Indian Banking - Maneuvering through Turbulence: Emerging strategies

Indian Banking Maneuvering

through Turbulence: Emerging

strategies

© 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Foreword – CII

Sudhir Deoras ChairmanCII Eastern Region

During the last two decades of ‘unshackling’ its chains, ‘the elephant’ that is Indian economy seldom came across such challenges as it does now. The twin tasks of reinvigorating economic growth and reining in inflation during the times of dwindling rupee value, weak global demand and persistent current account deficit present a mesh of problems that need immediate and coordinated actions on the fiscal and monetary front.

India’s economic growth that sunk to a decade low of 5 percent last year continues to plague the economy. While the performance of key sectors such as manufacturing, farm and mining are below par, the reforms process that began last year failed to generate enough momentum to restore the growth figures.

Against this backdrop, the banking sector has an important role to play in stimulating economic growth. Banking, arguably the fulcrum of our financial system, is a sector that can really help in deploying our national savings towards infrastructure development. This will in turn stimulate economic activity on one hand, and help sustain a high growth rate on the other.

The bigger the challenges, more is the need for innovative ideas and strategies by bankers to counter risks. Banks also have a larger role to play in increasing financial inclusion. Proposed licenses for new banks raise hope for increased penetration and enhanced credit availability.

The central bank has taken several policy initiatives on compliance and governance – something that could redefine the contours of the sector and benefit the economy in the long run.

The volatile economic scenario has forced banks to try various business models either to increase their bottomline or manage risks better. Adoption of new technologies and a constant pursuit of innovation to improve products and services will be crucial.

In this context, KPMG as our knowledge partner for Banking Colloquium 2013 has prepared a report. The study attempts to capture the current scenario and detail of the strategies being adopted by banks, way forward to compliance and governance, financial inclusion, technology in banking, market risk hedging and proposed new banks.

We hope the report will help the industry understand the emerging strategies needed to maneuver through these times of turbulence.


Foreword – KPMG

Ambarish Dasgupta Head - Management Consulting KPMG in India

Banks face challenges from many sources—Indian economy slow-down is one of them. Few factors responsible for GDP growth rate of 5 percent could be an over-cautious monetary policy that could not deliver on lowering the inflation rate but contributed to increase in the borrowing costs, government’s pending decisions on a few strategic policies, high current account deficit and oil prices. The sharp depreciation and uncertainty of the rupee in recent times has further aggravated the problems of the Indian economy.

Slower economy leads to deteriorating asset quality which is already causing stress to the banking sector. The RBI estimates that the gross NPA ratio of banks may rise to 4.4 percent by March 2014 as compared to 3.42 percent in FY 13. NPA ratio was 2.94 percent in FY12.

In an uncertain environment, banks are extremely concerned with liquidity risk and concentration & correlation risks and have to develop tools to calculate economic capital that will integrate credit and market risks. Currency volatility is also giving few bankers sleepless nights. Another challenge facing the banking sector is that of compliance and governance. ‘Fit and proper’ guidelines were issued by the RBI for directors to ensure appropriate officials at the helm. To reduce systemic risk, regulators have also placed lot of checks and balances in the sector.

From tapping new segments in the SME sector to funding cross-country aspirations as Indian corporates go global, Indian banks are pursuing multiple strategies for growth in an uncertain environment.

The Public sector banks (PSBs) are much ahead of the Private sector banks in their overseas presence, constituting over 90 percent of 171 overseas branches as of March 31st,2013.

To meet these requirements and challenges, industry players are harnessing technology for creating innovative and cost-efficient operating models to sustain profitability and viability. Discussions have been on branchless banking but a branch avatar will never go out of picture for less-technology savvy customers. Banks are also deliberating on social media initiatives to reach out to urban and emerging class and SMAC (social, mobile, analytics and cloud) on a whole could bring a new perspective on customer experience and on creating a sustainable business.

RBI’s objective of increasing financial penetration and credit availability with reaching out to the bottom of the pyramid has resulted in giving out clear guidelines to the new banking entrants(whenever they are on board)—open one in four branches in rural unbanked areas! The successful banking aspirants would have their task cut out as they balance the twin objective of reaching out to the emerging India in the Tier 3 to 6 cities while achieving financial inclusion.

This paper is an attempt to discuss the opportunities and challenges that lie ahead of the Indian banking industry.



Contents

Financial inclusion - Quest for profitability

13

Emerging strategies of Banking sector

01

09Governance and Compliance – Gearing up for the next level

SMAC - Future of technology

17

19 Hedging the market risk

Merit in banking on new licenses

21

Over the past couple of years, the Indian banking sector has displayed a high level of re-silience in the face of high do-mestic inflation, rupee depre-ciation and fiscal uncertainty in the US and Europe. This has necessitated the banks in India to concentrate much more on operating efficiency, outsourc-ing and cost optimization now than ever before. With deregu-lation of savings bank rate and bleak global economy, the banks are focusing on alterna-tive sources of revenue, like fee income, trade and vendor financing, geographic expan-sion et al to maximize their revenues. The Banking sec-tor in India has adopted and embraced technology to keep pace with the international development in the banking industry and offer quality prod-ucts to its clients. Technology has enabled banks to conceive and deliver products that are more in line with the require-ments of its clients on the one hand and also more cost efficient on the other. We have captured few emerging trends in the Banking space that are gaining traction.


Emerging strategies of Banking sector

1 RBI - Statistical Tables relating to Banking FY 122 As per RBI definition - Rural: population less than 10,000; Semi-Urban: 10,000 and above and less than 1 lakh; Urban: 1 lakh and above and less than 10 lakh; Metropolitan: 10 lakh and above

Focusing on the emerging IndiaBanks and regulators alike have woken up to the growing needs of emerging India. While the credit disbursal of all SCBs has doubled from FY08 to FY12 to INR 48,215 bn1, the share of non metro regions in the incremental credit pie has increased from 30 percent in FY09 to 39 percent in FY12, indicating that the Non-metro regions are increasingly gaining share.

The number of bank branches in urban and semi-urban2 areas has been growing at a fast pace. Fifty eight percent of ~25,000 branches opened in last five years were in urban and semi-urban regions.

Incremental credit disbursed by SCBs (INR bn)

Source: RBI - Statistical Tables relating to Banks in India FY 12

1 | CII-KPMG Indian Banking – Maneuvering through Turbulence: Emerging strategies

CII-KPMG Indian Banking – Maneuvering through Turbulence: Emerging strategies | 2

Even the number of bank branches in urban and semi-urban areas has been growing at a fast pace. The growing economic activity and increasing per capita income have been crucial factors driving the credit growth in these regions. Fifty eight percent ~25,000 branches opened in last five years were in urban and semi-urban regions.

RBI is keen to improve the banking situation in rural areas and has mandated banks to allocate at least 25 percent of new branches in unbanked rural centers. Further, the increasing number of High Net worth Individuals (HNWIs) in the non metro areas is leading to an increase in demand for better or more sophisticated services, including Private banking and Wealth management; banks are not only focusing on numbers in the emerging markets within the country but also on the quality of services being delivered in these regions, based on type of clientele.

