Universal Banking

By:- AMAN BHATTACHARYA

Universal Banking

04/08/2023 2Aman Bhattacharya

A system of banking where banks are allowed to provide a variety of services to their customers(world wide).

In universal banking, banks are not limited to just loans, checking and savings accounts, and other similar activities, but are allowed to offer investment services as well which helps to grow protocol between the nations.

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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

Advantages


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.

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To meet with the increasing demands of customers:- The establishment of new private sector banks and foreign banks have rapidly changed the competitive landscape in the Indian consumer banking industry and placed greater demands on banks to gear themselves up to meet the increasing needs of customers. For the dissatisfied current day bank customers, it is not only relevant to offer a wide menu of services but also provide these in an increasingly efficient manner in terms of cost, time and convenience.

E.g.: Today there is a lot of burden on staff members, they are given no or less number of bank holidays, the time limit is 8-8.

Merger with DFI {Biggest Challenge} :- Development Financial Institutions (DFIs) opting for conversion into Universal Banks by merger/reverse merger routes may also face certain difficult situations on account of Asset Liability Mismatches, burden of mounting NPAs and differences in regulatory prescriptions applicable to FIs and banks such as CRR and SLR requirements and priority sector lending. The asset profile of DFIs in India is predominately of long-term nature, which also includes a very high level of non-performing assets.

E.g.: NPAs of ICICI and IDBI were transferred to ICICI Bank and IDBI Bank respectively after their merger.

Disadvantage


High cost of funds for DFI:- Cost of deposits is high as the only source of funds is Fixed Deposits having higher Rate Of Interest. Costs of funds for Fixed Deposit are higher than CASA {Current account Savings account}. CASA has low cost, as the Rate Of Interest is low. Further, the cost at which DFIs have been raising resources in the past has generally remained high as compared to banks and maintenance of CRR/SLR of such liabilities, which may earn lower returns, would adversely affect the profitability of Universal Banks. Compliance of priority sector lending norms, which earn lower returns, may also create difficult situations for such bank. Risk Management is one of the major challenges, where in the financial activity carries with it various risks, which would need to be identified, measured, monitored and controlled by Universal Banks. The nature of risks and mitigating techniques for different financial product/services will be different and therefore, Universal Banks will be required to develop comprehensive system of each product/service and each kind of risk.

Improving risk management systems :- With the increasing degree of deregulation and exposure of banks to various types of risks, efficient risk management systems have become essential. For enhancing the risk management system in banks, Reserve Bank has issued guidelines on asset liability management and risk management systems in banks in 1999 and Guidelines Notes on Credit Risk Management and Market Risk Management in October 2002 and the Guidance Note on Operational risk management in 2005.

E.g.: Today most banks have stopped personal loans because there is no guarantee, no loans are granted for travel and tourism, i.e. holiday loans too are stopped.

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Statutory Liquid Ratio {SLR} and Cash Reserve Ratio {CRR} requirements of DFI:- In case DFIs are converted into banks they would also be subject to the reserve requirement like banks. CRR and SLR burden that wasn't there for DFI will be applied after its merger with any bank. This would mean that all liabilities issued by the DFIs in the past would also be subject to reserve requirements and since the assets structure of DFIs are largely of long term nature it would be very difficult for them to maintain the required level of SLR/CRR.

Supervisory and regulatory infrastructure:- Another aspect is related to building up of supervisory infrastructure. The regulatory framework would need to be strengthened so as to cover all aspects of Universal Banking either under control of one regulator or a co-coordinating mechanism would have to be developed among different regulators like the Reserve Bank of India, SEBI, Insurance Regulatory, Authority etc. The regulators will have to frame sound mechanism to protect the interest of all concerned including the customer, the Universal Banking Institution and the financial system of the country.

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Sharpening skills:- The far-reaching changes in the banking and financial sector entail a fundamental shift in the set of skills required in banking. To meet increased competition and manage risk, the demand for specialized banking functions, using IT, as a competitive tool has to go up. Special skills in retail banking, treasury, risk management, foreign exchange, development banking, etc, will need to be carefully nurtured and built. Thus, the twin pillars of the banking sector i.e. human resource and IT will have to be strengthened. Thus the need of the day is a combination of improved technology and quality human resources.

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Competition:- Monopolistic competition among universal banks

will decrease their profit margin. Government interferences:- Interferences by government in

public sector banks through RBI are hampering progress of universal banks.

Conflict of interest between commercial and investment banking:- Larger the banks, the greater will be the effects of the failure on the system. Also there is the fear that such institutions, by virtue of their sheer size would gain monopoly power in the market, which can have undesirable consequences for economic efficiency. Further combining commercial and investment banking can give rise to conflict of interest.

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Technology improvement and compensation and incentive systems for employees:- It is likely that Universal Banks of roughly the same size and providing roughly the same range of services may have very different cost levels per unit of output on account of efficiency differences in the use of labour and capital, effectiveness in the sourcing and application of available technology, and perhaps effectiveness in the acquisition of productive inputs, organization designs, compensation and incentive system-and just plain better management.

