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Report On Indian Banking Sector

May 2009

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Report On Indian Banking Sector May 2009 by All Rights Reserved. No part of this report

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REPORT ON INDIAN BANKING SECTOR

Contents

Executive Summary

1

1 History of Banking Sector in India

5

1.1 History of SBI and Associates

5

1.2 History of Other (Nationalised, Private and Foreign) Banks

6

1.2.1 Pre Independence (1840 to 1947)

6

1.2.2 Post Independence to Nationalisation (1947 to 1969)

7

1.2.3 Nationalisation to Liberalisation (1969 to 1991)

7

1.2.4 Liberalisation to current date (1991 to 2008)

8

1.3 Various Banking Groups

11

1.4 Regional Distribution of Branches

14

2 Role of Reserve Bank of India

16

2.1 RBI monetary and Credit Policy

16

2.2 Development in FY09 and role of RBI

17

2.3 Liquidity Adjustment Facility (LAF)

18

2.4 Cash Reserve Ratio (CRR)

20

3 Deposits

21

3.1 Sources of Funds for Banks

21

3.2 Distribution of Deposits of Banks

23

3.2.1 Distribution of Deposits by population

23

3.2.2 Distribution of Deposits by Ownership

24

3.3 Deposits mobilisation from household Sector

24

3.4 Type of Deposits

26

3.4.1 CASA Deposits

27

3.4.2 Term Deposits

28

3.5 Bank Group-wise Deposits Performance

30

3.5.1 SBI and Associates

30

3.5.2 Nationalised Banks

31

i

3.5 Bank Group-wise Deposits Performance 30 3.5.1 SBI and Associates 30 3.5.2 Nationalised Banks 31 i

REPORT ON INDIAN BANKING SECTOR

 

3.5.3

Private Sector Banks

33

 

3.5.4

Foreign Banks

34

4 Advances

36

4.1 Total Advances and growth for SCBs

36

4.2 Credit offtake in FY09

37

4.3 Sectoral Bank Credit

39

4.4 Retail loans

 

42

4.5 Lending to Sensitive Sector

43

4.6 Priority Sector lending

44

 

4.6.1 Priority Sector Lending for PSU and Private Banks

44

 

4.6.2 Priority Sector Lending for Foreign Banks

45

4.7 Bank Group-wise Performance

46

 

4.7.1 SBI and Associates

46

 

4.7.2 Nationalised Banks

48

 

4.7.3 Private Sector Banks

49

 

4.7

4

Foreign Banks

51

4.8 Bank group-wise deposit and advance maturity matching

52

5 Investments

 

54

5.1 SLR Investments

54

5.2 Non SLR Investments

57

5.3 Bank group-wise Credit and Investment to deposit ratios

59

6 Total Income

 

62

6.1 Interest on Advances and Investments

62

6.2 Other Income

 

63

 

6.2.1 Core Fee Income

63

 

6.2.2 Non-fee Income

64

7 Total Expenses

 

67

7.1

Operating Expenses

67

ii

Income 63   6.2.2 Non-fee Income 64 7 Total Expenses   67 7.1 Operating Expenses 67

REPORT ON INDIAN BANKING SECTOR

 

7.1.1 Staff Cost

69

 

7.1.2 Non-staff Cost

73

8 Spread

75

8.1

Spread for SCBs

75

8.2

Bank Group-Wise Performance

76

9 Profitability

80

9.1 Profitability for SCBs

80

9.2 Bank Group-Wise Performance

81

 

9.2.1 SBI and Associates

81

 

9.2.2 Nationalised Banks

82

 

9.2.3 Private Sector Banks

83

 

9.2.4 Foreign Banks

84

10 Non-Performing Assets (NPAs)

85

10.1 Trend in NPAs for SCBs

86

10.2 NPAs, Provisions and write back for banking groups

89

10.3 Sector-wise NPA Break-up

93

10.4 Recovery of NPAs

94

10.5 Bank Group-wise Performance

97

 

10.5.1 PSU Banks

98

 

10.5.2 Old Private Sector Banks

99

 

10.5.3 New Private Sector Banks

100

 

