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Banks: Other income imperative

Mar 29, 2003

Historically other income has not been considered as a significant component of the income of Indian banks. But FY02 changed all that as banks started booking gains on its G-Sec portfolios due to falling interest rates. While as a percentage of total income, other income has grown to 16% in FY02 (13% in FY01) on the back of 43% YoY growth in other income. However, compared to international standards it is still low. Internationally other income constitutes a significant part of total revenues (nearly 25-30%). Therefore, take a look at the trend of other income of Indian banks historically as well as the prospects of the same going forward. The major components of the other income for banks can be classified in to three streams. These are ‘commission, exchange and brokerage’, ‘exchange transaction’ and ‘sale of investments’. Commission exchange and brokerage involves the fees and commissions that the bank charges its clients for its lending activity. Exchange transaction income, on the other hand, is earned from the dealings of the bank in the Forex market mainly for trade financing extended to importers and exporters. Sale of investment income is derived from the bank’s investment activities. This income includes gains that banks have made from their G-Sec investments.

Commission, exchange and brokerage income of banks, which is largely dependent on the credit off-take, has shown a steady growth. This is supported by the fact that the cumulative credit outstanding of all Indian scheduled banks stood at Rs 3,019 bn (US$ 63 bn) in 1998 but it climbed up to Rs 6,099 bn (US$ 127 bn) in FY02. The growth in credit off take has been mainly precipitated rapid economic growth as well as banking sector reforms started from 1992. But we also observe that progressively the share of this income in other income has declined mainly due to sale of an increase in investment income in the period between FY00 and FY02.

Sale of investment income of banks has been largely a non-item until FY02. But in FY02 all this changed as banks started booking huge portfolio gains on account of falling interest rates. Falling interest rates led to an appreciation in the value of the G-Sec portfolio of Indian banks. This effect is apparent from the fact that in FY01 the income from sale of investments was close to Rs 30 bn (US$ 0.6 bn). But in FY02 this income jumped to Rs 100 bn (US$ 2 bn).

Exchange transactions, which are dependent on the country’s foreign trade, have not shown significant improvement and have actually fallen as a percentage of total other income. While Indian foreign trade has shown significant improvement in the last 6-7 years, this does not seem to have translated in to income for Indian banks.

Across bank categories other income growth has been largely stable but for FY02. For PSU and Private sector banks the gains from sale of investments have largely been responsible for the robust growth in other income in FY02. Foreign banks on the other hand have not witnessed, as much growth from this segment as their exposure to long dated high yielding G-Secs has been limited unlike private and public sector banks.

FY02 undoubtedly was an aberration and expectations of such gains in the future would be wishful thinking. The conditions that led to this significant rise in other income no longer exist. Significant fall in interest rates from current levels is not a possibility. However, we believe that the other income might still grow to be a larger part of a bank’s bottomline. Structural changes are taking place in the banking sector. Banks are no longer just places to keep your money safe. Today they are offering a range of services to meet the personal financial needs of the investors.

Banks are selling products like insurance and mutual funds that will earn them a commission fee. In fact new generation banks have already started the concept of bankassurance (essentially selling insurance products through their branches). Another area where banks earn additional income is by allowing other banks to use their ATM networks. Since smaller banks do not have large ATM networks they take the help of larger banks in order to extend their reach. Apart from these services banks also offer cash management services to corporates for which they receive a commission. And finally as the industry consolidates and credit off take picks up Indian banks will see an even bigger contribution of other income towards their total income.

Going forward the challenge here for banks is to slowly increase their other income component (with lower contribution of sale of investment income) in order to increase the stability in their earnings because of the cyclical nature of interest income. In the long run banks with adequate logistics in place will be in a better position to meet this challenge. Large banks with an extensive reach across the country will be the ones to look out for.

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