Population wise incremental branches in last 5 years

Source: RBI - Statistical Tables relating to Banks in India FY 12




Banks are constantly trying to increase their overseas expansion to meet the growing trade demandIndian banks have been increasingly growing their international presence in the recent past. In part to cater to the growing Indian diaspora in foreign countries (estimated at ~ 20 mn persons) and in part to meet the growing demands from cross border trade and economic activity.

The Public sector banks (PSBs) are much ahead of the Private sector banks in their overseas presence, constituting over 90 percent of 171

overseas branches as of March 31st, 20133. Many of the private banks do not have branches, but are present through representative offices.

Non resident Indians (NRIs) deposits aggregated USD 14.2 bn in the financial year ended March 2013, a y-o-y increase of 19 percent. The Indian Diaspora worldwide is estimated to be ~20 mn persons4 and is on a constant rise.

3 RBI Country-wise branches of Indian Banks at Overseas Centres as on March 31, 20134 Including Non Resident Indians and Person of Indian origin

5 Business Standard – June, 2013; http://www.business- standard.com/article/finance/icici-bank-for-more-branch- expansion-113062400758_1.html

The total trade, export and import, have clocked a 19 percent CAGR over the last year, period ending FY 13. The top trading partners are China, Middle East, US, HK, Singapore et al. The Banks have shown particular interest in opening branches in these regions which have a strong trade relationship with India. Total trade with China has grown at 17 percent CAGR from FY10 to FY13 and this has enticed banking players to open branches in China. For example, Axis Bank recently got permission from RBI to open a branch in China and ICICI Bank is awaiting RBI’s approval for the same. ICICI Bank is looking for foreign expansion by opening branches in Australia, South Africa and Mauritius5.

PSBs are also aiming to expand their presence abroad. SBI wants to explore territories where Indian Banks haven’t tread yet, like Latin America. Dena Bank is also awaiting RBI’s permission to open branches in US, UK and Africa. Overseas expansion in PSBs might be constrained on account of the limited capital headroom they have for such ventures, and the Government being hard pressed to find funds for recapitalizing PSBs. Therefore, PSBs might be very careful in their selection of target markets compared to well capitalized PBs.

Top Exports Markets (FY 2013, USD bn) Top Imports Sources (FY 2013, USD bn)

Country-wise branches of Indian Banks at overseas centres as on March 31, 2013

Source: Ministry of Commerce & Industry, Government of India

Source: Reserve Bank of India

Others include:Afganistan, Australia, Bahamas, Bahrain, Bangladesh, Belgium,

Cambodia, Cayman Islands, Channel Islands, France, Germany, Israel, Japan, Kenya, Maldives, Qatar,

Saudia Arbia, Seychelles, South Africa, South Korea, Oman, Thailand,



Supply Chain Financing (SCF) is gaining traction in IndiaSCF is rapidly gaining attention in international markets and is growing at a pace of 30 – 40 percent at major international banks according to a research6. Key elements of SCF include factoring, invoice discounting/reverse factoring, purchase order/invoice data management, bank assisted open account, open account payment, export/seller finance and buyer side finance. All the products aiming at providing better liquidity to the corporates and their entire value chain at lower financing rates. Currently, the growth in this domain comes from US and western European countries, but the future growth is expected to come from emerging economies like India and China.

With various government policies supporting exporters in India, the export credit is growing at a rapid rate (Three year CAGR at 14 percent and five year CAGR at 22 percent). A part of this is also supplier financing, which has been gaining popularity.

Banks are increasingly focusing on increasing their business from SCF. This can be witnessed in growing number of branches in Industrial units. The banks are holding awareness campaigns and seminars to educate the corporate world of the benefits of SCF. Certain players are focusing on developing expertise in particular sectors.

Factoring and reverse factoring have not gained much momentum in India and still offers an untapped market. Factor products offer greater flexibility compared to other instruments used for working capital finance. Although receivables enjoy property rights and are transferable, a statutory framework for factoring was introduced only in 2011 by way of the Factoring Regulation Bill.

Outstanding advances of SCBs to exporters (INR bn)

Source: Monetary policy department, RBI (http://www.rbi.org.in/scripts/PublicationsView.aspx?id=14681)

6 Demica Research, 2013

“In the context of serving our clients responsibly, value chain financing is an integral part of our business strategy covering both, our corporate clients as well as their vendor partners, who are largely SMEs. We have further sharpened our focus on this format of ‘supply-chain’ financing to meet priority sector obligations, given that our distribution network limits direct access to such borrowers.”

Abhijit Sen – CFO, Citibank




The Factoring bill essentially protects micro and small businesses from delayed payments for goods and services by larger entities. Traditional banks used to provide loans based on the borrower’s (i.e. the MSME player’s) ability to service the loan. Factoring will however evaluate the lending decision based on the ultimate debtor (i.e. the ultimate customer of the MSME). This will greatly improve the liquidity and working capital problems of MSME players.

With favourable legislations, factoring is gradually taking off in India. The Indian market constitutes a mere one percent of the world’s factoring market and 0.5 percent of the working capital requirement of Indian companies7 and is constantly growing.

As illustrated above, there is a huge gap between Indian factoring market and the international counterparts and offers a great opportunity for Indian banks to capture this gap. The factoring industry in India is dominated by PSBs and financial institutions. SBI Global Factors is the market leader with 80 percent of the market share. Other players include CanBank Factors, DBS, Axis Bank, HSBC and Standard Chartered7.


7 http://www.indiafactoring.in/Admin/DocFile/161-1204201 2%20-%20financial%20express.pdf

Indian factoring market in the last decade

Source: Factors Chain International

Comparison with major Asian Markets

Source: Factors Chain International

International

Domestic



8 Gartner Research- http://www.gartner.com/newsroom/id/23191159 Reserve Bank of India

Focus on improving operating efficiency and outsourcingWith increasing competition, emerging customer demands, regulatory interventions, technology-led disruptions, higher shareholder expectations, Indian banks are being forced to constantly review and revisit their operating models. The resulting changes are making Indian banks nimbler, more cost efficient, better focused on customer services and witnessing good returns through fee based services and products.

Indian banks are constantly optimising the use of technology as the change agent, in order to improve operational efficiency and enhance customer experience. It is estimated that Indian banking and securities companies will spend INR 416 bn (USD 6.75 bn) on IT products and services in 20138, which will be 13 percent increase from INR 370 bn (USD 6.0 bn) spent in 2012.

Emergence of low cost channels like internet banking, mobile banking, and mobile ATMs have been successfully implemented by many players and have also found wider acceptance in the customer base. This has led to enhanced focus on digital banking and self-service channel usage to reduce the cost of operations. The number of mobile banking transactions doubled to 5.6 mln in January 2013 from 2.8 mln in January 20129. The value of these transactions increased three-fold to INR 625 Cr (USD 105.73 mln) during the month from INR 191 Cr (USD 32.31 mln).

