The first banks were the merchants of the ancient world that made loans to farmers and traders

that carried goods between cities. The first records of such activity dates back to around 2000 BC in Assyria and Babylonia. Later, in ancient Greece and during the Roman Empire, lenders who were based in temples made loans but also added two important innovations: accepting deposits and changing money. During this period, there is similar evidence of the independent development of lending of money in ancient China and separately in ancient India. Banking, in the modern sense of the word, can be traced to medieval and early Renaissance Italy, to the rich cities in the north such as Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in 14th century Florence, establishing branches in many other parts of Europe.[1] Perhaps the most famous Italian bank was the Medici bank, established by Giovanni Medici in 1397.[2] The development of banking spread through Europe and a number of important innovations took place in Amsterdam during the Dutch Republic in the 16th century and in London in the 17th century. During the 20th century, developments in telecommunications and computing resulting in major changes to the way banks operated and allowed them to dramatically increase in size and geographic spread. The Late-2000s financial crisis saw significant number of bank failures, including some of the world's largest banks, and much debate about bank regulation.

Contents
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1 Earliest forms of banking

1.1 Mesopotamia 1.2 Egypt 1.3 India 1.4 China 1.5 Greece 1.6 Rome 2.1 Judaism 2.2 Christianity 2.3 Islam 3.1 Emergence of merchant banks 3.2 Crusades 3.3 Discounting of interest 3.4 Foreign exchange contracts 3.5 Italian bankers 3.6 Silver crisis

2 Religious restrictions on interest

3 Medieval Europe

4 Spread through Europe

4.1 Expansion to Germany and Poland 4.2 Spain and the Ottoman Empire 4.3 Emergence of the Court Jew 4.4 Netherlands 4.5 England 5.1 Goldsmiths of London 5.2 Debt as a new kind of money 5.3 Development of central banking 5.4 Removal of religious restrictions on earning interest 6.1 Europe 6.2 United States 6.3 Globalisation 7.1 1930s Great Depression 7.2 World Bank and the development of payment technology 7.3 1980s deregulation and globalisation 8.1 Late-2000s financial crisis

5 Advances in the 17th and 18th century

6 19th century

7 20th century

8 21st century 9 Major events in banking history 10 See also 11 References

11.1 Footnotes 11.2 Citations

12 Further reading

[edit] Earliest forms of banking

The history of banking is closely related to the history of money but banking transactions probably predate the invention of money. Deposits initially consisted of grain and later other goods including cattle, agricultural implements, and eventually precious metals such as gold, in the form of easy-to-carry compressed plates. Temples and palaces were the safest places to store gold as they were constantly attended and well built. As sacred places, temples presented an extra deterrent to would-be thieves.

[edit] Mesopotamia
In Mesopotamia during Assyrian and Babylon kingdoms he there are records of loans dating back to the 2nd millennium BC that were made by temple priests/monks to merchants. By the time of Hammurabi's Code, dating to ca. 1700 BCE, banking was well enough developed to justify laws governing banking operations.[nb 1]

[edit] Egypt
In Egypt, from early times, grain had been used as a form of money in addition to precious metals, and state granaries functioned as banks. When Egypt fell under the rule of a Greek dynasty, the Ptolemies (332-30 BC), the numerous scattered government granaries were transformed into a network of grain banks, centralized in Alexandria where the main accounts from all the state granary banks were recorded. This banking network functioned as a trade credit system in which payments were effected by transfer from one account to another without money passing. In the late 3rd century BC, the barren Aegean island of Delos, known for its magnificent harbor and famous temple of Apollo, became a prominent banking center. As in Egypt, cash transactions were replaced by real credit receipts and payments were made based on simple instructions with accounts kept for each client.

[edit] India
In ancient India during the Maurya dynasty (321 to 185 BC), an instrument called adesha was in use, which was an order on a banker desiring him to pay the money of the note to a third person, which corresponds to the definition of a bill of exchange as we understand it today. During the Buddhist period, there was considerable use of these instruments. Merchants in large towns gave letters of credit to one another.[3]

[edit] China
In ancient China starting in the Qin Dynasty (221 to 206 BC) the Chinese currency developed with the introduction of standardized coins which allowed the much easier trade across China and led to the development of letters of credit. These letters were issued by merchants that acted in ways that today we would understand as banks.[4]

[edit] Greece
Ancient Greece holds further evidence of banking. Greek temples, as well as private and civic entities, conducted financial transactions such as loans, deposits, currency exchange, and validation of coinage.[5] There is evidence too of credit, whereby in return for a payment from a client, a moneylender in one Greek port would write a credit note for the client who could "cash" the note in another city, saving the client the danger of carting coinage with him on his journey. Pythius, who operated as a merchant banker throughout Asia Minor at the beginning of the 5th century BC, is the first individual banker of whom we have records. Many of the early bankers in Greek city-states were metics or foreign residents. Around 371 BC, Pasion, a slave, became the wealthiest and most famous Greek banker, gaining his freedom and Athenian citizenship in the process.

[edit] Rome

Gold coin produced by the Roman Imperial Mint In Ancient Rome moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are

derived. As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign currency into the only legal tender in Rome that of the Imperial Mint.[6] The Roman empire formalized the administrative aspect of banking and instituted greater regulation of financial institutions and financial practices. Charging interest on loans and paying interest on deposits became more highly developed and competitive. The development of Roman banks was limited, however, by the Roman preference for cash transactions. During the reign of the Roman emperor Gallienus (260-268 AD), there was a temporary breakdown of the Roman banking system after the banks rejected the flakes of copper produced by his mints. With the ascent of Christianity, banking became subject to additional restrictions, as the charging of interest was seen as immoral. After the fall of Rome banking temporarily ended in Europe and was not revived until the time of the crusades. Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India in 1955.

Contents
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1 History 2 Post-Independence 3 Nationalisation 4 Liberalisation 5 Adoption of banking technology 6 Further reading 7 References 8 External links

[edit] History
Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock Bank: A company that issues stock and requires shareholders to be held liable for the company's debt) It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from the Confederate States, promoters opened banks to finance trading in Indian cotton. With large exposure to speculative ventures, most of the banks opened in India during that period failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently,

banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century. Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras and Pondicherry, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking center. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally under capitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments." The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara ( South Kanara ) district. Four nationalised banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking". During the First World War (19141918) through the end of the Second World War (1939 1945), and two years thereafter until the independence of India were challenging for Indian banking. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following table: Years 1913 1914 1915 1916 1917 1918 Number of banks Authorised capital Paid-up Capital that failed (Rs. Lakhs) (Rs. Lakhs) 12 274 35 42 710 109 11 56 5 13 231 4 9 76 25 7 209 1

[edit] Post-Independence
The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal, paralyzing banking activities for months. India's independence marked the end of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included:

The Reserve Bank of India, India's central banking authority, was established in April 1934, but was nationalized on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[Reference www.rbi.org.in] In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors.

