Universal banking final

S.I.E.S. College of Commerce and Economics Universal Banking

Chapter 1

Universal Banking

Page 1 of 93


1.1
Introduction

The banking scenario in India has been changing at fast pace from being
just the borrowers and lenders traditionally, the focus has shifted to more
differentiated and customized product/service provider from regulation to
liberalization in the year 1991, from planned economy to market.

The Indian banking has come a long way from being a sleepy business
institution to a highly proactive and dynamic entity. This transformation has
been largely brought about by the large dose of liberalization and economic
reforms that allowed banks to explore new business opportunities rather than
generating revenues from conventional streams (i.e. borrowing and lending).

The competition heated up with the entry of private and foreign banks
deregulation and globalization resulted in increased competition that refined the
traditional way of doing business. They have realized the importance of a
customer centric approach, brand building and IT enabled solutions. Banking
today has transformed into a technology intensive and customer friendly model
with a focus on convenience. The companies have redoubled their efforts to woo
the customers and establish themselves firmly in the market. It is no longer an
option for a company to provide good customer service, it is expected.

Reforms are continuing as part of the overall structural reforms aimed at
improving the productivity and efficiency of the economy. The sector is set to

Page 2 of 93


witness the emergence of financial supermarkets in the form of universal banks
providing a suite of services from retail to corporate banking and industrial
lending to investment banking. The financial services market has become a
battle ground with the marketers with the latest and the most sophisticated
weapons.

The Indian banking industry is currently in a transition phase. On the one
hand, the public sector banks, which are the mainstay of the Indian banking
system, are in the process of consolidating their position by capitalizing on the
strength of their huge networks and customer bases. On the other, the private
sector banks are venturing into a whole new game of mergers and acquisitions
to expand their bases. The use of technology has placed Indian banks at par with
their global peers. It has also changed the way banking is done in India.
‗Anywhere banking‘ and ‗Anytime banking‘ have become a reality. The
financial sector now operates in a more competitive environment than before
and intermediates relatively large volume of international financial flows.

The entry of banks into the realm of financial services was followed very
soon after the introduction of liberalization in the economy. Since the early
1990s structural changes of profound magnitude have been witnessed in global
banking systems. Large scale mergers, amalgamations and acquisitions between
the banks and financial institutions resulted in the growth in size and
competitive strengths of the merged entities. Thus, emerged new financial
conglomerates that could maximize economies of scale and scope by building
the production of financial services organization called Universal Banking.

Page 3 of 93


1.2
Meaning

The financial and banking sector as it existed in the pre-reform days was
highly regulated over-administered and subject to discretionary control and
direction. In this sense, financial sector reforms were designed to infuse, in the
words of the terms of reference of the Narsimham Committee, greater
competitive vitality in the system.

In the financial system, the players can be broadly classified into the
following groups: public sector banks, private sector banks, foreign banks, co -
operative banks, all- India financial institutions and non-banks.

A common element in all Development Financing Institution (DFI‘s) is
that they focus on investment rather than on conventional commercial banking
operations, i.e., on deposit taking and short-term credit. On the other hand, the
commercial banks continue to concentrate on their traditional business of
accepting deposits and advancing loans. With encouragement and sometimes
pressure, they have broaden their activities to include term credit and a broad
range of non-banking finance, including leasing, venture capital, housing and
household finance, mutual fund management, credit-card sponsorship, etc.

The term 'Universal Banking' in general refers to the combination of
commercial banking and investment banking. The concept of universal banking
is spreading fast among various types of banks.

Page 4 of 93


It is a multipurpose and multi-functional financial supermarket providing
both 'Banking and Financial Services' through a single window. As per the
World Bank," In Universal Banking, large banks operate extensive network of
branches, provide many different services, hold several claims on firms
(including equity and debt) and participate directly in the Corporate Governance
of firms that rely on the banks for funding or as insurance underwriters."

In a nutshell, a Universal Banking is a superstore for financial products,
under one roof. Corporates can get loans and avail of other handy services,
while individuals can bank and borrow. It includes not only services related to
savings and loans but also investment. However in practice the term 'Universal
Banking' refers to those banks that offer wide range of financial services beyond
the commercial banking functions like Mutual Funds, Merchant Banking,
Factoring, Insurance, Credit Cards, Retail loans, Housing Finance, Auto
Loans, etc.

However, Universal Banking does not mean that every institution
conducts every type of business with every type of customer. In the spectrum of
banking, specialized banking is on the one end and the Universal Banking on
the other.

Page 5 of 93


1.3
Empirical Background of Universal Banking:

The entry of banks into the realm of financial services was followed very
soon after Liberalization in the economy. Since the early 1990s, structural
changes of profound magnitude came to be witnessed in global banking
systems. Large scale mergers, amalgamations and acquisitions among the banks
and financial institutions resulted in the growth in size and competitive
strengths of the merged entities. There thus emerged new financial
conglomerates that could maximize Economies of Scale and Scope by building
the production of financial services organization called Universal Banking.

By the mid 1990s, all the restrictions on Project Financing were removed
and banks were allowed to undertake several activities in house. Reforms in the
insurance sector in the late 1990s, and opening up of this field to private and
foreign players also resulted in permitting banks to undertake sale of Insurance
products. At present, only an 'arms length' relationship between a bank and
insurance entity has been allowed by the regulatory authority, i.e.-IRDA
(Insurance Regulatory & Development Authority).

The phenomenon of Universal Banking as a distinct concept, as different
from Narrow Banking came to the forefront in the Indian context with II
Narsimham Committee (1998) and later the Khan Committee (1998) reports
recommending consolidation of the banking industry through mergers and
integration of financial activities.

Page 6 of 93


1.4
Universal Banking in India

In India Development financial institutions (DFIs) and refinancing
institutions (RFIs) were meeting specific sectoral needs and also providing long-
term resources at concessional terms, while the commercial banks in general, by
and large, confined themselves to the core banking functions of accepting
deposits and providing working capital finance to industry, trade and
agriculture. Consequent to the liberalization and deregulation of financial sector,
there has been blurring of distinction between the commercial banking and
investment banking.

Reserve Bank of India constituted on December 8, 1997, a Working
Group under the Chairmanship of Shri. S.H. Khan to bring about greater clarity
in the respective roles of banks and financial institutions for greater
harmonization of facilities and obligations. Also report of the Committee on
Banking Sector Reforms or Narsimham Committee (NC) has major bearing on
the issues considered by the Khan Working Group.

The issue of universal banking resurfaced in Year 2000, when ICICI gave
a presentation to RBI to discuss the time frame and possible options for
transforming itself into a universal bank. Reserve Bank of India also spelt out to
Parliamentary Standing Committee on Finance, its proposed policy for universal
banking, including a case-by case approach towards allowing domestic financial
institutions to become universal banks.

Page 7 of 93


Now RBI has asked FIs, which are interested to convert itself into a
universal bank, to submit their plans for transition to a universal bank for
consideration and further discussions. FIs need to formulate a road map for the
transition path and strategy for smooth conversion into a universal bank over a
specified time frame. The plan should specifically provide for full compliance
with prudential norms as applicable to banks over the proposed period.

Page 8 of 93


1.5
The need behind the Advent of Universal Banking

Liberalization and the banking reforms have given new avenues to
Development Finance Institutions (DFIs) to meet the broader market. They can
avail the options to involve in deposit banking and short term lending as well.
DFIs were set up with the objective of taking care of the investment needs of
industries. They have build up expertise in Merchant Banking and Project
Evaluation.

So, saddled with obligations to fund long gestation projects, the DFIs
have been burdened with serious mismatches between their assets and liabilities
of the balance sheet. In this context, the Narsimham Committee II had suggested
DFIs should convert into banks or Non-Banking Finance Companies.
Converting of these DFIs into Universal Banks will grant them ready access to
cheap retail deposits and increase the coverage of the advances to include short
term working capital loans to Corporates with greater operational flexibility. At
that time DFIs were in the need to acquire a lot of mass in their volume of
operations to solve the problem of total asset base and net worth. So, the
emergence of Universal Banking was the solution for the problem of the
banking sector.

Page 9 of 93


Chapter 2

Products And Services Offered By
Universal Banks coupled with
SWOT

Page 10 of 93


2.1

Products And Services Offered By Universal Banks

Broad Classification of Products in a Universal bank:

The different products in an universal bank can be broadly classified into:
 Retail Banking.
 Trade Finance.
 Treasury Operations.
Retail Banking and Trade finance operations are conducted at the branch
level while the wholesale banking operations, which cover treasury operations,
are at the hand office or a designated branch.

