Two and a half cheers for boring banking
Indian banks stand tall in a world still recovering from a global credit
crisis, but now may also be the time to push the envelope.
The year 2010 is a good milestone to do a review of the Indian banking industry for the decade, and to state its rightful position as the engine of India's growth story. The total assets of the Indian banking industry grew from $250 billion to $1.3 trillion during these 10 years - a cumulative average growth of 18 per cent compared to the average GDP growth of 7.2 per cent over the same period. The quality of banking assets, too, improved substantially - return on assets or RoA, which stood at roughly 0.5 per cent in 2000-01, rose to 1.05 per cent in 2009-10, even as net non-performing assets shrank from 6.8 per cent to 1.1 per cent over the same period.
This growth and quality enhancement was achieved on the back of the industry adding some 15,000 branches, 40,000 ATMs, introducing a range of products, better risk management and improved services through deployment of technology. Notably, fee-based income from sale of third-party products and treasury services saw a phenomenal growth, powered by the increased availability of insurance and mutual fund products for retail customers and enlarged trade finance and foreign exchange portfolios for corporate customers.
This is not to say that gaps do not exist. They do: banking services are available to only about 40 per cent of the population, retail credit continues to be abysmally low, credit to small and midsize companies is still limited, critical infrastructure projects are struggling for funding and no Indian bank figures in the list of top 50 large global banks. However, each gap only points to the significant opportunity that exists for the industry to continue its high growth trajectory.
In the last year of the past decade, the mayhem of 2008 was consigned to the back of our minds as India's GDP grew by over 7.5 per cent, with the economy looking poised to regain its pre-crisis growth rate of over 8.5 per cent per annum. A survey published by the Federation of Indian Chambers of Commerce & Industry in February 2010 revealed that roughly 85 per cent of the respondents felt that the banking system was in a good to excellent shape and poised for a sustained growth rate of 15-20 per cent over the next few years. That show of confidence reflects in the growth in bank credit to the private sector in India which, after declining to about 12 per cent in the fourth quarter of financial year 2009, started to show signs of a turnaround, logging 17 per cent growth in the first quarter of FY 2010.
In view of the unanimity of opinions on the sustained demand-led growth of the Indian economy, as well as also partially hedging for uncertainty in the global banking system and the growing imbalance in asset liability positions, we have tried to identify the key initiatives, challenges and opportunities for the Indian banking industry for the next two years. While we have indulged in crystalball gazing in the past, our views are based on predefined regulatory announcements that will fructify in the immediate future or macroeconomic initiatives that are already well under way. While it is tempting for us to include the impact of socio-economic trends such as the demographic advantage and rising incomes, we are restricting ourselves to three key areas: major regulatory changes, impact of the new tax codes and the result of the new risk paradigms.
A year ago, in a keynote address to the Indian Merchants' Chamber on the impact of the global crisis on Indian banking, the Governor of the Reserve Bank of India or RBI, D. Subbarao, had made a reference to American economist Paul Krugman's idea of making banking "more boring". At one level, the Governor argued, getting "back to banking basics" was a critical requirement, but at another level, in an interconnected world, contingent risks between "boring banks" and "casinos" could not be wished away.
In his words "even if each institution is healthy and safe on a standalone basis, systemic risk can build up because of procyclical, herd behaviour. It is, therefore, necessary to supplement micro-prudential regulation with macro-prudential oversight."
This oversight, whether as a direct outcome of the G20 initiatives or through the recommendations in the Basel III draft guidelines, will result in significant changes in the way banks grow.
From a structural perspective, banking in India is starting to go through a significant shift of philosophy. This is manifesting itself in a number of new regulatory interventions from the RBI in the areas of holding companies and their subsidiaries, foreign banks, new banking licences and infrastructure financing (see Banking on Change).
Consider, for example, foreign banks. As a direct outcome of the global banking crisis, the RBI seems to be keen to make foreign banks in India move towards a wholly-owned subsidiary model. For the banks, it would be a good opportunity to seek parity with their Indian counterparts in areas such as branch expansion, local acquisitions and raising capital and subordinated debt in the local markets; but this will be coupled with challenges such as meeting increased priority sector lending norms.
From an RBI perspective, a whollyowned subsidiary model would ensure that the local operations of foreign banks are free of contagion risks from their global operations and that the subsidiary has an opportunity to build a significant local balance sheet. The expected guidelines would focus on the enhanced capital required as a wholly-owned subsidiary, rights as a "deemed Indian bank" and some key restrictions.
