Retail Banking in Indiaspidi2.iimb.ac.in/~networth/CCS/2005/566 CCS-Retail Banking in India.pdf ·...

Contemporary Concern Studies

Retail Banking in India Trends, Problems and Prospects

SUBMITTED TO

PROF. P.C.NARAYAN

ON AUGUST 29, 2006

BY NITEESH JOSHI (0511173)

SONIA AGARWAL (0511189)

INDIAN INSTITUTE OF MANAGEMENT, BANGALORE

CCS Report Retail Banking in India

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ACKNOWLEDGEMENT

We wish to express our heartfelt gratitude towards Prof. P.C.

Narayan, whose invaluable guidance saw this project study being

culminated successfully. We also wish to thank Prof. Prakhya for

the time that he spent with us validating the regression study and

providing inputs to come up with better results and Prof. C. Sen

for his insights on retail credit off-take with variation in several

macro-economic variables.

Niteesh Joshi Sonia Agarwal


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TABLE OF CONTENTS

Abstract ............................................................................................................................... 4

Executive Summary ............................................................................................................ 5

Major Triggers for banks’ sharper focus on Retail Business.............................................. 6

Emerging Issues .................................................................................................................. 7

SWOT Analysis .................................................................................................................. 9

Market Segments and Industry Trends ............................................................................. 11

Housing Finance ............................................................................................................... 12

Indian Housing sector – Brief Overview ...................................................................... 12 Growth prospects .......................................................................................................... 13 Market Trends............................................................................................................... 16 Analysis of the Home Loans Market ............................................................................ 18

Type of Borrowers in the housing market................................................................. 18 Risks to growth rates................................................................................................. 18 Effect of Interest Rate Changes on the Portfolio ...................................................... 19 Distribution Channels ............................................................................................... 19 Innovative products................................................................................................... 20 Non Performing Assets ............................................................................................. 20 Cost of Funds ............................................................................................................ 20

Real Estate Pricing Bubble in Market............................................................................... 22

Analysis and Recommendations................................................................................ 24 Auto Finance..................................................................................................................... 27

Car and Utility Vehicle ..................................................................................................... 29

Key growth drivers.................................................................................................... 29 New Car Sales........................................................................................................... 30 New UV Sales............................................................................................................ 31 Used Car Finance Market ........................................................................................ 33

Increasing power of financiers...................................................................................... 33 Decreasing power of NBFC’s....................................................................................... 34 Market Trends............................................................................................................... 35

Commercial Vehicle ......................................................................................................... 38

Private sector banks to continue to have larger market share ................................. 39 Market Trends............................................................................................................... 39

Two-Wheeler .................................................................................................................... 41


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Key growth drivers.................................................................................................... 41 Market Share............................................................................................................. 42 Market Trend ............................................................................................................ 42

Consumer Durables Finance ............................................................................................. 44

Salient Features ........................................................................................................ 44 Future View............................................................................................................... 45

Credit Cards Finance......................................................................................................... 46

Profitability and success Factors.............................................................................. 46 Retail Credit and Macro-Economic Variables.................................................................. 48

Determining Credit-Worthiness........................................................................................ 51

Need for a Credit Report System...................................................................................... 52

FICO ................................................................................................................................. 55

Fair Credit Reporting Act (FCRA) ............................................................................... 56 Consumer Reporting Agencies.................................................................................. 56 Information Furnishers ............................................................................................. 57 How FICO works? .................................................................................................... 57

Credit Information Bureau (India) Ltd (CIBIL) .............................................................. 59

Analysis and Recommendations ....................................................................................... 62

Annexure........................................................................................................................... 65

References......................................................................................................................... 67


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ABSTRACT

The term retail banking encompasses housing loans, retail deposit schemes, retail

loans, credit cards, debit cards, insurance products, mutual funds, depository services

including demat facilities and a host of other services catering to the needs of the

individual customers. It can be seen that retail banking includes various financial

services and products forming part of the assets as well as the liabilities segment of the

Banks. In other words, it refers to taking care of the banking needs of individual

customers in an integrated manner.

In India retail banking has become one of the most attractive segments for banks

because of reasons that have been analyzed in this report. The primary objective behind

the study was to find out if the growth in this segment in India of long term nature or is it

more of a bubble nature. Even more importantly, we set out to discover the changes that

India would need to implement if the tremendous growth in this field has to be sustained

over the years.


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EXECUTIVE SUMMARY

Retail Banking has caught on in India only in past 5 years or so. While anything that

relates to serving individual customers can be termed as Retail Banking, however for

banks the primary business in India has come from Housing Finance, Auto Finance and

more recently from Credit Card finance. The industry is still in its growth phase, with

Indian banks learning more and more from the practices prevalent in well developed

western economies. With India’s population and growing per capita income the retail

banking is a huge avenue for revenues for the Indian Banks if only they can enhance

and leverage their existing national presence and technological capabilities.

However, lack of proper infrastructure and regulation is posing a challenge to this

growth. For banks to meet increasing demand for funds from individuals there would be

a need to develop an active secondary market for various securitized paper. Without an

active market to place say mortgage paper or credit card receivables, the banks would

need to raise more and more capital in order to meet their CAR requirements to keep in

tune with increasing loan portfolio size. For retail credit market to really take off in the

country it is imperative that measures are put in place to develop the secondary markets

and remove the current information asymmetry for quality of assets that exists in Indian

market at present.

One of the most important steps in this direction would be set up independent credit

rating bureaus in the country that would enable a credit score on individuals much like

FICO score in US. Though CIBIL has taken up the responsibility to bridge this

information gap since 2004, however, we still have a long way to go before the ratings

actually become the criteria being used by banks for credit disbursement. Also, given the

size of the country, just a single entity like CIBIL would not be sufficient to ensure a fair

and accurate database of credit history. Steps need to be taken that enough number of

rating agencies are in place and working together for banks to make well-informed

decision before giving out credit. The independence and integrity of operations of such

organizations would be a key determinant to success of retail banking in India.


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MAJOR TRIGGERS FOR BANKS’ SHARPER FOCUS ON RETAIL BUSINESS

• Financial dis-intermediation- In not so distant past, commercial banks used to

reply on corporate and blue-chip companies for both resources and deployment of

funds on a wholesale basis. However, the scenario has changed with the boom in

equity markets in India over past 5 years. The working capital requirements from the

blue chip companies have reduced which can be partly attributed to enhancements

in levels of efficiencies in productivity, improved sales realizations, etc. Further, the

corporate companies have their own avenues – on the one side, tapping public

deposits directly, raising commercial papers, issuance of shares and debentures,

etc. and on the other side, strategic investments, primary and secondary market

operations, etc. Today if any blue chip company would want to take credit from

banks, the banks would be forced to offer them very nominal interest rates because

of reduced bargaining power.

• Advent of economic liberalization - The entry of globally reputed companies has

offered world class products and services to Indian people. The desire for a higher

standard of living coupled with increased purchasing power, consumerism, and a

more willing attitude towards taking credit has resulted in a retail chase.

• Low NPAs and good returns- The objectives of any commercial bank would be to

build a profitable and healthy portfolio, with as big a clientele base as possible so

that the risks are spread. Retail banking is a great solution to this problem with its

potential to provide a decent return through low probability of NPAs. Also the credit

risk is spread over a huge client base making it a great combination of low risk and

high return.


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EMERGING ISSUES

• Knowing the Customer – The concept of MIS is relatively new to Indian banks even

more particularly PSBs. In order that the product lines are targeted at the right

customers – present and prospective – it is necessary that complete information

about the customers is available to the banks. In this regard, the customer data base

available with most of the public sector banks is not at all adequate at the moment to

take its advantage for cross-selling of products. In this regard, there is an urgent

need for setting up of a robust data warehouse from where meaningful data on

customers, their preferences, their spending patterns, etc. can be mined. Cleansing

and automation of existing data is the first step in this direction.

• Technology Issues – Retail banking required huge investment in technology in

order to remain competitive. Apart from putting in customer relationship management

system in place, investments in technology are necessary in order to successfully

manage growing retail portfolio. The key to reduction in transaction costs

simultaneously with increase in ability to handle huge volumes of business lies only

in technology adoption.

• Product Innovation – Product innovation remains a major challenge to Indian

banks. Retail banking calls for catering to individual based requirements and though

bank after bank is coming out with new products, not all are successful. Banks need

to come out with products suiting the needs and requirements of different types of

customers. Once again, customer profiling based on historical data is of essence.

Banks should also try to modify features of the existing products in order to keep

their demand up.

• Pricing of Products - Lot of players in the market are trying to win a larger market

share by simply under-pricing the competition without evaluating their cost of funds

involved, margins, etc. This can spell trouble for lot of banks if things start to go bad

in future. The much-needed transparency in pricing is also missing, with many

hidden charges. The situation cannot remain this way for long. With customers

getting increasing more educated about the credit terms, its only a matter of time


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before accurate disclosures are required by the banks explaining their pricing of

particular product.

• Process Changes - In order to provide much needed improvement in customer

service one of the basic requirement is simplified processes. The documentation

issues have to remain simple both in terms of documents to be submitted by the

customer at the time of loan application and those to be executed upon sanction.

• Rural Orientation – Most of the action retail front as of now is by and large confined

to metros and big cities. There is still a vast market available in rural India, which

remains to be tapped. FMCG companies have already taken the lead in showing the

way by coming out with exquisite products, packaging and promotion, keeping the

rural customer in mind. The PSBs are in a great position of strength when it comes to

rural market because of their already existent extensive branch network. They can

effectively leverage this to address the needs of rural customers in a big way.


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SWOT ANALYSIS

Strengths

• Its been statistically proven that a large chunk of low cost savings deposits and fixed

deposits, contributed by retail segment, are considered less volatile as compared to

other deposits. Non-volatility of these deposits helps the banks to comfortably draw

their ALM strategies more particularly for longer tenure.

• Low level of NPAs - Tendency to default on housing loan is low as house is

considered as the one of the most prized assets of an individual’s life. However,

tendency to default on other sub-segments of retail loan is comparatively higher.

