bric spotlight report india banking april 2011
TRANSCRIPT
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Fast Facts
Indias banking industry has evolved over a long period ofmore than two centuries.
Despite the recent growth of private banks, the sector is
dominated by government-controlled banks that hold nearly
three-fourths of total bank assets.
Indias banking industry is considered to be very stable with
healthy balance sheets and low exposure to risky assets. The
global financial crisis did not affect the Indian banks
significantly.
Nearly 40% of the population does not have a bank account and
only 15% have borrowed from banks.
Even after sustained growth since the nineties, the share of
consumer credit remains very low in total bank loans.
The banking sector in India has a relatively high proportion of
women CEOs. The chief executives of leading domestic
lenders ICICI Bank and Axis Bank, besides the country heads
of HSBC, JP Morgan, UBS, and RBS are all women. Until
recently, two among the Reserve Bank of Indias four deputy
governors were also women.
_____________________________________________________________________________
April 2011
In 2008, when the global banking
industry was being shaken by the
tremors of the unfolding financial
crisis, only one bank in India felt
the aftershocks, and this, only
because one of its overseas
subsidiaries had made an
opportunistic bet on debt issued by
the failed investment bank Lehman
Brothers. While the marketvaluations of all the leading banks
in India slipped as equity prices
tumbled, their businesses were not
affected and their balance sheets
remained healthy.
Most domestic commentators
continue to hold up this episode as
BRIC Spotlight
Banking Sector in India: Counting on Credit Growth
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evidence of the inherent strengths of the Indian banking industry and have lauded the Reserve
Bank of India (RBI), the countrys central bank and banking regulator, for sticking with its
conservative approach. When regulators around the world were loosening their grasp over thebanking and financial services industry, RBI steadfastly held on to the strings that prevented
banks in India from making risky investments and following highly aggressive business
practices.
Though some of the countrys younger banks have fast growing asset management and insurance
businesses, the industrys bread and butter is still industrial lending. Asset Backed Securities and
Collateralized Mortgage Obligations are still unheard of in the country, while Indian lenders
warmed up to the idea of teaser rate mortgages only after the global financial crisis. So far, they
do not appear to be any worse for it.
The Indian banking industry is also well capitalized and capital ratios are above the global
average. The average tier-1 capital adequacy ratio of the Indian banking industry is above 10%,
when compared to the Basel III norm of 8.5% including the contingency buffer. The average
total capital of banks in India stood at 14.5% as of March 31, 2010, compared to the Basel III
requirement of 10.5%.
Leading Indian Banks by Assets and Market Capitalization
BankMajority
ShareholdingAsset Size
(in $ Billions)
MarketCapitalization
(in $ Billions)
StockListing
State Bank of India Government 314 36.6Mumbai,London
ICICI Bank Private 81 25.6Mumbai,New York
Punjab National Bank Government 66 7.6Mumbai
Bank of BarodaGovernment
62 7.3Mumbai
Bank of IndiaGovernment
61 5.1Mumbai
Canara BankGovernment
59 5.5Mumbai
IDBI BankGovernment
52 2.9Mumbai
HDFC Bank Private 49 22.2Mumbai
Union Bank of India Government 43 3.7Mumbai
Axis Bank Private 40 11.6Mumbai,London
Market capitalization data based on full capitalization as on March 18, 2011
Bank Assets as on March 31, 2010; Source: Indian Banks Association
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However, it can also be argued that the cautious regulatory controls have stifled the growth of
the banking industry in India. This is the sector with the most entry barriers as the RBI has not
issued new banking licenses for well over a decade. Foreign shareholdings in domestic banks arerestricted and foreign banks have to wait years to get permission to start banking operations or
expand their network. Except for a few cases where the large banks were encouraged by the RBI
to acquire failing banks, the industry has not seen any meaningful consolidation.
As a result, while India continues to move up the ranks of the largest economies in the world,
most Indian banks are significantly smaller than their global counterparts. They are no match to
even banks in other emerging economies like China, and only one bank from India is ranked
among the global top-100 in terms of asset size. Also the cost of financial intermediation is
relatively high in India and banks enjoy wide net interest margins. Access to banking services is
poor across vast areas of the countrys rural hinterlands and as a result, more than 40% of thepopulation does not have bank accounts and only about 15% have received some form of bank
credit. The World Economic Forum currently ranks India 37 th out of 55 countries in financial
development, behind other large emerging economies like China, South Africa, and Brazil.
