dissector analysis - banking sector

B-Gyan - Business Interaction Committee, NITIE

DISSector A B-Gyan Initiative

DISSECTOR Banking Sector in India

A B-Gyan Initiative



Overview

The present Rs. 64 trillion (US$ 1.17 trillion) banking industry in India is governed by the

Banking Regulation Act of India, (1949) and is closely monitored by the Reserve Bank of India

(RBI). RBI manages the country's money supply and foreign exchange and also serves as a

bank for the Government of India and for the country's commercial banks.

According to an IBA-FICCI-BCG report, Indias GDP growth will make the Indian banking

industry the third largest in the world by 2025. The domestic banking industry is set for an

exponential growth in coming years with its assets size poised to touch USD 28,500 billion by

the turn of the 2025.

Despite the financial instability, Indian banks continued to display high levels of resilience

aided by strong economic policies. The industry saw a growth of 16% and 11.6% in total

income and net profit respectively in FY13. However, moderation in credit demand led to the

slowdown in credit off take from 17.9% in FY12 to 15.8% in FY13. Despite this, the banks

managed to retain deposit growth of 15% for FY12 and FY13.

RBI initiated a series of stringent policy measures to enable Indian banks adopt the Basel III

norms, to curb further depreciation of Indian rupee and improve asset quality of the banks.

These measures will ensure that the Indian banking sector evolves. Achieving higher growth

and maintaining asset quality will play a vital role in shaping the future of the industry in the

near term.

Structure of Indian Banking Industry

The Banking sector in India is structured as below:

Reserve Bank Of India

Banks

Scheduled Commercial Banks

Public Sector

Private Sector

Foreign Banks

Co-operative credit institutions

Regional Rural Banks

Urban Co-operative

Rural Co-operative Credit

Institutions

Financial Institutions

All India Financial Institution

State Level Insititution

Other Institutution

NBFCsCapital Market Intermediaries



Business Divisions in Banking

Key parameters to determine a banks performance

Retail banking

Loans to Individuals (Auto loan, Housing Loan, Education Loan and other personal loan) or small businesses.

Wholesale banking

Loans to Mid and Large Corporate (Working Capital loans, Project finance, Term loans, Lease Finance)

Treasury Operations

Investment in Equity, Derivates, Commodities, Mutual Funds, Bonds, Trading and Forex operations

Other Banking Businesses

Merchant Banking, Leasing business, Hire purchase, Syndication services, etc.

Business Divisions

Net

inte

rest

mar

gin

(N

IM) Interest income is the

income which the bankearns from its corebusiness of lending.Interest expense is theinterest paid to depositorson financial products likedeposits, savings accountetc.

NIM = (Interest income -Interest expenses) / Average earning assets

Op

erat

ing

pro

fit

mar

gin

s (O

PM

)

Operating profit for banksis calculated afterdeducting administrativeexpenses, which includesalary and networkexpansion cost.

OPM = (Net interest income - Operating expenses) / Total interest income

CA

SA r

atio

Its the ratio of current andsavings account depositsto the total deposit base ofthe bank. The bank paysout much lower interestrates on savings/currentaccounts than other typesof deposits like FDs.Raising money this way ischeaper than loans fromother sources like RBI,money market, etc.

Hence, higher the ratiomore profitable is thebank.

Cre

dit

to

dep

osi

t ra

tio

(C

D

rati

o)

The ratio indicatespercentage of funds lentby the bank out of thetotal amount raisedthrough deposits. Higherratio reflects ability of thebank to make optimal useof the availableresources.

Cap

ital

ad

equ

acy

rati

o

(CA

R)

A banks capital ratio isthe ratio of qualifyingcapital (utilized forexpansion) to riskadjusted (or weighted)assets. A ratio below theminimum defined bycentral bank indicatesthat the bank is notadequately capitalized toexpand its operations. N

on

-per

form

ing

asse

ts

(NPA

)

When a customerdefaults on a loan(interest is outstandingfor more than 90 days),the bank writes it offfrom its books and theloan is termed as a Non-Performing Asset (NPA).

Higher ratio reflects risingbad quality of loans.

NPA ratio = Net non-performing assets / Loans given

Return on Assets (ROA) & Return on Equity (ROE)

ROA = Net profit after taxes / assets

ROA indicates how efficiently a bank is being run because it indicates how much profits are generated by each dollar of assets.