Banks have either centralised mid/back office processes through a shared services center or have outsourced their technology requirements to a third party. In addition to focus, this also gives banks a huge cost advantage.

For example, Indian market has witnessed an increasing number of ATMs under outsourcing management. By outsourcing their ATM management to service providers like Fidelity National Information Services (FIS), the bank is able to focus on its core business expansion and customer service initiatives - allowing for more rapid growth while ensuring its customers have a high-quality, reliable ATM service. FIS the market leader and world’s largest provider of banking and payments technology manages about 11000 ATMS across India.

Karnataka Bank is the latest to join more than half of India’s top 30 banks who rely on FIS’. By outsourcing the management of its ATM estate to FIS, Karnataka Bank would be in a position to release vital capital to redeploy on core activities, increase operational efficiencies, provide better service to its customers and insulate itself from technology obsolescence. The announcement made by Karnataka Bank in May 2013 underscores a growing trend in India for banks to contract non-differentiating services, such as ATM driving, to expert providers such as FIS. Banks benefit by redirecting investments tied up in ATM equipment and operations to more strategic areas, thus deriving operational efficiencies. In addition, banks can leverage the ATM driving expertise of FIS to deliver a high-quality and reliable ATM service to their customers.

While transaction based banking operations are being successfully streamlined, Priority Sector Lending and Financial Inclusion still remain a challenge. The section on Financial Inclusion in the report elaborates on how to create a profitable model to deliver rural credit.

“Indian banks are now getting to be somewhat mature users of technology and are investing significantly in good data mining solutions to understand the behavioral trends of customers and offer intelligent cross sell solutions to customers, primarily to improve productivity. There is also concurrently an increasing trend towards outsourcing to retain flexibility, manage scale more efficiently and cut operating costs, essentially to leverage on partners’ strengths in specific areas”

Jaideep Iyer – Group President, Financial Management, Yes Bank



Max Life insurance. With the increasing trends in insurance penetration on both life and general insurance side, banks identify this as one of the key drivers of fee income growth.

Retail fee income is another area where banks have increased focus to augment their growth. Retail fee income of banks typically comprises commissions they earn from sale of third-party products, like insurance and mutual funds, transaction charges on savings and

current accounts, processing fees on consumer loans and credit cards, and fees from foreign exchange transactions and remittances.

Private sector banks are specifically focusing on income on foreign exchange transactions and remittances. Axis Bank, the third largest private sector lender in the country, reported close to 43 percent rise in retail fee income in FY13.


Changing dynamics of fee based income portfolioFee income has gained significant focus as a source of revenue in the past decade. With the rising pressure on cost of funds, it is imperative for banks to look at other avenues to boost their income. The fee income in FY 13 for 67 banks in our sample set10 was INR 64,418 Cr; clocking a three year CAGR of 12 percent and five year CAGR of 15 percent.

PSBs have constituted a large part (60 percent) of this basket since the beginning, owing to their reach and size.

Pressure on fee based incomeHowever, in recent times with the overall pressure on the economy and changing regulations, the fee based incomes of banks have come under pressure. Banks earned lower corporate banking fees due to slowdown in project finance. Also, with The Reserve Bank of India’s (RBI) recent measures to tighten liquidity and curb volatility in foreign exchange rates have led to a rise in bond yields leading to a drop in treasury incomes for banks. On the retail side, fee income earned by banks on account of sale of gold coins has dried up with the government banning sale of gold coins by banks. These factors have necessitated banks to revamp their fee based product portfolio.

Emerging trendsBanks looking to increase fee-based income are shifting focus to selling life insurance and general insurance policies (through bancassurance tie ups or as insurance brokers). Indian bank recently partnered with United India Insurance and launched a web portal for its ‘Arogya Raksha’ group mediclaim insurance policies. Moving forward, the bank is in talks with a life insurance company for a similar tie-up in the life insurance space. The bank expects a 30 percent11 growth in income from insurance this fiscal. Some of the other recent bancassurance tie-ups include PNB with Metlife and Axis Bank with

10 The sample set comprises of 26 PSBs, 18 PBs, and 23 Foreign banks11 http://articles.timesofindia.indiatimes.com/2013-06-14/india-business/39975382_1_fee-income-fee-based-income-fy-13

Fee Income (INR Cr)

Source: KPMG-Business Today Best Banks December 2012



The banking sector is crucial for an economy since it channelises savings into investments. It provides credit to the productive sectors and finances the needs of the real economy. For emerging economies, banks are more important since they are important drivers of financial inclusion and economic growth. Banks by nature are highly leveraged and interconnected. Hence, poor governance or failure in banks can trigger bigger crisis and threaten stability of the economy.

Banks in India are well regulated with The Reserve Bank of India adopting a forward looking yet cautious approach. In the 1990s, the tone of banking regulation shifted from prescriptive to prudential, shifting the onus from regulations to corporate governance. Various guidelines were issued over the years to improve corporate governance in banks. To get competent directors on board, the RBI issued ‘fit and proper’ criteria for directors which said that private banks should carry out due diligence to determine the suitability of the person for appointment as a director based on qualification, expertise, track record and integrity.

Governance and Compliance – Gearing up for the next level

In 2005, the Ganguly Committee recommended separation of Chairman and MD roles. The recommendation was implemented in private banks. The RBI also issued guidelines on ownership and governance in private banks to ensure that ownership and control of banks are well diversified and thus not detrimental to depositors’ interest. Moreover, any acquisition of shares in private sector banks resulting in a shareholding of 5 percent or more of the paid up capital requires the RBI’s prior approval. Banks are also mandated to have committees on audit, nominations and remuneration, fraud monitoring, and customer services. All these provisions put the corporate governance framework adopted by Indian banks on par with international standards.

Although improving regulatory landscape is a welcome move, regulation in isolation is not enough. It is a necessary but not a sufficient condition for good governance. Regulation can complement governance, not replace it. Good governance has to be institutionalized by individual banks for it to be effective. While broadly Indian banks have good governance standards, there is room for improvement.

In the sections below, we take a brief look at the important issues in governance and compliance in Indian banks and how they can be addressed.

Governance in Indian banksThe financial crisis of 2008 brought inadequate governance in banks and other financial institutions in sharp focus. Experts argue that simplistic assumptions and lack of rigorous questioning by bank boards led to the crisis. Banks’ boards, management, and employees faced conflict of interest routinely in their jobs. When faced with a conflicting situation, compensation structures in the financial sector, which should have ideally pushed the decision makers towards the better choice, instead encouraged excessive risk taking.

Once the crisis started in one area of the financial sector, it spread to other areas quickly due to blurred boundaries between banking, insurance and asset management businesses. Although Indian banks came out of the crisis relatively unscathed, they (particularly the public sector banks) face peculiar governance challenges in the form of government control.




Government’s control over public sector banksThe Indian banking sector is character-ised by the dominance of PSBs which account for approximately 70 percent of the industry1. The government through its agencies owns majority stakes in these banks and exerts influence through its monetary policy and direc-tives.

In the context of PSBs, it is difficult to adhere to public ownership and yet give near total autonomy to their boards as compared to private sector banks where the board has autonomy and all shareholders are treated at par.