[edit] Nationalisation

Banks Nationalisation in India: Newspaper Clipping, Times of India, July 20, 1969 Despite the provisions, control and regulations of Reserve Bank of India, banks in India except the State Bank of India or SBI, continued to be owned and operated by private persons. By the 1960s, the Indian banking industry had become an important tool to facilitate the development of the Indian economy. At the same time, it had emerged as a large employer, and a debate had ensued about the nationalization of the banking industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the Government of India in the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalisation." The meeting received the paper with enthusiasm. Thereafter, her move was swift and sudden. The Government of India issued an ordinance and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it received the presidential approval on 9 August 1969. A second dose of nationalization of 6 more commercial banks followed in 1980. The stated reason for the nationalization was to give the government more control of credit delivery. With the second dose of nationalization, the Government of India controlled around 91% of the banking business of India. Later on, in the year 1993, the government merged New Bank

of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalised banks from 20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy.

[edit] Liberalisation
In the early 1990s, the then Narasimha Rao government embarked on a policy of liberalization, licensing a small number of private banks. These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. The next stage for the Indian banking has been set up with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%,at present it has gone up to 74% with some restrictions. The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks.All this led to the retail boom in India. People not just demanded more from their banks but also received more. Currently (2007), banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. One may also expect M&As, takeovers, and asset sales. In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them. In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing, vehicle and personal loans. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide.[1][2][3]

[edit] Adoption of banking technology

The IT revolution had a great impact in the Indian banking system. The use of computers had led to introduction of online banking in India. The use of the modern innovation and computerisation of the banking sector of India has increased many fold after the economic liberalisation of 1991 as the country's banking sector has been exposed to the world's market.

The Indian banks were finding it difficult to compete with the international banks in terms of the customer service without the use of the information technology and computers.

Number of branche of scheduled banks of India as of March 2005 The RBI in 1984 formed Committee on Mechanisation in the Banking Industry (1984)[4] whose chairman was Dr C Rangarajan, Deputy Governor, Reserve Bank of India. The major recommendations of this committee was introducing MICR[5] Technology in the all the banks in the metropolis in India.This provided use of standardized cheque forms and encoders. In 1988, the RBI set up Committee on Computerisation in Banks (1988)[6] headed by Dr. C.R. Rangarajan which emphasized that settlement operation must be computerized in the clearing houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram.It further stated that there should be National Clearing of inter-city cheques at Kolkata,Mumbai,Delhi,Chennai and MICR should be made Operational.It also focused on computerisation of branches and increasing connectivity among branches through computers.It also suggested modalities for implementing on-line banking.The committee submitted its reports in 1989 and computerisation began form 1993 with the settlement between IBA and bank employees' association.[7] IN 1994, Committee on Technology Issues relating to Payments System, Cheque Clearing and Securities Settlement in the Banking Industry (1994)[8] was set up with chairman Shri WS Saraf, Executive Director, Reserve Bank of India. It emphasized on Electronic Funds Transfer (EFT) system, with the BANKNET communications network as its carrier. It also said that MICR clearing should be set up in all branches of all banks with more than 100 branches. Committee for proposing Legislation On Electronic Funds Transfer and other Electronic Payments (1995)[9] emphasized on EFT system. Electronic banking refers to DOING BANKING by using technologies like computers, internet and networking,MICR,EFT so as to increase efficiency, quick service,productivity and transparency in the transaction.

Number of ATMs of different Scheduled Commercial Banks Of India as on end March 2005
[7]

Apart from the above mentioned innovations the banks have been selling the third party products like Mutual Funds, insurances to its clients.Total numbers of ATMs installed in India by various banks as on end March 2005 is 17,642.[10]The New Private Sector Banks in India is having the largest numbers of ATMs which is followed by SBI Group, Nationalized banks, Old private banks and Foreign banks.[7]The total off site ATM is highest for the SBI and its subsidiaries and then it is followed by New Private Banks, Nationalised banks and Foreign banks. While on site is highest for the Nationalised banks of India.[7] BANK GROUP NATIONALISED BANKS STATE BANK OF INDIA OLD PRIVATE SECTOR BANKS NEW PRIVATE SECTOR BANKS FOREIGN BANKS NUMBER OF BRANCHES 33627 13661 4511 1685 242 ON SITE OFF SITE TOTAL ATM ATM ATM 3205 1567 4772 1548 3672 5220 800 1883 218 441 3729 579 1241 5612 797

[edit] Further reading

The Indian Banking system has managed to successfully sail through the financial tornado witnessed by the global economy on the back of sound policies of our apex bank and fiscal stimulus packages implemented by the Government. Strict regulations relating to the exposure to derivative instruments, relatively tighter norms on capital adequacy based on risk-weighted assets and timely intervention by the Reserve Bank of India (RBI) prevented the severe contagion of the global financial crisis to the Indian banking system. During the recessionary phase in October 2008March 2009 period, the RBI was swift to reduce the policy rates, both repo and reverse repo and provide liquidity to the economy by reducing the reserve ratios and offering adequate support to the banking system. Couple of fiscal stimulus packages by the Government, relaxation of norms for certain sectors like real estate and allowing the banks to restructure its advances too contributed to the sailing of Indian banks through the rough phase with minimal impact. According to the authors, the Indian Banking Sector is poised for significant growth in the coming years driven by: - Healthy outlook on GDP - Under penetrated financial system - Borrowings from infrastructure and mortgage finance (home loans) This report on Indian Banking Sector gives valuable insight of the sector encompassing its history and evolution, role of apex bank, trend analysis of deposits, advances and profitability. The trend analysis is also done for non performing assets and capital adequacy ratio. The trends are analysed in depth for various banking groups. The report provides the authors outlook on growth in credit off-take, growth in deposits, net interest margins, non-performing assets and profitability for the

