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Budget 2008-09: Banking FY08 is expected to initiate the reform process in the banking sector with several banks complying with Basel II guidelines and others gearing up for the same compliance in 2009. The second phase of opening up of Indian banking sector would commence in April 2009. Foreign banks will have the opportunity to own up to 74% of Indian private sector banks and 20% of government owned banks. These foreign banks with huge capital reserves, cutting edge technology, best international practices and skilled personnel will create a major competitive challenge for Indian banks, especially the public sector banks. According to official estimates, to maintain an average capital adequacy ratio (CAR) of 12.0% by March 2010, the public sector banks would roughly require an additional capital of Rs 3,000 bn. This is arrived at after considering requirements of capital to fund growth, expected NPA write offs and investments in IT and other infrastructure. Structural hurdles like restrictions on capital availability (due to high government ownership), restrictions on credit deployment and restrictive labour laws, weak corporate governance – have impaired the ability of Indian public sector banks to intermediate efficiently. Also, there are stringent restrictions on FII and FDI participation in the public sector banks. Read more

Budget Measures For 2008-09, agricultural credit target set at Rs 280,000 crore, with short-term crop loans continued to be disbursed at 7% per annum. Initial provision of Rs 1,600 crore made for interest subvention in 2008-09. PSU banks and regional rural banks (RRBs) to offer debt waiver on all agricultural loans disbursed upto March 2007 and due until the end of December 2007. Complete debt waiver on all loans given to small and marginal farmers. The banks will also launch one time settlement (OTS) scheme in respect of other farmers for all loans that were overdue on December 31, 2007 and which remained unpaid until February 29, 2008. Rebate of 25% against payment of the balance of 75% under OTS. The total value of relief to be offered to farmers is estimated at Rs 60,000 crore. The government has advised PSU banks and RRBs to add at least 250 rural household accounts every year at each of their rural and semi-urban branches. Further, the banks have been asked to recruit individuals such as retired bank officers and ex-servicemen as business facilitators or credit counselors. Public sector banks have been asked to include Indira Awas Yojana (IAY) houses under the differential rate of interest (DRI) scheme and lend up to Rs 20,000 per unit at an interest rate of 4%. Parent company allowed to set-off the dividend received from its subsidiary company against dividend distributed by the parent company; provided that the dividend received has suffered DDT and the parent company is not a subsidiary of another company. Banking Cash Transaction Tax (BCTT) being withdrawn with effect from April 1, 2009.  Budget Impact PSU banks are expected to face pressure on their net interest margins until the subsidy for waiver of agricultural loans and one time settlement of loans is released from the government. The cost of adding more rural households in their rural branches may increase the operating cost for the PSU banks. Including IAY houses under the differential rate of interest scheme at an interest rate of 4% will increase the proportion of sub-PLR lending for the PSU banks. Banks that receive dividend from their subsidiaries will benefit from the set off of dividend distribution tax. Inclusion of the Post Office Time Deposit Account to the basket of saving instruments under Section 80C of the Income Tax Act will reduce the attractiveness of bank term deposits.  Company Impact Large PSU banks like SBI, PNB and Bank of Baroda will face the pressure on their net interest margins until the subsidy for waiver of agricultural loans is released. The may also face higher delinquency rates due to the increased agri-credit targets. Banks like SBI and ICICI Bank that receive dividend from their subsidiaries will benefit from the set off of dividend distribution tax.  Industry Wish List Dr. Rupa Rege Nitsure – Chief Economist, Bank of Baroda In the Union Budget 2008-09, the government should openly kick-start the process of consolidation amongst the public sector banks, which will go a long way in strengthening this sector. The government may also think of introducing a few fiscal incentives for bank deposits, which are facing a tough competition from the capital market schemes as well as housing sector. As 85% to 90% of the banks’ funds still come from deposits, the government should introduce a few incentives, which can make these deposits an attractive avenue for investment for the household sector. Currently, 2% interest rate subvention is provided to crop loans up to a limit of Rs 0.3 m. The banks are charging an interest rate of 7% on these loans and take interest subvention of 2% per annum from the Government of India, thus yielding an effective interest rate of 9% per annum. It is felt that the interest rate subvention of 2% is to be increased to 3.5% making the effective interest rate of 10.5% per annum for banks. Reducing the government ownership in PSU banks to 33% as promised by the previous government. Granting more managerial autonomy to PSU banks so