Headwinds from international and domestic economic developments posed challenges to the banking
sector during the year 2011-12. While banks maintained their profitability, their asset quality
was impaired. As things stand, several initiatives are under way to strengthen the regulatory and
accounting frameworks aimed at increasing the resilience of the institutions. However, higher capital
standards, stricter liquidity and leverage ratios and a more cautious approach to risk is likely to
raise the funding costs of banks. Compliance with Basel III stipulations along with the credit needs
of a growing economy will require banks to tap various avenues to raise capital. Broad estimates
suggest that for public sector banks, the incremental equity requirement due to implementation of
Basel III norms by March 2018 is expected to be approximately ` 750-800 billion. Meeting these
capital requirements will entail the use of innovative and attractive market based funding channels
by the banks. The convergence with the International Financial Reporting Standards (IFRS) may
also place additional demands on the banks’ technical as well as human resources. Considering the
granularity of data required for effective supervisory review, efforts should be to automate data flow
from reporting entities through the adoption of straight-through processing systems. With regard to
financial inclusion, quantitative coverage has improved, but meaningful financial inclusion through
the evolution of sustainable business and delivery models needs to be achieved. Notwithstanding the
multitude of challenges, the regulatory responses and the inherent strengths underlying the Indian
economy should ensure that the banking system continues to play a positive role in supporting the
financing needs of our growing economy.
1. Introduction
1.1 The global economy showed deeper signs
of stress during the past year. With the deteriorating
macroeconomic situation in the euro area
interacting with a loss of growth momentum in
the US and in emerging and developing economies
(EDEs), the risks of potentially large negative
spillovers have increased. Domestically, the
macroeconomic situation continues to raise
concerns. Even as growth has slowed significantly,
inflation remains well beyond the comfort level of
the Reserve Bank.
1.2 The headwinds from domestic and
international economic developments posed
challenges to the banking sector during the year
2011-12. Though asset impairment increased, the
resilience of the Indian banking sector was manifested in an improvement in the capital base
and maintenance of profitability. A series of stress
tests conducted by the Reserve Bank in respect of
credit, liquidity and interest rate risks showed
that banks remained reasonably resilient.
However, under extreme shocks, some banks
could face moderate liquidity problems and their
profitability could be affected.
1.3 While global banking developments are
covered in Chapter II, some perspectives on the
factors that are likely to shape the banking milieu
in the period ahead and the challenges facing the
banks are outlined here.
2. Forces Shaping the Environment
1.4 The multi-pronged regulatory initiatives
undertaken in the area of prudential and capital requirements of banks along with a move towards
greater convergence in banking regulation globally
are likely to have a major impact on the functioning
of banks in the period ahead.
Move towards greater global convergence in
the banking regulation
1.5 The recent financial crisis has redefined
the broad contours of regulation of the banking
sector globally. The need for convergence in
banking regulation stems from the fact that while
banking has become global, banking regulation is
national. Therefore, addressing the issue of
regulatory arbitrage is at the centre-stage of policy
concern. The international standard-setting
bodies have been attempting to achieve convergence
by issuing broad principles that should shape
national regulatory frameworks.
1.6 In the post-crisis period, the Financial
Stability Board (FSB) has emerged as the most
important international body to address the
vulnerabilities in the global financial system and
to guide the development and implementation of
strong regulatory, supervisory and other policies
in the interest of financial stability. Besides
implementation of Basel III capital requirements,
the FSB is addressing the issue of Systemically
Important Financial Institutions (SIFIs), which
involves determination of global SIFIs and their
loss absorbency; resolution tools and regimes for
them; and supervisory intensity and effectiveness
for such SIFIs with the aim of reducing both the
probability and impact of the failure of a SIFI.
1.7 The broader endeavour of global
convergence in the banking regulation will,
however, have to account for country-specific
circumstances to enable customised adoption of
guidance of international standard-setting bodies
as already recognised in many cases by the Basel
Committee on Banking Supervision (BCBS). To
the extent that the systemically important
jurisdictions harmonise and converge to agreed
international best practices, there are positive
externalities from India’s stand-point. In particular,
the BCBS guidance on the conduct of the countercyclical capital buffer for India may require
some changes, as the recommended metric of
credit-to-GDP ratio could potentially impact the
structural drivers underlying credit growth in
India. Thus, there may be a need for some
adjustments to capital buffer guidance. The issue
is being examined by an internal group in the
Reserve Bank.
