Since the early 1990s, structural and functional changes of profound magnitude came to be witnessed in global banking systems. Large scale mergers, amalgamations and acquisitions among banks and financial institutions resulted in the growth in size and competitive strengths of the merged entities. There thus emerged new financial conglomerates that could maximise economies of scale and scope by 'bundling' the production of financial services. This heralded the advent of a new financial service organization, i.e. Universal Banking, bridging the gap between banking and financial-service-providing institutions. Universal Banks entertain, in addition to normal banking functions, other services that are traditionally non-banking in character such as investment-financing , insurance, mortgage-financing, securitisation, etc. Parallelly, in contrast to this phenomenon, non-banking companies too entered upon banking business.

It is a multi-purpose and multi-functional financial supermarket providing both banking and financial services through a single window. As per website of World Bank (www.worldbank.org) the concept is explained as follows - "In universal banking, large banks operate extensive networks 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."

To put in simple words, a universal bank is a superstore for financial products. Under one roof, corporates can get loans and avail of other handy services, while individuals can bank and borrow. To convert itself into a universal bank, an entity has to negotiate several regulatory requirements. Therefore, universal banks in a nutshell have been in the form of a group-concerns offering a variety of financial services like deposits, short term and long term loans, insurance, investment banking etc, under an umbrella brand. Citicorp is a reasonably good example of a global UB. JB Morgan is another. The concept has been prevalent in developed countries like France, Germany and US.

Indian Banks pursuant to the nationalisation and state ownership of the main players, took upon themselves the role of developoment bankers and diversified thier credit dispensations. Term Lending and credit delivery against hypothecaton of assets, which were unheard of earlier came to be accepted as a common measure of credit policy. All sectors of Indian economy were brought under purview of banks' financial support. A group of banks joined together as a consortium and diversified risk in financing bulk ventures sharing portions both amonst themselves and also along with the Term Lending Institutions. The entry of banks into the realm of financial services was to follow very soon. The first impulses for a more diversified financial intermediation were witnessed in the late 1980s and early 1990s when banks were allowed to undertake leasing, investment banking, mutual funds, factoring, hire-purchase activities through separate subsidiaries. By the mid-1990s, all restrictions on project financing were removed and banks were allowed to undertake several activities in-house. Reforms in the Insurance Sector in the late Nineties and opening up of this field to private and foreign players, also resulted in permitting banks to undertake sale of insurance products. At present, only an 'arms-length' relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. the Insurance Regulatory and Development Authority (Irda). Which means that commercial banks can enter insurance business either by acting as agents or by setting up joint ventures with insurance companies. And the RBI allows banks to only marginally invest in equity (5 per cent of their outstanding credit).

The phenomenon of universal banking as a distinct concept, as different from narrow banking, came to the fore-front in the Indian context with the second Narasimham Committee (1998) and later the Khan Committee (1998) reports recommending consolidation of the banking industry through mergers and integration of financial activities.

At this point it became relevant to consider opening Development finance Institutions to avail the options to involve in deposit banking and short-term lending as well. DFIs were set up with the objective of taking care of the investment needs of industries. They have, over time, built up expertise in merchant banking and project evaluation. Yet they have also backed bad investments and, as a result, become equity holders in defaulting enterprises through conversion of loans into equity. They also extend soft loans by way of equity contribution to medium and large industries. DFIs have developed core competence in investment banking. They take a lot of risks to prop up industries. They finance industries such as infrastructure industries, which have long gestation periods and have contributed significantly to the country's industrialisation process.

However the access of Developmental Finance Institutions to low cost funds has been denied. Saddled with obligations to fund long gestation projects, the DFIs have been burdoned with serious mismatches between their assets and liabilities side of the balance sheets. Their traditional lending to industries such as textiles and iron and steel has caused them serious problems at a time when the method of classifying balance-sheets has become more transparent. The Narasimham Committee (II) had suggested that DFIs should convert into banks or non-banking finance companies. Some of the issues addressed in the transition path relate to compliance with cash reserve ratio and statutory liquidity ratio requirements, disposal of non-banking assets, composition of the board, prohibition on floating charge of assets, restrictions on investments, connected lending and banking license.

Converting into UBs will grant them ready access to cheap retail deposits and increase the coverage of the advances to include short-term working capital loans to corporates with greater operational flexibility. The institutions can then effectively compete with the commercial banks. They will be able to attract more volumes because they meet most of the needs of their customers under one roof.

