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7/25/2019 KPMG CII Indian Banking
1/32
Indian Banking
Maneuvering
through Turbulence:
Emergingstrategies
7/25/2019 KPMG CII Indian Banking
2/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Foreword CII
Sudhir DeorasChairman
CII Eastern Region
During the last two decades of
unshackling its chains, the elephant
that is Indian economy seldom came
across such challenges as it does
now. The twin tasks of reinvigorating
economic growth and reining in
ination during the times of dwindling
rupee value, weak global demand
and persistent current account decit
present a mesh of problems that needimmediate and coordinated actions on
the scal and monetary front.
Indias economic growth that sunk to
a decade low of 5 percent last year
continues to plague the economy. While
the performance of key sectors such
as manufacturing, farm and mining
are below par, the reforms process
that began last year failed to generate
enough momentum to restore the
growth gures.
Against this backdrop, the banking
sector has an important role to play in
stimulating economic growth. Banking,
arguably the fulcrum of our nancial
system, is a sector that can really help in
deploying our national savings towards
infrastructure development. This will in
turn stimulate economic activity on one
hand, and help sustain a high growth
rate on the other.
The bigger the challenges, more is the
need for innovative ideas and strategies
by bankers to counter risks. Banks also
have a larger role to play in increasing
nancial inclusion. Proposed licenses
for new banks raise hope for increased
penetration and enhanced credit
availability.
The central bank has taken several
policy initiatives on compliance and
governance something that could
redene the contours of the sector and
benet the economy in the long run.
The volatile economic scenario has
forced banks to try various business
models either to increase their
bottomline or manage risks better.
Adoption of new technologies and
a constant pursuit of innovation to
improve products and services will be
crucial.
In this context, KPMG as our knowledge
partner for Banking Colloquium 2013 has
prepared a report. The study attempts
to capture the current scenario and
detail of the strategies being adopted
by banks, way forward to compliance
and governance, nancial inclusion,
technology in banking, market risk
hedging and proposed new banks.
We hope the report will help the
industry understand the emerging
strategies needed to maneuver through
these times of turbulence.
7/25/2019 KPMG CII Indian Banking
3/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Foreword KPMG
Ambarish DasguptaHead - Management Consulting
KPMG in India
Banks face challenges from many
sourcesIndian economy slow-down
is one of them. Few factors responsible
for GDP growth rate of 5 percent could
be an over-cautious monetary policy
that could not deliver on lowering the
ination rate but contributed to increase
in the borrowing costs, governments
pending decisions on a few strategic
policies, high current account decit andoil prices. The sharp depreciation and
uncertainty of the rupee in recent times
has further aggravated the problems of
the Indian economy.
Slower economy leads to deteriorating
asset quality which is already causing
stress to the banking sector. The RBI
estimates that the gross NPA ratio of
banks may rise to 4.4 percent by March
2014 as compared to 3.42 percent in FY
13. NPA ratio was 2.94 percent in FY12.
In an uncertain environment, banks are
extremely concerned with liquidity risk
and concentration & correlation risks
and have to develop tools to calculate
economic capital that will integrate
credit and market risks. Currency
volatility is also giving few bankers
sleepless nights. Another challenge
facing the banking sector is that of
compliance and governance. Fit and
proper guidelines were issued by the
RBI for directors to ensure appropriate
ofcials at the helm. To reduce systemicrisk, regulators have also placed lot of
checks and balances in the sector.
From tapping new segments in the
SME sector to funding cross-country
aspirations as Indian corporates go
global, Indian banks are pursuing
multiple strategies for growth in an
uncertain environment.
The Public sector banks (PSBs) are
much ahead of the Private sector banks
in their overseas presence, constituting
over 90 percent of 171 overseas
branches as of March 31st,2013.
To meet these requirements and
challenges, industry players are
harnessing technology for creating
innovative and cost-efcient operating
models to sustain protability and
viability. Discussions have been on
branchless banking but a branch avatar
will never go out of picture for less-
technology savvy customers. Banks
are also deliberating on social media
initiatives to reach out to urban and
emerging class and SMAC (social,
mobile, analytics and cloud) on a whole
could bring a new perspective on
customer experience and on creating a
sustainable business.
RBIs objective of increasing nancial
penetration and credit availability
with reaching out to the bottom of
the pyramid has resulted in giving out
clear guidelines to the new banking
entrants(whenever they are on
board)open one in four branches in
rural unbanked areas! The successful
banking aspirants would have their
task cut out as they balance the
twin objective of reaching out to the
emerging India in the Tier 3 to 6 cities
while achieving nancial inclusion.
This paper is an attempt to discuss the
opportunities and challenges that lie
ahead of the Indian banking industry.
7/25/2019 KPMG CII Indian Banking
4/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
7/25/2019 KPMG CII Indian Banking
5/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Financial inclusion - Quest for
protability
13
Emerging strategies of
Banking sector
01
09
Governance and Compliance
Gearing up for the next level
SMAC - Future of
technology
17
19
Hedging the market risk
Merit in banking on
new licenses
21
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Over the past couple of years,the Indian banking sector hasdisplayed a high level of re-
silience in the face of high do-mestic ination, rupee depre-ciation and scal uncertainty in
the US and Europe. This hasnecessitated the banks in India
to concentrate much more onoperating efciency, outsourc-ing and cost optimization now
than ever before. With deregu-lation of savings bank rate andbleak global economy, the
banks are focusing on alterna-tive sources of revenue, like
fee income, trade and vendornancing, geographic expan-sion et al to maximize their
revenues. The Banking sec-tor in India has adopted andembraced technology to keep
pace with the internationaldevelopment in the bankingindustry and offer quality prod-
ucts to its clients. Technologyhas enabled banks to conceive
and deliver products that aremore in line with the require-ments of its clients on the
one hand and also more costefcient on the other. We have
captured few emerging trendsin the Banking space that aregaining traction.
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Emergingstrategies of
Banking sector
1 RBI - Statistical Tables relating to Banking FY 12
2 As per RBI denition - Rural: population less than 10,000; Semi-Urban: 10,000 and above and less than 1 lakh; Urban: 1 lakh and
above and less than 10 lakh; Metropolitan: 10 lakh and above
Focusing on the emerging IndiaBanks and regulators alike have woken up to the growing needs of emerging India.
While the credit disbursal of all SCBs has doubled from FY08 to FY12 to INR 48,215
bn1, the share of non metro regions in the incremental credit pie has increased from
30 percent in FY09 to 39 percent in FY12, indicating that the Non-metro regions are
increasingly gaining share.
The number of bank branches in urban and semi-urban2areas has been growing at a
fast pace. Fifty eight percent of ~25,000 branches opened in last ve years were in
urban and semi-urban regions.
Incremental credit disbursed by SCBs (INR bn)
Source:RBI - Statistical Tables relating to Banks in India FY 12
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Even the number of bank branches in urban and semi-urban areas has been growing
at a fast pace. The growing economic activity and increasing per capita income have
been crucial factors driving the credit growth in these regions. Fifty eight percent
~25,000 branches opened in last ve years were in urban and semi-urban regions.
RBI is keen to improve the banking situation in rural areas and has mandated banks
to allocate at least 25 percent of new branches in unbanked rural centers. Further,
the increasing number of High Net worth Individuals (HNWIs) in the non metroareas is leading to an increase in demand for better or more sophisticated services,
including Private banking and Wealth management; banks are not only focusing
on numbers in the emerging markets within the country but also on the quality of
services being delivered in these regions, based on type of clientele.
