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Banking Note Final
Banking Note Final
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Vibha Batra vibha@icraindia.com +91-124-4545302 Karthik Srinivasan karthiks@icraindia.com +91-22-30470028 Puneet Maheshwari puneetm@icraindia.com +91-124-4545348
Indian banks, the dominant financial intermediaries in India, have made good progress over the last five years, as is evident from several parameters, including annual credit growth, profitability, and trend in gross non-performing assets (NPAs). While the annual rate of credit growth clocked 23% during the last five years, profitability (average Return on Net Worth) was maintained at around 15% during the same period, and gross NPAs fell from 3.3% as on March 31, 2006 to 2.3% as on March 31, 2011. Good internal capital generation, reasonably active capital markets, and governmental support ensured good capitalisation for most banks during the period under study, with overall capital adequacy touching 14% as on March 31, 2011. At the same time, high levels of public deposit ensured most banks had a comfortable liquidity profile. While banks have benefited from an overall good economic growth over the last decade, implementation of SARFAESI1, setting up of credit information bureaus, internal improvements such as upgrade of technology infrastructure, tightening of the appraisal and monitoring processes, and strengthening of the risk management platform have also contributed to the improvement. Significantly, the improvement in performance has been achieved despite several hurdles appearing on the way, such as temporary slowdown in economic activity (in the second half of 2008-09), a tightening liquidity situation, increases in wages following revision, and changes in regulations by the Reserve Bank of India (RBI), some of which prescribed higher credit provisions or higher capital allocations. Currently, Indian banks face several challenges, such as increase in interest rates on saving deposits, possible deregulation of interest rates on saving deposits, a tighter monetary policy, a large government deficit, increased stress in some sectors (such as, State utilities, airlines, and microfinance), restructured loan accounts, unamortised pension/gratuity liabilities, increasing infrastructure loans, and implementation of Basel III.
June 2011
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The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
June 2011
Background
The Indian financial sector (including banks, non-banking financial companies, or NBFCs, and housing finance companies, or HFCs) Chart 1: Credit Composition of Financial Sector Entities reported a compounded annual growth rate (CAGR) of 19% over the Public Sector last three years and their credit Banks NBFCRetail 65% portfolio stood at close to Rs. 49 5% trillion (around 62% of 2010-11 GDP) SCBs as on March 31, 2011. Banks 86% accounted for nearly 86% of the total NBFC Infrastructure credit, NBFCs for around 10%, and 6% HFCs for around 4%. Within banks, Foreign banks public sector banks (PSBs), on the 4% strength of their country-wide Private banks presence, continued to be the leader, HFCs 16% 4% accounting for around 76% of the total credit portfolio, while within the NBFC sector, large infrastructure financing institutions2 accounted for more than half the total NBFC credit portfolio; NBFCs that are into retail financing took up the rest.
Source: RBI, ICRA Research
While the Indian banking sector features a large number of players competing against each other, the top 10 banks accounted for a significant 57% share of the total credit as on March 31, 2011.
