Banking

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[Key Points | Financial Year '10 | Prospects | Sector Do's and Dont's] y Influenced by the global financial turmoil and repercussion of the subprime crisis, the global banking sector has been witness to some of the largest and best known names succumb to multi-billion dollar write-offs and face near bankruptcy. However, the Indian banking sector has been well shielded by the central bank and has managed to sail through most of the crisis with relative ease. Further with the economic buoyancy the world over showing signs of cooling off, the investment cycle has also been wavering. Having said that, the latent demand for credit (both from the food and non food segments) and structural reforms have paved the way for a change in the dynamics of the sector itself. Besides gearing up for the compliance with Basel II accord, the sector is also looking forward to consolidation and investments on the FDI front.

y Public sector banks have been very proactive in their restructuring initiatives be it
in technology implementation or pruning their loss assets. While the likes of SBI have made already attempts towards consolidation, others are keen to take off in that direction. Incremental provisioning made for asset slippages have safeguarded the banks from witnessing a sudden impact on their bottomlines.

y Retail lending (especially mortgage financing) that formed a significant portion of

the portfolio for most banks in the last two years lost some weightage on the banks' portfolios due to their risk weightage. However, on the liabilities side, with better penetration in the semi urban and rural areas the banks garnered a higher proportion of low cost deposits thereby economising on the cost of funds.

y Apart from streamlining their processes through technology initiatives such as

ATMs, telephone banking, online banking and web based products, banks also resorted to cross selling of financial products such as credit cards, mutual funds and insurance policies to augment their fee based income. Key Points Supply Liquidity is controlled by the Reserve Bank of India (RBI). Demand India is a growing economy and demand for credit is high though it could be cyclical. Licensing requirement, investment in technology and branch network.

Barriers to entry

Bargaining power High during periods of tight liquidity. Trade unions in public of suppliers sector banks can be anti reforms. Depositors may invest elsewhere if interest rates fall. Bargaining power For good creditworthy borrowers bargaining power is high of customers due to the availability of large number of banks Competition High- There are public sector banks, private sector and foreign banks along with non banking finance companies competing in similar business segments.

TOP Financial Year '10

y After a difficult FY09 Indian banks managed to grow their balance sheets in FY10
albeit at a lower average rate than that projected by the RBI. The monetary stimuli (reduction in repo rate, cash reserve ratio (CRR) and statutory liquidity ratio (SLR) offered to the banks by the RBI early in the fiscal made it easier to sustain margins But what really helped was the accretion of low cost deposits (CASA). Indian banks grew their advances and deposits by 16.9% YoY and 17.2% YoY respectively in FY10. The growth was mainly driven by a expansion in low cost deposits and growth in agricultural and large corporate credit. Having said that, higher delinquency levels in retail credit and debt restructuring took its toll on the sector.

Data source: RBI

y With lesser avenues of credit disbursal, banks had to park most of the liquidity

available with them with the RBI. In the retail portfolio, while home loans grew by 11% YoY, personal loans enjoyed a much smaller growth of 6% YoY due to bank's reluctance towards uncollateralized credit. Credit card outstanding in fact dropped by 27% YoY.

y Indian banks, however, enjoyed higher levels of money supply, credit and
deposits as a percentage of GDP in FY10 as compared to that in FY09 showing improved maturity in the financial sector.

Data source: RBI

y Despite poor pricing power lower cost of funds helped Indian banks grow their
net interest margins in FY10. While few like ICICI Bank chose to reduce their balance sheet size, most entities chose to reasonably grow their franchise as well as assets. Public sector banks outdid their private sector counterparts in terms of growth and franchise expansion in the last fiscal. Improved capital adequacy also helped banks to comfortably comply with Basel II. The higher efficiency levels were the hallmarks of better performance of Indian banks last year.

y Most banks had to restructure some loans in their portfolio during FY10 which

deferred their interest income. Further the PSU banks had also to provide for the loss of interest on the agri-loans waived by the government.

y In FY10, as per the RBI mandate, all commercial banks in India as well as

foreign banks operating in India migrated to the Basel II norms for capital adequacy. While some PSU banks are falling short of capital due to the same, they may witness some capital infusion from the government in FY11. TOP

Prospects y With banks having complied with Basel II and having sufficient capital in their books; it will be a challenge to deploy the same safely and profitably in the event of persistence of economic slowdown. Banks are likely to concentrate more on non funded income in this scenario.

y Banks, especially the private sector ones, are likely to face penetration concerns.
The lack of credit penetration and the geographic concentration of bank credit is evident from the fact that 5 states having the highest proportion of per capita credit enjoy 55% of the total credit disbursals in the country.

y RBI's roadmap for the entry of foreign banks and the acquisition of stake by the

foreign entities in Indian private banks has been deferred for the time being. However, the tussle for higher market share in the already fragmented sector is only set to aggravate.

y The proposal for Cabinet's approval to allow PSU banks to bring down the

government's stake in them below the stipulated 51%, which is yet to be tabled, can help the bank raise substantial capital without borrowing at high rates and give the entities an opportunity to enhance their capital adequacy ratios besides competing with their private sector peers.

