Banking Sector

Overview
The business of the banking industry is defined as the sum of its aggregate deposits and aggregate
advances as on a particular date. In 2006-07, SCBs had business worth Rs 46,782 billion. CRISIL
Research expects the banking business to grow to Rs 82,767 billion by 2009-10. The compounded
growth of the banking business is expected to moderate to 20.9 per cent owing to slower growth in
advances in 2008-09 and 2009-10.

Rs billion) 2003- 2004- 2005- 2006-07 2007-08 2008-09 2009-10 CAGR CAGR
04 05 06 E P P 2004- 2007-
2007 2010
Advances 8,636 11,508 15,168 19,812 24,221 29,764 35,717 31.9% 21.7%
Deposits 15,755 18,376 21,647 26,970 32,806 39,373 47,051 19.6% 20.4%
Business 24,392 29,884 36,815 46,782 57,027 69,137 82,767 24.2% 20.9%
E: Estimated; P: Projected
Source: CRISIL Research, RBI

From 2006-07 to 2009-10, we expect aggregate advances of SCBs to grow by 21.7 per cent, driven by
growth in all the three major areas of non-food credit (advances): agricultural credit, services credit, and
other commercial credit. Deposits are expected to grow by 20.4 per cent during the same period.

Figure 1: Growth in credit and deposits

E: Estimated; P: Projected
Source: CRISIL Research, RBI

Between 2003-04 and 2006-07, business had grown at a higher CAGR of 24.2 per cent, mainly
driven by a healthy growth of 31.9 per cent in advances. A large proportion of the companies across
sectors were in expansion mode, which was either financed through bank credit or other sources of
finance, both internal as well as external. In order to build up capacities, corporates were drawing
heavily from the banks leading to a very robust growth in the credit offtake.

Effect of Global Melt down

The global financial meltdown has had far reaching consequences for economies worldwide.
International credit markets tightened considerably as a result of rising defaults and foreclosures.
Although financiers in India have limited exposure to the international markets, they too have been
impacted by the turmoil in the global financial markets. Reduced availability of finance through external
commercial borrowings (ECBs) owing to rising risk aversion in the global markets has affected
domestic corporate sector growth, particularly investments in capacity expansion. This, in turn, has
affected capital formation and has manifested in terms of reduced level of consumption.

In the first half of 2008-09, growth in bank credit continued to be strong on account of limited avenues
for corporate credit. From the third quarter, however, the signs of global meltdown were visible in the
form of liquidity constraints and a slowdown in demand for corporate credit. In the interim period, the
Reserve Bank of India (RBI) has taken a host of monetary easing measures such as reducing the Cash
Reserve Ratio (CRR) and repo rate to release liquidity in the system. However, it will be some time
before demand for credit from the corporate sector picks up. This is expected to hamper the overall
growth story of the banking industry in the second half. Accordingly, CRISIL Research expects
moderation in credit growth in 2008-09 and even more subdued growth in 2009-10. The banking sector
is likely to face pressure on profitability, given the continued high cost of funds and the inability to pass
on the full increase in the same to borrowers. The banking sector is also expected to face some pressure
on asset quality, on account of loans to the retail segment and to small and medium enterprises (SMEs).

In August 2008, inflation reached a level of 12.82 per cent, the highest in the last 4-5 years. The
regulator responded by further tightening the monetary policy. In view of the overall monetary
conditions, the RBI increased the repo rate by 50 bps from 8.5 per cent to 9.0 per cent with effect from
July 30, 2008, and CRR by 25 bps to 9.0 per cent with effect from August 30, 2008.

Although money supply growth decelerated in the second quarter of 2008-09, it was placed at 19.0 per
cent as on September 26, 2008, as against the RBI?s comfort level of 17.0 per cent set out in July 2008.

