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Financial Services

Entering the Indiannancial services market*


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Entering the Indian fnancial services market PricewaterhouseCoopers

Indias soaring economic growth and the resultingsurge in demand or both corporate and consumer

nancial services are attracting ever greater interestrom international groups.

Several international groups are already well established inIndia; others are seeking out entry routes in niche areas suchas credit cards and private banking.

Further openings are set to ollow under government plansto eliminate the remaining restrictions on oreign ownershipin the banking sector.

This yer produced by PricewaterhouseCoopers1 examinesthe opportunities opening up in Indian fnancial services andhow prospective entrants can move into the market.

Introduction

1. PricewaterhouseCoopers re ers to the network o member frms o PricewaterhouseCoopers International Limited, each o which is a separate and independent legal entity.


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India already has more middle-class people on apurchasing power parity basis than the entire populationo the US and a consumer credit market that is growingby more than 40% per annum. 2 Another 100 millionpeople will have joined the middle class by 2010.

A number o overseas fnancial institutions includingHSBC, Citigroup, Standard Chartered and ABN Amrohave developed strong distribution networks and businessrelationships in India, either through direct o erings,

subsidiaries or joint ventures (JVs). Among Indias leading fnancial services brands arethe joint ventures set up by Prudential, GE Money,Merrill Lynch and Morgan Stanley.

Niche growth markets such as private banking andacquisition fnance have o ered a point o entry or anumber o leading international groups. Deutsche Bankand Barclays Bank are among the groups that areincreasingly active in both segments.

Goldman Sachs is an example o an institution that hastaken its Indian growth strategy to the next stage byselling its joint venture stakes and looking to developlarger scale onshore operations in areas such as realestate and asset management. 3

Although regulatory restrictions on branch opening andacquisition are still in place, oreign holdings in Indianbanks and other fnancial institutions continue to increaserapidly. This includes multiple oreign stakes in a numbero leading institutions. For example, ICICI Bank, Indiassecond largest bank, is now 74% oreign-owned.4

The Reserve Bank o Indias (RBI) road map or thepresence o oreign banks in India outlines plans oreasing and eventually eliminating restrictions on oreignownership a ter 2009. However, the opening up o theinsurance market to allow ull oreign ownership maytake longer.5

Plans or uller currency convertibility could provide aurther boost or oreign investment by opening up greater

access to Indias fnancial markets and providingincreased scope or the development o the sector.

Overview

2 Reserve Bank o Indias Report on Trends and Progress o Banking in India (2005/06).3 Economic Times , 16.3.06.4 Bloomberg and ICICI Bank Annual Report & Accounts (2006-2007)5 Reserve Bank o Indias Report on Trends and Progress o Banking in India (2004/05).


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Economic expansion is creating an increasingly largeand aspirant consumer class.

The Indian economy is marching ahead. GDP is expandingby more than 8% per year and the country is now the ourthlargest economy in the world on a purchasing power parity(PPP) basis and ninth on a market exchange rates (MER)basis. This rapid expansion is expected to continue asgrowth in the service and high technology manu acturingsectors accelerates.

Indias economic trans ormation is uelling the expansion oa middle class that already numbers more than 350 millionpeople and could exceed 500 million by 2010.6 The relative

youth o Indias consumers (69% o the population is under35) means that they are o ten keener to spend than to save.7 For example, car sales rose by 23% in 2006 to exceed onemillion (80% sold through fnance packages) and mobilephone connections doubled to reach 140 million.

Financial institutions have been quick to take advantage othe corresponding surge in demand or consumer credit which is growing by more than 40% per annum. Early mover

oreign entrants include GE Money, which markets Indias

leading credit card in a joint venture with the State Bank oIndia (SBI). The development o the credit market has beenaided by debt recovery legislation (tribunals were set up bythe Government in 1993 to speed up recovery, ollowed bytougher en orcement laws in 2002).

Yet, as with any emerging economy, 21st-centurycorporations and aspirational urban consumers co-existwith an older, under-developed India that cannot betrans ormed overnight. Although investment is beginning topick up, roads, telecommunications and other aspects othe in rastructure can o ten be di fcult. Businesses can also

ace signifcant bureaucracy and complex tax structures.

