The last decade was very beneficial for the Banking sector. In my this article, I have tried to highlight the probable factors that may / will influence the Banking Industry in the current decade (till 2020).
Indian Banking 2020: Opportunities and ChallengesBanks in India will be ending the last year of this decade on a high note. A spectacular growthrate coupled with an increase in profitability has led to an impressive performance asillustrated in Fig1.[Source: Annual reports; BCG analysis]Financial metrics witnessed a significant improvement. Bad debts fell dramatically. Starting atwell above 10 percent in the early 2000s, the gross NPA ratio is currently below 3 percent. Thecost to income ratio fell from well above 60 percent to below 45 percent. The Net InterestMargins (NIM) hovered around 3 percent with only a slight dip in the last 2 years. Consideringthe growth prospects of the Indian economy over the coming decade, the banking industryrightfully looks forward to a decade full of opportunities.However, there is no dearth of challenges. The banking industry has to live up to a range ofhigh expectations from several stakeholders. The Indian economy stands at a critical junctureof its evolution. Indians look at the next decade with a lot of hope. There are hopes of rapidgrowth, inclusive growth, wealth creation, trickle down of wealth, plenty of jobs, better livingstandards, quality infrastructure, world class Indian companies, world class convenient bankingand access to basic banking facilities. Demands from polity to support inclusion are growingshriller by the day. While many Indian industries have demonstrated low-cost innovations that
have caught the world’s fancy, Indian banks have yet to make a substantive impact. Theregulator who has zealously protected the banks’ turf for years may be forced to relent in light ofthe demands for faster development. Weak wholesale debt markets that have kept banks atcentre stage of corporate borrowing may finally deepen, leading to pressure on growth and / ormargins. Non Banking Finance Companies (NBFCs), who, barring a few exceptions almostbecame extinct in the last decade, may make a comeback. Changing customer preferencesand rapid technology evolution could pose challenges to banks in many ways. On top of it, thepublic sector will face a severe handicap in mobilizing itself unless it addresses its HR onpriority.The following major trends will impact the banks in the forms of opportunities or threats over thenext decade.Ten Major Trends that will Shape the Indian Banking Industry 1. Mortgages to cross Rs 40 trillion by 2020: Mortgages typify the retail banking opportunity in an economy. The total mortgages in the books of the banks have grown from 1.5 percent to 10 percent of the total bank advances, in a period of ten years. The ratio of total outstanding Mortgages, including the Housing Finance Companies (HFCs) to the GDP is currently 7.7 percent. If by 2020, this ratio were to reach percent, a number similar to that of China, we could expect the Mortgages industry growing at an average rate of over 20 percent during the next decade. The outstanding mortgages are expected to cross Rs 40 trillion which is higher than the entire loan book of the banking industry paged at Rs 30 trillion (as illustrated in Fig. 2). Fig 2: Mortgage penetration rate Mortgage loans / GDP (%) India 7.7% China 18.5% Malaysia 26.8% Korea 26% Germany 48% UK 80.5% USA 86% 0 50 100 Source: RBI;IBA; Capitaline; Analyst reports; BCG analysis.
2. Wealth managements will be big business with 10X growth: Going forward, wealth is expected to get further concentrated in the hands of a few. As illustrated in Fig 3, the top band of income distribution is expected to grow most rapidly over the next decade. By 2020, the top 5 percent households, predominantly residing in the metros and Tier I cities, will account for 30 percent of the total disposable income. Wealth management services will be demanded by the nouveau rich and will be an integral part of the product portfolio for both, private as well as public sector banks. Fig 3: Evolving Indian demographics to spur new demands for banking on two ends of the spectrum 3. ”The Next Billion” will be the largest segment: Also illustrated in the Fig 3 is the fact that the income group right below the middle class in the annual household income range Rs 90,000 to Rs 200,000 per annum will be the largest group of customers. These customers will be profitably served only with low cost business models having low break even ticket size of business. The next decade would witness banks experimenting with different low cost business models, smaller cost effective branches and new use of technology to serve this segment profitably.
