Emergence of Universal Banks in India

A universal bank is a kind of bank that takes part in diverse kinds of banking activities related to activities of both a commercial bank and an investment bank as well as providing other financial services such as insurance. Universal Banks are also called full-service financial firms, as they offer traditional banking facilities extended by commercial banks as well as provide project financing, wealth and asset management, trading, underwriting, researching as well as financial advisory, etc., under one roof.

In the Indian scenario, there is a very thin line between the role of Development Financial Institutions (DFIs) and Commercial banks due to the overlapping of their functions. After the merger of two important DFIs ICICI and IDBI with its banking units in 2004 most of DFIs functions are being performed by commercial banks and these commercial banks are actively involved in project financing like DFIs. Universal banks are one-stop shops for all your financial needs like credit requirements, deposits, securities transactions, asset management, underwriting, merchant banking, etc.

The principle of Universal Banking was recognized as a desirable goal in India:

Since the 1991 economic reforms Government of India reduced public funding to Development Financial Institutions (DFIs). With the change in the operating environment, the supply of low-cost funds has dried up for the DFIs forcing them to raise resources at market-related rates. The DFIs are unable to withstand the competition from banks due to their higher cost of funds. DFIs are also burdened with large NPAs due to exposure to certain sectors which have not performed well due to the downturn in the business cycle further adding to their cost of doing business. Further, their portfolio is almost entirely composed of long-term high-risk project finance and consequently, the viability of their business model has come under strain. Compared to DFIs Banks enjoy the natural advantage of low-cost funds and are, therefore, capable of providing long-term finance at lower rates despite higher intermediation costs and can derive at the same time the benefit of risk diversification across a wide spectrum of assets of varying maturities, subject of course, to the limitations imposed by their ALM considerations. With the change in the operating environment, the supply of low-cost funds has dried up for the DFIs forcing them to raise resources at market-related rates. The DFIs are unable to withstand the competition from banks due to their higher cost of funds. DFIs are also burdened with large NPAs due to exposure to certain sectors which have not performed well due to the downturn in the business cycle further adding to their cost of doing business. Further, their portfolio is almost entirely composed of long-term high-risk project finance and consequently, the viability of their business model has come under strain. A  Discussion Paper was prepared outlining the issues arising out of the recommendations of the Narasimham Committee II and the Khan Working Group. Extensive discussions were held on the issues brought out in the paper and a broad policy framework was outlined in the Mid-Term Review of Monetary and Credit Policy of 1999-2000 of RBI. The principle of Universal Banking was recognised as a desirable goal in the Indian scenario by converting Development Financial Institutions into Commercial Banks.

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