Indian Banking System

INDIAN BANKING SYSTEM

Submitted To:- Submitted By:-

Mr. Nitin Kumar Jain Pujil Khanna Pankaj Tiwari Avinash Jeswani

Robin Choudhary

PHASE I:-The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.

PHASE II:- Nationalisation of Imperial Bank of India with extensive banking facilities on a large scale specially in rural and semi-urban areas.

It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country.Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. 14 major commercial banks in the country was nationalised.

PHASE III:- This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimhama, a committee was set up by his name which worked for the liberalisation of banking practices.

“ Bank is an institution which trades in money, an establishment for the deposits, custody and issue of money, as also for making loans and discounts and facilitating the transmission of remittances from one place to another”.

Savings Bank : Running account for saving with restriction in number of withdrawal

Current Account: Running account without restriction on number of withdrawals

Term Deposit : Deposit of an amount for a fixed period where interest is paid monthly/Quarterly.

Special Term Deposit : Deposit of an amount for a fixed period where interest is compounded (Capitalized) and paid on maturity.

Recurring Deposit : Regular (Monthly) deposit of a fixed amount for a fixed period

A Decade of change and evolution…

Pre-reform

Extensive regulation

Focus on industrial sector

The 1990s Today

Indian economy

Financial sector

..financial sector mirroring macro-economic change

Liberalisation

Globalisation Structural

change – services

Resilient industry

Buoyant services sector

Highly segmented

Public sector dominance

Opening up of various sub-sectors

Private sector participation

Diversified financial groups

Globally benchmarked

PRE-GLOBALIZED SCENARIO OF SERVICE CULTURE IN THE INDIAN BANKS

SERVICE CULTUREWAS EXTREMELY

DEMOTIVATED & NON INTERESTED EMPLOYER& EMPLOYEE.

NON COMPETETIVE ATTITUDE.

PRODUCT FOCUSED & NOT CUSTOMERSERVICE FOCUSED.

CUSTOMER UNFRIENDLY

FORMALIZED

6

The Banking Sector Today

Depth

Countrywide coverage Large number of players Increasingly

sophisticated financial markets

Technology

Increasing use of technology in operations

Poised to expand and deepen technology usage

Diversification

Emergence of integrated players

Diversifying capital deployment

Leveraging synergies

Regulation

Robust regulatory system aligned to international standards

Efficient monetary management

7

Sector Snapshot

Size Total assets of US$ 335 billion Total deposits of US$ 279 billion

Total assets of US$ 335 billion Total deposits of US$ 279 billion

Number of banks

Over 290 scheduled banks Public sector: 27 Private sector: new – 9; old – 24 Foreign: 37 Over 190 regional rural banks

Over 290 scheduled banks Public sector: 27 Private sector: new – 9; old – 24 Foreign: 37 Over 190 regional rural banks

Branch network

Over 66,000 branches Public sector: 46,000 Private sector: 5,500 Foreign: 190 Regional rural: 14,400

Over 66,000 branches Public sector: 46,000 Private sector: 5,500 Foreign: 190 Regional rural: 14,400

8

A New orientation among banks…

Sell products Product research: what

will sell? Product sales and

profitability targets Product specialist

groups Introduce new

offerings every few years/months

“Branch banking” Focus - customer

acquisition

Meet customers’ needs Customer research:

what does the customer want?

Customer segment sales and profitability targets

Customer owners Customer specific new

offerings every week/day

Customer convenience Deepen relationships

Traditional/ public sector New/ private sector

Mobile &

Internet banking

ATM N

etwor

k

Good Waiting room

Promotional

discountsLow

interest rates

Intro. Of new

schemes

Change inProduct line

Consulta

ncy

servi

ce

Financial service

Flower of banking service

Technological Innovations in Banking sector.

Data Mining.

Tie up Arrangements

Plastic money.

Virtual banking-

don’t visit the branch

ATM

Insurance Product

Marketing Agents for Distribution of Products

Mobile Banking

Phone Banking

Innovation In Banking Product.

