Differentiated Banking & Next Generation Banking: Some Issues
and Challenges
Dr. Sanjay Tiwari
Introduction
With the debate on bringing the financial system under one regulation, there are opinios
in favour of differentiated banking models and just after Nachichet Mor Panel (2013)
constituted by the RBI, it has accelerated further. Indian banking system has witnessed
a history of transformation from traditional to modern; from to technology driven to
customer service driven; from single product to universal banking models and the
journey is still going on. The blurring of boundaries in the functioning of banks and
financial institutions led to the emergence of universal banking or umbrella banking in
1999 when the development financial institutions (DFIs) started losing their grip on the
development funding and banks known as universal banks undertook their role alongwith their already existing banking functions. According to the definition as mentioned
under Section 5 (B) of Banking Regulation Act, 1949, banking means “accepting, for the
purpose of lending or investment, deposits from the public, repayable on demand and
withdrawable by cheque and draft” India has been following the universal banking
model where banks are holding companies that operate different businesses like asset
management, insurance, asset reconstruction, stock broking, etc., through subsidiaries,
joint ventures and affiliates. India issues a single class of banking licence to both
domestic as well as foreign banks and all of them enjoy full and equal access to the
payments and settlement system and the deposit insurance cover.” The model of the so
called universal banking is now being challenged as the aspirations, needs, attitude and
behavior of customers of various types are undergoing paradigmatic shifts. On one
hand the profitability and sustainability of banks is under question while on the other the
multiple focus approach adopted by banks has increased the level of stress of the
banks whether public, private, foreign or any other because of regulatory and

Associate Professor, Department of Management Studies,; School of Law, Governance, Public Policy &
Management, Central University of Haryana, Jant-Pali, Mahendergarh (Haryana)
e-mail : stwarigju@rediffmail.com
mob: 09416628481, 08685825764
mandatory clauses to provide funding to the priority sector. The role of development
financing is still under distress and retail banking functions of the banks is not reaching
to a wider population of the country. The need for banking accessibility and usage to
differentiated segments of society i.e. women, differently abled people, micro and small
scale sector, artisans, old age persons, students, entrepreneurs, traders and others is
being felt today. There is also a debate on the big vs. small banks based on capital
adequacy. There is a divided opinion of the bankers themselves that whether they want
inclusive target to be achieved or strive for survival by adopting differentiated products,
services, technology, and processes for a different focus group. The biggest question is
“will the differentiated banks be able to make a difference?”
The paper has been written in view of the following objectives: to examine the pros and
cons of universal banking; to analyze the impact of technology on next generation
banking; to study the scope of next generation banking; to identify the sectors and
segments for whom differentiated banking is needed and to highlight regulatory,
technological, demographic and other issues and challenges of differentiated banking.
The methodology of this paper is proposition oriented, comparative and review oriented
based on secondary data obtained from authentic sources from government, private
agencies, reputed research institutions and reports of national and international
organizations and agencies of India and world.
Background
In 1991, the then government introduced a series of economic reforms including
financial sector reforms. The opening of banking sector for private parties and foreign
players was one of the significant achievements of the banking sector reforms as the
public sector banks were feeling pressure of performance in terms of operations and
financial both. The emergence of private and foreign entities in banking space led the
public sector banks to redevise their product line and open more services to the
burgeoning sectors of economy and during late 1990’s the public sector banks were
going public and selling their ownership stake to the public by way of IPO issues. It was
an end to the Financial Institutions Era which were also known as Development
Financial Institutions (DFIs) as big financial institutions like ICICI, IDBI, UTI and HDFC
which were established by central governments’ acts got converted into banks by taking
banking license and multiplying their activities from project financing to retail banking,
foreign exchange management, portfolio management in addition to the core banking
function of ‘taking deposits to give loans’. The growth in service sector was also
instrumental for the widening scope of banking services during that time period.
Universal Banking vs. Traditional Banking: Pros and Cons
The last one and half decade of banking is influenced with what is termed as ‘universal
banking’ or ‘umbrella banking’ i.e. a variety of banking services provided under one roof.