International capital standards for effective
risk management
1.8 In response to the need to implement Basel
III to strengthen the resilience of the Indian
banking sector, the Reserve Bank has announced
the final guidelines on Basel III capital regulations.
These would be effective from January 1, 2013 in
a phased manner with the Basel III capital ratios
to be fully implemented by end-March 2018.
Regarding the implementation of Basel III, one
issue had been why an emerging economy like
India, should adopt onerous regulation such as
Basel III norms which could, potentially, have a
negative impact on output growth. The rationale
for adopting these standards is two-fold. One,
India cannot remain non-compliant with
international standards, especially when Indian
banks are venturing abroad and the markets are
opened up for international participants. Two,
even while the financial system is much simpler
and does not have many of the features that led
to the crisis, the country is vulnerable to contagion
from the global economy and the higher defences
built under Basel III will provide the financial
system with the much-needed resilience.
1.9 The objectives of Basel III are to improve
the banking sector’s ability to absorb shocks
arising from financial and economic stress, thus
reducing the risk of spillover from the financial
sector to the real economy. Towards this end,
Basel III has some micro-prudential elements
along with a macro-prudential overlay that will
take care of issues relating to systemic risk.
1.10 Basel III guidelines stipulate a stringent
definition of regulatory capital and higher
requirement of common equity than Basel II. Under Basel III, common equity capital will be the
predominant form of regulatory capital and
innovative features such as step-up or other
incentives to redeem in non-equity capital
instruments are no longer acceptable. In addition,
Basel III has introduced two new liquidity
standards, viz., Liquidity Coverage Ratio (LCR)
and the Net Stable Funding Ratio (NSFR) to
improve the resilience of banks to liquidity shocks.
Need to further leverage technology in the
banking sector
1.11 Banks have adopted core banking solutions
(CBS) that effectively address the transactional
requirements of the banks. With the implementation
of CBS, the banking system is now seamlessly
integrated. With the basic technology adoption
being complete in banks, there is, therefore, a
need to move from a transaction processing
system to an information processing system. In
its IT Vision Document 2011-17, the Reserve Bank
of India has highlighted the need for banks to move
forward and leverage IT in areas like Management
Information Systems (MIS), overall risk
management, financial inclusion, customer
relationship management (CRM) and enhancing
automated data flow within the banks and to the
Reserve Bank without manual intervention. Banks
need to augment their innovation capabilities in
terms of new products, services and strategies
which would enable them to maximise their
efficiency gains (Box I.1).
1.12 With the computerisation and adoption of
CBS in banks almost reaching the final stage of
completion, the focus has now shifted to adoption
of more advanced technologies in banking which
would enhance their CRM by using appropriate
tools, improving internal effectiveness including
MIS and managing risks arising out of IT
implementation.
3. Operational and Strategic Responses
1.13 The strategic and operational responses
during the year pertained to policy initiatives with
regard to enhancing co-ordination among regulators and positioning of banks to meet the
needs of inclusive growth, besides a review of the
regulatory framework for the micro-finance sector.
Steps initiated towards improved crossborder
supervision and co-operation
1.14 The recent financial crisis has necessitated
a re-examination of the tools used by supervisors
to oversee financial institutions, particularly
systemically important institutions with crossborder
operations. One major flaw in this regard
has been the ineffective supervisory co-operation
among national bank supervisors. As a result,
need has been felt for the use of supervisory
colleges to supervise global financial institutions,
in particular, the systemically important financial
institutions. The overarching objective of a
supervisory college is to help its members develop
a better understanding of the risk profile of the
banking group. Moreover, information exchange
and co-operation between supervisors can help
strengthen the supervision of the individual
components of a banking group. Colleges can also
complement wider peer review processes by
promoting a coherent approach across different
jurisdictions to the consistent and effective
implementation of macro- and micro-prudential
policy tools.
1.15 The growing global activities of some large
Indian banks have necessitated putting in place a
formal mechanism of supervisory co-operation
and information exchange with host supervisors
for effective cross-border consolidated supervision.
In India, at present no supervisory colleges have
been set up. However, the Reserve Bank has been
attending the supervisory colleges of some of the
major foreign banks operating in India. The High-
Level Steering Committee on the Review of
Supervisory Processes for Commercial Banks
(Chairman: Dr. K.C. Chakrabarty) has
recommended setting up supervisory colleges for
large globally active Indian banks with a significant
(around 15 per cent) share of assets from foreign
operations as a percentage of total assets.
