Comparision of Banking System of Us ,Europe,India-1

International Financial System

Comparision Of Banking System Of US,Europe and India

Submitted To:

Mrs. Payal Singh

Submitted by:

Rashmeet Kaur

A1802011436

INTRODUCTION:

Recent time has witnessed the world economy develop serious difficulties in terms of lapse of banking & financial institutions and plunging demand. Prospects became very uncertain causing recession in major economies. However, amidst all this chaos India’s banking sector has been amongst the few to maintain resilience. A progressively growing balance sheet, higher pace of credit expansion, expanding profitability and productivity akin to banks in developed markets, lower incidence of nonperforming assets and focus on financial inclusion have contributed to making Indian banking vibrant and strong. Indian banks have begun to revise their growth approach and re-evaluate the prospects on hand to keep the economy rolling. The way forward for the Indian banks is to innovate to take advantage of the new business opportunities and at thesame time ensure continuous assessment of risks.

GENERAL BANKING SCENARIO

The predicament of the banks in the developed countries owing to excessive leverage and lax regulatory system has time and again been compared with somewhat unscathed Indian Banking Sector. An attempt has been made to understand the general sentiment with regards to the performance, the challenges and the opportunities ahead for the Indian Banking Sector. A majority of the respondents, almost 69% of them, felt that the Indian banking Industry was in a very good to excellent shape, with a further 25% feeling it was in good shape and only 6% of the respondents feeling that the performance of the industry was just average. In fact, an overwhelming majority (93.33%) of the respondents felt that the banking industry compared with the best of the sectors of the economy, including pharmaceuticals, infrastructure, etc. Most of the respondents were positive with regard to the growth rate attainable by the Indian banking industry for the year 2009-10 and 2014-15, with 53.33% of the view that growth would be between 15-20% for the year 2009-10 and greater than 20% for 2014-15.

Key effects of major International Banking Crisis

The banking crises have bought various losses. Private households that have suffered considerable loss in wealth will raise their saving rates.

The many recapitalization of banks implemented by various governments in Euro zone the UK and the USA a will raise medium term debt GDP ratio and hence current and future tax rate.

There is also some probability that venture capital financing will become more difficult in many OECD countries in the long run, since the risk premium have increased and since private equity funds will become eager to finance.

US Banking System

With nearly 90,000 branches and 371,000 automated teller machines (ATMs), US banking system is the largest in the world. As of September 30th 2004, US banks had US$9.88 trillion in assets and US$5.98 trillion in total loans. US banking is more diverse than in most Western countries. Despite ongoing consolidation, vigorous competition exists within the vast banking community, which includes financial holding companies that operate nationwide, dominant regional banks and smaller independents. Large foreign banks also continue to expand in the US market.

Federal Reserve The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded. Today, the Federal Reserve’s duties fall into four general areas: - conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates; - supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers; - maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; - providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system. A network of twelve Federal Reserve Banks and their Branches (twenty¬ five as of 2004) carries out a variety of System functions, including operating a nationwide payments system, distributing the nation’s currency and coin, supervising and regulating member banks and bank holding companies, and serving as banker for the U.S. Treasury. The twelve Reserve Banks are each responsible for a particular geographic area or district of the United States. Each Reserve District is identified by a number and a letter. Besides carrying out functions for the System as a whole, such as administering nationwide banking and credit policies, each Reserve Bank acts as a depository for the banks in its own District and fulfills other District responsibilities.

Member Banks The nation’s commercial banks can be divided into three types according to which governmental body charters them and whether or not they are members of the Federal Reserve System. Those chartered by the federal government (through the Office of the Controller

of the Currency in the Department of the Treasury) are national banks; by law, they are members of the Federal Reserve System. Banks chartered by the states are divided into those that are members of the Federal Reserve System (state member banks) and those that are not (state nonmember banks). State banks are not required to join the Federal Reserve System, but they may elect to become members if they meet the standards set by the Board of Governors. As of March 2004, of the nation’s approximately 7,700 commercial banks approximately 2,900 were members of the Federal Reserve System - approximately 2,000 national banks and 900 state banks. Member banks must subscribe to stock in their regional Federal Reserve Bank in an amount equal to 6 percent of their capital and surplus, half of which must be paid in while the other half is subject to call by the Board of Governors. The holding of this stock, however, does not carry with it the control and financial interest conveyed to holders of common stock in for-profit organizations. It is merely a legal obligation of Federal Reserve membership, and the stock may not be sold or pledged as collateral for loans. Member banks receive a 6 percent dividend annually on their stock, as specified by law, and vote for the Class A and Class B directors of the Reserve Bank. Stock in Federal Reserve Banks is not available for purchase by individuals or entities other than member banks.

Supervisory Function of the Federal Reserve The Federal Reserve has responsibility for supervising and regulating the following segments of the banking industry to ensure safe and sound banking practices and compliance with banking laws: - bank holding companies, including diversified financial holding companies formed under the Gramm-Leach-Bliley Act of 1999 and foreign banks with U.S. operations; - state-chartered banks that are members of the Federal Reserve System (state member banks); - foreign branches of member banks; - Edge and agreement corporations, through which U.S. banking organizations may conduct international banking activities; - U.S. state-licensed branches, agencies, and representative offices of foreign banks; - non- banking activities of foreign banks. Although the terms bank supervision and bank regulation are often used interchangeably, they actually refer to distinct, but complementary, activities. Bank supervision involves the monitoring, inspecting, and examining of banking organizations to assess their condition and their compliance with relevant laws and regulations. When a banking organization within the Federal Reserve’s supervisory jurisdiction is found to be noncompliant or to have other problems, the Federal Reserve may use its supervisory authority to take formal or informal action to have the organization correct the problems. Bank regulation entails issuing specific regulations and guidelines governing the operations, activities, and acquisitions of banking organizations.

Bretton Woods system

The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid-20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.

Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.

U.S Banking Crises

The late-2000s financial crisis, also known as the Global Financial Crisis (GFC) or the "Great Recession", is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in numerous evictions, foreclosures and prolonged unemployment. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, and a significant decline in economic activity, leading to a severe global economic recession in 2008.

The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2008.The bursting of the U.S. housing bubble, which peaked in 2007, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally. Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined. Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. Although there have been aftershocks, the financial crisis itself ended sometime between late-2008 and mid-2009.

Many causes for the financial crisis have been suggested, with varying weight assigned by experts. The United States Senate issued theLevin–Coburn Report, which found "that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street."

Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets. The 1999 repeal of the Glass–Steagall Act of 1933 effectively removed the separation that previously existed between Wall Street investment banks and depository banks. In response to the financial crisis, both market-based and regulatory solutions have been implemented or are under consideration.

European Banking System

The European System of Central Banks (ESCB) is composed of the European Central Bank (ECB) and the national central banks (NCBs) of all 27 European Union (EU) Member States.

Functions

Since not all the EU states have joined the euro, the ESCB could not be used as the monetary authority of the euro zone. For this reason the Euro system (which excludes all the NCBs which have not adopted the euro) became the institution in charge of those tasks which in principle had to be managed by the ESCB. In accordance with the treaty establishing the European Community and the Statute of the European System of Central Banks and of the European Central Bank, the primary objective of the Euro system is to maintain price stability (in other words control inflation). Without prejudice to this objective, the Euro system shall support the general economic policies in the Community and act in accordance with the principles of an open market economy.

The basic tasks to be carried out by the Euro system are:to define and implement the monetary policy of the euro zone;to conduct foreign exchange operations;to hold and manage the official foreign reserves of the Member States; andto promote the smooth operation of payment systems.

In addition, the Euro system contributes to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system. The ECB has an advisory role vis-à-vis the Community and national authorities on matters which fall within its field of competence, particularly where Community or national legislation is concerned. Finally, in order to undertake the tasks of the ESCB, the ECB, assisted by the NCBs, has the task of collecting the necessary statistical information either from the competent national authorities or directly from economic agents.

Organization

The process of decision-making in the Eurosystem is centralized through the decision-making bodies of the ECB, namely the Governing Council and the Executive Board. As long as there are Member States which have not adopted the euro, a third decision-making body, the General Council, shall also exist. The NCBs of the Member States that do not participate in the euro area are members of the ESCB with a special status – while they are allowed to conduct their respective national monetary policies, they do not take part in the decision-making with regard to the single monetary policy for the euro area and the implementation of such decisions.

The Governing Council comprises all the members of the Executive Board and the governors of the NCBs of the Member States without a derogation, i.e. those countries which have adopted the euro. The main responsibilities of the Governing Council are:

to adopt the guidelines and take the decisions necessary to ensure the performance of the tasks entrusted to the Eurosystem; to formulate the monetary policy of the euro area, including, as appropriate, decisions relating to intermediate monetary objectives, key interest rates and the supply of reserves in the Eurosystem, and to establish the necessary guidelines for their implementation.

