This article is written by Anumeha Agrawal, from Symbiosis Law School, Pune. This is an article on the Impact of Globalisation on the Indian Banking Sector by discussing the pre globalisation position and post globalisation position. It also covers the introduction of Insolvency and Bankruptcy Code, 2016 and lastly the advantages and disadvantages of the same.
Globalization is the integration of economies of the country, cross border trade, cross border capital flow, the widespread diffusion of technology and people. Undisputedly trade and finance have always been the driving force behind globalisation as a result the biggest impact of globalisation has been witnessed in the manufacturing and industrial sector and banking sector.
Globalisation in the Indian economy
Globalisation in India can be traced back to the liberalization of the economy in the 1990s, along with all the demands of IMF and World Bank included tariff and subsidies reduction and several other trade liberation measures and considerable steps to be taken to enable foreign investors and financial institutions like banks to create a market share in India.
Pre-globalisation banking sector
In India, the banks are not a novel concept but have been around from Vedic period but they were not the same as the modern institution of the bank, at the end of 18th century there were hardly any banks in India. Some banks were opened but failed to survive as it being a foreign concept was not trusted by the common people and due to exposure to speculative venture deposits were also lost.
At the time of colonisation European banks operated in India with the objective to aid colonial rulers in facilitating the construction and development activities. The first bank was English Agency House in Calcutta and Bombay in the 18th century. In the next century, Presidency banks were established. There were three major presidency banks in India, Bank of Madras and Bank of Calcutta which were merged into Imperial Bank of India and also Reserve Bank of India was established as the central bank of the country in 1935.
License Raj means the rule of licenses or permits, the nomenclature evidenced for the shift of powers from the Britishers (in British Raj) to the Government and the statutes. Another reason for the extensive use of the term to refer to the period from 1947 to 1990s is the extensive licenses required to establish a business, expand the business or any other commercial activity leading to red-tapism.
The Constitutional Assembly made a conscious decision not to declare a permanent economic system though largely socialism was followed. During this period the industrial revolution was at its peak resulting in the establishment of new industries and steep need of credit for the corporates.
All the sectors were heavily regulated by the government policies especially the foreign investment and import and export and the banking and finance sector was no exception.
By the time of independence, there were over 600 commercial banks however there was not much public trust in the institutions. Therefore, the government transformed Imperial Bank to State Bank of India in 1955.
But this was not considered a sufficient measure due to proximate relation between the commercial houses and financial institutions resulting in advancing credit facilities to these houses in a biased manner and not to the general public.
Nationalisation of banks
In the 1960s, it was observed that certain sectors of the economy like agriculture, small scale industries and weaker sections of society were ignored by the banking system, to an extent that the entire agriculture sector only availed 2.1% of the entire credit extended by the banks in the year 1951. There was a clear need to prevent:
- monopolistic trends
- the concentration of economic power
- misuse of economic resources
In the year 1969, the government passed The Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969 nationalised all the banks with deposits greater than 500 million, a total of 14 banks i.e. 84% of all branches and 70% of the country’s deposits.
As per the Prime Minister, the objectives of the reform were:
- Mobilisation of public savings to the maximum extent.
- Banking operations need to be granted by larger social purpose.
- Credit availability for big and small companies of the private sector are met.
- Credit need of all sectors are fulfilled.
- Promotion of entrepreneurs.
The government passed subsequent legislation The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 to further nationalise six other banks namely Andra Bank, Corporation Bank, New Bank of India, Oriental Bank of Commerce, Punjab & Sind Bank and Vijaya Bank. After this, 91% of total deposits came under the nationalised banks.
Nationalisation achieved some of its objectives like the expansion of branches, the total number of branches of commercial banks was 8,262 in June 1969 and it increased to 30,303 in June 1979.
The average population served per bank branch approximately 65,000 which decreased to 17,000 by the end of 1979. The percentage of branches in rural areas increased from 22.4% in June 1969 to 44.1% in June 1979.