that they have better specialists working for them at market-related packages and more independent directors on their boards Allowing PSU banks to close down loss-making rural branches Further liberalization of directed lending norms CII and FICCI Levy of BCTT (banking cash transaction tax) should be made applicable only in those cases where people buy drafts from banks without quoting their Permanent Account Number (PAN). All other assesses should be outside the purview of this levy. Increase the FII/ FDI limit in PSU banks from 20% to 49%. Allow another round of VRS in PSU banks and more powers to attract suitable talent  Budget over the years Budget 2005-06 Budget 2006-07 Budget 2007-08 Autonomy to RBI to implement reforms in banking sector. Amendment of the Banking Regulation Act. Allow banking companies to issue preference shares to boost their Tier-I capital. Introduce provisions to enable the consolidated supervision of banks and their subsidiaries by RBI. Increase bank lending to agricultural sector by 30% and PSU banks to increase number of agricultural borrowers by 5 m. Remove the lower and upper bounds to the statutory liquidity ratio (SLR) and removal of the limits on the cash reserve ratio (CRR) to provide flexibility to RBI to prescribe prudential norms 0.1% banking transaction tax to be imposed on cash withdrawals above Rs 10,000 on a single day. Enable RBI to lend or borrow securities by way of repo, reverse repo or otherwise. Removal of benefits available to depositors (Section 80-L) Banks to increase disbursements to farmers to Rs 1,750 bn by FY07 (with addition of 5 m farmers) and open a separate window for self-help groups (SHGs). Additional 0.4 m SHGs to be credit-linked by FY07 in association with NABARD. Farmers to be extended short-term credit at interest rate of 7% p.a. with an upper limit of Rs 0.3 m on the principal amount. Net capital support to banking sector (by way of issuance of special non-tradable government securities), standing at Rs 228 bn at the end of 9mFY06, to be restructured by their conversion to tradable SLRs. Fixed deposits with tenures of not less than 5 years to be included under Section 80 C for tax exemptions. Loans to food processing sector to be included in the priority-sector lending basket. ATM operations and collection services provided by banks in public issues to be brought under the service tax net. Banking Cash Transaction Tax (BCTT) to continue for some more time until the AIR system is able to capture all significant financial transactions. Farm credit target for FY08 set at Rs 2,250 bn with an addition of 5 m new farmers to the banking system and provision of Rs 17 bn for 2% interest subvention for short-term crop loans To augment resources for refinancing rural credit cooperatives, NABARD to issue Government guaranteed rural bonds to the extent of Rs 50 bn SARFAESI Act to be extended to loans advanced by Regional Rural Banks (RRBs). RRBs to be permitted to accept NRE/FCNR deposits and those that have a negative net worth to be recapitalised Cooperative banks to be allowed deduction in respect of provision for bad and doubtful debts under section 36(1)(viia). Also, amalgamation and de-merger of banking companies is tax neutral. This benefit to be extended to cooperative banks Cash withdrawals by Central and State Governments to be excluded from the scope of Banking Cash Transactions Tax (BCTT). Exemption limit for individuals and HUFs to be raised from Rs 25,000 to Rs 50,000 The government has proposed to acquire RBI's equity holding in State Bank of India (59% currently). It has provided a sum of Rs.400 bn for this purpose, but the transaction will be deficit neutral to the government. Also, the fund of Rs 7.5 bn created for awarding 0.1 m (of Rs 6,000 each per year) will be placed with the SBI, and the yield from the fund will be used for awarding the scholarships. Increase in dividend distribution tax from 12.5% to 15%. 1% higher education cess to charged. [Read more on Budget 2005-06] [Read more on Budget 2006-07] [Read more on Budget 2007-08] Key Positives Guidelines on bank mergers: The RBI’s guideline on bank mergers cleared the ambiguity persisting regarding the route that banks need to follow for their inorganic growth. While 'voluntary' merger between two banks requisite approval by two-thirds of the total board members and disclosure of the valuation details, financials and share price movements, dissenting shareholders would get the value as per the valuation computed by the RBI. Liberalisation of ECB norms: The government also liberalised the ECB norms to permit financial sector entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial institutions, which were earlier not permitted to raise such funds, explore this route for raising cheaper funds in the overseas markets. Restriction of voting rights: In another move to narrow down the impact of foreign entities on managements of domestic banks, the government in its new norms for ADR/GDR issues has specified that the voting rights of ADR/GDR holders will be restricted to 10% (which is as per RBI norms). Credit classification: To accelerate the initiatives for credit efficiency of the banking entities post Basel II (FY07 onwards), the RBI has suggested that banks will need to classify loans above Rs 50 m as 'non -retail exposure' and exercise credit rating on the same through their internal rating