Structure of The Financial Sector in India

Broadly, the financial sector in India can be broken into the following main divisions :

FINANCIAL Sector

Financial services

Banking Sector

NBFCs (Non Bankingfinancial Companies) Capital Markets Forex Markets Asset Management Insurance MFIs (Micro financeInstitutions)

ScheduledCommercialBanks (SCBs)

Private BanksPublic BanksForeign Banks

Regional Rural Banks

Scheduled Co- operative Banks

The sector has important effects not only on the domestic economy but also on the globaleconomy, thus it usually is the most heavily regulated sector by government

Financial Products of Banks

Loan ProductsDeposit Products Auto Loan Deposits

Other Products /Services Gold Loan House Loan Credit cards Saving Accounts Current Accounts Fixed /Recurring NRI servicesPOS TerminalsPrivate Banking Education Loan Corporate Salary A/C Demat Services

1

Retail Banking Loan against Securities Retail BankingBusiness

Commercial Banking Transaction Banking Term Loan Cash Management Guarantees Custodian Services Mutual Fund SalesForeign ExchangeServices

Key Segment Large Corporates Emerging Corporates Bill Collection Clearing Bank Services Financial Institutions Letter of Credit Tax Collections Government/PSUs Working Capital Banker to Public Issues Agriculture

2 Wholesale Banking Forex & Derivatives Wholesale Deposits

Product Segment Equities Derivatives Capital Market Commodities(Inc Hedging)

Other Financing Cash Management Statutory Reserve Financial Decisions Commodities

aDebt Securities Exchange Foreign Asset Liability Management 19

PEST Analysis on the Banking Industry

Factors Affecting the Industry

P

Political Factors

E

Economic Factors- Monetary Policy- Regulatory Framework- Budget & Budget Measures- Changes in interest rates - More savings- More Capital Formation- Increase in production ofgoods and Services- Banking Channels

S

Social Factors

T

Technological Factors- Increase in population- Changes in lifestyle- Easy way of lending money- Exploring banking facilities inrural areas - Internet Banking- IT Services & Mobile Banking- Credit Cards- Improvement in efficiency

PEST Analysis on the Banking Industry Political Factors Affecting the Industry

The Indian banking Industry is mostly dependent onthe monetary policy decided by the RBI

Stricter regulations with respect to capital andliquidity directly affects the business of banks

Banks need to adjust their interest ratesaccordingly, which may or may not favor them

Banks are forced to lend as per the guidelines ofRBI, that includes credit growth in all sectors

Budgetary Measures announced by thegovernment at the beginning of every financial year also lay down guidelines to banks to lend or accept deposits

The government can also increase credit in particular sectors such as increase in farmcredit, increase in infrastructure creditetc.(priority lending)

Sometimes the government gives debt waivers to certain sections of the society that need to beadhered to by banks as well

25

PEST Analysis on the Banking Industry Economic Factors Affecting the Industry

Economic factors in the country also effect theBanking Industry both favorably or unfavorably

When the economy is in good shape in terms ofhighper capita income, good agricultureharvest and normal inflation,banks have anedge as people are left with more money todeposit them with banks

This helps in morecapital formationas moredeposits can be realized

Also In the times of economic boom, more andmore FDIis brought into India through bankingchannels, that actually improves business forbanks and the economy in general

Economic prosperity encourages lendingbusiness for the banks but in times of recession banks face tough times to recover their money, issue fresh credit and NIMs are lower too

26

PEST Analysis on the Banking Industry Social Factors Affecting the Industry

The Indian banking system hasbeen progressingrapidly. There are still severaluntapped ruralmarkets, despite the large number of banks in India

Many farmers still take loans from moneylenders ata very high interest rate and small-scale industriescontinue to remain important for banks

However changes could be expected in the nearfuture for the unorganized sector

Thegrowing populationof India is a greatopportunity for Indian banks as a lot of peoplein the country want to open a bank accountand develop good savings habits