10.5.4 Foreign Banks

101

11 Capital Adequacy Ratio (CAR)

102

12 Consolidation: Is it imminent for the Indian banking sector??

105

13 FY09 Result Analysis

109

14 Outlook on Indian Banking Industry

112

14.1 Advances

112

14.2 Deposits

122

iii

Analysis 109 14 Outlook on Indian Banking Industry 112 14.1 Advances 112 14.2 Deposits 122 iii

REPORT ON INDIAN BANKING SECTOR

14.3 Investments

 

128

14.4 Core Fee Income

131

14.5 Net Interest Margins (NIMs)

132

14.6 Non-Performing Assets (NPAs) and Provisioning

139

 

14.6.1

Restructuring of Assets

145

14.7 Profitability

 

148

15 Ranking of Individual Banks

149

16 Players

182

16.1

Axis Bank

182

16.2

Bank of Baroda

184

16.3

Bank of india

186

16.4

Canara Bank

188

16.5

Central Bank of india

190

16.6

HDFC Bank

192

16.7

ICICI Bank

194

16.8

IDBI Bank

196

16.10

State bank of India

198

16.11

Syndicate Bank

200

16.12

Union Bank of India

202

iv

196 16.10 State bank of India 198 16.11 Syndicate Bank 200 16.12 Union Bank of India

REPORT ON INDIAN BANKING SECTOR

Figure Index

1.1

No. of Scheduled Commercial Banks in India

10

1.2

Classification of banks into various groups

11

1.3

No. of offices of commercial banks(both scheduled and non-scheduled including RRBs) over the years

13

1.4

Regional distribution of branches for schedule commercial banks as on March 31,

14

2008

1.5

Distribution of branches among regions for various bank groups

15

2.1

Changes in policy rate in FY09 to check inflation

17

2.2

Trend in repo and reverse repo rates over the years

18

2.3

Spread between Repo and Reverse repo rates

19

2.4

Large LAF injection during Jul to Oct’08 and subsequent absorption from Dec’08 to Mar’09s

19

2.5

Changes in CRR for Macro economic objective

20

3.1

Break-up of total resources of SCBs as on 31 st March 2008

21

3.2

Deposits as a Percentage of total resources for various bank groups

21

3.3

Total deposits and y-o-y growth in deposits of SCBs

22

3.4

Total deposits and y-o-y growth in deposits of SCBs (incl. RRBs) for FY09

22

3.5

Deposits as a percentage of GDP over the years

23

3.6

Percentage Distribution of total deposits by population

23

3.7

Break-up of deposits by ownership

24

3.8

Break-up of financial saving of household sector

25

3.9

Movement in interest rates on saving instruments

25

3.10

Trend in small saving mobilisation

25

3.11

Types of deposits

26

3.12

Proportion of low cost deposits in total deposits of SCBs

27

3.13

Share in incremental CASA deposits by various bank groups

28

3.14

Break-up of term deposits by ownership

28

3.15

Trend in spread between various maturities of deposits for PSBs

29

v

of term deposit s by ownership 28 3.15 Trend in spread between various maturities of deposits

REPORT ON INDIAN BANKING SECTOR

3.16

Break-up of term deposits into short-term and long-term deposits

29

3.17

Total deposits and y-o-y growth in deposits of SBI and Associates

30

3.18

Break-up of deposits and CASA ratio of SBI and Associates

31

3.19

Total deposits and y-o-y growth in deposits of Nationalised banks

31

3.20

Break-up of deposits and CASA ratio of Nationalised Banks

32

3.21

Total deposits and y-o-y growth in deposits of Private Sector Banks

33

3.22

Break-up of deposits and CASA of Private Sector Banks

33

3.23

Total deposits and y-o-y growth in deposits of Foreign Banks

34

3.24

Break-up of deposits and CASA of Foreign Banks

35

4.1

Total advances and y-o-y growth in advances of SCBs

36

4.2

Type-wise advances Break-up for SCBs

36

4.3

Security-wise break-up of total advances for SCBs

37

4.4

Total Credit and y-o-y growth in credit for SCBs (incl. RRBs) for FY09

37

4.5

Break-up of bank credit into various sectors

39

4.6

Lending to sensitive sectors for FY08

43

4.7

Bank group-wise lending to the sensitive sector (as a % of total advances)

43

4.8

Priority Sector lending for PSBs and Private Sector Banks (as a % of total advances)