However, a banks shareholders care about most is how much the bank is earning on their equity investment. This information is provided by return on equity (ROE).

ROE = Net profit after taxes / equity capital



Current Scenario The Competitive Landscape

Banking in India is moderately

consolidated, with the top 10 players

accounting for approximately 60 per

cent of the total industry. The Indian

banking sector is majorly dominated by

public sector banks. The figures

describe the respective shares of

government, private and foreign banks,

along with the market shares of the

leading players (based on total credit

portfolio).

The growth of the banking sector in

terms of percentage contribution to the

GDP has remained mostly uniform over

FY 06-10. The banking sector is currently

growing at approximately the same rate

as the countrys economy.

Another important parameter for

assessing the performance of the

banking industry is the domestic credit

provided as a percentage of the GDP, as

exhibited in the below figure to the

right.

74%

19%

7%

Split between types of Banks

Govt. Banks

Pvt. Banks

Foreign Banks

18%

6%

5%

5%

5%

5%4%4%3%

3%

42%

Market shares of Leading Banks

State Bank of India

Punjab NationalBankBank of Baroda

ICICI Bank

Bank of India

Canara Bank

HDFC Bank



Key Players in the Indian Banking Sector

Public Sector

State Bank of India (SBI)

State Bank of India is the largest banking and financial services company in India. In addition to the banking services, the Bank through their subsidiaries, provides a range of financial services, which include life insurance, merchant banking, mutual funds, credit card, factoring, security trading, pension fund management and primary dealership in the money market. As of December 2013, it had assets of US$388 billion and a net income of US$ 3.3 billion. The State Bank Group, with over 16,000 branches, has the largest banking branch network in India. The bank has 131 overseas offices spread over 32 countries. The bank offers convenience of over 21000 ATMs in India. Punjab National Bank (PNB)

Punjab National Bank is ranked as the 2nd largest bank in the country. PNB has total assets worth US$72 billion with a net profit of US$ 770 million. The bank has a wide network of 5189 branches which comprise of 2047 Rural, 1154 Semi Urban, 1111 Urban and 877 Metropolitan branches. PNB is recognized as the bank offering highest levels of customer satisfaction in Delhi and Chennai. In FY12, PNB forayed into life insurance business by tying up with Metlife India Insurance Company Ltd. In FY13, PNB installed Self Service Pass Book Printer terminals in branches and e-lobbies, which help the customer to get the passbook updated. During the same period, PNB has embarked on an ambitious organizational restructuring exercise named PNB Pragati. Bank of Baroda (BOB) Bank of Baroda is a state-owned bank headquartered in Vadodara. It serves both corporate and retail

customers in the areas of retail banking, investment banking, credit cards, and asset management. Its

assets are US$ 70 billion with a net profit of US$ 0.8 billion. It has a fairly wide network of 4283

branches (4172 branches in India) and offices, and over 2000 ATMs.

Comparison of the top 3 public banks:

SBI PNB BOB Financials (INR mn)

Income 12,08,729 4,06,306 3,30,961

Business 1,91,12,263 67,33,633 67,22,484

Assets 1,33,55,192 45,81,940 44,73,215

NII 4,32,911 1,34,144 1,03,170

Net Profit 1,17,073 48,842 50,070

Key Ratios (%)

RoA 0.88 1.19 1.24

NIM 3.38 3.21 2.56

NPM 9.69 12.02 15.13

C-I Ratio 45.23 39.75 37.55

CASA Ratio 44.81 35.34 26.9

CRAR - Basel II 13.86 12.63 14.67

Net NPA Ratio 1.82 1.52 0.54



Private Sector

ICICI Bank Ltd ICICI Bank Ltd is the second largest bank and the largest private sector bank in India by market capitalization. They are a publicly held banking company engaged in providing a wide range of banking and financial services including commercial banking and treasury operations. ICICI has total assets worth US$ 99 billion with a net profit of US$ 1.6 billion. The Bank has a network of 2,752 branches and 8,003 ATMs in India, and has a presence in 19 countries, including India. HDFC Bank

HDFC Bank Limited, incorporated in 1994, is the fifth largest bank in India by assets and the largest bank by market capitalization. The bank was promoted by the Housing Development Finance Corporation, a premier housing finance company of India. As of 31 March 2013, the bank had assets of US$ 70.2 billion and has reported net profit of US$ 978 million, up 31% from the previous fiscal year. Its customer base stood at 28.7 million customers on 31 March 2013. Axis Bank

