Sectoral Report- Banking

Prepared By:

Jamal FMS MBA(MS)

Table of Contents Introduction – Trends in Indian Banking Sector ........................................................................................ 3

Structure of the Indian Banking System ................................................................................................... 4

Banks vs NBFC: .................................................................................................................................. 4

SWOT Analysis: .................................................................................................................................... 5

STRENGTHS ..................................................................................................................................... 5

WEAKNESSES ................................................................................................................................... 5

OPPORTUNITY ................................................................................................................................. 6

THREATS .......................................................................................................................................... 7

Recent M&A: ....................................................................................................................................... 7

Top Players: ............................................................................................................................................. 9

By Market Capitalization (2010): .......................................................................................................... 9

By Net Worth(By Assets)(2010):......................................................................................................... 10

Major Government Policies: .................................................................................................................. 11

CAR as per Basel II Norms: ................................................................................................................. 11

Current Discussion Paper on Banking Licenses ....................................................................................... 12

Issue of Industrial Houses for Banking Licenses: ................................................................................. 12

Exposure to realty sector ................................................................................................................... 13

Advantages of Banking License: ......................................................................................................... 13

Disadvantages of Banking License: ..................................................................................................... 14

Analysis of Major Contenders for Banking License: ............................................................................ 14

Customer Loyalty: ................................................................................................................................. 15

Summary: .............................................................................................................................................. 16

References: ........................................................................................................................................... 19

Introduction – Trends in Indian Banking Sector The pace of development for the Indian banking industry has been tremendous over the past

decade. As the world reels from the global financial meltdown, India’s banking sector has been one of the very few to actually maintain resilience while continuing to provide growth opportunities, a feat unlikely to be matched by other developed markets around the world. Recent time has witnessed the world economy develop serious difficulties in terms of lapse of banking & financial institutions and plunging demand. Prospects became very uncertain causing recession in major economies. A relatively savings minded country, strong regulatory framework, progressively growing balance sheet, higher pace of credit expansion, expanding profitability and productivity akin to banks in developed markets, lower incidence of nonperforming assets and focus on financial inclusion have contributed to making Indian banking vibrant and strong.

The Indian banking system has undergone significant structural transformation since the 1990s. An administered regime under state ownership until the initiation of financial sector reforms in 1992, the sector was opened to greater competition by the entry of new private banks and more liberal entry of foreign banks in line with the recommendations of the Report of the Committee on the Financial System (chaired by Shri M. Narasimham). Prior to the initiation of financial sector reforms in 1992, the Indian financial system essentially catered to the needs of planned development, and the government sector had a predominant role in every sphere of economic activity. The lack of transparency, accountability, and prudential norms in the operations of the banking system led also to a rising burden of non-performing assets. On the expenditure front, inflexibility in licensing of branches and management structures constrained the operational independence and functional autonomy of banks and raised overhead costs. The financial environment during this period was characterized by segmented and underdeveloped financial markets. This resulted in a distortion of interest rates and the inefficient allocation of scarce resources.

During the 1990s, India underwent liberalization of the banking sector with the objective of enhancing efficiency, productivity, and profitability. Second, the banking sector underwent an important transformation, driven by the need for creating a market-driven, productive, and competitive economy in order to support higher investment levels and accentuate growth (Government of India, 1998). Third, studies of competition in emerging markets pertain to countries with a history of banking crises and subsequent consolidation. In these countries, concentration increased due to consolidation, and the studies tested whether this resulted in increase in competition or increase in the power of institutions. In the Indian context, it is interesting to examine if diversification of public sector banks and penetration of private and foreign banks have had an impact on competition.

Indian banks have begun to revise their growth approach and re-evaluate the prospects on hand to keep the economy rolling. The way forward for the Indian banks is to innovate to take advantage of the new business opportunities and at the same time ensure continuous assessment of risks. Commercial banks were allowed to start operations after the 1991 reforms. The entry of these banks has proved a great challenge to the public sector banks in terms of innovation and competition. Also, a large number of foreign players have entered and are trying to establish in the banking sector. The role of the global crisis has also transformed the way banking sector operates in India. Thus the objective is to get a better understanding of the Indian banking sector by taking the major players in the industry and quantitatively analyzing their strategy and competition in the market.

Structure of the Indian Banking System

(Source: http://www.ibef.org/download/Banking_060710.pdf)

Banks vs NBFC:

A NBFC cannot accept demand deposits (demand deposits are funds deposited at a

depository institution that are payable on demand -- immediately or within a very short

period -- like your current or savings accounts.)

