Universal Banking

• 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 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.

• About The Committee Which Recommended Universal Banking & What It      

       Suggested        

      The SH Khan Committee suggested the concept of Universal Banking. It also suggested to give banking licence 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’ licence 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.

• 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.

NEED OFUNIVERSAL BANKING IN INDIA

            The phenomenon of universal banking—as different from narrow banking—is suddenly in the news. With the second Narasimham 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.

         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. After the banking crisis of the 1930s, the US banned all forms of universal banking through what is known as the Glass-Steagal Act of 1933. This prohibited commercial banks from investment banking activities, taking equity positions in borrowing firms, selling insurance products etc. The idea was to mitigate risky behaviour by restricting commercial banks to their traditional activity of accepting deposits and lending.

           However, universal banking has been prevalent in different forms in many European countries, such as Germany, Switzerland, France, Italy etc. For example, in these countries, commercial banks have been selling insurance products, which have been referred to as Bancassurance and an Allfinanz.

         Research on the effects of universal banking has been inconclusive as there is no clear-cut evidence in favour of or against it anywhere. 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. Hence it becomes all the more imperative to know whether we need universal banks in India. And whether it is a more efficient than the traditional narrow banking. What are the benefits to banks from universal banking? 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. What it means is that 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. So, it entails less cost in performing all the functions by one entity instead of separate specialized bodies. A bank possesses information on the risk characteristics of its clients, which it can use to pursue other activities with the same clients. This again saves cost compared to the case of different entities catering to the different needs of the same clients. 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.  

           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. Now, let us turn to the benefits accruing to the customers. 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. A bank’s 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 firm’s activities. This is useful from the investors point of view. Of course, all these benefits have to be weighed out against the problems. The obvious drawback is that universal banking leads to a loss in economies of specialization. Then there is the problem of the bank indulging in too many risky activities. To account for this, appropriate regulation can be devised, which will ultimately benefit all the participants in the market, including the banks themselves.

In spite of the associated problems, there seems to be a lot of interest expressed by banks and financial institutions in universal banking. 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.

            Even though there might not be profits forthcoming in the short run due to the switching cost incurred in moving to new business. The long-run prospects, however, are very encouraging. At present, only an’ arms-length’ relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. the Insurance Regulatory and Development Authority (Irda). Which means 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, which they are lobbying to avoid. 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 universal banking.

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

UNIVERSAL BANKING: SOLUTION TO FIs PROBLEMS

               The financial institutions (FIs) such as ICICI, IDBI are reported to be exploring possibilities of conversion into universal banks as a solution for their problems. This follows the recommendation of the S.H.Khan Working Group. The FIS come into existence, in pursuance of the earlier policy of the State arranging funds for institutions set up for providing long-term finance. In the earlier period, FIS had access to the Long Term Operation Fund (LTO) set up the RBI out of its surpluses. With the initiation of reforms in 1996,the RBI discontinued the LTO.The term lending institutions, which had depended on LTO funds were left without funds. Added to this were the series of adverse developments in the industrial sector in India, partly as a result of opening up the economy. Many corporate become sick, as they were unprepared for strong competitive environment. Thus the FIs had also indulged in a liberal splurge of debt financing, in the optimistic expectation that liberalization would mean an improvement in prospects for industries. Thereafter FIs faced by a surge of NPAs.

         

              The problem of easier access to resources has been one of the driver’s behind the suggestion to make FIs universal banks. As UBs, FIs will it is expected, be able to access deposits from a wider depositor base. UB is term usually used to cover category of institutions which do various banking businesses including investment banking, securities trading, besides payment and settlement functions and also insurance. The emphasis of the Khan Working Group on UB is however more in the direction of converting the FIs to commercial banks.

       

                The RBI has rightly adopted a cautious approach to this problem and its solution. The conversion of FIs to commercial banks is not by itself a panacea. Conversion also implies that the banks will have to be subject to the statutory requirement such as SLR and CRR.RBI may give some relaxation in statutory requirement in case of new entrant FIs/Ubs.One more way is to asset reconstruction device to sell NPAsof the FIs and to generate funds. Assect Reconstruction Committees (ARCs) where recommended for commercial banks by the M.S.Verma Committee. Is balance sheets are heavily burdened with accumulated NPAs, therefore first they will have to sale these impaired assets through reconstruction cos. Conversion to UB is not a remedy for this fundamental problem. One suggestion is that FIs to be merged with commercial banks. But current level of NPAs of FIs will put additional burden.

             

             Therefore solution UB in the sense of converting the FIs to commercial banks may be neither adequate nor free from further trouble.

