Bric Spotlight Report India Banking April 2011

8/3/2019 Bric Spotlight Report India Banking April 2011

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Fast Facts

Indias banking industry has evolved over a long period ofmore than two centuries.

Despite the recent growth of private banks, the sector is

dominated by government-controlled banks that hold nearly

three-fourths of total bank assets.

Indias banking industry is considered to be very stable with

healthy balance sheets and low exposure to risky assets. The

global financial crisis did not affect the Indian banks

significantly.

Nearly 40% of the population does not have a bank account and

only 15% have borrowed from banks.

Even after sustained growth since the nineties, the share of

consumer credit remains very low in total bank loans.

The banking sector in India has a relatively high proportion of

women CEOs. The chief executives of leading domestic

lenders ICICI Bank and Axis Bank, besides the country heads

of HSBC, JP Morgan, UBS, and RBS are all women. Until

recently, two among the Reserve Bank of Indias four deputy

governors were also women.

_____________________________________________________________________________

April 2011

In 2008, when the global banking

industry was being shaken by the

tremors of the unfolding financial

crisis, only one bank in India felt

the aftershocks, and this, only

because one of its overseas

subsidiaries had made an

opportunistic bet on debt issued by

the failed investment bank Lehman

Brothers. While the marketvaluations of all the leading banks

in India slipped as equity prices

tumbled, their businesses were not

affected and their balance sheets

remained healthy.

Most domestic commentators

continue to hold up this episode as

BRIC Spotlight

Banking Sector in India: Counting on Credit Growth


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evidence of the inherent strengths of the Indian banking industry and have lauded the Reserve

Bank of India (RBI), the countrys central bank and banking regulator, for sticking with its

conservative approach. When regulators around the world were loosening their grasp over thebanking and financial services industry, RBI steadfastly held on to the strings that prevented

banks in India from making risky investments and following highly aggressive business

practices.

Though some of the countrys younger banks have fast growing asset management and insurance

businesses, the industrys bread and butter is still industrial lending. Asset Backed Securities and

Collateralized Mortgage Obligations are still unheard of in the country, while Indian lenders

warmed up to the idea of teaser rate mortgages only after the global financial crisis. So far, they

do not appear to be any worse for it.

The Indian banking industry is also well capitalized and capital ratios are above the global

average. The average tier-1 capital adequacy ratio of the Indian banking industry is above 10%,

when compared to the Basel III norm of 8.5% including the contingency buffer. The average

total capital of banks in India stood at 14.5% as of March 31, 2010, compared to the Basel III

requirement of 10.5%.

Leading Indian Banks by Assets and Market Capitalization

BankMajority

ShareholdingAsset Size

(in $ Billions)

MarketCapitalization

(in $ Billions)

StockListing

State Bank of India Government 314 36.6Mumbai,London

ICICI Bank Private 81 25.6Mumbai,New York

Punjab National Bank Government 66 7.6Mumbai

Bank of BarodaGovernment

62 7.3Mumbai

Bank of IndiaGovernment

61 5.1Mumbai

Canara BankGovernment

59 5.5Mumbai

IDBI BankGovernment

52 2.9Mumbai

HDFC Bank Private 49 22.2Mumbai

Union Bank of India Government 43 3.7Mumbai

Axis Bank Private 40 11.6Mumbai,London

Market capitalization data based on full capitalization as on March 18, 2011

Bank Assets as on March 31, 2010; Source: Indian Banks Association


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However, it can also be argued that the cautious regulatory controls have stifled the growth of

the banking industry in India. This is the sector with the most entry barriers as the RBI has not

issued new banking licenses for well over a decade. Foreign shareholdings in domestic banks arerestricted and foreign banks have to wait years to get permission to start banking operations or

expand their network. Except for a few cases where the large banks were encouraged by the RBI

to acquire failing banks, the industry has not seen any meaningful consolidation.

As a result, while India continues to move up the ranks of the largest economies in the world,

most Indian banks are significantly smaller than their global counterparts. They are no match to

even banks in other emerging economies like China, and only one bank from India is ranked

among the global top-100 in terms of asset size. Also the cost of financial intermediation is

relatively high in India and banks enjoy wide net interest margins. Access to banking services is

poor across vast areas of the countrys rural hinterlands and as a result, more than 40% of thepopulation does not have bank accounts and only about 15% have received some form of bank

credit. The World Economic Forum currently ranks India 37 th out of 55 countries in financial

development, behind other large emerging economies like China, South Africa, and Brazil.

