Indian Banking System

INDIAN BANKING SYSTEM

Submitted To:Mr. Nitin Kumar Jain

Submitted By:Pujil Khanna Pankaj Tiwari Avinash Jeswani Robin Choudhary

PHASE I:-The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. PHASE II:- Nationalisation of Imperial Bank of India with extensive banking facilities on a large scale specially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. 14 major commercial banks in the country was nationalised. PHASE III:- This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimhama, a committee was set up by his name which worked for the liberalisation of banking practices.

“ Bank is an institution which trades in money, an establishment for the deposits, custody and issue of money, as also for making loans and discounts and facilitating the transmission of remittances from one place to another”.  Savings Bank : Running account for saving with restriction in number of withdrawal  Current Account: Running account without restriction on number of withdrawals  Term Deposit : Deposit of an amount for a fixed period where interest is paid monthly/Quarterly.  Special Term Deposit : Deposit of an amount for a fixed period where interest is compounded (Capitalized) and paid on maturity.  Recurring Deposit : Regular (Monthly) deposit of a fixed amount for a fixed period

A Decade of change and evolution… Pre-reform 

Indian economy

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Extensive regulation Focus on industrial sector

The 1990s   

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Financial sector

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Highly segmented Public sector dominance

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Liberalisatio n Globalisation Structural change – services Opening up of various sub-sectors Private sector participation

..financial sector mirroring macro-economic change

Today  

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Resilient industry Buoyant services sector Diversified financial groups Globally benchmarke d

PRE-GLOBALIZED SCENARIO OF SERVICE CULTURE IN THE INDIAN BANKS FORMALIZED CUSTOMER UNFRIENDLY

SERVICE CULTURE WAS EXTREMELY

NON COMPETETIVE ATTITUDE. PRODUCT FOCUSED & NOT CUSTOMERSERVICE FOCUSED. DEMOTIVATED & NON INTERESTED EMPLOYER& EMPLOYEE.

The Banking Sector Today Depth   

Countrywide coverage Large number of players Increasingly sophisticated financial markets

Diversification   

Technology  

Increasing use of technology in operations Poised to expand and deepen technology usage

Emergence of integrated players Diversifying capital deployment Leveraging synergies

Regulation 

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Robust regulatory system aligned to international standards Efficient monetary management 6

Sector Snapshot Size

Number of banks

 Total Totalassets assetsof ofUS$ US$335 335billion billion  Total deposits of US$ 279 billion

Total deposits of US$ 279 billion

 Over Over290 290scheduled scheduledbanks banks  Public sector: 27

Public sector: 27

 Private Privatesector: sector:new new––9; 9;old old ––24 24  Foreign: 37

Foreign: 37

 Over Over190 190regional regionalrural ruralbanks banks

Branch network

 Over Over66,000 66,000branches branches  Public sector:  Public sector:46,000 46,000  Private Privatesector: sector:5,500 5,500  Foreign: Foreign:190 190  Regional Regionalrural: rural:14,400 14,400

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A New orientation among banks… Traditional/ public sector  Sell products  Product research: what will sell?  Product sales and profitability targets  Product specialist groups  Introduce new offerings every few years/months  “Branch banking”  Focus - customer acquisition

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New/ private sector Meet customers’ needs Customer research: what does the customer want? Customer segment sales and profitability targets Customer owners Customer specific new offerings every week/day Customer convenience Deepen relationships 8

Flower of banking service

cy n lta e u s vic n r Co se

Change in Product line I O ntro sc f n . he ew m es

Mobile & Internet banking N e t w Financial kr o service

Low interest rates

A MT

Good Waiting room al n io ot nts om cou r P is d

Technological Innovations in Banking sector. Phone Banking

Data Mining.

Mobile Banking

Plastic money. ATM Tie up Arrangements Virtual bankingdon’t visit the branch

Marketing Agents for Distribution of Products

Insurance Product

Innovation In Banking Product.

