TPL case study 1

Industry Background - The Indian Banking Industry

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SMART STRATEGIES WINNING TEAMS | 2014

The Indian Banking Industry

The Reserve Bank of India (RBI) is the central banking and monetary authority in India, and has regulatory and supervisory authority for the Indian financial system. Until 1991, the financial sector in India was heavily regu-lated and commercial banks and long-term lending institutions, the two dominant financial intermediaries, had mutually exclusive roles and objectives and operated in a largely stable environment, with little or no competition. Interest rates were administered, formal and informal parameters governed asset allocation, and strict controls limited entry into and expansion within the financial sector.

Beginning in 1991, the financial sector was progressively liberalized, and new private banks were allowed to com-mence operations. The various financial sector reforms have transformed the operating environment of the banks and long-term lending institutions. In particular, the deregulation of interest rates, emergence of a liberalized domestic capital market, and entry of new private sector banks, along with the broadening of long-term lending institutions’ product portfolios, have progressively intensified the competition between banks and long-term lending institutions.

Today, a number of financial intermediaries, both in the public and private sectors, are part of India’s financial sector. These include:

Commercial banks (public sector, private banks, co-operative and rural banks); Long-term lending institutions; Non-bank finance companies, including housing finance companies; Other specialized financial institutions, and state-level financial institutions; Insurance companies and mutual funds

The Indian banking industry has witnessed a period of consistent growth during the last decade, with banks along with their customers embracing robust systems and processes. Deposits have been growing at a CAGR of 21.2 per cent (in rupee terms) in the period 2006–13; in FY 13 total deposits stood at US$ 1,274.3 billion.

However, industrial slowdown and sticky consumer price inflation created a hostile environment for the country’s banking sector in 2013. The consumer price inflation was in the double digit range during the course of the year. As a result, RBI had to raise benchmark policy rates between May 2013 and January 2014. Although private banks were not much affected, most banks in the public sector felt the heat. The cost of servicing debt went up resulting in an increase in bad loans in the rate sensitive sectors. As a result, the profitability of nationalized players also suffered. The overall outlook for the banking sector is stable, and most banks have a sound financial position.

Rising per capita income, growing urbanization and consistent economic growth is anticipated to drive growth in the banking sector. Analysts anticipate that India’s banking industry will become the fifth largest globally by 2020, and the third largest by 2025. The banking sector itself is moderately consolidated, with the top 10 players accounting for approximately 60 per cent of the total industry. Recently, the RBI has granted two new banking licenses, allowed private ATM networks, approved a new payment gateway called RuPay, and is actively promot-ing the use of electronic transactions to enhance competition in the industry.

Commercial Banks

Commercial banks in India have traditionally focused primarily on meeting the short-term financial needs of industry, trade and agriculture. Scheduled commercial banks are banks that are listed in the schedule to the RBI Act and may further be classified as public sector banks, private sector banks and foreign banks. Scheduled com-mercial banks have a presence throughout India, with approximately 70% of bank branches located in rural or semi-urban areas of the country. A large number of these branches belong to the public sector banks.

Indian Banking Industry of 8


of 8Indian Banking Industry

All Scheduled Commercial Banks (Amount in Rs million)

Items Bank Group-wise Aggregates

2008-09 2009-10 2010-11 2011-12 2012-13

No. of banks 80 81 81 87 89

No. of offices 67,562 72,906 78,215 85,262 92114

No. of employees 954,684 955,990 1,001,096 1,048,520 1,096,984

Business per employee 73.98 86.23 99.03 109.95 121.33

Profit per employee 0.55 0.60 0.70 0.78 0.83

Public Sector Banks

Public sector banks make up the largest category in the Indian banking system. They include the State Bank of India and its seven associate banks, 19 nationalized banks and 196 regional rural banks. The public sector banks’ large network of branches enables them to fund themselves out of low cost deposits. The State Bank of India is the largest public sector bank in India.

Public Sector Banks (Amount in Rs million)


2008-09 2009-10 2010-11 2011-12 2012-13

No. of banks 27 27 26 26 26

No. of offices 57,979 62,080 65,800 70,969 75,779

No. of employees 731,524 739,646 755,102 774,329 80,1659



Regional Rural Banks

Regional rural banks were established from 1976 to 1987 by the central government, state governments and spon-soring commercial banks jointly with a view to develop the rural economy. Regional rural banks provide credit to small farmers, artisans, small entrepreneurs and agricultural laborers.