next two years till FY12. Their forecasts are based on its in-depth understanding of the sector and macro-economic variables and support from its analytically strong economic desk. Challenges The world economy has developed serious difficulties in recent times in terms of a lapse of banking & financial institutions and plunging demand. Prospects became very uncertain causing a recession in major economies. However, amidst all this chaos, Indias banking sector has been amongst the few to maintain resilience. A progressively growing balance sheet, higher pace of credit expansion, expanding profitability and productivity akin to banks in developed markets, lower incidences of non-performing assets and a focus on financial inclusion have contributed to making the Indian banking industry vibrant and strong. Indian banks have begun to revise their growth approach and re-evaluate the prospects on hand to keep the economy rolling. The way forward for Indian banks is to innovate to take advantage of the new business opportunities and at the same time ensure continuous assessment of risks. A rigorous evaluation of the health of commercial banks, recently undertaken by the Committee on Financial Sector Assessment (CFSA) also shows that the commercial banks are robust and versatile. The single-factor stress tests undertaken by the CFSA divulges that the banking system can endure considerable shocks arising from large possible changes in credit quality, interest rates and liquidity conditions. These stress tests for credit, market and liquidity risk show that Indian banks are by and large resilient. Thus, it has become far more imperative to contemplate the role of the banking industry in fostering the long term growth of the economy. With the purview of economic stability and growth, greater attention is required on both political and regulatory commitment to a long term development programme. This report discusses in detail the issues and challenges surrounding the Indian banking sector and the factors affecting it. The report discusses the key drivers, challenges and market forces affecting the banking sector on the whole. The report begins with an introduction to the banking sector, the history and evolution of the banking sector in India, the regulatory bodies of the government controlling the banking sector, followed by a detailed industry analysis of the banking sector. It then covers the macro & micro environmental factors like Porters 5 Forces Model and a detailed SWOT analysis to understand the market and its structure on the whole. This is followed by a look at the key drivers and challenges faced by the banking sector. There are many other risks like market risk and credit risks covered and the need of improving the efficiency of the system. The report covers key hurdles faced by the sector, followed by globalization issues. Current state With the growing expectations of the customers, banks are providing diverse services, combining innovation, quality, personal touch and flexibility in delivery. Now banks are moving to Tech banking which is easy to use, less time consuming and help in reduction in processing cost. The consumer segment and their behavior trend are very critical for banks to decide which product, service or branch they should start. In India public sector banks capture more than 50%

of Indian banking sector revenue but individually SBI bank holds maximum revenue in Indian in comparison to other banks in India. India is big and diverse country to meet the banking requirement of each and every individual in Indian the banking sector has develop a robust distribution network comprise of 74,112 bank branches and 63,543 ATMs. The penetration level of banks is highest in south India and the penetration level is lowest in North East state. Indian banking sector is facing several challenges but at the same time they are also enjoying country advantage and have plenty of opportunity like implementation models such as Bancassurance. Gdp

Banking, Financing, Insurance, Real Estate and Business Services make 10% of the GDP. Read more: http://wiki.answers.com/Q/What_is_the_contribution_of_the_banking_sector_in_the_GDP_o f_India#ixzz1iO3sriz9
Stating that the contribution of the banking sector to gross domestic product (GDP) was low at 35 per cent,

Banking and finance

Main article: Finance in India See also: Banking in India and Insurance in India

The Indian money market is classified into the organised sector, comprising private, public and foreign owned commercial banks and cooperative banks, together known as scheduled banks, and the unorganised sector, which includes individual or family owned indigenous bankers or money lenders and non-banking financial companies.[84] The unorganised sector and microcredit are still preferred over traditional banks in rural and sub-urban areas, especially for non-productive purposes, like ceremonies and short duration loans.[85] Prime Minister Indira Gandhi nationalised 14 banks in 1969, followed by six others in 1980, and made it mandatory for banks to provide 40% of their net credit to priority sectors like agriculture, small-scale industry, retail trade, small businesses, etc. to ensure that the banks fulfill their social and developmental goals. Since then, the number of bank branches has increased from 8,260 in 1969 to 72,170 in 2007 and the population covered by a branch decreased from 63,800 to 15,000 during the same period. The total bank deposits increased from 5,910 crore (US$1.12 billion) in 197071 to 3,830,922 crore (US$727.88 billion) in 200809. Despite an increase of rural branches, from 1,860 or 22% of the total number of branches in 1969 to 30,590 or 42% in 2007, only 32,270 out of 500,000 villages are covered by a scheduled bank.[86][87] India's gross domestic saving in 200607 as a percentage of GDP stood at a high 32.7%.[88] More than half of personal savings are invested in physical assets such as land, houses, cattle, and gold.[89] The public sector banks hold over 75% of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.[90] Since liberalisation, the government has approved significant banking reforms. While some of these relate to nationalised banks, like encouraging mergers, reducing government interference and increasing profitability and competitiveness, other reforms have opened up the banking and insurance sectors to private and foreign players.[1

 The service sector now accounts for more than half of India's GDP: 51.16 per cent
in 1998-99. This sector has gained at the expense of both the agricultural and industrial sectors through the 1990s. The rise in the service sector's share in GDP marks a structural shift in the Indian economy and takes it closer to the fundamentals of a developed economy (in the developed economies, the industrial and service sectors contribute a major share in GDP while agriculture accounts for a relatively lower share).

The service sector's share has grown from 43.69 per cent in 1990-91 to 51.16 per
cent in 1998-99. In contrast, the industrial sector's share in GDP has declined from 25.38 per cent to 22.01 per cent in 1990-91 and 1998-99 respectively. The agricultural sector's share has fallen from 30.93 per cent to 26.83 per cent in the respective years.

Some economists caution that if the service sector bypasses the industrial sector,
economic growth can be distorted. They say that service sector growth must be supported by proportionate growth of the industrial sector, otherwise the service sector grown will not be sustainable. It is true that, in India, the service sector's contribution in GDP has sharply risen and that of industry has fallen (as shown above). But, it is equally true that the industrial sector too has grown, and grown quite impressively through the 1990s (except in 1998-99). Three times between 1993-94 and 1998-99, industry surpassed the growth rate of GDP. Thus, the service sector has grown at a higher rate than industry which too has grown more or less in tandem. The rise of the service sector therefore does not distort the economy.

Within the services sector, the share of trade, hotels and restaurants increased
from 12.52 per cent in 1990-91 to 15.68 per cent in 1998-99. The share of transport, storage and communications has grown from 5.26 per cent to 7.61 per cent in the years under reference. The share of construction has remained nearly the same during the period while that of financing, insurance, real estate and business services has risen from 10.22 per cent to 11.44 per cent.

The fact that the service sector now accounts for more than half the GDP probably
marks a watershed in the evolution of the Indian economy.

