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Indian Banking Industry:Outlook and Opportunities Assessment 2007
w w w . t h e a s i a n b a n k e r . c o m
Indian Banking Industry:
Outlook and Opportunities Assessment 2007
IMPORTANT NOTICE Although the author and publisher have tried to provide information as accurately as possible, they accept no responsibility for any loss, injury or inconveniences suffered by any person using this document. The author and publisher have taken all reasonable care to ensure the data and information in this report is accurate and presents a fair representation of the subject matter. However, they do not accept the liability for damages incurred by any reader or any category of readers whatsoever. This document does not purport to provide any professional advice, and any analysis or commentary in the report should not be taken as providing any specific or general advice to any reader’s specific or general intentions whatsoever. First Publication: October 2006 ISBN: 981-05-6853-3 © 2006 The Asian Banker. All rights reserved The Asian Banker, incorporated in Singapore as T.A.B. International Pte Ltd, claims all rights as owner of intellectual property in this report. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form by any means, electronic, mechanical, photocopying, recording or otherwise, without the written permission of the publisher and the copyright owner.
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__________________________________________________________________________ Asian Banker Research – India Index of Acronyms
Index of Acronyms ALM Asset Liability Management ATM Automatic Teller Machine BANKEX Index of leading banking sector stocks listed on the Bombay Stock Exchange in India BN Billion BOB Bank of Baroda BOI Bank of India BOP Balance of payments BP Basis Point BPO Business Process Outsourcing CAGR Compound Annual Growth Rate CAR Capital Adequacy Ratio CASA Current Account - Savings Account Canara Canara Bank CBS Core Banking System CECA Comprehensive Economic Cooperation Agreement CBOP Centurion Bank of Punjab CIBIL Credit Information Bureau of India Ltd. CIR Cost-to-Income Ratio Citibank Citibank N.A. CRISIL Credit Rating Information Services of India Ltd. CDR Credit-to-Deposit Ratio CRM Customer Relationship Management CV loan Commercial vehicle loan CRAR Capital to risk-weighted assets ratio Crore Indian unit of measurement (1 crore = 10 million) DBS Development Bank of Singapore DCB Development Credit Bank DSA Direct sales agents ECB External Commercial Borrowings EFTPOS Electronic Funds Transfer at Point of Sale FDI Foreign Direct Investment FII Foreign Institutional Investor FOREX Foreign Exchange
__________________________________________________________________________ Asian Banker Research – India Index of Acronyms
GDP Gross Domestic Product GTB Global Trust Bank HDFC HDFC Bank ICICI ICICI Bank IDBI IDBI Bank IFCI The Industrial Finance Corporation of India IFR Investment Flucutation Reserves IMD India Millenium Deposit IMF International Monetary Fund IOB Indian Overseas Bank IPO Initial Public Offering IRB approach Internal ratings-based approach IT Information Technology KMB Kotak Mahindra Bank KYC Know-your-Customer LIC Life Insurance Corporation of India MN Million MOF Ministry of Finance MTN Medium term note NBFC Non Banking Financial Company NBFI Non Bank Financial Institution NGO Non-governmental organisation NIM Net Interest Margin NPL Non-Performing Loans NRI Non Resident Indians OBC Oriental Bank of Commerce P/B Price-to-Book (Ratio) PNB Punjab National Bank POS Point of Sales REMF Real Estate Mutual Fund RMA Rural Marketing Agent ROA Return on Assets ROE Return on Equity
__________________________________________________________________________ Asian Banker Research – India Index of Acronyms
RRB Regional Rural Bank Rs Rupee SBI Group SBI and its associate banks SBI State Bank of India SENSEX Bombay Stock Exchange Sensitive Index SLR Statutory Liquidity Ratio SME Small and medium-sized Enterprise StanChart Standard Chartered Bank state banks state-owned or public sector banks in India UBOI Union Bank of India UTI UTI Bank VRS Voluntary Retirement Scheme WTO World Trade Organisation Yes Yes Bank YOY Year on Year 2W loan Two Wheeler Loan e estimated figures f forcasted figures
__________________________________________________________________________ Asian Banker Research – India 4 Table of Content
Table of Contents Introduction Executive Summary Chapters 1 Macroeconomic Environment 1-1 India’s Economic Growth Prospects 1-2 Consumption and Business Outlook 1-3 Regional Comparison of Household Financial Asset Mix 1-4 Regional Comparison of Credit Depth and Credit Growth 1-5 Comparative Domestic Depth and International Penetration 1-6 Key Changes in the Regulatory Environment Governing Financial
Institutions 1-7 Policy Focus on Infrastructure and Agricultural Development 2 Macro Banking Environment 2-1 Financial Intermediation Trends in India 2-2 Bank Lending Growth vs. GDP Growth 2-3 Liquidity Profile of the Indian Banking System 2-4 Number and Types of Banking Institutions in India 2-5 Market Shares of State, Private and Foreign Banks 2-6 Banks’ Net Interest Margins 2-7 Market Position of India’s Top Ten Banks 2-8 Dominant Players: Assets and Profitability 2-9 The Role of NBFCs 3 Business Composition, Focus and Strategy 3-1 Revenue Growth vs. Growth in Market Capitalisation 3-2 Main Sources of Revenue 3-3 Non-interest Income Comparison 3-4 Asset Creation vs. Deposit Mobilisation 3-5 Cost Structure vs. Profitability 3-6 Asset Quality of Indian Banks 3-7 Bank Credit Growth 3-8 Bank Risk Management 3-9 Banks’ Capital Raising and IPO Prospects 3-10 Emerging Areas of Growth 3-11 Consolidation of Indian Banks: Rationale, Impediments and
Strategies 3-12 List of Domestic M&A Deals, 2004-2006 3-13 Foreign Banks’ Asset Growth, 2000-2005 3-14 Operations and Prospects of Foreign Banks in India 3-15 List of Foreign Acquisition Deals, 2004-2006 4 Distribution and Penetration 4-1 Branch Penetration in India and Peer Countries 4-2 Branch Growth of Indian Banks 4-3 Fee Income Generation 4-4 The Asian Banker Perception Survey on Branch Strategy 4-5 Modernising and Rationalising Branch Networks 4-6 Important Elements of Excellent Banking Service 4-7 ATM Penetration and ATM Growth
__________________________________________________________________________ Asian Banker Research – India 5 Table of Content
4-8 Bank Card Growth 4-9 Multi-Channel Development in India and Peer Counties 5 Tracking Technology and Infrastructure 5-1 Mapping the IT Infrastructure of Indian Banks 5-2 Level of IT Customisation and Optimisation 5-3 Level of System Integration vs. Intention to Adopt New
Technology 6 Key Challenges and Concerns 7 Conclusions 8 Appendix: Indian Banking Data Series 2001-2005 8.1 Basic statistical data
8.1.1 – Macro data (GDP, population, GDP/Capita) 8.1.2 – Price indices (Consumer and Producer price indices) 8.1.3 – Monetary statistics (Narrow money [M1], Money supply
[M2]) 8.1.4 – Inflation and unemployment (Inflation, Labour force,
Unemployment, Employment by economic activity, Labour force participation rate, Exchange rate)
8.2 Household demographics
8.2.1 – Number of households (HHs), HH income, Number of HHs by income band, Total HH borrowing
8.2.2 – Gross domestic savings (Gross domestic savings, Gross domestic savings/GDP)
8.2.3 – Poverty (Income ratio of the highest 20% to lowest 20%, Gini coefficient)
8.3 Banking industry profile
8.3.1 – GDP from Finance (GDP, GDP contribution from Finance) 8.3.2 – Number of institutions by category,
Number of inhabitants: per bank, per commercial bank, per branch
8.3.3 – Deposits in banks (Demand deposits, Time deposits) 8.3.4 – Average interest rates (Deposits: Savings, Time; Loans and
discounts) 8.4 Retail distribution
8.4.1 – ATMs (Number of networks, Number of machines, ATM penetration, Value of ATM transactions, Average value per transaction, Volume of transactions, Number of transactions/person)
8.4.2 – EFTPOS (Number of networks, Number of terminals, EFTPOS penetration, Value of EFTPOS transactions, Average value per transaction, Volume of transactions/person)
8.4.3 – Bank branches (Number of branches, Branch penetration) 8.4.4 – Infrastructure penetration rates (Fixed-line telephone,
Mobile phones, Personal Computers, Internet, Broadband)
__________________________________________________________________________ Asian Banker Research – India 6 Table of Content
8.5 Payment systems 8.5.1 – Cash (Cash penetration, Cash penetration as % of GDP) 8.5.2 – Credit cards (Number of credit cards, card penetration
[per person, per working population], Value of transactions [$ millions, per card, per person], Billing as a % of HH income, Volume of transactions, Average value/transaction)
8.5.3 – Debit cards (Number of debit cards, card penetration [per person, per working population], Value of transactions [$ millions, per card, per person], Volume of transactions, Average value/transaction)
8.5.4 – Cheques (Value of transactions, Volume of transactions) 8.6 Financial profile
8.6.1 – Balance sheet (Total assets, Loans, Deposits, Equity, Non-performing loans, NPLs as a % of total loans, NPLs as a % of GDP)
8.6.2 – Income statement (Net profits, Tier-1 capital) 8.6.3 – Operations: Return on average Equity, Return on average
assets, Cost-to-income ratio, Net interest margins; Liquidity: Net loans-to-total assets; Capital: Equity-to-total assets; Non-interest income as a % of total income
Charts 1 Macroeconomic Environment 1-1-1 India’s Economic Growth Prospects 1-2-1 Private Consumption Growth in India and Peer Countries 1-3-1 Regional Comparison of Household Financial Asset Mix 1-4-1 Regional Comparison of Credit Depth and Credit Growth 1-5-1 Domestic Depth and International Penetration 1-6-1 Regulatory Changes Relating to Foreign Banks and Non-Bank
Financial Institutions 2 Macro Banking Environment 2-1-1 India’s Financial Intermediation Trend by Share of Total Funds 2-2-1 Bank Lending Growth vs. GDP Growth 2-3-1 Liquidity Profile of the Indian Banking System 2-5-1 Positioning of Bank Groups in Aggregate Deposits and Gross
Bank Credit (2005) 2-5-2 Annual Growth Rates in Aggregate Deposits and Gross Bank
Credit (2005) 2-5-3 Retail Positioning and Growth of Indian Banks 2-6-1 Banks’ Net Interest Margin Forecasts 2-7-1 Market Position of India’s Top Ten Banks 2-8-1 Total Asset Comparison of State and Private Banks 2-8-2 Profitability of Indian Banks 2-9-1 Income and Expenditure of NBFCs
__________________________________________________________________________ Asian Banker Research – India 7 Table of Content
3 Business Composition, Focus and Strategy 3-1-1 Revenue Growth vs. Growth in Market Capitalisation 3-1-2 Top Revenue Generators for Indian Banks 3-2-1 The Asian Banker Survey on Main Sources of Future Revenue in
Retail and Corporate Banking 2005/2006 3-3-1 Non-interest Income Comparison 3-4-1 Asset Creation vs. Deposit Mobilisation 3-5-1 Cost Structure vs. Profitability 3-5-2 Growth in Core Operating Profits 3-6-1 Asset Quality of Indian Banks 3-7-1 Capital Adequacy Ratio vs. Loan-to-Deposit Ratio 3-8-1 Bank Risk Management (CAR) 3-9-1 Banks’ Capital Raising and IPO Prospects 3-12-1 List of Domestic M&A Deals, 2004-2006 3-13-1 Foreign Banks’ Asset Growth 3-14-1 Operations and Outlook of Foreign Banks in India 3-15-1 List of Foreign Acquisition Deals, 2004-2006 4 Distribution and Penetration 4-1-1 Branch Penetration in India and Peer Countries 4-1-2 Branch Penetration vs. GDP per Capita in India and Peer
Countries 2004 4-2-1 Branch Growth of Indian Banks: Private and State Banks 4-3-1 Fee income as % of Total Operating Revenue vs. Fee Income per
Branch 4-4-1 Winning Strategies in Branch Management 4-5-1 Modernising and Rationalising Branch Networks 4-6-1 Important Elements in Banking Service 4-7-1 ATM Penetration 4-7-2 ATM Growth 4-8-1 Bank Card Growth with Regards to Total Issuance 4-8-2 Growth in Credit Card Transactions: Value vs. Number of
Transactions 4-9-1 Total Customer Transactions Conducted Through Each Channel 4-9-2 Survey on Online Banking Strength of Banks in India 4-9-3 Evolution of Channel Strategies and Financial Services 5 Tracking Technology and Infrastructure 5-1-1 Mapping the IT Infrastructure of Indian Banks 5-2-1 Mapping Indian Banks in Achieving IT Customisation and
Optimisation 5-3-1 Level of System Integration vs. Intention to Adopt New
Technology
_____________________________________________________________________________ Asian Banker Research – India 8 Key Insights
Key Insights
Although strong credit growth and improving asset quality over the last years
across banks have created a positive outlook for the Indian banking industry,there are some potholes on the high road. The current resilience of the industryhas not been put to test yet in a major economic downturn or credit fall out.Weaknesses in process and service quality at front-end channels, lack of adequatedata authentication in the application and approval processes, violation of KYCnorms, incidents of home loan frauds and issues in technology advancement arestill a cause for concern.
Structurally, we believe there is no immediate systemic risk in the retail orcorporate banking sectors. The larger structural issues facing banks in the futurewill involve the challenges of smooth integration with global markets, capitalaccount convertibility and development of the corporate debt market.
A fragmented industry will find it difficult to stand up to the increasedcompetition after the expected liberalization of controls for foreign banks in2009. Despite the urgency, the consolidation of India’s state banks has notgathered critical mass although negotiations and attempts to experiment withstrategic alliances are afoot. The target of reducing the number of state banksfrom 27 to 10 seems unachievable unless the regulator develops a more forcefulstance.
We expect to see accelerated M&A activity among smaller domestic privatebanks trying to acquire peers or NBFCs to expand geographical imprint, branchpenetration or asset size. The difficulties of getting approvals for additional bankbranches and local bank acquisitions will also prompt foreign players to continueto expand inorganically by taking the less restricted NBFC route in the run-up to2009.
The opening up of the banking sector to global influences will call for enhancedcompetitive efficiency, requiring a transformation in human resourcedevelopment, IT upgrading, bundling of services and risk management practicesin line with international standards. The strengthening of the banking system willrequire a shift in focus for consolidation not for scale alone but to foster thecreation of operationally strong banks irrespective of size.
With thinning margins in corporate lending and increasing competition in tier 1cities, the emerging growth areas beyond retail lending are rural, infrastructureand SME finance. Successful lending models in the future will cover all points ofthe value chain and involve partnerships with business houses, NGOs, MFIs anddealers. Banks’ efficiency in processing small-ticket transactions and channelpenetration will become paramount. Strategic IT enhancement and networkconnectivity will be key to both.
In their retail banking evolution, Indian state banks are still largely product- orsales-focused but new private banks have taken the leap towards driving marketshare. These private banks are now leveraging on warehousing/CRM technologyand multiple channels to advance to the next stage, that is, relationship-focusedlending. They are developing diversified fee income sources and product rangelinkages for cross-selling as key competitive advantages.
Core banking rollouts for several state banks are on course but banks face thetough challenge of integrating their huge branch networks into the new systems.Once fully deployed, they will bring significant improvements in theircompetitive strength provided system integration and front-end alignments areeffected successfully.
__________________________________________________________________________ Asian Banker Research – India 9 Introduction
Introduction
The outlook for the Indian banking industry is the most positive in the
Asia Pacific. The industry is undergoing a major transformation. Yet, there
are significant differences in the evolutionary development and
competitive efficiency of the various players driving the industry.
Based on considerable demand for a greater understanding of the trends
affecting the Indian banking industry today, The Asian Banker is
publishing a comprehensive report that is of great importance to all
decision makers assessing the banks in this country.
The report reflects on our extensive and continued interviews with top
regulators, CEOs and senior executives of the full cross-section of banks in
the country as well as investors, suppliers and consultants who do business
with Indian banks. The report is supported by a strong set of data, charts
and tables that provide conceptual insights as well as hard-nosed data and
facts that decision makers can work into their own assessment.
The report provides a strong big picture perspective of the key themes
driving India’s banking industry today, supported by strong operational
and business level observations that provides the reader with an idea of the
tactical issues they will need to deal with when doing business in India.
The Asian Banker Industry Assessment Report 2006 on India assess the
profile and prospects of India’s banking industry, helps you understand the
drivers affecting the growth potential of the banking industry in the
country and learn the banks’ competitive positioning relative to each other.
__________________________________________________________________________ Asian Banker Research – India 10 Executive Summary
Executive Summary
India’s GDP growth has outstripped that of most of its Asian peers with
the exception of China. However, the low GDP per capita, rising
unemployment and rural poverty remain critical challenges to future
development.
With volatile oil prices, rising interest rates, a higher rate of inflation, and
a larger fiscal deficit and current account deficit, the GDP growth is
expected to slow down slightly in FY2007 to 7.9%. We expect to see
further monetary tightening during the year to curb inflation.
Liquidity in the market may become tighter in the later part of FY2007 due
to narrowing of the BOP surplus and slowing of forex reserve accretion.
However this may be mitigated by fresh doses of FDI, a pick-up in
portfolio investments, increased ECB limits, higher FII limits for
investment in gilts and corporate debt, and the continued inflow of
remittances.
The stock market correction of May 2006 temporarily affected
implementation of new investment plans and fresh IPO launches in the
corporate sector but with strong corporate earnings and reduction in oil
prices the market rallied to a new record in mid-October 2007. Capital
inflows have returned and pushed up the rupee value against the dollar.
Although the markets have yet to stabilize, output performance continues
to be strong and the slowdown has not derailed the overall growth of the
banking sector.
We believe the overall credit expansion will continue at strong but slightly
lower rates of 27% in FY2007 as deposit growth will not match credit
growth, the excess SLRs of previous years are drying up and Basel II
implementation will place additional demands on capital requirements.
Retail loan growth will remain strong till 2008. Besides housing loans,
auto and two-wheeler loans will see sustained growth in small cities and
rural areas in FY2007. The significant rise in purchasing power in India is
fuelling increased demand for an array of retail financial products and
services including consumer finance, wealth management and financial
__________________________________________________________________________ Asian Banker Research – India 11 Executive Summary
planning. Corporate lending grew at a robust rate exceeding 30% in
FY2006. With the increase in investment requirements of the infrastructure
sector, capacity additions and working capital requirements, demand for
corporate credit will rise further.
The high growth potential in retail credit is motivating the mid-tier and
small banks to build up operational and strategic strengths in a range of
retail segments. In FY2006, mid-sized private banks continued to grow
their retail portfolios aggressively, especially the new private banks.
India’s retail financial services industry has been flourishing. But for most
banks, their operational development in this segment is still at the product-
or sales-driven stage. In first-tier cities, where the overall market is nearing
saturation, banks have shifted their focus from sales to market share and
the intense competition has triggered price wars. This has been reflected in
shrinking net interest margins in the retail and corporate sectors for some
banks over the last three years. Some banks are aggressively competing for
market share despite lower margins based on the premise that high
volumes bring economies of scale and thereby improve profitability.
However, these banks may see a deterioration of asset quality over time.
Banks may also need to accept that they cannot differentiate much on the
same products beyond a point. They have to build up their attractiveness to
the customer through process quality differentiation as well as superior
pricing and service delivery. Banks with strong deposit mobilisation and
risk-based pricing will enjoy more consistent and sustained profit growth
over the long run.
Credit growth has been outpacing deposit growth and there is concern that
the latter may restrict future credit expansion. For state banks, the hiking
of deposit rates with a lagged increase in lending rates will also cause the
lending during the lag period to become less profitable despite loan
expansion.
Over the past few years, there has been a shift from asset creation to
deposit mobilisation among some banks to avoid possible funding issues.
The increase in low-cost deposits is, to some extent, being driven by better
technology and expanding ATM networks.
__________________________________________________________________________ Asian Banker Research – India 12 Executive Summary
Although state-owned banks control almost three-quarters of aggregate
deposits and gross bank credit in India, foreign banks had the highest
growth in deposits in 2005 while private sector banks led in credit growth.
In spite of their dominance in assets, state banks have the lowest
profitability. ROA has been highest for foreign banks followed by new
private-sector banks. Only a few of the larger banks will record an increase
in ROA in FY2007 compared to the previous year. Net profits of state
banks are likely to be adversely affected by bond losses.
The operating revenue margins of India’s largest banks fall within a
narrow range of 1.5% to 2.3% despite significant differences in size.
Revenue generation will become a priority for state banks in FY2007.
According to a survey by The Asian Banker, the most significant sources
of revenue growth in retail banking in the coming years will be mortgages,
personal loans, credit cards and wealth management, while corporate
revenues will be concentrated in SME financing, treasury services, cash
management and structured products.
Given the low penetration of home loans and huge demand for housing,
mortgage lending will continue to be a prime driver of retail expansion in
India. But banks must develop strong credit-underwriting ability and
innovative ways to handle sub-prime mortgage lending.
India’s young demographic profile offers high market potential for modern
retail products such as credit cards and personal loans tailored to the
younger age groups. Private banks have expanded the fastest and most
aggressively in the personal loan market but will need to watch out for
higher delinquencies.
With rising demand for wealth management products, assets under
management in India grew from $247 billion in 2001 to $355 billion in
2005. Domestically, the mass affluent segment which received little
attention from the banks initially now holds the most promise. Overseas,
banks are actively mobilising the wealthy NRI segment whose needs
__________________________________________________________________________ Asian Banker Research – India 13 Executive Summary
generally centre on remittances and real estate acquisitions. Some banks
are also keeping an eye on the “global Indian”, i.e. those who are based in
India but have substantial business earnings and capital overseas.
Volatility in trading incomes has prompted an accelerated drive among the
banks to open up fee income sources across both corporate and retail
lending. New private banks are racing ahead of not only Indian banks but
also many of their Asian peers in driving up fee income. The development
of complex fee-based services requires the support of an integrated IT
platform to get the productisation and pricing right but many banks do not
yet have this in place. Loan trading, which started in the industry in 2003,
will become another key focus and will enable banks to increase corporate
fee income and grow their loan books without incurring acquisition costs.
So far only a few banks are active in this area.
For the industry as a whole, gross non-performing loans have been
shrinking for the last four financial years. The improving asset quality in
Indian private banks and especially the state banks is an indicator of the
increasing soundness of India’s financial system although banks’ risk
capabilities have not been tested in a major economic downturn yet.
In general, risk management across banks has improved. Treasury profits
in the past few years have been used to raise provisioning levels. However
India’s credit bureau, launched in 2004, does not have enough depth yet
and is not linked to the customer scoring systems of banks as in the United
States. Only a few banks have adopted risk-based pricing in retail lending
and, in the absence of customer credit-rating systems, this tends to be on a
product basis rather than customer basis.
Indian banks were required to commence a parallel run of the revised
Basel II framework from 1 April 2006. RBI’s expectation is that by March
2007, Indian banks would have adopted the Standardised Approach for
credit risk and the Basic Indicator Approach for market and operational
risks. Feedback from bankers indicates that most banks are on track to
meet these requirements with close supervision from RBI.
__________________________________________________________________________ Asian Banker Research – India 14 Executive Summary
With strong credit growth ahead and preparations underway to convert
capital to comply with Basel II operational risk regulations by March
2007, capital raising activities among the banks have been increasing.
India’s exceptional growth in market capitalisation has helped to attract
international funds, not only for the large banks but also for mid-sized
banks. In fact, the growth in market capitalisation of Indian banks has
exceeded their revenue growth in the past few years, riding on the
unprecedented stock market boom and the overall positive outlook for the
banking industry. Private banks enjoy higher price-to-earnings and price-
to-book value ratios than state banks because investors perceive them as
being better managed. Indian banks raised well over $4 billion in equity
issuances from January 2005 to March 2006, but some banks will need
more capital in FY2007 to fund their loan growth.
The introduction of hybrid capital has reduced immediate concerns about
the capital raising capabilities of state banks. The move by RBI to allow
integration of investment fluctuation reserves (IFR) not only in Tier II
capital but also in the Tier I category from March 2006 will especially
assist the state banks, in the near term, to grow their loan book and Basel II
provisioning without necessarily tapping into the capital markets and
diluting their equity shares.
Retail banking will no longer be the only major source of growth as other
areas of banking gain prominence. Agricultural, SME and infrastructure
lending is set to take off. Core banking and computerisation have made it
possible for banks to viably process smaller-value accounts. This coupled
with the relatively lower returns from corporate sector lending and the
intensifying competition and thinning margins in retail lending has
encouraged them to take more interest in the rural, SME and personal loan
segments.
Pushing into unbanked rural areas will require the development of
innovative products (agricultural credit and personal loans catering to
various requirements of the rural customer) as well as simple payment
instruments suited to this segment. Banks are exploring creative ways to
develop the banking culture in rural areas through customised and
simplified channels (e.g. multilingual ATMs, multifunction smart cards)
__________________________________________________________________________ Asian Banker Research – India 15 Executive Summary
and at the same time mitigate risks through collateralised lending in
association with partners like business houses, NGOs, MFIs, logistics
companies and dealers.
Lending methods such as dealer financing and contract farming will
become key areas of focus in the coming years. For SMEs, a cluster-based
approach promoted by the government offers the possibilities of reduced
transaction costs, lower risks and an appropriate scale for improving
infrastructure catering to this segment.
Tier 2 cities in India are viewed as a gateway for ultimately penetrating the
rural hinterland. Many of these are situated near growing industrial hubs
and have a growing mass-affluent segment ready for a large variety of
retail offerings. The improved road, electricity and telecommunications
infrastructure in remote areas – a result of the government’s plan to invest
$40 million in creating rural infrastructure – will encourage private sector
businesses and banks to set up technology-enabled offices and branches in
these areas. We expect to see renewed momentum in branch expansion
among small and mid-tier banks, to extend their reach into rural areas to
tap the tremendous revenue potential in personal, 2W, CV and auto loans,
SME finance and infrastructural projects as well as the huge opportunities
for mobilising low-cost deposit funding.
Moving into the rural segment poses a challenge from the profitability
angle due to the small ticket size of transactions and low volumes.
Economies of scale will therefore come into play and only the banks
with the best distribution channels and mechanisms will be able to profit
from this market. Bank executives perceive that the key winning
strategies for branch management will be leveraging on alternative
sales/delivery channels and turning the branch into a stronger sales
platform through better customer segmentation for cross-selling.
Foreign and private sector banks with smaller branch networks than state
banks have been more active in exploring alternative sales/delivery
channels to complement branch expansion. These include ATMs,
internet banking, telebanking and mobile phone banking, call centres,
dealer networks and direct sales agents. Cost, information security,
__________________________________________________________________________ Asian Banker Research – India 16 Executive Summary
ignorance of the general populace about proper use of new technologies
and the broad-based preference for face-to-face interaction are the issues
that will need resolution in expanding ATM use. While ATMs and
internet banking have proved successful in some areas, banks in India
will need to assess whether and which of their customer segments are
ready for the alternative channels.
State banks are still struggling to bring down their high staff costs.
Operational expenses will rise dramatically for the majority of Indian
banks due to a strong expansion in their distribution strategies, upgrading
of IT infrastructure and increased investment in back-end technology.
However, success in leveraging on these investments could yield higher
returns in later years.
About 21 state banks have embarked on the use of CBS systems and over
14,000 branches have been CBS-enabled. They will now need to deal with
the networking of branches in remote areas and the challenges arising from
large-scale IT deployment including more scientific risk management,
better asset-liability management, effective anti-money laundering
measures, and security issues such as disaster recovery management and
fail-safe business continuity plans.
The fragmented profile of the Indian banking system has made
consolidation imperative given the increased competition that can be
expected after 2009, when the sector is opened further to foreign
competition. Vast geographical diversity, union pressures, political
interference and technological incompatibility between real-time core
banking and manual approaches have impeded the progress of state banks
on this front. We believe the regulators will need to revisit their policy and
take a more active role in pushing consolidation rather than only facilitate
and simultaneously encourage banks to develop operational strength
irrespective of size.
But M&A activity is on the increase among smaller private banks trying to
acquire peers or NBFCs to boost branch penetration or asset size,
motivated by the urgency to expand scale and/or geographical reach in
order to stay competitive after the liberalisation of controls in 2009.
__________________________________________________________________________ Asian Banker Research – India 17 Executive Summary
Given the restrictions imposed on foreign banks, foreign acquisition deals
completed in the past few years have been limited. Foreign banks will
continue the strategy of growth through both organic and inorganic means,
subject to applications being approved by RBI, to expand their networks in
India in the next two years before the market opens up. Restrictions on
branch expansion triggered a movement towards operating through NBFCs
has helped to enhance their activity areas and market share.
As to whether the promise of 2009 will materialise, we believe that given
the pressing need for foreign investments, the government is sensitive to
global investor opinion and hence almost certain to go ahead with further
liberalisation, after consultations with all the stakeholders to smoothen the
transition (bearing in mind that 2009 will also be an election year for
India).
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This chapter discusses the economic fundamentals thatare relevant to the banking industry in India today. Welook at India’s GDP growth prospects, consumptiontrends and business outlook as well as credit depth andgrowth of the financial system compared to regionalpeers to evaluate the prospects for bank lendinggrowth. We highlight key changes in the regulatoryenvironment relevant to foreign and Indian banks andthe policy focus on infrastructure and agriculturaldevelopment that will impact future trends in banklending.
Structure of Contents 1-1 India’s Economic Growth Prospects 1-2 Consumption and Business Outlook 1-3 Regional Comparison of Household
Financial Asset Mix 1-4 Regional Comparison of Credit Depth and
Credit Growth 1-5 Comparative Domestic Depth and
International Penetration 1-6 Key Changes in the Regulatory
Environment Governing FinancialInstitutions
1-7 Policy Focus on Infrastructure andAgricultural Development
Chapter 1 Macroeconomic Environment
1-1 India’s Economic Growth Prospects
___________________________________________________________________________ Asian Banker Research – India 18 Macroeconomic Environment
• In FY2006 (year ended 31 March 2006), India’s real GDP growth
of 8.4% outstripped that of most of its Asian peers with the
exception of China. The country’s robust economic expansion was
driven largely by strong domestic demand, supported by a sharp
rise in bank credit. Although its GDP growth is projected to slow
down slightly to 7.9% in FY2007, India is expected to continue to
outperform the other Asian countries except China.
• Following a round of monetary tightening in April 2006, the
Reserve Bank of India (RBI) raised its key interest rates by 25
basis points in June due to concerns over inflation. A further
increase can be expected towards the end of the year as the central
bank seeks to curb inflationary pressure.
• India’s outstanding growth and the opening up of the economy
have attracted investors from across the world. India has
experienced one of the fastest FDI (foreign direct investment)
growth rates in Asia with FDI inflows surging between 1999 and
2005. In FY2006, FDI flows to India exceeded $5 billion.
Portfolio investments by foreign institutional investors were more
than double that at around $11 billion, driving up valuations and
contributing significantly to India’s foreign reserves.
• The opening up of specific sectors like banking, insurance and
retail has been slow. But despite the Left Front’s opposition to the
India’s GDP growth is outperforming that of most other Asian countries Monetary tightening to curb inflation is expected FDI flows and portfolio investments have been high
1-1-1 India’s Economic Growth Prospects
Source: Asian Banker Research
0%
2%
4%
6%
8%
10%
12%
1998
1999
2000
2001
2002
2003
2004
2005
2006
(e)
2007
(f)A
nn
ual
% C
han
ge
in G
DP
IndiaChinaMalaysiaSingaporeSouth Korea
1-1 India’s Economic Growth Prospects
___________________________________________________________________________ Asian Banker Research – India 19 Macroeconomic Environment
easing of FDI regulations, privatisation and labour reform, the
Congress-led coalition government needs to address and resolve
these issues on an urgent basis. Continued inflow of FDI will
boost economic growth and employment and provide the much
needed funding for infrastructure development in India. However,
domestic savings must also be mobilised more effectively as FDI
alone may not be enough to lift the GDP growth rate to the
government’s target of 10% per annum.
