The Indian banking industry has traditionally remained a protected space.

Regulated deposit and lending rates and restrictions on

competition enabled comfortable spreads. There was little pressure on banks to come out of this quiescent and protected world.

However, several developments in combination have compelled banks to change the old ways of doing business. These include,
among others, the deregulation of interest rates {interest rates have been largely deregulated except for: (i) savings deposits, (ii)
non-resident Indian (NRI) deposits, (iii) small loans up to Rs 200,000, and (iv) export credit}, technological advancements,
disintermediation, pressures arising from a liberalised financial marketplace, increased emphasis on shareholder value,
macroeconomic pressures and banking crises in the 1990s.

Consequently, while lending and acceptance of deposits have continued to remain the mainstay of banking business, the greater
globalisation of banking operations in an increasingly market-driven environment has made risk management critical. Business is
defined as the sum of deposits and advances.

Bank group-wise performance

The business of all SCBs grew at a CAGR of 18.8 per cent between 2001-02 and 2005-06 on the back of 23.8 per cent growth in
advances and 15.8 per cent growth in deposits. During the same period, the business of other scheduled commercial banks
(OSCBs) grew at a CAGR of 26.9 per cent, the highest amongst all the bank groups, driven by strong growth in both advances and
deposits. The growth in business for the other bank groups was lower than the industry average. 

While foreign banks witnessed the lowest growth of 19 per cent in advances between 2001-02 and 2005-06, SBI and associates
saw the lowest increase in total deposits at 11.5 per cent.

Although the share of nationalised banks in the total business has come down, it has been hovering around 50 per cent since 2001-
02. In 2005-06, the share of SBI and associates in total business stood at 25 per cent, while that of OSCBs at 20 per cent. Foreign
banks had the lowest share in total business at 6 per cent.

Figure 1: Share of bank groups in total business of SCBs 

Source: CRISIL Research and RBI

SBI and associates

The business of SBI and associates grew at a CAGR of 15.4 per cent, the lowest amongst all SCBs, from Rs 5,157 billion in March
2002 to Rs 9,139 billion in March 2006, driven by a CAGR of 22.6 per cent in advances. During the same period, deposits grew at a
CAGR of 11.5 per cent. The share of advances in funds deployed increased from 38.7 per cent in 2001-02 to 56.7 per cent in 2005-
06, while the proportion of investments in funds deployed decreased from 43.7 per cent in 2001-02 to 34.3 per cent in 2005-06.

Nationalised banks 
The business of nationalised banks grew at a CAGR of 18.1 per cent from Rs 9,338 billion in March 2002 to Rs 18,147 billion in
March 2006, driven by a CAGR of 23.5 per cent in advances. Deposits grew at a slower CAGR of 15 per cent. 

The share of advances in funds deployed increased from 47.9 per cent in 2001-02 to 57.8 per cent in 2005-06, while the share of
investments in funds deployed declined from 40.6 per cent in 2001-02 to 32.2 per cent in 2005-06.

Other scheduled commercial banks

The business of OSCBs grew at a CAGR of 26.9 per cent, the highest amongst all SCBs, from Rs 2,859 billion in March 2002 to Rs
7,411 billion in March 2006, driven by a CAGR of 28 per cent in advances and 26.1 per cent in deposits. 

While the share of advances in funds deployed increased from 46.8 per cent in 2001-02 to 57.9 per cent in 2005-06, the share of
investments decreased from 39.7 per cent in 2001-02 to 33.4 per cent in 2005-06. The growth in advances was primarily driven by
the focus on retail credit, especially by the new private sector banks.

Foreign banks
Foreign banks, at a CAGR of 16.9 per cent registered the second lowest growth in business among the various bank groups
between 2001-02 and 2005-06. The business of foreign banks grew from Rs 1,131 billion in March 2002 to Rs 2,113 billion in March
2006, driven by a CAGR of 19 per cent in advances, which is the lowest among all SCBs. Deposits grew at a slower CAGR of 15.2
per cent for the same period. 

The share of advances in funds deployed increased from 47.0 per cent in 2001-02 to 54.8 per cent in 2005-06, while the share of
investments in funds deployed declined marginally from 33.9 per cent in 2001-02 to 30.1 per cent in 2005-06. 
Indian banking: The story so far

Unprecedented credit growth over the last 3 years

Chart 1: Indian banking story

Source: CRISIL Research

Right through the 1990s, non-banking financial companies (NBFCs) and housing finance companies (HFCs) dominated the retail
finance market, while banks focused on corporate credit. However, the slump in industrial credit offtake in the early 2000s made
banks seek other avenues to deploy funds. The reduced demand for credit — as depicted by the low credit-to-deposit (C/D)
ratio — forced banks to park their surplus funds in government securities. In the declining interest rate scenario, such
investments became particularly attractive for banks.

