Executive Summary

· The Indian financial sector is in for an overhaul. Financial sector reforms have long been regarded as an integral part of the overall policy reforms in India. India has recognized that these reforms are imperative for increasing the efficiency of resource mobilization and allocation in the real economy and for the overall macroeconomic stability.

· The reforms have been driven by a thrust towards liberalization. Several initiatives such as liberalization in the interest rate and reserve requirements have been taken on this front. At the same time, the government has emphasized on stronger regulation aimed at strengthening prudential norms, transparency and supervision to mitigate the prospects of systemic risks.

· Today the Indian financial structure is inherently strong, functionally diverse, efficient and globally competitive. During the last fifteen years, the Indian financial system has been incrementally deregulated and exposed to international financial markets along with the introduction of new instruments and products.

Overview

The Banking Sector

The banking sector is the most dominant sector of the financial system in India. Significant progress has been made with respect to the banking sector in the post liberalization period. The financial health of the commercial banks has improved manifolds with respect to capital adequacy, profitability, asset quality and risk management. Further, deregulation has opened new opportunities for banks to increase revenue by diversifying into investment banking, insurance, credit cards, depository services, mortgage, securitization, etc. Liberalization has created a more competitive environment in the banking sector. The aggregate foreign investment (FDI plus FII) limit for the private sector banking has been raised to 74 percent in the recent country budget. The competition has increased within the banking sector (with the emergence of new private banks and foreign banks) as well as from other segments of the financial sector such as mutual funds, Non Banking Finance Companies, post offices and capital markets.

Capital Markets

India has a long tradition of functioning capital markets. The Bombay stock exchange is over a hundred years old and the volume of activity has increased in the recent years. The process of reform of capital markets started in 1992 and aimed at removing direct government control and replacing it by a regulatory framework based on transparency and disclosure. The first step was taken in 1992 when SEBI was elevated to a full-fledged capital market regulator.

An important policy initiative in 1993 was the opening of capital markets for foreign institutional investors and allowing Indian companies to raise capital abroad. FII registrations in the country have gone up significantly over the years. The number of registered FIIs has gone up from 823 in December 2005 to 972 in October 2006. FIIs had made $10.7 billion worth of investment (Rs 47,181 crore) in calendar 2005. The FIIs have been rewarded well by attractive valuations and increasing returns. The depository and share dematerialization systems have been introduced to enhance the efficiency of the transaction cycle.

A number of significant reforms have been implemented in the spot equity and related exchange traded derivatives markets since the early 1990s. For instance, spot prices are mostly market-determined, trading volumes in the derivatives market exceed those in spot markets and market practices such as speed of settlement and dematerialization are close to international best practices

Insurance Sector

There exists huge scope of investment in the insurance sector in India. India has an enormous middle-class that can afford to buy life, health and disability and pension plan products. Further, insurance is one of the most important tax saving instrument in the country.

Insurance sector has been opened up for competition from Indian private insurance companies with the enactment of Insurance Regulatory and Development Authority Act, 1999 (IRDA Act). As per the provisions of IRDA Act, 1999, Insurance Regulatory and Development Authority (IRDA) was established on 19th April 2000 to protect the interests of holder of insurance policy and to regulate, promote and ensure orderly growth of the insurance industry. IRDA Act 1999 paved the way for the entry of private players into the insurance market, which was hitherto the exclusive privilege of public sector insurance companies/ corporations. Under the new dispensation Indian insurance companies in private sector were permitted to operate in India on the fulfillment of certain prerequisites. A large number of public and private players are competing today in both life and general insurance segments. The FDI cap/ Equity in the insurance sector is 26 percent under the automatic route subject to licensing by the insurance regulatory and development authority.

Venture Capitals

India is prime target for venture capital and private equity today, owing to various factors such as fast growing knowledge based industries, favourable investment opportunities, cost competitive workforce, booming stock markets and supportive regulatory environment among others. The sectors where the country attracts venture capital are IT and ITES, software products, banking, PSU disinvestments, entertainment and media, biotechnology, pharmaceuticals, contract manufacturing and retail. An offshore venture capital company may contribute upto 100 percent of the capital of a domestic venture capital fund and may also set up a domestic asset management company to manage the fund. Venture capital funds (VCFs) and venture capital companies (VCC) are permitted upto 40 percent of the paid up corpus of the domestic unlisted companies. This ceiling would be subject to relevant equity investment limit in force in relation to areas reserved for SSI. Investment in a single company by a VCF/VCC shall not exceed 5 percent of the paid up corpus of a domestic VCF/VCC. The automatic route is not available.