• The rise in unemployment and inequality since 2003 is a critical
issue faced by the government. India’s GDP per capita has more
than doubled in the past decade but remains one of the lowest in
Asia. The benefits of increasing opportunities in the call centre
and business process outsourcing (BPO) industries have been
confined to urban areas and agriculture remains the key source of
employment in rural areas. Population under the poverty line
increased in 2005, with the rise in poverty more pronounced in the
rural areas than in the cities. A more inclusive banking culture that
allows the common man and the rural sector to benefit from the
country’s progress is imperative.
• India was not been spared the impact of rising oil prices and
interest rates and the drying up of excess liquidity in Asian
emerging markets. The equity market sell-off on 12 May 2006
triggered an almost 30% fall in the stock indices. The stock market
has recovered substantially since then due to strong corporate
earnings and the fall in oil prices. Capital inflows have returned
causing a rally of the rupee against the dollar. Although the
markets have yet to stabilise, we believe that India’s fundamentals
remain sound and its long-term potential unquestionable.
• Despite the bearish sentiment in the stock markets in the months
following the correction, major foreign and local companies have
been going ahead with their investment or listing plans, thereby
reinforcing business confidence in the country. Reliance
Petroleum and Air Deccan, among others, launched new shares.
Lotus India Mutual Fund, a joint venture launched by Temasek
…but domestic savings also need to be mobilised Financial inclusion is necessary to help reduce unemployment and poverty Since the stock market correction, companies have been going ahead with investment plans
1-1 India’s Economic Growth Prospects
___________________________________________________________________________ Asian Banker Research – India 20 Macroeconomic Environment
Holdings and Sabre Capital Worldwide in August 2006, expects to
raise Rs 250 billion to invest in Indian equities and bonds.
• With the growth in investment and incomes, the consumer boom
and demand outpacing supply, the need for capacity additions and
working capital as well as the demand for corporate and retail
credit are set to increase. Banks and other financial institutions
will also be co-opted to participate in the increasing opportunities
in infrastructural and rural lending.
Corporate and retail credit as well as infrastructural and rural lending is set to increase
1-2 Consumption and Business Outlook
___________________________________________________________________________ Asian Banker Research – India 21 Macroeconomic Environment
• In the past three years, private consumption in India has been
among the highest in Asia. Wealthy Indians have been leading the
spending spree and pushing up urban consumption, which
accounted for over 75% of the country’s total growth in private
consumption. By 2007, the combined number of middle income
earners and the very rich is expected to exceed the number of
households with less than Rs 45,000 a year. Urban and rural
spending is set to grow.
• Rural consumer spending differs fundamentally from urban
consumer spending, which has developed into predominantly
lifestyle spending that includes entertainment, eating out,
vacations and luxury goods – though groceries still account for the
largest portion of spending at over 40%.
• Emerging consumer markets like healthcare, retail, insurance,
telecom and entertainment are transforming consumption patterns.
Organised retail is growing at 40-45% each year. In the next three
years, the proportion of organised retail sales to total retail
turnover can be expected to almost triple to about 6%. The
exponential rise in middle- class incomes, especially for the
younger employees with high disposable incomes, is fuelling the
increased expenditure on entertainment, cell phones and branded
Private consumption in India has been among the highest in Asia in the past three years
With rising incomes, urban
and rural spending is set to
grow
-2%
0%
2%
4%
6%
8%
10%
China India Indonesia Japan SouthKorea
Thailand
2004 2005 2006e 2007f
1-2-1 Private Consumption Growth in India & Peer Countries
Source: Asian Banker Research
1-2 Consumption and Business Outlook
___________________________________________________________________________ Asian Banker Research – India 22 Macroeconomic Environment
apparel and accessories. Household expenditure on transport and
communication is also rising.
• Banks will have to focus on the consumption and payment patterns
of the middle income earners and the very rich to map future
strategies, as their growing numbers will lead to a significant
increase in purchasing power and demand for an array of retail
financial products and services including housing and auto loans,
personal finance and wealth management. At the same time, the
need to push into unbanked rural areas will require the
development of innovative products including not only
agriculture-related credit and personal loans catering to various
requirements of the rural customer but also payment instruments
suited to this segment.
• Business confidence was temporarily shaken by falling stock
markets, rising inflation and interest rates and the Mumbai train
bombings. While global economic and political events can impact
the corporate investment cycle, the Indian economy is resilient
because of the huge size of its domestic market, its lower
dependence on exports and sound fundamentals. We believe that
the expanding service sector, growing outsourcing opportunities
and strong demographics will continue to ensure high revenues for
the business sector and increasing demand for corporate credit.
• Indian and foreign companies are investing resources to tap into
the consumer boom, thus presenting a growth opportunity for
banks. Reliance Industries is set to roll out hypermarkets, small
grocery stores and rural business hubs where agricultural products
can be traded. Bharti Enterprises may open a chain of grocery
stores in alliance with overseas super-store operators. Foreign
companies currently barred from retailing, plan to enter the
wholesale sector while single-brand retailers who were previously
permitted to have only franchise agreements can now own a
majority stake in their operations.
Banks will focus on the consumption and payment patterns of the middle income and the rich to map future retail strategies The push into rural areas will require the innovative products and suitable payment instruments
1-2 Consumption and Business Outlook
___________________________________________________________________________ Asian Banker Research – India 23 Macroeconomic Environment
• In the past few years, Indian companies have focused on utilising
production capacities at optimum levels. With demand outpacing
supply, capacity utilisation is reaching saturation levels and fresh
capacity additions may exceed Rs 6,000 billion over the next few
years. Growing sales will further boost working capital
requirements and the demand for corporate credit from banks.
• Large infrastructure projects such as the development of economic
export zones in Mumbai, Mundra and Ludhiana and the expansion
of roads, ports, power and telecom sectors will provide a big push
in corporate bank lending in 2006-2007. Construction of multiplex
retail outlets is booming, with multiplier effects on ancillary
industries like steel and cement. IT parks in tier 2 cities like Pune,
Hyderabad and Vishakhapatnam will also create real estate
infrastructure opportunities there.
• Infrastructure financing grew at 50% CAGR between 2000 and
2005 and constituted 15.5% of industry credit and 5.4% of total
bank advances in March 2005. According to analysts, over $300
billion in infrastructure investments can be expected over the next
six years (2006-2012). While a part of these would be funded by
equity and foreign debt issuance, much of it is likely to be funded
by domestic banks.
Growing working capital needs, capacity additions and infrastructure development will boost corporate lending by banks
1-3 Regional Comparison of Household Financial Asset Mix
___________________________________________________________________________ Asian Banker Research – India 24 Macroeconomic Environment
• The household asset mix of India is more advanced than that of
Indonesia, China, Thailand and many of its other Asian
counterparts. Just over 50% of the wealth is in the form of cash
and deposits in India, compared with over 70% in these three
countries. However, it lags behind Singapore and Hong Kong
where only 30-40% of household wealth is held in such form and
the capital markets are better developed and hence attractive
avenues of investment.
• Gross domestic savings in India have risen to almost 30% of GDP.
However Indian households, still invest a significant part of their
savings in physical assets especially in rural areas where parochial
attitudes are still prevalent. Reports reveal that Indians bought 850
tons of gold in 2005. Banks need to create products and a banking
culture ethos that will encourage a switch in their investments
from physical assets to financial products that yield higher returns.
• A second largest share of household savings in India is taken up
by insurance and pension funds. The Indian household sector’s
exposure to the capital markets is low as shown by the low level of
securities holdings. The government has permitted non-
government provident funds to invest 5% of their new inflows in
shares and 10% in equity-linked mutual funds to channel part of
these into the stock market.
India’s household asset mix is more advanced than that of Indonesia, China and Thailand….but lags behind Singapore and Hong Kong Cash and deposits have the largest share in the household financial assets mix The household sector’s exposure to the capital markets is low
0%
10%
20%
30%
40%
50%60%
70%
80%
90%
100%
India
Indon
esia
China
Thail
and
Kore
a
Taiwan
Hong K
ong
Malays
ia
Singap
ore
Asia
8
Miscellaneous
Securities
Insurance & Pension
Cash & Deposits
1-3-1 Regional Comparison of Household Financial Assets Mix 2006
Source: Asian Banker Research
1-3 Regional Comparison of Household Financial Asset Mix
___________________________________________________________________________ Asian Banker Research – India 25 Macroeconomic Environment
• India’s demographic profile favours the penetration of modern
financial products and services. Compared to China, India has an
advantage in the long term, a “demographic dividend”. By 2020,
the median age in India will be 29 years while China’s will be 37
years, a result of the latter’s one-child policy of the last 30 years.
Thus, India’s population of young people is larger than that of
China and will become the largest in the region in the next two
decades, boosting the country’s consumer spending power. Youths
are generally less conservative about taking credit and are early
takers of most modern retail products like credit cards. However,
by international standards, retail credit is currently underdeveloped
especially among state banks.
• The mass affluent segment in India is growing and this has drawn
more financial players to the market. We believe Indian consumers
are becoming highly receptive to the increasing array of attractive
retail products being offered. We also expect banks in India to put
more effort into understanding the needs of rural households and
to offer personal financial services to attract these household
savings.
India’s demographic profile and growing mass affluent segment favours the penetration of modern retail financial products and services
1-4 Regional Comparison of Credit Depth and Credit Growth
___________________________________________________________________________ Asian Banker Research – India 26 Macroeconomic Environment
India
Indonesia
Malaysia
SingaporePhilippines
Thailand China
Taiwan
-5%
0%
5%
10%
15%
20%
25%
30%
35%
0% 20% 40% 60% 80% 100% 120% 140% 160% 180%
Credit/GDP 2005
Cre
dit G
row
th (C
AG
R 2
003-
2005
)
36%
26%
17%
17%
49%
50%48%
11%
• With overall credit expansion of 28.3% per year (CAGR) between
2003 and 2005, India enjoyed one of the highest credit growth
rates in Asia Pacific during this period.
• Despite the strong growth, total lending has not increased in line
with GDP. The overall figures also hide the fact that many banks
have been reluctant or have not been ready operationally to expand
in riskier segments such as SME and rural lending.
• The overall credit-to-GDP ratio in India is relatively low at less
than 40%, compared to 250% in the United States, 150% in the
United Kingdom, nearly 150% in China and 75% in Thailand.
The corporate loan-to-GDP ratio of 38% in India is also low by
regional standards, with corporate lending in China standing at
over 140% of GDP.
• Retail credit is still in a nascent stage in India. The ratio of
household borrowings to GDP is just 4%, which is one of the
lowest in Asia. The ratio of credit cards to GDP at 0.4% and the
ratio of other retail loans to GDP at 4% are also relatively low
compared to the rest of the region. Consumer loans in India
1-4-1 Regional Comparison of Credit Depth and Credit Growth
Size indicates retail credit as a percentage of credit to total credit.
Source: Asian Banker Research
India enjoyed one of the highest credit growth rates in Asia Pacific between 2003-2005 …..but overall credit-to-GDP ratio in India is relatively low
1-4 Regional Comparison of Credit Depth and Credit Growth
___________________________________________________________________________ Asian Banker Research – India 27 Macroeconomic Environment
make up only 8% of GDP, while in Thailand, Malaysia, Taiwan
and Korea the share ranges from 13% to 58%.
• The potential for retail and corporate lending is immense,
provided banks take a leap in increasing operational efficiency
and extending their reach beyond the comfort zone of metros
and into hitherto unbanked segments.
The retail and corporate lending potential is immense
1-5 Comparative Domestic Depth and International Penetration
___________________________________________________________________________ Asian Banker Research – India 28 Macroeconomic Environment
• As a result of stricter control and insulation from international
markets, India’s financial system has been lagging behind its
Asian peers in terms of domestic depth and international
penetration.
• Measuring domestic depth by comparing assets, credit and
liabilities in the commercial banking system against GDP, India
ranks at the bottom in Asia with 53% while China has already
reached 131%.
• International financial penetration in terms of foreign direct
investment, loans and equity holdings as a percentage of GDP is
32% for India, way below the Asian average of 60%.
India’s financial system has lagged in terms of domestic depth and international penetration.
Source: World Bank
0%
30%
60%
90%
120%
150%
180%
210%
China India
% o
f GD
P
Domestic credit provided by banking sector
Loans, investments from overseas
1-5-1 Domestic Depth and International Penetration
1-6 Key Changes in the Regulatory Environment Governing Financial Institutions
___________________________________________________________________________ Asian Banker Research – India 29 Macroeconomic Environment
1-6 Key Changes in the Regulatory Environment Governing Financial
Institutions
• Regulatory reforms have been designed to move the financial
system towards “competition, consolidation and convergence” and
eventually create Indian banks that are truly global players. The
Reserve Bank of India (RBI) wants to see Indian banks rise to
international standards on all levels with its strong focus in
2006/2007 on working towards greater transparency and ethical
conduct in dealing with customers.
Foreign Banks
• Foreign banks have limited participation in the banking sector as
the RBI does not want to create a two-tier system consisting of
well-performing private banks and older private sector banks.
Current regulations aim to protect domestic players till 2009,
giving them time to restructure.
• In February 2005, a two-phase roadmap for foreign bank
investments was announced. Till 2009, foreign ownership will
only be allowed under restricted conditions with no likelihood of
full takeovers. The RBI decides which banks can be sold (these are
usually distressed, older private banks beset with significant bad
Foreign banks have limited participation in the banking sector No likelihood of full bank takeovers till 2009
2001 2003 2005 2009•Cap on FDI was raised to 49%, from 40% (non resident Indians) and 20% (other foreigners)
•For non-banks: 100% direct investment was permitted in 19 business categories, but the minimum capitalisation was regulated depending on the equity ratio
•Permitted structure of presence: Branches only
•Foreign voting rights limited to 10%
•Branching limit per year:12
•Permitted structure of presence: Branches or wholly-owned subsidiaries
•Cap on FDI lifted from 49% up to 74%
•Foreign party can have voting rights according to ownership level
•Branching limit per year:>12, subject to RBI approval
•Permitted structure of presence: National treatment will be allowed, including IPO, subject to 26% of paid-in capital being held by resident Indians
2001 2003 2005 2009•Cap on FDI was raised to 49%, from 40% (non resident Indians) and 20% (other foreigners)
•For non-banks: 100% direct investment was permitted in 19 business categories, but the minimum capitalisation was regulated depending on the equity ratio
•Permitted structure of presence: Branches only
•Foreign voting rights limited to 10%
•Branching limit per year:12
•Permitted structure of presence: Branches or wholly-owned subsidiaries
•Cap on FDI lifted from 49% up to 74%
•Foreign party can have voting rights according to ownership level
•Branching limit per year:>12, subject to RBI approval
•Permitted structure of presence: National treatment will be allowed, including IPO, subject to 26% of paid-in capital being held by resident Indians
1-6-1 Regulatory Changes Relating to Foreign Banks and
Non-Bank
Source: Asian Banker Research
1-6 Key Changes in the Regulatory Environment Governing Financial Institutions
___________________________________________________________________________ Asian Banker Research – India 30 Macroeconomic Environment
assets, outdated technology and poor management) and it prefers
the sale to be in a phased manner. It also keeps a tight rein on any
foreign investment in local private banks which exceeds certain
limits: 5% in the case of individual foreign banks and 10% for
foreign institutional investors or individual corporate entities.
Community banks are likely to resist such takeovers, slowing the
process. Distressed mergers like the one between PNB and IFCI
are more probable.
• Wholly-owned foreign subsidiaries must have a minimum
capitalisation of approximately $70 million. After 2009, foreign
acquisitions of local private banks may be allowed, subject to a
review of the outcome for the first phase of liberalisation. Wholly-
owned subsidiaries will be allowed to reduce their foreign stake-
holding to 74% through an IPO or offer for sale. Foreign banks
which currently own more than 5% of an Indian bank will have to
either seek RBI approval for acquisition of a private bank not
identified by RBI for takeover or scale back their investment to the
5% limit.
• Branch network expansion is limited, even for Singaporean banks
under the new Comprehensive Economic Cooperation Agreement.
RBI has questioned the proposals by DBS Holdings, Overseas-
Chinese Banking Corporation and United Overseas Bank to
restrict their activities to cities and high-end banking, as foreign
banks have been required to make 32% of their loans to “priority
sectors” since July 1993.
• Despite these constraints, international commercial and investment
banks are willing to stay and start their relationships with a small
stake that may give them preferred bidder status in future equity
acquisitions in case RBI modifies the regulations before 2009.
• Most bankers that The Asian Banker spoke to are of the view that
given the pressing need for foreign investments, the government is
sensitive to global investor opinion and hence almost certain to go
ahead with the awaited liberalisation of controls for foreign banks.
Despite constraints, foreign banks are willing to stay …as the government is expected to go ahead with liberalisation in 2009
1-6 Key Changes in the Regulatory Environment Governing Financial Institutions
___________________________________________________________________________ Asian Banker Research – India 31 Macroeconomic Environment
The timing of the liberalisation however may take into account the
interests of various stakeholders as 2009 is the scheduled election
year for India.
State Banks
• The Indian banking system continues to be dominated by public
sector banks, but the system is fragmented as no one bank holds
more than 10% of total system assets except SBI. To enable these
banks to stand up to international competition after 2009,
consolidation of state banks and improvement of their operational
efficiency will become top priorities in the coming years.
• The main beneficiaries of the regulatory changes announced in
2005 are therefore the state-owned banks, which control over
three-quarters of total assets in the financial system. RBI has given
public sector banks more freedom to make autonomous decisions
across the full range of their operations, including human
resources, domestic and foreign acquisitions, establishing of
overseas branches or subsidiaries, opening or closing of branches
and changing of business lines. Rather than seeking permission to
open new branches on a piecemeal basis, banks can obtain
approval based on an annual plan. Unprofitable branches can be
moved elsewhere in the state and extended counters converted to
full branches without specific RBI permission.
• These measures were intended to strengthen state-controlled banks
so that they could compete with private banks by increasing their
efficiency and expanding into new business lines and geographies.
• In addition, banks will be permitted to issue preference shares,
thereby allowing state-owned banks to raise capital without
diluting the government’s minimum 51% stake. The existing
limits on banks’ statutory liquidity and cash reserve ratios have
also been removed, giving RBI greater flexibility in setting the
requirements.
The main beneficiaries of the regulatory changes announced are the state-owned banks …but still no comprehensive roadmap for consolidation of these banks
1-6 Key Changes in the Regulatory Environment Governing Financial Institutions
___________________________________________________________________________ Asian Banker Research – India 32 Macroeconomic Environment
• The government wants to reduce the number of state banks from
27 to 10 in the next four years. However, contradictory regulations
from RBI and the finance ministry indicate that there is still no
comprehensive roadmap vis-à-vis consolidation similar to those of
Indonesia, Pakistan and Taiwan.
Retail Credit
• Currently, there are no specific regulations or laws framing the
management of consumer credit in India. The Reserve Bank of
India does not regulate the sector, though it has issued the
Guidelines on Fair Practices Code for Lender (2003). However,
there is increasing awareness and debate among banking
industry players and consumer groups on the need for specific
consumer credit regulations. With banks still focusing on
product-centred and growth-focused acquisition strategies, RBI
has set up an independent body, the Banking Codes and
Standards Board of India to ensure that these codes of conduct
for fair treatment to the customer are formulated and complied
with.
NBFCs
• There is a significant overlap in the functions of banks and
NBFCs. But NBFCs also specialise in certain products and
services that receive little or much less emphasis in the mainline
banking system including hire purchase and leasing, IPO funding,
small-ticket loans and venture capital.
• RBI set up a special committee to look into the issue of evening
out the regulatory discrepancies between banks and non-banking
finance companies (NBFCs).
• Non-deposit taking NBFCs (NBFCs-ND) enjoy a "regulatory
arbitrage'' in that they are not supervised in any substantial
manner. Bank borrowings are determined by exposure limits set
by the lenders. As there is no stipulation on the end use of the
funds, the leverage available to NBFCs-ND to gear their balance
sheet is practically unlimited. This raises major systemic issues
NBFC subsidiaries of foreign banks are allowed to undertake activities in which their parent banks are restricted
1-6 Key Changes in the Regulatory Environment Governing Financial Institutions
___________________________________________________________________________ Asian Banker Research – India 33 Macroeconomic Environment
and there is an anxiety over NBFCs investing heavily in stock
markets by leveraging their balance sheets.
• RBI is examining the issues involved in the financing of NBFCs
by banks so that the bankers are able to use the core competencies
of NBFCs to extend their reach. The revised policy relating to
NBFCs’ access to external commercial borrowing (with RBI
approval) to finance infrastructure projects is expected to invite
increased participation of NBFCs in infrastructure financing, thus
shifting the activities of NBFCs towards productive project
funding with lower systemic risk.
• The regulatory arbitrage enjoyed by NBFC subsidiaries of
foreign banks with a presence in India have included among
others, exemption from the CRAR requirement, credit and
investment concentration norms, restrictions on investment
in land and buildings and branch expansion. Higher credit
ratings enable them to raise low cost debt resources easily.
The world's largest financial services group Citicorp and
engineering and financial services giant GE have a
significant presence in the NBFC segment. Whether
authorities will view foreign ownership of financial
institutions in its entirety (i.e. where banks, NBFCs and even
BPO centres providing IT services are owned by the same
set of shareholders), or continue to set restrictions on a per-
entity basis, remains to be seen.
1-7 Policy Focus on Infrastructure and Agricultural Development
___________________________________________________________________________ Asian Banker Research – India 34 Macroeconomic Environment
1-7 Policy Focus on Infrastructure and Agricultural Development
• The government targeted a GDP growth of 8.1% in its 10th Five
Year Plan (FY2002-FY2007). The industry sector, which
performed poorly in the first two years of the Plan, turned around
with a growth rate of 7.7% in FY2004 and is now expanding at
over 10% per annum. The growth of the services sector has also
improved. But to accelerate GDP growth to over 8% and sustain
this rate, the government must upgrade infrastructure facilities as
well as improve agricultural growth, which decelerated sharply
from an average of 3.2% between 1980 and 1995 to a trend
average of 1.9% thereafter. This deceleration reflected a broad-
based slowdown in the country’s productivity growth.
• The government has invested Rs 1,74,000 crore ($40 billion) in
the Bharat Nirman programme aimed at creating rural
infrastructure and providing effective services benefiting millions
of rural poor in the next four years. The programme envisages
building 600,000 houses, adding ten million hectares of irrigation
capacity, connecting 66,802 hamlets with all-weather roads,
bringing electricity to 100,000 villages, and providing safe
drinking water and rural telephony to all villages.
• Besides government efforts, there is a need for private and foreign
investments in infrastructure. The increased flow of FDI in recent
years is not sufficient to fill the massive resource gap. With
improvements in the policy environment, attractive financial
returns on investments and manageable risks, the private sector’s
participation is expected to increase.
• The improved road, electricity and telecommunications
infrastructure in remote areas will encourage private sector
businesses and banks to set up technology-enabled offices and
branches in these areas. For example, Reliance Industries is setting
up rural business hubs, a move that will trigger not only
agricultural income growth but also the development of ancillary
Improvement in infrastructure facilities and agricultural growth is necessary to boost GDP …and encourage setting up of technology-enabled offices in remote areas
Improvement in infrastructure facilities and agricultural growth is necessary to boost GDP …and encourage setting up of technology-enabled offices in remote areas
1-7 Policy Focus on Infrastructure and Agricultural Development
___________________________________________________________________________ Asian Banker Research – India 35 Macroeconomic Environment
industries. As the rural economy improves, banks will find it
increasingly attractive to venture into rural banking to participate
in infrastructure development funding and offer SMEs and farmers
a variety of financial products and services.
Chapter 2 Macro Banking Environment
The second chapter provides an overview of thefinancial intermediation business, both at theinstitutional level as well as balance sheet levels ofspecific banks. We profile the types of bankinginstitutions in India and use the charts collated toreveal their competitive positioning based on assetsand deposits. We analyse how banks in India will faregiven the fluctuating liquidity situation and interest raterise in the market today. Based on the strategiescommunicated to us by leading bankers we examinemotivations driving banks to differentiate themselvesin the marketplace and compete for market share. Welook at dominating players in terms of assets andprofitability and discuss ways in which investors andservice providers can assess the institutional capabilityof foreign and local banks in India to focus on profit byidentifying the successful players and their strategies.We also discuss the role of NBFCs and highlight casestudies of successful foreign NBFCs in India.
Structure of Contents 2-1 Financial Intermediation Trends in India 2-2 Bank Lending Growth vs. GDP Growth 2-3 Liquidity Profile of the Indian Banking
System 2-4 Number and Types of Banking
Institutions in India 2-5 Market Shares of State, Private and
Foreign Banks 2-6 Banks’ Net Interest Margins 2-7 Market Position of India’s Top Ten Banks2-8 Dominant Players: Assets and
Profitability 2-9 The Role of NBFCs
2-1 Financial Intermediation Trends in India
___________________________________________________________________________ Asian Banker Research – India 36 Macro Banking Environment
• India’s GDP contribution from finance is about 15%, higher than
that of Australia, Indonesia, Japan, Malaysia, Philippines, Taiwan
and Thailand but lower than the finance sector’s contribution in
China, Hong Kong, Singapore and South Korea. Its financial
evolution has not been even, as some of its financial markets are
very well-developed compared to their Asian peers while others
are in a nascent state.
• The role of banks as financial intermediaries in mature economies
is weakened by the stock market and other intermediaries. Bank
deposits generally account for less than 30% of the total funds in
the financial market as depositors prefer to invest in capital
markets for higher returns from stocks, mutual funds, insurance
policies and bonds, especially in surging capital markets, thus
creating a threat of disintermediation.
• In India bank deposits account for less than 30% of total funds but
its financial evolution has not been even. Some of its financial
markets are very well-developed compared to their Asian peers
while others are in a nascent state. Hence the threat of
disintermediation for banks is limited in the near term.
Unevenly developed financial markets have lessened the threat of disintermediation for banks in the near term Stock markets dominate
0%10%20%30%40%50%60%70%
2000 2001 2002 2003 2004 2005 2006(e) 2007(f)
Stock Exchange Banks
Pension Funds Life Insurance
Mutual Funds
2-1-1 India’s Financial Intermediation Trend by Share of Total Funds
Source: Asian Banker Research
Note: The Unit Trust of India (the largest public sector mutual fund) was bifurcated into UTI MutualFund and the Specified Undertaking of the Unit Trust of India effective from February 2003. The latterdoes not fall within the purview of Mutual Fund regulations. UTI recorded a net outflow of Rs.94,340million in that year.
2-1 Financial Intermediation Trends in India
___________________________________________________________________________ Asian Banker Research – India 37 Macro Banking Environment
• India has a very good securities market system in place. It has two
of the world's largest demutualised stock exchanges that trade
stocks online. BSE and NSE ranked among the top 5 exchanges
globally in terms of number of transactions between 2002 and
2005 and had among the lowest transactions costs. Over 5,800
domestic companies were listed on the BSE and NSE as of
February 2006. Market capitalisation rose by over 300% between
2003 and 2005 because investors perceived Indian equity shares to
have lower risks amid the booming economic environment. India
remains well positioned to attract international funds, though the
increase of interest rates in the United States affected its
investment appeal for the short term following the market
correction of May 2006.
• Although the stock markets dominate the financial sector in India,
the banking sector has held its own, commanding the second
highest share of total intermediated funds. Its share of total fund
allocation fell from about 35% in 2000 to 23% in 2004 while the
share of the stock markets rose. This coincided with the decline of
average interest rates on savings deposits and 12-month time
deposits (and also 6-month time deposits which declined from
2001 till 2003) and the boom in the stock markets. Banks share of
funds has risen sharply since 2004 as they have been on an
aggressive deposit mobilisation drive motivated by the need to
raise funds for their ambitious credit expansion plans based on the
high growth rates experienced in the past few years, especially in
retail financial services. They have been fettered to some extent by
the fact that many Indian households still feel comfortable with a
relatively high proportion of cash holdings and investing in
physical assets like property and gold.
• Compared to the equity markets, India’s bond markets are not as
developed. Government bonds are not very liquid and corporate
bonds make up just 1-2% of India's financial stock compared to
the much higher levels in Thailand, Malaysia and South Korea.
Household exposure to capital markets is low though FII limits on
debt are being liberalised gradually. Developing the capital
The banking sector commands the second highest share of funds India’s bond markets are not well developed Penetration of insurance and pension funds is low
2-1 Financial Intermediation Trends in India
___________________________________________________________________________ Asian Banker Research – India 38 Macro Banking Environment
markets will involve an array of measures to enhance liquidity and
price transparency surrounding government debt, government
securities, interest rate futures and the derivatives markets.
• The share of the insurance and pension financial intermediation
is low in India. Less than 12% of the workforce is covered by
any pension plan and less than 15% of the population has
insurance against health risks. Insurance penetration is
especially low in non-life insurance. Public sector insurance
companies have not been able to penetrate the rural sector. The
insurance industry was opened to the private sector in 2000 and
although the private sector’s role in both life and non-life
insurance has increased rapidly its share is less than one-fourth
of the market.
• The numbers of mutual fund houses have increased since 1993
but in the last two years in particular, mutual funds have become
a popular investment vehicle. This is partly because interest in
mutual funds is a function of stock market sentiments and
growth in market capitalisation in these years was
exceptional. Many mutual funds in India are sponsored by the
government, banks and financial intermediaries and hence
considered a relatively safer way to invest in equities. Bank
deposits lost ground while the share of mutual funds rose in
2004, driving up the resource mobilisation by mutual funds to
Rs. 476,840 million. The bulk of the mobilisation was accounted
for by the better performing private mutual funds. Assets under
management rose from Rs.1396160 million in March 2004 to
Rs.2318620 million by March 2006.
• The role of real estate mutual funds will increase as RBI recently
allowed them to invest directly or indirectly in property companies
as well as deal in mortgage-backed and other securities. Foreign
players are also expected to drive up competition in the mutual
fund industry. For example, Singapore’s Temasek Holdings has
tied up with Sabre Capital Worldwide to launch a Rs 250 billion
mutual fund for Indian equities and bonds.
Mutual funds are becoming popular
2-1 Financial Intermediation Trends in India
___________________________________________________________________________ Asian Banker Research – India 39 Macro Banking Environment
• This does not mean that financial intermediation patterns in India
are set to shift in the near term. The switch from bank deposits
may represent a cyclical shift based on low interest rates and the
bull-run in stock markets rather than a structural shift. With the
overall growing pie, volatility in the stock markets and increased
deposit mobilisation efforts by banks to get deposits from new
account holders, we believe that the rise of mutual funds does not
pose any immediate disintermediation threat to banks. On the
contrary, many of the players in the mutual fund, asset
management and insurance industries are the subsidiaries or non-
banking institutional arms of banking groups. They include the
subsidiaries of ICICI, HDFC and PNB, and UTI Mutual Fund Ltd
is sponsored by SBI, PNB, BOB and LIC. Most banks have started
building their wealth management propositions only in the past 2-
3 years. The new private banks are targeting a broad spectrum of
segments including the mass affluent and overseas Indian
segments but many state banks still lack staff with the advisory
skills required.
• From the systemic and customer points of view, a rise in
disintermediation is in fact a positive factor as developed capital
markets take the pressure off banks by spreading risks in times of
financial distress.
• In most markets, large NPLs, declining deposit rates and high
operational inefficiencies strengthen the case for financial
disintermediation for savers and move them away from banks, and
towards NBFCs. With the rising deposit rates and declining NPLs
in India, banks in the country need to focus more on improving
their operational efficiencies to maintain their position in the
financial markets. A structural shift away from banks will
eventually depend on the development of a greater variety of
alternative capital market instruments and a higher risk-taking
mindset by the Indian people.