Bank Subsidiary Model needs to be reassessedAnother governance related issue in Indian banks is the corporate structure they follow. Currently in India, the bank subsidiary model is popular. Under this model, non-banking activities such as insurance, asset management etc are done in separately constituted subsidiaries of the bank. This model has its own set of problems and disadvantages. E.g. firstly, losses of subsidiaries could substantially damage the financial health of the bank and risk the safety of deposits. Secondly, since the bank will be responsible for equity infusion in the subsidiaries and their management, having several subsidiaries could stretch the bank’s finances and other resources. Thirdly, the proportion of foreign holding in holding banking company is not taken into account for the purpose of calculating the cap of foreign holding in subsidiaries. And finally, the subsidiary model could lead to ‘excessive leverage’ by the downstream affiliates.

The Shyamala Gopinath Working Group appointed by the Reserve Bank recommended that the financial holding company model should be preferred for the financial sector in India.

Revising the compensation structure to improve governanceAfter the 2008 financial crisis, compensation structure in banks came under sharp focus and criticism. Now it is widely acknowledged that aggressive and irrational incentives and excessive risk taking by bank executives fuelled the crisis. The compensation structure at times encouraged compromising long-term interests for short-term gains.

To check excessive risk-taking behavior, the RBI issued guidelines which aligned compensation structures with prudent risk taking and instituted a claw back mechanism. However, as of now there is no consensus on what is a good compensation structure for non-executive directors. Currently non-executive directors are paid sitting fees. There is a school of thought that believes that non-executive directors should be paid a regular or a fixed contractual remuneration. Although this is a good idea, it is difficult to implement in practice. Firstly, non-executive directors typically serve for shorter periods and have term limits. Secondly, in banks the results of risks taken manifest after a long gap. And finally since non-executive directors serve on several committees comprising of many directors, it is difficult to apportion responsibility on them individually. Hence, aligning non-executive directors’ compensation structure with outcomes of corporate governance is still a grey area.

Separating the roles of Chairman and Managing DirectorIn 2005 the Ganguly Committee appointed by the RBI recommended that the posts of the chairman of the board and the CEO of the bank should be bifurcated. The committee argued that this will bring about more focus and vision and necessary thrust to the functioning of the top management of the bank and also provide effective checks and balances. The committee’s

recommendations were implemented in private sector banks in 2007. However, the finance ministry did not favor the proposal and hence it was not adopted in public sector banks except in SBI and associates.

Allowing corporates into the banking spaceThe RBI has received 26 applications for new banking licences2. However, there is a lot of debate on whether large corporates should be allowed to start a bank. International experience in this regard has been mixed. While corporates can bring in professional management experience and capital, many experts fear that they will use the bank as a private pool of readily available funds.

However, to avoid this, the RBI has built in several safeguards in the new banking licence guideline. To keep non-serious players at bay, the guideline says that the applicant entity/group should have a past record of sound credentials and integrity, should be financially sound and have a successful track record of 10 years. It also underlines the importance of diversified ownership. It says that a Non-Operative Financial Holding Companies (NOFHC) should set up new banks. The NOFHC should retain their equity capital in the bank at a minimum of 40 percent for fuveyears after which they should reduce to 15 percent within 12 years. The guideline also has criteria on financial inclusion.

The above provisions clearly show that the regulator wants new banks to have good governance standards. Failing to meet the aforementioned conditions could have serious repercussions for new banks.

1 Reserve Bank of India

2 RBI Press Release “RBI discloses the names of applicants for new bank licences in the private sector”, Jul 2013



Importance of compliance at banksCompliance for banks is given a lot of importance as they are the engines of a country’s economy and, therefore, also more regulated. In fact, post the financial crisis regulatory supervision of banks has increased noticeably, underscoring the increasing importance of ‘regulatory compliance’ for banks.

Evolution of banking regulations and enforcement In 2010, Basel Committee on Banking Supervision (BCBS) issued comprehensive Basel III guidelines to improve the banking sector’s ability to absorb shocks arising from financial and economic stress. The guidelines recommend more stringent capital and liquidity requirements apart from suggesting enhancements to Basel II and market risk frameworks. In the same year the US introduced Dodd-Frank Act to enhance financial stability, orderly liquidation and other host of measures to ensure measures directed at hedge funds, insurance companies and banks.

Similarly, in India, RBI has been issuing a host of directives to improve governance and compliance at Indian banks in the last two years. Specifically, the regulator has issued key directives aimed at enhancing corporate governance at NBFCs, enhancing know your customer (KYC)/anti-money laundering (AML) norms, tightening regulatory oversight at foreign banks by making CEOs of such banks responsible for compliance, structuring the credit approval process by recommending a board-level credit committee, etc. The new guidelines for issuance of banking licenses are also indicative of this trend.

RBI is also strengthening its enforcement efforts. Its recent orders penalising 19 commercial banks for mis-selling derivative products to clients and 3-4 banks for violation of KYC/AML norms is indicative of this trend. Additionally, RBI recently constituted a High-Level Steering Committee which recommends the regulator to transition to a risk-based supervision (RBS) approach, which entails determining the intensity of supervision based

on a bank’s risk profile. This would necessitate banks to strengthen their governance, risk management and compliance frameworks.

Banking community’s response to this evolutionOften, companies tend to respond to more regulations, increased scrutiny and instances of wrong doing with another checklist or another layer of control or redundant procedures. This may or may not address the issue permanently. More importantly, this spontaneous reaction could create multiplicity in rules, increased compliance costs, unwanted bureaucracy and delayed decisions.

The spontaneous reaction is to a certain extent because organisations view compliance as a mere ‘cost of doing business’ and as an impediment to their operations. This could be counterproductive and often lead to misdirected compliance and control. This in turn could lead to overlapping and inconsistent rules and regulations that are difficult to comprehend or requirements that without a clear purpose or intention and remain merely on paper.

In fact, banks stand to gain more if they leverage compliance as a ‘value driver’ and comply with laws of the land ‘in sprit’. This comes from a good understanding of the consequences of non-compliance – on the bank and on the industry/economy as a whole – at all levels of the organization.

Compliance as a ‘value driver’In order to leverage it as a value-driver, banks should adopt a compliance framework that is proactive, rigorous, co-operative and pervasive.• Proactive: Addressing compliance

proactively involves a two-pronged strategy of assessing compliance risks, including upcoming ones, and inducing appropriate changes in policies, processes and controls to address these risks. It involves implementing best practices by complying with the ‘spirit’ of the regulations than merely the ‘letter’ of it.

• Rigorous: Adopting a ‘zero-tolerance’ approach to non-compliance involves making efforts to curtail all sorts of non-compliance and not just ‘material’ ones. Any non-compliance in regards to regulations is viewed seriously, regardless of the extent of the regulator’s supervision, and corrective actions are implemented in a timely manner to curtail any such future instances of non-compliance.

