INDIAN BANKING

THE ROAD AHEAD

SUB THEME:
TRANSFORMING
INDIA
THROUGH
CONSOLIDATION

PAPER ABSTRACT

The banking sector has a tremendous role in reinforcing the economy of the
nation by serving the micro needs of all the three sectors of the economy
namely agriculture, manufacturing and services at the centers of action in the
country.

The paper presenter concentrates on Banking Sector Consolidation at

the International scene and also throws light on the various factors driving
International consolidations. Mergers and Consolidations may go beyond
traditional inter bank mergers and one could see more alliances and mergers
in the years ahead. The factors discussed in brief include

1. Globalization outside banking sector.

2. Economies of scale.

3. Search for inter sector synergy.

4. New technology paradigm.

There is a tremendous challenge for the Indian Banking Sector

in this kind of changing banking scenario. The Public Sector Banks
may need to raise another Rs 60000 crores to meet the increasing
credit needs in the next 5-6 years. PSB’s need to raise an additional Rs
5000-6000 crores of capital annually for the next 5 years to continue to
finance 30% of the GDP with the economy growing at the rate of 7%
each year.

The paper presenter lays thrust on the challenges that can be

met through by the Government, domestic banks, new initiatives and
social considerations.

The paper focuses on the need for Consolidation in India as well

as on banking sector reforms at the micro levels of the economy in
order to lift the economic status of 260 million people who are below
the poverty line.

The Banking Scenario in India:

The Banking sector has a tremendous role in reinforcing the economy of the
nation by serving the micro economic needs of all the three sectors of the
economy namely agriculture, manufacturing and services at the centers of
action in the country.

The Banking Sector comprises of Public Sector Banks, Private Sector

Banks and Cooperative Banks. These banks are being regulated by Reserve
Bank of India which acts as the Regulator for the Banking Industry in India.

There are 27 Public Sector Banks in India with around 48000 branches,
a capital of Rs. 15000 Crores (approx), a deposit base of Rs. 14,21,000
Crores and an advances figure of Rs. 8,10,000 Crores.

There are 28 Private Sector Banks in India and the Total Paid up Share
Capital is around Rs. 3500 Crores and the Total Deposits in these Banks
sums upto Rs. 3,42,000 Crores.

Banking Sector Consolidation

The trends

The recent spurt in banking sector consolidation worldwide was kicked

off in late 1997, in Europe, by the move to merge two of Europe's largest
banks, United Bank of Switzerland and Swiss Bank Corp. In the United
States, the Citicorp - Travelers Group deal in early 1998 was quickly followed
by deals between BankAmerica Corp. and NationsBank Corp., and between
BancOne Corp. and First Chicago NBD Corp. Later that year, German
banking major, Deutsche Bank decided to takeover Bankers' Trust.

In Japan in 1999, Industrial Bank of Japan, Dai-Ichi Kangyo Bank and

Fuji Bank proposed to forge a new alliance, Mizuho Financial Group, which
will be the world's biggest financial group with assets of $1.3trillion. Sumitomo
Bank and Sakura Bank plan a merger that would create the world's second
biggest banking group with assets of over $900billion. Current leader,
Deutsche Bank has assets over $700billion.

Europe too witnessed hectic merger activity last year. In France, the
agreed merger between Societe Generale Bank and Paribas was upset by a
hostile takeover of the latter by Bank Nationale de Paris. Recently ING, the
Dutch banking and insurance group, offered to buy the entire share capital of
Credit Commercial de France, only to withdraw its offer later. NatWest in the
United Kingdom has received hostile bids from Bank of Scotland and Royal
Bank of Scotland.

Back home in India, HDFC Bank has taken over Times Bank. Bank of
Punjab is merged with Centurion Bank, Bank of Madura with ICICI Bank. A
merger of the seven associates of State Bank of India with the parent bank
too is being considered. SBI is also taking swift strides to acquire foreign
banks. A merger of Ashok Leyland Finance with IndusInd Bank is a pointer to
the fact that mergers and consolidations may go beyond traditional inter bank
mergers.