IT is in this context that RBI constituted on December 8, 1997, a Working Group under the Chairmanship of Shri S.H. Khan, Chairman IDBI, to bring about greater clarity in the respective roles of banks and financial institutions for greater harmonisation of facilities and obligations. The Commitee submitted comprehensive recommendations of which one was about Universal Banking. The working group made a strong pitch for "eventually" giving full banking licenses to the development financial institutions (DFIs) and called for mergers between strong banks and institutions. Till the time the DFIs are given full banking licenses, they should be permitted to have wholly-owned banking subsidiaries."Size, expertise and reach are now deemed crucial to sustained viability and future survival in the financial sector," the report says, and recommends that managements and shareholders of banks and DFIs be allowed to explore the possibility of gainful mergers not only of banks but also of banks and DFIs.

A universal bank can be a single company, a holding company with wholly owned subsidiaries, a group of entities with cross-holdings or even a flagship company which may or may not have independent shareholders. The panel has argued that the regulator should not impose the appropriate corporate structure. Calling for an enabling regulatory framework to ensure the transition towards universal banking, the panel said a function-specific and institution-neutral regulatory framework must be developed. "This concept of neutrality should be applicable to both foreign and local entities," it said.

Banks can very effectively exploit economies of scale and scope. In this way they are able to reduce average costs and thereby improve spreads if it expands its scale of operations and diversifies its activities. It entails less cost in performing all the functions by one entity instead of separate specialized bodies. A bank possesses information on the risk characteristics of its clients that it can use to pursue other activities of the same client. The bank's existing network of branches can act as shop for selling products like insurance.

The idea of "one-shop shopping" saves a lot of transaction cost and increases the speed of economic activity. It is truly the retail customer who gains the most from Universal banking. The wide range of financial products and services offered holds a greater appeal for the customer than specialized banks due to the comprehensive service provided by a universal bank.

There are certain challenges which need to be effectively met by the universal banks. Such challenges need to build effective supervisory infrastructure, volatility of prices in the stock market, comprehending the nature and complexity of new financial instruments, complex financial structures, determining the precise nature of risks associated with the use of particular financial structure and transactions, increased risk resulting from asymmetrical information sharing between banks and regulators among others. Moreover norms stipulated by RBI treat DFIs at par with the existing commercial banks. Thus all Universal banks have to maintain the CRR and the SLR requirement on the same lines as the commercial banks. Also they have to fulfill the priority sector lending norms applicable to the commercial banks. These are the major hurdles as perceived by the institutions, as it is very difficult to fulfill such norms without hurting the bottom-line.

"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 an 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."

(Source: http://www.banknetindia.com/banking/ub1.htm - Approach to Universal Banking )

"... The RBI released a 'Discussion Paper' (DP) in January 1999 for wider public debate. The feedback on the discussion paper indicated that while the universal banking is desirable from the point of view of efficiency of resource use, there is need for caution in moving towards such a system by banks and DFIs. Major areas requiring attention are the status of financial sector reforms, the state of preparedness of the concerned institutions, the evolution of the regulatory regime and above all a viable transition path for institutions which are desirous of moving in the direction of universal banking. It is proposed to adopt the following broad approach for considering proposals in this area:

"Though the DFIs would continue to have a special role in the Indian financial System, until the debt market demonstrates substantial improvements in terms of liquidity and depth, any DFI, which wishes to do so, should have the option to transform into bank (which it can exercise), provided the prudential norms as applicable to banks are fully satisfied. To this end, a DFI would need to prepare a transition path in order to fully comply with the regulatory requirement of a bank. The DFI concerned may consult RBI for such transition arrangements. Reserve Bank will consider such requests on a case by case basis.

"The regulatory framework of RBI in respect of DFIs would need to be strengthened if they are given greater access to short-term resources for meeting their financing requirements, which is necessary.

"In due course, and in the light of evolution of the financial system, Narasimham Committee's recommendation that, ultimately there should be only banks and restructured NBFCs can be operationalised."

[Excerpt from the Mid-term Review of the Monetary and Credit Policy of Reserve Bank of India for 1999-2000]

"Accordingly, the mid-term review of monetary and credit policy, October 1999 and the annual policy statements of April 2000 and April 2001 enunciated the broad approach to universal banking and the Reserve Bank's circular of April 2001 set out the operational and regulatory aspects of conversion of DFIs into universal banks. The need to proceed with planning and foresight is necessary for several reasons. The move towards universal banking would not provide a panacea for the endemic weaknesses of a DFI or its liquidity and solvency problems and/or operational difficulties arising from undercapitalisation, non-performing assets, and asset liability mismatches, etc. The overriding consideration should be the objectives and strategic interests of the financial institution concerned in the context of meeting the varied needs of customers, subject to normal prudential norms applicable to banks. From the point of view of the regulatory framework, the movement towards universal banking should entrench stability of the financial system, preserve the safety of public deposits, improve efficiency in financial intermediation, ensure healthy competition, and impart transparent and equitable regulation."

(Bimal Jalan - " Indian Banking and Finance: Managing New Challenges " India at the Twenty-third Bank Economists' Conference at Kolkata, on January 14, 2002.)