The Executive Board comprises the President, the Vice-President and four other members, all chosen from among persons of recognized standing and professional experience in monetary or banking matters. They are appointed by common accord of the governments of the Member States at the level of the Heads of State or Government, on a recommendation from the Council of Ministers after it has consulted the European Parliament and the Governing Council of the ECB (i.e. the Council of the European Monetary Institute (EMI) for the first appointments). The main responsibilities of the Executive Board are:

to implement monetary policy in accordance with the guidelines and decisions laid down by the Governing Council of the ECB and, in doing so, to give the necessary instructions to the NCBs; and to execute those powers which have been delegated to it by the Governing Council of the ECB.

The General Council comprises the President and the Vice-President and the governors of the NCBs of all 27 Member States. The General Council performs the tasks which the ECB took over from the EMI and which, owing to the derogation of one or more Member States, still have to be performed in Stage Three of Economic and Monetary Union (EMU). The General Council also contributes to: the ECB's advisory functions; the collection of statistical information; the preparation of the ECB's annual reports; the establishment of the necessary rules for standardizing the accounting and reporting of operations undertaken by the NCBs; the taking of measures relating to the establishment of the key for the ECB's capital subscription other than those already laid down in the Treaty; the laying-down of the conditions of employment of the members of staff of the ECB; and the necessary preparations for irrevocably fixing the exchange rates of the currencies of the Member States with a derogation against the euro.

The Euro system is independent. When performing Euro system-related tasks, neither the ECB, nor an NCB, nor any member of their decision-making bodies may seek or take instructions from any external body. The Community institutions and bodies and the governments of the Member States may not seek to influence the members of the decision-making bodies of the ECB or of the NCBs in the performance of their tasks. The Statute of the ESCB makes provision for the following measures to ensure security of tenure for NCB governors and members of the Executive Board:

a minimum renewable term of office for national central bank governors of five years;

a minimum non-renewable term of office for members of the Executive Board of eight years (a system of staggered appointments was used for the first Executive Board for members other than the President in order to ensure continuity); and

removal from office is only possible in the event of incapacity or serious misconduct; in this respect the Court of Justice of the European Communities is competent to settle any disputes.

The ECB's capital amounts to €5 billion. The NCBs are the sole subscribers to and holders of the capital of the ECB. The subscription of capital is based on a key established on the basis of the EU Member States' respective shares in the GDP and population of the Community. It has, thus far, been paid up to an amount just over €4 billion. The euro area NCBs have paid up their respective subscriptions to the ECB's capital in full. The NCBs of the non-participating countries have to pay up 7% of their respective subscriptions to the ECB's capital as a contribution to the operational costs of the ECB. As a result, the ECB was endowed with an initial capital of just under €4 billion.

In addition, the NCBs of the Member States participating in the euro area have provided the ECB with foreign reserve assets of up to an amount equivalent to around €40 billion. The contributions of each NCB were fixed in proportion to its share in the ECB's subscribed capital, while in return each NCB was credited by the ECB with a claim in euro equivalent to its contribution. 15% of the contributions were made in gold, and the remaining 85% in US dollars and Japanese yen.

Euro Debt and Banking Crisis

Introduction

Europe has been beset by two interrelated crises: (i) a banking crisis, stemming from losses in capital market securities (including US subprime and other structured products), as well as home-grown, boom-bust problems in the property markets of some EU countries; and (ii) a sovereign debt crisis exacerbated by recession, transfers to help banks, and in some cases very poor fiscal management over a number of years that was inconsistent with the principles laid down in the Stability and Growth Pact and the Maastricht Treaty. In late 2010, the sovereign debt crisis worsened on market concerns about the difficulty of budget consolidation; for the first time, the European Summit in October 2010 pondered the notion that private creditors might have to bear some of the pain via mechanisms being put together to deal with future sovereign-debt crises.

Greece and Ireland have faced very significant adverse movements in their yield spreads relative to euro-area benchmark bonds, and to a lesser extent this is also the case for Portugal, and Spain. The market has even begun to ponder whether the crisis could spread further, and whether the euro system in its current form is sustainable. Markets are concerned that the prospect of very weak growth and high unemployment resulting from fiscal consolidation, and years of painful structural adjustment, will make the temptation to restructure sovereign debt too great to be ignored. Such concerns add to the crisis countries’ problems, making it difficult for them to borrow, while the prevailing high interest rates increase their debt service costs. Where the marginal borrowing rate exceeds the average rate on the outstanding stock of debt, the debt-service burden will rise, making consolidation efforts even more difficult to achieve. Similarly, as growth weakens, tax revenues fall.

Policies to deal with unsustainable debt dynamics There are a number of ways to deal with the problem of explosive debt scenarios

The debt dynamics equation suggests a number of ways to deal with the problem of explosive debt scenarios:• Cutting spending and raising taxes to bring the budget balance to the point where it offsets the

debt-service burden, after allowing for the growth of the economy. Thus setting:

• Causing inflation to rise a great deal, noting that here g refers to the nominal growth of GDP (i.e. the sum of real growth and inflation). Inflation surprises essentially reduces the real burden of the debt.• Carrying out structural reforms to improve the real component of the rate of nominal growth (g). Labour market, pension and competition reforms will improve growth over the longer run.• Restructuring the level of outstanding debt (dt-

1). By applying a haircut to the outstanding stock of debt, the debt service burden is reduced. Alternatively, the effective interest rate can be reduced by renegotiating the terms and conditions of the outstanding debt with the holders.6The economic costs of doing this, however, can be to increase the likelihood of future exclusion from global capital markets, as well as credit rating downgrades that result in the bond issuer having to pay higher spreads. The main benefit is the ability to cut the debt-service burden to credible levels overnight, thereby making it easier for countries to achieve macro goals, including consistency with currency-union constraints on fiscal policy and debt – such as those embedded in the Maastricht Treaty.

Inflation is not a policy tool for the countries concerned

As EU monetary policy is in the hands of the ECB, the possibility of initiating an inflationary policy is not an option for the countries concerned. Were the ECB to carry out quantitative easing to the point where EU-wide inflation accelerated, this would benefit all European debt-service burdens; but it is not an immediate option for the crisis countries within Europe now.

The OECD favours labour market, pension and regulatory reforms that will not have an immediate effect

With respect to structural reform, the OECD certainly favours: (a) policies to improve the functioning of labour markets, and the requirement in a currency union that labour mobility play a key competitiveness adjustment role; (b) the reform of EU pension systems, to ensure they are fully funded, which is essential to reduce the fiscal burden on future generations; and (c) addressing the structure of competition within Europe and the consistency of regulations and governance for improving efficiency.7

However, structural reform is likely to be a

process the success of which will be measured in decades. The market tolerance for sovereign debt is unlikely to be improved by promises, of which there have been plenty, as the above market-implied probability-of-default calculations suggest.

Bank vulnerabilities and potential feedback on fiscal deficits

The EU stress tests of June 2010 did not fully allay concerns about bank losses and fiscal interplay. The stress-tested sovereign shock, for example, left out the bulk of holdings in the banking book.9 Blundell-Wignall and Atkinson (2010) point out that, excluding the sovereign shock, many of the 91 banks included did not generate enough write-offs or other adverse pressures to lead to actual losses. Most of the losses (i.e. impairments to the banking book and losses to the trading book) were covered by income. In other cases, net losses were small (the main exceptions being the Spanish cajas, small Spanish banks, Royal Bank of Scotland, ABN/Fortis, Hypo Real Estate, Dexia and two large Irish banks). Only 7 of the 91 banks failed the test (falling below 6% Tier 1 capital). However, the test shed virtually no light on the adequacy of capital to serve as a buffer to absorb losses, since this was not actually tested. For the system as a whole, and individually for most of the banks’, Tier 1 capital actually rises in the adverse scenario. Since the scenario is designed with a constant balance sheet assumption, it is unclear what is being tested besides the sensitivity of regulatory constructs. If capital rises as income exceeds losses, while the balance sheet is otherwise unchanged, a sensible capital ratio should rise. But the Tier 1 ratio actually falls by 0.7% for the system as a whole, entirely due to the rise in risk weights. This largely reflects the pro-cyclical features introduced in Basel II, which raise risk-weighted assets by EUR 824bn. This inability to subject the system to a reasonable amount of stress that would require new capital has already been surpassed by actual events.European banks are less-well capitalised than US banks. This is in part due to the absence of a leverage ratio requirement in Europe, where authorities instead rely on the Basel system, which applies capital requirements only to Risk-Weighted Assets (RWA) without any reference to the ratio of RWA to total assets (TA) in banks. EU banks systematically reduced the share of RWA to TA by a variety of techniques prior to the crisis and raised leverage commensurately to very high levels. RWA of the 91 stress-tested banks amounts to only 40% of TA (and much less than this in some large systemically important EU financial institutions)More transparency about the real situation at EU banks would help allay concerns in the financial markets. Just as the financial markets are factoring in the risk of restructuring for sovereign bonds, the prices of bank-debt certificates in the secondary market have again begun falling, particularly in Ireland and Spain, where the housing crises may have exacerbated pressures on banks.11This is especially the case for the Bank of Ireland and Allied Irish, and (though to a much lesser extent) for the cajas and small Spanish/Portuguese banks The market has become increasingly concerned that banks in Ireland and Spain may require further injections of capital to offset housing-related losses that were not picked up by the stress test. At the same time, the exposure of some banks in all four countries to market fears regarding a restructuring of sovereign debt would likewise require an increase in capital to act as a shock absorber. Both sets of fears may have some potential to impact fiscal policy (as has already been the case recently in Ireland)