44

4.9

Priority Sector lending for Foreign Banks (as a % of total Advances)

45

4.10

Total advances and y-o-y growth in advances of SBI and Associates

46

4.11

Type-wise break-up of total advances for SBI and associates

47

4.12

Security-wise break-up of total advances for SBI and associates

47

4.13

Total advances and y-o-y growth in advances of Nationalised Banks

48

4.14

Type-wise break-up of total advances for Nationalised Banks

48

4.15

Security-wise break-up of total advances for Nationalised Banks

49

4.16

Total advances and y-o-y growth in advances of Private Sector Banks

49

4.17

Type-wise break-up of advances for Private Sector Banks

50

4.18

Security-wise break-up of total advances for Private Sector Banks

50

vi

for Private Sector Banks 50 4.18 Security-wise break-up of total ad vances for Private Sector Banks

REPORT ON INDIAN BANKING SECTOR

4.19

Total advances and y-o-y growth in advances of Foreign Banks

51

4.20

Type-wise break-up of total advances for Foreign Banks

51

4.21

Security-wise break-up of total advances for Foreign Banks

52

5.1

Break-up of Investments

54

5.2

SLR Investment and Requirement by SCBs

55

5.3

SLR Investments by SCBs over the years

55

5.4

Mismatch between the CAGR in deposits and advances of SCBs

56

5.5

Credit-deposit and investment-deposit ratio of SCBs

57

5.6

Composition of Non-SLR Investments over the years for SCBs

58

5.7

Credit, Investment to deposit ratio for SBI and Associates

59

5.8

Credit, Investment to deposit ratio for Nationalised Banks

59

5.9

Credit, Investment to deposit ratio for Private Sector Banks

60

5.10

Credit, Investment to deposit ratio for Foreign Banks

60

6.1

Break-up of total income

62

6.2

Break-up of Interest income of SCBs

62

6.3

Trend in profit on sale/revaluation of Investments and 10 year bond yield

65

7.1

Break-up of total expenses

67

7.2

Operating cost as percentage of total assets for SCBs

67

7.3

Operating cost a percentage of total assets for PSBs

68

7.4

Operating cost a percentage of total assets for Private and Foreign Banks

69

7.5

Declining trend in staff cost as a percentage of operating cost for SCBs

69

7.6

Average business per unit of staff cost for various bank groups

70

7.7

Staff cost as a percentage of operating cost for various bank groups

71

7.8

Average business per unit of staff cost for PSBs

72

7.9

Average business per unit of staff cost for Private and Foreign Banks

72

8.1

Net Interest Margin for SCBs (in %)

76

8.2

Net Interest Margin for PSBs (in %)

77

8.3

Net Interest Margin for Private and Foreign Banks (in %)

79

vii

Net Interest Margin for PSBs (in %) 77 8.3 Net Interest Margin for Priva te and

REPORT ON INDIAN BANKING SECTOR

10.1

Classification of Asset into Standard and Non-performing

85

10.2

Trend in Gross NPAs to Gross Advances of SCBs

86

10.3

Trend in Net NPAs to Net Advances of SCBs

87

10.4

Addition and reduction in gross NPAs for SCBs over the years

89

10.5

Addition and reduction in gross NPAs for PSBs

89

10.6

Addition and reduction in gross NPAs for Private and foreign banks

90

10.7

Share of priority sector NPAs in total NPAs

97

10.8

Share of advances of PSBs to total banking gross advances and PSBs’ gross NPAs to total banking gross NPAs

98

10.9

Share of advances of PSBs to total banking net advances and PSBs’ net NPAs to total banking net NPAs

98

10.10

Share of Old Private Sector Banks to the total banking gross advances and Old Private Sector Banks’ gross NPAs to total banking gross NPAs

99

10.11

Share of Old Private Sector Banks to the total banking net advances and Old Private Sector Banks’ net NPAs to total banking net NPAs

99

10.12

Share of New Private Sector Banks to the total banking gross advances and New Private Sector Banks’ gross NPAs to total banking gross NPAs

100

10.13

Share of New Private Sector Banks to the total banking net advances and New Private Sector Banks’ net NPAs to total banking net NPAs