Population wise incremental branches in last 5 years
Source:RBI - Statistical Tables relating to Banks in India FY 12
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
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8/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
3 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies
Banks are constantly trying to increase their overseasexpansion to meet the growing trade demandIndian banks have been increasingly
growing their international presence
in the recent past. In part to cater
to the growing Indian diaspora in
foreign countries (estimated at ~ 20mn persons) and in part to meet the
growing demands from cross border
trade and economic activity.
The Public sector banks (PSBs) are
much ahead of the Private sector
banks in their overseas presence,
constituting over 90 percent of 171
overseas branches as of March 31st,
20133. Many of the private banks do not
have branches, but are present through
representative ofces.
Non resident Indians (NRIs) deposits
aggregated USD 14.2 bn in the nancial
year ended March 2013, a y-o-y increase
of 19 percent. The Indian Diaspora
worldwide is estimated to be ~20 mn
persons4 and is on a constant rise.
3 RBI Country-wise branches of Indian Banks at Overseas
Centres as on March 31, 2013
4 Including Non Resident Indians and Person of Indian origin
5 Business Standard June, 2013; http://www.business-
standard.com/article/nance/icici-bank-for-more-branch-
expansion-113062400758_1.html
The total trade, export and import, have
clocked a 19 percent CAGR over the
last year, period ending FY 13. The top
trading partners are China, Middle East,
US, HK, Singapore et al. The Banks have
shown particular interest in opening
branches in these regions which havea strong trade relationship with India.
Total trade with China has grown at
17 percent CAGR from FY10 to FY13
and this has enticed banking players to
open branches in China. For example,
Axis Bank recently got permission from
RBI to open a branch in China and ICICI
Bank is awaiting RBIs approval for the
same. ICICI Bank is looking for foreign
expansion by opening branches in
Australia, South Africa and Mauritius5.
PSBs are also aiming to expand their
presence abroad. SBI wants to explore
territories where Indian Banks havent
tread yet, like Latin America. Dena
Bank is also awaiting RBIs permission
to open branches in US, UK and Africa.
Overseas expansion in PSBs mightbe constrained on account of the
limited capital headroom they have for
such ventures, and the Government
being hard pressed to nd funds for
recapitalizing PSBs. Therefore, PSBs
might be very careful in their selection
of target markets compared to well
capitalized PBs.
Top Exports Markets (FY 2013, USD bn) Top Imports Sources (FY 2013, USD bn)
Country-wise branches of Indian Banks at
overseas centres as on March 31, 2013
Source:Ministry of Commerce & Industry, Government of India
Source:Reserve Bank of India
Others include:
Afganistan,
Australia,
Bahamas,
Bahrain,
Bangladesh,
Belgium,
Cambodia,
Cayman Islands,
Channel
Islands, France,
Germany, Israel,
Japan, Kenya,
Maldives, Qatar,
Saudia Arbia,
Seychelles,
South Africa,
South Korea,
Oman, Thailand,
7/25/2019 KPMG CII Indian Banking
9/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 4
Supply Chain Financing (SCF) is gaining traction inIndiaSCF is rapidly gaining attention in international markets and is growing at a pace of
30 40 percent at major international banks according to a research6. Key elements
of SCF include factoring, invoice discounting/reverse factoring, purchase order/
invoice data management, bank assisted open account, open account payment,
export/seller nance and buyer side nance. All the products aiming at providingbetter liquidity to the corporates and their entire value chain at lower nancing
rates. Currently, the growth in this domain comes from US and western European
countries, but the future growth is expected to come from emerging economies
like India and China.
With various government policies supporting exporters in India, the export credit
is growing at a rapid rate (Three year CAGR at 14 percent and ve year CAGR at 22
percent). A part of this is also supplier nancing, which has been gaining popularity.
Banks are increasingly focusing on increasing their business from SCF. This can be
witnessed in growing number of branches in Industrial units. The banks are holding
awareness campaigns and seminars to educate the corporate world of the benets
of SCF. Certain players are focusing on developing expertise in particular sectors.
Factoring and reverse factoring have not gained much momentum in India and
still offers an untapped market. Factor products offer greater exibility compared
to other instruments used for working capital nance. Although receivables enjoy
property rights and are transferable, a statutory framework for factoring wasintroduced only in 2011 by way of the Factoring Regulation Bill.
Outstanding advances of SCBs to exporters (INR bn)
Source:Monetary policy department, RBI (http://www.rbi.org.in/scripts/PublicationsView.aspx?id=14681)
6 Demica Research, 2013
In the context of serving our clients responsibly, value chain nancing is an
integral part of our business strategy covering both, our corporate clients
as well as their vendor partners, who are largely SMEs. We have further
sharpened our focus on this format of supply-chain nancing to meet priority
sector obligations, given that our distribution network limits direct access to
such borrowers.
Abhijit Sen CFO, Citibank
7/25/2019 KPMG CII Indian Banking
10/32 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
5 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies
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CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 6
The Factoring bill essentially protects
micro and small businesses from
delayed payments for goods and
services by larger entities. Traditional
banks used to provide loans based on
the borrowers (i.e. the MSME players)
ability to service the loan. Factoring will
however evaluate the lending decision
based on the ultimate debtor (i.e. the
ultimate customer of the MSME). This
will greatly improve the liquidity and
working capital problems of MSME
players.
With favourable legislations, factoring
is gradually taking off in India. The
Indian market constitutes a mere one
percent of the worlds factoring market
and 0.5 percent of the working capital
requirement of Indian companies7and is
constantly growing.
As illustrated above, there is a huge gap between Indian factoring market and
the international counterparts and offers a great opportunity for Indian banks to
capture this gap. The factoring industry in India is dominated by PSBs and nancialinstitutions. SBI Global Factors is the market leader with 80 percent of the market
share. Other players include CanBank Factors, DBS, Axis Bank, HSBC and Standard
Chartered7.
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
7 http://www.indiafactoring.in/Admin/DocFile/161-1204201
2%20-%20nancial%20express.pdf
Indian factoring market in the last decade
Source:Factors Chain International
Comparison with major Asian Markets
Source:Factors Chain International
International
Domestic
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7 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
8 Gartner Research- http://www.gartner.com/newsroom/id/2319115
9 Reserve Bank of India
Focus on improving operating efciencyand outsourcingWith increasing competition,
emerging customer demands,
regulatory interventions, technology-
led disruptions, higher shareholder
expectations, Indian banks are beingforced to constantly review and revisit
their operating models. The resulting
changes are making Indian banks
nimbler, more cost efcient, better
focused on customer services and
witnessing good returns through fee
based services and products.
Indian banks are constantly optimising
the use of technology as the change
agent, in order to improve operational
efciency and enhance customer
experience. It is estimated that Indianbanking and securities companies will
spend INR 416 bn (USD 6.75 bn) on IT
products and services in 20138, which
will be 13 percent increase from INR
370 bn (USD 6.0 bn) spent in 2012.
