This report on the Indian banking industry focuses on commercial banks. Commercial banks may be government owned banks, private sector banks, or foreign banks. The commercial banks in India have played a significant role in the development of the economy. With the structural reforms initiated in the economy in 1990s, it was imperative that a vibrant and competitive financial system be put in place to sustain the ongoing process of reforms. The result of the changes has led to the opening of the banking industry to the Indian private sector and foreign banks. The Government of India (GOI) has loosened many of the longstanding restrictions on foreign direct investment (FDI) in the past two years. The reforms have succeeded in easing external constraints on banking operations, efficient use of manpower, introduction of technology in the banks, transparency in reporting procedures, restructuring and recapitalizing banks and enhancing the competitive element in the market.
Over the coming years, banks in India will focus on the retail segment, cost reduction strategies, generating fee-based income, and brand building. Banks in India will be forced to adopt measures to survive, as the banking environment in India grows more competitive with the relaxation of restrictions, adoption of international standards, and increased efficiency through technology.
The banking industry in India is significantly different from that of other countries because of India’s geographic, social, and economic characteristics. Although the Indian banking industry opened up to private players only in 1993, the profitability of the Indian commercial banking sector is at par with most of the leading banking sectors of the world.
The Indian banking system can be broadly classified as organized and unorganized. The unorganized banking system is comprised of moneylenders, indigenous bankers, lending pawnbrokers, and traders. Whereas the organized banking system consists of scheduled banks and non-scheduled banks that are permitted by the Reserve Bank of India (RBI), India’s Central Bank, to undertake banking activities. The scheduled commercial banks (SCB) are required to follow guidelines set by the RBI. SCBs have access to financial assistance and refinance facilities from the RBI. Based on their ownership, scheduled commercial banks can be classified as Public Sector Banks (PSB), Private Sector Banks (“old and new” private banks), and Foreign Banks.
The banking sector in India is characterized by the predominance of Public Sector Banks (PSBs).
In FY04 (Indian fiscal year is from 1 April to 31 March), PSBs had 48,150 offices. Their assets of Rs.14, 714 billion ($334 billion) at the end FY04 accounted for 74.5% of the assets of all SCBs in India. It is estimated that 63.1% of the offices of PSBs are located in rural/semi-urban areas. This large network of branches enables the PSB’s to fund operations out of low-cost deposits. The State Bank of India (SBI) is the largest commercial bank in India. In FY04, SBI accounted for 20.6% of the aggregate assets of all commercial banks. Some of the other large PSBs are Punjab National Bank, Bank of Baroda, Canara Bank, Bank of India, Oriental Bank of Commerce and Corporation Bank.
However, with the entry of new private sector banks, the PSBs have suffered a gradual loss of market share. The PSBs accounted for 67.4% of the total assets during FY04, compared to 79.3% in FY03, and 52.3% in FY02.
In FY04, there were 30 private sector banks operating in India through 5,903 offices. Private banks are classified as old private sector banks and new private banks. In FY04, there were 20 old private sector banks operating in the country. These banks are regional in nature and estimated to have 4,473 offices. In July 1993, as part of the banking sector reform process, the RBI permitted entry to the private sector. This resulted in the introduction of new private banks. These new private sector banks operated through 1,430 branches in FY04.
The private sectors banks include ICICI Bank, HDFC Bank, UTI Bank, Federal Bank, Kotak Manhindra Bank and J&K Bank. In FY04, the total assets of the private sector banks aggregate
Rs. 3,673 billion ($83.5 billion) and accounted for 18.8% the total SCB assets. Though the share of private sector banks in total commercial bank assets increased from 12.6% in FY01 to 18.6% in FY04, most of the gain is accounted for by the new private sector banks. The share of the new private sector banks increased from 25.5% in FY97 to 67.1% in FY04.
There are 33 foreign banks operating through 222 offices. All offices of foreign banks in India are in the urban areas and metropolitan cities. In FY04, total assets of foreign banks aggregated at Rs.1, 363 billion ($31 billion) and accounted for 6.9% of total assets of all SCBs. In recent years, because of increased competition from new private banks the share of foreign banks in aggregate SCB assets has declined from 8.1% in FY1999 to 6.9% in FY04.
The major foreign banks in India are the Standard Chartered Bank, Citibank, Hong Kong & Shanghai Banking Corporation, ABN Amro Bank and the Deutsche Bank. The primary activity of most foreign banks in India had been corporate banking. However, since mid-1990s, foreign banks added consumer financing to their portfolio and today the foreign banks offer a wide-range of products such as automobile, home and household consumer loans as well as credit cards.
The commercial banks in India work broadly through three segments - corporate, retail and treasury. Earlier, Indian banking industry consisted mainly of the public sector banks, which were oriented towards the corporate and treasury segments. Declining interest rates, changing demographic profiles and the entrance of private and foreign banks are responsible for the emergence of the retail segment. In order to increase market penetration the retail banks in India started to develop and offer a wide range of products including car loans, housing loans, education loans, and credit cards. In FY03, bank retail assets grew at the rate of 30% per annum. Retail financing in India is currently estimated at $11 billion and is expected to triple by 2007. This expansion will require greater marketing and IT services.