• Retail finance provides a higher and rather consistent risk adjusted return to Banks

due to low level of NPAs.

• The advances given for retail credit generally low credit risk since they invariably

backed by tangible security in the form of mortgage of house/flat in case of housing

loans and tangible security, check off facility, post dated cheques, etc. in case of

other retail loans.

Weaknesses • High manpower cost, low productivity and lack of automation is still a cause of

concern for the public sector banks which increases intermediation cost for them as

compared to private sector banks/foreign banks.

• Longer tenure of loans, ranging from minimum 3 years to 15/20 years as against the

average deposits of less than 3 years. This mismatch between the maturity period

between deposit and loans increases the liquidity risk for the bank. At the same time,

it is this difference that allows banks to be profitable due to spread difference. Also,

the longer duration of credit increases the default risk since prediction for such a long

tenure becomes less accurate.

• Absence of regulatory framework to ensure transparency as explained further in the

report.


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Opportunities • Cross selling of products - The Banks now prepare database of their depositors to

study the nature of transactions being routed through the deposit accounts with a

view to ascertaining the lending requirements of their customers and thus come up

with appropriate products that would address the credit requirements of individuals.

Securitization of retail loan portfolio is something that has already started in India and

is expected to grow much bigger. Nationalized Banks, being in advantageous

position in terms of their geographical reach to a large number of borrowers, can

continue to book fresh business, improve their customer base to cross sell their

products and in due course off load the portfolio through securitization route

depending upon their ALM position. The major hurdle in the whole scheme still

remains absence of an active secondary market to trade securitization paper.

• In the medium term, growth in retail lending is expected to outperform other

segments due to greater reach of banks, increased use of technology (thereby

reduced cost of intermediation) and a changing mindset in Indian urban middle class

from “save and pay” to “borrow and buy”. The stigma attached to credit is fast

disappearing in India.

• The growth in retail lending is expected to continue at much higher rates in the time

to come as the retail loans to GDP are still less than 5% which is lower than the other

developed/developing countries.

• Retail lending provides an opportunity to the Banks to offset the lower demand of

funds from corporate sector in times of boom in equity markets.

Threats

• Incidences of concurrent borrowings are on increase in case of retail loans through

the credit card / other routes. This is a cause of concern for the Banks especially

since at present there is no way for banks to monitor this kind of misuse. The

problem can be tackled only with sharing of data between all banks about the credit

profile of their customers.

• The cost of maintaining low cost savings deposits is also increasing due to increased

competition and increase in interest rates in past couple of quarters. The Banks are

now compelled to provide free ATM/credit cards.


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MARKET SEGMENTS AND INDUSTRY TRENDS

The retail credit market has been broadly divided into:

• Housing Finance

• Automobile Finance

• Consumer Durables Finance

• Credit Card Finance

We next analyze each of these categories below.1

1 The information has been collected from various sources, the primary being reports of Crisil and RBI


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HOUSING FINANCE

Indian Housing sector – Brief Overview

Indian housing industry is marked by very high fragmentation with small builders in

unorganized sector accounting for more than 70% of the houses being constructed. The

government has recognized the importance of urban development to sustain the high

economic growth and the investment marked for housing industry has been growing with

every Five Year Plan. The estimated investment under Tenth Five Year Plan was Rs.

7263 billion.

For organized players the market still remains mostly limited to urban areas and Tier I

towns since demand from rural areas is likely to be met through Government spending.

The banks would clearly be limiting their housing finance portfolio to the houses in the

urban sector and therefore for the purpose of studying the growth in housing loans we

need to consider only the urban housing development at present. The demand for

financeable houses is expected to increase from 3.3-3.4 million units in 2003-04 to 4.7-

4.9 million units by 2008-09 with the value of financeable houses increasing from about

Rs 1,600 billion in 2003-04 to about Rs 3,000 billion in 2008-092.

In India, housing finance as an industry emerged in 1977 with the establishment of

India’s first housing finance company, Housing Development Finance Corporation

Limited (HDFC). In 1987, the National Housing Bank (NHB) was set up as a subsidiary

of the Reserve Bank of India (RBI) to regulate and provide refinance support to housing

finance companies. At present, approximately 350 housing finance companies (HFCs)

operate in the Indian market. Only 30 of these have been approved by the NHB for

refinance assistance. The HFCs approved by NHB account for over 95 per cent of the

assets of all the HFCs in the industry.

The commercial banks were not allowed to provide housing loans directly to retail clients

till 1998 and some banks launched subsidiaries for housing finance purposes to cater to

this market. However, even after RBI allowed banks to enter this market directly most of

the banks started to enter the field only in 2001-02. The private banks were the first one

to recognize the potential of this market and were soon followed by foreign banks and

2 CRIS INFAC


13

then public banks. Today as the banks have captured a majority share in the housing

finance market, most of them have merged the subsidiaries that they had set up earlier.

The market has grown at rate of about 40% from 1998-99 to 2003-04 at Rs. 569 billion.

The growth is expected to continue at double digit rate given the strong economic growth

on the back of IT boom.

Housing Loan Disbursements

0

100

200

300

400

500

600

1999-2000 2000-01 2001-02 2002-03 2003-04 E

Disbursements

Data Source: CRIS INFAC

The lending to the housing sector by the banks is done through 2 routes:

• Direct – when the disbursements are made to retail borrowers for

purchase/construction of houses

• Indirect - by investing in bond issued by housing finance companies.

The share of banks in the direct retail segment has been growing and growth in banks’

housing finance portfolio has been greater than growth in portfolios of HFCs, as

analyzed in latter part of this report.

Growth prospects

• The average age of a person buying a house has been decreasing sharply and is

approximated to be 35-36 years at present. The increase in demand has been

fueled by demand from lower age group with increasing income levels and ready

availability of finance. The housing purchase decision in India is mostly still taken

by male population. In view of the same, the urban male population elder than 25


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years (about the age when most marriages take place in this country) is perhaps

a good proxy of the housing demand. Projection for the increase in housing

demand based on this parameter is as shown below

Currently about 30% of Indian population belongs to 25-44 year age group and the %

has been growing over the years clearly bringing out the tremendous potential that this

segment has for banks.

• Along with financing the purchase of newly constructed houses, finance is also

sought for resale/purchase of existing houses. The number of such houses is

expected to go up to 1.23 million in 2008-09.

• India is fast moving in direction of nuclear families from the otherwise traditional

joint family system. Increasing urbanization and migration for employment

purpose are also narrowing down the average household size. This contraction

signals significant demand increase.


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Figure: Decreasing Household Houses Source: Census 2001

• Increase in urban middle class- The Indian urban middle class disposable

income has been on a rise continuously for past 5 years and is expected to reach

Rs. 194000 by 2009-10. With the increasing income people have been more

willing to take up credit to purchase the more expensive housing since the larger

EMI payments become possible.

• Increasing aspiration to own a house because of societal prestige issues and

also the asset value locked in which is expected to appreciate in future. Also

there has been a marked trend in the social acceptability of credit in Indian

society. While few years ago taking up credit was taken to be a sign of financial

instability, today it is viewed more as a mean to finance the desired increase in

living standards.

• The customer segment for retail housing portfolio can be divided between

salaried and non-salaried customer. Non-salaried class includes self-employed

population like lawyers, doctors etc. Banks have traditionally preferred to restrict

their housing loan portfolio to the salaried employees only given the income

stability. However there is a growing need of products designed to cater to self-

employed professionals.

• There has also been a shift in consumer preference from rented houses to

owned houses. The rising income level have and increasing rental rates, people

are more inclined to build their own houses. Also, it is popularly believed that real


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estate prices in India would continue to rise for quite some time in which case

several find owning a house as a highly profitable investment as well.

Distribution of household by ownership status

Source: Census Report

• Fiscal incentives: In order to induce demand, the government has provided tax

incentives to the borrowers that reduce the cost of borrowing, making the option

of availing of a loan to purchase/construct a house more economical. Currently,

interest payments up to Rs 150,000 on housing loans can be claimed as a

deduction from the taxable income and annual principal repayment up to Rs

20,000 is eligible for a rebate from the tax liability. Also, an exemption of long

term capital gains can be availed of in the case of re-investment in a second

property.

• Priority sector status to housing loans for banks : With RBI increasing the size of

housing loan portfolio to be considered as priority sector lending and removing

the geographical restriction placed earlier; banks have become more aggressive

in giving out loans for this purpose.

Market Trends

• Banks are becoming more willing to lend at high LTV ie they are supplying very

high amount of the total financing required to make house purchase increasing

their risk exposure. The average LTV value was as high as 66-70% in 2003-04.

One of the reasons for this increase in increasing competition due to which banks

have to try harder to make credit appear more attractive to the customers. The


17

credit worthiness of the borrower is assessed by the bank based on age, income,

dependents, earning family members, stability of income etc. The average LTV

on loans is likely to show minor growth in near future as well. Some of the banks

have been giving housing loans at more than 100% LTV in the guise of loans for

the purpose of interior decoration or furnishing. Differential interest rates are

charged on the two loans however the effective interest rate on the over all loan

for a particular customer turns out to be lower than what he would have achieved

had he tried to acquire credit from multiple sources. RBI has recently issued

guidelines that forbids bank to lend at 100% LTV in order to reduce exposure.

• One of the tactics that the banks have adopted fairly successfully is increasing

loan tenures leading to low EMI payments that attract customers. Since the

overall payment of the loan remains same the banks are actually reducing their

profit in term of NPV of loan repayment and hence the returns on loans have

decreased. With rising interest rates, lenders will have to resort to either

increasing the tenure of the loan or hiking the Equated Monthly Installment (EMI)

for the existing floating rate borrowers. However, lenders first prefer to raise the

tenure of the loan with a reasonable limit and then, if required increase the EMI

to pass on the increased interest rate. If the latter option is exercised, the

Installment-to- Income ratio (IIR) of the borrower could go up and impact his/her

ability to service the loan. This could make the borrower susceptible to defaulting

on his monthly payment obligations.