The government has opened many areas o commerce toull oreign ownership since beginning the move away rom

a command economy in the early 1990s (India joined theWorld Trade Organisation in 1995). However, fnance is oneo a number o sectors where the government has continuedto exert considerable control and protection, both throughtight regulation and as a signifcant shareholder in its ownright. Although India avoided the fnancial crises thata ected other Asian markets in 1997, concerns about asimilar setback continue to underpin Indian regulatorsgenerally cautious approach to liberalisation.

The combined state and central government defcit is 9%o GDP (three times higher than the euro-zone growth andstability ceiling). Servicing this debt still takes up more thana third o banking resources, which may detract institutions

rom commercial lending and other sources o retail/ corporate business. However, the government no longerobliges banks to hold a quota o government bonds andbanks government security holdings are gradually allingas a result.

6 More than 360 million Indian people have incomes above the National Council or Applied Economic Researchs (NCAER) threshold or middle class o more than $2,000 per person per annum.90 million earn between $4,500 and $22,000 per annum. Their purchasing power is much higher than it would appear in dollar terms ($3,000 per annum is seen as the threshold or buying a car inIndia, or example). The NCAER expects the middle class to reach 560 million people by 2010. (The Great India Market, 9.8.05).

7 Indias gross national savings rate (earnings over spending) is 26%, which, while higher than the US, is low by Asias generally cautious standards hal o Chinas, or example.(Wall Street Journal, 3.1.06).

Market environment

Figure Key acts

Sources: Indian Government, UNICEF, CIA World Factbook, Economist Intelligence Unit

Population 1.1 billion

GDP (2006) $3.7 trillion (PPP)

$796 billion (MER)

Per capita GDP $3,700 (PPP)

In ation 6.2%Unemployment 7.8%

Education

Adult literacy 58%

Universities 226

Engineering/tech colleges 426

Figure Comparative growth estimates

Source: Economist Intelligence Unit

2006 2007 2008( orecast) ( orecast)

India 9.2% 8.5% 8%

China 10.5% 9.5% 9%

Russia 6.7% 6.0% 5.5%

Brazil 2.9% 3.4% 3.5%


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The soaring demand or nancial services is attractingever increasing oreign investment.

BankingDemandDemand or banking services is growing signifcantly, albeitin a country where less than hal o households have a bankaccount. Deposits rose by 18% and bank credit grew by30% in 2005/06. It is in the retail sector that the surgein demand is most marked. Retail lending rose by 47%year-on-year up to June 2006. Housing loans grew by morethan 50% and loans to the retail commercial sector rose bymore than 100%. While corporate lending still predominates,these retail segments now account or 7.7% and 6% o theoverall lending market respectively. At around 30% o GDP,consumer credit in India is still low in comparison to other Asian markets, suggesting that there is considerable room

or urther growth (consumer credit/GDP is more than 100%in Singapore, Taiwan and Malaysia, or example).

The credit card market is growing by around 35% perannum, albeit rom a low starting point (receivables reached

$6 billion in 2006). The value o card-based and retailelectronic payments rose rom $1.38 billion in 2001/02 tomore than $51.85 billion in 2004/05 (though still some wayshort o the UK fgure o around $500 billion per annum).

Urban/ruralThe twin-speed development o Indias urban and ruraleconomies is re ected in what remains a relativelybi urcated banking market. While only 7% o Indias 68,000branches are located in towns and cities, they account or36% o deposits and 48% o retail credit. The corporateand urban retail markets have tended to be the primary

ocus o international institutions, in particular. However,opportunities or developing business outside the mainurban areas are likely to open up as living standards andconsumer demand increase. A number o groups aredeveloping multi-channel and segment strategies to bringa wider range o services to rural consumers.

StructureIndia has around 100 private, public and oreign-ownedbanks that together make up the Reserve Bank o Indias(RBI) top tier regulatory category o scheduled commercialbanks. At 10% or more, average return on equity (RoE)among these leading institutions (see Figure 3) is higher thanmany other emerging Asian markets.