Accordingly as an initial step, supervisory colleges
of SBI and ICICI Bank are being planned.
Box I.1 :
Technological Innovations and Efficiency Gains in the Banking Sector
With the advent of the process of liberalisation in the early
’nineties, the demands on banks’ resources and capabilities
increased as banks had to match the challenges of being
financial service providers in a globalised, competitive
environment. This posed a dual challenge for the banking
industry. The first challenge was to manage the growing needs
of their existing customer segments and business locations
for better and more efficient services, and the second was,
how to expand the reach of their services and business
beyond the traditional services and locations, which had
large socio-economic implications because large parts of the
population did not have access to even basic banking
services. At this juncture, banks in India were looking at
huge potential in business growth as well as several
constraints, such as inadequacy of infrastructure and human
resources, geographical, topographical and distance
limitations, communication inefficiencies, cost implications
and delivery, as well as the processing capability to manage
more business information and larger accounts.
Increased use of information technology emerged as the key
to meeting these challenges. Several measures were mooted
at the level of the Government, the Reserve Bank and
industry, which provided an impetus to adoption of
technology in the banking sector. CBS implementation has
made customer account maintenance seamless and enhanced
data storage and retrieval capabilities tremendously. It has
also enhanced the banks’ capacity to develop and market
new products, as technology has increased information
availability and the capacity for analysis and communication
manifold. Such capabilities and efficiencies are poised to
rise further with the advent and adoption of evolving
technologies like cloud computing and virtualisation, which
have the potential to significantly bring down financial and
management costs.
Economic theory supported by empirical evidence suggests
that, in general, increases in technology investment will raise
productivity, lower costs, and allow firms to operate more
efficiently. Information technologies and the innovations they
enable are strategic tools, since they reduce the costs of
financial transactions, improve the allocation of financial
resources and increase the competitiveness and efficiency
of financial institutions. Technological innovation not only
enables a broader reach for consumer banking and financial
services, but also enhances its capacity for continued and
inclusive growth (Subbarao, 2009).
Globally, the effect of IT on the banking industry has been
positive. In general, studies have concluded two positive
effects regarding the relation between IT and banks’
performance. First, IT can reduce banks’ operational costs
(the cost advantage). Second, IT can facilitate transactions
among customers within the same network (the network
effect). Eyadat and Kozak (2005) examined the impact of the
progress in IT on the profit and cost efficiencies of the US
banking sector during the period 1992-2003. The research
showed a positive correlation between the level of implemented
IT and both profitability and cost savings. Berger (2003) also
showed improvements in bank performance and consolidation
of the banking industry in the US during the deployment of
new technologies.
In the Indian context, technological innovation and
investment in IT during the period 2005-06 to 2009-10 led
to efficiency gains for the scheduled commercial banks
(Rajput and Gupta, 2011). Technology is encompassing the
entire set of business processes in the banking industry and
technological innovations are enabling banks to cope with
burgeoning customer requirements, social and developmental
expectations, strategic and competitive business needs,
internal control and risk management needs, governance
and regulatory reporting requirements.
However, going forward, banks need to innovate appropriately
in terms of products, services and strategies and will also
need to align their IT and business perspectives to fully
leverage the benefits of technology. Predictive analytics can
bring in competitive advantage in banking and help banks
move from product-centric to customer-centric operations.
References :
Rajput, N. and Gupta, M. (2011), ‘Impact of IT on Indian
Commercial Banking Industry: DEA Analysis’, Global Journal
of Enterprise Information System, Volume 3 Issue I.
Subbarao D. (2009), ‘Information Technology and Banking
– A Continuing Agenda’ Keynote Address delivered at the
Institute for Development & Research in Banking Technology,
Hyderabad.
Eyadat M. and Kozak, S. (2005), ‘The Role of Information
Technology in the Profit and Cost Efficiency Improvements
of the Banking Sector’, Journal of Academy of Business and
Economics.
Berger, A.N. (2003), ‘The Economic Effects of Technological
Progress: Evidence from the Banking Industry’, Journal of
Money, Credit and Banking, Volume 35.