Indian Banking sector a simple analysis

By Amol Agrawal

I have made a mention of this report from RBI in my previous posts. I have commented some important findings from the report covering Financial Market Integration, G-Sec Markets and Equity and Corporate Debt Markets. This post covers the Banking structure in the country and credit markets. The first question which often comes to mind is what are the different kinds of banks in India? The report says: There are wide range of financial institutions exist in the country to provide credit to various sectors of the economy. These include commercial banks, regional rural banks (RRBs), cooperatives [comprising urban cooperative banks (UCBs), State co-operative banks (STCBs), district central co-operative banks (DCCBs), primary agricultural credit societies (PACS), state co-operative and agricultural rural development banks (SCARDBs) and primary co-operative and agricultural rural development banks (PCARDBs)], financial institutions (FI) (term-lending institutions, both at the Centre and State level, and refinance institutions) and non-banking financial companies (NBFCs) Thankfully, the report gives a very good picture of Indias Credit System here :-) And it also explains each institutions role as well. How large is the credit market in India? Almost 54% of GDP and is increasing. Indian society is getting friendlier to credit. Total Outstanding Credit by all Credit Institutions 1991 1995 2000 2001 2002 2003 2004 2005 1,94,654 3,47,125 7,25,074 7,94,125 8,93,384 10,77,409 11,99,607 14,81,587 22.7 17.1 9.5 12.5 20.6 11.3 23.5 34.2 34.3 37.1 37.8 39.2 43.8 43.4 47.4

2006 1991 to 2000 2000 to 2006

19,28,336

30.2 15.7 17.7

54.1

Compound Annual Growth Rate (Per cent)

How much Credit do each of the instituions give? Commercial Banks clearly have a major sharte in the credit system. Distribution of Credit Category-wise Share (Per cent) 1991 1. 2. 3. 4. 5. 6. 7. 8. 9. Commercial Banks RRBs (and LABs) All-India Financial Institutions Urban Co-operative Banks State Co-operative Banks District Central Cooperative Banks 59.7 1.8 24.9 4.1 3.4 6.0 2006 78.2 2.1 5.8 3.6 2.1 4.2 2.5 0.9 0.7 100.0 Whom do Commercial banks give most of the credit to? The preference has moved from Industry to Services sector. Within services, the credit is being increasingly given as Housing Loans. Table 4.5: Distribution of Outstanding Credit of Scheduled Commercial Banks (Per cent to total credit) Sector M M M M M M M M ar- ar- ar- ar- ar- ar- ar- ar90 95 00 01 02 03 04 05 Agricu 15 11 9. 9. 9. 10 10 10 lture .9 .8 9 6 8 .0 .9 .8 Industr 48 45 46 43 41 41 38 38 y .7 .6 .5 .9 .4 .0 .0 .8 Transp 3. 1. 1. 1. 1. 1. 1. 1. ort 2 9 8 6 4 2 3 2 Person 9. 11 14 15 16 19 25 27 al 4 .3 .4 .8 .8 .6 .3 .0

Primary Agricultural Credit 3.3 Societies SCARDBs PCARDBs 0.7 1.0 100.0

All Institutions

Loans and Profes sional Servic es of which: Loans 0. 0. 0. 0. 0. 0. 0. 0. for 4 3 6 6 5 4 5 6 Purcha se of Consu mer Durabl es Loans 2. 2. 4. 4. 5. 6. 9. 11 for 4 8 0 7 0 5 7 .0 Housin g Trade 13 17 15 16 15 13 11 11 .9 .1 .6 .6 .4 .8 .5 .2

Financ 2. 3. 4. 4. 5. 6. 6. 6. ial 1 8 8 9 7 7 7 4 Institut ions Miscel 6. 8. 7. 7. 9. 7. 6. 4. laneou 8 5 1 5 5 7 2 6 s / All Others Total 10 10 10 10 10 10 10 10 0. 0. 0. 0. 0. 0. 0. 0. 0 0 0 0 0 0 0 0

What is the tenure of credit by Commercial Banks. As economies and financial systems mature one would expect to see movement in favor of long-term credit. Thankfully, we see it in case of India. Type of Credit to Industry By Banks (% of total) Short-Term Loans 1995 82.5 2000 74.3 Medium term 5.8 6.8 Long Term 11.6 18.9

2005 52.4

10.6

37.0

I dont want to praise the report more. One of the best on Indias Financial System and markets.

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