Index:: Introduction To Universal Banking
Index:: Introduction To Universal Banking
Index:: Introduction To Universal Banking
INTRODUCTION TO UNIVERSAL
BANKING
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systems. Large-scale mergers, amalgamations and acquisitions
among banks and financial institutions resulted in the growth in
size and competitive strengths of the merged entities. There thus
emerged new financial conglomerates that could maximize
economies of scale and scope by 'bundling' the production of
financial services. This heralded the advent of a new financial
service organization, i.e. Universal Banking, bridging the gap
between banking and financial-service-providing institutions.
Universal Banks entertain, in addition to normal banking
functions, other services that are traditionally non-banking in
character such as investment-financing, insurance, mortgage-
financing, securitization, etc. Parallel, in contrast to this
phenomenon, non-banking companies too entered upon banking
business. Universal banking usually takes one of the three forms
i.e. in-house, through separately capitalized subsidiaries, or
through a holding company structure. Three well-known
countries in which these structures prevail are Sweden and
Germany, the UK and the US.
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range of financial services, such as, commercial banking &
investment banking and other activities especially insurance. It
is a multi-purpose and multi-functional financial supermarket
providing both banking and financial services through a single
window. According to World Bank the concept is explained as
follows - "In universal banking, large banks operate extensive
networks 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."
Universal Banking (UB) usually takes one of the three
forms, i.e., in-house, through separately capitalized subsidiaries,
or through a holding a capital structure. Three well-known
countries in which these structures prevail are Sweden and
Germany, the UK & US. Universal in its fullest or purest form
would allow a banking corporate to engage ‘in-house’ in any
activity associated with banking, insurance, securities, etc.
However, there are very few countries, such as, Sweden and
Hong Kong, which allow universal banking in its purest form.
In Germany, banking and investment activities are combined,
but separate subsidiaries are required for certain other activities.
Under German banking statutes, all activities could be carried
out within the structure of the parent bank except insurance,
mortgage banking and mutual funds, which require legally,
separate subsidiaries. In the UK, a broad range of financial
activities is allowed to be conducted through separate
subsidiaries of the bank. The third model, which is found in the
US, generally requires a holding company structure and
separately capitalized subsidiaries.
2. Economies of scale
It means lower average costs, which arise when larger volume
of operations are performed for a given level of overhead on
investment. Economies of scope arise in multi-product firms
because costs of offering various activities by different units are
greater than the costs when they are offered together. Economies
of scale and scope have been given as the rationale for
combining the activities. A larger size and range of operations
allow better utilisation of resources/inputs.
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provides, it has been argued that a universal bank is able to
establish long-term relationship with the customers and provide
them with a package of financial services through a single
window.
• LIMITATIONS
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deregulation of financial sector, there has been blurring of
distinction between the commercial and investment banking.
Reserve Bank of India constituted on December 8, 1997, a
Working Group under the Chairmanship of Shri S.H. Khan to
bring about greater clarity in the respective roles of banks and
financial institutions for greater harmonization of facilities and
obligations. Also report of the Committee on Banking Sector
Reforms or Narasimham Committee (NC) has major bearing on
the issues considered by the Khan group. The issue of universal
banking resurfaced in Year 2000, when ICICI gave a
presentation to RBI to discuss the time frame and possible
options for transforming itself into an universal bank. Reserve
Bank of India also spelt out to Parliamentary Standing
Committee on Finance, its proposed policy for universal
banking, including a case-by-case approach towards allowing
Domestic financial institutions to become the universal banks.
Now RBI has asked FIs, which are interested to convert itself
into a universal bank, to submit their plans for transition to a
universal bank for consideration and further discussions. FIs
need to formulate a road map for the transition path and strategy
for smooth conversion into an universal bank over a specified
time frame.