It is not a part of the payment and settlement system and as such cannot issue cheques to

its customers; and

Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case

of banks.

SWOT Analysis:

STRENGTHS

· Indian banks have compared favourably on growth, asset quality and profitability with other regional

banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per

cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.

· Policy makers have made some notable changes in policy and regulation to help strengthen the sector.

These changes include strengthening prudential norms, enhancing the payments system and integrating

regulations between commercial and co-operative banks.

· Bank lending has been a significant driver of GDP growth and employment.

· Extensive reach: the vast networking & growing number of branches & ATMs. Indian banking system

has reached even to the remote corners of the country.

· The government's regular policy for Indian bank since 1969 has paid rich dividends with the

nationalisation of 14 major private banks of India.

· In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong

and transparent balance sheets relative to other banks in comparable economies in its region.

· India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government

of India holding a stake)after merger of New Bank of India in Punjab National Bank in 1993, 29 private

banks (these do not have government stake; they may be publicly listed and traded on stock exchanges)

and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs.

According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of

total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5%

respectively.

· Foreign banks will have the opportunity to own up to 74 per cent of Indian private sector banks and 20

per cent of government owned banks.

WEAKNESSES

· PSBs need to fundamentally strengthen institutional skill levels especially in sales and marketing,

service operations, risk management and the overall organizational performance ethic & strengthen

human capital.

· Old private sector banks also have the need to fundamentally strengthen skill levels.

· The cost of intermediation remains high and bank penetration is limited to only a few customer

segments and geographies.

· Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and

deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate

governance and ineffective regulations beyond Scheduled Commercial Banks (SCBs), unless industry

utilities and service bureaus.

· Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks

below 51% thus choking the headroom available to these banks for raining equity capital.

· Impediments in sectoral reforms: Opposition from Left and resultant cautious approach from the

North Block in terms of approving merger of PSU banks may hamper their growth prospects in the

medium term.

OPPORTUNITY

· The market is seeing discontinuous growth driven by new products and services that include

opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-

based income and investment banking on the wholesale banking side. These require new skills in sales &

marketing, credit and operations.

· Banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates

provided. This will expose the weaker banks.

· With increased interest in India, competition from foreign banks will only intensify.

· Given the demographic shifts resulting from changes in age profile and household income, consumers

will increasingly demand enhanced institutional capabilities and service levels from banks.

· New private banks could reach the next level of their growth in the Indian banking sector by continuing

to innovate and develop differentiated business models to profitably serve segments like the rural/low

income and affluent/HNI segments; actively adopting acquisitions as a means to grow and reaching the

next level of performance in their service platforms. Attracting, developing and retaining more

leadership capacity

· Foreign banks committed to making a play in India will need to adopt alternative approaches to win the

“race for the customer” and build a value-creating customer franchise in advance of regulations

potentially opening up post 2009. At the same time, they should stay in the game for potential

acquisition opportunities as and when they appear in the near term. Maintaining a fundamentally long-

term value-creation mindset.

· reach in rural India for the private sector and foreign banks.

· With the growth in the Indian economy expected to be strong for quite some time especially in its

services sector-the demand for banking services, especially retail banking, mortgages and investment

services are expected to be strong.

· the Reserve Bank of India (RBI) has approved a proposal from the government to amend the Banking

Regulation Act to permit banks to trade in commodities and commodity derivatives.

· Liberalisation of ECB norms: The government also liberalised the ECB norms to permit financial sector

entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial institutions,

which were earlier not permitted to raise such funds, explore this route for raising cheaper funds in the

overseas markets.

· Hybrid capital: In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise

perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find

takers, it would help PSU banks, left with little headroom for raising equity. Significantly, FII and NRI

investment limits in these securities have been fixed at 49%, compared to 20% foreign equity holding

allowed in PSU banks.

THREATS

· Threat of stability of the system: failure of some weak banks has often threatened the stability of the

system.

· Rise in inflation figures which would lead to increase in interest rates.

· Increase in the number of foreign players would pose a threat to the PSB as well as the private players.

