since the financial sector reforms were introduced in early 90's the
banking sector saw the emergence of new generation of
private sector banks. These banks gained at most
popularity as they have technology edge and better business models when
compared to public sector banks and the most important thing is they are
able to attract more volumes simply
because they meet their customers' requirements under
one roof. If the newer players can do that then why can't the bigger
players like the Financial Institutions (FIs) try their hands on it?
Here comes the concept of universal
banking, its Emergence, merits and related issues. The
present paper focuses on understanding the concept of universal banking
in India and attempts to explain the regulatory role,
regulatory requirements, key duration and maturity
distinction and lastly the optimal transition path. The paper also gives
an overview of the international experience and argues in favor of
developing a strong domestic financial system in order to compete in the
Banking is a multi-purpose and multi-functional financial supermarket
(a company offering a wide range of financial services e.g. stock,
insurance and real-estate
brokerage) providing both banking and financial services
through a single window. Definition of Universal Banking: 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
However in practice the term 'universal banking' refers
to those banks that offer a wide range of financial services, beyond
the commercial banking functions like Mutual Funds, Merchant Banking,
Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans,
Investment banking, Insurance etc. This is most common in European
example, in Germany commercial banks accept time deposits, lend money,
underwrite corporate stocks, and act as investment advisors to large
corporations. In Germany, there has never been any separation between
commercial banks and investment banks, as there is in
the United States. Universal banks are huge banks providing all type of
financial services. After 1990 when Mr. Manmohan singh who was the
Finance Minister, he stated a new wave
called Liberalization, privitation and Globalization,
the demand for universal banking increased overnight. Now mergers and
acquisitions were norm of the day which provided scope for financial
services. The phenomenon of Universal
Banking as a distinct concept, as different from Narrow
Banking came to the forefront in the Indian context with the Narsimham
Committee (199 and later the Khan Committee (199 reports
recommending consolidation of the banking
industry through mergers and integration of financial
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
1) 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 use economies of scale and scope.
2) 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.
3) 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 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
4) 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.
5) 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.
Disadvantages of Universal Banking
1) 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
2) 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
3) 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
of cutting-edge-technology in operations are unlikely to
improve the situation concerning NPAs.
History of Universal banking in India
banking involves a mix of commercial deposit and loan businesses and
investment banking. Universal banking took off in the
19th century, and conditions became more difficult in the 2oth century.
This is because there have been exogenous political shocks and
macro-economic instability during the 20th
century. The wider institutional context is important
for universal banking, and this includes central bank support. The
context has been less favorable in the 20th century. Globalization has
also had an impact on the banking
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
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.
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 Narasimham Committee (NC)
has major bearing on the issues considered by the Khan
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 an 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.
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.
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 corporate 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
banks like ICICI bank have expressed their desire to change into a
universal bank. That's why they want to merge ICICI with
ICICI bank. The Narsimham Committee II suggested that 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 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. Major areas requiring
attention are the status of financial sector reforms, the state of
preparedness of the concerned
institutions, the evolution of the regulatory regime and
above all a viable transition path for institutions which are desirous
of moving in the direction of universal banking.
SALIENT OPERATIONAL AND REGULATORY ISSUES
OF RBI TO BE ADDRESSED BY THE FIs FOR CONVERSION INTO A UNIVERSAL BANK
a) 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.
b) Permissible activities. Any
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.
d) 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
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
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.
g) 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.
h) 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.
i) 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.
j) 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.
k) 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
l) 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 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.
m) Managerial remuneration of the Chief Executive Officers. On
conversion into a universal bank, the appointment and remuneration of
the existing Chief Executive Officers may have to be reviewed
with the approval of RBI in terms of the provisions of
Section 35 B of the B. R. Act. The Section stipulates fixation of
remuneration of the Chairman and Managing Director of a bank by Reserve
Bank of India taking into account the
profitability, net NPAs and other financial parameters.
Under the Section, prior approval of RBI would also be required for
appointment of Chairman and Managing Director.
n) Deposit Insurance. An
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
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.
p) Priority sector lending. On conversion of an FI to a universal bank, the obligation for lending to
"priority sector" up to a prescribed percentage of their 'net bank credit' would also become applicable to it.
q) Prudential norms. After
conversion of an FI in to a bank, the extant prudential
norms of RBI for the all-India financial institutions
would no longer be applicable but the norms as applicable to banks would
be attracted and will need to be fully complied with.
(This list of regulatory and operational issues is only illustrative and not exhaustive).
of the major problems associated with universal banking is the issue of
Financial Institutions in India are governed by separate
Acts and banks are regulated and governed by RBI and Banking Regulation
Act 7. Financial Institutions in India have commercial banks as their
subsidiaries, but due to the
separation of regulation, the Financial Institutions
cannot have direct access to the resource base of its subsidiary bank.
Without any doubt, the regulatory burden for all participants in the
entire financial system should be
equalized in order to ensure that no participant might
end up having a disadvantage relative to any other.