No institution apart rom the SBI has been able to establishmore than a 10% share o the retail credit market. This

would suggest that there are still considerable openings ororeign institutions seeking to establish a presence in thisast growth market. Possible joint venture partners could

include some o the smaller players that account or nearly50% o market, who may be keen to attract the expertiseand capital backing o a oreign institution.

The Indian government owns or holds a majority stake in19 o the scheduled commercial banks, including the SBI,which is by ar the largest in terms o business and branchnetwork. The middle layer o the pyramid is made up osome 200 regional rural banks. At the grassroots are dozenso credit co-operatives, which tend to serve the poorersections o the community. Overall, the government ownsbanks that hold around three-quarters o the countrysbanking assets.

Openings in nancial services

RoE (per cent)25.0

20.0

15.0

10.0

5.0

0.005-0697-98 98-99 99-00 00-01 01-02 02-03 03-04 04-05

Figure Return on equity o scheduled commercial banks

Source: Reserve Bank o India


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As Figure 4 highlights, the new private sector banks(NPSBs) ormed over the past ten years tend to be moreproftable than their older or publicly-owned counterparts.The NPSBs have generally made more e ective use otechnology and are less encumbered by the restrictivelabour practices that are common in the public sector.This may make the NPSBs more appealing as prospectiveinvestment/acquisition targets.

Foreign investmentThere are 58 oreign banks operating in India, o which31 are trading through 245 licensed branch operations.Standard Chartered has the most branches, ollowed

by HSBC and Citigroup. Around 80% o oreign-ownedbranches are located in metropolitan areas. As Figure 4highlights, oreign banks are the best per ormers in thesector. Their concentration in a uent areas, corporatebanking and o shore fnancing naturally tends to delivera greater value-added return.

Organic growth o international banks has been inhibitedby the RBIs restriction on the number o branch openingsto 12 per annum. Banks can also set up wholly ownedsubsidiaries, though the qualifcation criteria, including

reserves, are exacting. The fnal option is an investmento up to 74% in an existing bank, though there is or thetime being at least a 10% ceiling on voting rights.

Despite the restrictions on voting rights, oreign holdingsin some o Indias most commercially attractive fnancialinstitutions continue to increase, either through the oreigninstitutional investor route or global depository receipts/ direct investment. For instance, multiple internationalinvestors hold 74% o the shares in the ICICI Bank8 and

69% o Centurion Bank,9

two o the countrys astest-growing NPSBs. At the same time, longstanding playerslike HSBC, Citigroup, Deutsche Bank, ABN Amro andStandard Chartered continue to expand their activities andmarket share. In 2006, Citigroup extended its oothold inthe rapidly developing Indian mortgage market by increasingits stake in the Housing Development Finance Corporation(HDFC) (see Figure 8 on page 8).

GE Moneys joint venture with the SBI, which was establishedin 1998, presents a model o success ul niche marketpenetration and development. The partnership has helpedto create Indias market-leading credit card. It combines theadvantages o SBIs market presence and strength as atrusted brand with GE Moneys global expertise in technology,business processes and innovative product development.

Joint ventures enable international groups to establishall-important local knowledge, local teams and clientrelationships within this culturally diverse marketplace.This initial investment can then provide a plat orm or urtherdevelopment. For example, Merrill Lynch has invested a

urther $500 million in its joint venture with DSP, a leadingund management and investment banking corporation.10

Goldman Sachs has taken its growth strategy a stage urtherby selling its stakes in its joint ventures with the KotakMahindra Bank and looking to develop larger scaleoperations encompassing securities, investment banking,private equity, real estate and asset management. 11 BarclaysBank is investing more than $200 million in the developmento its investment and corporate banking business in India.12 This includes targeting Indian SMEs, a segment until nowlargely untapped by international groups. In January 2007,Barclays announced that it would be moving into retailbanking in India by o ering credit cards and personal loans.13

Net profits to assets ratio (per cent)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

05-0620-01 01-02 02-03 03-04 04-05

Public sector banks Old private sector banks

New private sector banks Foreign banks

Scheduled commercial bank

Figure Bank proftability by segment

Source: Reserve Bank o India

8 As o 31 March 2006, ICICIs shareholding included 26.8% held through American Depository Receipts and 47.1% held by oreign institutional investors and non-resident Indians

(ICICI Bank Annual Report & Accounts 2006-2007).9 India News Online, 15.5.0610 DSP Merrill Lynch media release, 7.12.05.11 Economic Times , 16.3.06.12 Business Standard, 22.3.06.13 Financial Times , 29.1.07.