An industry built over more than two centuries
The origins of the banking industry in India go as far back as the 18th century but many of the
early banks promoted by groups of businessmen to finance their trading activities did not survive
long. Joint-stock banks made their entry during the second half of the 19th century and a few of
them, including Allahabad Bank and Punjab National Bank, have survived to this day. So have
several of the banks promoted by the small kingdoms during the first half of the 20th century,
which later came under the control of the Indian government. Foreign banks, including The
Chartered Bank, which came to the country in 1858, and HSBC, which followed in 1867, were
attracted to the increasing trade between India and Britain in the 19th century.
The early 19th century also saw the emergence of three large banks, Bank of Bengal, Bank of
Bombay, and the Bank of Madras, named after the three major cities that were the regional
administrative bases of the English East India Company, which ruled most of the country during
that period. Collectively called the presidency banks, they dominated the industry as bankers to
the government, and also functioned as the countrys central bank. The Imperial Bank of India
was established during the first half of the 20th century by the merger of the presidency banks,
and gave up its role as the central bank only after the Reserve Bank of India was formed by the
British government in 1935. It was subsequently renamed the State Bank of India after India
became free from British rule in 1947.
Interestingly, one of the earliest banking industry crises in India was triggered by the American
Civil War. As cotton supplies to Britain from the U.S. fell sharply after the war started in 1861,
demand for raw cotton exports from India surged. To exploit this opportunity better, some cotton
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owned. They remained so forcontrol of more than a dozen
banking industry came under
continued in 1980. The indust
when the government decided
Though the entry and growth
Indian banking industry, the g
command nearly three-fourth
the branch network.
However, the new private ban
utilizing technology to integr
been more aggressive in expl
Some of the largest private ba
asset management. Their stro
the leading private banks attra
balance sheet size.
Banking regulation remains
As in most countries, the centthe Reserve Bank of India is
government still drives the br
for foreign investments in the
While the Indian government
over the last two decades, it h
Accordingly, the aggregate fo
49% to 74% only in 2004, but
Private
Sector Banks
19%
Foreign
Banks
7%
Government-ControllePercentage Share o
traders set up b
export trade. H
ended in 1865 aU.S. resumed, d
cotton also reve
levels. Traders
inventories and
financed them
At the time of I
almost all majo
State Bank of In
the next two decades until 1969, when the fef the largest banks in the country. More than
government control after the forced acquisiti
ry remained closed to private promoters until
to issue new banking licenses as part of eco
of new private banks over the last two decad
overnment-controlled banks still dominate.
of the total banking industry assets and an e
ks have been far ahead of the government-co
te their network and offer more efficient ser
iting the business opportunities in the financ
nks in India are now also among the top play
g presence in the fast growing financial serv
ct far higher equity market valuations, despit
cautious
ral bank is entrusted with the role of bankingidely acknowledged as an efficient, but caut
ader policy framework for the industry, incl
sector.
has opened up most sectors of the economy t
as been more guarded about banking and fin
reign investment limit in domestic private ba
it remains at a low 20% in banks where the
Govt-
Controlled
Banks
74%
Banks DominateTotal Assets
4
nks to finance their
wever, as the war
nd exports from theemand for Indian
rted to the earlier
ho had large
the banks that
ent bankrupt.
dias independence,
banks except the
dia were privately
deral government tooknine-tenths of the
n of private banks
the early nineties,
omic liberalization.
s has transformed the
ogether they
ven bigger share of
ntrolled banks in
ices. They have also
ial services space.
ers in insurance and
ices sector has helped
e their relatively small
regulator in India andious regulator. The
ding setting the limits
o foreign investors
ncial services.
nks increased from
overnment is the
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major shareholder. The limit covers all investments by foreigners, including portfolio
investments.
In addition, the RBI has other restrictions that are aimed at ensuring wider distribution of bank
shareholding. Investments exceeding 5% of a banks equity capital by a foreign investor require
RBI approval, and a single foreign investor cannot hold more than 10%. These restrictions have
also been progressively applied to the domestic shareholders of the smaller private banks, but
some of the larger and healthier banks have been given specific exemptions. Further, no bank
can hold more than 5% of the shares of another bank, except when a bank on the verge of failure
is acquired.