Banks can proactively offset the disintermediation trend by diversifying
2-1 Financial Intermediation Trends in India
___________________________________________________________________________ Asian Banker Research – India 40 Macro Banking Environment
• Due to the thinness of the capital markets, banks’ traditional
intermediation role is secure for the time being. In the longer
term, the rise of mutual funds and other NBFIs may affect
their role as intermediaries but it is premature to predict a
decline in banks’ share of intermediated funds because of
greater investment in capital markets. India has a long way to
go before banks have to confront that threat structurally. We
believe that the winning banks will be those who proactively
offset the disintermediation trend by diversifying into these
areas.
2-2 Bank Lending Growth vs. GDP Growth
___________________________________________________________________________ Asian Banker Research – India 41 Macro Banking Environment
• Overall loan growth for the industry has increased dramatically in
the last five years. Industry perceptions in 2005 reflected the view
that even in the major cities it would not reach a plateau until
2008, continuing at around 30% a year. The retail financial
services industry has been growing at an even faster rate, at 40%
annually, albeit from a low base.
• However, we are of the view that with the increasing interest rate
environment and inflationary pressure in 2006, overall credit
expansion will continue to be strong but at a slightly lower rate of
27% in FY2007.
• Retail finance tends to be less sensitive to interest rates compared
to corporate credit, as demand for retail products like housing,
auto and personal loans and wealth management is correlated to
people’s life cycle stages/needs and changes in living standards
over time. Retail loan growth is expected to remain strong till
2008.
• Retail credit has been soaring since the year 2000. The easy
availability of housing loans, credit cards, small loans for
vehicles and household items through dealers, and instalment
schemes, as well as the rise of double-income families and
doubling of incomes across the board in recent years have
Bank lending has increased dramatically in the last five years Strong credit expansion to continue but at slightly lower rates
2-2-1 Bank Lending vs. GDP Growth
Source: Asian Banker Research
0%
5%
10%
15%
20%
25%
30%
35%
2003 2004 2005 2006(e) 2007(f )
GD
P G
row
th &
Len
ding
Gro
wth
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Lend
ing
as %
of G
DP
& Y
oY In
flatio
n R
ate
GDP Grow th Lending Grow th Inf lation Lending as % of GDP
2-2 Bank Lending Growth vs. GDP Growth
___________________________________________________________________________ Asian Banker Research – India 42 Macro Banking Environment
fuelled the consumer boom. The share of retail credit in the total
credit portfolio of the industry increased to 26% in March 2005.
• Favourable demographics, a burgeoning middle class,
urbanisation and under-penetration in the retail banking segment
will drive the future growth of consumer credit. Besides housing
loans, auto and two-wheeler loans will see sustained growth in
the coming years, especially in small cities and rural areas.
• Corporate lending also grew at a robust rate of more than 30% in
FY2006. With the expected increase in capacity additions,
working capital requirements and infrastructure investments,
corporate credit growth will accelerate.
• We believe that consumer credit will continue to be the main area
of competition in the foreseeable future as the appetite for retail
products is likely to grow for another 2-3 years at least. Even if
retail credit were to weaken slightly, we expect the strong
corporate sector to ensure that overall credit expansion will
continue unabated.
Consumer credit will be the main area of competition …but corporate credit growth will also pick up further
2-3 Liquidity Profile of the Indian Banking System
___________________________________________________________________________ Asian Banker Research – India 43 Macro Banking Environment
• There was ample liquidity in the system in 2005, with many banks
having a statutory liquidity ratio (SLR) well above the required
minimum of 25% and adequate growth in deposits to meet credit
demand.
• Liquidity in the market may become tighter in the coming year for
a variety of reasons:
- Liquidity has become dependent on forex reserve
movements. A liquidity crunch was triggered by the
redemption of India Millennium Deposits (IMD) in
December 2005. But shortly after, in March 2006, an
unprecedented increase of $11 billion in forex reserves
created surplus liquidity.
- According to analysts, forex reserves will need to increase
by about 10% to support credit growth of 25% without
straining liquidity. The narrowing of the balance of
payments surplus given the current account deficit and
consequent slowing of forex reserve accretion may tighten
liquidity.
• However fresh doses of foreign liquidity in the later part of
FY2007 (year ending 31 March 2007) may come from the pick-up
in portfolio investments and increased limits on external
commercial borrowings (ECB) and foreign institutional
Liquidity may become tighter if forex reserve accretion slows down
Source: Asian Banker Research
2-3-1 Liquidity Profile of the Indian Banking System
0
500
1,000
1,500
2,000
2,500
3,000
1Q03
2Q03
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
2006
e20
07f
Rs
(bill
ion)
50%
55%
60%
65%
70%
75%
80%
Deposits Credit CDR
2-3 Liquidity Profile of the Indian Banking System
___________________________________________________________________________ Asian Banker Research – India 44 Macro Banking Environment
investments in gilts and corporate debt, in addition to the
continued inflow of FDI and remittances.
• By February 2006, short-term (one-month) interest rates had
moved up by 130 bps from October 2005 to hit 6.33% due to
pressure on liquidity. The interest rates settled at around 6% after
the easing of liquidity in March 2006. State banks' interest rates on
deposits of over one year maturity moved up between April
2005 and March 2006 but their benchmark prime lending rates
(BPLRs) remained unchanged while those of private sector banks
moved up. Between March 2006 and July 2006, the further
upward adjustments in deposit rates made by some private sector
and foreign banks were higher than those by state banks. The
BPLRs of state banks and private sector banks moved up into a
range of 10.75-11.5 % and 11.00-14.5 % respectively while
BPLRs for foreign banks remained unchanged at 10.00-14.5 %.
Going forward, the movement of Indian banks' interest rates in
FY2007 will depend on global developments, domestic liquidity,
inflationary expectations, demand conditions and the lagged
impact of previous policy rate hikes.
• The record high credit-to-deposit ratio (CDR) of 72% in March
2006 points to a strong demand for credit which is likely to
continue for the next 2-3 years. But for state banks, with credit
growth outpacing deposit growth and deposit rates being hiked
with a lagged increase in lending rates, lending during the lag
period would have been less profitable even as it expanded.
• There is also concern that deposit growth may restrict credit
expansion. We believe that banks have been tapping into their
excess SLR reserves to fund credit growth. The SLR ratio which
was close to 42% for the industry in March 2004, fell to 30% in
September 2006. The strong growth lending growth is fast
depleting banks’ SLR holdings down to the minimum required
holding of 25%. This is intensifying competition for deposits
among banks and triggering a spate of deposit rate hikes.
Interest rates have moved up… Deposit growth may restrict credit expansion
2-4 Number and Types of Banking Institutions in India
___________________________________________________________________________ Asian Banker Research – India 45 Macro Banking Environment
2-4 Number and Types of Banking Institutions in India
• The development of the extensive public sector banking network
in India has been aimed at serving national development
objectives and targets. Banks were nationalised at various points in
the post-independence period to spread banking services. Credit
was directed to specific sectors like agriculture and small-scale
industries based on mandatory priority lending requirements often
at subsidised interest rates regardless of returns.
• The commercial banking structure in India consists of Scheduled
Commercial Banks and Unscheduled Banks. Scheduled banks
have to meet certain criteria set by the RBI and are subject to some
conditions and obligations towards RBI regulations. But at the
same time, banks conferred this status enjoy regulatory benefits.
For the purpose of performance assessment, RBI categorises them
as: public sector banks, old private-sector banks, new private-
sector banks, and foreign banks. Each group has its own regional
or sectoral target markets. Besides banks’ own operational
efficiency levels, the level of regulatory support or restrictions
relating to each group determines the benefits and limitations of
operating in India.
• Public sector banks (collectively referred to in this report as ‘state
banks’) comprise the SBI group and 19 nationalised banks. They
have extensive branch networks and enjoy the backing of the
central government. In addition, there are 196 regional rural banks,
40 foreign banks and 86 other scheduled commercial banks in
India.
The development of India’s banking network has been aimed at serving national development targets
2-4 Number and Types of Banking Institutions in India
___________________________________________________________________________ Asian Banker Research – India 46 Macro Banking Environment
Nationalised Banks Old Private Sector Banks New Private Sector Banks
Allahabad Bank Bharat Overseas Bank Centurian Bank of Punjab Andhra Bank City Union Bank Development Credit Bank Bank of Baroda Development Credit Bank HDFC Bank Bank of India Ing Vysya Bank ICICI Bank Bank of Maharashtra The Karnataka Bank IndusInd Bank Canara Bank Lord Krishna Bank Kotak Mahindra Bank Central Bank of India Nainital Bank UTI Bank Corporation Bank State Bank of India Yes Bank Dena Bank Tamilnad Mercantile Bank Indian Bank The Bank of Rajasthan Indian Overseas Bank The Catholic Syrian Bank Oriental Bank of Commerce The Dhanalakshmi Bank Punjab & Sind Bank The Federal Bank Punjab National Bank The Ganesh Bank of Kurundwad Syndicate Bank The Jammu & Kashmir Bank UCO Bank The Karur Vysya Bank Union Bank of India The Lakshmi Vilas Bank
The Ratnakar Bank The Sangli Bank The South Indian Bank The United Western Bank
Source: RBA
• State Bank of India (SBI) is India’s largest commercial bank
and serves as a proxy for the Indian economy. It has an asset
size of over Rs 4,900 billion and an 18% market share of
deposits in the country. The SBI group, including SBI and its
seven associate banks, has more than 13,000 branches and
controls over 25% of the national banking assets. SBI enjoys
a 60% share of government transactions and a 35% market
share in the foreign exchange market. The government and
foreign institutional investors (FIIs) own about 57% and
20% of the bank respectively. The bank has been expanding
its international presence and overseas assets now constitute
11% of its loan book.
• ICICI is the largest bank in India after SBI and the largest private-
sector bank. FII holding in the bank is permitted up to 74%. It is
the market leader in almost all its business lines including
2-4 Number and Types of Banking Institutions in India
___________________________________________________________________________ Asian Banker Research – India 47 Macro Banking Environment
mortgages, auto loans, CV (commercial vehicle) loans, life
insurance, general insurance and asset management. Its wide
distribution network and growing asset book are enabling a rapid
expansion of its insurance, asset management, venture capital,
investment banking and equity brokerage businesses.
• Private and foreign banks generally have much smaller networks
than the state-owned banks but are more efficient. Many of the
new private-sector banks burst onto the scene in the past few
years, bringing new products, more efficient systems and state-of-
the-art technology. They enjoy better profits and are set on
aggressive growth paths limited mainly by regulatory licences.
They have increased competition in the high-grade corporate
market, where margins had already declined with growing access
to global capital markets. They have also been catalysts for
dramatic changes in retail banking. The joint market share of
foreign and privately-owned banks in India is now 25% of total
assets.
• Regional rural banks (RRBs) emerged after 1975 as part of a
multi-agency approach to providing credit to the agro-sector. They
are state-sponsored and regionally-based commercial banks
focused on the development needs of the rural economy including
agriculture, small-scale industries and crafts, particularly small
and marginal farmers, agricultural labourers, artisans and small
entrepreneurs. SBI has sponsored 30 RRBs, which operate in 102
districts in 16 states. HARCOBANK, NABARD, SUCOBANK,
UBI and Syndicate Bank also operate in this space. But despite the
existence of RRBs, a large part of the rural economy still has
access to only informal finance and remains in the grip of
moneylenders.
New private and foreign banks have smaller branch networks than the state-owned banks but are generally more efficient
2-5 Market Shares of State, Private and Foreign Banks
___________________________________________________________________________ Asian Banker Research – India 48 Macro Banking Environment
• The public sector banks control almost three-quarters of aggregate
deposits and gross bank credit in India, with the single largest
entity being the SBI group. Together, the nationalised banks
account for the biggest shares of aggregate deposits and gross
credit. Local private-sector banks, a fragmented group of mostly
small and mid-tier banks, account for less than one-fifth of
deposits and credit while the foreign banks hold market shares of
just 7% and 5% respectively. The expansion of foreign banks in
India has been restricted and the public sector banks protected. But
this is expected to change after 2009 when the restrictions are
eased.
• In line with the higher incomes and greater acceptance of modern
financial products in the cities, deposit and credit size in
urban/metropolitan areas is higher than that in semi-urban and
rural areas for all bank types except regional rural banks. Among
commercial banks, the nationalised banks – a highly fragmented
group but each often strong in specific sectors or regions – are
clearly dominant in all areas.
Public sector banks control almost three-quarters of aggregate deposits and gross bank credit in India Deposit and credit size is higher in urban/metropolitan areas
2-5-1 Positioning of Bank Groups in Aggregate Deposits and Gross Bank Credit (2005)
Foreign Banks(7%)
Regional Rural Banks
(3%)
Other Scheduled
Commercial Banks(19%)
SBI & its Associates
(23%)
Nationalised Banks(48%)
Nationalised Banks(50%)
SBI & its Associates
(24%)
Other Scheduled
Commercial Banks(18%)
Regional Rural Banks
(3%)
Foreign Banks(5%)
DEPOSITS CREDIT
Source: Asian Banker Research
2-5 Market Shares of State, Private and Foreign Banks
___________________________________________________________________________ Asian Banker Research – India 49 Macro Banking Environment
• Foreign banks’ participation in extending credit and mobilising
deposits in semi-urban and rural areas has been negligible as they
have chosen to focus on the wealthier population segments and
hence competed mainly with local banks in urban areas. But in
terms of annual growth, foreign banks showed the highest rate of
increase in deposit mobilisation last year while private sector
banks led in credit lending growth.
• ICICI and HDFC together hold the bulk of market share in many
of the retail loan categories and are likely to be among the main
beneficiaries of the increased penetration of retail credit in India.
But UTI and PNB are also making their mark in the retail sector
and their share of the growing pie can be expected to increase.
2-5-3 Retail Positioning and Growth of Indian Banks
Source: RBI and Asian Banker Research
0%
10%
20%
30%
40%
50%
60%
70%
80%
State B
ank o
f India
HDFC B
ank
Syndic
ate B
ank
Punjab
Nati
onal
Bank
Canara
Ban
k
Bank o
f Baro
da
Orienta
l Ban
k of C
ommer
ce
Union B
ank o
f India
Bank o
f India
UTI B
ank
Centur
ion B
ank o
f Pun
jab
ICIC
I Ban
k
0%
10%
20%
30%
40%
50%
60%
70%
Retail Loan as a percentage of total loan (2005) Retail Loan as a percentage of total loan (2006) Retail loan grow th
Private sector banks led in credit lending growth in 2005
Annual Growth Rates in Aggregate Deposits and Gross Bank Credit (2005)
0%
5%
10%
15%
20%
25%
30%
35%
Rural Semi-Urban Urban Metropolitan TotalAg
gre
gate
Dep
osit
s a
nd
Gro
ss B
an
k
Cre
dit
Deposits Credit
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
SBI & itsAssociates
NationalisedBanks
Foreign Banks Regional RuralBanks
Other ScheduledCommercial Bank
Total
Ag
gre
gate
Dep
osit
s a
nd
Gro
ss B
an
k C
red
it
Deposits Credit
Source: RBI, Asian Banker Research
2-5-2 Annual Growth Rates in Aggregate Deposits and Gross Bank Credit (2005)
2-5 Market Shares of State, Private and Foreign Banks
___________________________________________________________________________ Asian Banker Research – India 50 Macro Banking Environment
• The tremendous potential in the retail credit business is motivating
mid-tier and small banks to build up operational and strategic
strengths in a range of retail segments. UTI, PNB and HDFC
showed strong year-on-year growth in their retail assets in FY2006
at 55%, 52% and 40% respectively. HDFC is among the top three
players in CV loans, auto loans, 2W (two-wheeler) loans and
personal loans. UTI is growing its incremental fee income from
credit cards and NRI (non-resident Indian) remittances. PNB is
focusing on vehicle, educational and flexi housing loans and
developing fee income sources. CBOP, after a successful
integration of the Bank of Punjab franchise, grew its retail loan
book in FY2006 to 70% of its total loans by broadening its
portfolio to include mortgages, personal loans and credit cards. It
also has plans to increase its fee income through cross-selling of
other retail products like third-party products and brokerage,
wealth management and financial advisory services.
Mid-tier and small banks are building up operational and strategic strengths in a range of retail segments
2-6 Banks’ Net Interest Margins
___________________________________________________________________________ Asian Banker Research – India 51 Macro Banking Environment
• Net interest income has been declining for some banks due to a
deteriorating net interest margin (NIM). The reasons are: a sharp
fall in investment yields, a slight rise in incremental deposit costs,
and pressure to keep lending rates for customers low (especially
with the price wars in the mortgage business).
• Banks aggressively undercut each other in 2005 to the extent that
the market saw the first signs of cartelised price fixing, namely by
SBI and PNB who were unwilling to lend below a fixed threshold.
In one instance, the undercutting even resulted in negative net
interest income in corporate lending. While corporate financing is
being offered at increasingly fine rates, the agricultural and SME
sectors are being charged interest of 9% to 10% and above. At
some banks, the position taken for short-term loans is that an
interest rate below 8% will not be acceptable even for prime
borrowers.
• ICICI, with its margin at 2.13% was among the weakest players in
NIMs in 2005. We believe that the bank’s strategy of aggressively
competing for market share rather than quality despite lower
margins is based on the premise that high volumes bring
economies of scale and thereby improve profitability. Other than
margins, profitability also depends on operating cost structure,
quality of portfolio and fee income. The management believes that
transaction volumes and CRM techniques can therefore be
Net interest income declined for some banks due to a deteriorating NIM Banks aggressively undercut each other in 2005
0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%5.0%
2003 2004 2005 2006(e) 2007(f)
Net In
teres
t Marg
in
Punjab National Bank Oriental Bank of CommerceUnion Bank of India HDFC BankCanara Bank Bank of BarodaState Bank of India Bank of IndiaUTI Bank ICICI BankYes Bank Average NIM
2-6-1 Banks’ Net Interest Margin Forecasts
Source: Asian Banker Research
2-6 Banks’ Net Interest Margins
___________________________________________________________________________ Asian Banker Research – India 52 Macro Banking Environment
leveraged on to earn fee income simultaneously with interest
income by bundling products and services through cross-selling to
boost profits.
• The HDFC management, on the other hand, takes the view that
product differentiation can be achieved only up to a certain point.
Differentiation in process quality as well as superior pricing and
service delivery are deemed more important. HDFC’s strategy is
to focus on quality, customer retention and relationship deepening
rather than acquisition. The bank’s margin of 4% in 2005 was the
highest in the industry.
• With the increase of lending rates in the retail and corporate
sectors, there was an improvement in NIM in FY2006 for banks
like HDFC, UTI, ICICI, SBI and PNB. Improvement in margins
can be expected for banks with excess SLR reserves and
substantial CASA (current account and savings account) deposits.
Banks with a high SLR need lower deposit growth to fund the
same growth in advances. With an increase in deposit rates, HDFC
and UTI have an advantage because of their high proportion of
low-cost deposit accounts, as do PNB and SBI. However, ICICI’s
margin can suffer if there is a sharp rise in interest rates as its
deposit mix has a relatively higher share of bulk deposits.
• With Basel II preparations, as banks will have to cater for
operational and market risks by March 2007, additional capital
will need to be provided for high-risk assets. The impact on
margins will see a stronger response from banks on a variety of
fronts in 2006. Rather than undercutting each other, banks need to
decide what business they want to be in and for what price, and the
capital adequacy level and deposit-mobilising ability of banks will
determine their loan growth potential. The reinforcement of the
drive by banks to mobilise low cost deposits is indicative of their
attempts to stabilise NIMs.
NIMs will improve for banks with higher SLR reserves and low cost deposits
2-7 Market Position of India’s Top Ten Banks
___________________________________________________________________________ Asian Banker Research – India 53 Macro Banking Environment
Total Assets
State Bank of India(20%)
ICICI Bank(11%)
Punjab National Bank (6%)
Canara Bank (6%)
Bank of India (5%)
Bank of Baroda(5%)
Union Bank of India(4%)
HDFC Bank (3%)
Central Bank of India(3%)
UCO Bank (3%)
Syndicate Bank(3%)
Others (31%)
Total Deposits
State Bank of India(18%)
ICICI Bank (8%)
Punjab National Bank(6%)
Canara Bank (6%)
Bank of India (4%)
Bank of Baroda (4%)
Union Bank of India(4%)
Central Bank of India (3%)
UCO Bank (3%)HDFC Bank (3%)
Syndicate Bank (3%)
Others(38%)
2-7-1 Market Position of India’s Top Ten Banks
2-8 Dominant Players: Assets and Profitability
___________________________________________________________________________ Asian Banker Research – India 54 Macro Banking Environment
• The huge branch networks of the larger state banks have accorded
them a major advantage that is reflected in their dominance in
aggregate assets in an otherwise fragmented banking structure.
The combined assets of the top three state banks are more than
double that of the top three local private-sector banks and this
huge gap is likely to prevail in the coming years.
• What is noteworthy about the leading private banks like ICICI and
HDFC is that their assets have been built up over a short span of
only four to five years through aggressively growing retail
franchises. By comparison, the state-owned banks like SBI, PNB
and Canara have been more focused on corporate lending and
priority sectors.
• We believe the future competition between banks will be played
out in retail lending, rural and SME finance as state banks have
started to build their retail portfolios more actively while some
new private banks are trying to expand their reach in rural areas
and lending to SMEs .
State banks dominate aggregate assets given a fragmented banking structure …but leading private banks built their assets in a much shorter span of time
Source: Asian Banker Research
2-8-1 Total Asset Comparison of State and Private Banks
*State Bank of India, Punjab National Bank, Canara Bank ** ICICI Bank, HDFC Bank, UTI Bank
0
2
4
6
8
10
2005 2006 (e) 2007(f)Agg
rega
ted
Ass
ets
(Rs
billi
on)
Top 3 State-Owned Banks* Top 3 Private Banks**
2-8 Dominant Players: Assets and Profitability
___________________________________________________________________________ Asian Banker Research – India 55 Macro Banking Environment
• According to RBI estimates for FY2005, foreign banks had the
highest return on assets (ROA) in the industry at 1.3%, followed
by new private-sector banks at 1.1%. Despite their dominance in
assets, the profitability of state banks was the lowest at 0.9%.
• The higher ROAs of foreign banks and private banks were
possible because they managed their NIMs better, developed
diversified sources of fee income and were able to meet operating
expenses from non-interest rather than interest income, and had a
lower cost of funds. Additionally, foreign banks have successfully
leveraged on their direct sales channels to become the dominant
players in the most profitable niches in mass retail. Their sales
forces comprise 60-70% of total headcount.
• We believe that only a few of the local banks (included in the
chart above) will record an increase in ROA in FY2007 compared
with FY2006. The strongest ROA performers among local banks
in FY2007 will be HDFC, IOB and OBC. Not only does HDFC
have the highest NIM and high fee income, but it has also
consistently maintained its asset quality and its provision coverage
of bad loans is the highest among Indian banks. Besides having
one of the best cost-efficiency ratios in the industry, IOB has
enjoyed consistent growth in core earnings and its NPLs have been
declining. For OBC, its merger with GTB has given it an
Profitability of Indian Banks
0.00.20.40.60.81.01.21.41.61.82.0
2004 2005 2006(e) 2007(f)
Retu
rn o
n As
sets
(%)
State Bank of India ICICI BankPunjab National Bank Canara BankBank of India Bank of BarodaUnion Bank of India Oriental Bank of CommerceIndian Overseas Bank HDFC BankUTI Bank Average
Source: Asian Banker Research
Foreign banks enjoy the highest ROA dominating the most profitable niches in mass retail
2-8 Dominant Players: Assets and Profitability
___________________________________________________________________________ Asian Banker Research – India 56 Macro Banking Environment
expanded pan-India presence. OBC’s cost-income ratio (CIR) is
expected to fall as GTB’s salary levels are brought in line with its
own.
• RBI’s recent restriction on the writing back of general provisions
into the profit and loss account will have some adverse impact on
banks that have been using current profits to provide for future
losses.
2-9 The Role of NBFCs
___________________________________________________________________________ Asian Banker Research – India 57 Macro Banking Environment
• Non-bank financial institutions (NBFIs) in India include All-
India Financial Institutions , created for long-term development
financing, non-banking financial companies (NBFCs) and
primary dealers who trade in government securities. The
operations and regulatory focus of each group are different.
• NBFCs are a heterogeneous group including: equipment leasing
companies, hire-purchase companies, loan companies, and
investment companies. Hire-purchase companies have the
highest share (59.6%) of total borrowings by all NBFCs.
Unsecured loans are the single largest source of funds for
NBFCs followed by secured loans, while advances constitute
their main assets.
• The boundaries separating commercial banks and NBFIs are
getting blurred. NBFCs are allowed to enter the credit card
market on their own or in association with other NBFCs or
scheduled commercial banks. Permission is granted selectively
by RBI based on the financial standing of the NBFC.
• In January 2006, there were 12,615 non-deposit taking NBFCs,
of which 104 have assets of at least Rs 100 crore (Rs 1 billion).
The boundaries separating commercial banks and NBFIs are getting
2-9-1 Income and Expenditures of NBFCs
Source: RBI
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
2001 2002 2003 2004 2005
Inco
me
and
Expe
nditu
re to
Ass
ets
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Net
Pro
fit to
Ass
ets
Income Expenditure Net Prof it
2-9 The Role of NBFCs
___________________________________________________________________________ Asian Banker Research – India 58 Macro Banking Environment
Citigroup, with five group companies, heads the list in terms of
aggregate assets followed by GE Capital and its associates. Just
ten companies hold 43.3% of the total assets of this segment,
and five of these are foreign-owned entities.
• NBFCs came into being to fill a void in mainline commercial
banking. They have greater cost efficiency than banks and
greater flexibility in product selection and in pricing of services.
Hence deposit-taking NBFCs in India have been able to pay
more on public deposits than banks. Their contribution to the
development of products such as hire-purchase and leasing is
well recognised.
• Regulatory restrictions on foreign banks in India have triggered
a movement of foreign players into non-bank channels to exploit
the huge retail potential. By forming joint ventures with local
NBFCs, foreign players can gain wider branch access without
the need to engage in priority-sector lending, which RBI
requires of all banks.
Case Studies of Successful Foreign NBFCs in India:
• GE Consumer Finance in India is a pioneer of consumer durable
finance and a key player in two-wheeler loans. The business
model focuses on a direct-to-customer approach through personal
loans, mortgages and home loan products and stronger customer
connection to build long-lasting relationships. It consolidated
under a new global umbrella brand name GE Money in 1994 to
deliver one consistent customer experience country-wide, using it
as a key differentiator across touch points and products.
GE’s growth strategy is to be the preferred lender in the under-
penetrated middle- and mass-market segments, which are still
largely unorganised and have not been credit-tested, by providing
financial solutions for their unique needs. It operates in the small-
ticket segment of personal loans which is not covered by banks
like ICICI. To ensure easy accessibility to customers, it set up
innovative alternative distribution channels to offer its personal
Restrictions on banks have prompted foreign players to move into non-bank channels to exploit the huge retail potential
2-9 The Role of NBFCs
___________________________________________________________________________ Asian Banker Research – India 59 Macro Banking Environment
loans, e.g. kiosks at India Post outlets, HPCL retail outlets (one of
India’s premier petroleum companies), railway and metro stations,
and bus terminals. Its NBFC status allows GE to effect segment
expansion at a much faster rate than RBI would permit for banks.
The GE model is being emulated by several companies. It now
faces the challenge of competitors scaling up in the middle/mass
segment including foreign banks like HSBC, StanChart and DBS.
However we believe it will come up with innovative ways to
decrease costs and grow distribution to counter the competition.
• Citifinancial is also a top player in consumer durable financing.
Although it entered the market only in 2000, later than GE, it has
grown at an aggressive pace with quick approvals and distribution.
Customers acquired through this segment can potentially be
migrated to personal loans ranging from $500 to $8,000. With an
increasing loan portfolio, more favourable interest rate options are
offered to the customer.
Citifinancial’s branch-based lending model achieves superior
returns through a credit evaluation process which minimises
lending risks. Its market leadership in personal loans and in prime
and sub-prime credit cards can be attributed to strong credit-
underwriting and collection systems, a distribution network of 300
branches and sales points in 150 cities, presence in market places,
effective storefront signage, and continuous training. It has over a
million accounts and is engaged in insurance, mortgage and
unsecured loan products. Unlike Citigroup’s banking arm in India,
it faces no restriction to branch growth.
• The GE model in India has been successful because it is based on
simple products made easily accessible to the customer.
Citifinancial’s success has come from its ability to up-sell, made
possible by its strong analytic capability and good understanding
of the interest rate continuum across products. However the two
models have some commonalities in their success: fast approval
process, strong credit and underwriting systems, robust evaluation
….to build market share before the expected liberalisation in 2009
2-9 The Role of NBFCs
___________________________________________________________________________ Asian Banker Research – India 60 Macro Banking Environment
to minimise risk, and sound technology platform to simplify
operations and processes.
• Clearly, the NBFC route offers many advantages and gives
foreign banks an opportunity to build up their market share
before 2009, when foreign participation in the banking sector is
liberalised. But going forward, conditions may get less
favourable for fresh players as RBI has increased its vigilance of
NBFC activities and existing players will try to set up cost
barriers for new entrants.
Chapter 3 Business Composition, Focus and Strategy
Structure of Contents
3-1 Revenue Growth vs. Growth in MarketCapitalization
3-2 Main Sources of Revenue 3-3 Non-Interest Income Comparison 3-4 Asset Creation vs. Deposit Mobilization 3-5 Cost Structure vs. Profitability 3-6 Asset Quality of Indian Banks 3-7 Bank Credit Growth 3-8 Bank Risk Management 3-9 Banks’ Capital Raising and IPO Prospects3-10 Emerging Areas of Growth 3-11 Consolidation of Indian Banks: Rational,
Impediments and Strategies 3-12 List of Domestic M&A Deals, 2004-20063-13 Foreign Banks’ Asset Growth, 2000-20053-14 Operations and Prospects of Foreign
Banks in India 3-15 List of Foreign Acquisition Deals, 2004-
2006
This chapter is designed to give readers an insight intothe business composition of the banks down to theproduct level. We assess their revenue growth, futuresources of revenue and prospects in emerging growthareas and how banks will develop a good mix ofbusinesses to strengthen their balance sheets. Wecompare and assess their potential for developing fee-based income and sustaining credit growth based ontheir capital adequacy and deposit mobilization andcapital-raising activities. We examine their assetquality and risk management capability especially inrelation to Basel II readiness. We examine the trendsand issues in the consolidation of Indian banks and thegrowth and outlook for foreign banks in India.
3-1 Revenue Growth vs. Growth in Market Capitalisation
___________________________________________________________________________ Asian Banker Research – India 61 Business Composition, Focus and Strategy
• The growth in the market capitalisation of Indian banks surpassed
the growth in their revenue in FY2004-FY2006, riding on the
unprecedented stock market boom and the overall positive outlook
for the banking industry given its high rate of loan growth.
Moreover, declining NPLs, better asset quality and improved risk
management have increased public confidence in Indian banking
institutions.
• The outlook for India’s banking industry is the most positive
among its Asian peers. Revenues in the Indian banking sector are
expected to grow significantly faster than those of any country in
the rest of the world until 2007.
• ICICI is one of the best performers in terms of shareholder value.
The positive market perception of ICICI is a result of the high
profile it maintains on account of its leadership in almost all retail
loan categories and a strong focus on expanding its reach through
distribution and sales.
• For top value performers HDFC and PNB, market valuations and
revenue performance are relatively closer when compared over a
The growth in market capitalisation of Indian banks exceeded their revenue growth The major banks were valued higher than their intrinsic revenue performance
BOI
Canara
PNB
OBC SBIUBI
BOB
HDFC
ICICIUTI
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
0% 20% 40% 60% 80%
Growth in Market Capitalisation (2003-2006)
Gro
wth
in R
even
ue (2
003-
2006
) Banks valued according to or below their performance
Banks valued higher than intrinsic performance
3-1-1 Revenue Growth vs. Growth in Market Capitalisation
Source: Asian Banker Research
3-1 Revenue Growth vs. Growth in Market Capitalisation
___________________________________________________________________________ Asian Banker Research – India 62 Business Composition, Focus and Strategy
three-year horizon. Both banks have been consistent performers in
loan growth momentum with better margins, high CAR and high
ROA.
