1. INDIA BANKING 2010 TOWARDS A HIGH PERFORMING SECTOR 9TH JULY, 09
2. SUMMARY: The failure to respond to changing market realities has stunted the development of the The last decade has seen many positive financial sector in many developing developments in the Indian banking sector. countries. A weak banking structure has The policy makers, which comprise the been unable to fuel continued growth, which Reserve Bank of India (RBI), Ministry of has harmed the long-term health of their Finance and related government and economies. In this white paper, we financial sector regulatory entities, have emphasize the need to act both decisively made several notable efforts to improve and quickly to build an enabling, rather than regulation in the sector. The sector now a limiting, banking sector in India. compares favorably with banking sectors in the region on metrics like growth, profitability and non-performing assets (NPAs). A few banks have established an GOOD PERFORMANCE, outstanding track record of innovation, growth and value creation. This is reflected QUESTIONABLE in their market valuation. HEALTH Indian banks have compared favorably on However, improved regulations, innovation, growth, asset quality and profitability with growth and value creation in the sector other regional banks over the last few years. The banking index has grown at a remain limited to a small part of it. The cost compounded annual rate of over 51 per cent of banking intermediation in India is higher since April 2001 as compared to a 27 per and bank penetration is far lower than in cent growth in the market index for the same other markets. Indias banking industry must period. Policy makers have made some strengthen itself significantly if it has to notable changes in policy and regulation to support the modern and vibrant economy help strengthen the sector. These changes which India aspires to be. While the onus for include strengthening prudential norms, enhancing the payments system and this change lies mainly with bank integrating regulations between commercial managements, an enabling policy and and co-operative banks. regulatory framework will also be critical to their success. www.dreamgains.com Page 2
3. However, the cost of intermediation remains based income and investment banking on the high and bank penetration is limited to only wholesale banking side. These require new skills a few customer segments and geographies. in sales & marketing, credit and operations. While bank lending has been a significant driver of GDP growth and employment, Second, banks will no longer enjoy windfall periodic instances of the failure of some treasury gains that the decade-long secular weak banks have often threatened the decline in interest rates provided. This will stability of the system. Structural expose the weaker banks. Third, with weaknesses such as a fragmented industry increased interest in India, competition from structure, restrictions on capital availability foreign banks will only intensify. Fourth, and deployment, lack of institutional support given the demographic shifts resulting from infrastructure, restrictive labor laws, weak changes in age profile and household corporate governance and ineffective income, consumers will increasingly regulations beyond Scheduled Commercial demand enhanced institutional capabilities Banks (SCBs), unless addressed, could and service levels from banks. seriously weaken the health of the sector. Further, the inability of bank managements (with some notable exceptions) to improve capital allocation, increase the productivity of their service platforms and improve the performance ethic in their organizations OUT OF THREE could seriously affect future performance. SCENARIOS WILL PLAY OUT BY 2010 OPPORTUNITIES AND The interplay between policy and regulatory CHALLENGES FOR interventions and management strategies will determine the performance of Indian PLAYERS banking over the next few years. Legislative actions will shape the regulatory stance The bar for what it means to be a successful through six key elements: industry structure player in the sector has been raised. Four and sector consolidation; freedom to deploy challenges must be addressed before success can capital; regulatory coverage; corporate be achieved. First, the market is seeing governance; labour reforms and human discontinuous growth driven by new products capital development; and support for and services that include opportunities in credit creating industry utilities and service cards, consumer finance and wealth management on the retail side, and in fee- bureaus. www.dreamgains.com Page 3
4. Management success will be determined on and human capital up gradation to reach the three fronts: fundamentally upgrading high-performing scenario. organizational capability to stay in tune with the changing market; adopting value- Three scenarios can be defined to creating M&A as an avenue for growth; and characterize these outcomes: continually innovating to develop new business models to access untapped HIGH PERFORMANCE : opportunities. Through these scenarios, we paint a picture In this scenario, policy makers intervene of the events and outcomes that will be the only to the extent required to ensure consequence of the actions of policy makers system stability and protection of and bank managements. These actions will consumer interests, leaving managements have dramatically different outcomes; the free to drive far-reaching changes. costs of inaction or insufficient action will