• IIR can be used to assess the risk profile of the lender portfolio. An increase in

EMI affects the IIR of borrowers. The impact of interest rates on the credit risk

depends on IIR of the borrower. For higher IIR, the credit risk increases because

income available for maintenance of regular living standard goes down which can

prompt default. For some private sector banks the percentage of portfolio with

more than 50% IIR is much higher than the industry average hinting at the

aggressive strategy adopted.


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Analysis of the Home Loans Market

Type of Borrowers in the housing market • Retail borrowers like salaried individuals or professionals like doctors etc.

Traditionally salaried individuals have been more preferred because of lower risk.

• Corporate borrowers for funding their housing projects for their staff

• Over 80% of current portfolio is on floating rate basis

Risks to growth rates • Increasing interest rates: In the last 4-5 years, during which the industry

witnessed a boom in housing finance, interest rates have decreased. To exploit

declining interest rates, most borrowers opted for floating rate loans. However,

since October 2004, interest rates have started firming up and most players have

increased the interest rates on their home loan products by 25-75 basis points.

The rising interest rates will affect potential borrowers as well as existing

borrowers, since over 80 per cent of the existing home loan portfolio is on a

floating rate basis. Although equated monthly installments (EMIs) can be kept

constant by raising loan tenures, it is difficult to do so for high-tenure loans since

even a marginal rise in interest rates can result in a substantial rise in the

repayment period of high-tenure loans.

• Costal Regulatory Zone (CRZ) Act and Urban Land Ceiling and Regulation Act

(ULCRA) Act restrict the supply of land.

• Taking notice of the speculative rise in land prices, RBI has increased risk

weights to housing for the purpose of calculation of CAR. Thus additional capital

needs to be raised by the banks for maintaining their housing loan portfolio to

maintain CAR which can in turn increase the cost of lending especially for

smaller players who may not be in a position to pass the costs to customers.

• There is a tendency of banks to give credit at high IIR (interest to income ratio)

especially to younger borrowers since the IIR would come down with increasing

income. However if interest rates harden then the risk of default increases

because of increased interest obligation.

• Removal of tax sops: If the tax incentives on housing are completely withdrawn,

the demand for housing finance will be affected in the short term as buyers would


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re-evaluate their purchase decisions. However, the effect of this is likely to be

limited since decision to purchase house in India is not an impulsive decision.

The Indian public believes that housing value would undergo perpetual

appreciation because of which they generally don’t postpone decision to

purchase house once they believe that they have enough savings.

Effect of Interest Rate Changes on the Portfolio • Floating rates are generally lower than fixed rate making them more attractive to

customers especially in a falling rates environment as present in India couple of

years back. It would slowly go down now as the interest rates harden back. The

shift is likely to be slow since most of the borrowers aren’t aware of interest rates

cycle and hence would continue to opt for floating rates for some time to come.

• With increasing interest rates, the prepayment rate of borrower’s is likely to

decrease in near future (for floating rate borrowers) which otherwise used to

decrease the average tenure of the bank’s loan portfolio.

• With increasing rates the EMI would go up which can lead to increased defaults.

This can be marginally controlled by increasing the loan tenure so that EMI

doesn’t go up. However the loan tenure cannot be extended beyond a certain

limit after which the lender would be forced to increase EMI payments.

Average ticket size for the loan has been on the rise because of rising real estate prices,

increasing income levels and greater acceptability of credit.

Distribution Channels • Office branches – SBI is way ahead than anyone else in terms of number and

reach of its office complexes across the country.

• Direct Selling agents – more powerful, increasing in popularity. Special

Advantage to corporations like LIC where LIC agents can be trained into DSAs

• The increasing reach of banks to Tier II towns and to rural areas is likely to be a

strong growth factor in coming few years.


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Innovative products • Increase in need for innovation in products since most of the players are offering

similar schemes to the customers and currently the differentiation is based on

customer service and counseling

• Some of the services on offer: flexibility to change from fixed to floating rate,

progressive monthly installments (instead of EMI) for young borrowers with rising

incomes, legal and technical advise

Non Performing Assets • While traditionally housing finance industry hasn’t seen many defaults, the

portfolio under risk is now increasing because of increase in loan-to-value by

several lenders in order to stay competitive and attract younger borrowers.

• Multiple Financing – some borrowers have been involved in scams where same

property is mortgaged with several lenders in order to obtain financing. The

problem has escalated because of lack of central credit monitoring agency.

• However most of the market players feel that NPAs in housing loan portfolio

continue to be negligible because of most of the defaults are temporary in nature

(ie they arise because of genuine lack of ability of borrower to pay due to say

loss of job or some unexpected expense) and such borrowers also ultimately

repay the amount outstanding.

Cost of Funds • HFCs have historically relied on public deposits, refinance from NHB and funding

from banks to meet their funding needs. But raising money through public

deposits proved to be an operationally expensive affair, so HFCs slowly reduced

their reliance on them. The larger HFCs have also started tapping the overseas

market for funds3.

• Banks with access to low cost savings and current deposits have lower cost of

funds especially since around 60-70% of the savings deposits are never

withdrawn. However, ignoring the statistics, use of savings deposits to finance

3 CRIS INFAC


21

new loans increases liquidity risk of banks for which borrowing might need to be

done in the call money market.


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REAL ESTATE PRICING BUBBLE IN MARKET

The real estate prices across the country have hit the roof in past few years. Property

prices in India are rising fast, and not just in the bigger cities of Bangalore, Delhi or

Mumbai. The trend has strengthened further since beginning of 2006 when the

Government of India opened the construction and development sector in February 2006,

and allowed 100 per cent foreign direct investment (FDI) under the ‘automatic route’ in

order to spur investment in the infrastructure sector4. Real estate funds set up to invest

only in India have already raised more than $2.7 billion. And new funds worth as much

as $4 billion are being planned by J.P. Morgan, Britain's Knight Frank, and other foreign

investors.

The surge in foreign investment, more joint ventures between Indian and foreign

companies, and the growth of India’s domestic industries have created more

employment opportunities. With more disposable income, workers are spending more on

consumer goods and services and buying homes. The real estate sector will continue to

derive its growth from the booming IT sector, since an estimated 70% of the new

construction is for the IT sector. As the tech boom spreads across the country, as more

Indians buy homes, and as the economy grows at faster than 8% a year, real estate is

attracting more investors, many of them from abroad. Merrill Lynch forecasts that the

Indian realty sector will grow from $12 billion in 2005 to $90 billion by 2015. Also

contributing to the strong growth has been the low interest rates environment that has

prevailed in the country for past few years and easy availability of housing finance.

However, the extremely steep rise in real estate prices have led some to believe that

there might be speculation coupled with land hoarding by developers driving the prices

artificially high. If we consider changes in real estate prices from 2004 to 2005; India

shares the top spot, along with Korea, with a 20 per cent hike in the last quarter of

20055, overwhelming the inflation rate many times over. While a portion of the current

demand is real, at least a quarter of this is being driven by speculation (in some pockets

of the country, as high as three-fourths of the sales are effected by pure investors). The

4 http://economictimes.indiatimes.com/articleshow/1540301.cms 5 http://www.hindu.com/pp/2006/07/08/stories/2006070800400800.htm


23

low interest rates have prompted cash rich individuals to take up debt and invest in real

estate and once prices hike up sell these assets before payment of first mortgage.

These buyers are unlikely to be the end-users and, hence, real estate is fast becoming a

speculative commodity. This has led to unaffordable price levels in many cities.

The prices have also come under pressure because of real estate developers slowing

down bookings of existing projects in order to make larger profits6. The artificial supply

scarcity further fuels the price hike. Lot of investors and developers have taken up

projects without considering the economic sustainability the same. There are around 250

malls being developed in Bangalore, Gurgaon and Mumbai over next 5 years; and only

10% are expected to be successful. The absence of a secondary market has led to a

classic information asymmetry situation and in India the real estate market is particularly

opaque. It is likely that lot of investors would end up loosing big time when the price

correction happens.

Eight years ago, real estate prices had hit the roof on the back of furious speculation and

shortage of land. The bubble burst in 1996 as speculators desperately liquidated their

holdings and prices tumbled by 40 per cent to as much as 80 per cent, virtually wiping

out their entire capital. In every cyclical environment, a downtrend is inevitable. When

the dream run comes to an end and prices fall, it leads to a decline in housing equity,

borrowing and spending; also widespread defaults could generate a contraction in

economic growth. The banks are sitting on huge portfolio of housing loans that have

been given out for these over-priced assets and in case of defaults they are likely to

suffer a tremendous setback.

And clearly the correction is not too far off in future. Interest rates in India have slowly

started rising. That means that loans will be harder to get and service. The bubble can

also burst due to new government taxes stemming from increasing crude oil and natural

gas prices. Though, optimism about future salaries can still hold the prices up for some

time to come.

6 http://www.rediff.com/money/2004/nov/08spec.htm


24

Urban Development Ministry has recently started to put in some policies to curb

speculative land deals7:

• The measure being considered is to force anyone in possession of urban

land to construct within six months of purchase. Otherwise, the land

concerned would be acquired by government agencies at existing floor-rates

which, in most cases, are significantly lower than current market rates.

• In a bid to protect consumers, the urban development ministry is planning to

create a statutory regulator for the real estate sector. A real estate

commission will be set up to frame guidelines and a code of conduct for

proper conduct.

Property dealers and architects will have to get themselves registered before

doing business The commission is likely to be formed as part of the proposed

real estate bill, which would institute a series of strict regulations for

dealers/agents as well as developers. The bill is expected to be introduced in

the winter session of Parliament.

• The proposed commission will also look into the earnings of the dealers and

brokers. At present, they charge a commission of up to 4% from buyers and

sellers, which are totally unregulated and not taxed.

Concerns about an asset-price bubble have led the Reserve Bank of India to raise the

risk weights on real estate loans extended by banks, and mortgage rates have gone

from 7.5% to about 9.5% as a result. That's still well below the 15% rates that most

Indians were used to, but it's enough to raise questions about whether the speculation of

the past year and a half, which has driven land prices up by 30% to 100% and real

estate stocks up as much as 2,000%, may be coming to an end.

