Competitiveness of the Indian Banking Sector- Public Sector Banks

Presentation at ISB Hyderabad Presentation at ISB Hyderabad

OVERALL BANKING SECTOR ROADMAP AND SOLUTION FOR PUBLIC SECTOR BANKS HAS TO KEEP IN MIND TWIN OBJECTIVES

Supporting GDP growth

Social/ macro-economic objectives

GDP projected to grow at 8-9% going

forward

Financial inclusion Agri- lending

Infrastructure spending to be more than

USD 600 bn in the next 5 years

Government sponsored schemes Currency market support Stock market support

500 mn new people added to middle class

households

Rural and semiurban per capital

consumption to reach current urban levels by 2017

Government debt

CONTENTS

Public sector banks today

Indian economy and imperatives for banking

Reforms needed

CREATION OF NATIONAL BANKING INSTITUTIONS HAS SERVED THE ECONOMY WELL BETWEEN 1980 AND 2000
Objective of Nationalization Inspired by a larger social purpose and to subserve national priorities and objectives such as Rapid growth in agriculture, small industries and exports Raising employment levels Encouragement of new entrepreneurs, and Development of backward areas
Sectoral deployment of non food bank credit (Rs. billions) CAGR 3,751
792

Number of branches

16.0% Others Wholesale trade Industry 19.6% 11.5% 3.6% 65,412 59,752 5,595 8,042 32,419 4,014 5,178 8,122
15,105 11,324 8,219 10,052 14,407

168
1,473

15.5% Metro 17.7% 16.2% 14.9% Urban Semi-Urban Rural

22 1,007 19 165 55 13 383 83 191 155 26 83 165 28

346 528 444

Other priority SSI Agriculture

34,791

32,734

1980 16

1990 82

2000 391

1980 Export Credit 17.2

1990

2000

"Average GDP growth at 5.6% in the same period" Source: RBI, IBA

Nationalized banks have played a key role in helping the UPA government achieve nine per cent growth in the last fiscal" Finance Minister P Chidambaram, Oct 9, 2007 3

VALUATIONS OF PSU BANKS ARE LOW DESPITE HIGHER PROFITABILITY

Bank profitability in India FY 2008 ROE
16.8 PSU banks 19.1 19.6 16.0 PSU banks

Bank valuation in India Mar 31 2008 P/E

11.0 5.9 7.8 7.2

P/B
1.6 1.1 1.5 1.1

11.7 Private banks 17.7 17.4 21.8 Private banks

20.6 29.4 26.4 21.9

1.8 4.1 3.2 3.7

Source: Annual reports, Prowess

SEVERAL FACTORS ARE RESPONSIBLE FOR LOWER VALUATIONS OF PUBLIC SECTOR BANKS 1. Lower asset quality Gross NPA levels of PSU banks at 2.7%, compared to 1.9%
for new private banks and 1.8% for foreign banks

2. Slower growth CAGR in balance sheet for private banks over 2003-07 is 35%,
more than double that of PSU banks at 16%

3. Lower productivity Profit per branch for PSUs is only Rs 0.5 crores compared to
Rs 2.5 crores for private banks. Profit per employee is also much lower at Rs 2.6 lakhs vs Rs 7.6 lakhs for the private sector

4. Different customer profile Foreign and private banks share of younger customers
is over 60% PSU banks have only 32% customers under the age of 40. Private sector banks also have a much higher share of the more profitable mass affluent segment

5. Losing share in fee based wholesale and retail banking products ECM, M&A,
Institutional equities, transaction banking and cross- sell of investment products, and insurance

PUBLIC SECTOR BANKS HAVE NOT EVOLVED ON SEVERAL DIMENSIONS OF THE BUSINESS MODEL IN RETAIL
Key dimensions of business model Superior customer service Proactive sales Public sector banks

ILLUSTRATIVE

Customer service levels and TATs below market practices

Focused on catching customers as they walk into the branch A few public sector banks (e.g., Bank of Baroda, SBI) have
recently started proactive sales, but their numbers are lower than competition

In-branch sales engine is not effective

World class operations

Distributed/decentralised configuration resulting in a varied

performance branches doing most of the operations

New access options

Limited/low level usage of entire range of channel options While ATM usage has increased in the recent past, penetration
of phone banking and internet banking is lower than competition
6

