Banking Sector Report

Overview
Evolution of Indian banking sector
1921: Closed market, State-owned Imperial Bank of India was the only bank existing.

1935: RBI was established as the central bank of country. Quasi central banking role of Imperial Bank
came to an end.

1936-55: Imperial Bank expanded its network to 480 branches. In order to increase penetration in
rural areas, Imperial Bank was converted into State Bank of India.

1956-2000: Nationalisation of 14 large commercial banks in 1969 & six more banks in 1980. Entry of
private players such as ICICI intensifying the competition. Gradual technology upgradation in PSU
banks.

2000 onwards: In 2003, Kotak Mahindra Finance Ltd received a banking license from RBI and became
the first NBFC to be converted into a bank. In 2009, the Government removed the Banking Cash
Transaction Tax which was introduced in 2005.

2020 onwards: As per Union Budget 2021-22, the government will disinvest IDBI Bank and privatise
two public sector banks. According to the RBI, India’s foreign exchange reserves reached US$ 601.36
billion as of June 3, 2022. National Asset reconstruction company (NARCL) will take over, 15 Non
performing loans (NPLs) worth Rs. 50,000 crores (US$ 6.70 billion) from the banks

Structure

Reserve Bank of India

Banks Financial Institutions

Scheduled Commercial Cooperative credit All India Financial Institution

Banks Institutions State-level Institutions
Other institutions
Public Sector Banks

Private Sector Banks

Foreign Banks

Regional Rural Banks

Urban Cooperative Bank

Rural Cooperative Bank

Key Banking Statistics

Total Banking Sector Assets

In FY18-FY21, bank assets across sectors increased. Total assets across the banking sector (including
public and private sector banks) increased to US$ 2.48 trillion in FY21.

In FY21, total assets in the public and private banking sectors were US$ 1,602.65 billion and US$
878.56 billion, respectively.

In FY21, assets of public sector banks accounted for 64.59% of the total banking assets (including
public, private sector and foreign banks).

Interest Income Growth

Public sector banks accounted for over 61.0% interest income in FY21.

Interest income of public banks reached US$ 96.60 billion in FY21.

In FY21, interest income in the private banking sector reached US$ 61.70 billion.

Other Income growth

In FY21, public sector banks accounted for about 57.0% of other income.

‘Other income’ for public sector banks stood at US$ 17.05 billion in FY21.

In FY21, ‘other income’ in the private banking sector was US$ 12.87 billion.

Trends in Investments

The credit deposit ratio stood at 70.64% as of January 2022.

Under Reserve Bank of India rules, banks must set aside 3% of deposits as cash reserve ratio (CRR)
and another 18% in statutory liquidity ratio (SLR) compliant holdings.

Growth Drivers and Opportunities

Banking sector accounts for 20-25% of the global economy in terms of market share. While banking
sector in India account for 7.7% of GDP. Banking sector employees about 10 lac personals in the
country.

Porters 5 Forces:
Competitive rivalry in the market- There is high competitive rivalry in the in the Indian financial
sector market. The country’s business and economic structures are growing at an annual growth rate
of 3.57 percent. As an outcome of this development, in order to provide financial services to
consumers, many banks and investors have flooded the business, bringing in intense competition
among major companies.

Threat of New Substitutes-The threat of is considered to be low as financial institutions continuously

have evolved, but their form and structure have been expanding and shifting over the generations.
Digitalization of products and services in the current era has adjusted the nature of financial dealing
and interaction between the consumers and the industry as a mode of alternative finance.
Moreover, as the use of modern options and advancement work can be able to distinguish
companies in exchange for the services they offer, but it is not substitutes a replacement.

Threat of New Entrant-The threat of new entrants in the financial industry, specifically the banking
sector, is low because barriers to entry into the banking sector make it very hard for stakeholders to
build a business in the market. When entering the market, various factors such as established rivalry
by existing companies and the confidence they have in the minds of the customer base are difficult
to overcome.