ChanginglifestyleoftheIndianurbanpopulationwho wantseasy ways of financingto their desires

27

PEST Analysis on the Banking Industry Technological Factors Affecting Industry

Indian banking has been consistently workingtowardsthedevelopmentoftechnologicalchanges and its usage in its operations

With theapplication of new and improvedtechnologies banks areexpected to reducecosts,time and provide higher customersatisfaction

Internet banking or banking via the phonecanbe considered a remarkabledevelopment in thebanking industryMobile bankingenables customers to checktheir account balance, transfer funds 24x7, billpayments, booking of bus/flight tickets, rechargeprepaid mobile and do a lot moreeffortlesslyand securely

Banking through cell phone benefits the bankstoo. It cuts down on the cost ofin-personbanking and helps reduce headcount atbranches

Technological developments facilitate the flow ofinformation and datafaster leading to fasterappraisal and decision-making as well

28Growth Drivers of the Banking Industry

High Growth ofthe IndianEconomy& FavorableDemographics

FinancialInclusion (FI)

Private Banking& WealthManagement

Technology Innovation

Growth in infrastructure, industry, services and agriculture is expected togrow corporate credit in the economy Nearly 35% of the Indian population has a median age of 25.5 yearswhich signifies that India will gain from its demographic dividend

Given that 40% of Indians lack access even to the simplest kind of formalfinancial services, the RBI on July 2011, mandated banks to allocate atleast 25% of the total number of branches proposed to be opened during ayear in unbanked rural centers Banks considering FI as a banking opportunity rather than a Regulatoryobligation are likely to see long term profitable growth and a cushionagainst market volatility

India not only enjoys a favourable demographic dividend but also has astrong population of High Net worth Individuals (HNWI) Given the improved performance of the equity markets in 2012 &increasing affluence beyond urban and metro areas the number of HNWIsis expected to rise further, HNWIS will continue to demand better ormore sophisticated service

New channels in banking services such as internet banking, mobilebanking have increased productivity and help in acquiring new customers As per a survey conducted by PwC, today banks spend 15% of the totalexpenditure on technology today

29

Key ChallengesIndian Banks will have to bring in an additional capital of Rs. 5 Lakhs CroreIntroductionof BaselIIINorms

IntensifyingCompetition

IncreasingNPA

LicensingRequirement

ManagingHumanResources to meet the Basel III norms. The government on its part has to infuse Rs.90,000 crore into the state-run banks to maintain majority shareholdingunder Basel IIIBasel III norms will be implemented in a phased manner starting fromJanuary 2013 (now pushed to April) 2015, to be implemented to the fullestby March 2018High competition due to a large number of players in the banking industry and other players such as NBFCs (less regulation)Such competition in the industry has decreased the market share of theexisting banks

Economic slow down and aggressive lending by the banks has turned loansinto non- performing assetsThis has impacted the profitability of the banks as they are required to havehigher provisioning amounts

For commencing a banking business in India, a banking license from the RBI hasto be acquired which has served as a associated protocol and formalities The last licenses issued were to Kotak Mahindra Bank and Yes Bank in 2003and 2004 respectively (as Kotak Mahindra Bank was earlier a NBFC)Latest Licenses t o be issued is IDFC & BANDHAN FINANCIAL SERVICES -2014

Banks have to incur substantial employee costs as the attrition of theemployees in this sector is very high

37Global vs. Indian Banking Industry

Indian Banking: Soundness, Health and Balanced Performance

Return on Equity (%)

CountryReturn On Cost: Income ratio (%)

Cost toCountryIncome Valuation (P-BV)