Analysis and Recommendations Some of the risks associated with real estate industry in India as analyzed by Ernst and

Young8 are as follows:

• The real estate market is not as transparent as international practices require

• Typically lease terms are short and tenancies turnover frequently

7 http://www.inrnews.com/indianrealestate/2006/07/policy_measures_being_consider.html 8 http://www.createum.com/consulting.htm


25

• Transfer taxes range from 4% to as high as 15% in some states and

applicable on all transactions including leases

• Quality of building standards are not uniform across the country and not as

stringent as in other more developed countries

• There is bureaucracy and possible delays in obtaining approvals which may

be required at the local state level.

• Government's tax policies are not in tandem with the liberalization initiatives

being undertaken in the sector.

• There are no substantial tax incentives for real estate development except in

the limited circumstances. Even in these situations, the tax incentive windows

have a short life left. The prevailing tenancy laws in India are not in favor of

owners of the land.

• The Urban Land Ceiling Act and Rent Control Acts have distorted property

markets in cities, leading to exceptionally high property prices. Moreover, a

high percentage of land holdings do not have clear titles.

• Land in India is typically held by individual or families. This restricts organized

dealing, and hinders transfer of titles.

• Land reforms are not in place.

In view of these risks associated with the current real estate markets it looks like the

banks are sitting on brink of a huge disaster. Clearly the Indian market is at present not

mature enough to see through the game being played by cash rich individuals and

developers together. In line with the moves already put in place by Ministry of Urban

Development and RBI, we believe that there is also a strong need to:

• Improve the information intermediation in the system wherein the assets can

be priced accurately and their prices not be artificially hiked

• Consequently, develop a strong secondary market for mortgage paper in

India so that banks can offload their risk in the market. The active secondary

market is also a great mechanism to make sure that prices are better

reflection of asset value. However, a lot of regulatory action has to be taken

by the government and RBI before we can reach that stage.

• In order to develop this market there is also need to have independent credit

rating agencies that can separately evaluate the true asset value to price the

mortgage paper. In line with same, CRISIL has already come out with 2 rating


26

– Developers rating and Project Rating. Given the highly fragmented nature

of real estate development in India it is necessary that more such

organizations come into play so that industry benchmarks can be developed

for comparison across the country.


27

AUTO FINANCE Three main sectors in this industry:

1. Car and Utility Vehicle finance industry

2. Commercial Vehicle finance industry

3. Two-wheeler finance industry

Recently growth in disbursements was driven by9:

• Uptrend in used vehicle finance

• Changing consumer mindset towards availing of finance, leading to a higher

proportion of vehicles sold being financed.

• Growth in demand for the underlying asset, driven by an increase in the

affordability due to a higher loan-to-value, coupled with increasing loan tenures

offered by financiers and increasing income levels.

• Growth in demand for higher tonnage / higher value vehicles due to highway

development, leading to the emergence of the hub and spoke system of

transportation.

• Higher level of funding the vehicle cost (inclusive of cost of body).

• Increase in penetration by the organized players in used vehicle finance and

refinance.

Salient features of this segment of finance market

- In sharp contrast to CDF, in terms of market share, banks continued to dominate the

scene for car, CV and two-wheeler finance, while the market share of NBFCs

continued to decline gradually.

- Auto Loan disbursements have larger tenures and are of bigger ticket size.

- The outstanding portfolio of the auto finance market recorded a healthy CAGR of

nearly 23 per cent during 2001-02 to 2005-06 to reach Rs 1,048 billion in 2005-06. It

is expected to decline approximately to 18 percent for the period 2006-2010.

- Power of the financiers on the upswing. The price reduction on cars, passed on by

the manufacturers to the consumers has been mostly pocketed by them improving

there profitability.

9 Crisil, May 2006


28

The way ahead for the players is:

- To sustain growth, one must be strongly present in both the new and the old auto

finance sector since there is a growing trend towards purchasing used cars

(second hand cars).

- Increasing competition in the car and utility vehicle (UV) has ensured that the

focus must shift from regional to a pan-India one.

- In case of commercial vehicles focus is shifting from small fleet operators (SFOs)

or large fleet operators (LFOs) to a healthy mix of both

Mature markets, within the auto finance market are those where the loan to value (LTV)

and proportion of vehicles purchased on finance have stabilized at high levels. Further,

interest rates in such markets would have bottomed out and losses as well as tenures

would have stabilized. The car, UV and CV finance markets exhibit all the characteristics

of mature markets except the tenures in these markets have not yet stabilized. We

expect the two-wheeler finance market to move the way the car, UV and CV finance

markets did when they were in their growth phases. We expect interest rates in the two-

wheeler finance market to move southward over the forecast period. However, the

decline in interest rates is expected to be marginal.10

10 Cris Infac May, 2006


29

CAR AND UTILITY VEHICLE

The past year, the sales volume growth of domestic passenger cars and Utility Vehicles

was subdues in comparison to the previous two years. Fewer launches of new car

models, floods in Gujarat and Maharashtra could probably be some of the reason for the

same; in addition to the fact that continuous high growth for the previous two years has

resulted in larger base. However, with prospective new launches and declining average

steel prices, the growth figures for next year are likely to improve.

The potential car and UV finance market comprises new car finance, new UV finance

and used car finance. The total market is expected to grow at a CAGR of 20.6 per cent

from Rs 374 billion in 2005-06 to Rs 791 billion in 2009-10.11

Key growth drivers • The used car finance market, expected to grow at a CAGR of over 34 per cent over

the next 4 years. This is one sector that is coming up rapidly. The share of organized

players has been increasing but still forms a very small portion of the market.

• The changing consumer mindset towards availing finance, leading to a higher

proportion of the vehicles sold being financed. Today, most of the people feel that a

car is a necessity rather than a luxury. They look to improving their standard of living.

With easy finance available and small EMIs, the sales of cars have increased

manifold.

• Growth in demand for cars and UVs, driven by an increase in affordability due to a

higher loan to value (LTV) coupled with increasing loan tenures offered by the

financiers and increasing household income levels. Competition has ensured that the

customer can avail of the best offers with each bank/financier trying to out-do each

other and attract the customer to itself. For the smaller segment of cars, the down-

payments are almost negligible making it very easy for the small income groups to be

able to afford a car.

11 Cris Infac Report, May 2006 – Auto Finance Industry


30

The new car and UV finance market, about Rs 293 billion in 2005-06, is expected to

record a CAGR of around 16 per cent during 2005-06 and 2009-10 to reach Rs 528

billion.

New Car Sales While new car sales volumes are expected to grow at a healthy rate of 17.8 per cent, the

average price of new cars will probably decline by around 4 per cent during 2005-06 and

2009-10. On account of this, the new car market is expected to grow at a CAGR of 13.5

per cent between 2005-06 and 2009-10 to reach Rs 547 billion. Consequently, the new

car finance market is expected to record a CAGR of 15.1 per cent during the same

period to reach Rs 379 billion. The higher growth expected in the new car finance market

is due to the expected higher finance penetration in the next 4 years.12

Table: New Car Finance Disbursements

12 Cris Infac, May 2006


31

New Car Market Vs New Car Finance Market

0

100

200

300

400

500

600

2001-02E 2004-05E 2005-06E 2006-07P 2009-10P

Rs b

illio

n

New Car Sales Value New Car Finance

Source: Cris Infac

Figure: LTV and Vehicles purchased on finance

New UV Sales The new UV market is likely to reach Rs 246 billion by 2009-10, recording a CAGR of 16

per cent. However, on account of the expected increase in the percentage of vehicles

purchased on finance and an almost stable average LTV, the new UV finance market is

expected to record a CAGR of 18.1 per cent, from Rs 76 billion in 2005-06 to Rs 149

billion in 2009-10.


32

New UV Market Vs New UV Finance Market

0

50

100

150

200

250

300

2001-02E 2004-05E 2005-06E 2006-07P 2009-10P

Rs

billi

on

New UV Sales Value New UV Finance

Source: Cris Infac

During the late 90s, this finance industry witnessed consolidation with most of the

NBFCs that had opened for financing auto loans, close down. Ever since, the share of

the banks in servicing auto loans has been growing rapidly.

The share of the new private sector banks in the car and UV finance market has

increased from about 32 per cent in 2002-03 to about 57 per cent in 2004-05. The share


33

of the major NBFCs, which continued their operations in the car and UV finance market,

has declined from about 26.7 per cent in 2002-03 to 19.8 per cent in 2004-05. In 2004-

05, the top five players accounted for about 81 per cent of the disbursements compared

to just 55 per cent in 2002-03.13

Used Car Finance Market With more and more people wanting to own a car, this segment has been growing

rapidly. More and more financiers are looking at this market, especially when auto

companies like Maruti have started schemes like ‘True Value’ to buy and sell used cars.

Though this market was initially highly unorganized, it is beginning to undergo a change

with the percentage of the organized sectors role increasing. This market is expected to

grow at an average CAGR of 34 per cent over the next 4 years.

Increasing power of financiers With the role of the financier becoming increasingly important in providing the means to

obtain the car and therefore influence the demand side, they have been able to pocket

52 per cent of the final price reduction that the manufacture has tried to pass on to the

customer. This has thus increased the profitability of the financier but adversely affected

the topline of the manufactures. The reduction in the price has not converted into the

sales that they were hoping.

It was expected that passing on the entire price reduction to the customer by the

manufacturer would have resulted in an additional demand for passenger cars, thereby

resulting in an increase in the manufacturer’s profitability. However, since the financier

has been able to pocket at least 52 per cent of the overall price reductions passed on by

the manufacturer to the customer, it has resulted in slower growth in car demand and

has deprived the manufacturer of improved profitability through economies of scale

benefits. However, in doing so, the profitability of the financier, especially the two large

private sector banks (ICICI and HDFC), has improved tremendously.



34

The price reduction has been due to budgetary as well as non-budgetary reasons. The

latter include price reduction on account of market forces.