TALENT, OPERATIONAL CONTROL, OWNERSHIP ARE BIGGEST ISSUES FOR PSU BANKS
Talent Operational

Unable to attract entry level talent

Rigid recruitment policies Slower growth to middle and senior management path Lower compensation/no ESOPs Poor performance culture Perceived lack of operating freedom

Fear of accountability
Accountability to government restricts decision making CVC guidelines adherence issues CAG Audit Procurement process L1/L2

Union issues
Transfers/Reassignments Disciplining Inability to mete out significant consequence management systems Ownership

Government ownership floor at 51% restricts ability to raise capital More than fair share in
Priority sector Minority lending Bankers to government Financial inclusion/rural
7

WHILE ON AN AGGREGATE, PERFORMANCE DIFFERENCE BETWEEN PSUs AND PRIVATE SECTOR IS SIGNIFICANT
FY 2002 Profit per branch (Rs crore)
PSU Bank average*

FY 2008

0.24

1.28

Private Bank average**

0.84

2.49

2002 Profit per employee (Rs lakh)

PSU Bank average*

2007

1.20

4.10

Private Bank average**

5.20

6.34

* Average of SBI, PNB, Canara Source: Annual reports

** ICICI, HDFC, Axis 8

A CLOSER LOOK SHOWS THAT AT LEAST FOR SBI, THE GAP IS NOT THAT STARK IN METRO AND URBAN (1/4)
Operating profit per branch, 2008, Rs. crore

Private sector SBI overall SBI- metro and urban SBI-rural 0,2 1,3 3,7

5,1

* ICICI, HDFC, Axis Source: Annual reports

A CLOSER LOOK SHOWS THAT AT LEAST FOR SBI, THE GAP IS NOT THAT STARK IN METRO AND URBAN (2/4)
Operating profit per employee, 2008, Rs. lakh

Private sector SBI overall SBI- metro and urban SBI-rural 1,9 9,0

13,0

15,9

* ICICI, HDFC, Axis Source: Annual reports

10

A CLOSER LOOK SHOWS THAT AT LEAST FOR SBI, THE GAP IS NOT THAT STARK IN METRO AND URBAN (3/4)
FY 2008 Deposits per branch (Rs crore)
SBI metro-urban avg (~3200 branches in ~500 cities) SBI rural avg (~6900 branches) Private Bank average*

99.69 22.44 157.97

Deposits per employee (Rs lakh)

SBI metro-urban avg (~3200 branches in ~500 cities) SBI rural avg (~6900 branches) Private Bank average*

FY 2008
435.89 217.94 402.63

* ICICI, HDFC, Axis Source: Annual reports

11

A CLOSER LOOK SHOWS THAT AT LEAST FOR SBI, THE GAP IS NOT THAT STARK IN METRO AND URBAN (4/4)
FY 2008 Advances per branch (Rs crore)
SBI metro-urban avg (~3200 branches in ~500 cities) SBI rural avg (~6900 branches) Private Bank average*

85.44 13.14 136.92

Advances per employee (Rs lakh)

SBI metro-urban avg (~3200 branches in ~500 cities) SBI rural avg (~6900 branches) Private Bank average*

FY 2008
373.56 127.67 348.99

* ICICI, HDFC, Axis Source: Annual reports

12

CONTENTS

Public sector banks today

Indian economy and imperatives for banking

Reforms needed

13

INDIAS GDP HAS RISEN STEADILY SINCE THE 1950S. . .

Real GDP growth* US$ billion 7.3% 9.0%

Average growth rate of 8.9% over 2003 - 2007

773 709

5.2%
464

4.4% 3.4%
60 118 279

1950 Population (Million)** 365

1970 548

1990 850

2000 1,016

2006 1,112

2007** 1,169

* Base year = 2002 ** 2007 figures are forecasts sourced from WMM Source: Global Insight; Economic Survey of India; Team Analysis

14

A GROWING WORKING AGE POPULATION WILL PROPEL GROWTH TILL 2035 LATER THAN CHINA
Working age population (age 15-60) Per cent of total population
72% 70% 68% 66%