The limits on foreign investment do not apply to foreign banks starting a subsidiary or branch
network, wholly-owned by the promoting bank. Like regulators in some other countries, in
granting new banking licenses, the RBI often favors applicants from countries that have
favorable policies for Indian banks seeking to open overseas branches or expand existing ones.
As a result, it may take several years for a new foreign aspirant to get a license. More than a
dozen applications from foreign banks for banking licenses now await RBI approval, including
well-known names like Goldman Sachs. The RBI has also been careful when allowing new
branches for existing foreign banks, but the number of branches approved has always exceeded
Indias WTO commitment of a dozen new branches a year.
Whats more, the RBI also has policies to direct bank credit to sectors that are deemed socially or
economically important by the government. Accordingly, all domestic banks are required to lend
at least 40% of their total net credit outstanding to exporters, farmers, small businessmen, and
low-income borrowers. For foreign banks, the requirement is lower at 32% of net credit. Limited
deposit insurance is available to customers of all banks, including foreign banks.
Though it influences the credit policies of the banking industry through specific lending
requirements, the Indian government generally has less sway over banks when compared to
select other emerging economies like China. By and large, banks in India do not boost or curtail
credit flows at the governments bidding. Though the government occasionally encourages the
banks to increase credit availability, as it did during the global financial crisis, even the
government-controlled banks are not forced to comply. This apparent autonomy, though limited
in many ways, has allowed most Indian banks to follow prudent credit standards and prevent
excessive bad loan losses. However, there have also been cases of banks being pushed to the
verge of failure by corruption and political manipulation.
Some of the leading banks have also occasionally disagreed with regulatory policies and
guidance, though the senior officers of all government-controlled banks are appointed by the
government with the consent of the RBI. For instance, the State Bank of India recently refused to
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withdraw its teaser rate mortg
dislike for such loans.
Industry structure evolving
The business composition of
decades, but the rate of chang
including construction, consti
This ratio has now come dow
consumer loans, which doubl
borrowers, the banks have the
generation projects that have
Though the growth in consu
semi-urban and even rural are
account for more than half of
increased substantially since t
Personal
Lending
19%
Farm
Sector and
Others
13%
Industrial Lending is thePercentage Share of
Personal
Loans
16%
Credit Card
Outstanding
3%
Other Loans
29%
Mortgages Form Bulk
ages from the market though the RBI repeate
at a measured pace
anks in India has seen significant changes o
has been more measured. Lending to indust
uted well over half of total bank credit durin
to 44% in 2010 and most of the decline has
d in share to nearly 20% during the same pe
most credit exposure to utilities. This reflect
ommenced construction in recent years.
er credit has been most evident in urban are
as are seeing excellent growth in this segmen
all consumer loans, as housing demand and h
he nineties. Also, rising consumer aspiration
credit demand for
automobiles and
Indian consumers
when it comes to
which has a shareconsumer loans. I
credit card outsta
recent years, thou
consumer spendin
grow.
Industry
44%
Services
24%
Biggest Segmentoan Assets
Utilities
28%
Steel
19%
Most Credit ExpoPercentage among In
Home
Mortgages
52%
f Personal Lending
6
dly expressed its
er the last two
rial borrowers,
g the mid-nineties.
been absorbed by
iod. Among industrial
s the number of power
s, in recent years
t. Home mortgages
ome prices have
are driving increased
purchasing
urables. However,
are more cautious
credit card debt,
of only 3% of allnterestingly, total
ding has declined in
gh aggregate
g has continued to
Textiles
18%
Chemicals
13%
Energy
11%
Road
Constructi
on
11%
ure to Utilitiesustrial Borrowers
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Government-Controlled Banks: As mentioned earlier, despite the rapid growth of the private
banks, the government-controlled banks continue to hold the dominant share in industry assets
and branch network. Except for some of the largest banks which have branches in most areas ofthe country, most of them have their business concentrated in a state or region. As they have
been around for a while and their brands are well-recognized, these banks are often among the
popular choices for both depositors and borrowers. The financial backing from the government
adds to their allure to depositors, and the government has consistently bailed out the failing
banks it controls, through capital infusions. Over the last couple of years, helped by a $3 billion
World Bank loan, the government has provided additional capital to several of the smaller banks.
At the same time, the government has steadfastly held on to its policy of retaining majority
shareholding in all banks under its control. This may restrict the capital raising options for some
of the banks, as the government shareholding is already close to the threshold. For instance, atthe State Bank of India, which may require the most capital as it is the largest, the government
holding is already down to 59%. Hence, the government may have to deploy additional capital if
it wants to retain majority holding of 51% or above. Without the support of institutions like the
World Bank, fiscal constraints may prevent the government from providing sufficient capital to
retain its majority shareholding.
