INDIAN BANKS AND THE GLOBAL CHALLENGES

INDIAN BANKS AND THE GLOBAL CHALLENGES

Introduction

 It gives me great pleasure and privilege to participate in the Seminar jointly hosted by Indian Merchants' Chamber and IBA at a juncture when financial services sector across jurisdictions is going through a strong phase of increasing globalisation. Integration of economies leads to integration of financial markets catalyzing the globalisation process. The growing role of the financial sector in allocation of resources has significant potential advantages for the efficiency with which our economy functions. Consequently, the adverse consequences of malfunction of the financial system are likely to be more severe than they used to be in the past. Hence, all our efforts today are focused at ensuring greater financial stability. Given the significance of the Indian banking system, one cannot afford to underplay the importance of a robust and resilient banking system.

Global challenges in banking

            Recently I was afforded an opportunity to speak on the challenges faced by the Indian banking industry. To recapitulate, I had identified a few broad challenges faced by the Indian banks in the following areas, viz., enhancement of customer service; application of technology; implementation of Basel II; improvement of risk management systems; implementation of new accounting standards; enhancement of transparency & disclosures; and compliance with KYC aspects. If we were to identify a few global challenges which banks face today, I am sure we would cover some common ground. An overview of the global challenges would include the following: Basel II implementation; enhancing corporate governance; alignment of regulatory and accounting requirements; outsourcing risks; and application of advanced technology. I propose to cover these aspects now.

Basel II implementation

            Basel II implementation is widely acknowledged as a significant challenge faced by both banks and the regulators internationally. It is true that Basel II implementation may be seen as a compliance challenge. While it may be so for some banks, I would venture to mention that Basel II implementation has another dimension which offers considerable opportunities to banks. I would like to highlight two opportunities that are offered to banks, viz., refinement of risk management systems; and improvement in capital efficiency

Comprehensive risk management:

 Under Basel I banks were focused on credit and market risks. Basel II has brought into focus a larger number of risks requiring banks to focus on a larger canvas. Besides the increase in the number of risks, banks are now beginning to focus on their inter-linkages with a view to achieve a more comprehensive risk management framework. Basel II implementation, therefore, is being increasingly seen as a medium through which banks constantly endeavour to upgrade the risk management systems to address the changing environment. Further, in the initial stages, banks were managing each risk in isolation. It is no longer adequate to manage each risk independently. Enterprises worldwide are, therefore, now putting in place an integrated framework for risk management which is proactive, systematic and spans across the entire organisation.  Banks in India are also moving from the individual silo system to an enterprise wide risk management system. While the first milestone would be risk integration across the entity, banks are also aware of the desirability of risk aggregation across the group both in the specific risk areas as also across the risks. Banks would, therefore, be required to allocate significant resources towards this endeavour.

Capital efficiency:

 Basel II prescriptions have ushered in a transition from the traditional regulatory measure of capital adequacy to an evaluation of whether a bank has found the most efficient use of its capital to support its business i.e., a transition from capital adequacy to capital efficiency. In this transition, how effectively capital is used will determine return on equity and a consequent enhancement of shareholder value. In effect, banks may adopt a more dynamic approach to use of capital, in which capital will flow quickly to its most efficient use. This revised efficiency approach is expected to guide the return-on-equity strategy and influence banks' business plans. With the extension of capital charge for market risks to the AFS portfolio this year and the coming into force of Basel II norms in March 2007, banks would need to shore up the capital levels not only for complying with these requirements but also for supporting the balance sheet growth. With a view to enhancing the options available to banks for augmenting their capital levels, the Reserve Bank has recently permitted banks to issue new capital instruments, including perpetual instruments. A notable feature of these instruments is that these are designed to help banks in not only managing their capital effectively but also efficiently.