Private Sector Banks

In July 1993, as part of the banking reform process and as a measure to induce competition in the banking sector, RBI permitted entry by the private sector into the banking system. This resulted in the introduction of nine private sector banks. These banks are collectively known as the “new” private sector banks. There are nine new private sector banks at present. In addition, 20 private sector banks existing prior to July 1993 are currently operating.

Private Sector Banks (Amount in Rs million)


2008-09 2009-10 2010-11 2011-12 2012-13

No. of banks 22 22 21 20 20

No. of offices 92,88 10,516 12,097 13,970 16001

No. of employees 193,578 188,332 217,953 248,284 269941



Foreign banks

As part of the liberalization process, RBI has permitted foreign banks to operate more freely, subject to require-ments largely similar to those imposed on domestic banks. Foreign banks operate in India through branches of their parent banks. The primary activity of most foreign banks in India has been in the corporate segment.



However, in recent years, some of the larger foreign banks have started to make consumer financing a larger part of their portfolios based on the growth opportunities in this area in India. These banks offer products such as automobile, finance, home loans, credit cards and household consumer finance. The government has also announced that foreign banks having branch presence in India will be permitted to acquire up to 74.0% shareholding in private sector banks in India.

Foreign Banks (Amount in Rs million)


2008-09 2009-10 2010-11 2011-12 2012-13

No. of banks 31 32 34 41 43

No. of offices 295 310 318 323 334

No. of employees 29,582 28,012 28,041 25,907 25384



Cooperative Banks

Cooperative banks cater to the financing needs of agriculture, small industry and self-employed businessmen in urban and semi-urban areas of India. The state land development banks and the primary land development banks provide long-term credit for agriculture. Presently, RBI is responsible for supervision and regulation of urban co-operative societies, and the National Bank for Agriculture and Rural Development (NABARD) for State Co-operative Banks and District Central Co-operative Banks.

Long-Term Lending Institutions

The long-term lending institutions were established to provide medium-term and long-term financial assis-tance to various industries for setting up new projects and for the expansion and modernization of existing facilities. These institutions provide fund based and non-fund based assistance to industry in the form of loans underwriting, direct subscription to shares, debentures and guarantees. The primary long-term lending institutions include Industrial Development Bank of India (converted into a banking company from October 2004), Industrial Finance Corporation of India Limited and Industrial Investment Bank of India.

The long-term lending institutions were expected to play a critical role in Indian industrial growth and accord-ingly, had access to concessional Government funding. However, in recent years, the operating environment



of the long-term lending institutions has changed substantially. Although the initial role of these institutions was largely limited to providing a channel for government funding to industry, the reform process required them to expand the scope of their business activities. Their new activities include:

Fee-based activities like investment banking and advisory services; and Short-term lending activity, including issuing corporate finance and working capital loans.

Non-Bank Finance Companies

There are over 13,617 non-bank finance companies in India as of June 30, 2004, mostly in the private sector. All non-bank finance companies are required to register with RBI. The non-bank finance companies may be categorized into entities, which take public deposits and those, which do not. The companies, which accept public deposits, are subject to strict supervision and capital adequacy requirements of RBI.

The scope and activities of non-bank finance companies have grown significantly over the years. The primary activities of the non-bank finance companies are consumer credit including automobile finance, home finance and consumer durable products finance, wholesale finance products such as bill discounting for small and medium-sized companies, and fee-based services such as investment banking and underwriting.

Housing Finance Companies

Housing finance companies form a distinct sub-group of the non-bank finance companies. As a result of the various incentives given by the Government for investing in the housing sector in recent years, the scope of their business has grown substantially. Until recently, Housing Development Finance Corporation Limited was the premier institution providing housing finance in

India. In recent years, several other players including banks have entered the housing finance industry. The National Housing Bank and the Housing and Urban Development Corporation Limited are the two government-controlled financial institutions created to improve the availability of housing finance in India.

Specialized Financial Institutions

In addition to the long-term lending institutions, there are various specialized financial institutions that cater to the specific needs of different sectors. They include the National Bank for Agricultural and Rural Development, Export Import Bank of India, Small Industries Development Bank of India, Risk Capital and Technology Finance Corporation Limited, Tourism Finance Corporation of India Limited, National Housing Bank, Power Finance Corporation Limited and the Infrastructure Development Finance Corporation Limited.