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Bring down CRR progressively
Phase out SLR
Redefine priority sector
Set up a super regulator to coordinate regulators’
activities
Develop risk-based supervisory framework
Usher in legal reforms in debt recovery
State level FIs be allowed to go public and come under
RBI
DFIs be permitted to have wholly-owned banking
subsidiaries
Remove cap on FIs’ resources mobilization
Grant authorized dealers’ license to DFIs
Set up a standing committee to coordinate lending
policies
SOME CONCEPTS…
• Universal Banking
Universal banking refers to elimination of the distinction
between the development financial institutions and the banks
and market segmentation that presently exists between them.
• Harmonization Of Role Of Banks And DFIs
Harmonization means the introduction of universal banking in a
limited sense, wherein the DFIs could become banks and
intermediate in the short-term end of the financial market (say
finance for working capital) and commercial banks could enter
the long-term end of the financial market (say project
financing). In other words, the harmonization allows the DFIs
and banks to move freely to the other end than where they are
presently placed.
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• The Main Areas Of Operations Of DFIs And Banks Presently
And How Universalisation Will Change That Role In Future.
DFIs are specialist institutions catering to different
sectors, appraising projects from technical and financial
parameters and finance long-term investment requirements. This
specialization has given edge to DFIs in terms of project
appraisal. On the other hand, the banks meet the short term
investment and production requirements and they have
developed expertise in providing working capital finance to
industry, exports, imports, small industry, agriculture etc. They
can take as intermediates in a big way at the other end of their
markets where they are less dominant presently. Some of them
may even diversify into insurance and other related areas.
• Requirement Of Cost Considerations In Universalisation
Cost of funds differentiates the DFIs from banks, as DFIs
incur higher costs for mobilizing long-term finance. Banks do
not normally mobilize substantial deposit resources with
maturities in excess of 5 years, which limits their capacity to
extend long-term loans. This has resulted in participation type of
relationship in financing by banks and DFIs.
• The Areas Of Conflict arising Between Banks And DFIs
There are conflicts relating to securities for the loans sanctioned
by the banks and DFIs. While the DFIs have first charge over
block assets, the banks have first charge on current assets, which
place both the banks and DFIs in different positions.
Another area of conflict is extension of refinance by DFIs
to banks to supplement banks’ long-term resources. But due to
higher cost of their funds, the DFIs find it a losing proposition.
• The Committee Which Recommended Universal Banking &
What It Suggeste The SH Khan Committee suggested the
concept of Universal Banking. It also suggested to give banking
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licence to DFIs, merging banks with banks or DFIs, bring down
CRR progressively, phase out SLR, redefine priority sector, set
up a super regulator to coordinate regulators’ activities, develop
risk-based supervisory framework, usher in legal reforms in debt
recovery, allow State level FIs to go public and come under
RBI, permit DFIs to have wholly-owned banking subsidiaries,
remove cap on FIs’ resources mobilization, grant authorized
dealers’ licence to DFIs, set up a standing committee to
coordinate lending policies etc.
• The Likely Gains From Universalisation .The
universalisation is expected to result in expansion of banks and
diversification into new financial and Para-banking services.
The business focus of the banks would emerge on profit lines.
This may at the same time result in reluctance on their part to
enter the smaller end of retail banking particularly, the small
borrowers in rural areas, who may find it difficult to access the
banking services, since they do not contribute substantially to
Banks’ Business Volumes Or Profits.
• The Apprehensions OfUniversalisation
The financial services may not become the privilege of
elitist. If the reforms with a human face are what we want, the
universal banking has to make adjustments and ensure that
financial services are available to all at affordable costs.
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reports recommending consolidation of the banking industry
through mergers and integration of financial activities, the stage
seems to be set for a debate on the entire issue.
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• The idea of ‘one-stop-shopping’ saves a lot of transaction costs
and increases the speed of economic activity. Another
manifestation of universal banking is a bank holding stakes in a
firm.
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burdened with accumulated NPAs; therefore first they will have
to sale these impaired assets through reconstruction cos.
