First Annual Dena Bank Foundation Day address by Mr V Leeladhar,
Deputy Governor of the Reserve Bank of India, to commemorate its
founder, the Late Pranlal Devkaran Nanjee, Mumbai, 26 May 2005.
* * *
It is indeed an honour to be invited to commence the Dena Bank Foundation
Day Lecture Series.
Today, as we remember the founders, we essentially pay homage to
their vision and drive that led to the establishment of the Dena
Bank. Shri Pranlalbhai Nanjee, inspired by his late father Shri
Devkaran Nanjee’s dream to start a bank and play a seminal
role in the development of the Indian banking industry, started
the Devkaran Nanjee Banking Company in January 1938, about three
years after the Reserve Bank was established. It was then incorporated
as a private limited company under the Indian Companies’ Act
on 26 May 1938. In a span of twenty five years, the bank grew in
size and stature to rank amongst the top 14 banks in India and was
converted into a public limited company and renamed as Dena Bank
Limited in December 1966. It was nationalized in July 1969 along
with 13 other banks in the first phase of bank nationalization in
India. Today, as the bank is gearing itself to enter the fast changing,
turbulent and uncertain environment that characterises the banking
terrain, we trust it will pick up the momentum of its first twenty
Founding days are always very special. They are one of the few ‘possessions’
which are owned by each and every one of the institution’s
fraternity alike. It is not only a day to feel proud, it is a day
to reflect, a day to share, and a day to celebrate. It is also an
opportunity to re-emphasise what the institution stands for, to
renew its symbols, its imagery and its values. These symbols and
imagery not only help project its corporate culture and identity,
but they also constitute an integral part of the institutions’
brand building exercise. Founding days constitute one of the few
opportunities for collective sharing in an institution. The coming
together and the camaraderie that this day evokes is perhaps the
appropriate moment to reinstate an emotive content into the work
The emotive content, team building, the ownership in work, how to
inspire, how to draw out from the staff the very best, are perhaps
new issues in the boardroom agenda in the world of Indian banking.
Strategy sessions are increasingly focusing on the ways of unleashing
the tremendous power of emotions that has been hidden in organizations
and using it in a constructive manner to energise
people and to maximise motivation. The desired outcome is to get
individuals cognitively, physically, affectively and personally
engaged in their work in the pursuit of institutional excellence.
The common theme underlying these perspectives is that leaders may
persuade with logic but they motivate through emotion and that a
strong motivation and psychological involvement is not possible
without an emotional attachment to the work or the work context.
What has brought about this change? For a few decades preceding
the onset of banking and financial sector reforms in India, banking
operated in an environment that was heavily regulated and had a
certain security of expectations built into it. Banks, the institutions
which evoked notions of ‘fortune, probity and prudence’,
charted their way slowly but surely, secure in the belief that the
regulatory environment protected their margins, their territories
and their branch network.
This also posed sufficient barriers to entry and protected them
against too much competition and a relationship based on the loyalty
contract bound their customers irrevocably to them. This environment
of complacent certainties has now changed bringing with it profound
implications for the manner in which banks operate, their responses
to customer needs, their agility, the never-ending quest towards
efficiency and the continuous search for ever newer pastures –
‘hunting for cheese’ and the more serious concern for
the need to continuously reassess and reposition themselves in their
The last decade has witnessed major changes in the financial sector:
New banks, new financial institutions, new instruments, new windows,
and new opportunities and, along with all this, new challenges.
While deregulation has opened up new vistas for banks to augment
revenues, it has entailed greater competition and consequently greater
risks. Cross-border flows and entry of new
products, particularly derivative instruments, have impacted significantly
on the domestic banking sector, forcing banks to adjust the product
mix, as also to effect rapid changes in their processes and operations
in order to remain competitive in the globalised environment. These
developments have facilitated greater choice for consumers, who
have become more discerning and demanding compelling banks to offer
a broader range of products through diverse distribution channels.
The traditional face of banks as mere financial intermediaries has
since altered and risk management has emerged as their defining
It is clear that we are at the beginning of this new phase in the
Indian banking. The recent measures announced by the Government
and the Reserve Bank of India for opening up India’s banking
sector to international investors will further increase the pressure
of competition. At the same time there is renewed emphasis by the
Government on the social sector together with thrust on rural and
agricultural lending. Caught between the competitive pressure, both
domestic and external, and the politics of development, banks will
have to be on their toes, become even more efficient in managing
funds and in meeting the needs and demands of customers.
Economic outlook and banking sector’s
During the last couple of years, global growth has been above the
forecast in almost every region stimulated by strong monetary and
fiscal measures. The domestic economic outlook is also bright with
the real GDP growth rate surpassing 8% last year and estimated to
be around 7% in the current year.
Industrial performance also improved considerably with a strong
manufacturing growth for the second consecutive year. Inflation
rate has been under control, barring some hiccup for a short period.