Price toCountryBook Value Bad Debt to Assets Ratio

CountryBad Debt to

TurkeyIndonesiaMalaysiaChinaIndiaSingaporeAustraliaCanada Equity19.60%17.8%17.4%16.7%15.3%14.6%14.0%12.4% IndonesiaGermanyFranceCanadaUSARussiaThailandAustralia Ratio79.30%75%73%66%65%59%57%56% IndonesiaMalaysiaCanadaRussiaThailandIndiaChinaAustralia Ratio3.62.3221.91.81.71.6 RussiaIndonesiaTurkeyUSAChinaSpainSouth KoreaIndia Assets Ratio2.4%2.0%1.3%1.2%0.9%0.7%0.6%0.6%South Korea10.1% Malaysia 55% Turkey 1.5 Singapore 0.5%SpainRussiaThailandFranceUSAGermany 8.2%7.9%6.9%4.0%2.7%-8.0% IndiaSouth KoreaSpainTurkeyChinaSingapore 47%47%42%42%40%40% SingaporeSouth KoreaUSASpainFranceGermany 1.40.90.80.80.50.3 ThailandMalaysiaGermanyAustraliaCanadaFrance 0.4%0.4%0.4%0.4%0.3%0.2%

49

Macro Economic Factors That Drive Banks

FY2012 was characterized bymany macro headwindspersistentlyhigh inflationkeeping interest rates high, moderation in industrial output, INRdepreciation, worsening balance of payments and ballooning fiscal deficit

However, higher capital standards, stickier liquidity and leverage ratios, a more cautiousapproach and deregulation in monetary policies by the RBI played a positive role

In this distressed macroeconomic situation, Indian banks emphasized their concentrationon maintaining balance sheet strength in terms of quality over growth

12%10%

Fiscal Deficit & Inflation

605040

44.6143.59

INR/USD

50.9545.14

44.65

51.15

54.548%6%4%2%0% 4%

3.30%2.50% 6% 6.50% 4.80%4.60% 3020100 39.972005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 March March March March March March March January Fiscal Deficit as % of GDP

Source : RBI & Economy survey 2011-12 Inflation 2006 2007 2008 2009 2010 2011 2012 2013

56Monetary Policy Transmission Mechanism

Repo rate hikeInflation Expectations of Repo rate

Lower expected profitability of the firms Rise in marketinterest rates Expectation

Strong Exchange Rate

More difficult to obtaincredit - Lower investment

Decrease inconsumption

Reduction inInvestment

Exportsdown, Imports up

Lower importprices

The credit channel

Reduction in demand

Lower Inflation

The Interest rate channel

The exchange rate channel

57

How Banks are Regulated in the System?

Financial Institutions

Banking

Scheduled Banks

Public

Private

Foreign

Cooperative Banks

Housing Finance

Non-BankingFinance

Development Finance

Non-Banking

Insurance

Insurance

MutualFunds etc.

Security Reserve Bank of India Regulatory and DevelopmentAuthority Exchange Boardof India59-Regulatory bodies `

30.00

25.00

20.00

15.00

10.00

5.00

0.00 Current Policy Rates

Indian Interest Rates

Repo Rate, Reverse Repo, CRR, SLR & MSF

Current Rates1

Policy RatesBank Rates9.00%Repo Rate8.00%Reverse Repo Rate7.00%

Reserves RatesCRR4.00%SLR22.00%Lending / Deposit RatesBase Rate10.00% -10.25%Deposit Rate8.00%-9.50%

Although the critical rates have reducedsince the global economic crisis of 2008,the RBI is still maintaining a tight Repo Rate Reverse Repo CRR SLR MSF monetary policy in order to curb inflationand attain stability along with superioreconomic Major Banking Regulations & their Effects

BASEL III Norms--------------------------------------------------An umbrella of rules and regulations to define the roadmapfor banks under its three pillars:- Pillar 1: Capital requirements: Minimum regulatory capitalrequirement based on risk weighted assets- Pillar 2: Supervisory review process: Framework to dealwith risks that banks face from time to time-Pillar 3: Market discipline: Increasing disclosures by banks to bring more transparencyGovernment Initiatives------------------------------------------Reduction inCRR, SLRand deregulationof interestratesIntroduction of capital to risk weighted assets ratio andfixed prudential normswill bring reduction in nonperforming assets and increase capital position of banks

