Banking Industry - Vision 2010
[Source: IBA Committee under the Chairmanship of Shri S C Gupta, CMD IOB ]

Change in the structure of banks

The financial sector reforms ushered in the year 1991 have been well calibrated and timed to ensure a smooth transition of the system from a highly regulated regime to a market economy. The first phase of reforms focused on modification in the policy framework, improvement in financial health through introduction of various prudential norms and creation of a competitive environment. The second phase of reforms started in the latter half of 90s, targeted strengthening the foundation of banking system, streamlining procedures, upgrading technology and human resources development and further structural changes. The financial sector reforms carried out so far have made the balance sheets of banks look healthier and helped them move towards achieving global benchmarks in terms of prudential norms and best practices.

Under the existing Basel Capital Accord, allocation of capital follows a one-size-fit-all approach. This would be replaced by a risk based approach to capital allocation. While regulatory minimum capital requirements would still continue to be relevant and an integral part of the three pillar approach under Basel II, the emphasis is on risk based approach relying on external ratings as well as internal rating of each asset and capital charge accordingly. The internal risk based approach would need substantial investments in technology and development of MIS tools. For a rating tool for internal assessment to be effective, past data for 3 to 5 years would be required and as such, Indian banking system will have to build up the capabilities for a smooth migration to the new method.

Another aspect which is included in Basel II accord is a provision for capital allocation for operational risk. This is a new parameter and even internationally evaluation tools are not yet fully developed. This would be another area where banking system will have to reckon additional capital needs and functioning of its processes.

The financial sector reforms have brought in the much needed competition in the market place. The competition to the existing banks came mainly from the techno-savvy private sector banks. In the coming years, we expect to see greater flow of foreign capital to come into the Indian banking sector. Opening up of banking sector to global players would see banks facing global competition.

Technology is expected to be the main facilitator of change in the financial sector. Implementation of technology solutions involves huge capital outlay. Besides the heavy investment costs, technology applications also have a high degree of obsolescence. Banks will need to look for ways to optimize resources for technology applications. In this regard, global partnerships on technology and skills sharing may help.

The pressure on capital structure is expected to trigger a phase of consolidation in the banking industry. Banks could achieve consolidation through different ways. Mergers and acquisitions could be one way to achieve this. In the past, mergers were initiated by regulators to protect the interests of depositors of weak banks. In recent years, market led mergers between private banks have taken place. It is expected that this process would gain momentum in the coming years. Mergers between public sector banks or public sector banks and private banks could be the next logical thing / development to happen as market players tend to consolidate their position to remain in competition.

Consolidation could take place through strategic alliances / partnerships. Besides helping banks to achieve economy of scale in operations and augment capital base, consolidation could help market players in other ways also to strengthen their competitiveness. The advantage could be in achieving better segmentation in the market. Strategic alliances and collaborative approach, as an alternative to mergers and acquisitions, could be attempted to reduce transaction costs through outsourcing, leverage synergies in operations and avoid problems related to cultural integration. If consolidation is taken too far, it could lead to misuse of dominant market positions. Rapid expansion in foreign markets without sufficient knowledge of local economic conditions could increase vulnerability of individual banks.

Public Sector Banks had, in the past, relied on Government support for capital augmentation. However, with the Government making a conscious decision to reduce its holding in Banks, most Banks have approached the capital market for raising resources. This process could gain further momentum when the government holding gets reduced to 33% or below. It is expected that pressures of market forces would be the determining factor for the consolidation in the structure of these banks. If the process of consolidation through mergers and acquisitions gains momentum, we could see the emergence of a few large Indian banks with international character. There could be some large national banks and several local level banks.

Opening up of the financial sector from 2005, under WTO, would see a number of Global banks taking large stakes and control over banking entities in the country. They would bring with them capital, technology and management skills. This will increase the competitive spirit in the system leading to greater efficiencies. Government policy to allow greater FDI in banking and the move to amend Banking Regulation Act to remove the existing 10% cap on voting rights of shareholders are pointers to these developments.

The cooperative banks have played a crucial part in the development of the economy. The primary agricultural societies which concentrate on short-term credit and rural investment credit institutions supported by District / State level cooperative banks have played a crucial role in the credit delivery in rural areas. The Urban Cooperative Banks have found their own niche in urban centres. These institutions in the cooperative sector need urgent capital infusion to remain as sound financial entities. Cooperative sector comes under State jurisdiction while commercial banking operations are regulated by the Reserve Bank of India. The duality in control had weakened the supervisory set up for these institutions. It is expected that certain amendments to the Banking Regulation Act introduced recently in the Parliament with the objective of strengthening the regulatory powers of the Reserve Bank of India would pave the way for strengthening of cooperative / financial institutions. It is expected that these banks would upgrade skills of their staff and improve the systems and procedures to compete with commercial bank entities.

Consolidation would take place not only in the structure of the banks, but also in the case of services. For instance, some banks would like to shed their non-core business portfolios to others. This could see the emergence of niche players in different functional areas and business segments such as housing, cards, mutual funds, insurance, sharing of their infrastructure including ATM Network, etc.

Rationalization of a very large network of branches, which at present has rendered the system cost ineffective and deficient in service would take place. Most of the banks would have adopted core-banking solutions in a fully networked environment. Back office functions would be taken away from branches to a centralized place. While brick and mortar branches would continue to be relevant in the Indian scenario, the real growth driver for cost cutting would be virtual branches viz., ATMs, Internet Banking, mobile banking, kiosks etc., which can be manned by a few persons and run on 24 x 7 basis to harness the real potential of these technological utilities, there will be strategic alliances / partnership amongst banks and this phenomenon has already set in.

As we move along, the concept of branch banking will undergo changes. Banks will find that many of the functions could be outsourced more profitably without compromising on the quality of service. Specialized agencies could come forward to undertake Marketing and delivery functions on behalf of banks. This could see banking products being sold outside the four walls of a branch. Banks would then concentrate on developing new products and earning fee based income.

The composition of bank staff will change. As total computerization will render a part of the workforce surplus, banks will go for a rightsizing exercise. Some may resort to another round of VRS to shed excess flab while some other may go for re-deployment to strengthen marketing arms. With greater use of technology and outsourcing of services in different areas, the manpower recruitment will mostly be in specialized areas and technology applications. With commitment shifting from the organization to the profession, we could see greater lateral movement of banking personnel. Training and skill development will, however, continue to be key HR functions. With the age profile of staff undergoing changes, banks will have to focus on leadership development and succession planning. Knowledge management will become a critical issue.

Management structure of banks will also undergo drastic changes in the coming years. Instead of the present pyramid structure, the banks will move towards reduction in tiers to ultimately settle for a flat structure. Product-wise segmentation will facilitate speedier decision-making.