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India opens up All this groundwork is likely to prove invaluable as Indiaapproaches a decisive stage o market liberalisation throughthe RBIs two-phased road map or the presence o oreignbanks in India. In the frst phase, which runs up to 2009,banks may be able to open more than 12 branches perannum, though the location will still be at the discretion othe RBI. The RBI may also sanction more oreign investmentin existing banks, though targets are likely to be limited tobanks identifed by the Reserve Bank or restructuring.14

The RBI does not appear to have a frm benchmark orinstitutions that it considers to be in need o restructuringand decisions are likely to be reached on a case-by-casebasis. However, the requirement or more capital is likelyto be a key criterion. Rabobank took a 20% stake in theYes Bank prior to its IPO in 2003 and retained a 15% stake

ollowing the otation. The investment has paid o , with theinitial share price having nearly doubled by June 2006 asYes established a strong presence in the technology SME

sector. 15 However, some better capitalised institutions mayremain o limits or the time being. It would appear that theRBIs initial pre erence would be to encourage investment inregional banks. Many o these would certainly provide a

oothold in the market, though time and resources may berequired to realise a return.

The key watershed is set to be 2009, when the road mapindicates that the remaining restrictions on oreign control,including the 10% ceiling on voting rights, will be eliminated.

It should be noted that the fnal go-ahead may be subject topolitical considerations, as 2009 is an election year.

A urther boost or both oreign and domestic investmentcould come with the proposed move to ull convertibilityo the Rupee. This would extend convertibility to the capitalaccount, which would open up greater international accessto investment in Indias debt markets and fnancial servicesinstitutions, and in turn provide a catalyst or the urtherdevelopment o the sector.

14 RBI Report on Trends and Progress o Banking in India (2004/05).15 Asia Money , 12.6.06.


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InsuranceUptake o insurance is low in India, even by comparisonto banking. Only one in eight Indians holds some ormo insurance. Just 8% o the population has li e insurancein a market that makes up only 2.3% o GDP.16 Comparisonswith other leading emerging markets (see Figure 5) underlinethe under-development and the consequent potential orgrowth within Indian insurance. From this low base, the Indianinsurance sector has been expanding by an average o 25%per annum since being opened up to private companies in1999.16 The li e market grew by 146% in 2006. The non-li emarket grew by 24% in 2006.16

Li e insurance is closely linked to mortgages, take-up owhich has until recently been very low in India. However,

urther acceleration in the growth o the li e insurancemarket could ollow Indias increasing urbanisation andrapid recent expansion o its mortgage market.

An increasingly popular route to market is bancassurance,especially through joint ventures, which combine theadvantages o specialist products with trusted relationships

with branch representatives. Examples include ICICILombard, Indias number one private general insurancecompany, which is a joint venture between ICICI Bank andthe US-based Fair ax Financial Holdings. Similarly, theleading private li e insurer is a joint venture between ICICIBank and UK-based Prudential (see Figure 6).

The popularity o bancassurance is helping to uel theincrease in the proportion o the insurance market held byprivately owned companies. Private insurers now holdaround a quarter o the market and their presence is growingacross all major li e and non-li e segments. While insuranceremains a predominantly state-controlled market, the JVsmentioned above highlight the increasing presence o oreigninvestors. The government has proposed an increase in theceiling or oreign holdings in insurance ventures rom 26%to 49%, although no frm date has been announced. 17

Figure Comparative insurance premiums ( 00 )

Source: Sigma Research

Market(million)

Per capita Li eper capita

Non-li eper capita

India $25,024 $22.70 $18.30 $4.40China $60,131 $46.30 $30.50 $15.80Russia $17,521 $122.80 $6.30 $116.50Brazil $23,955 $128.90 $56.80 $72.10

Figure Leading private li e insurers

Source: Insurance Regulatory and Development Authority Report (2005-06)

(ranked by business in orce)* Rank

ICICI Prudential 1

Bajaj Allianz 2

Max New York Li e 3

HDFC Standard Li e 4

Birla Sun Li e Insurance 5

* As o 31.3.06

16 Insurance Regulatory and Development Authority Journal, February 2007.17 Investment Commission o India, 16.7.07.


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Asset and wealth management Assets under management reached $68 billion in August2006, a year-on-year rise o more than 50%. As Figure 7highlights, the leading players include a number o oreign/ private joint ventures. With assets under management onlyaccounting or around 12% o bank deposits, the potential

or growth is evident.