• Co-operative: Making the process co-operative involves leveraging the synergy of compliance initiatives across the organisations and avoiding any duplication of efforts. This reduces the cost, complications and inconsistencies in regulatory compliance for banks. One of the ways to achieve this is by establishing an empowered, independent compliance function.

• Pervasive: Introducing a pervasive approach involves making compliance with regulations or the bank’s internal rules everyone’s responsibility. The bank’s employee performance system accords as much importance to compliance KPIs as given to business KPIs. It also involves timely training and communication to educate employees on the ‘intent’ behind regulations and the bank’s internal rules.



ConclusionIndian banking sector is at an inflexion point. To meet the demands of India’s huge potential, heavy infrastructure spending, and the government’s ambitious financial inclusion plan the banking sector will have to gear up for unprecedented challenges. To prepare for the upcoming challenges, the government formed a commission with a task of overhauling the regulatory landscape of financial sector. The commission – Financial Sector Legislative Reforms Commission – drafted a code called the Indian Financial Code (IFC). The IFC has called for a unified regulator for the financial services sector which will regulate insurance, capital market, pension funds and commodities derivatives market. It has recommended that the RBI should continue to exist outside the unified regulator although with modified functions of setting monetary policy, regulating banks and payment systems.

To what extent the RBI’s functions will be modified is not known yet. However, one of the most important challenges the sector is likely to face is the challenge of governance and compliance. Achieving optimal growth, balancing stakeholder expectations and complying with regulations is likely to be a tight rope walk for the sector. However, with support from the RBI and the government, it is likely to be a rewarding experience.



Financial exclusion has been an area of concern and casts shadows over the long-term sustainable growth of the Indian economy. Though the country has had a large unorganized sector (consisting of money lenders, chit funds, etc.) providing the financial services for a long time, the reach of the organized sector (banks, NBFCs, MFIs, NGOs, etc.) remained limited. The unregulated unorganised sector players, with their strong focus on earning profits, did little to bring in the financially excluded people in the mainstream.

The central bank prescribes the following four basic financial services to be provided to any individual to count her as ‘financially included.’• Access to basic savings

account• Availability of affordable

credit• Access to remittance

services• Opportunity to buy

insurance and investment products.


Financial inclusion - Quest for profitability

Data released by the World Bank depicts that on an average Indians over the age of 15 years remain considerably under-banked as compared to their global peers. While almost half the global population above 15 years has an account at a formal institution, the figure is only 35 percent in India. The scenario is even worse in case of female population. Looking at the same metric for the bottom 40 percent of the population by income, 41 percent population globally has an account as compared with 27 percent in case of India.

Financial inclusion status for population above 15 years: global comparison (in %)

Source: “India Commercial Banking Report - New Permits To Boost Competition In Underbanked Economy,” ISI Emerging Markets, accessed on 26 August 2013




Even the extent of financial exclusion in India is widespread as reflected in the following facts.1

• Highest number of households (145 million) excluded from banking

• 50 percent of the population does not have bank account

• Only 34 percent of the population engaged in formal banking

• Only 17 percent of population has any credit exposure especially in remote villages

• Out of 600,000 villages, only 30,000 (5 percent of total villages) have commercial bank branch

• Only 10 percent have life insurance cover while just 9.6 percent have any non-life insurance.

The policy makers have adopted a multi-pronged approach to address the issue of financial exclusion. Key elements of the strategy include:

• Evolving regulatory guidelines with development perspective

• Deepening banking reach and coverage

• Introduction of Innovative products

• Encouraging use of technology

• Financial literacy and financial inclusion- synced approach.

There has been an intense debate on the appropriate model for FI. RBI has favored bank-led model instead of the technology-led model which has been successful in many other countries. The model allows the country to leverage existing branch base for a planned, structured and sustained FI process. It also reduces the risk given the low literacy levels (and even lower financial literacy) of the potential set of customers leaving them vulnerable to players either not regulated at all or not regulated by the RBI.

Till date, India has had a limited success in achieving FI with the model. However, given the Indian scenario, the model facilitates a consistent and planned move towards the goal of FI while maintaining the financial stability.

Challenges in reaching out to the under-banked• Infrastructure: Both physical and digital connectivity are essential for institution

to provide financial services through a mix of channels depending on the cost and type of services offered. To illustrate, the widespread use of the kiosk banking has been inhibited by poor connectivity in the hinterland.

• In terms of credit, lack of credit history and limited collateral poses a challenge: Credit bureaus have not expanded their reach much to the rural areas; hence banks are hesitant to hand out loans to the under-banked with limited documentation in terms of proof of income. Also, asset ownership is limited and generally restricted to farm land with no clear documentation.

• Varied profile of consumers: Banking needs vary according to the customer profiles and due to diversity in population, it becomes difficult for bankers to understand this segment.

Global FI models and relevance for IndiaMany of the scalable and successful experiences globally have been led by telecom companies with the banks playing a secondary role.

• M-Pesa in Kenya: Parallel banking ecosystem managed by telecom companies, allowing the consumers to make majority of mobile banking payments, transfers and transactions on their mobile phones. It is a cost effective and adaptable system which has brought many people into the formal banking system and has grown rapidly with client base of around 10 million, roughly 40 percent of Kenya’s adult population.

• USAID MABS in Philippines: Microenterprise Access to Banking Services (MABS) assists network of partner rural banks in the development and introduction of innovative products, including mobile financial services. It’s a successful model that has more than 90 MABS-supported rural banks managing around 250,000 microloan borrowers and 1.5 million micro-savings accounts. These banks have also registered more than 250,000 mobile phone banking clients and have processed more than USD250 million in mobile banking transactions. This model could be used to provide training and technical assistance to rural banks in India which could give a boost to innovative product launches in the rural segment.

• MTN Mobile Money in South Africa: Mobile operator MTN and Standard Bank, through their joint venture MTN Banking, launched a mobile banking product MTN MobileMoney. Every MTN SIM card has an embedded banking application and only MTN subscribers can open MobileMoney accounts. Under MTN MobileMoney, 1.6 million people are registered users with over USD90 million transacted every month. Although Indian banks have started teaming up with mobile operators for providing banking services to unbanked people, banking regulations do not permit a lead role for telecom companies in India.

1 “Financial Inclusion and Financial Literacy – Indian Way,” Dr. KC Chakrabarty, RBI

“Our experience shows that the goal of financial inclusion is better served through mainstream banking institutions as only they have the ability to offer the suite of products required to bring in effective/meaningful financial inclusion.

The development of the habit of banking would lead to an increase in savings and investment improve the efficiency of allocation of capital and increase the ability of monetary authorities to stabilise the economy in times of crisis.”

Deepali-Pant Joshi – ED, Reserve Bank of India


Way forwardA meaningful FI could be achieved only through a collaborative effort of all the stakeholders involved. Policymakers could help provide a facilitating policy framework, infrastructure support and enabling environment whereas service providers should experiment with different models to serve the unbanked. Further, there has to be collaboration among service providers with financial institutions partnering with telecom, technology, and consumer product providers to create an enabling environment.

Government and regulator’s initiatives RBI has already made it very clear that the new banks, that will be given licenses, have to open one in four branches in rural areas. Premises of allowing new banks in the sector is to reach out to the bottom of pyramid.

