Merger Mania Vi

7/29/2019 Merger Mania Vi

1/58

MERGER MANIA VI

BY

S.SRINIVASAN

PRESIDENT

NATIONAL UNION OF BANK EMPLOYEES

(NUBE)

Now Once again Consolidation Rhetoric:

Some consolidation in banking space inevitable: FM

Consolidation alone will give banks the muscle, size and scale to act like world class

banks. We have to think global and act local and seek new markets, new classes ofborrowers.

P. Chidabaram

Pitching for consolidation in the banking industry, Finance Minister P Chidambaramsaid India would need one or two global-size banks as it marches ahead to become theworld's third largest economy. at the Bancon-2012 recently Pune on 24 November2014

"Finding new business models will inevitably lead to some consolidation ...

We must create at least 2 or 3 world size banks. China has done it.

"And if India wants to be ... and it will be the third largest economy in the world ... wemust also have one or two world size banks and some consolidation is inevitable," hesaid at Bancon-2012 meet here.

Unions have been opposing mergers and consolidations in the banking space.

"We should not fear consolidation. I know there is pride and identity, but ultimatelysome consolidation would have to take place in the banking system in this country," hesaid.

He further said that while consolidation takes place among top banks, there would beroom for local area banks as well.

"In fact, I regret that the idea of the local area bank which was started in 1996 stoppedafter first three licences were given. I think there is place for a local area bank forserving people of the region, local area, drawing strength from those people and serving

those people," he added.


2/58

There are 19 nationalised banks and scores of private and foreign banks in the country.In addition there is State Bank of India, which is the largest lender in the country. It hasalso five associate banks.

SBI has acquired board approval for the merger of the its remaining five associates withitself. It has already amalgamated two of its subsidiaries.

The Finance Ministry had recently asked large public sector banks to hand-hold smallercounterparts to improve the latter's functioning.

Hence it has become imperative for us to understand macro & micro economicindicators of China and India and in all aspects as well as important bankingindicators to expose the bankruptcy & hollowness of these rhetoric and grind to dustthese spurious logics peddled blitzkrieg in electronic and media by the FinanceMinster.

Comparison of India and China

The Stalwart of Indian Financial community nodded there heads sagaciously when

Prime Minster Mr.Manmohan Singh said in his speech If there is one aspect in

which we can confidentially assert that India is ahead of China it is the robustness

and soundness of banking system. Indian banks have been rated higher than

Chinese banks by the international rating agency Standards & Poors

Therefore the analogy ofthe FM comparing Indian banks with Chinese with regard toscale an size only is akin to seeing the part but not the whole, seeing the trees but not

the forest.

In the under mentioned tables A to D and the tables E, 1.1 to 2.2 under the heads inthe annexure

A) Indias recent performance and forecastsB) India Size of the economyC) Chinas recent performance and forecastsD) Chinas Size of the economyE) China and India Comparison In 2001-02

1.1 Overview 20101.2 Land Use in20081.3 Growth Rate of Gross Domestic Product1.4 Gross Domestic Investment and Savings1.5 Sectoral Share in GDP1.6 Rank on Global Competitiveness Index (GCI),

2010-111.7 Population and Demographic Profile of BRICS1.8 Social Sector Indicators, 2007

1.9 Fiscal Defi it of General Government1.10 Fiscal Balance of General Government1 11 Gross Debt of General Government


3/58

1.12 Fiscal Consolidation Policy1.13 Composition of Fiscal Adjustment Plans1.14 Monetary Frameworks1.15 Inflation: Average Consumer Prices1.16 Global Integration Economies1.17 BRICS Share of Global Trade1.18 BRICS Exports of Goods and Services

1.19 BRICS Share in World Exports1.20 BRICS Exports Profile 20091.21 High-technology Exports1.22 BRICS Share of World Exports of Services1.23 Imports of Goods and Services1.24 BRICS Imports Profile, 20091.25 BRICS Share of World Imports of Services1.26 Export Linkages of BRICS1.27 BRICS Share in Global Remittance Inflows1.28 Trade Balance and Current Account Balance1.29 Share of Global FDI Inflows1.30 Cross-country Movement of FDI Flows1.31 Cross-country Movement of Portfolio Flows1.32 BRICS and Foreign Exchange Reserves1.33 External Debt Stocks, Total1.34 BRICS Exchange Rate Regime1.35 Stock Market Performance1.36 Total Listed Domestic Companies1.37 Market Capitalization of Listed Companies1.38 Stocks Traded, Turnover Ratio1.39 Equity Valuation Measures: Dividend

Yield Ratios1.40 Emerging Market External Financing:

Total Bonds, Equities, and Loans1.41 Insurance Sector in Economies1.42 Prudential Indicators of the Banking Sector

in BRICS1.43 Bank Profitably Indicators1.44 Financial Services Accessibility1.45 Credit Depth of Information Index1.46 Domestic Credit Provided by Banking Sector2.1 Global Financial Crisis2.2 Size of Discretionary Measures in Financial Crisis

We have highlighted the indicators where India is ahead of china. If one only countsthe number ofhighlights fonts with those regularfontsit will amply convince even alaity that India lags behind in all most of the economic indicators when compared withChina. The different growth stages of India and China have been linked to differentinternal political changes. India continues to be an open, participatory, multipartydemocracy, with power at the centre being counterbalanced by that of the states in afederal system. China has an authoritarian, albeit liberalising, ne-party regime, wherestructural economic reforms have been associated with important political changes in


4/58

the Communist Party highly centralised power has been associated with theprogressive inclusion of a new middle class. In terms of per capita GDP (expressed aspurchasing power parity, PPP), China made impressive gains on the US, starting from1978. India, in contrast, has succeeded in accelerating economic growth mainly since1992.That only exposes the policies in place propounded and practiced by the

policymaker of this country, taking into consideration both the countries attended

independence around the same era


5/58

A) Indiasrecent performance and forecasts

2010 2011e 2012f 2013f

Real growth (annual % change) GDP# 8.7 7.3 7.5 8.1

Agriculture 4.9 4.7 3.5 4.0

Industry 9.2 4.7 7.0 8.0

Services 9.5 8.7 8.5 9.0

Contribution to growth (%)


Industry 1.8 0.9 1.4 1.6

Services 6.2 5.7 5.6 6.0

Economic Structure (% of GDP)*

Agriculture 14.4 14.1 13.5 13.0

Industry 20.2 19.7 19.6 19.6

Services 65.4 66.3 66.9 67.4

Inflation

WPI (annual % change, average) 9.6 9.4 7.0 5.8

B) IndiasSize of the economy

2010 2011e Share of 2011 world

total

Population (millions) 1,191 1,207 17.6%

GDP, market rates (US$ billions) 1,632 1,843 2.6%GDP, PPP rates (International $ billions) 4,058 4,470 5.7%

GDP per capita, market rates (US$) 1,371 1,527

GDP per capita, PPP rates (International $) 3,408 3,703

C) Chinas recent performance and forecasts

2010 2011e 2012f 2013f


6/58

Real growth (annual % change) GDP# 10.3 9.2 8.6 8.7


Industry 12.2 10.6 9.0 8.7

Services 9.5 8.9 9.2 9.7

Contribution to growth (%)


Industry 6.7 5.9 5.0 4.9

Services 3.4 3.2 3.3 3.5

Economic Structure (% of GDP)*


Industry 55.6 56.2 56.2 56.3Services 35.4 35.2 35.6 35.9

Inflation

CPI (annual % change, average) 3.3 5.4 3.9 3.9

D) Chinas Size of the economy2010 2011e Share of 2011 world

total

Population (millions) 1,341 1,348 19.6%

GDP, current prices (US$ billions) 5,878 6,988 10.0%

GDP, PPP rates (International $ billions) 10,120 11,316 14.4%

GDP, current prices (US$ billions) 4,382 5,184

GDP per capita, PPP terms (International $) 7,544 8,394

Source IMF


7/58

Consumer Price Indexes

Difference Consumer Prices in China are 110.05% higher than in India Consumer PricesIncluding Rent in China are 137.37% higherthan inIndia Rent Prices in China are 261.49%higher than inIndia Restaurant Prices in China are 110.78% higherthan inIndia GroceriesPrices in China are 116.26% higherthan inIndia Local Purchasing Power in China is 32.35%

lowerthan inIndia

Minimum Wage Comparisons Between China and India

China two to three times more expensive than India for skilled labor

Comparing labor costs is always a difficult art, not least because different countries havedifferent ways and mechanisms of measuring these. China, for example, levies a minimumwage across the board irrespective of employment type, whereas India imposes differentminimum levels dependent upon specific types of work. However, as the population

demographics are now shifting to a younger workforce in India from China, such comparisons,while not exact, provide some clues about the nature of costs associated within the labor poolsof each.