1.16 In this context, Reserve Bank has initiated
the process of setting up of a cross-border
supervision and supervisory co-operation
mechanism, which allows for signing Memorandum
of Understanding (MoU) with overseas regulators
on supervisory co-operation and exchange of
information with them (Box I.2).
Strategic role for banks in ensuring inclusive
growth
1.17 Banks play a dominant role in India’s
financial system and are, therefore, expected to
play a key role in furthering the agenda of financial
inclusion with a view to achieving inclusive growth
and development. Accordingly, a bank-led model of financial inclusion has been adopted in the
country. Based on the experience of countries like
Kenya, and the massive growth and expansion of
mobile phones in the country, there have been
demands for experimenting with a model of
mobile-led banking for financial inclusion.
However, it has been argued that mobile-led
banking takes care of only remittance products
as against a bouquet of products, such as a
variable recurring deposit product, an overdraft
and an emergency credit product in the form of
Kisan Credit Card (KCC)/General Credit Card
(GCC). Second, banks are prudently regulated and
this helps address the concerns about KYC/AML as also customer service. With respect to mobile
payment companies, the Reserve Bank does not
have similar regulatory authority. Third, entry into
the banking space has to be on open, transparent
and contestable criteria. Thus, it may not be
prudent to allow mobile operators privileged
access into commercial banking through the
mobile route. However, efforts have been made to
leverage the reach of mobile network companies
by allowing banks to appoint corporates to act as
Business Correspondents (BCs), but it is still early
days and the success of these arrangements
between banks and the companies will be analysed
in the coming years.
Box I.2 :
Bilateral Memorandum of Understanding (MoU) with Reserve Bank’s Overseas Counterparts for
Improved Cross-Border Supervision and Co-operation
Genesis
The concept of supervisory co-operation on cross-border
supervision dates back to the report released by the
Committee on Banking Regulations and Supervisory
Practices in 1975. However, the seminal idea of having a
form of MoU first found mention in the report titled “The
Supervision of Cross-Border Banking” (October, 1996) by
a working group which comprised members of the BCBS.
The Group recommended that the understandings between
the supervisors might take the form of bilateral MoUs or
exchange of letters which may formulate what each party
expects from the relationship. Taking forward the concept,
the BCBS released a document titled “Essential Elements
of a Statement of Co-operation Between Banking Supervisors”
in May 2001, listing key elements that could form part of a
statement of co-operation or MoU between “Home” and
“Host” country supervisors.
Need for MoU - Indian Scenario
Until recently, cross-border supervision of the overseas
operations of Indian banks has been carried out through a
combination of need-based on-site inspection, an off-site
reporting framework and informal exchange of supervisory
information with overseas regulators/supervisors. However,
during the past few years the cross-border operations of
Indian banks have expanded significantly. Some banks have
set up banking and other financial services subsidiaries
abroad. Against this backdrop, a need was felt to enter into
MoUs with bank regulators, and an Internal Working Group
(IWG) was constituted to lay down the road-map for adopting
a suitable framework. Based on the recommendations of
the IWG, a policy framework was put in place. The policy
provides, inter alia, for establishing legally non-binding formal arrangements for supervisory co-operation with
overseas supervisors through an MoU, in accordance with
the various BCBS Principles as well as in consonance with
the various laws/statutes of the land.
Establishment of MOUs with Overseas Supervisory
Authorities
To start with, 16 countries were identified. These were
primarily countries whose bank regulators had evinced
interest in having such an arrangement with the Reserve
Bank and also those jurisdictions where an MoU between
the Reserve Bank and the host country regulator was a
prerequisite for Indian banks. The Reserve Bank has also
started adopting the principle of mutual banking presence
to initiate a dialogue on an MoU with overseas regulators
and supervisory jurisdictions with such a mutual banking
footprint. In the process, the list of identified countries was
expanded to 38.
Current Status on Signing of MOUs with Overseas
Supervisors
So far, the Reserve Bank has executed MoUs with ten
overseas supervisors. In addition, proposals for MoUs with
28 overseas supervisors are in various stages of finalisation.
Going forward, while the current objective of the Reserve
Bank is to establish MoUs with the supervisors of those
jurisdictions where Indian banks have substantial
operations or are planning to scale up their operations, the
longer-term goal of the Reserve Bank is to first stabilise the
mechanism of the MoU through frequent interactions with
the host country supervisors and then to leverage on the
supervisory co-operation with these domains and benefit
from the knowledge and views of the host country
supervisors for better oversight of Indian banking entities.
