Innovations in Banking

Submitted To:

Mrs. Nancy Sachdeva

Lecturer, LHSB

Submitted By:

Prashant Gupta (RQ1903A22)

Vivek Vikas (RQ1903A23)

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Innovations in Banking

While the history of banking in India can be traced back several centuries, banking in the
modern sense of the word actually began towards the end of the 1700s.The Bank of
Hindustan, set up in 1770, by the British rulers in India was the earliest bank in the country.
Over the years, the British set up several other banks, notable among which were the three
Presidency Banks in the Presidencies of Bengal (in 1809), Bombay (in 1840) and Madras (in
1843).These three banks were very powerful in their respective Presidencies and functioned
as quasi-central banks, having even the power to issue currency notes.

Joint stock banking companies with limited liability began to make their appearance in the
early-1860s.Allahabad Bank Ltd. was the first joint stock bank established in India. The
Swadeshi Movement in the early-1900s provided an impetus to the setting up of banks owned
by Indians. In 1920, the British government in India passed the Imperial Bank of India Act
and amalgamated the three Presidency banks.

After India became independent from British rule in 1947, the newly formed government of
the country passed the Banking Regulations Act, 1949, laying down the guidelines for the
operation of commercial banks in the country. This regulation brought RBI under
government control (under the RBI Act, 1934, the RBI did not have any government
ownership). The RBI was also made the supervisory and regulatory authority of the banking
sector.

In the 1990s, the banking sector in India saw greater emphasis being placed on technology
and innovation. Banks began to use technology to provide better quality of services at greater
speed.

Internet banking and mobile banking made it convenient for customers to do their banking
from geographically diverse places. Banks also sharpened their focus on rural markets and
introduced a variety of services geared to the special needs of their rural customers.

Banking activities also transcended their traditional scope and new concepts like personal
banking, retailing and banc assurance were introduced. The sector was also moving rapidly
towards universal banking and electronic transactions, which were expected to change the
way banking would be perceived in the future.

Breakthrough in Funds Transfer

In May 2004, the curtain was finally lifted on the much discussed Real Time Gross
Settlement (RTGS) system, which many analysts considered, would revolutionize funds
transfer in the Indian banking sector.

RTGS is an electronic funds transfer system designed to allow the real time settlement of
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inter bank payments in a fully secure environment. It enables companies to transfer

outstanding funds between banks in real time, thus allowing them to settle payments
instantaneously and manage their working capital better. It is also expected to save significant
amounts of money in interest payments on floating funds lying in banks. The first RTGS
transaction took place when Standard Chartered Bank (SCB) executed a deal for Hindustan
Lever Ltd (HLL) with State Bank of India (SBI) being the receiving bank. The amount
transferred to SBI was Rs 100 million. Several commercial banks in India had been involved
in the phased implementation of RTGS for several preceding months.

Some of the early adopters of RTGS were SCB, SBI, Housing Development Finance
Corporation (HDFC) and Saraswat Bank. IndusInd Bank was also close to implementing the
system.

Commenting on the implementation of RTGS, a senior official at the Reserve Bank of India
(RBI) said, "We have achieved a very significant landmark in migrating high value funds
transfer from paper-based system to electronic based payment system".

RTGS was the latest in the line of payment delivery systems that have been implemented in
the Indian banking sector since the 1990s.

Some of the systems implemented earlier included the electronic clearing service (1995),
electronic funds transfer (EFT) facility (1997) and special electronic funds transfer system
(2003). Changes in the Indian banking sector in the late 1990s and early 2000s, are expected
to create high value for customers as well as the banks involved.

Innovations

1. The Shift to Relationship-Oriented Retail Banking

Traditionally the relationship between the bank and its customers has been via the branch
network. The head office had responsibility for the overall clearing network, the size of the
branch network and the training of the staff in the branch network. The bank monitored the
organisations’ performance and defined the limits for making decisions, but the information
available to both branch staff and their customer was only what existed in one geographical
location. (Gandy and Chapman,1996)
However, the modern bank cannot rely on its branch network alone. Customers are now
demanding new, more convenient, delivery systems. The telephone banking service is now
well established and increasingly people expect up-to-date ‘information-based banking
services’.
Services like Internet banking or interactive TV banking offer the customer two things: they
provide traditional banking services, but also offer much greater access to information on
their account status and on the bank’s many other services.
Retail banks have as a consequence of this a variety of options. They have many different
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products and many different ways of delivering them. They have to decide which products
they wish to sell; whether they wish to build those products themselves; how they should
deliver them, and who they wish to deliver them to. Technology underlies all these decision-
making processes. This makes technology’s influence over retail banking enormous. They
must be able to use local processing power to deliver a variety of products through different
media.
Decentralised client/server computing allows banks to address customers in a variety of
environments, via branches, ATM networks, over home PCs and so on. These, in turn, rely
on network technologies to pass data around the bank to the appropriate transaction
processors and databases.
The new technologies allow banks to turn their back on the fast moving consumer goods
(FMCG) mass marketing style of selling products, and have made it possible to develop
instead a more targeted approach to dealing with customer needs. Traditional mass marketing
is a scattergun approach, the alternative approach is micro-marketing to the specific needs of
individual customers. Such approaches generate a higher percentage of sales, and also
increase customers’ satisfaction with the service of the institution, as customers are not
constantly bombarded with irrelevant offers. Thus the other term now used to describe the
banks’ new posture is ‘customer-orientation’ (Smith and Walter, 1997). This means, among
other things,that banks are structured according to customer groupings, with separate
departments for