100

10.14

Share of Foreign Banks to the total banking gross advances and Foreign Banks’ gross NPAs to total banking gross NPAs

101

10.15

Share of Foreign Banks to the total banking net advances and Foreign Banks’ net NPAs to total banking net NPAs

101

11.1

Trend in total CRAR, Tier 1 and Tier 2 for SCBs

102

14.1

Industrial production y-o-y growth (in %)

112

14.2

GDP growth and Bank credit growth moves in tandem

115

14.3

Bank credit as a percentage to GDP

117

14.4

Share of various sectors in GDP

117

14.5

Sharp and prompt cut in CRR than earlier slowdowns

119

14.6

Projected sector-wise break-up of bank credit from FY09 to FY11

120

14.7

Average growth and y-o-y growth in credit for SCBs from FY1980 to FY2008

122

viii

FY09 to FY11 120 14.7 Average growth and y-o-y growth in credit for SCBs from FY1980

REPORT ON INDIAN BANKING SECTOR

14.8

Average growth and y-o-y growth in deposit for SCBs from FY1980 to FY2008

123

14.9

Difference between credit and deposit growth over the years

123

14.10

Share of demand deposits in incremental total deposits for SCBs

124

14.11

Share of saving deposits in incremental total deposits for SCBs

126

14.12

Trend in 10 years G-sec yield

129

14.13

Trend in SLR Investment of SCBs

130

14.14

Benchmark Prime Lending Rate (BPLR - maximum) over the years

132

14.15

Deposit rate of for more than 1 year maturity over the years

132

14.16

Spread between BPLR - maximum and deposits rate for more than 1 year maturity

134

14.17

Net Interest Margin (NIM) for SCBs over the years

134

14.18

Movements in interest rate on small saving instruments and bank deposit

136

14.19

Trend in BPLR and saving deposit rates

137

14.20

Trend in the spread between BPLR and saving deposit rates

137

14.21

Trend Repo and CRR for FY09

138

14.22

Share of small scale credit in industrial credit over the years

142

15.1

Ranking Parameter

149

ix

14.22 Share of small scale credit in industrial credit over the years 142 15.1 Ranking Parameter

REPORT ON INDIAN BANKING SECTOR

Table Index

1.1

List of banks under various banking groups

12

3.1

Interest spreads between short-term and long-term deposits as on December 2008 (in %)

30

3.2

CASA of Nationalised Banks (in %)

32

3.3

CASA of Private Sector Banks (in %)

34

3.4

CASA of Foreign Banks (in %)

35

4.1

Bank group-wise credit offtake for FY08 and FY09

38

4.2

Break-up of bank credit into various sectors

39

4.3

Provisional break-up of non-food credit for FY09

40

4.4

Share of various sector in incremental non-food credit for FY09

40

4.5

Provisional break-up of industrial credit for FY09

41

4.6

Share of various sector in incremental industrial credit for FY09

41

4.7

Bank group-wise provisional sectoral bank credit growth for FY09

42

4.8

Break-up of retail credit for SCBs

42

4.9

Break-up of Priority Sector Lending for PSBs and Private Sector Banks (Rs cr)

45

4.10

Break-up of Priority Sector Lending for Foreign banks (Rs cr)

46

4.11

Maturity-wise break-up of deposits for various bank groups

52

4.12

Maturity-wise break-up of advances for various bank groups

53

4.13

Maturity-mismatch between deposits and advances

53

6.1

Proportion of other income in total income for various bank groups

63

6.2

Trend in other income (excluding Profit on Sale/revaluation of investments and fixed assets) (Rs cr)

64

6.3

Bank group-wise share in interest and fee income for FY08

64

6.4

Profit on sale and revaluation of investment for various bank groups

66

7.1

Trend in operating cost excluding staff cost

73

7.2

Trend in advertising and publicity cost

73

8.1

Spread of the SCBs over the years (in %)

75

x

73 7.2 Trend in advertising and publicity cost 73 8.1 Spread of the SCBs over the

REPORT ON INDIAN BANKING SECTOR

8.2

Spread of the PSBs over the years (in %)

76

8.3

Spread of Old Private Sector Banks over the years (in %)

77

8.4

Spread of New Private Sector Banks over the years (in %)

78

8.5

Spread of Foreign Banks over the years (in %)

