Banking Sector of India - Essay Example

The economic reforms initiated by the Government of India (GOI) have changed the landscape of the banking sector in India. Various factors have led to the transformation of the sector - technological advancements and a liberalized marketplace – disintermediation, blurring of traditional roles and boundaries, emphasis on shareholder value creation (Kamath, 2003). Companies and governments seek high-quality banking services. The economic reforms have created a new segment of consumers – the huge Indian middle class and there is a new mix of players – private banks, public banks and foreign banks (Ravichandran, 2003). This has led to competition and generated new level of expectations among the consumers. The Reserve Bank of India (RBI) is the central bank of the country and it closely monitors the developments in the financial sector. The banking sector is dominated by Scheduled Commercial Banks (SCBs) including 27 Public Sector Banks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks as of March 2002 (Research & Markets, 2009). In addition, there were 67 scheduled co-operative banks consisting of 51 scheduled urban co-operative banks and 16 scheduled state co-operative banks. State Bank of India (SBI) is the largest bank in India with a market share of 20 percent while ICICI is the second largest bank in India. The commercial banks include the former development financial institutions (DFI) such as the ICICI and the IDBI. The commercial banks have on their books very long-duration GOI securities with some banks holding as much as 45 percent in these securities (Mor, Chandrasekhar & Wahi, 2005). The GOI and the RBI together direct and govern the functioning of the banks (Ravichandran, 2003). The initiatives or the stimulus package by the GOI has transformed the banking industry which reflects in the significant growth in the banking sector as studied by Dun & Bradstreet, an international research body. Taking into account all banks of India, as of 2009, there are 56,640 branches or offices, 893,356 employees and 27,088 ATMs (IBEF, 2009). Public sector banks dominate the industry comprising of 87.7 percent of all offices, 82% of staff and 60.3% of all ATMs. As on 2nd January 2009, the aggregate bank deposits stood at 21.2% while the ban credit touched 24% against 21.4% as on January 4, 2008. There has also been an increase in the total flow of resources from the banking sector to the commercial sector which stood at US$ 58.83 billion up to January 2, 2009. Credit expansion varies across bank groups. AS on January 2, 2009, credit expansion for public sector banks stood at 28.6 per cent, scheduled commercial banks (SCBs) including the regional rural banks (RRBs) at 24 per cent, foreign banks at 6.9 per cent and private sector banks at 11.8 per cent. With the relaxing of the structural regulation private banks have been established which has widened the choice for the consumers (Kohli, 2003). Nevertheless, public sector banks dominate the industry while the private sector and the foreign banks co-exist. Changes have come into the Indian banking industry after the collapse of Lehman Brothers. Corporate giants like Infosys have moved their deposits to State Bank of India (SBI), the largest public sector bank in India (IBEF, 2009). Apart from the bank rate cuts, cash withdrawals from banks will not attract tax from April 1, 2009. Banks have also reduced their deposit and lending rates between November 2008 and January 2009 due to the initiatives taken by the RBI. This led to a significant rise in bank loans. This has created significant opportunities for the Indian banking sector as there have been demographic shifts in terms of higher income levels and cultural shifts in terms of lifestyle aspirations of the Indian consumer (Kamath, 2003). Consumerism in India has increased the demand for competitive, sophisticated retail banking in India. Retail lending has become the focus area as banks have started segmenting the consumer (Kohli, 2003). The consumer needs a wide range of products and services – house loans, auto loans, a bank account, credit card for ongoing purchases, long-term investment plans to finance his child’s higher education, retirement pension plans (Kamath, 2003). Because of increased communication within the country, the bank consumer resides not just in the major cities but can now be found in small towns and villages as well, thereby demonstrating the increased demand for retail banking. Retail lending has helped the banks by way of higher lending and better recovery rates (Kohli, 2003). However, there is discontinuous growth of new products and services in retail banking and these require new skills in sales and marketing (McKinsey, 2009). However the Indian banking industry faces structural challenges. Some banks are sub-optimal in size and scale of operations. The international capital norms now require high level of sophistication in risk management, information systems, and technology (Kamath, 2003). These requirements pose a challenge to many participants in the Indian banking sector. Restructuring of the Indian economy has resulted in asset quality issues for the banking sector and resolution of these legacy issues is still pending. With gradual deregulation banks face several types of risks – market risks such as interest rate risk, liquidity risk, exchange