Decreasing power of NBFC’s The recent past has witnessed an increase in the interest rates by the banks. NBFCs

would then have a competitive edge and they would continue to provide loans at lower

rates. That’s what one would have expected. But the NBFCs followed the interest rate

hikes effected by the two dominant private sector banks. They had no other option but to

increase interest rates in line with that carried out by the two private sector banks, which

together control close to 60 per cent of the new car finance market. The reason for the

same was the fact that NBFCs have seen a larger increase (at least a 185 bps) in their

risk-free incremental cost of funds as against that (28 bps) for banks.

During the easy liquidity situation in the economy up to 2004-05, NBFCs operating in the

new auto (cars & UVs, CVs and Two-wheeler) finance market were able to lower their

cost of funds by engineering their funding profile such that their borrowings were

typically for the short-term (1 year and below), although their lending was typically for 3

years and above. However, in February 2006, when liquidity was under pressure, the

financial engineering benefit that was accruing to NBFCs at the risk-free total cost of

funds turned adverse.


35

Unlike the Consumer Durable Finance Market, NBFCs are losing their share to the

banks in the Car and Utility Vehicle finance market.

Market Trends • Average LTV for new cars to increase to 80 per cent by 2009-10

The average Loan-to-Value has increased from 74 percent in 2001-02 to 79 percent in

2004-05. It is expected to further increase to 80 percent in another 3-4 years. The

metros have been sufficiently covered by the banks. It is the Tier-II and the non-metro

areas where banks need to channelize their energies to increase penetration and

develop markets.

The LTV varies according to the vehicle and can be as high as 90-95 per cent (ex-

showroom price) for some models. The mini (Maruti 800) and compact segments (Maruti

Zen, Hyundai Santro, Tata Indica) enjoy a higher LTV compared to the other segments.

The average LTV for the mini and compact segment is about 85 per cent and 80 per

cent, respectively. The higher resale value available on these segments enables

financiers to fund a larger part of the cost of the vehicle.

The higher end vehicles attract a lower LTV due to the following reasons:

o The value of a high-end car depreciates faster than a low-end car once it

moves out of the showroom.

o The customer profile of this segment indicates that they prefer paying a

higher amount upfront and taking a smaller proportion of the ex-

showroom price of the vehicle on loan.


36

LTV according to various car segments

65

70

75

80

85

Mini Mid Compact Luxury

per

cent

2004-05E 2005-06E 2009-10P

Source: Cris Infac

• Increase in the share of 5 and 7 year loans leading to a longer average tenure

Till recently, the tenure for loans in this segment used to vary around 3 years. With

increase in competition, the financiers are trying to encourage customers by giving loans

for a longer duration and smaller EMIs, so that the loans become more affordable.

• Gross interest rate to the customer likely to decrease over the next 4 years

Increasing competition has resulted in lowering of interest rates. The gross interest rate

to the customer (GIRC) in the new car finance business has declined from 25 per cent in

1997-98 to 9.8 per cent in 2004-05. However, in 2005-06, the GIRC increased by an

average 50-60 bps as financiers hiked car loan rates by 25 bps in October 2005 and

then by 100 bps in March 2006 soon after the announcement of the excise duty cut on

small cars in the Union Budget 200614.

It is estimated that due to further competitive pressures the GIRC will decline by around

50 bps during 2006-07 and 2009-10 despite a 25 bps expected increase in the yield on

government security during the same period.

• Net interest rate to customers to be impacted by reduction in subventions

14 Crisil Report, Auto Finance, May 2006


37

Initially, the subventions that the financiers received from the manufacturers as well as

the dealers, was passed on to the customers. This reduced the net interest payable by

the customer since 90-95 per cent of the subvention was passed on. The manufacturers

offer these in order to push sales of ‘weak demand’ models. Additionally, increasing

competition in this segment is expected to increase the subventions given by the

manufacturers. The important point to note here is what percentage of this will be

passed on to the customers. With the power of the financiers increasing and they

pocketing most of the subventions given, the gap between GIRC and NIRC is expected

to decrease. Also, will this result into increase in volumes sold.

• Yield to Financiers likely to increase over next 4 years

The yield to the financier (YTF) had been constantly declining up to 2004-05 but in 2005-

06, the YTF increased by 70-80 bps. During 2005-06 to 2009-10, it is expected that the

YTF to rise by 1.9 percentage points. Taking into consideration the fact that the market

structure has moved to a ‘duopoly’, financiers will be in a better position to negotiate with

dealers and DSAs and, therefore, reduce payouts. Over the next 4 years, payouts to

dealers and commissions to DSAs is also expected to reduce.15

15 Crisil Report, Auto Finance, May 2006


38

COMMERCIAL VEHICLE

The recent ruling of the Supreme Court in November, 2005, banning the overloading of

trucks/medium & heavy commercial vehicles (M&HCVs), has the changed the former

forecasts for the growth of the Commercial Vehicle Finance market. Prior to the ruling,

the growth of sales volumes in this category was expected to slow down, the reasons

being increased competition, high capacity growth, and a rise in fuel prices that would

affect the truck operators profitability. After the ruling, the growth forecasts have been

revised and the CV demand is expected to rise.

The key growth drivers for the CV finance market are16:

• The used CV finance market, expected to grow at a CAGR of around 18.3 per cent

during 2006-2010.

• Increase in penetration by organized players in used vehicle finance and refinance.

• SC order banning the overloading of trucks coupled with stronger than expected GDP

growth led by industrial and infrastructure growth.

• Growth in demand for higher tonnage/higher value vehicles due to highway

development leading to the emergence of the hub and spoke system of transportation.



39

However, financiers would be faced with certain challenges in the coming years. These

include17:

• Likely decline in asset quality as players try to increase market share.

• Likely hike in fuel prices, without comparable change in freight rates. This will

negatively impact the profitability of truck operators and in turn their credit worthiness.

Private sector banks to continue to have larger market share Initially this market was dominated by the NBFCs. However, since the past few years,

this segment has seen change with new private sector banks entering this space. The

reasons for them doing so could be the reduction in credit offtake and the excess

liquidity that resulted. These banks thus entered the retail finance sector. Also, lending

to small fleet operators (SFOs) (classified as priority sector lending) helps banks achieve

their priority sector lending targets. These factors saw banks increase their focus

towards the CV finance market. Initially it was the private sector banks that ventured into

this space. They were soon followed by the foreign banks and the public sector banks.

Two of the biggest players in this space presently are ICICI and HDFC. State Bank of

India too has become one of the more dominant players in this segment. In 2004-05,

commercial banks accounted for 59 per cent of this market while the NBFCs

commanded about 26 per cent. Initially the new CV finance market was dominated by

NBFCs, which charged a higher rate of interest. With the entry of the private banks, the

interest rates plunged downwards.

The CV finance market is distinct from the car and UV finance market. While the car and

UV finance market is concentrated in metros, the CV finance market is spread across

National and State highways. Hence, banks and NBFCs require a sound origination and

distribution network, both for new as well as used CV finance.

Market Trends • Average LTV to reduce over the next 4 years

The LTV for this segment is expected to reduced, unlike that of the Car and UV

segment. This is probably on account of the growing proportion of the small commercial



40

vehicles (SCVs) and multi-axle vehicles (MAVs – because of a very low portion of the

body cost is financed).

• Average tenure to increase by 7 months

The LFOs tend to replace their fleet within 3-4 years while the SFOs tend to do so in 4-5

years. In such a case, the tenure of the loans has increased from an average of 3-3.5

years to 3.5-4 years. Due to the recent capacity constraint and the need to pass on the

fuel prices and freight rate increases, this industry underwent a change. The financiers

responded to this by providing longer tenure loans, such that the EMIs reduced making it

much more affordable and attractive to expand fleet.

• GIRC and NIRC to move up

Till recently the rates had been declining but it is now believed that these rates have

reached their lowest and will now rise due to the following reasons:

o Increase in the general interest rates

o The total amount of disbursements to SFOs and the first time users is

expected to rise in the next few years. Considering their high risk profile,

the banks will want to levy higher interest rate on the borrowings.

The NIRC too will move in line with the GIRC since there is no practice of manufacturers

passing on the subventions to the financiers.

• YTF expected to rise

Though the yield to financiers had been on a decline since the past few years, the

situation is expected to reverse. YTF is impacted by dealer payouts and commissions to

Direct Selling Agents (DSAs).


41

TWO-WHEELER

The youngest and newest segment of the three, this finance market is in the growing

stage while the markets of the other two are in their maturity phase.

The sales growth in this segment is primarily driven by the increasing household income,

easier availability of finance and the launch of new models and variants. Recently the

supply of scooters had been affected by labor strikes for two of the biggest players. It is

expected that the scooter sales will go up with relaxation of capacity constraints and

entry of new players in the market.

Key growth drivers18

• Increased focus of the organised financiers towards the non-metro markets leading to

higher number of two-wheelers being financed.

• Growth in demand for two-wheelers fuelled by factors such as:

o Rising household income levels and easy availability of finance;

o Lack of adequate transport facilities;



42

o Increasing student and young professional population driving the growth

in the urban markets and;

o Regular launch of new models leading to consumers changing/upgrading

their vehicles at a faster rate.

Market Share The Two-wheeler market is a comparatively new market and is still in its growth phase.

More and more organized players are entering this market. At present they have mostly

concentrated on the urban and semi-urban areas. There is much room for growth in the

rural areas where availability of finance for purchase of two-wheeler may result in very

high sales volumes. Once the market grows and competition begins to build up, the

industry will see consolidation.

Market Trend • Geographical Reach

Going forward, players are expected to increase their focus on the semi-urban/rural

markets. The risk profile of customers in these markets is higher as compared to the

urban markets. Given this fact, we believe that though competitive pressures will force

interest rates downward the decline in rates will be marginal.

• Average LTV and Tenure to increase

If the banks expect to penetrate the rural market, they need to make their offering as

attractive as possible. If the LTV is high and the tenure is longer, the payment of the

loans will be much easier for the rural (or semi-urban) people thus giving them the ability

to take up the loan. In these areas the sales will be more a result of push from the

financiers than demand generated from the customers. Also, some innovative schemes

that are already being pursued by some of the banks, like payment every two months

instead of monthly, have helped penetrate this market.

