Article Excerpt

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A PROFILE OF INDIA'S BANKING INDUSTRY 

PREPARED BY ASIA PULSE ANALYSTS (APRIL 2007) 

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OVERVIEW: 

India has a strong and vibrant banking sector comprising state-owned banks, private sector banks, foreign banks,
financial institutions and regional banks including cooperative banks, rural banks and local area banks. In addition
there are non-banking financial companies (NBFCs), housing finance companies, Nidhi companies and chit fund
companies which play the role of financial intermediaries. 

Since the launch of the economic liberalisation and global programme in 1991, India has considerably relaxed
banking regulations and opened the financial sector for foreign investment. India is also committed to further open the
banking sector for foreign investment in pursuance to its commitment to the World Trade Organisation (WTO). 

As monetary authority of the country, the Reserve Bank of India (RBI) regulates the banking industry and lays down
guidelines for day-to-day functioning of banks within the overall framework of the Banking Regulation Act, 1949,
Foreign Exchange Management Act, 1999 and Foreign Direct Investment (FDI) policy of the government.. 

State-owned banks 

The Indian banking sector is dominated by 28 state-owned banks which operate through a network of about 50,000
branches and 13,000 ATMs. The State Bank of India (SBI) in the largest bank in the country and along with its seven
associate banks has an asset base of about Rs. 7,000 billion (approximately US$150 billion). The other large public
sector banks are Punjab National Bank, Canara Bank, Bank of Baroda, Bank of India and IDBI Bank. 

The public sector banks have overseas operations with Bank of Baroda topping the list with 51 branches,
subsidiaries, joint ventures and representative offices outside India, followed by SBI (45 overseas branches/offices)
and Bank of India (26 overseas branches/offices). Indian banks, including private sector banks, have 171
branches/offices abroad. 

SBI is present in 29 countries followed by Bank of Barod (20 countries) and Bank of India (14 countries). 

Private sector banks India has 29 private sector banks including nine new banks which were granted licences after
the government liberalised the banking sector. Some of the well known private sector banks are ICICI Bank, HDFC
Bank and IndusInd Bank. Yes Bank is the latest entrant to the private sector banking industry. 

In terms of reach the private sector banks with an asset of over Rs 5,700 billion (about US$124 billion) operate
through a network of 6,500 branches and over 7,500 ATMs. 

Foreign banks As many as 29 foreign banks originating from 19 countries are operating in India through a network of
258 branches and about 900 ATMs. With total assets of more than Rs 2,000 billion ( about 44 billion US dollars) they
are present in 40 centres across 19 Indian states and Union Territories. Some of the leading international banks that
are doing brisk business in India include Standard Chartered Bank, HSBC Bank, Citibank N.A. and ABN-AMRO
Bank. In addition, 31 foreign banks (as on September 15, 2006) belonging to 14 countries were operating in India
through their representative offices. 

Freign banks operating in India: 

1. ABN-AMRO Bank N.V. (24 branches) 

2. Abu Bhabi Commercial Bank Ltd. (2 branches) 

3. Arab Bangladesh Bank Ltd. (1 branch) 

4. American Express Bank (7 branches) 

5. Antwerp Diamond Bank N.V. (1 branch) 

6. Bank International Indonesia (1 branch) 

7. Bank of America (5 branches) 

8. Bank of Bahrain & Kuwait (2 branches) 

9. Bank of Nova Scotia (5 branches) 

10. Bank of Tokyo-Mitsubhai UFJ Ltd. (3 branches) 

11. BNP Paribas (8 branches) 

12. Bank of Ceylon (1 branch) 

13. Barclays Bank Plc. (1 branch) 

14. Calyon Bank (5 branches) 

15. Citi Bank N.A. (39 branches) 

16. Shinhan Bank (1 branch) 

17. Chinatrust Commercial Bank (1 branch) 

18. Deutsche Bank (8 branches) 

19. DBS Bank ( 2 branches) 

20. HSBC Ltd. (45 branches) 

21. JP Morgan Chase Bank N.A. (1 branch) 

22. Krung Thai Bank Public Co. Ltd. (1 branch) 

23. Mizuho Corporate Bank Ltd. (2 branches) 

24. Mashreq Bank PSC (2 branches) 

25. Oman International Bank SAOG (2 branches) 

26. Standard Chartered Bank (81 branches) 

27. Sonali Bank (2 branches) 

28. Societe Generale (2 branches) 

29. State Bank of Mauritius (3 branches) The Netherlands-based ING Group has taken over the management of the
Indian private sector Vysya Bank Ltd. in October 2002 and is operating as ING Vysya Bank Ltd.

Regional banks 

Rural areas in India are served through a network of Regional Rural Banks (RRBs), urban cooperative banks, rural
cooperative credit institutions and local area banks. Many of these banks are not doing well financially and the
government is currently engaged in restructuring and consolidating them. Local area banks were of recent origin and
as on March 31, 2006 four such banks were operating in the country. 