In the meantime, banks also turned their energies towards retail finance, specifically products such as housing finance, vehicle
finance, and unsecured credit. The soft interest rates and rising income levels of consumers helped banks achieve rapid growth in
the retail finance industry. The industry's success and untapped potential attracted a large number of banks, thereby intensifying
competition.

The strong pace of bank credit growth over the last 3 years — led mainly by the hectic pace of growth in retail credit Ã
¢â‚¬â€ is undoubtedly a major highlight of the Indian banking story in recent times. Robust economic growth in general and
industrial growth in particular has aided in the 30-per-cent annual growth of loans and advances (credit) of scheduled commercial
banks (SCBs) during the last 3 years.

Figure 1: Interlinkages between deposit growth, C/D ratio, incremental C/D ratio and excess SLR

Source: CRISIL Research

However, the growth in credit has outpaced growth in deposits (the main source to fund credit) both in percentage and in absolute
terms during the period. This compelled banks to liquidate excess holdings of government securities such that the excess SLR for
the banking system as on March 31, 2007 was just 3 per cent above the statutory minimum 25 per cent stipulated by the Reserve
Bank of India (RBI).

Several banks now seem to be operating their SLR portfolios close to the statutory minimum level of 25 per cent, thereby limiting the
scope for further liquidation. This invariably increased the dependence of banks on deposits/borrowings for funding future credit
growth. Over the last 3 years, while credit has grown at a CAGR of 30.72 per cent, deposits have lagged at 18.62 per cent.

Banks struggle to fund credit growth with CASA

Current account and savings account (CASA) deposits are known as demand deposits or low-cost deposits and these have no
maturity period. In order to keep their borrowing costs under control, banks have always focused on garnering CASA deposits. Until
2005-06, the proportion of CASA deposits in total deposits of SCBs was more or less rising steadily as can be seen in the following
graph. However, CRISIL Research estimates that the share of CASA deposits in total deposits dipped to 37.92 per cent in 2006-07
from 38.61 per cent in 2005-06.

Figure 2: Share of low-cost deposits in total deposits

Source: CRISIL Research and RBI

Most banks struggled to fund the high credit growth solely with CASA deposits. This excessive mismatch between growth in credit
and growth in CASA deposits drove banks to other high-cost alternatives, such as term deposits. In the bargain, the composition of
term deposits changed — shortening tenures, increasing tickets.
Transformation in term deposit mix
As most banks struggled to fund the high credit growth solely with CASA deposits or low-cost deposits, they had to resort to other
high-cost term deposits for credit growth, transforming the composition of deposits in the process. Consequently, the changing
deposit mix for banks started affecting their cost of funds and their asset liability management (ALM) profiles.

As mentioned earlier, banks started vying for big-ticket term deposits with shorter maturities. These deposits are known as bulk
deposits. RBI classifies deposits larger than Rs 10 million as bulk deposits, and these typically have maturities of 1 year or less.

Depositors averse to locking investments for longer periods

Figure 3: Distribution of term deposits (by maturity)

Source: CRISIL Research and RBI

As can be seen from the preceding chart, bulk deposits (less than 1-year original maturity) accounted for close to 40 per cent of
term deposits accepted in 2006-07, as against close to 29 per cent in 1999-2000. Due to their shorter maturities, bulk deposits are
rolled over more frequently and are re-priced at higher rates of interest.

With the spread between long-term deposits and short-term deposits narrowing, depositors became averse to locking investments
for long periods, and hence, there was an increase in preference for short-term deposits. As a result, the maturity profile of term
deposits shortened significantly. Typical depositors in bulk deposits are corporates, financial institutions like mutual funds, high net
worth individuals (HNIs) etc. 

Banks start vying for bulk deposits

Figure 4: Distribution of term deposits (by ticket size)

Source: CRISIL Research and RBI

Bulk deposits (or deposits over Rs 10 million) accounted for close to 42 per cent of term deposits accepted in 2005-06 as against 18
per cent in 2001-02. These deposits are high-cost deposits where interest rates are typically higher than the prevailing card rates for
other term deposits.

At the same time, the proportion of retail deposits (deposits of up to Rs 1.5 million) has fallen to 48 per cent in 2005-06 from 74 per
cent in 2001-02. Since the average maturity of bulk deposits is short, it increases the lumpiness of the deposit base.

Rising trend in issue of CD by banks

Figure 5: Rising trend in banks issuing CDs

Source: RBI

Certificates of deposit (CDs) form a part of bulk deposits. The issuance of CDs increased sharply as banks endeavoured to raise
funds to meet the increased credit demand. The rising trend in CD issuances is an indicator of the growing proportion of bulk
deposits in the system. The amount of outstanding CDs more than doubled from Rs 436 billion in 2005-06 to Rs 950 billion in 2006-
07. The weighted average discount rate (WADR) of CDs also increased by around 215 basis points (bps) from 2005-06 and nearly
350 bps from 2004-05 to close at 11 per cent for 2006-07 thereby putting pressure on the cost of funds.

