Unleashing Banks & Financial sector growth by Sustained Strategic management through Smart Secured Governance

Indian banking industry has recently witnessed the roll out of innovative banking models like payments and small finance banks. RBI’s new measures may go a long way in helping the restructuring of the domestic banking industry

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Introduction

Indian banking industry has recently witnessed the roll out of innovative banking models like payments and small finance banks. RBI’s new measures may go a long way in helping the restructuring of the domestic banking industry.The digital payments system in India has evolved the most among 25 countries with India’s Immediate Payment Service (IMPS) being the only system at level 5 in the Faster Payments Innovation Index (FPII).

The Indian banking system consists of 12 public sector banks, 22 private sector banks, 46 foreign banks, 53 regional rural banks, 1,544 urban cooperative banks and 96,248 rural cooperative banks provide financial services to regular public such as loans, wealth management, investment services, currency exchange, safe deposit boxes and more.

  • Total transaction value in the Digital Payments segment amounts to US$81,197million in 2020.
  • Total transaction value is expected to show an annual growth rate (CAGR 2020-2023) of 3% resulting in the total amount of US$134,588million by 2023.
  • The market’s largest segment is Digital Commerce with a total transaction value of US$71,544million in 2020.
  • From a global comparison perspective it is shown that the highest cumulated transaction value is reached in China (US$1,928,753million in 2020).

As per RBI provisional data on global operations, the aggregate amount of gross losses of PSBs and Scheduled Commercial Banks (SCBs) wereINR. 8,06,412 crore and INR. 9,49,279 crore respectively. Secured Governancestrategy designed tominimise the revenue loss of banking sector.The value and valuation strategy offers sophisticated funding mechanism and tailored to the economic growth and generate huge employment opportunity.

 History of Banking System in India

In India, the banking system is as old as early Vedic period. The Rig Veda speaks only gold, silver copper and bronze and the later Vedic texts also mention tin, lead, iron and silver. Recently iron coins were found in very early levels at Attranji Kheri (U.P.) and Pandu Rajar Dhibi (Bengal) since the days of Buddha. In ancient India during the Maurya dynasty (321 to 185 BC), an instrument called adesha was in use, which was an order on a banker desiring him to pay the money of the note to a third person, which corresponds to the definition of a bill of exchange as we understand it today. During the Buddhist period, there was considerable use of these instruments. Merchants in large towns gave letters of credit to one another. A money economy existed in India. Before the establishment of banks, the financial activities were handled by money lenders andindividuals. At that time the interest rates were very high. Again there were no security of public savings andno uniformity regarding loans.

Banks are one of the most important economic wings of any country. In this modern time, money and its necessity is very important. A developed financial system of the country ensures to attain development. A bank provides valuable services to a country. To attain development there should be a good developed financial system to support not only the economic but also the society. So, a bank plays a vital role in the socio economic matters of the country. Today banks have become a part and parcel of our life. There was a time when the dwellers of city alone could enjoy their services. Now banks offer access to even a common man and their activities extend to areas hitherto untouched.

Sl. No. Category Number of Branches
1 Public Sector Banks 87,860
2 Private Sector Banks 32,375
3 Foreign Banks 300
4 All Co – Operative Banks 97,792
Total 218,327

So as to overcome such problems the organized banking sector wasestablished, which was fully regulated by the government. The organized banking sector works within thefinancial system to provide loans, accept deposits and provide other services to their customers.

Modern banking in India originated in the last decade of the 18th century. Among the first banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829–32; and the General Bank of India, established in 1786 but failed in 1791.