This example, comparison of seven cities in both China and India is made, to try and provide ageneral geographic spread in both countries. The minimum wage levels in each are set by therespective state and provincial governments. In the case of India, we have taken skilledconstruction workers as the base target. The results are as follows:

It should be noted that in China, a mandatory welfare payment is added to the minimum wageas paid by the employer and this typically adds an average 40 percent to 50 percent on top of

the minimum wage identified above. India does not levy a uniform welfare payment uponsalaries, and this can either be discounted completely or is a typical maximum of 10 percent ofwages.


8/58

The figures adequately demonstrate that Chinese minimum wages are two or three times thelevel of their Indian counterparts, and even higher when welfare payments are added on top.This bears out our previous findings that China now has the third highest employment costsin emerging Asia and that the population demographics now favor India.

In India, the development of a large, yet young labor force with an average age of 23 isshowing itself in lower minimum salary levels, whereas in China, where the average age of a

worker is now 37, the higher minimum wage and more expensive welfare to cater for that ageis now having a significant effect in demonstrating the labor cost gap. The message for laborintensive industries is clear India is now a key market for establishing operations.

Using a national sample of Urban Household Surveys, the above document indicates severalprofound changes in China's wage structure during a period of rapid economic growth.Between 1992 and 2007, the average real wage increased by 202 percent, accompanied by asharp rise in wage inequality. Decomposition analysis reveals 80 percent of this wagegrowth to be attributable to higher pay for basic labor, rising returns to human capital,

and increases in the state-sector wage premium. Employing an aggregate production

function framework, it accounts for the sources of wage growth and wage inequality in theface of globalization and economic transition. One finds capital accumulation, skill-biasedtechnological change, and export expansion to be the major forces behind the evolving wagestructure in China

Inference:

It can be inferred from the above data and reports highlights the simple facts of the two fastestgrowing economies of the world The Chinese dragon is way ahead of Indian elephant in

terms of their respective future economic growth. India can only compete with China

after decades and not as of now even if all the banks are to merged exposing the puerilelogic of consolidation.

China and India Banking Comparison

A comparison of China and India banking system is both exciting and challenging

.Let us analyze the same under the following heads so that comparison becomes objective and

meaningful, to expos and explode the myths of consolidation and comparison with china asbeing attempted by the Finance Minister.

Evolution of banking

China

The history of the Chinese banking system has been somewhat checkered. Nationalizationand consolidation of the country's banks received the highest priority in the earliest years

of the People's Republic, and banking was the first sector to be completely socialized. In

the period of recovery after the Chinese civil war (1949-52), the People's Bank of China

moved very effectively to halt raging inflation and bring the nation's finances under centralcontrol. Over the course of time, the banking organization was modified repeatedly to suit
http://www.china-briefing.com/news/2011/01/19/china-near-top-of-the-list-for-wage-overheads-in-emerging-asia.htmlhttp://www.china-briefing.com/news/2011/01/19/china-near-top-of-the-list-for-wage-overheads-in-emerging-asia.htmlhttp://en.wikipedia.org/wiki/Chinese_banking_systemhttp://en.wikipedia.org/wiki/Nationalizationhttp://en.wikipedia.org/wiki/Consolidation_(business)http://en.wikipedia.org/wiki/List_of_banks_in_the_People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Chinese_civil_warhttp://en.wikipedia.org/wiki/People's_Bank_of_Chinahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Financeshttp://www.china-briefing.com/news/2011/01/19/china-near-top-of-the-list-for-wage-overheads-in-emerging-asia.htmlhttp://www.china-briefing.com/news/2011/01/19/china-near-top-of-the-list-for-wage-overheads-in-emerging-asia.htmlhttp://en.wikipedia.org/wiki/Chinese_banking_systemhttp://en.wikipedia.org/wiki/Nationalizationhttp://en.wikipedia.org/wiki/Consolidation_(business)http://en.wikipedia.org/wiki/List_of_banks_in_the_People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Chinese_civil_warhttp://en.wikipedia.org/wiki/People's_Bank_of_Chinahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Finances


9/58

government departments, publicly and collectively owned economic units, and social, political,military, and educational organizations were required to hold their financial balances as bankdeposits. They were also instructed to keep on hand only enough cash to meet daily expenses;all major financial transactions were to be conducted through banks. Payment for goods andservices exchanged by economic units was accomplished by debiting the account of the

purchasing unit and crediting that of the selling unit by the appropriate amount. This practiceeffectively helped to minimize the need forcurrency.

Chinas banking sector was previously dominated by four wholly state-owned policy banksthe Agricultural Bank of China (ABC), the Bank of China (BOC), China Construction Bank(CCB), and the Industrial and Commercial Bank of China (ICBC).

Agricultural Bank of China Limited (ABC), is one of the "Big Four"banks in the People'sRepublic of China. It was founded in 1951, and has its headquarters in BeijingIn 1951, two

banks of the Republic of China, Farmers Bank of China and Cooperation Bank, merged toform Agricultural Cooperation Bank, which ABC regards as its ancestor. However, the bankwas merged into People's Bank of China, the central bank in 1952. The first bank bearing the

name Agricultural Bank of China was founded in 1955, but it was merged into the central bankin 1957. In 1963 the Chinese government formed another agricultural bank, and it was alsomerged into the central bank two years later. Today's Agricultural Bank of China was foundedin February 1979. It was restructured to form a holding company called Agricultural Bank ofChina Limited It was listed on the Shanghai and Hong Kong stock exchanges in July 2010

Bank of China's history goes back to 1905, when the Qing government established DaqingHubu Bank in Beijing, which was in 1908 renamed to Daqing Bank When the Republic ofChina was established in 1912, it was further renamed as Bank of China by President Sun Yat-sen's government, adding a new role of the central bank

China Construction Bank

CCB was founded on 1 October 1954 under the name of "People's Construction Bank ofChina and later changed to "China Construction Bank" on 26 March 1996. n 2005, Bank ofAmerica acquired a 9% stake in China Construction Bank for US$3 billion. It represented thecompany's largest foray into China's growing banking sector. China Construction BankCorporation was formed as a joint-stock commercial bank in September 2004 as a result of aseparation procedure undertaken by its predecessor, China Construction Bank, under the PRC

Company Law. Following the China Banking Regulatory Committee's approval on 14September 2004, the next day the bank (Jianyin) became a separate legal entity, owned by theChinese government holding company, Central Huijin Investment Company or simply Huijin.

Industrial and Commercial Bank of China Ltd. (ICBC) more commonly just Gnghng) isthe largest bank in the world byprofit and market capitalization. It is one ofChina's 'Big Four'state-owned commercial banks (the other three being the Bank of China, Agricultural Bank ofChina, and China Construction Bank). It was founded as a limited company on January 1,1984. The bank's Hong Kong operations are listed under the name ICBC Asia. It has purchasedthe Hong Kong subsidiary ofFortis Bankand rebranded it under its own name on 10 October

2005.

F th b it b id tl l th t N ti li ti d lid ti f th
http://en.wikipedia.org/wiki/Bank_deposithttp://en.wikipedia.org/wiki/Bank_deposithttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Big_four_banks#Chinahttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Beijinghttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Farmers_Bank_of_Chinahttp://en.wikipedia.org/wiki/People's_Bank_of_Chinahttp://en.wikipedia.org/wiki/Holding_companyhttp://en.wikipedia.org/wiki/Qinghttp://en.wikipedia.org/wiki/Beijinghttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Sun_Yat-senhttp://en.wikipedia.org/wiki/Sun_Yat-senhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Jianyinhttp://en.wikipedia.org/wiki/Central_Huijin_Investment_Companyhttp://en.wikipedia.org/wiki/Profit_(accounting)http://en.wikipedia.org/wiki/Market_capitalizationhttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Big_Four_(banks)http://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/Agricultural_Bank_of_Chinahttp://en.wikipedia.org/wiki/Agricultural_Bank_of_Chinahttp://en.wikipedia.org/wiki/China_Construction_Bankhttp://en.wikipedia.org/wiki/Hong_Konghttp://en.wikipedia.org/wiki/ICBC_Asiahttp://en.wikipedia.org/wiki/Fortis_Bankhttp://en.wikipedia.org/wiki/Nationalizationhttp://en.wikipedia.org/wiki/Consolidation_(business)http://en.wikipedia.org/wiki/Bank_deposithttp://en.wikipedia.org/wiki/Bank_deposithttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Big_four_banks#Chinahttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Beijinghttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Farmers_Bank_of_Chinahttp://en.wikipedia.org/wiki/People's_Bank_of_Chinahttp://en.wikipedia.org/wiki/Holding_companyhttp://en.wikipedia.org/wiki/Qinghttp://en.wikipedia.org/wiki/Beijinghttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Republic_of_Chinahttp://en.wikipedia.org/wiki/Sun_Yat-senhttp://en.wikipedia.org/wiki/Sun_Yat-senhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Jianyinhttp://en.wikipedia.org/wiki/Central_Huijin_Investment_Companyhttp://en.wikipedia.org/wiki/Profit_(accounting)http://en.wikipedia.org/wiki/Market_capitalizationhttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Big_Four_(banks)http://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/Agricultural_Bank_of_Chinahttp://en.wikipedia.org/wiki/Agricultural_Bank_of_Chinahttp://en.wikipedia.org/wiki/China_Construction_Bankhttp://en.wikipedia.org/wiki/Hong_Konghttp://en.wikipedia.org/wiki/ICBC_Asiahttp://en.wikipedia.org/wiki/Fortis_Bankhttp://en.wikipedia.org/wiki/Nationalizationhttp://en.wikipedia.org/wiki/Consolidation_(business)


10/58

Republic, and banking was the first sector to be completely socialized which

differentiates evolution of banking itself in China From India

In addition, there were several other smaller wholly state-owned policy banks, such as Bank ofCommunications, China Development Bank (also known as the State Development Bank ofChina), the Export Import Bank of China(China Exim Bank), and Huaxia Bank. Starting in

2005, China began transforming the whollystate-owned banks into joint-stock corporations, aprocess it calls equitization), that were to operate as commercial banks. As a result, onlythree whollystate owned banks remain in Chinathe Agricultural Development Bank ofChina, China Development Bank and China Exim Bank.