Another result of nationalisation was the increase in total lending to the priority sector was 14% in June 1969 and it increased to 30.9% at the end of June 1978. In March 1979, the Govt. suggested 33% of total credit to be directed to the priority sector which was increased to 40% by 1980.
The reform was severely criticized due to decrease in efficiency of the entire banking sector, i.e. the profits decreased and there was a huge increase in NPA due to lending to priority sectors and concessional rate of interests.
The globalisation of the banking sector
Due to above-mentioned reasons, a nine-member High-Level Committee head by Mr Narasimham was established to revive the banking and finance sector of the country, the following were its recommendations:
- A four-tier hierarchy was advised to be established with 3-4 banks at the top and the bottom the rural agriculture banks.
- Branch licensing policy ought to be abolished.
- Interest Rates should be de-regularised.
- Supervisory role over banks and financial institutions to be done by an RBI sponsored quasi-autonomous body.
- Promotion of competition among financial institutions by promoting the entry of private entities.
- Setting up an asset reconstruction fund to handle a portion of that loan portfolio of banks which is difficult to be recovered.
- It phased a reduction in cash reserve ratio and statutory liquidity ratio (dealt in detail below).
The government in furtherance to these recommendations took the following measures:
- The SLR and CRR reduced the profit percentage of the bank, from 1991 to 1997 SLR was reduced from 38.5% to 25% (reduced by 13.5% ) and the excess funds enhanced the allocation to the priority sectors like agriculture, SMEs etc.
- Scheduled commercial banks had only minimum floor rates and maximum ceiling rates.
- The rate of interests over Rs. 2 lakhs was completely deregulated, and the interest rates on deposits and advances of all co-operative banks only had a minimum lending rate of 13%.
- Recovery of Debts due to Banks and Financial Institutions Act, 1993 was enacted for the speedy recovery of debts to banks and financial institutions, with 6 tribunals and one appellate tribunal.
- There was freedom of operations given to scheduled commercial banks like the opening of new branches or closing of non-viable branches.
- Local Area Banks were established to channelize rural savings into investment.
- Lastly, RBI set up an independent Department of Supervision for the supervision of commercial banks.
Narasimham Committee -II
After the first report, apart from these changes, the Indian economy also witnesses huge changes under LPG reforms i.e. Liberalisation, Privatisation and Globalisation. The entry of foreign banks and the survival of Indian banks in the current form was threatened thus, the committee was established again.
The Committee made the following recommendations in its report:
- The sector can be strengthened by merging strong banks with strong banks and weak banks with weak banks (determined by the Current Account Convertibility) to make bigger banks having bigger customer base and resources i.e. the multiplier effect.
- The narrow banking should be practised by weak banks, i.e. only allowed to extend low-risk loans.
- The capital adequacy requirements should take the market risks into account in addition to the existing credit risk.
- The banking laws like the Banking Regulation Act and the RBI Act need to be amended.
- Government guarantees’ advanced and its prescription on risk weight for Government should be calculated in the same manner as for other advances.
- Higher norms for capital adequacy should be set, the minimum capital to risk assets ratio should be increased to 10%.
- PSBs should meet their credit requirements from the capital market instead of the Government.
- An asset should be classified as doubtful if it is under the substandard category for 18 months in the first instance and eventually for 12 months if it is identified but not written off.
The following measures were taken by the Government in furtherance of these recommendations:
- RBI monitored the potential weakness of the banks based on 5 parameters based on insolvency, profitability and earnings as recommended by the Working Group on Restructuring of Weak Public Sector Banks.
- Banks were mandatorily required to assign a risk weightage of 2.5% for government and other approved securities outside the SLR.
- In case of Govt. guaranteed advances and invoked and defaulted guarantees by the State Government on the end of FY1999-20 should be assigned 20% and at the end of FY 20-21 should be assigned 100%.
- Minimum capital risk asset ratio was enhanced to 9% w.e.f from FY 1999-20.