Bargaining Power of Buyers- Owing to the standardized primary product offerings from various
banks, consumers in the banking industry have a lot of negotiating power. The cost of using banking
products and services, as well as the features available, are not radically different. Consumers at any
time can ask for better services in return and can avail of a range of options available in the industry
as the money being used belongs to them.

Bargaining Power of Suppliers- The Bargaining power of suppliers is moderate in terms of the
offerings of specialized and limited products and services. Moreover, in terms of capital availability
financial industry depend on o sources like availability of loans, investments, and other instruments
that confirm the supply of money in the industry. Supplier transaction costs and market
segmentation factors can affect the position of suppliers in the environment of enterprises when it
comes to bargaining.

Drivers

 Rise in per capita income will lead to increase in the fraction of the Indian population that
uses banking services. Population in 15-64 age group is expected to grow strongly going
ahead, giving further push to the number of customers in the banking sector.
  Gross Value Added by agriculture, forestry and fishing is at Rs. 36.16 trillion (US$ 482.82
billion) in FY21. Rising incomes are expected to enhance the need for banking services in
rural areas, and therefore, drive growth of the sector. Programmes like MNREGA have
helped in increasing rural income, which was further aided by the recent Jan Dhan Yojan

 Rapid urbanisation, decreasing household size & easier availability of home loans has been
driving demand for housing. Credit to housing sector increased at a CAGR of 13.4% from
FY16 to FY20, wherein, value of credit to housing sector increased from to US$ 114.10 billion
in FY16 to US$ 188.68 billion in FY20

 Growth in disposable income has been encouraging households to raise their standard of
living and boost demand for personal credit. Credit under the personal finance segment
(excluding housing) rose at a CAGR of 15.46% from FY16 to FY19 and stood at US$ 151.75
billion in FY19.

Government Initiatives and schemes

Pradhan Mantri Suraksha Bima Yojana- This scheme is mainly for accidental death insurance cover
for up to Rs. 2 lakh (US$ 2,983.29). • Premium: Rs. 12 (US$ 0.18) per annum. • Risk Coverage: For
accidental death and full disability - Rs. 2 lakh (US$ 2,983.29) and for partial disability - Rs. 1 lakh
(US$ 1,491.65).

Pradhan Mantri Jeevan Jyoti Bima Yojana-This scheme aims to provide life insurance cover. •
Premium: Rs. 330 (US$ 4.92) per annum. It will be auto-debited in one instalment. • Risk Coverage:
Rs. 2 lakh (US$ 2,983.29) in case of death for any reason.
Atal Pension Yojana-Under the scheme, subscribers would receive fixed pension up to Rs. 5,000 (US$
74.58) at the age of 60 years (depending on their contributions)

Capital Infusion Scheme- Government has smoothly carried out consolidation, reducing the number
of public sector banks by eight. The Finance Ministry announced its plan to infuse Rs. 14,500 crore
(US$ ) as capital infusion in public sector banks to help maintain regulatory requirements and
financial growth.

Pradhan Mantri Jan Dhan Yojana-Under the scheme, each & every citizen will be enrolled in a bank
for opening a Zero balance account. Each person getting into this scheme will get Rs. 30,000 (US$
447.49) life cover while opening the account. Overdraft limit under such account is Rs. 5,000 (US$
74.58).

Strategies Adopted

Increased use of technology- As per Union Budget 2019-20, the Government proposed a fully
automated GST refund module and an electronic invoice system to eliminate the need for a separate
e-way bill.

Cross-selling- Major banks tend to increase income by cross-selling products to their existing
customers. Foreign banks have been able to grow business despite a much lower customer
coverage.

Capture latent demand- Expansion in unbanked rural regions helps banks to garner deposits.
Increasing tele-density and support of regulators have aided rural expansion.

Privatising Public Sector Banks (PSU)- As per the Union Budget 2021-22, government will disinvest
IDBI bank and privatise two public sector banks.

Merger Execution- In March 2020, the Government of India merged ten public sector banks into four
banks to drive credit growth, lift the slowing economy and boost the government’s target of a US $5-
trillion economy by 2025.