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. 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. It is proposed to adopt the following broad approach for considering proposals in this area. 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. Further, any conglomerate, in which a bank is present, should be subject to a consolidated approach to supervision and regulation.

           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 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. The regulatory framework of RBI in respect of DFIs would need to be strengthened if they are given greater access to short-term resources for meeting their   Financing requirements, which is necessary. In due course, and in the light of evolution of the financial system, Narasimham Committee's recommendation that, ultimately there should be only banks and Restructured NBFCs can be operationalised.

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.

• 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.

• 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 licence from RBI under Section 22 of the B. R. Act, for carrying on banking business in India, after complying with the applicable conditions.
• 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 east 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 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 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 authorized 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.

• 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.

UNIVERSAL BANKING - CURRENT POSITION IN INDIA

Universal banking

        Downstream                Upstream                         Downstream                 Upstream                                  

       Linkages                     Linkages                          Linkages                       Linkages

 

(The process started         (the process started         (the process started in    (Not yet allo-

in the 1980s but gained     in 1990s with IDBI,        2000 with banks &    -wed; legislative

Momentum in 1990s         ICICI and UTI allowed     DFIs allowed to      changes are reqd

when commercial banks    to set up banking subsi-    enter into                 to be introduced                                                                             started undertaking many   -diaries).                            Insurance               before this could

non-traditional activities)                                               business).               Take place. LIC                      

                                                                                                                     has reportedly

                                                                                                                     expressed its

                                                                                                                  intention to set  or    buy commercial bank.

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           In India, the financial system has traditionally been compartmentalized with three main types of financial intermediaries operating being commercial banks, DFIs and investment institutions (two insurance instutions, viz., LIC and GIC and one mutual fund, viz., UTI).  All these institutions were required to confine their operations strictly to their own areas, barring commercial banks, which were allowed to undertake some investment/merchant banking activity & project finance within prescribed limits. However, in the 1980s & the 1990s many significant changes took place, which increasingly blurred the distinctions between commercial banks and DFIs. In 1983, the Banking Regulation Act was amended and banks were allowed to undertake leasing activity through separate subsidiaries. In the late 1980s, commercial banks were allowed to set up subsidiaries for undertaking other non-traditional activities. Accordingly, many commercial banks were allowed to setup subsidiaries in the field of investment banking, mutual funds, factoring, hire purchases, etc., either wholly owned or jointly in collaboration with other banks/DFIs. In the mid-1990s,all restrictions on project finance activity by commercial banks were removed. Banks were allowed to undertake hire purchase & leasing activities in-house. Major DFIs, such as , IDBI,ICICI  and IFCI also setup subsidiaries in various fields, including commercial banking. They were also allowed to accept deposits within limits and subject to some conditions. DFIs , which traditionally extended only long term project finance have, of late, also started extending short-term loans including working capital. Recently, banks and DFIs have also been allowed to undertake insurance business. It may , thus, be seen from the above  that the  practice of  universal banking is already prevalent in India. It started  with universal banking in a narrow sense by allowing downstream linkages later followed by upstream linkages.  Recently, the practice of universal banking in a broad sense with downstream linkages has also been allowed. However, upstream linkages under broad universal banking have yet to take place.  

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UNIVERSAL BANKING CONCEPT IN FOREIGN COUNTRIES

• BACKGROUND

          A universal bank is a ‘one-stop’ supplier of all financial products and services such as deposits, short-term and long-term loans, insurance, investment banking, etc. Global experience with universal banking has been varied. After the banking crisis of 1930s, the US banned all forms of universal banking through what is known as the Glass-Steagal Act of 1933. This prohibited commercial banks from investment banking activities, taking equity positions in borrowing firms, selling insurance products etc. The idea was to discourage risky behaviour by restricting commercial banks to their traditional activity of accepting deposits and lending.  However, universal banking has been prevalent in different forms in many European countries, such as Germany, Switzerland, France, Italy, etc. Banks like ABN-AMRO, BNP Paribas, and Deutsche Bank have been universal banks for a long time. Nevertheless, the United States once again started moving cautiously towards universal banking through the Gramm-Leach-Bliley Act of 1999 which rolled back many of the earlier restrictions. This resulted in the grand merger of Citicorp (banking group) with Travelers (insurance group).

EXAMPLES OF UNIVERSAL BANKING IN FOREIGN COUNTRIES

 IN USA: -

1] Chase Manhattan Bank: the reorganization of a universal bank

       Chase Manhattan Bank, founded in 1877 in New York, is one of the large money center banks and , right from the beginning has followed a universal banking strategy, seeking to cover all the segments of financial intermediation: commercial banking, wholesale banking , money markets, capital markets, and foreign markets. A major part of Chase Manhattan’s business is concentrated in lending to large corporations and governments, both in United States and abroad.

