Definition of Universal Banking: As per the World Bank, "In Universal Banking,

large banks operate extensive network of branches, provide many different services,
hold several claims on firms(including equity and debt) and participate directly in the
Corporate Governance of firms that rely on the banks for funding or as insurance
underwriters".

In a nutshell, a Universal Banking is a superstore for financial products under one

roof. Corporate can get loans and avail of other handy services, while can deposit
and borrow. It includes not only services related to savings and loans but also
investments.

However in practice the term 'universal banking' refers to those banks that offer a
wide range of financial services, beyond the commercial banking functions like
Mutual Funds, Merchant Banking, Factoring, Credit Cards, Retail loans, Housing
Finance, Auto loans, Investment banking, Insurance etc. This is most common in
European countries.

For example, in Germany commercial banks accept time deposits, lend money,
underwrite corporate stocks, and act as investment advisors to large corporations. In
Germany, there has never been any separation between commercial banks and
investment banks, as there is in the United States.

THE CONCEPT OF UNIVERSAL BANKING

The entry of banks into the realm of financial services was followed very soon after
the introduction of liberalization in the economy. Since the early 1990s structural
changes of profound magnitude have been witnessed in global banking systems.
Large scale mergers, amalgamations and acquisitions between the banks and
financial institutions resulted in the growth in size and competitive strengths of the
merged entities. Thus, emerged new financial conglomerates that could maximize
economies of scale and scope by building the production of financial services
organization called Universal Banking.

By the mid-1990s, all the restrictions on project financing were removed and banks
were allowed to undertake several in-house activities. Reforms in the insurance
sector in the late 1990s, and opening up of this field to private and foreign players
also resulted in permitting banks to undertake the sale of insurance products. At
present, only an 'arm's length relationship between a bank and an insurance entity
has been allowed by the regulatory authority, i.e. IRDA (Insurance Regulatory and
Development Authority).

The phenomenon of Universal Banking as a distinct concept, as different from

Narrow Banking came to the forefront in the Indian context with the Narsimham
Committee (1998) and later the Khan Committee (1998) reports recommending
consolidation of the banking industry through mergers and integration of financial
activities.

UNIVERSAL BANKING – PROS AND CONS

The solution of Universal Banking was having many factors to deal with, which can
be further analyzed by the pros and cons.
Advantages of Universal Banking

• Economies of Scale. The main advantage of Universal Banking is that it

results in greater economic efficiency in the form of lower cost, higher output
and better products. Many Committees and reports by Reserve Bank of India
are in favour of Universal banking as it enables banks to explit economies of
scale and scope.
• Profitable Diversions. By diversifying the activities, the bank can use its
existing expertise in one type of financial service in providing other types. So,
it entails less cost in performing all the functions by one entity instead of
separate bodies.
• Resource Utilization. A bank possesses the information on the risk
characteristics of the clients, which can be used to pursue other activities with
the same clients. A data collection about the market trends, risk and returns
associated with portfolios of Mutual Funds, diversifiable and non diversifiable
risk analysis, etc, is useful for other clients and information seekers.
Automatically, a bank will get the benefit of being involved in the researching
• Easy Marketing on the Foundation of a Brand Name. A bank's existing
branches can act as shops of selling for selling financial products like
Insurance, Mutual Funds without spending much efforts on marketing, as the
branch will act here as a parent company or source. In this way, a bank can
reach the client even in the remotest area without having to take resource to
an agent.
• One-stop shopping. The idea of 'one-stop shopping' saves a lot of
transaction costs and increases the speed of economic activities. It is
beneficial for the bank as well as its customers.
• Investor Friendly Activities. Another manifestation of Universal Banking is
bank holding stakes in a form : a bank's equity holding in a borrower firm,
acts as a signal for other investor on to the health of the firm since the
lending bank is in a better position to monitor the firm's activities.

Disadvantages of Universal Banking

• Grey Area of Universal Bank. The path of universal banking for DFIs is
strewn with obstacles. The biggest one is overcoming the differences in
regulatory requirement for a bank and DFI. Unlike banks, DFIs are not
required to keep a portion of their deposits as cash reserves.
• No Expertise in Long term lending. In the case of traditional project
finance, an area where DFIs tread carefully, becoming a bank may not make
a big difference to a DFI. Project finance and Infrastructure finance are
generally long- gestation projects and would require DFIs to borrow long-
term. Therefore, the transformation into a bank may not be of great
assistance in lending long-term.
• NPA Problem Remained Intact. The most serious problem that the DFIs
have had to encounter is bad loans or Non-Performing Assets (NPAs). For the
DFIs and Universal Banking or installation of cutting-edge-technology in
operations are unlikely to improve the situation concerning NPAs.

UNIVERSAL BANKING IN INDIA

In India Development financial institutions (DFIs) and refinancing institutions (RFIs)

were meeting specific sect oral needs and also providing long-term resources at
concessional terms, while the commercial banks in general, by and large, confined
themselves to the core banking functions of accepting deposits and providing
working capital finance to industry, trade and agriculture. Consequent to the
liberalisation and deregulation of financial sector, there has been blurring of
distinction between the commercial banking and investment banking.

Reserve Bank of India constituted on December 8, 1997, a Working Group under the
Chairmanship of Shri S.H. Khan to bring about greater clarity in the respective roles
of banks and financial institutions for greater harmonization of facilities and
obligations . Also report of the Committee on Banking Sector Reforms or
Narasimham Committee (NC) has major bearing on the issues considered by the
Khan Working Group.

The issue of universal banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible options for transforming
itself into an universal bank. Reserve Bank of India also spelt out to Parliamentary
Standing Committee on Finance, its proposed policy for universal banking, including
a case-by-case approach towards allowing domestic financial institutions to become
universal banks.

Now RBI has asked FIs, which are interested to convert itself into a universal bank,
to submit their plans for transition to a universal bank for consideration and further
discussions. FIs need to formulate a road map for the transition path and strategy
for smooth conversion into a universal bank over a specified time frame. The plan
should specifically provide for full compliance with prudential norms as applicable to
banks over the proposed period.