The specialised character of FIs was at a stake as the newly established banking
companies took charge and role of so called DFI barring a few namely IFCI and SCI etc.
Though in states the state financial development corporations (SFDCs) and state
finance corporations (SFCs) are still alive, the nature of their functioning has also
undergone serious shifts. While banks have taken the role of financial institutions by
entering into project funding, portfolio services, merchant banking, forex management,
fund management and many more in addition to banking operations, the financial
institutions working in states are offering products which are banking in nature. The
basic definition of banking as envisaged in the Banking Regulation Act, 1949 “As per
Section 5 (b) of Banking Regulation Act, 1949 “ banking” means the accepting, for the
purpose of lending or investment, of deposits of money from the public, repayable on
demand or otherwise and withdrawable by cheque, draft, order or otherwise”.
Unlike a universal banking license which is a blanket license that allows banks to offer a
range of services, a differentiated license from the RBI will allow a bank to offer
specialized services in select verticals – such as project financing, mortgage banking,
industrial financing etc. Currently in India, the RBI issues a universal banking license to
both domestic as well as foreign banks. All banks in the country retain access to the
central payments and settlement system and are blanketed by the deposit insurance
cover. Recently IDFC and Bandhan Financial Services have been offered banking
licences to carry out banking activities.
Features of Differentiated Banks
Based on above discussion, the differentiated banks are characterised by the following
features:
 These are banks for serving different segments of customers
 These are highly specialised banking entities focusing on target group of
customers
 These are driven by innovation and technology perspectives
 The products and range of services provided by these banks are also
differentiated keeping in view the customised needs of the customers
 These serve the purpose of different segments of society e.g. women bank
opened in Mumbai is one such example and similarly there may be banks for
physically challenged people, students, younger employees and professionals
 The rates of interest charged will depend upon the nature of the clientele the
banks will possess.
Major advantages of Universal Banking
The following are the advantages of umbrella banking:
 A wide range of financial products offering including; projects funding,
development finance, mortgage, hire purchase, lease financing, retail banking,
industrial loans, long term debt, merchant banking ,foreign exchange
management, fund management, and asset management etc.
 Retail banking services like; personal loans, auto loans, credit cards, debit cards,
deposit service such as FDs, term deposits and recurring deposits etc.
 Under the priority sector lending requirements of achieving 40 per cent of net
bank credit as target for domestic banks, it has been made mandatory for the
foreign banks to achieve the minimum target of 32% of net bank credit for priority
sector lending. Within the target of 32%, two sub-targets in respect of advances
(a) to small scale sector (minimum of 10%), and (b) exports (minimum of 12%)
have been fixed. The foreign banks are not mandated for targeted credit in
respect of agricultural advances. There is no regulatory prescription in respect of
foreign banks to open branches in rural and semi-urban centres.
Cons of Universal Banking
 According to a Research Report by SBI “While universal banking model remains
the dominant and preferred model across the globe, there are countries, for
example the US, Australia, Singapore, Hong Kong (China) and Indonesia that
offer differentiated banking licence.”
 The exposure of deposits and funds to the risky assets like derivatives securities
may run a risk of default in future.
 The presence of universal banks in the rural and urban areas is not that
significant. Still the penetration of these banks in rural areas is far from reality.
 The increasing workload on the employees working for universal banks leads to
stress related problems and performance pressure.
 Two reverse objectives; one imposed by the RBI to abide by the priority sector
lending and industrial finance as mandated for providing industrial finance are
really tough to manage and balance.
 Managing traditional banking and non-traditional fee based banking services
under one roof are not manageable because of involvement of highly innovative
specialised products.