Private sector banks were the major issuers of CDs, followed by foreign banks. In particular, banks with limited branch network and
limited retail customer base have been resorting to issuance of CDs.

In the meantime, interest rates harden

From October 2005 onwards, interest rates in the economy started rising. With the hardening of interest rates, banks have seen an
increase in their cost of deposits (funds), both on the wholesale as well as retail side.

The cost of deposits for SCBs has gone up from 4.53 per cent in 2004-05 to an estimated 4.75 per cent in 2006-07.

Figure 6: Rising interest rate environment

Source: CRISIL Research and RBI

Increase in term deposit rates more pronounced at the shorter-end
While banks increased rates across the board on term deposits, the increase in deposit rates was more pronounced at the shorter
end. The mismatch between growth in credit and deposits, coupled with customer aversion to longer maturity products, forced
banks to shore up interest rates at the shorter end of deposits. This led to a narrowing of spreads between the long-term and short-
term deposits. The rush for bulk deposits by banks to fund credit growth pushed up interest rates on bulk deposits (including CDs).

Figure 7: Spread for public sector banks

Source: CRISIL Research and RBI

For public sector banks, the spread narrowed down to 75 bps in March 2007 from 100 bps in March 2005.

Figure 8: Spread for private sector banks

Source: CRISIL Research and RBI

For private sector banks, the spread narrowed down to 60 bps in March 2007 from 75 bps in March 2005. 

Lower or comparable returns on other long-dated instruments

Figure 9: Time deposits growth rate

Source: RBI Figure 10: Time deposits and small savings

Source: RBI

With the spread between short-term and long-term deposits having narrowed down, investors preferred short-term deposits and
were averse to locking their investments for long periods. The investor preference for short-term deposits could also be attributed to
lower or comparable returns on other longer maturity instruments like postal deposits, public provident fund etc, in addition to
greater economic activity and increase in interest rates on bank deposits (particularly, shorter maturities). With unchanged interest
rates on postal deposits, the accretion to postal deposits decelerated to 10.9 per cent in March 2007 from 17.2 per cent a year ago.
CRISIL Research believes that the extension of tax benefits under Section 80C for bank deposits with maturity of 5 years and above
has been a slow starter.

Retail credit growth expected to moderate in future

Figure 11: Growth in retail credit expected to moderate

Source: CRISIL Research and RBI

Retail credit (excluding housing finance) is typically of shorter maturity. Between 2002-03 and 2005-06, this component of non-food
credit has grown at over 37 per cent. We find that there is growing origination of shorter-term deposits and at the same time, lending
to floating rate, long-term asset classes such as housing and other term loans has increased significantly. There has consequently
been an increase in mismatches in shorter-term maturity buckets, which has affected the structural liquidity profile of the banking
system.

Long-term maturity assets like housing finance and other term loans have grown sharply. While housing finance has grown at a 60
per cent CAGR, term loans have grown at 37 per cent CAGR during 2002-03 to 2005-06.

However, going forward, we expect retail credit (excluding housing finance) to slowdown to a CAGR of 19 per cent, housing finance
to 32 per cent, and term loans to 25 per cent during 2005-06 to 2008-09. In effect, banks will need to broaden their deposit mix to
maintain structural liquidity.

The current scenario

We believe the RBI's stringent fiscal and monetary measures have started achieving the desired effect. In the first quarter of 2007-
08, credit growth slowed down to 26.7 per cent from the 30.0 per cent levels seen earlier. Hence, RBI intervention   aimed
at controlling the pace of credit growth — is expected to yield the desired results. Retail credit is also slowing down as
indicated by the quarterly results announced by major players. These factors, we believe, will lead to the curtailment of discretionary
spending and a conscious slowdown by banks in the wake of increased provisioning norms.

As mentioned earlier, we expect retail credit (excluding housing finance), which has been growing at around 40 per cent for the last
2-3 years, to slow down to a CAGR of 19 per cent during 2005-06 to 2008-09. The runaway growth in retail assets was one of the
key monitorables that led the RBI to act faster and more frequently. 

The current scenario in deposits

In the first quarter of the current fiscal, deposits growth for SCBs, for the first time, has started mirroring the loan growth in the
system. An expected moderation in credit growth would ease the pressure on garnering high-cost deposits.

Beginning the last quarter of 2006-07 and continuing in the first quarter of 2007-08, against the backdrop of slowdown in credit
growth and the prevailing liquidity situation, we find that banks have slowly begun reducing their dependence on short-term deposits
by lowering their deposit rates.