Market arithmetic for Spain

At the start of 2010, the Spanish banking system had minimum required capital of around €168bn, and actual capital of €195bn. This suggests a capital buffer of €27bn. Moody’s loss estimate (in November 2010) was €176bn, of which they suggest that about half has been recognised. This suggests that Spanish

banks would need to raise more capital. Markets are concerned about the possibility that losses could be larger than these estimates due to weakening property prices, including commercial property – an issue that reduces transparency about the true position of banks. At the same time the situation is very heterogeneous, with two large Spanish banks having a large share of the profits and less legacy non-performing loans to deal with, while some of the smaller players may face greater difficulties. At the same time, there is a quite substantial exposure to sovereign debt – a 30% haircut on sovereign debt would add another €63bn to banks’ capital needs. According to the fifth criterion concerning the likelihood of sovereign-debt haircuts, discussed above, this would substantially reduce the chance of debt restructuring. This may be one of the reasons that the markets give this possibility a relatively low probability at present.

Market arithmetic for Ireland

The Irish banking sector had minimum required capital of €51bn and actual capital of €63bn at the start of 2010, suggesting a buffer of €12bn. The official estimate for losses (in November 2010) was €85bn.12This amount is large relative to GDP, and the banks’ operating profits aren’t large enough to cover this over any reasonable period. At the same time, the banks’ exposure to sovereign debt is fairly small. In terms of criterion 5 mentioned earlier, this increases the likelihood of a sovereign-debt restructuring, according to market reasoning. The government has raised the capital requirements of the Bank of Ireland (BOI), Allied Irish (AIB), EBS Building Society and Irish Life and Permanent (ILP) to a new minimum of 10.5% core Tier 1 capital, and over-capitalisation of at least 12% by the end of February 2011, in order to cover further potential losses. This compares to the 9.8% on which the required capital is based in Table 3. This suggests on-going risk to the budget with respect to support for the banking system affecting the market assessments of restructuring via the first and second criteria above (the size of the primary deficit and debt as a share of GDP). The market probably believes that, ultimately, the bank debt instruments will need to bear some of the burden of relieving government budget pressures. This may be one of the reasons why some banks’ bond prices, too, have begun to fall.

Market arithmetic for Greece

The Greek bank sector had required capital of €23bn at the start of 2010 and actual capital of €31bn, suggesting a buffer for absorbing losses of €8bn. Estimates of bank losses for 2010 are not taken into account, but the exposure to sovereign debt of €61bn means that a 30% haircut would be difficult for banks to absorb. On the fifth criterion, this argues against such a haircut. On the other hand, Greek debt is at the highest level of the four countries considered, and the market gives Greece the highest probability of a restructuring.

Market arithmetic for Portugal

Required and actual capital positions suggest Portuguese banks have no buffer to absorb losses, but bank exposure to periphery sovereign debt is small in aggregate. According to the fifth market criterion, this should increase the likelihood of restructuring in market calculations, on fiscal grounds.

Bank exposure to known holdings of sovereign debt

As noted in Blundell-Wignall and Slovik (2010), bank exposures to sovereign debt are not evenly distributed:13Buiter and Rahbari (2010) have recently pointed out that average exposures to sovereign debt don’t matter: Averages give little information about specific banks’ capital needs, housing related losses, pre-tax income and holdings of government debt, which all differ widely. It is the outlier cases that are important in assessing the risk of financial crises. If the issue is to be properly managed by policy makers it is critical to focus on individual banks. A major lesson of the crisis was that failures of systemically important financial institutions led to counterparty and contagion effects that had widespread cross-border implications.

The markets and bank solvency and debt options

A second major concern in financial markets addressed in this paper is the uncertainty there is about how bank insolvency issues are to be dealt with and the risk that they might pose to fiscal consolidation in some countries, particularly where bank liabilities are subject to government guarantees. Bank bond prices have been subject to significant moves following official discussion of these issues. A run on deposits or failure to roll-over debt in the wholesale markets requires emergency liquidity lending in order to keep banks operating, which has been working well enough via ECB operations. But this does not deal with solvency issues resulting from losses on the assets side. Once existing equity holders are wiped out, the full resolution of a financial institution would involve the unsecured bondholders bearing the losses and the economy experiencing the deadweight losses associated with failures, inconsistent with principle 2 above (de-leveraging and activity effects). If government guarantees are in place, the pain is borne directly by the taxpayer instead.

INDIAN BANKING SYSTEM

Financial StructureThe Indian financial system comprises the following Institutions:Reserve bank of India at apex1. Scheduled banks

State co-operative banks Commercial banks

Commercial banks further divided into two categoriesa)Indian(public (state bank and its subsidiaries, other nationalized bank & RRB’s) and privateb)foreign

2. Non-scheduled bank Central co-operative bank and primary credit societies Commercial banks

Reserve bank of IndiaRBI is the banker to banks—whether commercial, cooperative, or rural. The relationship is established once the name of a bank is included in the Second Schedule to the Reserve Bank of India Act, 1934.Such bank, called a scheduled bank, is entitled to facilities of refinance from RBI, subject to fulfillment of the following conditions laid down in Section 42(6) of the Act, as follows:

It must have paid-up capital and reserve of not less than Rs. 5 lakhs. It must satisfy RBI that its affairs are not being conducted in a manner detrimental to

the interests of its depositors. Scheduled banks are require to maintain a certain amount of reserves with the RBI.

They in return, enjoy the facility of financial accommodation and remittance facility at concessional from the RBI

The classification of commercial banks into scheduled and non-scheduled categories that was introduced at the time of establishment of RBI in 1935 has been extended during the last two or three decades to include state cooperative banks, primary urban cooperative banks, and RRBs. RBI is authorized to exclude the name of any bank from the Second Schedule if the bank, having been given suitable opportunity to increase the value of paid-up capital and improve deficiencies, goes into liquidation or ceases to carry on banking activities. A system of local area banks announced by theGovernment in power until 1997 has not yet taken root. RBI has given in principle clearance to five applicants. Specialized development financial institutions (DFIs) were established to resolve market failures in developing economies and shortage of long-term investments. The

first DFI to be established was the Industrial Finance Corporation of India (IFCI) in 1948, and was followed by SFCs at state level set up under a special statute. In 1955, Industrial Credit and Investment Corporation of India (ICICI) was set up in the private sector with foreign equity participation. This was followed in 1964 by Industrial Development Bank of India (IDBI) set up as a subsidiary of RBI. The same year saw the founding of the first mutual fund in the country, the Unit Trust of India (UTI). A wide variety of financial institutions (FIs) has been established. Examples include the National Bank for Agriculture and Rural Development(NABARD), Export Import Bank of India (Exim Bank), National Housing Bank (NHB), and Small Industries Development Bank of India (SIDBI), which serve as apex banks in their specified areas of responsibility and concern. The three institutions that dominate the term-lending market in providing Financial assistance to the corporate sector are IDBI, IFCI, and ICICI. The Government owns insurance Companies, including Life Insurance Corporation of India (LIC) and General Insurance Corporation (GIC). Subsidiaries of GIC also provide substantial equity and loan assistance to the industrial sector, while UTI, though a mutual fund, conducts similar operations. RBI also set up in April 1988 the Discount and Finance House of India Ltd. (DFHI) in partnership with SBI and other banks to deal with money market instruments and to provide liquidity to money markets by creating a secondary market for each instrument. Major shares of DFHI are held by SBI. Liberalization of economic policy since 1991 has highlighted the urgent need to improve infrastructure in order to provide services of international standards. Infrastructure is woefully inadequate for the efficient handling of the foreign trade sector, power generation, communication, etc. For meeting specialized financing needs, the Infrastructure Development Finance Company Ltd. (IDFC) was set up in 1997. To nurture growth of private capital flows, IDFC will seek to unbundle and mitigate the risks that investors face in infrastructure and to create an efficient financial structure at institutional and project levels. IDFC will work on commercial orientation, innovations in financial products, rationalizing the legal and regular framework, creation of a Long-term debt market and best global practices on governance and risk management in infrastructure Projects NBFCs undertake a wide spectrum of activities ranging from hire purchase and leasing to pure investments. More than 10,000 reporting NBFCs (out of more than 40,000 NBFCs operating) had deposits of Rs1, 539 billion in 1995/96. RBI initially limited their powers, aiming to moderate deposit mobilization in order to provide depositors with indirect protection. It regulated the NBFCs under the provisions of Chapter IIIB of the RBI Act of 1963, which were confined solely to deposit acceptance activities of NBFCs and did not cover their functional diversity and expanding intermediation. This rendered the regulatory framework inadequate to control NBFCs. The RBI Working Group on Financial Companies recommended vesting RBI with more powers for more effective regulation of NBFCs. A system of registration was introduced in April 1993 for NBFCs with net owned funds (NOF) of Rs5 million or above.