• Improve Financial Literacy: The GoI and RBI should put in place a country-wide strategy to provide financial education using standard literacy material both as part of the school curriculum and as a part of the kit to educate adults.

• Aadhaar card: The nation-wide initiative to provide a unique identifier to every Indian, could be integrated with the service delivery mechanism. It could help address the main issue of complying with the ‘know your customer’ (KYC) norms that banks perceive to be probably the biggest hurdle in expanding their reach. Successful integration of Aadhaar with banks’ database would also allow banks to have a 360 degree view of their customers to better manage risk and cross sell more services.

Banker’s initiatives• Simplicity is the key: Due to

financial ignorance, developing simple easy to understand product for the rural population is the key to success.

• Leverage technology to develop innovative operating models: As discussed above, technology-based initiatives are leading examples for success in FI. BC channels and other low cost delivery models such as mobile banking would help bankers reach out to the bottom of pyramid.


“Microfinance sector has been quite successful (As a sector we reach around 2.5 crore women in India) to take financial products to poor and excluded but fallacy is that we are not considered an important channel of financial inclusion as a very important financial service i.e. acceptance of credit is beyond purview of MFIs. There is no reason to undervalue the potential of this channel, before looking to some other industry for solution.”

Chandra Shekhar Ghosh – Chairman & MD, Bandhan Financial Services Pvt. Ltd.






Traditionally banks have been the pioneers in harnessing new technology trends. The applicability of Moore’s law in the areas of telecommunication, internet and mobility were significant enablers for banks in achieving two extremely important business objectives – revenue enhancement with cost efficiencies. In existing times, the financial services industry is keenly exploring the transformation potential of the new generation of technologies available like Social media, Mobile, Analytics and Cloud (SMAC).

The increased commoditization of service offerings from banks has placed incessant demand on them to adopt variable cost structures, increase revenue, improve products and services, expand market share and achieve nonlinear revenue growth.

The Indian banking industry has to its credit a number of innovations, many of them driven by technology investments.

SMAC - Future of technology

The Indian Capital Markets sector moved to a T+2 settlement cycle, long before many developed economies. Similarly the introduction of NEFT and RTGS were watershed moments in India’s payment landscape which enabled a significant shift to electronic payment forms at a lower cost. The Pan India UID program when linked to financial transactions is expected to significantly plug the current leakages in Government welfare schemes.

In the current environment, the key focus areas of bank are lowering cost of funds, faster rollout of products achieving financial inclusion and priority sector lending targets in a profitable manner, compliance with various national and global regulatory norms and increased customer satisfaction.

Social mediaSocial media can be used as an effective tool to interact with the customers regarding queries and complaints. Once the queries or complaints have been posted on the social media page, the financial institution representative can address it in a timely fashion. If the activity requires any exchange of sensitive information, the financial institution may contact the customer directly using a secured channel of communication. Hence, social media can be efficiently used as the first level of query resolution and as this is a non core activity which is moved away from the branch and other delivery channels, it leads to cost savings for the firm.

Social media, being multidirectional, allows customers to convey sentiments regarding the firm. Therefore, it would be prudent for financial institutions to have presence on social media to gauge the attitude of the customers. In case of public airing negative sentiments, the financial institution can act swiftly thereby containing the issue.

The fundamental use that a social network can serve a financial institution is brand awareness. Financial institutions can engage the users of social media in different ways such as by displaying special offers and discounts, asking questions or conducting polls, displaying industry related news and opinions, etc. Engaging the social media users effectively can result in increase in brand awareness at a significantly lower investment compared to mainstream media.

However social media is considered to be unchartered territory under the apprehension that it is still evolving and it would be prudent to engage only after it has reached a mature stage.




MobilityIn a land where almost a billion people own mobile phones, cash is still king and large swathes of the population have no formal bank account, mobile payments are quickly becoming a critical part of India’s economy. Mobile phone penetration is booming and – while levels have not quite reached that of some Asian or European countries – few people in either the cities or the furthest reaches of the countryside are without some level of access to a mobile phone. Banks, on the other hand, are few and far in between; in fact, it is estimated that only about a quarter of all Indians have a bank account, while more than 60 percent own a mobile phone. Faced with these dynamics, it does not take long to realize that mobile payments will ultimately bring transformation to not only the payments industry, but society at large.

One of the most promising signs of India’s leadership in mobile payments comes from the high level of cooperation within the industry itself. On both the banking and the telecoms sides, we are seeing players come together and put aside their competitive differences in order to develop common standards and approaches to mobile payments. All stakeholders - banks, telecoms operators, technology providers, regulators and government organizations - have created the Mobile Payments Forum of India (MPFI), and are collaborating to address the market needs.

As a result, India has witnessed the ascendency of two initiatives that, together, are accelerating growth of the mobile payments market. Interbank Mobile Payment Service (IMPS) - a platform developed by National Payment Corporation of India is already adopted by more than fifty of India’s banks to offer instant payment and remittance services using SMS, WAP, and a range of mobile apps.

CloudThe advent of cloud computing has resulted in the dismantling of traditional cost structures. It enables organizations to shift from a CAPEX heavy model to a variable cost model. Software licenses,

servers, networking equipments, storage devices are typically considered to be the key CAPEX components. In a cloud model, the bank pays for what it needs when it needs it. Cloud also allows a bank to scale its business operations.

Using cloud services, it is easier to collaborate with partners and customers, which can lead to improvements in productivity and increased innovation. Cloud-based platforms can bring together disparate groups of people who can collaborate and share resources, information and processes.

The ability to respond to rapidly changing customer needs is a key competitive differentiator. Like companies in other industries, banks are continuously seeking ways to improve their agility and adjust to market demands. By enabling businesses to rapidly adjust processes, products and services to meet the changing needs of the market, cloud computing can facilitate rapid prototyping and innovation, which helps speed time to market.

However the adoption of cloud in banks has not achieved the scale that was originally envisaged. Security and Data Privacy concerns are attributed as some of the key reasons for this. Additionally banks are also concerned by risks of provider performance and downtime. The tax implications of using cloud services are also one area that some banks seek clarity on.

AnalyticsThe role of analytics has evolved from being a simple support function to that of a key business differentiator.

Analytics today can be effectively deployed at every stage of the consumer lifecycle. The Know your customer (KYC) activity in the customer onboarding process is increasingly dependent on analytics tools to identify the right set of customers. Anti-money laundering (AML) monitoring is another aspect where complex algorithms are used to identify reportable transactions. Similarly consumer spend analysis can assist banks in identifying cross sell and up sell opportunities. Loan originators

and servicers can differentiate themselves in the marketplace with superior underwriting techniques and sophisticated models that can predict potentially non performing portfolios with a high degree of accuracy. Analytics also is playing a significant role in optimal product pricing.

The banking industry is replete with examples of retail banking service providers that have harnessed the capabilities of analytics. As the banking industry gets more complex, analytics is forecasted to have a even more significant play.