Initially, banks offered higher rates of interest on shorter-maturity retail term deposits to reduce the dependence on bulk deposits.
Our industry interactions reveal that banks have started aligning the interest rates with the maturity profiles. We expect this trend to
gain momentum across the banking sector, given the high cost of bulk deposits.

The latest hike in the cash reserve ratio (CRR) by 50 bps to 7 per cent might result in a further slowdown in credit demand, thereby
forcing banks to revisit their deposit growth strategies. We believe that banks might further bring down short-term deposit rates to
manage margins in the reduced credit offtake environment. Consequently, going forward, we expect the maturity profile of term
deposits to correct slightly.

Figure 12: Distribution of term deposits by maturity (projected)

Source: CRISIL Research and RBI

CRISIL Research expects the proportion of bulk deposits (less than 1-year original maturity) to dip to 38.96 per cent of term deposits
accepted in 2008-09 from close to 40.00 per cent in 2006-07. 

In balance, CRISIL Research expects term deposits of SCBs to grow by 20-22 per cent, while aggregate deposits are expected to
grow by 19-21 per cent in 2007-08.

The current scenario in advances

There is a visible slowdown in credit growth as a result of several monetary tightening measures undertaken by the RBI in the last 1
year. The key driver of this slowdown has likely been mortgage and other retail credit growth.

With inflation and liquidity control being the primary focus, we expect the RBI to maintain a constant vigil through its monetary policy.
Upside risks to inflation in the form of higher oil and commodity prices might call for the interest rate environment to remain at the
current levels. This could have a dampening effect on credit growth.

Nevertheless, while loan growth is currently slowing down, our industry interactions indicate that banks believe that loan growth will
pick up in the busy season. CRISIL Research expects some moderation in non-food credit to 24-26 per cent in 2007-08 due to the
monetary tightening measures undertaken by the RBI.

SLR close to statutory minimum; can no longer support credit growth 

The period 2001-02 to 2003-04 of low demand for credit coincided with the period when banks were making efforts to raise their
capital levels and bring down NPA* levels. The application of capital adequacy norms   which required banks to maintain 9
per cent of their risk-weighted assets as capital — and the pressure to bring down NPA levels made banks slightly risk-
averse. As such, investments in government and other approved securities, which attracted zero-risk weights, became the banks'
preferred mode of investments. 

However, in the last 3 years, robust economic growth in general and industrial growth in particular aided rapid growth in bank credit.
In the wake of increased credit demand, banks started gradually readjusting their SLR portfolios.

In the last couple of years, the growth in deposits has not been able to keep pace with the high growth in credit, compelling banks to
liquidate excess holdings of government securities. This has now brought down excess SLR in the banking system to around 3.0
per cent as on March 31, 2007 from 16.7 per cent as on March 31, 2004.

CRISIL Research expects aggregate advances to grow at a CAGR of 24.3 per cent from 2005-06 to 2008-09, while aggregate
deposits are expected to grow at a CAGR of 20.0 per cent during the same period. Given the expected growth, CRISIL Research
believes that this will result in a tighter liquidity situation in the banking system, putting pressure on spreads/cost of funds, unless
currency-driven liquidity is infused into the system. With SLR now being close to the statutory minimum, there is limited cushion to
expand credit by drawing down on SLR. 
The other option is to grow deposits and borrowings at a faster rate. As deposits mobilisation efforts still face challenges, any
regulatory measure permitting a phased reduction in the SLR requirement from the current stipulated 25 per cent of NDTL** would
help release liquidity into the banking system, while keeping inflation range-bound. 

A cut in SLR could positively affect banks' earnings as the duration of liabilities has shortened and therefore the funds released by
the SLR cuts could earn additional returns.

In the following chapters, we discuss our expectations on banking business as well as on profitability in detail.

*NPA: Non-performing assets

Business

Business of SCBs to grow at CAGR of 21.8 per cent

Table 1: Business of SCBs in India 

(Rs billion) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P CAGR 
(per cent) 2003-2006 CAGR 
(per cent) 2006-2009
Deposits (i) 13,556 15,755 18,376 21,645 26,298 31,427 37,352 16.88 19.95 
Advances (ii) 7,392 8,636 11,508 15,166 19,289 23,928 29,160 27.07 24.35 
Business (i + ii) 20,949 24,392 29,884 36,810 45,587 55,355 66,513 20.67 21.80 
E: Estimate; P: Projected
Source: CRISIL Research and RBI

The business of the banking industry is defined as the sum of its aggregate deposits and aggregate advances as on a particular
date. In 2005-06, SCBs had business worth Rs 36,810 billion. CRISIL Research's analysis of the banking industry indicates that
banking business will grow to Rs 66,513 billion by 2008-09 at a CAGR of 21.8 per cent. 

From 2005-06 to 2008-09, we expect aggregate advances of SCBs to grow by 24.35 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 19.95 per cent during the same period.

