Future of Banking in India – Changing Imperatives

EXECUTIVE SUMMARY 

A healthy banking system is essential for any economy striving to achieve good growth and yet remain stable in an increasingly global business
environment. The Indian banking system has witnessed a series of reforms in the past, like deregulation of interest rates, dilution of government stake in
PSBs, and increased participation of private sector banks. It has also undergone rapid changes, reflecting a number of underlying developments. This
trend has created new competitive threats as well as new opportunities. This paper aims to foresee major future banking trends, based on these past
and current movements in the market. 

Given the competitive market, banking will (and to a great extent already has) become a process of choice and convenience. The future of banking
would be in terms of integration. This is already becoming a reality with new-age banks such as YES Bank, and others too adopting a single-PIN.
Geography will no longer be an inhibitor. Technology will prove to be the differentiator in the short-term but the dynamic environment will soon lead to its
saturation and what will ultimately be the key to success will be a better relationship management. 

OVERVIEW 

If one were to say that the future of banking in India is bright, it would be a gross understatement. With the growing competition and convergence of
services, the customers (you and I) stand only to benefit more to say the least. At the same time, emergence of a multitude of complex financial
instruments is foreseen in the near future (the trend is visible in the current scenario too) which is bound to confuse the customer more than ever unless
she spends hours (maybe days) to understand the same. Hence, I see a growing trend towards the importance of relationship managers. The success
(or failure) of any bank would depend not only on tapping the untapped customer base (from other departments of the same bank, customers of related
similar institutions or those of the competitors) but also on the effectiveness in retaining the existing base. 

India has witness to a sea change in the way banking is done in the past more than two decades. Since 1991, the Reserve Bank of India (RBI) took
steps to reform the Indian banking system at a measured pace so that growth could be achieved without exposure to any macro-environment and
systemic risks. Some of these initiatives were deregulation of interest rates, dilution of the government stake in public sector banks (PSBs), guidelines
being issued for risk management, asset classification, and provisioning. Technology has made tremendous impact in banking. ‘Anywhere banking’ and
‘Anytime banking’ have become a reality. The financial sector now operates in a more competitive environment than before and intermediates relatively
large volume of international financial flows. In the wake of greater financial deregulation and global financial integration, the biggest challenge before
the regulators is of avoiding instability in the financial system. 

RISK MANAGEMENT AND BASEL II 

The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in
the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term
success of a banking institution. 

Although capital serves the purpose of meeting unexpected losses, capital is not a substitute for inadequate decontrol or risk management systems.
Coming years will witness banks striving to create sound internal control or risk management processes. 
With the focus on regulation and risk management in the Basel II framework gaining prominence, the post-Basel II era will belong to the banks that
manage their risks effectively. The banks with proper risk management systems would not only gain competitive advantage by way of lower regulatory
capital charge, but would also add value to the shareholders and other stakeholders by properly pricing their services, adequate provisioning and
maintaining a robust financial structure. 

‘The future belongs to bigger banks alone, as well as to those which have minimised their risks considerably.’ 

CONSOLIDATION 

Consolidation, which has been on the counter over the last year or so, is likely to gather momentum in the coming years. Post April 2009, when the
restrictions on operations of foreign banks will go, the banking landscape is expected to change dramatically. Foreign banks, which currently account for
5% of total deposits and 8% of total advances, are devising new business models to capture the Indian market. Their full-fledged entry is expected to
transform the business of banking in many ways, which would be reflected in terms of greater breadth of products, depth in delivery channels and
efficiency in operations. 

Thus Indian banks have less than three years to consolidate their position. Despite the stiff resistance from certain segments, consolidation holds the
key to future growth. This view is underpinned by the following: 
► Owing to greater scale and size, consolidation can help save costs and improve operational efficiency. 
► Banks will also have to explore different avenues for raising capital to meet norms under Basel-II 
► Owing to the diversified operations and credit profiles of merging banks, consolidation is likely to serve as a risk-mitigation exercise as much as a
growth engine. 

Though there is no confirmation yet, speculative signals arising from the market point to the prospect of consolidation involving banks such as Union
Bank of India, Bank of India, Bank of Baroda, Dena Bank, State Bank of Patiala, and Punjab and Sind Bank. Further, the case for merger between
stronger banks has also gained ground — a clear deviation from the past when only weak banks were thrust on stronger banks. There is a case being
made for mergers between banks with a distinct geographical presence coming together to leverage their respective strengths. 