• The major state banks including SBI also enjoy a market
perception exceeding intrinsic value because they are viewed as
reliable government-backed institutions even though they have
much lower revenue growth rates. Their high SLR holdings and
national- and priority-sector commitments mean that relatively
less credit is available for private sector lending. They tend to opt
for less risky clients as their long-term strategy is based on
keeping their risks in check. SBI has a 60% share of government
transaction business. Most of its lending is conducted close to the
prime lending rate, resulting in reasonable but not the highest
range margins as enjoyed, for example, by HDFC Bank.
• In FY2006, Bankex under-performed Sensex by 37%. But what is
noteworthy is that some private banks out-performed Sensex while
state-owned banks underperformed the benchmark. The under-
performance of state banks may be due to fears of the effect of a
rising rate regime on margins and subdued growth in reported
profits.
• Low FII limits tend to depress state banks’ valuations. Among the
19 listed state banks, nine were close to their 20% FII limit
towards the end of FY2006. Among state banks with at least $1
billion in market capitalisation, only BOI, Syndicate Bank and
IOB still had leeway for incremental FII investment. However,
valuations of state banks sometimes fail to take into account their
vast reach, access to low-cost funds and improvement in asset
quality. On the other hand, private banks enjoy higher price-to-
earnings and price-to-book value ratios than state banks because
investors perceive them as being better managed.
Better managed private banks tend to have higher price-to-earnings and price-to-book value ratios than state banks
3-1 Revenue Growth vs. Growth in Market Capitalisation
___________________________________________________________________________ Asian Banker Research – India 63 Business Composition, Focus and Strategy
• There is little correlation between size and profitability as banks
seldom differentiate themselves in pricing. Despite significant
differences in size, India’s largest banks have operating revenue
margins within a narrow range of 1.5% to 2.3%.
• The Indian banking system has seen strong asset generation and
revenue growth over the last few years. Between 2001 and 2005,
assets of commercial banks grew by 30% CAGR while their
operating revenues rose by 41.5% CAGR. Combined revenues are
expected to expand further by 20% annually in the next two years.
• Overall, Indian banks enjoyed healthy net profits in FY2006.
However a closer look reveals that most of the state banks had
shown weak signals for revenue generation in the first half of
FY2006 and that their reported profits had come from drastically
reshuffling provisioning and hiding accelerated human resource
expenses. Revenue generation will take on high priority for state
banks in FY2007.
Indian banks’ operating revenue margins lie within a narrow range Revenue generation will become a high priority for state banks
0
20
40
60
80
100
120
State Bank of India
ICICI Bank
Punjab National B
ank
Canara Bank
Bank of B
aroda
Bank of In
dia
Union Bank of India
HDFC Bank
Oriental B
ank of Commerce
Syndicate Bank
UTI Bank
Oper
atin
g Re
venu
e (in
Rs B
illion
)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Reve
nue a
s % o
f Ave
rage
Ass
ets
Operating Revenue (Rs Billion) Revenue as % of Average Assets
3-1-2 Top Revenue Generators for Indian Banks
Source: Asian Banker Research
3-2 Main Sources of Revenue
___________________________________________________________________________ Asian Banker Research – India 64 Business Composition, Focus and Strategy
• According to a survey conducted by The Asian Banker, the most
significant sources of revenue growth in retail banking in the
coming years will be mortgages, personal loans, credit cards and
wealth management, while corporate revenues will be
concentrated in SME lending, trade and export finance, treasury
services, cash management and structured products.
• Penetration of home loans, credit cards and personal loans in India
is among the lowest in Asia, pointing to the huge untapped
potential in these retail segments.
• All banks in India have a foot in the booming mortgage market
which is growing at about 35% annually in terms of outstanding
loan value. Housing loans make up at least 50% of retail loans, yet
Retail banks’ revenues will be focused in mortgages, wealth management, personal loans and credit cards …and corporate revenues in SME lending, trade and export finance, treasury services, and cash management. Penetration points to the huge untapped potential in retail segments
0
1 0
2 0
3 0
4 0
5 0
Mortgages
Wealth Management
Personal Loans
Credit Cards
Bancassurance
Auto Finance
Subprime Lending
International Banking
Internet Banking
Num
ber o
f Res
pond
ents
3-2-1 The Asian Banker Survey on Main Sources of Future Revenue in Retail and Corporate Banking 2005/2006
0
1 0
2 0
3 0
4 0
5 0
6 0
SMEsTrade & Export Finance
Treasury
Cash Management
Structured Products
Middle Market
Equity Capital Markets
Financing
M&AsPrivate Equity
Investments
Debt Capital Markets
Num
ber o
f Res
pond
ents
Corporate Banking
Retail Banking
Source: Asian Banker Research
3-2 Main Sources of Revenue
___________________________________________________________________________ Asian Banker Research – India 65 Business Composition, Focus and Strategy
penetration is still low at 4% of GDP. Thus, the potential for
growth is huge with increasing urbanisation, rising disposable
incomes and tax incentives.
• Foreign banks showed the strongest growth in the housing loan
market between 1999 and 2002 but have since been overtaken by
domestic banks. However HDFC has been leading in outstanding
loans, having financed 2.4 million housing units in the last 27
years. It has been estimated that there is a shortfall of almost 40
million housing units in India, which suggests significant room for
growth in the demand for housing loans.
• Banks have more than doubled their share of housing loan
disbursements in the past five years. GE Money, an NBFC, is also
expected to see its mortgage portfolio grow substantially in the
long term because of its well developed sub-prime lending model
and aggressive direct-to-customer approach with easily accessible
and unique distribution channels.
• Competition in the mortgage market has been mainly based on
pricing and interest rates, and banks have been trying to expand
their customer base with similar strategies and minimal
product/value differentiation. Most banks offer a combination of
fixed and floating rates coupled with a life insurance policy or free
credit card. Structured home loans have become more attractive
since the launch of the Credit Information Bureau of India Ltd
(CIBIL) in April 2004. We believe that in the rising rate
environment, more and more customers will opt for fixed loan
rates. This poses a risk to the future profitability of banks as NIMs
for mortgages are already small compared to other retail loans.
• Another challenge that banks face is the rising incidence of frauds
in home loans, with builders pocketing loans taken in fictitious
names or for non-existent properties mortgaged to the banks.
Reports reveal that to win more business, some foreign and
private-sector banks have been disbursing loans without the
borrower having to give any margin money. RBI has warned
banks to undertake strict due diligence for disbursing these loans
Housing loan disbursements by banks increased sharply
Housing loan disbursements by banks increased sharply Indian banks need to learn to handle sub-prime mortgage lending to the mass market
3-2 Main Sources of Revenue
___________________________________________________________________________ Asian Banker Research – India 66 Business Composition, Focus and Strategy
and recently increased the risk weight on residential mortgages to
75%, much higher than the Basel II requirement of 35%.
• The mortgage business has been focused on medium to high net-
worth customers in urban areas, though 90% of the housing
shortage occurs in the economically weaker segments. Given the
low penetration of home loans and huge demand for housing,
mortgage lending will continue to be a prime driver of retail
expansion in India. But banks must develop innovative ways to
handle sub-prime mortgage lending and cater to mass-market
demand while keeping their retail portfolios and asset/liability
compositions balanced to avoid adverse effects on profitability.
• With the growing purchasing power across multiple age groups in
India, banks will increasingly focus on the consumption and
payment patterns of the middle class and the very rich to map their
future business strategies. Given India’s large population of young
people, who tend to have higher aspirations and are more receptive
to financial products, there is also tremendous market potential for
modern retail products such as credit cards and personal loans
tailored to the younger age groups.
• Earlier, many banks were not keen on lending to the personal
segment because they did not have the technology to process
small-value loans. This has now changed. Core banking, consumer
banking applications and computerisation have made it possible to
viably process both large-and small-value accounts. Moreover,
relative earnings from the corporate segments have fallen because
corporate entities are enjoying higher bargaining power given their
access to global markets and so tend to dictate the prices. This has
fuelled the interest of both private and state banks in growing the
personal loan segment. At Canara Bank, for instance, personal
loans grew by 36% in FY2006, almost as much as the growth in its
agricultural lending (a priority sector) which grew at 37%.
However banks will need to watch out for higher delinquencies in
this segment.
The market potential in credit cards and personal loans for the younger age groups is high Technology has made processing of small-value personal loans viable for banks With rising incomes, wealth management products are in high demand
3-2 Main Sources of Revenue
___________________________________________________________________________ Asian Banker Research – India 67 Business Composition, Focus and Strategy
• GE Money and Citifinancial, with their strong credit-underwriting
systems, are among the biggest players in sub-prime lending. State
banks have been losing market share in consumer durable
financing to small and mid-sized private banks such as HDFC,
UTI and ICICI, but they have been out-performing private banks
in mortgage and personal loan growth.
• With rising prosperity, the demand for wealth management
products has increased. The Asian Banker estimates that assets
under management in India grew from $247 billion in 2001 to
$355 billion in 2005. Banks have responded with a range of
offerings covering different customer segments. Most banks
entered the market only about two years ago. Products include
mutual funds, insurance, direct equity or real estate funds,
investment advice and commodities.
• Most foreign banks have targeted the upper-end private banking
segments. At Citibank, the top-end CitiGold customers are
serviced by dedicated relationship managers and the mass affluent
segments through the internet and other channels.
• On the other hand, India’s largest private bank ICICI operates in a
broad spectrum of segments ranging from salaried customers to
private banking clients and has garnered a large market share.
• Data warehousing and CRM technology, product linkages and
well-trained relationship managers are critical to establishing a
competitive wealth management business as they enable the bank
to pitch the right products to customers at the right time. HDFC,
which expects to increase its wealth management business to
about Rs 200 crores (Rs 2 billion) in the coming year, has spent
over Rs 10 crores (Rs 100 million) to develop a technology
platform focused on CRM and portfolio execution.
• Many state banks which engage in merchant banking are as yet
reluctant to offer investment advisory services in the absence of
Foreign banks have mostly targeted the upper-income segments
3-2 Main Sources of Revenue
___________________________________________________________________________ Asian Banker Research – India 68 Business Composition, Focus and Strategy
well-trained staff, although online trading and mutual funds are
offered.
• Domestically, the mass affluent segment shows the most promise
and is beginning to receive more attention from the banks. At the
same time, banks are actively pursuing the wealthy non-resident
Indians, whose needs generally centre on remittances and real
estate acquisitions. Banks are also keeping an eye on the “global
Indian” segment, comprising those who are based in India but
have substantial business earnings and capital overseas.
• Competition in wealth management has intensified among foreign
and new private banks. Poaching of relationship managers is on
the increase and staff attrition rates are high. Bankers have
revealed that the average tenure of relationship managers in India
is 1-2 years only. We believe the high turnover will prompt some
banks to reduce the role of relationship managers and instead rely
more on automated systems and centralised research tools to
process asset management in order to protect their customer base
and intellectual capital and, where possible, develop a team rather
than one-to-one approach to CRM.
New private banks are investing in the technology and human resources required… The mass affluent and non-resident Indian segments show the most promise
3-3 Non-Interest Income Comparison
___________________________________________________________________________ Asian Banker Research – India 69 Business Composition, Focus and Strategy
• Increased pressure on NIMs in the last few years and slowing
down of treasury sales accelerated the drive to open up fee income
sources across the banks’ entire lending business, both corporate
and retail. Moreover, trading incomes from forex, bonds and
equities, though more lucrative, are also more volatile. Indian
banks are therefore striving to push up fee income from diversified
sources such as cash management, mutual funds, insurance,
remittances, credit cards and a variety of transaction services for
which they charge processing fees.
• New private banks like ICICI, UTI and HDFC are ahead of not
only other Indian banks but also many of their Asian peers in
driving up fee income. Their fee income growth ranged from 40%
to 60% CAGR over the last three years.
• For ICICI, fee income was a key growth driver in FY2006 and
60% of it came from its retail business. This no doubt accounts for
its ability to compete in a low NIM environment. About half of its
auto and home loans are bundled with fee income from insurance.
Its fee income/operating income ratio is almost three times higher
than that of SBI, India’s largest commercial bank. Fee income
earned simultaneously with interest income through bundling is
the underpinning factor behind its profits.
New private banks are driving their fee incomes towards international standards
Source: Asian Banker Research
3-3-1 Non-Interest Income Comparison
19.3%
28.1%
36.6%
39.9%
45.2%
47.4%
Bank of China
Top State Banks Average***
DBS Group
Top Foreign Banks Average*
Bank of America
Top Private Banks Average**
* Citibank India, HSBC India ** ICICI Bank, HDFC Bank, UTI Bank *** State Bank of India, Punjab National Bank, Canara Bank
3-3 Non-Interest Income Comparison
___________________________________________________________________________ Asian Banker Research – India 70 Business Composition, Focus and Strategy
• UTI’s strong fee income showing is powered by diversification of
its fee income sources including credit transactions, cash
management, ATM sharing, distribution of third-party products
and capital markets. It is the third-largest debit card issuer and the
dominant player in debt syndication and placements in India.
• Besides transaction banking products, HDFC also focuses on
third-party product distribution, depository accounts, insurance,
investment advisory and POS terminals to generate higher fee-
based income.
• The much smaller CBOP and Yes Bank are equally banking on
cross-selling, wealth management, third-party product distribution
and advisory services to grow their fee income aggressively over
the next few years.
• With improvements in loan growth and asset quality, state banks
are beginning to focus on increasing their fee-based income,
though these tend to be linked to business from the government.
• Improved commissions from government business and an increase
in its service charges have helped boost SBI’s fee income.
• Another public sector bank, PNB, has tied up with Princeton
Financial Group of the United States for mutual funds and
insurance products and plans to launch its own credit card to help
generate fee income. Cross-selling has so far been limited and will
be viable only after its data warehousing and CRM programme
become operational.
• The development of complex fee-based services requires the
support of an integrated IT platform that enables the bank to get its
productisation and pricing right with respect to such services and
enhances its cross-selling ability. But many banks do not have this
in place yet.
State banks’ fee income is mostly linked to business from the government But cross-selling and diversified fee income sources will take-off only after their technology is upgraded ….as complex fee-based services require an integrated IT platform
3-3 Non-Interest Income Comparison
___________________________________________________________________________ Asian Banker Research – India 71 Business Composition, Focus and Strategy
• Loan trading, which started in the industry in 2003, will become
another key area of focus as banks attempt to increase corporate
fee income because it enables banks to grow their loan books
without incurring acquisition costs. Nationalised banks that lack
the analytical skills to acquire big-ticket assets rely on the analysis
provided by larger banks to acquire assets in smaller bites of
around Rs 25 crores (Rs 250 million) at a time. So far only a few
banks such as ICICI, Citibank, StanChart and UTI are active in
this area.
• We believe that while the new private banks and foreign banks are
moving rapidly towards international standards in fee income
generation with their innovative product offerings and aggressive
cross-selling, state banks are falling behind as a result of their
continued dependence on government business, cards and
traditional fee-based products. Diversification and development of
their fee income sources is likely to take off only after their
technology upgrading is advanced to the next level.
Loan trading will become another key source of fee-based income
3-4 Asset Creation vs. Deposit Mobilisation
___________________________________________________________________________ Asian Banker Research – India 72 Business Composition, Focus and Strategy
• The overall CDR of the Indian banking system reached a record
high of 72% – which is still low by regional standards – in March
2006 while the incremental CDR exceeded 100% for the last two
consecutive years.
• In the past few years, banks have increased their efforts in deposit
mobilisation to provide low-cost funds for rapid asset growth. The
trends in deposit growth and credit growth show that some banks
started preemptively strengthening their deposit base three years
ago to avoid potential funding issues. The increase in low-cost
deposits has, to some extent, been driven by better technology and
growing ATM networks.
• With the increase in deposit rates, the ability to maintain a low-
cost funding base will become critical to the success of Indian
banks in the longer term. They need to tailor strategies to ensure
continuity of this fund base, since the secondary money market is
not developed and borrowing for various tenures is limited and
costly. Furthermore, India does not have an interbank market with
a long-term money market where banks can borrow one- or two-
year funds easily as in the United States.
With the increase in deposit rates, the ability to maintain a low-cost funding base will become critical for banks
0%
5%
10%
15%
20%
25%
30%
35%
40%
0% 10% 20% 30% 40% 50% 60%
Loa n Grow th 2004-2006 (CAGR)
Dep
osit
Gro
wth
200
4-20
06 (C
AG
R)
BOI
UTI
ICICI
HDFC
HSBC (India)
PNBCitibank (India)
CanaraBOB
SBI
StanChart (India)Kotak
Source: Asian Banker Research
3-4-1 Asset Creation vs. Deposit Mobilisation
Deposit/Credit Growth 1:2
3-4 Asset Creation vs. Deposit Mobilisation
___________________________________________________________________________ Asian Banker Research – India 73 Business Composition, Focus and Strategy
• In FY2006, while many banks grew their lending much faster than
they mobilised deposits, the pace of deposit mobilisation in ICICI
and HDFC exceeded their loan growth. But for ICICI, this came
with higher deposit costs because of its low CASA (current
account and savings account) deposit base. On the other hand,
banks with high CASA deposits benefit from the fact that only
non-CASA deposits are re-priced with an increase in deposit rates.
• Aggregate deposit growth among foreign banks as a group was the
highest in the industry in 2005. Even at a well-capitalised foreign
bank like Citibank, a strategy of complementing asset creation
with deposit generation is favoured and fresh campaigns
advertising flexibility of deposits have been launched. Salary
increases across the board are expected to feed the deposit
mobilisation drive.
• While stronger deposit mobilisation is necessary to maintain the
industry’s high loan growth in the coming years, we believe that
banks will also have to keep a watchful eye on the composition
and cost of their deposits. With lending and deposit rates going up,
banks such as HDFC Bank, PNB and SBI will have more success
at increasing net interest margins in 2006-2007 due to their high
proportion of low-cost deposit accounts (at 40% or more of total
deposits).
Banks with a high proportion of low-cost deposits will have more success in increasing NIMs
3-5 Cost Structure vs. Profitability
___________________________________________________________________________ Asian Banker Research – India 74 Business Composition, Focus and Strategy
• The cost structure and profitability profile of the largest Indian
banks reveal that many state banks are still struggling to bring
their operational costs under control, while the top private banks
have been able to manage their costs more efficiently and hence
achieve higher profits.
• Among the revenue optimisers, i.e. banks with the highest ROAs,
HDFC is the clear leader with a low CIR and an ROA exceeding
2.5% in FY2006 while ICICI, Canara, UTI and OBC have ROAs
in the range of 1% to 2%.
• In contrast, the ROAs of SBI, BOB, BOI, Syndicate Bank and
UBOI were below 1%. We believe the reason for the inferior
performance of most state banks is their high CIR resulting from
excessive staff expenses which are difficult to bring down partly
because of union sensitivities. However for UBOI, one of the
fastest growing state-owned banks, its poor ROA in FY2006 was
due to a sudden fall in treasury profits as yields hardened, which
led to a fall in non-interest income given the lack of well-
diversified fee income sources to act as a buffer.
• PNB stands out among the state banks for its higher profitability.
In FY2006, it achieved the highest ROA among the public sector
banks because of good margins and a high proportion of low cost
deposits. It is developing its fee income source base.
State Bank of India
ICICI
Punjab National Bank
Canara Bank
Bank of Baroda
Bank of India
Union Bank of India
Oriental Bank of Commerce
HDFC
Syndicate Bank
UTI
Yes Bank
40%
45%
50%
55%
60%
0% 1% 2% 3%Return on Assets
Co
st-
to-I
nco
me R
ati
o
3-5-1 Cost Structure vs. Profitability
Source: Asian Banker Research
Revenue Optimisers
Many state banks are still struggling to bring their huge staff costs under control ….leading to inferior ROA performance
3-5 Cost Structure vs. Profitability
___________________________________________________________________________ Asian Banker Research – India 75 Business Composition, Focus and Strategy
Nevertheless, it has also been burdened with a high wage bill.
Fresh recruitments at PNB are now limited and it appears to be
moving in the right direction by deploying surplus staff towards
data loading and direct marketing.
• Area-focused banks tend to have a low CIR. Oriental Bank of
Commerce (OBC), which has the lowest operating expenses in its
peer group, has historically had a strong presence in northern and
western India. It was only after the merger with GTB (then
roughly 15% of the asset-size of OBC) in 2004 that it acquired a
southern presence.
• We expect that in the next few years, operational expenses will
grow dramatically for the majority of Indian banks due to a strong
expansion in their distribution strategies, the upgrading of IT
infrastructure and increased investment in back-end technology.
This is likely to be the case for state banks for several years to
come as they computerise their branches and put in core banking
systems. Large investments in technology result in a high CIR and
weak ROA in the beginning but will yield higher returns in the
future, provided banks are able to leverage on their investments
successfully.
Large investments in technology will also result in a high CIR and weak ROA till banks start to leverage on these investments
-100
0
100
200
300
400
500
600
FY05 1Q06 2Q06 3Q06 4Q06 FY06
Gro
wth
in C
ore
Ope
ratin
g P
rofit
(YoY
, %)
Oriental Bank of Commerce UTI Bank Canara BankBank of Baroda Corporation Bank State Bank of IndiaICICI Bank HDFC Bank
3-5-2 Growth in Core Operating Profits
Source: Asian Banker Research
3-5 Cost Structure vs. Profitability
___________________________________________________________________________ Asian Banker Research – India 76 Business Composition, Focus and Strategy
• The profit performance of many public sector banks has been
disappointing despite robust credit growth in some of them.
Growth in operating profits of banks such as Canara, BOB and
SBI has been muted primarily because of bond losses and declines
in trading income. SBI and some mid-sized state banks have also
reported a decline in net profits. However the picture is not
entirely gloomy as BOB, Corporation Bank and Canara Bank
moved from negative to positive net profit growth in FY2006.
• On the other hand, mid-sized private sector banks like ICICI,
HDFC and UTI sustained or increased the annual growth rate of
their net profits in FY2006 on the back of strong retail loan growth
and high fee income, with UTI Bank experiencing the sharpest
increase in net profits.
• Many financial companies assume that profit growth potential is
determined primarily by external factors such as market
movements, competition and technology, but forget that internal
organisational and operational qualities are vital to the delivery of
a consistent profit line. UTI, HDFC and ICICI have been strong
performers in both operating profit and net profit, but it is HDFC
Bank that has managed to sustain the most consistent profit growth
in both areas over the years. Strong management, high brand
value, good asset quality, good risk management and low net
NPLs distinguish HDFC from other players in the sector.
The profit performance of many state banks has been disappointing despite robust credit growth Internal organisational and operational qualities are vital for consistent performance in operating and net profit
3-6 Asset Quality of Indian Banks
___________________________________________________________________________ Asian Banker Research – India 77 Business Composition, Focus and Strategy
• The average of the gross and net NPL ratios for the selection of
major Indian banks shown has declined since 2004 reflecting the
continued trend towards the improving asset quality across Indian
banks. This trend is expected to continue through FY2007.
• According to RBI estimates, the overall NPL-to-capital ratio
(which shows the combined effect of improving capital adequacy
and asset quality, both crucial indicators of the soundness of the
country’s financial system) had dropped from 71% in March 1999
to 15.5% in March 2005.
• For the industry, gross non-performing loans (NPLs) declined for
two consecutive years in FY2003 and FY2004. High treasury
profits in these years enabled banks to write off their NPLs more
aggressively, while the recovery of NPLs was aided by better
economic conditions and banking reforms. This was a notable
achievement given the more stringent NPL classification standard
based on a 90-day overdue period, halved from 180 days
previously. The setting up of the Asset Reconstruction Corporation of
India also helped boost banks’ recoveries of NPLs. Amelioration of
non-performing assets remained robust in FY2005 and continued
apace for most banks in FY2006.
• ICICI’s comparatively high NPL rate among private sector banks
indicates higher risk taking in its portfolio management. With over
0
2
4
6
8
10
12
Bank of B
aroda
Punjab National Bank
Bank of In
dia
State Bank of India
Union Bank of India
Syndicate Bank
Canara Bank
Oriental Bank of C
ommerce
ICICI Bank
UTI Bank
HDFC Bank
Gros
s non
-perf
ormi
ng lo
ans a
s a %
of to
tal lo
ans
NPL'04 NPL'05 NPL'06(e) NPL'07(f)
3-6-1 Asset Quality of Indian Banks
Source: Asian Banker Research
Asset quality in both private and state banks has been improving
3-6 Asset Quality of Indian Banks
___________________________________________________________________________ Asian Banker Research – India 78 Business Composition, Focus and Strategy
• 70% as retail loans, its asset portfolio is vulnerable to system-wide
deterioration in the quality of retail assets and increased
delinquency may come with robust loan growth. Other banks like
UTI Bank and CBOP which are aggressively growing their retail
portfolios will also have to be mindful of this. For UTI Bank, a
rise in delinquencies in the retail segment could hurt profits
significantly given its low provision cover.
• NPLs continued to decline in FY2006 for all the major state banks
except UBOI which saw a sharp deterioration in asset quality in
the third quarter. The UBOI management believes the increase in
NPLs is of a technical nature and would be reversed in FY2007.
UBOI had one of the highest net NPL levels among the state-
owned banks in FY2006, as did SBI. But for SBI, the decline of its
NPL ratio to 1.87% is a good achievement considering its huge
asset size. The bank is believed to be seeking a buyer for its NPLs
as RBI is keen to resolve the country’s NPL issue through bad-
debt disposal.
• The level of NPLs for the housing segment has been one of the
lowest, but could go up with the rising incidence of home loan
frauds. Weak credit-risk monitoring and documentation processing
could worsen asset quality amid massive demand.
• Banks will have to look beyond acquisition and towards better risk
management to contain the NPL problem. HDFC Bank, with its
low net NPL ratio, has one of the best prudential policies in the
industry. Citibank, given its large volume-based business, has a
strong collection mechanism which accounts for its low charge-off
rates (as a percentage of total credit outstanding) compared to
other banks.
• While the improving asset quality among Indian banks is an
encouraging sign, the country’s banking sector has not gone
through a major economic downturn in the recent years and so the
banks’ risk capabilities, although strong, have not been tested yet.
Banks with a high proportion of retail assets are vulnerable to system-wide deterioration in retail asset quality Indian banks’ risk management capabilities have not been tested through a severe downturn
3-7 Bank Credit Growth
___________________________________________________________________________ Asian Banker Research – India 79 Business Composition, Focus and Strategy
• Most of the banks in India achieved loan growth exceeding 20% in
FY2006 with some like Yes Bank, ICICI and UTI growing
aggressively at 55% or more. Going forward, some banks may be
constrained by insufficient capital and/or a low funding base.
• Among the public sector banks, PNB and Bank of Baroda have
strong loan growth potential as they are maintaining a good
balance between their capital adequacy ratio (CAR) and loan-to-
deposit (LDR). The largest state bank SBI is also well placed for
future credit expansion. Its LDR is just above 65% and its CAR is
only slightly below 12%. With a large base of CASA deposits, its
average cost of deposits is less than 5%, which is hard for other
banks to match.
• The state banks in greatest need of raising more capital and
deposits are Bank of India, Union Bank of India and Syndicate
Bank, with their LDR exceeding 65% and CAR less than 12%.
Bank of India is likely to go for hybrid instruments overseas to
raise capital. To sustain its high loan growth, at 33% in FY2006,
Union Bank of India needs to shore up its Tier I capital which
remains low even after a recent capital-raising exercise. It is also
Bank of India(19%)
UTI Bank (55%)
HDFC (37%)
Union Bank of India (33%)
Syndicate Bank (36%)
State Bank of India (29%)
Punjab National Bank (24%)
Canara Bank(32%)Oriental Bank Of Commerce (32%)
ICICI (60%)
Bank of Baroda(38%)
Yes Bank(216%)
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
10% 11% 12% 13% 14% 15% 16% 17%
Capital Adequacy Ratio
Loan
-to-D
epos
it Ra
tio
Banks need to raise both capital and deposits
Banks need to compete for deposits more aggressively than for credit growth
Banks with excess liquidity but need to raise more capital
Banks with strong loan growth potential
Size indicates loan growth.
3-7-1 Capital Adequacy Ratio vs. Loan-to-Deposit Ratio
Source: Asian Banker Research
Some banks may be constrained by insufficient capital and/or a low funding base
3-7 Bank Credit Growth
___________________________________________________________________________ Asian Banker Research – India 80 Business Composition, Focus and Strategy
likely to use hybrid instruments in the later part of the year rather
than dilute its equity further. Syndicate Bank underwent a capital
raising exercise in 2005 which diluted government stakeholding in
the bank but it still needs more funds to support credit expansion.
• New private banks UTI and HDFC have excess liquidity, being
well stocked with low-cost deposits. UTI plans to raise capital
through hybrid instruments and subordinated bonds at home and
abroad (taking advantage of the MTN route) but may still require
an injection of equity capital in FY2007 because of its strong loan
growth (at 55% in FY2006). HDFC, with a higher CAR and
slower loan growth (37% in FY2006), should be fairly
comfortable sustaining its current growth rate without equity
dilution. But if the bank grows any faster and does not raise hybrid
capital, it would need more equity capital in FY2008.
• ICICI and Yes Bank have been growing their loan portfolio at an
aggressive pace. ICICI’s mega capital-raising in 2005 has given it
a favourable CAR. But although its deposit growth exceeded
growth in advances in FY2006, ICICI will need to maintain its
efforts in mobilising low-cost deposits if it is to keep up its rapid
acquisition going forward.
• As its deposit mobilisation and fee income generation are limited
by a still small branch network and delays in branch expansion
plans, Yes Bank’s NIM will be under pressure because of rising
cost of funds. Despite a comfortable CAR, it will need to raise
enormous amounts of equity capital to fund its phenomenal
growth rate which exceeded 200% in FY2006.
• Indian banks will have to do a fine balancing act between raising
capital and low-cost funding and pursuing their credit expansion
plans. Besides a deposit mobilisation drive, we believe the next
year will see increased use of hybrid instruments rather than equity
issuance to make up for deficiencies in capital adequacy without
diluting equity.
An increased used of hybrid instruments to make up capital deficiencies is likely in the coming year
3-8 Bank Risk Management
___________________________________________________________________________ Asian Banker Research – India 81 Business Composition, Focus and Strategy
• The average CAR of Indian banks, at 12%, is higher than that of
China, Taiwan, Korea and Thailand though lower than the levels
prevailing in Indonesia, Hong Kong and Singapore. India’s loan
delinquency ratio of 7.2% is also significantly lower compared to
its Asian peers.
• The outlook for NPL clean-up is positive. The practice of joint
corporate debt-restructuring among banks, the use of Debt
Recovery Tribunals for realisation of dues, and the power given by
the Securitisation Act to take recovery measures without court
intervention are facilitating faster resolution of bad debts. A
committee has also been formed to share best practices in risk
management among banks.
• Credit risk in India has been an area of concern mainly because of
the rapid growth in retail credit over the past 4-5 years and doubt
about whether banks have put in place appropriate risk
management practices for the whole spectrum of retail loan
categories. Many banks continue to process loan approvals at the
branch level, while foreign banks and a few of the new-generation
banks are run on more advanced models.
India’s loan delinquency ratio is much lower compared to its Asian peers Joint corporate debt-restructuring is facilitating faster NPL clean-up
3-8-1 Bank Risk Management (CAR)
Source: Asian Banker Research
0%
5%
10%
15%
20%
25%
India
Indon
esia
Hong K
ong
Singap
ore
Malays
ia
Thaila
ndKore
a
Taiwan
China
Cap
ital A
dequ
acy
Rat
io
Tier 1 Total (Inc. Tier 2) CAR
3-8 Bank Risk Management
___________________________________________________________________________ Asian Banker Research – India 82 Business Composition, Focus and Strategy
• Risk management at state banks has been improving. Treasury
profits in the past few years have been used to raise provisioning
levels to cater for any future downturns. As part of a long-term
strategy to keep its asset risk in check, SBI is not pursuing riskier
clients.