Conversion to UB is not a remedy for this fundamental problem.
One suggestion is that FIs to be merged with commercial banks.
But current level of NPAs of FIs will put additional burden.
Therefore solution UB in the sense of converting the FIs to
commercial banks may be neither adequate nor free from further
trouble.
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The principle of "Universal Banking" is a desirable goal
and some progress has already been made by permitting banks
to diversify into investments and longterm financing and the
DFIs to lend for working capital, etc. However, banks have
certain special characteristics and as such any dilution of RBI's
prudential and supervisory norms for conduct of banking
business would be inadvisable.
Though the DFIs would continue to have a special role in
the Indian financial System, until the debt market demonstrates
substantial improvements in terms of liquidity and depth, any
DFI, which wishes to do so, should have the option to transform
into bank (which it can exercise), provided the prudential norms
as applicable to banks are fully satisfied. To this end, a DFI
would need to prepare a transition path in order to fully comply
with the regulatory requirement of a bank. The DFI concerned
may consult RBI for such transition arrangements. Reserve
Bank will consider such requests on a case-by-case basis.
Financing requirements, which is necessary.
• Reserve Requirements:-
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Compliance with the cash reserve ratio and statutory
liquidity ratio requirements (under Section 42 of RBI Act, 1934,
and Section 24 of the Banking Regulation Act, 1949,
respectively) would be mandatory for an FI after its conversion
into a universal bank
• Permissible activities
Any activity of an FI currently undertaken but not
permissible for a bank under Section 6(1) of the B. R. Act, 1949,
may have to be stopped or divested after its conversion into a
universal bank.
• Nature of subsidiaries
If any of the existing subsidiaries of an FI is engaged
in an activity not permitted under Section 6(1) of the B R Act ,
then on conversion of the FI into a universal bank, delinking of
such subsidiary / activity from the operations of the universal
bank would become necessary since Section 19 of the Act
permits a bank to have subsidiaries only for one or more of the
activities permitted under Section 6(1) of B. R. Act.
• Restriction on investments
An FI with equity investment in companies in excess of
30 per cent of the paid up share capital of that company or 30
per cent of its own paid-up share capital and reserves, whichever
is less, on its conversion into a universal bank, would need to
divest such excess holdings to secure compliance with the
provisions of Section 19(2) of the B. R. Act, which prohibits a
bank from holding shares in a company in excess of these limits.
• Connected lending
Section 20 of the B. R. Act prohibits grant of loans
and advances by a bank on security of its own shares or grant of
loans or advances on behalf of any of its directors or to any firm
in which its director/manager or employee or guarantor is
interested. The compliance with these provisions would be
mandatory after conversion of an FI to a universal bank.
• Licensing
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An FI converting into a universal bank would be required
to obtain a banking licence from RBI under Section 22 of the B.
R. Act, for carrying on banking business in India, after
complying with the applicable conditions.
• Branch network
An FI, after its conversion into a bank, would also be
required to comply with extant branch licensing policy of RBI
under which the new banks are required to allot at east 25 per
cent of their total number of branches in semi-urban and rural
areas.
• Assets in India
An FI after its conversion into a universal bank, will be
required to ensure that at the close of business on the last Friday
of every quarter, its total assets held in India are not less than 75
per cent of its total demand and time liabilities in India, as
required of a bank under Section 25 of the B R Act.
• Deposit insurance
An FI, on conversion into a universal bank, would also be
required to comply with the requirement of compulsory deposit
insurance from DICGC up to a maximum of Rs.1 lakh per
account, as applicable to the banks.
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• Prudential norms
After conversion of an FI in to a bank, the extant
prudential norms of RBI for the all-India financial institutions
would no longer be applicable but the norms as applicable to
banks would be attracted and will need to be fully complied
with.