Retail Banking
―Retail banking is typical mass-market banking where individual
customers use local branches of larger commercial banks. Services offered
include: savings and checking accounts, mortgages, personal loans, debit cards,
credit cards, and so‖
Retail banking aims to be the one-stop shop for as many financial services
as possible on behalf of retail clients. Some retail banks have even made a push
into investment services such as wealth management, brokerage accounts,
private banking and retirement planning. While some of these ancillary services
are outsourced to third parties (often for regulatory reasons), they often

Page 11 of 93


intertwine with core retail banking accounts like checking and savings to allow
for easier transfers and maintenance.

Services provided by Retail Banks:
 Deposits
 Loans, Cash Credit and Overdraft
 Negotiating for Loans and advances
 Remittances
 Book-Keeping (maintaining all accounting records)
 Receiving all kinds of bonds valuable for safe keeping

Trade Finance
Trade finance is related to international trade.
While a seller (the exporter) can request the purchaser (an importer) to
prepay for goods shipped, the purchaser (importer) may wish to reduce risk by
requiring the seller to document the goods that have been shipped. Banks may
assist by providing various forms of support. For example, the importer's bank
may provide a letter of credit to the exporter (or the exporter's bank) providing
for payment upon presentation of certain documents, such as a bill of lading.
The exporter's bank may make a loan (by advancing funds) to the exporter on
the basis of the export contract.
Other forms of trade finance can include trade credit insurance, export
factoring, forfaiting and others. In many countries, trade finance is often
supported by quasi-government entities known as export credit agencies that
work with commercial banks and other financial institutions.

Page 12 of 93


In short, trade finance means money lent to exporters or importers.

It includes the following services:
 Issuing and confirming of letter of credit.
 Drawing, accepting, discounting, buying, selling, collecting of bills of
exchange, promissory notes, drafts, bill of lading and other securities.

Treasury Operations

Treasury management (or treasury operations) includes management of an
enterprise's holdings. It includes activities like trading in bonds, currencies,
financial derivatives and also encompasses the associated financial risk
management.All banks have departments devoted to treasury management, as do
larger corporations
Bank Treasuries may have the following departments:
a) A Fixed Income or Money Market desk that is devoted to buying and
selling interest bearing securities
b) A Foreign exchange or "FX" desk that buys and sells currencies
c) A Capital Markets or Equities desk that deals in shares listed on the stock
market.

In addition the Treasury function may also have a Proprietary Trading
desk that conducts trading activities for the bank's own account and capital, an
Asset liability management or ALM desk that manages the risk of interest rate

Page 13 of 93


mismatch and liquidity; and a Transfer Pricing or Pooling function that prices
liquidity for business lines (the liability and asset sales teams) within the bank.
Banks may or may not disclose the prices they charge for Treasury
Management products.

The operations include:
 Buying and selling of bullion. Foreign exchange
 Acquiring, holding, underwriting and dealing in shares, debentures, etc.
 Purchasing and selling of bonds and securities on behalf of constituents.

The banks can also act as an agent of the Government or local authority.
They insure, guarantee, underwrite, participate in managing and carrying out
issue of shares, debentures, etc.
Apart from the above-mentioned functions of the bank, the bank provides
a whole lot of other services like investment counseling for individuals, short-
term funds management and portfolio management for individuals and
companies. It undertakes the inward and outward remittances with reference to
foreign exchange and collection of varied types for the Government.

Page 14 of 93


2.2
Common Banking Products Available
Some of common available banking products which are in universal banks
are explained below:

Credit Card

Credit Card is ―post paid‖ or ―pay later‖ card that draws from a credit
line-money made available by the card issuer (bank) and gives one a grace
period to pay. If the amount is not paid full by the end of the period, one is
charged interest.
A credit card is nothing but a very small card containing a means of
identification, such as a signature and a small photo. It authorizes the holder to
change goods or services to his account, on which he is billed. The bank
receives the bills from the merchants and pays on behalf of the card holder.
These bills are assembled in the bank and the amount is paid to the bank
by the card holder totally or by installments. The bank charges the customer a
small amount for these services. The card holder need not have to carry
money/cash with him when he travels or goes for purchasing.
Credit cards have found wide spread acceptance in the ‗metros‘ and big
cities. Credit cards are joining popularity for online payments. The major
players in the Credit Card market are the foreign banks and some big public
sector banks like SBI and Bank of Baroda.

Page 15 of 93


Debit Cards

A debit card (also known as a bank card or check card) is a plastic card
that provides an alternative payment method to cash when making purchases.
Functionally, it can be called an electronic check, as the funds are withdrawn
directly from either the bank account, or from the remaining balance on the
card. In some cases, the cards are designed exclusively for use on the Internet,
and so there is no physical card.
In many countries the use of debit cards has become so widespread that
their volume of use has overtaken or entirely replaced the check and, in some
instances, cash transactions. Like credit cards, debit cards are used widely for
telephone and Internet purchases and, unlike credit cards, the funds are
transferred immediately from the bearer's bank account instead of having the
bearer pay back the money at a later date.
Debit cards may also allow for instant withdrawal of cash, acting as the
ATM card for withdrawing cash and as a check guarantee card. Merchants may
also offer cash back facilities to customers, where a customer can withdraw cash
along with their purchase.
Debit Card holder need not carry a bulky checkbook or large sums of cash
when he/she goes at for shopping. This is a fast and easy way of payment one
can get debit card facility as debit cards use one‘s own money at the time of
sale, so they are often easier than credit cards to obtain.

Page 16 of 93


Automatic Teller Machine

An automated teller machine (ATM), also known as a automated banking
machine (ABM) or Cash Machine and by several other names, is a computerized
telecommunications device that provides the clients of a financial institution
with access to financial transactions in a public space without the need for a
cashier, human clerk or bank teller.
On most modern ATMs, the customer is identified by inserting a plastic
ATM card with a magnetic stripe or a plastic smart card with a chip that
contains a unique card number and some security information such as an
expiration date or CVVC (CVV). Authentication is provided by the customer
entering a personal identification number (PIN).
Using an ATM, customers can access their bank accounts in order to
make cash withdrawals, credit card cash advances, and check their account
balances as well as purchase prepaid cell phone credit. If the currency being
withdrawn from the ATM is different from that which the bank account is
denominated in (e.g.: Withdrawing Japanese Yen from a bank account
containing US Dollars), the money will be converted at a wholesale exchange
rate. Thus, ATMs often provide the best possible exchange rate for foreign
travelers and are heavily used for this purpose as well.
ATMs are known by various other names including automatic banking
machine (or automated banking machine particularly in the United States)
(ABM), automated transaction machine, cash point (particularly in the United
Kingdom), money machine, bank machine, cash machine, hole-in-the-wall,

Page 17 of 93


autoteller (after the Bank of Scotland's usage), cashline machine (after the Royal
Bank of Scotland's usage), MAC Machine (in the Philadelphia area), Bankomat
(in various countries particularly in Europe and including Russia), Multibanco
(after a registered trade mark, in Portugal), Minibank in Norway, Geld
Automaat in Belgium and the Netherlands, and All Time Money in India.

Advantages of ATM’s:

To the Customers
 ATM‘s provide 24 hrs, 7 days and 365 days a year service.
 Service is quick and efficient
 Privacy in transaction
 Wider flexibility in place and time of withdrawals.
 The transaction is completely secure – you need to key in Personal
Identification Number (Unique number for every customer).

To Banks
 Alternative to extend banking hours.
 Crowding at bank counters considerably reduced.
 Alternative to new branches and to reduce operating expenses.
 Relieves bank employees to focus an more analytical and innovative
work.
 Increased market penetration.

Page 18 of 93


ATM‘s can be installed anywhere like Airports, Railway Stations, Petrol
Pumps, Big Business arcades, markets, etc. Hence, it gives easy access to the
customers, for obtaining cash.
The ATM services provided first by the foreign banks like Citibank,
Grind lays bank and now by many private and public sector banks in India like
ICICI Bank, HDFC Bank, SBI, UTI Bank etc. The ICICI has launched ATM
Services to its customers in all the Metropolitan Cities in India. By the end of
1990 Indian Private Banks and public sector banks have come up with their own
ATM Network in the form of ―SWADHAN‖. Over the past year upto 44 banks
in Mumbai, Vashi and Thane, have became a part of ―SWADHAN‖ a system of
shared payments networks, introduced by the Indian Bank Association (IBA).