 Retail banking for small private customers

 Banking for high net worth individuals
 Institutional investors
 Corporate finance
 instead of (or perhaps alongside) the old product-based structure in terms of
 Lending activities
 Payments services activities
 Brokerage activitie etc.

Micro-marketing means developing tools which enable central marketing units to target the
individual customer for specific services. The development of customer information systems
(CIS) able to deliver this can also be exploited at the customer service level. The CIS system
can also be used to develop a ‘virtual personal banking’ service by distributing this
information to customer-facing employees. Giving branch workers or telephone operators
access to a screen outlining the customer’s financial history with the institution and their
personal background, allows them to deal knowledgeably with a customer’s requirements.

2. Delivery Innovations in Retail Banking

There are many different ways in which a bank can do business with its customers:
 Traditional branch
 Automated Teller Machine
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 Multimedia Information Kiosk

 Telephone banking - call centres
 Telephone banking - voice recognition facilities
 Home Electronic Banking
 via the Internet
 Private modem to modem links
 Interactive Television
 Smart Phones

3. Banks and Electronic Commerce

Banks are an integral part of the value chain in retail and service industries. It is the bank
which enables transactions to take place by processing the exchange of money. However, the
very nature of retailing is beginning to change with the advent of ‘virtual’ shopping based on
distribution of services via multimedia electronic networks.
The concept of home shopping long predates the internet. Catalogue shopping has been long
established, mainly due to the potentially great distances between customers and retail
outlets.

4. Developments in payments services and process workflows

The whole payment industry is undergoing radical changes which affect both the economies
of banking services and the flow of economic exchange throughout the whole economy.
The future of virtual payments is far from settled, and some banks are working on Smart Card
payment systems which will revolutionise both virtual payments and high street payments.
The growing interest in Smart Cards reflects the main shift in payments processing. The shift
is away from paper-based and towards direct payments and plastic card payments.

Credit and debit cards, smart cards and the use of the electronic purse
It is clear that technology is rapidly changing the nature of the interaction between the bank
and its customers. It is also having a profound affect on the nature of the commodity which is
being transacted, money itself. For thousands of years money was a physical commodity
represented by coinage and paper.
Since the 1960s we have seen the introduction of credit cards, debit cards, direct debits, and
recently electronic wallets and electronic money. In recent years an increasing number of
payments have been made using direct debits and standing orders (usually for regular
payments in the consumer market) and by plastic cards, especially credit and, more recently,
debit cards.
Payments by cheques and by paper credit transfer have been slowly falling. The clearing and
issuing of credit cards is dominated by banks, but they have no exclusive control and many
nonbanks have entered the market. Banks already had the established position in money
clearing and their position in the card market was a natural continuation.
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The Electronic Purse: the next step

The electronic purse carries out a number of different functions and tackles the payment
process from a different direction. Payments are made from the card, which holds a record of
the amount of money stored in it. In effect the card is itself the money. This is the reverse of
the traditional debit or credit card, which gives access to an account rather than having a
record of value recorded on it. The difference is made possible by a smart card which has a
chip built into it. The semiconductor chip can take many forms. It could be merely a memory
device or could also have a CPU so that it has in-built intelligence. This makes possible a
change in what was the basic flow of money. The electronic wallet or purse’s main
distinction over credit and debit cards is that it is aimed at being a replacement for cash not
cheques. It is an instant transfer of value without the participation of a clearer.
For the retailer, the advantage is that, like cash, the value is transferred at the time of
payment, reducing the risk of non-payment. For the user it is much easier to carry and use
than a cheque book; and, unlike cash, users have the option of protecting their cards with a
PIN number.
Moreover, with the in-built intelligence of the card, further security can be added through the
use of biometrics information. There is a common view that sending credit card details via
the Internet is inherently dangerous, so smart cards with their ability to exchange information
securely over a modem link are seen as a possible solution to the weakness of magnetic strip
cards.