Overseas expansion- Although at a nascent stage, private & public banks are gradually expanding
operations overseas. Internationally, banks target India-based customers and investors settled
abroad.

Private vs PSU Banks

Public sector banks are banks, whose maximum shareholding is
with the government. On the other hand, private sector banks
are those whose maximum shareholding is with individuals and

institutions. At present, there are 27 public sector banks in India,

whereas there are 22 private sector banks and 4 local area
private banks.

Public sector banks dominate the Indian banking industry with a

total market share of about 73%, followed by private sector
banks with a market share of about 20%. Public sector banks
have been established for a long time, while private sector banks
have emerged in the last few decades and so the customer base
of public sector banks is greater than the private ones.

Transparency, in terms of rate of interest policies, is often seen

within the public sector. The rate of interest on deposits offered
by the public sector banks to its customers is slightly above the
private sector banks.

When it involves the promotion of employees, public sector

banks consider seniority as a base. Conversely, merit is the basis
of private sector banks to market employees. If we talk about
growth opportunities in a public sector bank, it is quite slow in
comparison to a private sector bank.

Job security is always present in a public sector bank but a

private sector bank job is secure only when the performance is
good because performance is everything in the private sector.
Along with job security, another pro of a public sector bank is the
after-retirement fund, which is pension. On the contrary, pension
schemes are not provided by private sector banks to their
employees. However, there are other retirement benefits like
gratuity offered by the bank.
 Exhibit 10: Market Share within the Banking Sector
5.4% 5.3% 5.4% 5.3% 5.2% 4.9% 4.8% 5.1% 5.2% 5.1%
100.0%
80.0%

35.9%

35.3%
36.0%

35.4%

35.7%
36.5%
36.6%
37.7%

37.5%
38.1%

60.0%
40.0%

59.6%
59.2%

59.4%

59.1%
59.1%
58.3%
58.1%
57.1%
56.9%
56.6%

20.0%
0.0%
Q4FY22 Q3FY22 Q2FY22 Q1FY22 Q4FY21 Q3FY21 Q2FY21 Q1FY21 Q4FY20 Q3FY20
PSU PVT Others

Banking Pre-covid and Post Covid

The COVID-19 pandemic has dramatically changed the way people bank and the sector has changed
drastically in a short span of time.

More day-to-day banking transactions will be completed via digital channels.

The transition towards digital was inevitable for routine activities—checking balances, making
payments and transfers, paying bills, even completing credit-card applications. Many of these
activities are habits, and once habits are embedded, they are unlikely to change. COVID-19 has
accelerated this trend, more people will bank this way—routine activities will stay digital.

Customers will still go to branches and turn to people for important life moments.

Even as the pandemic fades, people will still have a psychological need for human interaction at
important life moments. People need to feel reassured when it comes to life events, such as sending
a child overseas for education, managing generational wealth transfers, establishing a wealth plan,
coping with bereavement or buying a home. This means we can expect to see some return to
“normal” post-COVID-19—and touching base with bank branches will continue to make up a
significant proportion of this type of activity. People will value the convenience of a nearby branch
compared with a scheduled video call for different reasons, but the ubiquitous use of Zoom Video
Communications is likely to accelerate the frequency of virtual “face to face”.

Bank branches will become more like service lounges.

The way branches look and feel will change. Branches will become less about rows of tellers
managing daily transactions, which can now be completed online, and more like service lounges.
Agents will be on hand to guide customers through transactions on their own devices, and physical
space will be broken up into more casual seating areas for deeper private conversations. Changing
the layout of branches in this way will also support any ongoing social distancing.

Regulatory collaboration on digitisation will accelerate.

The pandemic enabled regulators and banks to work together to rapidly help customers to keep
banking during the early days of the outbreak—examples of which include collaboration to increase
the availability of video banking services in some markets. We predict that this cooperation will
accelerate further as increased digitisation persists and evolves into new areas, such as artificial
intelligence (AI) and machine learning (ML).

Established banks will become more like challenger banks beyond their home markets, and
partnerships will accelerate.