• Foreign banks like Citibank and Standard Chartered Bank have
strong risk-management capabilities. Among other things, they
have sophisticated segmentation and data-mining strategies, which
local bank HDFC has also developed. In addition, HDFC has a
centralised credit policy and a regional structure for credit
approvals distinct from its sales channels. This allows for
uniformity in approval processing and portfolio homogeneity and
removes dependence on the decisions of individual branch
managers.
• Although mortgages comprise almost 50% of the retail portfolio of
most major banks, it is perceived by banks as a relatively low-risk
segment. However, with the expected surge in housing loan
disbursements, delinquencies in this segment could increase
significantly in the absence of strong credit-risk management.
There is also concern that in the event of a credit squeeze and
consequent slowdown in construction, delinquencies could rise as
a major part of loans disbursed are for residential properties under
construction. We also believe that delinquencies on personal loans
and 2W (two-wheeler) loans could also rise as banks expand
aggressively into these segments, but this is unlikely to raise
systemic risk as they are secured and small-ticket loans.
• While there is now a credit bureau in India, it does not have
enough depth with respect to comprehensive information on the
customer and is not linked to scoring and customer performance
systems of banks. Some local banks have internal rating systems
based on application or behaviour scoring. A few banks like
HDFC have risk-based pricing in retail lending but, in the absence
of a customer credit-rating system, this tends to be on a product
basis rather than customer basis. By developing surrogate credit
Treasury profits have been used to raise provisioning levels …but India’s credit bureau lacks sufficient depth …and few banks have risk-based pricing
3-8 Bank Risk Management
___________________________________________________________________________ Asian Banker Research – India 83 Business Composition, Focus and Strategy
evaluation tools and risk profiling of existing customers, these
banks are able to profile what potential customers may want and
are able to price based on risk and cost of funds.
• On the corporate side, banks can make use of the ratings by
CRISIL. However some banks do have an internal rating model
based on the value and performance of the relationship to the
bank.
• The efficiency of a bank’s risk management system is influenced
by its staff incentive and remuneration structure. Some Indian
banks are learning to incorporate the demands of risk management
into remuneration structures but it is only partial, as a number of
financial and non-financial parameters come into play and there is
a need to strike a balance between loan targets and risk.
• Banks will be forced to convert capital to meet market and
operational risk guidelines prescribed under Basel II by 2007. As a
preemptive measure, since March 2006, RBI has allowed banks to
integrate investment fluctuation reserves into not only the Tier II
category but also Tier I. This will lift the Tier I capital by over
20%. Banks with a higher Tier I CAR and a high SLR such as SBI
and PNB will be better equipped to support strong loan growth in
the coming year.
• RBI has been increasing risk weights on several retail categories
including mortgages to deter irrational pricing. These risk weights
are currently much higher than those required under Basel II. We
believe there could be a reduction in these weights in March 2007
to bring them closer to Basel II requirements.
• The rush to meet Basel II implementation deadlines has led to an
increased focus on risk management practices in banks across the
board. With a host of consultants and software providers offering
Basel II-related services and systems, there has been a definite
strengthening of the system as a whole. Indian banks were
required to commence a parallel run of the revised Basel II
Risk management incentives have not been fully incorporated into remuneration structures Risk weights on several retail categories have been increased Most banks will meet Basel II requirements by March 2007
3-8 Bank Risk Management
___________________________________________________________________________ Asian Banker Research – India 84 Business Composition, Focus and Strategy
framework from 1 April 2006. RBI’s expectation is that by March
2007, Indian banks would have adopted the Standardised
Approach for credit risk and the Basic Indicator Approach for
market and operational risks. RBI is maintaining close supervision
on a bank-by-bank basis. Feedback from bankers indicates that
most banks are on track to meet these requirements.
• Beyond March 2007, a few banks may aspire to move to
Internal Ratings-Based (IRB) approaches. While
implementation of the Standardised Approach is possible
with core banking systems which most local banks are
putting in place, the IRB approaches require both current and
historical data and hence data warehousing which most
banks do not have. Only the foreign banks and leading
private banks like HDFC and ICICI have the potential to
move on to IRB approaches.
Most banks will meet Basel II requirements by March 2007 …but very few will move to the IRB approach
3-9 Banks’ Capital Raising and IPO Prospects
___________________________________________________________________________ Asian Banker Research – India 85 Business Composition, Focus and Strategy
• Many Indian banks need huge capital injections as they transform
themselves into modern banking institutions. With strong credit
growth ahead and preparations underway to convert capital to
comply with Basel II operational risk regulations by March 2007,
capital raising activities among the banks have been increasing.
Since RBI wants to keep a stake of 51% in state banks, it has
introduced new schemes to enable banks to raise capital without
diluting equity.
• The year 2005 saw many of the mid-sized banks seeking to
leverage on the strong markets by launching their second public
offerings. Strong performance indicators have helped large and
mid-sized banks to successfully tap into the international markets
for first- and second-tier capital mobilisation.
• From January 2005 to March 2006, Indian banks raised over $4
billion from equity issuances. The eye-turner was ICICI’s mega
capital-raising venture in 2005 which raised Rs 79.56 billion and
put it ahead of SBI in terms of market capitalisation.
• Many of the mid-tier and small banks including Canara Bank, UTI
Bank and Development Credit Bank (DCB) need additional capital
in FY2007. UTI announced a new debt issue in August 2006.
DCB has seen deterioration in its financials during the last two
years and several delays in its IPO plans, but an IPO is a
0
20,000
40,000
60,000
80,000
100,000
Andhra
Bank
Bank o
f Baro
da
ICIC
I Bank
Syndic
ate B
ank
Yes Ban
k
Orienta
l Ban
k of C
ommerce
Allaha
bad B
ank
Punjab
Nati
onal
Bank
Dena B
ank
Union B
ank o
f india
South
India
Bank
Centur
ion BOP
Federa
l Ban
k
Issu
e si
ze (R
s m
illio
n)
3-9-1 Bank’s Capital Raising and IPO Prospects (January 2005-March 2006)
Source: Asian Banker Research
Indian banks’ capital-raising has increased to cater for strong loan growth and Basel II preparations Large and mid-sized banks have successfully raised capital from international markets
3-9 Banks’ Capital Raising and IPO Prospects
___________________________________________________________________________ Asian Banker Research – India 86 Business Composition, Focus and Strategy
possibility for FY2007. UBOI will also need more capital even
after its latest Tier I issue. Indian Bank and Central Bank may go
for listing in FY2007 while BOI and UCO are considering hybrid
capital instruments.
• The introduction of hybrid capital has reduced concerns about the
capital-raising capabilities of state banks. The move by RBI to
allow integration of investment fluctuation reserves into not only
the Tier II category but also Tier I from March 2006 will also help
the state banks in the near term to grow their loan books and Basel
II provisioning without necessarily tapping into the capital markets
and hence diluting their equity.
• Commercial banks in general are much better placed to meet Basel
II requirements by March 2007 than co-operative banks and
regional rural banks, who will find it difficult to do so. After the
recent capital expansions, most of the major banks are reasonably
well-capitalised vis-à-vis Basel II readiness and their loan growth
plans. With the availability of hybrid instruments for Tier I capital
raising, we believe there will be less need for equity dilution and
consequently lower equity issuance in the coming year.
Hybrid capital availability has reduced state banks’ capital-raising concerns ….and lessened the need for equity issuance
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 87 Business Composition, Focus and Strategy
3-10 Emerging Areas of Growth
• Retail banking will no longer be the only major source of growth
in the coming years as other areas of banking gain prominence.
Agricultural finance, SME and infrastructure lending as well as
lending to the automobile and telecommunication markets are set
to take off. This would not only help offset any deceleration in
demand growth for consumer financial products due to interest
rate increases but also boost asset building.
• Core banking and computerisation have made it possible for banks
to viably process smaller-value accounts. This coupled with the
relatively lower returns from corporate sector lending and the
intensifying competition and thinning margins in retail lending has
encouraged them to take more interest in the rural, SME and
personal loan segments.
Rural Lending
• Over 75% of India’s population live in rural areas, yet this
segment remains severely underserved. Close to 45% of the
country’s GDP is generated in rural India but credit penetration is
only 16%, less than half of the national average. We believe rural
banking now offers viable opportunities for lending and
investment products.
• Lending methods such as dealer financing and contract farming
will become key areas of focus in the coming years. State agencies
are partially privatising the food-grain distribution process,
fuelling infrastructure investments that will give a boost to bank
lending. In dealer financing, banks pay farmers directly once the
produce (e.g. rice and wheat) is ready to be picked up by private
operators taking over the transportation, safe storage and
warehousing logistics of the commodities.
• The practice of contract farming has become more common
since PepsiCo, which entered India’s agro-business in 1989,
Thinning margins in corporate and retail lending are prompting banks to explore other viable growth areas Interest in rural and SME lending ha increased Dealer financing and contract farming will become a key focus
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 88 Business Composition, Focus and Strategy
successfully used this system for its export commitments.
Agricultural finance, conventionally based on production needs,
is more profitable if banks unlock and re-assess the entire value
chain from production to consumption. The new commodity
exchanges operate through the same intermediaries but pay
better prices to farmers. Banks are now involved in sugar cane,
pulses and fertiliser production, funding inputs, insurance
(including weather insurance), storage, warehousing and
transportation through dealers, thus enabling better pricing and
lower risks for the farmers. Farmers can store excess produce in
warehouses and sell when prices improve, and in the meantime
they can take loans from banks based on these warehouse
receipts.
• Several state banks and private banks are participating in micro-
financing for farmers through non-governmental organisations
(NGOs) and self-help groups which assist in the maintaining of
financial discipline and the recovery of loans. External
coordinators from NGOs are engaged to create awareness about
the financial assistance facilities and products available.
• With the largest branch networks in rural and semi-urban areas,
nationalised banks clearly have an advantage in terms of rural
bank lending. However, some private banks are trying to go
beyond traditional branch banking by operating through
franchisees, micro-finance institutes, rural marketing agents
(RMAs) and corporate partnerships which offer lower
operational costs and better information.
• RBI has directed state banks to double their lending to the
agricultural sector within three years. Thus agricultural lending
at public sector banks is expected to increase on average by 33%
annually during this time span. Unlike loans for farm machinery
which are time-specific, crop loans are of a recurring nature and
hence likely to become an attractive segment for banks. Farmers
and SMEs are primarily concerned with being given timely help.
Returns on agri-loans are becoming comparable to – and in
Banks are getting involved in financing various parts of the value chain from production to consumption ….and micro-financing for farmers through NGOs Returns on agri-loans are becoming favourable
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 89 Business Composition, Focus and Strategy
many cases more favourable than – returns on corporate loans,
where banks have to contend with the stronger bargaining power
of corporations given the latter’s access to global markets.
• For PNB, agricultural financing is a thrust area. Procedures for
opening bank accounts have been simplified for farmers. It has
also launched a Kisan Credit Card with liberalised provisions
that allow it to be used not only for crop loans and farm
machinery but also for personal purposes such as education,
weddings and other social functions. This additional facility can
help save farmers from the clutches of local moneylenders. PNB
sees the card as the most profitable part of its agri-segment.
• Besides distributing crop loans through the Kisan (farmer)
Credit Card programme, SBI offers a micro-financing scheme
that provides funding to women in rural India. ICICI and UTI
have used the kisan card as a means of payment. Dues to dairy
farmers, for example, are loaded onto the credit cards and can
then be converted to cash through a simple ATM transaction.
HDFC has launched a “Kisan Gold Card" with Visa at a 9%
interest rate with a 30% allocation for personal loans.
• While the main idea behind the kisan card concept is to create a
banking habit among rural dwellers across a spectrum of needs,
the core proposition in commodity financing through
commodity exchanges is to allow the farmer to receive money
against collateral. Collateralised commodity financing is likely
to become an attractive segment for banks.
• Bankers reveal that delinquencies in metro cities are often higher
for loans at lower pricing than for loans to the agricultural sector, a
fact that favours the increased focus on the latter. The viability of
extending branches to rural areas is also not likely to be an issue as
the costs of setting up a branch such as rentals and staff salaries
are lower in these areas. Moreover, it is unnecessary to have a
presence in every village, as small towns can be used to service
The farmer’s credit card serves a spectrum of needs and is profitable for banks Collateralised commodity financing will also become an attractive segment
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 90 Business Composition, Focus and Strategy
several villages through a hub-and-spoke model and centralised
processing.
• Agri-financing is increasingly looking to be a promising segment
that is not only profitable but also highly scalable. The lending
will be aligned with multi-product and infrastructure investment,
encompassing the consumption needs of the farmers and also
shifting towards the most profitable sectors in the agri-business.
SME Lending
• Banks will also ramp up their SME business in 2006-2007. The
government’s earlier focus on the SSI (small-scale industry) sector
has now expanded to encompass SMEs. With the government and
the Reserve Bank of India urging banks to step up lending to this
sector, most banks are offering dedicated services and products to
cater to the needs in this segment.
• The definition of SME in terms of turnover and assets varies
among banks. With the regulator providing no clarity on this,
banks define it to suit their portfolio management requirements.
For some banks, an SME is a company with total assets of Rs 100
crores (Rs 1 billion) or less. Other private and foreign banks are
using higher asset norms or turnover thresholds. Confusion reigns
in accounting terms too as some banks classify SME lending as
retail lending while some put it under the corporate middle market.
• A few years ago, the newer private-sector banks were averse to
scaling up SME lending. But now this segment is expected to see
growth of over 30% in FY2007. Banks are drawn by the high
returns with the annual yield on SME loans at above 9%, higher
than that in retail lending. That bank-switching costs for SMEs are
relatively high and SMEs are more likely to be loyal customers
would also add to this segment’s attractiveness to banks.
• ICICI has more than doubled its business in this segment in the
last three years. For Bank of India, the SME segment is driving the
For some state banks the SME segment is a growth driver New private-sector banks are no longer averse to scaling up their SME lending
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 91 Business Composition, Focus and Strategy
growth of its current account portfolio and is expected to grow to
become a key revenue source.
• Lending to the SSI/SME segment currently constitutes 11-12% of
the total lending at PNB. The bank has established special credit
cells for SMEs. It has four hubs devoted to SMEs and plans to
increase the number to ten in the coming year. Large volumes and
good interest rates help to cover the cost of transactions.
• The two main challenges that banks have been facing in SME
lending are the lack of information regarding small borrowers
and consequent costs incurred to develop the required
information systems, and the lack of expertise in small-ticket
loan pricing and risk assessment. Collateralised lending can help
mitigate these risks.
• Some banks have tied up with credit rating agencies with a view
to assigning ratings to SME borrowers. This ensures the quality
of lending is maintained and enables banks to determine the
appropriate interest rates, margins and collateral requirements
for these borrowers.
• A cluster-based approach for financing the SME sector may help
to reduce transaction costs, mitigate risks and provide an
appropriate scale for improving infrastructure catering to this
segment. Government agencies have initiated the process of
establishing Small Enterprises Financial Centres for identified
clusters where the risk profile of each cluster will be studied by
a professional credit-rating agency and the risk-profile reports
produced will be made available to commercial banks.
• Banks have become savvier in SME lending compared to a few
years ago. Moving away from working capital financing and
changing the chain of credit reflect innovative banking. Earlier,
manufacturers borrowed for work in progress, receivables and
finished goods. By switching from lending to the manufacturer
to lending to the dealer, banks are increasingly also able to lend
Collateralised lending mitigates the risks of lack of information and expertise in small-ticket loan pricing A cluster-based approach can help reduce transaction costs
3-10 Emerging Areas of Growth
___________________________________________________________________________ Asian Banker Research – India 92 Business Composition, Focus and Strategy
indirectly to SMEs via the dealer. Dealer financing not only
enables banks to take on the risk of lending to an SME customer
but also decreases the exposure for the manufacturer, who
receives his dues as soon as the finished goods are transferred to
the dealer who then carries the credit till the goods are passed to
the customer. For banks, their ability to leverage on this win-win
arrangement will therefore depend crucially on the extent of
their dealer network penetration.
Dealer financing enables banks to take on the risk of lending to an SME customer
3-11 Consolidation of Indian Banks: Rationale, Impediments and Strategies
___________________________________________________________________________ Asian Banker Research – India 93 Business Composition, Focus and Strategy
3-11 Consolidation of Indian Banks: Rationale, Impediments and
Strategies
• No Indian bank except SBI is of a global scale. The still
fragmented profile of the Indian banking system has made
consolidation imperative given that increased competition can be
expected after 2009, when the sector is opened further to foreign
competition.
• RBI has mandated that consolidation of the state banks should be a
top priority to prepare banks for increased competition from
foreign players, but implementation in this area has been
extremely slow. Contradictory regulations from RBI and the
finance ministry have impeded the materialisation of a
comprehensive roadmap similar to those in Indonesia and Taiwan.
With the goal of RBI being to create five or six banks that will be
among the world’s top 100 banks based on asset size, the number
of state banks will have to be reduced from 27 to 10 in the next
four years. This will be very challenging, considering that only 34
banks and non-banking finance companies have been merged in
the last 45 years, and most were directed to do so by RBI to
preserve stability in the banking system.
• There are three major reasons why an acceleration of
consolidation would be difficult in the Indian context: huge
geographic disparity within the country, unionisation of banks, and
technological incompatibility between real-time core banking and
manual approaches. Moreover, there is still room for organic
growth in the yet-to-mature consumer and wholesale markets.
• Nonetheless, state banks are already communicating behind the
curtain to pave the way for mergers and we expect to start seeing
more visible progress in consolidation efforts soon. For instance,
ongoing merger talks between Union Bank and Bank of India may
be finalised in the coming year. While the large state banks are
striving to enter the league of the world’s top 100 banks, small and
The fragmented profile of the Indian banking system has made consolidation imperative RBI wants to reduce the number of state banks to ten in four years Negotiations are afoot but the consolidation process has not yet taken off in a big way
3-11 Consolidation of Indian Banks: Rationale, Impediments and Strategies
___________________________________________________________________________ Asian Banker Research – India 94 Business Composition, Focus and Strategy
mid-sized banks are trying to make acquisitions and alliances to
fill regional gaps and expand their distribution network.
• Consolidation will bring huge cost savings to the banks but the
potential job losses remain a sensitive issue. Despite the strong
business case for consolidation, political factors dim the prospects
of faster negotiations and regulatory approvals.
• There is a need to build more awareness among unions to gain
their cooperation in the process but this would take time. Getting
the buy-in of unions would lower the possibility of strikes like the
incident in November 2005 which brought banking transactions to
a standstill.
• We believe there will be a shift in the motivation behind bank
mergers in India. Earlier mergers between weak or smaller banks
or agricultural banks were prompted by directions from RBI. But
increasingly, even reasonably healthy small banks are becoming
receptive to synergistic merger opportunities, motivated by the
urgency to expand scale and/or geographical reach so that they can
compete with foreign banks after the liberalisation of controls in
2009.
• In a positive move, Corporation Bank, Oriental Bank of
Commerce and Indian Bank have recently formed a first-of-its-
kind alliance to circumvent the sensitivities of consolidation as it
will not impact employees or customers. They will share both
infrastructure and staff and jointly look for larger loans (that
would typically go to bigger banks) as well as fee-based income
products. Cost savings on infrastructure and operations will help
improve profitability. How well these banks will be able to
coordinate back-end operations with front-line initiatives remains
to be seen. If successful, it will be the harbinger of a new trend
towards such alliances.
Potential job losses remain a sensitive issue The motivation behind bank mergers is shifting…..to expand scale and reach before 2009 Banks are also exploring alternate routes through unique alliances
3-12 List of Domestic M&A Deals, 2004-2006
___________________________________________________________________________ Asian Banker Research – India 95 Business Composition, Focus and Strategy
*Acquirer name not available.
• Since the completion of the merger between Centurion Bank and
Bank of Punjab in 2005, a deal involving Lakshmi Vilas Bank and
another involving Bank of Rajasthan have been announced. Tamil
Nadu Mercantile Bank and Catholic Syrian Bank are looking for
buyers and rumours of talks between several other local banks are
rife. The merger between Bharat Overseas Bank and IOB is
pending while there is speculation that another between UBOI and
BOI could go through this year. A merger involving Centurion
Bank of Punjab and Lord Krishna Bank has received the approval
of the respective boards of directors and now awaits the
shareholder and regulatory approvals. United Western Bank was
placed under moratorium in September 2006 and an amalgamation
% Stake Acquired
Estimated Transaction
Value ($)
Acquirer's Asset by 2004 ($)
Date of Acquisition Deal Status
Lakshmi Vilas Bank Ltd* 50% 21.2 mil n.a July-06 Announced Bank of Rajasthan Ltd* 83% n.a. n.a January-06 Announced Centurion Bank Ltd - Bank of Punjab Ltd. 100% 77.6 mil 774.5 mil October-05 Completed Industrial Development Bank of India Ltd - IDBI Bank 100% 385.5 mil 17.5 mil May-06 Completed ING Vysya* 75% 70.5 mil n.a April-05 Pending HDFC Bank Ltd –HDFC Securities 59% n.a. 9.6 mil October-04 Pending Oriental Bank of Commerce Ltd - Dena Bank Ltd n.a n.a. 9.3 mil September-04 Rumour ICICI Bank Ltd - Federal Bank Ltd n.a. n.a. 29.6 mil September-04 Rumour Oriental Bank of Commerce Ltd - Global Trust Bank Ltd. 100% n.a. 9.3 mil August-04 Completed
3-12-1 List of Domestic Acquisition Deals 2004-2006
Source: Asian Banker Research
3-12 List of Domestic M&A Deals, 2004-2006
___________________________________________________________________________ Asian Banker Research – India 96 Business Composition, Focus and Strategy
with Industrial Development Bank of India has been proposed by
RBI.
• Indian banks have also been exploring potential acquisitions of
local securities, mutual fund and finance companies to expand
their product portfolios.
• Foreign participation in domestic M&As will remain limited till
2009. State banks can only be merged with other state banks due
to ownership restrictions. Well performing mid-tier banks like
HDFC do not think small private banks are worth targeting
because there will be little impact on their geographical imprint,
market share and cost. At the same time, the small banks are
looking frantically to scale up and the M&A scene is already much
more active – but less talked about – at this layer than for the mid-
tier or large banks. Thus, what we are likely to see in the run-up to
2009 is accelerated activity among smaller private banks as they
try to acquire their peers or NBFCs in order to increase branch
penetration or asset size.
There is accelerated activity among smaller private banks to acquire peers or NBFCs to increase branch penetration or asset size
3-13 Foreign Banks’ Asset Growth, 2000-2005
___________________________________________________________________________ Asian Banker Research – India 97 Business Composition, Focus and Strategy
• The entry strategy of foreign banks in India can take the form of:
- Setting up a branch
- Setting up a wholly-owned subsidiary
- Acquiring a stake in a private bank, subject to a cap of
74%
- Taking over a distressed private bank identified for
acquisition by RBI
• Wholly-owned foreign subsidiaries must have a minimum
capitalisation of approximately $70 million. Individual foreign
banks are limited to equity stakes of 5% in local private banks
while foreign institutional investors and individual corporate
entities can hold up to 10%, with voting rights based on ownership
level. Foreign banks are now permitted to exceed the earlier
branching limit of 12 per year per bank, subject to RBI approval.
(Please refer to section 1-6 for details of the regulatory roadmap
for foreign banks.)
• More than 35 foreign banks currently operate in India, but they
account for a mere 7% of total assets. Until 2009, the presence of
foreign players will remain small, as foreign ownership will only
be allowed under restricted conditions and branch network
expansion will be limited, even for Singaporean banks under the
new Comprehensive Economic Cooperation Agreement. Just 15 to
20 new branch licences are given to foreign banks each year under
the WTO agreement.
Foreign banks share of total assets is low due to regulatory restrictions
Foreign banks share of total assets is low due to regulatory
3-13-1 Foreign banks’ Asset Growth
Source: Asian Banker Research
0
5
10
15
20
25
30
35
40
2000 2001 2002 2003 2004 2005U
S$ b
illio
ns0%
2%
4%
6%
8%
10%
12%
Total Assets (Foreign Banks) Foreign Banks' Assets as % of Total Banking assets
3-14 Operations and Prospects of Foreign Banks in India
___________________________________________________________________________ Asian Banker Research – India 98 Business Composition, Focus and Strategy
• The promise of 2009 combined with the phenomenal growth of the
Indian consumer and corporate credit markets is attracting several
foreign players.
• After its takeover of ANZ in India in 2000, Standard Chartered
Bank became the largest foreign bank in the country. The three US
banks that have banking operations in India are: Citigroup, Bank
of America and JP Morgan Chase. Several other banks have
expressed interest in setting up business in India including: Royal
Bank of Scotland, Switzerland's UBS, US-based GE Capital,
Credit Suisse Group, and Industrial and Commercial Bank of
China. General Electric (GE) has already announced its intention
to enter the retail banking business in India, having already created
a significant presence in consumer finance through its NBFC arm
GE Money.
• ANZ, Commonwealth Bank of Australia, National Australia Bank
and Royal Bank of Scotland are believed to be on the lookout for
stakes in private sector banks while ABN AMRO, Barclays,
Deutsche Bank, GE Money, BNP Paribas, Citigroup and JP
39
41
8
4 83
9
5 19
35
0
0.5
1
1.5
2
2.5
3
3.5
4
-2,000 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000
Total Asset Size ($ million)
RO
A (%
)
Size indicates number of branches
Standard Chartered Bank
Citibank
HSBC
ABN AMRODeutche Bank
Bank of America
BNP Paribas
American Express
Bank of Novia Scotia
DBS
3-14-1 Operations and Outlook for Foreign Banks’ in India
Source: Asian Banker Research
The phenomenal credit growth and expected liberalization in 2009 is attracting several foreign players
3-14 Operations and Prospects of Foreign Banks in India
___________________________________________________________________________ Asian Banker Research – India 99 Business Composition, Focus and Strategy
Morgan may opt for acquisitions. Large international securities
firms such as Merrill Lynch, Goldman Sachs and Lehman
Brothers are also eyeing the private banking segment of India’s
wealth management market.
• Given the tight regulations, foreign banks have adopted the
strategy of starting their relationships with local banks through a
small stake that may give them preferred bidder status in future
equity acquisitions in case RBI modifies its regulations before
2009. Even though this environment looks discouraging,
international banks have been fairly content with the status quo
behind the scenes.
• Although major acquisitions are ruled out for now, international
banks are circumventing this restriction by expanding their reach
through finance companies, which are not subject to the same
network limitations. For example, while Citibank has only 38
branches, Citigroup’s NBFC arms have over 300 branches. (Please
refer to section 2-9 for case studies of foreign NBFCs.) However,
RBI’s supervision of the NBFC segment has become more
rigorous and it has expressed concern over KYC (know-your-
customer) standards, stock manipulation and capital market
exposure of NBFCs. Besides tighter RBI control, new entrants
who want to explore this route may face “entry barriers” in the
form of cost advantages enjoyed by existing players.
• Foreign banks have been successfully leveraging on their direct
channels, where their sales forces make up between 60% and 70%
of total headcount, and dominating the most profitable niches in
mass retail. With their branch presence constrained by licences,
foreign banks have also made use of alternative channels including
ATMs, the internet and telebanking to increase customer reach.
• In wealth management, foreign banks already dominate the
segment comprising customer portfolios exceeding $250,000. The
greatest incremental scope, however, lies in the urban and rural
mass-affluent segments. Distribution networks are the key to
Foreign banks are circumventing the restrictions by expanding their reach through NBFCs …and leveraging on alternate channels
3-14 Operations and Prospects of Foreign Banks in India
___________________________________________________________________________ Asian Banker Research – India 100 Business Composition, Focus and Strategy
tapping these segments, but foreign banks have not extended their
operations to rural or even semi-urban areas so far. To some
extent, they may have mistimed the market in not expanding their
presence beyond tier 1 cities.
• As product offerings increase, foreign banks may aim for market
leadership within segments rather than overall leadership. Foreign
banks have been pursuing profitable niches wherever possible and
using branches judiciously. The use of internet banking is likely to
increase. At Citibank, it is being used even for first-time sales to
mass affluent customers besides after-sales service to high net-
worth customers.
• In the run-up to 2009, we believe foreign banks will continue to
grow aggressively so that they can take advantage of the
liberalised market conditions on a large scale. They will grow by
both organic and inorganic means and through alternative
channels, to expand their distribution network, scale up their
infrastructure and broaden their franchise and market share. The
learning process triggered by restrictions that led them to find
innovative solutions – such as experimenting with NBFCs selling
third-party products – may give them an advantage in terms of the
knowledge and experience gained.
• While credit cards have been an important product, expansion is
limited by the fact that working with lower-income groups is
considered viable by some foreign banks only if they can be
moved to high value-added products through good relationship
management and up-selling programmes.
• Clearly, confidence in the market is high and competition for
market leadership among existing players is set to increase. For
example, Citigroup will invest over $500 million in 2006 to grow
its business in India. This is the group’s largest investment in India
to date and a significant proportion of it will be injected into its
NBFC arm.
Competition for market leadership among existing foreign players is set to increase in the run-up to 2009
3-14 Operations and Prospects of Foreign Banks in India
___________________________________________________________________________ Asian Banker Research – India 101 Business Composition, Focus and Strategy
• As to whether the promise of 2009 will materialise, we believe the
market players are optimistic regarding the regulator’s
commitment to opening up the banking sector. Most bankers and
analysts that The Asian Banker spoke to are of the view that given
the pressing need for foreign investments, the government is
sensitive to global investor opinion and hence almost certain to go
ahead with the liberalisation expected in 2009 although the exact
timing will depend on consultations with the various stakeholders
involved bearing in mind that 2009 is an election year for India.
3-15 List of Foreign Acquisition Deals, 2004-2006
___________________________________________________________________________ Asian Banker Research – India 102 Business Composition, Focus and Strategy
• RBI continues to wield considerable discretionary power to
approve or reject foreign applications for takeover. Given the
restrictions, foreign acquisition deals completed in the past few
years have been limited as reflected in the table above. They have
been largely confined to buying small stakes or NPLs of local
banks or the Indian branch operations of other foreign banks.
• The branch licences granted by RBI are zone-specific and so
where licences are scarce, foreign banks are likely to look at
acquiring entities which have the licence for their targeted zone.
Bigger foreign banks that already have a presence in India may opt
for the inorganic route by taking over weaker banks that come
with large branch networks.
• Banks identified by RBI for takeover are usually the weak private
banks with bad assets. (Please see section 2-4 for a list of old
private banks.) But unless RBI declares these, foreign banks are
left to identify a suitable bank based on their own assessment and
% Stake Acquired
Estimated Transaction
Value ($)Date of
AcquisitionDeal
StatusStandard Chartered Bank-ICICI Bank Ltd. NPLs n.a 20.2mil May-06 Completed
International Finance Corp (IFC)-Federal Bank Ltd. 8% n.a. May-06 CompletedInvestor Group1-Development Credit Bank . 19% n.a. February-06 PendingJP Morgan & Co-HSBC NPLs 5.7mil February-06 CompletedInvestor Group2-Bank of Punjab Ltd. 13% 83.2mil December-05 CompletedStandard Chartered Bank plc - Bank of Bahrain and Kuwait BSC's Indian operations 100% n.a. June-05 AnnouncedEM Warburg Pincus & Co LLC - Kotak Mahindra Bank Ltd. 5% 20.7mil June-05 CompletedDeutsche Securities (Mauritius)-HDFC Bank Ltd. 4% 164.3mil March-05 CompletedStandard Chartered Bank-Sumitomo Mitsui Banking Corp (Indian Branch Operations) 100% 17mil September-04 CompletedBarclays Capital Mauritius-UTI Bank Ltd. 5% 29.6mil September-04 CompletedBank Muscat Al Ahli Al Omani-Centurion Bank Ltd. 7% 6.5mil August-04 CompletedAga Khan Fund for Economic Development, The - Development Credit Bank Ltd. 69% 30.9mil March-04 PendingKephinance Investment (Mauritius) Pte Ltd-Centurion Bank Ltd. 5% n.a. February-04 Completed
1An investor group including Housing Development Finance Corp Ltd, Khattar Holdings Pte Ltd and Amtel Finance.2An investor group, comprised of India Value Fund Trustee Co Pvt Ltd (4.73%), Johann Ltd (4.73%), a wholly-owned unit of Chrys Capital III LLC, and Citigroup Venture Capital International Growth Partnership Mauritius Ltd (3.99%), a wholly-owned unit of the Citigroup Venture Capital International Jersey Ltd which is asubsidiary of Citigroup Inc's Citigroup Venture Capital International.
