Project Report

1
Project Report

• An Empirical Study on Universal Banking and its
  Potential for Indian Market Consumers

2
Introduction
Universal 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. A Universal Banking is a
superstore for financial products under one roof.
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. Universal banking is the opposite
of narrow banking. Narrow banking legislation
would require banks to back their liabilities
with safe assets, such as government securities.
3
Narrow banking is the modern and more elaborated
version of the 100 percent reserve banking
principle, invoked by early economists to correct
the inadequacy of money reserve against the stock
of banknotes in circulation. The benefits of
narrow banking are First, by locking bank assets
in high-quality instruments, narrow banking
regulation would minimize bank liquidity and
credit risk. Second, since narrow banks would be
prohibited from supplying risky loans and would
collateralize deposits with high-quality assets,
confidence in the value of their liabilities is
tend to be increased. Third, with payment system
access restricted to narrow banks, payment would
be fully secure, because payment-system
participants would be protected against
liquidity, credit, and settlement risks, and
because any shock to non-banks would be isolated,
with no systemic fallout. The Banking sector was
opened up for the private sector in line with
Narsimham Committees recommendations.
4
The ICICIs decision to turn itself into a
universal bank ushered a new era in the banking
scenario. The second Narasimham Committee noted
that the global trends in banking industry
towards consolidation and convergence led to the
dismantling of boundaries among suppliers of
various financial products. The Khan Working
Group also recommended a progressive move towards
universal banking and development of enabling
regulatory framework. It is contended that
universal banking will result in greater economic
efficiency in the form of lower cost, higher
output, and better products and therefore is
believed to be the panacea for beleaguered
development financial institutions
(DFIs). Conflict of interests was one of the
major reasons for introduction of Glass-Steagall
Act of 1934 in United States. The Act prohibited
commercial banks from collaborating with
full-service brokerage firms or participating in
investment bank activities. The Glass-Steagall
Act was enacted during the Great Depression. It
protected bank depositors from the additional
risks associated with security transactions. The
Act was dismantled in 1999. However, the
enactment of the Gramm-Leach-Bliley Act (GLBA) in
November 1999 effectively repealed the
long-standing prohibitations on the mixing of
banking with securities or insurance businesses
and thus permitting broad banking. The repeal
of these prohibitions are due to the increasingly
persuasive evidence from academic studies of the
pre Glass-Steagall era, the recent favourable
experience in the U.S. following partial
deregulation of banking activities, the
experience of banking systems abroad with broader
scopes for banking activities, and rapid
technological change in telecommunications and
data processing.
5
THE CONCEPT OF UNIVERSAL BANKING 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, which could maximize economies of
scale and scope by building the production of
financial services organization, called Universal
Banking. Universal Banking, means the financial
entities the commercial banks, DFIs, NBFCs, -
undertake multiple financial activities under one
roof, thereby creating a financial supermarket.
Universal banking generally takes one of the
three forms - a. In-house Universal Banking.
E.g. Germany b. Through separately capitalized
subsidiaries. E.g. England. c. Operations
carried through a holding company. E.g. USA.
(Nair, 1998)
6
(No Transcript)
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Germany is one of the most commonly cited
countries with a full universal banking system.
Edwards (1996) states that the supply of external
finance in the model of universal banking
increases in line with the suppliers controlling
power over their borrowers behaviours. the
contribution of universal banks to the economy
should not be only measured in terms of external
funds they supply but also of improved
information flows as a result of banks improved
capability to compare companies within an
industry and across industries within the whole
economy. Most large enterprises will hire
managers, who usually are financial experts, to
handle daily business activities. The underlying
problem is that these managers may be less
concerned about long-run prospects of the company
while short-run profitability is of their first
priority. Their over-aggressiveness in maximizing
short-run profits could increase the risk of
bankruptcy. The representation of banks thus acts
as a buffer and promotes the long-term financial
health of enterprises. After investigating the
severity of moral hazard problems in association
with the universal banking system, it is
suggested that when banks are allowed to take
equity positions and participate in the
decision-making process of the companies, their
incentives to control moral hazard problems could
be attenuated seriously. In addition, banks with
controlling rights might sometimes lead
enterprises to misallocate their funds for the
sole benefits of the banks.
8