Emergence of low cost channels like
internet banking, mobile banking, and
mobile ATMs have been successfully
implemented by many players and
have also found wider acceptance in
the customer base. This has led to
enhanced focus on digital banking andself-service channel usage to reduce
the cost of operations. The number of
mobile banking transactions doubled to
5.6 mln in January 2013 from 2.8 mln
in January 20129. The value of these
transactions increased three-fold to
INR 625 Cr (USD 105.73 mln) during
the month from INR 191 Cr (USD 32.31
mln).
Banks have either centralised mid/
back ofce processes through a shared
services center or have outsourced
their technology requirements to a third
party. In addition to focus, this also gives
banks a huge cost advantage.
For example, Indian market has
witnessed an increasing number of
ATMs under outsourcing management.
By outsourcing their ATM management
to service providers like Fidelity NationalInformation Services (FIS), the bank
is able to focus on its core business
expansion and customer service
initiatives - allowing for more rapid
growth while ensuring its customers
have a high-quality, reliable ATM
service. FIS the market leader and
worlds largest provider of banking and
payments technology manages about
11000 ATMS across India.
Karnataka Bank is the latest to join
more than half of Indias top 30 banks
who rely on FIS. By outsourcing the
management of its ATM estate to FIS,
Karnataka Bank would be in a position
to release vital capital to redeploy on
core activities, increase operational
efciencies, provide better service
to its customers and insulate itself
from technology obsolescence. The
announcement made by Karnataka Bank
in May 2013 underscores a growing
trend in India for banks to contract
non-differentiating services, such asATM driving, to expert providers such
as FIS. Banks benet by redirecting
investments tied up in ATM equipment
and operations to more strategic areas,
thus deriving operational efciencies.
In addition, banks can leverage the ATM
driving expertise of FIS to deliver a high-
quality and reliable ATM service to their
customers.
While transaction based banking
operations are being successfully
streamlined, Priority Sector Lendingand Financial Inclusion still remain a
challenge. The section on Financial
Inclusion in the report elaborates on
how to create a protable model to
deliver rural credit.
Indian banks are now getting
to be somewhat mature users
of technology and are investing
signicantly in good data mining
solutions to understand the
behavioral trends of customers
and offer intelligent cross sell
solutions to customers, primarily
to improve productivity. There is
also concurrently an increasing
trend towards outsourcing to retain
exibility, manage scale moreefciently and cut operating costs,
essentially to leverage on partners
strengths in specic areas
Jaideep Iyer Group President, Financial
Management, Yes Bank
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CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 8
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Max Life insurance. With the increasing
trends in insurance penetration on both
life and general insurance side, banks
identify this as one of the key drivers of
fee income growth.
Retail fee income is another area where
banks have increased focus to augment
their growth. Retail fee income of banks
typically comprises commissions they
earn from sale of third-party products,
like insurance and mutual funds,
transaction charges on savings and
current accounts, processing fees on
consumer loans and credit cards, and
fees from foreign exchange transactions
and remittances.
Private sector banks are specically
focusing on income on foreign exchange
transactions and remittances. Axis
Bank, the third largest private sector
lender in the country, reported close to
43 percent rise in retail fee income in
FY13.
CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 8
Changing dynamicsof fee based incomeportfolioFee income has gained signicant
focus as a source of revenue in the past
decade. With the rising pressure on
cost of funds, it is imperative for banks
to look at other avenues to boost their
income. The fee income in FY 13 for
67 banks in our sample set10was INR
64,418 Cr; clocking a three year CAGR
of 12 percent and ve year CAGR of 15
percent.
PSBs have constituted a large part
(60 percent) of this basket since the
beginning, owing to their reach and size.
Pressure on fee based income
However, in recent times with the
overall pressure on the economy and
changing regulations, the fee based
incomes of banks have come under
pressure. Banks earned lower corporate
banking fees due to slowdown in project
nance. Also, with The Reserve Bank of
Indias (RBI) recent measures to tighten
liquidity and curb volatility in foreign
exchange rates have led to a rise in
bond yields leading to a drop in treasury
incomes for banks. On the retail side,fee income earned by banks on account
of sale of gold coins has dried up with
the government banning sale of gold
coins by banks. These factors have
necessitated banks to revamp their fee
based product portfolio.
Emerging trends
Banks looking to increase fee-based
income are shifting focus to selling
life insurance and general insurance
policies (through bancassurance tie upsor as insurance brokers). Indian bank
recently partnered with United India
Insurance and launched a web portal
for its Arogya Raksha group mediclaim
insurance policies. Moving forward,
the bank is in talks with a life insurance
company for a similar tie-up in the life
insurance space. The bank expects a
30 percent11growth in income from
insurance this scal. Some of the other
recent bancassurance tie-ups include
PNB with Metlife and Axis Bank with
10 The sample set comprises of 26 PSBs, 18 PBs, and 23 Foreign banks
11 http://articles.timesondia.indiatimes.com/2013-06-14/india-business/39975382_1_fee-income-fee-based-income-fy-13
Fee Income (INR Cr)
Source:KPMG-Business Today Best Banks December 2012
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2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
The banking sector is crucial foran economy since it channelisessavings into investments. It
provides credit to the productivesectors and nances the
needs of the real economy. Foremerging economies, banks aremore important since they are
important drivers of nancialinclusion and economic growth.Banks by nature are highly
leveraged and interconnected.Hence, poor governance orfailure in banks can trigger
bigger crisis and threatenstability of the economy.
Banks in India are wellregulated with The ReserveBank of India adopting a
forward looking yet cautiousapproach. In the 1990s, thetone of banking regulation
shifted from prescriptive toprudential, shifting the onusfrom regulations to corporate
governance. Various guidelineswere issued over the years to
improve corporate governancein banks. To get competentdirectors on board, the RBI
issued t and proper criteriafor directors which said that
private banks should carry outdue diligence to determine thesuitability of the person for
appointment as a director basedon qualication, expertise, trackrecord and integrity.
Governance andCompliance
Gearing up forthe next level
In 2005, the Ganguly Committee recommended separation of Chairman and MD
roles. The recommendation was implemented in private banks. The RBI also issued
guidelines on ownership and governance in private banks to ensure that ownership
and control of banks are well diversied and thus not detrimental to depositors
interest. Moreover, any acquisition of shares in private sector banks resulting in
a shareholding of 5 percent or more of the paid up capital requires the RBIs prior
approval. Banks are also mandated to have committees on audit, nominations andremuneration, fraud monitoring, and customer services. All these provisions put the
corporate governance framework adopted by Indian banks on par with international
standards.
Although improving regulatory landscape is a welcome move, regulation in isolation
is not enough. It is a necessary but not a sufcient condition for good governance.
Regulation can complement governance, not replace it. Good governance has to be
institutionalized by individual banks for it to be effective. While broadly Indian banks
have good governance standards, there is room for improvement.
In the sections below, we take a brief look at the important issues in governance
and compliance in Indian banks and how they can be addressed.
Governance in Indian banksThe nancial crisis of 2008 brought inadequate governance in banks and other
nancial institutions in sharp focus. Experts argue that simplistic assumptions
and lack of rigorous questioning by bank boards led to the crisis. Banks boards,
management, and employees faced conict of interest routinely in their jobs. When
faced with a conicting situation, compensation structures in the nancial sector,
which should have ideally pushed the decision makers towards the better choice,
instead encouraged excessive risk taking.