India

Towards Nationalization: objective ground realties

Pre-Independence Scenario of Commercial Banks in India

Banking in India originated in the last decades of the 18th century. The first bankswere TheGeneral Bank of India which started in 1786, and the Bank of Hindustan, both of which arenow defunct. The oldest bank in existence in India is the State Bank of India, which originatedin the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal.This was one of the three presidency banks, the other two being the Bank of Bombay and theBank of Madras, all three of which were established under charters from the British East India

Company. For many years the Presidency banks acted as quasi-central banks, as didtheir successors. In 1806, the Bank of Calcutta was established as a joint stock bank withlimited liability, which was brought under the Royal Charter in 1809 and renamed as Bank ofBengal. Subsequently, the Bank of Bombay and the Bank of Madras were established by theEast India Company in 1840 and 1843 respectively. The business of these. Presidency bankswere initially confined to discounting of bills or other negotiable private securities, keepingcash accounts, receiving deposits, and issuing and circulating cash notes. The Royal Chartergoverned the three Presidency banks, which was revised from time to time. There were nolegally recognized commercial banks with special right within India other than the Presidency

banks. The East India Company's government reserved the right to regulate the monetary and

credit system to itself The three banks merged in 1921 to form the Imperial Bank of India,which, upon Indias independence, became the State Bank of India. Indian merchants inCalcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of theeconomic crisis of 1848-49.

The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stockbank in India.(Joint Stock Bank : A company that issues stock and requires shareholders to beheld liable for the company's debt) It was not the first though. That honor belongs to the Bankof Upper India, which was established in 1863, and which survived until 1913, when it failed,with some of its assets and liabilities being transferred to the Alliance Bank of Simla.When the

American Civil War stopped the supply of cotton to Lancashire from the Confederate States,promoters opened banks to finance trading in Indian cotton. With large exposure to speculativeventures most of the banks opened in India during that period failed The depositors lost


11/58

the 20th century. Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. TheComptoired'Escompte de Paris opened a branch in Calcutta in 1860 and another in Bombay in1862; branches in Madras and Pondichery, then a French colony, followed. HSBC establisheditself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to thetrade of the British Empire, and so became a banking center. The Bank of Bengal, which latermerged with the Bank of Bombay and the Bank of Madras to form the Imperial Bank of Indiain 1921.The first entirely Indian joint stock bank was the Oudh Commercial Bank, established

in1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established inLahore in 1895, which has survived to the present and is now one of the largest banks in India.Around the turn of the 20th Century, the Indian economy was passing through a relative periodof stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrialand other infrastructure had improved. Indians had established small banks, most of whichserved particular ethnic and religious communities. The presidency banks dominated bankingin India but there were also some exchange banks and a number of Indian joint stock banks.All these banks operated in different segments of the economy. The exchange banks, mostlyowned by Europeans, concentrated on financing foreign trade. Indian joint stock banks weregenerally under capitalized and lacked the experience and maturity to compete with the

presidency and exchange banks.

The major innovations in banking method and organization came with the establishment ofBank of Bengal. These included the following.

1. Use of joint stock system for raising capital.2. Conferring of limited liability on shareholders by means of a charter.3. Provision for the note issue which could be accepted for public revenue

payments.4. General provision for acceptance of deposits from the general public. Imposition of

explicit limit on credit and the kind of securities it could accept.5. Provision for regulatory changes in the board of directors.

With the passing of the Paper Currency Act, 1861, the right to issue currency notes by

the Presidency banks was abolished and the same function was entrusted to the

Government. With the collapse of the Bank of Bombay, the New Bank of Bombay was

established in January 1868. A banking crisis that occurred during 1913 Revealed

weaknesses of the banking system such as the maintenance of an unduly proportion of

cash and other liquid assets, the grant of large unsecured advances to the directors of

banks and to the companies in which the directors were interested. Some of the banks

seem to have resorted to certain undesirable Activities and practices.

The period between 1906 and 1911, saw the establishment of banks inspired by theSwadeshimovement. The Swadeshi movement inspired local businessmen and political figuresto found

banks of and for the Indian community. A number of banks established then havesurvived tothe present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda,CanaraBank and Central Bank of India.

The fervour of Swadeshi movement lead to establishing of many private banks inDakshinaKannada and Udupi district which were unified earlier and known by the name SouthCanara( South Kanara ) district. Four nationalised banks started in this district and also a

leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradleof Indian Banking".


12/58

Year Number of banks that failed

1913 12

1914 42

1915 11

1916 13

1917 09

1918 07Total 94

The Central Banking Enquiry Committee which was constituted by GOI in 1929 to examinethe issue of establishing a central banking authority for India mentioned in the course ofdiscussion some important reasons for failure of banks. They were insufficient capital, poorliquidity of assets, combination of non-banking activities with banking activities,

irrational credit policy and incompetent and inexperienced directors. Finally ReserveBank of India Act was passed in 1934 and finally in 1935, the Central Bank was created andchristened as Reserve Bank of India

When the Reserve Bank of India Act. 1934 came into effect; an important function of the

RBI was to hold the custody of the cash reserves of banks and regulating their operations

in accordance with the needs of theeconomy through instruments of credit control. The

primary role of the RBI was conceived as that of the lender-of-last-resort for the purpose

of ensuring the liquidity of the short-term assets of banks.

The failure of the Travancore National and Quilon Bank (TNQ Bank) in the middle of1938 created a public scare. The role of the RBI in this episode came under public and

media gaze, the banking crisis of 1938 was largely a localized affair confined to South

India.

The RBI submitted to the Central Board, in October 1939, a Report on the non-scheduledbanks, with special reference to the distribution of their assets and liabilities. The Reportmentioned that several of these banks had poor cash reserves, low investment ratio, overextension of the advances portfolio and a large proportion of bad and doubtful debts.

Post independence

There had been a mushroom growth of banks whose financial position was suspect and all thisinformation was given only on the basis of dressed-up balance sheets, which did not disclosemany of the more unsatisfactory features. The regulatory measures taken on an interim basisincluded the Banking Companies (Inspection) Ordinance, 1946 and the Banking Companies(Restriction of Branches) Act, 1946. The Bill as amended by the Select Committee wasintroduced in the Legislative Assembly on February 8, 1949 and was passed on February 17,1949 as the Banking Regulation Act.

The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal,paralyzing banking activities for months India's independence marked the end of a regime of


13/58

by the government in 1948 envisaged a mixed economy. This resulted into greater involvementof the state in different segments of the economy

In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bankof India (RBI) "to regulate, control, and inspect the banks in India."The Banking Regulation Act also provided that no new bank or branch of an existing bank

could be opened without a license from the RBI, and no two banks could have commondirectors. However, despite these provisions, control and regulations, banks in India except theState Bank of India, continued to be owned and operated by private persons. This changedwith the nationalization of major banks in India on 19 July 1969.