RBI regulations

In India, banks lending to individual is based on their income. The banks do religiously verify an individual’s income and expenditure before sanctioning any loans.

Mortgage loan still insists on down payment (15% to 30%) and this prevented many who dreamt of having properties completely at bank’s expense.

70% of the banks in India are still nationalized.

RBI issued market stabilization schemes and bonds and absorbed dollars; now if overseas investors suck out dollars after selling shares, there is no shortage of dollars to sell to them; and, there will be no domestic liquidity crisis because the RBI can buy back those bonds and pump rupees into the market.

RBI has made banks keep 7.5 per cent of their deposits in cash, and another 25 per cent of their deposits in government bonds. So even if there were to be a run on a bank they still would have the liquidity to tackle the situation.

RBI insists the bank to keep the capital ratios within the range of 11% to 13% (Regulation is 9 %)

Indian banks are not focusing on the business structure like securitization and collateralized debt obligation (CDO) – Again thanks to RBI regulations.

Another crucial factor RBI had the right person in the right job at right time. He was Y V Reddy, the former RBI governor (6th Sept 2003 to 5th Sept 2008). He made sure that Indian banks did not get too caught up in the bubble mentality.

Last but not the least -Culture – Indians are not very comfortable with credit. Indians generally think, “if you spend more than you earn, you will get in trouble“. In India, joint families still exist and family members help each other in times of economic crisis so they don’t go to banks to borrow money.

State bank group: This consists of the State Bank of India (SBI) and Associate Banks of SBI. The Reserve Bank of India (RBI) owns the majority share of SBI and some Associate Banks ofSBI.SBI has 13 head offices governed each by a board of directors under the supervision of a central Board. The boards of directors and their committees hold monthly meetings while the executive committee of each central board meets every week.Nationalized banks: In 1969, the Government arranged the nationalization of 14 scheduled commercial banks in order to expand the branch network, followed by six more in 1980. A merger reduced the number from 20 to 19. Nationalized banks are wholly owned by the Government, although some of them have made public issues. In contrast to the state bank group, nationalized banks are centrally governed, i.e., by their respective head offices. Thus, there is only one board for each nationalized bank and meetings are less frequent (generally, once a month). The state bank group and nationalized banks are together referred to as the public sector banks (PSBs).Regional Rural Banks (RRBs): In 1975, the state bank group and nationalized banks were required to sponsor and set up RRBs in partnership with individual states to provide low-cost financing and credit facilities to the rural masses.Co-operative banks: The cooperative banks also perform basic functions of banking but differ from commercial banks in the following respects:• Commercial banks are joint-stock companies under the Companies Act of 1956, or public sector banks under a separate Act of the Parliament Co-operative banks were established under the Co-operative Societies Acts of different states;• co-operative banks have a three-tier setup, with state cooperative bank at the apex,

central/district co-operative banks at district level, and primary cooperative societies at rural level;• Only some of the sections of the Banking Regulation Act of 1949 (fully applicable to commercial banks), are applicable to cooperative banks, resulting in only partial control by RBI of cooperativeBanks; and• Cooperative banks function on the principle of cooperation and not entirely on commercial parameters.

Comparison Of Banking Systems

India could become the third largest banking sector by 2050 after China and US, leaving Japan,

UK and Germany behind.

India is an emerging economy and comparison of Indian economy with other countries such as the US, European Union , Canada, Japan and China is needed to study international economy and business. People want to compare economies to make strategies. This article will help you understand better Indian markets, consumers, industries and overall growth picture of India in Comparison with US, EU, Canada, Japan, China and rest of the world.

India is a large country having population of more than a billion, second highest in the world. It is also the largest democracy in the globe. GDP India is fourth highest in the world in PPP terms. Here is a comparison of Indian economy vs. the US, EU, Canada, Japan, China and rest of the world.

Indian GDP ranks to No.12 in nominal term of world GDP after US, Japan, UK, Germany, China, France, Italy, Spain, Canada, Brazil and Russia. However, India ($3000B) comes to No.4 after US (America) (($13800B), China ($7000B) and Japan ($4300B) in PPP terms .

India is a large economy. It has GDP of $1100 B (2007) or RS.55000 B. It is approximately two percent of the GDP of the world i.e. $55000 B. It does not tell the real story because world GDP is calculated based on US dollars. However, Indians have to buy, sell and spend in Indian rupee. Price parity parameter shows comparatively better picture. In PPP method, Indian GDP is calculated to $3000B that is approximately 4.7 percent of world GDP of $64000B in PPP.

India has particularly strong long-term growth potential.Indian banking sector in general and the

Reserve Bank of India were applauded post financial crisis for fiscal prudence. Post downturn,

Indian banks have become more efficient due to tighter credit assessment and disbursals, cost

efficient model, weeded out non profitable and highly risky portfolios and increased the CASA

substantially resulting in lower cost of funds for the bank.

Indian banks have improved their cost to income ratio by 6 per cent on an average, he added.

India’s largest private sector bank, ICICI Bank improved its cost to income ratio from 53 per

cent in 2007 to 38 per cent in 2010, owing to shift in strategy from aggressive growth to cost

rationalization.

China could overtake US in 2023 and India could overtake Japan in 2033. India’s domestic

banking assets are expected to grow to $38,484 in 2050 from $945.

India is an emerging economy and comparison of Indian economy with other countries such as the US, European Union, Canada, Japan and China is needed to study international economy and business. India is a large country having population of more than a billion, second highest in the world. It is also the largest democracy in the globe. GDP India is fourth highest in the world in PPP terms. Indian GDP ranks to No.12 in nominal term of world GDP after US, Japan, UK, Germany, China, France, Italy, Spain, Canada, Brazil and Russia. However, India ($3000B) comes to No.4 after US (America) (($13800B), China ($7000B) and Japan ($4300B) in PPP terms.India is a large economy. It has GDP of $1100 B (2007) or RS.55000 B. It is approximately two percent of the GDP of the world i.e. $55000 B. It does not tell the real story because world GDP is calculated based on US dollars. However, Indians have to buy, sell and spend in Indian rupee. Price parity parameter shows comparatively better picture. In PPP method, Indian GDP is calculated to $3000B that is approximately 4.7 percent of world GDP of $64000B in PPP.More over India is growing at the rate of eight to nine percent per annum whereas most of the developed countries including US, Canada, Japan and countries of EU and UK are growing at a very slow speed until last year. Only China has shown greater growth rate than India.Picture is little different this year. Most of the developed countries have started showing tendency of negative growth. This will surely affect India and China but they can manage their growth in a positive range. It is expected that China will manage a growth rate of eight to nine percent where as India will anywhere between seven to eight percent.India has achieved highest growth rate in stock market in the world. If we compare the stock markets of India and America since 9/11

Highest growth in stock market

More over India is growing at the rate of eight to nine percent per annum where as most of the developed countries including US, Canada, Japan and countries of EU and UK are growing at a very slow speed until last year. Only China has shown greater growth rate than India.

Picture is little different this year. Most of the developed countries have started showing tendency of negative growth. This will surely affect India and China but they can manage their growth in a positive range. It is expected that China will manage a growth rate of eight to nine percent where as India will anywhere between seven to eight percent.

India has achieved highest growth rate in stock market in the world. If we compare the stock markets of India and America since 9/11, we find fascinating facts. Dow Jones fell after 9/11 to 8235 on 21st September 2001. The BSE (India) also fell during those days to reach a low of 2595. Particular data for Shanghai (China) and Hangseng (Hong Kong) are not available to me (If anyone has the data, please inform me) but those were around 1400 and 11000 respectively. Dow Jones is trading at 8787 (While writing this hub Dec. 09, 2008). If we compare it with the previous Dow Jones data (21st sept.2001), it has gained mere 550 points over the period of more than seven years. Where as BSE India has traded at (on eighth Dec.2008, 9th market closed) 9162 level. It has jumped from 2595 to 9162, that is a gain of 6567 points or approximately 250 percent! Hangseng is 14753 and Shanghai is 2037 today. As I do not have actual data of 21st Sept. of both these indexes it is not justified to calculate the gain but it is some thing around thirty to fifty percent.