• The difficulty in monitoring large universal
  banks is also a major concern. The consequence of
  inefficient monitoring could lead to financial
  instability. Benston (1994) states that universal
  banks tend to be larger so that collapse of a
  single bank of this type could cause substantial
  distress in the financial system. When several of
  those large universal banks are to collapse, this
  will greatly increase the risk to the economys
  payments system. At the same time, it is more
  difficult to regulate universal banks because of
  their close and complex ties to businesses.
  Hence, financial regulators either have to
  regulate universal banks very tightly, thus
  hindering economic efficiency, or be faced with
  the possibility of a taxpayer bailout.
• THE NEED BEHIND THE ADVENT OF UNIVERSAL BANKING
• To make pace with the present need of corporate.
  means there is a need of developing a strong
  domestic financial system to cater the need of
  the corporate sector. It is possible if banks
  have strong capital/asset base. It fortifies the
  importance of Universal Banking. Along with that,
  the ongoing clamor of Mergers and Acquisitions in
  the corporate sector, this needs financial
  assistance as well as consulting. Indian banking,
  with the help of Universal Banking has technology
  edge and better business models, compared to
  pre-liberalizations era, today they are able to
  attract and gain more volumes simply because they
  meet their customers' requirements better than
  anyone else.
• . Funds Mobilization and Credit Rationing. The
  traditional activities of banks are deposit
  taking and lending. Deposits are liabilities of
  banks, while funds extended by banks to borrowers
  are their assets. The fundamental function of
  banks is to mobilize available funds from the
  surplus units to the deficit units.

9
There are three basic mechanisms that banks apply
in order to monitor their borrowers. First, a
bank can directly obtain information of the
borrowers cash flow when the bank itself handles
the borrowers deposit account. The second
arrangement is more formal as restrictive
covenants are stipulated in a loan contract. The
borrower is required to maintain a pre-set range
of liquidity determined by the bank. Lastly, the
bank is granted the right to monitor the
operation of the enterprises that borrow from
them. Universal banks often apply the last
mechanism and maintain a close and extensive
connection with borrowers.
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SWOT Analysis

• StrengthsEconomies 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.
• Profitable Diversions By diversifying the
  activities, the bank can use its existing
  expertise in one type of financial service in
  providing other types.
• 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.
• 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.
• One stop shopping.
• Investor friendly activities 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.

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Weaknesses Grey area of Universal Bank 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. NPA problem remained intact
The most serious problem of DFIs have had to
encounter is bad loans or Non Performing Assets
(NPA). but the IDBI has got worst hit of NPAs,
considering the negative developments at Dabhol
Power Company (DPC). Threats Big Empires
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. Opportunities To increase
efficiency and productivity 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.
12

• 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.
• To eradicate the 'Financial Apartheid
  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.