E-Cheques

E-cheques are a mode of electronic payments. E-cheques work the same
way as paper cheques and are a legally binding promise to pay. This technology
was developed couple of years ago by a consortium of Silicon Valley IT
researchers and merchant bankers and since then has been promoted by many of
the financial bodies. E-cheques work the same way as paper cheques and are a
legally binding promise to pay. The payment system uses digitally signed XML
documents that provide mechanism to authenticate parties to a transaction. E-
cheques are defined using FSML (financial services markup language) which
allows for addition and deletion of document blocks, signing, co-signing,
endorsing, etc.

Page 19 of 93


Signatures are accompanied by bank-issued certificates which tie the
signer's key to a bank account. It seems that consumers would gain from having
E-cheques available to make payments for online purchases. The online
merchants on the other hand could receive payments instantly and since the
customer‘s bank will be involved in the transaction. It would be impossible for
E-cheques to bounce. Banks can do paperless, efficient transactions.

A typical electronic cheque transaction takes place in the following manner:

 The customer accesses the merchant server and the merchant server
presents its goods to the customer.
 The consumer selects the goods and purchases them by sending an e-
cheque to the merchant.
 The merchant validates the e-cheque with its bank for payment
authorisation.
 The merchant electronically forwards the e-cheque to its bank.
 The merchant‘s bank forwards the e-cheque to the clearing house for
cashing.
 The clearing house jointly works with the consumer‘s bank clears the
cheque and transfers the money to the merchant‘s banks.
 The merchant‘s bank updates the merchant‘s account.
 The consumer‘s bank updates the consumer‘s account with the withdrawal
information.

The e-chequing is a great boon to big corporate as well as small retailers.
Most major banks accept e-cheques. Thus this system offers secure means of
collecting payments, transferring value and managing cash flows.

Page 20 of 93


Electronic Funds Transfer (EFT)

Many modern banks have computerised their cheque handling process
with computer networks and other electronic equipments. These banks are
dispensing with the use of paper cheques. The system called electronic fund
transfer (EFT) automatically transfers money from one account to another. This
system facilitates speedier transfer of funds electronically from any branch to
any other branch. In this system the sender and the receiver of funds may be
located in different cities and may even bank with different banks. Funds
transfer within the same city is also permitted. The scheme has been in
operation since February 7, 1996, in India.

The other important type of facility in the EFT system is automated
clearing houses. These are the computer centers that handle the bills meant for
deposits and the bills meant for payment. In big companies pay is not disbursed
by issued cheques or issuing cash. The payment office directs the computer to
credit an employee‘s account with the person‘s pay.

Telebanking

Telebanking refers to banking on phone services a customer can access
information about his/her account through a telephone call and by giving the
coded Personal Identification Number (PIN) to the bank. Telebanking is
extensively user friendly and effective in nature.

Page 21 of 93


 To get a particular work done through the bank, the users may leave his
instructions in the form of message with bank.
 Facility to stop payment on request. One can easily know about the
cheque status.
 Information on the current interest rates.
 Information with regard to foreign exchange rates.
 Request for a DD or pay order.
 D-Mat Account related services.
 And other similar services.

Mobile Banking

A new revolution in the realm of e-banking is the emergence of mobile
banking. On-line banking is now moving to the mobile world, giving everybody
with a mobile phone access to real-time banking services, regardless of their
location. But there is much more to mobile banking from just on-line banking. It
provides a new way to pick up information and interact with the banks to carry
out the relevant banking business. The potential of mobile banking is limitless
and is expected to be a big success. Booking and paying for travel and even
tickets is also expected to be a growth area.

According to this system, customer can access account details on mobile
using the Short Messaging System (SMS) technology where select data is
pushed to the mobile device. The wireless application protocol (WAP)
technology, which will allow user to surf the net on their mobiles to access

Page 22 of 93


anything and everything. This is a very flexible way of transacting banking
business.

Already ICICI and HDFC banks have tied up cellular service provides
such as Airtel, Orange, Sky Cell, etc. in Delhi and Mumbai to offer these mobile
banking services to their customers.

Internet Banking

Internet banking involves use of internet for delivery of banking products
and services. With internet banking is now no longer confirmed to the branches
where one has to approach the branch in person, to withdraw cash or deposits a
cheque or requests a statement of accounts. In internet banking, any inquiry or
transaction is processed online without any reference to the branch (anywhere
banking) at any time.

The Internet Banking now is more of a normal rather than an
exception due to the fact that it is the cheapest way of providing banking
services. As indicated by McKinsey Quarterly research, presently traditional
banking costs the banks, more than a dollar per person, ATM banking costs 27
cents and internet banking costs below 4 cents approximately. ICICI bank was
the first one to offer Internet Banking in India.

Page 23 of 93


Benefits of Internet Banking:
 Reduce the transaction costs of offering several banking services and
diminishes the need for longer numbers of expensive brick and mortar
branches and staff.
 Increase convenience for customers, since they can conduct many banking
transaction 24 hours a day.
 Increase customer loyalty.
 Improve customer access.
 Attract new customers.
 Easy online application for all accounts, including personal loans and
mortgages

Financial Transaction on the Internet:

Electronic Cash: Companies are developing electronic replicas of all existing
payment system: cash, cheque, credit cards and coins.

Automatic Payments: Utility companies, loans payments, and other businesses
use on automatic payment system with bills paid through direct withdrawal from
a bank account.

Direct Deposits: Earnings (or Government payments) automatically deposited
into bank accounts, saving time, effort and money.

Page 24 of 93


Stored Value Cards: Prepaid cards for telephone service, transit fares, highway
tolls, laundry service, library fees and school lunches.

Point of Sale transactions: Acceptance of ATM/Cheque at retail stores and
restaurants for payment of goods and services. This system has made
functioning of the stock Market very smooth and efficient.

Cyber Banking: It refers to banking through online services. Banks with web
site ―Cyber‖ branches allowed customers to check balances, pay bills, transfer
funds, and apply for loans on the Internet.

Demat:
Demat is short for de-materialisation of shares. In short, Demat is a
process where at the customer‘s request the physical stock is converted into
electronic entries in the depository system.

In January 1998 SEBI (Securities and Exchange Board of India) initiated
DEMAT ACCOUNTANCY System to regulate and to improve stock investing.
As on date, to trade on shares it has become compulsory to have a share demat
account and all trades take place through demat.

One needs to open a Demat Account with any of the branches of the bank.
After opening an account with any bank, by filling the demat request form one
can handover the securities. The rest will be taken care by the bank and the

Page 25 of 93


customer will receive credit of shares as soon as it is confirmed by the
Company/Register and Transfer Agent. There is no physical movement of share
certification any more. Any buying or selling of shares is done via electronic
transfers.

1. If the investor wants to sell his shares, he has to place an order with his
broker and give a ―Delivery Instruction‖ to his DP (Depository Participant).
The DP will debit hi s account with the number of shares sold by him.
2. If one wants to buy shares, he has to inform his broker about his Depository
Account Number so that the shares bought by him are credited in to his
account.
3. Payment for the electronic shares bought or sold is to be made in the same
way as in the case of physical securities.

Page 26 of 93


2.3
UNIVERSAL BANKING SERVICES
Banking covers so many services that it is difficult to define
it. However, these basic services have always been recognized as the hallmark
of the genuine banker. These are:

 The receipt of the customer‘s deposits
 The collection of his cheques drawn on other banks
 The payment of the customer‘s cheques drawn on himself

There are other various types of banking services like:
 Advances – Overdraft, Cash Credit, etc.

 Deposits – Saving Account, Current Account, etc.

 Financial Services – Bill discounting etc.

 Foreign Services – Providing foreign currency, travelers cheques, etc.

 Money Transmission – Funds transfer etc.

 Savings – Fixed deposits, etc.

 Services of place or time – ATM Services.

 Status – Debit Cards, Credit Cards, etc.

Page 27 of 93


2.4
Universal Banking coupled with SWOT
The solution of Universal Banking was having many factors to deal with
which further categorized under Strengths, Weaknesses, Opportunities and
Threats:

Strengths:

Economies Of Scale

The main advantage of Universal Banking is that it results in greater
economic efficiency in the form of lower cost, higher output and better
products. Various Reserve Banks Committees and reports in favor of Universal
Banking, is that it enables banks to exploit economies of scale and scope. It
means a bank can reduce average costs and thereby improve spreads if it
expands its scale of operations and diversifying activities.

Profitable Diversions

By diversifying the activities, the bank can use its existing expertise in
one type of financial service in providing other types. So, it entails less cost in
performing all the functions by one entity instead of separate bodies.

Page 28 of 93


Resource Utilization

A bank possesses the information on the risk characteristics of the clients,
which it can use to pursue other activities with the same client. A data collection
about the market trends, risk and returns associated with portfolios of Mutual
Funds, diversifiable and non diversifiable risk analysis, etc are useful for other
clients and information seekers. Automatically, a bank will get the benefit of
being involved in Research.