Core Product Basic Product Expected Product Augmented Product

Potential Product

The basic necessity to use banking services in order to handle finance more efficiently

Safety of depositsLoanable funds etc.

Timely serviceLong banking hours.Low interestRate.

Good waiting roomsfriendly employeesWelcome note.

Occasional greeting at home

Surprise gifts.

Additional Banking Services

Merchant Banking

Loan Syndication.

Mutual Fund

Factoring.

Forfeiting.

Venture Capital.

Major drivers for Banking Sector, world wide

Key Banking Key Banking Technology AspectsTechnology Aspects

Cost• Cutting Cost through Integration• Better Information Management

Risk Management Complexities•Easier Risk Identification•Easier to Assess Risks

Customer• Reaching Customers Faster• Managing Diverse Needs

Competition• Competitive Edge in

its Strategic Group

“The winners will be those institutions that tie their technology to their strategies in order to meet their challenges.”

Performance & Evaluation• Better Metrics to Benchmark

Against• Objective Evaluation Process

Technology- leads the Winning Combination

Importance of Core Banking Solution

Benefits of CBS

Faster Response to Customer Demands

Allows Faster New Product Developments

CBS Architecture Allows for Existing Products to be Quickly Customized

Online Validation of Data – at the Time of Entry

Independent from the Organization Structure and Supports the four Primary Entities – Customer, Account, Product and Business Organization

Runs in Real Time Update Mode

History:- Become operational on April 1,1935Nationalized in the year 1949

Major objectives:-Regulate the issue of banknoteMaintain reserve with a view to securing monetary stabilityTo operate the credit and currency system of the country to its advantageFunctions of RBIThe function are classified into three heads;-1.Traditional functions2.Promotional functions3.Supervisory functionsHow it controls banks & economy :-Tools-(as on 28th nov,2009)CRR- 5.00%REPO RATE- 4.75%REVERSE REPO RATE- 3.25%STATUTORY LIQUIDITY RATIO(SLR)- 25%BANK RATE- 6.00%

Government equity in banks has been reduced and strong banks have been allowed to access the capital market raising additional capital.

Bank now enjoying the operational freedom in terms of opening of new branches and bank having good track record of profitability given flexibility in recruitment.

New private sector banks have been set up and foreign banks are allowed to expand their function in India including through subsidiaries.

Banks are also allowed to set up off shore banking units in SEZ.

New instrument have been introduced for better flexibility and better risk management like interest rate exchange, cross currency forward contract.

Private Sector Banks

Investment rationale • Private sector banks are better capitalized compared to PSU Banks in

case of rising NPLs• More seasoned loan book resulting in less incremental NPLs• NIM are stable as the PLR cut is not much compared to PSU banks• Pvt Sector banks to improve margins due to steep decline in deposit cost

(decline in wholesale deposit cost by 400-500 bps point)• Top 3 pvt banks has a significant portion of their revenue coming from

capital market linked business. While the capital markets are expected do well in the near future it bodes well for the private sector banks

• Majority of the top private banks (except AXIS bank) are in a process to consolidate their balance sheet, to restructure their balance sheet, reduced NPLs, restructured loans and slippages which is good in the long term

• Increased thrust on the CASA deposit i.e., primarily focusing on the low cost deposit

• Private banks have been historically innovative and technologically superior

• Best Picks: Axis Bank, HDFC Bank, Yes Bank, Jammu and Kashmir Bank

Private Sector Banks

Things to watch for:

• Private sector banks have been conservative in last few quarters, restructuring there balance sheet which will have a negative impact on the NIMs, profitability, ROE in the coming quarters

• Private sector banks have relied heavily on capital market linked activity, approximately 30-40% of their revenue and net worth is relied on third party distribution products. Any downfall in the capital market will have a significant impact on the bottom line of the company

• Private sector banks trades at a lower ROE (13-14%) compared to public sector banks (17-18%)

• Cost of funding at 6.5% is higher in comparison to Public sector banks (6%)

• Private sector banks might need to account for MTM losses, provisions etc due to its presence in uncertain international markets