Table 1: Key Players in Indian Banking Sector
Name of Bank
Credit Portfolio as in March 2011 (Rs. billion) 7,567 2,421 2,287 2,164 2,131 2,125 1,600 1,571 1,424 1,297 42,874
NIMs (201011)
Tier I Capital % as in March 2011 7.8% 8.4% 10.0% 13.2% 8.3% 10.9% 12.2% 8.1% 9.4% 6.4% 9.7%
Return on Net Worth (2010-11) 13% 24% 24% 10% 17% 26% 17% 16% 19% 18% 17%
Gross NPA % as in March 2011 3.3% 1.8% 1.4% 4.5% 2.2% 1.5% 1.1% 1.8% 1.1% 2.2% 2.3%
State Bank of India Punjab National Bank Bank of Baroda ICICI Bank Bank of India Canara Bank HDFC Bank IDBI Bank Axis Bank Central Bank of India Total banking sector3
18% 6% 5% 5% 5% 5% 4% 4% 3% 3% 100%
2.9% 3.5% 2.8% 2.3% 2.5% 2.6% 4.2% 1.8% 3.1% 2.7% 2.9%
NIM: net interest margin Source: Annual Reports, Results of banks, ICRA Research
2 3
Such as Power Finance Corporation, Rural Electrification Corporation, and other infrastructure NBFCs The data pertains to SCBs, except for NIMs and Returns on Net Worth, which are for select Public Sector Banks + Private Sector Banks covering more than 90% of the universe
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June 2011
Strong growth in infrastructure credit drives credit growth in 2010-11; pace of deposit growth slows
Total banking credit4 stood at close to Rs. 39 trillion as on March 25, 2011 and reported a strong 21.4% growth in 2010-11, led by credit to the Chart 2: Trend in Growth of Banking Assets
80000 70000 60000 40% 35% 30% 25% 20% 15% 10% 5% 0%
infrastructure sector and to NBFCs. In 2011-12, although the pace of credit growth has been subdued in the first two months (up just 0.2% from March 2011 levels), it is in line with the pattern noticed in the previous years (0.1% in 2010-11 and 0.4% in 200910). According to ICRAs estimates, private banks reported a higher overall credit growth of around 26% in 2010-11 (10% in previous year) as compared with PSBs, which achieved around 22% (20% in previous year).
Historically, the banking sectors credit portfolio has been growing at over 20% per annum over the last several years (except in 2009-10, when the growth rate moderated to 17% mainly because of the decline in ICICI Banks credit portfolio). Over the years, credit growth has outpaced deposits growth; the credit portfolio reported a CAGR of 24% over the last eight years, while deposits achieved a CAGR of 19% and the investment portfolio of 14% over the same period. The higher growth in credit could be achieved because of the slower growth in investments and the increase in capital. In 2010-11, while deposits growth for SCBs slowed down to 17%, credit growth was maintained at 21% with the growth in investments being just 13%. The higher credit growth versus deposits growth led to an increase in the credit deposits ratio (CD ratio) from 72.2% as in March 2010 to 75.7% as in March 2011, although the CD ratio moderated to 74.2% as on May 27, 2011, largely because of the slow credit growth in comparison with deposits during the first two months of 2011-12.
Table 2: Domestic Credit Portfolio Composition of SCBs
Growth (y-o-y)
Agriculture and Allied Activities loans Non-Agri Corporate Loans Commercial Real Estate loans Loans to NBFCs Power Sector Loans Other Infrastructure Loans Other Corporate Loans Retail Loans Housing loans Credit Card Outstanding Vehicle Loans Other Retail Loans Total Non-Food Credit
y-o-y: year-on-year Note: Amounts in Rs. billion Source: RBI, ICRA Research
4,161 921 1,134 1,878 1,920 14,528 3,009 201 638 2,008 30,400
4,603 1,118 1,756 2,692 2,575 17,076 3,461 181 793 2,419 36,674
11% 21% 55% 43% 34% 18% 15% -10% 24% 20% 21%
June 2011
During 2010-11, the infrastructure sector, particularly power, and NBFCs were the key drivers of the credit growth achieved by the banking sector. Credit to the power sector reported a growth of 43%, while other infrastructure credit grew by 34% during 2010-11, against an overall credit growth of 21%. As in March 2011, the infrastructure sector (including power) accounted for 14% of the total credit portfolio of banks. Within the power sector, historically banks have been taking exposure to State power utilities as well as independent power producers (IPPs). Going forward, with many banks approaching the exposure cap on lending to the power sector and given the concerns hovering over the prospects of the sector itself, the pace of growth of credit to this segment could slow down. However, in the short to medium term, the undisbursed sanctions to power projects are likely to provide for a moderate growth. As for bank credit to NBFCs, the same increased by 55% in 2010-11 and accounted for around 5% of the banks total credit portfolio as in March 2011. Moreover, around half of this went to infrastructure related entities, and the rest mainly to NBFCs engaged in retail financing. Most of the NBFCs are focused on secured assets classes, have reported low NPA percentages, and are well-capitalised. As for banks retail lending, this continued to lag overall credit growth during 2010-11. Retail credit grew by 17% in 2010-11 against the overall credit growth of 21%, although the 17% figure marked a significant increase over the 4.1% reported in 2009-10. Credit to commercial real estate also increased in 2010-11, reporting a 21% growth that year as against nil in 2009-10.
