FINANCIAL SERVICES IN INDIA

BANKING INDUSTRY

KHUSHAL PURIRAHUL AGARWALSOURAV MISHRA

Structure of the Banking Industry

Policy and Regulation Framework for Banking System

Evolution of Banking Reforms in India

Evolution of Banking Reforms in India … contd.

Market size

India’s banking sector is dominated by public sector banks, i.e. 65% of the Gross credit suppliers.

The Bank credit market in India is lower than the global benchmark on account of lower penetration in the rural areas and tier-3 cities. Higher credit % reflects higher financial inclusion. This clearly reflects that lower PCI of rural areas has not attracted banks to service them.

World average: 169.8%

Market size and Cost of Intermediation

Cost of Intermediation still remains higher than other countries due to small ticket size, regulatory cost associated with SLR, CRR and PSA (Priority Sector Advances) on account of Hawkish monetary policy to contain recent inflationary pressure.

Population Group-wise distribution of Deposits and Credits of SCBs

Deposits Maturity Profile

The recent decrease in the FD seen from 2009-10 was because of slashing of rates by the larger banks.

The short tern nature of deposit in New-Pvt Banks and Foreign Banks will make it difficult to finance the infrastructure loans under the BOT contract method.

Credit composition

The Advances to Agri-sector decreased over the last year owing to the increase of NPA from the sector.

The Retail Advances is slowly picking up due to hint of consolidation and approval of FDI investments.

Textile investment has soared because of import of new technology and expertise, the industry is set to triple its size by 2020 .

Key Drivers for Growth

Infrastructure investment in 11-th Five year plan was around 20 lakh crore. Private participation was 36.8%.

The investment in 12-th plan is set to be around 40 lakh crore. Private participation is expected to be > 45%.

The private bank lending to Infrastructure projects is set to increase due to less risky profile of BOT projects and higher yield compared to G-sec.

CAGR of credit to Power sector was 35% as compared to overall credit CAGR (over last 3 yrs) of 23%.

Key Drivers for Growth….. Contd.

The SSI NPA increased due to working capital crunch.

The Agri-sector NPA decreased initially due to waiver of loans by the Govt. but rose as the impact receded.

The sharp increase in NPA of the retail was due to adverse credit selection during the expansionary phase.

The sharp increase in NPA of Foreign Banks during 2008-10 was on account of aggressive lending for purchase through credit cards and consumer durables.

Key Drivers for Growth….. Contd.

The average CRAR is comfortably placed above 9% Basel-II norms.

The financing by the Govt. through the World bank to increase the CRAR of banks cloase to the base value.

Return on Advances adjusted to CoF is more than All SCBs average for Foreign and Pvt. Banks that reflects their higher capability/efficiency.

The increase in CASA ratio from 2008-09 to 2009-10 was because of shifting of funds from FD to CA and SA owing to the decrease in long-term interest rates. High CASA ratio leads to low cost of funds .

Profitability Pattern and Trends

RONW in Public Banks is higher because of high leverage.

C-I ratio for Pvt. Banks are higher on account of high advertisement cost and rent charges.

Higher NIM for Pvt. Banks because of increase in growth of deposits and lower NPAs resulting in higher interest income.

The public bank on an average have a lower exposure to the fee-based sources of revenue.

2007 2008 2009 2010 2011

Financial Inclusion

The PSA is seen to be lower than the base value of 40% because of decrease in direct lending and buying loans from RRBs or MFIs to meet the shortfall.

More than 50% of the Public banks surveyed fell short of the min PSA requirement (40%). The ratio was higher for the Private sector in the weaker section advances. Very few of the FBs fell short of their 32% target in PSAs. CBs lending are higher because they facilitate their lending to Agri-sector through KCCS.

Performance Index / Return to shareholders

Since Apr-2008 SBI ICICI PNB SENSEXAvg Annual Return 5.64% 5.06% 22.44% 1.79%

Post financial crisis monetary policy was eased. During recovery, banking sector outperformed other major industries (because of higher investment in Infrastructure sector; Government spent heavily in that sector)

Key Players in Indian Banking Sector

Name of BankCredit Portfolio as

in March-11(Rs. billion)

Market Share (%)

NIMs (2010-11)

Tier I Capital % as in March-

2011

Return on Net worth

(2010-11)

Gross NPA % as in

March-2011State Bank of India 7,567 16.44% 2.90% 7.80% 13% 3.30%ICICI Bank 2,164 5.51% 2.30% 13.20% 10% 4.50%Punjab National Bank 2,421 5.17% 3.50% 8.40% 24% 1.80%Canara Bank 2,125 4.36% 2.60% 10.90% 26% 1.50%Bank of Baroda 2,287 4.17% 2.80% 10.00% 24% 1.40%Bank of India 2,131 4.12% 2.50% 8.30% 17% 2.20%HDFC Bank 1,600 4.10% 4.20% 12.20% 17% 1.10%IDBI Bank 1,571 3.50% 1.80% 8.10% 16% 1.80%Axis Bank 1,424 3.35% 3.10% 9.40% 19% 1.10%Central Bank of India 1,297 2.79% 2.70% 6.40% 18% 2.20%Total Banking Sector 42,874 100% 2.90% 9.70% 17% 2.30%Source: Annual Reports

Financial details of top 3 cos in terms of Mcap

Name of Bank Profit / Emp (Cr.)