India

Brazil
64% 62% 60% 58% 2000

China Russia G6
2005 2010 2015 2020 2025 2030 2035 2040
15

Source: Global Insight; Team Analysis

HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA

Average household disposable income Thousand; Indian rupees; 2000

Compound annual growth rates 1985-2005 2005-2025

500

Actual

Forecast

Urban

400
5.8% All India

300

200
4.6% 2.8% 3.6%

5.3% 3.6%

Rural

100

0 1985

1990

1995

2000

2005

2010

2015

2020

2025

Source: McKinsey Global Institute

16

THE SHAPE OF INDIA'S INCOME PYRAMID WILL CHANGE DRAMATICALLY AS INCOMES GROW
Household income brackets Thousand, Indian rupees, 2000 Globals (>1,000) Strivers (5001,000) 2005 Seekers (200500) Aspirers (90200) Deprived (<90) Globals (>1,000) Strivers (5001,000) 2015 Seekers (200500) Aspirers (90200) Deprived (<90) Globals (>1,000) 2025 Strivers (5001,000) Seekers (200500) Aspirers (90200) Deprived (<90)
Source: MGI India Consumer Demand Model, v1.0

Number of households Million 1.2 2.4 10.9 91.3 101.1 3.3 5.5 55.1 106.0 74.1 9.5 33.1 94.9 93.1 49.9

Aggregate consumption Trillion, Indian rupees, 2000 1.2 1.0 2.1 8.5 4.1 4.1 2.7 11.8 12.2 3.3 14.1 16.5 24.6 11.9 2.4

Middle class to
swell from just under 50 million today to about 583 million by 2025

By 2025, India will

produce 2 million globals annually

Share of incomes
of the middle class and globals will rise from less than 30% today to more than 80% by 2025

17

CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$600 BILLION ON INFRASTRUCTURE DURING 200712
Area Expected spend US$ billion Roads 96 Key projects Area Expected spend US$ billion Key projects

Six-laning of 6,500 kms and

four-laning ~18,000 kms of corridors and highways

Communication

77

Growing subscriber base to

600 million, including 200 million rural telephone connections Providing broadband access to 20 million and 40 million internet connections

Railways

73

Dedicated Freight Corridors

between Mumbai-Delhi and Ludhiana-Kolkatta, ~10,300 kms of new railway lines; modernisation of 21 railway stations Water 57

Water supply and sanitation

projects

Power (generation, transmission, and distribution) Ports

177

Additional generation
capacity of ~70,000 MW (includes rural areas)

Irrigation

62

Developing 16 million
hectares through major, medium and minor irrigation works

21

Capacity addition of 485

million MT in major Ports; 345 million MT in minor Ports

Gas

Gas distribution
infrastructure LNG terminals, gas transmission lines, city gas distribution

Airports

10

Modernisation and
redevelopment of 4 metro and 35 non-metro airports Construction of 7 green-field airports in North East

Storage

Storage to support
agricultural development

Total

585

Source: Planning commission

18

INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING GLOBAL FOOTPRINT

Cross-border M&A by Indian companies
The recent spurt in outward FDI is caused by: Regulatory changes:
Indian companies can now make overseas investments equal to 300% of their net worth on an automatic approval basis Number of Deals* Average Deal Size**

350 1400 1200 1000 800 600 400 200 0 2000 2007 2008 50 470 100 50 0 1086 300 250 200 150

Easy access to capital

Decline in interest rates coupled with liberal lending policies adopted by banks Active participation by PE firms Nearly 20% of the deals were backed by private funds in 2006

* Number of deals for calendar year 2000, and till May 08 ** Average deal size (in US $ mn) is based on deals for which the values has been disclosed Source: Dealogic; Team Analysis

19

SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA OPPORTUNITY . . .