The RBI was nationalized on January 1, 1949 in terms of the Reserve Bank of India

Towards Nationalisation: objective realities

By the 1960s, the Indian banking industry had become an important tool to facilitate the

development of the Indian economy. At the same time, it had emerged as a large employer,and a debate had ensued about the possibility to nationalise the banking industry. IndiraGandhi, the-then Prime Minister of India expressed the intention of the GOI in the annualconference of theAll India Congress Meeting in a paper entitled Stray thoughts on Bank

NationalisationThe paper was received with positive enthusiasm. Thereafter, her move was swift and sudden,and the GOI issued an ordinance and nationalised the 14 largest commercial banks with effectfrom the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, describedthe step as a "masterstroke of political sagacity. Within two weeks of the issue of the

ordinance, theParliament passed the Banking Companies (Acquisition and Transfer ofUndertaking) Bill, and itreceived the presidential approval on 9 August 1969The year 1969 was a landmark in the history of commercial banking in India. In July of thatyear, the government nationalized 14 major commercial banks of the country. In April 1980,Government nationalized 6 more commercial banks. A disturbing feature of the pre-nationalization banking policy was the negligible share of agricultural sector in bank credit.This share hovered around 2 per cent of total commercial bank credit. The privately-ownedcommercial banks were neither interested nor geared to meet the risky and small creditrequirements of the farmers. Similarly, the share of other non-industrial sectors in bank creditwas also low. The State Bank of India was constituted on July1,1955. Later, the State Bank of

India (Subsidiary Banks) Act waspassed in 1959 enabling the State Bank of India to take overeight former State-associated banks as its subsidiaries

A second dose of nationalization of 6 more commercial banks followed in 1980. The statedreason for the nationalization was to give the government more control of credit delivery. Withthe second dose of nationalization, the GOI controlled around 91% of the banking business ofIndia. Later on, in the year 1993, the government merged New Bank of India with Punjab

National Bank. It was the only merger between nationalized banks and resulted in thereduction of the number of nationalized banks from 20 to 19. After this, until the 1990s, thenationalized banks grew at a pace of around 4%, closer to the average growth rate of the Indian

economy

The following steps were taken by the Government of India to Regulate Banking Institutions in


14/58

1949: Enactment of Banking Regulation Act. 1955: Nationalisation of State Bank of India. 1959: Nationalisation of SBI subsidiaries. 1961: Insurance cover extended to deposits. 1969: Nationalisation of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks.

1980: Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector bank India rose to

approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and immenseconfidence about the sustainability of these institutions.

On the eve of the independence 1947 there were 648 commercial banks comprising of 97

scheduled and 551 non scheduled banks. The Imperial Bank was taken over by the StateBank of India (SBI), by the State Bank of India Act 1952. In 1953 the Palai Central bankcollapsed. A similar fate faced most of the banks run by the erstwhile maharajas, due to thelarge funds siphoned off. Most of these banks that had existed were the offshoots of locallandlords/Maharajas or big traders and moneylenders who sought to extend the scope of

their financial activities. Most were in a state of collapse, due to irregularities To save thesebanks from default and to bail out the maharajas, 10 banks belonging to the princely state weretaken over by SBI in 1956 these included the State Bank of Patiala, Saurashtra, Bikaner,Jaipur, Indore, Baroda, Mysore, Hyderabad, Travancore and a number of smaller ones likeSangli, manipur, Mayurbanj, etc.

In 1959 Palai Central Bank Ltd, Kerala which had reportedly financed some assembly /parliament elections went into liquidation. It was followed by failure of Lakshmi Bank LtdAkola, in the next year .The list of such banks before Nationalization will be to big too benamed here. In the late 1950s the government appointed the Mahalanobis Committee to lookinto the precarious conditions of the private Banks.The Mahalanobis Report, recommendedbesides handing out the standard formulae to reduce flab, trim size, etc.,This periodwitnessed consolidation of banking it suggested the amalgamation of the less profit

making banks with the others. The Reserve Bank of India thus made it compulsory forreconstruction and / or merger of the weak units with the sound ones as per the Banking

Companies Act of 1960.This resulted in the number of banks being reduced from 605 in 1950;to 423 in 1956; to 292 in 1961, to 102 in 1966 and on the eve of nationalization in 1969, to just86.out of which 72 were scheduled and 14 nationalized.

Following the recommendations of the Rural Banking Enquiry Committee, the then ImperialBank of India was asked to open 114 new branches in rural and semi-urban areas within a

period of 5 years from 1.7.1951 to 30.5.1955. Only 63 branches were opened by it. Creditdisbursed to the rural areas was practically nil.In the aforesaid background and on therecommendations of All India Rural Credit Survey Committee, State Bank of India Act wasenacted in 1955, transferring the Imperial Bank of India to State Bank of India. Reserve Bank

of India contributed nearly 97% of the equity of SBI.within a period of 5 years from itsinception; SBI opened 415 branches as against a target of 400 branches given to it. Pursuant to

j


15/58

State bank of India and the constitution of Associate banks accelerated the pace of extendingbanking facilities all over the country. Thus, the period of 1955 to 1959 marked the beginningof public sector banking. The aforesaid steps provided a fillip to provisions of credit to ruralsector and also the expansion of bank branches. The need to bring about wider diffusion of

baking facilities and to change the uneven distributive pattern of bank lending was realized bythe Govt. This forced the Government to introduce the scheme of social control in1968.with a view to ensuring an equitable and purposeful distribution of credit within the

available resources and keeping in view the relative priorities of developmental needs theNational Credit Council was set up in 1968 to assess the demand for bank credit from varioussectors of the economy and to determine their respective priorities in allocation.

Unlike China only on July 19, 1969, (22 years after independence) fourteen major banks

of the country were nationalized despite Banking determining the backbone of the

economy. Big business required massive investments in infrastructure if it was to grow. Lackof infrastructure and capital was leading to stagnation and decline. Nationalisation and theexpansion of banking, was a necessary factor, to systematically tap the peoples savings

in order to generate the necessary capital. The rural sector faced an agrarian crisis. Thewidespread famine in 1967 found the rulers panic-strickenThe PL-480 grain doles, had, bynow got thoroughly discredited An alternative had to be found. The Green Revolutionwastheir answer to stem off peasant uprisings which gained acceptance and momentum among the

progressive sections of the population. There were three basic elements in the method of theGreen Revolution:

1. Continued expansion of farming areas;2. Double-cropping existing farmland;3. Using seeds with improved genetic

The initiation of the Green Revolution required certain amounts of seed capital, given on aconcessional (even free) basis to farmers, to encourage them to turn to the HYV varieties.Such capital and widespread disbursement could best be achieved through nationalized

banking. A vast network of rural banking was needed to be set up, first to promote the

green revolution; second to tap the surplus created to channel it into savings for use by

government/big business for infrastructural development. Besides, linked to this, the

focus for rural development changed.... from asset generation to poverty alleviation. Thiscoincided with Indira Gandhis slogan ofGaribi Hatao. While in the first two decades focuswas on irrigation, land development etc; now the focus changed to poverty alleviation schemes

like IRDP, Jawahar Rojgar Yojna, Indira Vikas Yojna etc, etc. All these schemes wereintricately linked with bank lending and finance, necessitating a wide network of branches.Both the Green revolution and so-called poverty alleviation schemes (employment

generation) were geared to extending the market for commodities. Hence nationalization

of banks was also an instant solution for immediate infusion of funds into the rural

populace in pursuance of the above goals By the mid-1970s, there were 196 RRBs, 24,000cooperative banks, 92,000 Primary Agricultural Credit Societies, 2966 lending units for long-term credit and a host of other financial institutions for rural banking like NABARD, etc. Andon April 15, 1980 six more commercial private banks were taken over by the Indiangovernment. It is easy now to take for granted, or even dismiss or disparage, what an

extraordinary and important step that was. It was not step at random or because of the whimsof the leadership of the time, but reflected a process of struggle and political change which had

d thi i t t d d f th l I th t l f ti li ti h d d f


16/58

the opposition. . The need for nationalization was felt mainly because private commercialbanks were not fulfilling the social and developmental goals of banking which are so essentialfor any industialising country. The developmental goals of financial intermediation were not

being achieved other than for some favoured large industries and established business houses.Whereas the industrys share in credit disbursed by commercial banks almost doubled between1951 and 1968, from 34% to 68%, agriculture received les than 2% of the total credit. Otherkey areas such as credit to exports and small industries were also neglected .the expansion of

commercial baking had largely excluded rural areas and small borrowers. The stated purposeof nationalization was to ensure that credit allocation occur in accordance with plan priorities.Thus Bank nationalization in India was also necessary to bail out the collapsing private

banks; it was a key necessity to give the necessary fiscal push to an economy that had

reached the end of its tether.

Public Sector Banking in India has grown stupendously in the last 43years. It has benefited thecommon man in no small measure. Green revolution, white revolution, etc. are all attributableto the contributions of our public sector banks. So, nationalization of banks, was eminentlysuccessful in tapping peoples saving to create the capital for big business, to usher in the

green revolution for agri-business, to extend the market; and to set up a vast network forpoverty alleviation.