Similarly, on the subject of new banking licences, the final guidelines are expected to take some time to evolve and will be followed by a committee-based selection of "fit and proper" candidates. However, it is fairly clear that these banks will be required to have a higher capital base than the current one and will have to meet the financial inclusion commitments. It is expected that the major stand-alone non-banking finance companies and those owned by corporate houses will be vying for a banking licence.
In addition to the structural changes being thought through by the RBI, Indian banking also needs to prepare itself for the impact of the Direct Taxes Code or DTC from 2011 and potentially for the Goods and Services Tax or GST from 2012. In terms of the DTC, every business constitutes a separate source of income.
The implementation of GST is expected to have the most visible and immediate impact on the compliance front, as there will be a central law for GST and multiple state-specific laws. This would mean that a bank with operations across India would need to obtain registrations in all states where services are supplied - 28 states and seven Union Territories - along with the central GST registration.
The likely transition to the International Financial Reporting Standards or IFRS by FY 2013 is also going to keep banks busy. These standards cover a very large geography of accounting and are extremely important for financial institutions and entities with large exposures to financial instruments, derivative products, securitisations and asset sale activities. It is important that the financial services sector in India considers, analyses and prepares for the many challenges posed by the transition to the IFRS in a timely manner.
Along with such challenges, banks will also have their hands full dealing with opportunities for growth, thanks to a number of initiatives taken up by industry as well as at the national level (see Opportunities Galore). Take, for instance, the Unique Identification or UID programme. Expected to cover over 600 million Indians in the next few years, this programme will be the trigger for a high-growth phase in retail credit. The irrefutable individual identity and the ability to centralise data using the UID number as the taxonomy header and linking it to an address will enable the sharing of positive and negative credit history, proxy information and other behavioural details.
Then there is mobile banking. The ultimate challenge for the banking world is to enable a low-cost transaction model. When coupled with the UID programme, this can become the transformational model for inclusion that the country is demanding.
Now add to the UID programme and a wireless platform the concept of business correspondents, and financial inclusion looks even less of a pipe dream. Recently, the RBI allowed "for-profit" organisations to structure themselves as partners to banks as business correspondents. There is a wide range of activities that the correspondent can do - cash collection, disbursal, bill payments, money transfer, amongst others. One can envisage that companies with large primary distribution networks will see a good opportunity to create a services-based revenue model.
Last but not least is the opportunity that already exists and can only grow larger: financing the small & medium enterprises or SMEs. It is estimated that SMEs account for over 10 per cent of GDP (and roughly 50 per cent of manufacturing output).
However, only four to five per cent of SMEs receive credit services from the banking sector. With improving risk profiles and performance of SMEs and the better spreads enjoyed by banks for this type of credit, the opportunity remains extremely attractive.
Indian banking has seldom been in a sweeter spot - not just in terms of the respect the sector now commands in the post-crisis global banking forums but, more importantly, as it readies itself to address the massive growth opportunity that lies ahead. The springboard has been set. Seize the next decade.
Trivedy, Makhijani, Menon and Vishwanath are EDs at KPMG; Sur is Director, KPMG. The views and opinions are those of the authors and do not necessarily represent the views and opinions of KPMG in India
This growth and quality enhancement was achieved on the back of the industry adding some 15,000 branches, 40,000 ATMs, introducing a range of products, better risk management and improved services through deployment of technology. Notably, fee-based income from sale of third-party products and treasury services saw a phenomenal growth, powered by the increased availability of insurance and mutual fund products for retail customers and enlarged trade finance and foreign exchange portfolios for corporate customers.
| Banking on change Regulatory interventions from the RBI are on the cards.
|
In the last year of the past decade, the mayhem of 2008 was consigned to the back of our minds as India's GDP grew by over 7.5 per cent, with the economy looking poised to regain its pre-crisis growth rate of over 8.5 per cent per annum. A survey published by the Federation of Indian Chambers of Commerce & Industry in February 2010 revealed that roughly 85 per cent of the respondents felt that the banking system was in a good to excellent shape and poised for a sustained growth rate of 15-20 per cent over the next few years. That show of confidence reflects in the growth in bank credit to the private sector in India which, after declining to about 12 per cent in the fourth quarter of financial year 2009, started to show signs of a turnaround, logging 17 per cent growth in the first quarter of FY 2010.
In view of the unanimity of opinions on the sustained demand-led growth of the Indian economy, as well as also partially hedging for uncertainty in the global banking system and the growing imbalance in asset liability positions, we have tried to identify the key initiatives, challenges and opportunities for the Indian banking industry for the next two years. While we have indulged in crystalball gazing in the past, our views are based on predefined regulatory announcements that will fructify in the immediate future or macroeconomic initiatives that are already well under way. While it is tempting for us to include the impact of socio-economic trends such as the demographic advantage and rising incomes, we are restricting ourselves to three key areas: major regulatory changes, impact of the new tax codes and the result of the new risk paradigms.