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UNIVERSAL BANKING - CURRENT
POSITION IN INDIA
Now RBI has asked FIs, which are interested to convert itself
into a universal bank, to submit their plans for transition to a
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universal bank for consideration and further discussions. FIs
need to formulate a road map for the transition path and strategy
for smooth conversion into a universal bank over a specified
time frame. The plan should specifically provide for full
compliance with prudential norms as applicable to banks over
the proposed period.
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SWOT
The solution of Universal Banking was having many factors to
deal with which further categorized under Strengths,
Weaknesses, Opportunities and Threats.
Strengths:
* Economies Of Scale
The main advantage of Universal Banking is that it results in
greater economic efficiency in the form of lower cost, higher
output and better products. Various
Reserve Banks Committees and reports in favor of Universal
Banking, is that it enables banks to exploit economies of scale
and scope. It means a bank can reduce average costs and thereby
improve spreads if it expands its scale of operations and
diversifying activities.
* Profitable Diversions
* Resource Utilization
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diversifiable and non diversifiable risk analysis, etc are useful
for other clients and information seekers. Automatically, a bank
will get the benefit of being involved in Research.
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Weaknesses:
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Most of the NPAs came out of loans to commodity sectors, such
as steel, chemicals, textiles, etc. the improper use of DFI funds
by project promoters, a sharp change in operating environment
and poor appraisals by DFIs combined to destroy the viability of
some projects. So, instead of improving the situation
Universal Banking may worsen the situation, due to the
expansion in activities banks will fail to make thorough study of
the actual need of the party concerned, the prospect of the
business, in which it is engaged, its track record, the quality of
the management, etc.
ICICI suffered the least in this section, but the IDBI has got
worst hit of NPAs, considering the negative developments at
Dabhol Power Company(DPC)
Opportunities:
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In terms of total asset base and net worth the Indian banks have
a very long road to travel when compared to top 10 banks in the
world. (SBI is the only Indian bank to
appear in the top 100 banks list of 'Fortune 500' based on sales,
profits, assets and market value. It also ranks II in the list of
Forbes 2000 among all Indian companies) as the asset base sans
capital of most of the top 10 banks in the world are much more
than the asset base and capital of the entire Indian banking
sector. In order to enter at least the top 100 segment in the
world, the Indian banks need to
acquire a lot of mass in their volume of operations.
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The respondents were businesses engaged in activities such as
fruits and vegetables vendors, laundry services, provision stores,
petty shops and tea stalls. 97% of them do not depend the
banking system for funds. Notbecause they do not want credit
from banking sources, but because banks do not want to lend
these entrepreneurs.
It is a situation of Financial Apartheid in the informal sector. It
means with the help of retail and personal banking services
Universal Banking can reach this
stratum easily.
Threats:
*Big Empires
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If the banks are not prudent enough, deposit rates could shoot
up and thus affect profits. To increase profits quickly banks may
go in for riskier business, which could lead to a full in asset
quality. Disintermediation and securitization could
further affect the business of banks.
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THE FUTURE TREND OF UNIVERSAL
BANKING INDIFFERENT COUNTRIES
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specialized institutions. In particular, they are able to exploit
economies of scale and scope in banking. These economies are
especially important for banks operating on a global scale and
catering to customers with a need for highly sophisticated
financial services. As we saw in the preceding section, universal
banks may also suffer from various shortcomings. However, in
an increasingly competitive environment, these defects will
likely carry far less weight than in the past.
