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Commercial Banks¶ Share Prices on the Rise :: A Perspective

The banking system in India is the most extensive. The total asset value of the entire banking sector in India is nearly US$ 270 billion. The total deposits is nearly US$ 220 billion. Banking sector in India has been transformed completely. Presently the latest inclusions such as Internet banking and Core banking have made banking operations more user friendly and easy. Peculiar characteristic of Indian banks unlike their western counterparts such as high share of household savings in deposits (57.4% of total deposits), adequate capitalisation, stricter regulations and lower leverage makes them less prone to financial crisis, as was seen in the western world in mid FY09. The Scheduled Commercial Banks (SCBs) in India have shown an impressive growth from FY04 to the mid of FY10. Total deposits, advances and net profit grew at CAGR of 19.6%, 27.4% and 20.2% respectively from FY03 to FY08. Banking sector recorded credit growth of 33.3% in FY05 which was highest in last 2 and half decades and credit growth in excess of 30% for three consecutive years Even as global financials face growth and asset-quality issues, Indian banks offer a healthy growth trajectory with minimal balance-sheet risks. Over the next few years, financial penetration will continue to rise as banks expand into new areas, focus on building their retail liability franchise and strengthen their risk-management systems. Despite the high growth rate of the past decade, penetration for most financial products/services in India remains low and this, coupled with a conducive economic environment, will drive a 17% credit CAGR over FY10-14. Fee growth is likely to be healthy as a pickup in corporate activity further boosts retailfee momentum. Industry consolidation will continue and big-scale M&A activity is unlikely. Target Market Still Expanding: While existing penetration levels are low, the ³bankable population´ is expanding at a healthy pace led by economic growth momentum, especially in rural India, and favourable demographic. The structural opportunity for banks is evident from the fact that more than 30% of Indians are below 15 years of age and over the next five to 10 years will enter in the ³bankable population´ category. Meanwhile, outstanding bank credit in the 15 days up to January 29, 2010 rose by US$ 4.32 billion, pointing to a revival in credit growth. This is the highest year-on-year growth recorded since August 14, 2009. Furthermore, the outstanding bank credit in the 15 days up to February 12, 2010, rose by US$ 4.87 billion to US$ 658.24 billion, according to data from the Reserve of Bank of India (RBI), marking a 15.07 per cent year-on-year growth in credit.

Reasons Elaborated 1. Government Initiatives The government plans to invest US$ 3.63 billion into public sector banks to aid them for maintaining their capital adequacy ratio (CAR), as per the Union Budget presented by the Union Finance Minister in February 2010. Out of the total allocation, US$ 2.1 billion would be used for recapitalisation of the public sector banks during April-June 2010 and US$ 1.5 billion will be invested during the rest of 2010-11. The RBI has allowed banks to make changes in the repayment schedules or drawdown without prior approval from the central bank. However, such a change could be made on the condition that the average maturity of the loan should remain the same. The move is expected to make external commercial borrowing (ECB) transactions easier. Transactions both through automatic and approval routes can take advantage of this change. Now, without the prior approval of RBI, Indian companies may borrow up to US$ 500 million in a year. Further, RBI also allowed domestic scheduled commercial banks to open up their branches in Tier III to Tier VI regions that have population of up to 49,999 without the prior permission of the central bank. Banks such as PNB and UCO Bank are planning to take advantage of this initiative and would open around 440 and 89 branches, respectively, in such regions. The Monetary Policy Statement 2010-11, dated April 20, 2010, specifies the following monetary measures: i. ii. iii. The repo rate has been raised by 25 basis points from 5.0 per cent to 5.25 per cent with immediate effect. The reverse repo rate has been raised by 25 basis points from 3.5 per cent to 3.75 per cent with immediate effect. The cash reserve ratio (CRR) of scheduled banks has been raised by 25 basis points from 5.75 per cent to 6.0 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning April 24, 2010.

2. Stimulus packages have eased pressures in high-stress sectors Indian government has announced multiple measures, aiming to accelerate demand in sectors like real estate, steel, autos, and extend support to labour-intensive, exportoriented sectors like gems and jewellery and textiles. The impact has been fairly prompt and visible, with industries such as autos, cement and real estate already showing a pickup in activity, partly driven by the pentup demand itself.