Aided by a good macro economic environment, banks’ bottom
line has improved significantly over the last three years. However,
let us not forget that a major contributor to the windfall gains
has been treasury profits fuelled by a secular decline in interest
rates during the three years period from 2001 to 2004 and consequent
profit booking on sale of government securities. From the current
year, with the hardening of interest rates, this trading component
of profits is no longer going to shore up banks’ profitability.
On the contrary, most banks have been required to provide for the
decline in the market value of their investments portfolio. Thankfully,
one offsetting factor has been the strong pick up in the credit
off-take due to buoyant demand in the economy and revival of industrial
activity, which have resulted in substantial increase in banks’
core interest income.
Globalisation – a challenge as well
as an opportunity
Currently, the most important factor shaping the world is globalisation.
The benefits of globalization have been well documented and are
being increasingly recognised. Integration of domestic markets with
international financial markets has been facilitated by tremendous
advancement in information and communications technology. But, such
an environment has also meant that a problem in one country can
sometimes adversely impact one or more countries instantaneously,
even if they are fundamentally strong.
There is a growing realisation that the ability of countries to
conduct business across national borders and the ability to cope
with the possible downside risks would depend, inter alia, on the
soundness of the financial system. This has consequently meant the
adoption of a strong and transparent, prudential, regulatory, supervisory,
technological and institutional framework in the financial sector
on par with international best practices. All this necessitates
a transformation: a transformation in the mindset, a transformation
in the business processes and finally, a transformation in knowledge
management. This process is not a one shot affair; it needs to be
appropriately phased in the least disruptive manner.
High capital inflows: not an unmixed
As you all know, liquidity position in the financial sector has
been quite comfortable in the recent times. The buoyant capital
market coupled with an appreciating rupee vis-à-vis US dollar
has been attracting large foreign institutional inflows during the
last two years. While we have an all time high foreign exchange
reserves of more than $140 billion, high capital inflows pose a
big challenge to monetary and exchange rate management. In this
context, operationalisation of Market Stabilisation Scheme (MSS)
has given an additional instrument for liquidity and monetary management.
To sum up the challenge, I would like to quote a statement of Dr.
Y. V. Reddy, Governor, Reserve Bank of India, which he made at the
annual meeting of Bank for International Settlement (BIS) on June
And I quote, “…..Special defences need to be put in
place for ensuring financial stability in the case of countries
like India that are faced with the prospect of volatile capital
flows. The issues relating to cross-border supervision of financial
intermediaries in the context of greater capital flows are just
emerging and need to be addressed.”
Interest rate risk for Indian banks
– profits under pressure
The rapid and relatively substantial rise in rupee interest rates
in recent months has brought into focus the market risk faced by
Indian banks. Your own bank’s current years profits have been
badly affected due to increased provisioning requirement on the
investment portfolio. Your fourth quarter results have shown massive
losses due to Mark to Market (MTM) losses on your G-Sec portfolio.
The story is not much different for most of the public sector banks.
The benchmark 10-year yield on government securities has risen from
5.2% in May last year to around 7.2% at this point. The spike in
interest rates has affected the trading profits of banks. We in
Reserve Bank have been regularly carrying out quantitative impact
studies of rising yields on banks’ economic value. While,
financial media, and some academic circles have been portraying
an overly alarming and pessimistic picture regarding banks’
potential interest rate risk, our analyses reveal that gradually
increasing interest rate regime is unlike to erode banks’
equity, given the likely increase in net interest income (NII),
some residual unrealized gain on the portfolio (though, I must confess,
most of it has evaporated), and the recent forbearance by RBI permitting
banks to hold a larger proportion of securities under the ‘held
to maturity’ (HTM) category that need not be marked to market.
Of course, as I cited your own bank’s example, banks had to
take a one time hit before shifting the securities from trading
to banking book.
Different banks, however, vary in their levels of vulnerability,
with some new private banks being less susceptible to market risk
compared with most old private banks and some government banks.
In the medium term, however, most banks are likely to need to increase
their equity to meet growing regulatory capital allocation for market
Technology is the key
The decade of 90s has witnessed a sea change in the way banking
is done in India. Technology has made tremendous impact in banking.
Anywhere banking and anytime banking have become a reality. This
has thrown new challenges in the banking sector and new issues have
started cropping up which is going to pose certain problems in the
near future. The new entrants in the banking are with computer background.
However, over a period of time they would acquire banking experience.
Whereas the middle and senior level people have rich banking experience
but their computer literacy is at a low level. Therefore, they feel
the handicap in this regard since technology has become an indispensable
tool in banking.
Foreign banks and the new private sector banks have embraced technology
right from the inception of their operations and therefore, they
have adapted themselves to the changes in the technology easily.
Whereas the Public Sector Banks (PSBs) and the old private sector
banks (barring a very few of them) have not been able to keep pace
with these developments. In this regard, one can cite historical,
political and other factors like work culture and working relations
(which are mainly governed by bipartite settlements between the
managements and the staff members) as the main constraints. Added
to these woes, the PSBs were also saddled with some nonviable and
loss making branches, thanks to the social banking concept thrust
upon them by the regulatory authorities in 1960s.