3-15-1 List of Foreign Acquisition Deals, 2004-2006
Source: Asian Banker Research
Foreign acquisition deals have been largely confined to buying small stakes or NPLs of local banks
3-15 List of Foreign Acquisition Deals, 2004-2006
___________________________________________________________________________ Asian Banker Research – India 103 Business Composition, Focus and Strategy
then await RBI’s verdict. Foreign banks which own more than 5%
of an Indian bank have to either seek RBI approval for acquisition
of a private bank not identified by RBI for takeover or scale back
their investment to the 5% limit.
• After the playing field for foreign banks expands further in 2009,
they should be able to cast their net wider to include not only
distressed banks with attractive branch networks but also better
run banks with potential for fast loan growth. Attributes that
foreign banks are likely to look for in acquisition targets are:
strong product range, good loan growth, adept management,
advanced technology, and presence in emerging growth segments.
• The smaller new-generation private banks like Indusind Bank,
Kotak Mahindra Bank, Centurion Bank of Punjab and Yes Bank
could thus become targets for acquisition. For instance, the loan
growth of Centurion Bank of Punjab is expected to be 52% CAGR
over the next two years, retail advances constitute over 70% of its
loan portfolio, and its NIMs are among the highest in the industry.
For Yes Bank, its key differentiator is knowledge banking and fee
income is already the mainstay of its business strategy, though
delays in branch expansion could hamper its loan growth.
• For some of the smallest banks, survival in the increasingly
competitive environment will become more difficult. Having to
gear up for attracting the right M&A opportunity after 2009 could
be a motivation to develop attractive product portfolios and
suitable processes and segment strengths that foreign banks are
likely to seek in potential acquisition targets.
After 2009, foreign banks may target not only distressed banks but also better-run banks …they will target banks with a strong product range and loan growth, good management, advanced technology and presence in growth segments
Chapter 4 Distribution and Penetration
In this chapter we look at the penetration and growth ofchannel infrastructure in India as well future prospectsand the different strategies and technologymodernization programs undertaken to develop itfurther. We compare and analyse the differences in thefee generation capabilities of banks’ branches andexamine the progress and issues for state banks inmodernising and rationalizing their branch networks.We highlight key service quality elements to watch intimes of massive customer acquisition. We look atdevelopments in India’s promising payment cardmarket. We examine and compare banks’ positioningfor multiple channel development especially on-linebanking and the prospects for channel integration inthe future.
Structure of Contents 4-1 Branch Penetration in India and Peer
Countries 4-2 Branch Growth of Indian Banks 4-3 Fee income generation 4-4 The Asian Banker Perception Survey on
Branch Strategy 4-5 Modernising and Rationalizing Branch
Networks 4-6 Important Elements of Excellent Banking
Service 4-7 ATM Penetration and ATM Growth 4-8 Bank Card Growth 4-9 Multiple Channel Development in India
and Peer Countries
4-1 Branch Penetration in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 104 Distribution and Penetration
• Given India’s geographical size and diversity, distribution of
delivery channels such as branches and ATMs plays an
important role in expanding the customer franchise. In a market
where demand is outpacing supply in retail financial services,
having the right distribution of channels is critical.
• Overall branch penetration in India is low compared to some
other countries in Asia Pacific. But within India, it varies
between rural, semi-urban and urban/metropolitan areas.
• In India’s rural areas, which are spread across states with diverse
language-culture mixes, vernacular and cultural identification with
the financial service provider is important to the customer. Banks
with strong localised knowledge are better placed to penetrate this
segment. Customer loyalty in the semi-urban and rural segments is
still to some extent driven by cultural and political factors rather
than based on pricing and efficiency alone.
• Not surprisingly, nationalised banks as a group have the highest
branch presence in rural India, followed by regional rural banks.
SBI and other state banks have placed about 40% to 45% of
their branch networks in rural areas, whereas for private banks it
is less than 20% on average. Foreign banks have no branch
presence in rural areas so far. Once the state banks’ branches
With demand outpacing supply having the right distribution channels is critical Overall branch penetration in India is low but varies across different areas Nationalised banks have the most branches in rural India
4-1-1 Branch Penetration in India and Peer Countries
Source: Asian Banker Research
*2004
264
182166
111
64 62
31
0
50
100
150
200
250
300
US* Hong Kong Mumbai Singapore China India Indonesia
Num
ber o
f Bra
nche
s 20
05 (p
er m
illio
n po
pula
tion)
4-1 Branch Penetration in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 105 Distribution and Penetration
come online with core banking, their operational efficiency and
competitiveness in this segment are expected to improve.
• In semi-urban areas too, state banks including the SBI Group
dominate, followed by private sector banks, while the presence
of foreign banks is negligible.
• Branch growth in semi-urban areas in the past year has been
rapid especially among the new-generation private banks. Many
tier 2 cities in India have already reached branch penetration
levels comparable to Singapore’s as these are viewed as a
gateway to the rural hinterland. Also, many of these are situated
near growing industrial hubs and have a growing mass-affluent
segment ready to be tapped for a large variety of retail offerings.
• In urban/metropolitan areas, state-owned banks lead in branch
numbers but local private banks and foreign banks enjoy higher
visibility. With the customer base here more IT savvy and
literate, the appeal of these banks’ better appointed offices,
superior technology, innovative product offerings and delivery
through alternative channels has helped them to collectively
garner a higher share of deposits and lending in this segment
than the SBI group. The numerous other state banks are
individually more prominent in their respective states or regions.
• Besides affordability issues, the relatively simpler appearance of
state bank branches even in metros is attributed to their
alignment to national policy and the common man’s needs.
Ostentatious trappings in government-linked institutions can be
questioned in a country with huge inequalities in income
distribution.
• By focusing on metros, foreign banks have to some extent
miscalculated on their expansion of branch presence into tier 2
cities. But in addition, they were disadvantaged by limits on
branch licences granted by RBI. It was also partly a matter of
choice, as they simply opted to focus on wealthier segments in
Private and foreign banks enjoy better visibility in urban areas and metros New private banks are rapidly expanding branches in semi-urban areas Foreign banks’ branch presence beyond metros is limited
4-1 Branch Penetration in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 106 Distribution and Penetration
metros and to use less-regulated NBFC arms and alternative
channels to expand beyond metros. With heightened competition
in urban retail segments, increased regulatory vigilance of
NBFCs and limitations on future penetration with alternative
channels, foreign banks may need to revisit their organic
expansion strategies or use the M&A route for banks identified
by RBI for takeover.
• Plotting the number of branches per million population against
GDP per capita, we are able to assess the level of branch
penetration in the context of the demand for financial services
commensurate with the country’s economic development.
• India’s overall branch penetration is higher than that in the
Philippines and Indonesia and close to Thailand’s even though
its per capita income is lower. Partly, this is a reflection of the
much higher branch density in India’s tier 1 and tier 2 cities,
where branch penetration is comparable to that of more
developed countries. Another reason is that face-to-face
transactions are still important to customers in semi-urban areas
and especially rural areas, where a large part of the population is
still illiterate or semi-literate.
Face-to-face transactions are still important in semi-urban and rural areas
Australia
JapanSingapore
South KoreaHong Kong
Taiw an
Malaysia
IndonesiaPhilippines
Thailand
ChinaIndia
0
50
100
150
200
250
300
0 10,000 20,000 30,000 40,000 50,000
GDP per capita
Bra
nche
s (#
) per
mill
ion
popu
latio
n
Branches/million populationSource: Asian Banker Research
4-1-2 Branch Penetration vs. GDP per capita in India and Peer Countries 2004
4-2 Branch Growth of Indian Banks
___________________________________________________________________________ Asian Banker Research – India 107 Distribution and Penetration
• Developed and developing countries across Asia have had
differing patterns in branch growth. While China, Hong Kong,
Singapore, Taiwan and Indonesia have seen a decline in the past
few years, India, Thailand, Malaysia, Japan and the Philippines
have witnessed expansion.
• Overall branch expansion in India during 2004 and 2005 was
around 1.2% and 1.5% respectively. We expect branch growth
to be 1.6% in 2006, subject to branch licence approvals by RBI.
• While state banks will be more concerned with rationalisation
than with expansion of branch networks, we will see renewed
momentum in expansion among private banks in the coming
years. Specifically, we expect small and mid-tier banks to
expand their reach into rural areas to tap the huge revenue
potential in personal, 2W, CV and auto loans, SME segments
and infrastructural projects, and to build up their low-cost
funding base through deposit mobilisation.
• HDFC, UTI, Andhra and IDBI in particular are expanding
rapidly. HDFC had 530 branches in 230 cities as of December
2005 with 55% of these outside the ten most populous metros. It
aims to add at least 150 branches and 40-50 cities per year for
62,000
64,000
66,000
68,000
70,000
72,000
2000
2001
2002
2003
2004
2005
2006
(e)
2007
(f)Nu
mbe
r of B
ranc
hes
0.0%0.2%0.4%0.6%0.8%1.0%1.2%1.4%1.6%1.8%2.0%
Bran
ch G
row
th (Y
oY,%
)
Total Number of Branches Branch Growth
4-2-1 Branch Growth of Indian Banks: Private & State Banks
Source: Asian Banker Research
State banks are concerned with rationalization of branch networks The momentum in branch expansion is coming from small and mid-tier private banks
4-2 Branch Growth of Indian Banks
___________________________________________________________________________ Asian Banker Research – India 108 Distribution and Penetration
the next two years, subject to approvals, to prepare for its push
into the rural unbanked segments. UTI aims to have one branch
in each of the 572 districts in India. It has been adding one
branch per week for the last few years and already covers half
the total number of districts.
• Rapid expansion into rural areas is not considered detrimental to
the cost-income ratio at banks which have central processing
systems, as there is no difference between urban and rural areas
in the processing of customer approvals. Since branches in rural
areas can take advantage of the lower rental and staffing costs
prevailing in these areas, profitability is not perceived to be an
issue.
• The branch expansion strategy of these banks is based on a hub-
and-spoke model focused around specific retail and corporate
lending hubs. Being in every village is not considered critical.
All branches are expected to be liability-oriented with a view to
capturing a large number of current and savings accounts, while
asset growth is driven by different sales teams. For instance, in
retail banking, UTI’s asset centres are in 30 cities and growing
at the rate of 20 cities per year. For corporate lending, only 11
centres are considered critical as most corporate decision-
making takes place in HQs which tend to be concentrated in
specific locations in the country. Manufacturing plants outside
these centres can be looked after by service branches.
• While the mid-tier banks have aggressive branch expansion plans,
actual growth will depend on the award of RBI licenses. Under the
old policy, individual licenses had to be approved for each branch.
Under the relaxed licensing policy introduced in 2005, banks are
required to submit an annual plan of branches and ATMs they
wish to set up. Between October 2005 and July 2006, only CBOP
was granted approval – for 30 licenses in total. RBI has not
explained the delay in sanctioning branch licenses. A possible
explanation may lie in the IPO scam and demat scam in the first
quarter of FY2007 that led to accusations by foreign banks that
Branch expansion strategy of these banks is based on a hub-and-spoke model Branches are expected to be liability-oriented Delays in grant of branch licences will be detrimental for these banks
4-2 Branch Growth of Indian Banks
___________________________________________________________________________ Asian Banker Research – India 109 Distribution and Penetration
some local banks are not following KYC norms. RBI may be
waiting for the report of the Joint Parliamentary Committee
investigating the demat scam before granting fresh licenses.
Delays in the granting of branch licenses by RBI will be
detrimental to the growth plans of small and mid-tier private
banks.
4-3 Fee Income Generation
___________________________________________________________________________ Asian Banker Research – India 110 Distribution and Penetration
• Increasing competition, pressure on NIMs, volatility in trading
incomes and disintermediation are some of the factors galvanising
some banks to put more effort into moving out of their comfort
zones, to look beyond their interest income and develop
diversified sources of fee income.
• State banks continue to be heavily dependent on interest income,
with fee income still comprising a small part of their revenues. On
the other hand, the new-generation private banks are aggressively
building up fee income not only as a buffer but also as a key
growth driver. Low fee income coupled with much larger branch
numbers has resulted in weaker fee income per branch for state
banks.
• SBI as the largest bank, generates the most total fee and other non-
interest income among the Indian banks. But ICICI, despite having
a branch network less than one-fourth the size of SBI’s, is fast
catching up with SBI in total fee income generation and is already
way ahead of SBI and other local banks in terms of fee income per
branch. It has leveraged on its CRM system for extensive product
cross-selling through its branch networks and direct sales agents.
A sizeable part of its fee income stream comes from the NRI
business from overseas branches.
UBIPNB
BOISBI Canara Bank
HDFC Bank
ICICI
UTI Bank
0
5,000
10,000
15,000
20,000
25,000
0% 10% 20% 30% 40%
Fee Income as % of Total Income
Fee
Inco
me
per B
ranc
h (in
Rs
'000
)
4-3-1 Fee Income as% of Total Operating Revenue vs. Fee Income per Branch
Source: Asian Banker Research
State banks have low fee incomes per branch on account of low fee income and large branch networks ….while new private banks are ahead of them
4-3 Fee Income Generation
___________________________________________________________________________ Asian Banker Research – India 111 Distribution and Penetration
• Increasing customer reach through direct selling agents (DSAs)
puts less cost-pressure on the branch and boosts fee income per
branch, but many state banks are reluctant to outsource marketing
as they view the commission-based arrangement as a dilution of
commitment to the bank and its products. Some do not have
separate sales staff at all. The teller staff handle accounts and
market products simultaneously.
• Still burdened with over-staffed branches and in the process of
putting core banking systems in place, state banks will take several
more years to raise their fee income per branch to levels
comparable to those of the new private banks.
4-4 The Asian Banker Perception Survey on Branch Strategy
___________________________________________________________________________ Asian Banker Research – India 112 Distribution and Penetration
• Banking executives in India perceive that the key winning
strategies for branch management are leveraging on alternative
sales/delivery channels and turning the branch into a stronger
sales platform through better customer segmentation for cross-
selling. Centralisation of branch processes and restructuring of
oversized branches are also considered important and, notably,
have been given more prominence by bankers in India than in
other Asian countries like Thailand and Malaysia.
• Since the top 40 urban locations (by population size) in India have
been contributing almost 80% of total retail lending, banks have
been actively experimenting with distribution channels beyond
branches and strengthening or refocusing product lines for rural
area penetration. Banks have been rapidly expanding into tier 2
cities in recent years with the ultimate goal of penetrating rural
areas.
• Moving beyond tier 1 cities poses a challenge from the
profitability angle due to the small ticket size of transactions and
low volumes. Economies of scale will therefore come into play
and only the banks with the best distribution channels and
mechanisms will be able to profit from this market.
• Private sector banks with smaller branch networks than state banks
have been more active in exploring alternative sales/delivery
0
10
20
30
40
50
60
70
80
90
Alternat ivedeliverychannels
Turningbranches into
salesplat forms
Centralisat ionof the
processes ofbranches that
areindependent
Restructuringof oversized
branches
Centralisat ionof the
managementof branches
that areindependent
Expansion ofbranch
network
Establishingspecialised
businessbranch units
Internationalexpansion
% o
f Res
pond
ents
4-4-1 Winning Strategies in Branch Management
Source: Asian Banker Research
Banks will leverage on alternative sales/delivery channels and using the branch as a stronger sales platform Centralisation of branch processes and restructuring of oversized branches will also be important
4-4 The Asian Banker Perception Survey on Branch Strategy
___________________________________________________________________________ Asian Banker Research – India 113 Distribution and Penetration
channels to complement branch expansion. These include ATMs,
internet banking, telebanking and mobile phone banking, call
centres, dealer networks and direct sales agents. At ICICI, more
transactions are now done through ATMs and internet and mobile
phone banking than through branches. For foreign banks, because
of the regulatory limit on their number of branches, alternative
sales/delivery channels including dealer networks and direct sales
agents are critical.
• Banks are sometimes wary of opening additional branches to
penetrate new markets as the branch is the most expensive
distribution channel. The renewed focus on branches among
private sector banks has to do with the focus on relationship
banking. For existing branches, at the margin, the branch can be
regarded as the cheapest sales channel in the sense that the channel
is already in place driving liability generation and much of the
origination comes from existing customers. With appropriate
CRM and data warehousing, the effectiveness of cross-selling at
the branches can be improved. The origination costs would be
lower and it would be easier to offer preferential pricing to
existing customers.
• Cross-selling will be a major thrust at branches of private banks
including ICICI, UTI and HDFC. Most state banks have weak
cross-selling capabilities due to the absence of data warehousing
systems.
• Channel transformation and technology advancement go hand in
hand. With the deployment of core banking, more state banks will
acquire the ability to offer new products across multiple channels.
The establishment of regional processing will remove back-office
functions from branches, thus enabling branch staff to devote more
time to customer service and cross-selling.
• Over time, as processing and approvals are moved to centralised
systems and ATMs, telebanking and internet banking provide
cheaper means of servicing customers, the branch will become
Banks with smaller branch networks are exploring alternative channels more actively Cross-selling is a major thrust at new private banks’ branches State banks need technology advancement to effect multiple channel and product development
4-4 The Asian Banker Perception Survey on Branch Strategy
___________________________________________________________________________ Asian Banker Research – India 114 Distribution and Penetration
primarily a sales rather than processing channel. But branches will
remain important for many years to come because: India’s rural
masses favour across-the-counter transactions and are likely to be
conservative towards alternative channel usage, SME clients
prefer to deal with banks through this channel, and they are an
effective means of generating low-cost deposit funding.
• Given the inflated property prices, banks concerned with rising
costs could move towards flexibility in managing their branch real
estate, leasing rather than buying premises and “right sizing”
branches to suit the products, clientele and location. Banks are also
encouraged to prioritise customer convenience, consider the
location of competitors and their own retail focus in devising their
branch location strategy. Good staff skills and operational
efficiency cannot substitute for the right location.
Branches will remain important …but “right sizing” branches will help contain costs
4-5 Modernising and Rationalising Branch Networks
___________________________________________________________________________ Asian Banker Research – India 115 Distribution and Penetration
• Indian banks’ branch expansion drive, high human resource
expenses and technology upgrading initiatives have pushed up
the industry’s cost-to-income ratio from 47% in 2003 to 54%
by end-2005. Strong expansion of the branch network and
direct sales forces in 2006 without immediate returns on the
investment will further increase CIRs.
• The ratio of staff expenses to operating expenses for several
state banks is as much as two to three times higher than that of
the more technology-intensive foreign banks and new-
generation banks like ICICI, HDFC and UTI. State banks are
weighed down by a surplus in headcount, with the proportion of
human resource expenses in their total operating cost being one
of the highest in Asia.
• Implementation of the voluntary retirement scheme (VRS) in
2000-2001 led to a slight reduction of staff count in state banks.
But in the post-VRS years, pension provisioning has increased
significantly, the per-employee cost has risen with the composition
of staff showing a shift towards having more officers than general
staff and operating expenses increased with the higher salaries
negotiated by unions.
• The larger state banks saw a deterioration of operational cost
efficiency in FY2006. For SBI, total staff expenses increased by
The industry CIR has increased State banks are weighed down by a surplus in headcount and high IT costs
SBI
ICICI
PNB
CBBB
BOIUBI
OBC
SB
UTI
IOB
YES
HDFC
0%
10%
20%
30%
40%
50%
60%
70%
80%
0% 10% 20% 30% 40% 50% 60% 70%
Cost-to-Income Ratio
Staf
f Exp
ense
s/O
pera
tiona
l Exp
ense
s
4-5-1 Modernising & Rationalising Branch Networks
Source: Asian Banker Research
New Private Banks
State Banks
4-5 Modernising and Rationalising Branch Networks
___________________________________________________________________________ Asian Banker Research – India 116 Distribution and Penetration
18% because of higher wage costs following a revision of wages
in line with economic growth. The bank may also have to set
aside around Rs 8 billion to create a fund to pay additional
pensions. This cost would have to be amortised over three years
to reduce the impact on profits.
• PNB has already implemented core banking in 77% of its branch
network, so incremental technology costs are likely to be lower
in the next few years. However its wage bill remains substantial.
• State banks in India are in dire need of rationalising and
modernising their branch networks. Not only does their
headcount cost make up a higher proportion of their total
operating cost compared with other banks, but they are also
running into a demographic crisis. These banks urgently need to
refresh their aging human resource pools to face the new
challenges in a digitalised environment and to cater to the
changing requirements of customer service.
• A fundamental problem is that autonomy of decision-making
at state banks is constantly curtailed by union pressures and
political interference and, as public sector institutions, they are
often expected to be employment providers as well. Natural
attrition, rather than proactive downsizing, is expected to bring
operating costs down.
• Some state banks are making moves in the right direction. At
PNB, for instance, fresh recruitment is limited and some
surplus staff are being redeployed to direct marketing in cities,
creation of customised products and data-loading operations
(in anticipation of the increased informational requirements of
cross-selling). But generally, redeployment at state banks is
taking place slowly and needs to move faster.
• Success in rationalising and modernising branch networks will
depend on how quickly the banks are able to redeploy surplus
staff and leverage on their investments in IT upgrading. We
State banks need to refresh their human resource pools …but autonomy of decision-making at state banks is curtailed
4-5 Modernising and Rationalising Branch Networks
___________________________________________________________________________ Asian Banker Research – India 117 Distribution and Penetration
therefore do not believe we will see significant progress till after
2007-2008 when their core banking rollouts are completed, as
many state banks are still working on the basics of branch
networking.
4-6 Important Elements of Excellent Banking Service
___________________________________________________________________________ Asian Banker Research – India 118 Distribution and Penetration
• Processing and service quality in times of massive customer
acquisition is likely to emerge as a key issue. While Indian banks
are becoming quite tech-savvy in their operations, they have
neglected the human factor. Quality not only depends on
sophisticated back- and front-end applications but also requires,
first and foremost, well trained front-line staff who are able to
discern how and when customers have to be approached with
appropriate products.
• According to an AC Nielsen survey conducted for The Asian
Banker Excellence in Retail Financial Services Programme in
2004, what Indian banking customers want most from their banks
are: improvement in customers’ access to banking services by
enhancing the branches, fast turnaround times, excellent customer
service, and low rates and fees. The survey shows that these
factors are more important to customers, not only in India but also
in most other Asian countries, than an extensive range of products
or aggressive advertising and promotions.
• For the banks, developing product width has become important for
driving profits through cross-selling. However, banks need to be
careful of “customer fatigue” and over-investing in providing
products that the customers may not value as much as the basics of
convenient access and efficient customer service on vanilla
products. This will be an especially critical issue in servicing the
semi-urban and rural areas in India.
0% 20% 40% 60% 80% 100%
Aggressive advertising and promotions
Extensive range of products
Good image
Low rates and fees
Excellent customer service
Short processing time
Easy access to banking services
Customer Responses
4-6-1 Important Elements in Banking Services
Source: AC Nielsen
Indian banks have neglected the front-line factor in processing and service quality Customers value the basics of convenient access and efficient service
4-7 ATM Penetration and ATM Growth
___________________________________________________________________________ Asian Banker Research – India 119 Distribution and Penetration
ATM Penetration
• With the bulk of the Indian population living in rural areas, low
literacy and prevalence of conservative attitudes, branch banking
remains pervasive rather than self-service channels. ATM
penetration in India is much lower than that of its Asian peers.
ATM growth, after a big spurt in 2002, settled at just over 27% per
annum for the last two years.
• In Japan and Australia, which are developed countries with more
mature financial systems, the number of ATMs exceeds the
number of branches by over 10:1 and 4:1 respectively. Even in
countries like Malaysia and Thailand, the ratio is at least 2:1. In
India, it is the other way round.
• Branches outnumber ATMs by almost 4:1 in India. Branch
numbers surpass ATM numbers because of the dominance of state
banks, which are “branch-heavy”. State banks and old private
banks have introduced ATM networks but these are small
compared to their sprawling branch networks.
• On the other hand, foreign banks and the new-generation private
sector banks, with their centralised back-end operations, have
leveraged strongly on ATMs as an alternative channel while trying
1304
410 405
192
50 43 160
200
400
600
800
1000
1200
1400
US*
Singap
ore
Hong K
ong
Mumba
i
China
Indon
esia
India
Num
ber o
f ATM
s 20
05 (p
er m
illio
n po
pula
tion)
ATM penetration in India is low Branches far outnumber ATMs for state banks …but ATMs outnumber branches for private and foreign banks
Source: Asian Banker Research
*2004
4-7 ATM Penetration and ATM Growth
___________________________________________________________________________ Asian Banker Research – India 120 Distribution and Penetration
to optimise use of their limited branches for sales and deposit
mobilisation. Their number of ATM counters is more than thrice
the number of branches, and they have more than twice as many
off-site ATMs as they have on-site ATMs. The largely urban
customer base of foreign banks is relatively IT-savvy and
comfortable with ATM usage.
• The total number of ATMs in India increased from 4,500 in 2000
to over 17,500 in 2005. Collectively, new private banks have the
most number of ATMs followed by state banks, old private banks
and foreign banks. Individually, SBI has the highest number of
ATMs followed by ICICI.
• The earliest ATMs were offline, unconnected to the ledger. Hence
limits were set on individual customer withdrawals. Although this
limitation can now be removed with more recent technology,
problems of unauthorised access and information stealing have
come to the fore and many local banks are not fully ready to deal
with these. Information security at remote locations therefore has
been one of the factors impeding ATM growth.
• The cost of expanding ATM networks is also an issue for state
banks. Ignorance of the general populace about proper use of new
ATM numbers have increased substantially over the past five years Many banks are not fully ready to deal with the problems of unauthorized access
Source: Asian Banker Research
4-7-2 ATM Growth
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2000
2001
2002
2003
2004
2005
2006
(e)
2007
(f)
Num
ber o
f ATM
s
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
ATM
Gro
wth
(YoY
, %)
Total Number of ATMs ATM Grow th
4-7 ATM Penetration and ATM Growth
___________________________________________________________________________ Asian Banker Research – India 121 Distribution and Penetration
technologies can add to maintenance costs. Some state banks like
PNB have placed ATMs in public places like railway stations and
are now experimenting with a new cost-cutting scheme whereby
ATMs will be owned, developed and maintained by other parties
and the bank would make payments only on a transaction basis.
• Cost and security issues aside, some state bank officials also
believe that the rural population and ageing customers prefer the
human touch and branch banking to ATMs.
• For these reasons, more state banks are opting for ATM sharing
arrangements besides growing their own ATM networks. For
instance, Union Bank of India has 500 ATM counters on its own
but its customers have access to the 1,500 ATMs of Bank of India,
Dena Bank, Indian Bank, Syndicate Bank and United Bank of
India under the Cash Tree arrangement. Recently, the bank signed
a sharing agreement with SBI that would give its customers access
to over 5,500 SBI counters.
• With increasing interest in rural banking, several banks including
ICICI are experimenting with a simplified version of their teller
machines for rural areas. Some banks currently effect payments to
farmers through prepaid kisan credit cards to be encashed at
ATMs. It will take more of such initiatives and time to accustom
the rural customers to the ATM habit.
• While the overall number of ATMs is increasing, we do not expect
ATM growth rates to escalate substantially in the coming year
given the cost and security issues and the inclination of state banks
towards ATM sharing arrangements.
Rural customers need simplified and customized ATMs Banks are exploring cost-cutting schemes like ATM-sharing
4-8 Bank Card Growth
___________________________________________________________________________ Asian Banker Research – India 122 Distribution and Penetration
• Given the under-developed revolving culture in India, debit cards
are the most used payment instruments in India and are popular
due to their accessibility and convenience and because there is no
risk of running up large debts. They are used for low-value
purchases, although there has been a movement towards higher-
value purchases which has undermined the relative share of credit
cards.
• The debit card market has grown faster since 2004 with the
conversion of ATM cards into debit cards as banks started to issue
debit cards for savings account holders and introduced new
variants of debit and charge cards and the overdraft function. The
number of debit cards is now thrice that of credit cards.
• Starting from a very low base in the 1980s, the growth rate of
credit cards in India is one of the strongest in Asia. By 2010, India
will have 35 to 40 million credit cards, according to industry
players.
Debit cards are the most used payment instruments in India
56% 59%66%
71%76% 73%
76%
44%41%
34%
29%
24%27%
24%
0.00
20.00
40.00
60.00
80.00
100.00
120.00
2001 2002 2003 2004 2005 2006 2007
Tota
l Num
ber o
f Ban
k C
ards
(in
mill
ion)
Number of Debit Cards Number of Credit Cards
14.8
59.0
42.230.2
20.5
98.0
70.0
4-8-1 Bank Card Growth with regards to Total Issuance
Source: Asian Banker Research
4-8 Bank Card Growth
___________________________________________________________________________ Asian Banker Research – India 123 Distribution and Penetration
• However, credit card penetration is still low with the card base
covering only about 3% of the working population compared to
14% in China, 75% in Malaysia and even higher levels in
developed countries. The value of credit card transactions in India
also grew at a slower pace than the number of transactions
between 2001 and 2005. Card spending as a percentage of
consumer expenditure is expected to reach just 2% in 2007
compared to 19% for Singapore and 37% for South Korea.
• Thus the industry still has a long way to go to reach regional
standards. Currently, the credit card industry is in a phase where
banks primarily want to acquire more customers rather than focus
on usage and retention strategies. The majority of Indians spend
less than $35 per card on average each month.
• Traditionally, Indian consumers are reluctant to incur debt unless
it is considered necessary, such as for large purchases like houses
or vehicles, and prefer to use payment options which do not allow
for revolving credit. Where credit cards are used, consumers have
a tendency to pay bills in full each month rather than use a
revolving credit option. This limits the potential of high returns on
credit cards, even where they are in wide circulation. The new
generation of young IT-savvy professionals, however, is more
receptive to the credit habit.
Source: Asian Banker Research
Australia
China
Hong Kong
India
Indonesia
Japan
Malaysia
Philippines
Singapore
South KoreaTaiwan
Thailand
0%
5%
10%
15%
20%
25%
30%
0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
Growth in Number of Transactions 2001-2005 (CAGR)
Gro
wth
in V
alue
of T
rans
actio
ns
2001
-200
5 (C
AG
R)
4-8-2 Growth in Credit Card Transactions: Value vs. Number of Transactions
Credit card growth in India is one of the strongest in Asia but penetration is still low The credit card industry is still in an acquisition phase
4-8 Bank Card Growth
___________________________________________________________________________ Asian Banker Research – India 124 Distribution and Penetration
• Earlier, banks too were reluctant to issue credit cards to consumers
without a proven credit history, since many consumers had only
recently opened bank accounts.
• Foreign banks in India have taken the lead in credit card
penetration. Citibank enjoys the highest credit card spend and best
profitability, while Stanchart claims to have the edge in the
revolving segment. Domestic banks started their credit card
business later than foreign banks. The large initial investment that
the business requires prevented state banks and smaller banks
from entering earlier. SBI Cards was launched as a joint venture
company with GE Money in 1998 but PNB is only now
planning to launch its own card.