Wealth management is a particular ocus o internationalinterest. Barclays Bank, one o the groups which is

extending its onshore wealth management capabilitiesin India, estimates that this segment will grow by 15%per year over the next three years.18

NBFCsNon-banking fnancial companies (NBFCs) are anotherimportant segment o an increasingly convergent sector.From their origins in project fnancing they have nowexpanded their services into a variety o areas ranging romequipment leasing and hire purchase to high-interestinvestment plans. Some NBFCs are being allowed to extendtheir services into banking areas such as credit cards.

Mergers and acquisitionsThe competitive and regulatory pressures or consolidationare leading to a rapid increase in M&A activity, with morethan $1.3 billion worth o deals announced in the Indianfnancial services sector in 2006 (6.8% o total deal value).It is signifcant that our o the fve largest investmentsinvolved international groups (see Figure 8). Such activity islikely to accelerate still urther as international groups seekto establish ootholds and jockey or position ahead o theplanned opening up o the market in 2009.

Basel II is likely to provide a urther catalyst or consolidation.In an interview with theFinancial Times in July 2005,Hoshang Sinor, Chie Executive o the Indian Banking Association, said that the impact o Basel II and otherpressures could reduce the number o scheduled commercialbanks rom around 100 to 25 by 2009.19 Further down thepyramid, consolidation o the co-operative sector is gatheringpace, with the RBI keen to encourage larger co-operativebanks to take over their smaller and weaker counterparts.

Figure Assets under management (May 00 ) o leadingund managers (equity) based on an exchange rate

o $ = Rs

Source: Association o Mutual Funds in India

Reliance Capital Asset Management $14,081 million

Prudential ICICI Asset Management $12,072 million

UTI Asset Management $9,540 million

HDFC Asset Management $8,606 millionFranklin Templeton Asset Management (India) $6,256 million

Figure Most valuable M&A deals in 00

Source: Dealtracker

Target Acquirer Nature o transaction Value $ million

HDFC Citigroup Increasing stake to 12.68% 671India Bulls Financial Services Farallon Capital Not disclosed 143IL & FS Abu Dhabi Investment Authority Acquiring 10% stake 100IDFC Barclays Bank Acquiring 4.7% stake 84Sangli Bank ICICI bank Merger 67FS deal value in 2006 o $1.374 billion, making up 6.8% o Indian deals by value and 8.3% by volume

18 Private Banker International , 27.6.06.19 Financial Times , 27.7.05.


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0 Entering the Indian fnancial services market PricewaterhouseCoopers

Realising the market potential o Indian nancial servicesis likely to require an investment in time as well as capital.

Demand or fnancial services in India is taking o .International fnancial institutions are playing an increasingrole in the expansion o Indias large corporations. A vastSME market remains largely untapped. On the retail side,India already has more middle-class people on a purchasingpower parity basis than the entire population o the US anda consumer credit market that is growing by more than 40%

per annum. By 2010, another 100 million people will have joined this increasingly credit-hungry consumer class.

The competitive demands or enhanced service, productchoice/quality and risk/capital management are creating

urther openings or international fnancial services groups,either directly or through joint ventures. Although some othe initial investments by international groups have beenlong-term strategic plays on the development andrestructuring o the market, the revenue potential is nowbeginning to come to ruition. Early movers are also well-positioned to take advantage o the opening up o themarket to ull oreign ownership.

Although the door is open to new entrants they acecompetition rom established players, ranging rom theincreasingly nimble and adept NPSBs, such as ICICI andCenturion, to global groups with more than a centurysexperience o this market, such as Citigroup. Some newentrants may there ore initially look to niche markets suchas private banking be ore seeking to establish broadermass market operations. Others may seek to build onthe plat orm o o shore service centres in India to provideinternet and telephone services within the country itsel . Another possible option would be the acquisition o under-

capitalised institutions that are coming up or sale as parto the government-inspired drive or consolidation.