Changes in regulations and bank be high. Specifically, at one extreme, the capabilities reduce intermediation costs sector could account for over 7.7 per cent of leading to increased growth, innovation GDP with over Rs. 7,500 billion in market and productivity. Banking becomes an cap, while at the other it could account for even greater driver of GDP growth and just 3.3 per cent of GDP with a market cap employment and large sections of the of Rs. 2,400 billion. Banking sector population gain access to quality banking intermediation, as measured by total loans as products. Management is able to overhaul a percentage of GDP, could grow marginally bank organizational structures, focus on from its current levels of ~30 per cent to ~45 industry consolidation and transform the per cent or grow significantly to over 100 banks into industry shapers. per cent of GDP. In all of this, the sector could generate employment to the tune of In this scenario we witness consolidation 1.5 million compared to 0.9 million today. within public sector banks (PSBs) and Availability of capital would be a key factor within private sector banks. Foreign the banking sector will require as much banks begin to be active in M&A, buying as Rs. 600 billion (US$ 14 billion) in capital out some old private and newer private to fund growth in advances, non-performing banks. Some M&A activity also begins to loan (NPL) write offs and investments in IT take place between private and public sector banks. www.dreamgains.com Page 4
5. As a result, foreign and new private banks In this scenario, M&A activity is driven grow at rates of 50 per cent, while PSBs primarily by new private banks, which take improve their growth rate to 15 per cent. over some old private banks and also merge The share of the private sector banks among themselves. As a result, growth of (including through mergers with PSBs) these banks increases to 35 per cent. Foreign increases to 35 per cent and that of foreign banks also grow faster at 30 per cent due to banks increases to 20 per cent of total sector a relaxation of some regulations. The share assets. The share of banking sector value of private sector banks increases to 30 per adds in GDP increases to over 7.7 per cent, cent of total sector assets, from current from current levels of 2.5 per cent. Funding levels of 18 per cent, while that of foreign this dramatic growth will require as much as banks increases to over 12 per cent of total Rs. 600 billion in capital over the next few assets. The share of banking sector value years. adds to GDP increases to over 4.7 per cent. EVOLUTION: STAGNATION: In this scenario, policy makers intervene to Policy makers adopt a pro-market stance but set restrictive conditions and management is are cautious in liberalizing the industry. As a unable to execute the changes needed to result of this, some constraints still exist. enhance returns to shareholders and provide Processes to create highly efficient quality products and services to customers. organizations have been initiated but most As a result, growth and productivity levels banks are still not best-in-class operators. are low and the banking sector is unable to Thus, while the sector emerges as an support a fast-growing economy. This important driver of the economy and wealth scenario sees limited consolidation in the in 2010, it has still not come of age in sector and most banks remain sub-scale. comparison to developed markets. New private sector banks continue on their Significant changes are still required in growth trajectory of 25 per cent. There is a policy and regulation and in capability- slowdown in PSB and old private sector building measures, especially by public bank growth. The share of foreign banks sector and old private sector banks. remains at 7 per cent of total assets. Banking meanwhile, is only 3.3 per cent of GDP. www.dreamgains.com Page 5
6. NEED TO CREATE A MARKET-DRIVEN BANKING SECTOR WITH ADEQUATE FOCUS ON SOCIAL DEVELOPMENT Focus strongly on social The term policy makers used in this development by moving away from document, as mentioned earlier, refers to the universal directed norms to an Ministry of Finance and the RBI and explicit incentive-driven framework includes the other relevant government and regulatory entities for the banking sector. by introducing credit guarantees and We believe a co-ordinate effort between the market subsidies to encourage various entities is required to enable positive leading public sector, private and action. This will spur on the performance of foreign players to leverage the sector. The policy makers need to make technology to innovate and co-ordinate efforts on six fronts: profitably provide banking services to lower income and rural markets. Help shape a superior industry structure in a phased manner through Create a unified regulator, distinct managed consolidation and by from the central bank of the country, enabling capital availability. This in a phased manner to overcome would create 3-4 global sized banks supervisory difficulties and reduce controlling 35-45 per cent of the compliance costs. market in India; 6-8 national banks controlling 20-25 per cent of the Improve corporate governance market; 4-6 foreign banks with 15-20 primarily by increasing board per cent share in the market, and the independence and accountability. rest being specialist players (geographical or product/ segment Accelerate the creation of world focused). class supporting infrastructure (e.g., payments, asset reconstruction c...