3. Supportive regulatory regime has boosted growth, profitability A tightly regulated environment and a conservative regulator have always led to sub-optimal operating metrics for Indian banks. As the regulator continues to adopt global banking practices, easing some regulatory requirements, Indian banks are likely to see an improvement in their growth trajectory, and more importantly, profitability. Even after the number of regulatory reforms over the past 15 years, the Indian banking sector remains the most tightly regulated one in the region and also globally. The tight regulatory regime has helped Indian banks to withstand the Asian financial crisis and, more recently, the subprime turmoil relatively unhurt. However, it has also led to a sub-optimal profitability metrics for Indian banks for a long period of time, at times hindering the growth of the market¶s financial system per se. Over the next five years, RBI may continue with its regulatory-easing policies, allowing more efficient use of capital and a commercially competitive landscape, with reduced dependence on ³regulatory will´ like branch licences. 4. Public Sector Bank shares have been good performers Going forward, PSBs¶ which are close to the required lower level of government stake and have concentrated presence in particular region are likely to consider its merger with other PSB as an important option if they want to sustain the growth seen in past. With in the group of banks, foreign and private sector banks grew at higher rate than the industry from FY03 to FY08 primarily because of lower base effect and rapid expansion undertaken by these banks. In FY09, overall growth in credit and deposits was led by PSBs. However, growth of private and foreign banks was significantly lower in FY09 due to their high exposure to stressed sectors and problem at parent level for foreign banks. Motilal Oswal says ³I think PSU banking as a whole starting from SBI till say UCO Bank and Central Bank and all those laggards my sense is that there is lot of scope for it to be doing well particularly if economy does 8%-8.5%-9% for the next 3-4 years these banks will shine. You have sent the bank profits the early birds which have come out like Can Bank, HDFC Bank or whatever has come out they are brilliant. So I don't have any doubts that these banks are going to make tonnes of money. There is no competition in banking whatsoever and RBI is going very slow in terms of issuance of new licences particularly to big guys. So I mean in this kind of a surging economy and limited availability banking services I think these guys are going to make lot of money.´

5. Consolidation of Banks in India India would see a large number of global banks controlling huge stakes of the banking entities in the country. The overseas banking units would bring along with it capital, technology, and management skills. This would lead to higher competition in the banking frontier and ensure greater efficiency. The FDI norms in the banking sector would give more leverage to the Indian banks. Thus, a consolidation phase in the banking industry in India is expected in the near future with mergers and acquisitions gathering more pace. One might also see mergers between public sector banks or public sector banks and private banks. Credit cards, insurance are the next best strategic places where alliances can be formed. The consolidation phase has already begun; ICICI bank has acquired Bank of Rajasthan already. State Bank of Indore and State bank of Saurashtra has merged with SBI and SBI plans to merge more of its associates ( State Bank of Mysore, State Bank of Bikaner and Jaipur, State bank of Hyderabad, Punjab and Sind bank and State Bank of Travancore) The consolidation will lead to improved competitiveness, larger customer reach and mitigated risks. 6. NPL issues not structural; credit cycle fairly manageable y Even though credit has grown at a healthy pace over the past five years,the proportion of exposure to risky sectors remains low (below 20%). y Corporate leverages are much lower than in previous cycles and profitability has improved significantly y Better risk-management system and legal framework for recoveries. A significant improvement in recovering the NPAs, lowest ever increase in new NPAs combined with a sharp increase in gross advances for SCBs translated into the best asset quality ratio for banking sector in last two decades. Gross NPAs to gross advances ratio for SCBs decreased from the high of 14% in FY2000 to 2.3% in FY08.

7. Private banks are better positioned in the future I believe private banks are better positioned to leverage from the changing banking landscape as their superior soft skills will drive market-share gains in retail liabilities, enabling them to expand margins. Their ability to generate higher fee revenues will also widen their ROE differential with PSU banks. Meanwhile, even though a few PSU banks have caught up on the technology gaps, they lack the much required softer skills. Further, we view the bridging of the technology gap as a constant cycle for PSU banks. While they will continue to lose market share, within the group, diversity will increase: few Tier I banks will maintain their market share while Tier II banks will continue to lose theirs.

Faced with a limited branch network and RBI¶s tight licensing regime for branches, private-sector banks have aggressively built up a more effective, non-branch distribution network focused around ATMs, internet banking, mobile banking cards, etc. Given that more than 47% of customers rarely visit bank branches and 80% of the visits pertain to cash deposits and withdrawals this model has been a good substitute to the traditional branch-network approach. Supported by a strong non-branch distribution network and customer-friendly layouts, private banks¶ branches have scored higher than those of their PSU counterparts on most efficiency parameters such as business per branch, deposits per branch and, most importantly, Casa per branch. I believe it¶s the effective use of technology, not the technology itself, that gives private banks their edge to build retail franchise, despite a limited distribution network. On the other hand, PSU banks have rolled out technology platforms but still do not seem to be leveraging it efficiently. Abhishek Banerjee KHR2009PGDMF127 Marketing- M2