Privates Banks in India

The Pre Independence ERA: Private Banks in India was started way back in the pre independence era. The State bank of India which was started in the year 1806 became the Bank of Bengal and it was the first private sector bank in India. Till 1935 it was only the private banks that took care of the banking facilities in India. The bank of Bengal, Bank of Bombay, Bank of Madras which were otherwise called as the presidency banks went on to form a imperial bank. However in the year 1935 the Reserve Bank of India was established which took over the controls from these banks and became the apex bank for all the banks. Ever since that the private banks in India have undergone a lot of changes. Post Independence:

In the year 1994 the RBI issued the liberalization policy where it issued licenses for a limited number of players to get into the banking business. Globalization also played its part in bringing foreign direct investments in India and hence many foreign banks like HSBC, ING, and ABN AMRO also played a very pivotal role in building a effective banking system. Private banks in India concentrate more on retail banking and they also provide various investment schemes as well as insurance policies to the customers thus giving a very stiff competition to the scheduled and the nationalized banks. Global Trust Bank was the first bank after the banking regulation policy 1994 which however became defunct. Role of Private Banks: HDFC by far can be called the best private which has survived for almost more than a decade and a half and is playing a very major role in our banking system. Some of the other private banks in India are ICICI bank, J&K Bank, Karnataka Bank, ING Vysya Bank, Kotak Mahindra Bank, Federal Bank etc. Recently Induslnd Bank, Yes bank have also been started and they are making a mark in commercial and investment banking. The private banks have started providing value added services to customers and they shall be responsible for all most all the modern method of banking such as the internet banking, mobile banking, ATMs and they should be also lauded for bringing in savings habits among its customers by introducing a lot of savings schemes. Banks like Kotak Mahindra are very good in investment banking and they also fund many business units by giving short term and long term loans. Private Banks have played a very big role in bringing competition among different players and they also played a huge role in dealing with the recession period. These banks along with the nationalized banks upon the proper advice of RBI have made sure India has one of the best banking systems in the world.
How many Currently there are 22 private sector banks in India with a total of 10387 branches all over India. There is a significant increase in brunches for last few years. From 2008-09 to 2009-2010 Indian private sector banks have grown with a 12.98% growth rate. HDFC Bank is the largest private sector bank with 1729 branches in India. ICICI Bank the second largest bank in India with 1717 branches, Axis Bank the third largest private bank in India that has 1019 branches in India. Private banking in India was practiced since the begining of banking system in India. The first private bank in India to be set up in Private Sector Banks in India was IndusInd Bank. It is one of the fastest growing Bank Private Sector Banks in India. IDBI ranks the tength largest development bank in the world as Private

Banks in India and has promoted a world class institutions in India. The first Private Bank in India to receive an in principle approval from the Reserve Bank of India was Housing Development Finance Corporation Limited, to set up a bank in the private sector banks in India as part of the RBI's liberalisation of the Indian Banking Industry. It was incorporated in August 1994 as HDFC Bank Limited with registered office in Mumbai and commenced operations as Scheduled Commercial Bank in January 1995. ING Vysya, yet another Private Bank of India was incorporated in the year 1930. Bangalore has a pride of place for having the first branch inception in the year 1934. With successive years of patronage and constantly setting new standards in banking, ING Vysya Bank has many credits to its account.

Challenges facing Banking industry in India

The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. These multiple changes happening one after other has a ripple effect on a bank (Refer fig. 2.1) trying to graduate from completely regulated seller market to completed deregulated customers market. ._Deregulation: This continuous deregulation has made the Banking market extremely competitive with greater autonomy, operational flexibility and decontrolled interest rate and liberalized norms for foreign exchange. The deregulation of the industry coupled with decontrol in interest rates has led to entry of a number of players in the banking industry. At the same time reduced corporate credit off take thanks to sluggish economy has resulted in large number of competitors batting for the same pie. ._New rules: As a result, the market place has been redefined with new rules of the game. Banks are transforming to universal banking, adding new channels with lucrative pricing and freebees to offer. Natural fall out of this has led to a series of innovative product offerings catering to various customer segments, specifically retail credit.

Challenges Facing Indian Banking Industry

Bank
Matching skills
Better Service

Demanding customers Squeezed spreads New channels New Players

Figure 2.1 Deregulation

Need for new orientation Diffused Customerr loyalty Pressure on Efficiency New rules of the game Missed opportunitie Hightened Competition

._Efficiency: This in turn has made it necessary to look for efficiencies in the business. Banks need to access low cost funds and simultaneously improve the efficiency. The banks are facing pricing pressure, squeeze on spread and have to give thrust on retail assets. ._Diffused Customer loyalty: This will definitely impact Customer preferences, as they are bound to react to the value added offerings. Customers have become demanding and the loyalties are diffused. There are multiple choices, the wallet share is reduced per bank with demand on flexibility and customization. Given the relatively low switching costs; customer retention calls for customized service and hassle free, flawless service delivery. ._Misaligned mindset: These changes are creating challenges, as employees are made to adapt to changing conditions. There is resistance to change from employees and the Seller market mindset is yet to be changed coupled with Fear of uncertainty and Control orientation. Acceptance of technology is slowly creeping in but the utilization is not maximized. ._Competency Gap: Placing the right skill at the right place will determine success. The competency gap needs to be addressed simultaneously otherwise there will be missed opportunities. The focus of people will be on doing work but not providing solutions, on escalating problems rather than solving them and on disposing customers instead of using the opportunity to cross sell. Strategic options with banks to cope with the challenges Leading players in the industry have embarked on a series of strategic and tactical initiatives to sustain leadership. The major initiatives include: ._Investing in state of the art technology as the back bone to ensure reliable service

delivery ._Leveraging the branch network and sales structure to mobilize low cost current and savings deposits ._Making aggressive forays in the retail advances segment of home and personal loans ._Implementing organization wide initiatives involving people, process and technology to reduce the fixed costs and cost per transaction ._Focusing on fee based income to compensate for squeezed spread, (e.g. CMS, trade services) ._Innovating Products to capture customer mind share to begin with and later the wallet share ._Improving the asset quality as per Base II norms Transformation initiatives needed for banks The ECS value proposition for helping banks in their transformation agenda We at ECS have vast experience in partnering with leading players in banking for addressing these challenges in a holistic manner. Our expertise is reflected in our product offerings for addressing the key challenges. A select few are outlined below: ._Strategy Sales & Marketing strategy for both retail & wholesale banking Expanding geographies ._Brand Understanding the values of the brand Repositioning the brand to communicate the values ._Organization restructuring Re organization of the bank in line with the strategic thrust ._Re engineering of the key business processes Redesign of Sales processes to increase conversion ratio Six Sigma process improvements for branch channel, Call Center & back office processes Centralization of branch operations and deferred processes to free up resources ._Cost efficiency Reduction in Total cost of acquisition Reduction in transaction costs Reduction in fixed and overheads cost ._Right sizing and matching of skills Manpower modeling for branch & back office at various volume scenarios Productivity improvement for sales & service functions Competency Assessments & profiling ._Creating a high performing organization Define new roles & responsibilities, KRA

Assessing competencies of people across levels and match the position with the skill set Designing and implementing a new PMS for restructured organization ._Change management & creating a new mind set Developing critical mass of champions and drive Change across the organisation to move from conventional banking to new age banking

Rediff.com Business Challenges the Indian banks face

Challenges the Indian banks face

February 17, 2005 07:39 IST

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It is by now well recognised that India is one of the fastest growing economies in the world.
Evidence from across the world suggests that a sound and evolved banking system is required for sustained economic development. India has a better banking system in place vis a vis other developing countries, but there are several issues that need to be ironed out. In this article, we try and look into the challenges that the banking sector in India faces. Interest rate risk