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ISSUES & CHALLENGES IN UNIVERSAL
BANKING
I. Challenges in Universal Banking
There are certain challenges, which need to be effectively
met by the universal banks. Such challenges need to build
effective supervisory infrastructure, volatility of prices in the
stock market, comprehending the nature and complexity of new
financial instruments, complex financial structures, determining
the precise nature of risks associated with the use of particular
financial structure and transactions, increased risk resulting
from asymmetrical information sharing between banks and
regulators among others. Moreover norms stipulated by
RBItreat DFIs at par with the existing commercial banks. Thus
all Universal banks have to maintain the CRR and the SLR
requirement on the same lines as the commercial banks. Also
they have to fulfill the priority sector lending norms applicable
to the commercial banks. These are the major hurdles as
perceived by the institutions, as it is very difficult to fulfill such
norms without hurting the bottom-line. There are certain
challenges, which need to be effectively met by the universal
banks. Such challenges includeweak supervisory infrastructure,
volatility of prices in the stock market, comprehending the
nature and complexity of new financial instruments, complex
financial structures, determining the precise nature of risks
associated with the use of particular financial structure and
transactions, increased risk resulting from asymmetrical
information sharing between banks and regulators among
others.
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II. Issues of concern for Universal Banking:
1. Deployment of capital:
If a bank were to own a full range of classes of both the
firm’s debt and equity the bank could gain the control necessary
to effect reorganization much more economically. The bank will
have greater authority to intercede in the management of the
firm as dividend and interest payment performance deteriorates.
2. Unhealthy concentration of power:
In many countries such a risk prevails in specialized
institutions, particularly when they are government sponsored.
Indeed public choice theory suggests that because Universal
Banks serve diverse interest, they may find it difficult to
combine as a political coalition – even this is difficult when
number of members in a coalition is large.
3. Impartial Investment Advice:
There is a lengthy list of problems, involving potential
conflicts between the bank’s commercial and investment
banking roles. For example there may be possible conflict
between the investment banker’s promotional role and
commercial banker’s obligation to provide disinterested advice.
Or where a Universal Bank’s securities department advises a
bank customer to issue new securities to repay its bank loans.
But a specialized bank that wants an unprofitable loan repaid
also can suggest that the customer issues securities to do so.
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CURRENT ISSUES
UNIVERSAL BANKING- Rising Popularity
As competition intensifies banks are likely to morph into
financial supermarkets. Leading the pack is Universal banks,
which offer a wide gamut of services targeted at a broader
customer base. Their services range from commercial banking
and investment banking to insurance and mobile banking.
The popularity of universal banks has been on the rise. Few
years ago, investment banks like JP Morgan, Morgan Stanley,
Lehman Brothers and Merrill Lynch were the leaders in
managing G-3 currency bond deals. But times have changed.
Today, universal banks like Citigroup, Deutsche Bank and
Barclays Capital, are dominating the markets. By gobbling up
smaller banks, these banks have transformed themselves into
universal banks in Asia. This has resulted in higher capital costs
for companies in Asia.
1. Relationship Business
Banking has always been a relationship business.
Universal banking, focuses on fostering better relationships with
customers, which is used a retention tool. Universal banks can
also give advantage of lower fees to a customer who gets all his
banking needs from the same bank, be it purchase of foreign
exchange, managing pension funds or underwriting bonds etc.
By acting as lender and underwriter, universal banks are in a
better position to understand how a secondary stock offering or
an acquisition will affect critical ratios and covenants in loan
agreements. And, since banks conduct due diligence before
making a loan, they can jump in quickly if a corporation wants
to have a last-minute junk-bond offering.
In Asia, bankers do have relationship lending but their
approach is based on loan tying. If the bank loses money on its
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loans, it recoups its capital from other business driven out of the
lending process. In contrast, the universals decide, after
carefully considering the returns on capital. As long as the
required return from the relationship transaction is in line with
their projections, universals go in for loan tying. As opposed to
this, investment banks consider returns purely on cost basis.
They are more interested in synchronizing the costs of a
particular department with the fees charged in the deal. So,
while universal banks have the leverage to subsidize their fees
with relationship loans investment banks stand deprived.
2. Universals' practice in Asia
Universals constantly look to lower their fees to grab a deal.
