November 28, 2012

MA0037 [Banking Related Laws and Practices] Set2 Q1

Q 1. Explain the pros and cons of extending core banking facility.

Ans:

Core Banking is a multi-purpose and multi-functional financial supermarket (a company offering a wide range of financial services e.g. stock, insurance and real-estate brokerage) providing both banking and financial services through a single window.

Definition of Core Banking: As per the World Bank, "In Core Banking, large banks operate extensive network of branches, provide many different services, hold several claims on firms(including equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks for funding or as insurance underwriters".

In a nutshell, a Core Banking is a superstore for financial products under one roof. Corporate can get loans and avail of other handy services, while can deposit and borrow. It includes not only services related to savings and loans but also investments.

However in practice the term 'Core banking' refers to those banks that offer a wide range of financial services, beyond the commercial banking functions like Mutual Funds, Merchant Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans, Investment banking, Insurance etc. This is most common in European countries.

For example, in Germany commercial banks accept time deposits, lend money, underwrite corporate stocks, and act as investment advisors to large corporations. In Germany, there has never been any separation between commercial banks and investment banks, as there is in the United States.


THE CONCEPT OF CORE BANKING

The entry of banks into the realm of financial services was followed very soon after the introduction of liberalization in the economy. Since the early 1990s structural changes of profound magnitude have been witnessed in global banking systems. Large scale mergers, amalgamations and acquisitions between the banks and financial institutions resulted in the growth in size and competitive strengths of the merged entities. Thus, emerged new financial conglomerates that could maximize economies of scale and scope by building the production of financial services organization called Core Banking.

By the mid-1990s, all the restrictions on project financing were removed and banks were allowed to undertake several in-house activities. Reforms in the insurance sector in the late 1990s, and opening up of this field to private and foreign players also resulted in permitting banks to undertake the sale of insurance products. At present, only an 'arm's length relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. IRDA (Insurance Regulatory and Development Authority).

The phenomenon of Core Banking as a distinct concept, as different from Narrow Banking came to the forefront in the Indian context with the Narsimham Committee (1998) and later the Khan Committee (1998) reports recommending consolidation of the banking industry through mergers and integration of financial activities.

CORE BANKING – PROS AND CONS
The solution of Core Banking was having many factors to deal with, which can be further analyzed by the pros and cons.


Advantages of Core Banking

Economies of Scale. The main advantage of Core Banking is that it results in greater economic efficiency in the form of lower cost, higher output and better products. Many Committees and reports by Reserve Bank of India are in favour of Core banking as it enables banks to explit economies of scale and scope.
Profitable Diversions. By diversifying the activities, the bank can use its existing expertise in one type of financial service in providing other types. So, it entails less cost in performing all the functions by one entity instead of separate bodies.
Resource Utilization. A bank possesses the information on the risk characteristics of the clients, which can be used to pursue other activities with the same clients. A data collection about the market trends, risk and returns associated with portfolios of Mutual Funds, diversifiable and non diversifiable risk analysis, etc, is useful for other clients and information seekers. Automatically, a bank will get the benefit of being involved in the researching
Easy Marketing on the Foundation of a Brand Name. A bank's existing branches can act as shops of selling for selling financial products like Insurance, Mutual Funds without spending much efforts on marketing, as the branch will act here as a parent company or source. In this way, a bank can reach the client even in the remotest area without having to take resource to an agent.
One-stop shopping. The idea of 'one-stop shopping' saves a lot of transaction costs and increases the speed of economic activities. It is beneficial for the bank as well as its customers.
Investor Friendly Activities. Another manifestation of Core Banking is bank holding stakes in a form : a bank's equity holding in a borrower firm, acts as a signal for other investor on to the health of the firm since the lending bank is in a better position to monitor the firm's activities.


Disadvantages of Core Banking

Grey Area of Core Bank. The path of Core banking for DFIs is strewn with obstacles. The biggest one is overcoming the differences in regulatory requirement for a bank and DFI. Unlike banks, DFIs are not required to keep a portion of their deposits as cash reserves.
No Expertise in Long term lending. In the case of traditional project finance, an area where DFIs tread carefully, becoming a bank may not make a big difference to a DFI. Project finance and Infrastructure finance are generally long- gestation projects and would require DFIs to borrow long- term. Therefore, the transformation into a bank may not be of great assistance in lending long-term.
NPA Problem Remained Intact. The most serious problem that the DFIs have had to encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Core Banking or installation of cutting-edge-technology in operations are unlikely to improve the situation concerning NPAs.

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