Towards Nationalization: Subjective compulsions

India held general elections to the 4th Lok Sabha. The country had its fourth outing at thehustings since Independence in August 1947. This fourth general elections, which wereconducted for 520 seats from 520 constituencies, represented 27 Indian states and unionterritories. For the second time, there were only one-seat, constituencies and two-seatconstituency were abolished in 1962 elections. Congress which till now had never won less

than 73 per cent of the seats in Parliament, it was more bad news ahead

It was more bad news ahead. It's internal crisis stared at its face in the results of the 1967elections. For the first time, it lost nearly 60 seats in the Lower House, managing to win 283seats. Until 1967, the grand old party had also never won less than 60 per cent of all seats inAssembly elections. It also suffered a major setback as non-Congress ministries wereestablished in Bihar, Kerala, Orissa, Madras, the Punjab and West Bengal. Among all this,Indira Gandhi, elected to the Lok Sabha from Rai Bareili constituency, was sworn in as thePrime Minister on March 13, 1967. In order to keep dissident voices at bay, she appointedMorarji Desai, who had opposed her candidature as PM after Lal Bahudur Shastri's death, as

Deputy Prime Minister of India and Finance Minister of India. Some reasons for the dismalperformance were that both popular prime ministers Jawaharul Nehru and Lal Bahudur Shastrihad died, since then the Congress had been in crisis with Indira Gandhi and Moraji Desai bothwanting the position of Prime Minister. In the end Indira was chosen, mostly because of thesupport of Senior Congress leader Kumararasami Kamaraj who was also the chief minister ofmadras (Now Tamil Nadu). The Congress' dismal electoral performance forced her to becomeassertive and opt for a series pro people policy measures and one such measure of, devaluation(June 1966) Nationalisation of Banks and abolition of privy purses in tune with her slognGaribi Hatao (Meaning "Abolish Poverty" in Hindi). and the proposed anti-poverty programsthat came with it which were designed to give Gandhi an independent national support, based

on rural and urban poor.

O J 23 25 1967 th All I di C C itt i d t i t i
http://en.wikipedia.org/wiki/4th_Lok_Sabhahttp://en.wikipedia.org/wiki/Lok_Sabhahttp://en.wikipedia.org/wiki/4th_Lok_Sabhahttp://en.wikipedia.org/wiki/Lok_Sabha


17/58

nationalisation of general insurance and the state takeover commodity-wise of trading inimports, exports and foodgrains as the second, third and fourth points. In a memorandumsubmitted by 118 Congress MPs to the then Congress president K. Kamraj, it was pointed outthat the banking institutions were to be so organised that th e vested interests were not allowedto appropriate all the benefits ``...We have to ensure that these institutions are managed bysuch persons who are motivated for the development of the socialist society''.The leader of the young Turks, Mr. Chandra Shekhar had appointed a committee of four

economists to report to him on bank nationalisation. The Committee made a strong plea forbank nationalisation on the following grounds:

-- The nationalised banking set-up would vigorously pursue expansion programmes to coverrural areas, smaller towns and lower income groups.

-- Preempt credit for priority industries.

-- Pay special attention to inter-sectoral balances and balanced regional development.

-- Take away the stranglehold of the few industrial houses on credit and reduce their controlover the community's resources.

-- Co-ordinate all the activities of the credit institutions.

-- Ensure stability in the functioning of the credit institutions and inspire more confidenceamong the depositors.

-- Encourage healthy competition between large and small industrial house.

The Committee argued that the RBI's control over banks had ensured proper planneddevelopment. Social control over banks would not succeed. The Committee pleaded for acomplete takeover of the banking system. The Committee pleaded for a complete takeover ofthe banking system. This report, which must have been handed over to the then PrimeMinister, Indira Gandhi, was kept confidential and published in October 1969, only after the

banks were nationalised. In July 1969, the leaders of the young Turks submitted amemorandum to Kamaraj, asking for nationalisation of privat e commercial banks and generalinsurance companies. The same month, Indira Gandhi submitted a note to the AICC meeting inBangalore. She stated that the Congress had always favoured the nationalisation of financial

institutions. She criticised the banks post-social control, for having industrialists as chairmen.Thus, social control could not reduce the concentration of power. She pointed out that withnationalisation the proportion of bank investments in Government securities would go up. She

believed the Government could command more banks' assets only through nationalization.Major banks should be not only socially controlled, but publicly owned, Indira Gandhi, thethen prime minister, announced on All India Radio in 1969. Nationalisation followed.


18/58

Thus we could see bank nationalization as a powerful weapon in the factional fight

against the powerful emergence of Syndicates at that time .There were also reports in 1968news papers that then, RBI Governor, L. K. Jha was against bank nationalization, and asimilarly strong view was been held by Prof. J. J. Anjaria, the then Deputy Governor. Anumber of questions arise regarding the procedure adopted by the then government in suddenlyswitching from social control to bank Nationalisation. There was no official report, which hadgathered expert opinions and evidence, on the need either for social control or for Bank

Nationalisation. The chiefs of private banks had not been consulted as to the need andimplications of the proposed measure. There is no record of any written memoranda by topgovernment officials, which examined the implications of either social control or Bank

Nationalization. As in the case of the devaluation decision, some economist argue thatthat everything was done in an ad hoc and arbitrary manner to suit political exigencies as

being continued by governments in power even today whether it is re-privatizations

moves of banks through serious amendments such as Banking Laws (Amendment) Bill to

raise the voting rights in private sector banks progressively from the present 10% to 26%

and now Consolidation Of Banks.

Chinas banking system is not a good model for India

Degree of State Ownership

The state role is particularly strong in China, and India, where the state controls the majority ofthe banking sector i.e., 80%, and 68%, respectively.

The high degree of state ownership of commercial banks has traditionally been accompaniedby a strong emphasis on lending to state-owned enterprises (SOEs) in China. The large state-

controlled banks are heavily concentrated in lending to SOEs whereas the second- and third-tier, joint stock, and city commercial banks are somewhat more oriented toward non- stateenterprises. The Indian banking system can be characterized by a large number of banks withmixed ownership. However, 27 public sector banksnamely, banks owned and controlled bythe statecontinue to dominate the Indian commercial banking landscape. Together, these

banks account for three quarters of the market share. Even though these public sector bankshave access to capital markets, government policy is to ensure that its equity interest does not,as a result of public issues by banks, go below 51 percent. The government owns 75% of

banking assets in India while the private sector holds around 18% and the rest foreignownership. In China, the public sector owns 51% of assets and the private sector 48%, with

negligible foreign ownership.

The Robustness of the Banking Sector

The strength of Indian banks is still better in comparison to China banking

System. as reflected in the table below


19/58

TABLE SHOWING COMPARATIVE BANKING SYSTEM OF

CHINA AND INDIA

China India

Year 2003 2010 2003 2010Share of global financial stock (in $

trillions)5.1 13.7 0.9 1.9

Financial Depth (financial stock as

%age of GDP)323% (2003) 137% (2003)

Growth of Financial Stock

CAGR(1993-2000)14.5% (2003) 11.9% (2003)

(Source: Global Financial Stock Database)

According to Standard & Poors, the Indian banking sector is fundamentally strongerthan Chinas, at least for now. Indian banks ratio of gross nonperforming assets

including NPLs, parts of restructured assets, and foreclosed propertiesstood at 810

percent as of March 2005 compared with 3135 percent for the Chinese banks as of

December 31, 2004. According to the CBRC, the NPL ratio for major commercial banks inChina stood at 10 percent by the end of August 2005.

The difference in asset quality can be explained by a number of factors, according to Standard& Poors. For example, there are structural differences in the economic development models.Indian banks play an indirect role in the government fiscal operations, providing funds to thecentral government through their subscription to government bonds in line with statutoryliquidity ratio requirements. In contrast, Chinese banks, the state-owned banks in particular,are directly used as fiscal instruments to fund state-owned enterprises. Further, Indian bankscredit risk management systems are comparatively more advanced than Chinas, mainly

because Chinese banks spent decades under policy lending regulations that placed very lowpriority on developing a credit risk management platform.

In terms of capital adequacy, with relatively better interest margins (the benign interest rate

regime continued to favor the Indian banking sector, with net interest margin for the publicsector banks inching up from 2.98 percent in 200304 to 3.03 percent in 200405), lowprovisioning needs, and stronger net profitability, Indian banks have been able to build astronger capital base than Chinese banks.

The Robustness of the Banking Supervisory System

Overall, a cursory review of public information would suggest that the Indian bankingsupervisory system is also, to some extent, stronger than that in China. Two indicators arequite meaningful. Basically, a large part of Chinas banking sector is insolvent and the priority

is to restore the banking sector to normal. Therefore, China cannot afford to introduce adeposit insurance scheme quickly, because the fund would not be enough to absorb the stockproblem Similarly China cannot adopt Basel II because it asks for not 8 percent of capital


20/58

long way in these two areas, which is a sign of a strong supervisory system and a strongbanking system as well.

Neither the existence of deposit insurance nor preparations for Basel II are particularlymeaningful indicators of the strength of the supervisory system; the issues are much more

basic, including sound rules for asset classification, risk management, measuring capitaladequacy at full provisioning, and rules enforcement. First, India has already set up a deposit

insurance scheme to provide a degree of cover for both depositors and lenders.

The Deposit Insurance and Credit Guarantee Corp. is wholly owned by the Reserve Bank ofIndia, operating separate insurance funds to protect bank depositors and banks with exposuresto priority sectors identified and supported by the government.

The Deposit Insurance Scheme covers all classes of banks in India, including cooperativebanks. Deposit insurance is compulsory and the cover per depositor per bank account is Rs.100,000 and covers about 75 percent of total banking system deposits.

The premium payable under the scheme by insured banks is equal to five basis points of totaldeposits and will increase to 10 basis points from 2005 onward.