During the period of British rule merchants established the Union Bank of Calcutta in 1829, first as a private joint stock association, then partnership. Its proprietors were the owners of the earlier Commercial Bank and the Calcutta Bank, who by mutual consent created Union Bank to replace these two banks. In 1840 it established an agency at Singapore, and closed the one at Mirzapore that it had opened in the previous year. Also in 1840 the Bank revealed that it had been the subject of a fraud by the bank’s accountant. The largest and the oldest bank which is still in existence is the State Bank of India (S.B.I). It originated and started working as the Bank of Calcutta in mid-June 1806. In 1809, it was renamed as the Bank of Bengal. This was one of the three banks founded by a presidency government; the other two were the Bank of Bombay in 1840 and the Bank of Madras in 1843. The three banks were merged in 1921 to form the Imperial Bank of India, which upon India’s independence, became the State Bank of India in 1955. For many years the presidency banks had acted as quasi-central banks, as did their successors, until the Reserve Bank of India was established in 1935, under the Reserve Bank of India Act, 1934. In 1960, the State Banks of India was given control of eight state-associated banks under the State Bank of India (Subsidiary Banks) Act, 1959. These are now called its associate banks.

Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian rebellion, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally undercapitalised and lacked the experience and maturity to compete with the presidency and exchange banks.

In 1969 the Indian government nationalised 14 major private banks; one of the big banks was Bank of India. A second round of nationalizations of six more private commercial banks followed in 1980. The stated reason for the nationalization was to give the government more control of credit delivery. With the second round of nationalizations, the Government of India controlled around 91% of the banking business of India. These nationalised banks are the majority of lenders in the Indian economy. They dominate the banking sector because of their large size and widespread networks.

India is one of the top 10 economies in the world, where the banking sector has tremendous potential to grow. The last decade saw customers embracing ATM, internet and mobile banking. As on January 31st, 2020, the total number of ATMs in India increased to 210,263 and is further expected to increase to 407,000 by 2021. As of 2017, 80% of the adult population has bank accounts. As on July, 2019 the number of debit and credit cards issued were 840.6 million and 50.3 million, respectively. Assets of public sector banks stood at INR. 72.59 lakh crores (US$ 1,038.76 billion) in FY19. As per Union Budget 2019-2020, Provision coverage ratio of banks reached highest in 7 years. As per RBI, as of January 10, 2020, India recorded foreign exchange reserves of approximately US$461.21 billion.

Deposits as of Jan 2020, stood at INR. 133.24 lakh crore (US$ 1,906.45 billion) and credit to non-food industries reached INR. 100.23 lakh crore (US$ 1.43 trillion) as on January 31,2020. On the back of a growing Indian economy It has the potential to become the fifth largest banking industry in the world by 2020 and the third largest by 2025, according to an industry report.

The face of Indian banking has changed over the years. Banks are now reaching out to the masses with technology to facilitate greater ease of communication, and transactions are carried out through the Internet and mobile devices. A bank is a financial institution that provides banking and other financial services to their customers. A bank is generally understood as an institution which provides fundamental banking services such as accepting deposits and providing loans. There are also nonbanking institutions that provide certain banking services without meeting the legal definition of a bank. Banks are a subset of the financial services industry. A banking system also referred as a system provided by the bank which offers cash management services for customers, reporting the transactions of their accounts and portfolios, throughout the day. The banking system in India should not only be hassle free but it should be able to meet the new challenges posed by the technology and any other external and internal factors. For the past three decades, India’s banking system has several outstanding achievements to its credit. The Banks are the main participants of the financial system in India. The Banking sector offers several facilities and opportunities to their customers. All the banks safeguards the money and valuables and provide loans, credit, and payment services, such as checking accounts, money orders, and cashier’s cheques. The banks also offer investment and insurance products. As a variety of models for cooperation and integration among finance industries have emerged, some of the traditional distinctions between banks, insurance companies, and securities firms have diminished. In spite of these changes, banks continue to maintain and perform their primary role—accepting deposits and lending funds from these deposits.

Now, the existing situation has created various challenges and opportunity for Indian Commercial Banks. In order to encounter the general scenario of banking industry we need to understand the challenges and opportunities lying with banking industry of India.

Key Challenges in Banking Sector of India

Developing countries like  India, still  has  a  huge  number of  people who do  not  have  access  to banking services due  to  scattered and fragmented  locations.  But  if  we  talk  about those people who  are  availing  banking  services,  their  expectations  are  raising  as  the  level  of  services  are increasing  due  to  the  emergence  of  Information  Technology  and  competition.  Since, foreign banks are playing in Indian market, the number of services offered has increased and banks have laid emphasis on meeting the customer expectations.

