Published on January 19, 2008
BANKING IN INDIA: THRUST AND CHALLENGES - Lessons from Global Financial Services Industry National Seminar SPONSORED BY UGC: BANKING IN INDIA: THRUST AND CHALLENGES - Lessons from Global Financial Services Industry National Seminar SPONSORED BY UGC Kamala Nehru College, University of Delhi 24th -25th JANUARY, 2008 Limitations: Limitations There may be differences amongst individual banks, banking segments like public and private sector, domestic and foreign, old and new; in respect of their experience about the framework that I shall be presenting. Some of the ideas, processes, re-engineering, might have already been implemented while some of the ideas have yet to come. Since I am not a practitioner my presentation may not hold the same interest and importance across the board. It must be understood that there is difference between technologies and the ‘practice’ of such technologies. Thus, whatever I say has to be read in the light of the above limitations. Financial engineering: Financial engineering Financial markets were confronted with drastic changes in the demand conditions and supply conditions, which in turn brought changes in the financial/economic environment. To survive in the new environment, financial institutions search for innovations and design new products and services that would meet customer needs and prove profitable, a process called financial engineering. Key drivers of change in the industry are : Key drivers of change in the industry are Financial Innovations Technological Developments Globalization Liberalization, deregulation and restructuring Demographic Shifts Consumer Preference Financial Innovations led to: Financial Innovations led to Complex financial instruments. Credit derivatives. Securitization. Structured finance. Hedge funds. (Un) bundling risks more efficiently. Technological Developments have led to : Technological Developments have led to Elimination of inefficient paper based and manual processes Increases in computing power and faster data transmission, financial engineering Data mining Increasing digitization with bundling/unbundling of products/services Better risk management practices Dismantling the barriers to competition and entry Technological Developments have led to: Technological Developments have led to Opportunities for new types of service providers (viz., online banks and brokerages, aggregators) and portals (like Yahoo and Microsoft), non-financial entities (telecommunication and utilities) within and across countries. Enabling entry (through online channels) into core/niche segment. Economies of scope (‘synergies’ between different lines of business). The delivery of a broad array of financial services through one provider. Technological Developments have led to: Technological Developments have led to Creating more personalized interactions and customized services. Reducing asymmetric information and transaction costs, permitting individuals to gather and analyze information more efficiently. Facilitating multi-channel interaction and delivery strategy. Proliferation of choices for customers. Globalization led to : Globalization led to Intensifying competition, with new providers emerging across countries providing access to new markets and opportunities. Dismantling of restrictions to international capital flows. Cross-border transactions including mergers and acquisitions and managing new risks. Emergence of global conglomerates. Introduction of worldwide standards in most fields of finance (e.g., Basel capital adequacy agreement for banks); European Integration, Single market, EMU; Demographic Shifts : Demographic Shifts Ageing of population and increase in both the proportion of the population over retirement age and the length of time individuals spend in retirement. Impact on saving rates and the demand for investment funds. Problem of funding an increasing number of pensions. Increase in prosperity/wealth. Increasing demand for long term investment products due to the shifts toward contributory private pension system. Changing Consumer Preferences : Changing Consumer Preferences Emphasis on the performance characteristics of the product, high quality of service New standards of convenience Transparency, ease of market comparisons, one-stop shopping The banking industry has responded to these change by using a wide range of technologies : The banking industry has responded to these change by using a wide range of technologies Financial product technologies. Information technology Telecommunications Financial technologies : Financial technologies They embody economic and statistical models to create, for instance, financial derivatives and to improve portfolio management. Financial innovations create new and complex products They enhance the capability of financial products/services to satisfy multiple needs of the customers. Financial technologies and Information Technologies: Financial technologies and Information Technologies Financial technologies, which help managing credit and market risks, depend heavily on the use of Information Technologies to collect, process , evaluate and disseminate the data. Information Technologies: Information Technologies Facilitate a much more efficient and effective