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THE FUTURE TREND OF UNIVERSAL BANKING IN
DIFFERENT COUNTRIES International Scenario
Universal banks have long played a leading role
in Germany, Switzerland, and other Continental
European countries. The principal financial
institutions in these countries typically are
universal banks offering the entire array of
banking services. Continental European banks are
engaged in deposit taking, real estate and other
forms of lending, foreign exchange trading, as
well as underwriting, securities trading, and
portfolio management. Salient Characteristics of
the German and Swiss Banking Systems It is
certainly true that in countries like Germany and
Switzerland large universal banks with nationwide
networks of branches play an important, if not
dominant, role. Universal Banking and
Specialization In Germany and Switzerland,
financial institutions may be classified into
broadly similar groups big banks,
government-owned savings banks, regional banks,
cooperative banks, branches of foreign banks, and
private banks. In addition, both countries
feature one of two remaining groups of diverse
and highly specialized institutions. Regional
banks tend to be more specialized than the big
institutions. The largest German regional banks,
however, have turned into truly universal
institutions. In Switzerland most of the regional
banks, in fact, are small savings banks heavily
engaged in mortgage lending. These banks do not
play a significant role in investment banking and
they are not active abroad.
14
Cooperative banks, like government-owned savings
banks, are institutions focusing on the savings
business. Although initially conceived as
self-help organizations, which mainly accepted
deposits from and lent funds to members of the
cooperative, they gradually evolved into
universal banks when they set up central
institutions, as was done in Germany. In
Switzerland, by contrast, cooperative banks
remained less important, as indicated by their
respective shares in total assets of the banking
system (Table 1). Due to their small market
share, Swiss cooperative banks have not expanded
into universal banking to any great extent.
Table 1 point to two striking differences in the
structure of German and Swiss banks' earnings.
First, German institutions, as a whole, resemble
more closely traditional commercial banks than
their Swiss counterparts. In Germany, the average
ratio of commission income to net revenue is much
lower than in Switzerland. The relatively high
Swiss ratio reflects the important role played by
Swiss banks in underwriting, securities trading,
and portfolio management. Second, in Germany,
that ratio displays a much smaller variability
across the various banking groups than in
Switzerland. In Germany it fluctuates between 12
to 30 percent as compared to a range of 9 to 80
percent in Switzerland. Thus, while German banks,
on average, are less universal than their Swiss
counterparts, universal banking in Germany is
more evenly spread across the various groups of
financial institutions than in Switzerland.
15
Are the Objections to Universal Banking
Justified? There are four major objections to
universal banking. In his study of the
Glass-Steagall Act, George Benston (1990) reviews
critically these objections. In his view, the
case for separation of commercial and investment
banking rests on weak foundations 1. Riskiness
and Lender-of-Last Resort Problems As a result
of the recent collapse of the real estate market,
many Swiss banks are compelled to make provisions
against bad mortgage loans. . If large
institutions run into solvency problems, central
banks may be confronted with the dilemma of "too
big to fail." 2. Conflicts of Interest If
universal bank attempts to hide blunders in
underwriting by shifting unsaleable securities to
its trust department, its customers are likely to
be confronted with relatively low returns on
their portfolio investments. Competitors,
including specialized banks, have an incentive to
bid away customers from the low-performing
universal institution. Thus, market forces tend
to induce universal banks to eradicate
conflict-of-interest problems. 3. Concentration
of Power The intensification of competition and
the regulatory changes mentioned earlier have
curbed the power of the big Swiss banks.
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The Future of Universal Banking The German and
Swiss experiences suggest that three factors will
determine future growth of universal banking.
First, they are able to exploit economies of
scale and scope in banking. These economies are
especially important for banks operating on a
global scale and catering to customers with a
need for highly sophisticated financial services.
Second, although universal banks have expanded
their sphere of influence, the smaller
specialized institutions have not disappeared.
Third, No single type of universal banking system
exists. We have shown that the German and Swiss
universal banking systems differ substantially in
this regard.
17
TABLE 1Banking Structure in Germany and
Switzerland, 1991
Number of Banks(End of Year) Percentage Share of Banking Group in Total Assets(End of Year)
Germany
Big Banks 4 9 4 9
Regional Banks 198 14 198 14
Government-owned Savings Banks 757 34
Saving Banks 746 20
Central Savings Banks 11 14 11 14
Cooperative Banks 3158 15
Credit Cooperatives 3154 11
Central Cooperative Banks 4 4
Private Banks 84 1
Branches of Foreign Banks 60 1
Other Financial Institutions 102 25
Total 4363 100
18
Number of Banks(End of Year) Percentage Share of Banking Group in Total Assets(End of Year)
Switzerland
Big Banks 4 49
Regional Savings Banks 189 8
Cantonal Banks 28 20
Cooperative Banks 2 3
Private Banks 19 1
Branches of Foreign Banks 16 1
Other Banks 222 16
Finance Companies 112 2
Total 592 100
19
Commissions as Percentage of Net Revenue
Germany
Big Banks 26
Regional Banks 21
Government-owned Savings Banks 14
Saving Banks 14
Central Savings Banks 12
Cooperative Banks 1 16
Credit Cooperatives 14
Central Cooperative Banks 30
Private Banks 29
Branches of Foreign Banks 29
Other Financial Institutions n.a.
Total 18
Switzerland
Big Banks 47
Regional Savings Banks 19
Cantonal Banks 21
Cooperative Banks 9
Private Banks 80
Branches of Foreign Banks 34
Other Banks 54
Finance Companies 32
Total 44
Sources Deutsche Bundesbank (1992a Tables 13,
22a 1992b42-47), and Swiss National Bank (1992
Tables III, 1, 1 40.0-40-8).
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UNIVERSAL BANKING IN INDIA