Financial institutions India has seven major state-owned financial institutions which include Industrial Development
Bank of India (IDBI), Industrial and Financial Corporation of India (IFCI), Tourism Finance Corporation of India (TFCI),
Exim Bank, Small Industries Development Bank of India (SIDBI), National Bank for Agriculture and Rural
Development (NABARD) and National Housing Bank (NHB). These institutions provide term loans and arrange
refinance. There are also specialised institutions like the Power Finance Corporation (PFC), Indian Railway Finance
Corporation (IRFC), Infrastructure Development Finance Company (IDFC) and state-level financial corporations.
Non-banking financial companies 

India also has a vibrant NBFC sector comprising 13,000 NBFCs that are registered with the RBI and fund activities
like equipment leasing, hire purchase etc. Out of the total about 450 NBFCs are allowed by the RBI to collect funds
from the public. Large NBFCs have an asset base of about Rs 3,000 billion (about 65 billion US dollars). 

Recent developments: 

State Bank of India has acquired 76 per cent stake in Giro Commercial Bank, a Kenyan bank for US$7 million. 

Bank of Baroda is planning to acquire a bank in Africa to consolidate its presence in the continent. 

Canara Bank is helping Chinese banks recover their huge non-performing assets (NPA). 

ICICI bank is in the process of taking over Sangli Bank, a private sector bank based in Maharashtra. 

The RBI has recently allowed the Commonwealth Bank of Australia, Banche Popolari unite S.c.r.l. (based in Italy),
Vneshtorgbank (Russian trade bank), Promsvyazbank (Russian commercial bank), Banca Popolare di Vicenza
(Italian bank), Monte Dei Paschi Di Siena (Italian bank) and Zurcher Kantonalbank (Swiss bank) to set up
representative offices in India. 

GOVERNMENT REGULATIONS: 

Although the banking companies are registered under the Companies Act, 1956 they are regulated by the RBI which
grants licence to companies for operating a bank, opening branches and off site ATMs, fixes statutory liquidity ratio
(SLR) and cash reserve ratio (CRR), and lays down other conditions for day-to-day operations. The RBI permission is
also needed for board level appointments in banks. 

With regard to interest rates, individual banks are free to fix rates with the exception of savings bank rate which is
decided by the RBI. The individual banks are free to fix lending rates...

The Indian banking industry has been on the path of reformation and recovery ever since the process
of liberalization had begun. While the earlier highly regulated, or rather, restricted system had
hampered down heavily on the sector as a whole, the liberalization process led to a total makeover of
the entire sector, making it more customer and industry friendly. One of the major policies that
liberalization brought in was the removal of entry barriers to the banking sector, thus ushering in a
number of foreign and private banks. Thus, thanks to liberalization, the Indian banking sector became
a true monopolistic competition.

This resource focuses on three major key ideas, attempting to integrate it with the monopolistically
competitive market structure of the banking sector. The three ideas in question are:

1. The Structure Conduct Performance Paradigm

2. The Role of the RBI in the Banking Sector

While the two topics seem to be unrelated, the resource shall try to find a connecting thread linking
each of the three ideas with the market structure of the Indian banking industry.

The Structure Conduct Performance Paradigm

The Structure Conduct Performance Paradigm (referred to as the SCPP hereafter) is a key school of
thought that tries to explain the performance of firms through the existing market structure. In a
nutshell, the SCPP argues that the market structure of a sector or market influences the conduct of
the firm. This in turn, influences the performance of the firm. In short, there is a linear unidirectional
relation between the market structure and the performance of the firm. This relatively simple model
has been criticized and has been replaced with a different school of thought called the New Empirical
Industrial Organization. I shall try to look at the Indian banking industry through the SCPP and try to
find whether this paradigm can be seen in tandem with the industry.

The market structure influences the organizational structure of the firm and also influences several
other major decisions that a firm has to take, including pricing and production decisions. But the
market structure as a whole defines two major features of the market:

1) The number of buyers and sellers in the market

2) Barriers to entry and exit. 

One need only try to look at the implications of the same in relation to the Indian banking industry to
find out that this holds true. The current market structure in the Indian banking industry falls under
the monopolistic competition type. This implies that there are numerous firms in the industry, each
selling similar or the same products, but presented to the consumers as entirely different products.
Post liberalization, the numbers of banks in the Indian context have increased rapidly. Governmental
barriers to the same have been removed, and the market itself has imposed minor barriers. 

The SCPP next describes the role of the conduct of the firm in its performance. Since there’s a linear
relation between the market structure and the conduct of the firms in the industry, it is relatively easy
to view the conduct of the various banks in the Indian sector with relation to the monopolistic
competitive market. The most visible aspects of the conduct of the firm in relation to the paradigm are
setting the price and production parameters. In the case of the banking sector, this would be
translated into setting the interest rate and amount of money to be lent. 

