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Banking: Consolidation holds the key - Views on News from Equitymaster
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  • Jan 8, 2001

    Banking: Consolidation holds the key

    The banking sector has finally attracted some buying interest towards the fag end of the year. The sector, which has remained lacklustre since the past two years, suddenly came in the limelight with liberalization of financial sector.

    Mergers and acquisitions amongst the banks have been found as an effective remedy for fragmentation. Mergers can prove to be very effective in strengthening the Indian financial sector. After the merger of Times Bank with HDFC Bank in the last year, ICICI Bank took lead this year by announcing to merge with Bank of Madura. ICICI Bank would emerge as the largest private sector bank in the country with this merger. The announcement of the merger also sparked buying interest in many old private sector banks, which were trading at attractive valuations.

    Not only the private sector banks but also the public sector banks became the market favourites. The decision of the government to dilute its stake in 19 nationalised banks to 33% positively affected the sentiment of the public sector banking (PSB) stocks. The government is, however, reluctant to give away management control in the public sector banks.

    Therefore, the consolidation in the government owned banks is unlikely in the near term. The freedom of decision-making and statutory difficulties is likely to slow down the speed of reforms. The very thought of privatisation appears to have brought some improvement in the efficiency of public sector banks. While steps have been taken to introduce technology, improve customer service and reduce manpower, it still has a long way to go before it meets the efficiency levels of some of the private sector banks.

    PSBs have done well in the recent past to improve their asset quality. The recent report of RBI on Trends and Progress of Banking in India points to the fact that during FY00 PSBs showed an overall decline in the share of NPA’s (Non performing assets) to total advances as well as to total assets. The number of public sector banks whose NPAs have fallen below the 10% level have risen to 22 in FY00 compared to 18 in the previous year. In contrast the ratio of net NPAs to net advances of the new private sector banks was much improved (at 5.6%) as on March 2000.

    The NPA recovery process for government banks was slow mainly because of higher percentage of priority sector lending (18% to the agricultural sector). The government regulations require them to lend to sectors where there is low growth opportunity resulting in large NPAs. These hurdles make PSBs an unattractive investment.

    Added to this were the Reserve Bank of India’s disappointing guidelines relating to disclosure of non performing assets by banks. Accordingly, the substandard assets of the bank will now be classified as doubtful assets within a period of 18 months from the assets becoming non-performing (from the earlier 24 months). This could result in higher provision for non-performing assets for the bank during the year, in turn depressing bottomlines. However, the new guidelines also offer some advantages. Investment portfolio of banks is re-classified to reduce their mark to market losses on investments in future. Banks could now mark 75% of their portfolio to market instead of 100% earlier. Thus, lower provision for losses in investments could help banks to show higher growth in profits.

    With the technology advancements banks are moving towards providing value added services to the customers with the newer channels. Private banks have taken a lead in introducing emerging technologies. After online banking and ATMs, they are now offering WAP (Wireless Application Protocol) enabled mobile banking services.

    Banks are increasingly focusing on retail marketing to increase their wafer thin spread. Their foray into areas like credit/debit cards, housing loans, personal loans, consumer durable loans, loan against shares, depository services, acting as a custodian for stock exchanges and cash management services is likely to provide them healthy bottomline growth. Also, banks are tapping new areas like insurance and pension funds to widen their product base.

    Notwithstanding the above positives, the attractiveness of the sector in future depends on the speed with which the government is affecting the reform process. The unlocking of value in the government owned banks could come only with the actual divestments. Private banks on the other hand will continue to enjoy higher valuations as long as they are able to adapt to new technologies, maintain lower levels of NPAs and outstanding financial performance.



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