• Indian Scenario
• Commercial banks . Ever since the process of
  liberalization hit the Indian shores, the banking
  sector saw the emergence of new-generation
  private sector banks. . Off late, commercial
  banks in India have been permitted to undertake a
  range of in-house financial services. Some banks
  have even setup their own subsidiaries for their
  investment activities. Subsidiaries include in
  the area of merchant banking, factoring, credit
  cards, housing finance etc.
• 2. Financial Institutions
• DFIs were traditionally engaged in long term
  financing, as their main objective was to take
  care of the investment needs of industries and to
  contribute to a better industrial climate.
• Indian Perspective on Universal Banking
• The following are the issues which are key in
  Indian context.
• i. Regulatory burden
• ii. Regulatory requirements
• iii. Distinction between maturity and duration
• iv. Optimum Transition path

21

• Regulatory burden . DFIs in India are governed
  by separate Acts and banks are regulated by RBI
  and Banking Regulation Act. In India there is an
  urgent need to reduce the regulatory burden,
  particularly for banks vis-à-vis mutual funds and
  insurance companies, if the banks are expected to
  compete in free market place.
• ii. Regulatory requirements
• 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 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..
•   c)     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 and experience.  

22
  e)    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.   f)    
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. 
23
  i)    Licensing. An FI converting into a
universal bank would be required to obtain a
banking licence from RBI under Section 22 of the
B. R. Act, for carrying on banking business in
India, after complying with the applicable
conditions.     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 Act.   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 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.
24
  o)       Authorized Dealer's License. Some of
the FIs at present hold restricted AD licence
from RBI, Exchange Control Department to enable
them to undertake transactions necessary for or
incidental to their prescribed functions.   On
conversion into a universal bank, the new bank
would normally be eligible for full-fledged
authorised dealer licence and would also attract
the full rigour of the Exchange Control
Regulations applicable to the banks at present,
including prohibition on raising resources
through external commercial borrowings.   p)    
Priority sector lending. On conversion of an FI
to a universal bank, the obligation for lending
to "priority sector" up to a prescribed
percentage of their 'net bank credit' would also
become applicable to it . 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.   iii. Distinction between
Maturity and Duration The interim report of S H
Khan committee has argued that the distinction
between commercial and investment banking have
become increasingly blurred with banks providing
both working capital and term loans to corporates
but DFIs can provide only term loans as they
cannot accept short term deposits. The committee
further argued that DFIs should be given banking
licenses eventually and until then they should be
allowed to establish 100 percent banking
subsidiaries while they continue to play their
present role. iv. Optimal Transition path . The
S H Khan working group and the discussion paper
on the subject prepared by RBI eventually felt
that DFIs should transform themselves into
commercial banks but in a phased manner.
25
The 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. In
India Development financial institutions (DFIs)
and refinancing institutions (RFIs) were meeting
specific sect oral 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 liberalisation and
deregulation of financial sector, there has been
blurring of distinction between the commercial
banking and investment banking. 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. IS UNIVERSAL BANKING GOOD OR
BAD FOR THE COUNTRY? Universal banking brings
about convergence of financial services under one
roof. The initial impetus to the concept
worldwide was the need to bring down the
intermediation costs. Universal banking, which
may result in changed priorities of FIs, will
seriously hinder our efforts to build a
manufacturing sector that can compete with the
best on its own terms.
26
UNIVERSAL BANKING THE MEANS AND THE ENDS ARE
CONTROVERSIAL Universal banking is about to
become a reality. As a financial intermediary,
banks accepted deposits which they lent and the
difference between the interest earned (from the
borrowers) and that paid (on deposits) called the
spread has traditionally formed the major part of
their income. To fund their long-term lending
activities, DFIs looked to the government for