Dow has increased mere six percent in more than seven years and China and Hong Kong index has raised by thirty to fifty percent (roughly estimated) but Indian stock exchange index BSE has shown an amazing growth of more than two hundred fifty percent.

Fifth highest foreign currency reserve in the world

India has fifth highest foreign currency reserve in the world.Foreign currency reserves of China, Japan, Russia, Taiwan and India were $ 1905, $997B, $485B, $282 B and $247 B respectively in 2007. This shows that Foreign currency reserve of India was the fifth highest in the world after that of China, Japan, Taiwan and Russia. The most interesting fact is that Indian foreign currency reserve had been increased 64 percent in comparison to 32 percent of China and 57 of Russia, 9 of Japan and below 3 percent of Taiwan on year-to-year basis.It is worth mention that so called rich countries likes of the US, Canada, France and the UK are not in this list.Composite economic scenario of India:GDP India is twelfth largest economy in the world in nominal parameter but that does not show the real picture.GDP India represents the fourth largest economy in the world in price parity parameter (PPP).India has the second highest growth rate in the world after China.

BSE stock index of India has grown at the fastest pace beating all stock indexes in the world including America, Canada, China, Japan and of course, all stock markets in European Union. India has no.1 growth rate among stock markets in the world.

Compared to America, Indian Bank system is in a better position and more stable. Indian banks are in a strong position as the ratio between lending and deposit is vast in India. On the other

hand, American banks, till the recession, gave loan to the people even with zero income. But now, there are changes in bank regulations along with restructuring in lending. American banks used to believe that real estate sector never goes down and thus, lent on it without any hesitation, but they were wrong. Now banks have understood this and made some changes.

India continues to be an attractive place for investment. The growth rates of the country will about five percent which is higher than America. Agriculture is one of the factors, which will help survive during slow down. While for American economy, this year will be quite disturbing, but next year onwards, it will be a good time.The Indian financial system has been witnessing an exciting era of transformation. The banking sector has seen major changes with deregulation of interest rates and the emergence of strong domestic private players as well as foreign banks. At the same time, there is some evidence of credit constraints for India’s SME firms that rely heavily on trade credit. Corporate governance norms in India have strengthened rapidly in the past few years. Family businesses, however, still dominate the landscape and investor protection, while excellent on paper, appears to be less effective owing to an overburdened legal system and corruption. In the last few years microfinance has contributed in a big way to financial inclusion and is now attracting venture capital and for-profit companies – both domestic and foreign.

The Impact of Inflation on Bank Lending

By now, everybody knows inflation is bad. Hyperinflations—when inflation rates are extremely high—are the horrorstories, but few doubt the harmful effects of inflation rates in the teens either. Over the past several decades, central banks around the world have been pretty successful at dramatically lowering inflation rates. Can we now stop worrying about inflation? Probably not. There is good reason to believe that inflation is harmful even at what oneMight consider relatively moderate rates—annual rates of perhaps 5 to 10 percent.Effect on Banking sector Because of high inflation, RBI has increased the CRR rates, which means withdrawal of more free flow of funds from the banking sector and their lending source of funds come down, there by price rice can be controlled. Naturally the banks liquidity will be affected and they have to make money only with the limited source available with them. Now after this Financial Tsunami RBI has reduced the CRR hike and there by more funds into the market and asked the bankers to lend more money to mutual funds and there by save the falling share prices because of heavy selling from FIIs

■ Theoretical Insights into InflationA key insight of the recent theories is that inflation exacerbates so-called frictions in credit

markets. In smoothly operating credit markets, banks can easily adjust nominal interest rates

when they need to, but frictions create obstacles that make this adjustment difficult. Government

ceilings on interest rates are an example of such an obstacle. Obstacles can also arise from the

actions of banks themselves, when they respond in the best possible way to the incentives and

risks that are created by existing laws, regulations, policies, and economic conditions. Since

empirical studies have shown that credit market frictions are more severe in developing countries

than developed countries, these frictions may play an important role in explaining the impact

inflation has on economic growth in these countries.

One way inflation might affect economic growth through the banking sector is by reducing the

overall amount of credit that is available to businesses. The story goes something like this.

Higher inflation can decrease the real rate of return on assets. Lower real rates of return

discourage saving but encourage borrowing. At this point, new borrowers entering the market are

likely to be of lesser quality and are more likely to default on their loans. Banks may react to the

combined effects of lower real returns on their loans and the influx of riskier borrowers by

rationing credit. That is, if banks find it difficult to differentiate between good and bad

borrowers, they may refuse to make loans, or they may at least restrict the quantity of loans

made. Simply charging a higher nominal interest rate on loans merely makes the problem worse

because it causes low-risk borrowers to exit the market. And in those countries with government-

imposed usury laws or interest rate ceilings, increasing the nominal interest rate may not be

possible. Whatever the cause, when financial intermediaries ration credit in this way, the result is

lower investment in the economy. With lower investment, the present and future productivity of

the economy tends to suffer. This, in turn, lowers real economic activity.

But there is something peculiar about the effect of inflation on the financial sector: It appears to have important thresholds. Only when inflation rises above some critical level does rationing occur. At very low rates of inflation, inflation does not cause credit rationing. This implies that beneath some thresh-old, higher inflation might actually lead to increased real economic activity. This beneficial outcome can occur only in countries where inflation and nominal real returns on assets. To test these hypotheses empirically, we looked at data for around 100 countries (full details of the study appear in Boyd and Champ 2003). For each country, we averaged data on a number of economic variables across various time periods in the 1980s and 1990s. Averaging across a long time horizon gives us some notion of the long-run effects of inflation. Incidentally, the time period we looked at is not one of particularly high world-wide inflation: The median inflation rate was around 8 percent across all our sam-ples. Prior studies looked at episodes in which average inflation was consider-ably higher, but they yielded similar results to ours.

The Impact of Inflation on Bank Lending

Several economists have found that countries with high inflation rates have inefficiently small banking sectors and equity markets. This effect suggests that inflation reduces bank lending to

the private sector, which is consistent with he view that a sufficiently high rate of inflation induces banks to ration credit.

This finding also holds for the data we examined. Figure 1 shows one measure of bank lending in an economy—total bank lending to the private sector as a ratio to GDP. For this analysis, the sample period is 1980–95. The median inflation rate is 8.5 percent, with inflation rates ranging from 0.8 percent to 85.9 percent.

We break the cross-country data into quartiles. The first quartile includes those countries with average inflation in the lowest 25 percent of the sample. The fourth quartile includes those countries with the highest inflation averages. In figure 1, we present the median and mean values of the banking sector size measure for each of the inflation quartiles. Below each quartile group, the range of the inflation rate for each of the quartiles is listed. For example, the lowest inflation quartile covers inflation rates less than 5.4 percent, and the highest inflation quartile contains countries with inflation rates in excess of 17.4 percent.

We see that the amount of bank lending declines with inflation. Moreover, inflation affects bank lending even at relatively low inflation rates—the median ratio of bank lending to GDP in the second quartile is 10 percent smaller than in the first quartile, and the median inflation rate in the second quartile is only 6.6 percent. Many people might be surprised that such a “small” rate of inflation could cause such a fall in credit. At the highest inflation quartile, the effect is dramatic, with the ratio of bank lending to GDP only 15 percent

Although suggestive, such a simple graph does not take into account other factors that can affect the size of the banking sector. However, after controlling for other variables (in a multivariate statistical analysis), we still find a statistically significant negative relationship between inflation and banking sector size. In fact, at the median inflation rate, a one percentage point increase in inflation is associated with a one percentage point decline in the ratio of bank lending to GDP. Other studies have found similar effects of inflation on alternative measures of banking sector

size, such as the ratio of total bank assets to GDP or the ratio of the liquid liabilities of the financial sector to GDP.

The Impact of Inflation on Asset Returns and Bank Profitability

inflation in sufficiently high doses kicks off a chain of events that ultimately leads to stunted economic growth. The chain begins when high inflation lowers the real return on assets. We uncover substantial evidence for this effect in the data, but not complete support. We find that inflation is negatively associated with real money market rates, real treasury bill rates, and real time-deposit rates; that is, as inflation increases, the real rate of return on these instruments falls. The one example where we don’t find what we might expect is with nominal interest rates on bank loans. We would expect banks to adjust their nominal rates to account for inflation. (One might not expect nominal rates to rise one for one with inflation over a short period of time, since banks might not be immediately aware that inflation has stepped up, but over longer periods, it should be evident.) We find no significant statistical relationship between inflation and the real bank loan rate. However, as we detail later, inflation does appear to have a negative impact on bank profitability measures.

The impact of inflation on real rates is most evident at the extreme. The economies in our highest-inflation quartile experienced real money market rates and real treasury bill rates of around zero percent on average during the time period studied. The real time deposit rate for the high-inflation countries was approximately –3 percent. Negative real interest rates provide little incentive for saving, as savers actually lose purchasing power.