4. The number of branches to grow 2X; ATMs to grow 5X:India has a very low penetration of branches and ATMs as compared to some of the otherdeveloped and developing nations as illustrated in Fig 4. Exhibit 1 highlights the usagepattern of various banking channels in terms of number of visits. It is evident that the bankbranches and ATMs are by far the most popular channels, despite a decade of promotion ofalternate channels. The experience in developed economies also corroborates thatbranches and ATMs continue to be the critical channels, although certain transactions haveshifted to alternate channels. As such, there is a requirement of at least 40,000-50,000additional branches and 160,000-190,000 additional ATMs in the coming decade. This willbe 3 times more than the branches and ATMs launched in the last decade.Fig 4: Low channel penetration levels:
5. Mobile banking to see huge growth and will redefine transaction-banking paradigm:As illustrated in Fig. 5, the uptake of internet and call centres is low in all segments otherthan foreign banks. Comparing with usage pattern in US, the significant potential in onlineand phone channels is apparent. However, India may evolve differently. The penetration ofinternet and broad band access in India has been low so far. However, with the advent ofmobile banking, the access to banking facilities could completely get revolutionized over thenext decade. Even if 25-30 percent of mobile users have GPRS / 3G activated, there wouldbe 250 million to 300 million customers who would access banking services over the mobile.On the other hand, customer survey of over 3000 customers in urban areas has indicatedthat call centres and internet are the most dissatisfying channels. We expect the Indianbanking industry to invest significant attention in technology innovation to drive nextgeneration framework for transaction banking. Indian banks could set an example for therest of the world.Fig 4: Channel usage by bank category
6. Customer Relationship Management (CRM) and data warehousing will drive the nextwave of technology in banks:The average number of banking products per customer in India is significantly lesser thanthe global benchmarks. There is a significant potential for cross selling amongst allcategories of banks in India. Given that cross selling is highly cost – effective as comparedto all other means of customer acquisition, banks will adopt CRM strategies aggressively inpursuit of cost-effective business models described in point 3 above.7. Banking margins will come under pressure:The next decade will see a dramatic change in margins as the wholesale debt marketsdeepen and corporate customers access the whole same markets directly. Further, shouldthe savings bank rate be liberalized, banks will move to a regime of low margins. The publicsector banks expect to see their margins squeeze with a much higher likelihood ascompared to the private sector / foreign banks. The NIM of the public sector banks hasconsistently declined and this perhaps reflects in the pessimistic view on future marginsadopted by the public sector.8. New models to serve the Small and Medium Enterprises (SME): Fig 5 illustrates theresults of a survey conducted by FICCI to gauge the level of satisfaction among large,medium and small business customers with regards to banking services. The largecustomers are more satisfied across all dimensions as compared to the medium and smallsized ones. The smallest businesses are most dissatisfied. Due to higher risk and lowerticket size, the SME typically get less attention. Banks are yet to create innovative modelsto serve SMEs with sufficient and timely credit at the right price. In general, the level ofdissatisfaction is higher on pricing and product range. A further analysis highlights that thedissatisfaction on pricing is higher for the private sector banks while dissatisfaction onproduct range is higher for the public sector ones. As the yield in large corporate bankingfalls with further deepening of wholesale debt markets, the banking industry in India will findcost-effective ways to serve the SME customers where yields are quite high. Fig 6highlights the top 3 new expectations of business customers in the next decade, as per ourrecent survey. The SMEs hope to get the basics – good relationship management, fastcredit decisions and a complete product range all at one place.
Fig 5: banks will need to innovate to meet the expectations of SME customers9. Investment banking will grow over ten-fold:Investment banking will be among the fastest growing segments in the banking industryrising from 4 percent to 7 percent of the entire corporate banking revenue pool. The largercorporate customers expect to demand higher support for international expansion andmergers and acquisitions over next decade as shown in Exhibit 1. Further, as the wholesaledebt markets deepen, the larger corporate would avail of advisory and capital marketservices from banks to access capital markets. The revenue pool will shift from traditionalcorporate banking to investment banking and advisory. Banks with international presencestand to benefit.
Fig 6: Top 3 expectations from banks in the next decade10. Infrastructure financing to hit over Rs. 20 trillion on commercial banks books:As India continues to rely on private funding for infrastructure development, infrastructurewill occupy a larger share of the balance sheets. Half of the debt finance for infrastructuretoday comes from banks. By 2020, banks would have accumulated infrastructure assetsworth Rs 20-25 trillion on their books. This would touch 12-15 percent of the total advances.Infrastructure loans coupled with home loans would together account for about 25-30percent of the total advances of the banking industry. This would be the limit to which bankswill be comfortable taking long term assets on their books. Even as the asset liabilitymismatch issues are resolved by IIFCL and the government, the real challenge for bankswould be to develop skills to undertake the risks of long gestation infrastructure projects andmanage concentration risk in infrastructure.Two Challenges of the DecadeThere are two areas in which the Indian banking industry will be severely challenged to finda solution over the next decade. First pertains to the rising expectation from banks to find aneconomically viable solution for financial exclusion. The second pertains to humanresources challenge in the public sector. While the first challenge demands unusualinnovation and experimentation, the second threatens to cripple the ability of the largestsegment of the banking industry from being able to innovate and stay competitive. It isunclear that the solutions to these two challenges will be identified unless the banks were toaccord highest priorities to these and work in concert.1. Financial inclusion:The issue of financial inclusion is at the centre stage of the agenda of the government.While the expectation from banks is high, the government is also starting to look at non
banking industries to come forward with a solution. Needless to say, if the answer does not come from banking industry, non banks will be welcome to nibble at its revenue pool. It is a strategic priority given that the customer segment in question will be the largest in number over the next decade and banks stand to lose this relationship. As illustrated in Fig 7, the banking industry in not very confident of finding a solution. Fig 7: Bankers’ expectations vary. 2. The HR challenge in public sector:The public sector banks enter the next decade with the same expectations as their privatesector peers but with a severe disadvantage in human resources. The HR challenge of publicsector banks has reached a tipping point. Due to a legacy of several decades, the public sectorbanks will witness unprecedented loss of skills and competencies in form of retiring senior andmiddle management executive over the next few years. That coupled with the need for largescale re-skilling, attracting and retaining fresh talent, controlling the growing employee aresignificant challenges. As illustrated in Fig 7, the public sector banks are almost unanimous intheir concern about the future challenges of attracting and retaining talent.Bankers’ Expectations VaryFig 7 above summarizes the views of the public and private sector/ foreign banks captured by arecent survey conducted by IBA. The survey responses highlight perceptions that converge onsome issues and diverge on others. The responses capture anxieties of banks regardingcertain challenges in the next decade.