Public Sector Banks

Investment Rationale

• Despite higher ROE, PSU banks are trading at a lower P/BV• Strong operating performance and profitability• Strong Earnings growth• Improving Quality of earnings• No MTM losses• Banks have significant franchise value• Improving quality of earnings• PSU banks have been more aggressive in lending which will help it

to increase its profitability, NIMs, ROE• Increased focus on low cost deposit by rapidly increasing the

branches leading to a decline in the funding cost• Improved focus on non-banking revenues (Asset Management,

Private Equity, IB etc), leveraging on its existing branch network• Best Picks: BOB, Corporation Bank

Public Sector Banks

Things to watch for:

• PSU Banks are likely to face more margin pressure compared to private sector banks:

– Lending rates have been cut much more then private sector banks– Lending in a weak corporate environment– High cost deposit mobilized during the second half of 2009– Excess investment in government securities and parking of excess funds with

RBI carry's a negative yield on investment portfolio• PSU banks are more likely to be persuaded by Government to reduce the lending

rates• Operating expenses for the PSU banks are likely to go up due to higher wage

increase and transfer from PF to pensions• Restructuring has been high in PSU banks resulting in a increase in NPLs• Cautious on fundamentals due to slowing loan growth, declining margins (NIMs)

and rising credit costs• Employee productivity and profit per branch have always been a concern in

compare to private sector banks• Traditionally, PSU banks have been laggard in technology• Asset quality will be a concern in a long run due to aggressive lending in a weak

corporate environment• Yield on advances at 9.5% is lower compared to private banks (11%)

Public Sector v/s Private sector Banks

C/DInv/DepAsset/EquityCost of DepYield on DepYield on InvNIMNII/Total IncRoERoA

73%33%17.36.07.49.52.4

67.117.21.0

77%77%41%41%10.310.36.56.57.37.311112.72.7

57.357.313.413.41.01.0

Pvt Banks Public Banks

Future Outlook

• Strong re-bound in the economic activity should drive a significant loan growth in the second half of the fiscal

• Historically, loan growth to real GDP multiplier has been 3.3x in the past 25 years. Based on the GDP projection of 6%+, I except loan growth at 20%+ for the entire fiscal

• Decline in the cost of funding as the high cost term deposit mobilized in Q3 and Q4 of FY09 is likely to mature in the coming quarters

• The deposit rate is unlikely to fall below 7.5% in the recent time as the small saving scheme offers 8% interest rate. A fall below 7.5% interest rates is unlikely as it will disturb banking system

• Interest rates are likely to go up in Q4FY10 due to high fiscal deficit and monsoon failure

• Increase in the interest rates has a inverse relationship with the banking stock

• Bond yields are expected to harden up in the coming quarters due to high government borrowings which will lead to a increase in MTM provisions in the bank portfolio, having an negative impact on the bottom line

Future Outlook…Cont

• PSU banks to remain under pressure as they can be pressurized by the government to lower their lending rates

• Gross NPLs and restructured loans are likely to stable or go down as they are most likely to get peaked in 2Q2010 and due to lower provisions on account of improving loan growth and economic activity

• Non Interest revenue is likely to be the flavor of the time in the near future. Improved economic and capital market activity should drive a rebound in non-interest revenue

• CASA ratio is likely to improve due to narrowing of the differences between term deposits and saving deposits. Also, managements across the board have placed more emphasis on low cost deposit

• PSU banks are expected to get more aggressive in loan growth to spurt growth in the economy and private banks are more likely to consolidate their balance sheet in the near term

• Trading income is likely to come down due to hardening of bold yields• NIM is likely to go up in the second half of the fiscal due to decline in

the funding cost, increase in credit off take, strong domestic demand

Important numbers

• Highest credit Growth– PSU Banks: PNB(38%)– Pvt Banks: Axis(28%)

• Highest Deposit Growth– PSU Banks: SBI(36%)– Pvt Banks: Axis(24%)

• NIM– PSU Banks: PNB(3.4%)– Kotak Mahindra Bank(6%), HDFC BK(4.1%)

