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Banking: Latent demand? - Views on News from Equitymaster
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  • Dec 2, 2005

    Banking: Latent demand?

    At the recently held banker's conference (BANCON), top bankers across the country deliberated on the possible avenues of growth in the sector and the untapped pockets of the country's economy where unorganized credit is still thriving. The statistics revealed therein, implicating India as an underbanked economy, have been accentuated by the Reserve Bank of India (RBI)'s 'Trends and Progress in Banking', which also concurs with the latent demand for organised credit in the country.

    Here are some of the salient points from BANCON and RBI's Trends and Progress in Banking that point to a faster growth in credit offtake in the future.

    • Banking industry needs to raise Rs 600 bn of capital over the next five years to push up the loan to GDP ratio from current 43% to 50% (as high as 250% in developed nations).

    • Almost 65% of the Indian population is dependent on agriculture and resides in rural India. At present only 5% of agricultural produce is being financed in India. Of this, 80% is in retail and rest is in semi-wholesale and wholesale segments. Currently, we have around 150 m households in rural India with an average borrowing capacity of Rs 6,000 per household, which creates a market in excess of Rs 900 bn. There is a huge demand for the organised rural credit, as institutional credit is available only to one-third of the rural farmers and the remaining demand for credit is provided by moneylenders who charge exorbitant interest rates, ranging from as high as 50% to 100% p.a.

    • Only 27% of the rural households in India have access to formal sources of lending.

    • Retail assets in the banking system grew at a CAGR of 46% in the last 5 years. The contribution of retail credit to the overall credit growth was 42% in FY05. Even then, it is contemplated that the segment is poised to grow at a CAGR of 24% over the next 10 years.

    • Retail assets are 22% of the country's banking assets (40% to 60% in developed economies). Further, retail credit to GDP is a mere 6% in India, against 15% in China, 24% in Thailand, and 52% in Taiwan.

    • Only 60% of the individuals who can afford mortgage loans have accessed loans from the system. Likewise about 29% of the customers who can avail auto loans have done so.

    All said, what further needs to be looked into by the bankers is that not only are most segments catered to, but also, they are done profitably. For the same, rational pricing is critical. In fact, most banks which have now acknowledged having resorted to 'suicidal pricing' to gain market share, have reverted back to fixing floor rates for high-risk loans. Especially, in segments such as consumer loans wherein the sector average NPAs are reported to be as high as 8% to 10%, additional precautions are pertinent.

    Nevertheless, what adds to our comfort is the fact that the average earning levels in the economy today is higher than the prevalent leverage levels and interest rates. To put things into perspective, 5 years back, auto loans were priced at 22% p.a. (at present about 14%) and mortgage loans were priced at 14% to 16% p.a. (at present floating rate loans are priced at 8% to 8.5%). Also, the expected FY06 real GDP growth rate of 7.5% (nominal GDP growth of 11.7% less inflation of 4.2%) offers scope for further economic expansion.

    Given this, our stance on the banking sector remains optimistic based on strong credit off-take, relatively healthy asset quality and immune treasury book, and diversification of revenue streams. Moreover, the government's focus on phased implementation of international best practices will help banks to meet the increased competition from foreign players and prepare for the post FY09 era wherein foreign banks will be allowed to take stake in domestic entities.

    Also, an accelerated pace of IT implementation will facilitate smooth migration to Basel II norms along with reduced costs and improved efficiencies. However, any steep rise in interest rates remains a key concern to the sector's valuations.



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