       After a decade of meteoric growth during 1960s, Chase Manhattan’s performance started to fall off in the 1970s for external & internal reasons.

        One of the external reasons was the ground lost in the North American bond market in the strong advance by other specialized banks such as Salomon Brothers or Citicorp. One of the main internal reasons was the lack of consistent strategic vision in the bank, whose efforts were divided into different businesses.

         These circumstances alarmed the bank shareholders and financial community. As a result of the combination of factors and increasing competition, Chase’s return on assets fell below 0.5 % in the first half of the 1970s. In a way, the situation of Chase Manhattan reflects the consequences of dramatic changes that took place in the financial system during 1970s – particularly intense in USA- & the considerable difficulties experienced at that time by the universal banks (which they continue to experience to adapt to new situation)

            The year 1982 was particularly bad one for Chase Manhattan reflects the consequences of the dramatic changes. The reason was the occurrence of three financial fiascos within a very short : two loans operations to brokerage companies on North American Public debt market ($ 117 million and $42 million, respectively ) and investment in a bank that failed as a result of energy crisis ($ 161 million).

     The perception of the urgent need for a change led to Chase’s senior management to implement a new action plan in 1985. the purpose of this plan was to strengthen its presence in commercial and wholesale banking in the united states, leaving the international market somewhat to one side. To this end, the bank’s executive committee took a series of steps, two of which we consider particularly important.

First was the purchase of a bank, First Lincoln Corporation of Rochester, New York, with 172 branches, and the purchase of six savings and loan associations, which Chase immediately turned into commercial banks. The purpose of these actions was to increase market share in the commercial banking and medium-sized company loans segments. The second measure was to reorganize the bank into three main areas: retail banking, investment banking, and institutional banking (including relations with financial institutions, cash management, portfolio management, and leasing).

          However these efforts failed to achieve the hoped-for results. In 1990, the bank’s pretax income was so low that Chase’s share price on the New York Stock exchange fell to an all-time low. Rumours of a hostile take-over bid or the advisability of a merger with chemical or Manufacturers Hanover were rife in 1990. However, with the change of executive management in 1991, the bank started to climb out of its trough.

            This new period opened with three major decisions. The first was the alienation of those business units that were clearly unprofitable or in which Chase had no particular expertise which include discontinuation of commercial banking in Europe, which Chase had found unprofitable and fiercely competitive.

           The second decision was to consolidate several business units that were clearly important for Chase: the retail banking division, which accounted for 50 per cent of the bank’s total revenues in 1989, and cash management, portfolio management and safekeeping services. The third decision, which was closely related to the other two, was reorganization of its business into three units, from which all of the banks were  co- ordinate:

a) A commercial banking and retail-banking unit concentrated on the east coast, seeking   to operate with private households and small & medium-sized companies;

b) A retail financial products unit for the entire Unite States, including credit cards, investment products, mortgages, and financing consumer durables such as automobiles;

c) A general financial services unit, mainly targeting North American companies and chase customers. This unit was concerned with risk management, portfolio management and international corporate banking.

  Chase’s merger with Chemical Banking will allow the new bank to cut down on costs & gain market share in some businesses.

2] Citicorp: a global universal bank

         Citicorp: First National City Corporation, Citicorp, is the name of the holding company of a group of financial institutions operating in various segments of the financial industry. This bank was formed in 1812 and its original name was City Bank of New York. In 1955, it merged with first National Bank of New York, thus marking the birth of Citicorp.

        By the close of the nineteenth century, it was already the largest bank in the United States, with a tradition of innovation and service acknowledged by corporate customers an rival banks alike. Before the Great Depression of the 1930s, Citibank had started on a major diversification of business, entering the capital market, investment banking, and international banking businesses. However, this diversification process came to a stop when Congress approved the Glass-Stegal Act.

           After the Second World War, innovation in Citicorp, as in the other large American Banks dropped off considerably. The main reason for this was that the package of regulatory majors approved in the early 1930s considerably limited the banks penetration into new businesses. In fact, this restriction was one of the reasons that Citicorp started to promote its international banking business in the early 1960s, under the influence of its CEO, George Moore. Moore’s vision consisted of two clear principles. First, give the best possible service to the American Companies that were starting to expand abroad, particularly in Europe. The aim was to make Citicorp the naturals choice for those American companies with business abroad. The second principle was to recruit young professionals with significant entrepreneurial and innovative potential as a key to developing financial services that the large companies might need.