cheap funds and tax breaks. Part of the SLR
securities which banks have been compelled to buy
were instruments issued by one of the DFIs. Banks
meet their funding requirements by accepting
deposits of less than three year duration. At a
larger level there is always the need for setting
up a level playing field for all-former DFIs
which have converted to universal banks as well
the more established banks. WHAT UNIVERSAL
BANKING CAN RESULT FOR INDIA With official
committees recommending a move towards universal
banking, DFIs, led by ICICI, are getting set to
storm the banking arena. With universal banking,
banks will offer a wide range of financial
services, beyond solely commercial banking or
investment banking. Advantages it results in
greater economic efficiency It enables asset
diversification It offers reasonable protection
from economic cycles
27
In India, banks have traditionally been prime
lenders for working capital loans and DFIs
financed term loans. Now, with DFIs told to move
towards universal banking, banks have been
allowed to diversify into investments and
long-term financing, and DFIs will lend for
working capital. RBI has mentioned that DFIs
would need to prepare a transition path in order
to fully comply with the regulatory requirement
of a bank and such requests will be considered on
case by case basis.
Services on offer ICICI IDBI SBI HDFC LIC
Insurance Yes No Yes Yes Yes
MF Yes Yes Yes Yes Yes
Banking Yes Yes Yes Yes Yes
Merchant banking Yes Yes Yes No No
Broking Yes Yes Yes Yes No
Retail finance Retail finance Retail finance Retail finance Retail finance Retail finance
Housing Yes No Yes Yes Yes
Credit/debit cards Yes No Yes Yes No
28
SBI and LIC can be considered universal banks.
SBI deals with MFs and investment banking, and
its insurance initiative with Cardiff SA brings
it closer to the universal bank objective. And
LIC's move to acquire a stake in Corporation Bank
makes it a serious candidate. ICICI has begun
reducing the number of its subsidiaries, and is
planning to merge with ICICI Bank, in a bid to
turn into a universal bank in 12-18 months. THE
ROAD AHEAD TO INDIA The choice between universal
and specialized banking may affect interest
rates, underwriting costs, and the efficiency of
secondary markets in securities. Furthermore, the
presence or absence of formal bank relationships
may affect the quality of investments undertaken,
strategic decision-making, and even the
competitiveness of industry. A universal bank is
a one-stop supplier for all financial products
and activities, like deposits, short-term and
long-term loans, insurance, investment banking
etc. Global experience with universal banking has
been varied. Universal banking has been prevalent
in different forms in many European countries,
such as Germany, Switzerland, France, Italy etc.
Nevertheless, the United States has once again
started moving cautiously towards universal
banking through the Gramm-Leach-Bliley Act of
1999 which rolled back many of the earlier
restrictions. Some recent phenomenon, like the
merger between Citicorp (banking group) and
Travelers (insurance group) confirmed the fact
that universal banking is here to stay. a bank
can reduce average costs and thereby improve
spreads if it expands its scale of operations and
diversifies its activities. By diversifying, the
bank can use its existing expertise in one type
of financial service in providing the other
types.
29
A banks equity holding in a borrower firm acts
as a signal for other investors on the health of
the firm, since the lending bank is in a better
position to monitor the firms activities. This
is useful from the investors point of view. that
commercial banks can enter insurance business
either by acting as agents or by setting up joint
ventures with insurance companies. And the RBI
allows banks to only marginally invest in equity
(5 per cent of their outstanding credit).
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. Even then, some
groups like the HDFC (commercial banking and
insurance joint venture with Standard Assurance),
ICICI (commercial banking), SBI investment
banking) etc., have already started diversifying
from their traditional activities through setting
up subsidiaries and joint ventures. In a recent
move, the Life Insurance Corporation increased
its stakes in Corporation Bank and is planning to
sell insurance to the customers of the Bank.
Corporation Bank itself has been planning to set
up an insurance subsidiary since a long time.
Even a specialized DFI, like IIBI, is now talking
of turning into a universal bank.
Do Universal Banks Increase the Risk of Financial
Instability? Universal banks are said to be
particularly vulnerable, because of their close
ties to business, particularly their role in
underwriting and distributing securities. If one
or several universal banks were to collapse, it
might lead to a systematic financial crisis,
possibly including a risk to the economy's