Differentiated Banking: Rationale and Concept
Differentiated banking as a concept may be new to India but its operations are very
much in European nations and some of the Asian countries. Differentiated banking
practices are in prevalent in countries such as Singapore, Indonesia, Australia, and the
UK. Hong Kong also offers differentiated banking licenses. The idea of getting to a
differentiated banking environment was introduced by the RBI in its 2007-08 Annual
Policy Statement but the time for transition to a differentiated banking environment
seems close at hand. A number of foreign banks such as UBS and Barclays PLC have
shown great interest in procuring such licenses. The Nachiket Mor Committee for
financial inclusion constituted by the RBI first mooted the idea of having differentiated
banks in the country and the panel’s suggestions include specialised payment banks,
retail banks, wholesale banks, infrastructure banks etc.
Mckinsey (2013) in its Report has come out predictions that in future private banking
space in India will grow as “the UHNW (Urban High Net Worth) segment with assets in
excess of USD 40 million is the prime opportunity in India and accounts for over 60
percent of private bank AUM. Moreover, with an annual growth rate of AUM in excess of
50 percent, this segment is expanding faster than the overall market. On a geographic
basis, Mumbai and Delhi dominate with over 65 percent of AUM, though other
metropolitan areas (notably Chennai and Bangalore) are growing significantly faster
than the private banking industry as a whole.”
A recent SBI research report suggests that India may not yet be ready for a
differentiated banking system. “We, however, feel it would be bit early to introduce such
a model in the domestic context”. There is also the very real fear that agriculture, small
and medium enterprises may be neglected in such an environment. Currently the
stipulation of priority sector norms ensure that commercial banks allocate 40% of the
net credit lending to agriculture, and small and medium enterprises. The report also
suggests that it could become untenable for differentiated banks to survive on one or
two products alone. The report also suggests the differentiated licensing model could
first be tried out in the case of credit cards, remittances and such payment and
settlement business.
However, this is unlikely to happen for many reasons. First, there will be concentration
risk and a downturn in a particular sector can jeopardise the operations of a bank.
Precisely for this reason, India’s most project finance institutions had to reinvent
themselves and become banks. Secondly, the sector-specific banks also run the risk of
asset-liability mismatches. For instance, a mortgage bank or a bank dedicated to
infrastructure financing will have long-term assets, backed by short- to medium-term
deposits.
So the focus is more likely to be on banks with different structures. The Nachiket Mor
panel on financial inclusion has spoken about at least two such categories—payments
and wholesale banks. The payments banks can be created by converting prepaid
payment issuers (PPIs).
There are more than two dozen PPIs that provide mobile wallets or cards that
customers can use to make payments with the money that’s stored in them. They can
gradually convert themselves into banks and even others can join them. Over a period
of time, they can start offering other services as well.
The panel wants such banks to have a minimum entry capital of Rs.50 crore, one-tenth
of what a full-service bank requires, since they will have a near-zero risk of default.
With increasing competition, emerging customer demands, regulatory interventions,
technology-led disruptions, higher shareholder expectations, Indian banks are being
forced to constantly review and revisit their operating models. The resulting changes are
making Indian banks nimbler, more cost efficient, better focused on customer services
and witnessing good returns through fee based services and products.
The Indian banking industry has to its credit a number of tech-driven innovations.
Adoption of multiple channels like internet banking, mobile banking, and mobile ATMs
has resulted in greater efficiencies, wider reach and cost optimization. According to the
KPMG-CII study, it is estimated that Indian banking and securities companies will spend
Rs 416 billion ($6.75 billion) on IT products and services in 2013, which will be a 13%
increase from Rs 370 billion ($6.0 billion) spent in 2012.
Technology and Innovation Driven Banking: Next Generation Banking
Increasing customers’ expectations, burgeoning demand of consumer products,
enhanced life style expenses and propensity to spend has given rise to technology
driven banking solutions. According to CII-KPMG (2013) “It is estimated that Indian
banking and securities companies will spend INR 416 bn (USD 6.75 bn) on IT products
and services in 2013, which will be 13 percent increase from INR 370 bn (USD 6.0 bn)
spent in 2012”.Traditionally banks have been the pioneers in harnessing new
technology trends. The applicability of Moore’s law in the areas of telecommunication,
internet and mobility were significant enablers for banks in achieving two extremely
important business objectives – revenue enhancement with cost efficiencies. In existing
times, the financial services industry is keenly exploring the transformation potential of
the new generation of technologies available like Social media, Mobile, Analytics and
Cloud (SMAC).