National Strategy on financial literacy aims
to further the financial inclusion process
1.18 Financial literacy is a prerequisite for
achieving the objectives set out under financial
inclusion, as it enables the common man to
understand the need and benefits of the products
and services offered by formal financial institutions.
Financial education plays a vital role in making
the demand side respond to the initiatives of
supply-side interventions. Increased emphasis is
now being given towards creating awareness and
spreading financial literacy as an important
demand-side push towards achieving the goal of
financial inclusion. Since a large number of
stakeholders are involved in spreading financial
literacy, a broad national strategy is a prerequisite
to ensure that they work in tandem with the
strategy. Towards this objective, a draft National
Strategy prepared under the aegis of the Sub-
Committee of the Financial Stability and
Development Council (FSDC) has been
simultaneously released by all financial sector
regulators including the Reserve Bank. With this
move, India has joined countries like the
Netherlands, New Zealand, Spain, the UK and the
Czech Republic, which have already implemented
a national strategy for financial education.
Regulatory framework for the micro-finance
sector to ensure customer protection and
financial health
1.19 The micro-finance sector comprising the
Self-Help Group (SHG)-Bank linkage programme,
for-profit Non-Banking Finance Companies-Micro-
Finance Institutions (NBFC-MFIs) registered with
the Reserve Bank and all other small not-for-profit
MFIs registered as trusts, societies, etc., plays an
important role in extending credit as part of
financial inclusion efforts in India. While the SHGBank
linkage programme was sought to be
strengthened by NABARD through fresh guidelines,
the focus firmly remained on the NBFC-MFIs. It
may be recalled that the State of Andhra Pradesh
had issued an Ordinance in October 2010, which
was later enacted into a law, making registration of MFIs functioning in the State compulsory with
a view to regulate their functioning. The Reserve
Bank had then set up a Sub-Committee of its
Central Board of Directors (Chairman: Shri
Y.H.Malegam) to study the issues and concerns,
inter-alia, with regard to interest rates, lending
and recovery practices in the micro-finance sector.
Based on the recommendations of the Malegam
Committee, a separate category of NBFC-MFIs has
been created. The proposed regulatory framework
puts in place restrictions and safeguards with
regard to minimum standards of governance,
management and customer protection as well as
the financial health of MFIs. A fair and adequate
regulation of NBFCs will encourage the growth of
this sector, while adequately protecting the
interests of borrowers. A Micro Finance Institutions
(Development and Regulation) Bill, 2012 proposing
to exempt MFIs registered with and regulated by
the Reserve Bank from State money-lending acts,
under which NBFC-MFIs were regulated by the
Andhra Pradesh Government, is pending in
Parliament. In the long run, MFIs will benefit from
such a regulatory framework, as it enables orderly
growth and reduces uncertainty.
4. Challenges
1.20 Going forward, a move towards higher
capital requirements and the need for meaningful
financial inclusion are the primary challenges
before banks. The convergence to International
Financial Reporting Standards (IFRS) is also likely
to pose demands on banks’ resources. The
slippage in asset quality needs to be contained
and the risks posed by global factors need to be
addressed carefully.
Move towards Basel III to entail capital
infusion
1.21 Effective implementation of Basel III is
needed for developing the resilience of the banking
sector to future shocks. The challenges in
implementing Basel III should not be
underestimated. In general, Basel III will increase
the capital requirements on Indian banks. The current capital adequacy levels for the Indian
banking system are comfortable. However, the
capital requirements, including equity, would be
substantial to support the high GDP growth;
further the credit to GDP ratio, which is currently
quite modest at about 55 per cent, is bound to
increase substantially due to structural changes
in the economy.
1.22 Broad estimates suggest that in order to
achieve full Basel III implementation by end-March
2018, public sector banks (PSBs) would require
common equity of `1.4-1.5 trillion on top of
internal accruals, in addition to `2.65-2.75 trillion
in the form of non-equity capital. Banks would
have continued to require additional capital to
meet Basel II capital ratios had Basel III capital
ratios not been implemented. Therefore, in case
of PSBs, the incremental equity requirement due
to enhanced Basel III capital ratios is expected to
be `750-800 billion. Similarly, major private
sector banks would require common equity of
`200-250 billion on top of internal accruals, in
addition to `500-600 billion in the form of nonequity
capital. These projections are based on the
conservative assumption of uniform growth in
Risk-Weighted Assets of 20 per cent per annum
individually for all banks and individual bank’s
assessment of internal accruals (in the range of
1.0-1.2 per cent of Risk-Weighted Assets).