Once the crisis started in one area of the nancial sector, it spread to other
areas quickly due to blurred boundaries between banking, insurance and asset
management businesses. Although Indian banks came out of the crisis relatively
unscathed, they (particularly the public sector banks) face peculiar governance
challenges in the form of government control.
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Governments control over publicsector banks
The Indian banking sector is character-
ised by the dominance of PSBs which
account for approximately 70 percent of
the industry1. The government through
its agencies owns majority stakes
in these banks and exerts inuence
through its monetary policy and direc-
tives.
In the context of PSBs, it is difcult to
adhere to public ownership and yet give
near total autonomy to their boards
as compared to private sector banks
where the board has autonomy and all
shareholders are treated at par.
Bank Subsidiary Model needs to bereassessed
Another governance related issue in
Indian banks is the corporate structure
they follow. Currently in India, the bank
subsidiary model is popular. Under this
model, non-banking activities such
as insurance, asset management etc
are done in separately constituted
subsidiaries of the bank. This model
has its own set of problems and
disadvantages. E.g. rstly, losses of
subsidiaries could substantially damage
the nancial health of the bank and
risk the safety of deposits. Secondly,since the bank will be responsible for
equity infusion in the subsidiaries and
their management, having several
subsidiaries could stretch the banks
nances and other resources. Thirdly,
the proportion of foreign holding
in holding banking company is not
taken into account for the purpose of
calculating the cap of foreign holding in
subsidiaries. And nally, the subsidiary
model could lead to excessive leverage
by the downstream afliates.
The Shyamala Gopinath Working
Group appointed by the Reserve Bank
recommended that the nancial holding
company model should be preferred for
the nancial sector in India.
Revising the compensation structureto improve governance
After the 2008 nancial crisis,
compensation structure in banks came
under sharp focus and criticism. Now it
is widely acknowledged that aggressive
and irrational incentives and excessive
risk taking by bank executives fuelled
the crisis. The compensation structure
at times encouraged compromising
long-term interests for short-term gains.
To check excessive risk-taking behavior,
the RBI issued guidelines which
aligned compensation structures with
prudent risk taking and instituted a
claw back mechanism. However, as
of now there is no consensus on what
is a good compensation structure for
non-executive directors. Currently
non-executive directors are paid sitting
fees. There is a school of thought that
believes that non-executive directors
should be paid a regular or a xed
contractual remuneration. Although this
is a good idea, it is difcult to implement
in practice. Firstly, non-executive
directors typically serve for shorter
periods and have term limits. Secondly,
in banks the results of risks taken
manifest after a long gap. And nally
since non-executive directors serve
on several committees comprising ofmany directors, it is difcult to apportion
responsibility on them individually.
Hence, aligning non-executive directors
compensation structure with outcomes
of corporate governance is still a grey
area.
Separating the roles of Chairmanand Managing Director
In 2005 the Ganguly Committee
appointed by the RBI recommended
that the posts of the chairman of theboard and the CEO of the bank should
be bifurcated. The committee argued
that this will bring about more focus
and vision and necessary thrust to the
functioning of the top management
of the bank and also provide effective
checks and balances. The committees
recommendations were implemented in
private sector banks in 2007. However,
the nance ministry did not favor the
proposal and hence it was not adopted
in public sector banks except in SBI and
associates.
Allowing corporates into the bankingspace
The RBI has received 26 applications
for new banking licences2. However,
there is a lot of debate on whether
large corporates should be allowed to
start a bank. International experience
in this regard has been mixed. While
corporates can bring in professional
management experience and capital,
many experts fear that they will use the
bank as a private pool of readily available
funds.
However, to avoid this, the RBI has built
in several safeguards in the new banking
licence guideline. To keep non-serious
players at bay, the guideline says that
the applicant entity/group should have
a past record of sound credentials and
integrity, should be nancially sound
and have a successful track record of 10
years. It also underlines the importance
of diversied ownership. It says that
a Non-Operative Financial Holding
Companies (NOFHC) should set up newbanks. The NOFHC should retain their
equity capital in the bank at a minimum
of 40 percent for fuveyears after which
they should reduce to 15 percent within
12 years. The guideline also has criteria
on nancial inclusion.
The above provisions clearly show that
the regulator wants new banks to have
good governance standards. Failing to
meet the aforementioned conditions
could have serious repercussions for
new banks.
1 Reserve Bank of India
2 RBI Press Release RBI discloses the names of applicants
for new bank licences in the private sector, Jul 2013
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Importance ofcompliance at banksCompliance for banks is given a lot of
importance as they are the engines of
a countrys economy and, therefore,
also more regulated. In fact, post the
nancial crisis regulatory supervisionof banks has increased noticeably,
underscoring the increasing importance
of regulatory compliance for banks.
Evolution of banking regulations and
enforcement
In 2010, Basel Committee on
Banking Supervision (BCBS) issued
comprehensive Basel III guidelines to
improve the banking sectors ability to
absorb shocks arising from nancial
and economic stress. The guidelinesrecommend more stringent capital
and liquidity requirements apart from
suggesting enhancements to Basel
II and market risk frameworks. In the
same year the US introduced Dodd-
Frank Act to enhance nancial stability,
orderly liquidation and other host of
measures to ensure measures directed
at hedge funds, insurance companies
and banks.
Similarly, in India, RBI has been
issuing a host of directives to improvegovernance and compliance at Indian
banks in the last two years. Specically,
the regulator has issued key directives
aimed at enhancing corporate
governance at NBFCs, enhancing
know your customer (KYC)/anti-money
laundering (AML) norms, tightening
regulatory oversight at foreign banks by
making CEOs of such banks responsible
for compliance, structuring the credit
approval process by recommending a
board-level credit committee, etc. Thenew guidelines for issuance of banking
licenses are also indicative of this trend.
RBI is also strengthening its
enforcement efforts. Its recent orders
penalising 19 commercial banks for
mis-selling derivative products to clients
and 3-4 banks for violation of KYC/
AML norms is indicative of this trend.
Additionally, RBI recently constituted a
High-Level Steering Committee which
recommends the regulator to transition
to a risk-based supervision (RBS)approach, which entails determining
the intensity of supervision based
on a banks risk prole. This would
necessitate banks to strengthen their
governance, risk management and
compliance frameworks.
Banking communitys response to
this evolution
Often, companies tend to respond to
more regulations, increased scrutiny and
instances of wrong doing with another
checklist or another layer of control or
redundant procedures. This may or may
not address the issue permanently.
More importantly, this spontaneous
reaction could create multiplicity in
rules, increased compliance costs,
unwanted bureaucracy and delayed
decisions.
The spontaneous reaction is to acertain extent because organisations
view compliance as a mere cost of
doing business and as an impediment
to their operations. This could be
counterproductive and often lead to
misdirected compliance and control.
This in turn could lead to overlapping
and inconsistent rules and regulations
that are difcult to comprehend or
requirements that without a clear
purpose or intention and remain merely
on paper.
In fact, banks stand to gain more if
they leverage compliance as a value
driver and comply with laws of the
land in sprit. This comes from a good
understanding of the consequences of
non-compliance on the bank and on
the industry/economy as a whole at all
levels of the organization.
Compliance as a value driver
In order to leverage it as a value-driver,
banks should adopt a complianceframework that is proactive, rigorous,
co-operative and pervasive.