risk (Kohli, 2003). In respect of lending they face default risk and portfolio risk and they also face other risks like reputational risk and operational risks. Apart from commercial lending there is an increased demand for project financing but banks lack risk quantification and capital attribution methodologies (Mor, Chandrasekhar & Wahi, 2005). The banks and the DFIs are not in a position to correctly assess the risks inherent in these projects and meet the required demand. This is an opportunity for banks wanting to enter India with their risk assessment techniques in place but there is no link between the cost of funds and the rates that are offered on loans. To meet the additional capital requirement, the public sector banks have been permitted to access the market fur funds (Kohli, 2003). Interest rates have been deregulated and direct lending has been progressively reduced. Non-Performing Advances (NPAs) are now dealt through different bodies such as establishment of Debt Recovery Tribunals (DRTs), Lok Adalats, and the system of One-Time Settlement (OTS) of dues through mutual negotiation. The GOI has also passed the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SERFAESI) Act, which is a step towards better recovery of advances. Despite improved regulations, growth, innovation and value creation in the banking sector, the cost of banking intermediation in India is higher and bank penetration is far lower and is limited to a few customer segments and geographies (McKinsey, 2009). Structural weaknesses exist in the industry which needs to be addressed. These include fragmented industry structure, restrictions on capital availability and deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate governance and ineffective regulations. Unless these issues are addressed it could weaken the health of the sector. Both opportunities and challenges exist for new entrants. Competition from foreign banks in India has intensified. The banking sector thus has to strengthen itself if India has to achieve a vibrant and robust economy. This requires an enabling and regulatory framework. The Indian banking industry has seen a lot of reforms but constraints still exist. Changes in policy and regulation and capability-building measures are still lacking (McKinsey, 2009). Consolidation has been taking place in the industry but it is restricted to a few mergers in the private sector. Mergers are market-driven instead of being externally imposed. Mergers are usually driven by few private banks that take over some old private banks and also merge among themselves. The growth of these banks has increased to 35 percent and foreign banks have also grown at a rate of 30% due to relaxation of some regulations. Growth and productivity levels become low if under these circumstances restrictions are imposed. The new private banks specialize in derivative business including commodity-based products, investment banking, besides acting as advisory in mergers and acquisitions. Banks are now growing out of their focus on banking services and are becoming financial services provider as well in an attempt to offer one-stop-shop services (Kohli, 2003). Technology has become the enabler and is driving the industry towards greater heights. Large scale computerization of banks has allowed them to offer intensive services and even online banking. Today there are alternate channels of delivery of services – the ATMs, telebanking and internet banking. The emphasis has shifted from micro-management of banks to risk-based supervision. Thus the opportunities in India are immense as the economy is robust and growing. The Indian consumer has started demanding services and requires a wide range of products and services. While services have picked up risk assessment still is low. Technology is in place to support the growth of the banking sector and restrictions have been relaxed but there is discontinuous growth of new products and services. Foreign banks co-exist with the private banks while the public sector banks dominate the industry. Foreign banks can capitalize on the weaknesses of the existing banks and offer better services thereby creating better value. Reference: IBEF, 2009, Banking, retrieved online May 1, 2009 from http://www.ibef.org/industry/Banking.aspx Kamath, KV 2003, Indian Banking Sector: Challenges and Opportunities, retrieved online May 1, 2009 from http://www.vikalpa.com/pdf/articles/2003/2003_july_sep_83_99.pdf Kohli, SS 2003, Indian Banking Sector: Challenges and Opportunities, retrieved online May 1, 2009 from http://www.vikalpa.com/pdf/articles/2003/2003_july_sep_83_99.pdf McKinsey, 2009, India Banking 2010 Towards a High-performing Sector, McKinsey&Company, retrieved online May 1, 2009 from http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/india_banking_2010.pdf Mor, N Chandrasekhar, R & Wahi, D 2005, China and India - learning from each other, Chapter I, Banking Sector Reform in India, retrieved online May 1, 2009 from http://prasad.aem.cornell.edu/doc/books/chinaandindiafulldocument.pdf#page=19 Ravichandran, N 2003, Indian Banking Sector: Challenges and Opportunities, retrieved online May 1, 2009 from http://www.vikalpa.com/pdf/articles/2003/2003_july_sep_83_99.pdf Research & Markets, 2009, Indian Banking Sector, retrieved online May 1, 2009 from http://www.researchandmarkets.com/reports/34200/indian_banking_sector Read More