GLOBALIZATION/ OVERSEAS EXPANSION 

Growing integration of economies and the markets around the world is making global banking a reality. The surge in globalization of finance has already
begun to gain momentum with the technological advancements which have effectively overcome the national borders in the financial services business.
Widespread use of internet banking will widen frontiers of global banking, and make marketing of financial products and services on a global basis
possible. In the coming years globalization will spread further on account of the likely opening up of financial services under WTO. India is one of the 104
signatories of Financial Services Agreement (FSA) of 1997. This gives India’s financial sector including banks an opportunity to expand their business on
a quid pro quo basis. 

As per Indian Banks' Association report ‘Banking Industry Vision 2010’, there would be greater presence of international players in Indian financial
system and some of the Indian banks would become global players in the coming years. So, the new mantra for Indian banks is to go global in search of
new markets, customers and profits. 

TECHNOLOGY 

There is an imperative need for not mere technology upgradation but also its integration with the general way of functioning of banks to give them an
edge in respect of services provided to their constituents, better housekeeping, optimizing the use of funds and building up of MIS for decision making,
better management of assets & liabilities and the risks assumed which in turn have a direct impact on the balance sheets of banks as a whole.
Technology has demonstrated potential to change methods of marketing, advertising, designing, pricing and distributing financial products and services
and cost savings in the form of an electronic, self-service product delivery channel. These challenges call for a new, more dynamic, aggressive and
challenging work culture to meet the demands of customer relationships, product differentiation, brand values, reputation, corporate governance and
regulatory prescriptions. Technology holds the key to the future success of Indian Banks. 

Internet, wireless technology and global straight-through processing have created a paradigm shift in the banking industry. The explosive growth of both
the Internet and mobile and wireless technology is revolutionizing the way the financial industry conducts business. The overall wireless technology
market is expected to grow profoundly in the coming years. 

REGULATIONS 

The RBI's approval for banks to raise funds abroad through innovative capital instruments holds great significance. Such fund-raising, which includes
preference shares, will, however, not just substitute equity; it could have unintended consequences on the strategies of banks and their profitability.
While the cost of raising monies through such instruments is likely to be higher (close to 10 per cent), the consequent higher leverage on equity funds is
likely to result in expansion of return on net worth. This is because the same amount of capital supports a higher volume of business, generating higher
profits. 
Banks are likely to be able to raise long-term preference shares at coupon rates between six per cent and eight per cent. The positive impact on bank
profitability could thus be significant. 
Preference capital can be used as the currency for acquisition. The advantage for public sector banks is that they no longer need to bother about
government stake falling below 51 per cent. Banks such as Dena Bank, Oriental Bank of Commerce and Andhra Bank are most likely to benefit from this
move. 

SKILLED MANPOWER 

There will be a sea change for employees too. Secure jobs will be replaced by contractual appointments, for a specified period of time. The unions will
merge into the shadows and bank managements will turn effective. As a result there will be swifter turn over of personnel in banks. But at the same time,
skilled personnel from other disciplines will enter banks in increasing numbers. 
Factors like skills, attitudes and knowledge of the human capital play a crucial role in determining the competitiveness of the financial sector. The quality
of human resources indicates the ability of banks to deliver value to customers. Capital and technology are replicable but not the human capital which
needs to be valued as a highly valuable resource for achieving that competitive edge. 

Business model, which comprises a comprehensive range of business solutions delivered through a unique balance of portfolio and relationship
management must be incorporated. 

FUTURE CHALLENGES & SUGGESTIONS 

Challenges 
►Competition 
►Customer Retention 
►Globalization 
►Shrinking Margin 

Suggestions 
►Strong In-house research & market Intelligence 
►Focused marketing- Focus on region-specific campaigns rather than national media campaigns 

The growth of the retail financial services sector has been a key development on the market front. Indian banks (both public and private) will not only be
keen to tap the domestic market but also to compete in the global market place. New foreign banks will be equally keen to gain a foothold in the Indian
market. 

CONCLUSION: 

What will the future of Indian banking and insurance look like? Will the reform in banking and insurance sectors face the same fate as in power and
telecom? It is increasingly evident that the economy offers opportunities but no security! Therefore, the future will belong to those who develop good
internal controls, checks and balances and a sound market strategy. Business Growth, Cost Efficiency and Evolution are therefore regarded as key
drivers which will have to be addressed.