How cost-efficient are Indian banks?

Banks form the core of the country's financial system. Hence healthy and profitable banks help in ensuring stability and resilience of the entire financial system. The recent decline in economic growth and global uncertainties have proved challenging to banks. This has resulted in rising impairment of assets, pressures on margins and volatility in non-interest income. Further, increased competition, higher cost of operation and regulatory tightening have added to their woes. In this backdrop, Indian banks have some achievements to their credit. Focus on technology, processes and people have enabled them in achieving greater efficiencies. But have Indian banks really fared well?

An analysis of cost parameters for Indian banks reveals certain interesting results. On the efficiency and productivity front, public sector banks have demonstrated perceptible improvement vis-a-vis its private peers. The following cost based parameters reveal the state of Indian banks:

Table 1: Cost parameters-Operating expenses ratios

All Banks (%)	1992	1993	1995	1997	1999	2001	2003	2005	2007	2009	2011	2013
Operating Exp to Avg. Assets	2.60	2.82	3.00	3.01	2.88	2.84	2.35	2.32	2.12	1.87	1.86	1.75
Operating Exp to Avg. Business	2.09	2.27	2.51	2.51	2.39	2.34	1.93	1.85	1.59	1.39	1.36	1.26
Cost Income Ratio	55.58	72.46	63.41	61.00	64.30	63.38	48.36	49.56	50.13	44.68	45.23	45.02

Source: The Reserve Bank of India- RBI
While public sector banks have shown a significant decline in these ratios, the private and foreign banks instead have shown increase.

Another distinct trend has been observed. During the period 1992-2013, the overall operating expenses grew at a CAGR of 14.65% (as per the RBI data). The staff expenses during the same period grew at a CAGR of 13.63%. Importantly, the public sector banks have reported the lowest CAGR for operating expenses. Operating efficiency parameters decide the health of the bank. But margins and effective deployment of assets tells us their balance sheet strength. Have a look at the table below:

Table 2: Margins and Profitability parameters- Improving trend

All Banks (%)	1992	1993	1995	1997	1999	2001	2003	2005	2007	2009	2011	2013
Net Interest Margin	3.30	2.65	3.26	3.40	3.03	3.06	2.91	3.08	2.86	2.62	2.91	2.79
Gross Income to Avg. Assets	4.68	3.89	4.72	4.93	4.48	4.48	4.86	4.67	4.24	4.19	4.12	3.89
Net Profit to Average Assets	0.37	1.14	0.47	0.70	0.53	0.54	1.05	0.97	1.00	1.10	1.06	1.02

Source: RBI
The above parameters definitely indicate susceptible improvement in productivity and efficiency of Indian banks. Also, public sector lenders have performed better than the private and the foreign peers. However, this progress has not been consistent and sustainable. And this can best be proved in comparison with global standards.

Back home Indian banks have made considerable progress on the efficiency and productivity front. But benchmarking the Indian banks against the global productivity standards reveals the true picture. Considering the objective of extending affordable banking services to the unbanked poor, India needs to target a level which is at par with other countries.

Table 3: Global comparison-India lags behind

Parameters (%)	Year	India	China	Indonesia	Malaysia	Korea	UK	Canada
Operating expenses to Total Assets	2003	2.24	1.63	3.39	2.07	3.74	1.34	3.23
	2006	2.13	1.43	3.97	1.91	2.07	1.39	2.57
	2009	1.71	0.92	2.85	1.27	1.20	0.86	2.09
	2012	1.65	0.80	3.29	1.27	1.05	1.03	1.74
Net Interest Margin	2003	2.77	2.33	4.90	2.67	2.84	0.86	2.36
	2006	2.81	2.30	5.90	2.15	2.72	1.06	1.76
	2009	2.39	2.27	5.60	3.11	2.17	0.94	1.82
	2012	2.70	2.75	5.30	2.38	2.40	1.02	1.85
Net Profit to Total Assets	2003	1.00	0.49	1.66	1.10	0.02	0.37	0.75
	2006	0.88	0.62	1.56	0.99	0.98	0.53	0.95
	2009	1.01	0.86	2.60	1.20	0.60	0.06	0.57
	2012	0.98	1.28	2.60	1.60	0.70	0.09	0.86

Source: RBI
On the global platform, Indian banks are yet to catch-up. In terms of operating costs to assets ratio, Indian banks lag behind their Asian peers and ones in the developed world.

Enhancing operational efficiency does not merely imply curtailing costs. Neither passing on the inefficiencies to customers and putting up a good profitability show is a sign of healthy bank. There is more to do with efficiency. Efficiency is more about staff, capital and franchise management. Three key changes in our view would prove instrumental in strengthening the footing of Indian banks:

1. Implementing robust IT systems to ensure quick breakeven of new franchises

2. Increasing focus on retail and SME business with tight control on asset quality

3. Improving pricing stability both for liability and asset products

Thus while Indian banks have some way to go before becoming cost competent with their global peers, a gradual move towards it will be rewarding for shareholders..