The contributing factors

The factors driving the international consolidation trend are as follows -

1) Globalisation outside the banking sector

 Mergers and acquisitions in other industries / sectors of the economy

have spurted. Banking is a critical lifeline for business. In order to retain
increasingly globalised client relationships, the banking sector too has
to replicate the new economic structure.
 Clients travelling across geographical zones and expecting the same
banking service need to be served any place any time - through
branches or correspondent relationships.

2) Economies of scale: This manifests itself in several ways:

 "Brick and mortar" banks have a higher incidence of fixed costs. Higher
volumes would boost earnings growth.
 "Click" banks need to operate beyond geographical boundaries on
account of higher set-up costs and service expectations of clients.
 Big participant benefit helps large banks close better deals in the
financial markets.
 Higher size of assets / liabilities tend to be inherently diversified and
thus minimise risks.

3) From products to relationships

There is a perceptible change in banking philosophy from pushing products to

retaining relationships. They need to offer wider range of service to expand
the relationship. This makes it imperative to acquire or have strategic
alliances with organisations that offer complementary products and services
or possess different strengths.

4) Search for inter-sector synergy

The push to "bancassurance", seen in the Citibank-Travelers Group deal and

the failed bid by NatWest for Legal and General group; the attempt to
combine commercial banking and investment banking, seen in the deals that
brought together Deutsche Bank, Morgan Grenfell, Bankers Trust and BT
Alex Brown are typical examples.

5) Blurring industry boundaries - an emerging trend

Wal-Mart, the world's largest retailer is seeking to establish a banking network
to complement the retail reach that it already possesses. Net companies
outside the existing banking framework have been trying to offer quasi
banking services through the net. Soft Bank of Japan started operations with
no physical facilities. Thus, the banking landscape is going through a
transformation.

6) New technology paradigm

Advances in technology have made it possible to stretch comfortably and

effectively the reach across time-zones and the relationship across products
and services. Further, there is an increase in both the critical mass and the
level at which diseconomies set in. All this has created a totally new
technology paradigm that banks seek to exploit through consolidation.

Challenge for the Indian banking sector

Indian banks have a long way to go before they reach the size of their
international counterparts. Even the biggest Indian bank, State Bank of India,
is nowhere on the international scale, with assets in the range of $50billion.
Absence of significant scale benefits and higher implicit costs of several
services are perpetuating the poor ranking of Indian banks in the international
league tables.

Shareholding structure, government regulations and sheer size of the

country ensure that the existence of Indian banks is not at stake at this stage.
What is at stake is the banking support that is available for Indian economic
activity, and thereby the international competitiveness of various sectors.
What is also at stake is the scope for the banking industry to earn superior
returns through differentiated wider services.

Further, it is quite conceivable that with passage of time, as government

holding in banks is progressively divested, regulatory authorities will be
unable to hold back the international giants from buying out Indian banks.

A time limit for implementation of Basle II norms is around the corner.

Banks have taken many steps to ensure initial compliance with standard
norms. It is in this connection that the Finance Minister has stated that banks
in India will need another Rs 60000 crores in the coming years.The challenge
can be met through some concerted action -

1) Government

The Government needs to do away with artificial fragmentation

of the financial sector. A case in point is the segregation of
banks and financial institutions induced by policy. If this is
 changed, we may well see mergers between the two sectors to
create organisations of size.

2) Domestic Banks

Domestic Banks - private as well as public - need to

continuously explore options to acquire or merge with other
institutions to enhance their size, service or skill-set. This could
also mean looking beyond the national boundaries as truly
global corporations do.

3) New Initiatives

The recent crisis in the far-East has demonstrated the need for a
robust banking sector. Therefore the whole structure of Regional
Rural Banks (RRBs) and Urban Co-operative Banks (UCBs)
needs to be strengthened.

This may be the time to come out with interesting initiatives with
regard to structure of RRBs and UCBs so that private sector
organisations - banks as well as non-banks - play a greater role
in meeting the needs and aspirations of hitherto neglected parts
of the country.

4) Social considerations

The full benefit of mergers can only be realised if they are

followed up with some hard measures such as re-location /
closure of branches, rationalisation of employee strength etc. It
would be a welcome change if the management and unions
collaborate in seeking appropriate social security from the
Government - financed out of the divestment of stake in these
banks.