Proactive:Addressing compliance
proactively involves a two-pronged
strategy of assessing compliance
risks, including upcoming ones,
and inducing appropriate changes
in policies, processes and controls
to address these risks. It involves
implementing best practices by
complying with the spirit of the
regulations than merely the letterof it.
Rigorous: Adopting a zero-
tolerance approach to non-
compliance involves making
efforts to curtail all sorts of non-
compliance and not just material
ones. Any non-compliance in
regards to regulations is viewed
seriously, regardless of the extent
of the regulators supervision, and
corrective actions are implemented
in a timely manner to curtail any such
future instances of non-compliance.
Co-operative:Making the process
co-operative involves leveraging
the synergy of compliance
initiatives across the organisations
and avoiding any duplication of
efforts. This reduces the cost,
complications and inconsistencies
in regulatory compliance for banks.
One of the ways to achieve this
is by establishing an empowered,
independent compliance
function.
Pervasive:Introducing a pervasive
approach involves making
compliance with regulations or the
banks internal rules everyones
responsibility. The banks employee
performance system accords as
much importance to compliance
KPIs as given to business KPIs.
It also involves timely training
and communication to educate
employees on the intent behind
regulations and the banks internal
rules.
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ConclusionIndian banking sector is at an
inexion point. To meet the demands
of Indias huge potential, heavy
infrastructure spending, and the
governments ambitious nancial
inclusion plan the banking sector will
have to gear up for unprecedented
challenges. To prepare for
the upcoming challenges, the
government formed a commission
with a task of overhauling the
regulatory landscape of nancialsector. The commission Financial
Sector Legislative Reforms
Commission drafted a code called
the Indian Financial Code (IFC).
The IFC has called for a unied
regulator for the nancial services
sector which will regulate insurance,
capital market, pension funds and
commodities derivatives market.
It has recommended that the RBI
should continue to exist outside
the unied regulator althoughwith modied functions of setting
monetary policy, regulating banks
and payment systems.
To what extent the RBIs functions
will be modied is not known yet.
However, one of the most important
challenges the sector is likely to
face is the challenge of governance
and compliance. Achieving optimal
growth, balancing stakeholder
expectations and complying with
regulations is likely to be a tight
rope walk for the sector. However,
with support from the RBI and
the government, it is likely to be arewarding experience.
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Financial exclusion has beenan area of concern and castsshadows over the long-term
sustainable growth of theIndian economy. Thoughthe country has had a large
unorganized sector (consistingof money lenders, chit funds,
etc.) providing the nancialservices for a long time, thereach of the organized sector
(banks, NBFCs, MFIs, NGOs,etc.) remained limited. Theunregulated unorganised
sector players, with theirstrong focus on earning
prots, did little to bring in thenancially excluded people inthe mainstream.
The central bank prescribes thefollowing four basic nancialservices to be provided to any
individual to count heras nancially included.
Access to basic savingsaccount
Availability of affordablecredit
Access to remittance
services
Opportunity to buy
insurance and investmentproducts.
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Financialinclusion - Quest
for profitability
Data released by the World Bank depicts that on an average Indians over the age
of 15 years remain considerably under-banked as compared to their global peers.
While almost half the global population above 15 years has an account at a formal
institution, the gure is only 35 percent in India. The scenario is even worse in case
of female population. Looking at the same metric for the bottom 40 percent of the
population by income, 41 percent population globally has an account as compared
with 27 percent in case of India.
Financial inclusion status for population above 15 years: global comparison (in %)
Source:India Commercial Banking Report - New Permits To Boost Competit ion In Underbanked Economy, ISI Emerging Markets,
accessed on 26 August 2013
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Even the extent of nancial exclusion in India is
widespread as reected in the following facts.1
Highest number of households (145 million)excluded from banking
50 percent of the population does not havebank account
Only 34 percent of the population engaged
in formal banking
Only 17 percent of population has any creditexposure especially in remote villages
Out of 600,000 villages, only 30,000 (5percent of total villages) have commercial
bank branch
Only 10 percent have life insurance coverwhile just 9.6 percent have any non-life
insurance.
The policy makers have adopted a multi-
pronged approach to address the issue of
nancial exclusion. Key elements of the
strategy include:
Evolving regulatory guidelines withdevelopment perspective
Deepening banking reach and coverage
Introduction of Innovative products
Encouraging use of technology
Financial literacy and nancial inclusion-synced approach.
There has been an intense debate on the
appropriate model for FI. RBI has favored
bank-led model instead of the technology-
led model which has been successful in
many other countries. The model allows the
country to leverage existing branch base for aplanned, structured and sustained FI process.
It also reduces the risk given the low literacy
levels (and even lower nancial literacy) of
the potential set of customers leaving them
vulnerable to players either not regulated at all
or not regulated by the RBI.
Till date, India has had a limited success in
achieving FI with the model. However, given
the Indian scenario, the model facilitates a
consistent and planned move towards the goal
of FI while maintaining the nancial stability.
Challenges in reaching out to the under-banked Infrastructure:Both physical and digital connectivity are essential for institution
to provide nancial services through a mix of channels depending on the cost
and type of services offered. To illustrate, the widespread use of the kiosk
banking has been inhibited by poor connectivity in the hinterland.
In terms of credit, lack of credit history and limited collateral poses a
challenge:Credit bureaus have not expanded their reach much to the rural
areas; hence banks are hesitant to hand out loans to the under-banked with
limited documentation in terms of proof of income. Also, asset ownership is
limited and generally restricted to farm land with no clear documentation.
Varied prole of consumers:Banking needs vary according to the customer
proles and due to diversity in population, it becomes difcult for bankers to
understand this segment.
Global FI models and relevance for IndiaMany of the scalable and successful experiences globally have been led by telecom
companies with the banks playing a secondary role.
M-Pesa in Kenya:Parallel banking ecosystem managed by telecom companies,
allowing the consumers to make majority of mobile banking payments, transfers
and transactions on their mobile phones. It is a cost effective and adaptable
system which has brought many people into the formal banking system and
has grown rapidly with client base of around 10 million, roughly 40 percent of
Kenyas adult population.
USAID MABS in Philippines:Microenterprise Access to Banking Services
(MABS) assists network of partner rural banks in the development and
introduction of innovative products, including mobile nancial services. Its a
successful model that has more than 90 MABS-supported rural banks managing
around 250,000 microloan borrowers and 1.5 million micro-savings accounts.
These banks have also registered more than 250,000 mobile phone bankingclients and have processed more than USD250 million in mobile banking
transactions. This model could be used to provide training and technical
assistance to rural banks in India which could give a boost to innovative product
launches in the rural segment.
MTN Mobile Money in South Africa: Mobile operator MTN and Standard
Bank, through their joint venture MTN Banking, launched a mobile banking
product MTN MobileMoney. Every MTN SIM card has an embedded banking
application and only MTN subscribers can open MobileMoney accounts. Under
MTN MobileMoney, 1.6 million people are registered users with over USD90
million transacted every month. Although Indian banks have started teaming
up with mobile operators for providing banking services to unbanked people,
banking regulations do not permit a lead role for telecom companies in India.
1 Financia l Inclusion and Financial Literacy Indian Way,
Dr. KC Chakrabarty, RBI
Our experience shows that the goal of nancial inclusion is better served
through mainstream banking institutions as only they have the ability to
offer the suite of products required to bring in effective/meaningful nancial
inclusion.