• CASA– PSU Banks: PNB(38%), SBI(38%)– Pvt Banks: HDFC BK(45%), Axis Bank (40%)

• Provision– PSU Banks: PNB(89%), BoB(81%)– Pvt Banks: HDFC Bk(71%), Axis Bank(59%)

• Credit Spread– PSU Banks: PNB(4.9)– Pvt Banks: Yes Bank(4.4)

NEW INITIATIVES TAKEN BY PSBs

• Technology savvy: SBG daily 11 lakh ATM transactions amounting to

• Rs 140 crore per day

• Specialized branches

• New products targeted at specific groups

• Change in structure, systems and procedures involving quick

• turnaround time to meet world standards

• Marketing orientation

• Change in ambience

• Recruitment of specialists

• Tie-ups, sharing networks, and strategic alliances

Structural Issues

• Non-performing assets

• Legacy systems

– Low levels of technology

• Seller’s market mindset

– Low level of innovation in products and services

– Limited responsiveness to customers’ needs

The Indian banking sector has responded to these structural issues by adopting certain strategic imperatives

Legacy Issues addressed…• Challenges of a changing competitive environment

– Small and unviable pre-liberalization units– Large investments post-liberalization impacted by

global commodity cycles and high interest rates• Supportive legal and regulatory changes

– Setting up of Debt Recovery Tribunals and enactment of SARFAESI Act, reducing delays in enforcement of security and creating effective legal deterrent

– Corporate Debt Restructuring Forum for restructuring viable companies

– Enabling framework for asset reconstruction companies

• Proactive approach to resolution and increase in provisioning levels in the system

With significant success in resolution

0.02.04.06.08.0

10.012.0

1997 1998 1999 2000 2001 2002

4%

15%

43% 43%40%

30%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Chin

a

Thai

land

Mal

aysi

a

Japa

n

S. K

orea

Indi

a

(%)

Position much stronger than other Asian economies

Net NPL accretion tapering off with progress in asset resolution and increase in provisioning levels

Source: E&Y, RBI

US$ bn Net NPAs of banks & FIs

Gross NPAs as % of GDP

Bank Lending as percentage of Deposits

(2004) Country Lending as percent of

Deposits

China 130

UK 114

Malaysia 101

USA 92

India 61

Raghuram Rajan on Rewriting the Rules for India's Banks

Rajan said he sees the challenges facing India's banking industry against the backdrop of three forces,

or "tensions," in its socio-economic setting. The first tension is between the "haves" and the

"have-nots." This is not so much an urban-rural divide, he noted, but one that plays out as high income

vs. low income; well managed states vs. poorly managed states; good institutions vs. bad institutions;

and upper castes vs. lower castes. "There are lots of cleavages which reflect this [tension], but

fundamentally it's an economic divide," he said.

Continued

The second tension "is between the private sector and the public sector, or between the markets and the state," Rajan continued. He pointed

out that a common reading of this "clash" is that it represents the rich-poor divide, where the markets are seen as favoring the rich and the

state as fighting on behalf of the poor. "This is where the wires get crossed in India," he said. "It is not necessarily [true] that currently or

going forward, the state is doing the right thing by the poor. In fact, what is happening is the state is treating the poor miserably."

Continued

Rajan said the third clash is one "between the foreign and the domestic sectors," and that this is compounded by the first two tensions. “

Summary The reform and liberalization process has transformed the

Indian economy

Structural shift with service sector growthImmense potential to leverage technology and

knowledge capital

Improved competitiveness in manufacturing after intermediate period of restructuring & rationalization

Growing international linkagesExports, manufacturing and distribution

overseasIndia as a manufacturing base

Globally benchmarked businesses, capable of competing internationally

Summary (contd).

The banking sector has achieved significant success in addressing legacy concerns

Resolution of asset quality concerns through recovery, restructuring and provisioning

Focus on technology and customer orientation The economic transformation provides major opportunities

for the banking sector

Retail finance – credit and banking services Corporate finance - banking services and

structured finance The sector is poised to capitalize on these opportunities