The government-controlled banks also have pension liabilities, which are not fully recognized on
their balance sheets. These liabilities arose from a settlement with older employees who wanted
to revert to a defined benefit program, which some of them had opted out several years back in
favor of a defined contribution plan. The aggregate liabilities for all banks are currentlyestimated to be below $3 billion and banks are expected to recognize their additional liabilities
over a period of several years. New bank employees are not offered defined benefit pension
plans and hence these liabilities are not expected to accumulate in the future.
Foreign Banks are Ahead in Most Profitability and Return Ratios
Cost of Funds%
Net InterestMargin %
Return on TotalAssets %
Total CapitalAdequacy %
Government-controlled Banks
5.3 3.8 1.0 13.3
Private Banks4.8 5.1 1.3 17.5
Foreign Banks2.8 7.2 1.3 17.3
Data as on March 31, 2010; Source: Reserve Bank of India
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Private Banks: Apart from the new banks that started in the nineties, this group also includes the
older private banks, which escaped nationalization in 1969 and 1980. In performance parameters
and business style, these subgroups are distinct from each other. The new private banks haveaggressive business strategies and generate a relatively higher percentage of their total income
from fee-based services. They have also utilized technology better and some of them have
extensive financial services businesses. The older private banks, on the other hand, are more
comparable to the government-controlled banks, but they are much smaller in size.
The largest private banks have enjoyed higher equity market valuations because of their presence
in financial services, besides the perception that they are better placed to exploit the future
opportunities in the banking sector. Unlike the government-controlled banks, the private banks
have no restrictions on raising additional capital, other than the governments foreign investment
limits. They also have leaner organizations and a younger workforce, factors that are considereda distinct competitive advantage.
Foreign Banks: Though foreign banks have a long history in India, they have remained only a
small part of the banking industry. Among them, they had only 310 branches as of last year and
almost all of them are concentrated in major cities. Most foreign banks focus on business
banking in India, servicing the domestic operations of their global clients. But the aggressive
overseas expansion by some of the large Indian businesses has opened up more opportunities for
these lenders in recent years. Foreign banks derive more than a quarter of their total revenues
from fee-based services, a far higher ratio than the domestic banks. Only a handful of the foreign
banks have made serious efforts to expand their retail business.
All foreign banks in India now operate as fully-owned branches of their parents, though the RBI
has encouraged them to open domestic subsidiaries. The foreign banks have not opted for the
subsidiary model as there is some skepticism about the future policy requirements. The
Committee on Financial Sector Assessment, appointed by the RBI, recently opined that the 74%
Foreign Banks also have more Fee Income, but have Higher Employee Costs and Bad Loans
Other Income% of Total
Income
Employee Costsas % of Total
CostBad Loans
% of Net AssetsNumber ofBranches
Government-controlled Banks13.6 14.8 1.1 61,301
Private Banks
19.6 12.8 1.0 10,387
Foreign Banks27.4 23.5 1.8 310
Data as on March 31, 2010; Source: Reserve Bank of India
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foreign investment limit should be made applicable to subsidiaries of foreign banks as well. If
imposed, this limit, which currently applies to only domestic private banks, will force foreign
banks to seek domestic equity partners in their subsidiaries. The committee, however, favorslisting the foreign bank subsidiaries on the domestic stock exchanges. Interestingly, depository
receipts of Standard Chartered, which is one of the largest and oldest foreign banks in India, are
listed on the domestic exchanges.
Consolidation moves stifled by employee and political opposition
Over the past several years, the Indian government and the RBI have tried to encourage some of
the government-controlled banks to gain size through mergers. Though the bank managements
have favored the idea, the bank employee unions and some political parties have vehemently
opposed it. While the resistance is mostly because of their economic ideologies, regional factors
have also played a part. Several of these banks have a strong presence in select states and the
respective state governments view the banks as important institutions, which are crucial for the
regional economy. Naturally, the state governments are wary of mergers, which may dilute the
regional focus of the banks.