The development of the habit of banking would lead to an increase in savings
and investment improve the efciency of allocation of capital and increase the
ability of monetary authorities to stabilise the economy in times of crisis.
Deepali-Pant Joshi ED, Reserve Bank of India
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Way forwardA meaningful FI could be achieved only
through a collaborative effort of all the
stakeholders involved. Policymakers
could help provide a facilitating policy
framework, infrastructure support and
enabling environment whereas serviceproviders should experiment with
different models to serve the unbanked.
Further, there has to be collaboration
among service providers with nancial
institutions partnering with telecom,
technology, and consumer product
providers to create an enabling
environment.
Government and regulators
initiatives
RBI has already made it very clearthat the new banks, that will be given
licenses, have to open one in four
branches in rural areas. Premises of
allowing new banks in the sector is to
reach out to the bottom of pyramid.
Improve Financial Literacy:The
GoI and RBI should put in place a
country-wide strategy to provide
nancial education using standard
literacy material both as part of the
school curriculum and as a part of
the kit to educate adults.
Aadhaar card:The nation-wide
initiative to provide a unique
identier to every Indian, could be
integrated with the service delivery
mechanism. It could help address
the main issue of complying with theknow your customer (KYC) norms
that banks perceive to be probably
the biggest hurdle in expanding
their reach. Successful integration
of Aadhaar with banks database
would also allow banks to have a
360 degree view of their customers
to better manage risk and cross sell
more services.
Bankers initiatives
Simplicity is the key:Due tonancial ignorance, developing
simple easy to understand product
for the rural population is the key to
success.
Leverage technology to develop
innovative operating models:As
discussed above, technology-based
initiatives are leading examples for
success in FI. BC channels and other
low cost delivery models such as
mobile banking would help bankers
reach out to the bottom of pyramid.
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Micronance sector has been quite
successful (As a sector we reach
around 2.5 crore women in India) to
take nancial products to poor andexcluded but fallacy is that we are not
considered an important channel of
nancial inclusion as a very important
nancial service i.e. acceptance of
credit is beyond purview of MFIs.
There is no reason to undervalue
the potential of this channel, before
looking to some other industry for
solution.
Chandra Shekhar Ghosh Chairman & MD,
Bandhan Financial Services Pvt. Ltd.
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Traditionally banks havebeen the pioneers inharnessing new technology
trends. The applicability ofMoores law in the areas oftelecommunication, internet
and mobility were signicantenablers for banks in achieving
two extremely importantbusiness objectives revenue enhancement with
cost efciencies. In existingtimes, the nancial servicesindustry is keenly exploring
the transformation potentialof the new generation of
technologies availablelike Social media, Mobile,Analytics and Cloud (SMAC).
The increased commoditizationof service offerings from bankshas placed incessant demand
on them to adopt variable coststructures, increase revenue,improve products and services,
expand market share andachieve nonlinear revenue
growth.
The Indian banking industryhas to its credit a number
of innovations, many of
them driven by technologyinvestments.
SMAC - Future oftechnology
The Indian Capital Markets sector moved to a T+2 settlement cycle, long before
many developed economies. Similarly the introduction of NEFT and RTGS were
watershed moments in Indias payment landscape which enabled a signicant
shift to electronic payment forms at a lower cost. The Pan India UID program when
linked to nancial transactions is expected to signicantly plug the current leakages
in Government welfare schemes.
In the current environment, the key focus areas of bank are lowering cost of
funds, faster rollout of products achieving nancial inclusion and priority sector
lending targets in a protable manner, compliance with various national and global
regulatory norms and increased customer satisfaction.
Social mediaSocial media can be used as an effective tool to interact with the customers
regarding queries and complaints. Once the queries or complaints have been
posted on the social media page, the nancial institution representative can address
it in a timely fashion. If the activity requires any exchange of sensitive information,
the nancial institution may contact the customer directly using a secured channel
of communication. Hence, social media can be efciently used as the rst level ofquery resolution and as this is a non core activity which is moved away from the
branch and other delivery channels, it leads to cost savings for the rm.
Social media, being multidirectional, allows customers to convey sentiments
regarding the rm. Therefore, it would be prudent for nancial institutions to
have presence on social media to gauge the attitude of the customers. In case of
public airing negative sentiments, the nancial institution can act swiftly thereby
containing the issue.
The fundamental use that a social network can serve a nancial institution is
brand awareness. Financial institutions can engage the users of social media in
different ways such as by displaying special offers and discounts, asking questions
or conducting polls, displaying industry related news and opinions, etc. Engaging
the social media users effectively can result in increase in brand awareness at a
signicantly lower investment compared to mainstream media.
However social media is considered to be unchartered territory under the
apprehension that it is still evolving and it would be prudent to engage only after it
has reached a mature stage.
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MobilityIn a land where almost a billion people
own mobile phones, cash is still king
and large swathes of the population
have no formal bank account, mobile
payments are quickly becoming a critical
part of Indias economy. Mobile phonepenetration is booming and while
levels have not quite reached that of
some Asian or European countries few
people in either the cities or the furthest
reaches of the countryside are without
some level of access to a mobile phone.
Banks, on the other hand, are few and
far in between; in fact, it is estimated
that only about a quarter of all Indians
have a bank account, while more than
60 percent own a mobile phone. Faced
with these dynamics, it does not takelong to realize that mobile payments will
ultimately bring transformation to not
only the payments industry, but society
at large.
One of the most promising signs of
Indias leadership in mobile payments
comes from the high level of
cooperation within the industry itself.
On both the banking and the telecoms
sides, we are seeing players come
together and put aside their competitive
differences in order to develop commonstandards and approaches to mobile
payments. All stakeholders - banks,
telecoms operators, technology
providers, regulators and government
organizations - have created the Mobile
Payments Forum of India (MPFI), and
are collaborating to address the market
needs.
As a result, India has witnessed the
ascendency of two initiatives that,
together, are accelerating growth of
the mobile payments market. InterbankMobile Payment Service (IMPS) - a
platform developed by National Payment
Corporation of India is already adopted
by more than fty of Indias banks to
offer instant payment and remittance
services using SMS, WAP, and a range
of mobile apps.
CloudThe advent of cloud computing has
resulted in the dismantling of traditional
cost structures. It enables organizations
to shift from a CAPEX heavy model to a
variable cost model. Software licenses,
servers, networking equipments,
storage devices are typically considered
to be the key CAPEX components. In
a cloud model, the bank pays for what
it needs when it needs it. Cloud also
allows a bank to scale its business
operations.
Using cloud services, it is easier
to collaborate with partners and
customers, which can lead to
improvements in productivity and
increased innovation. Cloud-based
platforms can bring together disparate
groups of people who can collaborate
and share resources, information and
processes.
The ability to respond to rapidly
changing customer needs is a key
competitive differentiator. Likecompanies in other industries, banks are
continuously seeking ways to improve
their agility and adjust to market
demands. By enabling businesses
to rapidly adjust processes, products
and services to meet the changing
needs of the market, cloud computing
can facilitate rapid prototyping and
innovation, which helps speed time to
market.
However the adoption of cloud in banks
has not achieved the scale that wasoriginally envisaged. Security and Data
Privacy concerns are attributed as some
of the key reasons for this. Additionally
banks are also concerned by risks of
provider performance and downtime.
The tax implications of using cloud
services are also one area that some
banks seek clarity on.