Large government borrowings may allow for just 17-18% credit growth in 201112
Since March 2010, the RBI has raised the repo rate by 275 basis points (bps), which in turn has been transmitted by the banking system via increases in the base and prime lending rates, besides deposit rates. Going forward, while the RBIs tight monetary stance may exert a downward pressure on the demand for credit, considering the anticipated GDP growth (around 8%), investments in infrastructure and lower funds flow from the capital markets, credit demand could still remain high. However, banks capacity to meet credit demand could get constrained by the volume of deposits they are able to mobilise and by the large amount of funds they would need to keep aside to fund the government deficit. In case the government deficit is in line with the Budget numbers, the net borrowing of the Government of India (GOI) and the State governments via bonds would reach an estimated Rs. 4.7 trillion in 2011-12 (Rs. 4.1 trillion in 2010-11). As banks fund around 40% of these bonds, they would need to set aside Rs. 1.9 trillion for the purpose. If deposits were to grow by 17%, the balance funds (incremental deposits + internal capital generation + fresh external capital increase in investments in government bonds) would support only 17-18% credit growth. Any higher growth would require intervention from the RBI. Further, in case the government deficit is higher because of lower tax collection and underprovided fuel & food subsidies, the maximum possible credit growth would be still lower. At the same time, a higher-than-expected deposit growth could allow banks expand their credit base.
On asset quality, PSBs report some deterioration while private banks show improvement
The Gross NPA percentage of SCBs did not increase by the extent that the stress in the Indian market during 2008-09 would warrant because of large loan restructuring over last 2-3 years (4-5% of total advances); Gross NPAs declined marginally from 2.4% as in March 2010 to 2.3% as in March 2011. However, higher provisioning led to a reduction in Net NPAs from 1.1% as in March 2010 to 0.9% as in March 2011.
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Indian Banking Sector: Challenges unlikely to derail the progress made Table 3: Trend in Asset Quality Indicators of SCBs
June 2011
SCBs Gross NPAs (%) Net NPAs (%) Fresh NPA Generation Rate (%) Net NPAs/Net Worth (%) PSBs Gross NPA (%) Net NPA (%) Net NPAs/Net Worth (%) Private banks Gross NPAs (%) Net NPAs (%) Net NPAs/Net Worth (%)
FY06 3.3 1.2 2.0 10.1 FY06 3.6 1.3 13.1 FY06 2.1 0.9 6.3
FY07 2.5 1.0 1.7 9.2 FY07 2.7 1.1 12.1 FY07 2.1 0.9 7.8
FY08 2.3 1.0 1.8 7.8 FY08 2.2 1.0 11.2 FY08 2.4 1.1 6.1
FY09 2.3 1.1 2.1 8.6 FY09 2.0 0.9 11.4 FY09 2.9 1.3 7.5
FY10 2.4 1.1 2.2 9.1 FY10 2.2 1.1 13.5 FY10 2.7 1.0 5.3
FY115 2.3 0.9 2.0 10.0 FY11 2.3 1.1 13.4 FY11 2.3 0.6 3.2
Over the last two years, PSBs Gross NPAs rose from 2% to 2.3%, while private banks NPAs declined from 2.9% to 2.3%. The Gross NPA percentage of the PSBs got impacted by slippages from restructured accounts, agri debt relief, and slippages because of automation of asset classification. Better provisioning coverage and a stronger capitalisation profile allowed private banks report better solvency (Net NPA/Net Worth) than PSBs during last few years.
