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Universal Banking in India Research Team | Posted On Saturday, February 21,2009, 07:55 PM

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Universal Banking in India



What is universal banking in India

Generally banking that includes investment services in addition to services related to savings and loans are called universal banking. However in practice the term 'universal banks' refers to those banks which offer a wide range of financial services, beyond commercial banking, investment banking, insurance etc. Universal banking is a combination of commercial banking, investment banking and a range of other activities including insurance. If specialized banking is the one end universal banking is the other end. This type of banking is most common in European countries. Universal banking has some advantages and disadvantages. The main advantage of universal banking is that it results in superior economic efficiency in the form of lower cost, higher output and better products. How larger the banks the greater the effects of failure on the system. Also there is the fear that such institutions, by virtue of their absolute size, would gain monopoly power in the market, which can have important undesirable consequences for economic efficiency. Also combining commercial and investment banking can gives rise to divergence of interests. Divergence of interests was one of the major reasons for introduction of Glass-Steagall Act in US. Since the early 1990s, banking systems worldwide have been going through a quick revolution. Mergers, amalgamations and acquisitions have been carried out on a large scale in order to gain size and to focus more penetratingly on competitive strengths. This consolidation has formed financial conglomerates that are expected to maximize economies of scale and scope by ‘bundling’ the production of financial services. The general trend has been towards downstream universal banking where banks have undertaken traditionally non-banking activities such as investment banking, mortgage financing, securitization, and particularly, insurance (bank assurance). Upstream linkages, where non-banks undertake banking business, are also on the increase. The global experience can be classified into broadly three models. First one is Swedish or Hong Kong type model in which the banking corporate engages in in-house activities associated with banking. In Germany and the UK, certain kinds of activities are required to be carried out by separate subsidiaries. In the US type model, there is a holding company structure and separately capitalized subsidiaries.

In India, the first impulses for a more diversified financial intermediation were witnessed in the 1980s and 1990s when banks were permitted to undertake leasing, investment banking, mutual funds, factoring, hire-purchase activities, etc. through separate subsidiaries. By the mid-1990s, all restrictions on project financing were detached and banks were allowed to undertake several activities in-house. In the recent period, the focus is on Development Financial Institutions (DFIs), which have been permitted to set up banking subsidiaries and to enter the insurance business along with banks. Development Financial Institutions (DFIs) were also allowed to carry out working capital financing and to raise short-term funds within limits. It was the Narasimham Committee II Report (1998) which suggested that the DFIs must convert themselves into banks or non-bank financial companies, and this conversion was authorized by the Khan Working Group (1998). The Reserve Bank’s Discussion Paper (1999) and the feedback thereon pointed out the attractiveness of universal banking from the point of view of efficiency of resource use, but it also emphasized the need to take into account factors such as the status of reforms, the state of preparedness of the institutions, and a feasible transition path while moving in the desired direction. From the point of view of the regulatory framework, the movement towards universal banking must establish stability of the financial system, protect the safety of public deposits, develop efficiency in financial intermediation, guarantee healthy competition, and impart transparent and equitable regulation.

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