Commercial Bank Management

PGSEM and PGPDecember 09-February 2010

This course is focused on…

• Functional aspects of commercial banking– Liabilities management– Credit management– Capital adequacy management– Investment management

• Risk management– Liquidity risk management – Interest rate risk management– Credit risk management– Operational risk management– Risk capital allocation Indian Banking policy and the environment is the backdrop of the

course

Scheme of Evaluation • Three quizzes (30%)- quiz dates-16th September, 30th

September, 14th October • Assignment-2 (25%)• Final test (45%)

Banking Sector in India :An Overview

Evolution of Indian Banking

• Post-Independence(1947-69): Monopoly, concentration of economic power

• Nationalization(1969): Social control, directed credit • Financial sector reforms(1992): Competition,

deregulation• Consolidation(2001): Universal banking models, mergers

etc… • Financial inclusion, Leveling the playing field (2008):

Indian Banking (1947-1970)

• Government take over of RBI(January 1949)• Enactment of Banking Regulation Act 1949• Committee on Rural Credit Survey(1951)The Committee

recommended one strong integrated state partnered commercial banking institution to stimulate banking development in general and rural credit in particular.

• The Imperial Bank of India was taken over by the Government of India and called as State Bank of India in 1955

• Nationalization of private banks in 1969 and 1980

Impact of Nationalization(1970 to 1992)

• Substantial increase in banking business in terms of per capita branches, deposits, and deployment of credit.

• Penetration of banking activity to rural and semi-urban areas

• Excessive focus on quantitative achievement and social obligations, often at the expense of achieving profitability and efficiency

• Capital base was eroded• Rise in quantum of bad Loans• Poor customer service

Indian Commercial banks: At a glance

  Jun-69 Mar-80 Mar-92 Mar-07

Number of Commercial Banks  73 75 77 82         

Number of Bank Offices in India 8262 32149 60570 73836Rural 1833 15105 35269 30560Semi-urban 3342 8122 11356 16484Urban 1584 5178 8279 13840Metropoliton 1503 4014 5666 12952         Deposits (Rs in millions) 46460 426528 2654629 26969803Advances (Rs in million) 35990 270081 1598078 19812163         

Deposits of Public Sector Banks NA 391841.9 2358874 19941995.8

Advances of Public sector banks    248876.2 14401229 14401228.9         Percentage of  Deposits of Public sector banks   92% 89% 74%Percentage of  Advances of Public sector banks   92% 90% 73%

Financial Sector reforms: A beginning

• Chakravarthy Committee Report (1985) and Vaghual Committee(1990) brought some changes in the financial markets. The innovative instruments like Treasury bills, CPs, CDs have become new avenues for banks.

• Entry of Banks into para banking services (late eighties); Merchant banking, Mutual Funds, Leasing, Factoring etc...

McKinnon-Shaw-Maxwell Fry Hypothesis

• Excessive intervention in the financial system leads to financial repression and comes in the way of financial intermediation and its contribution to resource mobilization needs to be qualified

Bank Management: Three fundamental approaches

• The accommodation principle: Banks should accommodate the legitimate credit demands of commerce, industry and agriculture

• The profit maximizing principle: • The stock adjustment principle

Profit Maximizing Principle

• Neo classical marginal principle• Banks select asset portfolio by understanding cost-

benefit analysis so as to maximize the return, net of cost, from the entire portfolio.

• It is also risk-return approach• This approach attempts to incorporate the element of

uncertainty inherently associated with decision making process

• The asset choice modeling assumes greater importance

Stock Adjustment Principle

• Banks have a desired level of each balance sheet item and they adjust the stocks of each of the variables so as to close the gap between actual and desired levels

Reforms in Banking Sector-post 1992

• Competition Enhancing Measures• Measures Enhancing Role of Market Forces • Prudential Measures • Institutional and Legal Measures • Supervisory Measures• Technology Related Measures

Implications of reforms on bank management

• How do banks manage liabilities and funds?• How to price deposits and minimise cost of funds?• How to rate the loans?• What are the risk-return characteristics of loans?• How to price the loans?• How to fix the exposure norms? • How to estimate expected and unexpected losses on

loans?• How to manage market risks?