Way forwardThe collective usage of SMAC has a multiplier effect on the benefits delivered. These tools can be applied at different stages of any typical banking process. For example, the data generated by users’ social media postings can be coupled with location-based data from their mobile devices, which can, in turn, be analysed in real time on a virtual cloud platform. The explosion of data and analytics technology allows banks to store, manipulate, and analyse greater volumes of data and extract meaningful insights about customers’ preferences.

This comprehensive view of the customer can be used to effectively engage existing and potential customers through tailored marketing strategies. Services and products can be presented based on customers’ preferences. Individualised sales and marketing strategies can help banks target different customers for easy mobile deposits, mortgage loans, small business loans, and so on.

Ultimately, this granular, 360-degree customer view made possible through SMAC technologies can improve the loyalty of existing customers, help banks engage these customers in new services, and increase the market share for banks by attracting new customers.



Banks have long faced the risk of losses from undesirable market movements. This signifies that institutions should have the best possible approaches to understand, model and manage market risk and to estimate capital reserves they need to provide as buffer against their market exposures. As Indian banks moves towards the Value at Risk (VaR) based approach to capture trading book risks, this chapter captures some of the challenges banks need to focus on before the banks migrate to the new regime.

Hedging the market risk

The trading book supervisory regime introduced in 1996, requires financial institutions to measure risks resulting from the transactions held in their trading book and to cover market risks by regulatory capital. Market risk includes: interest rate risk, equity position risk, settlement and counterparty risk and foreign exchange risk. This regime offers firms the use of either a standardised approach or an internal models approach to calculate the capital requirements associated with the trading book. Most of the internationally active banks favour the internal models approach, built on the Value at Risk (VaR) methodology. Both the general risk, arising from general market movements, and the specific risk, related to changes in the credit quality of issuers, to be covered by adequate capital.

During the 2008 financial crisis it became evident that many banks had built up materially undercapitalised trading book exposures. The revisions introduced under Basel 2.5 aimed to reduce cyclicality of the market risk framework and to increase the overall levels of market risk capital held by banks, particularly for those areas exposed to credit risk. It introduced measures through incremental risk charge (“IRC”). However, regulators are still of the view that the market holds inappropriate levels of capital with regards to the Trading Book. The Basel III requires banks to carry out Credit Valuation Adjustment (CVA) capital charge to protect themselves against the potential mark to market losses associated with deterioration in the creditworthiness of the counterparty, if the deals are done in OTC market.

Complete assessment of risks in trading bookIn addition to the increase in default risk, the growing presence in trading book, of corporate bonds and structured products, which are generally less liquid, has resulted in an escalation of certain types of risk. The latter, which include liquidity risk, concentration risk and correlation risk, are not fully addressed in current regulations on market risk.




Going forwardThe Basel Committee is also considering replacing “Value at risk (“VaR”)” measurement by expected shortfall (“ES”). ES is a method of measuring the riskiness of a position by considering both the size and likelihood of losses. ES has advantages over VaR as it captures tail risks.

The current volatility in “Currency Market” is clear demonstration of how abruptly market conditions and volatility can change. In fact far from extreme events, the high volatility has become almost a part of the normal market conditions. Being concerned about the situation, RBI in a draft circular last month, has put the onus to banks on measuring the effect of volatility to its corporate clients. Based on the impact on the earnings of its clients, banks have to enhance the provisioning requirements and in high volatile cases (where earnings are affected by over 70 percent) the risk weights to corresponding client increases by 25 percent. With the current volatility, decline in asset qualities and new capital norms (Basel III), many banks are looking to raise fresh capital. The banks also need to strengthen the ‘Oversight’ Board to review the trading book positions and take appropriate actions swiftly to save the interest of the institution. To aid the process, strong technology platform along with appropriate analytics are essential pre-requites.

But if the cost of doing business remains high the business could simply be switched into unregulated or more lightly regulated institutions such as hedge funds. Perhaps the pendulum is shifting too far to the side of conservatism and will make traditional banking difficult and bring about newer models of delivery of financial products in the global economy.

Liquidity risk

The liquidity of a financial instrument plays a key role in determining the holding period for a bank of such an instrument and therefore in assessing the regulatory capital requirement to which it is subject. In general, credit risk in the trading book is subject to lower regulatory capital requirements than in the banking book. The difference in capital can be mainly attributed to the different time horizons on which the risks are assessed: one year for credit risk (corresponding to a horizon for estimating the probability of default of the issuer) and ten days for market risk (corresponding to a horizon for the closing out or hedging of positions).

The preferential treatment granted to the trading book can be ascribed to the fact that the positions are held for short-term sale and they can be easily unwound or hedged on the market. However, in practice, this is often not the case. Many of the instruments held by the bank in trading book may not be very liquid. The market liquidity also varies according to economic cycles. Nevertheless, the assumption that positions can be closed out or hedged within ten days, which is currently used as a basis for calculating capital requirements using Value at Risk (VaR) models, may prove inappropriate for the increasingly frequent case of illiquid positions. The inclusion of such positions in the trading book therefore generally results in insufficient capital requirements.

Concentration and Correlation risksConcentration risk is another risk, which is not captured appropriately by the institutions. Indeed, most corporate bonds include the same names in their reference portfolio, giving rise to concentration risk on an entity and/or a sector associated with their widespread use in institutions’ active credit portfolio management.

Another, correlated risk, which needs to be captured, is correlation between different risk types (credit, interest, currency, equity risks). An increase in trading in such instruments, mispriced in relation to the real risks incurred, would constitute structural risks.

Economic capital and stress testingTo overcome some of the challenges, one of the solutions the leadings banks have been considering is to developing tools for calculating economic capital, which will integrate credit and market risks and their different components. Economic capital for all types of risk is generally calculated at the one-year horizon with a confidence interval determined by the bank on the basis of the probability of default corresponding to its current or targeted rating. While the main tool for measuring economic capital associated with market risk often remains a VaR calculation based on a 10-day holding period, some regulators have devised complementary approaches using stress testing and/or scaling up the VaR to reflect a horizon for closing out or hedging positions assumed to exceed ten days.

Furthermore, although modeling credit risk correlations is not as yet common practice, progress is being made in this area. Some models now incorporate contagion effects, which allow banks using them to capture the impact on credit risk from declines in overall market liquidity, the failure of large firms or adverse industry-level developments. Such approaches make it possible to better take into account extreme or tail risks as well as liquidity risk.

Banking supervisors, in addition to the increase in the current VaR multiplier and/or considering stress scenarios, will enhance the review and the assessment of the methods developed by banks to calculate and monitor their economic capital modeling.



Banking turf is set to change. The RBI had set the ball rolling when they opened the stage with the intention to hand out licenses to new entrants. Undoubtedly, the official reason was to bring a large number of hitherto unbanked and under-banked population in the formal financial system, but how many aspirants will be allowed to get into the ring is RBI’s prerogative. In 1993, when the RBI licensed some private banks, it received 113 applications but only 10 banks got the license1.

