Banking Feature

Banking in itself was a very challenging and exciting assignment of the life, but the request to become a Guest Editor of a special issue on Banking in which today’s prominent Bankers were providing their views was most exciting.

It is undoubtedly the most challenging period from which Banking sector especially Indian Banks are going through. You conceive an area in which banks are engaged and you will find that Banks are in hot soup.

A few years back, when economic growth was robust that was growing in the range of 9 to 10 per cent the concept of Banks growing at 2.5 time of GDP was thought to be thumb rule. Capital requirements were assessed based on this projection.  With declaration in the economy, however there are various other issues which are gaining prominence over growth. Entire thinking has gone topsy-turvy. Entire banking systems are now critically placed.

Compare growth of deposit in last few years and you will conclude that growth has come down drastically. It is better not to talk about CASA which is main strength for a bank to leverage pricing of its various other services & product. Even the treasury operation, due to volatility in stock market and bond rates has left them high & dry.

 Most of the public sector banks are in a situation almost similar to nineties, when they were saddled with very high NPA. But this time challenge is more severe as lot private sector players are in the market that are not facing similar problems. But the irony is they are also not in position to provide impetus of growth to the Banking sector aspires.

In this challenging time the views of present day Bankers colleague will certainly provide some insight to overcome the present crisis.

Dalal Street Investment Journal has been regularly bringing articles before its reader informing them about their views of current market scenario. Its reader investors have been greatly benefited with its articles on investments. The present issue on Banking will certainly give them insight on how banks especially public sector banks are going to overcome the challenge as now all banks beside their own survival is also concerned about its market Capitalization &return to its shareholder.

The financial crisis that had its origin in the sub-prime crisis in year 2007 is a watershed moment for the banks globally, including India. During the period 2003-2008, banks in India pursued indiscriminate growth and diversified their portfolios without worrying much about controlling costs or quality of lending. The Indian economy grew at an average rate close to 9 per cent annually before it was punctured by the financial crisis of 2008. The credit growth, which normally grows around two to two and half times of GDP growth, clocked an average growth of 28 per cent in the same period, little more than three times of GDP growth. Then, the financial crisis caused an abrupt about-face from growth to survival. The financial performance of the banks started to witness a marked deterioration. Credit growth, for example, almost halved to 15 per cent between FY09 and FY15 and for the last year it dropped into single digit. The profit of the banks too saw a similar trend and for FY15, out of 39 listed public and private sector banks in India, 14 banks saw their profit de-grow and some of them even reported losses.

Nevertheless, painting all banks with same brush will do injustice to banks that have bucked the trend and performed better even in worsening economic conditions. If we compare the best and the worst banks under different financial matrices, we find that the difference between the performances is getting wider and wider. For example, the difference in return of assets (RoA) by best banks and worst banks has increased from 1.62 per cent in FY11 to 3.61 per cent in FY15. Similar is the case with return on equity where the difference between best and worst has increased to 54 per cent from 22 per cent in the same period. All this is getting reflected in the shareholder’s return. The share price of IndusInd Bank has increased at a compounded annual growth rate (CAGR) of 39 per cent between FY10 and FY15, while that of Dhanlaxmi Bank has declined by 25 per cent. The problem will definitely get compounded with the arrival of new banks, payment banks and small banks. They are definitely going to increase the competition and eat some of the business of the incumbent banks. Digitally-based entrants such as Paytm, Reliance Jio, etc. with their disruptive business model will only increase the competition.  

Therefore, this is the time for all those banks languishing in their performance to get their act together and realign their strategy with the changing times to survive and remain competitive in the industry. This might create short-term pain for the banks but will help in reaping long-term benefits.

Recently the plan of private sector lender DCB Bank to double its branches to 300 from the current 150 in a year is aimed to prepare itself for the future. It is a different story that it did not get good response from the investor community and the share price of the bank fell by 30 per cent in a few trading sessions after the bank announced its strategy. The usual response of focusing intently on cutting costs, trimming payrolls, and “right-sizing” operations may not be enough or right in the ever-changing banking industry landscape. What’s needed is a more balanced approach – one that enables banks to improve operating efficiency but also to upgrade its capabilities to respond to market needs and prepare for the future.

According to a recent report by Bain Capital, “Any strategy should define a broader set of options than most banks have considered, around their business portfolio, risk appetite and capital allocation. Some leading banks are weighing options that feel radically different from one another, rather than being a variation on a theme. Their decisions cluster in three areas: the bank’s overall ambitions, where it should compete by country, product and customer segment, and how it can win in each chosen market.”

The best example in the Indian context is IndusInd Bank, one of the best banks under various matrices, which has carefully chosen its area of specialisation to lend to. Fields like defence, healthcare, financial services, diamond financing were picked to develop specialisation and increase business. The result is that the credit growth of the bank is almost double of the industry average in the last few years.