5. Process Changes in Technology

Technology is often presented as a clearly divided series of generations. The following table
summarises the history of the shift in computing from centralised mainframe technologies to
decentralised computing. Alongside this is an outline of the business functions these changes
have enabled, i.e. the movement from simply using technology to automate back-office
functions to the use of technology in front-office areas and the creation of completely new
customer services, the first of these being the ATM.

6. The Process of Innovation in Banking and the Role of IT

Gandy and Chapman (1996) see technology as a dynamic force. It forms an increasingly vital
element in the competitive financial service industry, and also alters the very nature of selling
and delivering financial products. Bankers face the certainty that technology will increasingly
mould the future development of the banking industry. At the same time technology firms
have come to the realisation that banking is one of the largest and most sophisticated markets
for their products. The needs of the financial industry are a driving force in the development
of ne information-based technologies.
The information revolution is implementing changes at many levels in the banking
infrastructure. What this shows is that technology has moved from its role as a mere means of
automating existing functions to the key determining role in the organisation of financial
institutions,becoming a major factor in the decision-making process and a principal element
in delivering banking services to customers. Now that technology no longer just replicates the
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actions of a human being, but institutes entirely new ways of working and interacting with
customers, financial institutions face the enormous task of adapting the technological
infrastructure to the new tasks of interactive decision support and information gathering to
whilst steering away from the use of technology as machines silently devoted to account-
keeping.
Technology investments are often justified on the basis of a leap of faith, or with arguments
along the lines that the investment must be made in order to keep up with the competition.
That said, analysis is almost always carried out. The potential costs of an individual IT
project can often be identified relatively easily. A major problem comes with identifying
benefits. This is particularly true for long term projects. Over a period of years, markets,
internal organisational structures and technology can all change radically. This further
complicates the issue of how to deal with the already nebulous intangible benefits of
technology such as improved service levels.

Future Trend and Factors Driving Innovations

Innovation has always been an important area of focus for all industries, not just for Banks.
However, in view of the economic slowdown, it is common knowledge that banks have been
taking a very conservative approach over the last two years as many have been consolidating
their portfolio and innovating products had lost its importance and has taken a back seat. We
have not seen many innovative products designed for customers during the consolidation
phase, and rightly so, as the primary focus of Banks has been in cleansing their portfolio and
tightening credit extension apart from being extremely guarded in getting only credit worthy
customers in their books.

The scene in the Indian Banking industry is changing; the various global economies have
started showing signs of revival leaving behind them the worst recessionary phase and
moving towards growth. The Prime Minister of India, during the recent platinum jubilee
celebrations of Reserve Bank of India, has encouraged Banks to be more innovative. Please
recall the budgetary announcement by the Finance Minister on opening up the Banking space
by offering additional banking licenses to private players and NBFC’s. It is expected that at
least 5 more International Banking giants will set up operations in India in the next 1-2 years,
bringing with them superior technology. These are exciting times for customers in India and
challenging times for existing Banks, more so for the Public Sector Banks.

The choice before the customer today is far wider both in the selection of banks as well
asproducts than ever before. The future growth is largely in retail banking. Innovating
products backed by superior service are vital to provide the cutting edge.

Here’s a quick look at some factors which may probably be the key drivers for Innovation
in Banking, keeping in mind customer expectations and behaviour changes:

1. With intense competition between banks which is going to be more severe in the coming
years and with more private players waiting to step in, adopting new technology has assumed
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added importance, especially for public sector banks. The key to success is adopting state-of-
the-art technology and continuously accelerating business processes.

2. Investment and innovation in technology will result in further advancement in credit

analytics systems that will help them assess customer behavior and enhance portfolio
profitability. Experience in matured markets has proven the value of credit bureaus in the
development of consumer credit. With the possibility of more credit bureau’s competing with
CIBIL looming large, further advancement and innovation to quickly assess customer credit
history will be a critical factor to provide convenience banking to customers. The day is not
far away where you call up your Bank for a loan, provide your UID/PAN Number, your
credit score verified, eligibility calculated and the processing is completed almost
instantaneously and the loan amount gets credited to your account within 24 hours.

3. The 3G spectrum auction expected in mid 2010 across various circles to private telecom
providers in India will further open up immense migration possibilities to more convenient
channels. It may not be too long where the customer would access his bank account using a
secured application through his mobile phone. Needless to say, a secured and fast internet
banking platform will become a basic necessity.

