20-03-2014, 04:58 PM
Competition, consolidation and systemic stability in the Indian banking industry
Competition, consolidation.pdf (Size: 79.82 KB / Downloads: 93)
Introduction
The banking sector reforms undertaken in India from 1992 onwards were basically aimed at ensuring
the safety and soundness of financial institutions and at the same time at making the banking system
strong, efficient, functionally diverse and competitive. The reforms included measures for arresting the
decline in productivity, efficiency and profitability of the banking sector. Furthermore, it was recognised
that the Indian banking system should be in tune with international standards of capital adequacy,
prudential regulations, and accounting and disclosure standards. Financial soundness and consistent
supervisory practices, as evident in our level of compliance with the Basel Committee’s Core
Principles for Effective Banking Supervision, have made our banking system resilient to global shocks.
Forces for change
India has not faced any major economic/financial crises, though in 1990-91, there was some pressure
on the external sector with the current account deficit and external debt servicing reaching large
proportions. However, due to prudent macroeconomic policies, it was possible to return the country to
a sustainable growth path. As well as the long history of regulation and supervision, Indian banks have
limited exposure to sensitive sectors such as real estate, equity, etc, strict control over off-balance
sheet activities, larger holdings of government bonds (which helps limit credit risk), relatively well-
diversified credit portfolios, statutory restrictions on connected lending, adequate control over currency
and maturity mismatches, etc, which has insulated them from the adverse impact of financial crisis and
contagion. Banks in India have played a significant role in the development of the Indian economy.
However, with the structural reforms initiated in the real economy from the early 1990s, it was
imperative that a vibrant and competitive financial system should be put in place to sustain the
ongoing process of reforms in the real sector.
The financial sector reforms have provided the necessary platform for the banking sector to operate on
the basis of operational flexibility and functional autonomy, thereby enhancing efficiency, productivity
and profitability. The reforms also brought about structural changes in the financial sector and
succeeded in easing external constraints on its operation, introducing transparency in reporting
procedures, restructuring and recapitalising banks and enhancing the competitive element in the
market through the entry of new banks. The ongoing revolution in information and communication
technology has, however, largely bypassed the Indian banking system given the low initial level of
automation. The competitive environment created by financial sector reforms has nonetheless
compelled the banks to gradually adopt modern technology, albeit to a limited extent, to maintain their
market share. Banks continue to be the major financial intermediaries with a share of 64% of total
financial assets. However, non-bank financial companies and development finance institutions are
also emerging as alternative sources of funding.
Privatisation of state banks
State banks in India have, over the years, played a very significant role in the development of the
economy and in achieving the objectives of the nationalisation undertaken in 1969 and 1980, namely
to reach the masses and cater to the credit needs of all segments, including weaker sections, of the
economy. The period 1969-90 witnessed rapid branch expansion and an adequate flow of credit to all
sectors, including the neglected sectors of the country. From 1990, however, it was recognised that
steps were needed to improve the financial health of banks to make them visible, efficient and
competitive to serve the emerging needs and enhance the efficiency of the real sector. While the role
of the large state banks has not undergone any structural changes and they continue to serve the
varying needs of the economy, what has changed significantly, as a result of the reform process, is the
focus on their consolidation, efficiency, resilience, productivity, asset quality and profitability through
liberalisation, deregulation and adoption of prudential standards in line with international best
practices.
Domestic mergers
Under the Banking Regulation Act, banking companies cannot merge without the approval of the
Reserve Bank of India. The government and the Reserve Bank do not play a proactive role in either
encouraging or discouraging mergers. It is our endeavour that the government and the RBI should
only provide the enabling environment through an appropriate fiscal, regulatory and supervisory
framework for the consolidation and convergence of financial institutions, at the same time ensuring
that a few large institutions do not create an oligopolistic structure in the market. Mergers should be
based on the need to attain a meaningful balance sheet size and market share in the face of
heightened competition and driven by synergies and locational and business-specific
complementarities.
Behaviour of foreign banks
The presence of foreign banks does not imply negligence of particular sectors of the economy. In
India, foreign banks are required to comply with priority sector lending norms, where the commitments
are lower than those applicable to domestic banks under a tailor-made structure suitable to them. The
experience is that foreign banks adhere to the Reserve Bank prescriptions. Generally, however, due to
their limited knowledge of the local industry and branch network, foreign banks are very conscious
about their asset quality and a major shift in the share of foreign banks may result in neglect of the
credit requirements of small and medium-sized businesses, whose development is crucial for
emerging markets, but which are perceived as carrying relatively higher risks.
Foreign banks constantly evaluate the political, economic and financial climate in financial markets
and vary their investment/lending decisions. While the credit risk management processes and
practices vary among banks, all internationally active banks have centralised policies and country and
transfer risk monitoring, reporting and limiting mechanisms. While the traditional scope encompassed
only sovereign and transfer risk, large flows of loans to non-G10 countries’ commercial entities have
induced banks to broaden the scope of country and transfer risk management to incorporate the
potential default of foreign private sector counterparties arising from country-specific economic factors.
In response to the Asian crisis and more recent events, banks in India are required to strengthen their
country and transfer risk monitoring and analysis in an effort to identify incipient problems and to
adjust exposures more promptly and systematically.
Conclusion
The financial sector reforms have brought about significant improvements in the financial strength and
the competitiveness of the Indian banking system. The prudential norms, accounting and disclosure
standards, risk management practices, etc are keeping pace with global standards, making the
banking system resilient to global shocks.
The consolidation and convergence of banks in India has, however, not kept pace with global
phenomena. The efforts on the part of the Reserve Bank of India to adopt and refine regulatory and
supervisory standards on a par with international best practices, competition from new players,
gradual disinvestment of government equity in state banks coupled with functional autonomy, adoption
of modern technology, etc are expected to serve as the major forces for change. In the emerging
scenario, the supervisors and the banks need to put in place sound risk management practices to
ensure systemic stability.