An industry built over more than two centuries

The origins of the banking industry in India go as far back as the 18th century but many of the

early banks promoted by groups of businessmen to finance their trading activities did not survive

long. Joint-stock banks made their entry during the second half of the 19th century and a few of

them, including Allahabad Bank and Punjab National Bank, have survived to this day. So have

several of the banks promoted by the small kingdoms during the first half of the 20th century,

which later came under the control of the Indian government. Foreign banks, including The

Chartered Bank, which came to the country in 1858, and HSBC, which followed in 1867, were

attracted to the increasing trade between India and Britain in the 19th century.

The early 19th century also saw the emergence of three large banks, Bank of Bengal, Bank of

Bombay, and the Bank of Madras, named after the three major cities that were the regional

administrative bases of the English East India Company, which ruled most of the country during

that period. Collectively called the presidency banks, they dominated the industry as bankers to

the government, and also functioned as the countrys central bank. The Imperial Bank of India

was established during the first half of the 20th century by the merger of the presidency banks,

and gave up its role as the central bank only after the Reserve Bank of India was formed by the

British government in 1935. It was subsequently renamed the State Bank of India after India

became free from British rule in 1947.

Interestingly, one of the earliest banking industry crises in India was triggered by the American

Civil War. As cotton supplies to Britain from the U.S. fell sharply after the war started in 1861,

demand for raw cotton exports from India surged. To exploit this opportunity better, some cotton


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owned. They remained so forcontrol of more than a dozen

banking industry came under

continued in 1980. The indust

when the government decided

Though the entry and growth

Indian banking industry, the g

command nearly three-fourth

the branch network.

However, the new private ban

utilizing technology to integr

been more aggressive in expl

Some of the largest private ba

asset management. Their stro

the leading private banks attra

balance sheet size.

Banking regulation remains

As in most countries, the centthe Reserve Bank of India is

government still drives the br

for foreign investments in the

While the Indian government

over the last two decades, it h

Accordingly, the aggregate fo

49% to 74% only in 2004, but

Private

Sector Banks

19%

Foreign

Banks

7%

Government-ControllePercentage Share o

traders set up b

export trade. H

ended in 1865 aU.S. resumed, d

cotton also reve

levels. Traders

inventories and

financed them

At the time of I

almost all majo

State Bank of In

the next two decades until 1969, when the fef the largest banks in the country. More than

government control after the forced acquisiti

ry remained closed to private promoters until

to issue new banking licenses as part of eco

of new private banks over the last two decad

overnment-controlled banks still dominate.

of the total banking industry assets and an e

ks have been far ahead of the government-co

te their network and offer more efficient ser

iting the business opportunities in the financ

nks in India are now also among the top play

g presence in the fast growing financial serv

ct far higher equity market valuations, despit

cautious

ral bank is entrusted with the role of bankingidely acknowledged as an efficient, but caut

ader policy framework for the industry, incl

sector.

has opened up most sectors of the economy t

as been more guarded about banking and fin

reign investment limit in domestic private ba

it remains at a low 20% in banks where the

Govt-

Controlled

Banks

74%

Banks DominateTotal Assets

4

nks to finance their

wever, as the war

nd exports from theemand for Indian

rted to the earlier

ho had large

the banks that

ent bankrupt.

dias independence,

banks except the

dia were privately

deral government tooknine-tenths of the

n of private banks

the early nineties,

omic liberalization.

s has transformed the

ogether they

ven bigger share of

ntrolled banks in

ices. They have also

ial services space.

ers in insurance and

ices sector has helped

e their relatively small

regulator in India andious regulator. The

ding setting the limits

o foreign investors

ncial services.

nks increased from

overnment is the


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major shareholder. The limit covers all investments by foreigners, including portfolio

investments.

In addition, the RBI has other restrictions that are aimed at ensuring wider distribution of bank

shareholding. Investments exceeding 5% of a banks equity capital by a foreign investor require

RBI approval, and a single foreign investor cannot hold more than 10%. These restrictions have

also been progressively applied to the domestic shareholders of the smaller private banks, but

some of the larger and healthier banks have been given specific exemptions. Further, no bank

can hold more than 5% of the shares of another bank, except when a bank on the verge of failure

is acquired.

The limits on foreign investment do not apply to foreign banks starting a subsidiary or branch

network, wholly-owned by the promoting bank. Like regulators in some other countries, in

granting new banking licenses, the RBI often favors applicants from countries that have

favorable policies for Indian banks seeking to open overseas branches or expand existing ones.

As a result, it may take several years for a new foreign aspirant to get a license. More than a

dozen applications from foreign banks for banking licenses now await RBI approval, including

well-known names like Goldman Sachs. The RBI has also been careful when allowing new

branches for existing foreign banks, but the number of branches approved has always exceeded

Indias WTO commitment of a dozen new branches a year.