In accordance with the SCPP, the next factor in line would the performance of the firm, which is seen
as having a linear relation with the conduct of the firm, and hence, the market structure of the
industry. Performance of a firm is looked from two different angles: physical and financial. In the case
of the Indian banking industry, liberalization led to an improved performance in both the financial and
physical sectors. 

Although a cursory look at the same would lead one to the conclusion that the SCPP holds true, one of
its flaws is that the SCPP is assumed to be a linear irreversible paradigm. However, it can be
empirically shown that the SCPP is indeed reversible. The easiest illustration of the same would be a
case of a merger or acquisition in an oligopoly. The conduct of the firm, that is, to merge with or to
acquire another firm, will lead to a change in the market structure. 
Also, another shortcoming of the SCP Paradigm is that it does not take into account external factors.
Thus, in an industry, a financial meltdown such as the one last year would definitely influence the
performance and the conduct of the firm, eventually even leading to a change in the market structure.

Role of the Reserve Bank in the banking sector

The Reserve Bank of India, being the central bank of the country, has numerous monetary and
financial functions to overlook. Even in a liberalized country such as the United States, the Federal
Reserve has similar functions to perform. This implies that the market mechanism should not be given
the sole rein to running the banking industry and setting the market rates.The functions of the
Reserve Bank which have a direct bearing on the banking sector are:

1. Financial Supervision- This aspect of the Reserve Bank is under the aegis of a Board for Financial
Supervision (BFS). The objective of the BFS is: “to undertake consolidated supervision of the financial
sector comprising commercial banks, financial institutions and non-banking finance companies.” The
functions that comes under the abovementioned objectives are: 

i. Restructuring of the system of bank inspections 

ii. Introduction of off-site surveillance, 
iii. Strengthening of the role of statutory auditors and 
iv. Strengthening of the internal defences of supervised institutions. 

Thus, the BFS does such acts as the supervising financial institutions, consolidated accounting, looking
at legal issues in bank frauds, providing assessments of non-performing assets and maintaining a
supervisory rating model for banks. 

2. Monetary Authority- The Reserve Bank is the monetary authority of the country. This implies that
the Reserve Bank formulates implements and monitors the monetary policy of the country. The
various monetary policies involves the availability of liquidity in the economy (i.e. the amount of
money supply to the economy), and setting the interest rates in the country. These rates include the
Statutory Liquidity Ratio (SLR), the Cash Reserve Ratio (CRR) and the Cash Adequacy Ratio (CAR)
among others. By this function, the Reserve Bank maintains price stability in the economy and
ensures that cash flow to various (important) sectors is maintained. In relation to the banking
industry, the setting of interest rates is of utmost importance. This limit prescribes the conduct of the
banks in the economy. It also acts as an entry barrier to the sector.

3. Regulator of the Banking System - Being the regulator of the banking, the Reserve Bank
“prescribes a set of broad parameters from within which the country’s banking and banking and
financial system functions".

The specific aims of financial regulators are usually:

• To enforce applicable laws
• To prosecute cases of market misconduct, such as insider trading
• To license providers of financial services
• To protect clients, and investigate complaints
• To maintain confidence in the financial system.

It is evident from these points that the Reserve Bank does have an amount of control over the
functioning and the conduct of the banks in the sector. The Reserve Bank and SEBI (Securities and
Exchange Bureau of India) thus can even force banks to withdraw from the sector in the case of
occurrence of unfair practices.

4. Banker to the banks - The Reserve Bank acts as the banker to the various banks in the country
and maintains banking accounts to all the scheduled banks in the country.

References
• Jay Mehta and Ram Kumar Kakani -Motives for Mergers and Acquisitions in the Indian Banking
Sector – A Note on Opportunities& Imperatives. 
 EXECUTIVE SUMMARY
The rise of retail lending in emerging economies like India has been of recent origin. Asia Pacific’s vast
population, combined with high savings rates, explosive economic growth, and underdeveloped retail
banking services, provide the most significant growth opportunities for banks. Banks will have to serve the
retail banking segment effectively in order to utilize the growth opportunity.

Banking strategies are presently undergoing various transformations, as the overall scenario has changed
over the last couple of years. Till the recent past, most of the banks had adopted fierce costcutting
measures to sustain their competitiveness. This strategy however has become
obsolete in the new light of immense growth opportunities for banking industry. Most bankers
are now confident about their high performance in terms of organic growth and in realising high
returns. Nowadays, the growth strategies of banks revolve around customer satisfaction.
Improved customer relationship management can only lead to fulfilment of long-term, as well as,
short-term objectives of the bankers. This requires, efficient and accurate customer database
management and development of well-trained sales force to develop and sustain long-term
profitable customer relationship.