AnalyticsThe role of analytics has evolved from
being a simple support function to that
of a key business differentiator.
Analytics today can be effectively
deployed at every stage of the
consumer lifecycle. The Know your
customer (KYC) activity in the customer
onboarding process is increasingly
dependent on analytics tools to identify
the right set of customers. Anti-money
laundering (AML) monitoring is another
aspect where complex algorithms are
used to identify reportable transactions.Similarly consumer spend analysis can
assist banks in identifying cross sell and
up sell opportunities. Loan originators
and servicers can differentiate
themselves in the marketplace with
superior underwriting techniques and
sophisticated models that can predict
potentially non performing portfolios
with a high degree of accuracy.
Analytics also is playing a signicant role
in optimal product pricing.
The banking industry is replete with
examples of retail banking service
providers that have harnessed the
capabilities of analytics. As the banking
industry gets more complex, analytics
is forecasted to have a even more
signicant play.
Way forwardThe collective usage of SMAC has
a multiplier effect on the benets
delivered. These tools can be applied
at different stages of any typical
banking process. For example, the
data generated by users social media
postings can be coupled with location-
based data from their mobile devices,
which can, in turn, be analysed in
real time on a virtual cloud platform.
The explosion of data and analytics
technology allows banks to store,
manipulate, and analyse greater
volumes of data and extract meaningfulinsights about customers preferences.
This comprehensive view of the
customer can be used to effectively
engage existing and potential
customers through tailored marketing
strategies. Services and products can
be presented based on customers
preferences. Individualised sales and
marketing strategies can help banks
target different customers for easy
mobile deposits, mortgage loans, small
business loans, and so on.
Ultimately, this granular, 360-degree
customer view made possible through
SMAC technologies can improve the
loyalty of existing customers, help
banks engage these customers in new
services, and increase the market share
for banks by attracting new customers.
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Banks have long faced the riskof losses from undesirablemarket movements. This
signies that institutionsshould have the best possibleapproaches to understand,
model and manage marketrisk and to estimate capital
reserves they need to provideas buffer against their marketexposures. As Indian banks
moves towards the Value atRisk (VaR) based approachto capture trading book risks,
this chapter captures someof the challenges banks need
to focus on before the banksmigrate to the new regime.
Hedging themarket risk
The trading book supervisory regime introduced in 1996, requires nancial
institutions to measure risks resulting from the transactions held in their trading
book and to cover market risks by regulatory capital. Market risk includes: interest
rate risk, equity position risk, settlement and counterparty risk and foreign exchange
risk. This regime offers rms the use of either a standardised approach or an
internal models approach to calculate the capital requirements associated with the
trading book. Most of the internationally active banks favour the internal modelsapproach, built on the Value at Risk (VaR) methodology. Both the general risk, arising
from general market movements, and the specic risk, related to changes in the
credit quality of issuers, to be covered by adequate capital.
During the 2008 nancial crisis it became evident that many banks had built up
materially undercapitalised trading book exposures. The revisions introduced under
Basel 2.5 aimed to reduce cyclicality of the market risk framework and to increase
the overall levels of market risk capital held by banks, particularly for those areas
exposed to credit risk. It introduced measures through incremental risk charge
(IRC). However, regulators are still of the view that the market holds inappropriate
levels of capital with regards to the Trading Book. The Basel III requires banks to
carry out Credit Valuation Adjustment (CVA) capital charge to protect themselvesagainst the potential mark to market losses associated with deterioration in the
creditworthiness of the counterparty, if the deals are done in OTC market.
Complete assessment of risks in trading bookIn addition to the increase in default risk, the growing presence in trading book,
of corporate bonds and structured products, which are generally less liquid, has
resulted in an escalation of certain types of risk. The latter, which include liquidity
risk, concentration risk and correlation risk, are not fully addressed in current
regulations on market risk.
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Going forwardThe Basel Committee is also
considering replacing Value at risk
(VaR) measurement by expected
shortfall (ES). ES is a method of
measuring the riskiness of a position by
considering both the size and likelihoodof losses. ES has advantages over VaR
as it captures tail risks.
The current volatility in Currency
Market is clear demonstration of
how abruptly market conditions and
volatility can change. In fact far from
extreme events, the high volatility has
become almost a part of the normal
market conditions. Being concerned
about the situation, RBI in a draft circular
last month, has put the onus to banks
on measuring the effect of volatilityto its corporate clients. Based on the
impact on the earnings of its clients,
banks have to enhance the provisioning
requirements and in high volatile
cases (where earnings are affected
by over 70 percent) the risk weights
to corresponding client increases by
25 percent. With the current volatility,
decline in asset qualities and new
capital norms (Basel III), many banks
are looking to raise fresh capital. The
banks also need to strengthen theOversight Board to review the trading
book positions and take appropriate
actions swiftly to save the interest
of the institution. To aid the process,
strong technology platform along with
appropriate analytics are essential pre-
requites.
But if the cost of doing business
remains high the business could simply
be switched into unregulated or more
lightly regulated institutions such as
hedge funds. Perhaps the pendulumis shifting too far to the side of
conservatism and will make traditional
banking difcult and bring about newer
models of delivery of nancial products
in the global economy.
Liquidity risk
The liquidity of a nancial instrument
plays a key role in determining the
holding period for a bank of such an
instrument and therefore in assessing
the regulatory capital requirement to
which it is subject. In general, credit risk
in the trading book is subject to lower
regulatory capital requirements than
in the banking book. The difference
in capital can be mainly attributed to
the different time horizons on which
the risks are assessed: one year for
credit risk (corresponding to a horizon
for estimating the probability of default
of the issuer) and ten days for market
risk (corresponding to a horizon for the
closing out or hedging of positions).
The preferential treatment granted tothe trading book can be ascribed to
the fact that the positions are held for
short-term sale and they can be easily
unwound or hedged on the market.
However, in practice, this is often not
the case. Many of the instruments held
by the bank in trading book may not be
very liquid. The market liquidity also
varies according to economic cycles.
Nevertheless, the assumption that
positions can be closed out or hedged
within ten days, which is currently
used as a basis for calculating capitalrequirements using Value at Risk
(VaR) models, may prove inappropriate
for the increasingly frequent case of
illiquid positions. The inclusion of such
positions in the trading book therefore
generally results in insufcient capital
requirements.
Concentration and Correlation risks
Concentration risk is another risk, which
is not captured appropriately by the
institutions. Indeed, most corporatebonds include the same names in
their reference portfolio, giving rise to
concentration risk on an entity and/or a
sector associated with their widespread
use in institutions active credit portfolio
management.
Another, correlated risk, which needs
to be captured, is correlation between
different risk types (credit, interest,
currency, equity risks). An increase in
trading in such instruments, mispriced
in relation to the real risks incurred,would constitute structural risks.
Economic capital andstress testingTo overcome some of the challenges,
one of the solutions the leadings banks
have been considering is to developing
tools for calculating economic capital,
which will integrate credit and marketrisks and their different components.
Economic capital for all types of risk
is generally calculated at the one-year
horizon with a condence interval
determined by the bank on the basis of
the probability of default corresponding
to its current or targeted rating. While
the main tool for measuring economic
capital associated with market risk
often remains a VaR calculation based
on a 10-day holding period, some
regulators have devised complementaryapproaches using stress testing and/or
scaling up the VaR to reect a horizon
for closing out or hedging positions
assumed to exceed ten days.
