3. Executive Summary
The last decade has seen many positive and quickly to build an enabling, rather than a
developments in the Indian banking sector. The limiting, banking sector in India.
policy makers, which comprise the Reserve Bank
of India (RBI), Ministry of Finance and related GOOD PERFORMANCE,
government and financial sector regulatory QUESTIONABLE HEALTH
entities, have made several notable efforts to Indian banks have compared favourably on
improve regulation in the sector. The sector now growth, asset quality and profitability with other
compares favourably with banking sectors in the regional banks over the last few years. The bank-
region on metrics like growth, profitability and ing index has grown at a compounded annual
non-performing assets (NPAs). A few banks have rate of over 51 per cent since April 2001 as com-
established an outstanding track record of pared to a 27 per cent growth in the market index
innovation, growth and value creation. This is for the same period. Policy makers have made
reflected in their market valuation. However, some notable changes in policy and regulation to
improved regulations, innovation, growth and help strengthen the sector. These changes
value creation in the sector remain limited to a include strengthening prudential norms, enhanc-
small part of it. The cost of banking intermedia- ing the payments system and integrating regula-
tion in India is higher and bank penetration is far tions between commercial and co-operative
lower than in other markets. India’s banking banks.
industry must strengthen itself significantly if it
However, the cost of intermediation remains high
has to support the modern and vibrant economy
and bank penetration is limited to only a few cus-
which India aspires to be. While the onus for this
tomer segments and geographies. While bank
change lies mainly with bank managements, an
lending has been a significant driver of GDP
enabling policy and regulatory framework will
growth and employment, periodic instances of
also be critical to their success.
the “failure” of some weak banks have often
The failure to respond to changing market reali- threatened the stability of the system. Structural
ties has stunted the development of the financial weaknesses such as a fragmented industry
sector in many developing countries. A weak structure, restrictions on capital availability and
banking structure has been unable to fuel contin- deployment, lack of institutional support infra-
ued growth, which has harmed the long-term structure, restrictive labour laws, weak corporate
health of their economies. In this “white paper”, governance and ineffective regulations beyond
we emphasise the need to act both decisively Scheduled Commercial Banks (SCBs), unless
3
4. addressed, could seriously weaken the health of industry utilities and service bureaus.
the sector. Further, the inability of bank manage- Management success will be determined on
ments (with some notable exceptions) to improve three fronts: fundamentally upgrading organisa-
capital allocation, increase the productivity of tional capability to stay in tune with the changing
their service platforms and improve the perform- market; adopting value-creating M&A as an
ance ethic in their organisations could seriously avenue for growth; and continually innovating to
affect future performance. develop new business models to access
untapped opportunities.
OPPORTUNITIES AND CHALLENGES Through these scenarios, we paint a picture of
FOR PLAYERS the events and outcomes that will be the conse-
The bar for what it means to be a successful play- quence of the actions of policy makers and bank
er in the sector has been raised. Four challenges managements. These actions will have dramati-
must be addressed before success can be cally different outcomes; the costs of inaction or
achieved. First, the market is seeing discontinu- insufficient action will be high. Specifically, at
ous growth driven by new products and services one extreme, the sector could account for over
that include opportunities in credit cards, con- 7.7 per cent of GDP with over Rs.. 7,500 billion in
sumer finance and wealth management on the market cap, while at the other it could account
retail side, and in fee-based income and invest- for just 3.3 per cent of GDP with a market cap of
ment banking on the wholesale banking side. Rs. 2,400 billion. Banking sector intermediation,
These require new skills in sales & marketing, as measured by total loans as a percentage of
credit and operations. Second, banks will no GDP, could grow marginally from its current levels
longer enjoy windfall treasury gains that the of ~30 per cent to ~45 per cent or grow signifi-
decade-long secular decline in interest rates pro- cantly to over 100 per cent of GDP. In all of this,
vided. This will expose the weaker banks. Third, the sector could generate employment to the
with increased interest in India, competition from tune of 1.5 million compared to 0.9 million today.
foreign banks will only intensify. Fourth, given the Availability of capital would be a key factor — the
demographic shifts resulting from changes in banking sector will require as much as Rs. 600
age profile and household income, consumers billion (US$ 14 billion) in capital to fund growth in
will increasingly demand enhanced institutional advances, non-performing loan (NPL) write offs
capabilities and service levels from banks. and investments in IT and human capital upgra-
dation to reach the high-performing scenario.
ONE OF THREE SCENARIOS WILL Three scenarios can be defined to characterise
PLAY OUT BY 2010 these outcomes:
The interplay between policy and regulatory inter- High performance: In this scenario, policy
ventions and management strategies will deter- makers intervene only to the extent required to
mine the performance of Indian banking over the ensure system stability and protection of con-
next few years. Legislative actions will shape the sumer interests, leaving managements free to
regulatory stance through six key elements: drive far-reaching changes. Changes in regula-
industry structure and sector consolidation; free- tions and bank capabilities reduce intermedia-
dom to deploy capital; regulatory coverage; cor- tion costs leading to increased growth, innova-
porate governance; labour reforms and human tion and productivity. Banking becomes an
capital development; and support for creating even greater driver of GDP growth and employ-
4
5. ment and large sections of the population gain increases to 35 per cent. Foreign banks also
access to quality banking products. grow faster at 30 per cent due to a relaxation
Management is able to overhaul bank organi- of some regulations. The share of private sec-
sational structures, focus on industry consoli- tor banks increases to 30 per cent of total sec-
dation and transform the banks into industry tor assets, from current levels of 18 per cent,
shapers. while that of foreign banks increases to over
In this scenario we witness consolidation with- 12 per cent of total assets. The share of bank-
in public sector banks (PSBs) and within pri- ing sector value add to GDP increases to over
vate sector banks. Foreign banks begin to be 4.7 per cent.