Increased digitisation for customers will also drive increasing partnerships between banks and
platforms, such as online retailers and social media, so that they can bank where they spend or
socialise. Separately, we’re seeing new digital entrants into retail-banking markets around the world,
but we also predict that as digital platforms become more scalable, established international banks
will begin to challenge them with digitally centric offerings, both inside and outside their home
markets. The benefit of both changes for consumers will be clear: more choice. For the established
banks, it’s an opportunity to compete in new markets, segments and marketplaces.

RBI Policies and Stance

Reserve Bank of India maintains a stance of withdrawal of accommodative monetary policies with
tightening of liquidity in the economy. Prioritising inflation over growth, the RBI hiked repo rate, the
rate at which the RBI lends short-term funds to banks, to 5.40 per cent from 4.90 per cent earlier.
Analysts said the market was largely expecting 35-50 basis points rate hike. With this, the RBI has
effectively raised rates by 180 basis points since April.
MPC committee expect that India’s inflation peak is behind us, and while we cannot fully rule out the
possibility of a sub-7 per cent print again in Q2, we see a deceleration toward 5.3 per cent in
Q4FY23. That said, the uneven risks of geopolitics and the impending pass-through of high input
costs prevail. Note that we have not been in the aggressive rate hike camp for India and have argued
for a judicious policy mix. We see the terminal rate not crossing 5.75 per cent.
The Standing Deposit Facility rate and the Marginal Standing Facility Rate are adjusted higher to 5.15
per cent and 5.65 per cent, respectively.
The Governor said the MPC has been emboldened to go for this 50 bp hike since the economic
activity is resilient and 'withdrawal of accommodation stance is necessary to anchor inflation
expectations "The RBI governor went so far as to say that " the Indian economy is holding steady in
an ocean of turbulence. The capacity utilization in industry at 75 per cent is higher than the long-
term average.

The Increase in interest rate augurs well for large banks, where most loans are linked with MCLR and
will get reprised as the interest rate increase. While, they also have a strong CASA ratio maintaining
the cost of capital in control.

But the there can be a temporary headwind of MTM losses, for the bond portfolio they holds.

Basal III Committee findings impact on Indian Banking sector

The Basel committee comprises of the representative and the regulatory authorities from the central
banks from all the G-20 countries.

The Basel III committee norms are more stringent and have a tighter regulation. Basel III is
fundamentally different from Basel I and Basel II from two perspectives which are as follows:
• Basel III is more comprehensive in nature
• Basel III considers both micro-prudential elements to address the institution level and system wide
risk.
Thus we can expect to have a safer financial system with reduced probability of banking crisis as the
long term impact of Basel III.
Since the norms of Basel III are more stringent, implementing Basel III would be a challenge for the
entire banking sector. The immediate impact of Basel III would be as follows.
• Banks would in requirement of capital to meet the new capital adequacy norms. Stricter capital
definition of Basel III will again lower down the bank's total available capital.
• Banks having more exposure in trading position, securitization portfolio, derivatives, repo-style
transaction are expected to suffer more.
• Banks might reduce their dividend as they need to rebuild their capital bases, which can have a
negative impact on the investors. Banks might find it difficult to attract investors.
• Banks under Basel III would need to maintain higher amount of capital which will mainly comprise
of common equity as per the new definition of regulatory capital under Basel III. This would bring
down the Return-on-Equity (RoE) for the banks. The fall in return on equity will drive down the
investor's appetite towards banking sector capital issuance.
• Higher capital requirement will adversely impact the Net Interest Margin (NIM) and the Net
profitability of the bank.
• Major challenge which the Indian public sector banks are likely to face during implementation of
Basel III is to maintain the level of Capital and Leverage ratios as well as maintain a decent growth
without getting into risky business.
• On comparing the private sector banks and public sector banks we can infer that private sector banks
are in a better position for Basel III implementation as the private banks have much higher capital
adequacy ratio and a better asset quality than that of public sector banks.
• As the capital requirement of the banks increases, this in turn would increase the weighted average
cost of capital. Thus banks might increase the lending rates. Banks might pass their rise in funding
cost to customers by increasing the lending spread.

