1. INDIA BANKING 2010
TOWARDS A HIGH PERFORMING SECTOR
9TH JULY, 09

2. SUMMARY:
The failure to respond to changing market
realities has stunted the development of the
The last decade has seen many positive
financial sector in many developing
developments in the Indian banking sector.
countries. A weak banking structure has
The policy makers, which comprise the
been unable to fuel continued growth, which
Reserve Bank of India (RBI), Ministry of
has harmed the long-term health of their
Finance and related government and
economies. In this “white paper”, we
financial sector regulatory entities, have
emphasize the need to act both decisively
made several notable efforts to improve
and quickly to build an enabling, rather than
regulation in the sector. The sector now a limiting, banking sector in India.
compares favorably with banking sectors in
the region on metrics like growth,
profitability and non-performing assets
(NPAs). A few banks have established an GOOD PERFORMANCE,
outstanding track record of innovation,
growth and value creation. This is reflected
QUESTIONABLE
in their market valuation. HEALTH
Indian banks have compared favorably on
However, improved regulations, innovation, growth, asset quality and profitability with
growth and value creation in the sector other regional banks over the last few years.
The banking index has grown at a
remain limited to a small part of it. The cost
compounded annual rate of over 51 per cent
of banking intermediation in India is higher since April 2001 as compared to a 27 per
and bank penetration is far lower than in cent growth in the market index for the same
other markets. India’s banking industry must period. Policy makers have made some
strengthen itself significantly if it has to notable changes in policy and regulation to
support the modern and vibrant economy help strengthen the sector. These changes
which India aspires to be. While the onus for include strengthening prudential norms,
enhancing the payments system and
this change lies mainly with bank integrating regulations between commercial
managements, an enabling policy and and co-operative banks.
regulatory framework will also be critical to
their success.
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3. However, the cost of intermediation remains
based income and investment banking on the
high and bank penetration is limited to only
wholesale banking side. These require new skills
a few customer segments and geographies.
in sales & marketing, credit and operations.
While bank lending has been a significant
driver of GDP growth and employment,
Second, banks will no longer enjoy windfall
periodic instances of the “failure” of some treasury gains that the decade-long secular
weak banks have often threatened the decline in interest rates provided. This will
stability of the system. Structural expose the weaker banks. Third, with
weaknesses such as a fragmented industry increased interest in India, competition from
structure, restrictions on capital availability foreign banks will only intensify. Fourth,
and deployment, lack of institutional support given the demographic shifts resulting from
infrastructure, restrictive labor laws, weak changes in age profile and household
corporate governance and ineffective income, consumers will increasingly
regulations beyond Scheduled Commercial demand enhanced institutional capabilities
Banks (SCBs), unless addressed, could and service levels from banks.
seriously weaken the health of the sector.
Further, the inability of bank managements
(with some notable exceptions) to improve
capital allocation, increase the productivity
of their service platforms and improve the
performance ethic in their organizations OUT OF THREE
could seriously affect future performance. SCENARIOS WILL PLAY
OUT BY 2010
OPPORTUNITIES AND The interplay between policy and regulatory
CHALLENGES FOR interventions and management strategies
will determine the performance of Indian
PLAYERS banking over the next few years. Legislative
actions will shape the regulatory stance
The bar for what it means to be a successful through six key elements: industry structure
player in the sector has been raised. Four and sector consolidation; freedom to deploy
challenges must be addressed before success can capital; regulatory coverage; corporate
be achieved. First, the market is seeing governance; labour reforms and human
discontinuous growth driven by new products
capital development; and support for
and services that include opportunities in credit
creating industry utilities and service
cards, consumer finance and wealth
management on the retail side, and in fee-
bureaus.
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4. Management success will be determined on and human capital up gradation to reach the
three fronts: fundamentally upgrading high-performing scenario.
organizational capability to stay in tune with
the changing market; adopting value- Three scenarios can be defined to
creating M&A as an avenue for growth; and characterize these outcomes:
continually innovating to develop new
business models to access untapped HIGH PERFORMANCE :
opportunities.
Through these scenarios, we paint a picture In this scenario, policy makers intervene
of the events and outcomes that will be the only to the extent required to ensure
consequence of the actions of policy makers system stability and protection of
and bank managements. These actions will consumer interests, leaving managements
have dramatically different outcomes; the free to drive far-reaching changes.
costs of inaction or insufficient action will Changes in regulations and bank
be high. Specifically, at one extreme, the capabilities reduce intermediation costs
sector could account for over 7.7 per cent of leading to increased growth, innovation
GDP with over Rs. 7,500 billion in market and productivity. Banking becomes an
cap, while at the other it could account for even greater driver of GDP growth and
just 3.3 per cent of GDP with a market cap employment and large sections of the
of Rs. 2,400 billion. Banking sector population gain access to quality banking
intermediation, as measured by total loans as products. Management is able to overhaul
a percentage of GDP, could grow marginally bank organizational structures, focus on
from its current levels of ~30 per cent to ~45 industry consolidation and transform the
per cent or grow significantly to over 100 banks into industry shapers.
per cent of GDP. In all of this, the sector
could generate employment to the tune of In this scenario we witness consolidation
1.5 million compared to 0.9 million today. within public sector banks (PSBs) and
Availability of capital would be a key factor within private sector banks. Foreign
— the banking sector will require as much banks begin to be active in M&A, buying
as Rs. 600 billion (US$ 14 billion) in capital out some old private and newer private
to fund growth in advances, non-performing banks. Some M&A activity also begins to
loan (NPL) write offs and investments in IT take place between private and public
sector banks.