Interest rate risk can be defined as exposure of bank's net interest income to adverse movements in interest rates. A bank's balance sheet consists mainly of rupee assets and liabilities. Any movement in domestic interest rate is the main source of interest rate risk. Over the last few years the treasury departments of banks have been responsible for a substantial part of profits made by banks. Between July 1997 and Oct 2003, as interest rates fell, the yield on 10-year government bonds (a barometer for domestic interest rates) fell, from 13 per cent to 4.9 per cent. With yields falling the banks made huge profits on their bond portfolios. Now as yields go up (with the rise in inflation, bond yields go up and bond prices fall as the debt market starts factoring a possible interest rate hike), the banks will have to set aside funds to mark to market their investment. This will make it difficult to show huge profits from treasury operations. This concern becomes much stronger because a substantial percentage of bank deposits remain invested in government bonds. Banking in the recent years had been reduced to a trading operation in government securities. Recent months have shown a rise in the bond yields has led to the profit from treasury operations falling. The latest quarterly reports of banks clearly show several banks making losses on their treasury operations. If the rise in yields continues the banks might end up posting huge losses on their trading books. Given these facts, banks will have to look at alternative sources of investment. Interest rates and non-performing assets The best indicator of the health of the banking industry in a country is its level of NPAs. Given this fact, Indian banks seem to be better placed than they were in the past. A few banks have even managed to reduce their net NPAs to less than one percent (before the merger of Global Trust Bank into Oriental Bank of Commerce [ Get Quote ], OBC was a zero NPA bank). But as the bond yields start to rise the chances are the net NPAs will also start to go up. This will happen because the banks have been making huge provisions against the money they made on their bond portfolios in a scenario where bond yields were falling. Reduced NPAs generally gives the impression that banks have strengthened their credit appraisal processes over the years. This does not seem to be the case. With increasing bond yields, treasury income will come down and if the banks wish to make large provisions, the money will have to come from their interest income, and this in turn, shall bring down the profitability of banks. Competition in retail banking The entry of new generation private sector banks has changed the entire scenario. Earlier the household savings went into banks and the banks then lent out money to corporates. Now they need to sell banking. The retail segment, which was earlier ignored, is now the most important of the lot, with the banks jumping over one another to give out loans. The consumer has never been so lucky with so many banks offering so many products to choose from. With supply far exceeding demand it has been a race to the bottom, with the banks undercutting one another. A lot of foreign banks have already burnt their fingers in the retail game and have now decided to get out of a few retail segments completely. The nimble footed new generation private sector banks have taken a lead on this front and the public sector banks are trying to play catch up. The PSBs have been losing business to the private sector banks in this segment. PSBs need to figure out the means to generate profitable business from this segment in the days to come. The urge to merge

In the recent past there has been a lot of talk about Indian Banks lacking in scale and size. The State Bank of India [ Get Quote ] is the only bank from India to make it to the list of Top 100 banks, globally. Most of the PSBs are either looking to pick up a smaller bank or waiting to be picked up by a larger bank. The central government also seems to be game about the issue and is seen to be encouraging PSBs to merge or acquire other banks. Global evidence seems to suggest that even though there is great enthusiasm when companies merge or get acquired, majority of the mergers/acquisitions do not really work. So in the zeal to merge with or acquire another bank the PSBs should not let their common sense take a back seat. Before a merger is carried out cultural issues should be looked into. A bank based primarily out of North India might want to acquire a bank based primarily out of South India to increase its geographical presence but their cultures might be very different. So the integration process might become very difficult. Technological compatibility is another issue that needs to be looked into in details before any merger or acquisition is carried out. The banks must not just merge because everybody around them is merging. As Keynes wrote, "Worldly wisdom teaches us that it's better for reputation to fail conventionally than succeed unconventionally". Banks should avoid falling into this trap. Impact of BASEL-II norms Banking is a commodity business. The margins on the products that banks offer to its customers are extremely thin vis a vis other businesses. As a result, for banks to earn an adequate return of equity and compete for capital along with other industries, they need to be highly leveraged. The primary function of the bank's capital is to absorb any losses a bank suffers (which can be written off against bank's capital). Norms set in the Swiss town of Basel determine the ground rules for the way banks around the world account for loans they give out. These rules were formulated by the Bank for International Settlements in 1988. Essentially, these rules tell the banks how much capital the banks should have to cover up for the risk that their loans might go bad. The rules set in 1988 led the banks to differentiate among the customers it lent out money to. Different weightage was given to various forms of assets, with zero per centage weightings being given to cash, deposits with the central bank/govt etc, and 100 per cent weighting to claims on private sector, fixed assets, real estate etc. The summation of these assets gave us the risk-weighted assets. Against these risk weighted assets the banks had to maintain a (Tier I + Tier II) capital of 9 per cent i.e. every Rs100 of risk assets had to be backed by Rs 9 of Tier I + Tier II capital. To put it simply the banks had to maintain a capital adequacy ratio of 9 per cent. The problem with these rules is that they do not distinguish within a category i.e. all lending to private sector is assigned a 100 per cent risk weighting, be it a company with the best credit rating or company which is in the doldrums and has a very low credit rating. This is not an efficient use of capital. The company with the best credit rating is more likely to repay the loan vis a vis the company with a low credit rating. So the bank should be setting aside a far lesser amount of capital against the risk of a company with the best credit rating defaulting vis a vis the company with a low credit rating. With the BASEL-II norms the bank can decide on the amount of capital to set aside depending on the credit rating of the company.

Credit risk is not the only type of risk that banks face. These days the operational risks that banks face are huge. The various risks that come under operational risk are competition risk, technology risk, casualty risk, crime risk etc. The original BASEL rules did not take into account the operational risks. As per the BASEL-II norms, banks will have to set aside 15 per cent of net income to protect themselves against operational risks. So to be ready for the new BASEL rules the banks will have to set aside more capital because the new rules could lead to capital adequacy ratios of the banks falling. How the banks plan to go about meeting these requirements is something that remains to be seen. A few banks are planning initial public offerings to have enough capital on their books to meet these new norms. In closing Over the last few years, the falling interest rates, gave banks very little incentive to lend to projects, as the return did not compensate them for the risk involved. This led to the banks getting into the retail segment big time. It also led to a lot of banks playing it safe and putting in most of the deposits they collected into government bonds. Now with the bond party over and the bond yields starting to go up, the banks will have to concentrate on their core function of lending. The banking sector in India needs to tackle these challenges successfully to keep growing and strengthen the Indian financial system. Furthermore, the interference of the central government with the functioning of PSBs should stop. A fresh autonomy package for public sector banks is in offing. The package seeks to provide a high degree of freedom to PSBs on operational matters. This seems to be the right way to go for PSBs. The growth of the banking sector will be one of the most important inputs that shall go into making sure that India progresses and becomes a global economic super power.