Perhaps most importantly, we find that inflation has a dramatic negative impact on the profitability of banks. Various measures of bank profitability—net interest margins, net profits, rate of return on equity, and value added by the banking sector—all decline in real terms as inflation rises, after controlling for other variables. Figure 2 plots banks’ real net interest margins against the inflation quartiles to give one example. (The real net interest margin is a measure of the inflation-adjusted spread between a bank’s lending rate and its cost of obtaining funds.) We see that even at fairly modest inflation rates of between 5.1 percent and 9.1 percent, the real net interest margin turns negative. Such low real rates of return suggest that the incentives to expand bank operations simply are not as strong as inflation rises.

RESERVE RATIOThe portion (expressed as a percent) of depositors' balances banks must have on hand as cash. This is a requirement determined by the country's central bank, which in the U.S. is the Federal Reserve, in India by Central Bank. The reserve ratio affects the money supply in a country.

In the United Kingdom and in certain European countries, there is no compulsory ratio, although banks will have their own internal measures and targets to be able to repay customer deposits as they forecast they will be required.

In Europe, the reserve requirement of an institution is calculated by multiplying the reserve ratio for each category of items in the reserve base, set by the European Central Bank, with the amount of those items in the institution's balance sheets. These figures vary according to the institution.

In the United States, specified percentages of deposits—established by the Federal Reserve Board—must be kept by banks in a non-interest-bearing account at one of the twelve Federal Reserve Banks located throughout the country.

The required reserve ratio in the United States is set by federal law, and depends on the amount of checkable deposits a bank holds.

Reserve Requirements

Liability TypeRequirement

% of liabilities Effective date

Net transaction accounts 1

     $0 to $11.5 million2 0 12-29-11

     More than $11.5 million to $71.0 million3 3 12-29-11

     More than $71.0 million 10 12-29-11

Nonpersonal time deposits 0 12-27-90

Eurocurrency liabilities 0 12-27-90

These breakpoints are reviewed annually in accordance with money supply growth. No reserves are required against certificates of deposit or savings accounts.

The reserve ratio requirement limits a bank's lending to a certain fraction of its demand deposits. The current rule allows a bank to issue loans in an amount equal to 90% of such deposits, holding 10% in reserve. The reserves can be held in any combination of till money and deposit at a Federal Reserve Bank.

In india, Reserve ratio is decided by RBI and revised gradually.

Cash Reserve Ratio (CRR 5.50% (wef 28/01/2012) -announced on 24/01/2012 Decreased from 6.00% to 5.50% which was continuing since 24/04/2010

Statutory Liquidity Ratio (SLR) 24%(w.e.f. 18/12/2010) Decreased from 25% which was continuing since 07/11/2009

Challenges and Opportunities for Indian Banking Industry

Indian Banking industry was deregulated since 1994, private players were allowed to enter and this step transformed the structure of Indian banking system. Since 1994 world has seen two major financial crises including the subprime crisis due to which giant like Lehman Brothers, Washington Mutual etc collapsed. The structure of Indian Banking industry is different than USA. We are having instrument like SLR which is not being used in USA. Perhaps this extra security feature makes our system strong, we follow Bessel 2 norms and all the Indian banks maintain all the CAMELS ratios better than the benchmark Bessel 2 norms. The Indian Banking system has successfully managed the financial tornado due to sound policies of our central bank and fiscal stimulus packages implemented by the Government. Due to strict regulations, tighter norms on capital adequacy and close watch by the Reserve Bank of India (RBI) prevented the severe impact of the global financial crisis to the Indian banking system. During the recessionary

phase between October 2008 to March 2009, the RBI reduced the policy rates, both repo and reverse repo and provide liquidity to the economy by reducing the reserve ratios and offering adequate support to the banking system. he Indian banking market is growing at an astonishing rate, with Assets expected to reach US$1 trillion by 2010. An expanding economy, middle class, and technological innovations are all contributing to this growth. The country’s middle class accounts for over 32 crore people. In correlation with the growth of the economy, rising income levels, increased standard of living, and affordability of banking products are promising factors for continued expansion. The banking system is reorienting its approach to rural lending. “Going Rural” could be the new market mantra. Rural market comprises 74% of the population, 41% of Middle class and 58% of disposable income.

The banking sector is seeing constant growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. Second, given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks. This segment of customers prefer to do banking from their workplace or home only, as a bank’s point of view it is good because the operational costs is going down. Banks are now offering new technologically sophisticated products like Mobile Banking, internet banking, E-Remit, to attract technically sophisticated customer segment. Now the point of contact is reducing and Banks are taking this challenge as an opportunity, through its innovative products.

Banks are targeting to open new branches in Tier 2 & 3 cities along with opening new branches in rural areas to penetrate this market. Their aim is to offer products to each and every segment of customers. Specialised branches are being opened to target the niche like overseas branches or Corporate branches. The manpower shortage is really a big worry for the banking industry and to retain existing employees is also a big challenge. But better HR policies and chances of better growth in Banking industry are attracting the youths.

Although due to competition created by Private and Foreign banks government banks initially faced tough competition but their core competency is trust of our customers which make us different than others ,as a government banks they have some corporate social responsibility so unlike private players they not only think about the profitability but also our responsibility. So their brand equity is RELATIONSHIP with their customers and now with prompt and efficient services these government banks are making long lasting relationship with their customers. After the deregulation in banking industry the level of service has been improved and in long run the future of Indian banking industry is good.

NEWS ARTICLES

1 ) U.S. Banks Face Contagion Risk From Europe Debt

U.S. banks face a “serious risk” that their creditworthiness will deteriorate if Europe’s debt crisis deepens and spreads beyond the five most-troubled nations, Fitch Ratings said.

“Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen,” the New York-based rating company said yesterday in a statement. Even as U.S. banks have “manageable” exposure to stressed European markets, “further contagion poses a serious risk,” Fitch said, without explaining what it meant by contagion.

The “exposures” of U.S. lenders to major European banks and the stressed nations of Greece, Ireland, Italy, Portugal and Spain, known as the GIIPS, are smaller than those to some of the continent’s larger countries, Fitch said.

The six biggest U.S. banks -- JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. and Morgan Stanley (MS) -- had $50 billion in risk tied to the GIIPS on Sept. 30, Fitch said. So-called cross-border outstandings to France for all except Wells Fargo were $188 billion, including $114 billion to French banks. Risk to Britain and its banks was $225 billion and $51 billion, respectively.

Europe’s debt crisis has toppled four elected governments, with the last two, in Greece and Italy, falling last week. Italian bond yields remained at about 7 percent -- the threshold that led Greece, Portugal and Ireland to seek bailouts -- and shares of French banks, including BNP Paribas (BNP) SA and Societe Generale (GLE) SA, dropped amid concern they’ll need more capital.

Stocks Slump

U.S. stocks slumped yesterday after the Fitch report was released. The Standard & Poor’s 500 Index slid 1.7 percent and the 24-company KBW Bank Index fell 1.9 percent. U.S. stock declines continued today, with the S&P benchmark dropping 1.8 percent at 12:41 p.m. in New York.

The Fitch report is a worst-case scenario and is “oddly out of step” with the rating firm’s previous reports, analysts at HSBC Holdings Plc said today. U.S. banks may even benefit as investors shift money from Europe, HSBC said.

Ratings on the U.S. banking industry are stable and take into account lenders’ improved capital and liquidity position, Fitch said. The rating company’s assumption is that “euro zone sovereign debt concerns will be dealt with in an orderly fashion” and that a disorderly restructuring of sovereign debt or the “forced exit” of a nation from the euro will not occur, according to the report.

Relative Safety

Investor demand for the relative safety of Treasuries during the European debt crisis has sent the difference between U.S. short-term yields and bank rates surging to levels not seen in more than two years.

The gap between the London interbank offered rate and the overnight index swap, or what traders expect the Federal Reserve’s benchmark to be over the term of the contract, widened to 38 basis points today, the highest level since June 2009.

U.S. five-year swap spreads climbed to 45 basis points, the most since August 2009. Investors use swaps to exchange fixed and floating interest rates. The spread, the gap between the fixed component and the yield on similar-maturity Treasuries, is a measure of bank creditworthiness.

TED Spread

The TED spread, the difference between what lenders and the U.S. government pay to borrow for three months, widened to 47 basis points today, or 0.47 percentage point, the most since June 2010. The TED spread was as wide as 4.64 percentage points in October 2008 when credit markets froze and the U.S. economy was in a recession.

While U.S. banks have hedged some of their risk with credit-default swaps, those may not be effective if voluntary debt forgiveness becomes “more prevalent” and the insurance provisions of the instruments aren’t triggered, Fitch said in the report. The top five U.S. banks had $22 billion in hedges tied to stressed markets, according to Fitch.