Alternative avenues of funds dry up for the industry

Figure 1: Variation in the sources of funds for the industry (Rs billion)

Source: RBI
Bank credit is one of the major sources of funds for the industry given that much of the capital
expenditure (Greenfield and Brownfield) is largely debt-funded. Additionally, over the last few years,
Indian corporates have been actively tapping alternative avenues for raising funds which included
domestic avenues such as capital markets, issue of debentures and commercial paper (CP) and the
external sources of finance such as ECBs, American depository receipts/Global depository receipts
(ADRs/GDRs) etc. In 2006-07, out of the total funds raised by the industry, around 52 per cent of
the funds were raised from sources other than bank credit. This number swelled to 58 per cent in
2007-08, signalling the prominence of alternative avenues in overall funds for the industry.

Key Steps for Stimulating Economic Growth

On October 6, the RBI took cues from the declining inflationary pressures and decreased the CRR
by 50 bps to 8.5 per cent. In view of the evolving liquidity situation, on October 10, the RBI cut the
CRR further by 100 bps to 7.5 per cent, with effect from the fortnight beginning October 11, 2008.
CRR was further reduced by 100 bps to 6.5 per cent on October 15, 2008. 5 days later, on October
20, 2008, the repo rate was reduced by 100 bps to 8.0 per cent.

In view of the worsening global and domestic credit crunch, the RBI began to take various steps post
mid-September 2008. In addition to cuts in the policy interest rates and reserve requirements (CRR and
SLR), a number of credit and re-finance facilities for specific sectors were implemented.

On December 6, the RBI reduced the repo rate by 100 bps from 7.5 per cent to 6.5 per cent and the
reverse repo rate by 100 bps from 6.0 per cent to 5.0 per cent, with effect from December 8.

Source: RBI

1. The RBI decided to provide refinance of Rs 70 billion to the Small Industries Development
Bank of India (SIDBI), to increase credit delivery to employment-intensive SME sectors, and around
Rs 40 billion to National Housing Bank (NHB).

2. The India Infrastructure Finance Company Ltd (IIFCL) has been authorised to raise Rs 100
billion through tax-free bonds by March 2009, the proceeds of which will be used to re-finance bank
lending of longer maturity to eligible infrastructure projects.
3. Classification of home loans given by the banks to housing finance companies under Rs 2
million as priority sector lending.
4. The government has effected an across-the-board cut of 4 percentage points in the ad-valorem
cenvat for the remainder of the current fiscal on all products other than petroleum and those where the
current rate was below 4 per cent.

5. For exporters, the government gave 2 per cent (till March 2009, subject to a minimum of 7 per
cent) interest subvention on both pre and post shipment credit for labour-intensive export sectors.

Growth of Banks

HDFC Bank and Axis Bank continue to remain as leaders of the private sector banks. Both the banks
have maintained the advances growth and NIM. SBI, Punjab National Bank, Bank of India and Union
Bank are expected to lead among PSU Banks.

The State Bank of India is planning to open 1,000 new branches across the country to cover 100,000
villages in the coming FY 2009-10, according to the bank Chairman, Mr O P Bhatt. The bank had
decided to rope in 300 new customers every year for each branch using initiatives. According to Mr
Bhatt, the bank could get a record US$ 5.54 billion during December 2008, the highest amount collected
by any bank in the country.

Scheduled commercial banks’ credit to the commercial sector expanded by 27.0 per cent (year-on-year)
as on November 21, 2008, as compared with 23.1 per cent a year ago. Non-food credit of scheduled
commercial banks expanded by 26.9 per cent, year-on-year, as on November 21, 2008, higher than 23.7
per cent a year ago.

According to earlier RBI data, for the third quarter (September 26-December 27, 2008), total bank credit
was up US$ 21.91 billion compared with a growth of US$ 22.91 billion in the same period a year ago. In
the preceding quarter, credit had risen by US$ 26.50 billion.

RBI data for deposits shows that for the Oct-end December 31, 2008 period, although deposit growth
has slowed to US$ 25.99 billion against US$ 33.18 billion in the April-end to September, 2008 period, it
was still stronger in the December 31 quarter period, 2008, as compared to the year-ago quarter when
absolute growth was US$ 16.37 billion.

Net banking capital amounted to US$ 4.8 billion in April-September 2008 as compared with US$ 5.7
billion in April-September 2007. Accounting for a part of banking capital, non-resident Indian (NRI)
deposits showed a net inflow of US $ 1.1 billion in April-September 2008, increasing from net outflow
of US$ 78 million in April-September 2007.