- Banks were permitted to access capital from the markets.
- The period to classify an asset as doubtful was reduced from 24 to 18 months and provisioning of not less than 50% of total doubtful assets is required.
Basel norms are global standards approved and accepted by several banks, the objective of the establishment of such norms was to increase coordination between the central banks all over the world. It also wanted to promote transparency in the banking sector and reliance on banks to recover from financial shocks These were given by the Basel Committee on Banking Supervision.
Basel I norms
Base-I norms came out in 1988 it focused on credit default risk and the maintenance of adequate capital. The capital adequacy ratio was 8%. The capital was classified as Tier 1 and Tier 2.
Tier 1 was the core capital of the banks which is permanent and reliable including equity capital and disclosed reserves whereas Tier 2 was supplementary capital including provisions for NPAs, cumulative non-redeemable preference shares, undisclosed reserves.
The bank assets were clarified into 5 categories depending on their risk percentage, 0%, 10%, 20%, 50% and 100%.
India adopted the Basel I Norm framework in 1992-93 under RBI guidelines, the compliance was a phase for the banks having an oversea presence, the deadline was March 1994 and the other could comply by March 1996.
Basel II norms
Basel II was released in 2004. Primarily, it has three interdependent frameworks, minimum capital, supervisory review and market discipline.
Minimum Capital: There is a requirement of maintenance of minimum capital adequacy of 8% of risk-weighted assets. Also the two categories of the capital created by Basel I Norms Basel 2 created Tier 3 for the short term subordinated loans.
Regulatory Requirement: The banks also had to develop and practice risk management techniques for credit risk, market risk and operational risks. The basic indicators of risk were to be identified and a standardised approach to be developed.
Market Discipline: Lastly, many disclosure requirements were added like CAR, risk exposure etc. to the central bank. This was to increase transparency in the banking sector and to enable central banks to keep a tab on the position of the commercial banks.
India adopted Basel II Norms in 2009 under RBI Guidelines.
Basel III norms
Basel III was adopted after the 2007-8 financial crisis, 2010. The norms raised the capital adequacy ratio to 12.9%. The tier 1 and tier 2 capital ratio were to be maintained at a minimum of 10.5% and 2% respectively.
Furthermore, a capital conservation buffer of 2.5%, counter-cyclical buffer of 0-2.5% was to be maintained as well.
There were two types of liquidity ratio required to maintain the Liquidity Coverage Ratio (“LCR”) and Net Stable Fund Rate (“NSFR”).
Impact of globalisation
There was a profound impact of globalisation on the banking sector of the country, some of them are:
Integration of the financial market
Globalisation, as stated above, aims to form a more connected market by free cross border movement of capital, technology and other resources. The financial market is no exception as the markets were opened for foreign investors. The investors were allowed to invest in foreign markets, this was achieved by relaxing the existing policy norms of closed economies, and developing international standards for business.
The Indian LPG economic reforms and then subsequent adoption of international practices and standards like enabling entry of foreign banks, enhancing private bank operations, reducing government’s stake in banking and adoption of Basel norms I and II are some examples of it.
Deregulation of the market
During License Raj, the banks needed to obtain licenses and go through extensive government procedures for all banking and financing activities like the determination of pricing, determination of interest rates, restriction on certain activities and the compliances to start or shut down the operations.
After the liberalisation steps were taken to re-establish autonomy in the banking sector, it was one of the recommendations by the Narasimham Committee like accessing the capital market, interest rates were determined by the banks and not the government. And most importantly the individual branch licensing was liberalised to a large extent allowing banks to determine the number and the locations based on commercial viability.
Diversification of services provided by the banks
Post globalisation the banks diversified in their services, diversification of services are of the following three types:
Narrow spectrum diversification
Narrow Spectrum Diversification (“NSD”) is the diversification of services by banks in a field related to banking itself. These are usually vertical integrations by banking industry players. Two examples of this can be:
- Universal banking- multi-purpose and multi-functional providing banking and financial services, it serves the needs of corporates and individuals both. SBI provides universal banking services.