  1. Rural Market: Banking in India is generally fairly mature in terms of supply, product range and reach, even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region.
  2. Management of Risks: The growing competition increases the competitiveness among banks. But, existing global banking scenario is seriously posing threats for Indian banking industry. We have already witnessed the bankruptcy of some foreign banks.
  3. Global Banking: It is practically and fundamentally impossible for any nation to exclude itself from world economy. Therefore, for sustainable development, one has to adopt integration process in the form of liberalization and globalization as India spread the red carpet for foreign firms in 1991. The impact of globalization becomes challenges for the domestic enterprises as they are bound to compete with global players. If we look at the Indian Banking Industry, then we find that there are around 300 foreign bank franches operating in India, which becomes a major challenge for Nationalized and private sector banks. These foreign banks are large in size, technically advanced and having presence in global market, which gives more and better options and services to Indian traders.
  4. Non – performing Asset (NPAs)

The Reserve Bank of India’s (RBI) macro stress tests shows the gross non-performing assets (NPAs) of commercial banks to jump from 9.3% in September 2019 to 9.9% in the next one year. This finding is based on a baseline scenario which assumes the continuation of the current economic situation in the future. The GDP is down to 4.5% in the second quarter of financial year 2019-20, and is expected to hover around 5% for the entire fiscal.

The public sector banks, that control two-third of the banking sector in terms of deposits and advances, would see their NPAs increase to 13.2% by September 2020, from 12.7% in September 2019. The private banks, however, may see their NPAs increase to 4.2% from 3.9% in the same period. The foreign banks, which control less than 5% of the total banking assets, will see NPAs rise to 3.1% from 2.9% during this one year period.

The asset quality deterioration will also have a direct impact on the capital ratios. The RBI report says the capital adequacy ratio of 53 banks is projected to decline to 14.1% by September 2020 from 14.9% in September 2019. In fact, there will be as many as three banks that would see their capital adequacy falling below the minimum regulatory level of 9% by September 2020. This is while assuming no further capital is infused into these banks.

Currently, credit growth in the industry has already weakened because of slowdown in key sectors of the economy, especially real estate, construction, auto, etc. The loans and advances have slowed from 13.2% in March 2019 to 8.7% in September 2019. In recent past, retail growth actually compensated for the loss in corporate lending growth, but slowdown in some key retail assets like auto and real estate is now impacting the retail assets story. In fact, there are also concerns around the asset quality in retail because of job losses, stagnant income and no job creation in the economy.

According to the RBI report, the credit growth of PSBs has declined to 4.8% year-on-year in September 2019, from 9.6% in March 2019. The credit growth of private sector banks has moderated to 16.5% from 21%.

  1. Intense Competition: The RBI and Government of India kept banking industry open for the participants of private sector banks and foreign banks. The foreign banks were also permitted to set up shop on India either as branches or as subsidiaries. Due to many new players have entered the market such as private banks, foreign banks, non-banking finance companies, etc. The foreign banks and new private sector banks have spearhead the hi-tech revolution. For survival and growth in highly competitive environment banks have to follow the prompt and efficient customer service, which calls for appropriate customer policies and customer friendly procedures.
  2. Timely Technological up gradation: Already electronic transfers, clearings, settlements have reduced translation times. To face competition it is necessary for banks to absorb the technology and upgrade their services.

While much of the growth has been focused on retail consumer businesses, like payments and lending, new technologies have the potential to drive unprecedented transformations and competitive shifts in commercial and wholesale markets as well. The same technologies that enable new entrants to compete with established incumbents are also changing how incumbents themselves operate, manage information, and engage with customers.

Over the years, the need for credit in MSMEs is increasing. However, the credit allocation to the small firms has not been up to the mark. According to RBI, MSMEs have faced a decline in lending for more than 2 years since 2015. Moreover, the Micro-Units Development and Refinance Agency (MUDRA) scheme which aims to provide credit for expanding existing small business hasn’t been successful either. The loans are majorly extended to well-performing sectors.