Easy marketing on the foundation a of Brand name

A bank has an existing network of branches, which can act as shops for
selling products like Insurance, Mutual Fund without much efforts on
marketing, as the branch will act here as a parent company or source. In this
way a bank can reach the remotest client without having to take recourse to an
agent.

One stops shopping

The idea of 'one stop shopping' saves a lot of transaction costs and
increases the speed of economic activities. It is beneficial for the bank as well as
customers.

Investor friendly activities

Another manifestation of Universal Banking is bank holding stakes in a
firm. A bank's equity holding in a borrower firm, acts as a signal for other
investors on to the health of the firm, since the lending bank is in a better
position to monitor the firm's activities.

Page 29 of 93


Easy handling of business cycles

Due to various shifts in business cycles, the demand for products
also varies at different points of time. It is generally held that universal banks
could easily handle such situations by shifting the resources within the
organization as compared to specialized banks. Specialized firms are also
subject to substantial risks of failure.

Because their operations are not well diversified. By offering a broader
set of financial products than what a specialized bank provides, it has been
argued that a universal bank is able to establish long-term relationship with the
customers and provide them with a package of financial services through a
single window.

Page 30 of 93


Weaknesses:

Grey area of Universal Bank

The path of Universal Banking for DFIs is strewn with obstacles. The
biggest one is overcoming the differences in regulatory requirements for a bank
and DFI. Unlike banks, DFIs are not required to keep a portion of their deposits
as cash reserves.

No expertise in long term lending

In the case of traditional project finance an area where DFIs tread
carefully, becoming a bank may not make a big difference. Project finance and
Infrastructure Finance are generally long gestation projects and would require
DFIs to borrow long term. Therefore, the transformation into a bank may not be
of great assistance in lending long-term.

NPA problem remained intact

The most serious problem of DFIs have had to encounter is bad loans or
Non Performing Assets (NPA). For the DFIs and Universal Banking or
installation of cutting edge technology in operations are unlikely to improve the
situation concerning NPAs. Most of the NPAs came out of loans to commodity
sectors, such as steel, chemicals, textiles, etc. the improper use of DFI funds by
project promoters, a sharp change in operating environment and poor appraisals
by DFIs combined to destroy the viability of some projects. So, instead of

Page 31 of 93


improving the situation Universal Banking may worsen the situation, due to the
expansion in activities banks will fail to make thorough study of the actual need
of the party concerned, the prospect of the business, in which it is engaged, its
track record, the quality of the management, etc.

ICICI suffered the least in this section, but the IDBI has got worst hit of NPAs,
considering the negative developments at Dabhol Power Company (DPC).

Page 32 of 93


Threats:

Big Empires

Universal Banking is an outcome of the mergers and acquisitions in the
banking sector. The Finance Ministry is also empathetic towards it. But there
will be big empires which may put the economy in a problem. Universal Banks
will be the largest banks, by their asset base, income level and profitability there
is a danger of 'Price Distortion'. It might take place by manipulating interests of
the bank for the self interest motive instead of social interest. There is a threat to
the overall quality of the products of the bank, because of the possibility of
turning all the strengths of the Universal Banking into weaknesses. (e.g. - the
strength of economies of scale may turn into the degradation of qualities of bank
products, due to over expansion. If the banks are not prudent enough, deposit
rates could shoot up and thus affect profits. To increase profits quickly banks
may go in for riskier business, which could lead to a full in asset quality.
Disintermediation and securitization could further affect the business of banks .

Page 33 of 93


Opportunities:

To increase efficiency and productivity
Liberalization offers opportunities to banks. Now, the focus will be on
profits rather than on the size of balance sheet. Fee based incomes will be more
attractive than mobilizing deposits, which lead to lower cost funds. To face the
increased competition, banks will need to improve their efficiency and
productivity, which will lead to new products and better services.

To get more exposure in the global market
In terms of total asset base and net worth the Indian banks have a very
long road to travel when compared to top 10 banks in the world. (SBI is the only
Indian bank to appear in the top 100 banks list of 'Fortune 500' based on sales,
profits, assets and market value. It also ranks II in the list of Forbes 2000 among
all Indian companies) as the asset base sans capital of most of the top 10 banks
in the world are much more than the asset base and capital of the entire Indian
banking sector. In order to enter at least the top 100 segment in the world, the
Indian banks need to acquire a lot of mass in their volume of operations.

Pure routine banking operations alone cannot take the Indian banks into
the league of the Top 100 banks in the world. Here is the real need of universal
banking, as the wide range of financial services in addition to the Commercial
banking functions like Mutual Funds, Merchant banking, Factoring, Insurance,
credit cards, retail, personal loans, etc. will help in enhancing overall
profitability.

Page 34 of 93


To eradicate the 'Financial Apartheid'

A recent study on the informal sector conducted by Scientific Research
Association for Economics (SRA), a Chennai based association, has found out
that, 'Though having a large number of branch network in rural areas and urban
areas, the lowest strata of the society is still out of the purview of banking
services. Because the small businesses in the city, 34% of that goes to money
lenders for funds. Another 6.5% goes to pawn brokers, etc.

The respondents were businesses engaged in activities such as fruits and
vegetables vendors, laundry services, provision stores, petty shops and tea stalls.
97% of them do not depend the banking system for funds. Not because they do
not want credit from banking sources, but because banks do not want to lend
these entrepreneurs. It is a situation of Financial Apartheid in the informal
sector. It means with the help of retail and personal banking services Universal
Banking can reach this stratum easily.

Page 35 of 93


Chapter 3

Committee Reports, Guidelines &
its Impact

Page 36 of 93


3.1
Khan Committee On Universal Banking
The khan committee on harmonizing the role and operations of
development financial institutions and banks submitted its report on April 24,
1998 with following recommendations: -

 Give banking license to DFIs

 Merge banks with banks, DFIs

 Bring down CRR progressively

 Phase out SLR

 Redefine priority sector

 Set up a super regulator to coordinate regulators‘ activities

 Develop risk-based supervisory framework

 Usher in legal reforms in debt recovery

 State level FIs be allowed to go public and come under RBI

 DFIs be permitted to have wholly-owned banking subsidiaries

 Remove cap on FIs‘ resources mobilization

 Grant authorized dealers‘ license to DFIs

 Set up a standing committee to coordinate lending policies

Page 37 of 93


Recommendations:

 About Universal Banking

Universal banking refers to elimination of the distinction between
the development financial institutions and the banks and market segmentation
that presently exists between them.

 About Harmonization Of Role Of Banks And DFIs

Harmonization means the introduction of universal banking in a
limited sense, wherein the DFIs could become banks and intermediate in the
short-term end of the financial market (say finance for working capital) and
commercial banks could enter the long-term end of the financial market (say
project financing). In other words, the harmonization allows the DFIs and banks
to move freely to the other end than where they are presently placed.

 About The Main Areas Of Operations Of DFIs And Banks Presently
And How:

Universalisation Will Change That Role In Future.

DFIs are specialist institutions catering to different sectors, appraising
projects from technical and financial parameters and finance long-term
investment requirements. This specialization has given edge to DFIs in terms of
project appraisal. On the other hand, the banks meet the short term investment
and production requirements and they have developed expertise in providing
working capital finance to industry, exports, imports, small industry, agriculture

Page 38 of 93


etc. They can take as intermediates in a big way at the other end of their markets
where they are less dominant presently. Some of them may even diversify into
insurance and other related areas.

 About Requirement Of Cost Considerations In Universalisation

Cost of funds differentiates the DFIs from banks, as DFIs incur higher
costs for mobilizing long-term finance. Banks do not normally mobilize
substantial deposit resources with maturities in excess of 5 years, which limits
their capacity to extend long-term loans. This has resulted in participation type
of relationship in financing by banks and DFIs.

 About The Areas Of Conflict arising Between Banks And DFIs

There are conflicts relating to securities for the loans sanctioned by the
banks and DFIs. While the DFIs have first charge over block assets, the banks
have first charge on current assets, which place both the banks and DFIs in
different positions.

Another area of conflict is extension of refinance by DFIs to banks to
supplement banks‘ long-term resources. But due to higher cost of their funds,
the DFIs find it a losing proposition.

Page 39 of 93


 About The Committee Which Recommended Universal Banking &
What It Suggested

The S H Khan Committee suggested the concept of Universal Banking. It
also suggested to give banking license to DFIs, merging banks with banks or
DFIs, bring down CRR progressively, phase out SLR, redefine priority sector,
set up a super regulator to coordinate regulators‘ activities, develop risk-based
supervisory framework, usher in legal reforms in debt recovery, allow State
level FIs to go public and come under RBI, permit DFIs to have wholly-owned
banking subsidiaries, remove cap on FIs‘ resources mobilization, grant
authorized dealers‘ license to DFIs, set up a standing committee to coordinate
lending policies etc.

