indian banking system-survey

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INDIAN BANKING SYSTEM: THE

CURRENT STATE & ROAD AHEAD

ANNUAL SURVEY

September 2006

Federation of Indian Chambers of Commerce & Industry

Federation House, Tansen Marg, New Delhi 110 001

Indian Banking System: The Current State and Road Ahead 1


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Executive Summary

Indias banking sector is growing at a fast pace. It has become one of the most

preferred banking destinations in the world. Indian markets provide growth

opportunities, which are unlikely to be matched by the mature banking markets

around the world. FICCI conducted a survey to analyze the potential offered by

Indian Banking System and achievement of global competitiveness by Indian banks.

The questions largely revolved around where we are, how will India go about it, what

structures need to be created and when will it happen?

Some of the major strengths of the Indian banking industry, which have helped

mark its place on the global banking scene as highlighted by our survey

respondents were Regulatory Systems (84.21%), Economic Growth Rate

(63.15%), Technological Advancement (52.63%), Risk Assessment Systems

(47%) and Credit Quality (42.1%)

Some of the areas that need to be geared up for future growth, identified by the

survey respondents are Diversification of markets beyond big cities (84.2%),

HR Systems (63.15%), Size of banks (52.63%) High Transaction Costs

(47.3%), Banking Infrastructure (42%) and Labour Inflexibilities (42%). To a question on achieving global competitiveness, Consolidation in the

financial sector has emerged to be the most significant measure required to

create world class banking system followed by Strict Corporate Governance

Norms, Regional Expansion, Higher FDI limits and FTAs.

On being asked to rate India on certain essential banking parameters

(Regulatory Systems, Risk Assessment Systems, Technological Systems and

Credit Quality) in comparison with other countries i.e China, Japan,

Sinagapore, Russia, UK and USA, the following results emerged:

Regulatory systems of Indian banks were rated better than China and

Russia; at par with Japan and Singapore but less advanced than UK and

USA.



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On the question on the state of preparedness of Indian banking sector to

tackle the challenges being faced by them, the following results emerged:

In view of increased competition, Implementation of Basel II norms by March 2007

and opening up of sector in 2009, 95 per cent of the respondents view that this is

the right time for the consolidation in the financial sector. 94 per cent

respondents also fully supported governmentpoint of view of creating of 6-7

banks as big as the State Bank of India.

92 per cent of Public sector banks respondents voiced that they do not have

sufficient autonomy to offer attractive incentive packages to their employee to

ensure their commitment levels. Out of these, 82per cent of respondents

expressed that to improve their productivity levels it is essential to offer

competitive compensation packages at all levels.

58 per cent of respondents expressed that Indian Banking Sector is prepared to

achieve the Basel II milestone by 31st March 2007 whereas the remaining

voiced that the deadline should get extended. 83 per cent respondents also

highlighted that presently there are sufficient instruments in the market to meet

the increased capital requirements of Indian Banks



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The Indian Banking System: The Current State and Road Ahead

Annual Survey

Introduction

Indias banking sector is growing at a fast pace. India has become one of the mostpreferred banking destinations in the world. The reasons are numerous: the economy

is growing at a rate of 8%, Bank credit is growing at 30% per annum and there is an

ever-expanding middle class of between 250 and 300 million people (larger than the

population of the US) in need of financial services. All this enables double-digit

returns on most asset classes which is not so in a majority of other countries. Foreign

banks in India achieving a return on assets (ROA) of 3%, their keen interest in

expanding their businesses is understandable even more so when compared with the

measly 1% average ROA for the Top 1000 banks in the world.

Indian markets provide growth opportunities, which are unlikely to be matched by the

mature banking markets around the world. Some of the high growth potential areas to

be looked at are: the market forconsumer finance stands at about 2%-3% of GDP,

compared with 25% in some European markets, the real estate market in India is

growing at 30% annually and is projected to touch $ 50 billion by 2008, the retail

credit is expected to cross Rs 5,70,000 crore by 2010 from the current level of Rs

1,89,000 crore in 2004-05 and huge SME sector which contributes significantly to

Indias GDP.



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Indian Banking Sector: Strengths and Weaknesses

Lets have a look at what our respondents have to say about present state of Indians

banking systems some of its strengths that we are proud of and some weaknesses

that need to be worked upon .