Between 2002-03 and 2005-06, business had grown at a slightly lower CAGR of 20.67 per cent, mainly driven by a CAGR of 27.07
per cent in advances. The period saw a slowdown in industrial growth; many corporate entities restructured their loan portfolios, and
hence, credit offtake was low. With a lack of avenues for the investment of surplus funds, banks turned to retail financing. According
to CRISIL Research estimates, the identified retail finance portfolio of banks — comprising car and utility vehicle (car and
UV) finance, commercial vehicle (CV) finance, two-wheeler finance, credit card receivables, retail tractor finance, and housing
finance — grew at a CAGR of 46.36 per cent in that period.

Deposits, borrowings to remain key sources of funds for SCBs

The main sources of funds for the banking sector are deposits and borrowings. Apart from these, banks can also tap internal
accruals and funds raised through the equity market to meet their funding requirements. We expect this pattern to continue, with no
significant change, during 2007-08 and 2008-09.

Table 2: Sources of funds for SCBs 

(Rs billion) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P
Deposits 13,556 15,755 18,376 21,645 26,298 31,427 37,352 
Borrowings 865 961 1,683 2,054 3,309 4,018 4,852 
Reserves and surplus 758 942 1,237 1,579 1,813 2,144 2,460 
Capital 215 223 259 252 265 280 287 
Total 15,395 17,882 21,555 25,530 31,685 37,868 44,951 
E: Estimate; P: Projected
Source: CRISIL Research and RBI

Figure 1: Proportion of different sources of funds for SCBs

P: Projection
Source: CRISIL Research and RBI

Deposits expected to grow at a CAGR of 19.95 per cent

SCBs' deposits comprise term deposits, savings deposits, and demand deposits (current deposits).

CRISIL Research's projections show the total deposits of SCBs growing at a CAGR of 19.95 per cent from Rs 21,645 billion in
2005-06 to Rs 37,352 billion in 2008-09. This would be driven by growth rates of 21.36 per cent, 19.92 per cent, and 13.14 per cent
in term deposits, savings deposits, and demand deposits, respectively.

Total deposits of all SCBs grew at a CAGR of 16.88 per cent during 2002-03 to 2005-06, mostly due to growth in savings deposits
and demand deposits, which saw a CAGR of 21.55 per cent and 21.21 per cent, respectively.
Table 3: Deposits of SCBs 
(Rs billion) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P CAGR 
(per cent) 2003-2006 CAGR 
(per cent) 2006-2009
Demand deposits 1,645 2,031 2,345 2,929 3,445 3,802 4,242 21.21 13.14 
Savings deposits 3,023 3,737 4,448 5,428 6,528 7,807 9,362 21.55 19.92 
Term deposits 8,888 9,987 11,582 13,287 16,325 19,818 23,748 14.34 21.36 
Total 13,556 15,755 18,376 21,645 26,298 31,427 37,352 16.88 19.95 
E: Estimate; P: Projected
Source: CRISIL Research and RBI

As one can see from the following table, the proportion of term deposits in the total deposit mix has come down from 65.57 per cent
in 2002-03 to 61.39 per cent in 2005-06. However, CRISIL Research estimates that, in 2006-07, the proportion of term deposits in
aggregate deposits would have risen to 62.08 per cent as banks struggled to raise low-cost deposits or current and savings account
(CASA) deposits and therefore, had to rely more on term deposits. Going forward, we expect growth in aggregate deposits to be led
by term deposits, with the share of term deposits in the total increasing to 63.58 per cent in 2008-09. We believe that, going forward,
it will not be easy for banks to increase the share of CASA in the total deposits mix.

Table 4: Share of various deposits 

(per cent) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P
Demand deposits 12.13 12.89 12.76 13.53 13.10 12.10 11.36 
Savings deposits 22.30 23.72 24.21 25.08 24.82 24.84 25.06 
Term deposits 65.57 63.39 63.03 61.39 62.08 63.06 63.58 
Total 100.00 100.00 100.00 100.00 100.00 100.00 100.00 
E: Estimate; P: Projected
Source: CRISIL Research and RBI

On an incremental basis, the proportion of term deposits dipped from 62.00 per cent in 2002-03 to 52.16 per cent in 2005-06.
However, in 2006-07 the proportion of term deposits in incremental deposits is estimated to have risen to 65.28 per cent. Going
forward, the proportion of term deposits is expected to increase to 68.12 per cent in 2007-08 and then decrease to 66.31 per cent
due to a higher growth in savings and demand deposits.