• Proportion of vehicles purchased through finance

The proportion of two-wheelers purchased on finance has increased over the past few

years. With the increase in the ease of availability of finance, increase in the freshly


43

graduated working class, increased reach to more geographies and highly attractive EMI

schemes, this sector can look forward to a healthy growth.

• GIRC expected to decline over the next few years

There can be two reasons to explain the GIRC declining in the next few years. Firstly, in

order to reach out to the semi-urban and the rural classes whose ability to payback loans

is very low, interest rates will have to be lowered to reduce their cost and attract them to

take up loans. Secondly, increasing competition will ensure that each financier tries to

offer the lowest rates possible, lowering the GIRC as a result. One point to note though

is that this decline will be very marginal.


44

CONSUMER DURABLES FINANCE

Consumer durables can be categorized under two main heads: Consumer Electronics

and Consumer Appliances (further divided into white and brown goods). Consumer

Durables demand has gone up with:

• rising income levels

• double-income families

• changing lifestyles

• availability of credit

• increasing consumer awareness

• introduction of new models

• falling prices

Salient Features - Disbursements for Televisions, Air Conditioners, Refrigerators and Washing

Machines constitute approximately 80-85% of the business for Consumer

Durables Financing. Today these are no more considered luxury items.

- The market size of the consumer durables industry in 2004-05 (as per CRIS

INFAC’s definition) was Rs 141.3 billion, which is expected to touch Rs 218.0

billion by 2009-10.

- Aggregate disbursements under CDF for the four consumer durables under

consideration were Rs 36 billion in 2004-05, and are expected to grow at 10 per

cent CAGR to reach Rs 59.3 billion by 2009-10.

- Unlike in other retail loan segments, this sector sees maximum business from the

semi-urban areas.

- The organized CDF mainly consists of NBFCs rather than banks (include CDF in

their personal loans).

- The CDF market is dominated by three major NBFCs . GE Countrywide

Consumer Financial Services, CitiFinancial Consumer Finance India (formerly

Associates India Financial Services) and Bajaj Auto Finance.

- NBFCs have an upper hand in this sector because:

o Close proximity to the customers; better understanding of their psyche


45

o Tie-ups with most durables companies to provide direct loans at the retail

stores itself

o Well developed network that provides volumes to business

o Can charge processing fee and give loans at zero per cent interest rates

- Reasons for banks not pursuing this sector aggressively :

o Loans are of shorter tenure (8-10 months) and smaller ticket size

o RBI has warned against zero-per cent interest rates

Future View - Banks to progressively get out of this space per se by providing this service

under the personal loans only

- The disbursements to grow at roughly 10% CAGR for the period 2005-2010

o Lower growth in penetration

o Loan-to-value ratios reaching saturation levels

o Decline in average price levels of the durables


46

CREDIT CARDS FINANCE

• Increasing usage for payment in recent years but still significantly lower than

some other Asian economies like Malaysia and Singapore

• Gradual shift from image of a premium/status granting product to a convenient

alternate mode of payment

• Largely dominated by foreign banks. Recently the Indian banks with significantly

larger geographical reach have entered the domain like SBI and ICICI

• Increased attractiveness because of waiver of joining fee by most of the banks

making it easier for people to hold multiple cards

• Increasing retail outlets providing credit card payment facilities

• Lot of innovative scope and several players have tied up with commercial entities

as co-branding arrangements.

o Cards like sports card, wild life card are offered to connect with the

customer better.

o Banks have also tied up with Railways, Oil companies, Telecom service

providers etc as co-branding partners. Increasingly the consumer durable

companies are also being tied up as partners.

o Affiliation cards where a fraction of the proceeds go to an affiliated social

service organization

o International cards that allow payment across the globe

o Corporate cards for volume selling of cards to corporate employees at

attractive rates

Profitability and success Factors • High margin business

• Success to be driven by higher margins, credit management, efficiency in back

office operations and strategic alliances with commercial entities to promote the

brand and build a strong customer base.

• Setting up of CIBIL in 2004 has helped banks to better access the financial

history of borrowers and make informed decisions about credit worthiness before

issuing credit cards. However, data from PSUs can’t be relied upon to great


47

extent because of lack of computerization till recent past. CIBIL is based on

reciprocal sharing mechanism where only member who share their data would be

able to access data from other banks. While the differential rates are not the

norm currently in the industry, however if the credit rating mechanism proves to

be successful in bringing down NPAs then it’s a matter of time before India also

moves in the direction of lower rates to retail customer with better credit history.


48

RETAIL CREDIT AND MACRO-ECONOMIC VARIABLES

While each of the identified market segments has its own respective drivers for growth,

nevertheless we believe that there are some macroeconomic variables that should

significantly display a high correlation with the retail credit being taken up by the public.

Some of such factors are:

• GDP/GDP growth

• Interest rates in India and abroad (especially US)

• Exports/Imports

• Inflation

• Average household income levels

• Employment levels

However, the concept of retail banking in India is relatively new and not much of

historical data is available on an annual basis in order for us to derive a meaningful

mathematical relationship. In order to obtain near 30 data points to validate the normality

assumption for the data set we decided to take quarterly number. We deliberately

introduced cyclicity in the data set by dividing available figures for each year into

quarters in fixed proportions. The proportion of retail credit being disbursed each quarter

was decided by analyzing the retail portfolio composition of ICICI Bank (largest retail

bank in India) for 3 years, and applying the average weights for each quarter to the

industry figures.

Variables considered:

Unfortunately figures for GDP or Employment levels aren’t really meaningful on a

quarterly frequency. We therefore need to search for a proxy variable which displays a

more immediate change in correspondence with the retail credit off take.

• We believe that one such variable is international crude oil prices. The oil prices in

the international market end up effecting whole economy in a tremendous manner

and it is a variable that is independent of monetary and fiscal policy of the local

government. The rising oil prices can lead the government to increase its own deficit


49

by controlling the domestic oil prices or it can pass to the public through an increase

in inflation. In a mature free market, the rise in oil prices would inadvertently be

associated with an expected rise in interest rate in order to keep a check on inflation.

The difference would essentially arise from the fact that whether the rise in oil prices

is because of increasing demand or an artificial supply deficit. A rise in oil prices

because of increasing demand hints at a growing economy which in turn means that

the income levels of people would be on a rise and they would be more willing to

take up credit. However, increasing in oil prices are expected to lead to increase the

interest rates in the country after lag of a quarter or so which in turn would again

dampen the credit off-take.

• Sensex - the stock market in a country is generally reflection of the expectation

levels in the economy and in public. A rising market index often hints a high optimism

about the future. We believe that in India especially with low level of information

intermediation, it is a lot easier for people to take sensex as an appropriate indicator

of increase in future income and they would therefore be more willing to take up

credit in order to finance their rising living standards.

• Interest Rates – With fall in interest rates the credit off take would increase with low

repayments that need to be made by individuals.

Based on these observations we ran a regression of quarterly figures (derived) for retail

credit disbursed against WTI Brunt Crude Oil prices, Sensex and interest rate (Yield on 1

year Government Bonds).

• The model showed that all three variables are highly significant and overall can

explain more than 94% of variation in the credit off-take.

• The importance of the variables based on standardizes beta values came out at Oil

prices> Sensex> Interest rates

• Interestingly the coefficient of oil prices came out as positive, indicating that in India

the credit off take has increased in spite of increasing oil prices. This is counter-

intuitive since the oil prices should fuel inflation which in turn would lead to increase

in interest rates.

• There was a positive correlation with Sensex. A large part of the retail portfolio

consists of housing loans. One of the major impacts that a rising Sensex would have

is to increase real estate prices. In India, that has indeed been the case over past

few years where a lot of speculation has taken place in the real estate market.


50

Housing purchase decision is not something that people take on an impulse. People

wouldn’t postpone the decision to purchase house because they see interest rates

going up by few basis points. The expected perpetual asset value appreciation holds

great strength for Indian investors, which displays an immature market.

• The interest rates show a negative correlation as expected, thus a fall in interest

rates would lead to increase in credit being taken up.

Also, in order to test hypothesis about Sensex affecting retail off take primarily because

of rising real estate prices, we ran a regression with only housing loan portfolio against

the sensex. The results showed that Sensex is a highly significant variable in

determining variation in housing loan disbursed and alone explained more than 60%

variation. Clearly the lack of information intermediation and absence of secondary

market to trade mortgage paper to determine its fair value is leading to increasing

speculative environment wherein people are willing to take up credit for investing in real

estate thus artificially driving up the home prices.

For testing this hypothesis we conducted the study again for US market as well. We

correlated the retail credit disbursed in US against NASDAQ Composite. We achieved a

significant negative correlation between the two. In any mature market a rising stock

prices would be lead to increase in interest rates leading to a decreased credit off-take.

In Indian markets things have been going in opposite direction hinting that someone has

been playing havoc with the markets. As long as we don’t have a more rigid regulatory

structure in place for credit system in this country such anomalies would continue to

exist.

There are certain other factors which haven’t been factored in the current model which

might lead to some level of distortion for eg:

• Increasing geographical reach of the banks to rural India and Tier II cities as a result

of which the consumer base is increasing which is not necessarily related to any of

the macro-economic factors we have discussed above

• Changing mindset of Indian consumers wherein credit is no longer considered a

social stigma and people are more willing to take up loans in order to fulfill their

aspirations


51

DETERMINING CREDIT-WORTHINESS In US, FICO score has been developed as a standard to determine the credit-worthiness

of a person. It is an industry standard for calculating a reliability factor for people

applying for credit. The score is a number that the creditors use to determine whether

they should give the loan or not and what interest rates should be charged on

mortgages, auto loans and credit cards, etc.

The score itself is calculated based on the information in your credit report. This report is

used to check whether or not one is eligible to receive credit or not along with other

information. Between your score and the report, one’s financial health is dependent on

maintaining a good credit rating.