 About The Likely Gains From Universalisation

The universalisation is expected to result in expansion of banks and
diversification into new financial and Para-banking services. The business focus
of the banks would emerge on profit lines. This may at the same time result in
reluctance on their part to enter the smaller end of retail banking particularly,
the small borrowers in rural areas, who may find it difficult to access the
banking services, since they do not contribute substantially to Banks‘ Business
Volumes or Profits.

Page 40 of 93


 About The Apprehensions Of Universalisation

The financial services may not become the privilege of elitist. If the reforms
with a human face are what we want, the universal banking has to make
adjustments and ensure that financial services are available to all at affordable
costs.

Page 41 of 93


3.2
Need Of Universal Banking In India

1. The phenomenon of universal banking—as different from narrow banking
is suddenly in the news. With the second Narsimham Committee (1998)
and the Khan Committee (1998) reports recommending consolidation of
the banking industry through mergers and integration of financial
activities, the stage seems to be set for a debate on the entire issue.

2. A universal bank is a ‗one-stop‘ supplier for all financial products and
activities, like deposits, short-term and long-term loans, insurance,
investment etc.

3. The benefits to banks from universal banking are the standard argument
given everywhere also by the various Reserve Bank committees and
reports—in favour of universal banking is that it enables banks to exploit
economies of scale and scope.

4. So that a bank can reduce average costs and thereby improves spreads if it
expands its scale of operations and diversifies its activities.

Page 42 of 93


5. The bank can diversify its existing expertise in one type of financial
service in providing the other types. So, it entails less cost in performing
all the functions by one entity instead of separate specialized bodies.

6. A bank has an existing network of branches, which can act as shops for
selling products like insurance. This way a big bank can reach the
remotest client without having to take recourse to any agent.

7. Many financial services are inter-linked activities, e.g. insurance and
lending. A bank can use its instruments in one activity to exploit the
other, e.g., in the case of project lending to the same firm, which has
purchased insurance from banking

8. The idea of ‗one-stop-shopping‘ saves a lot of transaction costs and
increases the speed of economic activity. Another manifestation of
universal banking is a bank holding stakes in a firm.

9. In India, too, a lot of opportunities are there to be exploited. Banks,
especially the financial institutions, are aware of it. And most of the
groups have plans to diversify in a big way.

10. At present, only an‘ arms-length‘ relationship between a bank and
an insurance entity has been allowed by the regulatory authority, i.e. the

Page 43 of 93


Insurance Regulatory and Development Authority (IRDA). This means
that commercial banks can enter insurance business either by acting as
agents or by setting up joint ventures with insurance companies.

11. Development financial institutions (DFIs) can turn themselves into
banks, but have to adhere to the statutory liquidity ratio and cash reserve
requirements meant for banks, which they are lobbying to avoid.

All these can be seen as steps towards an ultimate culmination of financial
intermediation in India into universal banking.

Page 44 of 93


3.3
Approach To Universal Banking

The Narsimham Committee II suggested that Development Financial
Institutions (DFIs) should convert ultimately into either commercial banks or
non-bank finance companies. The Khan Working Group held the view that
DFIS should be allowed to become banks at the earliest. The RBI released a
'Discussion Paper' (DP) in January 1999 for wider public debate. The feedback
on the discussion paper indicated that while the universal banking is desirable
from the point of view of efficiency of resource use, there is need for caution in
moving towards such a system by banks and DFIs.

The principle of "Universal Banking" is a desirable goal and some
progress has already been made by permitting banks to diversify into
investments and long-term financing and the DFIs to lend for working capital,
etc. However, banks have certain special characteristics and as such any dilution
of RBI's prudential and supervisory norms for conduct of banking business
would be inadvisable.

Though the DFIs would continue to have a special role in the Indian
financial System, until the debt market demonstrates substantial improvements
in terms of liquidity and depth, any DFI, which wishes to do so, should have the
option to transform into bank (which it can exercise), provided the prudential

Page 45 of 93


norms as applicable to banks are fully satisfied. To this end, a DFI would need
to prepare a transition path in order to fully comply with the regulatory
requirement of a bank. The DFI concerned may consult RBI for such transition
arrangements. Reserve Bank will consider such requests on a case-by-case
basis. Financing requirements, which is necessary. In due course, and in the
light of evolution of the financial system, Narsimham Committee's
recommendation that, ultimately there should be only banks and Restructured
NBFCs can be operationalised.

Page 46 of 93


3.4
RBI Guidelines for Existing Banks/FIs for Conversion into
Universal Banks:
Salient operational and regulatory issues to be addressed by the FIs For the
conversion into Universal bank are: -

 Reserve Requirements:-

Compliance with the cash reserve ratio and statutory liquidity ratio
requirements (under Section 42 of RBI Act, 1934, and Section 24 of the
Banking Regulation Act, 1949, respectively) would be mandatory for an
FI after its conversion into a universal bank

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

 Disposal of non-banking assets

Any immovable property, howsoever acquired by an FI, would,
after its conversion into a universal bank, be required to be disposed of
within the maximum period of 7 years from the date of acquisition, in
terms of Section 9 of the B. R. Act.

Page 47 of 93


 Composition of the Board
Changing the composition of the Board of Directors might become
necessary for some of the FIs after their conversion into a universal bank,
to ensure compliance with the provisions of Section 10(A) of the B. R.
Act, which requires at least 51% of the total number of directors to have
special knowledge and experience

 Prohibition on floating charge of assets
The floating charge, if created by an FI, over its assets, would
require, after its conversion into a universal bank, ratification by the
Reserve Bank of India under Section 14(A) of the B. R. Act, since a
banking company is not allowed to create a floating charge on the
undertaking or any property of the company unless duly certified by RBI
as required under the Section.

 Nature of subsidiaries
If any of the existing subsidiaries of an FI is engaged in an activity
not permitted under Section 6(1) of the B R Act, then on conversion of the
FI into a universal bank, delinking of such subsidiary / activity from the
operations of the universal bank would become necessary since Section
19 of the Act permits a bank to have subsidiaries only for one or more of
the activities permitted under Section 6(1) of B. R. Act.

Page 48 of 93


 Restriction on investments
An FI with equity investment in companies in excess of 30 per cent
of the paid up share capital of that company or 30 per cent of its own
paid-up share capital and reserves, whichever is less, on its conversion
into a universal bank, would need to divest such excess holdings to secure
compliance with the provisions of Section 19(2) of the B. R. Act, which
prohibits a bank from holding shares in a company in excess of these
limits.

 Connected lending
Section 20 of the B. R. Act prohibits grant of loans and advances by
a bank on security of its own shares or grant of loans or advances on
behalf of any of its directors or to any firm in which its director/manager
or employee or guarantor is interested. The compliance with these
provisions would be mandatory after conversion of an FI to a universal
bank.

 Licensing
An FI converting into a universal bank would be required to obtain
a banking license from RBI under Section 22 of the B. R. Act, for
carrying on banking business in India, after complying with the applicable
conditions.

Page 49 of 93


 Branch network
An FI, after its conversion into a bank, would also be required to
comply with extant branch licensing policy of RBI under which the new
banks are required to allot at least 25 per cent of their total number of
branches in semi-urban and rural areas.

 Assets in India
An FI after its conversion into a universal bank, will be required to
ensure that at the close of business on the last Friday of every quarter, its
total assets held in India are not less than 75 per cent of its total demand
and time liabilities in India, as required of a bank under Section 25 of the
B R Act.

 Format of annual reports
After converting into a universal bank, an FI will be required to
publish its annual balance sheet and profit and loss account in the in the
forms set out in the Third Schedule to the B R Act, as prescribed for a
banking company under Section 29 and Section 30 of the B. R. Act.

 Managerial remuneration of the Chief Executive Officers
On conversion into a universal bank, the appointment and
remuneration of the existing Chief Executive Officers may have to be
reviewed with the approval of RBI in terms of the provisions of Section
35 B of the B. R. Act. The Section stipulates fixation of remuneration of

Page 50 of 93


the Chairman and Managing Director of a bank by Reserve Bank of India
taking into account the profitability, net NPAs and other financial
parameters. Under the Section, prior approval of RBI would also be
required for appointment of Chairman and Managing Director.