Both sectors agree to different degrees on the potential of mobile banking and wealth management. The public sector perceives a higher imminent threat from squeezing margins and believes that there is a need to scale up and expand globally. The private sector, on the other hand, believes that the margins are reasonably secured and feels a relatively lesser need for international presence and scale. Despite the recent hectic activity on financial inclusion, 14 percent of the public sector and 9 percent of the private sector banks feel that it is “very likely” that a profitable model of financial inclusion will be arrived at by the industry. However, 36 percent of the public sector banks and 27 percent of private sector banks feel that their bank will be participating in financial inclusion in a profitable manner. Finally, there is utmost unanimity amongst public sector banks that attracting and retailing talent will be the biggest challenge. Overall, the public sector appears more paranoid about the future of their competitiveness while the responses from their counterparts in the private sector are more sanguine.Crucial Role for NBFC and DFIEncourage NBFC in specialized segmentsBanks may not be able to live up to all expectations. There are many opportunities that are easyto capture but there are also many that require significant innovation or specialized skills thatconventionally not banks’ strengths. The latter opportunities are at the extremes of spectrum.Very large ticket, long term infrastructure lending requires risk management expertise that goesbeyond traditional credit appraisals at banks. There will be significant space for specializedentities in risk assessment and structuring of infrastructure finance. Very low ticket unsecuredcredit requires sophisticated risk management and cost control that is not easy in businessmodel of conventional banks. Gaps in SME finance can be filled with asset based lending,operating leases, and factoring. Specialized NBFCs can play a major role in all of these. Theseare niches. But each one of them is individually large to sustain significant balance sheets.Importance of NBFC needs to be recognized to make the decade’s promise come true for India.Positive regulatory environment to support NBFC will be crucial.Rural infrastructure needs a government backed DFI to address market failures.Financial inclusion is being pursued as a crucial driver of inclusive growth. However, financialinclusion is necessary but not sufficient. Sustainable inclusive growth requires financial inclusionto be supplemented (if not preceded) by rural infrastructure development and stimulation of ruraleconomy through livelihood generation interventions. While commercially viable models arebeing encouraged for financial inclusion, the same is not possible in the case of ruralinfrastructure development and livelihood generation. Market failures abound. Currently ruralinfrastructure is supported by government through myriad agencies and departments-NABARD(through RIDF funding to states), MoRD (through PURA and PPP initiatives), REC, variousstate government agencies, etc. India needs a pivotal agency with appropriate government
backing to finance rural infrastructure. No DFI across the world survives without access tocheap source of funds supported by the government.In the current institutional landscape of India, NABARD is most suited to play this role. Italready channelizes RIDF funds to states for rural infrastructure development. However, RIDFfunds are hardly sufficient for the purpose and need to be augmented. NABARD supported ruralinfrastructure development is credited to be higher quality compared to initiatives of stategovernment due to higher standards of quality control and emphasis on livelihood generationand citizen participation. Explicit government financial support to NABARD has to bestrengthened. NABARD has to be restructured to expand the breadth of its product portfoliofrom simple loans to state governments to structured finance options that meet needs of notonly different state governments and but also private sector which will participate in selectsegments of rural infrastructure through PPP route. Conclusion:Through this research, we conclude that: During the last decade, the Banking Industry has done a fantastic revolution in the Indian Market. Also, based on the analysis on the last decade’s performance, we can as of now forecast the major trends or factors that may impact the current decade and thus take measures accordingly. However, there are pros and cons of each aspect, which cannot be avoided but of course we can be prepared for them. The current decade will watch a crucial role of the NBFC and DFIs. In addition, it needs to be witnessed what the government can do about the rural development with the help of DFI. The Financial Inclusion and the HR challenge in the public sector needs to be handled critically. ____________________________________________________________