1.23 For every bank, it is critical to work out the
most cost-effective model for implementing Basel
III. Banks will have to issue fresh capital
particularly towards the later years of
implementation. Although Indian banks have the
advantage of a strong starting base in the form of
a higher capital to risk-weighted assets ratio
(CRAR) with a larger component of core equity
capital, the large equity needs, though over an
extended time-frame, could put downward
pressure on the banks’ Return on Equity (RoE).
In the long term, the higher capital requirements
would bring down risks in the banking sector
inducing investors to accept a lower RoE. In the
short term, though, the only solution is to raise
productivity. The Government of India being the
owner of public sector banks will have to play a
proactive role in this process.
Issues in convergence with International
Financial Reporting Standards (IFRS)
1.24 The Ministry of Corporate Affairs (MCA),
Government of India, released a road map in
January 2010 which entailed IFRS convergence
in a phased manner commencing from April 1,
2011 onwards, with commercial banks in India
scheduled to converge with effect from April 1,
2013. India’s path to convergence with IFRS has
however, become difficult due to several issues,
both domestic and international. The convergence
of certain categories of corporates that was
scheduled for April 1, 2011 has not happened.
Currently lack of clarity exists regarding the
convergence schedule in India.
1.25 At the global level, the International
Accounting Standards Board (IASB) has embarked
on a project to replace the existing standard on
financial instruments (IAS 39: Financial
Instruments: Recognition and Measurement) with
the new standard IFRS 9: Financial Instruments.
This project has not progressed as per schedule
since IASB could not finalise certain critical
proposals relating to impairment and hedge
accounting. In view of the developments at the
international level, it appears unlikely that IFRS
9 would be ready in its entirety before mid-2013.
The biggest challenge to the banking sector in
India which is of equal concern to regulators is
the lack of clarity and uncertainty regarding the
finalisation of IFRS 9 and its convergence with US
Generally Accepted Accounting Principles (GAAP),
besides of course the major technical and human
resources issues arising for Indian banks in the
course of convergence.
Need for improvement in the asset quality of
banks
1.26 The asset quality of banks is an important
indicator of their financial health, and also reflects
the efficacy of banks’ credit risk management and
the recovery environment. The asset quality of the
banking system has deteriorated significantly
during the year 2011-12 after a period of sustained
improvement. Inadequate credit appraisal during
the boom period of 2003-07 coupled with the adverse economic situation in the domestic as well
as the external front resulted in the current
increase in NPAs. To further strengthen the NPA
management framework of the Indian banks, in
terms of the Monetary Policy Statement for the
year 2012-13, banks were advised to put in place
a robust mechanism for early detection of signs
of distress, and measures to preserve the economic
value of assets. Banks were also advised to have
proper system-generated segment-wise data on
their NPA accounts, write-offs, compromise
settlements, recovery and restructured accounts.
Financial system remains robust though
global factors pose elevated risks
1.27 The financial system of the country remains
robust. Risks to stability are, however, elevated
due to global factors and domestic macroeconomic
factors. Domestic growth has slowed. Savings and
investment rates are also lower. Although inflation
has moderated, it is still above the level conducive
for sustained growth. Risks are also posed by the
high levels of current account and fiscal deficits.
Risks from global developments, viz., growth
slowdown, continuing instability in the euro area,
uncertain capital flows and the impact of
deleveraging by banks, could be accentuated by
domestic macroeconomic risks. Notwithstanding
these, the intrinsic strength of the domestic
economy remains intact. The findings of the
periodic Systemic Risk Surveys conducted by the
Reserve Bank reveal that financial system
stakeholders retained their confidence in the
stability of the system. However, distress
dependencies among banks have risen, warranting
closer monitoring.