State Level Financial Institutions

State financial corporations were set up to finance and promote small and medium-sized enterprises. The state financial institutions are expected to achieve balanced regional socio-economic growth by generating employment opportunities and widening the ownership base of industry. At the state level, there are also state industrial development corporations, which provide finance primarily to medium-sized and large-sized enterprises.

Changing Banking Environment

The RBI has formulated several policies and initiatives that are directly impacting the country’s banking sector over the last few years. Some of these initiatives are:

Deregulation of savings rates: RBI has deregulated the savings bank deposit interest rates from an earlier norm of 4 per cent per annum to aid product and price innovation. This has resulted in an increase in inter-est rates, and especially on deposits of a high amount due to intense competition. Higher interest rates imply higher costs for banks, and this has an impact on their profitability. On the other hand, costs have risen for large scale borrowers as hikes in interest rates are accompanied with a rise in loan rates.



Provision Coverage Ratio (PCR) of 70 per cent mandatory: The mandatory directive to maintain a PCR of 70 per cent benefits all commercial banks. The current PCR can be used to minimize NPAs during economic downturn.

Basel III guidelines: The RBI has planned the implementation of the Basel III norms, which would require a capital infusion of approximately US$ 60 billion over the next five years. These norms would require the systemically important banks to maintain a higher level of capital. The Governor of the Reserve Bank of India in 2012, commented that Basel III would make Indian banks stronger in the long run, thereby enabling them to invest in the real sectors of the economy.

Relaxation of branch authorization policy for Tier II cities: Domestic banks no longer need RBI approval to set up service offices, central processing centers and administrative offices in the Tier II cities. Further, a similar relaxation to expand into Tier III to Tier VI cities already exists. The policy is expected to spread the organized banking to the remote areas of the country, and aid financial inclusion.

Relaxation of mobile payment guidelines: With the increasing popularity of mobile banking, the RBI removed the cap of Rs. 50,000 for transactions through mobile phones. This relaxation allowed banks to assess the involved risk, and place their own limits while granting customers with mobile banking facilities.

Issue of financial guidelines for new bank licenses: The RBI is now issuing new bank licenses to all enti-ties that satisfy the eligibility criteria. This move is expected to encourage healthy competition and promote financial inclusion in the banking industry.

Subsidiary route for foreign banks: The RBI is encouraging foreign players entering the Indian banking indus-try to conduct business through wholly owned subsidiaries. Further, it is promoting existing important foreign players to incorporate themselves as wholly owned subsidiaries of foreign parent companies. This move is expected to benefit foreign players by allowing them to expand their consumer base to semi urban areas

What’s Next for the Industry?

With a view to moving towards a dynamic banking structure, a recent RBI Discussion Paper has suggested the following basic building blocks for the industry:

Introduction of on-tap licensing to enhance competition, and bring in new ideas and variety into the system. Implementing a domestic systemically important bank framework to deal with negative externalities of

large banks Creating three or four global-sized banks to have a global presence through consolidation among large

public and private sector banks Allowing banks for niche segments to take care of specialized banking needs through differentiated licensing. Encouraging investment banks and investment banking activities. Encouraging inclusion to reach out to the excluded and under-banked regions Enhancing the regulatory and supervisory regimes with increased intensity of supervision for the sys-

temically important banks. Evolving an efficient deposit insurance and resolution mechanism to support the envisaged tiered structure. Converting urban co-operative banks which meet the necessary criteria into commercial banks or local

area banks/small banks. Expanding the size and capacity of banking structure which enhances the ability of the banking system

to cope with multiple demands made on it for credit and varied services by diverse customer base

The RBI Vision Document 2012-15 on Payment and Settlement Systems sets out a road map for ensuring the benefits of a structured modern payment and settlement system, including innovative products, to reach beyond the currently served target groups. The document looks at how to promote electronic modes of pay-ment, and reduce cash usage in the society by:

1. proactively promoting electronic payments,2. increasing efficiency of payments through standardization and capacity building in terms of systems and

human resources and implementing giro payments (automatic bill payments)



3. facilitating migration of government payments and receipts to electronic mode,4. promoting use of pre-paid payment instruments, Electronic Benefit Transfer (EBT), Direct Transfer of

Subsidies (DTS) and e-commerce,5. ensuring compliance with new international standards.