The corporate banking segment in India supplies capital for business ventures to large and medium sized businesses. This banking segment accounts for more than 60 per cent of the banking assets and is the main business for the banks. This trend is likely to continue since SMEs are dependent on bank loans for their operations. Commercial banks provide a range of products and services including working capital finance, project term loans, corporate term loan, structured finance, dealer finance, channel finance, equipment leasing, loan syndication, and cash management services.
IT services are also becoming more popular with bank customers. ATMs, credit cards, and Internet banking, which are already widely used around the world, have yet to reach their full potential in India. These services and products are all expected to grow in the coming years. ATMs, numbered at 12,000 in 2004, are estimated to increase to 35,000 by 2007. Factors driving the growth of ATMs and other technology-based services are increased competition, the need to reduce transaction expenses, customer demand, geographic reach, and the potential for revenue collection.
One promising IT service in India is “m-banking” (mobile banking). M-banking service is cheaper than ATMs and attracts a high potential consumer demand. M-banking will most likely surpass Internet banking because it is more accessible to Indian customers who are more likely to have mobile phone access rather than Internet access. Worldwide m-banking commerce was valued at $5 billion in 2004 and is expected to surpass $35 billion by 2007. However, better technology for m-banking needs to be developed, especially for authenticating mobile devices. Both private and public sector banks have started offering m-banking services.
The recent financial reforms and greater competition in the banking industry have made it necessary for banks in India to cut costs through greater implementation of IT technology. Modernizing operations not only reduces costs, but also increases accuracy and responsiveness that make banks more competitive. Indian banks have been slow to adopt technology and therefore face increasing competition from foreign banks that already have IT infrastructure in place. In 2002-03, IT spending by Indian banks was only 1 percent of the revenue compared to 7 percent spent by banks in the U.S.
The Indian banking industry has also witnessed an increasing amount of mergers. This trend is likely to continue so that banks may remain competitive by taking advantage of larger customer bases, economies of scale, the cross sale of services, and the sharing of customer information and physical capital. Moreover, since public banks are restricted from merging with other banks, foreign banks that merge with private Indian banks will be able to gain an advantage from consolidation.
Problems that plague the Indian banking industry include poor capitalization, excessive liquidity, over-investment in government papers, reluctance to lend that hinders growth in the manufacturing sector, and inefficient operating processes. Indian banks also possess a high level of non-performing assets (NPAs), although this number remains low when compared to other Asian banking systems.
Successful banks in India will focus on the retail sector, generating fee-based income, cost reduction strategies, and brand differentiation. Banks will be forced to adopt these measures to survive, as the banking environment in India grows more competitive with the relaxation of restrictions and adoption of international standards.
Foreign banks currently possess only a marginal portion of the banking market in India, 7 percent of assets, 5 percent of deposits, and 7 percent of advances. Foreign presence in the banking sector is sure to increase because of both the expanding demand for banking services and the compliance with international standards set forth by WTO and Basel II agreements.
The foreign banks in India operate quite differently from the domestic banks. Fees produce a substantial portion of income (23 percent on average, compared to 9 percent each for public and private banks). The cost of deposits for foreign banks is near 4 percent, that is 2 points lower than public and private banks. The return on assets for foreign banks is double that of domestic banks. Foreign banks are more competitive due to greater technology use and better risk management.
India has agreed to provide a greater role for foreign banks as a part of the World Trade Organization (WTO) agreement. As a result the Indian banking industry is undergoing a rapid dismantling of long-standing regulations in preparation for the opening of the sector, which will be completed by 2009. The Government of India (GOI) has loosened many of the longstanding restrictions in the past two years. Increases in the presence of foreign banks, private banks, and foreign direct investment (FDI) have fostered a more competitive banking environment. The 2003-04 annual budget increased the limit of FDI in private banks from 49 percent to 74 percent. This increase allows foreign owners greater management control over private banks. The private banks benefit from the increase in FDI because FDI provides much-needed capital at competitive prices. A higher Capital Adequacy Ratio (CAR) improves the overall health of the Indian banking system.
By the end of 2006, Indian banks must adhere to the Basel II international capital adequacy standards. Banks will require greater information sharing systems and technology to better supervise risk. Also, banks will need to strengthen their CAR to avoid imposed restrictions on bank lending. Basel II compliance is one of the major drivers behind reforms in the Indian banking industry.
The Indian economy is growing strongly which ensures better debt recovery and asset valuation. Progressive bank reforms and low interest rates will increase borrowing activity. The banking sector in India offers great opportunity to foreign banks that possess the technology to serve the Indian population.
Information Source: Cygnus report “Indian Commercial Banking” 2004, RBI Banking Bulletins 2004 & 2005, and ICRA report “Indian Banking Industry” January 2005.
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