Asset quality related challenges ahead Spill-over from restructuring window not over yet
In 2008-09, the RBI allowed a second time restructuring of corporate advances (excluding commercial real estate advances) and a one-time restructuring of commercial real estate advances. As part of this exercise, banks mostly allowed deferment of principal repayment by eligible borrowers by allowing a moratorium of six to 12 months. From ICRAs discussions with bankers it has emerged that some of the restructured corporate borrowers needed loan restructuring because of genuine liquidity issues, while some others merely took advantage of the scheme and did not necessarily have weak credit profiles. Restructured advances accounted for around 4% of SCBs total advances as on March 31, 2011. For PSBs, restructured advances were higher at 4.5% as in March 2011 because of their higher lending to the corporate sector, while for private banks, such advances were lower at around 1% of their credit portfolio as in March 2011. Some of these restructured accounts have slipped into the NPA category over the last two years (in the range 8-20% for various banks), and with the operating environment deteriorating, slippages from restructured advances could continue into 2011-12 as well.
Estimated by ICRA for public sector banks and private banks; data not available for foreign banks
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June 2011
and commercial loss reduction measures, tariff revisions, etc.) would be critical for improving the financial viability of State utilities and also for reducing the counter-party credit risks of entities serving the power sector.
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June 2011
In the banking system, historically, there has been a positive correlation between growth in deposits base and increase in interest rates; periods with high interest rates have seen relatively high deposits growth, as in a high interest rate regime bank fixed deposits become more attractive than many other instruments. At present, it appears that given the outlook on interest rates, banks may be able to mobilise retail deposits at a higher pace in 2011-12 than in the previous year.
41.00% 39.00%
37.00% 35.00% 33.00% 31.00%
29.00%
27.00% 25.00%
FY 07
FY 08
CASA % for PSBs
FY 09
FY 10
FY 11
In 2010-11, according to ICRAs estimates, the overall deposits of private banks Source: RBI, Annual Reports/Results of banks, ICRA Research increased by 22%, while that of PSBs increased by 18%. Within deposits, low cost deposits (CASA, current and saving accounts) increased by 27% for private sector banks, and by 15% for PSBs. CASA deposits represented 41% of the total deposits for private banks, and for a lower 33% for PSBs. For banks, having significant low cost deposits (CASA) as a proportion of total deposits could help them keep their cost of funds under control even in a scenario of rising interest rates in the system.
High proportion of certificates of deposits could impact NIM and liquidity negatively
ICRAs analysis of the current liquidity situation shows that Indian banks have been raising bulk funds in the form of certificates of deposit (CDs) and high-cost deposits from corporate entities mostly for short tenures. The share of CDs outstanding increased to 8.2% as in March 2011 from 7.2% as in September 2010 and 7.6% as in March 2010, with the total CDs outstanding increasing from Rs. 3.4 trillion to Rs. 4.2 trillion during this period. The high proportion of CDs (instead of retail deposits) could adversely impact the liquidity profile of banks and their NIMs in a scenario of rising interest rates.
13.00% 12.00%
11.00% 10.00% 9.00% 8.00%
7.00% 6.00%
FY 07 FY 08 FY 09 FY 10 FY 11
I capital and Capital to Riskweighted Assets Ratio (CRAR), respectively, although the CRAR and Tier I capital of SCBs declined in 2010-11. The decline is attributable largely to strong credit growth and the fall in the capitalisation level of the countrys largest bank, State Bank of India (SBI).
The capitalisation profile of private banks continues to be better than Tier I capital CRAR that of PSBs, with the private banks CRAR at around 16% and that of PSBs at around 13%, as in March Source: RBI, ICRA Research 2011. However, continuous government support (via capital infusion) to enable PSBs maintain a minimum Tier I capital of 8% is likely to result in these banks being able to maintain a comfortable capitalisation profile over short to medium term.