  1. Structural issues – However while Bank nationalisation served its purpose of PSU Banks achieving increased banking penetration all over India and that it resulted in increase in bank deposits consequently pushing the domestic savings upwards. Thus this helped the government to find resources for economic growth pushing ahead credit delivery process. However the benefits were soon overshadowed by the duality of regulatory control (RBI vs Govt) for PSU Banks and the increasing influence of the govt on the professional management of Banks. The landmark milestone in this regard was the resignation of R.K Talwar, CMD of SBI in 1976 – and govt’s exercise of control has only increased.

RBI oday thus exercises a lesser control of over PSU Banks as compared to private sector banks – as there is an overlap with Department of Financial Services.

Further, the majority control of the Govt in PSU Banks ensured that compliance to CAG & Govt rules impacted their ability to hire on market competitive salaries – as they were increasingly subjected to parity level issues with civil services. Thus today there is exists a queer situation of a fresh student from IIM-Ahmedabad get higher starting salary than SBI CMD. Also there is no freedom for the Bank CEO to recruit & select his senior management team – that is done by a separate Banking Board Bureau. This has resulted in loss of talent to other private sector & foreign banks who do not suffer from such constraints. This structural problem has caused the government of India to infuse Rs 3.8 lac crores in PSU Banks’ capital since 2011.

Cyber Security

The number of cases of frauds reportedby banks increased by 15% in 2018-19 on a year-on-year basis, with theamount involved rising by 73.8%, thoughmostly related to occurrences in earlier years.

Fifty-seven banks, including six cooperativebanks, were subjected to IT examinations toassess their level of cyber security preparednessand compliance with the circulars, advisories andalerts on cyber security issued by the ReserveBank from time to time. Targeted thematicexaminations were also carried out, focusing onapplications, infrastructure and systems used bythe banks. During the year, three cyber drills wereconducted on hypothetical scenarios as tabletop exercises for informing banks’ prospectivereviews of Cyber Crisis Management Plans/Incident Response Mechanisms.  During the year, key risk indicatorswere revised to ensure that banks provide amore accurate quantitative indication of cyberrisk posture and adequacy of cyber controlsimplemented by banks. Banks were advisedto ensure that members of the Board, seniormanagement and CXOs (viz., Chief InformationOfficer, Chief Technology Officer, Chief RiskOfficer and Chief Information Security Officer)undergo mandatorycertification in IT and cybersecurity.

However, increased use of IT to support this fraud avoidance as also greater customer service across banking products reduces pressure on branch banking but creates increased demand for staff  in operational & IT-enabled services in concentrated locations – thus requiring the banks to develop banking back-office operations hubs and thus more real estate. Increasing banking penetration will create an even a greater need for such banking operations hubs. Banks can locate these hubs in these industrial cluster hubs as anchor tenants and enhance value.

Banks can fund these Industrial Cluster hubs through equity and debt. Once the project is operational and fully occupied, it can refinance the debt through a REIT structure and get an upfront premium & higher equity valuations once completion &rentalizing risks are over.

wereconducted on hypothetical scenarios as tabletop exercises for informing banks’ prospectivereviews of Cyber Crisis Management Plans/Incident Response Mechanisms.

During the year, key risk indicatorswere revised to ensure that banks provide amore accurate quantitative indication of cyberrisk posture and adequacy of cyber controlsimplemented by banks. Banks were advisedto ensure that members of the Board, seniormanagement and CXOs (viz., Chief InformationOfficer, Chief Technology Officer, Chief RiskOfficer and Chief Information Security Officer)undergo mandatorycertification in IT and cybersecurity.

However, increased use of IT to support this fraud avoidance as also greater customer service across banking products reduces pressure on branch banking but creates increased demand for staff  in operational & IT-enabled services in concentrated locations – thus requiring the banks to develop banking back-office operations hubs and thus more real estate. Increasing banking penetration will create an even a greater need for such banking operations hubs. Banks can locate these hubs in these industrial cluster hubs as anchor tenants and enhance value.