Recent M&A: List of recent M & A’s in the Indian Banking Industry:

Date of merger Acquirer bank Target bank

Assets of target bank as a percentage of acquiring bank’s assets* (%)

Number of branches of target bank

In progress ICICI bank Bank of Rajasthan NA 458

Feb-08 HDFC Bank Centurion Bank of Punjab 20 (March 2007) 394

Aug-07 Centurion Bank of Punjab Lord Krishna Bank 11(March 2007) 110

Apr-07 ICICI Bank Sangli Bank 0.5(March 2007) 190

Mar-07 Indian Overseas Bank Bharat Overseas Bank 6 (March 2006) 102

Oct-06 IDBI United Western Bank 8(March 2006) 230

Sep-06 Federal Bank Ganesh Bank of Kurundwad 1 (March 2006) 32

Oct-05 Centurion Bank Bank of Punjab 106 (March 2005) 136

Aug-04 Oriental Bank of Commerce Global Trust Bank 17 (March 2004) 104

Feb-03 Punjab National Bank Nedungadi Bank 2 (March 2002) 173

Mar-01 ICICI Bank Bank of Madura 36 (March 2000) 350

Feb-00 HDFC Bank Times Bank 75 (March 1999) 39 (Source: http://www.ibef.org/download/Banking_060710.pdf)

Some reasons for M&A in the banking industry are:

Growth - Organic growth takes time and dynamic firms prefer acquisitions to grow

quickly in size and geographical reach.

Synergy - The merged entity, in most cases, has better ability in terms of both revenue

enhancement and cost reduction.

Managerial efficiency - Acquirer can better manage the resources of the target whose

value, in turn, rises after the acquisition.

Strategic motives - Two banks with complementary business interests can strengthen

their positions in the market through merger.

Market entry - Cash rich firms use the acquisition route to buyout an established player in

a new market and then build upon the existing platform.

Tax shields and financial safeguards - Tax concessions act as a catalyst for a strong bank

to acquire distressed banks that have accumulated losses and unclaimed depreciation

benefits in their books.

Regulatory intervention - To protect depositors, and prevent the de-stabilisation of the

financial services sector, the RBI steps in to force the merger of a distressed bank.

Top Players:

By Market Capitalization (2010):

(Source:http://www.capitaline.com )

In terms of market capitalization, SBI is the largest player followed by ICICI. New players like YES bank

have performed very well and have a considerable market capitalization compared to older and

traditional players like Corporation bank and Canara bank. In terms of percentage, SBI holds 23% of the

market and ICICI 15%

.

(Source:http://www.capitaline.com )

0.00

50,000.00

100,000.00

150,000.00

200,000.00

Market Cap(Crores)

Market Cap

ICICI Bank 15%

HDFC Bank 13%

Axis Bank 7%

YES BANK 2%

SBI 23%

PNB 5%

Canara Bank 3%

Corporation Ban 1%

Others31%

Market Cap(2010)

By Net Worth(By Assets)(2010): In the below pie-chart we can see that SBI holds almost 20% of the net worth of Indian banking industry.

Also in the private players ICICI is the highest with 7% and other public players like PNB and Canara Bank

hold 6% and 5% respectively.

(Source:http://www.capitaline.com )

ICICI Bank 7%

Axis Bank 4% HDFC Bank

3%

YES BANK 1%

SBI 20%

PNB 6%

Canara Bank 5%

Corporation Ban 2%

StanChartered0%

CitiBank0%

Others52%

Net Worth(by assets)

Major Government Policies:

Current RBI Guidelines

1

Guidelines

No credit facilities to the promoters

At least 25 percent of their total number of branches in rural and semi urban centers.

Listing on stock exchange

Foreign equity

restricted to 40%

Continuous capital adequacy ratio of 10%

40% lending to

priority sector

*Source: RBI Discussion Paper Regarding New Banking Licences

CAR as per Basel II Norms: As per RBI guidelines, SCB’s have to maintain a minimum of 9% as CAR (capital adequacy ratio) under

BASEL II norms to shield against external risks. CAR Ratio for the chosen banks:

2008 2009 2010

CitiBank 12.00 13.23

StanChar 10.59 11.56

Axis Bank Ltd. - 13.69 15.8

HDFC Bank Ltd. - 15.7 17.44

ICICI Bank Ltd. 13.97 15.53 19.41

YES Bank - 16.6 20.6

Canara Bank 13.25 14.1 13.43

Corporation Bank N.A. 13.61 15.37

Punjab National Bank 13.46 14.03 14.16

State Bank of India (SBI) 12.64 14.25 13.39

(Source:http://www.capitaline.com & http://www.iba.org.in)

Almost all banks have a good CAR and above the permissible level. The private players like ICICI, Yes and

HDFC have a good CAR ratio.

