Impact of Globalization on Indian Banking System

Sparshy Saxena and Satbir Samra

The Indian Banking scene in under a constant cycle of change. The number of banks and their customer-
orientation, technology, diversification, competition and the resultant factors have changed the take on
the perception of a bank as merely being a financial institution. Through its take on globalization, the
Indian Banking sector has undergone varied changes in terms of reforms and nationalization. The
reforms that have been brought into force have changed the market of Indian banking, increasing the
players (both foreign as well as private) and, most importantly, supporting the banking framework with
financial stability and risk absorption capacity. The paper maps the trend of the banking sector across an
expanse stretching from 1985 to 2008, the change in the working of the sector pre- and post events like
nationalization and globalization. It also analyses the impact of reform implementation on the sector as
well as the challenges faced by the Indian banks.

1|I mp a ct o f Gl ob alisa ti o n o n The In di an B an king Se cto r

INTRODUCTION
A bank is a financial institution which
engages in the business of keeping money
for savings and checking accounts or for
exchange or for issuing loans and credit etc.
(http://wordnet.princeton.edu/perl/webwn,
retrieved Jan 20, 2009). The banking section
is vital to any nation’s economy. It is of
prime importance as it has a multiplier effect
on the economy. It also leverages on the
funds by issuing credit creation. The
banking institution in India can be broadly
divided into Scheduled and Non-Scheduled
Banks. (For the hierarchical display of the
banking structure, refer Exhibit 1.1)
A bank is a financial
institution which engages
in the business of keeping
money for savings and
checking accounts or for
exchange or for issuing
loans and credit.
its sleeve. One of them is its extensive reach.
Not confining itself to only the
metropolitans, it has shown a reach to even
the remote areas of the country.
The first conservative bank was set up in
1786. The banking system has been
differentiated under various categories with
each section comprising of branches. The
entire history of the banking industry can be
classified under three phases.
Phase I extends from the earlier time period
till 1969. Phase II covers the period from
the nationalization of the banks till before
the implication of economic reforms. The
Phase III covers the period from after the
implication till present date.(for data
regarding the number of banks under various
categories on a scale from 1985 to 2005,
refer Exhibit 1.2).
The banking sector before the economic
reforms assumed a very traditional method
of working. Phase III paved way for the
advent of globalization, thereby changing
the Indian banking scene.

THE PAST TREND OF THE INDIAN

BANKING INDUSTRY

For the past three decades, the Indian

banking sector has had many credits under

2|I mp a ct o f Gl ob alisa ti o n o n The In di an B an king Se cto r

GLOBALISATION and THE INDIAN
BANKING SYSTEM

REFORM IMPLEMENTATION

Prior to the nationalization of banks, the

banking sector, in the year 1991. The
services were enjoyed by only the industrial
reforms reviewed the system conforming
urban group. 14 banks saw the
to the expanding and emerging need of
nationalization in the year 1969 and six in
the Indian economy. The capital
1980. Thus this led to a monopoly of
adequacy norms, which required banks
government owned banks till the start of the
to have a risk-adjusted capital adequacy
1990s. The banks faced a risk form factors
ratio to absorb risks, as per Basel I
like;
accord was also implemented at this
Need to maintain reserve, time. The regulations that were brought

Interest rates into effect are represented in Exhibit 1.3.

Lack of Competition A second committee was appointed to

Political influence suggest remedial measures for the sector

(Ramasastri A.S & Achamma in the year 1998. The resultant reforms

Samuel (2006), RBI Occasional are shown in Exhibit 1.4. Accordingly,

papers) Basel II was also implemented in effect

from March 31, 2007.
During the early 1990s, the government,
under Narasimha Rao, adopted a policy of The reforms have the reduced the

liberalization which paved the way for amount of equity holdings in banks, but

private participation (mergers and in turn allowing them to access the

acquisitions) and foreign investors. The capital market to raise funds.

phase of Indian banking from 1991 onwards Recruitment policies have become more

was essentially a period of prudential flexible with time allowing banks to

banking. The union government appointed a access a talent pool of staff. In terms of

committee headed by Mr. Narasimha Rao to operations, opening of branches has

study and formulate reforms within the

3| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

become much more feasible. The reforms compared to the traditional security-based
have increased the participation of private as lending. They are more development
well as foreign entities in terms of expansion oriented rather than being commercially
of their operations oriented