A year ago, in a keynote address to the Indian Merchants' Chamber on the impact of the global crisis on Indian banking, the Governor of the Reserve Bank of India or RBI, D. Subbarao, had made a reference to American economist Paul Krugman's idea of making banking "more boring". At one level, the Governor argued, getting "back to banking basics" was a critical requirement, but at another level, in an interconnected world, contingent risks between "boring banks" and "casinos" could not be wished away.
This oversight, whether as a direct outcome of the G20 initiatives or through the recommendations in the Basel III draft guidelines, will result in significant changes in the way banks grow.
From a structural perspective, banking in India is starting to go through a significant shift of philosophy. This is manifesting itself in a number of new regulatory interventions from the RBI in the areas of holding companies and their subsidiaries, foreign banks, new banking licences and infrastructure financing (see Banking on Change).
Consider, for example, foreign banks. As a direct outcome of the global banking crisis, the RBI seems to be keen to make foreign banks in India move towards a wholly-owned subsidiary model. For the banks, it would be a good opportunity to seek parity with their Indian counterparts in areas such as branch expansion, local acquisitions and raising capital and subordinated debt in the local markets; but this will be coupled with challenges such as meeting increased priority sector lending norms.
From an RBI perspective, a whollyowned subsidiary model would ensure that the local operations of foreign banks are free of contagion risks from their global operations and that the subsidiary has an opportunity to build a significant local balance sheet. The expected guidelines would focus on the enhanced capital required as a wholly-owned subsidiary, rights as a "deemed Indian bank" and some key restrictions.
Similarly, on the subject of new banking licences, the final guidelines are expected to take some time to evolve and will be followed by a committee-based selection of "fit and proper" candidates. However, it is fairly clear that these banks will be required to have a higher capital base than the current one and will have to meet the financial inclusion commitments. It is expected that the major stand-alone non-banking finance companies and those owned by corporate houses will be vying for a banking licence.
| Opportunities galore Banks have many options for growth
|
The implementation of GST is expected to have the most visible and immediate impact on the compliance front, as there will be a central law for GST and multiple state-specific laws. This would mean that a bank with operations across India would need to obtain registrations in all states where services are supplied - 28 states and seven Union Territories - along with the central GST registration.
The likely transition to the International Financial Reporting Standards or IFRS by FY 2013 is also going to keep banks busy. These standards cover a very large geography of accounting and are extremely important for financial institutions and entities with large exposures to financial instruments, derivative products, securitisations and asset sale activities. It is important that the financial services sector in India considers, analyses and prepares for the many challenges posed by the transition to the IFRS in a timely manner.
Along with such challenges, banks will also have their hands full dealing with opportunities for growth, thanks to a number of initiatives taken up by industry as well as at the national level (see Opportunities Galore). Take, for instance, the Unique Identification or UID programme. Expected to cover over 600 million Indians in the next few years, this programme will be the trigger for a high-growth phase in retail credit. The irrefutable individual identity and the ability to centralise data using the UID number as the taxonomy header and linking it to an address will enable the sharing of positive and negative credit history, proxy information and other behavioural details.
Then there is mobile banking. The ultimate challenge for the banking world is to enable a low-cost transaction model. When coupled with the UID programme, this can become the transformational model for inclusion that the country is demanding.
Now add to the UID programme and a wireless platform the concept of business correspondents, and financial inclusion looks even less of a pipe dream. Recently, the RBI allowed "for-profit" organisations to structure themselves as partners to banks as business correspondents. There is a wide range of activities that the correspondent can do - cash collection, disbursal, bill payments, money transfer, amongst others. One can envisage that companies with large primary distribution networks will see a good opportunity to create a services-based revenue model.
Last but not least is the opportunity that already exists and can only grow larger: financing the small & medium enterprises or SMEs. It is estimated that SMEs account for over 10 per cent of GDP (and roughly 50 per cent of manufacturing output).
However, only four to five per cent of SMEs receive credit services from the banking sector. With improving risk profiles and performance of SMEs and the better spreads enjoyed by banks for this type of credit, the opportunity remains extremely attractive.
Indian banking has seldom been in a sweeter spot - not just in terms of the respect the sector now commands in the post-crisis global banking forums but, more importantly, as it readies itself to address the massive growth opportunity that lies ahead. The springboard has been set. Seize the next decade.
Trivedy, Makhijani, Menon and Vishwanath are EDs at KPMG; Sur is Director, KPMG. The views and opinions are those of the authors and do not necessarily represent the views and opinions of KPMG in India