I believe that banks should focus on these areas to improve their performance:

Improving Efficiency: The environment under which banks operate is changing every day. Therefore bankers’ need to understand whether their organisation is prepared enough under the new environment to provide service as is being done by new players or is it still delivering services that were appropriate a decade ago. One of the most important constituents that will bring such change is employees of your organisation. Therefore, your staff should be motivated enough to adopt new paradigms to counter competition from companies that operate in a brick and mortar-less office.  In order to achieve this, banks should provide necessary skilling/ re-skilling programmes to all staff in a comprehensive manner. They should not stick to old methods of deputing them to old model staff training colleges, which will skill them for an environment that was prevalent decades ago. Moreover, banks should keep their employees informed of steps of protecting honest employees and punishing delinquents. This will help to create an environment of fearless banking amongst employees.

In addition to these, banks should also learn lessons from Non-Banking Financial Companies (NBFCs), who have excellent turnaround time. They are able to complete the entire process of sanctioning of credit in 15 days compared to 3-6 months of duration taken by banks. Hence, sharing of best practices in a cross-section of department and industry will help to improve the overall operational efficiency of the banks. Information technology (IT) will remain the backbone and an indispensable area to improve productivity of banks. Hence, you need to assess whether IT is harnessed to its full potential in order to achieve the desired efficiency level.

There is no one-size-fits-all approach. Some banks assertively promote electronic account openings, remote deposit capture via smart devices, and accounts that are designed to be virtually paperless. Whatever may be the approach, it should be such that the benefit should more than offset the added costs.

Accelerating Income: This is a major area where the banks need to take a strategic decision, especially recognising areas of core-competitiveness and developing them. This may include product, geography, business, etc. It will help them to be more focused and exploit the opportunities available in that field. Therefore, if a bank decides to concentrate in some particular geography, be it domestic or international, how many offices (branch) the bank is ready to swap/sell to new entrants or other players? The pricing strategy of various products also needs to be looked into based on efficiency of service the banks provide.

Non-interest and non-fund income provide much stability and smoothness in the earnings of the banks. Many a times when the loan growth is muted they provide good support to the earnings of the banks. Therefore, banks need to have planning in place on how to increase non-interest, non-fund income in the overall income of the banks. Cross-selling of products has been existent in the system for long; however, they are not utilised in an effective manner. Therefore banks need to have a relook on how more products are being sold to a customer and more benefits flow to them.

For many banks in India as well as globally, treasury operations and forex-related transactions bring substantial revenue to the bank. Thus, treasury operations need to be revitalised and their functions need to be linked to performance-linked incentives to generate much-needed income.

Finally, for interest income, which is as core as interest payment, a policy giving clear dos and don'ts  should be made available to acquire an asset, to protect the bank, its staff, and most importantly, shareholders. Lastly, but most importantly, have you in place a strategy to take advantage of the Jan Dhan account for increasing banks’ income

Talent and culture: Productivity improvement is not dependent on technology alone. Some of the most significant opportunities involve using established performance management techniques, such as clearly defined expectations and scorecards, improved motivation and rewards systems, and better training and supervision. A staff policy where their continuity depends on their contribution to the organisation has to be evolved. They have to be given the new mantra that the old concept of holding hands of customer in their difficult time no more works as their own existence is now at stake. Top leadership has to first demonstrate it followed by down the line practice.
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“BANKING HAS BEEN WITNESS TO SEVERAL INNOVATIONS”

The Indian banking landscape has turned into a very happening place over the years. It’s not just the player mix, but the very approach to banking that has undergone a quantum shift. Against this background, Arun Tiwari, CMD, Union Bank of India, talks about the overall banking scenario and how it will move forward

Credit growth remains anaemic despite economy growth by more than 7 per cent. What explains this and when do you see credit growth picking up?

Credit being a nominal variable, its growth shows better co-movement vis-a-vis growth in nominal GDP than the growth in real GDP. Given the fact that inflation has effectively grounded, the nominal variable stands much in vicinity of the real one. The national income statistics for quarter ended June 30, 2015 reveal that while growth in real GDP (at 2011-12 prices) stood at 7 per cent, growth in nominal GDP (at current prices) stood at 8.8 per cent for the quarter ended June 30, 2015. It was a marked contrast to 13.4 per cent nominal GDP growth noted in quarter ended June 30, 2014. The present bank credit growth of 9.5 per cent, thus, becomes self-explanatory. Having said that, economic recovery remains tentative; weaker corporate earnings are reflective of this. Corporate debt deleveraging is happening, though gradually. The credit demand, at present, is mostly for working capital needs and retail loans. It could take a couple of quarters before it comes from new project-related requirements.

In the last one year there has been a significant change in the landscape of the Indian banking sector with the start of two new banks and introduction of payment banks and small finance banks. How do you see these developments impacting the overall banking sector? Are any of these threats to your existing business?