 Deposit insurance
An FI, on conversion into a universal bank, would also be required
to comply with the requirement of compulsory deposit insurance from
DICGC up to a maximum of Rs.1 lakh per account, as applicable to the
banks.

 Authorized Dealer's License
Some of the FIs at present hold restricted AD license from RBI,
Exchange Control Department to enable them to undertake transactions
necessary for or incidental to their prescribed functions. On conversion
into a universal bank, the new bank would normally be eligible for full-
fledged authorized dealer license and would also attract the full rigor of
the Exchange Control Regulations applicable to the banks at present,
including prohibition on raising resources through external commercial
borrowings.

 Priority sector lending
On conversion of an FI to a universal bank, the obligation for
lending to "priority sector" up to a prescribed percentage of their 'net bank
credit' would also become applicable to it .

Page 51 of 93


 Prudential norms
After conversion of an FI in to a bank, the extant prudential norms
of RBI for the all-India financial institutions would no longer be
applicable but the norms as applicable to banks would be attracted and
will need to be fully complied with.

Page 52 of 93


3.5
Impact Of Universal Banking

Since the early 1990s, banking systems worldwide have been going
through a rapid transformation. Mergers, amalgamations and acquisitions have
been undertaken on a large scale in order to gain size and to focus more sharply
on competitive strengths. This consolidation has produced financial
conglomerates that are expected to maximize economies of scale and scope by
‗bundling‘ the production of financial services. The general trend has been
towards downstream universal banking where banks have undertaken
traditionally non-banking activities such as investment banking, insurance,
mortgage financing, securitization, and particularly, insurance. Upstream
linkages, where non-banks undertake banking business, are also on the increase.

The global experience can be segregated into broadly three models. There
is the Swedish or Hong Kong type model in which the banking corporate
engages in in-house activities associated with banking. In Germany and the UK,
certain types of activities are required to be carried out by separate subsidiaries.
In the US type model, there is a holding company structure and separately
capitalized subsidiaries.

In India, the first impulses for a more diversified financial intermediation
were witnessed in the 1980s and 1990s when banks were allowed to undertake

Page 53 of 93


leasing, investment banking, mutual funds, factoring, hire-purchase activities
through separate subsidiaries. By the mid-1990s, all restrictions on project
financing were removed and banks were allowed to undertake several activities
in-house. In the recent period, the focus is on Development Financial
Institutions (DFIs), which have been allowed to setup banking subsidiaries and
to enter the insurance business along with banks. DFIs were also allowed to
undertake working capital financing and to raise short-term funds within limits.

It was the Narsimham Committee II Report (1998) which suggested that
the DFIs should convert themselves into banks or non-bank financial
companies, and this conversion was endorsed by the Khan Working Group
(1998). The Reserve Bank‘s Discussion Paper (1999) and the feedback thereon
indicated the desirability of universal banking from the point of view of
efficiency of resource use, but it also emphasized the need to take into account
factors such as the status of reforms, the state of preparedness of the institutions,
and a viable transition path while moving in the desired direction.

Accordingly, the mid-term review of monetary and credit policy, October
1999 and the annual policy statements of April 2000 and April 2001 enunciated
the broad approach to universal banking and the Reserve Bank‘s circular of
April 2001 set out the operational and regulatory aspects of conversion of DFIs
into universal banks. The need to proceed with planning and foresight is
necessary for several reasons. The move towards universal banking would not
provide a panacea for the endemic weaknesses of a DFI or its liquidity and

Page 54 of 93


solvency problems and/or operational difficulties arising from
undercapitalization, non-performing assets, and asset liability mismatches, etc.

The overriding consideration should be the objectives and strategic
interests of the financial institution concerned in the context of meeting the
varied needs of customers, subject to normal prudential norms applicable to
banks. From the point of view of the regulatory framework, the movement
towards universal banking should entrench stability of the financial system,
preserve the safety of public deposits, improve efficiency in financial
intermediation, ensure healthy competition, and impart transparent and equitable
regulation.

Page 55 of 93


3.6
Universal Banking – Pros And Cons

The solution of Universal Banking was having many factors to deal with,
which can be further analyzed by the pros and cons.

Advantages of Universal Banking

 Economies of Scale: The main advantage of Universal Banking is that it
results in greater economic efficiency in the form of lower cost, higher
output and better products. Many Committees and reports by Reserve Bank
of India are in favour of Universal banking as it enables banks to exploit
economies of scale and scope.

 Profitable Diversions: By diversifying the activities, the bank can use its
existing expertise in one type of financial service in providing other types.
So, it entails less cost in performing all the functions by one entity instead of
separate bodies.

 Resource Utilization: A bank possesses the information on the risk
characteristics of the clients, which can be used to pursue other activities
with the same clients. A data collection about the market trends, risk and
returns associated with portfolios of Mutual Funds, diversifiable and non

Page 56 of 93


diversifiable risk analysis, etc, is useful for other clients and information
seekers. Automatically, a bank will get the benefit of being involved in the
researching
 Easy Marketing on the Foundation of a Brand Name: A bank's existing
branches can act as shops of selling for selling financial products like
Insurance, Mutual Funds without spending much efforts on marketing, as the
branch will act here as a parent company or source. In this way, a bank can
reach the client even in the remotest area without having to take resource to
an agent.

 One-stop shopping: The idea of 'one-stop shopping' saves a lot of
transaction costs and increases the speed of economic activities. It is
beneficial for the bank as well as its customers.

 Investor Friendly Activities: Another manifestation of Universal Banking
is bank holding stakes in a form : a bank's equity holding in a borrower firm,
acts as a signal for other investor on to the health of the firm since the
lending bank is in a better position to monitor the firm's activities.

Page 57 of 93


Disadvantages of Universal Banking

 Grey Area of Universal Bank. The path of universal banking for DFIs is
strewn with obstacles. The biggest one is overcoming the differences in
regulatory requirement for a bank and DFI. Unlike banks, DFIs are not
required to keep a portion of their deposits as cash reserves.

 No Expertise in Long term lending. In the case of traditional project
finance, an area where DFIs tread carefully, becoming a bank may not make
a big difference to a DFI. Project finance and Infrastructure finance are
generally long- gestation projects and would require DFIs to borrow long-
term. Therefore, the transformation into a bank may not be of great
assistance in lending long-term.

 NPA Problem Remained Intact. The most serious problem that the DFIs
have had to encounter is bad loans or Non-Performing Assets (NPAs). For
the DFIs and Universal Banking or installation of cutting-edge-technology in
operations are unlikely to improve the situation concerning NPAs.

Page 58 of 93


Chapter 4

Page 59 of 93


4.1
Introduction To ICICI Bank
The Industrial Credit and Investment Corporation of India limited (ICICI)
was formed in 1955 at the initiative of the World Bank, the government of India
and representatives of Indian industry. The principal objective was to create a
development financial institution for providing medium-term and long-term
project financing to Indian businesses. Until the late 1980s, ICICI primarily
focused its activities on project finance, providing long-term funds to a variety
of industrial projects. ICICI typically obtained funds for these activities through
a variety of government-sponsored and government-assisted programs designed
to facilitate industrial development in India. Today ICICI is one of the largest
financial institutions in India. It provides a wide range of products and services
aimed at fulfilling the banking and financial needs of India's corporate and retail
sectors.

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian
financial institution, and was its wholly-owned subsidiary. ICICI's shareholding
in ICICI Bank was reduced to 46% through a public offering of shares in India
in fiscal 1998, an equity offering in the form of ADRs listed on the NYSE in
fiscal 2000, ICICI Bank's acquisition of Bank of Madura Limited in an all-stock
amalgamation in fiscal 2001, and secondary market sales by ICICI to
institutional investors in fiscal 2001 and fiscal 2002. In the 1990s, ICICI
transformed its business from a development financial institution offering only
project finance to a diversified financial services group offering a wide variety

Page 60 of 93


of products and services, both directly and through a number of subsidiaries and
affiliates like ICICI Bank.

After consideration of various corporate structuring alternatives in the
context of the emerging competitive scenario in the Indian banking industry,
and the move towards universal banking, the managements of ICICI and ICICI
Bank formed the view that the merger of ICICI with ICICI Bank would be the
optimal strategic alternative for both entities, and would create the optimal legal
structure for the ICICI group's universal banking strategy.