active in M&A, buying out some old private and Stagnation: In this scenario, policy makers
newer private banks. Some M&A activity also intervene to set restrictive conditions and
begins to take place between private and pub- management is unable to execute the
lic sector banks. changes needed to enhance returns to share-
As a result, foreign and new private banks holders and provide quality products and serv-
grow at rates of 50 per cent, while PSBs ices to customers. As a result, growth and pro-
improve their growth rate to 15 per cent. The ductivity levels are low and the banking sector
share of the private sector banks (including is unable to support a fast-growing economy.
through mergers with PSBs) increases to 35 This scenario sees limited consolidation in the
per cent and that of foreign banks increases to sector and most banks remain sub-scale. New
20 per cent of total sector assets. The share of private sector banks continue on their growth
banking sector value add in GDP increases to trajectory of 25 per cent. There is a slowdown
over 7.7 per cent, from current levels of 2.5 in PSB and old private sector bank growth. The
per cent. Funding this dramatic growth will share of foreign banks remains at 7 per cent
require as much as Rs. 600 billion in capital of total assets. Banking sector value add,
over the next few years. meanwhile, is only 3.3 per cent of GDP.
Evolution: Policy makers adopt a pro-market
stance but are cautious in liberalising the
NEED TO CREATE A MARKET-DRI-
VEN BANKING SECTOR WITH ADE-
industry. As a result of this, some constraints
QUATE FOCUS ON SOCIAL DEVELOP-
still exist. Processes to create highly efficient MENT
organisations have been initiated but most
The term “policy makers” used in this document,
banks are still not best-in-class operators.
as mentioned earlier, refers to the Ministry of
Thus, while the sector emerges as an impor-
Finance and the RBI and includes the other rele-
tant driver of the economy and wealth in 2010,
vant government and regulatory entities for the
it has still not come of age in comparison to
banking sector. We believe a co-ordinated effort
developed markets. Significant changes are
between the various entities is required to
still required in policy and regulation and in
enable positive action. This will spur on the per-
capability-building measures, especially by
formance of the sector. The policy makers need
public sector and old private sector banks.
to make co-ordinated efforts on six fronts:
In this scenario, M&A activity is driven primari-
Help shape a superior industry structure in a
ly by new private banks, which take over some
phased manner through “managed consolida-
old private banks and also merge among
tion” and by enabling capital availability. This
themselves. As a result, growth of these banks
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6. would create 3-4 global sized banks control- keting, service operations, risk management
ling 35-45 per cent of the market in India; 6-8 and the overall organisational performance
national banks controlling 20-25 per cent of ethic. The last, i.e., strengthening human cap-
the market; 4-6 foreign banks with 15-20 per ital will be the single biggest challenge.
cent share in the market, and the rest being Old private sector banks also have the need to
specialist players (geographical or product/ fundamentally strengthen skill levels.
segment focused). However, even more imperative is their need to
Focus strongly on “social development” by examine their participation in the Indian bank-
moving away from universal directed norms to ing sector and their ability to remain independ-
an explicit incentive-driven framework by intro- ent in the light of the discontinuities in the sec-
ducing credit guarantees and market subsi- tor.
dies to encourage leading public sector, pri- New private banks could reach the next level
vate and foreign players to leverage technolo- of their growth in the Indian banking sector by
gy to innovate and profitably provide banking continuing to innovate and develop differenti-
services to lower income and rural markets. ated business models to profitably serve seg-
Create a unified regulator, distinct from the ments like the rural/low income and afflu-
central bank of the country, in a phased man- ent/HNI segments; actively adopting acquisi-
ner to overcome supervisory difficulties and tions as a means to grow and reaching the
reduce compliance costs. next level of performance in their service plat-
Improve corporate governance primarily by forms. Attracting, developing and retaining
increasing board independence and accounta- more leadership capacity would be key to
bility. achieving this and would pose the biggest
challenge.
Accelerate the creation of world class support-
ing infrastructure (e.g., payments, asset recon- Foreign banks committed to making a play in
struction companies (ARCs), credit bureaus, India will need to adopt alternative approach-
back-office utilities) to help the banking sector es to win the “race for the customer” and build
focus on core activities. a value-creating customer franchise in
advance of regulations potentially opening up
Enable labour reforms, focusing on enriching
post 2009. At the same time, they should stay
human capital, to help public sector and old
in the game for potential acquisition opportu-
private banks become competitive.
nities as and when they appear in the near
term. Maintaining a fundamentally long-term
NEED FOR DECISIVE ACTION BY value-creation mindset will be their greatest
BANK MANAGEMENTS
challenge.
Management imperatives will differ by bank.
The extent to which Indian policy makers and
However, there will be common themes across
bank managements develop and execute such a
classes of banks:
clear and complementary agenda to tackle
PSBs need to fundamentally strengthen insti- emerging discontinuities will lay the foundations
tutional skill levels especially in sales and mar- for a high-performing sector in 2010.
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