Indian banking has to operate with a global mindset even while fulfilling
local banking requirements. By joining in the effort to make this happen, we
will get the banking service we need. Else, we will deserve the banking
service we get.

Credit rating agency Standard and Poor's has expressed the view that
consolidation is the biggest challenge for the Indian banking sector and banks
must focus more on fee- based income to sustain profits.

While strong credit growth and improved loan quality has helped Indian
banks, they need to strengthen risk management processes.
The growth (in loans) comes with the challenges of putting pressure on the
risk processes. So that needs to be strengthened as the books grow.
 As the interest rate environment is becoming more and more volatile
compared to the past, market risk management techniques need to be
adopted by banks.

India has about 300 banks led by State Bank of India and the
government wants some of the public sector ones to merge and become more
competitive. Public sector banks account for 70 per cent of all loans and
deposits.

Lending in India has surged in the past year, reflecting huge demand for
money from businesses expanding in an economy that is expected to grow by
7 per cent in the year to March 2006.

Need For Consolidation

Consolidation in the banking industry is crucial from various aspects. The

factors inducing consolidation include technological progress, excess
retention capacity, emerging opportunities and deregulation of various
functional and product restrictions. A strong banking system is critical for
sound economic growth so it is natural to improve the comprehensiveness
and quality of the banking system to bring efficiency in the performance of the
real sectors. The past one decade has seen the transformation of the banking
industry throughout the world from a highly protected and regulated industry
to a competitive and deregulated one. Especially, globalization coupled with
technological development has shrunk the boundaries by which financial
services and products are being provided to the customers residing at any
part of the globe. Further, due to innovations and improvements in service
delivery channels, the trend of global banking has now been marked by twin
phenomena of consolidation and convergence. The trend towards
consolidation has been driven by the need to attain meaningful balance sheet
size and market share in the face of intensified competition, whereas the trend
towards convergence is driven across the industry to provide most of the
financial services such as banking, insurance, investment, cash management,
etc., to the customers under one roof.

Banking Sector Reforms:

A perceptive analysis of the current discussions on banking sector reforms

reveals that banking sector reforms in India have acquired two distinct faces:
one which may be broadly categorised as the Basle face and the other Indian
face. While the Basle face is the most visible, only the contours of the Indian
face are now beginning to emerge. We must realize that for India's economic
development, the Indian face is as important as the Basle face.

The Basle Face :

In the 1990s, the endeavour of the policy-maker, was to benchmark the
services of the Indian banking system against "international best practices
and standards". This objective was sought to be achieved by implementing
the Basle I norms. For instance, the minimum Capital to Risk Assets Ratio
(CRAR) has been set at 9 per cent, that is, one point above the international
norms. The actual CRAR now stands at 12 per cent. Similarly, risk
management models evolved by the Bank for International settlement (BIS)
have been sought to be transplanted on to the Indian banking system.
Commercial banks are now poised to implement Basle II norms from March
2007; and this would require more capital due to the fact that operational risk
is not captured under Basle I.

One of the major objectives of banking sector reforms was to

enhance efficiency and productivity of banks through competition. The
administered structure of interest rates was dismantled and the level of pre-
emption of resources for reserve requirement was reduced, New banks were
allowed to be established in the private sector and the conditionalities of entry
of foreign banks liberalised. Since 1993, 12 new private sector banks came
into existence. Foreign direct investment (FDI) in private sector banks is now
allowed upto 74 per cent, subject to guidelines. What has been the over-all
impact of these reforms on the banking system? As Dr. Y.V. Reddy,
Governor, Reserve Bank of India has shown concretely: "the overall efficiency
and stability of the banking system in India" has greatly improved. As we have
seen, capital adequacy of Indian banks is at the international level. The
percentage of gross non-performing assets (NPAs) to gross advances has
declined from 14.4 per cent in 1998 to 7.2 per cent in 2004. During the last
five years, the business per employee for public sector banks more than
doubled to around Rs. 25 million in 2004. So far so good.