Disclosure practices also make it difficult to gauge U.S. banks’ risk, Fitch said. Firms including Goldman Sachs and JPMorgan don’t provide a full picture of potential losses and gains in the event of a European default, giving only net numbers or excluding some derivatives altogether.

Guarantees provided by U.S. lenders on government, bank and corporate debt in Greece, Italy, Ireland, Portugal and Spain rose by $80.7 billion to $518 billion in the first half of 2011, according to the Bank for International Settlements.

U.S. banks that run money-market funds may face additional risk if the funds suffer losses on European debt and the lenders are forced to offer support, Fitch said.

Also yesterday, Moody’s Investors Service downgraded the senior debt and deposit ratings of 10 German public-sector banks, citing its assumption that “there is now a lower likelihood” that the lenders would get external support.

2) The euro zone: the central bankers' latest view on the crisis

When Central Bankers talk, people listen. Or maybe they don't. In any case, two of Europe's most important central bankers spoke to the press today and they had some very interesting things to say.

First, Mario Draghi, new head of the European Central Bank, making his maiden speech before the European Parliament. Forgive me for quoting at length:

"What I believe our economic and monetary union needs is a new fiscal compact ... Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively."

This is as close as Draghi could get to stating the obvious, if the euro is to survive, tax policies will have to be set at euro zone level, not at national level. That much was clear by a point the ECB chief added a minute later.

"Other elements might follow ... " What are those other elements? Euro zone wide political institutions that have the ability to set fiscal policy.

Draghi concluded, "A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations."

Okay, it's not up there with, "We the People of the United States, in order to form a more perfect union," or any of Alexander Hamilton's more forceful contributions to the Federalist Papers. But clearly Draghi sees where the solution to the euro zone crisis lies. The question is whether the currency can survive the short term assault by the bond markets on its individual members sovereign debt.

According to Sir Mervyn King, Governor of the Bank of England, the answer to that question is, nobody knows. King was speaking at a press conference to present the latest analysis of the bank's Financial Stability Board.

Describing the situation, King came up with the sound bite of the week: "It is not a liquidity crisis, it is a solvency crisis." He was referring to yesterday's coordinated intervention by central banks around the world to prop up Europe's beleaguered retail banks. These institutions are holding an awful lot of iffy sovereign national debt.

King acknowledged that the bank was making contingency plans for the breakup of the euro zone. "Maybe it (the euro zone) won't breakup, maybe it will continue in various forms but maybe there will still be questions of default. None of us really know."

He also urged the country's private banks to begin making contingency plans to build up cash reserves - including not paying out massive bonuses to its top executives!

Who is listening to all this? As I write markets seem to be doing better ... but that is probably because the central banks - including the Federal Reserve - showed yesterday they were willing to provide a backstop for the banking system. Money talks, as they say, and something else walks.

CASE STUDY

The intensifying American banking crisis threatens the stability of its economy and the world’s. Where is it leading?

Global financial stability has been shaken and America is facing a growing economic crisis that could make the 1930s look like “good times.” The U.S. banking system is on the verge of disaster, as banks have recorded over $100 billion in losses, with hundreds of billions more forecasted. Simply put, America’s banks are staring into a financial abyss.

What started with subprime mortgage losses in 2007 is now growing into a full-blown financial crisis. Consider just one example. As of January 2008, Stockton, Calif. (pop. 280,000), had 4,200 homes in default or foreclosure, with bad loans totaling a staggering $1.4 billion. According to CBS News, Stockton has gone from being one of the hottest real estate markets to the foreclosure capital of America. Prices of homes in the city have dropped as much as 70%.

In many of the nation’s cities, towns and smaller communities, Stockton-like scenarios are playing out. Banks are busy auctioning off houses at “fire sale” prices.

And the news keeps growing worse. Once proud banking titans Merrill Lynch and Citigroup had to look to investments from Asian and Middle Eastern governments (through “Sovereign-Wealth Funds”) to shore up their balance sheets. They were rescued by life-saving injections of $6.6

billion and $14.5 billion, respectively. European banks have also been affected, as Swiss, German, French and British banks have suffered billions of dollars in losses.

The losses are not confined to banks alone. One of the world’s largest insurance companies, American International Group, recently reported losses from the mortgage crisis of up to $5 billion—up from a previous estimate of $2 billion. This may be a sign of coming reassessments by others as the crisis intensifies.

At a meeting of the G7 finance leaders, German Finance Minister Peer Steinbrueck stated that the G7 feared losses from the subprime mortgages could reach as high as $400 billion (nearly as large as the entire economy of Holland, ranked 16th worldwide). Highlighting the gravity of the economic situation, U.S. Treasury Secretary Hank Paulson described it as “challenging and uncertain.”

A deadly combination of the credit crunch, the collapsing housing market, increasing energy prices, and the threat of rising inflation are rapidly weakening America’s economy.

The crisis threatens to engulf banks and other financial institutions, affecting pension funds, mutual funds and insurance companies. The situation is so grave that President George W. Bush and the Federal Reserve (the Fed) have implemented unprecedented emergency measures, including stimulus plans, tax rebates and interest rate freezes, in an effort to prevent total collapse. The stability of the global economy is at stake.

Traditional vs. Modern Banking

Banks traditionally operated by taking deposits from their customers and lending money to those seeking loans. The difference between the interest rate paid on deposits and the higher one charged on loans (the “spread”) was their profit. If customers defaulted on their loans, banks were liable to depositors for payment—the banks held the risk “on the books,” 100% their responsibility. It was therefore in a bank’s best interest to carefully screen customers’ ability to repay before providing loans. The customer needed to have a good job, adequate assets, and was required to make a sizable down-payment. This conservative approach to lending enabled banks to make tidy profits for decades, while staying financially sound. However, the 1990s saw banks change their traditional way of operating. Seeking higher and higher profits to satisfy shareholders and to secure executive performance-pay bonuses, banks decided they could make even higher profits if they loaned out more money. To do this, they used other people’s money through “securitization,” a process that allows banks to convert hundreds, even thousands, of mortgages into bonds and then sell the bonds to investors, such as pension funds, mutual funds, insurance companies and other banks. Banks did not make a profit through the “spread” anymore, but instead made a fee for having put together (“originated”) the loan, now owned by other investors.

Further, the bonds were insured by specialized insurance companies (so-called “monoline” insurers), and were rated as safe investments by the rating agencies (i.e., Standard & Poor’s, Moody’s, and Fitch).

Since the loans were now “off the books” and insured, the banks felt comfortable about “originating” even more loans. Through their new fee-based income, banks made much higher profits than ever before.

Reckless Lending

In their quest for higher profits, banks no longer felt the need to carefully screen loan applicants, as they once did. Customers who did not qualify for loans under the banks’ standard lending procedures (i.e., “subprime” customers) were now targeted as a lucrative source of income, and marketed aggressively to. Loans were provided to people with no income, no job and no assets (so-called NINJA loans).Additional “sweetener” incentives were also provided, such as no down payment required and interest-only payments. Those who initiated the loans and approved them were no longer attached to the risk, and were paid handsomely for their efforts.The subprime mortgage market became a ticking bomb, ready to explode at any time.

Enter the Fed: Expand Image

Thinking ahead: Federal Reserve Chairman Ben Bernanke discusses “Savings” during an Economics Club of Washington luncheon (Oct. 4, 2006). Mr. Bernanke called for an urgent reform of Social Security and Medicare, warning that failure to do so soon could lead to dire economic consequences for future generations.

Two developments have played a significant role in the development of modern banking and the current crisis.

The first was deregulation of the U.S. financial services industry with the 1999 repeal of the Glass-Steagall Act, after years of lobbying by the banks. Carefully crafted during the Great Depression to control speculation in the stock market, Glass-Steagall prevented retail banks, insurance companies and investment banks from owning each other. With the repeal of Glass-Steagall, massive financial services conglomerates were suddenly formed, combining these three types of financial institutions. Industry behemoths such as Citigroup and JP Morgan quickly came into being. This meant that retail banks seeking higher and higher profits could now dive headlong into high-risk speculative ventures through ownership of (or being owned by) investment banks, which led to disastrous consequences during the Stock Market Crash of 1929.

The second was the low interest rate policy pursued by the Federal Reserve. Low interest rates encouraged banks to target subprime customers with variable rate mortgages. Banks offered initially low interest rates (“teaser” rates), to be increased two or three years later. Because of

rising house prices, customers took the bait believing they could refinance their homes at an affordable rate when the time for the reset arrived.

A Culture of Greed

In many cases, mortgage brokers misrepresented terms and conditions to eager customers who provided them with fraudulent information. Sometimes banks did not even bother to check the information provided. “Predatory lending” was compounded by “predatory borrowing”!