They create special purpose entities, which allow them to write
off risky assets. These special purpose entities help universals
create capital against them. The proceeds from these kinds of
activities enable them to charge lesser interest for extended
loans. Universals like HSBC and Standard Chartered have
dominated the corporate market for over three years. The capital
markets have put the emphasis back on lending. Asia's loan
volumes have surpassed volumes of equity and equity-linked
issuance in 2002, and corporate loan volume is much higher
than corporate bond issuance. This has helped universal banks
make their presence in the market.
Citigroup, HSBC, Standard Chartered, ING, Bank of
America and ABN AMRO make wide use of special purpose
entities for the simple reason that these entities will help them
exploit a regulatory loophole in their funding. These entities
allow banks to transfer loans from the balance sheet into a
vehicle that transforms them into capital-generating assets.
Since the special purpose entities remain in the bank’s
possession, they offset loan costs at below-market rates. This
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strengthens the banking relationship and also the risk tied to the
underlying asset disappears.
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UNIVERSAL BANKING: AN OVERVIEW
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COMMENTS/VIEWS OF EXPERTS
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• Universal Banks deploy capital as efficiently as the stock
market
While there is some merit in this, the evidence in support
is quite weak. It has been observed that the Universal banks
have certain advantages in restructuring firms. The transaction
costs of takeovers and mergers are high in stock market system
and night well is lower with a universal bank.
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Case Study
Bank Profile
United Bank for Africa PLC (UBA) is the product of a
merger of two of Nigeria’s top five banks, UBA and Standard
Trust Bank Plc (STB). Today, consolidated UBA is largest
financial services institution in sub- Saharan Africa (excluding
South Africa) with a balance sheet size in excess of 400 billion
naira (approx. US$ 3 bn), and over two million active customer
accounts. With over 400 retail distribution outlets across
Nigeria, UBA also has a presence in New York, Grand Cayman
Island and aspires to expand within Sub-Saharan Africa.
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and the deployment extended to the US, UK & other countries
where UBA has a presence.
Bank Profile
Solution Overview
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successfully manage the resultant increase in transaction levels
from 400,000 transactions a day in 2000 to nearly 2.1 million by
2005 with an associated growth in peak volumes by 5.5 times.
With Finacle, the bank currently has the ability to process 0.27
million cheques per day and manage 7000 concurrent
users.
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channels, thus increasing overall efficiency. Currently, only 25
percent of all transactions take place through branches and 75
percent through other delivery channels. This reduction in
routine transactions through the branch has enabled ICICI Bank
to aggressively use its branch network as customer acquisition
units.
On an average, ICICI Bank adds 300,000 customers a month,
which is among the highest in the world.
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Conclusion
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become a universal bank offering a well diversified portfolio of
financial services. It currently has assets of over US$ 79 billion
and a market capitalization of US$ 9 billion and services over
14 million customers through a network of about 950 branches,
3300 ATM's and a 3200 seat call center (as of 2007). The
hallmark of this exponential growth is ICICI Bank’s unwavering
focus on technology.
United Bank for Africa PLC (UBA) is the product of a
merger of two of Nigeria’s top five banks, UBA and Standard
Trust Bank Plc (STB). Today, consolidated UBA is largest
financial services institution in sub- Saharan Africa (excluding
South Africa) with a balance sheet size in excess of 400 billion
naira (approx. US$ 3 bn), and over two million active customer
accounts. With over 400 retail distribution outlets across
Nigeria, UBA also has a presence in New York, Grand Cayman
Island and aspires to expand within Sub-Saharan Africa. In its
determination to continue to leverage on a robust IT
infrastructure designed to achieve excellent service delivery to
its teeming clientele, UBA opted for universal banking solution,
comprising core banking, corporate e-banking, alerts, CRM and
treasury solutions in October 2005.
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Bibliography
BOOKS
Harmonizing the Role and operations of development Financial
Institutions and banks-a discussion paper of R.B.I., Mumbai.
“Universal Banking”- International comparisons & Theoretical
perspectives” by Jordi Canals.
MAGAZINES
Annual Report of ICICI bank
Indian Institute Journal
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