1273572 Manpreet Kaur, F1, Q45 Indian Banking: Outlook for 2014?

Meaning of Bank

A bank is a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly by loaning or indirectly through capital markets. A bank links together customers that have capital deficits and customers with capital surpluses.

India Banking

Banking in India in the modern sense originated in the last decades of the 18th century. The first banks were Bank of Hindustan (1770-1829) and The General Bank of India, established 1786 and since defunct.

The largest bank, and the oldest still in existence, is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India in 1955. For many years the presidency banks acted as quasi-central banks, as did their successors, until the Reserve Bank of India was established in 1935.

In 1969 the Indian government nationalised all the major banks that it did not already own and these have remained under government ownership. They are run under a structure know as 'profit-making public sector undertaking' (PSU) and are allowed to compete and operate as commercial banks. The Indian banking sector is made up of four types of banks, as well as the PSUs and the state banks, they have been joined since the 1990s by new private commercial banks and a number of foreign banks.

Banking in India was generally fairly mature in terms of supply, product range and reach-even though reach in rural India and to the poor still remains a challenge. The government has developed initiatives to address this through the State bank of India expanding its branch network and through the National Bank for Agriculture and Rural Development with things like microfinance.

Banking Outlook 2014

Continued slowdown of the domestic economy along with weak and uneven global growth posed considerable challenges to the Indian banking sector during 2012 and 2013 as well. However, it was the comfortable capital base which continues to lend resilience to the Indian banking sector. Weak corporate sector performance, risk aversion by banks due to rise in bad debts, regulatory bottlenecks and lower rate of return due to high inflation led to deceleration in credit and deposit growth which in turn affected the profitability of the banks. The prolonged phase of slowdown strongly impacted the asset quality of the banks. The sector witnessed a rise in the Non-Performing Assets (NPAs) along with increase in the restructured advances.

The evolving growth inflation dynamics along with the risks emanating from the volatility in the exchange rate and large current account deficit posed challenges to the monetary policy management. While the softening in the inflation rate during the second half of FY13 had given the RBI much needed space to reduce the repo rate so as to stimulate growth, inflation yet again reared upwards during the Jul-Sept 2013. As a result after reducing the repo rate by 75 basis points during Jan-13 to May-13, the RBI again raised the repo rate in Sept-13 and Oct-13 by 25 basis points each. The RBI also had to undertake exceptional liquidity tightening measures since July to address the significant exchange rate volatility, most of which has been withdrawn since Sept-13 on signs of improvement in the external environment.

Since FY13, the RBI has initiated a series of policy measures to enable Indian banks to adopt the Basel III norms and improve asset quality of the banks. These measures coupled with issue of new banking licenses will ensure that the Indian banking sector evolves going ahead

Demand for credit is expected to stay low in 2014 as Indian economy continues to grow at a lower rate-

The slowdown which has gripped the Indian economy has continued into 2013 as GDP growth slipped to 4.7% in the first three quarters of 2013 as compared to 5.1% in 2012. This moderation in GDP growth and sluggish industrial activity has restricted the overall demand for bank credit. With overall GDP growth expected to remain subdued, with growth picking up during the second half of the year, credit off take is likely to witness some buoyancy during H2 2014.

NPA as a percent of gross advances increased to 3.6% in FY13 as compared to 3.1% in FY12 while doubtful assets increased to 1.5% of total assets in FY13 against 1.2% in FY12. NPA was highest for the public sector banks, reaching 4.1% of gross advances in FY13 against 3.3% recorded during the previous fiscal period. On the other hand gross NPA as a percent of gross advances stood at 2.0% for private sector banks and 2.9% for foreign banks in FY13 compared to 2.1% and 2.6% respectively in the year ago period

Significant increase in restructured asset as indicated by higher CDR (Corporate Debt Restructuring) also points towards worsening asset quality of Indian banks. Number of cases approved for CDR increased by 37% in FY13 over the past year to 401. Aggregate debt that was brought under CDR mechanism increased by 52% in FY13 over previous year to reach ~INR 23 bn. By the end of July-September quarter, total number of CDR cases approved reached 431 while the aggregate debt touched ~INR 27 bn. Maximum distress in debt was witnessed in iron & steel sector and infrastructure sector. High exposure to projects in infrastructure and iron & steel sector is the primary reason for higher NPAs for public sector banks.