4. RBI’s recent directive on payment of interest on daily balance maintained in the savings
account effective 1st April 2010 will result in higher outflow to Banks. This will also result in
the interest rates for short term deposits (7 - 90 days) undergoing an upward revision as
against the 2.5% - 3.5% being paid currently by banks on these deposits. While most Banks
seem to have enhanced their technology to comply with this interest calculation
methodology, this change however would result in an increased outflow of around 20% in
interest credits. Banks will find ways to innovate and encourage customers to use their debit
cards for purchases, bring the average daily balance down and gain the differential between
interchange spend and interest payouts. These strategies of promoting debit card usage will
also keeps the banking system going, interchange revenues flowing in and ensuring that
credit exposure by way of credit cards is minimized.

5. Continuous innovation on the product offerings by Banks is paramount to ensure that their
products stand out from the crowd. A lot of effort and innovation from Banks is required to
make their product the preferred choice of the customer. This needs to be backed by a
powerful and customized loyalty program for customers to be continuously encouraged to
keep using their card. Service is an extremely vital cog in the wheel and the Banks which
make the investment to have superior service levels as their USP will have a clear advantage.
Investment in providing a chat interface as a service channel for routine enquiries would be in
line with times to come.

6. Ten years ago, a customer would have been happy to bank with those who provided just a
fixed deposit or a recurring deposit in addition to his savings account and a credit card.
Today, there is a need to spread the wealth around, diversify the savings into shares, fixed
de¬posits, mutual funds, pension products and insurance. Banks have a choice – offer all
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these as part of their Convenience Banking to customers or lose him. This desire and the
compulsion to be the one-stop shop for the entire customer’s investment and borrowing needs
will ensure a lot of banks adopt this model increasingly.

7. Smart Cards embedded with microprocessors or memory chips will become tamper proof
and replace the existing plastic cards, offering customers a secure digital identity. This will
also provide convenience to customers; provide access to bank’s website and individual
accounts, accurate tracking of usage, spend analysis and manage long term customer
relationships through efficient, timely and valuable services to them.

8. Biometric ATM’s will replace the conventional ATM’s across the country, apart from all
banks investing in additional ATM’s. Banks can authenticate the identity of the customer in
three ways; most common being something the user knows (passwords or personal
identification numbers), something the user has (a security token etc) or something the user is
(a physical characteristic like fingerprint, palm geometry etc., called as biometric). With
increasing threats on compromise of passwords and account take over’s and misuse of cards,
biometric form of authentication (which have withstood the test of scrutiny coming out as the
most secure form) for ATM and POS transactions would be the way ahead. Statistics show
that India’s ATM density is around 35 ATM’s per million people which is abysmally low
compared to the US’s ATM density of 1300. This is an area of focus for many banks clearly,
offering a branding and marketing proposition for their investments apart from interchange
revenues on usage.

9. Cheques will gradually be phased out and replaced by RTGS and NEFT and other
electronic forms of money transfers and payment mechanisms offering superior turnaround
times. Operational efficiency in processing electronic payment mechanisms will undergo a
radical change, with the beneficiary receiving the credit real time online.

10. The 2010 Census process which has begun is going to throw up interesting focus areas for
Banks. The demographics of our country, with 54% of the Indian population being under 25
years of age and 60% within 40 years of age, will be a key driver to create a large retail
customer base. With increasing income levels and an annual GDP growth of 8.5-9%
predicted for the next 2-3 years, this segment is a good target market to sell insurance, mutual
funds, credit cards etc.

With so much of talk about inclusive growth and focus on rural development, there is a
considerable gap between demand and supply for all financial services, especially in rural
segments. Almost 70% of the rural population does not have a bank account, 85% do not
have access to credit and less than 10% have any kind of insurance (life, health, crop
insurance etc). More importantly, still 60% of the rural poor borrow from moneylenders,
friends and other sources.

While banks have largely stayed away from lending to this segment leaving it to the
microfinance companies and institutions, the statistics suggest that non-performing loans in
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the rural sector are similar to urban averaging between 1-2%. It would make enormous
business sense for banks and over the next few years, we would be seeing many banks enter
into micro finance which will, hopefully narrow the gap between banking services provided
in urban and rural India.

Here’s a look at some statistics on how the various segments within the Banking industry
today are placed in terms of financial strength to take on these challenges:

• SBI & Associates have been aggressive in their ability to attract capital, deposits and
investments and have been in the forefront in advances, followed by nationalized banks and
other scheduled banks. This also shows in their increase in income from interest and other
incomes. Foreign banks have been very cautious in their advances.

• Foreign Banks have a distinct advantage - their Business per employee is almost 100%
better than most banks in India and their profit per employee is 400% higher. Their cost of
funds (CoF) is also significantly lower by almost 25% compared to all banks and they have
performed well to get superior returns on assets. A superior CRAR, higher than the overall
industry average gives a lot of comfort but a significantly higher net NPA ratio at 1.80 is still
a cause of concern.