Financial sector reforms were initiated as part of overall economic reforms in he country and wide ranging reforms covering industry, trade, taxation, external sector, banking and financial markets have been carried out since mid 1991. A decade of economic and financial sector reforms has strengthened the fundamentals of the Indian economy and transformed the operating environment for banks and financial institutions in the country. The sustained and gradual pace of reforms has helped avoid any crisis and has actually fuelled growth.

The most significant achievement of the financial sector reforms has been the marked improvement in the financial health of commercial banks in terms of capital adequacy, profitability and asset quality as also greater attention to risk management. Further, deregulation has opened up new opportunities for banks to increase revenues by diversifying into investment banking, insurance, credit cards, depository services, mortgage financing, securitisation, etc. At the same time, liberalisation has brought greater competition among banks, both domestic and foreign, as well as competition from mutual funds, NBFCs, post office, etc voting rights has been removed.

Key Players (Indian)

Banks

ABN Amro Bank

American Express

Bank of America

Bank of India

Bank of Maharashtra

Barclays Bank

Calyon Bank

Canara Bank

Central Bank of India

Centurion Bank

Citi Group

Deutsche Bank

HDFC

HSBC

ICICI

Indian Bank

IDBI

ING Vysya

Kotak Mahindra Bank

RBI

SBI

SIDBI

Standard Chartered Bank

 

Insurance

Max New York Life

LIC

ICICI Prudential

ICICI Lombard

HDFC Standard Life

HDFC Chubb

Chola Mandalam

Birla Sunlife

AXA Life

Bajaj Allianz

Aviva

United India Assurance

New India Assurance

Tata AIG

Royal Sundaram

Kotak Mahindra Life Insurance

MetLife

Mutual Funds

ABN Amro Asset Management

Ace Richesse India Pvt Ltd

Alliance Capital Mutual Funds

Association of Mutual Funds in India

Birla Sunlife Mutual Fund

BOB Mutual Fund

Bombay Stock Exchange Ltd

Canbank Mutual Fund

Chola Mutual Fund

Deutsche Mutual Fund

DSP Merrill Lynch Mutual Fund

Fidelity Mutual Fund

Franklin Templeton Mutual Fund

GIC Mutual Fund

HDFC Mutual Fund

HSBC Investment

HSBC Mutual Fund

ICICI Securities Ltd

ING Vysya Mutual Fund

JM Financial Mutual Fund Ltd

Kotak Mahindra Mutual Fund

LIC Mutual Fund

LKP Forex Ltd

Morgan Stanley Mutual Fund

Motilal Oswal Mutual Funds

Multi Commodity Exchange Of India Ltd

Prudential ICICI Mutual Fund

Reliance Capital Asset Management Ltd (ADAG)

Sahara Mutual Fund

SBI Mutual Fund

Securities and Exchange Board of India(Sebi)

Sundaram Mutual Fund

Tata Investment Corporation Ltd.

Tata Mutual Fund

UTI Mutual Fund

Current Trends

Some of the major reform initiatives in the last decade that have changed the face of the Indian banking and financial sector are:

Interest rate deregulation. Interest rates on deposits and lending have been deregulated with banks enjoying greater freedom to determine their rates.
Adoption of prudential norms in terms of capital adequacy, asset classification, income recognition, provisioning, exposure limits, investment fluctuation reserve, etc.
Reduction in pre-emptions – lowering of reserve requirements (SLR and CRR), thus releasing more lendable resources which banks can deploy profitably.
Government equity in banks has been reduced and strong banks have been allowed to access the capital market for raising additional capital.
Banks now enjoy greater operational freedom in terms of opening and swapping of branches, and banks with a good track record of profitability have greater flexibility in recruitment.
New private sector banks have been set up and foreign banks permitted to expand their operations in India including through subsidiaries. Banks have also been allowed to set up Offshore Banking Units in Special Economic Zones.
New areas have been opened up for bank financing: insurance, credit cards, infrastructure financing, leasing, gold banking, besides of course investment banking, asset management, factoring, etc.
New instruments have been introduced for greater flexibility and better risk management: e.g. interest rate swaps, forward rate agreements, cross currency forward contracts, forward cover to hedge inflows under foreign direct investment, liquidity adjustment facility for meeting day-to-day liquidity mismatch.
Several new institutions have been set up including the National Securities Depositories Ltd., Central Depositories Services Ltd., Clearing Corporation of India Ltd., Credit Information Bureau India Ltd.
Limits for investment in overseas markets by banks, mutual funds and corporates have been liberalised. The overseas investment limit for corporates has been raised to 100% of net worth and the ceiling of $100 million on prepayment of external commercial borrowings has been removed. MFs and corporates can now undertake FRAs with banks. Indians allowed to maintain resident foreign currency (domestic) accounts. Full convertibility for deposit schemes of NRIs introduced.
Universal Banking has been introduced. With banks permitted to diversify into long-term finance and DFIs into working capital, guidelines have been put in place for the evolution of universal banks in an orderly fashion.
Technology infrastructure for the payments and settlement system in the country has been strengthened with electronic funds transfer, Centralised Funds Management System, Structured Financial Messaging Solution, Negotiated Dealing System and move towards Real Time Gross Settlement.
Adoption of global standards. Prudential norms for capital adequacy, asset classification, income recognition and provisioning are now close to global standards. RBI has introduced Risk Based Supervision of banks (against the traditional transaction based approach). Best international practices in accounting systems, corporate governance, payment and settlement systems, etc. are being adopted.
Credit delivery mechanism has been reinforced to increase the flow of credit to priority sectors through focus on micro credit and Self Help Groups. The definition of priority sector has been widened to include food processing and cold storage, software upto Rs 1 crore, housing above Rs 10 lakh, selected lending through NBFCs, etc.
RBI guidelines have been issued for putting in place risk management systems in banks. Risk Management Committees in banks address credit risk, market risk and operational risk. Banks have specialised committees to measure and monitor various risks and have been upgrading their risk management skills and systems.
The limit for foreign direct investment in private banks has been increased from 49% to 74% and the 10% cap on voting rights has been removed. In addition, the limit for foreign institutional investment in private banks is 49%.

