The document summarizes key points from a meeting with India's Ministry of Finance on developments in the banking sector and upcoming reforms. It notes that the government remains committed to adequately capitalizing public sector banks and that bank performance evaluations will increasingly emphasize qualitative productivity parameters over growth. Recommendations to improve employee productivity at public sector banks are also being considered. The document expresses that these steps are moving in the right direction if properly executed.

1. 29 March 2012
Update
India Financials
Meeting with MoF; Focus to capitalize banks
adequately; Productivity improvement to be
performance parameter
We met with the Ministry of Finance to understand their views on the ongoing
developments in the economy, the banking sector and impending financial
sector reforms. Key takeaways:
 Government remains committed to provide adequate capital to public
sector banks (PSBs). The idea behind recent capital infusion in PSU banks by
the government and LIC is to help them achieve Tier I ratio of 9% by FY13 in
view of the increased capital requirements under Basel III guidelines.
 In the performance evaluation process of PSBs, more emphasis is laid on
qualitative productivity enhancement parameters such as improvement in
CASA, margins, return ratios, asset quality and recoveries from written-off
accounts. Besides this, Statement of Intent will also include growth
parameters for productive sector of the economy. There will be a long term
Memorandum of Understanding (MoU) signed between banks and
government emphasizing above parameters with yearly milestones in place.
 Steps will be taken to (1) improve productivity of PSU bank employees
based on recommendations of the Khandelwal Committee, and (2) relax
limits for performance-linked incentives for PSU bank employees. However,
final consensus is yet to be formed.
 Succession planning for PSU banks will be done well in advance; CMD and
ED will be given longer tenure for effective implementation of strategies.
 Growth can revive with focus on reduction in systemic interest rates.
Supply-side constraints, which are creating inflationary pressures, should be
tackled more structurally as monetary policy singularly can’t curb inflation.
The government is focusing on the financial reforms related bills in budget
session to be passed.
Our view: Marching in the right direction; execution is the key
 Steps taken (and proposed to be taken) by the Ministry of Finance are in
the right direction; they augur well for improving the core operating
performance of PSBs.
 Steps proposed to improve the employee and overall productivity through
adopting Khandelwal Committee recommendations (as and when it
happens) and increasing focus (in the Statement of Intent) on qualitative
parameters rather than growth are encouraging. If executed correctly, this
could lead to valuation re-rating for PSBs.
 Government’s commitment to provide adequate capital to PSBs for meeting
their funding requirements is also encouraging.
 Our preferred bets: PSU banks – SBIN and PNB; Private banks – ICICIBC;
Midcap banks – YES and INBK.
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2. India Financials
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On Interest rates & inflation: Limited correlation – Sharp fall in rates
required especially for productive sectors
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29 March 2012
Growth could be revived with focus on Hence the focus should be on reviving
growth through reduction in systemic interest rates.
Cost of funds remain quite high with banks base rate at 10%+. Banks should
consider to pass on the benefit on account of regulatory actions (eg 125bp CRR
cut by the RBI) to productive sectors. The banks may not reduce their base
rates, but should lower rates in select products such as Housing, SME,
Education, Agri, Auto loans etc.
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3. India Financials
Our view
 Our economist expects RBI to start cutting rates in the forthcoming monetary
policy (expected 50bp in April 2012). However, the quantum and pace of rate
cuts going forward will highly depend on the growth and inflation dynamics
during different time periods.
 Banks have already started cutting rates for select products. Considering tight
liquidity condition, moderating growth, and higher pressure on banks to cut
interest rates, 4QFY12 NIMs are likely to be peak; we expect to see gradual fall
thereafter. Nevertheless, we expect this to be limited to 10-20bp for FY13.
Our economist expects rate cuts to start by Apr’12 and expects
150bp rate cuts by the year-end
:
:
On PSU banks recapitalization: Government committed to provide
adequate capital to PSBs
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
The government remains committed to provide adequate capital to PSBs. During
FY11, it recapitalized PSBs to take its minimum shareholding to 58% levels.
The idea behind the recent capital infusion in PSU banks by the Government of
India and LIC of India is to help them achieve tier I ratio of 9% by FY13 in view of
the increased capital requirements due to recent Basel III guidelines.
Government intends to maintain a minimum shareholding at 51% levels.
Our view: The government has re-iterated its intention to provide adequate capital
support to PSBs, which is positive and removes the hangover of shortfall of capital
for PSB growth.
29 March 2012
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4. India Financials
Capital Infusion in various banks by GoI and LIC (combined)
Tier I ratio as on Dec’11
GOI and LIC holding post capital infusion
:
:
On PSBs performance evaluation: Focus increases on qualitative
parameters
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29 March 2012
The Ministry of Finance has revamped the Statement of Intent (SoI; containing
targets for next year) signed by PSBs every year, based on which the
performance of a PSB or any CMD is evaluated.
From current year onwards, the focus has shifted from growth to productivity
enhancement by bringing in more qualitative parameters in the SoI such as
improvement in profit per employee, CASA, margins, return ratios, asset quality
and recoveries from written-off accounts. Going forward, the ministry is also
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5. India Financials
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
contemplating to link capital infusion in PSBs based on their performance on the
abovementioned parameters.
However, banks will have to continue to achieve the mandated direct lending
targets (like priority sector lending, agri lending etc.)
The banks will also have to submit a performance improvement roadmap for a
five-year period v/s providing annual performance targets currently.
Our view: We expect this step to considerably change the single-minded focus of
PSBs on growth as the sole performance evaluation parameter. This would also lead
to banks utilizing capital in more efficient manner. This would also compel PSBs to
become more competitive and make operations leaner, resulting into higher returns
for all the stakeholders.
RoA (%; FY11) of PSBs
RoE (%; FY11) of PSBs
:
:
Focusing on HR issues of PSB: Longer tenor for CMD and ED; Higher
incentives to improve employee productivity
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In June 2010, committee chaired by Mr A K Khandelwal submitted a report on
the HR issues of the PSBs. The committee has made various recommendations
intended to improve the employee productivity of PSB employees, including
relaxing limits on performance-linked incentives.
Succession planning for PSU banks will be done well in advance; CMD and ED
will be given longer tenure for effective implementation of strategies.
Most recommendations made by the committee are accepted; however,
consensus is yet to be formed. The final guidelines are expected soon.
Our view: We believe, if implemented, this too would be a step in the right
direction, and would improve the employee productivity for PSU banks. This would
also help banks resolve the issue of overstaffing. Moreover, if the current caps for
performance linked incentives are relaxed, it could help PSBs to improve employee
productivity to a great extent. All in all, we believe it should be a positive step for
PSBs in attracting right talent and improving productivity.
29 March 2012
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6. India Financials
Business per employee of PSBs (INR m; FY11)
Core OP per employee of PSBs (INR m; FY11)
:
:
Profit per employee of PSBs (INR m; FY11)
:
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7. India Financials
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