These political and regional undercurrents have also prevented the consolidation within the State
Bank Group. The State Bank of India has several regional subsidiaries, which were promoted by
the former kingdoms, but were subsequently taken over by the federal government. Though all of
them are under the State Bank umbrella, each of these subsidiaries is very closely identified with
their respective states or regions. The group has been trying for the last several years to merge all
the subsidiaries with the parent, but progress has been very slow. Five more subsidiaries, of
which three are listed on the domestic exchanges, await consolidation.
Largest Foreign Banks in India Asset Size and Branches
Assetsin $ Billions
Number ofEmployees
Number ofBranches
Citibank 21 4,613 43
Standard Chartered 20 7,903 95
HSBC 206,685 50
Deutsche Bank 61,498 13
RBS 52,716 31
Barclays 51,083 7
Data as on March 31, 2010; Source: Reserve Bank of India
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Consumer credit to drive fu
Like in most other emerging
despite the recent growth. A
takes away most of the p
incomes of the lower i
groups. This leaves very
earnings surplus available fo
servicing and reduces
creditworthiness, and banks
hesitant to lend to them. Hen
marketing efforts by ban
promote consumer finance prand services are now mostly l
to cities and towns where the
larger concentration of
income customers.
However, as average income
customers with sufficient ear
likely to be measured and the
consumer credit will become
made more attractive by Indiare likely to see faster income
more receptive towards new f
Even in business banking, In
of total business credit to GD
reflects the substantially larg
requirement if Indian industr
in India, while exchange risks
borrowers. Hence, it is likely
to be financed by banks.
However, it is also widely a
achieve its potential without
competition, financial interm
widely across the vast rural ar
it is believed that domestic
reports and policy statemen
references to these issues, it
ure growth in banking
economies, the share of consumer credit rem
verage income levels are still very low and
rsonal
ncome
little
r debt
their
ill be
e, the
ks to
oductsimited
re is a
higher
levels are expected to rise further, the nu
ings surplus will also grow. Though the gro
potential loan size will remain small, the ag
larger because of the large population siz
as demographic advantage of a relativelygrowth. Besides, younger customers are gen
inancial products and services.
ia may continue to offer attractive growth o
in India is less than half the level in China.
er industrial sector in China, it also indicat
sustains its growth. Bond markets remain g
reduce the attractiveness of international bo
that most of the increased industrial credit
ccepted that the Indian banking industry
further regulatory initiatives. It is evident
diation costs will remain high and banking s
eas of the country. Also, to improve efficien
anks in India need to build scale through
s by the Indian government and the RBI
is hoped that entry barriers will come down
13
10
10
12
67
96
101
30
40
42
96
96
78
- 50 100 1
Brazil
Russia
India
China
Japan
US
UK
Ratio of Household Debt to GDP
Househol
10
ains very low in India,
subsistence spending
ber of potential bank
th of income levels is
regate market size for
. This market will be
oung population, whoerally considered to be
pportunities. The ratio
While this gap mostly
es the potential credit
rossly underdeveloped
d markets to domestic
equirements will have
ay find it difficult to
that without increased
ervices will not spread
cy and compete better,
onsolidation. As past
have made repeated
in the banking sector
114
50 200 250
till Very Low in India
Business
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and restrictive policies will b
will be further liberalized, w
players and foreign banks.
The government and the RB
banking licenses to domestic
wider shareholding distributi
have large public shareholdi
attractiveness of the Indian b
including some of the most pr
The banking sector is one of
role in promoting economic g
of banking services to rural
ensuring sustainable income
have a mature banking indu
economy.
-60%
-20%
20%
60%
100%
140%
Jun -07 Dec-07
Banks ha
diluted. It is expected that the shareholding
ile new banking licenses will be made avai
I have already announced a new policy fr
applicants. While the RBI is expected to mai
n in banks, corporations with good reputatio
gs, may also be allowed to promote new
anking sector, it has been reported that nea
ominent business groups, are eager to acquir
he most crucial sectors in any economy, and
rowth. In India, the sector is even more imp
areas may also play a significant role in
evels. If favorable regulatory support is en
stry with sufficient scale and reach to su
Jun-08 Dec-08 Jun-09 Dec-09 Jun-
ve Outperformed the Broader Market
S&P CN
Bank Nif
11
and investment norms
lable to both domestic
mework to issue new
ntain its preference for
n and track record that
anks. Confirming the
ly a dozen applicants,
licenses.
plays an instrumental
rtant as the expansion
reducing poverty and
ured, India will likely
port its fast growing
10 Dec-10
ince 2009
Nifty 50 Index
ty Index
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