Acquisitions of Indian companies by MNCs No. of Deals* 416 339 325 557 832 1226 58.447 495 Break-up by sector Per cent of Total Deal Value, 2007
Others
19 35

Services

30.243 20.163 9.109 Value US$ billion 11.282 4.545 6.053

Telecom 24
10

Manufacturing 9 High Tech Construction

2002 2003 2004 2005 2006 2007 2008^

^ 2008: As on May 2008 * Includes all completed deals even where deal value is not available ** Includes Finance, Insurance, Leisure & Recreation, Professional Services, Healthcare, Transportation and Publishing, Dining & Lodging & Retail *** Includes Chemicals, Machinery, Auto / Truck, Consumer Products, Textile and Food & Beverage Manufacturing Source: Dealogic; Press articles; Company website; Team Analysis

20

IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC SUPER POWER OF THE 21ST CENTURY

India most rapid growth potential of the BRICs Real GDP growth (Per cent) 9 Fastest growing global 8 economy by 2012 7 India 6 5 China Brazil 4 3 2 Russia 1 0 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 India will contribute a giant share of the incremental GDP growth of major world economies* Per cent
20.1

5.0 2.1

2000

2020

2050

11th largest economy today (GDP US$560 billion) 4th largest by 2025 (GDP US$3,200 billion, six-fold increase)
* Major world economies considered are the BRIC and G6 countries Source: Goldman Sachs BRIC report 2003 21

AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR TO CHINA 15 YEARS AGO

Real GDP growth PPP adjusted* US$ billion
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

Triggers behind growth inflection in India

Taxes: Laws simplified

resulting in better compliance and ease of tax payment

China CAGR = 10.1% (1990-2005) Inflection in China GDP India 1990-2005 CAGR = 5.98% 1978: China liberalizes 1992: India liberalizes

Infrastructure: Increased
investment in infrastructure e.g., Ultra Mega Power Projects

Liberalisation: FDI in key

sectors like airports, NBFCs, Insurance, electrical equipments, telecommunications, construction etc allowed

1980 1985 1990 1995 2000 2005 2010

* Base year: 2002 Source: Global Insight; Team Analysis

Lead indicators of inflection visible in India

22

WHILE BANKING REVENUE POOLS ARE EXPECTED TO GROW AT A RAPID CLIP, COMPLEXITY WILL INCREASE
Key growth drivers Overall banking sector core revenue pools US$ billion** CAGR Per cent 23 71.8 Margin compression
13.6

Retail
Robust growth in middleclass asset ownership, e.g., houses, cars Increased acceptance of consumer credit Investment products to increase in demand Wholesale Shift from plain vanilla lending to more complex feebased products and service Emergence of investment banking Need to fund large scale infrastructure New business models evolving in SME Financial inclusion and profitable business model for rural

17

16.7

23

32.5 SME Rural WB Retail

6.2 24.8

15

6.9
11.4 16.7 7.9

17

FY 07

FY 12

* Includes revenue pools of NBFCs, HFCs in retail, and DFIs in corporate ** Using 2006 average exchange rate

23

IMPERATIVES FOR BANKING SECTOR

Retail

Provide the new products

demanded Create infrastructure for new channel access Provide financial advice Build stronger relationships Leverage new technologies for customer value management

Rural

Capture fully the banking

potential in the mass affluent and upwards Serve across product categories Raise standards to match urban customers Create a new model to reach the unbanked Savings as much as lending New technology which does not need physical presence Partnerships a must New methods of managing channels

24

IMPERATIVES FOR BANKING SECTOR

Wholesal e

Fund infrastructure growth pegged

at excess of US$600 billion in the next 5 years through variety of instruments Provide cost efficient credit and services to the large and mid corporate sector Credit at the right time in the right quantum Trade intermediation services (factoring, forfaiting, structured finance) Hedging services (interest rates, fx, commodities) Investment/ Surplus management products (structured products) Transaction intermediation services (local and global) Provide capital raising and advisory services Equity raising DCM as a viable substitute to credit M&A/ PE advisory to large and mid corporate (help Indian corporates in their quest to go global)

SME

Go beyond credit
Transaction services PE advisory Corporate structuring Relationship management Creation of a model which combines institutional skills and local touchpoints is critical Shift mindset from treating SME as priority sector to being business

25

CONTENTS

Public sector banks today

Indian economy and imperatives for banking

Reforms needed

26

TRANSFORMATION OF THE INDIAN BANKING SECTOR HAS SEVEN KEY ELEMENTS

A: Industry structure B: Social development C: Unified regulator D: Corporate governance E: Supporting infrastructure F: Labor reforms G: Real sector reforms