• New credit-card businesses took about two years to become
profitable for some of the new private banks. However, as the gap
between the better-run domestic banks and foreign banks in
standard cards closes, ICICI could overtake Citibank in terms of
card spend in the classic card category. SBI Cards has recently
overtaken Citibank to become the second largest credit card issuer
after ICICI by focusing on a strong distribution network especially
in the less penetrated non-metros, salaried and self-employed
customers, relying on sales executives and its co-branded strategy.
• Most of the Indian banks have weak cross-selling capabilities
despite their large customer base. On average, less than 30% of
new credit card customers come from an existing customer base.
Since the credit card market is demand-driven, acquisition cost is
still relatively low, ranging between $20 and $30 per card.
However this could go up significantly in the coming years and
could hit between $45 and $55, according to industry sources.
Banks therefore need to start focusing on cross-selling credit cards
to existing customers early on since they are the more profitable
and loyal ones.
• ICICI has made cross-selling a significant driver in its retail
expansion with almost one-third of credit card issues coming from
The gap between the better-run domestic banks and foreign banks in standard cards is closing Banks need to focus on cross-selling credit cards to existing customers
4-8 Bank Card Growth
___________________________________________________________________________ Asian Banker Research – India 125 Distribution and Penetration
cross-selling activities. However, delinquencies in the credit card
business will remain high for some time and its aggressive
acquisition strategy will come with the price of higher charge-off
rates.
• Aggressive acquisition strategies have also spawned consumer
complaints. These usually relate to offers of unsolicited cards, lack
of information on terms and conditions of repayment, wrong
activation and outright harassment. Most of the complaints that
RBI receives against foreign banks are related to credit cards.
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 126 Distribution and Penetration
• Comparing the average monthly value of customer transactions
conducted via each channel for the best 15 retail players in the
Asia Pacific region and retail players in India, we see that channel
distribution in India is still “branch-heavy”. On average, Indian
banks’ alternative channel penetration is low compared to some of
its Asian peers.
• In India, the penetration levels of telephones, mobile phones,
Internet and PCs are among the lowest in Asia. This limits the
possibilities of alternative channel use to specific groups of
customers in the immediate future. For instance, while mobile
Internet banking is taking off in Japan, South Korea, Hong Kong
and Singapore, it has yet to make a mark in India given the low
mobile/internet penetration and the general preference for face-to-
face transactions.
• Attitudes, capabilities and experiences in alternative channel
development differ across Indian banks. While some Indian banks
have ”entry level” Internet sites, others offer Internet banking
services at more advanced levels such as online fund transfers,
payments and cash management.
• SBI’s online services include account opening, fund transfers,
utility bill payments, ticketing, mutual fund investments, credit
card payments, and even donations to charities. At PNB, the
Indian banks’ alternative channel penetration is low …and their level of development differs vastly across banks
Brick and mortar 47%
ATM, cash deposits 19%
Internet banking 15%
Call centre7%
Mobile banking9%
Self-service Kiosk3%
Brick and mortar 79%
ATM, cash deposits 11%
Internet banking 7%
Call centre2% Mobile banking
1%
4-9-1 Customer Transactions (Value) conducted through each Channel Best Banks in Asia Indian Banks
Source: Asian Banker Research
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 127 Distribution and Penetration
Internet is proving more popular than telebanking and mobile
phone banking. A key benefit of offering railway and air ticketing
through the internet has been a big decrease in the cost of
transactions. It plans to start outward calls from call centres
shortly. The management’s expectation is that 25% of the business
would be transacted through alternative channels in the next two
years. Canara Bank and some smaller state banks offer online
banking to a limited extent, but net banking is confined to
branches networked under a core banking system (CBS). Evolving
up the e-chain will involve not only providing basic information
but also offering interactivity and transaction capability as well as
collaborating with partners.
• Our survey of the online strength of banks in India rated banks on
two aspects:
1. Transactional strength – Comes from options to ‘move’
money, e.g. fund transfer, bill payment, investment and loyalty
point redemption.
2. Administrative strength – Denotes options to retrieve
information and customise transactions, e.g. balance enquiry,
scheduled fund transfer and bill payment, and personalised
menu.
The ability to compete on functionality is still a majordifferentiator as banks vary significantly in our strength ranking
4-9-2 Survey on Online Banking Strength of Banks in India
Source: Asian Banker Research
0%
10%
20%
30%
40%
50%
60%
70%
0% 20% 40% 60% 80% 100%
Administrative Strength
Tran
sact
iona
l Str
engt
h
Canara, PNB, BOI BOB
StanChart (India)
Citibank (India)
ICICI
SBI
CBI
UTI
HDFC
YES
UBI
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 128 Distribution and Penetration
• New private banks ICICI, HDFC and UTI achieved the highest
scores on transactional strength and are well-developed on the
administrative side as well. In fact, in terms of online banking
transactional strength, ICICI and HDFC are comparable to or not
far behind some of the best performers in Singapore and Hong
Kong. SBI has developed its transactional and administrative
strengths evenly but other state bank sites surveyed have yet to
develop these to a significant level. Foreign banks which do not
offer online trading in various categories for which the online
demand is yet to mature scored lower than new private banks that
have put up these facilities.
• Geographically, some state bank officials perceive that a limited
online banking network is enough in smaller towns and rural areas
as Internet banking facilities are not relevant in these segments.
• Foreign and new private banks are much more advanced than the
state banks in terms of the number of Internet sites and their level
of development. ICICI’s channel usage is relatively balanced
across its multiple channels and branches account for only about
25% of total transaction volume. Citibank’s Internet channel plays
a dual role. It provides transactional convenience to customers and
is used as a sales channel to sell wealth management products to
the younger mass-affluent segment as the branch is no longer
considered suitable for small-ticket transactions. It thus augments
the bank’s direct marketing and telecalling strategies. Account
opening, customer profiling and transacting are accomplished
seamlessly.
• Citibank in India has also discouraged branch visits by imposing a
service charge for branch processing of transactions that could be
conducted over the Suvidha ATM and Internet channels. For state
banks, it would be extremely difficult to use such practices given
public expectations with regard to the obligations of these banks.
Foreign and new private banks are more advanced than state banks in their on-line banking development
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 129 Distribution and Penetration
• When banks evaluate the various distribution/sales channels, two
factors are considered most important: customer acquisition
capability and origination cost and quality. Beyond branch and
ATM expansion, banks in India have been trying to rapidly
expand coverage of the dealer networks across consumer products.
Different channels have different levels of origination cost and
quality. For example, although the car dealer channel may be large
for auto loans, it is expensive as loans are passed to the banks
offering the highest origination commission. Customer acquisition
costs are increasing because of higher dealer/channel fees. Even
new private banks which are actively experimenting with
alternative channels have found that sourcing through branches or
exclusive sales channels yields lower costs and better origination
quality.
• As they weigh the use of alternative channels, Indian banks and
Asian banks in general need to carefully assess the readiness of the
customers or risk leaving behind those who would like to deal
with simple and easy-to-understand channels like the branches.
Overestimating the acquisition potential of some channels and
underrating others is another possible pitfall in using the multiple-
channel approach.
• Banks also need to ensure that they are ready to harness the full
power of the alternative channels. Some banks in Asia, for
instance, have placed an overweight focus on Internet banking and
installed powerful platforms but do not know how to market or
strategise it. Compounding the problem is that besides higher
development costs for new products, accelerated homogenisation
of banking products, more competition from NBFCs and higher
customer expectations, online channels carry the additional risk of
diminished customer loyalty given the ease of moving to another
site.
Banks are also expanding coverage of the dealer network channels Banks need to assess customer readiness and their own ability to mobilize alternative channels
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 130 Distribution and Penetration
• Channel strategies ought to evolve in tandem with the focus of
financial services. Looking at the evolution of channel strategies in
Asia, we believe that the majority of players across the region
have not reached the stage of channel integration.
• In India, most of the state banks are still in the product- or sales-
focused stage of their financial services evolution and have yet to
move on to developing significant alternative channel distribution.
But for banks that have invested in core banking systems, cross-
channel expansion will now be more cost-effective. Some are in
negotiations with MNCs or have set up alliances with other
financial intermediaries to distribute mutual funds and insurance
products in preparation for increased cross-selling.
• New private banks which have moved to focusing on market share
are increasingly taking a multiple-channel approach, including tie-
ups with other parties for micro-finance and distribution of third-
party products, to increase their reach and expand product lines
and distribution channels beyond first-tier cities. At HDFC and
ICICI, there is a definite thrust to identify the most economical
Channel strategies move in tandem with the evolution of financial services Banks in India have a long way to go towards developing a CRM focus and channel integration
Product Market Share Focus
Relationship Focus
Sales Focus
Evolution of Financial Services
Migration Channel Distribution
Channel Optimisation
Channel Integration
Evolution of Channel Strategies
4-9-3 Evolution of Channel Strategies and Financial Services
NNeeww PPrriivvaattee BBaannkkss
SSttaattee BBaannkkss
• Customisation
• Market demand still strong
• Market demand becomes stable
• New products
• Consolidation
• Heavy investment in CRM and staffing
• Linking CRM system with front-end channels
• Striving to put out new products
• Growth is demand-driven
4-9 Multi-Channel Development in India and Peer Countries
___________________________________________________________________________ Asian Banker Research – India 131 Distribution and Penetration
channels for each product segment, signifying channel
optimisation commensurate with their market-share focus.
• The next stage of evolution entails shifting the focus from market
share to customer relationships. In the coming years, smart banks
will increasingly leverage on their investment in CBS and CRM
systems to reap the competitive advantages of channel
optimisation and integration.
Some new private banks are moving towards channel optimisation
In evaluating the current level of IT evolution we mapout a profile of Indian banks’ infrastructure. We look attheir operational profile to answer which banks areahead in the race. By using highly insightfuloperational and conceptual charts, we position futurewinners on their customization and optimization insales and analytic capabilities and reveal which banksare more inclined to systematically integrate newtechnology in their operations. Based on our interviewswith leading banks’ technology seniors and vendors,we identify the key areas of future technologyrequirements and spending by Indian banks and foreignbanks in India. IT vendors and consultants will findthis chapter useful from a prospecting point of view,but investors will also understand better the roadmapthat Indian banks will have to take in investing in newtechnology to become better players.
Structure of Contents 5-1 Mapping the IT Infrastructure of Indian
Banks 5-2 Level of IT Customization and
Optimization 5-3 Level of System Integration vs. Intention
to Adopt New Technology
Chapter 5 Tracking Technology and Infrastructure
5-1 Mapping the IT Infrastructure of Indian Banks
_______________________________________________________________________________ Asian Banker Research – India 132 Tracking Technology and Infrastructure
• Sales-driven competition is not sustainable over the long run. We
believe that some of the players in India need to begin moving their
focus from accounts to customer relationship management and build
on their CRM programme on a continuing basis. This requires IT
enablement to shift from an account-based IT system to a CRM-based
IT system.
• Mapping the IT infrastructure of banks in the country provides a sense
of the operational profile of banks. We believe most of India’s state
banks are now in the process of getting core banking systems into
place. The new-generation private sector banks like ICICI and HDFC
started out with automated platforms but have moved to CRM
technologies and data warehousing, joining the league of some leading
foreign banks which already have these systems.
• India has been an active market for core banking in the past few years.
The big push came from the entry of new-generation private banks,
whose centralised core processing systems empowered them with
stronger product and channel distribution capabilities. This led to
customer attrition for the reigning state banks, forcing them to upgrade
to more competitive, advanced and cost-effective centralised systems.
At the time, foreign banks with centralised core banking systems had
already attracted the high net-worth customers.
Account Centric Relationship Centric
Singapore Banks
Australia Banks
PNB
SBI
CB
BOI
BOB
ICICI
HDFC
StanChart
HSBC
Citibank
Ban
k S
ize
by
Ass
ets
UTI
Account Centric Relationship CentricAccount Centric Relationship Centric
Singapore Banks
Australia Banks
PNB
SBI
CB
BOI
BOB
ICICI
HDFC
StanChart
HSBC
Citibank
Ban
k S
ize
by
Ass
ets
UTI
Integrated CBS
RobustMiddleware
e-EnablementandCRM
BranchNetworking
CentralisedData
Centre
Branch
Computerisation
5-1-1 Mapping the IT Infrastructure of Indian Banks
Source: Asian Banker Research
India’s state banks are still in the process of getting core banking systems into place ….while new private banks started with automated platforms and are now moving towards CRM technologies
5-1 Mapping the IT Infrastructure of Indian Banks
_______________________________________________________________________________ Asian Banker Research – India 133 Tracking Technology and Infrastructure
• Over 50% of core banking deals in that have come to the market in the
last three years were from India. Unlike the situation in China, where
large banks have tended to dish out piecemeal contracts to a few
vendors at often incredible bargains, many Indian banks have gone into
the core banking market for centralised, integrated and packaged end-
to-end solutions because of the complexity of integrating new
applications with the archaic existing structures. The banks have
preferred local vendors due to familiarity with the local system and
business requirements, reliability of domain knowledge, sophistication
of technology and cost effectiveness. The leading vendors have been
Infosys, TCS (with FNS) and I-flex.
• Top Indian banks have opted for open-architecture core banking
solutions with real-time processing capability, relational databases
supporting easy customer-information access and complex products,
user-friendly product development tools for non-technical staff, and
interfaces with in-house or third-party legacy systems. For systems
integration, they have opted for third-party services from companies
such as Infosys, TCS, HP and IBM. With the exception of PNB, all the
largest state banks have also outsourced their data centre operations
given the lack of experience in centralised data processing.
• State banks now face a tough challenge in integrating their branches
into the new systems because of their extensive network which
includes branches in far-flung areas where telecommunications and
infrastructure facilities are still developing. We believe the top two
state banks, SBI and PNB, will complete their rollout by 2007-2008
with other major state banks like Canara, BOB and BOI following in
the two years thereafter.
• The scale and impact of SBI’s core banking exercise, encompassing
around 14,000 branches and more than ten million customers, cannot
be underestimated. If successful, it will result in a massive
transformation across people, systems and processes. It will improve
corporate governance and turn SBI into a pacesetter, triggering
technology adoption among lagging banks and consolidation of
Indian banks are opting forend-to-end solutions …and have preferred local vendors because of their domain knowledge Integrating far-flung branches into the new systems will be challenging The scale of SBI’s core banking exercise will empower it with a huge competitive advantage
5-1 Mapping the IT Infrastructure of Indian Banks
_______________________________________________________________________________ Asian Banker Research – India 134 Tracking Technology and Infrastructure
smaller banks as they try to acquire sufficient scale to face SBI’s new
competitive advantage.
• Several small and mid-tier banks have also modernised their core
processing systems, using mostly the same vendors as the top banks.
These include Union Bank of India, UTI Bank, Syndicate Bank, Indian
Bank, Karnataka Bank, Central Bank of India and Centurion Bank of
Punjab.
• While the Indian operations of major foreign banks like Citibank,
StanChart and HSBC are supported by IT systems comparable to those
of their operations in Singapore and Hong Kong, we believe their
project management experience in India may not match that in these
countries.
• Among domestic banks, we believe that HDFC and ICICI are leading
in infrastructure construction and are trying to focus on developing
accurate customer targeting. For example, HDFC is able to extract data
from different businesses and consolidate these into their data
warehouse to generate a single 360-degree view of the customer, with
the objective of offering preferential pricing and pre-approval based on
the relationship. These data warehouse extracts are available to
personal bankers at branches for individual high-end customers with
managed portfolios, while other customer touch points have access to
segment data displaying customer profitability and campaign eligibility
based on predictive modelling and analytics.
• With the market evolving from proprietary technology to packaged
solutions, the majority of banks will find it increasingly easy to
upgrade to CRM-based IT systems. Commensurate change
management and human resource training will be critical. CRM
integration must be effected at the institutional level rather than for
specific business lines alone.
Change management and human resource training commensurate with the new technologies will be critical
5-1 Mapping the IT Infrastructure of Indian Banks
_______________________________________________________________________________ Asian Banker Research – India 135 Tracking Technology and Infrastructure
• With largely similar system capabilities in place, banks will need to
compete on efficient front-end services. Not many banks, however,
have additionally invested in systems like secure front-end processes
or appropriate staff training and incentives for CRM execution.
5-2 Level of IT Customisation and Optimisation
_______________________________________________________________________________ Asian Banker Research – India 136 Tracking Technology and Infrastructure
• To move towards CRM and customer retention strategies, we believe
that banks will need to build up both their sales capabilities and their
analytical skills to get the best from the available tools and existing
customer pool.
• Size does not influence who takes the lead on CRM implementation.
The mapping of Indian banks’ sales and analytical capabilities reveals
that India’s second largest bank ICICI and the smaller HDFC are both
doing well on the operational and analytic tracks in a complementary
manner.
• The experiences of Asian banks show that the best practice is
prioritising one aspect of CRM first and then developing capabilities in
the other, as this reduces the teething problems of a CRM rollout. For
smaller banks, customer acquisition and retention take precedence.
Hence, it would make sense to give priority to operational CRM with
front-end customer systems to support the automation of sales service
and marketing. On the other hand, large banks with strong business
silos may find merit in giving priority to the development of a good
segmentation strategy based on analytics.
Banks need to build up both sales capabilities and analytical skills in moving towards CRM strategies Banks can prioritise one aspect of CRM first and then develop capabilities in the other
PNB
Chinese banksRecency , Frequency, MonetaryAnalysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Targeting Productcustomisation
Data Warehouse
Single customer
view
Currentcustomer
data capture
Service customisation
and optimisation
Leadmanagement
Sales forceautomation
Analytics Track
Op
era
tio
na
l Tra
ck
Customization and Customization and optimization enable optimization enable
banks to offer the right banks to offer the right customers the right customers the right product at the right product at the right
timetime
BOB
SBIUTI
HDFC
ICICI
HSBC (India)
StanChart (India)
Citibank (India)
PNB
Chinese banksRecency , Frequency, MonetaryAnalysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Targeting Productcustomisation
Data Warehouse
Single customer
view
Currentcustomer
data capture
Service customisation
and optimisation
Leadmanagement
Sales forceautomation
Analytics Track
Op
era
tio
na
l Tra
ck
Customization and Customization and optimization enable optimization enable
banks to offer the right banks to offer the right customers the right customers the right product at the right product at the right
timetime
Chinese banksRecency , Frequency, MonetaryAnalysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Targeting Productcustomisation
Data Warehouse
Single customer
view
Currentcustomer
data capture
Service customisation
and optimisation
Leadmanagement
Sales forceautomation
Analytics Track
Op
era
tio
na
l Tra
ck
Chinese banksRecency , Frequency, MonetaryAnalysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Recency , Frequency, MonetaryAnalysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Customer Modelling
Addition of credit riskscore
Activity -basedcosting
Channel preference
Profitability Analysis
Targeting Productcustomisation
Data Warehouse
Single customer
view
Currentcustomer
data capture
Service customisation
and optimisation
Leadmanagement
Sales forceautomation
Analytics Track
Op
era
tio
na
l Tra
ck
Customization and Customization and optimization enable optimization enable
banks to offer the right banks to offer the right customers the right customers the right product at the right product at the right
timetime
BOB
SBIUTI
HDFC
ICICI
HSBC (India)
StanChart (India)
Citibank (India)
Source: Asian Banker Research
5-2-1 Mapping Indian Banks in Achieving IT Customisation and Optimisation
5-2 Level of IT Customisation and Optimisation
_______________________________________________________________________________ Asian Banker Research – India 137 Tracking Technology and Infrastructure
• ICICI’s experience illustrates the point. In the initial stages, it focused
on sales and service. As it grew its customer base, effective customer
segmentation became necessary so as to allow the most profitable
customers to be identified, prioritised and retained. This was achieved
through analytics, which prompted a forced attrition strategy whereby
extra charges were imposed on unprofitable segments with low
balances to deter the customers from transacting heavily with the bank.
Having developed a large customer base, it could afford to lose a few,
although the bank’s overall strategy continues to have a dual focus on
customer acquisition and customer retention.
• Banks that have developed a strong analytic track can derive cross-
selling/up-selling strategies from this. HDFC Bank is a good example.
The bank was able to formally introduce its retention and up-selling
strategy last year and ran hundreds of campaigns covering several
thousand customers who were selected based on predictive modelling
and analytics, which required the use of its data warehousing facility to
analyse customer history, assess product eligibility at that point in
time, and determine the approval limits and waivers that would apply.
• We believe that passing the benefits of lower rates and better service to
existing customers rather than aggressive customer acquisition can
better serve a long-term CRM strategy for banks that are already
profitable and have reached a state where higher volumes per se may
not bring substantial incremental economies of scale but add to credit
risks over time. In India, despite the growing market, the rationale of
paying attention to deepening relationships with existing customers
through retention and cross-selling/up-selling efforts is partly based on
the rising costs of additional customer acquisitions through dealers
who charge high commissions thus rendering the product less
profitable.
• The cross-sell ratio is a good indicator of a bank’s customer modelling
capability. Not many banks in India report theirs. But we believe cross-
sell ratios are in the range of 1.2 to 2.1 (lower than in many of India’s
Asian peers) with the new-generation private banks at the upper end of
the spectrum.
Smaller banks benefit by focusing on sales and service first Banks have used segmentation strategies based on analytics once they grew larger Profitable banks can pass the benefits of lower interest rates and better service to existing customers
5-2 Level of IT Customisation and Optimisation
_______________________________________________________________________________ Asian Banker Research – India 138 Tracking Technology and Infrastructure
• While some Indian banks have application scoring, we believe very
few Indian banks have advanced applications such as behaviour
scoring and the extent to which these are actively used at this stage
remains questionable as they are hard to implement.
• Banks without CRM and data warehousing capabilities will find it
difficult to make offerings based on accurate cost-benefit analytics.
Among state banks, it will be a few years before CRM systems and
culture take root because they are still in the process of putting core
banking in place or networking their branches under CBS. Banks that
already have core banking systems are encouraged to adopt advanced
CRM systems as incremental costs to install these are low.
• Even with core banking systems in place, banks without data
warehousing will have difficulty moving to IRB (internal ratings-
based) approaches for Basel II, as such approaches require not only
current data but also historical data.
• SBI, PNB and Canara Bank have expressed interest in data
warehousing. We are told that PNB is looking for a vendor for data
warehousing and hopes to proceed on its plans within the next two
years. Typically, however, decision making at state banks is a long-
drawn-out process that takes two to three years. Thereafter, data
warehousing itself would take a few or several years to evolve
depending on the cooperation of all the stakeholders involved.
• Some state banks, if they do invest in a CRM system, have the
potential to become formidable competitors given their already
dominant asset sizes, provided they are also able to align their human
resource capabilities and management culture to it. But this is unlikely
to happen in the short term, given the slow progress on the
rationalisation and modernisation of branch networks and the
redeployment of staff as a result of political and union pressures.
After CBS, the incremental costs of installing CRM systems are low …but adoption of CRM systems by state banks will have to await till their core banking roll-outs are completed
5-3 Level of System Integration vs. Intention to Adopt New Technology
_______________________________________________________________________________ Asian Banker Research – India 139 Tracking Technology and Infrastructure
• Banks in India can be divided into three broad categories according to
their level of system integration and intention to adopt new technology:
The Traditional Institution
• This category includes most of the state banks in India. They tend to
have a conservative attitude towards adoption of technology and low
integration abilities. They adopt a “wait and see” approach, letting
others experiment first. While global banks understand that IT
spending is essential to business growth, traditional banks sometimes
tend to view it as a necessary evil. They are encumbered with mindset
issues. Their large rural branch networks are difficult to bring under a
central processing system till there is commensurate development in
telecommunications and infrastructure.
The Progressive Institution
This classification applies to the new-generation private banks with a
strong interest in experimental technology, good system integration,
and sufficient skills to successfully implement new technology. We
believe the more forward-looking state banks including SBI and PNB
will evolve into progressive institutions in due course.
State banks are more conservative about technology adoption than new private banks
5-3-1 Level of System Integration vs. Intention to Adopt New Technology
Source: Asian Banker Research
UTIOther new private banks
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
BOB
ICICI
HDFC
Canara
Citibank
Stanchart
HSBC
Other state banks
UTIOther new private banks
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
BOB
ICICI
HDFC
Canara
Citibank
Stanchart
HSBC
Other state banks
UTIOther new private banks
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
BOB
ICICI
HDFC
Canara
Citibank
Stanchart
HSBC
Other state banks
UTIOther new private banks
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
System Integration
Adoption of New Technology
Low
ExperimentalConservative
HighThe systemic institution
The experimental institution
The progressive institution
The traditional institution
PNBSBI
BOB
ICICI
HDFC
Canara
Citibank
Stanchart
HSBC
Other state banksOther state banks
5-3 Level of System Integration vs. Intention to Adopt New Technology
_______________________________________________________________________________ Asian Banker Research – India 140 Tracking Technology and Infrastructure
The Systemic Institution
The banks in this group have a very strong in-house development
capability and a highly advanced level of system integration.
Technology-wise, their attention is primarily on operational efficiency
and effectiveness of the underlying systems, not merely system
integration and implementation. We believe that this covers the major
foreign banks operating in India and that some of the leading new-
generation private banks like ICICI, HDFC and UTI will also become
systemic institutions over time.
• For large vendors marketing core banking systems, their experience in
dealing with Indian banks may be slightly different from that of
smaller vendors marketing other software applications. For the core
banking systems, banks appear more amenable to sourcing the best
systems. Cost is an issue and the negotiations are typically demanding
and lengthy. But banks are serious about transforming their systems
given the perceived benefits and competitive pressures. The fact that
world-class IT vendors with good domain knowledge are available
locally is reassuring to Indian banks. The scale and duration of these
projects demand a certain level of commitment to maintaining a long-
term relationship with the vendor and system integrator.
• For smaller vendors selling software application packages, the state
banks tend to ask for rate cuts and are often slow on payments. Their
approach to dealing with the small vendor is transaction-oriented rather
than aimed at developing a long-term relationship. Mainline
application fixes are not always strategically planned and often take
place only when the applications have broken down.
• Private banks generally take a longer-term view on applications and
plan the timing of installations and enhancements strategically. They
also bargain with vendors but are more on time with payments.
• There may be fewer opportunities in the future for vendors selling core
banking systems as most of the top and mid-tier banks have already
Indian banks are serious about transforming their systems …but cost is an issue and negotiations often lengthy
5-3 Level of System Integration vs. Intention to Adopt New Technology
_______________________________________________________________________________ Asian Banker Research – India 141 Tracking Technology and Infrastructure
made their decisions. However once Indian banks complete their core
banking rollouts, there will be opportunities in data warehousing,
payments, channels, CRM and other business applications. We believe
that information security, mirroring and backup technology for data
centres (to ensure business continuity in the event of disasters) and
faster delivery of services will also become key concerns for banks.
• In addition, we are likely to see increased demand for ALM (asset-
liability management) and other treasury enhancement applications
that enable better exposure management, speed-enabling technology,
risk management systems to meet Basel II requirements, and
identification software to identify individuals across multiple
databases.
• For Basel II risk management requirements, banks have found it better
to use different software specifically suited for different businesses
along with a system for integration. For certain businesses, local
vendors with domain expertise have been preferred based on the
perception that foreign systems would need modification in the Indian
context.
• Going forward, we will see more focus on front-end rather than back-
office systems. The main areas of technology spend by banks will
likely be security systems, CRM-related data warehousing, and
information management and business intelligence systems.
Indian banks will need security systems, CRM-related data warehousing, and information management and business intelligence systems
We look into the major challenges for the bankingindustry as a whole and also for the various players, inthe wake of banking consolidation and thetransformation of domestic banks into modern salesand customer orientated financial institutions. Byidentifying key areas of concern in risk and assetmanagement, performance and operations, capitalraising activities, distribution and penetration channelsas well as IT infrastructure, we bring together our keyfindings in a unified and comprehensive view forbusiness applications and strategy discussions for thebenefit of investors, players in the marketplace, as wellas service providers and consultants wanting to servethe Indian banks. Readers will find our key conclusionsuseful for their business decision-making needs.
Chapter 6-7 Major challenges, key concerns and conclusions
6 Key Challenges and Concerns
_______________________________________________________________________________ Asian Banker Research – India 142 Key Challenges and Concerns
6 Key Challenges and Concerns
• Although with strong credit growth, improving net interest margins
and asset quality the outlook for the Indian banking industry is
positive, some challenges remain and new ones are emerging.
• The benefits of increasing employment opportunities and rising
incomes have not spread to the rural poor. Despite strong credit
growth, total lending in India has not increased in line with GDP as
many banks have been reluctant or have not been ready operationally
to expand in segments such as SME and rural lending which are
perceived to be riskier than others. A more inclusive banking culture
that allows these sectors to benefit has become imperative for
sustaining India’s economic growth and boosting credit lending.
• A large part of household savings, especially in rural areas, is still
invested in physical assets and gold. Banks now face the challenge of
creating innovative products to attract these savings so that they can be
mobilised into financial assets which can then be channelled towards
the financing of productive investments.
• The country’s increasing dependence on volatile capital inflows from
FIIs in maintaining foreign exchange reserves is a cause for concern.
Liquidity in the banking system has become closely tied to forex
movements and hence subject to fluctuations which banks need to cater
for to maintain consistent loan growth.
• With loans growing faster than deposits, there is concern that deposit
growth will be a restricting factor for credit expansion, although banks
with a higher SLR will need much lower deposit growth to fund the
same growth in advances. But to ensure profitability, Indian banks will
have to keep a watchful eye on not only the volume of deposit
mobilisation but also the composition and cost of those deposits. The
loan growth will be less profitable for state banks because their lending
rate increases have been lagging deposit rate hikes.
6 Key Challenges and Concerns
_______________________________________________________________________________ Asian Banker Research – India 143 Key Challenges and Concerns
• Operationally, retail financial services in India have not yet reached the
front-end stage of being driven by CRM to maximise the returns from
an existing customer base, as in more mature financial systems. State
banks are still largely in the product- or sales-focused stage, while
some private banks have shifted their focus to increasing market share
but not yet fully evolved to customer relationship management.
• In first-tier cities, where the overall market is nearing saturation, price
wars have emerged amid aggressive customer acquisition. This has
been reflected in net interest margins in the retail and corporate sectors
over the last three years with some banks showing negative net interest
income. Rather than engage in undercutting, banks need to decide what
business they want to be in and for what price, and their capital
adequacy level will determine their risk-taking ability on different
assets and the sustainability of loan growth.
• Some banks are focusing on market share in existing segments despite
lower margins and high cost of funds to keep up high volumes.
However these banks need to be wary of deterioration of asset quality
over time although growth in delinquencies may be dwarfed by strong
asset growth in the short run. We are concerned that banks which focus
on customer acquisition without appropriate pricing may end up with
poor asset quality in the long run.
• All banks, including the foreign players, are departing from the
strategic marketing rule of either targeting the rich or catering
primarily to the mass market and not both. In a trend towards universal
banking, banks previously focused on wealthier segments are
venturing into micro-financing while mass market players are
extending their business into wealth management and bancassurance.
Creating innovative strategies to appeal to both target groups will be
the name of the game.
• Many banks are targeting the same customer segments with similar
strategies and little product/value differentiation. We believe that
banks should build up their attractiveness to customers through
superior pricing and service delivery.
6 Key Challenges and Concerns
_______________________________________________________________________________ Asian Banker Research – India 144 Key Challenges and Concerns
• While Indian banks are very good in processing large volumes given
their advanced technology, these banks must now learn to develop and
maintain process and service quality at the front-end channels.
Technological progress does not equal significant improvement in
customer service quality in the industry. Quality not only depends on
sophisticated back- and front-end applications but also requires, first
and foremost, front-line staff who can discern how and when
customers have to be approached with appropriate products. The basics
of convenient access and efficient customer service need to be
prioritised above product range.
• The trend of poaching and consequently high attrition rate of
relationship managers among foreign and new private banks may
compel some of these banks to increase their reliance on automated
systems and centralised research tools to process asset management in
order to protect their customer base and intellectual capital.
• Interest-based income still dominates revenues at the state banks. Their
continued dependence on government business, cards and traditional
fee-based products will see them lagging behind the foreign banks and
new private banks in developing diversified sources of fee income.