Enhancing corporate governance

            A good "governance culture" is crucial for financial stability but since it is an ‘intangible', rules may not be able to capture its essence effectively. Therefore, banks may have to cultivate a good governance culture building in appropriate checks and balances in their operations. There are four important forms of oversight that should be included in the organisational structure of any bank in order to ensure appropriate checks and balances:

 (1) Oversight by the board of directors or supervisory board;

(2) Oversight by individuals not involved in the day-to-day running of the various business areas;

 (3) Direct line supervision of different business areas; and

(4) Independent risk management, compliance and audit functions.

In addition, it is important that key personnel are fit and proper for their jobs. Although some ownership structures might have the potential to alter the strategies and objectives of a bank, these banks will also face many of the same risks associated with weak corporate governance. Consequently, the general principles of sound corporate governance should also be applied to all banks irrespective of their unique ownership structures.

Compliance With International Accounting Standards

            One of the prime international standards considered relevant for ensuring a safe and sound banking system is the ‘Core Principles for Effective Banking Supervision' issued by the Basel Committee on Banking Supervision (BCBS). Accounting standards are now a part of the set of twelve standards that have been identified by the Financial Stability Forum as conducive to a robust financial infrastructure. Financial reporting and prudential supervision have slightly different perspectives. While the former is oriented towards capturing the historical position, the latter has a forward looking element particularly with reference to measurement of impairment and capital. An important challenge, therefore, is to ensure that accounting standards and prudential frameworks are mutually consistent. While working towards achieving this consistency between the two sets of standards, it is essential for the regulators to be in a position to address any implications that the changes in accounting standards may have for the safety and soundness of banks5.

            It is in this background that RBI has issued draft guidelines on outsourcing, which is intended to provide direction and guidance to banks to effectively manage risks arising from such outsourcing activities. The underlying principles for any outsourcing arrangement by a bank are that such arrangements should neither diminish the bank's ability to fulfill its obligations to its customers and the RBI nor impede effective supervision by RBI. Outsourcing banks, therefore, should take steps to ensure that the service provider employs the same high standard of care in performing the services as would be employed by the banks if the activities were conducted within the banks and not outsourced. Accordingly, banks are not expected to outsource any activity that would result in their internal control, business conduct, or reputation being compromised or weakened.

Application Of Advanced Technology

Technology is a key driver in the banking industry, which creates new business models and processes, and also revolutionises distribution channels. Banks which have made inadequate investment in technology have consequently faced an erosion of their market shares. The beneficiaries are those banks which have invested in technology. Adoption of technology also enhances the quality of risk management systems in banks. Recognising the benefits of modernising their technology infrastructure banks are taking the right initiatives.  While doing so, banks have four options to choose from: they can build a new system themselves, or buy best of the modules, or buy a comprehensive solution, or outsource. In this context banks need to clearly define their core competencies to be sure that they are investing in areas that will distinguish them from other market players, and give them a competitive advantage6. A further challenge which banks face in this regard is to ensure that they derive maximum advantage from their investments in technology and avoid wasteful expenditure which might arise on account of uncoordinated and piecemeal adoption of technology; adoption of inappropriate/ inconsistent technology and adoption of obsolete technology.

Capacity building

As dictated by the changing environment, banks need to focus on appropriate capacity building measures to equip their staff to handle advanced risk management systems and supervisors also need to equally equip themselves with appropriate skills to have effective supervision of banks adopting those systems. In the likelihood of a high level of attrition in the system, banks need to focus on motivating their skilled staff and retaining them7. Skill requirements would be significantly higher for banks planning to migrate to the advanced approaches under Basel II. Capacity building gains greater relevance in these banks, so as to equip themselves to take advantage of the incentives offered under the advanced approaches.

            .

CONCLUSION

            The global challenges which banks face are not confined only to the global banks. These aspects are also highly relevant for banks which are part of a globalised banking system. Further, overcoming these challenges by the other banks is expected to not only stand them in good stead during difficult times but also augurs well for the banking system to which they belong and will also equip them to launch themselves as a global bank.

R.Yuvarani

M.Phil Scholar,

Department of Commerce

Periyar University, Salem-11