The merger would enhance value for ICICI shareholders through the
merged entity's access to low-cost deposits, greater opportunities for earning
fee-based income and the ability to participate in the payments system and
provide transaction-banking services. The merger would enhance value for
ICICI Bank shareholders through a large capital base and scale of operations,
seamless access to ICICI's strong corporate relationships built up over five
decades, entry into new business segments, higher market share in various
business segments, particularly fee-based services, and access to the vast talent
pool of ICICI and its subsidiaries. In October 2001, the Boards of Directors of
ICICI and ICICI Bank approved the merger of ICICI and two of its wholly-
owned retail finance subsidiaries, ICICI Personal Financial Services Limited
and ICICI Capital Services Limited, with ICICI Bank. The merger was
approved by shareholders of ICICI and ICICI Bank in January 2002, by the
High Court of Gujarat at Ahmadabad in March 2002, and by the High Court of
Judicature at Mumbai and the Reserve Bank of India in April 2002. Consequent
to the merger, the ICICI group's financing and banking operations, both
wholesale and retail, have been integrated in a single entity.

Page 61 of 93


4.2
History Of ICICI Bank
1955: The Industrial Credit and Investment Corporation of India Limited (ICICI)
incorporated at the initiative of the World Bank, the Government of India
and representatives of Indian industry, with the objective of creating a
development financial institution for providing medium-term and long-term
project financing to Indian businesses. Mr. A. Ramaswami Mudaliar elected
as the first Chairman of ICICI Limited ICICI emerges as the major source
of foreign currency loans to Indian industry. Besides funding from the
World Bank and other multi-lateral agencies, ICICI also among the first
Indian companies to raise funds from International markets.

1956: ICICI declared its first Dividend at 3.5%.

1958: Mr. G. L. Mehta was appointed the 2nd Chairman of ICICI Ltd.

1960: ICICI building at 163, Backbay Reclamation was inaugurated.

1961: The first West German loan of DM 5 million from Kredianstalt was obtained

by ICICI.

1967: ICICI made its first debenture issue for Rs.6 crores, which was
oversubscribed.

Page 62 of 93


1969: First two regional offices in Calcutta and Madras were opened.

1972: Second entity in India to set-up merchant banking services.

Mr. H. T. Parekh appointed as the third Chairman of ICICI.

1977: ICICI sponsors the formation of Housing Development Finance Corporation.

Managed its first equity public issue.

1978: Mr. James Raj appointed as the fourth Chairman of ICICI.

1979: Mr. Siddharth Mehta appointed as the fifth Chairman of ICICI.

1982: Becomes the first ever Indian borrower to raise European Currency Units.

ICICI commences leasing business.

1984: Mr. S. Nadkarni appointed as the sixth Chairman of ICICI.

1985: Mr. N. Vaghul appointed as the seventh Chairman and Managing Director of

ICICI.

Page 63 of 93


1986: ICICI first Indian Institution to receive ADB Loans. First public issue by an
Indian entity in the Swiss Capital Markets. ICICI along with UTI sets up
Credit Rating Information Services of India Limited, (CRISIL) India's first
professional credit rating agency. ICICI promotes Shipping Credit and
Investment Company of India Limited. (SCIC) .The Corporation made a
public issue of Swiss Franc 75 million in Switzerland, the first public issue
by any Indian equity in the Swiss Capital Market.

1987: ICICI signed a loan agreement for Sterling Pound 10 million with
Commonwealth Development Corporation (CDC), the first loan by CDC for
financing projects in India.

1988: ICICI promotes TDICI - India's first venture capital company.

1993: ICICI sets-up ICICI Securities and Finance Company Limited in joint
venture with J. P. Morgan. ICICI sets up ICICI Asset Management
Company.

1994: ICICI sets up ICICI Bank.

1996: ICICI becomes the first company in the Indian financial sector to rise

GDR. ICICI announces merger with SCICI. Mr. K. V. Kamath appointed
the Managing Director and CEO of ICICI Ltd.

Page 64 of 93


1997: ICICI was the first intermediary to move away from single prime rate to
three-tier prime rates structure and introduced yield-curve based pricing. The
name "The Industrial Credit and Investment Corporation of India Limited
"was changed to "ICICI Limited". ICICI announces takeover of ITC Classic
Finance.

1998: Introduced the new logo symbolizing a common corporate identity for the
ICICI Group. ICICI announces takeover of Anagram Finance.

1999: ICICI launches retail finance - car loans, house loans and loans for consumer
Durables. ICICI becomes the first Indian Company to list on the NYSE
through an Issue of American Depositary Shares.

2000: ICICI Bank becomes the first commercial bank from India to list its stock on
NYSE. ICICI Bank announces merger with Bank of Madura.

2001: The Boards of ICICI Ltd and ICICI Bank approved the merger of ICICI with
ICICI Bank.

2002: Moodys assign higher than sovereign rating to ICICI. Merger of ICICI
Limited, ICICI Capital Services Ltd and ICICI Personal Financial Services
Limited with ICICI Bank.

Page 65 of 93


4.3

SWOT Analysis Of ICICI Bank

 STRENGTHS:

ICICI's distribution network is a major strength of the company. It has
physical presence across 42 cities. It also has a strong network of marketing
agents, ATMs and call centers.

ICICI offers a wide range of products and services to its corporate and
retail customers. This has increased its market share and enabled it to move
a step ahead to achieve its vision of being a Universal Bank.

 WEAKNESSES:

The company has a large amount of non-performing loans.

 OPPORTUNITIES:

The signs of Indian economy reviving have created a lot of
opportunities for the company. The industrial production has gone up by 8%
and this is expected to favor the company.

The revival in the economy will reduce the NPAs and could result in
growth of credit.

 THREATS:

Increased competition from foreign banks which have begun to foray into
financial services segment will pose a threat to the company's market share and
hence its bottom line.

Page 66 of 93


4.4

Merger Of ICICI & ICICI Bank
The merger is a culmination of a dream, which began five years ago. This
process was initiated in 1996. The time when SCICI merged with ICICI, in 1997-
98 ICICI acquired ITC classic and Anagram finance by way of acquisition, in
2000, ICICI bank gobbled up Bank of Madura. Reverse merger of ICICI‘s MD &
CEO K.V. Kamath started articulating on it in 1996. At first, it seemed
impossibility latter, it looked imperative.

On 25the of October India‘s first true-blue universal bank was born, as ICICI
reverse merged into its sibling ICICI Bank to create a Rs. 95,000 crores asset base
monolith, only second after SBI that has the asset base of 3,16,000 crores. HDFC
Bank is left at third place with asset size of Rs. 19000 crores. Earlier the reverse
merger looked like a bailout strategy for Non Performing Assets (NPA) ridden
ICICI, but later the merger seemed justified because of possibility of numerous
benefits through size and diverse portfolio of products of two entities. Swap ration
for merger is decided to be two shares of ICICI for one share of ICICI Bank.
st
Merged entity became fully operational from 31 March, 2002. ICICI requires this
five-month to meet all regulatory requirements.

The other interesting aspect of reverse merger is its methodology. ICICI Bank
has adopted the ―purchase method‖ of accounting principles (GAAP) for the
merger, unique in India. ICICI‘s assets and liabilities will be ―fair valued‖ for the
purpose of incorporation in the accounts of ICICI Bank on the appointed date. This
accounting practice is opportunity for ICICI to bring down its level of NPA.

Page 67 of 93


The new entity will have the capital adequacy ratio of 11.25 per cent with Tier
I capital contributing 7.5 per cent and Tier II 3.75 per cent.

Merged entity will have following features: -

a) Strong retail franchise will be able to access low- cost savings bank and
current account.
b) Funding cost will be reduced.
c) Leverage on its large capital base, products suite, extensive corporate and
retail customer relationship, technology enabled distribution system & vast
talent pool.
d) Retail segment will be a key driver for growth.
e) Reduction in the cost to income ratio due to scale of operations will provide
competitive age.
f) It will reduce the pressure on the capital adequacy front.
g) Long term of the merger would offset the temporary hiccups.
h) The benefits of leveraging and cross selling will set off the cost of carrying
the reserves.
i) Creation of an asset reconstruction companies (ARC) to manage NPAs.
j) Merger has been completed without seeking concessions on the reserve
requirements; this is an important aspect of reverse merger.