Supervisory of financial conglomerates:- In view of increased focus on empowering supervisors to undertake consolidated supervision of bank groups and since the Core Principle for Banking Supervisory issued by the BASEL committee on Banking Supervision have underscored consolidated supervision as an independent principle, the Reserve Bank of India had introduced, as an initial step, consolidated accounting and other quantitative methods to facilitate consolidated supervision. The components of consolidated supervision include, consolidated financial statements intended for public disclosure, consolidated prudential reports intended or supervisory assessment of risk and application of certain prudential regulations on group basis. In due course, consolidated supervision as introduced above would evolve to cover.

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Strengths:

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. Various Reserve Banks Committees and reports in favor of Universal Banking, is that it enables banks to exploit economies of scale and scope. It means a bank can reduce average costs and thereby improve spreads if it expands its scale of operations and diversifying activities.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 it can use to pursue other activities with the same client. A data collection about the market trends, risk and returns associated with portfolios of Mutual Funds, diversifiable and non diversifiable risk analysis, etc are useful for other clients and information seekers. Automatically, a bank will get the benefit of being involved in Research.

SWOT


Easy marketing on the foundation a of Brand name:- A bank has an existing network of branches, which can act as shops for selling products like Insurance, Mutual Fund without much efforts on marketing, as the branch will act here as a parent company or source. In this way a bank can reach the remotest client without having to take recourse ton 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 customers.

Investor friendly activities:- Another manifestation of Universal Banking is bank holding stakes in a firm. A bank's equity holding in a borrower firm, acts as a signal for other investors on to the health of the firm, since the lending bank is in a better position to monitor the firm's activities.

Cont…..


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 requirements 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. 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 of DFIs have had to encounter is bad loans or Non Performing Assets (NPA). For the DFIs and Universal Banking or installation of cutting-edge-technology in operations are unlikely to improve the situation concerning NPAs.

Weakness


Big Empires:- Universal Banking is an outcome of the mergers and acquisitions in the banking sector. The Finance Ministry is also empathetic towards it. But there will be big empires which may put the economy in a problem. Universal Banks will be the largest banks, by their asset base, income level and profitability there is a danger of 'Price Distortion'. It might take place by manipulating interests of the bank for the self interest motive instead of social interest. There is a threat to the overall quality of the products of the bank, because of the possibility of turning all the strengths of the Universal Banking into weaknesses. (e.g. - the strength of economies of scale may turn into the degradation of qualities of bank products, due to over expansion .

Threats


To increase efficiency and productivity:- Liberalization offers opportunities to banks. Now, the focus will be on profits rather than on the size of balance sheet. Fee based incomes will be more attractive than mobilizing deposits, which lead to lower cost funds. To face the increased competition, banks will need to improve their efficiency and productivity, which will lead to new products and better services.

To get more exposure in the global market:- In terms of total asset base and net worth the Indian banks have a very long road to travel when compared to top 10 banks in the world. (SBI is the only Indian bank to appear in the top 100 banks list of 'Fortune 500' based on sales, profits, assets and market value. It also ranks II in the list of Forbes 2000 among all Indian companies) as the asset base sans capital of most of the top 10 banks in the world are much more than the asset base and capital of the entire Indian banking sector. In order to enter at least the top 100 segment in the world, the Indian banks need to acquire a lot of mass in their volume of operations.

Pure routine banking operations alone cannot take the Indian banks into the league of the Top 100 banks in the world. Here is the real need of universal banking, as the wide range of financial services in addition to the Commercial banking functions like Mutual Funds, Merchant banking, Factoring, Insurance, credit cards, retail, personal loans, etc. will help in enhancing overall profitability.

Opportunity


To eradicate the 'Financial Apartheid' :- A recent study on the informal sector conducted by Scientific Research Association for Economics (SRA), a Chennai based association, has found out that, 'Though having a large number of branch network in rural areas and urban areas, the lowest strata of the society is still out of the purview of banking services. Because the small businesses in the city, 34% of that goes to money lenders for funds. Another 6.5% goes to pawn brokers, etc.

The respondents were businesses engaged in activities such as fruits and vegetables vendors, laundry services, provision stores, petty shops and tea stalls. 97% of them do not depend the banking system for funds. Not because they do not want credit from banking sources, but because banks do not want to lend these entrepreneurs. It is a situation of Financial Apartheid in the informal sector. It means with the help of retail and personal banking services Universal Banking can reach this stratum easily.

The Need of Universal Banking:- To make pace with the present need of corporates.Now a day, there is a large market of General Insurance and Project Financing. As only a bank is not able to fund it properly, due to insufficient asset base and net worth. So, to overcome this, they form a consortium of lenders, for funding the Greenfield and Brownfield projects. (In the month June a consortium of 20 lenders led by SBI has committed a 14 year project finance term loan for a special purpose company promoted BPCL, which is starting a Greenfield project in Madhya Pradesh) The point of consideration here is the consortium partner – Bank of Baroda, Bank of Maharashtra, Central Bank of India, LIC, Indian Overseas Bank. Most of the partners are nationalized banks.

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Thank You!

Documents

Universal Banking