In clear contrast, despite the government-orchestrated financial restructuring of banks ingeneral, 30 percent of Chinas banking sector, measured in terms of assets, is stillundercapitalized. These include many small city commercial banks, not to mention creditcooperatives, where efforts to restore their solvency are still under way.

In full recognition of the benefits of a deposit insurance system, the central bank in China hasstarted to formulate the detailed arrangements for such a system. However, a number of risks

inherent in the deposit insurance system need to be addressed, such as moral hazard(particularly following the full liberalization of interest rates), potential cross subsidy to thedisadvantage of large and well-capitalized banks, and practical difficulty in assigning a risk-adjusted premium. Therefore, a deposit insurance system for China can only be expected to

become a reality after a few more years. And this is most likely to happen when the entirebanking sector has been made sounder.

Further evidence for the argument is Indias readiness to adopt Basel II, a set of moredemanding capital standards, designed originally for internationally active banks in G-10countries only. As complex as Basel II is, India is determined to implement it effective March

31, 2007.

They will initially adopt the standardized approach for credit risk and the basic indicatorapproach for operational risk. After adequate skills are developed, both by the banks and also

by the supervisor, some banks may be allowed to migrate to the internal ratings-basedapproach (IRB). Despite the benefit of a favorable perception overseas that India is conformingto best international standards, it is estimated that the banking sector may see a net depletion of200 basis points in capital adequacy following the adoption of Basel II, as it asks for morecapital for emerging markets. For one thing, operational risk is just an add-on. Of course, thismay entail raising fresh capital. And in the case of public sector banks, the room for raising

further capital would be constrained by the policy requirement to keep the governmentsshareholding at 51 percent or more. It is important to note that in March 2001, the ReserveBank of India required all banks to meet a higher minimum capital requirement of 9 percent


21/58

China, on the other hand, does not have the luxury to shift to Basel II so soon, because manybanks are now trying hard to come to grips with Basel I. In light of market conditions, theChinese supervisor intends to mandate the IRB approach only for large Chinese banks in

perhaps five years time, while continuing to adopt Basel I for the rest of the banking industry.

Other Head-To-Head Comparison Of The Banking Sectors Of The World'sFastest Growing Major Economies.

Size Stack

Chinese banks trump Indian counterparts in number and scale. China had 3,769 banking

institutions in 2010, with more than 250 commercial banks, 196,000 business outlets and

2.991 million employees. India pales in comparison, with 167 commercial banks, 87,768

business offices and 0.8 million employees.

It's the same story in asset size. At least 11 Chinese banks are perched in the top 100 categorybased in terms of market size while only three Indian banks make the cut here. To get an ideaof the scale difference, consider this: Industrial and Commercial Bank of China, the largestChinese bank, boasts of a market size of $201 billion while its Indian counterpart SBI's marketsize is only a fifth at $40 billion. But against the backdrop of a challenging environment, SBIChairman announced that Net Profit of the Bank increased by 41.66% from Rs8,265 crores in

FY''11 to Rs 11,707 crores in FY''12, one of the highest net profits earned by any corporatein the country. Operating Profit for your Bank crossed Rs30,000 crores mark, rising by24.62% to Rs31,574 crores in FY''12 from Rs25,336 crores in FY''11, indicating that coreoperations remain robust.

But is also a fact that Indian banking system still ahs not provided loans to company and

farmers as an estimate Indias Bank loan to GDP ratio (around 37%) is far lower than

that of China where according to IMF it has 136% loans to GDP ratios.

According a recent study by Mckinsey Global Institute (MGI), Indias financial depth

(financial stock as a % of GDP) is 137% where as in china it is 323%. Also Chinassaving rate is twice to that of Indias. Now Indias saving rate is also on an increase.
http://economictimes.indiatimes.com/topic.cms?search=Commercial%20Bank%20of%20Chinahttp://economictimes.indiatimes.com/topic.cms?search=Commercial%20Bank%20of%20China


22/58

Not-so Sweeping Coverage

China may have larger and richer banks, but is surprisingly almost at a par with India in termsof coverage, or rather lack of coverage, of population that uses formal or semi-formal financial

services. A McKinsey study shows that in India and China, the percentage of adult populationthat doesn't use formal or semi-formal financial services is 51-75%.

Power Performance

Banks from both sides have recorded high revenue growth, unlike counterparts of developedcountries. For instance, McKinsey data show revenues of Indian and Chinese banks grew19.8% and 13.7% in 2007-10, respectively. The non-performing asset ratio of the countries'

banks too is comparable. NPAs of Indian banks stood at 2.5% in 2010 while those of theChinese were 1.7%. Likewise, the cost to income ratio, another measure of banking efficiency,

is only a tad different. Indian banks: 42% and Chinese banks: 39%. An important indicatorof the banking industry's health and efficiency is its non-performing assets. On this count

too, Indian banks are way ahead of their Chinese counterparts and on par with the

global giants.

The banking sectors of the two countries are also strikingly similar in the huge publicownership of assets, unlike in developed nations. The government owns 75% of banking assetsin India while the private sector holds around 18% and the rest foreign ownership. In China,the public sector owns 51% of assets and the private sector 48%, with negligible foreignownership.

Measure of Woes

Most experts agree that the woes of China's banking sector are bigger than India's, thanks tothe huge fiscal stimulus package the Chinese government handed to banks during the 2008recession to overcome a slowdown in exports. Up to $2.5 trillion of new loans was disbursed,accounting for 30% of GDP in 2009.

China's banks became a vehicle for the government to provide cheap credit to projects bygovernment enterprises To make matters worse there was growing pressure on banks to


23/58

performing loans (NPL) of Chinese banks. Analysts at Fitch Credit Ratings predict that theratio of total credit/GDP in China is likely to reach 185% of GDP by the year end from 124%of GDP in 2007. Such high credit/GDP ratios have led to banking crises. Japan in the late1980s is a notable example. An S &P report says Credit penetration in China is by far thehighest in BRIC. The ratio of private sector loans to GDP was 131% in December 2011, alevel which would leave China's banking system vulnerable to an unexpected hard landing.LGFPs (local government financing platforms) represen20% of total loans in China. It could

also be a weak spot because they have generally weak financial profiles marked by highleverage, poor debt service capacity, and significant asset-liability mismatch. It is estimatedthat about 30% of LGFP loans could turn sour in the next three years if local governmentsdon't extend any support. Chinese banks' credit performance would worsen if restrictivegovernment policies induce a liquidity squeeze in these vulnerable segments under theirregulatory forbearance exercise taken up by the Government this year.

Cyclical vs Structural

In contrast, Indian banks are far more conservative than their Chinese counterparts, even more

so during global crises. Not surprisingly, the scale of credit expansion in India was muchsmaller. Yet the balance sheet of Indian banks' is weaker than in 2008 as "the impaired loanratio is closer to 6% as against 3.5% in 2008", according to Morgan Stanley analysts. Thegross NPA ratio of scheduled commercial banks in India increased marginally to 2.52% inJune 2011 from 2.35% in March 2011.

The reasons for this are more cyclical than systemic; Indian banks face pressures from weakglobal and domestic macroeconomic conditions. Slowing growth, rising interest rates andweaker asset quality have cast a shadow on sectors such as real estate, infrastructure andaviation, which together constitute up to a third of total loans. Anxieties in performance due

to infrastructural lending are a common thread running through Indian and Chinese banks.

Still, the problem is inherent to mainly PSU lenders in India. Bank analysts say the assetquality of private banks in India has improved, with declining credit costs over the last twoyears. So while a cyclical slowdown will escalate NPAs, the profitability of Indian banksremains healthy. ButLoans are only about a third of India's GDP compared with over100% in China. Nor can India seal off its financial system to the same extent as

China.An S&P report states Credit growth in India is relatively moderate 16%-17% in fiscal2013, compared to the nominal GDP growth of 14.5%. A slowdown in the economy, policy

paralysis, has been delaying approval of new projects particularly in the infrastructure sector,

low business confidence, which is affecting new investments in the country, high domesticinterest rates, and inflation are likely to limit credit growth. The asset quality of Indian banksdeteriorated due to the moderation in economic activity, high inflation, high interest rates, andrupee depreciation. Small and midsize companies are particularly vulnerable. Stress is alsomounting on some highly leveraged large companies. Sectors under stress include airlines,state electricity utilities, micro finance institutions, some aggressively bid road projects,smaller steel and textiles companies, private electricity producers that are facing a fuelshortage, and construction and real estate.

The sharp depreciation of the rupee against the U.S. dollar, about 24% year on year as of July

20, 2012, has adversely affected corporate borrowers that have not hedged their foreigncurrency debt. Foreign currency loans constitute over 10% of total loans. But retail loans

ti t f ll b l d i i th h 't l d th
http://economictimes.indiatimes.com/topic.cms?search=NPLhttp://economictimes.indiatimes.com/topic.cms?search=Fitch%20Credit%20Ratingshttp://economictimes.indiatimes.com/topic.cms?search=Morgan%20Stanleyhttp://economictimes.indiatimes.com/topic.cms?search=NPLhttp://economictimes.indiatimes.com/topic.cms?search=Fitch%20Credit%20Ratingshttp://economictimes.indiatimes.com/topic.cms?search=Morgan%20Stanley


24/58

employment rate, and wages are still rising. We expect retail loans performance to sustain inthe short-term.