IT and Banking

Indian banks are continuing to transform their businesses by deploying technology-intensive solutions to in-crease revenue, enhance customer experience, optimize cost structure and manage enterprise risk. While these are fairly common themes among banks, there is a wide variation in the technology agendas and implementation capability across different players of the banking industry.

The implementation of core banking platform has automated basic processes, enabled the movement to a single customer view and allowed for optimization of work across branch and hub network. Core banking platform have also given banks a strong launch pad to offer digital channel capabilities — almost all banks today are feverishly building out their online and mobile channel offerings. Several banks have deployed best in class online and mobile banking features including personalization, bank wide customer relationship views and cross channel integration. In September, 2013, ICICI Bank launched its Facebook banking service, Pockets. The service enables customers to transfer funds and pay bills from within the website.

Bank of India (BoI) launched its card-less cash withdrawal facility in March 2014. Under this service, a BOI customer can transfer money to anyone, using the bank’s ATMs or through Internet banking. The sender has to provide the beneficiary’s mobile number, a sender code, and the amount through internet banking or text message. The beneficiary, after receiving a code from the bank can visit any BOI ATM with instant money transfer facility and withdraw the money within a fortnight of the transfer.

ATM deployments and technology-enabled business correspondent (BC) network have allowed banks to service large parts of the Indian hinterland. Responding to Basel norms and a more aggressive supervisory regime, banks have undertaken risk and compliance management system implementations. Many banks have responded by improving risk management processes and upgrading their systems and infrastructure. While these initiatives are fairly standardized across banks as far as the approach is concerned, several banks are still at a very nascent stage from a maturity perspective. The integration of risk management and enterprise-level applications is still at preliminary stages. Just a handful of leading banks have implemented enterprise risk management systems and business intelligence capabilities to assist in risk-based strategic decision making.

Information management and analytics are in focus as banks have built out large data warehouses in an attempt to leverage their data assets to better understand, sell and serve their customers. While private sector banks



embarked on single view of the customer and customer lifecycle management frameworks in 2011–12, the initia-tives of public sector banks were focused on enterprise data warehousing, though some large public banks have started taking steps toward strengthening business intelligence (BI) through single view of the customer.

The impact of these BI initiatives is still a couple of years away, according to Ernst & Young. Banks will have to gain an understanding of customers and put in place metrics such as customer satisfaction and service quality to drive effectiveness of customer management initiatives. The investments made in BI have also been primarily around the consumer/retail segment of customers. Banks are yet to leverage investments in these technologies for corporate customers and functions such as finance, treasury, operations, risk management, compliance, audit and human resources

The BFSI sector is forecast to spend Rs 477 billion on IT products and services in 2014, an increase of 12.7 percent over the previous year according to Gartner. This spending includes internal IT services (includ-ing personnel), third-party IT services, software, data center technologies, devices and telecom services. Spending on internal services (that includes IT personnel) is projected to grow the fastest, largely due to the expansion strategies of banks across the country, especially in rural areas, which require more personnel on the field. “Banks focus on expanding their branch network. There will be about 2,000 new branches in India by the end of this year,” says Vittorio D’Orazio, research director at Gartner. Software is expected to be the second-fastest growing segment, with 19.2 percent growth in 2014. In the software segment, vertical specific software is the fastest sub-segment due to core banking system replacements and other back-office consolidation that will steer banks from internally developed software to external packages. “The modernization of the back-office, and increased challenges from new more demanding customers, as well as the need to be compliant with international regulations will be the main trends,” adds Vittorio.

For additional resources, insight and information on the banking industry in India:1. www.ibef.org/industry/banking-india.aspx2. www.ibef.org/download/Banking-Sector-04jan.pdf3. http://www.rbi.org.in/scripts/AnnualPublications aspx?head=Trend%20and%20Progress%20of%20Ban

ing%20in%20India4. http://www.gjeis.org/index.php/gjeis/article/view/335465. twitdoc.com/upload/ceciho758/indiabankingoutlook.pdf6. http://www.accenture.com/us-en/outlook/Pages/outlook-jounal-2014-digital-disruptors-how-banking-got-

agile.aspx7. http://www.gartner.com/newsroom/id/26717168. ijergs.org/files/documents/The-Role-of-Retail15.pdf9. http://www.ey.com/Publication/vwLUAssets/EY-Banking-on-Technology/$File/EY-Banking-on-Technology.pdf


TPL case study 1

Technology

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