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Financial Institutions: Right strategies needed - Views on News from Equitymaster
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  • May 19, 2001

    Financial Institutions: Right strategies needed

    Advancement in technology and opening up of the economy has widened the scope of 'Finance'. Financial institutions (FIs) world-over are considered as the hubs for financial activity. Indian FIs are also gearing up to transform into 'Universal Banks', to capitalize on the opportunities available in the sector with the opening up of the Indian economy. They are becoming the focal point of economic activity in the country.

    Until 1992, Indian FIs were regulated by the government policy in almost all business activities - sanctions, industry allocations, lending and borrowing rates. However, with the deregulation of lending and borrowing rates, removal of subsidized funding, stringent accounting norms and greater operational freedom, they are now operating in a more liberal environment.

    Over the years, development financial institutions have played a vital role in long-term and project financing. The trend is changing with banks funding long-term finance and FIs meeting the medium and short term needs of the business masses. The sky is the limit with 'Universal Banking' expected to become a reality. FIs can now offer a whole range of financial services beyond commercial and investment banking.

    The recent guidelines of RBI have however dampened the sentiment of FIs for transiting towards 'Universal Banking'. As per the guidelines, FIs are required to adhere to the prudential norms in line with banks for becoming universal banks. They will have to maintain a cash reserve ratio (CRR) of 7.5% and statutory liquidity ratio (SLR) of 25%, along with norms of 40% priority sector lending. However, unlike banks, FIs are deprived of low cost funds from the public. With the higher cost of resources than banks and imposition of CRR and SLR would further pressurize their cost of operations. Apart from maintaining these statutory ratios, the RBI has given clear indication as regards the board of directors. The composition of the board should be changed with at least 51% of the directors having special knowledge in banking. On becoming universal banks, FIs will also have to de-link subsidiaries engaged in activities not permitted under the Banking Regulation Act.

    Though the process of drafting roadmaps towards universal banking began one year back, it apparently gathered momentum only in recent times after the RBI asked all FIs to make serious efforts for moving towards becoming universal banks. But, unless the RBI eases such prudential norms for FIs or for the banking industry as a whole, it is difficult for any FI to make concrete steps in this direction.

      Sanctions Disbursements
    (Rs bn) April-Jan '00 April-Jan '01 Change April-Jan '00 April-Jan '01 Change
    ICICI 359 472 31.3% 185 253 37.2%
    IDBI 204 205 0.6% 117 113 -3.0%
    IFCI 17 10 -38.0% 23 13 -42.1%
    AIFIs* 778 889 14.2% 464 520 12.0%

    * All India Finanacial Institutions

    It was a time full of challenges for the finance sector in the financial year 2001. Apart from stringent provision requirements from the regulators, FIs were also affected by a slowdown in the economic and the industrial activity. The index of industrial production in financial year 2001 was put at 4.9% compared to 6.7% in the previous year. Growth in sanctions and disbursement, at a rate of 26% and 19% respectively in FY00, tapered down to 14% and 12% respectively in the first 10 months of the financial year 2001. ICICI, a market leader (share of over 48% in disbursements) has however beaten the industry trend by reporting a healthy growth rate of over 30% in both sanctions and disbursements. Comparatively better quality of services provided by the institution has enabled it to maintain excellent growth rates.

    The performance of FIs in the past few years is affected by rising level of non-performing assets (NPAs). Among the leading FIs, IFCI is marred with the highest level of NPAs (20.7% of net advances). On the other hand ICICI is aggressively initiating process to bring down the NPA level. Over exposure to the sectors such as steel, textiles and chemicals have dragged down the profitability of FIs, as most of these loans are turning bad. This has forced FIs to change their focus towards more lucrative and growth-oriented sectors like infrastructure, oil & gas and telecom. This will not only diversify their loan portfolio but will also minimize the risk of turning into NPAs.

    Particulars ICICI IDBI* IFCI*
    Net NPA as a % of loan portfolio 5.2% 12.3% 20.7%
    Capital adequacy ratio 14.6% 14.5% 8.8%
    ROE ** 16.2% 9.0% 3.0%

    * Figures for FY00
    ** Excluding the accelerated provision of Rs 8 bn.

    Nevertheless, the future for the finance sector seems bright in the light of opening up of new income avenues such as insurance, fee based income and retail lending. However, high cost of funds will continue to result in sliding interest spread, which could deteriorate the performance of FIs. The challenge for them now is to sustain their performance in the scenario of increasing competition from other financial intermediaries (banks). Not surprisingly, this is possible only if they are given the operational freedom to compete with other private sector players for funds and business.



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