27

A. INDIAN BANKS MINISCULE ON THE GLOBAL PAGE

Megabanks will be even larger . . . Market capitalisation of top-30 banks US$ trillions 15.5 Ind & Comm Bk Of China China Construction Bank HSBC Holdings Plc Bank Of China Ltd JP Morgan Chase & Co Bank Of America Banco Santander Sa Mitsubishi UFJ Financial Group Citigroup Inc Wells Fargo & Co BNP Paribas Unicredit SPA Banco Bilbao Vizcaya Argenta Intesa Sanpaolo Sberbank Goldman Sachs Banco Itau Holding Royal Bank Of Scotland Group Sumitomo Mitsui Financial Group Royal Bank Of Canada 244 194 192 144 129 128 118 107 104 84 84 83 76 75 72 69 69 67 66 62 . . . increasing the already great gap among the top banks US$ billions**

8.5

2.5 0.1

1990

2005

2020 with market growth only*

2020 with expected consolidation*

Share of global assets Per cent

30

30

45

The 2 largest Indian banks (SBI and ICICI) have market capitalisation of about ~US$ 20-25 bn
* Based on historical growth rates; Global Insight estimates; MGI estimates ** As of 11 June, 08 Source: Bloomberg, Datastream; McKinsey

28

A. CHANGES NEEDED IN THE INDUSTRY STRUCTURE

Develop mechanisms for identifying anchor banks- strong and

solvent institutions

Layout out blue-print for the sector Encourage market driven consolidation Create 4-5 global sized institutions, 6-8 national champions Reduce government participation in the sector; create holding
company; introduce concept of golden shares

Give public sector banks more operational freedom and access

to talent

Increase level of foreign participation to ~20% of banking assets

29

GOVERNMENT SHOULD ALLOW IMMEDIATE OPERATIONAL CONTROL TO PSUs

People management

Ability to attract talent at entry and senior levels through

appropriate compensation

All of these can be

achieved easily if government holding decreases below 51%

Ability to consequence manage non-performance Ability to reward and accelerate track of high performers Ability to affect personnel related changes without
interference from unions Governance

Government can
still be single largest shareholder Through direct holdings/ holding company Through other Public sector holding such as LIC, GIC etc. This will allow PSU banks to raise capital as well

Ability to appoint partners without getting constraint by

CVC guidelines

Freedom from CAG Audit Ability to reconstitute boards

Consolidation

Allow consolidation of PSU with PSU and private banks.

This will also be accompanied by ability to leverage synergies through Reduction in staff Elimination of overlapping branches Synergies captured through structural changes in organisation

30

CASE EXAMPLE OF A SUCCESSFUL TRANSITION TO PRIVATE SECTOR BANK: CBA (COMMON WEALTH BANK OF AUSTRALIA)
Impact of Privatization

Extensive organizational restructure

Governments Role

Established in 1911, first bank to conduct both

savings & general (trading) bank business, with the security of a Federal Government guarantee.

Corporatisation in 1950s - dual function of both a

commercial and central bank were divided

As a result of banking industry deregulation and foreign

bank entry in the mid 1980s, the bank underwent internal reorganization, develop new products, and massive computerization.

Division of Retail Banking into three units, Personal Banking, Business Banking and Banking Operations (initiated April/May 1993) Enhanced Customer Service Program (including a new customer service computer system) and removal of the majority of processing functions from branches so staff can focus on customer service and sales. Internet site launched on September 1995. Launched CommSec - a low cost telephone based share trading service for the 'Do it Yourself' investor, developing the business to become Australia's leading broker.

Merged with Colonial Limited in 2000 - created a strong,

dynamic and globally relevant financial services group

To increase its presence and scale, CBA acquired New

Zealand based ASB Bank Ltd in 1989, and State Bank of Victoria in 1990. The latter created Australia's largest domestic bank and further strengthening its leadership in retail branch banking.

Awarded Bank of the Decade in November 1999 and named

Best Bank at the Australian Banking and Finance Awards for the years 1996, 2000 & 2002.