Key Challenges Ahead

(i) Improving profitability: Increasing competition and narrowing of spreads has a direct impact on the profitability of the banking and financial service organizations. The challenge for them is how to manage with thinning margins while at the same time working to improve productivity, which remains low in relation to global standards. This is particularly important because with dilution in banks’ equity, analysts and shareholders now closely track their performance. Thus, with falling spreads, rising provision for NPAs and falling interest rates, greater attention will need to be paid to reducing transaction costs. This will require tremendous efforts in the area of technology and for banks to build capabilities to handle much bigger volumes.

(ii) Risk management: The deregulated environment brings in its wake risks along with profitable opportunities, and technology plays a crucial role in managing these risks. In addition to being exposed to credit risk, market risk and operational risk, the business of banks would be susceptible to country risk, which will be heightened as controls on the movement of capital are eased. In this context, banks are upgrading their credit assessment and risk management skills and retraining staff, developing a cadre of specialists and introducing technology driven management information systems.

(iii) Sharpening skills: The far-reaching changes in the banking and financial sector entail a fundamental shift in the set of skills required. To meet increased competition and manage risks, the demand for specialized banking functions, using IT as a competitive tool is set 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 financial sector i.e. human resources and IT will have to be strengthened.

(iv) Greater customer orientation: In today’s competitive environment, financial institutions will have to strive to attract and retain customers by introducing innovative products, enhancing the quality of customer service and marketing a variety of products through diverse channels targeted at specific customer groups.

(vi) Corporate governance: Besides using their strengths and strategic initiatives for creating shareholder value, financial institutions have to be conscious of their responsibilities towards corporate governance. Following financial liberalisation, as the ownership of financial institutions gets broadbased, the importance of institutional and individual shareholders will increase. In such a scenario, they will need to put in place a code for corporate governance for benefiting all stakeholders of a corporate entity.

(vi) International Standards: Introducing internationally followed best practices and observing universally acceptable standards and codes is necessary for strengthening the domestic financial architecture. This includes best practices in the area of corporate governance along with full transparency in disclosures. In today’s globalised world, focusing on the observance of standards will help smooth integration with world financial markets.

People Challenges

So far, the organizations in the Banking and Financial Services Industry have concentrated on increasing profitability by way of technical and procedural advancement. The need to enhance productivity of their people who in turn would contribute to additional and sustained levels of growth of the organizations, is now being felt. The key challenges that need to be addressed are as follows:

Improved Customer Service Skills: Employees in the customer service departments of financial institutions increasingly face the pressure from customers to continuously deliver better. While they are well equipped with knowledge of the products and services being offered, the need to enhance relationship-building skills with customers is being emphasized upon.

Innovation: Government and nationalized financial institutions need to pick pace with the private banks and other financial institutions with reference to infrastructure, technology, pay scales and other perks being offered.

Consultative Selling: While most financial institutions are well equipped with the concept of product sales, the consultative selling approach needs to be incorporated. It is important for financial institutions to create the “best first impression” and project the most effective professional image.

Stress Management: With increasing levels of competition, there is also an increase in the levels of stress that people experience.

In a nutshell, leadership, team focus, customer service and communication are the key challenges currently being faced by the Banking and Financial Services in India.

People & Business Skills Inventory

Based on the trends and the outlook of the banking sector, the people and business skill inventory (apart from core banking skills and knowledge) looks like

1. Communication / Presentations

2. Sales (generic/solution selling)

3. Leadership
a. Innovation
b. Motivation
c. Managing teams / conflict

4. Customer service

5. Change Management

6. Stress Management