Banks sold risky bonds as safe investments to unsuspecting investors. Rating agencies, paid by the banks, rated risky bonds (those with subprime components) as safe—even giving them the highest rating.

With substantial increases in real estate prices occurring every year, builders went on a building spree around the nation.

This created a sense of “easy money”—“something for nothing.” In their greed, many were “scamming the system.” At a meeting in Toronto, Canada, billionaire investor Warren Buffet commented, “It’s sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end” (Reuters).

Crisis Strikes

The crisis started in the summer of 2007. Due to the surplus of homes on the market, housing prices fell moderately—tipping the scales. Also around this time, the first batch of interest rate resets came due. Faced with exploding monthly payments, falling house prices, and an inability to refinance their mortgages, many customers defaulted on their loans. Lenders call it “jingle mail,” as so many homeowners are just turning in their keys.

Confronted with higher monthly payments on mortgages that are greater than the value of their homes, homeowners are abandoning their mortgages. Many feel no moral obligation to fulfill what they promised to repay, believing it is better to walk away from their homes. They feel that while this hurts their credit rating, in the short-term it hurts less than the downward spiral toward bankruptcy.

This change in attitude is in stark contrast to years ago when borrowers felt a moral duty to pay off their loans. With the morals and values of the nation disintegrating, many lack the character and fiscal responsibility of previous generations.

An American City at the Edge of Bankruptcy Vallejo, Calif., is deep in a financial crisis. Years of overspending have left the city, as City Councilwoman Stephanie Gomes called it, “teetering on the edge of bankruptcy” (Associated Press). The city, population 126,000, faces an immediate $10 million general fund cash shortage and almost a $13.8 million deficit for the next fiscal year. Vallejo may soon run out of funds. The City Council has drawn up an emergency plan that

would cut $20 million from the current budget, with most cuts coming from city-funded jobs. The emergency plan includes cutting city salaries 5% by June 30, 2008, reducing firefighter and police officer salaries by 15%, and electrical worker funding by 8%. Overall, 17% of general funds positions would be cut, requiring layoffs. However, the spending cuts must be approved by unions of these groups. Current labor pacts are in force until 2010, meaning the unions are not legally required to negotiate. Contracts for public safety jobs such as police officers and firefighters make up 80% of the city’s general fund budget. Similar cuts have been proposed before to ebb Vallejo’s overspending but have always been voted against by the unions.

Though there are many causes of the city’s financial problems, the fire department proves to be a prime example of the budgeting troubles. During the past years, the fire department has suffered from staff shortages, forcing many firefighters to work overtime, with some making $100,000, or even $200,000, a year. Further, upon hearing the city was in dire financial straits, more than 14 fire employees retired, meaning Vallejo must spend an additional $4 million in buyout costs.

Vallejo’s current liability for already earned retiree benefits of retired and active city employees is $135 million, with another $6 million being accrued per year.

“It’s not a question of whether it is right or wrong for employees to give up anything. This is totally a question of survival of the city,” said Councilwoman Joanne Shivley (Times-Herald).

Being the first city in California to declare Chapter 9 bankruptcy means there is no template or previous case to predict what this would do to the city. City Manager Joseph Tanner said in a report to the City Council that without a compromise with the unions, his estimate for insolvency was late April 2008.

Crisis Spreads

As the crisis intensifies, mortgage defaults are multiplying. And everyone is on the hook. “Monoline” insurance companies have suddenly become liable for multiple billions of dollars of debt. Investors have been left holding bonds that may never be repaid. Banks are finding it difficult to sell additional bonds as investors have backed out of the market, leery of poor investments. Thus, the banks’ fee income has dried up—leaving them with massive deficiencies in capital.

As credit problems mount, banks have sharply reduced lending to each other and the public, fearful the loans will not be repaid (the “credit crunch”).

Shockwaves from the crisis are also being felt in other sectors of the economy. Evidence of this is clear, as liquidity dries up and less money is available to finance commercial loans. Recently, a group of bankers were unable to back $14 billion of debt to finance an entertainment company. Other major deals in the tens of billions are now in jeopardy. Deutsche Bank had to repossess some Manhattan buildings because a well-known developer was unable to refinance $7 billion of

debt. The credit crunch has pushed beyond retail banking; it is now affecting major business deals and even commercial real estate. And municipal bonds (used to fund cities, colleges and hospitals), which were once considered safe investments, can no longer readily find buyers.

As more and more loans arrive at interest rate resets, more defaults will occur, deepening the crisis. A financial tsunami is rapidly approaching America’s shores!

Kings Become Beggars

Increasingly, America’s banks have been forced to look to other nations for capital. Recently, U.S. banks received massive infusions of capital from Asian and Middle Eastern sources that are purchasing larger stakes in America’s largest bank institutions.

During the G7 meeting mentioned earlier, Toshihiko Fukui, governor of the Bank of Japan, made a statement that could have serious ramifications, as the banking crisis further deteriorates: “If everyone does the same thing it won’t be any more effective. Each country needs to do what is best for its own particular situation.”

In the near future, will countries that have so often supported America financially stop doing so, causing the crisis to spiral out of control? Recent news spotlighted a trend in New York that was unimaginable just a few years ago: Some shops are now accepting Euros for payment of merchandise. While accepting foreign currency has been the norm along the Canadian and Mexican border, accepting it in the financial capital of the world is a sign of a weakening U.S. economy. This distrust of American capital is just the tip of the iceberg, as people and nations are learning there are alternatives to the U.S. for security and investment. Time will tell if the ongoing financial irresponsibility of America will cause the world “to do what is best for its own particular situation.” If this happens, it will hasten the demise of the U.S. as the world’s financial leader. There are indications that this has already begun. In its Jan. 15 issue, theFinancial Times noted, “The U.S. looks poised to lose its mantle as the world’s dominant financial market because of a rapid rise in the depth and maturity of markets in Europe, a study suggests. The change may have occurred already, not least because the U.S. markets are beset by credit woes, according to research by McKinsey Global Institute.”

The American banking crisis shows the vulnerability of the global economic system. The world is looking for an alternate, and America will be replaced as the financial engine of the world by a superpower soon to arise in Europe.The good news is that a new—and far superior!—global economy will one day be established. Instead of being rooted in greed and corruption, this future worldwide financial system—which will benefit every nation, small and great—will be based on outgoing concern for others. From individuals to businesses to government bodies, all will practice fiscal responsibility during the soon-coming age the Bible refers to as “the world to come” 

An American City at the Edge of Bankruptcy

Vallejo, Calif., is deep in a financial crisis. Years of overspending have left the city, as City Councilwoman Stephanie Gomes called it, “teetering on the edge of bankruptcy” (Associated Press). The city, population 126,000, faces an immediate $10 million general fund cash shortage and almost a $13.8 million deficit for the next fiscal year. Vallejo may soon run out of funds.

Mayor Osby Davis downplayed the option of bankruptcy, refusing to call it the only possibility and promising to look to other solutions. “I like to look on the positive side,” Mr. Davis told local television station NBC11.

“I’m confident we’re going to be able to work this out without having to file bankruptcy. It’s not an alternative we want the public to believe we’re moving toward with any intention.”

The City Council has drawn up an emergency plan that would cut $20 million from the current budget, with most cuts coming from city-funded jobs. The emergency plan includes cutting city salaries 5% by June 30, 2008, reducing firefighter and police officer salaries by 15%, and electrical worker funding by 8%. Overall, 17% of general funds positions would be cut, requiring layoffs.

However, the spending cuts must be approved by unions of these groups. Current labor pacts are in force until 2010, meaning the unions are not legally required to negotiate.

Contracts for public safety jobs such as police officers and firefighters make up 80% of the city’s general fund budget.

Similar cuts have been proposed before to ebb Vallejo’s overspending but have always been voted against by the unions.

Though there are many causes of the city’s financial problems, the fire department proves to be a prime example of the budgeting troubles. During the past years, the fire department has suffered from staff shortages, forcing many firefighters to work overtime, with some making $100,000, or even $200,000, a year. Further, upon hearing the city was in dire financial straits, more than 14 fire employees retired, meaning Vallejo must spend an additional $4 million in buyout costs.

Vallejo’s current liability for already earned retiree benefits of retired and active city employees is $135 million, with another $6 million being accrued per year.

“It’s not a question of whether it is right or wrong for employees to give up anything. This is totally a question of survival of the city,” said Councilwoman Joanne Shivley (Times-Herald).

Being the first city in California to declare Chapter 9 bankruptcy means there is no template or previous case to predict what this would do to the city.

City Manager Joseph Tanner said in a report to the City Council that without a compromise with the unions, his estimate for insolvency was late April 2008.

The city now waits for the decision of four main unions or it will quickly run out of options. Councilwoman Shivley told NBC11 that the cuts being “purposed in order to remain solvent will decimate city services.” She continued, “Anything other than totally new contracts is a Band-Aid.”