Leader in many areas Privatized to ensure competitive neutrality is restored

30% sale in 1991, further 20% sale in 1993 and remaining sold in 1996. # 1 in total deposits (29% market share) # 1 in mortgage (23% market share) # 2 in credit card (22% market share)

Government still enforces ban of mergers among the

top 4 banks

8th largest bank in Asia Pacific in terms of market cap (US$

67 billion) with profit of US$ 3 billion in 2006

Market cap 12% higher than 2nd largest National Australia

Bank
Source: Press search; Corporate website

31

CASE EXAMPLE OF A SUCCESSFUL MAJORITY OWNED GOVERNMENT BANK: DBS (DEVELOPMENT BANK OF SINGAPORE)
Success Governments Role

The largest bank in South East Asia in terms of assets,

US$129 billion in 2006, 22% larger than 2nd largest UOB in Singapore. Also a leading bank in Hong Kong

Established in 1968 as a DFI Received seed capital from several established banks
in Singapore and diversified into commercial banking 1 year later

21st largest bank in Asia Pacific by market cap (US$ 23,140

million)

Net profit of US$ 1,153 million in 2006 Largest network of branches in Singapore, plus branches in
Hong Kong, Indonesia, China, India, Japan, Korea, Malaysia, Myanmar, the Philippines, Taiwan, Thailand, U.K, the U.S. and the Middle East

Its pioneer move to pay interest on current account was

protested strongly by other banks, but to no avail - 5 of 7 local banks petitioned the Finance Ministry, Association of Banks and Monetary Authority of Singapore

Merged with POSBank, another state bank, in 1998 in

line with government aim to create global/regional player. Annual cost saving from the acquisition estimated at S$30 million per year.

Market leader in many areas

Leader in IPOs and regional equity transactions in the Singapore capital market. Top-rated custodian for institutional investors Key player in the Singapore money market Leader in domestic treasury services Leader in corporate lending

A boost to retail banking, freeing DBS banking officials

to service their clients overseas, including the bigger Singapore companies with regional operations.

The Bank's "AA-" credit rating is among the highest in the AsiaPacific region.

Current government holding of 27.7% DBS operates like a private sector bank in terms of
talent and procedures

Innovative - many firsts - from introducing Saturday afternoon

banking to playing a significant role in the interbank market, after interest rates were freed in mid-1975

Source: Press search; Corporate website

32

PUBLIC SECTOR BANKS WILL NEED TO PULL FIVE LEVERS TO COMPETE IN THE EMERGING BANKING LANDSCAPE
1 Rapidly implement IT and operations initiatives Build sales and marketing capabilities Strengthen risk management

Close the technology gap with the private sector banks Restructure operating platforms by centralizing and outsourcing operations Redesign processes to match competition on TATs, productivity, error
rates and cost of operations

Re-focus the efforts of core strengths branch network and staff on sales Convert to a sales and marketing led organization Proactively target emerging mass affluent and affluent segments Strengthen risk management skills to enable Basel II compliance
Risk modeling Review and collections IT support

Focus on reskilling employees to shift attention to sales and marketing,

4 Build human capital

5 Prepare for local consolidation

and infusing specialist skills through external recruiting (e.g., in treasury, cash management) Comprehensive change in mindsets and behavior enable effective play in the process of local consolidation Providing operational freedom in solving the talent issue across levels and wrt performance management will help significantly across all levers
33

Pro-actively build skills in acquisition and post-merger management to

THANK YOU

34

OTHER CHANGES NEEDED (1/2)

Offer market based incentives for under-penetrated segments e.g., subsidy
B. Social development auctions, creation of credit guarantee corporation Remove rural branch restrictions Remove directed lending Ensure insurance provisioning on loans to urban and rural poor Reimburse banks the admin cost for rural banking to allow lower interest rates charged to customers

C. Unified regulator

Improve regulations for STCBs, RRBs, MFIs, NBFCs and remove regulatory
arbitrage Move to a coordinated regulator model Separate central bank and regulator roles New unified Financial Services Modernization Act to bring together, under a single umbrella, all aspects of financial services on the lines of legislations in US and UK

D. Corporate governance

RBI to guide Indian banks towards adopting international standards in corporate governance Improve corporate governance primarily by increasing board independence and
accountability Enhance corporate governance norms, Institute penalty for weak corporate governance Ensure independence by appointing directors appointed on the recommendation of a nomination committee based on clearly defined and transparent criteria.
35