INDIAN BANKS AND THE GLOBAL CHALLENGES

Integration of economies leads to integration of financial markets catalyzing the globalisation process. The growing role of the financial sector in allocation of resources has significant potential advantages for the efficiency with which our economy functions. Consequently, the adverse consequences of malfunction of the financial system are likely to be more severe than they used to be in the past. Hence, all our efforts today are focused at ensuring greater financial stability. Given the significance of the Indian banking system, one cannot afford to underplay the importance of a robust and resilient banking system. The enhanced role of the banking sector in the Indian economy, the increasing levels of deregulation along with the increasing levels of competition have facilitated globalisation of the India banking system and placed numerous demands on banks. Operating in this demanding environment has exposed banks to various challenges. The last decade has witnessed major changes in the financial sector - new banks, new financial institutions, new instruments, new windows, and new opportunities - and, along with all this, new challenges. While deregulation has opened up new vistas for banks to augment revenues, it has entailed greater competition and consequently greater risks. Demand for new products, particularly derivatives, has required banks to diversify their product mix and also effect rapid changes in their processes and operations in order to remain competitive in the globalised environment. Globalisation - a challenge as well as an opportunity Globalisation of domestic banks has also been facilitated by tremendous advancement in information and communications technology. Globalisation has thrown up lot of opportunities but accompanied by concomitant risks. There is a growing realisation that the ability of countries to conduct business across national borders and the ability to cope with the possible downside risks would depend, inter-alia, on the soundness of the financial system and the strength of the individual participants. Adoption of appropriate prudential, regulatory, supervisory, and technological framework on par with international best practices enables strengthening of the domestic banking system, which would help in fortifying it against the risks that might arise out of globalisation. In India, we had strengthened the banking sector to face the pressures that may arise out of globalisation by adopting the banking sector reforms in a calibrated manner, which followed the twin governing principles of non-disruptive progress and consultative process1. Global challenges in banking

An overview of the global challenges would include the following: Basel II implementation; enhancing
corporate governance; alignment of regulatory and accounting requirements; outsourcing risks; and application of advanced technology. Basel II Implementation Basel II implementation is widely acknowledged as a significant challenge faced by both banks and the regulators internationally. It is true that Basel II implementation may be seen as a compliance challenge. While it may be so for some banks, Basel II implementation has another dimension which offers considerable opportunities to banks, two opportunities that are offered to banks, viz., refinement of risk management systems; and improvement in capital efficiency.
Comprehensive risk management: Under Basel I banks were focused on credit and market risks. Basel II has brought into focus a larger number of risks requiring banks to focus on a larger canvas. Besides the increase in the number of risks, banks are now beginning to focus on their inter-linkages with a view to achieve a more comprehensive risk management framework. Basel II implementation, therefore, is being increasingly seen as a medium through which banks constantly endeavour to upgrade the risk management systems to address the changing environment. Further, in the initial stages, banks were managing each risk in isolation. It is no longer adequate to manage each risk independently. Enterprises worldwide are, therefore, now putting in place an integrated framework for risk management which is proactive, systematic and spans across the entire organisation. Banks in India are also moving from the individual silo system to an enterprise wide risk management system. While the first milestone would be risk integration across the entity, banks are also aware of the desirability of risk aggregation across the group both in the specific risk areas as also across the risks. Banks would, therefore, be required to allocate significant resources towards this endeavour. Capital efficiency: Basel II prescriptions have ushered in a transition from the traditional regulatory measure of capital adequacy to an evaluation of whether a bank has found the most efficient use of its capital to support its business i.e., a transition from capital adequacy to capital efficiency. In this transition, how effectively capital is used will determine return on equity and a consequent enhancement of shareholder value. In effect, banks may adopt a more dynamic approach to use of capital, in which capital will flow quickly to its most efficient use. This revised efficiency approach is expected to guide the return-on-equity strategy and influence banks business plans. With the extension of capital charge for market risks to the AFS portfolio this year and the coming into force of Basel II norms in March 2007, banks would need to shore up the capital levels not only for complying with these requirements but also for supporting the balance sheet growth. With a view to enhancing the options available to banks for augmenting their capital levels, the Reserve Bank has recently permitted banks to issue new capital instruments, including perpetual instruments. A notable feature of these instruments is that these are designed to help banks in not only managing their capital effectively but also efficiently.

Enhancing corporate governance The issues related to corporate governance have continued to attract considerable national and international attention in light of a number of high-profile breakdowns in corporate governance. This becomes all the more relevant for banks since they not only accept and deploy large amount of uncollateralized public funds in fiduciary capacity, but also leverage such funds through credit creation. Banks are also important participants in the payment and settlement systems. In view of the above, legal prescriptions for ownership and governance of banks in Banking Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI from time to time. In view of the importance of the banking system for financial stability, sound corporate governance is not only relevant at the level of the individual bank, but is also a critical ingredient at the system level. Effective risk management systems determine the health of the financial system and its ability to survive economic shocks. To a large extent, many risk management failures reflect a breakdown in corporate governance which arise due to poor management of conflicts of interest, inadequate understanding of key banking risks, and poor Board oversight of the mechanisms for risk management and internal audit. Corporate governance is, therefore, the foundation for effective risk managements in banks and thus the foundation for a sound financial system2. Therefore, the choices which banks make when they establish their risk management and corporate governance systems have important ramifications for financial stability. These systems can affect how the institution functions and how others perceive it in the marketplace 3. A good governance culture is crucial for financial stability but since it is an intangible, rules may not be able to capture its essence effectively. Therefore, banks may have to cultivate a good governance culture building in appropriate checks and balances in their operations. There are four important forms of oversight that should be included in the organisational structure of any bank in order to ensure appropriate checks and balances: (1) oversight by the board of directors or supervisory board; (2) oversight by individuals not involved in the day-today running of the various business areas; (3) direct line supervision of different business areas; and (4) independent risk management, compliance and audit functions. In addition, it is important that key personnel are fit and proper for their jobs. Although some ownership structures might have the potential to alter the strategies and objectives of a bank, these banks will also face many of the same risks associated with weak corporate governance. Consequently, the general principles of sound corporate governance should also be applied to all banks irrespective of their unique ownership structures 4. Compliance with international accounting standards One of the prime international standards considered relevant for ensuring a safe and sound banking system is the Core Principles for Effective Banking Supervision issued by the Basel Committee on Banking Supervision (BCBS). Accounting standards are now a part of the set of twelve standards that have been identified by the Financial Stability Forum as conducive to a robust financial infrastructure. Financial reporting and prudential supervision have slightly different perspectives. While the former is oriented towards capturing the historical position, the latter has a forward looking element particularly with reference to measurement of impairment and