EPS GrowthYoY % EV/EBITDA P/BV P/E CD Ratio (%) Int Expended/

Int Earned %State Bank of India ( Pub) 0.04 -10.22% 17.07 2.70 21.92 79.90% 60.04%ICICI Bank (Private) 0.10 24.08% 17.68 2.33 25.90 92.97% 65.28%Punjab National Bank (Pub) 0.08 13.48% 16.07 1.93 8.95 76.25% 56.25%

Key Players – Performance Analysis

Private Banks, though low in market share, have over-performed the Public banks in terms of EPS growth. PNB has emerged as one of the highly efficient among Public banks.

Industry Concentration – Herfindahl-Hirschman Index

Company Name NoC Full Year Data (Rs. Cr) Year ended - 2011-Mar

Price Information as on 30-09 -2011

Equity SalesSales MCAP NP LTP Eq MCAP

Banks - Public Sector 28 14253.7 426935.4 72.18% 46774.6 3,22,178.15Bank of Baroda 394.28 24,695.10 4.17% 4,241.80 764 30,122.99Bank of India 546.48 24,393.50 4.12% 2,488.71 316 17,268.77Canara Bank 443 25,767.04 4.36% 4,025.53 444 19,669.20Central Bank 646.61 16,485.61 2.79% 1,252.48 102 6,595.42IDBI Bank 984.61 20,684.47 3.50% 1,652.14 103 10,141.48Punjab Natl.Bank 316.81 30,599.06 5.17% 4,431.46 952 30,160.31St Bk of India 634.99 97,218.96 16.44% 8,274.75 1,911 1,21,346.59Banks - Private Sector 116 37944.6 164578.7 27.82% 25857.9 3,34,906.27Axis Bank 412.32 19,786.94 3.35% 3,392.82 1,021 42,097.87HDFC Bank 467.41 24,263.36 4.10% 3,926.90 467 1,09,140.24ICICI Bank 1,152.32 32,621.95 5.51% 5,120.00 875 10,08,280.00Source: www.capitaline.com

All 144 Banks Top 10 in Sales

HHI (Sales) 494.95 428.73 (87%)

Concentration Ratio (Top 10 Cos.) 53.51%

Rest 21 Public banks accounts for 31% of MCAP.

Since the HHI of top 10 cos is 429 compared to overall industry value of 495, the Bank industry in India seems to be Oligopolistic market.

Due to the unavoidable service requirement of financial intermediation and high regulations the industry is not attractive to Pvt. plalyers. The Fee based services of banks is still in nascent stage.

Recent significant and important changes in policy

Implementation of BASEL I in 1992 Movement to Market based Exchange Rate Regimen in 1993 Legislative Amendment to allow Public Sector Banks to raise Capital Funds

from Market Abolition of Automatic monetization in 1997 by replacing “Ad-hoc

treasury bills” with “Ways & Means Advances” FERA replaced by FEMA for better management of Foreign Exchange Introduction of “Liquidity Adjustment Facility” Introduction of “Market Stabilization Scheme” to absorb access liquidity

created by RBI’s foreign Exchange Operations BASEL II implemented completely in 2007 Shift from BPLR to Base Rate in 2010

M. Porter’s Five Forces Analysis

> Read Speaker’s Notes

Current Outlook: Inverted Yield Curve & Asset Liability Mismatch

Maturity (Yrs)

Maturity (Days)

Mar-11 Apr-11 May-1106-Jun-11

07-Jun-11 Jul-11 Aug-11

0.997 363.998 7.846 7.852 8.512 8.196 8.608 8.592 8.555

9.992 3646.984 8.166 8.081 8.235 8.376 8.334 8.415 8.375

Spread (bps) 32 23 -28 18 -27 -18 -18

In developing countries, like India, the inverted yield curves are true reflection of Inflationary pressure and the effectiveness of the Hawkish monetary policies to contain the inflationary expectation in future. Because of the high interest rates, the short-term deposits seem to be high than in the long-term G-sec. Lower deposits in long-term bonds can also exacerbate ALM.

Challenges before Indian banking Sector

• Increased stress on Infrastructure Sector may bring down the actual investments because of the recent weakening signs of the economy which can stall the infrastructure projects.

• The urge to Merge: The SBI is the only bank to feature in the list of Top 100 banks, the rest of them are too small compared to the global average.

• Competition I Retail Baking: The new private banks have made this a lucrative sector and the PSBs are still playing catch-up

• Risk Management: Higher revenues will be driven by higher advances so a sound risk management mechanism will be necessary

• Stringent regulation and Micro-management by regulators• Redressal mechanism for customer grievances• Financial Inclusion: The need to tap the income savings of rural India and bring

them into the financial market.

References

• Khan M Y , Indian Financial System, Tata Mcgraw Hill, 2010• Jyoti, Ajay and Manoj, Banking outlook-CRISIL Research Report, CRISIL, 2011• www.data.worldbank.org/indicator (World bank database Indicator) • https://www.cia.gov/library/publications/the-world-factbook/ (CIA Fact Book)• http://www.capitaline.com/ (Capital-line database)• www.rbi.org.in • www.bseindia.com• www.planningcommission.gov.in• www.mckinsey.com• www.indiastat.com• ISI Emerging Market