The Reserve Bank of India on January 21, 2009 fixed the Reference rate for the US currency at Rs 48.93
per dollar and the single European unit at Rs 63.70 per euro from Rs 49.12 per dollar and Rs 63.61 per
euro, respectively.

Government initiatives

• During 2008-09 (as per data up to November 18, 2008), as per RBI guidelines, scheduled
commercial banks (SCBs) increased their deposit rates for various maturities by 50-175 basis
points. The interest rates range offered by public sector banks (PSBs) on deposits of maturity of
 one year to three years increased to 9.00-10.50 per cent in November 2008 from 8.25-9.25 per
cent in March 2008. On the lending side, the benchmark prime lending rates (BPLRs) of PSBs
increased to 13.00-14.75 per cent by November 2008 from 12.25-13.50 per cent in March 2008.
Private sector banks and foreign banks also increased their BPLR to 13.00-17.75 per cent and
10.00-17.00 per cent from 13.00-16.50 per cent and 10.00-15.50 per cent, respectively, during
the same period. Accordingly, the weighted average BPLR of public sector banks, private sector
banks and foreign banks increased to 13.99 per cent, 16.42 per cent and 14.73 per cent,
respectively.
• The number of automated teller machines (ATMs) has risen and the usage of ATMs has gone up
substantially during the last few years. Use of other banks’ ATMs would also not attract any fee
except when used for cash withdrawal for which the maximum charge levied was brought down
to US$ .409 per withdrawal by March 31, 2008. Further, all cash withdrawals from all ATMs
would be free with effect from April 1, 2009.

Bank initiatives

• Since December 2008, the government has announced series of measures to augment flow of
credits to around US$ 2,66,274 to SMEs. To improve the flow of credit to industrial clusters and
facilitate their overall development, 15 banks operating in Orissa including the public sector
State Bank of India (SBI) and the Small Industries Development Bank of India (SIDBI) have
adopted 48 clusters specially in sectors like engineering tools, foundry, handloom, food
processing, weaving, rice mill, cashew processing, pharmaceuticals, bell metals and carpentry
etc.
• PSBs are now cashing in the auto loan segment after the exit of private players owing to the
slowdown. Auto loans usually have three components - car loans, two-wheeler loans and
commercial vehicle loans. PSBs are primarily focussing on car and two-wheeler loans. Prevalent
interest rates in the car loan segment now range between 11 per cent and 12.5 per cent per
annum. For instance, according to the Union Bank of India Chairman and Managing Director,
MV Nair, his bank had recently tied up with Maruti Suzuki India for financing the latter's
product and it has a US$ 163.84 million auto loan portfolio.
• The government has told public sector banks (PSBs) to extend credit to fund-starved Indian
industry, especially exporters and small and medium sector enterprises to address their credit
needs. SIDBI would be lending US$ 1.33 billion out of US$ 1.47 billion credit from RBI to
public sector banks. This is being provided to the PSBs at 6.5 per cent (SIDBI is getting the
credit at 5.5 per cent) under the condition that the banks will have to lend this credit to the
medium and small-scale industry units at an interest rate of 10 per cent before March 31, 2010.
• According to SBI Chairman, O P Bhatt, contribution of small and medium enterprises (SMEs) is
nearly 40-50 per cent to GDP growth of the nation, and this sector also accounts for 50 per cent
of the industrial output. "Banks could accrue a revenue of over US$ 5.73 billion by encouraging
the SMEs," Bhatt said adding, "SME's sector is to grow fastest in the next five years, with 14 per
cent growth in terms of revenue and 13 per cent in terms of profits." The bank in order to help
units tide over the current downturn, had introduced products like “SME Care” specially in
Jharkhand, which provides units to access 20 per cent additional funds over and above their
existing overdraft limit. Already, according to an official, the MSME ministry has proposed to
RBI that the sector be given a mandatory 15 per cent share of the total priority sector lending

Prepared By:
Rohit Agarwal
Team Online, CRISP 2009