Table 5: Share of various deposits in incremental deposits 

(per cent) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P
Demand deposits 7.46 17.57 11.98 17.87 11.08 6.95 7.43
Savings deposits 30.54 32.45 27.15 29.98 23.64 24.93 26.25
Term deposits 62.00 49.98 60.87 52.16 65.28 68.12 66.31
Total 100.00 100.00 100.00 100.00 100.00 100.00 100.00
E: Estimate; P: Projected
Source: CRISIL Research

Table 6: Growth in deposits of SCBs 

(per cent) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P
Demand deposits 7.45 23.49 15.45 24.90 17.61 10.35 11.59 
Savings deposits 18.27 23.61 19.04 22.03 20.26 19.58 19.93 
Term deposits 11.94 12.37 15.97 14.72 22.86 21.40 19.83 
E: Estimate; P: Projected
Source: CRISIL Research

Term deposits set to grow at a CAGR of 21.36 per cent from 2005-06 to 2008-09
The total term deposits of SCBs stood at Rs 13,287 billion during 2005-06. CRISIL Research estimates that in 2006-07 term
deposits of SCBs grew by 22.86 per cent to reach Rs 16,325 billion. According to our projections, this figure will grow at a 21.36 per
cent CAGR from 2005-06 to 2008-09 to Rs 23,748 billion during 2008-09.

During 2002-03 to 2005-06, term deposits recorded a growth of 14.34 per cent on account of their perceived safety vis-à-vis
other investment instruments such as equities and mutual funds.

Savings deposits to grow at a CAGR of 19.92 per cent from 2005-06 to 2008-09 
At a total figure of Rs 5,428 billion during 2005-06, savings deposits accounted for nearly 25.08 per cent of the total deposit base of
SCBs in India.
In our view, this proportion will remain more or less at the same level in 2008-09 after being slightly lower in 2006-07 and 2007-08.
CRISIL Research expects savings deposits to grow at a CAGR of 19.92 per cent to reach Rs 9,362 billion in 2008-09. If we look at
the growth figures year-wise, we expect savings deposits to grow by 19.58 per cent in 2007-08 and 19.93 per cent in 2008-09.

Figure 2: Household break-up in savings deposits

* stands for 'not elsewhere classified'

Source: RBI

As on the last reporting Friday of March 2005, nearly 86.10 per cent of the total savings deposits of SCBs were owned by the
household sector, about 7.20 per cent were owned by the government, 5.50 per cent by the foreign sector, while the remaining was
owned by the corporate and financial sectors. Within the household sector, an estimated 89.80 per cent of the total savings deposits
were owned by individuals and hence were considered a stable source of funds.

The strong growth expected in savings deposits will be driven by an increase in the amount per savings account and stable growth
in the number of savings accounts. Rising income levels and increasing penetration of banks, both in the urban and rural areas, will
be key driving factors of the growth in savings deposits.

Figure 3: Savings bank deposits — growth in number of accounts, amount per account

E: Estimate; P: Projected
Source: CRISIL Research and RBI

Demand deposits to grow at a CAGR of 13.14 per cent from 2005-06 to 2008-09
After term deposits and savings deposits, the third component of bank deposits is demand deposits   also known as
current deposits. Firms maintain demand deposits to meet their day-to-day cash requirements. Further, when a firm takes working
capital or term loan from a bank, the amount is generally parked as a demand deposit until utilised by the company. Amounts raised
through initial public offerings (IPOs) and external commercial borrowings (ECBs) are also generally stationed in the current
account, until further use. 

Demand deposits remain the most volatile component of bank deposits, and have shown uneven year-on-year growth over the last
10 years.

In 2005-06, bank demand deposits stood at Rs 2,929 billion. According to CRISIL Research's analysis, this figure is set to grow at a
CAGR of 13.14 per cent to Rs 4,242 billion in 2008-09. The driver for this growth is the current upturn in the industrial cycle and
increased IPO activity in equity markets.

From 2002-03 to 2005-06, demand deposits grew at a CAGR of 21.21 per cent from Rs 1,645 billion in 2002-03 to Rs 2,929 billion
in 2005-06.

Figure 4: Ownership of current deposits with SCBs (2004-05)

Source: RBI

Figure 5: Household break-up in demand deposits (2005)

* stands for 'not elsewhere classified'

Source: RBI

As on the last reporting Friday of March 2005, 48.2 per cent of total demand deposits were owned by the household sector, followed
by the corporate sector, which accounted for 22.0 per cent. Within the household sector, individuals owned 47.6 per cent of the total
demand deposits followed by proprietary and partnership firms, which owned 30.2 per cent. 

Advances to grow at a CAGR of 24.35 per cent during 2005-06 to 2008-09

Advances are divided into food and non-food credit. Non-food credit is further divided into agricultural credit, services credit, and
other commercial credit.

The total advances of SCBs grew by 31.79 per cent in 2005-06. In 2006-07, we estimate total advances grew by 27.18 per cent, led
by growth in credit to agriculture, industry credit and continued growth in retail credit. 