            As a result of this expansion in its financial businesses, the bank started to redefine its mission: from being a mere financial intermediary, the bank wished to become an organization that offered all the financial services that another, non-financial organization could possibly need. This vision of banking would probably be shared nowadays by all banks with a vocation in universal banking. However, in the early 1960s, this vision was far from common. Bank redefined its mission from being a mere financial intermediary, to become an organization that offered all financial services to non-financial organization. The expansion of Citicorp in U.S. and rest of the world was based on 3 critical actions –

1. Creation of a holding co in 1967, to guarantee that each of the bank’s businesses had the decentralization.
2. Consolidation of a strong retail banking sales network in US and rest of the world, to provide all types of financial services to household and private individuals,
3. Penetration of financial markets particularly in exchange market
4. Major investment in information technologies.

         

     George Moore stepped down in 1967 and was succeeded by Walter Wriston, who was CEO until 1984. Wriston consolidated this strategy under the general formulation, the five I’s: institutional banking, individual banking, investment banking, information technology, & finally insurance. John Reed succeeded Wriston in 1984. Until then, Reed had been chairman of retail banking unit. Then he decided to enlarge the retail-banking unit, in which he had worked previously, and which was profitable and less risky for Citicorp. In early 1990s, Citicorp was the US universal bank that offered the most financial services. In credit cards, Citicorp was the top US bank and the second largest institution, after American Express.

           Citicorp’s clout in the financial services world is undeniable. Citicorp can adequately manage its different businesses in so many geographical markets with the same efficiency as a local specialist.

 IN UNITED KINGDOM                                    

1.BARCLAYS BANK

1.Goldsmith bankers

Barclay’s origins can be traced back to a modest business founded more than 300 years ago in the heart of London's financial district.

In the late 17th century, the streets of the City of London may not have been paved with gold, but they were filled with goldsmith-bankers. They provided monarchs and merchants with the money they needed to fund their ventures around the world.

John Freame and his partner Thomas Gould in Lombard Street founded one such business in 1690. The name Barclay became associated with the company in 1736, when James Barclay - who had married John Freame's daughter - became a partner.

2. A new joint-stock bank

Private banking businesses were commonplace in the 18th century, keeping their clients' gold deposits secure and lending to credit-worthy merchants. In 1896, 20 of them formed a new joint-stock bank.

A web of family, business and religious relationships already connected the leading partners of the new bank, which was named Barclay and Company. The company became known as the Quaker Bank, because this was the family tradition of the founding families.

3. Domestic growth

The new bank had 182 branches, mainly in the East and South East, and deposits of £26 million - a substantial sum of money in those days. It expanded its branch network rapidly by taking over other banks, including Bolithos in Cornwall and the South West in 1905 and United Counties Bank in the Midlands in 1916.

In 1918 the company amalgamated with the London, Provincial and South Western Bank to become one of the UK's 'big five' banks. By 1926 the bank had 1,837 outlets.

Barclays acquired Martins Bank in 1969, the largest UK bank to have its head office outside London. And in 2000 it took over The Woolwich, a leading mortgage bank and former building society founded in 1847.

4. International growth

The development of today's global business began in earnest in 1925, with the merger of three banks - the Colonial Bank, the Anglo Egyptian Bank and the National Bank of South Africa to form Barclays international operations. This added businesses in much of Africa, the Middle East and the West Indies.

In 1981, Barclays became the first foreign bank to file with the US Securities and Exchange Commission and raise long-term capital on the New York market. In 1986 it became the first British bank to have its shares listed on the Tokyo and New York stock exchanges.

      Barclays' global expansion was given added impetus in 1986 with the creation of an investment banking operation. This has developed into Barclays Capital, a major division of the bank that now manages larger corporate and institutional business.

        In 1995 Barclays purchased the fund manager Wells Fargo Nikko Investment Advisers. The business was integrated with BZW Investment Management to form Barclays Global Investors.

5. Recent Developments

Innovation has proceeded apace. The telephone banking service Barclaycall was introduced in 1994 and on-line PC banking in 1997, whilst customized services have also developed with the introduction of Barclays Private Bank and Premier Banking. In 2001 Barclays formed a strategic alliance with Legal & General to sell life pensions and investment products throughout its UK network. Barclays has recently set itself the goal of becoming the employer of choice' and has led the way in the implementation of equal opportunities policies.

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 became the first Indian company to get listed on the NYSE on September 22, 1999. The Company's vision is to transform into a 'Universal Bank' by offering a wide range of products and services to corporate and retail customers in India through a number of business operations, subsidiaries and affiliates.

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 crore, which was oversubscribed.  