What does the future hold for the Indian banking system? In this
context, we need to ponder over Dr. Reddy's prophetic pronouncement: "
consolidation and convergence are not doubt critical to the future of banking
but I believe that governance and financial inclusion would also emerge as the
key issues for a country like India, at this stage of socio-economic
development" (reference cited above). This brings us to the Indian face of
banking sector reforms.

The Indian Face :

While the objectives of evolving "giant size" banks by consolidation and of

making such Indian banks "globally competitive" are indeed laudable medium-
term objectives to be aimed at, there are some neglected areas in domestic
banking which need to be addressed immediately. In the milieu of the new
banking culture fostered by reforms, lending to agriculture and priority sectors
generally had become unfashionable. The relative magnitude of the flow of
credit to agriculture had shrunk and the interest rate regime discriminated
openly against agriculture. There was a significant reduction in small farmer
borrowers. The rural credit delivery system had become practically moribund.
These issues which are, in a way, unrelated to the Basle reforms, have now
acquired a sense of urgency because we need to step up agricultural growth
to 4 per cent, from the average level of 1.5 per cent posted in more recent
years.

It is this realisation which has led the Government of India to take policy
initiatives in the following three areas: Enlarging the flow of bank credit to
agriculture and small scale industries, and rebuilding the cooperative credit
structure. In all these three areas, the elements of "inclusion" and
"governance", to which Dr. Reddy reforms, are prominent.

First, the New Common Minimum Programme (NCMP) announced by

the UPA Government in 2004 stipulates that bank credit to agriculture be
doubled in the next three years. Public Sector banks (PSBs) have applied
themselves seriously to attaining this target. In the first year itself, credit to
agriculture has been stepped up by some 30 per cent. This is indeed a
welcome development.

Second, the policy package announced by the Ministry of Finance,

Government of India, in August 2005, for small and medium enterprises
(SMEs) stipulates that credit to SMEs should be doubled in the next five
years: from Rs.67,000 Crore in 2004-05 to Rs. 1,35,000 Crore in 2009-10.
That is, PSBs should achieve a 20 per cent year-on-year expansion on credit
to this sector. (For details see. Economic and Political Weekly, August 20,
2005).

Third, about the rebuilding of the cooperative credit institutions. The

Government of India constituted in August 2004, a Task Force, under the
Chairmanship of Prof. A. Vaidyanathan to formulate a practical and
implementable plan of action and also assess the broad dimensions of the
financial assistance that Government of India will have to extend to rejuvenate
the rural cooperative credit structure. In its Report submitted in February
2005, the Task Force has placed the overall financial assistance required at
Rs. 10,839 Crore and an additional Rs. 4,000 Crore towards contingencies
needs to be provided. NABARD has been designated as the Nodal Agency to
coordinate the implementation of the entire programme .

Micro-Finance Institution :

While on this subject it is necessary to refer to another subtle reform that is

taking place in the rural credit delivery system, namely, micro-finance. The
programme of linking Self-Help Groups (SHGs) with the banking system has
emerged as the major micro-finance programme. The RBI has been seeking
to create an appropriate environment for the nurturing of non-governmental
organistions engaged in micro-finance activities. Banks are being encouraged
to adopt the agency model by using the infrastructure of civil society
organisations, rural kiosks and village knowledge centers for providing credit
support to farm or rural sector generally. (see RBI Annual Report, 2004-05).
The main thrust here that reform of the rural credit delivery system is as
important as the reform of the commercial banks. Rural Credit needs to be
treated not as an appendage to the commercial banking system but as an
integral part of it.

CONCLUSION

Bankers have a mission of great challenge. With a total annual credit

performance of Rs 80000 crores banking sector reforms at micro levels will
enable the upliftment of the economic status 260 million people who are
below the poverty line. Consolidation of banks has become the road map fo
transforming India into a developed economy.

BIBLIOGRAPHY

BANK QUEST AND IIB VISION - The journal of INDIAN INSTITUTE OF

BANKING & FINANCE.

REPORT ON TRENDS AND PROGRESS OF BANKING. (2004-05)

RBI ANNUAL REPORT (2004-05)

RBI Governor’s Speech – BANKING SECTOR REFORMS IN INDIA. (RBI

bulletin June- 2005.