Whats more, the RBI also has policies to direct bank credit to sectors that are deemed socially or

economically important by the government. Accordingly, all domestic banks are required to lend

at least 40% of their total net credit outstanding to exporters, farmers, small businessmen, and

low-income borrowers. For foreign banks, the requirement is lower at 32% of net credit. Limited

deposit insurance is available to customers of all banks, including foreign banks.

Though it influences the credit policies of the banking industry through specific lending

requirements, the Indian government generally has less sway over banks when compared to

select other emerging economies like China. By and large, banks in India do not boost or curtail

credit flows at the governments bidding. Though the government occasionally encourages the

banks to increase credit availability, as it did during the global financial crisis, even the

government-controlled banks are not forced to comply. This apparent autonomy, though limited

in many ways, has allowed most Indian banks to follow prudent credit standards and prevent

excessive bad loan losses. However, there have also been cases of banks being pushed to the

verge of failure by corruption and political manipulation.

Some of the leading banks have also occasionally disagreed with regulatory policies and

guidance, though the senior officers of all government-controlled banks are appointed by the

government with the consent of the RBI. For instance, the State Bank of India recently refused to


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withdraw its teaser rate mortg

dislike for such loans.

Industry structure evolving

The business composition of

decades, but the rate of chang

including construction, consti

This ratio has now come dow

consumer loans, which doubl

borrowers, the banks have the

generation projects that have

Though the growth in consu

semi-urban and even rural are

account for more than half of

increased substantially since t

Personal

Lending

19%

Farm

Sector and

Others

13%

Industrial Lending is thePercentage Share of

Personal

Loans

16%

Credit Card

Outstanding

3%

Other Loans

29%

Mortgages Form Bulk

ages from the market though the RBI repeate

at a measured pace

anks in India has seen significant changes o

has been more measured. Lending to indust

uted well over half of total bank credit durin

to 44% in 2010 and most of the decline has

d in share to nearly 20% during the same pe

most credit exposure to utilities. This reflect

ommenced construction in recent years.

er credit has been most evident in urban are

as are seeing excellent growth in this segmen

all consumer loans, as housing demand and h

he nineties. Also, rising consumer aspiration

credit demand for

automobiles and

Indian consumers

when it comes to

which has a shareconsumer loans. I

credit card outsta

recent years, thou

consumer spendin

grow.

Industry

44%

Services

24%

Biggest Segmentoan Assets

Utilities

28%

Steel

19%

Most Credit ExpoPercentage among In

Home

Mortgages

52%

f Personal Lending

6

dly expressed its

er the last two

rial borrowers,

g the mid-nineties.

been absorbed by

iod. Among industrial

s the number of power

s, in recent years

t. Home mortgages

ome prices have

are driving increased

purchasing

urables. However,

are more cautious

credit card debt,

of only 3% of allnterestingly, total

ding has declined in

gh aggregate

g has continued to

Textiles

18%

Chemicals

13%

Energy

11%

Road

Constructi

on

11%

ure to Utilitiesustrial Borrowers


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Government-Controlled Banks: As mentioned earlier, despite the rapid growth of the private

banks, the government-controlled banks continue to hold the dominant share in industry assets

and branch network. Except for some of the largest banks which have branches in most areas ofthe country, most of them have their business concentrated in a state or region. As they have

been around for a while and their brands are well-recognized, these banks are often among the

popular choices for both depositors and borrowers. The financial backing from the government

adds to their allure to depositors, and the government has consistently bailed out the failing

banks it controls, through capital infusions. Over the last couple of years, helped by a $3 billion

World Bank loan, the government has provided additional capital to several of the smaller banks.

At the same time, the government has steadfastly held on to its policy of retaining majority

shareholding in all banks under its control. This may restrict the capital raising options for some

of the banks, as the government shareholding is already close to the threshold. For instance, atthe State Bank of India, which may require the most capital as it is the largest, the government

holding is already down to 59%. Hence, the government may have to deploy additional capital if

it wants to retain majority holding of 51% or above. Without the support of institutions like the

World Bank, fiscal constraints may prevent the government from providing sufficient capital to

retain its majority shareholding.

The government-controlled banks also have pension liabilities, which are not fully recognized on

their balance sheets. These liabilities arose from a settlement with older employees who wanted

to revert to a defined benefit program, which some of them had opted out several years back in

favor of a defined contribution plan. The aggregate liabilities for all banks are currentlyestimated to be below $3 billion and banks are expected to recognize their additional liabilities

over a period of several years. New bank employees are not offered defined benefit pension

plans and hence these liabilities are not expected to accumulate in the future.