Basel II accord, capital and market discipline
The most prominent on our minds in the context of banking these
days, perhaps, are the implications arising out of the Basel II
accord. Two deserve special mention – one relates to capital
and the other to market discipline. Where capital is concerned,
the prescriptions have ushered in a transition from the traditional
regulatory and market measures of capital adequacy to an evaluation
of whether a bank has found the most efficient use of its capital
to support its new business mix, i.e., from capital adequacy to
capital efficiency. In this transition, how effectively capital
is used will determine returns on equity and a consequent enhancement
of shareholder value. In effect, future plans may, therefore, include
the fluid use of capital, an approach that has been called the "just-in-time
balance sheet" management, in which capital flows quickly to
its most efficient use. This transition in how capital is used and
how much capital is needed will become a significant factor in return-on-equity
strategy for years ahead and banks’ strategic plans may be
required to execute this kind of approach.
The accord also has, as an underlying principle, the reliance on
the market to assess the riskiness of banks. This translates into
an increased focus on transparency and market disclosure, critical
information describing the risk profile, capital structure and capital
adequacy. Besides making banks more accountable and responsive to
better-informed investors, these processes enable banks to strike
the right balance between risks and rewards and to improve the access
to markets. Improvements in market discipline also call for greater
coordination between banks and regulators.
India has been a participant in the international initiatives to
ensure improved processes of market discipline that are being worked
out in several fora, such as, the multilateral organisations, the
BIS, the Financial Stability Forum, and the Core Principles Liaison
Group. Concurrent efforts are underway to refine and upgrade financial
information monitoring and flow, data dissemination and data warehousing.
Banks are currently required to disclose in their balance sheets
information on maturity profiles of assets and liabilities, lending
to sensitive sectors, movements in NPAs, besides providing information
on capital, provisions, shareholdings of the government, value of
investments in India and abroad, and other operating and profitability
indicators. Financial institutions are also required to meet these
disclosure norms. Banks also have to disclose their total investments
made in equity shares, units of mutual funds, bonds and debentures,
and aggregate advances against shares in their notes to balance
The critical regulatory initiatives taken by the Reserve Bank of
India to prepare the banking sector for these changes are : (i)
the Reserve Bank’s endeavour to ensure that the banks have
suitable risk management framework oriented towards their requirements
dictated by the size and complexity of business, risk philosophy,
market perceptions and the expected level of capital; (ii) The introduction
of Risk Based Supervision (RBS) in 23 banks on a pilot basis; (iii)
the drive to encourage banks to formalize their capital adequacy
assessment process (CAAP) in alignment with their business plan
and performance budgeting system; (iv) Ensuring better disclosure
so as to have greater transparency in the financial position and
risk profile of banks and (v) finally, the Reserve Bank at its end
is in the process of building capacity to ensure it can vet models
for banks who will be adopting the IRB / Advanced Measurement approaches.
As banks have two years lead-time to prepare themselves for Basel
II, they are encouraged to focus on capacity building and undertake
impact analyses. On the basis of the impact studies, banks would
be required to put in place appropriate strategies and plans for
raising fresh capital or augment capital through internal resources.
Banks may also need to redefine their business strategy with a view
to altering their profile of risk exposures or adopt a combination
of both these approaches to meet the capital requirement.
Organizations all over are rushing to implement the latest ideas
on management, sometimes to the point of overuse. Most of these
ideas are about doing things better, about improving operational
effectiveness. If everybody however is competing on the same set
of variables, then the standard gets higher but no one gets ahead.
And getting ahead – then staying ahead - is the basis of strategy
and creating a competitive advantage. Strategy is about setting
yourself apart from the competition. Its therefore not just a matter
of being better at what you do, its rather a matter of being different
at what you do. The major challenge now for banks as well as any
other organisation is therefore how to develop their social architecture
that generates intellectual capital as the quintessential driver
of change. Developing the individual or human capacity is an integral
element of building capacity and, in fact, capacity building initiatives
are now increasingly becoming almost an index of institutional quality.
Capacity building would in the days to come not only influence the
structure of institutions, it would also determine how they are
Taking the banking industry to the heights of excellence, especially
in the face of the afore-detailed emerging realities, will require
a combination of new technologies, better processes of credit and
risk appraisal, treasury management, product diversification, internal
control and external regulations and, not the least, human resources.
Standing as we do at this critical juncture, I trust innovative,
illuminating ideas, fresh insights and alternative ways of thinking
about the competitive yet cooperative combat that the world of banking
and finance is readying itself for will mark Dena Bank’s business
strategies and institutional development plans and will give you
the emotive content to carry forth Shri Nanjee’s legacy of
financial entrepreneurship and set the lead to position your institution
not just as a national but as a global player. I wish you every
success in your all future endeavours.