2005-06 2009-10

RoA Net NPA RoA* Net NPA* RoA Net NPA RoA* Net NPA*

Axis Bank (1) 1.18 0.98 1.07 1.01 1.67 0.4 1.28 1.03

Corporation Bank (2) 1.24 0.64 0.89 1.16 1.24 0.31 1 0.91

HDFC Bank (1) 1.38 0.44 1.07 1.01 1.53 0.31 1.28 1.03

ICICI Bank (1) 1.3 0.72 1.07 1.01 1.13 2.12 1.28 1.03

Oriental Bank (2) 1.39 0.49 0.89 1.16 0.91 0.87 1 0.91

Punjab Nat. Bk (2) 1.09 0.29 0.89 1.16 1.44 0.53 1 0.91

SBI (3) 0.89 1.88 0.87 1.63 0.88 1.72 0.91 1.5

Current Discussion Paper on Banking Licenses

Issue of Industrial Houses for Banking Licenses:

• Consideration for industrial houses which serve the government’s purpose of inclusive banking

• Most developed countries do not specifically restrict industrial companies from setting up banks

• United Kingdom has allowed industrial groups to participate in banking. Tesco Bank is a prime

example

• In USA, certain exceptions like GM, GE, BMW, Volkswagen &Volvo were allowed

• Banks backed by industrial houses can come up with huge amounts of capital to start with

• Capital infusion is quick and easy when required incase backed by an industrial house

• Promoters not in a necessity to dilute stake quickly

• Possibility of consolidation in banking sector increases

• Telecom Licensing method of providing licenses to various circles can be emulated in providing

licenses

Exposure to realty sector

Most corporate houses vying for have realty sector exposure

Ex:

• Tata group: Tata Realty & Infrastructure

• Mahindra & Mahindra: Mahindra Lifespace

• Reliance Capital: Reliance Property Developers

• Indiabulls Group: Indiabulls Real Estate

• Religare group: Religare Realty

• L&T: L&T Urban Infrastructure

Advantages of Banking License:

• Access to low cost CASA deposits

• Access to long-term funds at low cost

• Access to low-cost Liquidity Adjustment Facility

• Issue of Negotiable Instruments and utilization of Float Money

• Options to raise funds through issue of CDs

• Increase in brand value

• Access to huge customer base including Corporates

• Increase in large value transactions

Disadvantages of Banking License:

Analysis of Major Contenders for Banking License: • IFCI

• Ownership issues

• Financial Problems-losses and bailout by government

• MMFSL

• Strong management

• Impeccable track record

• Strong financials

• Rural/Semi urban presence

• LIC Housing Finance Ltd.

• No experience in lending industry & faces concentration of risk as it is not much

diversified

• Lack of focus on core industry

Head Bank NBFC

Business Banking regulation act

expressly bars any business

other than that permitted by

the act [sec 6 (1)]

No bar on non---financial business

Leasing And Hire

Purchases

Limit of 10% of their assets No limit

Operating lease Not permitted Permitted

Ownership Structure (In

Case M&M Wants To

Merge With Another

firm)

Not more than 10% of capital

in a bank may be acquired

without the approval of the

RBI

There is no limit as to the percentage

holding. No need for express permission for

a change involving control.

Strict (SLR: 25%, CRR:7.5%, CRAR: 9%)

12 months’ overdue is

permitted in case of lease and hire

purchase transactions. 6 months in case of loans and other

exposures

Sectoral Exposures Limits on investment in

capital market and other

specific segments. Need to

allocate minimum percentage

of assets to certain segments

Scanty limitations. Investment in real

estate and unquoted equity shares is

controlled. Capital market exposure is only

required to be reported

Capital Adequacy Norms Lenient (CRAR: 12.5%)

Provisioning 90 days past due leads to

NPA characterization and calls

for provisioning

• Reliance Capital

• Conflicts of interest/ allegations of manipulation and unethical practices about the

industrial house

• Concentration of economic power

• Aditya Birla Nuvo

• No presence in rural areas

• Main business in Capital markets and Corporate finance

• Religare

• Major presence in urban markets

• Main business in Capital markets and coporate finance

Customer Loyalty:

Customer loyalty is a very important factor in banking industry dynamics.

A few banks have established an outstanding track record of innovation, growth and value creation. This

is reflected in their market valuation and repeated customer as well as customer retention. First, the

market is seeing discontinuous growth driven by new products and services that include opportunities in

credit cards, consumer finance and wealth management on the retail side, and in fee-based income and

investment banking on the wholesale banking side. With increased interest in India, competition from

foreign banks will only intensify. Given the demographic shifts resulting from changes in age profile and

household income, consumers increasingly demand enhanced institutional capabilities and service levels

from banks.

Several banks like SBI and PNB in the public sector score well in customer loyalty by providing excellent

services. In the private sector, ICICI and Axis bank have good customer retention. In case of foreign

banks, they have positioned only in the Urban areas and thus are not very attractive in terms of the

middle class.