Table 1: Next Generation Banking Models
The
“Intelligent The “Socially Engaging” The
Multichannel” Bank
Bank
“Financial/Non-
Financial
Digital
Ecosystem” Bank
 Multichannel
architecture,
powered by analytics
(real-time event
management, etc.)
 Advanced digital
advisory
 Need-based
offerings optimized
by channels
Source: Accenture
 Customer
engagement where
they spend their time
(e.g. on social
media) based on
personal interests
 Leverage influencers
 Co-creation based
on increased
customer intimacy
 Bank as trust center
with an extended
proposition (financial
and non-financial)
 “The bank where you
are” leveraging the
power of mobile
 M-payment services
Convergence of collaboration, communication, community and content has buzzwords
in new banking technology which strives for bringing synergies among the stakeholders
of society and it can be achieved through usage of tools and technology as recorded by
a Report (Accenture, 2013) that “use of collaboration and community tools (such as
tele-presence, video conference, co-browsing capabilities, desktop sharing and social
networks) will provide better connectivity with customers and across the workforce.”
This will enable new remote sales and service propositions, use of social networks as
enabling tools for sales and service, and increased use of the remote workforce.” Also
the key focus of banking with differentiated product line is the generation Y or millennial
generation i.e. the young population who has born during 1980s to 1990s as they are
accustomed with email, multi-player games, MP3 music, digital cameras, mobile
phones, social networks and other trappings of the digital world. Banks therefore, need
to target this generation by adopting truly differentiating approach, including innovative
new advertising formats, tailored offers pushed over new remote channels, and new
packages relevant to millennials’ needs and their innovative communication means.
Omni channel banking is gaining importance in Western world as omni channel
architecture characteristics in retail banking space have “the capability to track the
context of the end user access to great levels of detail – for example their location, who
they are and their preferences. Technology has now advanced so that just as much
insight can be gleaned about the transaction a customer is trying to achieve as from the
core data of the transaction (IBM, 2013)”. The next generation banking is derived by the
usage of mobiles, technology, digitization, social media and user friendly applications
known as apps.
Table 2: Differentiated Branch Formats of Banks
Cash-less,
Light
branches— Full-service,
kiosks— maintain maintain for sales
hubs—maintain
for service
for
Flagships—
innovate, attract
advanced
banking
COV. 50%
services
COV. 30%
sales
COV. 15%
sales
COV. 5%
sales
sales
services
services
services
100% transactions
50% transactions
and 50% sales
40% transactions
and 60% sales
30% transactions
and 70% sales
−−Open with staff 1-2
days per week
−−Tailored hours
−−Extended hours
−−Extended hours
−−Reciprocity income
−−Sales lead generation
−−Minimal staffing
levels (not bank
skilled employees,
people from retailing
sector)
−−Regular staffing:
meeter and greeter,
cashier and
peripatetic RMs
−−Sales lead
generation
−−Center of sales
and service
excellence
−−Fully automated
−−Belonging to full
service/light
branches
−−Tailored
−−Able to accept and
manage anything
−−Belonging to fullservice branches
−−Standard merchandising
merchandising
(focus on area and seasonal
−−Specific staffing:
dedicated business
cashiers and
permanent RMs
−−Highly specialized
mortgage, trading
advisers
−−Supports light
branches for
complex service/sales
−−Full merchandising
campaigns)generating
−−Location of
experts
−−Supports all other
types for regulated
sales
−−Tailored
branch traffic
Advanced ATM
−−Specific staffing
(depending on
area/segment
served): dedicated
business cashiers
and permanent RMs
merchandising,
focus on innovation
Remote advisory
Digital meeter and greeter
Self-service, innovative tools
−−Opening
differentiated
supported by hubs
hours
per
needs
local
−−Flexible concepts
−−Possible
franchising
model
Source: Accenture
Edwards & Mishkin (1995) observed in their study that “to enhance the competitiveness
and efficiency of financial markets, banks could be permitted to engage in a diversified
array of both bank and nonbank products and services. This general regulatory strategy
can successfully keep in check excessive risk taking by banks while providing the
flexibility for both banks and regulators to restructure the banking system to achieve
greater long-term stability”.