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June 2011
Unamortised pension/gratuity liability could lower Tier I of PSBs (excluding SBI) by 30-35 bps
In 2010-11, PSBs reopened the pension option for employees who had not opted for pension earlier (including retired employees) and also enhanced the gratuity limits from Rs. 3.5 lakh to Rs. 10 lakh following the amendment to the Payment of Gratuity Act, 1972. The RBI allowed banks to amortise these liabilities over a maximum five years, beginning the financial year ended March 31, 2011, subject to minimum amortisation of 1/5th of the total liability every year. However, with the likely switch to International Financial Reporting Standards (IFRS) from April 1, 2013 (as scheduled for the Indian banking industry), the full unamortised liability would be knocked off from the opening balance of reserves, and consequently, banks may have to absorb the entire liability over the next two to three financial years. For the 24 PSBs6 analysed by ICRA, as on March 31, 2011, the total unamortised pension and gratuity liabilities were around Rs. 203 billion (11% of their net worth). If the unamortised liability is adjusted against the Tier I capital of PSBs as on March 2011, then the Tier I capital declines by 30-35 bps from the 9% level of March 2011. While unamortised liability is moderate for PSBs as a whole, it is relatively high for a few banks (bank-wise unamortised liability as on March 31, 2011 at Annexure 1).
Basel III Norm Common equity (after deductions) Conservation buffer Countercyclical buffer Common equity + Conservation buffer + Countercyclical buffer Tier I (including the buffers) Total capital (including the buffers) 4.50% 2.50% 0-2.5% 7-9.5% 8.5-11% 10.5-13%
Existing RBI Norm 3.6% (9.2%) Nil Nil 3.6% (9.2%) 6% (10%) 9% (14.6%)
Note: Figures within parentheses pertain to aggregated capital adequacy of banks covering over 95% of the total banking assets as on March 31, 2010. Source: Basel committee documents, RBI, Basel II disclosure by various banks
At an aggregate level, Indian banks fare well against the Basel III requirement for capital. However, some may appear inferior on comparison; for instance, nine banks had Tier I capital of less than 8.5% as on March 31, 2011. Considering the stricter deductions from Tier I and the fact that some of the existing perpetual debt (around Rs. 250 billion) would become ineligible for inclusion under Tier I, some banks may need to infuse superior or core capital (equity capital or Tier I). Additional capital may also be required to support a growth rate that exceeds the internal capital generation rate, which is likely.
Excluding SBI
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June 2011
Profitability profile stable; higher operating expenses, credit provisions offset increase in NIMs
The profitability profile of SCBs has remained steady over the years with the ratio of Profit after Tax to Average Total Assets (PAT/ATA) being in the 0.9-1.1% range. In 2010-11, while the profitability of SCBs benefited from the improvement in NIMs, the benefit was partly offset by the increase in their operating expenses and in credit provisioning, with banks rushing to raise the provisioning cover to 70% 7. The rise in operating expenses largely followed the increase in the liability for pension & gratuity expenses 8.
Chart 5: Trend in Profitability of SCBs and PSBs
2.50%
2.00% 1.50% 1.00%
0.50%
0.00%
FY 06
FY 07
FY 08
FY 09
FY 10
FY 11
FY 06
FY 07
FY 08
FY 09
FY 10
FY 11
Net interest income/Average total assets Profit after tax/Average total assets
Net interest income/Average total assets Profit after tax (PAT)/Average total assets
Increase in interest rate on savings deposits could reduce NIM by 5-15 bps
In recent periods, the spread between the savings bank (SB) deposit and term deposit rates has widened significantly. In May 2011, the RBI decided to raise the SB deposit interest rate from 3.5% to 4.0%. At the systemic level, SB deposits are estimated to account for 22-23% of total bank deposits (as of March 31, 2011). The increase in interest rate on SB deposits could raise the cost of deposits by around 13 bps at the systemic level. If banks do not pass on this additional cost to borrowers, their NIMs could be diluted by 10 bps, even as the post-tax impact would be lower at 6-7 bps; therefore, the return on equity could get diluted by less than 1%. The impact would be higher for banks with a large proportion of SB deposits (SBI, Punjab National Bank, ICICI and HDFC Bank) than for those with a smaller share of such deposits (UCO Bank, Oriental Bank of Commerce or OBC). Overall, the impact on NIMs for various banks ranges from 5 to 15 bps, which even if not very significant per se, would add to the pressures on profitability.