Basel III norms are framed keeping in mind the lessons learnt from the financial crisis of 2007-2008.
RBI norms of Basel III being more conservative, we can expect to have a safer financial system in the
future given the fact that Basel III is implemented properly. If we study the added features of Basel III
we can find immense long term benefits, but the matter of concern lies in the fact that short and
medium term cost of Basel III implementation is very high. The impact of Basel III on individual
banks is dependent entirely on their existing capital structure and asset quality. In order to minimize
the negative impact of Basel III and reduce the implementation cost banks need to banks need to
strategize their action on the basis of their priorities which could be the following.
• Optimization of Risk Weighted Assets.
• Having stricter credit approval policy
• Improving liquidity risk management through stress testing and scenario analysis.
• Adjusting the lending rates.
• Investing in less risky segments and having less exposure in securitised transaction.
Thus on the concluding note we can infer that even though there are many challenges of Basel III
implementation through proper planning there could be a smooth transition to Basel III. Again the
phase in period of Basel III implementation of Basel III in India is from 2013 to 2018, which is quite
sufficient for the Indian Banks.

Key Ratio’s

Banks Capital CASA Ratio PB Ratio ROA NIM (%)

Adequacy
Ratio
HDFC Bank 18.8% 48.16% 3.4 1.78 3.48
ICICI Bank 19.51 46.28% 2.84 1.55 3.25
Kotak Mahindra 23.4% 60.68% 4.84 1.99 3.91
Bank
Axis Bank 19.31% 51.41% 2.11 0.61 3
IndusInd Bank 16.34% 42.78% 1.53 1.14 3.73
Yes Bank 19.6% 31.11% 0.91 0.33 2.03
PNB 13.88% 46.45% 0.43 0.28 2.19
Bank of India 12.51% 40.08% 0.39 0.46 1.91
Canara Bank 13.69% 33.92% 0.67 0.48 2.19

Credit Card Market

India has traditionally been a debit card market. However, the growth in credit card issuance in the
last decade has changed this narrative and credit cards are being used prominently. This growth is
further accelerated by the various products and services being offered by FIs, and such products are
being increasingly used by customers, especially the millennial population.

Credit card issuance has grown significantly in India at a compound annual growth rate (CAGR) of
20% in the last four years. The number of credit cardholders increased from 29 million in March
2017 to 62 million1 in March 2021. It has further grown by 26% and 23% respectively in 2019 and
2020. However, the COVID-19 pandemic affected the growth rate of India’s credit card industry and
it grew by only 7% in 2020–21. The growth rate is expected to improve marginally in FY21–22 but
will remain slow due to the restrictions on card issuance by some large banks and payments
networks.

A total of 31 card issuers in India have issued approximately 62 million cards till now. Out of the 31
issuers, the top six have a market share of around 81% while the rest account for the remaining 19%,
as per RBI data released in March 2021.
Income from interest accounts for the highest of the total revenue earned by card issuers.
Approximately 40–50% of the card revenue comes from interest income which is paid by
approximately 15–20% of the revolving customers. The issuer charges interest ranging between 18–
42% from customers depending on the product that they are using.
Interchange income is earned from the fee charged by the issuer to process every credit card
transaction. Interchange income is paid by the acquirer to the issuer from the MDR earned by the
acquirer by charging the merchant for every transaction. Typically, the issuer charges around 1.2–2%
as interchange fee for different card and customer segments. This contributes to around 20–25% of
the overall revenue earned by the card issuer.

The remaining revenue is earned by the issuer through various fees and charges like joining/ annual
fee, over-limit fee, late payment fee, cash advance fee, cheque/NACH bounce fee, EMI conversion
fee and foreclosure. The issuer also earns revenue from interest levied on various transactions,
balance conversion, loan above allocated/within limits, etc.