• The development of complex fee-based services requires the support of
an integrated IT platform for the bank to get its productisation and
pricing right with respect to such services and optimise cross-selling.
But many banks do not yet have this in place.
• Banks need to balance their retail asset portfolios. Those with asset
portfolios highly skewed towards specific retail segments could be
vulnerable to any system-wide deterioration in the quality of these
retail assets. We are concerned that higher delinquency may arise with
robust loan growth if not provided for by an adequate provision cover.
• Asset quality has improved across private and state banks. However,
they must remain vigilant as the Indian banking sector has not gone
6 Key Challenges and Concerns
_______________________________________________________________________________ Asian Banker Research – India 145 Key Challenges and Concerns
through a major economic downturn in the last few years and hence
their risk capabilities have not been tested yet.
• India’s credit bureau still lacks depth and is not linked to scoring and
customer performance systems of banks as in the United States. In the
absence of customer credit-rating systems, very few banks have
adopted risk-based pricing in retail lending.
• Indian banks must learn to implement staff reward systems to shore up
risk management capabilities. In the few banks that have tried, the
incentives are still only partial because of the need to strike a balance
between loan targets and risk.
• After a recent spate of capital issuances, many banks are adequately
capitalised for now vis-à-vis Basel II requirements and their loan
growth plans, but some of the smaller banks may need further equity
capital. The introduction of hybrid capital instruments has reduced
immediate concerns about the ability of state banks to raise capital
without diluting government ownership. However, continued
dependence on hybrid instruments may be a weak resolution if capital
account convertibility is introduced and capital requirements go up
even further to cater for higher risks.
• Expansion of the formal finance sector into previously unbanked
segments has often been associated with increased prudential risk in
other countries. In rural areas, banks face the challenge of low
transaction values, higher transaction costs and low literacy levels of
target customers. Indian banks’ increased focus on rural and SME
lending is prompted by improved prospects and better technological
capability to handle small-ticket transactions cost-effectively, and is
aided by supportive measures from the government and RBI in the
form of information sharing and credit rating models for SMEs. They
will need to find innovative ways to develop the banking culture in
rural areas through customised and simplified channels (e.g.
multilingual ATMs, multifunction smart cards) and at the same time
mitigate risks through collateralised lending in association with
partners like NGOs, micro-finance institutions, logistics companies
6 Key Challenges and Concerns
_______________________________________________________________________________ Asian Banker Research – India 146 Key Challenges and Concerns
and dealers. Turnover and asset norms for SMEs need to be defined
and standardised across banks to track and compare estimates of
lending to this sector.
• In penetrating the rural segments, economies of scale will be
paramount and only the banks with the best distribution channels and
mechanisms will be able to leverage on this market to boost
profitability. As the branch continues to be the preferred channel in a
cultural milieu that favours face-to-face interaction, many small and
mid-tier banks have formulated aggressive branch expansion plans for
the coming years but delays in getting branch licences could hurt their
growth plans in FY2007.
• Having significantly smaller branch networks than the state banks will
prompt private local banks and foreign banks to increase their reliance
on alternative delivery and sales channels. For now, multiple-channel
development in India is still under-evolved. Few players have moved
their focus from channel distribution to channel optimisation and the
industry is still a long way from channel integration. Low penetration
of telephones, mobile phones, internet and PCs limits the possibilities
of alternative channel use to specific groups of customers.
• Many state banks are on course for their core banking rollout, but now
face a tough challenge in integrating their branches into the new
systems given their wide network and numerous branches in far-flung
areas where telecommunications and infrastructure facilities are still
developing. Moreover, banks will need to translate the benefits of
superior technology into better products and front-end service quality
for customers.
• Few Indian banks have CRM and data warehousing technology.
Without this technology, banks will find it difficult to make cross-sell
or up-sell offerings based on accurate cost-benefit analytics. For those
who do have it, the challenge is to effect CRM integration at the sytem
level rather than for specific business lines alone.
6 Key Challenges and Concerns
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• Aggressive acquisition strategies in credit cards have spawned
consumer complaints. These usually relate to offers of unsolicited
cards, lack of information on terms and conditions of repayment,
wrong activation and outright harassment. The rising number of such
complaints has prompted the regulator to develop a code on ethical
banking but compliance by banks will need to be monitored.
• The profitability of state banks continues to be low compared to that of
foreign and new private banks because of their large investments in
technology, the difficulty of bringing down their high staff costs and
their lack of developed fee-income sources. These banks need to
urgently refresh their ageing human resource pools to meet the new
challenges in a digitalised environment and the operational
requirements of customer service. Redeployment of surplus staff to
direct sales and data loading has started but is proceeding slowly.
• Despite the strong business case and urgency for the consolidation of
India’s state banks, sensitivities over the potential job losses, political
restraints, union issues and difficulties in technological integration are
slowing the progress on this front.
• The deregulation of the banking industry coupled with the emergence
of new technologies is enabling new competitors to enter the financial
services market quickly and efficiently. There has been some switching
away of savings from bank deposits to the mutual funds industry which
has experienced strong growth in the past few years fueled by the stock
market boom. In the long term, banks will need to find ways to counter
this disintermediation trend by diversifying into new areas.
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 148 Conclusion
7 Conclusions
• India’s Banking Industry: Outlook and Opportunities Assessment
Report is an essential resource for industry practitioners doing business
in India, including bankers, investors, consultants and vendors. Here,
we draw a list of conclusions that are specific to their business
decision-making needs.
For bankers:
• With the increasing interest rates and inflationary pressure continuing
in 2006, overall credit expansion in India will continue at a slightly
slower, but still strong, pace compared to the previous year. We expect
credit growth of 27% in FY2007.
• Banks that adopt a universal banking model by expanding into mutual
funds, asset management, insurance, corporate advisory and
investment banking through subsidiaries or non-banking institutional
arms will be able to maintain a dominant position in the financial
market and generate more fee income.
• Despite strong demand for credit, deposit growth may be a restraining
factor for credit expansion in FY2007. But banks with a higher SLR
will need much lower deposit growth to fund the same growth in
advances (though a high SLR also hits their balance sheet as less credit
is available for private sector lending).
• With the increase in deposit rates, the ability to maintain a low-cost
funding base will be critical to the profitability of Indian banks in the
long term. Banks will have to tailor their strategies to ensure continuity
of this fund base, since the secondary money market is not developed
and borrowing for various tenures is limited and costly. Those with
substantial CASA deposits will benefit from the fact that only non-
CASA deposits are re-priced with an increase in deposit rates.
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 149 Conclusion
• Banks may need to accept that they cannot differentiate much on the
same products beyond a point. Those who focus on asset quality,
customer retention and relationship deepening, low-cost deposit
mobilisation and risk-based pricing will enjoy more consistent and
sustained profit growth over the long term.
• Consumer credit will continue to be the main area of competition in the
foreseeable future, as the appetite for retail products is likely to keep
growing for another two to three years at least. Our survey shows that
in the coming years, the most important sources of revenue growth in
retail banking in India will be mortgages, personal loans, credit cards
and wealth management, while corporate revenues will be
concentrated in SME lending, treasury services, cash management and
structured products. In wealth management, banks will strengthen the
mass affluent and overseas Indian segments.
• Currently, some of the biggest players in sub-prime lending are foreign
NBFCs with their strong risk management and credit underwriting
systems that can handle higher delinquencies. Local banks must
develop the ability to handle the risks of sub-prime lending in order to
compete effectively in this segment.
• Banks need to diversify their revenue mix. Fee income earned
simultaneously with interest income through bundling can boost
profits, but requires an integrated IT platform that allows banks to get
their productisation and pricing right. Loan trading can also enable
banks to increase corporate fee income and grow loan books without
incurring acquisition costs.
• With rapid credit expansion, risk management will take on greater
significance. We encourage banks to build reward/bonus systems into
remuneration structures to incentivise staff and increase the efficiency
of risk management.
• RBI’s risk weights on retail categories are currently much higher than
those required by Basel II. However we believe there could be a
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 150 Conclusion
reduction in these weights in March 2007 to bring them closer to Basel
II requirements. Banks are on track to adopting the Standardised
Approach for credit risk and the Basic Indicator Approach for
operational risks by March 2007. But beyond March 2007, banks
without data warehousing will find it extremely difficult to move to the
IRB approach as this will require not only current data but also
historical data.
• SME lending and rural finance have become increasingly viable
propositions with annual yields even higher than those of some retail
segments. The kisan credit card, covering a spectrum of farming and
personal loan requirements, and collateralised commodity financing
through commodity exchanges are likely to become attractive growth
segments for banks.
• In penetrating the rural segment, only the banks with the best
distribution channels and mechanisms will be able to profit from this
market. The key winning strategies for banks in branch management
will be leveraging on alternative sales/delivery channels and turning
the branch into a stronger sales platform through better customer
segmentation for cross-selling.
• Processing and service quality in times of massive customer
acquisition is likely to emerge as a key issue. Banks which lose sight
of the basic requirement of providing efficient customer service
through well trained front-line staff do so to their own detriment. We
believe that banks will need to go beyond acquisition strategies and
determine the optimal customer-quality base given the linkages in their
product range and their operating structures and systems, within which
cross-selling can be conducted effectively without compromising
process quality.
• While ATMs and internet banking have proved successful in some
areas, banks in India will need to assess whether or which of their
customer segments are ready for alternative channels. There will be
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 151 Conclusion
customers who continue to prefer branch transactions and a one-size-
fits-all approach will not work.
• The practice of having “flexible branches” (e.g. leased premises,
mobile banking) and “outsourced ATMs” (owned, developed and
maintained by other parties) as well as ATM-sharing arrangements will
be useful for banks concerned about cost issues. Those with advanced
IT systems, however, are encouraged to leverage better on their
investment in CBS and/or CRM systems to reap the cost advantages of
channel optimisation and eventually channel integration.
For investors:
• In FY2006, Bankex under-performed Sensex. But on the whole, strong
loan growth, declining NPLs, better asset quality and improved risk
management have increased public confidence in Indian banks over the
past few years. Some private banks out-performed the Sensex while
state-owned banks under-performed the benchmark.
• The under-performance of state banks was due to fears of margins
being adversely affected by rising deposit rates coupled with lagged
lending-rate increases and the subdued growth in profits as a result of
high IT and other operational costs. These banks’ valuations are
depressed by their low FII limits but do not take into account their vast
reach, access to low-cost funds and improvement in asset quality.
Although their ROA is likely to remain comparatively low for a few
years due to the ongoing IT upgrading, the completion of their core
banking rollout is expected to put the top state banks on an enhanced
competitive footing.
• Analysts reveal that since the stock market meltdown in May 2006,
almost all banks have under-performed the market and bank stocks
were trading at or below “worst scenario” values around mid-July 2006
indicating that the stocks may have bottomed out. Bankex has since
moved up but we believe bank stocks will remain volatile in the short
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 152 Conclusion
term. Operating and net profits of private banks should improve with
strong credit growth and better liquidity, but net profits of the state
banks may be adversely affected by bond losses and hence show
relatively modest growth.
• Many banks are well-capitalised for now after a spate of capital raising
measures in the past 18 months to cater for Basel II requirements and
their loan growth plans. Furthermore, hybrid instruments can now be
used for raising Tier I capital. Thus, we believe there will be less
equity issuances in the coming months. However some of the smallest
private banks experiencing exponential loan growth may opt for equity
issuance in FY2007. Delays in getting branch licences could impact
the loan and deposit growth plans of private mid-tier banks and compel
them to go for equity issuance as well. Not many other banks will
launch IPOs; we believe only a few old private banks and small state
banks may go for a listing in FY2007.
• A key thrust in the next three years will be to speed up consolidation of
local banks through mergers and acquisitions before the anticipated
liberalisation in 2009. As state banks can only be merged with other
state banks due to ownership restrictions, we expect more alliances
among state banks as well as accelerated M&A activity among smaller
private banks trying to scale up inorganically by acquiring peers or
securities, insurance and home-finance companies to expand branch
penetration, asset size or geographical footprint.
• Due to RBI‘s restrictive stance, the scope for foreign acquisition deals
in the next three years will be limited to taking over of the distressed
assets of old private banks and small stakes in local banks subject to
the regulatory caps on investment (5% for individual foreign banks and
10% for foreign institutional investors). Foreign players may continue
to explore investments in registered NBFCs, especially in fast moving
areas like two-wheeler finance, personal credit and other sub-prime
consumer segments which tend to have higher profitability. But the
period of unrestricted proliferation of branch channels and unethical
credit borrowing and collection techniques on the part of some NBFCs
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 153 Conclusion
may be over soon, judging from recent signals from RBI and its
increased vigilance of the activities of foreign NBFCs.
For consultants and vendors:
• The upgrading of technology infrastructure will continue in 2006-
2007. State banks, especially, are increasing their efforts in data
centralisation, branch networking, upgrading of application layers and
core banking.
• Most tier 1 and tier 2 banks have already made decisions but some
small banks may enter the market for core banking systems. The trend
among Indian banks is to opt for centralised, integrated and packaged
end-to-end solutions and bottom-up infrastructure change because of
the complexity of integrating new applications with the existing
archaic structures. They tend to prefer using third-party services for
systems integration and outsourcing their data centre operations given
the lack of data processing experience. Since multinational vendors
with domain knowledge are locally available, foreign vendors
interested in pursuing these deals will need to convince Indian banks
that they can deliver comparable or superior service and/or offer
favourable pricing.
• Core banking system rollouts for the top state banks will be completed
by 2007-2008 with the other state banks following in 2009-2010. Once
these are completed, there will be opportunities for vendors in data
warehousing, payments, channels, CRM-related information
management and business intelligence systems, and other business
applications. A few of the top state banks have already started speaking
to vendors about data warehousing.
• The core banking and CRM culture will trigger transformation across
people, systems and processes. We believe banks will need consulting
services on change management and HR training to align staff
mindsets and skills to the new systems.
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 154 Conclusion
• We believe that in the coming years, banks will prioritise information
security, mirroring and backup technology for data centres (to ensure
business continuity in the event of a disaster) and faster delivery of
services. There will be increased demand for ALM and other treasury
enhancement applications that enable better exposure management,
effective anti-money laundering systems, speed-enabling technology,
and identification software to identify individuals across multiple
databases.
• Rapid credit growth will require further investments in risk
management systems and in the hiring of qualified staff and
consultants to help implement Basel II requirements. For Basel II risk
management systems, banks have had a better experience with using
specific software suited to specific businesses along with an
appropriate system for integration rather than a single application.
• Currently, only a few private banks have data warehousing and CRM
systems and not many have invested in systems like secure front-end
processes and appropriate training and incentives for CRM execution.
As system capabilities converge with more banks adopting core
banking systems, banks will begin to focus on creating service
differentiation through more efficient front-end services.
• Very few local banks have behaviour scoring applications. We do not
believe local banks are ready to implement these yet.
• Expansion of operations beyond first-tier cities to cover the 75% of the
population living in rural areas will require additional investments.
Small and mid-tier private banks are investing in aggressive branch
and ATM expansion beyond metros. For greater flexibility, some
banks are opting to lease rather than buy premises. Local banks are
also experimenting with a cost-saving scheme whereby third parties
are invited to develop and maintain the ATMs while banks pay
commission on a transaction basis.
7 Conclusions
_______________________________________________________________________________ Asian Banker Research – India 155 Conclusion
• Bankers will be on the lookout for more dealer networks and tie-ups
for transportation, safe storage and warehousing arrangements as
alternative sales/delivery channels given the success of this model in
agricultural and SME lending.
• Products that address the infrastructural deficiencies in remote areas
hold promise in enhancing financial inclusion. These include:
computer systems which do not require uninterrupted electric power
supply; networking systems using radio frequency or other
unconventional communication methods; and customised systems such
as low-cost multilingual ATMs or multifunction smart cards with built-
in security and identification features.
The report is supported by a full range of latestavailable primary data at the operational and businesslevels that decision makers will need for making theirown assessments.
Chapter 8 Appendix: India Banking Data Series 2001-2005
8 Appendix
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India –8.1. Basic statistical data
2001 2002 2003 2004 2005
Table 8.1.1 Macro data GDP (Rupees billions) at current prices 22,821 24,696 27,483 30,949 35,058 Growth 9.2% 8.2% 8.5% 6.5% 7.0% GDP (US$ millions) at current prices 473,661 514,179 622,841 710,154 779,936 Growth 6.0% 8.6% 21.1% 14.0% 9.8%
Population (millions) 1,037 1,055 1,077 1,094 1,107 Growth 1.8% 1.7% 2.1% 1.5% 1.2% Population age distribution 0-14 33.2 33.0 32.2% 31.7% 31.2% 15-64 62.1 62.4 63.0% 63.5% 63.9% 65+ 4.7 4.7 4.8% 4.8% 4.9%
GDP/Capita (Rupees) 22,007 23,409 25,518 28,289 31,669 Growth 7.3% 6.4% 9.0% 6.4% 11.9% GDP/Capita (US$) 457 487 578 649 705
Table 8.1.2 Price indices Composite consumer price index (1982 = 100) 458.0 476.3 499.2 529.1 549.2 YoY change 3.9% 4.0% 4.8% 6.0% 3.8% Producer price index (1993-94=100) Agriculture, 1981-82 = 100 148.4 150.7 179.4 168.6 170.5 YoY change 0.0% 1.5% 19.0% -6.0% 1.1% Mining, 1993/94 = 100 131.9 132.4 157.8 165.4 162.5 YoY change 1.2% 0.4% 19.2% 4.8% -1.8% Manufacturing, 1993/94 = 100 167.0 172.3 210.7 231.4 245.0 YoY change 2.7% 3.2% 22.3% 9.8% 5.9%
Table 8.1.3 Monetary statistics (Rupees billions) Narrow money supply (M1) 4,228 4,736 5,787 6,463 7,363 Currency in circulation 2,414 2,763 3,200 3,625 3,980 Demand Deposits 1,792 1,988 2,586 2,840 3,371 Quasi money 10,775 12,532 12,617 14,942 17,383 Money supply (M2) 4,279 4,786 5,838 6,513 7,414
Monetary Statistics (US$ millions) M1 87,763 98,601 131,154 148,293 163,814 Growth 8.0% 12.3% 33.0% 13.1% 10.5% M2 88,809 99,651 132,296 149,450 164,935 Growth 8.0% 12.2% 32.8% 13.0% 10.4%
Table 8.1.4 Inflation and unemployment Inflation (YoY change, %) 3.9% 4.0% 3.8% 3.8% 4.3%
Labour force (million) 458 475 486 472 496 Unemployed (million) 42 41 31 34 44 Unemployment rate (%) 9.2% 8.7% 6.3% 7.2% 8.9% Employment by economic activity Agriculture (%) 24.6% 22.7% 23.1% 21.1% … Industry (%) 25.4% … … … … Service (%) 49.7% 51.5% 50.9% 51.7% … Labour force participation rate Women (%) 29.2% 28.6% 28.3% 28.1% … Men (%) 70.8% 71.4% 71.7% 71.9% … Exchange rate (domestic currency vis-a-vis US$) Year-end 48.180 48.030 44.125 43.580 44.950
Note: All information as at financial year ended March (e.g. 2004 is as at 3/2004), unless otherwise stated.
8 Appendix
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India –8. 2. Household demographics
2001 2002 2003 2004 2005
Table 8.2.1 Number of households ('000) 188,391 194,559 199,028 198,900 … % urban population 27.8% 28.2% 28.5% 28.7% …
Household income (Rupees billions) at current prices 18,197 19,757 21,972 23,686 29,005 Household income (US$ billions) at current prices 378 411 498 543 645 Household income/GDP (%) 80% 80% 80% 77% 83%
Number of households ('000) by income band US$'000 p.a. 0-1 79,086 80,786 81,549 49,725 … 1-3 53,907 56,110 55,692 65,637 … 3-5 19,120 19,902 21,879 35,802 … 5-10 17,318 18,026 19,890 23,868 … 10+ 18,960 19,735 20,018 23,868 … Total number of households ('000) 188,391 194,559 199,028 198,900 …
Total household borrowings (Rupees billions) 4,577 4,939 5,359 5,707 6,080 HH borrowings/HH income 25% 25% 24% 24% 21% HH borrowings/GDP (%) 20.1% 20.0% 19.5% 20.0% 17.3%
Table 8.2.2 Gross domestic saving (Rupees billions) 4,963 5,380 6,490 7,975 9,074 Gross domestic saving (US$ billions) 103 112 147 183 202 Gross domestic saving/GDP (%) 21.7% 21.8% 23.6% 25.8% 25.9%
Table 8.2.3 Poverty Population in poverty (%) … … … 25% 29% Rural … … 27% 27% 29% Urban 30% … 24% 24% 25%
Income ratio of highest 20% to lowest 20% … … 5.7X … …
Gini coefficient 1) … … 0.38 0.41 0.42
1) The Gini coefficient is the most commonly used indicator of inequality. The coefficient ranges between 0, where there is no concentration (perfect equality and income is distributed completely equally), and 1 where there is total concentration (perfect inequality in income distribution).
8 Appendix
_________________________________________________________________________ Asian Banker Research – India 158 Appendix
India –8.3. Banking industry data
2001 2002 2003 2004 2005
Table 8.3.1 GDP from finance GDP (Rupees billions) at current prices 22,821 24,696 27,483 30,949 35,058 GDP contribution from finance 2,671 2,962 3,483 3,966 4,523 % contribution 11.7% 12.9% 13.0% 13.1% 14.8%
Table 8.3.2 Number of financial institutions by category Central bank - State Bank of India 1 1 1 1 1 State Bank of India associates 7 8 8 8 8 Nationalized banks 19 19 19 19 19 Regional rural banks 196 196 196 197 196 Foreign banks 42 40 36 36 40 Other scheduled commercial banks 100 98 93 90 86 Combined total 365 362 353 351 350
Number of inhabitants: Per bank 3,437,500 3,502,373 2,988,669 3,068,376 3,626,246 Per commercial bank 10,277,778 10,542,857 10,762,861 11,039,026 11,322,277 Per branch 15,033 15,151 15,531 15,723 15,839
Table 8.3.3 Deposits in banks (Rupees billions) Demand deposits 1,594 1,691 1,878 2,304 3,007 Time deposits 8,297 9,621 11,239 13,151 15,590 Deposits in banks (US$ millions) Demand deposits 31,482 35,207 42,569 52,874 66,895 Time deposits 197,242 231,468 254,714 301,771 346,820
Table 8.3.4 Average interest rates (%) Deposits: Savings 4.0 4.0 3.5 3.5 3.5 Time 6 months 6.6 6.3 4.0 5.3 5.9 12 months 7.1 7.0 5.3 4.3 5.0 Loans and discounts: Commercial bills ... ... ... ... … Export credit 10.0 ... ... ... …
8 Appendix
_________________________________________________________________________ Asian Banker Research – India 159 Appendix
India – 8.4. Retail distribution
2001 2002 2003 2004 2005
Table 8.4.1 Automated teller machines (ATMs) Number of networks 2 2 2 2 2 Number of machines 5,800 9,000 11,000 14,000 17,800 ATM penetration (ATMs/million population) 5.6 8.5 10.2 12.3 16.1
Value of ATM transactions (Rupees millions) 456,212 550,000 548,803 572,216 596,627 Value of ATM transactions (US$ millions) 9,469 11,451 12,593 13,130 13,273 Average value per transaction (Rupees) 898 670 547 448 367 Average value per transaction (US$) 19 14 12 10 8
Volume of ATM transactions (millions) 508.1 821.3 1,003.8 1,277.5 1,624.3 Number of transactions/person 0.49 0.78 0.93 1.17 1.47
Table 8.4.2 Electronic fund transfer at point of sale (EFTPOS) Number of networks ... ... ... ... … Number of terminals 40,000 50,000 65,000 84,000 98,000 EFTPOS penetration (EFTPOSs/million population) 38.6 47.4 60.4 76.8 88.5
Value of EFTPOS transactions (Rupees millions) 1) 38,883 51,839 53,170 61,641 74,630 Value of EFTPOS transactions (US$ millions) 807 1,079 1,205 1,414 1,660 Average value per transaction (Rupees) 1,187 1,184 1,087 1,074 1,108 Average value of per transaction (US$) 25 25 25 25 25
Volume of EFTPOS transactions (millions) 1) 32.8 43.8 48.9 57.4 67.4 Number of transactions/person 0.032 0.042 0.045 0.052 0.061
Table 8.4.3 Bank branches Number of branches 65,933 66,259 66,514 67,313 68,339 Branch penetration (Branches/million population) 65.8 64.4 63.6 63.1 61.6
Table 8.4.4 Infrastructure penetration rates Fixed-line telephone (millions) 39.4 41.4 48.7 44.3 49.0 Phone penetration (Phones/million population) 38,000 39,261 45,173 40,338 44,235 Phone penetration (% of population) 3.8% 3.9% 4.5% 4.0% 4.4%
Mobile phones (millions) 3.6 12.7 22.0 46.0 62.4 Mobile penetration (Mobile phones/million population) 3,449 12,026 20,420 42,048 56,348 Mobile penetration (% of population) 0.3% 1.2% 2.0% 4.2% 5.6%
Personal computers (millions) 4.6 6.0 18.3 24.2 32.0 PC penetration (PCs/million population) 4,436 5,687 17,000 22,091 28,909 PC penetration (% of population) 0.4% 0.6% 1.7% 2.2% 2.9%
Internet users (millions) 10.0 12.0 14.0 33.5 50.6 Internet penetration (Users/million population) 9,643 11,375 13,000 30,608 45,709 Internet penetration (% of population) 1.0% 1.1% 1.3% 3.1% 4.6%
Broadband subscribers '000 20.0 61.1 147.1 231.4 364.0 Broadband penetration (users/million population) 19.3 57.9 136.6 211.5 328.8 Broadband penetration (% of population) 0.0% 0.01% 0.01% 0.02% 0.03%
Note: All information as at financial year ended March (e.g. 2004 is as at 3/2004).
8 Appendix
_________________________________________________________________________ Asian Banker Research – India 160 Appendix
India –8.5. Payment systems
2001 2002 2003 2004 2005
Table 8.5.1 Cash penetration Cash penetration (Rupees/person) 2,336 2,575 2,971 3,313 3,595 Cash penetration (US$/person) 48 54 67.3 76.0 80.0 Cash penetration as % of GDP 12.8% 12.9% 11.1% 11.6% 11.8%
Table 8.5.2 Credit cards Credit card density Number of credit cards (millions) 6.5 8.4 10.3 12.2 14.2Credit card penetration (credit cards/person) 0.006 0.008 0.010 0.011 0.013Credit card penetration (credit cards/working population)
0.016 0.019 0.023 0.028 0.031
Credit card transactions Value of credit cards transactions (Rupees millions) 124,903 142,885 154,020 183,570 238,000Value of credit cards transactions (US$ millions) 2,592 2,975 3,491 4,212 5,295Value of credit cards transaction/card (Rupees) 19,180 17,000 15,000 15,000 16,808Value of credit cards transaction/card (US$) 398 354 340 344 374Value of credit cards transaction/person (Rupees) 120 135 143 168 215Value of credit cards transaction/person (US$) 2.5 2.8 3.2 3.9 4.8Credit card billing as a % of household income 0.7% 0.7% 0.7% 0.8% 0.8%
Volume of credit cards transactions (millions) ... … 63 103 114 Average value per transaction (Rupees) ... … 2,444 1,783 2,086 Average value per transaction (US$) ... … 55 41 46
Table 8.5.3 Debit cards Number of debit cards - ATMs and EFTPOS (millions)
8.3 12.1 19.9 30.0 44.8
Debit card penetration (debit cards/person) 0.008 0.011 0.019 0.027 0.041
Value of debit cards transactions (Rupees millions) 495,095 601,839 752,299 1,015,604 1,371,065 Value of debit cards transactions (US$ millions) 10,276 12,530 17,049 23,304 30,502 Value of debit cards transaction/card (Rupees) 59,736 49,759 37,743 33,896 30,577Value of debit cards transaction/card (US$) 1,240 1,036 855 778 680Value of debit cards transaction/person (Rupees) 477 570 699 928 1,239 Value of debit cards transaction/person (US$) 10 12 16 21 28
Volume of debit cards transactions (millions) 540.8 865.1 864 1,019 1,691.6 Average value per transaction (Rupees) 915 696 871 997 811 Average value per transaction (US$) 19 14 20 23 18
Table 8.5.4 Cheques Value of cheques transaction (Rupees billions) 125,753 134,243 115,960 110,595 115,822 Value of cheques transaction (US$ billions) 2,610 2,795 2,628 2,538 2,577
Volume of cheques transactions (millions) 901.5 1,013.9 1022.8 1128.9 1163.8 Number of transactions per inhabitant 0.87 0.96 0.95 1.03 1.05
8 Appendix
_________________________________________________________________________ Asian Banker Research – India 161 Appendix
India –8.6. Financial profile of commercial banks1)
2001 2002 2003 2004 2005
Table 8.6.1 Balance sheet US$ billions Total assets 103.8 257.9 366.6 470.8 542.9 YoY change 11.0% 148.5% 42.1% 28.4% 15.3% Net loans 42.9 106.1 159.9 208.1 266.1 YoY change 14.0% 147.3% 50.7% 30.1% 27.9% Equity 4.9 12.9 19.3 26.4 32.5 YoY change 7.9% 163.3% 49.6% 36.8% 23.1%
Non-performing loans 4.8 5.0 5.9 5.6 4.9 YoY change 20.4% 4.2% 18.0% -5.1% -12.5% NPLs as a % of gross loans 11.2% 4.7% 3.7% 2.7% 1.8% NPLs as a % of GDP 1.0% 1.0% 0.9% 0.8% 0.6%
Table 8.6.2 Income statement US$ billions Net interest revenue 3.1 6.8 10.3 13.9 16.2 YoY change 20.7% 117.0% 52.1% 34.9% 16.6% Other operating income 1.3 3.9 6.9 9.7 8.9 YoY change 8.1% 195.2% 77.6% 39.8% -8.3% Total operating income 4.4 10.7 17.2 23.5 25.0 YoY change 16.6% 140.3% 61.4% 36.9% 6.4%
Overheads - Personnel expenses 1.8 3.5 5.2 6.2 6.8 - Other operating expenses 0.9 2.2 3.2 4.7 6.0 Total overheads 2.8 5.7 8.4 10.9 12.8 YoY change 18.8% 107.9% 45.9% 30.4% 17.3%
Loan loss provisions 0.6 1.6 2.6 3.5 1.3 YoY change 29.0% 156.7% 56.7% 34.8% -63.0% Others -0.2 -0.5 -1.1 -1.4 -4.4 Profit before tax 0.9 2.8 5.2 7.8 6.6 YoY change 11.6% 222.9% 82.8% 50.6% -15.5% Net profits 0.7 2.2 3.7 5.4 4.4 YoY change 3.4% 228.7% 72.9% 45.1% -19.2%
Tier 1 capital 0.6 0.7 0.8 1.7 2.8 YoY change 38.1% 18.8% 15.3% 112.5% 64.7%
Table 8.6.3 Ratios Operations: Return on average equity (ROAE) 12.2% 21.1% 22.4% 24.7% 17.1% Return on average assets (ROAA) 0.6% 1.0% 1.2% 1.4% 1.0% Cost-to-income ratio 62.2% 53.8% 48.7% 46.3% 51.1% Net interest margins 3.4% 4.0% 3.5% 3.5% 3.4%
Liquidity: Net loans-to-total assets 41.3% 41.1% 43.7% 44.2% 49.0% Net loans-to-deposits 47.7% 49.1% 51.5% 52.3% 57.7%
Capital: Equity-to-total assets 4.8% 5.0% 5.3% 5.6% 6.0%
Non-interest income as a % of total income 29.8% 36.6% 40.3% 41.1% 35.4%
Note: All information as at financial year ended March (e.g. 2005 is as at 3/2005). Note:1)Including banks with more than US$1 million in assets.
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