52

NEED FOR A CREDIT REPORT SYSTEM

Some of the reasons that we felt necessitated the building of a Credit-Report System,

like the one operating in US at present are:

• Increased credit volumes: Credit Bureaus will help in increasing the volume of

credit given by allowing greater lending opportunities to lenders and easier access

to the borrowers. The existence of credit bureaus in developed countries has

facilitated increased market penetration of credit (to more than 66% as a

percentage of GDP as compared to 3% for India) while keeping non-performing

loans in check (approximately 1% of outstanding credit).19

• Operating efficiencies:

o Credit Portfolio Quality: In order to increase the credit off-take in the

country without increasing the default risk, one needs a proper

information system in place that can inform the creditor of the risk he

is taking by lending to the applicant. Proper dissemination of the credit

information will ensure that the banks do not take greater risks when

increasing their credit issuance. The bureaus will help its members to

judiciously mix relationship-based lending with information-based

lending. Concurrent borrowers and serial defaulters will be identified

and minimized early in the approval process thus reducing the cost to

the banks.

o Speed and Cost: The use of the reports of the credit bureaus will

make processing loans faster, easier and cheaper by reducing the

time it takes to make additional search to verify the details of the

applicant. The average loan in India is sanctioned in 2-3 days. Credit

grantors using Credit Information Reports will be able to significantly

reduce this turn round time and thus have a competitive edge in the

marketplace.20

• Differential pricing: The information asymmetry that presently exists causes all

borrowers to be charged same interest rates with an assumed level of risk. This

way wrong interests rates might be applied to the borrower – higher rate to a

19 http://www.cibil.com/benefits.htm 20 http://www.cibil.com/benefits.htm


53

sound applicant discouraging him from further borrowing and lower rate to an

unworthy customer while the bank bears higher risk. A credit score for the

borrowers will make it easier for the banks to give credit to the borrowers at the

interest rates which is appropriate for the risk they will suffer by lending.21

• Credit grantors: The use of CIRs will enable loan officers to make objective and

informed credit decisions quickly, competitively and cost-effectively. The use of

CIRs will enable them to increase their lending volumes and improve the quality of

their credit portfolios while reducing their delinquencies and loan processing costs.

This will translate into improved profit margins.

• Borrowers: The widespread use of credit data will provide consumers with fast and

easy access to the lending resources they need while reducing operating and risk

costs for credit grantors. These reduce costs will be passed on to an extent to

consumers with demonstrated credit performance in the form of lower interest

rates. This easy availability of reasonably price credit will provide borrowers with

the means to a higher standard of living.22

• Securitization: There is a critical need for a vibrant secondary market to develop to

help the banks finance further credit issuance. This can be done by developing the

securitization market which will help banks offload their lendings from the balance

sheet. For such a scenario to exist, the underlying asset (the loans themselves)

should be well rated and their default risks calculated so that the investor is well

aware and comfortable with the fund he is investing into.

• Improved management of Default risk and NPAs: This type of a system will also

encourage the people against defaulting. Each person will instead try to improve

his score by paying back on time so that he is charged a lower rate the next time

he applies for a loan. This will improve the entire system and help the banks avoid

making bad loans, reducing its Non-performing Assets (NPAs).

• Encouraging Taxpayers: If we link this with the PAN number (used to file for

taxes), this could also help in encouraging individuals to report a correct figure of

their income. If the income is higher, it will show that he is better positioned to

repay the loan/EMIs thus giving him a reason to reveal his real income.

21 http://www.cibil.com/benefits.htm 22 http://www.cibil.com/benefits.htm


54

• Introduction of Basle II Accord: With the enforcement of Basle II, the banks will be

required to maintain an additional market and operational risk charge. In such a

case, the banks will need to be able to assess and rate their credit disbursements

well; maintain a healthy credit mix minimizing the risk charge that entails.


55

FICO

FICO is an acronym for Fair Isaac Corporation (traded publicly under the symbol FIC)

and refers to the best-known credit score in the United States which is calculated using

mathematical formulae developed by this company. The FICO score is primarily used in

the mortgage industry, although some other lenders also use the FICO score. Banks and

other institutions that use scores as a factor in their lending decisions may deny credit or

charge higher interest rates to borrowers whose scores are below certain numbers.23

Fair Issac created the Beacon FICO score whose ratings range from 350 to 850, with the

latter being the best rating and therefore resulting in lower interest rate charged. Below

600 the loan might be turned down or one might be required to pay very high interest

rates.

The statistical models that generate credit scores are subject to federal regulations. The

Federal reserve Board’s Regulation B, which implements the Equal Credit Opportunity

Act, expressly prohibits a credit scoring model from considering any prohibited basis

such as race, color, religion, national origin, sex or marital status. The regulation also

stipulates that if an adverse action is taken due to a bad credit score, then specific

reasons have to be given to the individual. Ambiguity like “failed to score high enough” is

not enough and the reason stated has to be more specific.

Credit scores are designed to measure the risk of default by taking into account various

factors in a person's financial history. Although the exact formulae for calculating credit

scores are closely guarded secrets, Fair Isaac has disclosed the following components

and the approximate weighted contribution of each is:

• 35% - punctuality of payment in the past

• 30% - capacity to used: the ratio of current revolving debt (credit card balances, etc) to

total available revolving credit (credit limits)

• 15% - length of credit history

• 10% - types of credit used (installment, revolving, consumer finance)

• 10% - recent search for credit and/or amount of credit obtained recently24

23 http://en.wikipedia.org/wiki/Credit_score_%28United_States%29 24 http://en.wikipedia.org/wiki/Credit_score


56

25

Current income and employment history do not influence the FICO score, but they are

also weighed when applying for credit. For instance, an unemployed individual with no

other sources of income will not usually be approved for a home mortgage, regardless of

his or her FICO score.

Fair Credit Reporting Act (FCRA) The Fair Credit Reporting Act (FCRA) is an American federal law that regulates the

collection, dissemination, and use of consumer credit information. It, along with the Fair

Debt Collection Practices Act (FDCPA), forms the base of consumer credit rights in the

US.

Consumer Reporting Agencies CRAs are entities that collect and disseminate information about consumers to be used

for credit evaluation and certain other purposes. They maintain databases from which

they calculate and furnish a consumer’s credit report.

Under FCRA, these companies have a lot of responsibilities, some of which include26:

• Provide a consumer with information about him or her in the agency's files and to take

steps to verify the accuracy of information disputed by a consumer. Under the FACTA

laws passed in 2003, consumers are now able to receive one free credit report a year.

• Conduct reasonable investigations into consumer disputes about incorrect information

on their credit reports

• If negative information is removed as a result of a consumer's dispute, it may not be

reinserted without notifying the consumer within 5 days, in writing.

• CRAs may not retain negative information for an excessive period of time. The FCRA

spells out how long negative information, such as late payments, bankruptcies, tax

25 http://www.myfico.com/CreditEducation/ 26 http://en.wikipedia.org/wiki/FCRA


57

liens or judgments may stay on a consumer's credit report - typically 7 years from the

date of the delinquency.

The 3 big CRAs (mentioned later), do not interact with information furnishers directly as

a result of consumer disputes.

At present, there are 3 major credit bureaus that carry information about the person and

his credit. This results in each individual having 3 different scores if the data with the

three agencies is different. These bureaus are:

1. TransUnion

2. Experian

3. Equifax

Information Furnishers27

An information furnisher, as defined by the FCRA, is a company that provides

information to consumer reporting agencies. Typically, these are creditors, with which a

consumer has some sort of credit agreement. (credit card companies, auto finance

companies and mortgage banking institutions, to name a few). However, others may

include collection agencies (third-party collectors), state or municipal courts reporting a

judgment of some kind, past and present employers and bonders.

These agencies have to report to the CRAs under the following guidelines:

• They must provide complete and accurate information to the CRAs

• The duty to investigate disputed information from consumers falls on them.

• They must inform consumers about negative information which has been or is about to

be placed on the consumer’s credit report within 30 days.

As a result of the FACT (Fair and Accurate Credit Transaction) Act, each resident is

entitled to a copy of their credit disclosure from each of the CRAs once in every twelve

months. However, this information does not contain the credit score which has to be

purchased at a nominal price.

How FICO works?28

• When you apply for credit – whether for a credit card, a car loan, or a mortgage –

lenders want to know what risk they’d take by loaning money to you.

27 http://en.wikipedia.org/wiki/FCRA 28 http://www.myfico.com/CreditEducation/


58

• FICO scores are the credit scores most lenders use to determine your credit risk. You

have three FICO scores, one for each of the three credit bureaus – Experian,

TransUnion, and Equifax. Each score is based on information the credit bureau keeps

on file about you. As this information changes, your credit scores tend to change as

well.

• Your 3 FICO scores affect both how much and what loan terms (interest rate, etc.)

lenders will offer you at any given time.

• Taking steps to improve your FICO scores can help you qualify for better rates from

lenders.


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CREDIT INFORMATION BUREAU (INDIA) LTD (CIBIL)

“Rapid industrialization. An expanding economy. Growing aspirations. Increased

incomes. Improved lifestyles. Availability of high quality products and services. An

expanding market.”29 – CIBIL website

With the above scenario prevailing in the country, the credit off-take has greatly

increased in the country. Along with that so have the competition and the defaulting on

the loans. In such a case then, risk assessment becomes of prime importance.

Comprehensive credit information about the borrower is essential to mitigate possible

losses associated with such a scale-up.

As a solution, Credit Information Bureau (India) Ltd. (CIBIL) was set up in 2000. CIBIL

launched its Consumer Bureau operations in 2004 with a database size of 4 million

records from 12 members. The database grew significantly to over 20 million from

approximately 30 members during 2005. Credit information reports from CIBIL enable

banks to offer differential pricing to customers with a good credit record and reduce

defaulters, thereby decreasing potential NPAs.30

In 2005, SBI and HDFC divested their equity stake in favour of significant data providers

with representation from all the categories of credit grantors. ICICI Bank, Punjab

National Bank, Bank of India, Central Bank of India, Union Bank of India, Bank of

Baroda, Citibank, HSBC and Sundaram Finance now own shares in CIBIL. Additionally,

international players - TransUnion and Dun & Bradstreet - own a stake and promote

CIBIL. They have provided it with the requisite technological and software support.