- Retail Banking- focus on banking for the general public and not a large company or corporations, it includes checking and savings accounts, personal loans, credit cards etc.
Broad spectrum diversification
Broad Spectrum Diversification (“BSD”) includes the services which are unrelated to banking, some examples of such services are:
- Merchant banking- banking activities related to securities transactions and the stock market. Bank of Baroda provides merchant banking to its customers.
- Insurance Services- banks have started to extend insurance services and these are quite popular in the general public, SBI Life Insurance, HDFC Life Sanchay and ICICI Prudential Life are one of the best insurances in the market.
Alliance Diversification (“AD”) refers to diversification by banks by tie-ups, joint ventures or other alliances with other banking or non-banking entities. Thus these can be NSD or BSD just there are multiple entities involved.
SBI Life is a JV with Cardiff and SBI Asset Management is a JV with Societe Generale.
The entry of foreign banks
Currently, there are 37 foreign banks and over 270 banking branches operating in the Indian market, however, in the year 1980, the number of foreign banks was merely 14 banks which significantly increased in 1990 to 24 and its highest to 41 in 2000. According to RBI, before liberalisation, the share of foreign banks in total commercial banks was 9.5 % in 1980 which increased to 13.9% in 2000.
The entry of private banks
In the 1990s new policies for licensing private banks were issued in 1993 which only allowed 8 private banks to function and after India’s commitments under WTO w.r.t. Foreign investment etc. the foreign banks were allowed to open 12 branches a year, the share of private bank’s deposits of the total deposits was 4% and it increased to 18% in 2010.
Reduction in entry barriers in the banking sector led to an increase in the number of participants like several new private banks and foreign banks which led to an increase in efficiency and competition in the market.
The government also strengthened the PSBs by lending its capital to them and also enabling them to raise capital from the public. Functional autonomy of PSBs was also considerably increased.
Indian banks become global
Liberalisation has not only provided access to the foreign banks to Indian market but also provided Indian banks access to foreign banks and an opportunity to expand their organisation. In the year 1991, there was the negligible global presence of Indian banks and by 2020 there are in total 136 branches of Indian Banks at oversea centres with both Bank of Baroda and State Bank of India having 36 i.e. the highest number of branches.
SBI has branches in 19 countries including Singapore (highest number of branches, 6) the United States of America, South Korea, Belgium, Bangladesh etc.
Bank of Baroda has a considerable overseas presence in 14 countries including the United States of America, United Arab Emirates, United Kingdom, Singapore, Thailand, Malaysia, China, Australia etc. It also has subsidiaries in 8 foreign countries.
Impact on Public Sector banks
Indian Public Sector Banks (“PBS”) went through sizable changes like independence in conducting its operations, and the compulsory priority sector lending was reduced. This enabled the PSBs to look for more commercial viability in their operations which were earlier more connected by the social policies the government aimed to achieve through their policies norms. The Banking Companies Act 1970/80 amendment enabled the PSBs to raise funds from the capital market by way of securities or debt instruments.
Improvement of the banking sector
Due to a reduction in cost, overhead expenses and interest margins or domestic banks.
There has been greater transparency in the banking operations after the globalisation due to the Central Vigilance Commission (“CVC”) direction of following open policy by the banks, including disclosures with regards to the net Non Performing Assets, the maturity profile of loans, investments, and financial details of subsidiaries as well.
The entry of well established foreign banks and private banks established by huge corporates raised the level of services provided to the customers and forced the existing banks to raise their services to the same level as well.
Introduction of IBC
Need for IBC
A recent and one of the largest reforms in the banking sector is the introduction of Insolvency and Bankruptcy Code, 2016. The legislation particularly deals with corporate insolvency and one of its major objectives was to provide ease and faster exit for the businesses.