Credit offtake to slowdown

In 2005-06, SCBs witnessed one of the highest credit growth trends in the history of Indian banking. A booming industry in rapid
capital expenditure mode generated immense demand from corporates for term funding. On the business front, we expect a
moderation in credit growth over the next 2-3 years as the capital expenditure cycle ebbs and the economy moves towards a phase
of consolidation. 

Table 7: Non-food credit of SCBs 

(Rs billion) 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P CAGR 
(per cent) 2003-2006 CAGR 
(per cent) 2006-2009
Agricultural credit 735 905 1,253 1,723 2,252 2,928 3,718 32.83 29.23
Services credit 1,507 1,925 2,329 2,912 3,617 4,418 5,374 24.55 22.66
Other commercial credit 4,655 5,446 7,510 10,124 12,955 16,131 19,595 29.56 24.62
E: Estimate; P: Projected
Source: CRISIL Research and RBI
In 2006-07, non-food credit is estimated to have constituted 97.59 per cent of the total advances of SCBs. The sectoral deployment
of credit serves as a very good indicator of the level of risk in the credit portfolio of banks.

CRISIL Research estimates that non-food credit will grow at a CAGR of 24.80 per cent during 2005-06 to 2008-09 as against a
CAGR of 28.86 per cent during 2002-03 to 2005-06. Our expectation of a relative deceleration in non-food credit going forward is
due to the reduced demand for credit. 

Other commercial credit is expected to grow at a CAGR of 24.62 per cent between 2005-06 and 2008-09, due to moderation in
industrial credit. Other commercial credit consists of industrial credit, other priority sector credit, and wholesale trade credit (other
than food procurement). CRISIL Research estimates that other commercial credit will grow at a CAGR of 24.62 per cent from Rs
10,124 billion in 2005-06 to Rs 19,595 billion in 2008-09. Industrial credit, which forms 55-60 per cent of other commercial credit,
comprises credit availed by the large, medium and small-scale industries across various sectors.

Growth in industrial credit is expected to moderate to 25.19 per cent in 2007-08 and further to 22.89 per cent growth in 2008-09 vis-
à-vis an estimated growth of 27.02 per cent in 2006-07.

Slowdown in retail credit to moderate services credit

Figure 6: Services credit

E: Estimate; P: Projected
Source: CRISIL Research and RBI

The services credit portfolio of SCBs consists mainly (45-50 per cent) of retail credit. The rest comprises loans to NBFCs; to
individuals against shares, debentures and bonds; advances against fixed deposits; loans to tourism and tourism-related hotels etc.

Figure 7: Retail credit

E: Estimate; P: Projected
Source: CRISIL Research and RBI

CRISIL Research estimates that the outstanding retail credit portfolio of SCBs will grow at a CAGR of 23.71 per cent during 2005-06
to 2008-09 from Rs 1,278 billion in 2005-06 to Rs 2,419 billion in 2008-09. Retail credit (excluding housing finance) is estimated to
grow at a CAGR of 19 per cent, while housing finance is expected to grow at a CAGR of 32 per cent during the same period.

As per CRISIL Research's estimates, during 2002-03 to 2005-06, the retail credit portfolio of banks grew at a CAGR of 46.36 per
cent. This high growth in the retail credit portfolio of banks was mainly on account of the following factors:
• Focus on disbursements to the household sector for housing loans, CV loans, car and two-wheeler loans by large public
and private sector banks;
• Increasing penetration of banks vis-à-vis NBFCs; and 
• Lower interest rates contributing to growth in demand, increasing tenure of housing, commercial vehicle and car loan
portfolios.

CRISIL Research believes that banks, with their low-cost funds advantage, will continue to dominate the retail finance market.
Agricultural credit growth to continue to remain strong 

Figure 8: Agricultural credit

E: Estimate; P: Projected
Source: CRISIL Research and RBI

Agricultural credit, which forms about 12 per cent of total bank credit, plays an important role in poverty alleviation and creation of
employment by promoting agricultural and agriculture-related businesses.

Apart from direct finance to farmers, agricultural credit also consists of lending to allied farming activities, subscription to bonds
issued by NABARD, loans to co-operative marketing societies, and loans to co-operative banks of producers. Credit to agriculture is
a part of priority-sector lending prescribed for SCBs. Domestic SCBs and foreign banks are required to extend a minimum of 40 per
cent and 32 per cent, respectively, of their net bank credit to the priority sector with sub-targets for lending to various sectors. For
domestic SCBs, the sub-target for lending to agriculture is 18 per cent of net bank credit, while there is no specified target for foreign
banks.

Credit to agriculture has been a major thrust area in recent years. On June 18, 2004, the government announced a comprehensive
policy envisaging the doubling of credit to agriculture in 3 years. Several measures have been initiated as a follow-up to that
announcement.

