This report was researched and compiled by Christopher Hindle and Marie Verpilleux of Global Business Reports
India is home to one of the fastest growing banking markets in the world. According to the Indian Banks' Association (IBA), the overall banking industry's business grew at a CAGR of about 20% between 2002 and 2007, increasing its value from $470bn to $1.171trn over the period. As of 4 January this year, aggregate bank deposits had increased by 23.8%, year-on-year, and, significantly, banks' asset quality has also shown continued improvement. Furthermore, since banking services have to date only penetrated an estimated 35% of the nation's 192m households, there remains huge untapped potential for growth. Such strong performance has been derived from the underlying strength of the economy but, parallel to its growth, the Indian banking sector is also undergoing a transformation aimed at making the sector better able to meet the needs of the country's citizens and corporations in the globalised twenty first century. "We had gone through a very bad phase in banking," admits the IBA's CEO, H.N. Sinor. "But due to the reform process we have now emerged stronger because of it. Balance sheets were couched with infirmities and we didn't have the prudential norms one might expect. But, because of the regulators and their gradual approach, today the whole banking system is much stronger than 10 years ago. We have the confidence now to take on the risks associated with operating in the global environment." Indeed, the regulatory systems of Indian banks are already better rated than those of China and Russia and on a par with those of Japan and Singapore. However, there is also recognition that without an acceleration of the reform process, Indian banks are in danger of being left behind.
Alongside a handful of foreign banks that firmly established themselves in the country under British rule, the vast proportion of India's banking sector traces its roots back to the centuries-old system of regional banks that later grew and spread across the country as their customers migrated. Under the leadership of the then prime minister, Indira Gandhi, these banks were nationalised in 1969 - part of process that also introduced targets for lending to rural areas and the promise of secure jobs for the country's underclass. While the share of foreign and private sector banks in total deposits has increased significantly since 1991, over 75% remains in the hands of the so called public sector banks, which, with a few exceptions, remain highly bureaucratic, weak in the adoption of new technologies and often saddled with a legacy workforce from a bygone era. Of course, the idea of using banks as a tool for social reform is today sorely at odds with India's plans to become a global economic powerhouse.
According to Sinor his major concern is "fragmentation". Despite India's rapidly growing middle class and the global ambitions of the country's corporate stars, its banks are tiny in global terms and their focus is still predominantly local. In India some 40 or so of the smaller banks currently fight it out over a share of just 27% of assets, while only one, the State Bank of India, makes it into the world's top 100 (at 83). This is in stark contrast to China, which is represented in the list by four banks in the top 35 alone. For an illustration as to how Indian banks are failing to compete one only has to look at the spate of multi billion cross-border deals that Indian companies have been involved in over the past couple of years: Not one has relied on a state bank, or even on one of India's more efficient private banks. "Lacking the capital and currency strength to finance large transactions, we need to concentrate on consolidation and have 5-6 players emerge as strong players with the opportunity to then go on to become global players," says Sinor.
Although Indian banks had little direct exposure to the US sub-prime crisis, there is also growing concern that, with global economic uncertainty continuing, the smaller players are simply without the capacity at present to absorb shocks that may occur in the global markets. "In view of the global turmoil and increasing competition in the banking space it is important for the banks to achieve scale," says Shailendra Bhandari, (pictured right) former managing director and CEO of Centurion Bank of Punjab and now an executive director on the board of HDFC Bank, which, in February, bought out its smaller rival.
What should provide a strong incentive for consolidation over the coming year is a look ahead to 2009, which is due to see both the implementation of Basel II norms across the industry and also the second phase of the RBIs road map for the presence of foreign banks in India. Set out in 2005, by the end of 2009 the road map is scheduled to accord foreign banks the same treatment as Indian banks, including IPOs (subject to 26 %of paid-up capital being held by resident Indians). With the opening of the sector to foreign players many expect the intensification in competition to drive consolidation and force the spread of best-in-class technology and working practices across the Indian banking sphere. But, making changes has so often proved difficult and slow and the roadmap is still undergoing final consultation. Public sector banks, which will be most affected by the shake up in salary structures that they would need to undergo in order to compete, are at present highly unionised. Since 2009 is an election year, many industry insiders fear that the imperative for change will be lost. "I'm not holding my breath for next year" says, Bhandari.