With continued deceleration in the industrial growth, pick-up in activity in infrastructure and iron & steel sector is expected to be delayed. Since concentration of distressed assets is higher in these sectors asset quality deterioration in Indian banks is set to worsen. However the effectiveness of cabinet committee on investment in clearing stalled infrastructure project would play a major factor in determining the asset quality of the banking sector going ahead. A faster clearance rate would help Indian banks contain the pace of growth of distressed loan assets.

Capital infusion in public sector banks set to continue to meet Basel III norms and ensure credit growth
Indian banks have implemented Basel III norms from April 1st, 2013 in phases and will be fully implemented by March 31, 2018. To comply with capital adequacy ratios set under Basel III, public sector banks will require an additional capital of Rs 4.15 tn over the period FY2014-18. Government which is the majority stakeholder in public sector banks has infused close to Rs 477 bn in these banks during the past five years. For the period 2013-14 Indian government has earmarked Rs 140 bn capital infusion in PSU banks. This would help PSU banks in meeting Basel III capital requirements as well as in maintaining credit growth which has slowed down in 2012-13.Risk based supervisory review process would be widened Changes in global and domestic banking landscape has prompted RBI to shift the risk based supervision of banks from the existing CAMELS (Capital Adequacy, Asset Quality, Management, Earning, Liquidity and Systems Control) approach to the more robust RBS (Risk Based Supervision) approachRBS phase I has already been implemented under which 29 banks – together accounting for 66% of total assets of Indian banking system – have already been brought under RBS.. Under FIP (2010-13), almost all unbanked villages with a population more than 2000 have been covered with a banking outlet. As on Mar-13, the total number of banking outlets in villages with a population of more than 2,000 stood at ~120,000 which represents a growth of 214% over corresponding figure in FY10. During the same period the total number of basic savings bank account opened through rural branches increased by 67% to reach 101 million. The above statistics points towards the effectiveness of FIPs in penetrating rural areas and improving the financial inclusion in the country. This success has prompted the central banks to continue with the FIP policy. FIP 2013-16 would focus on increasing banking presence in villages having population below 2,000.

 Competition in the banking sector to intensity with the entry of new banks To promote financial inclusion and make the sector competitive, RBI has invited applications for granting new banking licenses. In response,

RBI has received 26 applications for new bank licenses (since then one of the applicant has withdrawn the application) from corporates/industrial houses. The successful candidates are expected to be finalized by end Mar-14. Regulations and guidelines laid out by RBI are likely to ensure that the new banks would improve the financial inclusion initiatives. Entry of new players would increase the competition in the sector thereby increasing the choice for customers as well as introduction of innovative financial products and services.

Competition from foreign banks set to intensify.

In its second quarter review of monetary policy FY14, RBI announced a scheme of subsidiarisation for foreign banks. As per the scheme foreign banks who will convert into Wholly Owned Subsidiary (WOS) would be given near-national bank treatment which includes freedom in opening branches anywhere in the country (except in certain regions where prior RBI approval is required). A framework for enabling this scheme was released by RBI in Nov-13. Currently, foreign banks operate in India in branch form. However, a foreign bank which has started operations in India before Aug-10 has the option of continuing its operation in branch mode, but it would be incentivized if they convert to WOS mode.

Treatment on par with nationalized banks and freedom in expanding branch network is expected to propel foreign banks to opt for WOS route. Consequently, the extent of competition from foreign banks would go up which would eventually provide customers with better choices.