Credit to agriculture, after displaying some swings until 2001-02, has grown strongly, largely reflecting the renewed policy thrust on
credit to agriculture. During 2002-03 to 2005-06, agricultural credit recorded a CAGR of 32.83 per cent from Rs 735 billion in 2002-
03 to Rs 1,723 billion in 2005-06.

CRISIL Research expects agricultural credit to grow at a CAGR of 29.2 per cent from Rs 1,723 billion in 2005-06 to Rs 3,718 billion
in 2008-09 — a slight dampening as compared with performance in the previous period.

However, banks have restructured their operations — many banks have set up strategic business units to cater to the
demand for farm credit. With several banks, including private sector banks, now focusing aggressively on this segment, we expect
agricultural credit to be one of the key growth drivers of non-food credit, going forward.

Food credit to grow at a CAGR of 5.2 per cent during 2005-06 to 2008-09

Figure 9: Food credit

E: Estimate; P: Projected
Source: CRISIL Research and RBI

Food credit mainly consists of bank credit to the Food Corporation of India (FCI) for procuring foodgrain from the market at the
minimum support price (MSP) for distribution through the public distribution systems (PDS).

In 2006-07, it is estimated that food credit grew by 14.33 per cent due to greater procurement operations by the FCI. In 2007-08,
CRISIL Research expects food credit to decline by 3 per cent to Rs 451 billion on account of lower procurement operations, coupled
with flat growth in the offtake of foodgrain from the PDS. Post this, in 2008-09, we expect some improvement with food credit
increasing by 5 per cent.

Asset quality
The revival of the capital expenditure drive from 2004-05 has increased the risk of over-capacities in many industries. With the
interest rate re-priced at higher levels, it could exert pressure on the pricing power and profit margins of companies, leading to more
instances of delinquency in the industrial sector, and consequently, a rise in NPA for banks.

Figure 10: NPA classification in SCBs

E: Estimate; P: Projected
Source: CRISIL Research and RBI

Share of standard assets to remain stable

The sharp credit growth in 2005-06 was underpinned by a steady improvement in asset quality. Banks have strengthened credit
management, which has led to an upgradation in existing NPAs. With better credit management, restructuring of loan portfolios and
higher provisions/write-offs, the share of standard assets in total advances has gone up from 91.16 per cent in 2002-03 to 96.65 per
cent in 2006-07. CRISIL Research estimates that the share of standard assets would have grown further to 97.07 per cent in 2006-
07, and this share is expected to remain stable at those levels in the current and next fiscal year. On the other hand, the share of
sub-standard assets is estimated to go up from 0.96 per cent in 2005-06 to 1.35 per cent in 2008-09.

One of the main reasons why we believe that the share of standard assets would have increased in 2005-06 is due to the
upgradation of the Dabhol Power Co to a standard asset from an NPA. Due to this upgradation in status, in 2005-06, the reduction
in gross NPAs is estimated to have been Rs 45 billion.

Net NPAs expected to be around 1.18 per cent in 2008-09

Table 8: NPAs of SCBs 

Basis 2002-03 2003-04 2004-05 2005-06 2006-07 E 2007-08 P 2008-09 P
Gross NPAs Rs billion 688 649 592 519 579 697 831
Net NPAs Rs billion 297 244 218 185 231 296 353
Gross NPAs Per cent 8.84 7.19 5.13 3.35 2.93 2.85 2.79
Net NPAs Per cent 4.01 2.83 1.95 1.22 1.17 1.21 1.18
Provisions for NPAs Rs billion 323 357 345 305 347 401 478
Provision cover Per cent 54.64 60.69 62.01 63.49 60.00 57.50 57.50
E: Estimate; P: Projected
Source: CRISIL Research and RBI

CRISIL Research believes that the main reason for the high credit growth has been the revival of the capital expenditure cycle from
2004-05. This is reflected in the increase in the share of term credit among the advances of all banks as the healthy profitability and
cash accruals of the corporate sector have increasingly been able to finance additional working capital requirements.

This capital expenditure drive has increased the risk of over-capacities in many industries. With the interest rate re-priced at higher
levels, it could put pressure on the pricing power and profit margins of companies, leading to more instances of delinquency in the
industrial sector, and consequently, a rise in NPA for banks. While NPAs as a proportion of advances are likely to fall, in absolute
amounts NPAs are expected to increase.

CRISIL Research estimates that in 2008-09 the gross NPA ratio will come down to 2.79 per cent as against 3.35 per cent in 2005-
06, while the net NPA ratio will drop to 1.18 per cent from 1.22 per cent during the same period.

At the gross level, NPAs — which stood at Rs 519 billion during 2005-06 — are expected to go up to Rs 831 billion
in 2008-09. Net NPAs are estimated to increase to Rs 353 billion from Rs 185 billion in 2005-06.