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.  

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

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

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 has 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.

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 crore asset base monolith, only second after SBI that has the asset base of 3,16,000 crore. HDFC Bank is left at third place with asset size of Rs. 19000 crore. 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. Merged entity would become fully operational from 31st 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.

      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: -

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

                                   

• 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 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 have 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 can not raise funds. Merger with banks would provide them with access to cheaper funds and retail deposits. It is not possible for government to recapitalise 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 crore in addition to a normal provisioning of Rs. 276 crore. 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 crore.

6. Talent pool of 8275 employees.

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.

 

        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.

     All these reasons have some merit, but from the investor’s point of view, it remains to be seen whether this will lead to greater shareholder value, or not. Hence, from an investor’s point of view, one can expect short-term hiccups and  it might be more prudent to wait and watch, rather than jump into the scrip right now.

          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.

         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 NAPS 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, it will only succeed as a universal bank it is controls costs and reduces non-performing assets. There are no efforts in these two directions. Moreover it is in such a hurry to become a universal bank before the end of this financial year that it failed to take adequate notice of one important factor-the dissatisfaction of 23 per cent of its shareholders, who rejected the merger ratio at the Court convened meeting of January 30.

              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 these been factored in, it may have changed the merger ratio and also benefited ICICI’s other institutional shareholders.  

POST MERGER INTERNATIONAL STRATEGY

             ICICI Bank has formulated its post-merger international strategy. In phase-I the bank intends to have a presence in 10 countries. The country managers to head the various operations have been identified. Post merger, the new entity-ICICI Bank-will be the second largest commercial bank in the country after SBI. The bank will be bigger that Bank of Baroda and Bank of India, which also have a large international presence.

             Based on an analysis of business potential in various geographies, ICICI Bank has identified key target markets in Phase-I for retail & corporate banking. These are the US & Canada in North America, the UK in Europe, Saudi Arabia Kuwait, United Arab Emirates, Qatar, Oman and Bahrain in the Gulf and Singapore in East Asia. In each of the regions a country manager will be in charge of ICICI Bank’s entire operations.

            A team comprising executives deputed from ICICI Bank as well as those recruited locally will support the country manager. The profile of the team members will depend on the specific local banking and home products being offered in that region. The country manager will be responsible for obtaining regulatory approval for branch approval, achieving business targets, managing local alliances, distribution of home country products and developing marketing and operating local banking products.

        Lalitha Gupte will be in charge of the international business division, while Bhargav Dasgupta, international banking head will be responsible for the international banking business. Nimesh Shan, who is head in Dubai, has been appointed as the country manager for the UAE. He also has the responsibility for business generation from other GCC countries. Sonjoy Chatterjee, who heads the representative office in the UK, has been appointed as the country manager for the UK. In North America, M Madhav Kalyan has been appointed as the country manager for the US and will be based in New York. He will also be responsible for ICICI Bank’s business in Canada until a country manager is identified.

           In East Asia, Suvek Namkiar will be the country manager for Singapore. ICICI Bank also plans to provide consulting/training & other services to banks & other amenities internationally. A separate group, Internationally Banking Advisory Group, will be formed initially within the International Business Group.  

INTERNATIONAL RESTRUCTURING - FOR LIFE AFTER MERGER

      ICICI on 12th March 2002, announced an internal restructuring of portfolios across the organization, wherein CEO K.V. Kamath, after taking over as MD & CEO of the merged entity, ICICI Bank, will look into technology organizational excellence – the division responsible for institutionalization of quality initiatives. Sanjiv Kerkar, heading ICICI Lombard General Insurance, will head organizational excellence and Girish Nayak will head the technology management group. Both will report to Mr. Kamath.

      Sandeep Bakshi will take over as the new MD of ICICI Lombard, replacing Mr. Kerkar. This will be effective from the date of merger. Mr. Bakshi is heading the northern & eastern regions for growth client group. Mr. N. Vaghul, who was recently inducted in to the bank board , will take over as Chairman of the ICICI Bank following RBI approval.

       ICICI has also announced the internal structure of the new bank. Lalita Gupte, will take over as joint MD in charge of international banking, while H.N. Sinor will be the joint MD in charge of domestic banking. Among others S Mukherjee, will be in charge of project finance, Kalpana Morparia will head the corporate center, Nachiket Mor will head wholesale banking and Chanda Kochar will be in charge of retail banking.

       The business process outsourcing (BPO) group, which would be a division within the international business group, would be hived off into the separate company to be headed by Ananda Mukherji. BPO’s primary focus will be to leverage skills that ICICI has developed.