Axis Bank Ltd (Axis Bank) was promoted in 1993, jointly by UTI, LIC, GIC and United India Insurance Company Ltd. Axis Bank offers the entire spectrum of financial services covering large and mid-corporates, SME, agriculture and retail businesses. Axis Bank operates its business into four segments namely treasury, retail banking, corporate & wholesale banking and other banking business. The network of Axis Bank spreads across 1,139 cities and towns. In FY13, the bank added 325 branches and 1321 ATMs to its network. In FY13, the bank launched two new products namely Micro Power and Service Power for providing finance to micro or small enterprises. Comparison of the above private banks:

ICICI Bank HDFC Bank Axis Bank

Financials (INR mn)

Income 4,10,454 3,25,300 2,74,149

Business 50,92,277 44,21,264 38,98,638

Assets 47,36,471 33,79,095 28,56,278

NII 1,07,342 1,22,968 80,177

Net Profit 64,653 51,671 42,422

Key Ratios (%)

RoA 1.5 1.77 1.68

NIM 2.44 4 3.04

NPM 15.75 15.88 15.47

C-I Ratio 43.05 48.97 44.7

CASA Ratio 43.45 48.4 41.54

CRAR - Basel II 18.52 16.52 13.66

Net NPA Ratio 0.73 0.18 0.27



Concerns

Increasing NPA Despite remaining sufficiently capitalized, non-performing assets of Indian banks continued to remain a great concern, with gross NPAs increasing significantly from 3.1% in FY12 to 3.7% in FY13 and rising.

Prevailing slowdown in the domestic economy, declining business confidence in the industry due to slackening demand, prevailing high interest environment, and high exposure of Indian banks, especially public sector banks, to the real estate, textile, infrastructure (specifically power and telecom segments), in addition to the priority sector are few of the reasons for the substantial increase in NPAs. To improve the banks ability to manage their non-performing assets (NPAs) and restructured accounts in an effective, the RBI proposed the following measures in its Monetary Policy Statement:

To mandate banks to put a robust mechanism in place for early detection of signs of distress, and measures, including prompt restructuring to preserve the economic value of such accounts.

To mandate banks to have proper system generated segmentwise data on their NPA accounts, write-offs, compromise settlements, recovery and restructured accounts.

Slower credit growth due to subdued domestic demand Despite the increased infusion of liquidity by the RBI, growth of bank lending contracted to 15.8% in FY13 from 17.9% in FY12. FY13 saw lower credit demand across various sectors on the back of slowdown in domestic economic activity and uncertain global macroeconomic environment, which resulted in subdued industrial production and investment activities. Credit supply also slowed down due to greater risk aversion of banks on the back of weakening economic environment and rising non-performing assets, resulting in banks opting for SLR investments due to large government market borrowings. Intensifying competition for PSBs As a result of globalization, many new banks have entered the Indian banking industry, intensifying the competition. Due to new emerging competition, Indian banks, especially PSBs, are trying their best to improve their performance and preparing to compete in the emerging global market. New private sector banks and foreign banks have more customer-centric policies, high quality services, new attractive schemes and computerized branches, attracting more and more customers to their banks. In this context, there is a need to examine the efficiency of public sector banks operating in India. However, the upside of this challenge is that due to intensifying competition banks will become more efficient.



Key policy developments impacting performance of banks in FY13

RBI reduced repo rate by 100 bps in FY13 from 8.5% in FY12 to 7.5% in FY13.

RBI reduced Cash Reserve Ratio (CRR) by 75 bps in FY13 from 4.75% in FY12 to 4% in FY13.

RBI reduced Statutory Liquidity Ratio (SLR) by 100 bps from 24% in FY12 to 23% in FY13.

The deposit rate of major banks for one year maturity and above moderated from 8.50-9.25% in FY12 to 7.5-9.0% in FY13.

The base rate of major banks dropped from 10.0-10.75% in FY12 to 9.70-10.25% in FY13.

RBI to issue new bank licenses in FY14, which will contribute towards financial inclusion as well as intensify competition leading to development of banking sector.

Implementation of Basel III capital regulation in India, effective from Apr 2013, which will be fully implemented in a phased manner by Mar 2018.