Emerging Trends

• Deposit banking to financial services• Balance sheet exposures to off-balance sheet exposures• Capital adequacy to capital efficiency• Physical distribution to virtual distribution• Fragmentation to consolidation • Data to information to knowledge

IN D IA N C O M M E R C IA L B A NK IN G :IN S T IT U T IO N A L S E T U P

S B I a n d A sso c ia tes(8)

N a tio na lise d B an ks(19 + 1)

R R B s(1 93)

P u b lic S ec tor

O ld B a n ks(19 )

N e w B a n ks(8)

L A B s(4)

D o m es tic b a n ks F o re ig n b an ks(31)

P r iv a te S e ctor

C o m m erc ia l B an ks C o pe ra tiv e b an ks(28 05)

R e se rve B a nk o f Ind ia

Scheduled Commercial Banks

• A bank which is included under second schedule of the RBI Act. Under Section 42(6) of the Act, the RBI may include any bank after satisfying minimum criteria.

• The minimum criteria is Banks whose deposits are more than Rs. 150 Cr, they are all Scheduled Banks

STATE BANK OF INDIA & ITS ASSOCIATES

NATIONALISED BANKS PRIVATE BANKS FOREIGN BANKS REGIONAL RURAL BANKS

8

2025

29

96

Institutional Structure of Commercial Banks in India

SBI group13%

Nationalised Banks52%

Private Banks26%

Foreign Banks10%

Advances of Various Banking Groups as on 31 March 2007

SBI group23%

Nationalised Banks50%

Private Banks20%

Foreign Banks6%

Deposits of various banking Groups as on 31st March 2007

Banking Sector: Emerging Trends

Forces of change

• Competition• Deregulation and reregulation• Technology• Globalisation• Global Regulation: Basel-II

Foreign banks entry time-table

ROADMAP PRIOR TO MARCH 2005 2005-2009 AFTER 2009

Structure of foreign bank presence in India

Branches onlyBranches or wholly-owned subsidiaries

Full national treatment, including IPO, subject to 26% of paid-in capital being held by resident Indians

Aggregate FDI limit in private banks

49%74% for banks identified as distressed by RBI

74%

Foreign voting rights limit10%

Branching limit per year12

Unchanged

Proposed amendment to allow voting rights to reflect ownership level

>12 subject to RBI approval

5% foreign investment limit in private banks by individual foreign banks10% foreign investment limit in private banks by FIIs or individual corporate entities

Competition from Non-Banks

• In US, GE and Ford emerged as the largest financial services companies

• In UK, Sainsbury, Marks & Spencer and Tesco are taking deposits and making loans

• Fixed costs of entering into various markets has come down due to technology

• Australian retail giant Woolworths is launching its credit card in calendar year 2008. After that, the company would consider offering other financial services including home loans or insurance to its customers.

Year Retailer Product Provider Brand Promoted in Store

         

Jun-96 Tesco Instant Access Savings Account Natwest Tesco

Oct-96 Sainsbury Instant Access Savings Account Bank of Scotland Sainsbury

    Credit Cards    

Dec-96 Safeway Deposit Account Abbey National Abbey National

Feb-97 Tesco Instant Access Savings Account RBS Tesco

Mar-97 Morrisons Savings Account Midland Midland

Jul-97 TescoCredit Card Travel Insurance, Foreign Currency RBS, Direct lane Tesco

Jul-97 Sainsbury Mortgages Bank of Scotland Sainsbury

Sep-97 Asda Insurance Lloyds-Tsb Lloyds-Tsb

Jan-98 Safeway Instant Access Account Abbey National Abbey National

Jan-98 Sainsbury Home Insurance Royal and Sun Alliance Royal and Sun Alliance

Mar-98 Tesco Home Insurance Direct Line Tesco

Jun-98 Sainsbury Pet Care Insurance Royal and Sun Alliance Royal and Sun Alliance

Source: Andrew Alexander and Jane Pollard, Banks, Grocers and the changing retailing of financial services in Britain, JRCS, 2000

Competition from Non-Banks

• Controlling communication networks and gate ways are emerging as “brokers” directing the customers

• The loyalty of customer is increasingly broker oriented rather than ultimate producer of the product

