shri v leeladhar : indian banking – the challenges ahead text of the third natarajan memorial lecture delivered by shri v leeladhar, deputy governor, reserve bank of india, chennai, 14 november 2005. * * * i deem it an honour to have been invited to deliver this year ’ s g natarajan memorial lecture. i did not have the good fortune of meeting late shri g. natrajan but i have heard a lot about him from my friend shri v. a. george. as a father of a mentally challenged child i had an insight into the activities of smt. poonam natrajan, founder chairperson of vidya sagar, formerly known as spastic society of india, chennai. i am grateful to her for inviting me to address this august gathering. recently i had an opportunity to read late natrajan ’ s book – rupee watch, the story of the indian forex market retold ( 1993 - 99 ) which gives us an idea of the deep insight he had on the india forex markets during those turbulent days. to pay my homage to this great visionary, i thought nothing could have been more appropriate subject for todays address than – “ indian banking – the challenges ahead ”. in recent years, there has been a considerable widening and deepening of the indian financial system, of which banking is a significant component. with greater liberalisation, the financial system has come to play a much larger role in the allocation of resources than in the past and its role in future can be expected to be much larger than at present. the growing role of the financial sector in the allocation of resources has significant potential advantages for the efficiency with which our economy functions. consequently, the adverse consequences of malfunction of the financial system are likely to be more severe than they used to be in the past. hence, all our efforts today are focused at ensuring greater financial stability. given the significance of the indian banking system, one cannot afford to underplay the importance of a strong and resilient banking system. the pre - reform period witnessed the following major regulatory constraints on the banking sector which not only distorted the efficiency of the interest rate mechanism but also adversely affected the viability and profitability of banks : - large pre - emptions – both in terms of the statutory holding of government securities ( statutory liquidity ratio, or slr ) and cash reserve ratio ( crr ) ; and - complex structure of administered interest rates ;

also prepared bench mark documents covering cheque clearing – both mechanical and manual, as also retail electronic products which cover the aspects of minimum standards that have to be put in practice to ensure their efficient operations. these benchmark standards are applicable to both the processing centres run by the reserve bank as well as other commercial banks. another issue that merits attention is that of service charges. it can be argued that the competitiveness and competition or a buyer ’ s market would bring down costs in a near - tomedium timeframe and definitely in the longer run. yet, the fears of cartelisation, excessive cost - recovery in the initial years and lack of transparency in the cost - structure are concerns that need to be addressed. while the charges - framework should be remunerative to providers they should not be prohibitive to users. the challenges lie in striking a balance between cost and cost - recovery, including the issues relating to transparency in the charges framework and rationalisation of charges across banks / service providers. in uk, the office of fair trading ( oft ) has been addressing these issues. we, in india, have recently mandated the service charges that could be levied by banks for providing electronic payment products to their customers, as also for usage of shared - atm networks by banks'customers. besides other kinds of financial risks and risk mitigation measures that need to be taken, operational risk assumes significant importance in the context of retail payments and their settlement mechanisms because of the wider scope of operations of such systems which is not limited to a few players ( unlike large - value or inter - bank payment systems ). while retail payment systems need to be sized appropriately to handle substantial volumes and reduce the load on large - value payment systems, appropriate and well - tested business - continuityplans with sufficient built - in - redundancies should also be in place to ensure availability of the retail payment systems in the eventuality of any disruption / contingency. i am sure important issues such as process innovation, outsourcing, business continuity planning etc will be substantially covered during the seminar deliberations. while banks and other financial intermediaries are often the major players in any payment system arrangement, the role of non - bank operators such as technology and communication service - providers, support services for atm networks, issuance of pre - paid payment instruments, etc certainly cannot be ignored. modern payment systems, be it wholesale or retail, depend extensively on technology and communications for their effective and efficient functioning. the role of