The banking system in India is significantly different from that of the other Asian nations, because of the
country’s unique geographic, social, and economic characteristics. Though the sector opened up quite
late in India compared to other developed nations, like the US and the UK, the profitability of Indian
banking sector is at par with that of the developed countries and at times even better on some
parameters. For instance, return on equity and assets of the Indian banks are on par with Asian banks,
and higher when compared to that of the US and the UK. Banks in India are mainly classified into
Scheduled Banks and Non-Scheduled Banks. Scheduled Banks are the ones, which are included in the
second schedule of the RBI Act 1934 and they comply with the minimum statutory requirements. Non-
Scheduled Banks are joint stock banks, which are not included in the second Schedule of the RBI Act
134, on account of the failure to comply with the minimum requirements for being scheduled.

STRENGTH
■ Indian banks have compared favourably on growth, asset quality and profitability with other regional
banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per
cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.

■ Policy makers have made some notable changes in policy and regulation to help strengthen the sector.
These changes include strengthening prudential norms, enhancing the payments system and integrating
regulations between commercial and co-operative banks.

■ Bank lending has been a significant driver of GDP growth and employment.

■ Extensive reach: the vast networking & growing number of branches & ATMs. Indian banking system
has reached even to the remote corners of the country.

■ The government's regular policy for Indian bank since 1969 has paid rich dividends with the
nationalisation of 14 major private banks of India.

■ In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong
and transparent balance sheets relative to other banks in comparable economies in its region.

■ India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government
of India holding a stake)after merger of New Bank of India in Punjab National Bank in 1993, 29 private
banks (these do not have government stake; they may be publicly listed and traded on stock exchanges)
and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs.
According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of
total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5%
respectively.

■ Foreign banks will have the opportunity to own up to 74 per cent of Indian private sector banks and 20
per cent of government owned banks.

WEAKNESS
■ PSBs need to fundamentally strengthen institutional skill levels especially in sales and marketing,
service operations, risk management and the overall organisational performance ethic & strengthen
human capital.

■ Old private sector banks also have the need to fundamentally strengthen skill levels.

■ The cost of intermediation remains high and bank penetration is limited to only a few customer
segments and geographies.

■ Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and

deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate governance
and ineffective regulations beyond Scheduled Commercial Banks (SCBs), unless industry utilities and
service bureaus.

■ Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks
below 51% thus choking the headroom available to these banks for raining equity capital.

■ Impediments in sectoral reforms: Opposition from Left and resultant cautious approach from the North
Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium
term.

OPPORTUNITY
■ The market is seeing discontinuous growth driven by new products and services that include
opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-
based income and investment banking on the wholesale banking side. These require new skills in sales &
marketing, credit and operations.

■ banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates
provided. This will expose the weaker banks.

■ With increased interest in India, competition from foreign banks will only intensify.

■ Given the demographic shifts resulting from changes in age profile and household income, consumers
will increasingly demand enhanced institutional capabilities and service levels from banks.

■ New private banks could reach the next level of their growth in the Indian banking sector by continuing
to innovate and develop differentiated business models to profitably serve segments like the rural/low
income and affluent/HNI segments; actively adopting acquisitions as a means to grow and reaching the
next level of performance in their service platforms. Attracting, developing and retaining more leadership
capacity

■ Foreign banks committed to making a play in India will need to adopt alternative approaches to win the
“race for the customer” and build a value-creating customer franchise in advance of regulations potentially
opening up post 2009. At the same time, they should stay in the game for potential acquisition
opportunities as and when theyappear in the near term. Maintaining a fundamentally long-term value-
creation mindset.

■ reach in rural India for the private sector and foreign banks.

■ With the growth in the Indian economy expected to be strong for quite some timeespecially in its
services sector-the demand for banking services, especially retail banking, mortgages and investment
services are expected to be strong.

■ the Reserve Bank of India (RBI) has approved a proposal from the government to amend
the Banking Regulation Act to permit banks to trade in commodities and commodity derivatives.

■ Liberalisation of ECB norms: The government also liberalised the ECB norms to permit financial
sector entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial
institutions, which were earlier not permitted to raise such funds, explore this route for raising cheaper
funds in the overseas markets.

■ Hybrid capital: In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise
perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find
takers, it would help PSU banks, left with little headroom for raising equity. Significantly, FII and NRI
investment limits in these securities have been fixed at 49%, compared to 20% foreign equity holding
allowed in PSU banks.

THREATS
■ Threat of stability of the system: failure of some weak banks has often threatened the stability of the
system.

■ Rise in inflation figures which would lead to increase in interest rates.

·
■ Increase in the number of foreign players would pose a threat to the PSB as well as the private players.