A large proportion of problem loans in India will be restructured. This, and the improvedmonitoring and recovery of nonperforming loans (NPLs) by government-owned banks, islikely to moderate the increase in such loans. Government-owned banks had seen a largeone-off upsurge in NPLs due to the introduction of automated (system-based) NPL

recognition in 2011. The stress is rising and the credit costs of banks is expected to be high inthe next few years.

There are also indicators that Nonperforming assets as a percentage of total loans could morethan double by the first quarter of 2013, from 5% in March 2011if one definesnonperforming assets as NPLs, restructured loans, and foreclosed loans. The SACP of someof these banks could deteriorate, although the ratings may not be affected due to expectationof continued government support for these banks.

Return on assets

But there's an interesting twist to the story. Despite being small in terms of capital base

and assets, Indian banks are way ahead of their global counterparts when it comes to

return on assets, a parameter which denotes efficiency. Indian banks fare well against

global peers as performance indicators foretell.

Despite being small in terms of capital base and assets, Indian banks are way ahead of

their global counterparts when it comes to return on assets, a parameter which denotesefficiency. Except for Bank of America and Citigroup, not too many of the global giants canmatch Indian banks in terms of ROA. Among the top four Chinese banks only ChinaConstruction Bank had an ROA of 1.29 per cent. The other three bank's ROA varied

between 0.05 and 0.81 per cent. Among the top 10 global giants, JP Morgan Chase, CreditAgricole, Mitsubishi Tokyo, Mizo Financial and BNP Paribas had an ROA of less than 1

per cent. (Data of International Monetary Fund, for the year 2005)

The exhibits 1, 2 & 3 will provide growth in Banking Industry in the form of Return onAssets and financial metrics from the year 2000. And also highlights that Indian Banking

sector is showing all the positive signs in the form of financial performance.

Exhibit 1. Return on Assets For 2011

Country ROA For 2011

France 0.6.

Germany 0.2

Greece -0.3Italy 0.2

Japan 0 4


25/58

Country ROA For 2011

Spain 0.5

United Kingdom 0.2

United States 1.2

Russia 2.3

China 1.0...

Malaysia 1.8

India 1.1Brazil 3.3

Mexico 1.6

Source: Compiled from Financial Soundness Indicators, IMF, Report On Trend And

Progress Of Banking In India 2010-11

Exhibit 2. Indian Banking Industry- Growth with rising

Profitability

Source: The Boston Consulting Group, September

2010


26/58

Exhibit 3 Financial metrics- Improvements in quality of assets, operating

efficiency, stable margins

Source: The Boston Consulting Group,

September 2010

Banking Sector Performance: Selected Indicators 2005

Country ROA ROE Cost/ Income NPL/Asset

Japan - -16.0 10 34

Taiwan 0. 6.5 9 10

China 0. 4.9 7 43

India 1. 18.5 7 11

Korea 0. 10.9 7 20

(Source: Ernst & young)

If one compares with the latest data Except for Bank of America and Citigroup, not too

many of the global giants can match Indian banks in terms of RoA. Last year, Bank of

America's RoA was 1.91 per cent, while that of Citigroup's was 1.63 per cent. Andhra

Banks RoA was not far behind at 1.59 per cent. In fact, its RoA was the highest among

all Asian banks.

Among other Indian banks, Oriental Bank of Commerce's RoA was 1.41 per cent, HDFC

Bank's] 1.29 per cent, ICICI Bank and Allahabad Bank's 1.20 per cent, Punjab National Bank's1.12 per cent and Canara Bank's 1.01 per cent. Last year, SBI's RoA was 0.94 per cent.


27/58

Among the top four Chinese banks only China Construction Bank had an RoA of 1.29 percent. The other three bank's RoAs varied between 0.05 and 0.81 per cent. Among the top 10global giants, JP Morgan Chase, Credit Agricole, Mitsubishi Tokyo, Mizo Financial and BNPParibas had an RoA of less than 1 per cent.

Payment systems

Though opening a chequing account is still a novel idea for many Chinese individuals, Chinanow is still in the transitional period to introduce personal cheques Cheques in China, thoughwidely used in the corporate world, have been long kept away from common consumers.Although some big cities such as Shanghai and Guangzhou have gradually allowed theapplications of personal cheques, people do not take to the new payment option due to theinconvenience and relatively high threshold for applications. Banks also appear hesitant to

promote personal cheques because of the higher risks in transactions resulted from the lack ofpersonal credit systems throughout the country. In Beijing alone, the clearing centre handlesmore than 140,000 cheques daily, and in Guangzhou, about 130,000 cheques per day. A bank

such as Industrial and Commercial Bank of China in Shanghai handles around 40,000 chequeson a daily basis. If personal cheques are widely used in China, a much higher volume ofcheques will be processed daily. There are 860 Bankers clearing houses in India, of which 840are managed by State Bank of India and its Associates, 14 by Reserve Bank of India, and therest 6 by nationalised banks The cheques cleared in the clearing houses managed by ReserveBank of India account for 62% in terms of volume and 86% in terms of value of the totalcheques cleared in the country.

Despite the widely touted explosion in online banking, clearing houses in India countryprocessed during the year 2003-2004 as per RBI statistics 1,022.80 million cheqeus amounting

toRs. 115,959 billion were cleared which included both MICR & non MICR instruments .During 2011-2012 the umber of cheques cleared stood at 1341.87 million amounting toRs.99,012.14 billion.

Under the retail electronic payment system the ntotla number of inssrumed procedd during2003-2004 stood at 166.94 million amounting toRs. 521.43million and in 2011-12, 1159.84million amounting toRs. 22,075.33billion. Under large value clearing and settlementthenumber of instrument sprocessed in 2011-12 stod at 55.04 million amounting Rs.10,79,790.59billion

Source: Reports on Currency and Finance, Reserve Bank of India.

Needless to underscore here that this herculean task is done by miniscule portion of the

0.8 million bank employees India as against 2.8 million employees in China , where

volume of cheque transactions in clearing house pales into insignificance when compared

with India, which bespeaks the mettle and efficiency of Indian bank employee.

Indian, Chinese banks plunge at different rates

What's the difference between falling 20 meters and falling 60 meters? Well, in the firstinstance you go "thud, aaaaaarrrggghhh", and in the second you go "aaaaaarrrggghhh, thud".


28/58

In the long run, experts believe the Chinese banking system poses greater dangers and is morelikely to collapse from the sheer weight of its problem loans. Foreign banks looking to enter

both markets must do so with eyes wide open.

Legend has it that Chinese bankers keep a shredder handy in their office for the express

purpose of destroying business cards of their borrowers. You see, they never intend to callthem back about the loans, as that's the responsibility of a different department.

The latest gross domestic product (GDP) figures from China should make the People's Bank ofChina nervous, as indeed it has. (The central bank announced further restrictions to lending onJuly 21, 2012.) While export-oriented growth remains high on the back of Americans being toolazy to manufacture anything themselves, the sector's profitability continues to decline.

Using official data from both the United States and China, it is easy to calculate that theaverage price of Chinese goods sold in the US has been falling the past few years, despite

rising input costs (copper, for example). That puts manufacturers in a quandary, as the goodold Chinese maxim of "work hard, be successful" simply doesn't work in practice.

So they do the next best thing - ie, borrow from banks and speculate in the local asset markets,particularly property and stocks. Walk around the Pudong district ofShanghai and you can seethe impact of a building boom, with great monuments to corporate success all around you.More troubling, you will see the same sights greeting you in downtown Guangzhou, Shenzhen,Chengdu and, of course, Beijing.India's banks are smaller, more conservative and potentially in much less trouble than China's.China is a manufacturing economy, and the proportion of Grade A office space thus appears

far higher than is economically warranted. This is, however, also the reason for the ChineseGDP to ramp up nicely, as all the infrastructure and building activity adds to recordedeconomic growth.

Banks, trying to recover their money from companies' manufacturing operations, findthemselves having to support such speculation to improve their chances, echoing the "ever-greening" scandal of Japanese banks in the 1980s and 1990s. The party comes to an abrupt haltonce liquidity is drained away from the system. This is precisely what the central bank is nowdoing with hikes in lending rates and, more important, by issuing policy diktats aimed atremoving bankers' temptations to lend. A continuation of restrictive banking policies reduces

the country's ability to absorb the people being thrown off by public-sector companies, as thesector aims to achieve profitability. With profits unlikely to improve any time soon, as theexport sector remains fiercely competitive, this means further job losses are unavoidable.When economic growth slows, China's government will have much to worry about, and willlikely instruct the central bank to reduce or withdraw its restrictions. In effect, this would pushthe resolution of any asset bubble to the longer term, which would obviously also cause amanifold increase in the costs of dealing with the problems.