Banks can fund these Industrial Cluster hubs through equity and debt. Once the project is operational and fully occupied, it can refinance the debt through a REIT structure and get an upfront premium & higher equity valuations once completion &rentalizing risks are over.

Secured Governance advocates a pragmatic approach of taking Advantage of Valuation of Assets Created

Indian banks — particularly public sector banks — are loaded down with many problem including non-performingloans are one of the major problem. This means that due to perceived risks and consequent extra cautious asset acquisition approach they find it difficult to grow their new lending to industry, thus credit delivery and growth suffers.Financial industry should put in place a robust system to solve the NPA problem of the banking sector.Secured Governance is a novel strategy that consists in promoting infrastructure (Industrial Cluster HUBs) development that integrated with all key supporting sectors such as transport, auto & auto-components, power, telecom, healthcare, education etc.This is not new. We all know when development takes place property valuation increases. Who benefits from this? More often than not it is incidental and taken advantage off by land and property middlemen. Imagine a model where this valuation can be ploughed back into the project and also benefit the bank and all the people around. First the development cost of the Industrial Cluster HUB is reduced, and can actually be at negligible cost to the government if carefully planned. Next as the population sees thisas benefitting them and they participate more enthusiastically, thus helping with early completion of the project rather than being an impediment.The strategy provides a genericpathway to capture a part of the increasedvalue by investment made by private stakeholders and helps repayment of loan for infrastructure (HUB) development. This mechanism can help to reduce the GNPA ratio drastically by providing a cushion from the upside of the land valuation increase in the HUB project

Benefits of Secured Governance in Banking Industry

  • funding to the projects could be minimized through SG concept;
  • Enhance financing strategies and public private collaboration through SG;
  • Creative (Bankers) and innovative (private entrepreneur) actors come together to identify links and connections can help find unexpected solutions to complex challenges and unleash the power of collective innovation;
  • Drawing effectively public funding and support can unleashrapid growth of the nation.

Secured Governance – Project Development & Bank Funding

Secured Governance concept focuses on strengthening the Private Public Participation while substantially reducing governmental involvement. Government can play a carefully calibrated supervisory and a monitoring role rather than getting entangled into the nitty-gritty of projects. Majority of the investments will be made by the private entities which would definitely require huge bank funding. Now since most of the developmental work comes under public infrastructure and services the banks may find it unattractive to fund such projects. We propose that Govt. against this infrastructure can grant more FSI to such projects giving way to smooth flow of funds.

Value and Valuation of the allied projects will make it a self-sustaining mechanism while bringing unprecedented growth and development for the nation. It will also be a win-win for each municipal body, state govt. and union govt. as well as it create additional employment and generate taxes for them.

Supporting Productivity Enhancements by Technology Enhancements

  • Foster collaboration across functional, Service, Agency and national high performance computing communities;
  • New and advanced technologies can provide a wide range of productivity enhancing benefits, including increased efficiency, cost reduction, increased speed, greater reachand increased reliability of process and transactions.

Conclusion

  • Post N-Covid related lockdown in India, the economic activity will be at an all-time low and thus increasing the chances of a rapid increase in stress assets & NPAs. The existing NPA problem as stated above would only become more acute need urgent steps to get then economy rolling back again.
  • Banks can allocate between 5 to 10% of their free lendable resources (after computing SLR & CRR allocations) for equity type of instruments. This is because the balance part of the bank balance sheet resources are borrowed funds on which they have to pay interest – they can thus have exposure to deferred earning assets only up-to a limit.This amount could vary also based on the level of stressed assets & capital market exposure each bank has. Real Estate or Project development exposure would also have to be computed as a part of the above “equity-type” exposure as that is the nature of this exposure as well.
  • Secured governance structure as discussed above, by providing an upside hedge, can act as a catalyst for reducing Non-performing assets (NPAs) in banking sector significantly. Value of this Industrial ClusterHUB which grows many folds.
  • Industrial Cluster HUB (HUB) ─ A city or area is usually to be a focal point for the Banking & Financial associated services as well. There would be synergy, or the potential mutual benefit achieved through the combining of banking services with industries. The Project Special Purpose Vehicle (SPV) becomes an indirect source of business through incremental financing for banks by attracting new investments to help finance the debt obligations..