Some of the major strengths of the Indian banking industry, which helps mark its

place on the global banking scene as highlighted by our survey respondents were

Regulatory Systems (84.21%), Economic Growth Rate (63.15%), Technological

Advancement (52.63%), Risk Assessment Systems (47%) and Credit Quality

(42.1%)

Major Strength Areas *

Regulatory Systems(84.21%)

Economic Growth Rate(63.15%)

TechnologicalAdvancement (52.63%)

Risk AssessmentSystems (47%)

Credit Quality (42.1%)

Areas To Be Geared Up

For Future Growth *

Diversification ofmarkets beyond big cities(84.2%)

HR Systems (63.15%)Size of banks (52.63%)High Transaction Costs

(47.3%)

Banking Infrastructure(42%)

Labour Inflexibilities(42%)

Turnaround

success strategies


IndianBankingSector


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StrategiesTo Be Adopted For Creating WorldClass Banking System

ConsolidationStrict Corporate GovernanceNormsRegional Expansion (Bothwithin India as well asOutside)Higher FDI limitsFTA with countries whereIndia has comparativeadvantage in banking sector

Some of the areas that need to be geared up for future

growth, identified by the survey respondents were

Diversification of markets beyond big cities (84.2%), HR

Systems (63.15%), Size of banks (52.63%), High

Transaction Costs (47.3%), Banking Infrastructure

(42%) and Labour Inflexibilities (42%). Availability and

reach of quality products is confined to just big cities. Thus

it is essential now to expand the gamut of banking services

both within India as well as outside. Size of the banks is also

a critical element in the chase for avenues for growth as it

facilitates banks to attain new capabilities, technologies andproducts at lower operating costs.

Banking in India has to travel a long way to achieve global

competitiveness, but surely it is on its way. But the key

questions at this hour how will India go about it, what

structures need to be created and when will it happen?

To find out what we need to do to be there, we asked our

respondents to rank the various Global strategies which if

adopted would accentuate Indias pace towards it (On a

scale of 1 to 5 with 5 being the Most important Global



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Trend). The results of the Mode score being accorded by the

Public, Private & Foreign banks are presented below:

0

1

2

3

4

5

Consolidat ion StrictCorporate

Governance

Norms

RegionalExpansion

(Both within

India as w ell

as Outside)

Highe r FDIlimits

FTA's

Global Strategies for Indian Banking System

(Overall Mode score of all banks)

As evident from graph above, consolidation emerged to be the

most significant measure required to create world class

banking system followed by Strict Corporate Governance

Norms, Regional Expansion, Higher FDI limits and FTAs.

Indias Steps towards Global Competitiveness

Of the many Asia Pacific countries, China, Taiwan, South

Korea and India will continue to influence the development

of the Asian markets. China and India are one of the fastest



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growing economies in the world as evident from the graphs

below.

Real GDP Growth Rate

10.5

8.37.5

5.6 5.5 5.3 5.1 4.5 4

0

2

4

6

8

10

12

Chin

aIn

dia

Sing

apore

Hong

Kon

g

Malay

sia

Indo

nesia

Korea

Thaila

nd

Taiw

an

%

Source: Morgan Stanley Research

Loan Growth

27.6

13.4

9.98.1 7.7

6.4 6.45.1

0

5

10

15

20

25

30

India

Chin

a

Malay

sia

Hong

Kon

g

Korea

Taiw

an

Thaila

nd

Sing

apore

%

Source: Morgan Stanley Research

These above-mentioned countries, though at different stages

of development, have the potential to become major growth

markets for traditional banking, investment banking,

insurance, and securities products. As a result, leading

international and regional banks are interested to establish

their presence in these countries.



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How do we compare with these economies and with some

other economies in terms of banking systems? Does our

banking systems have the necessary systems in place? This

is what we have tried to analyse in this section.

The Indian banking sector has scored over its counterparts

not only in developing but even in developed world such as

Japan, Singapore and Australia on significant parameters.

According to Moodys Investors Services data, Indian

lenders have posted highest ROE of 20.38% (system

average of three years), closely followed by Indonesia at

20.19% and New Zealand 18.83%. Japan, the biggest

economy in Asia posted negative returns of 6.42%, implying

that the banks there made losses. Banks of Phillippines and

Australia have posted an ROE of just 4.40% and 11.44%

respectively.

We asked our respondents to rate India on certain essential

banking parameters (Regulatory Systems, Risk Assessment

Systems, Technological Systems and Credit Quality) incomparison with other countries i.e China, Japan,

Sinagapore, Russia, UK and USA.