Summary:

Indian banks have to be encouraged to expand fast, both through organic growth and through

consolidation, in order to fuel the growth of large firms and to strengthen their risk assessment systems,

for catering to the requirements of smaller firms. Various policy measures are in process to help this

transition along. However, when we look at the global scenario, only 22 Indian banks figure in the list of

top 1000 banks and there are only 5 Indian banks in the list of top 500 banks. The biggest Indian bank,

State Bank of India, has a market capitalization of under US$ 10 billion compared to the market

capitalization of US$ 243 billion of Citigroup. Indian banking sector has a long way to go before we can

say that Indian banks are relatively significant players. Having said that, there are sufficient reasons to

believe that the Indian Banking sector is poised for tremendous growth and with proper policy

framework in place, it would be very soon, matching their global counterparts on most of the relevant

banking indicators/ parameters (except size for some time to come).

The growth drivers in banking are rising literacy rate, especially in rural India. Projected per capita GDP is

expected to increase from US$ 380.8 in 2000–01 to US$ 2,097.5 in 2026, reflecting higher disposable

income. Some other key drivers are,

‘Any where’, ‘any time’ banking

Improved processes and bundled product offerings

Faster service

Customer-specific products or offerings on a regular basis

‘Bank’ customer has replaced ‘Branch’ customer

Focus on understanding customer needs or preferences

Segmentation or differentiation of customers

Customer-driven strategies

Also, a large number of micro, small and medium enterprises (MSMEs) with significant growth

opportunities in their respective sectors have come up. Conducive banking environment with well-

capitalized banks provides a base to meet the growing need for banking services. India has a well-

balanced mix of public and private sector banks. While public sector banks provide stability to the

banking system in the country, private sector banks add the necessary dynamism to it. With an

increasingly global footprint, the Indian banking industry has adopted certain global best practices such

as International Financial Reporting Standards (IFRS) and Basel II. These not only position India at an

international level, but also provide confidence to foreign players planning to establish businesses in

India.

Some opportunities are,

Development of newer modes of banking

Product innovation

India has now entered the era of online banking, e-commerce and m-commerce, which makes

banking simple. Also, the use of ATMs and credit cards has increased tremendously in the last few years.

There has been a major change in the products offered by banks, from a few standard credit and deposit

products to a number of customized offerings to suit the requirements of various categories of

customers.

Alliances with non-traditional players

Improved information systems

Banks are now looking for acquisition targets among other categories of financial institutions,

such as non-banking financial companies (NBFCs), development financial institutions (DFIs), brokerage

firms, etc., to provide the entire gamut of financial services. Banks are aiming to have an improved

credit infrastructure, with the formation of Credit Information Bureau (India) Limited (CIBIL). Other

credit information bureaus are expected to further boost the credit infrastructure.

Improving performance of PSU banks

Higher growth, improved productivity for branches, better customer profiles, implementation of

technology and improved products, coupled with significant positive structural changes, have led to the

improvement of PSUs on almost all financial and operational parameters.

Increased scrutiny

Due to the global financial crisis in 2008–09, tighter regulations for non-banking entities are

being implemented. Main focus of the regulations has been to provide a level playing field between

bank-sponsored NBFCs and non-bank associated NBFCs besides other issues of regulatory convergence

and regulatory arbitrage.

The interplay between policy and regulatory interventions and management strategies will

determine the performance of Indian banking over the next few years. Legislative actions will shape the

regulatory stance through some key elements like industry structure and sector consolidation, freedom

to deploy capital, regulatory coverage, corporate governance, labor reforms and human capital

development and support for creating industry utilities and service bureaus.

Management success will be determined on three fronts like fundamentally upgrading

organizational capability to stay in tune with the changing market, adopting value-creating M&A as an

avenue for growth and continually innovating to develop new business models to access untapped

opportunities.

References:

1) http://www.capitaline.com

2) http://www.indiastat.com/

3) http://www.ibef.org/download/Banking_060710.pdf

4) REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2008-09 (RBI publications)

5) A Study On Financial Ratios Of Major Commercial Banks by Dr. Y. Sree Rama Murthy, RESEARCH

STUDIES 2003: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1015238

6) Key Statistics of Public Sector banks: http://www.iba.org.in/kbp/PublicSecBanks1.xls

7) Key Statistics of Private Sector banks: http://www.iba.org.in/kbp/PrivateSecBanks.xls

8) Key Statistics of Foreign banks: http://www.iba.org.in/kbp/Foreignsecbanks3806.xls

9) India Banking 2010 Towards a High-performing Sector:

http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/india_banking_2010.pdf