Foreign Banks are Ahead in Most Profitability and Return Ratios

Cost of Funds%

Net InterestMargin %

Return on TotalAssets %

Total CapitalAdequacy %

Government-controlled Banks

5.3 3.8 1.0 13.3

Private Banks4.8 5.1 1.3 17.5

Foreign Banks2.8 7.2 1.3 17.3

Data as on March 31, 2010; Source: Reserve Bank of India


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Private Banks: Apart from the new banks that started in the nineties, this group also includes the

older private banks, which escaped nationalization in 1969 and 1980. In performance parameters

and business style, these subgroups are distinct from each other. The new private banks haveaggressive business strategies and generate a relatively higher percentage of their total income

from fee-based services. They have also utilized technology better and some of them have

extensive financial services businesses. The older private banks, on the other hand, are more

comparable to the government-controlled banks, but they are much smaller in size.

The largest private banks have enjoyed higher equity market valuations because of their presence

in financial services, besides the perception that they are better placed to exploit the future

opportunities in the banking sector. Unlike the government-controlled banks, the private banks

have no restrictions on raising additional capital, other than the governments foreign investment

limits. They also have leaner organizations and a younger workforce, factors that are considereda distinct competitive advantage.

Foreign Banks: Though foreign banks have a long history in India, they have remained only a

small part of the banking industry. Among them, they had only 310 branches as of last year and

almost all of them are concentrated in major cities. Most foreign banks focus on business

banking in India, servicing the domestic operations of their global clients. But the aggressive

overseas expansion by some of the large Indian businesses has opened up more opportunities for

these lenders in recent years. Foreign banks derive more than a quarter of their total revenues

from fee-based services, a far higher ratio than the domestic banks. Only a handful of the foreign

banks have made serious efforts to expand their retail business.

All foreign banks in India now operate as fully-owned branches of their parents, though the RBI

has encouraged them to open domestic subsidiaries. The foreign banks have not opted for the

subsidiary model as there is some skepticism about the future policy requirements. The

Committee on Financial Sector Assessment, appointed by the RBI, recently opined that the 74%

Foreign Banks also have more Fee Income, but have Higher Employee Costs and Bad Loans

Other Income% of Total

Income

Employee Costsas % of Total

CostBad Loans

% of Net AssetsNumber ofBranches

Government-controlled Banks13.6 14.8 1.1 61,301

Private Banks

19.6 12.8 1.0 10,387

Foreign Banks27.4 23.5 1.8 310



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foreign investment limit should be made applicable to subsidiaries of foreign banks as well. If

imposed, this limit, which currently applies to only domestic private banks, will force foreign

banks to seek domestic equity partners in their subsidiaries. The committee, however, favorslisting the foreign bank subsidiaries on the domestic stock exchanges. Interestingly, depository

receipts of Standard Chartered, which is one of the largest and oldest foreign banks in India, are

listed on the domestic exchanges.

Consolidation moves stifled by employee and political opposition

Over the past several years, the Indian government and the RBI have tried to encourage some of

the government-controlled banks to gain size through mergers. Though the bank managements

have favored the idea, the bank employee unions and some political parties have vehemently

opposed it. While the resistance is mostly because of their economic ideologies, regional factors

have also played a part. Several of these banks have a strong presence in select states and the

respective state governments view the banks as important institutions, which are crucial for the

regional economy. Naturally, the state governments are wary of mergers, which may dilute the

regional focus of the banks.

These political and regional undercurrents have also prevented the consolidation within the State

Bank Group. The State Bank of India has several regional subsidiaries, which were promoted by

the former kingdoms, but were subsequently taken over by the federal government. Though all of

them are under the State Bank umbrella, each of these subsidiaries is very closely identified with

their respective states or regions. The group has been trying for the last several years to merge all

the subsidiaries with the parent, but progress has been very slow. Five more subsidiaries, of

which three are listed on the domestic exchanges, await consolidation.

Largest Foreign Banks in India Asset Size and Branches

Assetsin $ Billions

Number ofEmployees

Number ofBranches

Citibank 21 4,613 43

Standard Chartered 20 7,903 95

HSBC 206,685 50

Deutsche Bank 61,498 13

RBS 52,716 31

Barclays 51,083 7



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Consumer credit to drive fu

Like in most other emerging

despite the recent growth. A

takes away most of the p

incomes of the lower i

groups. This leaves very

earnings surplus available fo

servicing and reduces

creditworthiness, and banks

hesitant to lend to them. Hen

marketing efforts by ban

promote consumer finance prand services are now mostly l

to cities and towns where the

larger concentration of

income customers.