capital. An important challenge, therefore, is to ensure that accounting standards and prudential frameworks are mutually consistent. While working towards achieving this consistency between the two sets of standards, it is essential for the regulators to be in a position to address any implications that the changes in accounting standards may have for the safety and soundness of banks 5. Derivative activity in banks in India has been increasing at a brisk pace. While the risk management framework for derivative trading, which is a relatively new area for Indian banks (particularly more in respect of structured products), is an essential pre-requisite, the absence of clear accounting guidelines in this area is matter of significant concern. It is widely accepted that as the volume of transactions increases, which is happening in the Indian banking system, the need to upgrade the accounting framework needs no emphasis. The World Banks ROSC on Accounting and Auditing in India has commented on the absence of an accounting standard which deals with recognition, measurement, presentation and disclosures pertaining to financial instruments. The Accounting Standards Board of the Institute of Chartered Accountants of India (ICAI) is considering issue of Accounting Standards on the above aspects pertaining to financial Instruments. These will be the Indian parallel to International Financial Reporting Standard 7, International Accounting Standards 32 and 39. The proposed Accounting Standards will be of considerable significance for financial entities and could therefore have implications for the financial sector. The formal introduction of these Accounting Standards by the ICAI is likely to take some time in view of the processes involved. In the meanwhile, the Reserve Bank is considering the need for banks and financial entities adopting the broad underlying principles of IAS 39. Since this is likely to give rise to some regulatory / prudential issues all relevant aspects are being comprehensively examined. The proposals in this regard would, as is normal, be discussed with the market participants before introduction. Adoption and implementation of these principles are likely to pose a great challenge to both the banks and the Reserve Bank.
Dr. Alan Bollard, Corporate governance in the financial sector, Christchurch, New Zealand, 7 April 2003. Mark W. Olson, Business Trends and Management Challenges for the Banking Industry, Annual Economic Outlook Conference, Middle Tennessee State University, Murfreesboro, Tennessee, 16 September 2005.
3 4 5

Enhancing corporate governance for banking organisations, Consultative document issued by BCBS, July 2005. Malcolm D Knight, Banking and insurance regulation and supervision: Greater convergence, common challenges, Madrid, 22-23 September 2004.

Outsourcing Risks Banks are increasingly using outsourcing for achieving strategic aims leading to either rationalisation of operational costs or tapping specialist expertise which is not available internally. 'Outsourcing' may be defined as a bank's use of a third party, including an affiliated entity within a corporate group, to perform activities on a continuing basis that would normally be undertaken by the bank itself. Typically outsourced financial services include applications processing (loan origination, credit card), document processing, investment management, marketing and research, supervision of loans, data processing and back office related activities etc. Outsourcing might give rise to several risks including, strategic risk, reputation risk, compliance risk, operational risk, exit strategy risk, counterparty risk, country risk, access risk, concentration risk and systemic risk. The failure of a service provider to provide a specified service, ensure security/ confidentiality, comply with legal and regulatory requirements can lead to financial losses/ reputational risk for the bank and could also lead to systemic risks for the entire banking system in a country. It would therefore be imperative for the bank outsourcing its activities to ensure effective management of these risks. It is in this background that RBI has issued draft guidelines on outsourcing, which is intended to provide direction and guidance to banks to effectively manage risks arising from such outsourcing activities. The underlying principles for any outsourcing arrangement by a bank are that such arrangements should neither diminish the banks ability to fulfill its obligations to its customers and the RBI nor impede effective supervision by RBI. Outsourcing banks, therefore, should take steps to ensure that the service provider employs the same high standard of care in performing the services as would be employed by the banks if the activities were conducted within the banks and not outsourced. Accordingly, banks are not expected to outsource any activity that would result in their internal control, business conduct, or reputation being compromised or weakened. Application of advanced technology Technology is a key driver in the banking industry, which creates new business models and processes, and also revolutionises distribution channels. Banks which have made inadequate investment in technology have consequently faced an erosion of their market shares. The beneficiaries are those banks which have invested in technology. Adoption of technology also enhances the quality of risk management systems in banks. Recognising the benefits of modernising their technology infrastructure banks are taking the right initiatives. While doing so, banks have four options to choose from: they can build a new system themselves, or buy best of the modules, or buy a comprehensive solution, or outsource. In this context banks need to clearly define their core competencies to be sure that they are investing in areas that will distinguish them from other market players, and give them a competitive advantage6. A further challenge which banks face in this regard is to ensure that they derive maximum advantage from their investments in technology and avoid wasteful expenditure which might arise on account of uncoordinated and piecemeal adoption of technology; adoption of inappropriate/ inconsistent technology and adoption of obsolete technology. Capacity Building As dictated by the changing environment, banks need to focus on appropriate capacity building measures to equip their staff to handle advanced risk management systems and supervisors also need to equally equip