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14.3

7.1

78.6

14.29

71.43

14.29

29.41

35.29

17.65

17.65

5.89

58.82

52.94

11.76

17.65

47.06

17.65

17.65

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

China Japan Singapore Russia UK USA

Regulatory Systems of India vis a vis other countries

Be

At

Be

Regulatory systems of Indian banks were rated better than

China and Russia; at par with Japan and Singapore but

less advanced than UK and USA.

21.42

78.57

14.29

64.29

21.43

50

14.29

35.71

21.43

78.57

64.29

14.29

21.43

64.29

14.29

21.43

0%

20%

40%

60%

80%

100%


Risk Assessment Systems of India vis a vis other countries

Bet

At P

Be

Risk management framework is a key strength for sustainable

growth of banks. How have we performed in this area?



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Respondents rated Indias Risk management systems more

advanced than China and Russia; at par with Japan, and less

advanced than Singapore, UK and USA. This shows we need to

work out this but we are not too far.It is with this confidence we

are going ahead with the challenge of implementing Basel II by

April 2007. 83% of our respondents highlighted that Basel II

implementation would take us a step ahead in global

competitiveness.

23

23

54

42.9

42.9

14.29

64.29

14.29

21.43

21.43

35.71

42.86

71.43

7.14

21.43

78.57

21.43

0%

20%

40%

60%

80%

100%


Technological Systems of India vis a vis other countries

A

Technology has given birth to a new era in banking.

Technology can be the key differentiator between two banks

and a major factor to attain competitive edge. Though slow in

the beginning, Indian banks seem to have paced up in

adoption of advanced technology, as is evident from our

survey results. Technological systems of Indian banks have

rated more advanced than China and Russia; at par with

Japan, but less advanced than Singapore, UK and USA.



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21.43

78.57

28.57

14.28

57.14

28.57

50

21.43

14.29

14.29

71.43

57.14

42.86

64.29

35.71

0%

10%

20%

30%

40%

50%

60%

70%

80%90%

100%


Credit Quality of India vis a vis other countries

While enhancement of credit is an important function of the

Banks, it is equally imperative to keep a check on the

quality of credit to ensure good health of the banking system

and effective functioning of market for distressed assets.

One of the key fundamentals of Indian banking sector

Credit Quality too has been rated fairly well in comparison

with other countries. Majority of respondents quoted

credit quality of Indian banks better in comparison with

China, Japan and Russia; at par with Singapore but

below par with UK and USA. As a percentage of GDP,

the Net NPA of Indian banks stands mere to just 1.4% as on

March 2006 as compared with 3.1% in 2004-05. As a

percentage of GDP, gross NPA in India is just 1.9 %compared with 6.7% in China as on March 2005.

It is evident that India fares well on these critical

parameters. But are the existing International banks happy



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doing business here? Well, our foreign bank respondents

seem to be happy here and wish to expand further. 75 per

cent of the foreign banks respondents rated their

working experience in India as extremely good. Given

Indias potential over the next decade and beyond, all

the foreign banks respondents stated that they have

formulated strategies for future expansion in India.

Future Global Expansion Strategy of India

In order to gain further access to the global trade, the

government is expanding the Free Trade Agreements

(FTAs) with many countries (like Singapore, Thailand, and

other ASEAN members).

55 per cent of the respondents highlighted that the

FTAs signed by India till now have helped enhance

global trade and thus been of help to banks in their

global expansion strategy.

After the Comprehensive Economic Co-Operation

Agreement (CECA) with Singapore, the government is now

planning a similar deal with the 25-member European

Union. The EU is also likely to ask India to liberalise its

financial sector on the lines of the India-Singapore CECA.

The CECA with Singapore may have been appreciated but a

similar deal with EU may not be as advantageous for Indianbanks as evident from our survey results. EU banks are

considered as one of the most globally competitive and

successful banks. In consideration of this fact, 85 per cent

of domestic banks respondents also emphasized that



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India should not give full domestic status to EU based

banks under the proposed India-EU CECA.

New Business Opportunities

With the interest income coming under pressure, banks are

urgently looking for expanding fee-based income activities.

Banks are increasingly getting attracted towards activities

such as marketing mutual funds and insurance policies,

offering credit cards to suit different categories of customers

and services such as wealth management and equity trading.

These are indeed proving to be more profitable for banks

than plain vanilla lending and borrowing. 69 per cent of

respondents stated that 20 30 % proportion of their total

Income is constituted by fee-based incomes.