Data integrity is a prerequisite for effective
supervisory review
1.28 The need for granular data for policy
decisions has increased. It is, therefore, important
to further improve the database of the banking
infrastructure in the country. In keeping with the
Reserve Bank’s IT Vision, the efforts should be to
automate data flow from the reporting entities
through the adoption of appropriate straightthrough-processing systems. The use of data
warehousing for processing should be strengthened
to improve the quality, integrity and delivery of
data. Second, there is a need for close coordination
between statisticians and bank
supervisors, both in the commercial and cooperative
banking space, to identify and mitigate
data gaps in the supervisory review process and
to facilitate appropriate risk assessment for the
banking system. Third, the data reporting system
needs to be geared towards automated data
capture from the source systems. An improved
and granular database of the banking infrastructure
in the country is essential to gauge the extent of
financial inclusion and to assess the efficacy of
various policy actions taken in this regard. To
ensure faster and more accurate transmission of
uniform data for quick decision-making, data
should be captured at the base-level entity. This
can be facilitated by a move away from the existing
return-based reporting system to a data-based
reporting system.
Financial inclusion: need for meaningful
inclusion
1.29 Universal financial inclusion is both a
national commitment and a policy priority. The
Reserve Bank and the Government of India have
taken several initiatives in this direction. The
provision of BCs in several villages has created a
sense of awareness among villagers about banking.
However, major challenges remain as about 40
per cent of our population lacks access to even
the simplest kind of formal financial services. In
order to ensure that the financial inclusion
initiatives fructify, there is a need to enlarge the
number and value of transactions in no-frills
accounts.
1.30 Banks should endeavour to have a BC
touch-point in every village. However, to make it
a self-sustaining business model, banks should,
over a period of time, ensure that all banking
services, viz., remittances, recurring deposits,
entrepreneurial credit in the form of KCC and
GCC, insurance (life and non-life) and other
banking services are available to all residents of the village through a mix of brick-and-mortar
branches and a BC network.
Enhanced usage of technology requires
improved risk management tools
1.31 Due to the operational risks associated with
the use of technology, information security is an
area that is gaining importance. The issues related
to information security, data integrity and storage
as also communication channels have acquired
challenging dimensions in the electronic
environment. The IT management systems in the
banks have to be robust enough to meet these new
challenges effectively, on a continuing basis.
5. The Way Forward
1.32 Going forward, banks will need to move
towards the mandated higher capital standards,
stricter liquidity and leverage ratios and a more
cautious approach to risk. This implies that Indian
banks will need to improve efficiency even as their
costs of doing business go up. They will need to
refine their risk management skills for enterprisewide
risk management. In addition, banks need
to have in place a fair and differentiated risk
pricing of products and services since capital
comes at a cost. This involves costing, a quantitative
assessment of revenue streams from each product
and service and an efficient transfer-pricing
mechanism that would determine capital
allocation.
1.33 During the year 2011-12, the NPA stock
has risen. The slippage ratio of the banking
system, which showed a declining trend during
2005-08, increased during 2008-12. Banks need
to, not only utilise effectively, the various measures
put in place by the Reserve Bank and the
Government of India for the resolution and
recovery of bad loans, but also have to strengthen
their due diligence, credit appraisal and postsanction loan monitoring systems to minimise and
mitigate the problem of increasing NPAs.
1.34 Going ahead, banks need to tap into
untapped business opportunities for resources to
power the growth engine. This requires harnessing
resources and fortune at the bottom of the
pyramid. Small customers are an important key
to big business opportunities waiting to be tapped.
The challenge before banks is to make the best
use of technology and innovation to bring down
intermediation costs while protecting their bottom
lines. The recent regulatory initiatives like the
deregulation of savings bank deposit interest rates
and opening up government business to more
banks, imminent steps, such as licensing of new
banks and subsidiarisation of the foreign bank
branches, on the one hand, and the changing
profile and simultaneously rising aspirations and
expectations of customers on the other, should
make the turf more competitive and increasingly,
a buyers’ market. As the Indian banking sector is
propelled forward to a higher orbit, banks would
have to strive to remain relevant in the changed
economic environment by reworking their
business strategy, designing products with the
customer in mind and focussing on improving the
efficiency of their services. The challenge for
Indian banks is to reduce costs and pass on the
benefits to both depositors and lenders.
1.35 Notwithstanding the multitude of challenges
to be braved by the Indian banking sector against
the backdrop of a difficult domestic and global
macroeconomic environment, the regulatory
responses and the inherent strengths underlying
the Indian economy would ensure that the banking
system withstands the transitory difficult phase
and plays a positive intermediation role in
supporting the financing needs of our growing
economy.
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