• The possession of brand name is inspiring confidence

The 6 Cs Traditional Model Internet Enabled

Cross Sell Product driven Value driven

Connectivity Stand alone Connected

Channels Few Multiple

Consolidation LowHigh-across products and banks

CompetitionWithin Industry Outside Industry

ConvenienceShort time window 24 x 7x 365

(Source: Sanjiv Singhal (2003) Internet Banking: The Second Wave, p 43)

Impact of Technology

“The PC will be the information highway. The mobile phone will be the transaction highway”

-Kees Van Rossum, Executive Vice President, Retail Banking, Post bank

Country Bank Mobile OperatorFinland Leonia/Various SoneraGermany Deutsche Mannesmann  Direkt T-mobil  Hypo Vereinsbank Viag Interkom  LBBW MobilComItaly Banca Intesa Omnitel

 Banco di Roma/Fineco Telcom Italia

Japan Sakura Bank NTT DoCoMoNorway Den Norske Bank TelenorSpain BBVA Telefonica MovilesSweden Swed Bank TelenorEngland Lloyd's BT-Celinet  Natwest Orange

Leverage on Technology

• Operational efficiency• Customer Management• Product Management• Distribution

Consolidation

Mergers and Acquisitions: Driving factors

• Economies of Scale– Overcapacity– High cost distribution and transaction infrastructures

such as branch networks and IT platforms that lend themselves to rationalization

• Economies of Scope– Universal Banks– Barriers in product innovation leads to innovation on

distribution side• Capital adequacy requirements

Potential Industry Structure

Small Medium Large

Size

Few

Many

Financial Inclusion

• Financial inclusion is delivery of banking services at an affordable cost to the vast sections of disadvantaged and low income groups.

• As banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of the public policy.

Financial Inclusion

• The Financial Inclusion Task Force in UK has identified three priority areas for the purpose of financial inclusion– access to banking – access to affordable credit– access to free face-to-face money advice

• UK has established a Financial Inclusion Fund to promote financial inclusion and assigned responsibility to banks and credit unions in removing financial exclusion.

• Basic no frills accounts have been introduced.

Financial Inclusion: Initiatives of UK

• Credit unions have been established, accompanied by tighter regulations to ensure greater protection for investors.

• Post Office Card Account (POCA) has been created for those who are unable or unwilling to access a basic bank account.

• The concept of a Savings Gateway has been piloted. This offers those on low-income employment, £1 from the State for every £1 they invest, up to a maximum of £25 per month.

• Community Finance Learning Initiatives (CFLIs) were also introduced with a view to promoting basic financial literacy among housing association tenants.

Indicator of banking growth

Opportunity

Benchmarking of Indian Banking Sector

CountryReturn on

AssetsGross NPL to

Gross Advances CRARProvisions to

NPLCapital to

Assets1 2 3 4 5 6

India 1.0* 2.3* 13.0* 52.6* 6.4** Emerging and Developing Economies Brazil 1.1 4.3 18.5 157.3 9.2Mexico 1.2 3.8 15.2 143.7 9.1Russia 0.5* 7.6 18.5 90.8 13.6*China 1* 1.8 12.0* 134.3 5.4United Arab Emirates 2.2* 2.5* 16.2 101.5* 10.6*South Africa 1 5.1 13.5 _ 7.9* Advanced Economies USA 0.2 3.8 13.5 66.5 10.1UK -0.5 1.6 12.9* 54.6^ 4.4*Japan 0.2 1.7 13.4 25.5 3.6*France 0.4** 2.8** 10.2** 51.3** 4.2*Germany 0.3** 2.7** 12.9** 56.7* 4.5*Italy 0.3* 5.5 10.8* 46.1* 6.6*Canada 1.3 0.9 10.3 29.8 5.8Korea 0.5* 1.5 12.9 125.3 9.5 * Data pertains to 2008.

** data pertains to 2007

^ Data pertains to 2006

Note: Data pertains to 2009.

Source: Global Financial Stability Report, October 2009, IMF.

All India Average (based on 2001 Census) 59%

Kerala 89%

Bihar 33%

Nagaland 21%

Haryana, Chandigarh and Delhi 84%

UK (British Bankers Association Survey1992) 94%

Ratio of Deposit Accounts to Adult Population