       The senior general managers are Balaji Swaminathan – heading the finance group; P.H. Ravikumar will head the agri-business group and small & medium enterprises; Ramni Nirula will look after corporate banking. The domestic banking division will be split in to retail banking group (RBG) & wholesale banking group. Retail banking will aim at being the largest business powerhouse through the distribution of a range of products like mutual funds and insurance policies.

        The RBG itself will split into 6 divisions – retail asset group to be headed by V. Vaidynathan, retail channel and liabilities group to be headed by Amitabh Chaturvedi , retail operations group and rural & micro banking group to be headed by M.N. Gopinath, retail strategy and new product group to report to Mohan Shenoi,retail channel infrastructure group to be looked after by O.P. Srivastava and retail technological group to be headed by Pravir Vohra. Auto finance, mortgage, personal loans and credit cards will come under retail asset group.

          The wholesale banking division will comprise of 6 groups. The corporate solution group (CSG) and the Government solution group(GSG) , corporate operations and technology group will be headed by Madhabi Puri Buch.

       Vishakha Mulye will head structured product & Portfolio management group.

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 crore 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 crore in additional to the normal provisioning of Rs.276 crore 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 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 our 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.

ISSUES &CHALLENGES IN UNIVERSAL BANKING

1. Challenges in Universal Banking

        There are certain challenges, which need to be effectively met by the universal banks. Such challenges need to build effective supervisory infrastructure, volatility of prices in the stock market, comprehending the nature and complexity of new financial instruments, complex financial structures, determining the precise nature of risks associated with the use of particular financial structure and transactions, increased risk resulting from asymmetrical information sharing between banks and regulators among others. Moreover norms stipulated by. Thus all Universal banks have to maintain the CRR and the SLR requirement on the same lines as the commercial banks. Also they have to fulfill the priority sector lending norms applicable to the commercial banks. These are the major hurdles as perceived by the institutions, as it is very difficult to fulfill such norms without hurting the bottom-line. There are certain challenges, which need to be effectively met by the universal banks. Such challenges include weak supervisory infrastructure, volatility of prices in the stock market, comprehending the nature and complexity of new financial instruments, complex financial structures, determining the precise nature of risks associated with the use of particular financial structure and transactions, increased risk resulting from asymmetrical information sharing between banks and regulators among others.

2. Issues of concern for Universal Banking:

• Deployment of capital:

      If a bank were to own a 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. The bank will have greater authority to intercede in the management of the firm as dividend and interest payment performance deteriorates.

• Unhealthy concentration of power:

         In many countries such a risk prevails in specialized institutions, particularly when they are government sponsored. Indeed public choice theory suggests that because Universal Banks serve diverse interest, they may find it difficult to combine as a political coalition – even this is difficult when number of members in a coalition is large.

• Impartial Investment Advice:

        There is a lengthy list of problems, involving potential conflicts between the bank’s commercial and investment banking roles. For example there may be possible conflict between the investment banker’s promotional role and commercial bankers obligation to provide disinterested advice. Or where a Universal Bank’s securities department advises a bank customer to issue new securities to repay its bank loans. But a specialized bank that wants an unprofitable loan repaid also can suggest that the customer issues securities to do so.

CURRENT ISSUES

• UNIVERSAL BANKING- Rising Popularity

As competition intensifies banks are likely to morph into financial supermarkets. Leading the pack is Universal banks, which offer a wide gamut of services targeted at a broader customer base. Their services range from commercial banking and investment banking to insurance and mobile banking.

The popularity of universal banks has been on the rise. Few years ago, investment banks like JP Morgan, Morgan Stanley, Lehman Brothers and Merrill Lynch were the leaders in managing G-3 currency bond deals. But times have changed. Today, universal banks like Citigroup, Deutsche Bank and Barclays Capital, are dominating the markets. By gobbling up smaller banks, these banks have transformed themselves into universal banks in Asia. This has resulted in higher capital costs for companies in Asia.

1. Relationship Business

          Banking has always been a relationship business. Universal banking, focuses on fostering better relationships with customers, which is used a retention tool. Universal banks can also give advantage of lower fees to a customer who gets all his banking needs from the same bank, be it purchase of foreign exchange, managing pension funds or underwriting bonds etc. By acting as lender and underwriter, universal banks are in a better position to understand how a secondary stock offering or an acquisition will affect critical ratios and covenants in loan agreements. And, since banks conduct due diligence before making a loan, they can jump in quickly if a corporation wants to have a last-minute junk-bond offering.