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New Business Opportunities tapped by banks

Derivatives Trading

36.8%

Wealth

Management

21.05%

Forex Management

68.4%Bancassurance

73.6%

Selling of Mutual

Funds 73.6%

*

Bancassurance and selling of mutual funds were

recognized as the most tapped business opportunities by

the bankers closely followed by Forex Management. Out

of these selling of mutual funds was identified as the

most profitable venture by 47 per cent of respondents.

Today, India has 83000 HNWIs, a 19.3% increase in

number over 2004.This data clearly exemplifies the fact that

the number of wealthy individuals in the country is growing

at a rapid pace. However, presently, there are only a handful

of entities which offer high-end private banking in India.

Just about 21.5 per cent of our survey respondents stated

of having tapped this opportunity. This area has a huge

potential for growth.

Penetration of Banking Services



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The penetration of banking services to Indian households

stands at a mere 35.5%. According to the data released by

the Census office, even relatively prosperous states like

Maharashtra, Gujarat and Karnataka have less than half of

their total households operating a bank account. Delhi was

ranked 8th with only 51% of the population having access to

banking facilities.

Some of the efforts highlighted to increase this

penetration level were:

Tapping the Rural markets (87.5 per cent

respondents)

It is time that Indian banks capitalize upon the

untapped potential of the rural markets. Rural India

is now being viewed more as an opportunity than as

a challenge. 44 per cent of respondent banks

perceived Rural markets as difficult but

Profitable market whereas 43 per cent view it as

Lucrative and Profitable Market. Improving

macro indicators like better education, higher incomelevels and comfort with technology clearly indicates

the rural Indias potential of massive economic

upsurge.



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Perception about Rural markets by Banks

High Cost Market

& Difficult Market

13%

Lucrative and

Profitable

43%

Difficult yet

Profitable

44%

Opening more branches in Tier II and Tier III towns

(62.5 per cent respondents)

Fierce competition in the business of banks in metro

cities has brought into sharp focus the untapped

potential in the emerging markets of the Tier-II and

Tier III

cities across the country. In fact, analysts have

forecasted that the next retail boom is waiting to

happen in these smaller towns and cities, as the

urban markets have now saturated. Many public

sector banks are now enhancing their focus towards

the Tier-II cities, as most of them have lost their

considerable market share in the metros to their

private sector and foreign counterparts.

Innovation and Customization: New Products andServices

By 2015, market will become intensely customer centric

and dominated by global mega banks and densely populated

by specialist financial services providers. Innovation in



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products, processes, relationships and business models will

be the primary path to sustainable growth. Consumer today

is open to ideas, demands flexiblity and is looking for

innovation and new products.

On an average an Indian bank sells 1.4 products to every

customer whereas in Spain it is 1.8, in UK 2.6, in Norway it

is about 2.7 and in France it is about 3. Indian banks

acknowledged the need to expand their product portfolio

as endorsed by 94 per cent of our survey respondent

banks.

80

40

20 20

0

10

20

30

40

50

60

70

80

Delivery

Channels

Closed

Customer

Mindset

Regulatory

Support

Knowledge

and efforts

made by the

ground level

personnel

%

Hindrances faced during introduction of New Products

*

The respondents also highlighted a few hindrances faced by

them in churning products in tandem with their counterparts

in other countries. Effective delivery channels (80 per

cent) was identified as one of the major hindrance being

faced at the time of



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introducing new products or schemes followed by closed

customer mindset (40 per cent). Regulatory support and

Knowledge and efforts made by the ground level personnel

were other factors earmarked by the respondents.

Consumers Insight: Success Path for Bankers

One of the biggest problems facing senior managers of

banks today is attracting customers and attaining growth,

often in an environment where products and prices among

competitors are close substitutes. Traditional bases for

differentiation, such as product features or cost, are

becoming less tangible. So the managements are forced to

look for new ways to appear attractive to its target market

and simultaneously retain the existing one.

We asked our respondents to rank their business strategies

that have helped them in increased customer acquisition and

retention (On a scale of 1 to 8 with 8 being the Most

important marketing strategy). The results of the Mode score

being accorded by the Public, Private & Foreign banks are

presented below:



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Strategies Succesful in Customer Acqusition &Retention

0 1 2 3 4 5 6 7

Bank by Phone

Additional Customer Service Counters

Door Step Banking

Marke t Campaigns

Additional Sales force

Advertisements

Expansion of ATM Network

Technological Upgradation

Technology has moved from being just a business enabler to

being a business driver. Be it customer service, reducing

operational costs, achieving profitability, developing risk

management systems, we turn to technology for providing

necessary solution. Technological upgradation was clearly

identified as one of the most successful strategy in

Customer Acquisition and Retention followed by

Expansion of ATM Network, Advertisements and

additional sales force.