The Indian banking landscape has indeed become a very happening place over the years. It’s not just the player mix, but the very approach to banking has undergone a quantum shift. Financial inclusion has been the guiding force behind the changes. We have been witness to over 189 million new banking accounts opened under Pradhan Mantri Jan Dhan Yojana. This platform is being leveraged to provide universal social security. It promises much more in the near future. As for the new entrants to competition, in my view, they are more than welcome.

If one juxtaposes credit penetration vis-a-vis size of the economy, India remains an under-banked economy. The credit to GDP ratio is around 55 per cent in India, implying enormous opportunities for all, without making it a zero-sum exercise for incumbents. On the contrary, more competition could help incumbent banks raise their efficiency and customer service standards, as it happened earlier, thus, making it a win-win situation for all.

How do you see the overall interest rates moving in the next one year, especially after the recent rate cut by Reserve Bank of India? How will it impact you financially?

Interest rates have trended lower in 2015 so far and the RBI stance remains accommodative. It is a result of improved macro-fundamentals, with inflation cooling rapidly to more comfortable levels. Despite a rain-deficit year, India’s medium-term inflation outlook remains benign as commodities are seen softer with global demand tentative. Our domestic industry is operating below 3/4^th of installed capacity; implying that supply side price pressures remain distant. It bodes well for interest rates in the coming year(s) as the RBI can take further measures to support growth without worrying much about inflation. Seen together, in my view, the RBI is not done with rate cuts in the current cycle. In a softer interest rate environment, everyone stands to benefit. Loan servicing becomes easier and loan appetite improves in general. Banks also benefit from treasury profits on their investment portfolio. 

The NPAs remain at elevated levels. When do you see them stabilizing and reducing?

Banks can effectively manage what is internal to them. Large chunks of NPAs are for reasons beyond their control. Whether we talk of infrastructure, commodities, metals, exports, etc., there is a play of a global cycle coupled with broader policy logjam at home, which has been holding up recovery in their cash flows. When borrowers fail to meet their commitments, it cumulates in our balance-sheets as NPAs. Encouragingly, if we look at the trend over the last few quarters, while the NPAs have grown in actual value, the rate of creation has reached a plateau or declined. As economy further gains in strength, this trend should sustain going forward. More satisfactorily, the government and the RBI, together with banks, have largely fixed the systemic concerns with a slew of measures aimed at early stress recognition, better risk management through information sharing, and balancing the bank-borrower power structure to deal with deviants. These together will yield better asset quality in the near future.

Do you feel that with such developments, the industry will see some inorganic moves such as big bank buying small banks or payment banks, etc.?

Inorganic moves are more frequent when there is a general buoyancy of expectations in the economy. In the current state of affairs, there would be more of value seeking while bargaining gets tougher. I think players are looking for strategic complementarities and fostering long-term partnerships, such that when there is a turn in tide, valuations rise and benefit all.  

What is the role that technology and innovation play in the growth of banks?

Banking has been witness to several innovations ― of systems, processes and products― which have made life better for customers over the last few decades. Technology has indeed been a driver of innovations. There are two tech-enabled developments in banking which, in my view, could have a disruptive impact, going forward. First, banking being conversant with social media, viz. Facebook, Twitter, Whatsapp, LinkedIn, YouTube, etc. and second, deepening of e-commerce in India, which has larger implications for retail payments.

Banks have to strategically play on digital channels as customers spend much of their time online today. However, banks have to be discerning in their approach. They should analyze the digital trails of consumers and the offerings have to be tailored as per customers’ needs and expectations. More importantly, all this needs to happen on a real-time basis. It is here that the banks will benefit from the advances made in data analytics technology and will further strengthen their customer relationship management (CRM).

What is your take on the emergence of shadow banking and how is it impacting your business?

Shadow banking, though in disrepute for perpetrating the global financial crisis of 2008, has a very larger ambit. It emerged to fill in the gaps between customers’ varied financial needs and what the regulated financial service providers, like banks, could offer at the time. It has, importantly, thrived on skillfully navigating the legal grey areas, often to its advantage; also creating some value for people in the process. It did inflict huge negative externalities on unsuspecting citizens; much of the clean-up continues till date in several of the advanced economies. Shutting it down completely, however, could be unfortunate, much like throwing the baby out with the bath water. What is needed is to bring them under the purview of law, plug in regulatory gaps, and create an enabling ecosystem where there is freedom of enterprise, innovation and proper accounting of costs— private as well as social. Exceptions notwithstanding, India has an enviable record of supervising and nurturing such enterprises, formally referred here as non-banking financial companies (NBFCs). Our regulators have also been positively creating a level playing field for banks as well as NBFCs. There is more space for collaboration than competition in meeting the varied needs of our economy.