           In Asia, bankers do have relationship lending but their approach is based on loan tying. If the bank loses money on its loans, it recoups its capital from other business driven out of the lending process. In contrast, the universals decide, after carefully considering the returns on capital. As long as the required return from the relationship transaction is in line with their projections, universals go in for loan tying. As opposed to this, investment banks consider returns purely on cost basis. They are more interested in synchronizing the costs of a particular department with the fees charged in the deal. So, while universal banks have the leverage to subsidise their fees with relationship loans investment banks stand deprived.

2. Universals' practice in Asia

        Universals constantly look to lower their fees to grab a deal. They create special purpose entities, which allow them to write off risky assets. These special purpose entities help universals create capital against them. The proceeds from these kinds of activities enable them to charge lesser interest for extended loans. Universals like HSBC and Standard Chartered have dominated the corporate market for over three years. The capital markets have put the emphasis back on lending. Asia's loan volumes have surpassed volumes of equity and equity-linked issuance in 2002, and corporate loan volume is much higher than corporate bond issuance. This has helped universal banks make their presence in the market.

       Citigroup, HSBC, Standard Chartered, ING, Bank of America and ABN AMRO make wide use of special purpose entities for the simple reason that these entities will help them exploit a regulatory loophole in their funding. These entities allow banks to transfer loans from the balance sheet into a vehicle that transforms them into capital-generating assets. Since the special purpose entities remain in the bank’s possession, they offset loan costs at below-market rates. This strengthens the banking relationship and also the risk tied to the underlying asset disappears.

      This is how universal banks operate. Universals offload assets such as bonds, receivables and asset-backed securities into a special purpose entity. Then they issue short-term commercial paper against these assets at very cheap rates. The rate can be in the range 7 to 10 basis points below London Inter-Bank Offer Rate.

        For instance, Korea Development Bank (KDB) had sought a one-year USD 400 million loan in 2002. Several banks like ABN AMRO, Barclays Capital, Deutsche Bank and Bank of Tokyo and Mitsubishi offered KDB a mouth-watering lending rate of 10 basis points over London Inter-Bank Offer Rate (LIBOR). It was a cheap loan for one-year maturity by any standard, the average being 30 basis points over LIBOR for a one-year maturity. Two months after the deal, three loan arrangers of KDB were involved in a bond issue. Following this, KDB

Closed a USD 300 million bond and a USD 450 million bond issues. Barclays Capital acted as a book-runner for both these issues, and ABN AMRO and Deutsche co-managed the deals.

          Structured finance bankers, be it universal banking institutions or investment banking houses, agree that special purpose entities, as a tool of relationship, bolsters business. Universals, thereby, grasp the business by offering competitive fees and cheap loans, which investment banks fail to do. As long as loan tying lowers the company’s cost of capital, the corporate are comfortable with this concept.

3. Future of universal banks in Asia

     Universal institutions such as HSBC, Citigroup, Standard Chartered, ABN AMRO, BNP and Barclays are increasingly dominating loan markets. The specialized investment banks don't have access to a commercial bank's varied deposits to lend from. These banks tend concentrate at their returns on equity. However, investment banks like UBS, which have massive balance sheets, have become very selective about their lending in Asia. Even universal banks like Deutsche Bank are scaling down due to pressure in its home.

          Universal banks tend to bond their relationship lending with successful companies. The investment banks are under increasing pressure to lend money the way the universals do. A three-year collapse of equity markets of Asia is making its impact on corporate capital structures. The regulatory considerations also affect the functioning of the business.

UNIVERSAL BANKING: AN OVERVIEW

          Universal Banking includes not only services related to savings and loans but also investments. However in practice the term “universal banks’ refers to those banks that offer a wide range of financial services, beyond commercial banking and investment banking, insurance etc. Universal banking is a combination of commercial banking, investment banking and various other activities including insurance. If specialized banking is the other. This is most co in European countries.

          Scenario in India has also changed after the Narasimham Committee(1998) and the Khan Committee (1998) reports recommended consolidation of the banking industry through mergers, and integration of financial activities. Today, the shining example is ICICI Bank, second largest bank (in India) in terms of the size of assets, which has consolidated all the services after the merger of ICICI Ltd with ICICI Bank. There are rumors of merger of IDBI with IDBI Bank. With the launch of retail banking, Kotak Mahindra has also embarked on the path of Universal banking.