Towards Basel III Regime

Basel III norms are guidelines framed by a committee of central banks based in Basel, Switzerland, of which RBI is also a member. The norms aim to toughen up the banking system in every country to withstand financial shock. They focus on the risks that banks are vulnerable to, particularly after the crisis in the banking sector, which was triggered by the problem in the US sub-prime mortgage market.

Indian banks have initiated the process of implementing Basel III norms in a phased manner since January 1, 2013, and it will be implemented fully by March 31, 2018. Once implemented, Basel III guidelines ensure that banks would be well capitalized to manage all kinds of risks. The existing Basel II norms stipulate that banks should maintain Tier-I capital, or core capital, and Tier-II capital that comprise instruments with debt-like features. Under Basel III, banks will have to maintain a minimum 5.5% in common equity (as against 3.6 now) by March 31, 2015, create a capital conservation buffer (consisting of common equity) of 2.5% by March 31, 2018, and maintain a minimum overall capital adequacy ratio of 11.5% (against the current 9%) by March 31, 2018. It essentially targets bank-level (micro-prudential) regulation, which will help raise the resilience of individual banks to periods of stress, and macro-prudential regulation to prevent system-wide risks that can build up across the banking sector and the pro-cyclical amplification of these risks over time. Early Warnings: It is estimated that the new norms will push up the capital needs of Indian banks by $20-30 billion. Since banks will now need additional capital for doing the same level of business, they may see a sharp drop in their return on assets (ROA).

The higher capital requirements have drawn warnings from analysts and financiers about their impact on bank lending rates and wider economic growth. About $15 billion was needed for Indian banks to support 18% growth, of which around $11-12 billion was needed by the PSU banks. Additionally, banks would be required to maintain liquidity coverage ratio and net stable funding ratio of above 100 percent.

The Basel III norms come at a time when banks are under pressure to set aside funds for a potential increase in bad loans.



Way Forward

The RBI has issued a paper entitled Banking Structure in India The Way Forward in August 2013.

The RBI recognises that today's banking structure in India has both the need and scope for further

growth in size and strength. It is reviewing the Indian banking structure to cater to the needs of Indias

growing and globalizing economy and to deepen financial inclusion, and has also been guided by

lessons learned from the global financial crisis particularly relating to banking structure.

The key features discussed in the paper for the future of Indian banking are highlighted below:

Government Ownership

Under the Basel III capitalisation norms, banks require large-scale infusion of capital by shareholders.

Since the Government is the majority shareholder of most PSBs, additional capital will be required to

be infused by the Government. While there are benefits to financial stability offered by government

ownership, there also arises mixed performance in comparison with private sector banks. As per RBI,

the Governments ownership in public sector banks needs to be reduced to 33% from the existing 51%

to reduce the Governments burden of recapitalising the banks.

Bank licensing

Differentiated licensing should be adopted where certain banks will be licensed only for servicing niche

segments such as infrastructure financing, retail banking, SME financing, etc. The proposed new

licensing policy suggests adopting continuous authorisations for opening new banks in India

(compared to the present stop and go review policy as to whether to allow new banks to enter the

market).

Improve risk management mechanism

Along with adopting strategies to combat high risk perception, increased usage of rating services must

be employed. Besides, SME specific risk management procedures must be setup to make the business

more viable, as the risk perception associated with lending to small enterprises is generally very high.

The availability and ease access to reliable data/information to both banks and regulators/supervisors

of the banking system is a key for prudent risk management. Hence, strengthen the existing system

would be another challenge for the banking industry.

Overseas presence of Indian banks

Large Indian banks, which have a global presence, should be consolidated to create three to four global

banks which are able to compete globally with the top international banks. This would enable such

banks to generate economies of scale, meet financing needs of infrastructure and large projects and

offer India as a banking destination to the world.

Envisaged structure for banking sector

RBI has envisaged a reoriented banking system with distinct tiers. The first tier would consist of a few

large Indian banks with a global presence along with branches of foreign banks in India. The second

tier would comprise mid-sized banking institutions, including subsidiaries of foreign banks and niche

banks providing investment and wholesale banking services. The third tier covers old private sector

banks, regional rural banks, and multi-state urban cooperative banks. The fourth tier would include

small privately owned local banks and cooperative banks, catering to the credit requirements of the

unorganised sector in unbanked and under-banked areas.

The tiered structure would increase competition driving efficiencies in the banking sector and also

pave the way of a market driven consolidation.

dissector analysis - banking sector

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