Core Product

Basic Product

Expected Product

Augmented Product

Potential Product

The basic necessity Safety of deposits Timely service Good waitingOccasional to use banking Loanable fundsLong banking hours. rooms greeting at home services in order to etc. Low interest friendly handle finance Rate. employees Surprise gifts. more efficiently Welcome note.

Additional Banking Services

Merchant Banking

Loan Syndication.

Mutual Fund

Factoring.

Forfeiting.

Venture Capital.

Major drivers for Banking Sector, world wide

Technology- leads the Winning Combination “The winners will be those institutions that tie their technology to their strategies in order to meet their challenges.”

Cost

• Cutting Cost through Integration • Better Information Management

Customer

• Reaching Customers Faster • Managing Diverse Needs

Competition

Key Banking Technology Aspects

Performance & Evaluation • Better Metrics to Benchmark Against • Objective Evaluation Process

• Competitive Edge its Strategic Group

Risk Management Complexities

•Easier Risk Identification •Easier to Assess Risks

in

Importance of Core Banking Solution Benefits of CBS 

Faster Response to Customer Demands

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Allows Faster New Product Developments

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CBS Architecture Allows for Existing Products to be Quickly Customized

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Online Validation of Data – at the Time of Entry

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Independent from the Organization Structure and Supports the four Primary Entities – Customer, Account, Product and Business Organization

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Runs in Real Time Update Mode

History:- Become operational on April 1,1935 Nationalized in the year 1949 Major objectives:Regulate the issue of banknote Maintain reserve with a view to securing monetary stability To operate the credit and currency system of the country to its advantage Functions of RBI The function are classified into three heads;1.Traditional functions 2.Promotional functions 3.Supervisory functions How it controls banks & economy :Tools-(as on 28th nov,2009) CRR- 5.00% REPO RATE- 4.75% REVERSE REPO RATE- 3.25% STATUTORY LIQUIDITY RATIO(SLR)- 25% BANK RATE- 6.00%

 Government equity in banks has been reduced and strong banks have been allowed to access the capital market raising additional capital.  Bank now enjoying the operational freedom in terms of opening of new branches and bank having good track record of profitability given flexibility in recruitment.  New private sector banks have been set up and foreign banks are allowed to expand their function in India including through subsidiaries.  Banks are also allowed to set up off shore banking units in SEZ.  New instrument have been introduced for better flexibility and better risk management like interest rate exchange, cross currency forward contract.

Private Sector Banks Investment rationale • Private sector banks are better capitalized compared to PSU Banks in case of rising NPLs • More seasoned loan book resulting in less incremental NPLs • NIM are stable as the PLR cut is not much compared to PSU banks • Pvt Sector banks to improve margins due to steep decline in deposit cost (decline in wholesale deposit cost by 400-500 bps point) • Top 3 pvt banks has a significant portion of their revenue coming from capital market linked business. While the capital markets are expected do well in the near future it bodes well for the private sector banks • Majority of the top private banks (except AXIS bank) are in a process to consolidate their balance sheet, to restructure their balance sheet, reduced NPLs, restructured loans and slippages which is good in the long term • Increased thrust on the CASA deposit i.e., primarily focusing on the low cost deposit • Private banks have been historically innovative and technologically superior • Best Picks: Axis Bank, HDFC Bank, Yes Bank, Jammu and Kashmir Bank

Private Sector Banks Things to watch for: • •

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Private sector banks have been conservative in last few quarters, restructuring there balance sheet which will have a negative impact on the NIMs, profitability, ROE in the coming quarters Private sector banks have relied heavily on capital market linked activity, approximately 30-40% of their revenue and net worth is relied on third party distribution products. Any downfall in the capital market will have a significant impact on the bottom line of the company Private sector banks trades at a lower ROE (13-14%) compared to public sector banks (17-18%) Cost of funding at 6.5% is higher in comparison to Public sector banks (6%) Private sector banks might need to account for MTM losses, provisions etc due to its presence in uncertain international markets