COMMENTS/VIEWS OF EXPERTS

             GEORGE BENSTON-THE PROFESSOR OF FINANCE AND ECONOMICS IS A VISITING FACULTY AT UNIVERSITY OF LONDON HAS EXAMINED CERTAIN FUNDAMENTAL ISSUES IN DETAIL IN HIS STUDIES, WHICH ARE STATED BELOW: -

• Universal bank raises the risk of financial instability

      Universal Banks tend to grow so large that failure of one can cause economic distress and that narrow, specialized banks may be better. However, the lessons from savings and loans societies scandal do not support this. In fact, neither theory nor experience seems to validate the assumption that limitations on banking – like the separation of commercial and investment banking – either were or more likely to be effective in reducing risk-taking. Incidentally, most of the activities in which universal banks deal are no more risky than the ordinary commercial bank activities. A study of the combined effect of commercial and investment banking on risk reveals that while the returns would be considerably higher, the risks would only be strictly higher. The residual risks regarding a depository institution should be addressed by high capital adequacy, replacing the economic capital before it falls below zero etc., (as against book capital)

• Universal Banks deploy capital as efficiently as the stock market

         While there is some merit in this, the evidence in support is quite weak. It has been observed that the Universal banks have certain advantages in restructuring firms. The transaction costs of takeovers and mergers are high in stock market system and night well is lower with a universal bank.

• Universal Banks Create Unhealthy A Concentrate Of Power

      In fact, we have seen in many countries, such a risk prevails in specialized institutions, particularly when they are government sponsored. Indeed, public choice theory suggests that UB serve diverse interest, they find it difficult to combine as a political coalition-even this is difficult when the number of members in coalition is large.

• Universal Banks tends reduce consumer choice

     The German experience does not appear to support this. Further, it is open for a consumer to approach different universal banks for different services although there are examples of “tie-ins” and “shut-outs”. But then, there will be other universal banks would be competing and therefore, they may not go for “tie-ins”. Besides, there would be regulatory controls also. The only exception is the situation in which bank tie-in-sales extend its monopoly power to an artificially tied product by forcing away independent suppliers out of the business and keeping those and other potentials suppliers away from entering the market.  

 VIEWS BY Mr.B.SAMAL, CHAIRMAN AND MANAGING DIRECTOR, ALLAHABAD BANK OVER UNIVERSAL BANKING

• Views on universal banking and current Position of Allahabad Bank

               Universal banks may be considered as one-stop financial supermarket offering a broad range of services. In a narrow sense, universal banking denotes combination of banking and insurance/investment activities. The second Narasimhan Committee noted the global trends in banking industry towards consolidation and convergence leading to dismantling of boundaries among suppliers of various financial products. The same trend is visible in India too, as banks are already providing a range of financial services either in-house or through subsidiaries. Picking a cue from the Narasimhan Committee, the Khan Working Group also recommended a progressive move towards universal banking and development of enabling regulatory framework

          For that purpose. It is contended that universal banking will result in greater economic efficiency in the form of lower cost, higher output and better products. The sector participants would be free to choose the size and product-mix of their operations in such a way that would optimize use of resources. Therefore, there appears to be a general agreement about inevitability of emergence of universal

banking in India, although differences remain on the pace, modalities and sequences of the events. Allahabad Bank has spotted the opportunity in the insurance sector, as India has a very high potential for growth in insurance because of low level of penetration. We have already tied up with ICICI-Prudential Insurance Company for marketing their product

       

       As a student of BMS I had a great opportunity to do a project of “Universal Banking” which was indeed a wonderful experience and has enhanced my knowledge in banking sector.  

    This study on Universal Banking is important not only to an organization, shareholders, banking sector but also to an Indian economy as a whole. Due to globalization and liberalization our economy is opening its door for reforms.   The onset of universal banking will undoubtedly accelerate the pace of structural change within the Indian banking system. The financial institutions as a segment will essentially convert into banks. This can potentially impose a better corporate control structure on the firms, they can be sources of long-term finance, and they can contribute to real sector restructuring. Universal Banking is totally a new concept in Indian Banking system and ICICI Bank is the first financial Institution to go ahead with this concept.

    Thus Universal banking, in fact, provides for a cafeteria approach or, if one were to vary the metaphor, it would take on the role of a one-stop financial supermarket.

• BOOKS

        Harmonizing the Role and operations of development  

     Financial Institutions and banks-a discussion paper of  

     R.B.I., Mumbai.

“Universal Banking”- International comparisons  

      & Theoretical perspectives” by Jordi Canals.

• MAGAZINES

        Annual Report of ICICI bank

 Indian Institute Journal

• SITES

 www.rbi.org.in

 www.icicibank.com

 www.banknetindia.com

 www.barclays.com

 www.indiainfoline.com

 www.galintranet.godrej.com

 www.indiatimes.com

 www.icfaipress.org

 www.financialexpress.com

 www.kannan.com

 www.allahabadbank.com

        www.economiotimes.com