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Banks: And the tussle continues... - Views on News from Equitymaster

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Banks: And the tussle continues...

Jul 13, 2006

As the June quarter results of the banking sector start trickling in from today (starting with UTI Bank), investors are eagerly awaiting numbers that will reassure them of sustenance in credit growth and persistence of the capex cycle in the economy. While concerns over liquidity and margin pressure loom large, apprehension over capital constraints (with the onset of Basel II) and ability to counter foreign counterparts also seem to be weighing heavy on investor sentiment. The Reserve Bank of India (RBI), in line with its FY09 target of paving the way for entry of foreign banks into India, is contemplating granting permission for larger number of branches (nearly five times) to the foreign banks. While this comes as a welcome development to the foreign entities, at a time when liquidity pressure is already slowing the growth prospects of the sector, one may question the prudence of such a step with regard to the health of the domestic entities.

One can recollect that that the RBI chose to postpone the opening up of the banking sector to the foreign entities until FY09, to ensure the relative strength of the Indian banks vis-a-vis their foreign counterparts. In the interim, Indian banks are expected to clean up their books, meet global regulatory norms (Basel II) and consolidate their share. Until then, no single foreign entity is allowed to hold more than 5% stake in an Indian bank.

Growth in the pie...
With Indian corporates going on a capex overdrive over the last couple of years, the contribution of non-food bank credit to the capex funding has accelerated. Similar has been the case in retail consumer lending. In fact, the latter has been the main propeller of a quantum leap in credit growth in the last three fiscals. This is accentuated by the fact that the non-food credit to GDP ratio has grown from 51% in FY03 to 80% in FY06. Lower interest rates and higher income levels have also driven demand for mortgage loans, which have constituted nearly 50% of the incremental retail demand.

PSU vs. Private sector banks
It however, needs to be pointed out that all banks have not been equal beneficiaries of the growth in the pie. While private sector banks capitalised on the latent growth opportunities in retail lending, their PSU counterparts were laggards in catching up with them. As a result, while the larger PSU banks steadily lost market share, some of the smaller ones could barely hold on to theirs. At the same time, some of the private sector banks nearly managed to double their market share (see adjacent chart).

The private sector banking entities also subjugated their PSU counterparts by capturing a large share of the fee income pie with their business interests spread across domains like insurance, venture capital and asset management. Even when it came to inorganic growth, it was only SBI that managed to keep pace with its private sector peers.

Foreign banks - flexing their muscles
The current regulations allow foreign banks to acquire majority stake in only weak domestic banks identified by the RBI. Contrasting this, globally, banks have witnessed consolidation by way of mega amalgamation deals like the one struck between Standard Chartered Bank and ANZ Grindlays or the Citibank-Travelers merger. Also, many foreign banks (including Citi, HSBC and Standard Chartered) have invested billions in picking up large stakes in Chinese banks and insurance companies.

2005 Foreign Bank assets % of GDP
in US$ bn % of total bank assets
India 36 8.0 6.0
Brazil 107 27.0 18.0
China 71 2.0 4.0
Korea 65 8.0 10.0
Singapore 159 76.0 148.0
Hong Kong 570 72.0 344.0
Source: BIS
However, it could be quite a different story after April 2009, when the foreign banks have greater freedom for inorganic growth in the country. What they have done in Singapore, Hong Kong, China and elsewhere in recent years is rather indicative of the same. Their handicap of limited penetration and concentration in a niche customer segment could also be overcome with greater liberty from the RBI.

Consolidation is the 'mantra'...
While PSU banks continue to be cushioned from competition, the private sector banks seem to be the 'likely victims' of the consolidation drive. The well-heeled private sector entities, while on one hand are being deprived of foreign equity, and on the other, will also feel the heat of the financial muscle of foreign entities taking stake in their weaker counterparts. Credit growth and margin sustenance apart, investors shall therefore, also have to keep a close look on how the consolidation drive in the sector pans out.


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