Enter, The Universal Bank

Financial institutions could be looking harder at transforming themselves into

one-stop finance shops as differences with commercial banks blur.

Over the past few years, India's two traditional financial establishments, commercial banks and financial institutions (FIs), have begun to almost resemble each other. Commercial banks are stepping into long-term lending, which was typically the realm of financial institutions, and the behemoth government-owned development banks are now considering short-term lending.

The obvious question: is India's financial system looking at mergers between banks and FIs? Answer: Not in the immediate future. But over a longer time frame, with synergies between the two financial organisations developing rapidly, India could be looking at universal banking, which could involve major intra-institutional mergers and expansions.

 

"Universal banking indicates that while the core area of business will continue to be long-term lending, institutions will be able to offer an array of services like stockbroking, commercial banking, merchant banking and mutual fund under the same umbrella," explains A Lahiri, economic adviser, IDBI.

The trend is already clear from the plans of ICICI, the Rs 4,109 crore net worth FI. "We are planning to merge all the subsidiaries over the next three years to form a universal bank," says a senior executive.

The first step in that process was in April, 1996 when SCICI, the shipping finance conglomerate, merged with ICICI. Other building blocks that are in close synergy with ICICI's concept of becoming a universal bank include ICICI Bank, ICICI Securities, its merchant banking arm, I-AMC, the asset management company, the technology division, TDICI, ICICI Brokerage services Ltd (I-BSL) and ICICI Investors' Service.

More FIs are increasingly thinking on these lines because the gap between their activities and those of banks has steadily been narrowing. Apart from not being able to participate in payment systems, there is almost nothing that a financial institution cannot do and a bank can do, says Basudeb Sen, chief general manager, Unit Trust of India, India's largest mutual fund.

Consider banking. Before October 1994, banks had a lending limit of Rs 50 crore on term loans. This has gradually been enhanced to Rs 200 crore. As of now, banks can singly or jointly participate up to Rs 500 crore in term loans for non-infrastructure projects and up to Rs 1,000 crore for infrastructure projects.

On the other hand, institutions, which were corporate India's traditional long- term lenders, have now been allowed to participate in lending towards working capital requirements, which has conventionally been a commercial banking specialty in India.

Institutions have also recently been allowed to mobilise short-term fixed deposits (FDs) for one year compared to three years before. The limits for short term borrowing including FDs and certificate of deposits (CDs) has been raised from Rs 800 crore and Rs 2,500 crore respectively to one time the net worth of the borrower.

Interest rates for FIs' fixed deposits have also not been subjected to any limits. Similarly, for banks, rates for deposits above one year have been freed. Until recently short-term deposits was the domain of the banking sector.

Leveraging synergy

This growing similitude is prompting a number of institutions to look at exploring possible synergies. A beginning has been made. Recently IDBI, India's largest development bank, held talks with Bank of Baroda (BoB) for a tie-up for advancing working capital loans. IDBI currently disburses short-term loans only through its subsidiary IDBI Bank.

The kind of synergies that could develop include BoB providing its 2,464- strong distribution network to IDBI to disburse short-term loans. Simultaneously, IDBI could share a part of its Rs 37,308-crore portfolio, consisting mostly of long-term assets with BoB.

Says C B Rammorthy, general manager, BoB, "Banks understand working capital better and institutions follow long-term lending more, therefore synergies of both could be utilised for mutual benefit. " This tie-up, says Rammorthy, could be the precursor to many similar agreements.

The obvious question is whether such synergies would not be better utilised if the two entities merged. For one, exposure limits would increase. For another, as A K Dam, executive director, UTI Bank, points out, "If mergers do take place, the new entities can be more competitive in the international scenario."

If IDBI were to merge with the IDBI Bank and ICICI were to merge with ICICI Bank, the new entities would become the second and third largest banks, after SBI in India. While the total assets of SBI stand at Rs 144,470 crore, the assets of IDBI are at above Rs 56,000 crore and ICICI's assets for the year ending March 31, 1996 were Rs 23,529.12 crore.

Currently a number of private sector banks are wary of picking up a long-term loan portfolio because they are dependent on short-term resources. This could result in asset-liability mismatches. Mergers would partially address this issue since banks would be able to leverage institutional funds, which are long term in nature.