Some institutions may pre er to wait until restrictions onoreign ownership are removed, which under current plans

should take place in 2009. The potential purchase targetsare then likely to include some o the larger and bettercapitalised banks and NBFCs that have up until now beenlargely shielded rom oreign acquisition by governmentprotection. However, is it wise to wait that long? Someo the most attractive targets are already in oreign hands,albeit in multiple ownership, and the purchase price o thosethat remain is mounting.

Future developments


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Contacts

I you would like to discuss any o the issues raised in this paper in more detail, please speak with your usual contactat PricewaterhouseCoopers or call one o the ollowing:

Nick Page (Editor)Partner, Transaction ServicesPricewaterhouseCoopers (UK)[email protected] 20 7213 1442

Jairaj Purandare (Author)Country Leader, Financial ServicesPricewaterhouseCoopers (India) [email protected] 22 6669 1400

Deepak Kapoor (Author)Managing PartnerPricewaterhouseCoopers (India)[email protected] 124 4620502

Ashwani PuriLeader, Advisory ServicesPricewaterhouseCoopers (India)[email protected] 124 4620501

Amrish ShahExecutive Director, Mergers & Acquisitions (Tax)PricewaterhouseCoopers (India)[email protected] 22 6669 1390

Bimal TannaExecutive Director, Transaction ServicesPricewaterhouseCoopers (India)[email protected] 22 6669 1555

Gautam MehraExecutive Director, Financial Services (Tax)PricewaterhouseCoopers (India)[email protected] 22 6669 1320

Nick Page is a partner in PricewaterhouseCoopers Transaction Services Financial Services team in London. The authorsare senior members o PricewaterhouseCoopers Financial Services, Transaction Services and Advisory teams in India.PricewaterhouseCoopers is a leading advisor to the fnancial services industry in India and has played a prominent role insome o the most important deals in the sector. The team includes more than 40 fnancial services transaction specialists,fve o them partners, who are primarily ocused on banking and investment management, with expertise in insurance, realestate and leasing. M&A, valuation and due diligence, and non-per orming loans advice is supported by specialists in keyareas such as tax.

Subjects covered in the Financial ServicesM&A fyer series

Entering the Gul fnancial services market

Entering the fnancial services market in Taiwan

Entering the Chinese investment management industry

European banking consolidation

Recent Financial ServicesM&A-related publications

Financial Services M&A: Going or growth in Asia (2007)

Financial Services M&A: Going or growth in Europe (2007)

Going or growth: The outlook or mergers andacquisitions in the fnancial services sector in Asia (2006)

Financial services M&A: Review and outlook or mergersand acquisitions in the European fnancial servicesmarket (2006)


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The member frms o the PricewaterhouseCoopers network (www.pwc.com) provide industry- ocused assurance, tax and advisory services to buildpublic trust and enhance value or its clients and their stakeholders. More than 140,000 people in 149 countries share their thinking, experience andsolutions to develop resh perspectives and practical advice.

The PricewaterhouseCoopers Financial Services M&A suite o collateral is produced by experts in their particular feld at PricewaterhouseCoopers,to review important issues a ecting the fnancial services industry. This report has been prepared or general guidance on matters o interest only, andis not intended to provide specifc advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) isgiven as to the accuracy or completeness o the in ormation contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopersfrms do not accept or assume any liability, responsibility or duty o care or any consequences o you or anyone else acting, or re raining to act,

in reliance on the in ormation contained in this publication or or any decision based on it.For urther in ormation please contact ine Bryn, Marketing Director, Global Financial Services, PricewaterhouseCoopers LLP, London,on +44 20 7212 8839 or at [email protected]

For additional copies please contact Maya Bhatti at PricewaterhouseCoopers LLP, London, on +44 20 7213 2302 or at [email protected]

2007 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers re ers to the network o member frms o PricewaterhouseCoopersInternational Limited, each o which is a separate and independent legal entity. Designed by studio ec4 18751 (07/07)


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