mechanism. Ceiling on dividends: The RBI has raised the ceiling on the dividends that commercial banks are permitted to pay to 40% of a bank’s net profits, from the earlier 33.3 %. The caveat, however, is that banks can now pay dividends if their NPAs are less than 7% of their total advances and they have had a capital adequacy ratio (CAR) of at least 9% for three consecutive years. As not meeting any of the said guidelines makes a bank ineligible for dividend payment, it ensure that bank sustain a healthy asset book in the longer term. Hybrid capital: In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find takers, it would help PSU banks, left with little headroom for raising equity. Significantly, FII and NRI investment limits in these securities have been fixed at 49%, compared to 20% foreign equity holding allowed in PSU banks. Final guidelines on securitisation: The apex bank having issued the draft guidelines on securitisation in April 2005 is expected to issue the final mandate on the same by the end of February 2006. The move is aimed at ensuring that standard assets securitised constitute a true sale and an arm’s length is maintained between the originating bank and the special purpose vehicle (SPV) to which the assets are transferred.    Key Negatives Holding structure conundrum: The RBI expressed its discomfort with regard to creating intermediate holding companies and has suggested exploring the possibility of creating banks or financial holding companies on the lines of financial structure operating in the US. Currently a typical bank-centric organisation structure is followed in India. However, the proposed structure will involve a multi-layered financial conglomerate and may also have a few tiers of intermediate holding companies apart from the holding company at the top. This derailed the plans of banks like ICICI Bank SBI to list their insurance subsidiaries separately. No interest on CRR: The staggered three-staged rise in the CRR from 6% to 7.5% bore a telling impact on the banking sector’s liquidity scenario. Besides together locking in liquidity to the tune of approximately Rs 25 bn from being deployed in productive revenue-generating resources (advances and investments), the removal of interest payable by the RBI on CRR maintained by banks above 3.5% of net demand and time liabilities, made it completely non-remunerative for the latter. Interest rate dampener: The interest rate movement in the short term is likely to be with an upward bias as is evident from the RBI’s 25 basis points rise in the repo rate. A corresponding rise in deposit rates, not commensurate with rise in yields, may pressurise the margins (NIMs) for the sector. Increase in risk weightage: The National Housing Bank (NHB) has further tightened norms for housing finance companies (HFC) in the wake of the risk foreseen due to high asset prices. The NHB has increased the risk weightage for loans to the commercial real estate sector from 100% to 125%. Also, the investment in mortgage-backed-securities (MBS) will attract risk weightage of 125%. The decision comes close on the heels of the NHB increasing the risk weightage on home loans from 50% to 75%. Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks below 51% thus choking the headroom available to these banks for raining equity capital. Higher provision for standard assets: The RBI has increased the provisioning requirement on standard assets from 0.25% to 0.4%, thus increasing the provisioning liability for banks. Impediments in sectoral reforms: Opposition from Left and resultant cautious approach from the North Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium term. Budget Impact: Banking Sector Analysis for 2007-08 | Banking Sector Analysis for 2009 Latest:  Banking Sector Report  Feedback Name E-mail Your comments

Sector Performance COMPANY PRICE (Rs) ARMAN HOLDINGS 62.0 (0.2%) AU SMALL FINANCE BANK 601.2 (-1.3%) AXIS BANK 1,133.5 (0.5%) BANDHAN BANK 184.5 (-0.1%) BANK OF BARODA 268.8 (0.0%) BANK OF INDIA 150.5 (0.1%) BANK OF MAHARASHTRA 67.8 (3.9%) BIRLA SUN LIFE BANKING ETF 48.7 (-0.1%) CANARA BANK 618.0 (0.3%) CAPITAL SMALL FINANCE BANK LTD. 346.5 (0.8%) CENTRAL BANK 65.9 (0.3%) CITY UNION BANK 160.4 (2.1%) CSB BANK 386.2 (-4.2%) DCB BANK 138.7 (1.6%) DHANLAXMI BANK 44.3 (-0.2%) EDELWEISS NIFTY BANK ETF 4,531.7 (0.3%) EQUITAS SMALL FINANCE BANK 99.1 (-0.1%) FEDERAL BANK 157.1 (0.7%) FINO PAYMENTS BANK 293.6 (0.1%) HDFC BANK 1,510.5 (-0.0%) ICICI BANK 1,111.6 (-0.1%) ICICI PRU BANK ETF 48.6 (-0.4%) ICICI PRU PRIVATE BANKS ETF 24.1 (-0.1%) IDBI BANK 88.6 (0.7%) IDFC FIRST BANK 84.7 (1.5%) INDIAN BANK 527.3 (-0.0%) INDIAN OVERSEAS BANK 67.0 (0.1%) INDUSIND BANK 1,450.0 (-3.1%) J&K BANK 132.5 (0.0%) JANA SMALL FINANCE BANK LTD. 506.9 (4.1%) KARNATAKA BANK 228.5 (0.6%) KARUR VYSYA BANK 190.8 (-0.4%) KOTAK BANKING ETF 491.7 (-0.4%) KOTAK MAHINDRA BANK 1,615.5 (-1.7%) KOTAK PSU BANK ETF 733.5 (0.1%) PNB 136.8 (0.7%) PUNJAB & SIND BANK 62.0 (0.3%) RBL BANK 266.9 (1.8%) SBI 803.0 (-1.2%) SHREE WORSTEX 60.4 (5.0%) SOUTH IND.BANK 30.5 (0.4%) SURYODAY SMALL FINANCE BANK 206.6 (-0.5%) SYNDICATE BANK 15.2 (3.8%) TAMILNAD MERCANTILE BANK 487.2 (-1.0%) TATA NIFTY PRIVATE BANK ETF 246.0 (-0.3%) UCO BANK 57.1 (0.6%) UJJIVAN SMALL FINANCE BANK 53.3 (-0.2%) UNION BANK 151.1 (0.8%) UTKARSH SMALL FINANCE BANK 59.6 (1.3%) YES BANK 26.1 (0.5%)

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