Reverse mergers, that is, when FIs merge with banks, would be equally useful given the kind of concessions institutions enjoy. Since FIs have mostly been backed by government funding, they are free from the reserve ratio requirementsa cash reserve ratio (CRR) of 10 per cent and statutory liquidity ratio (SLR) of 25 per cent that banks have to keep on their domestic deposits. However,since institutions are not allowed to accept demand deposits there is no reason for subjecting them to reserve requirements says Kalpana Morparia, general manager, ICICI.

Nor do they have priority sector lending obligations and restrictions on investments in the shares to 5 per cent of their incremental deposits in shares as banks do. In fact, with institutions raising huge amounts of funds from the public through their various bond issues, there is almost as much retail money with the institutions as there is with banks, says the head of a public sector bank.

Merger hurdles

So if mergers or reverse mergers promise so much, why have they not happened? The current regulationsthose of the Reserve Bank of India (RBI) and of the governing institutionsform the first hurdle.

Banks are governed by the Banking Regulation Act, but the major FIs were formed by Acts of Parliament.

IDBI was set up under an Act of parliament in 1964, as a wholly owned subsidiary of RBI. It was de-linked from RBI on February 16, 1976 and made the principal financial institution when its ownership was transferred to the government of India.IFCI was set up in 1948 under another Act. From July 1, 1993 it has become a separate company with the name IFCI Ltd. ICICI was set up under the Companies Act, 1955.

All these Acts would need to be amended to allow mergers. Moreover, RBI regulations currently state that the promoter group needs to maintain an arm's length with their bank. This indicates that transactions between the two have to be on a market-related basis. So the case for a merger can be examined only if this RBI directive is changed.

Earlier many FIs had wanted to set up banks as divisions. They dropped the suggestion when authorities stipulated that reserve requirements would be levied.

There are structural issues involved as well. For instance, "If IDBI were thinking of a merger, the bank would not be allowed to expand at the rate at which it is currently expanding," says S Anand, senior vice president, treasury, IDBI Bank. In any case, Anand points out, there is little possibility of an IDBI bank-FI merger in the immediate future. One, because the FI is still largely a government institution so a decision on as radical a step as a merger is likely to take time.

Compared to this ICICI, which is mostly FI-owned, has better organisational flexibility to merge with its banking counterpart. The resistance, however, could come from within. "Why should the two merge if they can exploit the synergies despite remaining separate entities," argues a senior official at ICICI.

Personnel, in fact, could prove another barrier to bank-FI mergers. In Japan a number of bank mergers proved unsuccessful because the work ethics and the personnel policies of the two merging entities were different. Some of the major cases of failure are the Sakura Bank and Dai-Ichi Kangyo Bank.

In India, the failure rate of bank-FI mergers could be high for this reason too.Despite areas of activities being similar managing human resources of separate entities is problematic.

As for UTI, the focus is different from that of a development financial institution. UTI was set up as a trust under the UTI Act, 1963 to encourage savings and investments and participate in income and gains that UTI would make through managing funds.

"The activity is essentially that of asset management for mutual funds. And banks cannot be merged with mutual funds," says Basudeb Sen, adding, "UTI handles asset management, market mutual fund products and looks at investor services. While certain functions like investment banking can be handled by banks, UTI's entire operations cannot be handled by a bank."

Mergers also tend to be competition driven. And although there are hundreds of banks in India, there are only three big financial institutions and there is little likelihood of more emerging.

Also, infrastructure financing requirements are as yet far from being fulfilled and the institutions are definitely not short of business. Though institutions are short on disbursements they are not short on sanctions as their books for the next few years are full. One index: for 1995-96, the sanctions for All India Financial Institutions stood at Rs 64,115 crore and the disbursements during the year stood at Rs 36,312 crore. The kind of capital required is too large and government backing is essential.

That is why, instead of merging with other banks, FIs could be looking at integrating their subsidiaries and broadbasing their activities. ICICI chief K V Kamath has taken the first step. As the differences between banks and FIs blur, more institutions are likely to follow.