Credit, Leasing Safe Deposit Lockers, and
accepting articles under safe custody.
5. Financial services included long term lending for
industrial and infrastructure projects, housing
finance, financing hire-purchase and leasing
transactions, providing insurance cover, selling
mutual-fund products etc.
6. A stream of financial products have therefore
come into usage to meet specific needs of both
investors and borrowers. The range of product
covers fund raising, underwriting, hedging or
arbitrage instruments.
7. Banks undertake leveraging transformations as
part of their intermediation - asset-liability, debtequity, collateralised/ non-collateralised,
maturity, size and risk. This necessarily involves
other types of financial intermediaries as
counterparties, in syndications and co-financing
strategies, as also in the sharing of risk.

8. Mergers, amalgamations and acquisitions have

been undertaken on a large scale in order to gain
size and to focus more sharply on competitive
strengths. This consolidation has produced
financial conglomerates that are expected to
maximise economies of scale and scope by
'bundling' the production of financial services.
9. The general trend has been towards downstream
universal banking where banks have undertaken
traditionally non-banking activities such as
investment banking, insurance, mortgage
financing, securitization, and particularly,
insurance.
10.
Upstream linkages, where non-banks
undertake banking business, are also on the
increase.
11.
In India, when banks were allowed to
undertake leasing, investment banking, mutual
funds, factoring, hire-purchase activities through
separate subsidiaries. All restrictions on project
financing were removed and banks were allowed
to undertake several activities in-house.
12.
In the recent period, the focus is on
Development Financial Institutions (DFIs), which
have been allowed to set up banking subsidiaries
and to enter the insurance business along with
banks.

BANKS' ENTRY IN TO INSURANCE BUSINESS

With the passage of the Insurance Regulatory and
Development Authority (IRDA) Act, 1999, the Insurance
Regulatory and Development Authority has been set up with

statutory powers to function as the sector regulator for

insurance in India.
The Act, while allowing private participation including
foreign equity participation up to 26% of the paid-up
capital, has come out with regulations on various
aspects of insurance business such as, licensing of
agents, solvency margin for insurers, accounting
norms, investment norms and registration of Indian
insurance companies.
With the issuance of notification specifying insurance
as a permissible form of business under Section 6(1)
(o) of the Banking Regulation Act, 1949, RBI has
issued guidelines for entry of banks into insurance
business.
Accordingly, those banks which satisfy the vital
parameters set therein - minimum net worth of
Rs.500 crore, eligibility criteria in regard to net worth,
capital adequacy, profitability, reasonable level of
non-performing advances - would be allowed to set up
insurance joint ventures on risk participation basis.
Banks which are not eligible as joint venture
participants, would be allowed to take up strategic
investment up to a certain limit for providing
infrastructure and services support without taking on
any contingent liability provided these banks satisfy
some of the criteria specified therein.

SUBSIDIARIES OF BANKS
In terms of Section 19(1)(a) of the B.R.Act, 1949,
banks can form subsidiaries to undertake activities
which banks themselves are allowed to engage in
under Section 6(1)(a) to (o) of the Act. Section 6(1)
(a) to (n) of the Act cover traditional banking

activities. Under Section 6(1)(o) of the B.R.Act, 1949,

Govt. of India has notified certain para-banking
activities as eligible activities for banks to undertake
either departmentally or by setting up subsidiaries.
Further, in terms of Section 19(1)(c) of the Act,
Reserve Bank may allow a bank to adopt only its
subsidiary route for any activity which is considered
to be in the interest of banking or in the public
interest, with the approval of Govt. of India.
So far, subsidiaries have been formed by banks to
undertake activities such as equipment leasing,
merchant banking, hire-purchase finance, factoring
venture capital, housing finance, mutual funds (asset
management companies), stock broking, credit card
services, primary dealership in Government securities
market [under Section 19(1)(a) of the B.R.Act],
assaying and hallmarking of gold, computer related
services [under Section 19(1)(c) of the B.R.Act]. With
the issuance of notification specifying insurance as a
permissible form of business under Section 6(1)(o) of
the B.R.Act, 1949, SBI has been allowed to set up a
subsidiary for doing insurance business.

In short the thinking now is to develop as "Universal

Banking Organizations", described as "supermarket
for financial products".

What is Universal Banking

It is a multi-purpose and multi-functional financial
supermarket providing both banking and financial
services through a single window.

A universal bank can be a single company, a holding

company with wholly owned subsidiaries, a group of
entities with cross-holdings or even a flagship
company which may or may not have independent
shareholders.

Universal Banking - Benefits arising from &

Challenges Faced

Exploit economies of scale and scope.

Reduce average costs and thereby improve spreads

A bank possesses information on the risk characteristics of its

clients that it can use to pursue other activities of the same
client.

The bank's existing network of branches can act as shop for

selling products like insurance.

Challenges to be met in Universal Banking

1.
2.
3.
4.
5.
6.