Some experts believe that rather than the end game being forced on the Chinese banks by theirown central bank, extraneous forces are more likely to cause the adjustment. Some possible

examples include a recession in the US and Europe, uncovering of other banking scandals inChina and, of course, internal disquiet in the country. When the reckoning does come, expectalso to see a large scale increase in problem loans from the retail sector as was observed in the
http://atimes.com/atimes/Others/shanghai.htmlhttp://atimes.com/atimes/Others/beijing.htmlhttp://atimes.com/atimes/Others/shanghai.htmlhttp://atimes.com/atimes/Others/beijing.html


29/58

late 1990s. Chinese people will take every opportunity to avoid paying back their loans, and abank failure presents the perfect opportunity to do so. The resulting avalanche of bad loans willcost the country about 20% of its GDP, in my opinion.

Meanwhile, legend has it that becoming an Indian banker is the cherished dream of the middleclasses, but defaulting to banks is the path to riches for India's upper classes.

The Indian banking system is a relatively small part of the economy, with banking assets toGDP barely crossing a third, and with nationalized banks such as the State Bank of India groupmaking up a large portion. That said, private and foreign banks have an increasing role to playin the system, far higher than their command of banking assets would suggest. India's banksface losses on so-called priority loans as well as the long workout process that problem loansare subject to. However, these loans are isolated, with a few leading public-sector banksabsorbing a bulk of these exposures. Also, and quite unlike in China, India's politicalestablishment is not very sensitive to the level of interest rates, and is therefore unlikely tooppose the Reserve Bank of India's judgment in the matter.

Indian banks have been profitably lending to the middle classes for centuries now, as bankinggoes back a few generations, particularly in the richer parts of the country such as the northand the west. The explosive growth rate in personal and mortgage finance in recent years,however, bears close watching. A number of Indian middle-class borrowers have tapped thewillingness of commercial banks to lend money, a development over the past 10 years thatdestroyed the dominance of the Housing Development Finance Corp in the sector.

With new private-sector and foreign banks leading the charge in innovation, even themoribund public sector has had to catch up. By and large, even with large economic riskslooming - for example, borrowing by individuals working in call centers and information

technology - companies could become substantially more risky if a downturn hits these sectors.Similarly, the central bank is worried about inflation causing further rate hikes, which I believewill pressure quite a few of these young borrowers and lead to bad debts climbing above 5%.

In terms of skill sets, though, unlike in China, Indian bankers go through years of credittraining, with cross-department exposure available to all officers in nationalized banks. Thishas allowed the nationalized banks to dominate the market for large corporate lending.Changes in the mid-1990s allowed for specific banks to assume the lead position in bankingconsortiums, thereby reducing the ability of large corporate borrowers to "borrow from Peterto pay Paul". Larger consortiums, particularly those comprising non-nationalized banks, have

been shown to have lower loan losses. This experience is vastly different from that of China.

This leads us to the main causes of banking losses in India, namely corruption, a slow legalprocess and government meddling. The ruling Congress party started the fashion for openhouse loans (known locally as loan mela), wherein banks tend to lend small amounts of moneyto a large number of poor peasants. Most of these loans have led to losses.

The second area of losses is due to the prevalence of corruption, particularly at the heart of thesecond-tier nationalized banks such as Indian Bank. These losses have usually revolved aroundsingle banks taking on the total exposure of politically connected corporates that find

themselves in dire financial straits for various reasons. The process of declaring bankruptcyand imposing financial restructuring is overly long, and usually contributes to higher lossesgiven default


30/58

The worst-case scenario comes about if the Reserve Bank of India hikes rates even as aslowdown bites into the export-oriented sectors. Resulting losses from this scenario wouldcross 5% of GDP in my opinion, even after considering the lower severity of default. On theother hand Despite threat of bad loans, steady growth to keep Indian banking sector afloatSo there is very little in common between Indian and Chinese economies, barring the love ofinternational investors, who are enamoured by the economic growth rate. But there's growing

noise about the health of the banking system in both the countries. In fact, China's bankingregulators and heads of top banks had to address the media last Sunday to calm the fears thatthe banking system is in the middle of a bad loans storm. It is anybody's guess whether itconvinced investors or not.

The fear about the Indian banking system is almost similar, thanks to the scores of defaults andrestructuring of loans to prevent a loan from getting classified as bad. Are the bad loans in theIndian banking system so bad that it can wreck the economy? If history is any indicator, theyare not. Think of the fact that bad loans were almost a quarter of the total banking system

before the Bretton Woods twins forced economic reforms on the nation. The thousands ofcrores of defaults, be it Kingfisher Airlines or Deccan Chronicle Holdings, that make headlines

are certainly worrying. But all these are a tiny sum compared to the total size of the bankingindustry. These are just about less than 5% of advances and can go up by a few percentage

points even if 20% of the restructured loans turn bad.

Even if they double in the next few years, the sheer pace of growth of the industry's profits isenough to take care of the bad loans, say bankers. "I think it is exaggerated," says Aditya Puri,chief executive and managing director at HDFC Bank. "That is not a catastrophic situation.Banks can absorb this loss through their profitability." The situation may have deterioratedcompared with the best of the days before the 2008 credit crisis. But both the regulator and

banks have woken up to the damage that bad loans can cause if left unattended.

Doubts about bad loan numbers from both India and China remain and are not taken at facevalue. There is always a tendency to sweep them under the carpet. But if market valuations arean indicator, Indian banks are faring better than their Chinese counterparts in the eyes of theinvestors. Industrial and Commercial Bank of China, the world's largest, trades at a price to

book value of 1.3 times, compared with State Bank of India's 1.4. The average industryvaluation for Chinese banks is at 1.1 times the book value, while for Indian banks it is at 1.9,data from Bloomberg shows.

"All I want to say is that it is not an alarming thing," the Reserve Bank of India governor

Duvvuri Subbarao said on bad loans. "Our banks are resilient, they can withstand NPAs of thislevel." Skeptics can ignore the assurance, given that any regulator's job is to protect theindustry that he is regulating. But when it comes to Subbarao, probably a higher weightingcould be given to his words than any other as his past deeds have shown that he means what hesays.

In 2008 and 2009 foreign banks, burned by bad consumer loans and shaken by events

elsewhere, withdrew credit. Some private Indian banks slammed the brakes on, too,

including the largest, ICICI, which faced rumours of insolvencyscurrilous, as it turned

out, but gleefully repeated by at least one state-bank boss at the time. The public banks,

meanwhile, and in particular State Bank of India (SBI), which has a fifth of the market,had an influx of deposits and undertook a lending splurge. SBI's balance-sheet doubled

b t M h 2007 d M h 2011


31/58

Wage gap rises ever higher at China's banks

The high profits and high salaries on offer at Chinese banks have been brought into question asthe country's economy begins to slow, with senior executives now earning as much as 80 timesthe salary of a general employee. The flawed management structure and limited power ofstockholders to constrain the board and senior executives of banks have led to the unfair wage

policy, said analysts, adding that the high salaries and bonuses enjoyed by senior executivesshould be linked to the operational risks of their banks. SBI insists that its expansion did notreflect a Chinese-style, government-directed effort to offset the global slump. Yet

although they remain tiny compared with Chinese giants like ICBC and China

Construction Bank, there is often more than a whiff of Beijing about the Indian state

lenders. Their loan books are skewed towards more socially worthy projects; their

bosses' pay is modest; and they have a hybrid status as firms that are listed but have the

state as a majority shareholder. Whereas the annual salaries for the president and vicepresident of Ping An Bank were the highest in the country at 8.69 million yuan (US$1.4million) and 5.79 million yuan (US$917,000) respectively. The highest and lowest average

monthly salary of executives at banks came to 33,500 yuan (US$5,300) for Agricultural Bankof China and 15,400 yuan (US$2,440) at Bank of Ningbo, respectively. The flawedmanagement structure and limited power of stockholders to constrain the board and seniorexecutives of banks have led to the unfair wage policy, said analysts, adding that the highsalaries and bonuses enjoyed by senior executives should be linked to the operational risks oftheir banks. Concerned over low salary structure in PSU banks, the Reserve Bank on Tuesdaysaid that in the absence of suitable compensation package they would lose talent to privatesector lenders. The executive compensation in the public sector, as is well known, is lowerthan that in the private sector...If public sector banks are required to compete with privatesector banks on a level playing field, there is a good case for compensating them too on a

competitive base", RBI Governor D Subbarao said a conference organized by IBA and FICCI.While endorsing the suggestion the governor whole heartedly. a logical corollary one can drawis that Bank employees can legitimately expect the same concerns to bestowed on them inthe 10 bipartite when talks are afloat of in making Indian banks competitive globally in

pursuit of its ranking with in the first 100 banks.

Bank staff salaries in China

A Chinese daily reported that despite the economic downturn, but the Bankstaff pay growth

remains strong. Reported from the agencies has just been pu

Merger Mania Vi

Documents

Transcript of Merger Mania Vi