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Banking and it's challenges in India

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General awareness or GK  is a must for cracking MBA entrance exams and for updating you on this MBARendezvous.com -India's content lead MBA website  has started series of articles to equip MBA aspirants with general awareness with the hope that you would get success in various MBA entrance exams.

Following article on”Banking and it's challenges in India” is part of our series on general awareness: 

Banks are the most important institution for institutional credit in India. Banking industry in India is almost two centuries old as the first bank opened in India was Bank of Hindustan opened by Europeans in 1779 in Calcutta while the first bank managed by Indians was Oudh Commercial Bank. Since then, Indian financial sector had covered a long distance. According to RBI data, there are 171 banks operating in India with more than 82,400 branches across the country. 
 
Apart from assisting in the rapid development of the economy through financial contribution, the commercial banks were also expected to expand the institutional base, directed lending to disadvantaged borrowers, and to provide credit provision at concessional rates of interest. Since private banks in early post independence period were majorly catering to the needs of the affluent sections of the society neglecting vast rural population, top 14 banks were nationalized in 1969 and later six more in 1980. But nationalized banks later itself become white elephants incurring consequent losses and become dependent on the budgetary support of the government. 
 
There was an urgent need of reforms and therefore government established Narsimhan Committee to recommend for reforms in Banking sector, meanwhile allowing private sector to set up banks and Axis Bank (earlier as UTI Bank), ICICI Bank and HDFC Bank were established. This move along with the rapid growth in the economy of India revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. Financial reform process which was initiated a decade ago has covered almost all the important facets of banking and has resulted in improved bank perform. 
 
However, of late, new challenges have emerged for the banking sector to cope with the local as well as global factors. Exposure to State power utilities (2-3% of total exposures), a large number of which are incurring losses, airlines (1.5-2%), and AP-based micro lending institutions has increased the vulnerability of banks of late. As a result, The Gross NPA percentage (for public and private sector banks) could increase to 2.3-2.7% as on March 31, 2012 from 2.3% the previous year. Further, if interest rates continue to rise, it could negatively impact asset quality. 
 
In order to attain the objective of financial inclusion, industry needs to proactively increase its activity in rural India. ICICI Bank Ltd. merged the Bank of Rajasthan Ltd. in order to increase its reach in rural market and market share significantly. State Bank of India (SBI), the largest public sector bank in India has also adopted the same strategy to retain its position. It is in the process of acquiring its associates. SBI merged with its associate bank State Bank of Indore in 2010. However mere mergers and acquisitions are unlikely to attain the objective of financial inclusion.
 
Globalization has also exposed the Indian banks to the vulnerabilities of global financial vagaries. The 2008-09 financial crises could not create a meltdown in like that in US but it certainly affected the performance of Indian banking industry. The growing competition increases the competitiveness among banks. But, existing global banking scenario is seriously posing threats for Indian banking industry. We have already witnessed the bankruptcy of some foreign banks. Though, as of now, there is no visible flaw in the risk management techniques of the Indian banks but they must be constantly upgraded to cope with the fast changing global financial scenario. 
 
Though large banks are found strong enough to cope with the global as well as local challenges but small and local banks face difficulty in bearing the impact of global economy therefore, they need support and it is one of the reasons for merger. Some private banks used mergers as a strategic tool for expanding their horizons. There is huge potential in rural markets of India, which is not yet explored by the major banks. Therefore ICICI Bank Ltd. has used mergers as their expansion strategy in rural market. They are successful in making their presence in rural India. 
 
Over the last few years, the falling interest rates, gave banks very little incentive to lend to projects, as the return did not compensate them for the risk involved. This led to the banks getting into the retail segment big time. It also led to a lot of banks playing it safe and putting in most of the deposits they collected into government bonds. The banking sector in India needs to tackle these challenges successfully to keep growing and strengthen the Indian financial system.
 
Transparency and disclosure norms as part of internationally accepted corporate governance practices are assuming greater importance in the emerging environment. Banks are expected to be more responsive and accountable to the investors. Banks need to disclose in their balance sheets a plethora of information of assets and liabilities, lending to sensitive sectors, movements in Non Performing Assets (NPAs), capital, shareholdings of the government, value of investment in India and abroad, operating and profitability indicators.
 
Furthermore, the interference of the central government with the functioning of Public Sector Banks (PSBs) should stop. A fresh autonomy package for public sector banks is in offing.  The package seeks to provide a high degree of freedom to PSBs on operational matters. This seems to be the right way to go for PSBs.
 
Banking is the most vital sector of any economy and turmoil in the industry affects the entire economy. Therefore, growth of the banking sector will be one of the most important inputs that shall go into making sure that India progresses and becomes a global economic super power.
 
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