Currently, out of 125 credit grantors who have accepted membership to CIBIL, 75

members have started giving data on customers to CIBIL. Another 20 members are

expected to give data soon. Data sharing is based on the principle of reciprocity, which

means that only members who have submitted all their credit data, may access Credit

Information Reports from CIBIL.31

29 http://www.cibil.com/web/overviewin.htm 30 http://www.hdfc.com/17052005.htm 31 George Mathew for Indian Express, July 12, 2006


60

CIBIL had by February 2006 amassed 42 million individual records from various banks

and finance companies. Within the next 8-10 months, the figure is said to touch the 100

million mark. ‘‘The credit score could be in the range of 400-800... where 800 is the best

rating and 400 is the lowest with defaults. Every bank customer is rated in the US. The

system will come to India also,’’ S Santhanakrishnan, chairman of CIBIL said.32

The RBI in its recent ruling (2006) for credit information companies has allowed credit

borrowers to have access to their credit history maintained by these agencies. But this

will come at a price. The customers will have pay a nominal fee of Rs 100 to the

company; the maximum fee being capped at Rs 500 by the apex institution.

In its new set of guidelines, the apex bank has extended the gamut of specified users of

credit information to include the Securities & Exchange Board of India (SEBI) and the

Insurance Regulatory and Development Authority (IRDA), insurance companies and

brokers registered with IRDA and SEBI. This also includes telecom services providers,

rating agencies and trading members registered with a recognized commodity

exchange.33

The system that is developing in the country is very much in line with the incumbent one

in the US. The RBI guidelines seem to have taken inspiration from those existing there.

Some of them include34:

• The credit information company must put in place suitable criteria to ascertain former's

identity.

• It has been necessitated that the company divulging credit information must update

the records at least within 15 days after being requested by an institution or a

specified user.

• In case the specified user gets a report suggesting denial of extending credit to a

prospective borrower, the RBI has asked companies to send the borrower a written

rejection notice within 30 days of the decision.

• The notice will also have to include the reasons for rejection along with a copy of the

said credit information report.

32 George Mathew for Indian Express, July 12, 2006 33 Business Standard, April 6, 2006 34 Business Standard, April 6, 2006


61

• It has asked user institutions denying credit, to provide the borrower the name of the

credit information company issuing the report and any other information used in

making the decision.

The basic Consumer CIR broadly contains35:

• Borrower information

i. Name

ii. Date of birth

iii. Identification numbers; e.g. PAN, Passport No., Voter ID No.

iv. Address

• Account Information

i. Account type

ii. Ownership indicator

iii. Sanctioned amount

iv. Date Opened / Sanctioned

v. Date of last payment

vi. Current balance

vii. Date closed

viii. Amount overdue

ix. Suit-filed status

x. Days past due / Asset classification

35 http://www.cibil.com/web/consumer.htm


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ANALYSIS AND RECOMMENDATIONS Some of the shortcomings of the system we believe are as follows:

• Lack of accurate and appropriate data/information: One of the drawbacks of this

system might be the lack of sufficient information on the factors that will be used to

calculate the scores. Most of the credit information or otherwise personal financial

information is not very accurate (people always try to avoid taxes by showing lower

income or higher expenditures). This is one of the biggest problems facing this

country. There is a dearth of proper maintenance and storage of past historical

data. There is thus a great desire to have proper record keeping facility in India.

The existing databases are mostly obsolete or don’t have enough historical data

(data too recent). To have a good credit scoring system, one needs to back it with

enough data points which should be accurate and well maintained.

• Information Asymmetry: Another shortcoming maybe that credit worthy borrowers

will actively seek the credit rating (who really don’t need it) while the bad borrowers

will actively avoid being rated. Later, once this system evolves and everyone gets

rated, this problem will not persist but at the onset, the creditors may not get

enough information to distinguish between credit worthy and unworthy customers.

• Obsolete Technology: The technology that the TransUnion is set to be providing

CIBIL is based on old mainframes and databases that are slow and difficult to

scale-up. Though the expertise that TransUnion is providing maybe essential but

the technology (hardware as well as software) that they are using back in US is

built with old systems whose maintenance costs are themselves astronomical.

CIBIL needs to build its system with incumbent technology for better networking

and operations. This is not only for its networks with other banks and institutions

but for internal back-end work too.

• Scale-up: The scale of operations in India is likely to grow exponentially and one

organization is not enough to manage the entire database. With lack of information

that is available this may become very difficult. Information sharing between the

banks too has to be managed well without the risk of the information getting in the

wrong hands. The kind of scales we are looking at in the future will be very difficult

unless the technology that is adopted in the initial stages is built for the same.


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• Initial ‘Corporate loans rating’ focus: CIBIL was set-up with corporate loan rating as

its core activity. Consumer credit rating and corporate rating are inherently very

different and thus the existing expertise in terms of resources and manpower may

not be adequate for the individual credit system that they are trying to set-up.

• Time Horizon: The time it takes in India to implement a change or introduce a new

system is very long. It will take atleast another 5-8 years before the credit rating

reports and scoring to become the norm and be accepted as a standard. It will

take a lot of effort and time for this system to reach a status that it enjoys in the

more developed countries.

The following are some of the recommendations on how to further develop the above

system in India.

• Require multiple scores: The concept of FICO gained popularity in the early 80s in

US when Fair Isaac developed the score. In India, for such a system to develop,

we need to have a similar standard in place. Though CIBIL is in the process of

developing such a standard, it is necessary that more than one score standard

should develop as to avoid wrong information being passed due to data

asymmetry. If more than one score is developed, any inconsistency among the

various scores will ensure the mitigation of making mistakes by relying solely on

one score.

• Multiple Credit Bureaus: Presently CIBIL is doing credit scoring but that too is in

the nascent stage. One agency is not enough to serve the entire population. If we

are to develop a system that mitigates the information asymmetry risk, then we

require more than one credit bureau like the way it is structured in the US.

• Autonomy of the Credit Bureaus: RBI should avoid interfering with the system.

There is a need to develop independent agency/regulation to look after the smooth

functioning. The banks themselves can take responsibility for entire thing. For

example, the ownership of CIBIL lies with different scheduled banks and

international credit bureaus. This will increase the efficiency of the agency and the

main stakeholders of the system will be directly responsible for it.

• Regulatory Framework: One of the important pre-requisite is the establishment of

an organization or a ‘watchdog’ agency that keeps a check on the information

sharing between the banks. Alternatively, this can also be achieved through an Act

or through regulations which the RBI has proposed. This is needed to avoid any


64

misuse of information. It is important that the data that is collected is accurate and

there is little scope of tampering it. Also, there should be no bias in the calculation

to favor one sector of society and purposely ignore another.

• Better Market Infrastructure: - if we are to develop the retail credit market in India

with the kind of success that we have achieved in our Equity markets and to some

extent even in our Foreign Exchange markets, we need to place a far better

market infrastructure in place than one available at present. There is a severe lack

of data points available if one is to make any kind of predictive model. In order for

markets like credit cards to develop there is need of extensive information

collection of customer profiles and that infrastructure is not in place. We need an

organization which can do for Retail Credit market what NSE managed to do for

Equity markets in terms of providing consistent and extensive set of data points for

analysis and further market development.

• Development of a Vibrant Secondary Market: In order for this market to take off,

there is need for development of a vibrant secondary market where the investors

can be ensured better liquidity of their invested portfolio and the market forces

ensure the quality of the underlying portfolio. The rated portfolio will ensure faster

development of this market and boost the confidence of the investors to invest in

the secondary market. The banks in order to increase the credit off take should be

able to devolve its incumbent debt from its balance sheet and reduce bad loans

and credit defaults. Securitization will help the banks to transfer risk and issue

more credit to better rated customers (if the CIRs are available).


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ANNEXURE

1. Regression results –

a. Quarterly data of retail credit disbursed in India as the dependent variable

b. Independent variables- Yield on 10 year government paper as a proxy for

interest rates and average Sensex value for each quarter

Regression StatisticsMultiple R 0.9559R Square 0.9137Adjusted R Square 0.9068Standard Error 67.1595Observations 28

ANOVA

df SS MS F Significance FRegression 2 1193215.7 596608 132.274 5.04364E-14Residual 25 112759.9 4510.395Total 27 1305975.6

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept 241.019 69.278 3.479 0.00186081 98.34 383.70Interest Rate -45.539 5.966 -7.633 5.4749E-08 -57.83 -33.25Sensex 0.098 0.008 12.253 4.5826E-12 0.08 0.11


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2. Regression results of retail credit disbursement in US against NASDAQ composite

Regression StatisticsMultiple R 0.590R Square 0.348Adjusted R Square 0.340Standard Error 177857.3Observations 88

ANOVA

df SS MS F Significance FRegression 1 1.4498E+12 1.4498E+12 45.83 1.50192E-09Residual 86 2.72046E+12 31633228714Total 87 4.17025E+12

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept 2.25E+06 58737.376 38.380 6.86E-56 2137552.81 2371084.9NASDAQ -167.50 24.741 -6.770 1.5E-09 -216.68 -118.3


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REFERENCES

1. CRIS INFAC – for monthly reports for last 7 years on Indian Economy, Banking

and Retail Finance space

2. Indian Bank’s Association – for IBA monthly journal providing useful insights

about challenges in front of Indian Banks to succeed in retail space

3. Rating reports published by ICRA, FITCH, CARE and Capital Intelligence

4. http://capitaline.com/ - online corporate database covering more than 10000

Indian companies for ICICI Balance sheets for past 3 years

5. https://cdbmsi.reservebank.org.in - Reserve Bank of India website for data on

Indian Banking Industry and data series of Indian economy

6. http://www.indiastat.com – online database on socio-economic factors and

statistics on Indian Banking Industry

7. http://www.hindu.com, http://www.indianexpress.com – for news articles and

discussions on real estate bubble and opaque nature of housing finance industry

8. http://www.risk.net/public/showPage.html?page=335601 – article on possible

impact of Basel II norms on retail credit

9. http://www.myfico.com/CreditEducation/ - For information on FICO calculation

10. http://www.cibil.com/web/overviewin.htm - website of CIBIL

11. http://www.hdfc.com/17052005.htm

12. http://en.wikipedia.org – For information about credit rating bureaus in US and

FICO

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