Banking & Research - VI

In the recent past, the financial sector has received renewed focus all over the globe. In 

several countries, either policy errors or bad decisions have inflicted severe losses on the financial intermediary and the financial system as a whole. As country after country is embracing deregulation that enabled capital to move across countries freely at the click of a mouse, financial system has become more policy-sensitive.  Thus, pursuing policies and practices that could enhance the efficiency and effectiveness of financial system and particularly banking sector has assumed critical significance. The 1997 financial crisis that occurred in the East Asian countries has only heightened the concern for financial stability in the world and in the process central banks all over the world have realized not only the urgency for promoting healthy financial institutions as a crucial pre-requisite towards this end but also in implementing challenging yet exciting reforms.

Taking a cue from these developments, the Reserve Bank of India launched many bold reforms, notable among them being: Prudential norms and transparency of balance sheets; capital adequacy requirements and 4-way classification of assets; provisioning norms; deregulation of interest rates; implementation of asset liability management measures; introduction of risk management in banks; recovery measures like compromise settlements, corporate debt restructuring, rehabilitation facilities to sick units; computerization of branches; voluntary retirement scheme for employees; investment in hardware, software and training of staff; permission for online banking, internet banking, ATMs, etc.

All these measures have no doubt helped the banking system rely less on detailed controls and directions from the Reserve Bank of India and more on their own initiative as a response to the changing market scenario. It also encouraged them to take independent decisions and be conscious of the accompanying responsibility or accountability. But this fragile transitional phase is also posing many challenges particularly to public sector banks. Today banks are transacting business in various segments of the financial market spectrum. The current spree of deregulation and the resulting proliferation of financial innovations across the system are increasing banks’ exposure to risk. With the entry of the ‘tech-savvy’ new private banks and the free access granted to the corporate world to mobilize capital from international financial markets, competitive pressures are intensified. At the same time, the public sector banks are also required to fight out the policy-induced problem of NPAs whose existence is in fact a threat to the very stability of financial system in the country. Against these odds, public sector banks are today trying to reinvent themselves to face the competition emanating from the private and domestic foreign banks.

Against this backdrop it would be interesting to go through the research findings presented in the article, “Can Public Sector Banks Compete with Foreign/Private Banks? A Statistical Analysis”. The authors make an attempt to compare the public sector banks among themselves using a statistical tool – Closed Model. They have chosen four factors, namely efficiency, financial strength, profitability and size and scale by giving an equal weightage of 25% to each factor. They have, using these parameters, carried out cluster analysis for 27 Public Sector Banks (PSBs). It was followed by a comparison of PSBs with that of private and foreign banks using Open Model Technique. These banks were compared based on the same four factors that were used under closed model.

Based on the scores obtained, the authors have graded the banks into four categories: The best (score less than 4), better (with score 4 - 6), good (with score of 7-9) and moderate (with score 10 and above). The study involving 27 PSBs in the closed model revealed that Bank of Baroda, Corporation Bank, Oriental Bank of Commerce, State Bank of India, Canara Bank, Punjab National Bank, State Bank of Hyderabad and State Bank of Patiala are the best banks. In the open model, 11 out of the 86 banks examined were graded as best banks. They are Bank of America, City Bank NA, Deutsche Bank AG, Corporation Bank, HDFC Bank, ABN-Amro Bank NV, Global Trust Bank, HSBC, ICICI, Oriental Bank of Commerce and Standard Chartered Bank. As the study identifies the factors that made banks move from one cluster to the other, the management of banks can as well analyze their strengths and weaknesses and initiate corrective measures to move forward with sustainable growth and profitability.

It is well known that countries, essentially engage in international trade for two reasons. One, to leverage on ‘comparative advantage’ that they enjoy in producing a good vis-à-vis the trading partner; and two, to achieve the economies of scale in production. Indeed as Paul Samuelson, the Nobel laureate Economist said comparative advantage is the best-known economic principle that defines international trade patterns. Yet, with the change in exchange rates, countries that once enjoyed ‘cost-advantage’ in exporting goods to the importer may suddenly lose it or vice versa. And relative prices of currencies may change overtime, sometimes drastically, particularly among the developing countries. Hence, the relationship between the trade balance and exchange rates has assumed greater importance for developing economies.  Against this backdrop the article, “Real Exchange Rate and Trade Balances of India, Pakistan and Sri Lanka with the US”, explores the impact of real exchange rates on the trade balances between India, Pakistan and Sri Lanka and their major trading partner – USA. The findings reveal that the real exchange rate significantly impacts the balance of trade of the three countries with the USA. The findings support the generalized Marshall Lerner condition. The impulse response functions indicate that a depreciation of a domestic currency can lead to an initial rise in the trade balance.  The study also reveals that the foreign real income does not seem to be a significant determinant of trade balance of Sri Lanka, Pakistan and India.

Electronic money systems are becoming a common means of payment in a number of countries. It’s a mechanism that facilitates payments mostly of limited value in which e-money can be considered as an electronic surrogate for coins and bank notes. It is a system through which electronic value is transferred under the responsibility of a system supervisor who monitors the security of electronic value creation. Electronic value is defined as a monitory claim on an EV issuer which is: (i) Stored on an electronic device; (ii) issued on receipts of funds for an amount not less than the monitory value issued; and (iii) accepted as a means of payment by the undertakings.

E-money system generally works under the threat of unsecured and un-trusted environment and therefore requires an adequate handling of risks relating to counterfeits damages and criminal events. In order to protect issuers, merchants and customers from these risks, the payment system should provide appropriate technical and organizational protection on the following lines: Access control; assessment of players; atomicity; authentication; availability; commitment and validation; competence and responsibility; confidentiality; cryptography and protocols; detection of abnormal events etc.; identification; integrity; life cycle; limitations; non-evaporation; partition; secret management; security update; traceability; transaction order; trusted location; trusted path etc. This is what the document entitled “electronic money systems objectives” prepared by ECB discusses at length.

(IUPJBM-Vol.3 no.1)