Banks could provide loans to not only public and private industries that come up in these HUB locations but also for investment in the infrastructure development.

  • The presence of industry and banks would need other related services likeaccounting& tax services such as payroll processing, as also catering, taxi & transportation services.

These HUBs wouldprovide a very hedge against the NPA losses of the banking sector and thus would help keep India on the global map as Centre of excellence in the Financial & IT/ITeS Services. The developmental impact of a HUB on business and real estate valuations could also help recoup the private investment of infrastructure development and minimise the loan repayment, not to speak of the large employment opportunity in these HUBs.

The HUB will thus emerge as an important economic growth centre which will be globally benchmarked in terms of design and services. Depending upon each local economy, companies from all sectors including Financial Services, Technology and all other services sector couldbe targeted as potential occupants within the city.

Implementations steps –

Post N-Covid lock down, the economy will need out of box ideas to kickstart the economy. Also the banking sector could be staring at an increased level of NPAs unless steps like these are adopted.

  1. Create a Bank Holding Trust Company & an AMC – with government at 49% levels – this would oversee the day to day operations of the PSU Banks with Govt alongwith RBI, SEBI, IRDA & PFA focusing on banking & financial sector policy and development on a armslength basis. This would bring operational autonomy and the ability to hire staff on competitive salaries. Also RBI would then be able to regulate the entire sector (both private, foreign & PSU Banks) on a level playing field.
  2. Union Govt & RBI to create a policy& procedure document for all banks to implement this plan. Union govt. to then get on board all the state govt. on board with this policy. Union & State Govt. to control the permissions for a licence to build such a HUB – so as to avoid indiscrete land acquisition and reduce duplicity of projects. Each state could identify what kind of HUB they would like to create & the sectoral focus if any – keeping in mind their own unique situation. Multiple projects will diminish the upside value of these investments like in Telecom services & Power generation sector.
  3. RBI to also discuss with all foreign banks locally incorporated locally listed entities which will give tremendous fillip to banking & financial services including Operation and IT enabled business. This will also add to enhanced capital market activity.
  4. Govt & RBI to formulate clear guidelines for Banks who like to get into these project developments on how to build capacity and staff this portfolio acquisition and monitoring.
  5. Initially banks could allocate 1-2% of their lendable portfolio for launching one pilot project at least in each state.

India needs to be becoming a major international HUB for the Global Bankingindustry.Thegoal of the Secured Governance strategy is to develop many mini HUBs in semi urban cities and nano HUBs in rural areas. Besides it could provide a route into financial professionsand develops skills that are useful in a range of banking & insurance sectors. These HUBs could be a financial andbusiness centre established by non-government organisations of India to attract international financialservices and multinational corporationsto growand develop the market for financialservicesinthe region.The secured governance HUB development aimsto help all registered small, medium and large scale firm’s growth and generatenew and sustainable revenue streams. It providesaccessto local and regional investmentopportunities in large scale.

These HUBs development that yield net present value in terms of demonstrable user fees or a direct increase in additional revenues to the government and policy makers can enhance the efficiency and productivity with used to create resilient economic prosperity.It couldenhance access to direct and indirect job opportunities and services for both skilled levels.


 

 

 

By Suneet Kumar Maheshwari

Global Thought leader and Ex MD, L&T Infra and Finance

 

 

 

By Dr. P. Sekhar

Chairman of Global Smart Cities Panel, Micro Tech Global Foundation

 

 

Summary
Article Name
Unleashing Banks & Financial sector growth by Sustained Strategic management through Smart Secured Governance
Description
Indian banking industry has recently witnessed the roll out of innovative banking models like payments and small finance banks. RBI’s new measures may go a long way in helping the restructuring of the domestic banking industry
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THE POLICY TIMES
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