payments system. . Although, compared to
commercial banking alone, returns from combined
commercial and investment banking (and other
activities, such as mortgage banking, insurance,
and real estate investment) would be
significantly higher, and risk would be slightly
higher.
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Do Universal or Specialized Banks Enhance
Economic Development More? Some legislators and
government officials believe that they can
enhance economic development by directing
resources towards specific goals. Will Universal
Banks Deploy Capital as Efficiently as the Stock
Market? Critics of universal banking worry that
such institutions will injure stock markets,
because when universal banks trade and hold
equity securities, they are sometimes said to
discourage the development of an active stock
exchange and independent stock brokers and
dealers. Universal banks also have certain
advantages in restructuring firms. The
transactions cost of takeovers and mergers are
high in a stock market system. and might well be
lower with a universal bank If, instead of being
restricted to loans, a bank were to own the full
range of classes of both the firm's debt and
equity, the bank could gain the control necessary
to effect reorganization much more economically.
Will Universal Banks Crowd Out Other Financial
Institutions? Economies of scale and scope and
efficiency indicate some advantage for universal
banks over specialized banks. Will Universal
Banks Reduce Consumer Choice? Universal banks
have neither significant economies of scale or
scope nor great political power. Second, even if
universal banks were to dominate financial
markets, consumers could still patronize one bank
for loans, another for underwriting, and a third
for securities trading. Consequently, consumers'
choices would not necessarily decline.
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• Can Universal Banks Give Impartial Investment
  Advice?
• Many of the possible conflicts specified either
  do not disadvantage consumers or would occur only
  if the bank were operated contrary to the
  interests of its shareholders.
• FINDINGS
• After considering issues of financial stability,
  economic development, competition among financial
  institutions, concentration of economic and
  political power, consumer choice, and conflicts
  of interest, I find that universal banking can
  provide considerable benefits and would pose few
  problems for the economy.
• Considerations Though, the above research
  results in Universal Banking being beneficial for
  India customers offering various advantages,
  still, caution must be applied in implementing
  Universal banking because of the following
  considerations
• Dis-intermediation (i.e. replacement of
  traditional bank intermediation between savers
  and borrowers by a capital market process) .
• 2. There is an ample room for financial deepening
  (by banks DFIs) since loan market will continue
  to grow.
• 3. DFIs as a folder of equity in most of the
  projects promoted in the past have never used the
  tool advantageously.
• 4. DFIs are now only moving into working capital
  finance, an area in which they need to gain lot
  of expertise and this involves creation of
  network of services (including branches) in all
  fields like remittances, collections etc.

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5. Reforms in the Indian capital market are still
in the half way stage. The priority will be to
ensure branch expansions, financial deepening of
credit markets, and creation of an efficient
credit delivery mechanism that can compete with
the capital market.
RecommendationsThe following are the steps
suggested for successful implementation of
Universal Banking in India a. Equalise the net
regulatory burden across the financial system
(including banks, DFIs, mutual funds, NBFCs and
Insurance companies). b. Lower the regulatory
burden on the over regulated entities. c. Promote
and encourage strong competition. d. Do not
allow the merger of a weak bank with a viably
strong DFI or vice-versa. e. DFIs should be
permitted to set up a 100 percent owned banking
subsidiaries. f. Need is felt to re-examine the
minimum level of SLR requirement in order to meet
the best of international standards.
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CONCLUSION Indias financial sector is
relatively bank-oriented, and banks are the
primary supplier of financial services. With the
regulatory allowance for universal banking,
Indian banks continue to expand its coverage of
financial services in response to customer demand
and profitability concerns. It is believed that
the concept of financial supermarkets could play
a significant role in future given that an
increasing number of transnational companies have
been set up in the region and also by the opening
of Indian Banking sector to foreign players.
Thank You