Public Sector Banks Investment Rationale • • • • • • • • • • •

Despite higher ROE, PSU banks are trading at a lower P/BV Strong operating performance and profitability Strong Earnings growth Improving Quality of earnings No MTM losses Banks have significant franchise value Improving quality of earnings PSU banks have been more aggressive in lending which will help it to increase its profitability, NIMs, ROE Increased focus on low cost deposit by rapidly increasing the branches leading to a decline in the funding cost Improved focus on non-banking revenues (Asset Management, Private Equity, IB etc), leveraging on its existing branch network Best Picks: BOB, Corporation Bank

Public Sector Banks Things to watch for: •

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PSU Banks are likely to face more margin pressure compared to private sector banks: – Lending rates have been cut much more then private sector banks – Lending in a weak corporate environment – High cost deposit mobilized during the second half of 2009 – Excess investment in government securities and parking of excess funds with RBI carry's a negative yield on investment portfolio PSU banks are more likely to be persuaded by Government to reduce the lending rates Operating expenses for the PSU banks are likely to go up due to higher wage increase and transfer from PF to pensions Restructuring has been high in PSU banks resulting in a increase in NPLs Cautious on fundamentals due to slowing loan growth, declining margins (NIMs) and rising credit costs Employee productivity and profit per branch have always been a concern in compare to private sector banks Traditionally, PSU banks have been laggard in technology Asset quality will be a concern in a long run due to aggressive lending in a weak corporate environment Yield on advances at 9.5% is lower compared to private banks (11%)

Public Sector v/s Private sector Banks

C/D Inv/Dep Asset/Equity Cost of Dep Yield on Dep Yield on Inv NIM NII/Total Inc RoE RoA

Pvt Banks

Public Banks

77% 41% 10.3 6.5 7.3 11 2.7 57.3 13.4 1.0

73% 33% 17.3 6.0 7.4 9.5 2.4 67.1 17.2 1.0

Future Outlook • • • • • • •

Strong re-bound in the economic activity should drive a significant loan growth in the second half of the fiscal Historically, loan growth to real GDP multiplier has been 3.3x in the past 25 years. Based on the GDP projection of 6%+, I except loan growth at 20%+ for the entire fiscal Decline in the cost of funding as the high cost term deposit mobilized in Q3 and Q4 of FY09 is likely to mature in the coming quarters The deposit rate is unlikely to fall below 7.5% in the recent time as the small saving scheme offers 8% interest rate. A fall below 7.5% interest rates is unlikely as it will disturb banking system Interest rates are likely to go up in Q4FY10 due to high fiscal deficit and monsoon failure Increase in the interest rates has a inverse relationship with the banking stock Bond yields are expected to harden up in the coming quarters due to high government borrowings which will lead to a increase in MTM provisions in the bank portfolio, having an negative impact on the bottom line

Future Outlook…Cont • • • • • • •

PSU banks to remain under pressure as they can be pressurized by the government to lower their lending rates Gross NPLs and restructured loans are likely to stable or go down as they are most likely to get peaked in 2Q2010 and due to lower provisions on account of improving loan growth and economic activity Non Interest revenue is likely to be the flavor of the time in the near future. Improved economic and capital market activity should drive a rebound in noninterest revenue CASA ratio is likely to improve due to narrowing of the differences between term deposits and saving deposits. Also, managements across the board have placed more emphasis on low cost deposit PSU banks are expected to get more aggressive in loan growth to spurt growth in the economy and private banks are more likely to consolidate their balance sheet in the near term Trading income is likely to come down due to hardening of bold yields NIM is likely to go up in the second half of the fiscal due to decline in the funding cost, increase in credit off take, strong domestic demand

Important numbers •

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Highest credit Growth – PSU Banks: PNB(38%) – Pvt Banks: Axis(28%) Highest Deposit Growth – PSU Banks: SBI(36%) – Pvt Banks: Axis(24%) NIM – PSU Banks: PNB(3.4%) – Kotak Mahindra Bank(6%), HDFC BK(4.1%) CASA – PSU Banks: PNB(38%), SBI(38%) – Pvt Banks: HDFC BK(45%), Axis Bank (40%) Provision – PSU Banks: PNB(89%), BoB(81%) – Pvt Banks: HDFC Bk(71%), Axis Bank(59%) Credit Spread – PSU Banks: PNB(4.9) – Pvt Banks: Yes Bank(4.4)