To build effective supervisory infrastructure,

Volatility of prices in the stock market,
Comprehending the nature and
Complexity of new financial instruments,
Complex financial structures,
All Universal banks have to maintain the CRR and the SLR
requirement on the same lines as the commercial banks.
7. Also they have to fulfill the priority sector lending norms
applicable to the commercial banks.

RBI Guidelines for Existing Banks/FIs for

Conversion into Universal Banks
Salient operational and regulatory issues to be
addressed by the FIs for conversion into a
Universal Bank

a. Reserve requirements: Compliance with the cash

b.

c.

d.

e.

f.

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
Permissible activities : Any activity of an FI
currently undertaken but not permissible for a
bank under Section 6(1) of the B. R. Act, 1949,
may have to be stopped or divested after its
conversion into a universal bank.
Disposal of non-banking assets: Any immovable
property, howsoever acquired by an FI, would,
after its conversion into a universal bank, be
required to be disposed of within the maximum
period of 7 years from the date of acquisition, in
terms of Section 9 of the B. R. Act.
Composition of the Board: Changing the
composition of the Board of Directors might
become necessary for some of the FIs after their
conversion into a universal bank, to ensure
compliance with the provisions of Section 10(A)
of the B. R. Act, which requires at least 51% of
the total number of directors to have special
knowledge and experience
Prohibition on floating charge of assets: The
floating charge, if created by an FI, over its
assets, would require, after its conversion into a
universal bank, ratification by the Reserve Bank
of India under Section 14(A) of the B. R. Act,
since a banking company is not allowed to create
a floating charge on the undertaking or any
property of the company unless duly certified by
RBI as required under the Section.
Nature of subsidiaries: If any of the existing
subsidiaries of an FI is engaged in an activity not
permitted under Section 6(1) of the B R Act , then
on conversion of the FI into a universal bank, de-

g.

h.

i.

j.

k.

linking of such subsidiary / activity from the

operations of the universal bank would become
necessary since Section 19 of the Act permits a
bank to have subsidiaries only for one or more of
the activities permitted under Section 6(1) of B.
R. Act.
Restriction on investments: An FI with equity
investment in companies in excess of 30 per cent
of the paid up share capital of that company or 30
per cent of its own paid-up share capital and
reserves, whichever is less, on its conversion into
a universal bank, would need to divest such
excess holdings to secure compliance with the
provisions of Section 19(2) of the B. R. Act, which
prohibits a bank from holding shares in a
company in excess of these limits.
Connected lending: Section 20 of the B. R. Act
prohibits grant of loans and advances by a bank
on security of its own shares or grant of loans or
advances on behalf of any of its directors or to
any firm in which its director/manager or
employee or guarantor is interested. The
compliance with these provisions would be
mandatory after conversion of an FI to a
universal bank
Licensing : An FI converting into a universal bank
would be required to obtain a banking licence
from RBI under Section 22 of the B. R. Act, for
carrying on banking business in India, after
complying with the applicable conditions.
Branch network: An FI, after its conversion into a
bank, would also be required to comply with
extant branch licensing policy of RBI under which
the new banks are required to allot at east 25 per
cent of their total number of branches in semiurban and rural areas.
Assets in India : An FI after its conversion into a
universal bank, will be required to ensure that at

l.

m.

n.

o.

the close of business on the last Friday of every

quarter, its total assets held in India are not less
than 75 per cent of its total demand and time
liabilities in India, as required of a bank under
Section 25 of the B R Act.
Format of annual reports : After converting into a
universal bank, an FI will be required to publish
its annual balance sheet and profit and loss
account in the in the forms set out in the Third
Schedule to the B R Act, as prescribed for a
banking company under Section 29 and Section
30 of the B. R. Act .
Managerial remuneration of the Chief Executive
Officers: On conversion into a universal bank, the
appointment and remuneration of the existing
Chief Executive Officers may have to be reviewed
with the approval of RBI in terms of the
provisions of Section 35 B of the B. R. Act. The
Section stipulates fixation of remuneration of the
Chairman and Managing Director of a bank by
Reserve Bank of India taking into account the
profitability, net NPAs and other financial
parameters. Under the Section, prior approval of
RBI would also be required for appointment of
Chairman and Managing Director
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.
Authorised Dealer's Licence: Some of the FIs at
present hold restricted AD licence from RBI,
Exchange Control Department to enable them to
undertake transactions necessary for or
incidental to their prescribed functions. On
conversion into a universal bank, the new bank
would normally be eligible for fulfledged
authorised dealer licence and would also attract

the full rigour of the Exchange Control

Regulations applicable to the banks at present,
including prohibition on raising resources through
external commercial borrowings.
p. Priority sector lending: On conversion of an FI to
a universal bank, the obligation for lending to
"priority sector" up to a prescribed percentage of
their 'net bank credit' would also become
applicable to it .
q. Prudential norms: After conversion of an FI in to
a bank, the extant prudential norms of RBI for
the all-India financial institutions would no
longer be applicable but the norms as applicable
to banks would be attracted and will need to be
fully complied with. (This list of regulatory and
operational issues is only illustrative and not
exhaustive)