However, as an implication of the

Risk Management along
with the Capital
Adequacy requirement
has been one of the
major effects of the
Globalization which has
lead to financial stability
within the Indian banking
Sector
within the country. This has increased the
level of competition faced by the public
banks, thereby pushing them to become
more customer-oriented and thus offer
services comparable to those of the private
and foreign players. The post-globalisation
banking sector has diversified their
businesses into various fields like insurance,
credit cards, infrastructure financing, gold
banking and leasing of assets. This product
mix is offered on a customized basis to the
consumers of the bank. The introduction of
hi-tech technology has further enhanced the
operations and made the whole process more
accurate and faster. The banking sector is
now more purpose and viability based as
implementation of the reforms, the banks
experience a think spread as compared to an
earlier healthy spread.
Globalization created the ground for the
creation of institutions like Credit
Information Bureau India Ltd., National
Securities Depositaries Ltd., Clearing
Corporation of India Ltd., Central
Depositaries Services Ltd. The extent of
investment within banks by foreign entities
and NRI deposits has been relaxed. The
overseas investment limit for corporate has
been extended to up to 100% of the net
profit. Maintenance of foreign currency
accounts is possible under the implication of
the new reforms.
Risk management in terms of capital
adequacy has been of the most vital effects
of globalization and reform implementation
on the Indian banking sector. The capital
adequacy ratio has been increased to 9% of
risked assets. This has insured the fiscal
stability within the banking system as it has
increased the ability to face risks with
liquidity.

4| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

Overall, the deregulation has thrown open
the banking sector to face not only internal
competition but also competition from other
financial market entities like mutual funds,
NBFCs and post office.
There would be a greater presence of
international players in the Indian financial
system and some of the Indian banks would
become global players in the coming years
(Indian Banks’ Association, “Banking
Industry Vision 2010,” n.d). With the advent
of the globalization, the banks not only face
competition from the external market but
also from the internal environment, on
account of increased private players.
Even with the prospects of a bright global
future, the present stance of the Indian banks
is not very rosy amidst the top banks of the
world. This weakens the proposition that the
home banks can compete on an international
level.
As compared to the old 4-6-4 (Borrow at
4%- Lend a 6%- Go Home at 4) ideology
(http://en.wikipedia.org/wiki/Bank,
Retrieved January 20, 2009), a globalised
working has improved the way Indian banks
used to work. The government has
encouraged Private and Foreign
participation. Private banks have been
5| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor
provided incentives for going international.
Foreign ventures are invited alongwith they
getting a substantial investor’s share in the
Indian banks. Mergers and acquisitions and
mergers face a favorable environment.
(Necessary reforms mentioned in Exhibits
1.4 and 1.5). The existing market has been
thrown open for competition and has
become more of a buyers’ market rather
than being a sellers’ market.
A supportive regulatory framework provides
aids for the banks to tap the global market.
V Leeladhar (2005) states certain steps
which have been undertaken to improve the
global opportunities. Prudential accounting
norms in relation to the asset classification,
income recognition and loan loss
provisioning have already been
implemented. The core principles of
Effective Banking Supervision, Basel
Committee have been complied with by
India. Accounts are being presented as per
the U.S GAAP. The government stake in
certain public sector banks has been
reduced, thereby enhancing public equity..
These implementations have increased the
scope of overseas operations by the Indian
Banks.
Universal Banking with Mergers and Institution, IDBI has also adopted the same
Acquisitions strategy, and has already transformed
itself into a universal bank.
Banking industry is developing slowly and Now the process of its progeny IDBI Bank
steadily and development of “large number merging itself with the parent IDBI is
of small banks” to “small number of large underway, and is likely to be completed
banks .” proves it. This new era is going to soon. All these mergers and acquisitions
be one of consolidation around identified may lead to promote the concept of financial
core competencies. Mergers and acquisitions super market chain, making available all
in the banking sector are going to be the types of credit and non fund facilities under
order of the day. under one roof, i.e.under same organization.
Three years ago we saw the successful Consolidated accounting and supervisory
merger of HDFC Bank and Times Bank and techniques would have to evolve as there are
Stanchart and ANZ Grindlays. It many risks in mergers and acquisition as
demonstrated that trend towards good will is also calculated
consolidation is almost an accepted fact. We
can see such signs in respect of a number of
old private sector banks, many of banks are
unable to manage non performing assets
which is main hindrance for development
Coming times may usher in large banking
institutions, if the development financial
institutions go for conversion into
commercial banking by following
recommendation of Narasimhan (II). In
India, one of the largest financial
institutions, ICICI, took the lead towards
universal banking with its reverse merger
with ICICI Bank coming through a couple
of years ago. Another mega financial

6| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

FUTURE CHALLENGES OF THE
INDIAN BANKING SECTOR

(i) Improving profitability:

In order to increase profitability, banks are
required to take many decisions like strategy
to compete with international players. The
challenge for banks is management of
thinning margins while, at the same time
working to improve productivity which
remains low in relation to global standards.
(ii) Reinforcing technology :
Now a days technology has become an
integral part of banking. So, advancement in
technology is mandatory for the
development of banking sector. Customers
have become very demanding and banks
have to deliver customised products through
multiple channels, allowing customers
access to the bank round the clock.
(iii) Risk management:
In banking, extensive business gives rise to
more risk and to avoid all risks like credit
risk, market risk, and operational risk, banks
need to adopt technology-driven
management and information system.
(iv) Sharpening skills:
To meet the increased competition and to
manage risks, the demand for specialised
banking functions, using IT as a competitive
tool, is set to go up. Special skills in retail
banking, treasury, risk management, foreign
exchange, development banking, etc., will
need to be carefully nurtured and built.
(v) Greater customer orientation: In
today’s competitive environment, banks will
have to strive to attract and retain customers
by introducing innovative products,
enhancing the quality of customer service
and marketing a variety of products through
diverse channels targeted at specific
customer groups.
(vi) Corporate governance:
Besides using their strengths and strategic
initiatives for creating shareholder value,
banks are required to be conscious of their
responsibilities towards corporate
governance.

7| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

(vii) International standards: capabilities and products, but yet with this
back-up, banks need to review their working
Introduction of internationally followed
and basic principles in order to reach a
best practices and observing universally
global or an international platform
acceptable standards and codes is necessary
sucessfully. In times of economic instability,
for strengthening the domestic financial
factors like dollar volatility, lowering of
architecture. In today’s globalised world,
reserve limits, flattening of a consumer
focusing on the observance of standards will
boom, it would indeed be a challenge to the
help smoother integration with world
Indian banking sector to co-manage
financial markets.
profitability and achieving a global standard.

CONCLUSION

With the entry of foreign players and

increased competition, the banks have been
pushed into a phase of self-realisation in
order to improve profitability as well as their
position in the market. This has lead to a
diversification of the services to activities
that are not traditionally institutional in
nature. In light of the necessary need for the
banks to go global, the possibility of their
extension is difficult. Some of the potential
banks do have the required human resource

8| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

 EXHIBITS

Exhibit 1.1

Source : www.wikipedia.org

Exhibit 1.2

Source : Ramasastri A.S & Achamma Samuel (2006), RBI Occasional papers

9| I mp a ct of Glo bali sa ti on o n The I ndi an Ba nki ng Se ctor

Exhibit 1.3
The Narsimha Committee Report (1991)
Reforms Listed
Lowering of SLR to 25% over a period of
5 years.
CRR operational flexibility by RBI
Phasing out of Directed credit program.
Regulation of Interest rate.
Minimum Capital Adequacy Ratio for banks.
Asset valuation at realizable value.
Uniform following of the accounting
principles.
No income recognition in terms of
Non-Performing Assets.
Asset classification to be followed as
prescribed.
Pre-Payment of the balance sheet according
to the International Accounting standards.
Tribunals for speedy recovery of debts.
Establishing of Asset Reconstruction Funds.
Encouragement of Mergers and
Acquisitions.
No further Nationalisation of Banks.
Abolishment of licensing.
Rationalizing of foreign operations of the
Indian banks
Organizational control over the internal
management
Encouragement of foreign banks
Computerization of activities
Provision of internal autonomy
Avoidance of over-regulation
Source: RBI (1991): Narasimha Committee Report
10 | I m p a c t o f G l o b a l i s a t i o n o n T h e I n d i a n B a n k i n g S e c t o r
Exhibit 1.4
The Narsimha Committee Report (1998)
Reforms Listed
Consideration of the Market and credit
ratio
Increase in Capital to Risk assets to 10%
from 8%.
Tapping of capital markets or Central
government for bank funding.
No further recapitalization of banks
from Government budget.
Target level of NPA for 2003 as below
3.1%.
International recognition of 96 days for
Income recognition
Public availability to full disclosure
Adaptation of risk management
techniques
Inception of new technology
Close scrutiny of computer credit.
Appointment of statutory auditor by the
bank auditor.
Conversion of financial institutions into
banks over a period of time.
Scope definition in terms of external and
regional possibilities.
Allowing the set-up of subsidiary joint
ventures by foreign banks in India.
Reform of the deposit insurance scheme.
Review of the financial institutions.
Source: RBI (1998): Narasimha Committee Report
 BIBLIOGRAPHY

Ramasastri A.S & Samuel Achamma (2006) : “Banking sector Developments In India, 1980-
2005:What the Annual Accounts Speak?”, Reserve Bank of India Occasional Papers,
Summer and Monsoon 2006

V Leeladhar (2005) : “Contemporary and Future Issues in Indian banking”, Speech in

Kanara Chamber of Commerce and Industry, March 11

Reddy Y.V. (2005) : “Banking sector reforms in India : An Overview”, Reserve Bank of
India Bulletin,June

Reserve Bank of India (1991) : Report on the Financial System (Narasimha Committee
report)

Dr. K Sabrinath & Mrs. Sethu Ravi (n.d) : “Challenges and Opportunities Surging in the
Recent Banking Scenario”

Kapila Raj & Kapila Uma (1992) Banking, Financial Sector Reforms in India, Delhi
Academic Foundation

http://wordnetweb.princeton.edu/perl/webwn?s=banking, Retrieved January 20, 2009

11 | I m p a c t o f G l o b a l i s a t i o n o n T h e I n d i a n B a n k i n g S e c t o r