Customer Retention and Customer Satisfaction are

inexorably inter - linked. While consumers may be happy to

make payments and interact with their bank through

convenient and cheaper banking channels, they still

expect high standards of service. A consistent service

reflects the banks brand and image across all channels.



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93.75 per cent of respondent banks informed that superior

service pre and post banking has been one of the essential

factors rated high by their customers. 75 per cent of

respondent banks felt that Personal touch in the dealings

has helped them in winning customers.

Key Factors that convert a satisfied customer into a loyal customer

Better service pre

and post banking

93.75%

Being a leader in

offering innovative

products from time

from time 37.5%

Offering Customized

Products 37.5%

Ensuring Customer

Security 37.5%

Personal Touch 75%

*

Some forthcoming Challengesbefore Indian Bankers

Presently some of the top most concerns of the stakeholders

of the banking industry i.e. government, regulator and

bankers are consolidation in the financial sector, improving

HR systems of Public sector banks thereby improving their



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competitiveness and successful implementation of Basel II

norms.

Size and Efficiency: Is consolidation the answer?

The RBIs roadmap for the banking sector envisages greater

access to foreign banks in India from April 2009. The

increased competition, it is argued, would be tough on

smaller banks. Besides, the Basel II capital adequacy

framework, which kicks off from March 2007, is expected

to increase the banks capital requirement. PSU banks short

on capital can look to mergers instead of government

capitalization. 95 per cent of the respondents also view thatthis is the right time for the consolidation in the financial

sector. What is needed is a roadmap for managed

consolidation. Voluntary mergers are certainly better than

forced ones. Forced mergers are always a compromise and

cannot lead to maximization of shareholders value.

The government is planning to kick off consolidation in the

sector by lining up a series of merger and acquisition

proposals for the public sector banks, thus enabling

creation of 6-7 banks as big as the State Bank of India.

The idea behind the move is to create large players

that can take on the competition when the sector is

thrown open three years from now. 94 per cent

respondents also fully supported this view of the

government.

The presence of 6 7 large sized banks does not rule out

the relevance of small/niche/regional banks in the

market, as highlighted by 83 per cent of respondents.



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Small niche banks thrive even in the most competitive

markets. The state-owned banks that have regional character

can look for geographical diversification though inorganic

growth.

HR Excellence for PSB Banks

In this market driven economy, a level playing field is

required for PSU banks to compete with new private sector

and foreign banks. 92 per cent of Public sector banks

respondents voiced that they do not have sufficient

autonomy to offer attractive incentive packages to their

employee to ensure their commitment levels. Out of

these, 82 per cent of respondents expressed that to improve

their productivity levels it is essential to offer competitive

compensation packages at all levels.

Skill development too is a critical challenge and PSBsseem to be moving fast towards it as evident from survey

results. 67 per cent of PSBs quoted that sufficient skill

development efforts are being made for their employees

to gear them up to meet challenges of growing

competition.

Basel II: Some Last minute preparations

58 per cent of respondents expressed that Indian

Banking Sector is prepared to achieve the Basel II



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milestone by 31st March 2007 whereas the remaining

voiced that the deadline should get extended.

83 per cent respondents highlighted that presently there

are sufficient instruments in the market to meet the

increased capital requirements of Indian Banks. Most of

the banks are preferring to raise their capital through upper

Tier II and hybrid Tier I route as an equity issue will dilute

the ROE (return on equity). However, some of the banks

expressed that in another one-years time, banks should

be permitted to issue preference shares.

58 per cent of respondents also expressed the need of

regulatory support in successful implementation of these

norms. Some of such areas identified by them are guidelines

on consolidation of banking sector, greater capital

flexibility, support for the establishment of PD, LGD etc,

necessary amendment to the banking regulation act.

* Results are not mutually exclusive

Source

Newspapers

Business Standard

Economic Times

Websites

The Banker

Asian Banker



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Reports

BCG Study

India & China: New Tigers of Asia

Part II, Morgan Stanley

World Wealth Report 2006


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