Globalisation only allows the investors to invest internationally but the choice of where to invest resides on the investors themselves. As a result, there is a competition among the countries to make their markets the best option for the investors. The earlier insolvency regime in the country was extremely complex and led to a delay in the completion of the process almost 4 and a half years which was substantially more than other developed countries like the USA and UK where the periods were 1and a half year and 1 year respectively. Therefore, there was a clear need to simplify and consolidate the insolvency and bankruptcy law particularly for body corporates to increase foreign investment.
Impact of IBC
The code provided an exhaustive framework for corporate insolvency and bankruptcy and even revival of sick companies, the clarity of legislation is an important aspect foreign investors look into when investing in a country.
The code was proved useful in inviting new investments in the market and increasing India’s international position in the World Bank’s Ease in Doing Business, in 2015 the ranking was 142nd and within five years of functioning of the Code the country is on 63rd position.
According to the World Bank, an average of 42.5% of the filled amount was recovered through IBC in 2018-19 as compared to 14.5% under SARFAESI, 3.5% under DRT and 5.3% in Lok Adalats.
Although there are several factors attributable to such improvement IBC is one of the contributors to it.
Pros and cons of globalisation
There are undeniable advantages of globalisation of financial markets like market stability, uniform regulation and creating an investor trusted market. There has been an overall increase in the product quality and service qualities in the global market which is beneficial to the customers. It not only provided a wider market access but also the wider set of investors.
In addition to these, there are also some disadvantages of globalisation mostly due to improper and delayed implementation of standards or protective measures. Some of them are:
Impact of Recessions
But the integration has led to the interdependence of economies which has also paved the way for the transfer of disruptions as well, the great depression of the 1930s started with the United States of America but spread throughout the globe leading to millions of persons getting unemployment.
Another such example was the 2007-09 financial crisis, it was started in 2006 by the housing crises of the United States and the biggest global banks failed. Some of them were Lehman Brothers, Douglas National Bank, ANB Financial, Washington Mutual and a total of 465 banks failed and shut by the Federal Deposit Insurance corporation between 2008-12.
The financial crisis impacted the European banks significantly, Romania entered into recession in 2009. According to Eurostat Statistics, 2009 the total GDP growth of EU15 was 3 in 2006 which reduced to -4.1 by the year 2009.
Although the Indian Banking Sector was not much affected by the 2008 recession, the reason for this was the non- integration of Indian finance sector particularly the banking sector to the global market. The Indian banks were also not exposed to mortgage-backed securities which were the root cause of the crisis.
The decrease in MSME lending
The impact of globalization was unsettling on the MSME sector of the country due to their lack of resources and smaller scale of operations it was difficult to compete with the global players. MSMEs are not only important in a country for the creation of employment and domestic production but also for the banking sector as a considerable portion of lending used to be facilitated to MSMEs, however that has reduced. According to the RBI Report on MSMEs, the demand for credit by MSMEs is estimated to be 37 trillion and the overall supply is 14.5 trillion thus there is an estimated gap of 20-25 trillion.
Fugitive economic offences
One of the major problems of globalisation is that there has been an increase in the commission of economic offences and economic fugitive offenders, these are the persons accused of committing an economic offence who elope to foreign jurisdictions to safeguard themselves from prosecution.
In the last decade itself, India has witnessed the biggest banking frauds in its history all three of which were economic fugitive offenders, three such infamous offenders are Rajiv, Nirav Modi and Vijay Mallya. There is an urgent need to better the extradition treaties with other countries to prevent such scams concerning public money deposited in banks.
Indian has signed extradition treaties with 48 countries and also passed Fugitive Economic Offenders Act, 2018 but its prompt implementation is required.
To sum up it can be stated globalisation has aided the development of the Indian banking sector and increased the efficiency and profitability in a manifold manner, by providing more autonomy and less government regulation in the sector. However the same is not devoid of challenges which are to be faced by increased competition and disparity in the scale of operations.
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