Interest rate sensitivity may rise; ability to pass on increase in cost of funds to influence trend in NIMs
As Chart 6 shows, banks have historically reported an increase in NIM in a rising interest rate scenario, although the trend was broken in Chart 6: Quarterly Movement in NIM vs. Interest Rates
10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00%
NIMs (RHS)
SB rate (RHS)
Repo rate
the fourth quarter (Q4) of 2010-11 by a higher rise in the cost of funds versus yield in advances. This positive correlation could be partly explained by the lag effect in term deposit re-pricing and partly by CASA deposits (34% of deposits or 28% of total liabilities), which are not interest rate sensitive; that is, interest rates are not linked to market rates. Going forward, the interest rate sensitivity of banks could increase as the proportion of infrastructure loans
Banks were asked by the RBI to achieve and maintain a provision cover ratio of 70% Operating expenses as percentage of ATA rose in 2010-11 after having been on a declining trend for several years
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June 2011
(which are not as dynamically aligned to variable benchmark rates as loans to other sectors) increases and also if interest rates on SB deposits are deregulated. Overall, a temporary slack in credit growth (as is typically seen in the first half of a financial year) and adjustments in the lending rate to incorporate a higher rate on SB deposits (and such other factors) may lead to a dip in the NIM in the first half of 2011-12, but the margin could recover subsequently, depending on the credit off-take.
Credit provision9 as % average credit Credit provision as % average total assets (ATA)
of of
June 2011
20 18 16 14 12 10 8 6 4 2 0
around 1.4%) over the same period. However, despite lower profitability, the return indicators (Return on Net Worth) of the PSBs remain higher than those of private banks primarily because of higher leveraging. During 2010-11, PSBs reported a Return on Net Worth of around 18%, and private banks of around 14%.
Going forward, a temporary slack in credit growth (typical in the first half) Gearing (times) for PSBs (RHS) Gearing (times) for private banks (RHS) and adjustments in lending rates (to incorporate a higher rate on saving Source: RBI, Annual Report/Results of banks, ICRA Research deposits, etc.) may lead to a dip in the NIM in the first half of 2011-12. Subsequently, the NIM could recover, depending on the credit off-take. Overall, despite the high levels of operating expense, banks are expected to report good core profitability, given their reasonable NIMs and lower credit provisions. At the same time however, depreciation on investments because of rising yields (50-75 bps from the March 31, 2011 levels) could pull down profitability by 5-10 bps.
Return on net worth % for PSBs Return on net worth % for private banks
Summing up
For SCBs, the cost of funds could go up partly because of the increase in the saving bank rate (by 5-15 bps) and partly because of higher incremental costs. A temporary slack in credit growth (as is typically seen in the first half of financial year) and adjustment in the lending rate (to incorporate the higher rate on saving deposits, etc.) may lead to a dip in the NIM in the first half of 2011-12, which could however recover subsequently, depending on the credit off-take. The credit profiles of borrowers could weaken in 2011-12 because of a tight liquidity situation, higher interest rates, and moderation in GDP growth rate. The vulnerability of banks because of their increasing exposure to State power utilities is likely to increase, unless tariffs are revised upwards. However, these may not reflect in the Gross NPA percentage as there may be some regulatory respite. The Gross NPA percentage (for PSBs and private sector banks) may remain in the 2.3-2.7% range, as against 2.3% as on March 31, 2011. However, following regulatory relaxations, incremental credit provisions for 2011-12 could reduce to 0.35-0.45% of Average Total Assets as against 0.6% in 2010-11. An increase in the proportion of infrastructure loans (from the current 14% of domestic credit) and deregulation of saving rates could worsen the asset-liability management (ALM) profile and increase the interest rate sensitivity of banks. Indian banks continue to enjoy a comfortable capitalisation as compared with existing RBI norms with their Tier I capital close to 9%. Thus, apart from SBI, none of the PSBs may need significant Tier I capital in the short term. However, some of the fast-growing small private sector banks may need Tier I capital over short to medium term.
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June 2011
S No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Name of the bank Allahabad bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab National Bank Punjab & Sind Bank State Bank of Hyderabad State Bank of Patiala State Bank of Bikaner & Jaipur State Bank of Mysore State Bank of Travancore Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank Total of 24 PSBs
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