Source: McKinsey analysis

B. CREDIT GUARANTEE SCHEMES CAN PROMOTE SOCIAL OBJECTIVES WHILE MINIMISING DISTORTIONS TO THE FINANCIAL SYSTEM
Korea Credit Guarantee Fund Potential credit guarantee structure Government Commercial banks

Extends guarantees for loans to promising

enterprises that lack tangible collateral Risks of default shared with credit institutions Flexible guarantee fee ranging from 0.5% to 2% depending on creditworthiness, guarantee period and guarantee amount Joint funding by government and commercial banks

Credit guarantee corporation Independent board Executive management Guarantee to cover part of the risk Collateral-short but viable, creditworthy SME Features

Taiwan small and medium business guarantee fund

Extends credit guarantees to small and medium

enterprises short of required collateral Only those Contracted Financial Institutions (CFIs) signing an Entrustment Contract (and making donations) are eligible to provide guarantee service Annual guarantee fee of 0.75% Paid up capital contributed by central and local government and CFIs

Competition between banks to disburse the loan

Pricing of loans based on best practice credit

processes and credit guarantees provided Customers served by institutions with required skills and infrastructure to serve low income segment

36

B. A MARKET-BASED SUBSIDY PROGRAM WOULD PROMOTE BANK INTEREST IN LOW INCOME SEGMENTS
Chile government program Ownership: Chilean Social investment fund (FOSIS), Ministry of Planning and Cooperation (MIDEPLAN) Concept: Banks given a fixed amount of money for each loan granted to micro entrepreneur Process: Subsidy budget granted through a bi-annual auction Achievements

Four large commercial banks

have entered micro-finance and make loans to about 100,000 customers RBI could consider a similar market-based bidding system to encourage make sure commercial banks to enter the low-income segment

On an average one third of micro

enterprises in Chile are customers of these four banks

By 2000, value of subsidy for an

average loan amount of US$ 1,200 had fallen to US$ 80 from US$ 240 in 1993

Commercial banks invited to bid on a

per loan subsidy needed

Bidding banks propose subsidy details

on loans

Chilean banking regulator needs

to spend very little time supervising this micro loan portfolio

Winning banks are those offering to

make the largest number of micro loans for the smallest subsidy

37

C. AS AN INTERMEDIATE STEP, INDIA COULD HAVE RBI AS THE C0ORDINATING REGULATOR

Now: Multiple regulatory agencies Regulating authority Commercial banks and FIs Cooperative banks Regional rural banks Capital markets Insurance companies Housing financing companies RBI Intermediate: Coordinating body

RBI

+ +

State Registrar of Cooperative Societies NHB

RBI

RBI takes over

the activities of different regulatory agencies Internal separation of regulatory and central bank function

RBI

NABARD

IRDA RBI

SEBI Reg. of coop.

IRDA

SEBI

NHB

38

C. ULTIMATELY, REGULATION SHOULD BE SEPARATED FROM THE CENTRAL BANK

Intermediate: Coordinating body Final: Unified regulator separate from Central Bank

RBI Internal
FSA RBI Insuran ce Securi ties regulation function of RBI handed over to a separate regulator with legislative sanction Unified body regulates commercial banks, cooperative banks, capital markets, insurance, securities, mutual funds and microfinance institutions
39

NHB RBI

IRDA

Banking

SEBI

Reg. of coop.

OTHER CHANGE NEEDED (2/2)

E. Supporting infrastructure

Accelerate credit bureau and payment infrastructure Support creation of industry utilities for processing e.g., Symcor in Canada Amend banking regulations to enable formation of holding company to own
governments shareholding in PSBs and their other financial service

Address loopholes in SARFAESI to ensure banks get a fair hearing Implement recommendations of Patel Committee for development of primary
and secondary debt market

F. Labor reforms

Push labor reforms, support re-skilling of employees Greater flexibility in surplus labour and freedom to link compensation with
performance

G. Real sector reforms

Real economy reforms required to complement financial system reforms

Product market reforms: Elimination of reservation of products for SSI, removal of licensing requirements, reduced duties and unrestricted FDI Land market reforms: Fast-track courts to settle land market disputes, computerize land records and cut stamp duties State ownership: Transfer management of productive/commercial assets to the private sector; contract out the construction and management of new infrastructure.

Source: McKinsey analysis

40