Page 68 of 93


4.5
Benefits From Merger

1) Biggest benefit that would accrue to the merged entity is operational and
economic efficiency. Both ICICI and ICICI Bank operate through different
premises in a city. Merger would facilitate use of common infrastructure and
computer network to carry out their operations. It would drastically reduce
duplication of functions and operational costs and improve efficiency. ICICI,
being a financial institution, takes care of long term fund requirement of
corporate while ICICI Bank gives short term loan for financing the working
capital requirement of corporate and individuals. Now under one roof ICICI
will be able to do project finance investment banking, housing finance and
consumer loans.
2) Merged entity would have a network of 396 existing branches and extension
counter, 140 existing retail finance offices and centers of ICICI. Such a huge
distribution network would help it to reach a large number of corporate and
retail customers. With cross-selling ICICI would be able to increase its
revenues. Profits are expected to improve by at least 3% because of better
utilization of funds and economies of scales in operation. With merger ICICI
will become a single shop for all type of finances and can leverage better its
credit appraisal skills and infrastructure.
3) Indian commercial banks, like ICICI Bank, have access to cheaper deposits
from general public. As they have idle funds they invest these funds into
government securities over the required Statutory Liquidity Ratio (SLR).
SLR investments earn average return of 8.5% only. These banks can earn

Page 69 of 93


higher return if they finance long term requirements of corporate with these
funds. On the other hand financial institutions like ICICI have shortage of
funds and are saddled by poor asset quality. So weakness of both ICICI and
ICICI Bank has become the strength for both the entities after merger.
4) Problem with financial institutions these days is that due to slack capital
market and high level of poor assets, they cannot raise funds. Merger with
banks would provide them with access to cheaper funds and retail deposits.
It is not possible for government to recapitalize sick financial institutions all
the times. Merger is the right move towards improving the financial health
of them. ICICI has the NPA of 5.1%, achieved after accelerated provisioning
of Rs. 813 crores in addition to a normal provisioning of Rs. 276 crores. On
the other hand ICICI Bank has the NPA as low as 1.41%. With merger total
NPA level of merged entity would come down substantially.

5) Asset based of Rs. 95000 crores.

6) Talent pool of 8275 employees.

Page 70 of 93


4.6
Issues Behind The Merger

Undoubtedly the most significant event of the past few months was the
merger of ICICI with its progeny, ICICI Bank. It is easily the largest merger seen
in corporate India and has the potential to seriously shake up India‘s banking
industry.

The merger has been on the cards of a while, and it was more a question of
―when‖ rather than ―if‖. Investors have been prepared for this, a fact what is
probably a major but not the only reason for ICICI Bank‘s relatively lower
valuation compared to HDFC Bank.

The rationale for the union goes something like this. ICICI was a leftover of an
era when the government provided financial institution low-cost funds and ensured
the monopoly over big-ticket lending. This allowed them to fix interest rates at
very high levels. But this changed in the nineties and ICICI along with other
financial institutions faced competition from bank and other financial entities.
Banks have access to cheap funds and can lend at cheaper rates. So a major reason
for the merger is to allow ICICI access to these low cost deposits.

Page 71 of 93


From the point of view of ICICI Bank, the management feels that they will
gain due to increased size and scale. In fact, a lot is being made of the fact that the
merged entity is now second only to State Bank of India.

Further, the management believes they will be able to better utilize synergies
between the two companies. Earlier, ICICI‘s presence in areas such as consumer
lending meant that ICICI Bank could not offer similar products. Moreover, ICICI
Bank will also gain due to ICICI‘s strong corporate relationships and access to the
vast talent pool of ICICI and its subsidiaries.

The reverse merger between ICICI and ICICI Bank will be smooth because
ICICI is in the strange position of being both, a government organization and not
one at the same time. It is still recognized as a ―specified financial institutions‖
under Section 4A of the Companies Act. This entitles it to several privileges such
as being recognized as a ―permitted security‖ for investment by trusts and others,
preferential treatment in terms of risk weightage attached to its bonds, and
protection from disclosure norms. At the same time, there are no checks on its
investment decisions and no control on salaries. This is why ICICI can pay Rs. 1
crore to CEO K.V. Kamath while the Industrial Development Bank of India (IDBI)
chief has to settle for a small fraction of that amount. The anomaly arises because
though government shareholding in ICICI has fallen much below 51 percent
(which allows it to claim to be a non-government concern when it suits its
purpose), it is yet to be denotified under Section 4A.

Page 72 of 93


But the same is not true of other Financial Institutions (FIS) that will also
have to go the ICICI way into universal banking. All FIS will have to do that as
their access to cheap funds has been cut off. Their spreads have narrowed; they can
only survive by accessing the cheap deposit bases of banks. But the merger of an
IDBI or an IFCI with a bank is not going to be easy. If one were to look at a new
private sector bank, the salaries there would want an IDBI, loaded with more than
its fair share of NPAS. An older, nationalized bank would bring to the table its
quota of NPAS too, not to talk about a slothful staff and union problems.

One can never accuse the ICICI management of not being aggressive
enough. But while its belligerent expansion has kept it in the headlines, it has often
failed to carry other stakeholders along. This time round its ―Agenda for the new
millennium‖- the much-hyped conversion to universal bank seems to have run into
rough weather. It is obvious that ICICI‘s investors are unhappy about the merger
ratio and intend to fight for their rights. Several cases have already been filed in the
Bombay High Court and the Investor Grievances Forum is also lobbying hard with
institutions and bureaucrats against the merger ratio.

Ignoring the interests of other stakeholders is typical of ICICI‘s management
and has frequently landed it is trouble. It has been sued several times for trying to
ram through restructuring proposals which protects its own lending at the cost of
others. A recent example is that of Arvind Mills, where a group of secured foreign
lenders, led by Commerz Bank have filed civil and criminal charges against ICICI.
The merger of ICICI with ICICI Bank seems to be following a similar trajectory.
Although it is clear that ICICI has no future as a development financial institution,

Page 73 of 93


it will only succeed as a universal bank it is controls costs and reduces non-
performing assets.

Let us examine the merger of ICICI with ICICI bank. Firstly, it is curious
that of the three valuation methods recognized by SEBI, ICICI has chosen one that
hurts its own shareholders the most. ICICI is indeed saddled with large NPAs, but
that did not stop the management from collecting fat pay packets every year.
Moreover, the goodwill it commands as a development financial institution, which
is reorganized under section 4A of the Companies Act, has been ignored, as also
the fact that it has frequently been able to raise large sums of money through what
are dangerously termed ‗ safety bonds‘. Had there been factored in, it may have
changed the merger ratio and also benefited ICICI‘s other institutional
shareholders.

Page 74 of 93


4.7

ICICI Bank- One Year After Universal Banking
Conversion to Universal Bank by ICICI did not happen overnight. ICICI CEO
Kamath's predecessor Narayan Vaghul started the process of strategic
diversification. Kamath hastened the process and in the last 5 years pushed ICICI
towards setting up a portfolio of subsidiaries and associated companies. With a
capital base of Rs.728 crores ICICI Bank was set up in 1994. With aggressive
marketing and infrastructure of 400 branches and over 600 ATM's the bank grew
rapidly. The intent to become international player was very clear when both ICICI
and ICICI Bank got listed on the New York Stock Exchange (NYSE). ICICI has
also forayed into insurance. To become Universal Bank ICICI had accelerated
provisioning of Rs.813 crores in additional to the normal provisioning of Rs.276
crores to bring down the NPA to the more acceptable 5.1 percent.

Impact of The Merger

The merger of ICICI and two of its subsidiaries with ICICI bank has
combined two organizations with complementary strengths and products & similar
processes & operating architecture. The merger has combined the large capital
base of ICICI with the strong deposit raising capability of ICICI Bank, giving
ICICI bank approved ability to increase its market share in banking fees and
commissions, while lowering the overall cost of funding through access to lower-
cost retail deposits. ICICI Bank would now able to leverage the strong corporate
relationships that ICICI has built, seamlessly providing the whole range of
financial products and services to corporate clients. The merger has also resulted in
the integration of retail finance operations of ICICI, and its two merging

Page 75 of 93


subsidiaries, and ICICI into one entity, creating an optimal structure for the retail
business and allowing full range of asset and liability products to be offered to all
retail customers.

Challenges Faced On Account Of Merger

The merger itself posed many challenges i.e. of raising large incremental
resources, deploying them to meet regulatory norms, steering through statutory
processes and obtaining regulatory and shareholders‘ approvals.

Present Goals and Targets of ICICI Bank

1. To leverage the strengths of the merged entity to deliver value to
stakeholders.
2. To focus on maximizing economic value of assets through innovative
solutions and aggressive recovery actions.
3. To adopt global best practices to deliver financial solutions to their
customers to convert India-linked banking opportunities in the selected
international markets.
4. To capitalize on new business opportunities, leverage their brand &
distribution capability, proactively adopt technology and develop human
capital.

Comments/ Views on Present Position Of The ICICI Bank

Presently ICICI has established as a full-fledged Universal bank and has by
passed all the teething problems. As a first Universal bank in the Country, our bank
is now marching ahead towards its predetermined goals and ready to capture global
business too.

Page 76 of 93

Universal banking final

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Similar a Universal banking final

Similar a Universal banking final (20)

Último

Último (20)

Universal banking final