NEW INITIATIVES TAKEN BY PSBs • • • • • • • • • •

Technology savvy: SBG daily 11 lakh ATM transactions amounting to Rs 140 crore per day  Specialized branches  New products targeted at specific groups  Change in structure, systems and procedures involving quick turnaround time to meet world standards  Marketing orientation  Change in ambience  Recruitment of specialists  Tie-ups, sharing networks, and strategic alliances

Structural Issues • Non-performing assets • Legacy systems – Low levels of technology • Seller’s market mindset – Low level of innovation in products and services – Limited responsiveness to customers’ needs The Indian banking sector has responded to these structural issues by adopting certain strategic imperatives

Legacy Issues addressed… • Challenges of a changing competitive environment – Small and unviable pre-liberalization units – Large investments post-liberalization impacted by global commodity cycles and high interest rates • Supportive legal and regulatory changes – Setting up of Debt Recovery Tribunals and enactment of SARFAESI Act, reducing delays in enforcement of security and creating effective legal deterrent – Corporate Debt Restructuring Forum for restructuring viable companies – Enabling framework for asset reconstruction companies • Proactive approach to resolution and increase in provisioning levels in the system

With significant success in resolution (% ) 50.0%

Gross NPAs as % of GDP

43%

43%

40.0%

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Position much stronger than other Asian economies

40% 30%

30.0% 20.0%

15%

10.0%

4%

US$ bn

1 2 .0 1 0 .0 8 .0 6 .0 4 .0 2 .0 0 .0

India

S. Korea

J apan

Malaysia

Net NPL accretion tapering off with progress in asset resolution and increase in provisioning levels

Thailand

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China

0.0%

Net NPAs of banks & FIs

1997 1998 1999 2000 2001 2002

Source: E&Y, RBI

Bank Lending as percentage of Deposits (2004) Country

Lending as percent of Deposits

China

130

UK

114

Malaysia

101

USA

92

India

61

Raghuram Rajan on Rewriting the Rules for India's Banks Rajan said he sees the challenges facing India's banking industry against the backdrop of three forces, or "tensions," in its socio-economic setting. The first tension is between the "haves" and the "have-nots." This is not so much an urban-rural divide, he noted, but one that plays out as high income vs. low income; well managed states vs. poorly managed states; good institutions vs. bad institutions; and upper castes vs. lower castes. "There are lots of cleavages which reflect this [tension], but fundamentally it's an economic divide," he said.

Continued The second tension "is between the private sector and the public sector, or between the markets and the state," Rajan continued. He pointed out that a common reading of this "clash" is that it represents the rich-poor divide, where the markets are seen as favoring the rich and the state as fighting on behalf of the poor. "This is where the wires get crossed in India," he said. "It is not necessarily [true] that currently or going forward, the state is doing the right thing by the poor. In fact, what is happening is the state is treating the poor miserably."

Continued Rajan said the third clash is one "between the foreign and the domestic sectors," and that this is compounded by the first two tensions. “

Summary 

The reform and liberalization process has transformed the Indian economy  Structural

shift with service sector growth

 Immense

potential to leverage technology and knowledge capital

 Improved

competitiveness in manufacturing after intermediate period of restructuring & rationalization

 Growing

international linkages

 Exports,

manufacturing and distribution

overseas  India

 Globally

as a manufacturing base

benchmarked businesses, capable of competing internationally

Summary (contd). 

The banking sector has achieved significant success in addressing legacy concerns  Resolution

of asset quality concerns through recovery, restructuring and provisioning

 Focus 

on technology and customer orientation

The economic transformation provides major opportunities for the banking sector  Retail

finance – credit and banking services

 Corporate

finance - banking services and structured finance

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The sector is poised to capitalize on these opportunities