--------------------------------These reforms will require Indian banks toraise aroundRs.6,00,000 crores by 2020, for which the FinMin has advised banksto push into mergersand consolidations--------------------------------

These strategic changeswill leave more loanablefunds with banks and help them widen theircredit networkForeign Direct Investment--------------------------------------Plugging inforeigninvestorsmoney directly into theIndian financial marketFDI limit for a foreign banks is 74% of the total paid-upcapital of the bank

Other Reforms------------------------------------------------------ -------------------------------FDI will bring better riskmanagementcapability, soundtechnology and highergrowth prospects-------------------------------Banking diversification andgeneration banks introduction of new These reforms will givebanks greater strengthOperational autonomy,say a bank satisfies the CAR then it gets freedom in opening branches, upgradingcounters, liberal lending options etc to fight competition and help them stand out in the market

61

Changing Industry Dynamics by New Rules

BASEL III Norms

Indian Banking Sector

Basel III norms: A comprehensive set of reformmeasures, developed by the Basel Committee on banking supervision and regulation

Government Initiatives

Government Initiatives: The two regulatory bodies, RBI and SEBI are taking every step possible to strengthen the economy by safeguarding the banking sector

Foreign Direct Investment: With the approval of FDI, foreign banks can set up their branches in India, whichprovides a world class banking experience and creates healthy competition

Other Reforms: Deregulating interest rates, bank diversification and new generationForeign Direct Investment(FDI) banks are some other effective changes towards a more positive direction OtherReforms

62 `Banking SectorRecent Deals (M&A)

Announced

Stake

ValueDate

December2011

April2011

November2010

August 2010

July 2010February2008 Target

Barclays Bank Plc, PerformingCredit Card Portfolio

Tamilnad Mercantile Bank Ltd.

Enam Securities Direct Pvt. Ltd.

Bank of Rajasthan Ltd.

Kotak Mahindra Bank Ltd

Centurioun Bank of Punjab Acquirer

StandardCharteredBank India

Standard CharteredBank India

Axis Bank Ltd.

ICICI bank Ltd.

Sumitomo MitsuiBanking Corporation

HDFC Bank (%)

100

4.64

NA

100

4.50

100 ($US mn)

36.00

NA

439.79

658.65

294.00

2200.00

Banking SectorRecent Deals (PE)

AnnouncedDateJanuary 2013

Investor

Ratnakar Bank Ltd.

Investee

Aditya Birla PE, Norwest venturecapital partners and FearingCapital Stake(%)

NA Value($US mn)

54.00April2012March2012February2011February2011 Karur Vysya Bank Ltd.Olympus Capital Holdings Asia

Karur Vysya Bank Ltd.ChrysCapital V LLC

IndusInd Bank Ltd.General Atlantic Pvt. Ltd.

Ratnakar Bank Ltd.Beacon India Private Equity Fund, Housing Development Finance Corp. Ltd., Norwest Venture Partners, India EvolvingFund , Samara CapitalPartners,Cartica Capital LLC, Gaja Capital Fund 4.80

3.90

0.60

NA 38.47

31.23

14.57

163.00March2010 Dhanlaxmi Bank Ltd. Arcstone Capital LLC 5.00 9.30

67Major Players in the Industry

Major Banks in India

These are the smallbanks in terms ofmarket capitalizationOBC

Market Cap (in Thousand Crores)These are the mid-sized banks consisting of 3 public banks and 2 privatebanks

These are thegrowing banks that consist of 2 public banks and 2 privatebanks

These are thepremium oldgeneration banks consisting of 2 privateand 1 public bank

FederalAllahabad

UBIYesCanaraIndusindBank of IndiaAxis Bank of BarodaPunjab NationalKotak Mahindra

SBIICICIHDFC

76