themselves with appropriate skills to have effective supervision of banks adopting those systems. In the likelihood of a high level of attrition in the system, banks need to focus on motivating their skilled staff and retaining them7. Skill requirements would be significantly higher for banks planning to migrate to the advanced approaches under Basel II. Capacity building gains greater relevance in these banks, so as to equip themselves to take advantage of the incentives offered under the advanced approaches. A relevant point in this regard is that capacity building should be across the institution and not confined to any particular level or any particular area. The demand for better skills can be met either from within or from outside. It would perhaps be worthwhile to first glean through the existing resources to identify misplaced or hidden or forgotten resources and re-position them to boost the banks efforts to capitalise on available skills. This does not undermine the benefits that a bank may derive by meeting their requirements from the market, but is only intended to prioritise the process. The global challenges which banks face are not confined only to the global banks. These aspects are also highly relevant for banks which are part of a globalised banking system. Further, overcoming these challenges by the other banks is expected to not only stand them in good stead during difficult times but also augurs well for the banking system to which they belong and will also equip them to launch themselves as a global bank. WHY GLOBAL BANKS ARE BANKING ON INDIA Follow the money for a sure bet, they say -- and the world's big and small banks are doing just that in India's juggernaut economy. India is viewed as one of the biggest growth stories among emerging markets explains only part of the attraction for foreign banks. The country's central bank has outlined the roadmap for foreign players to grow, allowing them to set up branches in rural India and take over weak banks with an investment of up to 74% and promises to do more. Credit off-take has grown 25%-30% annually in recent years, with most of the new action in retail consumer lending, which tends to be happy hunting ground for foreign banks. Not everybody in the industry is happy, of course, to see bigger room for foreign banks, which some view as not adequately embracing India's developmental agenda. Mirroring India's economic bounties, India's banking industry has been on a high since the beginning of this decade, with advances growing annually at an average of 23%. The Indian banking industry is made up of 28 public sector banks, 30 foreign banks and 29 private banks, excluding cooperative banks and regional rural banks. Globalisation is here to stay
the most dramatic impact of globalization is on remote servicing in India of banks' back-office processes. the huge improvements in telecommunications and computing technology combined with vast variations in factor costs across the world and tight immigration laws will lead to large shifts in work that doesn't require customer interface. The beginning of this trend is evident mostly in outsourcing of voice-based services. This will lead to huge improvements in the efficiency of the financial services industry's operations both in cost and quality and lead to a further integration of the global financial industry. Tarashankar Bhattacharya, managing director of India's largest bank, the State Bank of India, says he welcomes foreign banks so long as he has a level playing field with them. One of his chief complaints here is while Indian banks have to lend a minimum of 40% of their assets to government-specified "priority sectors" such as agriculture and small scale industries, that requirement is lower at 32% for foreign banks operating in India. Banks don't relish priority sector lending because they come with low profit margins and a high incidence of delinquencies. Bhattacharya's lament is shared by CEOs of most state owned banks in India. They complain that they are constantly reined in from competing effectively. They cannot, for instance, pay market-linked salaries. Except in rare cases, they are unable to create or hold onto the best talent. They cannot acquire other banks without lengthy and often unsuccessful bureaucratic wrangling. And, as Bhattacharya says, they cannot lend or invest in the booming stock markets as they please. Nor can they raise much needed capital easily. All this, government-owned bankers privately admit, is because they continue to be viewed as instruments of social policy, rather than as commercial institutions by their principal owner, the government. And yes, along with the rest of Indian industry, they cannot downsize at will. The RBI appears to recognize this. The regulator says a calibrated approach is necessary in the absence of a safety net and labor law reforms. It takes some pride in the fact that India has never faced significant financial sector turmoil like other emerging markets. It wants to ensure consolidation in the domestic sector first before allowing foreign banks a freer entry. The RBI also wants the large public sector banks to merge with each other to create big banks. Many private banks have taken the cue, albeit with gentle nudges, and have grown with acquisitions. But the big state-owned banks are yet to follow. In September 2005, Indian finance minister P. Chidambaram made a strong pitch for mergers and acquisitions amongst public sector banks. He was speaking at the centennial celebrations of the Bank of India, another large bank. "A country as large as India cannot be content with one large bank (referring to the State Bank)," he said. "Bank of India should lead the way in creating a giant bank which will take on the world's best and biggest." But the State Bank, which typically sets the ideological agenda for the rest of the banking industry, now openly says that thinking global is critical to domestic success. The State Bank of India hasn't had much traction in acquiring other Indian banks, but it has made significant strides internationally. It kicked off that effort in February 2005 when it paid $10 million for a 51% stake in Indian Ocean International Bank, the fourth largest in Mauritius. year, State Bank bought two other banks -- Indonesia's PT Bank IndoMonex and Kenya's Giro Commercial Bank. It is now actively scouting for other acquisitions in Asia and Africa. State Bank's current chairman O. P. Bhatt, however, has said his bank would not acquire small banks any more. "We would buy reasonably big banks if there is a strategic fit," he says. Citibank's Nayar says globalization forces local banks in emerging-market countries to adopt international best practices in order to stay competitive. These areas include risk management techniques, technology upgrades, more efficient capital allocation tools, focus on marketing and sales and other such areas resulting in improved operating and financial leverage. 'But it is not entirely a one-way street," he says. "There are also areas where international banks are adapting and learning from local best practices, particularly in areas like SME (small and medium enterprises) lending and agri-financing. The main impact is higher efficiency levels in the banking system in terms of more optimal capital allocation, better profitability, prudent risk management and greater competition, which ultimately benefits the end customer through new products and services at affordable prices." ALL ROADS LEAD TO CONSOLIDATION

Consolidation within the banking industry is imperative. Commoditization of the traditional banking products and the need to invest in technology, marketing and product innovation has made size and scale critical success factors in this industry. Consolidation is imminent, and foreign banks with their large capital and product expertise can play a significant role in this process. The Indian financial system is not yet very strong to take on stiff foreign competition. There is still not a level playing field between Indian banks and foreign banks; the latter does not have developmental obligations like 40% lending to the priority sector where returns are low." Foreign banks are not required to direct more than 32% of their net credit to the "priority sectors" identified by the RBI, which include agriculture, small-scale industries and exports. ICICI's Kamath concedes that over the years foreign banks have contributed to the development of the Indian banking industry in areas like product knowledge and risk management services, but doesn't see any new gains on the horizon. "Frankly, we have nothing to learn from them [now]," he says. "Both in terms of products and technology, we are ahead of them. Citibank's Nayar says the RBI's approach to opening up the banking sector to foreign investors is well calibrated, but would like quicker branch permissions and access to some government and public sector business. "Foreign banks continue to face constraints in these areas and this significantly impacts their ability to grow their footprint, customer base and restricts access to savings deposits," he adds. Kamath doesn't buy the contention of the foreign banks' lobby that they don't enjoy enough growth freedom. He in fact sees the current regulatory regime offering them "sufficient flexibility," and points out that the central bank has stated its resolve to be liberal in granting branch licenses. "The only major restriction for them is on the acquisition of existing banks, and that too will be revisited in the second stage of the roadmap that the RBI has set out (beginning March 2009)," he says. "Essentially, the question is not one of the country's openness but of whether foreign banks are willing to commit capital and enter the Indian market for the long haul." Nayar points out that India isn't alone in opening up the banking sector as globalization advances, and that foreign investors are focused on the opportunities these throw up in many developing countries. "The RBI has a well-calibrated approach for opening up of the banking sector to foreign investors," he says of the central bank's phased and cautious approach. "Countries like Korea, Russia and Brazil have opened up their banking sectors significantly." India's banking industry has so far avoided a major financial crisis, unlike those in other developing countries, and that deserves a hand, says Nayar. "Indian banking has been relatively well managed and, more importantly, well regulated," he says. "Most of the other emerging economies have seen at least one period of significant turmoil in the last decade or so -- the Asian financial crisis in the late 1990s, the Latin American meltdown in 2001-02, and Mexico in the early 1990s." Much now depends on how the RBI picks up the threads three years hence in 2009 when it reviews the progress achieved in the current openingup phase. Boston Consulting Group's Sinha says the best course of action is to allow foreign banks entry into India up to a level that can be fixed in a variety of ways. "The Australians have a four-pillar policy where their biggest four banks cannot buy each other or be ought by foreigners" In India, says Sinha, this could the State Bank of India, the Life Insurance Corporation of India (an insurer and not a

commercial bank) and three other players who in turn would have consolidated with some smaller players Together they would control between 60 and 70% of total banking assets. This way, he says, all the constituents would be satisfied.