utilization of information over ranges of services and customers. This is, in part, due to data storage, data processing and data mining capabilities. through enhancing data storage, data processing and data mining capabilities. This helps broadening access to the target customers TELECOMMUNICATION: Emergence of Internet and the IT connectivity.: TELECOMMUNICATION: Emergence of Internet and the IT connectivity. As the process of purchasing financial products becomes more commoditized and is electronically dis-intermediated, the financial services market is likely to evolve into ‘manufacturers’ and ‘distributors’ of financial products and services. Purchase of a Mutual Fund product is one example where the investor, electronically buys an instrument/product developed and capitalized by financial institution (the AMC) and the ISP or portal deposits through ECS mandate electronically in the demat account of the investor the product which has so been purchased. Internet banking: Internet banking The prevailing model of Internet banking today is the one that is thoroughly integrated within the existing banking infrastructure, which combines click and mortar systems. The “click and mortar” model – a strategy combining physical and Internet presence – has thus become the dominant model. Further, many global financial service providers have developed specialized SME-related Internet banking. Internet and payment system: Internet and payment system Internet model disassociates network from physical infrastructure. It allows interconnection between heterogeneous networks and provides ubiquitous common standards, whose development is no longer controlled by a single entity or even a group of entities. Internet and payment system: Internet and payment system With internet, payment system has changed from closed networks and proprietary protocols to an open network infrastructure. It involves direct non-hierarchical links between the buyer, the vendor and any intermediaries, as well as between them and technology providers. Financial institutions and e-finance: Financial institutions and e-finance Challenges to financial institutions and financial service providers do not consist in disintermediation but the changing nature of intermediation. E-finance has stimulated the emergence of new categories of intermediaries such as financial portals, transaction aggregators and financial applications service providers. Electronic Banking: Electronic Banking Impact of internet banking on market structure: Impact of internet banking on market structure Internet banking has reduced barriers to entry in many areas. It has become much less expensive, for example to launch a new bank as electronic delivery modes reduce the need to depend on a bank branch network. Internet banking offers entry and expansion opportunities that small banks traditionally lacked. With advances in technology providing ubiquitous connectivity and integration capabilities: With advances in technology providing ubiquitous connectivity and integration capabilities Running a sizable distribution network facilitates economies of scale The same network is used in providing an increasing array of financial products and products. Thus it helps in achieving scope economies. Changes in global banking industry: Changes in global banking industry Economies of scope and scale have been put forward as rationale behind mergers, acquisitions and consolidation in the banking industry. Many investment banks are offering traditional commercial banking products and moving into retail brokerage. On the other hand, cross-industry mergers are taking place between banks and insurance companies. Advantages of large size: Advantages of large size A greater bank size implies the potential for improved diversification at a given level of return. Enhanced diversification reduces the cost of risk management Lower cost of risk management may encourage a bank to take on more risk. Thus the overall level of risk is an endogenous choice made by the bank. However, large banks need not necessarily be more innovative.: However, large banks need not necessarily be more innovative. Boot and Thakor(1997) observed that innovation would be lower in a universal banking than in one in which commercial and investment banking are functionally separated. While larger institutions can better recoup the fixed costs of financial innovations, Boot(2003) argues that larger institutions are less likely to innovate due to inherent bureaucracy. Ambiguous impact of IT: Ambiguous impact of IT There is a potential for scope and scale economies inherent in applications in IT. But a variety of factors may undermine the possibility of realizing these economies. For example, too much competition in existing activities weakens the rationale for scope expansion and favors more focused strategies. Responding to change: Responding to change Slide29: Entry and Market Dynamics LAC, Long-run Price Short-run price (Industry) ACn LACn LACo ACo Lp Qn Qo QMax Output LEGEND ACn = Long Run Average Cost of New Bank Qmax = Maximum size ACn = Average Cost of New Bank Qo = Output of Old Bank ACo = Average Cost of Old Bank Lp = Long Run Price LACo = Long Run Average Cost of New Bank Qn = Output of new Bank Slide30: Thank you!!