Furthermore, although modeling credit
risk correlations is not as yet common
practice, progress is being made in this
area. Some models now incorporate
contagion effects, which allow banks
using them to capture the impact on
credit risk from declines in overall
market liquidity, the failure of large rmsor adverse industry-level developments.
Such approaches make it possible to
better take into account extreme or tail
risks as well as liquidity risk.
Banking supervisors, in addition to the
increase in the current VaR multiplier
and/or considering stress scenarios,
will enhance the review and the
assessment of the methods developed
by banks to calculate and monitor their
economic capital modeling.
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Banking turf is set to change.The RBI had set the ball rollingwhen they opened the stage
with the intention to handout licenses to new entrants.Undoubtedly, the ofcial
reason was to bring a largenumber of hitherto unbanked
and under-banked populationin the formal nancial system,but how many aspirants will
be allowed to get into the ringis RBIs prerogative. In 1993,when the RBI licensed some
private banks, it received 113applications but only 10 banks
got the license1.
Till now, `nancial inclusionwas the responsibility of
public sector banks but byusing inclusive growth asthe base for licenses, RBI has
made private sector banksequally responsible in socialobjectives. As one can see
from the table, currently,public sector banks have more
branches than any other bankgroup in the rural and semi-urban areas.
Merit inbanking on new
licenses
No. of branches of Scheduled Commercial Banks as on 31st March, 2013
Bank Group Rural Semiurban Urban Metropolitan Total
Public Sector 23286 18854 14649 13632 70421
Private Sector 1937 5128 3722 3797 14584
Foreign Banks 8 9 65 249 331
Regional Rural
Banks12722 3228 891 166 17007
Total 37953 27219 19327 17844 102343
Source: Department of Financial Services, June 2013
One can argue, whether new banks are required in the Indian banking sector. If we
look at statistics, India being one of the top 10 economies of the world and with
relatively lower domestic credit to GDP percentage provides great opportunity for
the banking sector to grow. Indian Banking is expected to become 5th largest by
the year 2020 and 3rd
largest by the year 2025. Banking credit is likely to grow at ~17percent CAGR in the medium term leading to increased credit penetration.
1 Indias Aspiring Banks Line up for Licenses, January 17,
2013 in India Knowledge@Wharton
A large portion of rural populations still remains unbanked. Any new banking
aspirant should create a business plan which will provide banking facilities
and services for the bottom of the pyramid.
This is a difcult task, so only those who are able to understand this specic
market should establish rural branches, lest their portfolio may become sub-
optimal and operations saddled with high cost.
Hemant Kanoria CMD, SREI Infrastructure Finance Ltd.
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In fact, rural and semi-urban areas
are still under-penetrated with
banking services and with increasing
consumption they provide great
opportunity for banking services to grow
in these areas.
As per Census 2011, 58.7 percent
households are availing banking
services in the country2. There are
102,343 branches of Scheduled
Commercial Banks (SCBs) in thecountry, out of which 37,953 (37
percent) bank branches are in the rural
areas and 27,219 (26 percent) in semi-
urban areas, constituting 63 percent of
the total numbers of branches in semi-
urban and rural areas of the country.
However, a signicant proportion of the
households, especially in rural areas,
are still outside the formal fold of the
banking system. New banks would help
in inclusive growth.
Lets assume that licenses have been
handed out and new entrants are in a
competitive space, face-to-face with
strong opponents that have been in
the industry for eons. What will they
do differently to succeed? The answer
will denitely depend on the motive
behind the banking application but can
they survive by just being another bank?
Each one of them has to differentiate,
make a mark and establish a brandamongst hordes of other brands to
ensure success. They have to manage
the lending risk to ensure their success.
Past experiences show that not all
banks that got licenses have survived
the grit and determination to scale
businesses.
The banking sector has had rough years
since Lehman in 2008 but there is still
lot of scope for new entrants in the
private sector. What has attracted the
new entrants to this sector? Economistsare positive that the dark clouds
hovering over the Indian economy
will move away and it will move to 7-9
percent growth orbit in the next 10
years. In the process of growth, banking
sector will also benet and grow further.
Apart from the fact that the
opportunities are in galore in the banking
sector (current and future), the ROA for
private banks was 1.31 percent for FY13
as compared to 0.73 percent for PSBs
in the same period.3The average netNPAs to net advances for public sector
banks as on FY13 was 1.99 percent as
compared to 0.84 percent for private
sector banks.4
2 Department of Financia l Service, June 2013
3 The average ROA for private sector excludes Ratnakar
Bank and City Union. Source: Capitaline
4 D Subbarao speech on Banking structure in India on 13th
August, 2013
Banking credit is expected to grow at CAGR ~17% in the medium term (INR Bn)
Source:RBI, KPMG in India analysis
Signicant head-room for growth
Domestic credit to GDP (% 2011)
Source:World Bank report 2012
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Rural branches as the nal frontier
Along with the above requirements,
RBI requires new banks to open
one in four branches in rural areas.
However, various challenges inherent
in rural nance have led to inadequate
access to nancial services for therural population. How the new banks
maneuver around the high risk and
operational cost would be of great
interest to the stakeholders. Rural
economy is largely a cash economy,
which adds to the complexity and risk
of operations. New banks with strong
rural strategies, cost-effective operating
models, branches in tier-5 to 6 cities,
strong alliances with MFIs and BCs with
proper governance control and local
market knowledge would spell successin the rural areas.
Learning from the past to secure
future!
The RBI is cautious about the new
banks as they are concerned about
depositors money; therefore, they will
review all the banking licenses from a
t and proper angle. There is no doubt
about the fact that governance and
strong risk management processes will
get priority when the RBI is deciding onlicenses. Post license, new banks have
to adhere to strong risk management
processes to ensure that there are
no lapses in the regulatory norms and
they are not the reason for triggering
systemic risk in the banking system.
ConclusionOperating in the niche area protably
and creating a viable business would be
the key concern for all new bankers as
they have to adhere to all the statutory
reserve requirements that may affect
their credit availability:
SLR (Statutory liquidity ratio)
currently at 23 percent
CRR (cash reserve ratio) norms
currently at 4 percent
Banks have to be Basel-III
compliant.
Banks have to lend 40 percent of
their advances to the priority sector
Dynamic Provisioning.
The new governor, Mr. RaghuramRajan, has indicated that the bank
licenses would be handed out before or
within January 2014. How new banks
would change the enviornment would
be of interest to all stakeholders.
Success of new banks would depend
on:
Sectoral expertise/ knowledge
The new players have to make their
mark on customers who already are
banking with other eminent players.
What will set them apart? Whatwill ensure success for new banks?
Sectoral expertise/ knowledge based
on products (asset-based nance,
commodity-based nance), on industry
(engineering, infrastructure, telecom,
media, technology etc), nature of
their work (transporters, distributors,
exporters, importers etc) or on
geography (North, South, East or West)
will denitely put them ahead of the
race and help them attain consumers
trust.In case of retail, asset-backed lending
applicants who have an edge with their
customer base, loan book and sectoral
knowledge would be ahead in the race
as opposed to other applicants who
have to start from scratch. The transition
from an NBFC to a bank will depend
on strong management as they would
be moving in new businesses with
uncharted risk areas.
Customer segmentation is the ke