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5. As a result, foreign and new private banks In this scenario, M&A activity is driven
grow at rates of 50 per cent, while PSBs primarily by new private banks, which take
improve their growth rate to 15 per cent. over some old private banks and also merge
The share of the private sector banks among themselves. As a result, growth of
(including through mergers with PSBs) these banks increases to 35 per cent. Foreign
increases to 35 per cent and that of foreign banks also grow faster at 30 per cent due to
banks increases to 20 per cent of total sector a relaxation of some regulations. The share
assets. The share of banking sector value of private sector banks increases to 30 per
adds in GDP increases to over 7.7 per cent, cent of total sector assets, from current
from current levels of 2.5 per cent. Funding levels of 18 per cent, while that of foreign
this dramatic growth will require as much as banks increases to over 12 per cent of total
Rs. 600 billion in capital over the next few assets. The share of banking sector value
years. adds to GDP increases to over 4.7 per cent.
EVOLUTION:
STAGNATION:
In this scenario, policy makers intervene to
Policy makers adopt a pro-market stance but set restrictive conditions and management is
are cautious in liberalizing the industry. As a unable to execute the changes needed to
result of this, some constraints still exist. enhance returns to shareholders and provide
Processes to create highly efficient quality products and services to customers.
organizations have been initiated but most As a result, growth and productivity levels
banks are still not best-in-class operators. are low and the banking sector is unable to
Thus, while the sector emerges as an support a fast-growing economy. This
important driver of the economy and wealth scenario sees limited consolidation in the
in 2010, it has still not come of age in sector and most banks remain sub-scale.
comparison to developed markets. New private sector banks continue on their
Significant changes are still required in growth trajectory of 25 per cent. There is a
policy and regulation and in capability- slowdown in PSB and old private sector
building measures, especially by public bank growth. The share of foreign banks
sector and old private sector banks. remains at 7 per cent of total assets. Banking
meanwhile, is only 3.3 per cent of GDP.
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6. NEED TO CREATE A MARKET-DRIVEN
BANKING SECTOR WITH ADEQUATE FOCUS
ON SOCIAL DEVELOPMENT
 Focus strongly on “social
The term “policy makers” used in this development” by moving away from
document, as mentioned earlier, refers to the universal directed norms to an
Ministry of Finance and the RBI and
explicit incentive-driven framework
includes the other relevant government and
regulatory entities for the banking sector. by introducing credit guarantees and
We believe a co-ordinate effort between the market subsidies to encourage
various entities is required to enable positive leading public sector, private and
action. This will spur on the performance of foreign players to leverage
the sector. The policy makers need to make technology to innovate and
co-ordinate efforts on six fronts: profitably provide banking services
to lower income and rural markets.
 Help shape a superior industry
structure in a phased manner through  Create a unified regulator, distinct
“managed consolidation” and by from the central bank of the country,
enabling capital availability. This in a phased manner to overcome
would create 3-4 global sized banks supervisory difficulties and reduce
controlling 35-45 per cent of the compliance costs.
market in India; 6-8 national banks
controlling 20-25 per cent of the  Improve corporate governance
market; 4-6 foreign banks with 15-20 primarily by increasing board
per cent share in the market, and the independence and accountability.
rest being specialist players
(geographical or product/ segment  Accelerate the creation of world
focused). class supporting infrastructure (e.g.,
payments, asset reconstruction
companies (ARCs), credit bureaus,
back-office utilities) to help the
banking sector focus on core
activities.
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7.  New private banks could reach the
 Enable labour reforms, focusing on next level of their growth in the
enriching human capital, to help Indian banking sector by continuing
public sector and old private banks to innovate and develop
become competitive. differentiated business models to
profitably serve segments like the
rural/low income and affluent/ HNI
segments; actively adopting
NEED FOR DECISIVE acquisitions as a means to grow and
ACTION BY BANK reaching the next level of
performance in their service
MANAGEMENTS platforms. Attracting, developing
and retaining more leadership
capacity would be key to achieving
Management imperatives will differ by this and would pose the biggest
bank. However, there will be common challenge.
themes across classes of banks:
 Foreign banks committed to making
 PSBs need to fundamentally a play in India will need to adopt
strengthen institutional skill levels alternative approaches to win the
especially in sales and marketing, “race for the customer” and build a
service operations, risk management value-creating customer franchise in
and the overall organizational advance of regulations potentially
performance ethic. The last, i.e.,
opening up post 2009. At the same
strengthening human capital will be
the single biggest challenge. time, they should stay in the game
for potential acquisition
opportunities as and when they
 Old private sector banks also have appear in the near term. Maintaining
the need to fundamentally strengthen a fundamentally long-term value-
skill levels. However, even more creation mindset will be their
imperative is their need to examine greatest challenge.
their participation in the Indian
banking sector and their ability to The extent to which Indian policy makers
remain independent in the light of and bank managements develop and execute
the discontinuities in the sector. such a clear and complementary agenda to
tackle emerging discontinuities will lay the
foundations for a high-performing sector in
2010.
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