Issues and Challenges of Differentiated Banking
Though the government has issued licenses to two companies to start banking
operations, the differentiated banking needs to be analyzed from regulatory, technical
and prudential perspectives. The apprehensions are already in the air about the
functioning and nature of banks being termed as differentiated banks. Since there is a
change of the government at the Centre, it would be early to jump to conclusion about
the differentiated banking models. The debate over the regulatory role of
RBI and the
proposed FSLRC (Financial Sector Legislative Reforms Commission) suggested by
justice Shri Krishna is still on. There exists a contradiction whether system will revert
back to the earlier era in which banks, financial institutions, specialized financial
institutions and development financial institutions were simultaneously working. The
biggest question is yet to be answered that whether the regulatory role of maintaining
fiscal prudence and monetary stability by the RBI will be jeopardized? Until 1999, there
used to be one regulator of DFIs i.e. IDBI which is now in banking business enjoying
listed company status. Similarly in infrastructure project financing there was IDFC and in
housing finance there was HDFC as apex body which are now-a-days working as
banks. What will be the future of these banks if the differentiated banking models are
adopted? Capital adequacy will again be a big issue as the source of funding will be
deposits or government or public it is still not clear. Asset liability mismatches (ALM) will
be posing big challenge to the sustainability of these banks as traditional banking is
based on the principles of long term lending and short term borrowing while the lending
and borrowing by the differentiated banks will be based on needs rather than sound
prudence. There are chances that the capital invested by the differentiated banks will be
exposed to market risk as the banks will put their funds in risky assets e.g. derivatives
and hedge funds to take the leverage of higher returns but this would prove to be a
dangerous proposition without less control over the investment decisions. Also, there
will be need of separate regulators for differentiated banks because of their different
products lines, service offerings, clientele, areas and modus operandi of doing
business. Too many regulators will have to work in tandem with the RBI which would
neither be feasible nor pragmatic and this may lead to furtherance of regulatory tussles.
The planned target of financial inclusion also seems to be very far away from reality
provided these banks operate as these will be interested in serving the needs of their
affiliates or industry groups in one way or the other.
Another point of worry is that with only one or two products of selling how the
differentiated banks will survive and from where these will get funding in case of crisis
as it is based on the fees paid by the consumers.
Since the new age banking is characterized by the heavy usage of technology, there
cann’t be any denial from the perceived possibility of technological risk as observed by
Thorat (2013) “While the use of technology-aided delivery channels has grown multifold,
so has the scope for fraudulent transactions through impersonations and identity thefts.
Banks would also need to quickly put in place lasting technology-based solutions to
thwart the efforts of fraudsters and minimize the customer complaints”.
Conclusion
Introduction of differentiated banking seems to be a good idea but in a country like India
where there exists differentiated markets and consumer groups of each category, the
concept may be contextualized according to the needs of the customers. The question
of creating a balance between long term sustainability and financial inclusion target
seems to be unattainable as only a small portion of customers fall under the privileged
categories who want value driven banking instead of mass scale universal banking. The
technological turbulence and risk management are other two dimensions which pose
serious challenge to the regulator. The debate of having multiple vs. single regulator in
Indian financial system is also a big cause of worry as there are apprehensions
expressed on the potential role of proposed FSLRC and RBI. One school of thought
proposes differentiated banking models within the present traditional set of institutions
while the other advocates the separate models and structures by creating niche
segments but ultimately there is no clarity on the regulatory conflicts and risk
management aspects. Adopting models from foreign countries may attract the attention
but contextualizing in Indian settings is more important otherwise we may also face
2008 like financial crisis which witnessed collapse of big banking and financial
institutions due to non-adherence to traditional ways of banking rules. Now it is up to the
new government in power that how it foresees the niche segment of banking and the
mass based banking models.
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