Universal Banking – an Indian perspective
Navneet Agarwal

If we look at the early Nineties the forces of globalization were unleashed on the so far protected Indian environment. The financial sector was crying out for reform. Public sector banks which had a useful role to play earlier on now faced deteriorating performance. For these and certain other reasons private banking was sought to be encouraged in line with the Narasimham Committee's recommendations.

If we again take a glace at the early nineties: the nationalized banking sector had outlived its utility; in fact they became burdened with unsolicited legacies; the casualty – Customer service; need for computerization, including networking among the vast branch network was felt. Private banking in that context was viewed a brand new approach, to bypass the structural and other shortcomings of the public sector. A few of the new ones that were promoted by the institutions such as the IDBI and ICICI did establish themselves, though in varying degrees, surviving the market turmoil of the 1990.That was possible apart from other factors due to the highly professional approach some of them adopted: it helped them stay afloat clear of the pitfalls of nationalized banking. Yet in less than a decade after the advent of these new generation banks, some of the successful ones are being forced to change and one mode of such change is resorting to Universal banking.

Universal Banking – The concept

To put in simple words, a universal bank is a superstore for financial products. Under one roof, corporates can get loans and avail of other handy services, while individuals can bank and borrow. To convert itself into a universal bank, an entity has to negotiate several regulatory requirements. Therefore, universal banks in a nutshell has  been in the form of a group offering a variety of financial services like deposits, short term and long term loans, insurance, investment banking etc, under an umbrella brand. Citicorp is a reasonably good example of a global UB. The concept has been prevalent in developed countries like France, Germany and US. As for India, how far the ICICI mega-experiment takes off remains to be seen.

Universal Banking – A panacea for beleaguered development financial institutions

From the customer point of view the idea of universal banking might be appealing, but the driving force towards it is rooted in more mundane considerations. Specifically, the development financial institutions (DFIs), such as the ICICI, have had to find new niches in the liberalization era. They are at present dealing with two major problems:

• The termination of subsidized funding and

• A significant chunk of loans turning bad.

Moreover their access to low cost funds has been denied. (Spectacularly true for IDBI but the other two in the triumvirate the IFCI and the ICICI have also suffered). Used to fund long gestation projects, the DFIs have been saddled with serious mismatches between their assets and liabilities side of the balance sheets. The clinching argument in favour of a radical transformation, however, arises from the deteriorating state of the DFIs' financials. Their traditional lending to industries such as textiles and iron and steel has caused them serious problems at a time when the method of classifying balance-sheets has become more transparent. The Narasimham Committee (II) had suggested that DFIs should convert into banks or non-banking finance companies. Of the three DFIs, the relatively better-off ICICI was the earliest to articulate a new strategy to combat the problems by taking the step of converting itself into a universal bank. Some of the issues addressed in the transition path relate to compliance with cash reserve ratio and statutory liquidity ratio requirements, disposal of non-banking assets, composition of the board, prohibition on floating charge of assets, restrictions on investments, connected lending and banking license.

Bearing on DFI’s

Two major areas of the business affected are:

• Access to cheap retail deposits and
• Increase in the breadth of the advances to include short-term working capital loans to corporates.
• Greater operational flexibility.

The institutions can now effectively compete with the commercial banks. They will be able to attract more volumes because they meet most of the needs of their customers under one roof. But some homework needs to be done for providing a suite of services under one roof, the institutions would have to learn to,

• Cross-sell their products,
• Improve distribution channels,
• Adapt to technology to reduce costs in long run and
• Explore more competitive revenue streams.

Bearing on banks

With large Term lenders converting into Commercial banks, the existing players in the industry are likely to face stiff competition, lower bottom-line ultimately leading to a shakeout in the industry with only the operationally efficient banks will stay into the business, irrespective to the size.

In a nutshell the benefits to the bank can be summed as,

• Banks can very effectively exploit economies of scale and scope. In this way they are able to reduce average costs and thereby improve spreads if it expands its scale of operations and diversifies its activities.

• 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 that it can use to pursue other activities of the same client.

• The bank’s existing network of branches can act as shop for selling products like insurance.

Benefits accruing to customers

The idea of "one-shop shopping" saves a lot of transaction cost and increases the speed of economic activity. It is truly the retail customer who gains the most from Universal banking. The wide range of financial products and services offered holds a greater appeal for the customer than specialized banks due to the comprehensive service provided by a universal bank.

Challenges in universal banking

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.

Again with consolidation in the banking industry, there can be only a limited number of universal banks. They could also be highly monopolistic in nature and may form cartels, thus tending to ignore the small customers.

Moreover norms stipulated by RBI treat DFIs at par with the existing commercial banks. 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.

Future of Universal Banking in India

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. At the same time, universal banking causes conflicts of interest which are particularly pronounced for banks in transition economies. The remedy lies in implementing and improving corporate governance in banks through privatization and strengthening banking supervision. This is the key to an efficient and effective universal banking system.

Navneet Agarwal
MBA (IB), 2^nd year
Indian Institute of Foreign Trade (IIFT)
School of International Business Management
Email: nav_agl@yahoo.co.in

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