The credit card market in India is still under- penetrated. It was only 3% of the total population
above 15+ years as per World Bank. This has grown to currently be around 5–6%, which is still very
under-penetrated compared to other countries like the United States (66%), United Kingdom (65%)
and Brazil (30%). And is expected is grow at a fast pace going ahead.
HDFC and HDFC Bank Merger

The Board of HDFC announced on Monday (4/4/22) its amalgamation with HDFC Bank LTD. HDFC
LTD will cease to exist after the merger and the merged entity will be HDFC BANK. The subsidiaries of
HDFC LTD will also become subsidiaries of HDFC BANK.

Swap ratio in merged entity will be 42:25. That is for every 25 shares in HDFC LTD Shareholders will
receive 42 shares of HDFC BANK.

Post the merger HDFC Bank will be 100% owned by public shareholders as 41 percent of the equity
of HDFC BANK will be held by shareholders of HDFC LTD.

Merger is expected to be completed within 18 months, subject to completion of formalities and

completion of conditions.

Possibilities

The merger will reduce HDFC BANK’s vulnerability towards unsecured loans as it will enhance the
proportion of loans towards the housing loan portfolios which are secured by mortgage of assets.

Merged entity will enjoy superior capital efficiency as housing loans are less risky than retail loans,
reducing the bank's nonperforming assets.

HDFC LTD has a humongous 77 lakh customers and 21 lakh depositors, and HDFC Bank has a 6.8
crore customer base. This merger will bolster the customer base of HDFC group and will enable it to
cross-sell its products or services to customers or depositors of each other.

One of the priority sector lending areas is lending towards affordable housing schemes. The merger
will help HDFC Bank in meeting the requirement of priority sector lending.

HDFC bank CASA ratio is 48 percent depicting a higher share (48 percent) of deposits in current and
savings accounts. Due to the merger, HDFC Bank will be able to utilize its cheaper funds and make
them available to HDFC LTD customers and offer better housing products at cheaper interest rates
thereby acquiring market share from its peers.

HDFC Bank is expected to reap stupendous benefits from the merger as its loans are expected to
increase by 42 percent and it will expand its market share from the current 11 percent to 15 percent.
Further, its earnings per share are expected to increase by 200 basis points and its return on equity
is anticipated to also increase by 200 basis points.

Hurdles
The main Hurdle to go ahead with the merger will be that of Regulatory approval from RBI. Apart for
this, the combined entity must meet several regulatory criteria proposed by the regulator.

Another important challenge is that, the shareholders of HDFC Bank has to undergo a very high
dilution of the ownership. Moreover, the financial metrics of the combined entity will be below par
with that HDFC bank at least for the near term.

Wealth Creation by Banks

HDFC Bank

One of the Biggest wealth creators in the Indian stock market history over the years is HDFC Bank.

It is incorporated in 1994 as a subsidiary of HDFC in Mumbai, Maharashtra. The firm has generated
more than 1000% return. The main reason for the same is the superior financial management of
HDFC Bank. It’s promoter Deepak Parikh has established, a popular brand name in form of HDFC
bank based on the quality of services they provide. The main factors which contribute towards such
tremendous growth over the years include innovative methods like setting up superior settlement
mechanism in Indian stock market and forming a platform for co-operative banks to do transaction
with ease.

Kotak Mahindra Bank

In Feb 2003, Kotak Mahindra bank received a banking licence from RBI. With this, it became the
first non-banking finance company in India to be converted into a bank. Kotak Mahindra Finance was
then renamed as Kotak Mahindra Bank. It was promoted by Uday Kotak. The bank developed a
strong investment banking and financing business with superior operating performance. Over the
years the bank focused on HNI clients and is catering to a dominant chuck of HNI clients. This
enabled the bank to have superior credit quality and Net interest margin when compared to its
counterparts. Also, they have the highest capital adequacy ratio in the industry.

These factors enabled Kotak Mahindra bank to generate superior return to its shareholders and has
been a consistent compounder ever since.

Conclusion
Banking sector in Indian has given a positive and encouraging responses to the financial sector
reforms. Entry of new private banks and shaken up public sector banks to competition. The financial
sector reforms have brought India financial system closer to global standards. With the India
increasingly getting integrated with the global financial world, the Indian banking sector has a still
long way to go to catch up with their counter parts.