However, as average income

customers with sufficient ear

likely to be measured and the

consumer credit will become

made more attractive by Indiare likely to see faster income

more receptive towards new f

Even in business banking, In

of total business credit to GD

reflects the substantially larg

requirement if Indian industr

in India, while exchange risks

borrowers. Hence, it is likely

to be financed by banks.

However, it is also widely a

achieve its potential without

competition, financial interm

widely across the vast rural ar

it is believed that domestic

reports and policy statemen

references to these issues, it

ure growth in banking

economies, the share of consumer credit rem

verage income levels are still very low and

rsonal

ncome

little

r debt

their

ill be

e, the

ks to

oductsimited

re is a

higher

levels are expected to rise further, the nu

ings surplus will also grow. Though the gro

potential loan size will remain small, the ag

larger because of the large population siz

as demographic advantage of a relativelygrowth. Besides, younger customers are gen

inancial products and services.

ia may continue to offer attractive growth o

in India is less than half the level in China.

er industrial sector in China, it also indicat

sustains its growth. Bond markets remain g

reduce the attractiveness of international bo

that most of the increased industrial credit

ccepted that the Indian banking industry

further regulatory initiatives. It is evident

diation costs will remain high and banking s

eas of the country. Also, to improve efficien

anks in India need to build scale through

s by the Indian government and the RBI

is hoped that entry barriers will come down

13

10

10

12

67

96

101

30

40

42

96

96

78

- 50 100 1

Brazil

Russia

India

China

Japan

US

UK

Ratio of Household Debt to GDP

Househol

10

ains very low in India,

subsistence spending

ber of potential bank

th of income levels is

regate market size for

. This market will be

oung population, whoerally considered to be

pportunities. The ratio

While this gap mostly

es the potential credit

rossly underdeveloped

d markets to domestic

equirements will have

ay find it difficult to

that without increased

ervices will not spread

cy and compete better,

onsolidation. As past

have made repeated

in the banking sector

114

50 200 250

till Very Low in India

Business


11/12

and restrictive policies will b

will be further liberalized, w

players and foreign banks.

The government and the RB

banking licenses to domestic

wider shareholding distributi

have large public shareholdi

attractiveness of the Indian b

including some of the most pr

The banking sector is one of

role in promoting economic g

of banking services to rural

ensuring sustainable income

have a mature banking indu

economy.

-60%

-20%

20%

60%

100%

140%

Jun -07 Dec-07

Banks ha

diluted. It is expected that the shareholding

ile new banking licenses will be made avai

I have already announced a new policy fr

applicants. While the RBI is expected to mai

n in banks, corporations with good reputatio

gs, may also be allowed to promote new

anking sector, it has been reported that nea

ominent business groups, are eager to acquir

he most crucial sectors in any economy, and

rowth. In India, the sector is even more imp

areas may also play a significant role in

evels. If favorable regulatory support is en

stry with sufficient scale and reach to su

Jun-08 Dec-08 Jun-09 Dec-09 Jun-

ve Outperformed the Broader Market

S&P CN

Bank Nif

11

and investment norms

lable to both domestic

mework to issue new

ntain its preference for

n and track record that

anks. Confirming the

ly a dozen applicants,

licenses.

plays an instrumental

rtant as the expansion

reducing poverty and

ured, India will likely

port its fast growing

10 Dec-10

ince 2009

Nifty 50 Index

ty Index


12/12

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Thomas White International, Ltd.One Financial Place,440 South LaSalle Street,Suite 3900,Chicago, Illinois 60605.Email: [email protected]

Thomas White India Pvt., Ltd.Suite 300, 3rd FloorPhoenix Towers16/1 Museum RoadBangalore 560001Tel.: 91-80-40187777

www.thomaswhite.com

This publication is for informational purposes only. This publication is not intended to provide tax, legal, insurance or otherinvestment advice. Unless otherwise specified, you are solely responsible for determining whether any investment, security or otherproduct or service is appropriate for you based on your personal investment objectives and financial situation. You should consult anattorney or tax professional regarding your specific legal or tax situation. The information contained in this publication does not, inany way, constitute investment advice and should not be considered a recommendation to buy or sell any security discussed herein.

It should not be assumed that any investment will be profitable or will equal the performance of any security mentioned herein.Thomas White International, Ltd, may, from time to time, have a position or interest in, or may buy, sell or otherwise transact in, orwith respect to, a particular security, issuer or market on our own behalf or on behalf of a client account.

FORWARD LOOKING STATEMENTS

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Thomas White International, Ltd. 2011

Bric Spotlight Report India Banking April 2011

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