Till now, `financial inclusion’ was the responsibility of public sector banks but by using inclusive growth as the base for licenses, RBI has made private sector banks equally responsible in social objectives. As one can see from the table, currently, public sector banks have more branches than any other bank group in the rural and semi-urban areas.

Merit in banking on new licenses

No. of branches of Scheduled Commercial Banks as on 31st March, 2013

Bank Group Rural Semiurban Urban Metropolitan Total

Public Sector 23286 18854 14649 13632 70421

Private Sector 1937 5128 3722 3797 14584

Foreign Banks 8 9 65 249 331

Regional Rural Banks

12722 3228 891 166 17007

Total 37953 27219 19327 17844 102343

Source: Department of Financial Services, June 2013

One can argue, whether new banks are required in the Indian banking sector. If we look at statistics, India being one of the top 10 economies of the world and with relatively lower domestic credit to GDP percentage provides great opportunity for the banking sector to grow. Indian Banking is expected to become 5th largest by the year 2020 and 3rd largest by the year 2025. Banking credit is likely to grow at ~17 percent CAGR in the medium term leading to increased credit penetration.

1 India’s Aspiring Banks Line up for Licenses, January 17, 2013 in India Knowledge@Wharton

“A large portion of rural populations still remains unbanked. Any new banking aspirant should create a business plan which will provide banking facilities and services for the ‘bottom of the pyramid’.

This is a difficult task, so only those who are able to understand this specific market should establish rural branches, lest their portfolio may become sub-optimal and operations saddled with high cost.”

Hemant Kanoria – CMD, SREI Infrastructure Finance Ltd.




In fact, rural and semi-urban areas are still under-penetrated with banking services and with increasing consumption they provide great opportunity for banking services to grow in these areas.

As per Census 2011, 58.7 percent households are availing banking services in the country2. There are 102,343 branches of Scheduled Commercial Banks (SCBs) in the country, out of which 37,953 (37 percent) bank branches are in the rural areas and 27,219 (26 percent) in semi-urban areas, constituting 63 percent of the total numbers of branches in semi-urban and rural areas of the country. However, a significant proportion of the households, especially in rural areas, are still outside the formal fold of the banking system. New banks would help in inclusive growth.

Let’s assume that licenses have been handed out and new entrants are in a competitive space, face-to-face with strong opponents that have been in the industry for eons. What will they do differently to succeed? The answer will definitely depend on the motive behind the banking application but can they survive by just being another bank? Each one of them has to differentiate, make a mark and establish a brand amongst hordes of other brands to ensure success. They have to manage the lending risk to ensure their success. Past experiences show that not all banks that got licenses have survived the grit and determination to scale businesses.

The banking sector has had rough years since Lehman in 2008 but there is still lot of scope for new entrants in the private sector. What has attracted the new entrants to this sector? Economists are positive that the dark clouds

hovering over the Indian economy will move away and it will move to 7-9 percent growth orbit in the next 10 years. In the process of growth, banking sector will also benefit and grow further.

Apart from the fact that the opportunities are in galore in the banking sector (current and future), the ROA for private banks was 1.31 percent for FY13 as compared to 0.73 percent for PSBs in the same period.3 The average net NPAs to net advances for public sector banks as on FY13 was 1.99 percent as compared to 0.84 percent for private sector banks.4

2 Department of Financial Service, June 2013

3 The average ROA for private sector excludes Ratnakar Bank and City Union. Source: Capitaline

4 D Subbarao speech on Banking structure in India on 13th August, 2013

Banking credit is expected to grow at CAGR ~17% in the medium term (INR Bn)

Source: RBI, KPMG in India analysis

Significant head-room for growth

Domestic credit to GDP (% 2011)

Source: World Bank report 2012



Rural branches as the final frontier

Along with the above requirements, RBI requires new banks to open one in four branches in rural areas. However, various challenges inherent in rural finance have led to inadequate access to financial services for the rural population. How the new banks maneuver around the high risk and operational cost would be of great interest to the stakeholders. Rural economy is largely a cash economy, which adds to the complexity and risk of operations. New banks with strong rural strategies, cost-effective operating models, branches in tier-5 to 6 cities, strong alliances with MFIs and BCs with proper governance control and local market knowledge would spell success in the rural areas.

Learning from the past to secure future!

The RBI is cautious about the new banks as they are concerned about depositors’ money; therefore, they will review all the banking licenses from a ‘fit and proper’ angle. There is no doubt about the fact that governance and strong risk management processes will get priority when the RBI is deciding on licenses. Post license, new banks have to adhere to strong risk management processes to ensure that there are no lapses in the regulatory norms and they are not the reason for triggering systemic risk in the banking system.

ConclusionOperating in the niche area profitably and creating a viable business would be the key concern for all new bankers as they have to adhere to all the statutory reserve requirements that may affect their credit availability:

• SLR (Statutory liquidity ratio) currently at 23 percent

• CRR (cash reserve ratio) norms currently at 4 percent

• Banks have to be Basel-III compliant.

• Banks have to lend 40 percent of their advances to the priority sector

• Dynamic Provisioning.

The new governor, Mr. Raghuram Rajan, has indicated that the bank licenses would be handed out before or within January 2014. How new banks would change the enviornment would be of interest to all stakeholders.

Success of new banks would depend on:

Sectoral expertise/ knowledge

The new players have to make their mark on customers who already are banking with other eminent players. What will set them apart? What will ensure success for new banks? Sectoral expertise/ knowledge based on products (asset-based finance, commodity-based finance), on industry (engineering, infrastructure, telecom, media, technology etc), nature of their work (transporters, distributors, exporters, importers etc) or on geography (North, South, East or West) will definitely put them ahead of the race and help them attain consumers’ trust.

In case of retail, asset-backed lending applicants who have an edge with their customer base, loan book and sectoral knowledge would be ahead in the race as opposed to other applicants who have to start from scratch. The transition from an NBFC to a bank will depend on strong management as they would be moving in new businesses with uncharted risk areas.

Customer segmentation is the key

Opening the market 10 years after the last round of bank licenses means that the current banks are already entrenched in consumer’s mind and wallets. Customer service is no longer a virtue. New banks are expected to ‘wow’ the customer with their services. However, Identifying the gaps whether in an urban or rural area in terms of high-end innovative products, need, pricing or business models would put the new banks on the road to success. New banks have to analyse the gaps in between the saturated markets— MSME, only women-led businesses, wholesale banking, traders, totally under-banked markets with unorganized professions or corporate banking — and use different operating models to reach out to their customers. They have to use different customer segmentation techniques to think differently in terms of products and offer innovative need-based products to the customers at a low cost.



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We would like to acknowledge the efforts put in by Shashwat Sharma, Kunal Pande, Himanish Chaudhuri, Neha Punater, Kuntal Sur, Rohan Padhi, Jignesh Desai, Raghavendra Pai, Natasha Wig, Jiten Ganatra, Rishi Malhotra, Anagha Deodhar and Swati Ahuja for the development of this paper.


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Indian Banking Maneuvering

through Turbulence: Emerging

strategies

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Indian Banking - Maneuvering through Turbulence: Emerging strategies

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