78

9.1

Statement of Profit for SCBs

80

9.2

Statement of Profit for SBI and Associates

81

9.3

Statement of Profit for Nationalised Banks

82

9.4

Statement of Profit for Private Sector Banks

83

9.5

Statement of Profit for Foreign Banks

84

10.1

Provisioning Requirement for non-performing asset depending upon the classification category

86

10.2

Gross and Net NPAs of SCBs (Rs cr and in %)

87

10.3

Gross and Net NPAs of various bank groups (Rs cr and in %)

91

10.4

Distribution of banks by the ratio of Net NPAs to Net Advances

93

10.5

Sector-wise classification of NPAs for SCBs and PSBs

93

10.6

Sector-wise classification of NPAs for Private Sector Banks

94

10.7

Financial Assets Securitised by Securitisation and reconstruction companies

95

10.8

NPAs recovered through various Channels

96

10.9

Recovery of direct agriculture advances

96

11.1

Resources raised by banks over the years (Rs cr)

103

11.2

Bank group-wise trend in CRAR ratio over the years (in %)

103

11.3

Distribution of banks by CRAR

104

12.1

List of banks amalgamated since nationalization of banks in India 1969

105

12.2

List of countries and no. of banks operating within a country

106

12.3

Fund infusion by government into PSBs

107

12.4

Government holdings in PSBs

107

13.1

Profit and Loss account for PSBs

109

13.2

Profit and Loss account for Private Sector Banks

110

xi

13.1 Profit and Loss account for PSBs 109 13.2 Profit and Loss account for Private Sector

REPORT ON INDIAN BANKING SECTOR

13.3

CASA ratio various banks in FY 08 & FY 09

111

13.4

Restructured Assets in Rs. cr and in % of total Advances

111

14.1

Sector-wise and Used based growth in industrial production

113

14.2

GDP growth rate across the country

114

14.3

GDP growth and bank credit growth for block of years

116

14.4

Projected credit growth for various banking group (%)

120

14.5

Projected credit growth for various banking group (Rs cr)

120

14.6

thus changing share in total credit in favour of PSU banks

121

14.7

Average growth and standard deviation in deposit and credit growth from FY1980 to FY2008 (in %)

122

14.8

Trend in incremental total and demand deposits for FY09 (Rs cr)

125

14.9

Trend in incremental total and demand deposits over the years (Rs cr)

125

14.10

Deposit growth for various bank groups (in %)

126

14.11

Projected deposit growth for various banking group (%)

127

14.12

Projected deposit growth for various banking group (Rs cr)

127

14.13

thus changing the share in total deposits in favour of PSBs

127

14.14

Profit on sale/revaluation of investments for SCBs

128

14.15

Trend in Core fee income growth and projection

131

14.16

Cut in BPLR and deposit rates by various banks

133

14.17

Speeding up of sub-PLR lending by PSU banks at a lower interest rate to following sectors

135

14.18

Projection for NPAs for various bank groups

139

14.19

Sector-wise exposure of industrial credit

140

14.20

Dependence of Indian corporates on borrowed funds

141

14.21

Break-up of bank retail credit for SCBs and expected slippages

143

15.1

Calculation of no. banks included in Ranking Analysis

150

xii

for SCBs and expected slippages 143 15.1 Calculation of no. banks included in Ranking Analysis 150

REPORT ON INDIAN BANKING SECTOR

Annexures

Overall Ranking based on various parameters

151

Ranking based on Size

153

 

Ranking based on no. of branches

155

 

Ranking based on total business

156

 

Ranking based on Net profit

157

Ranking based on Profitability

158

 

Ranking based on Net Interest Margin

160

 

Ranking based on Return on Assets (ROA)

161

 

Ranking based on Return on Equity (ROE)

162

 

Ranking based on CASA Ratio

163

 

Ranking based on Core Spread

164

Ranking based on Quality

165

 

Ranking based on Capital Adequacy Ratio

167

 

Ranking based on Tier 1 Capital Adequacy Ratio

168

 

Ranking based on Gross NPAs to Gross Advances

169

 

Ranking based on Net NPAs to Net Advances

170

 

Ranking based on proportion of Unsecured advances in total advances

171

Ranking based on Growth

172

 

Ranking based on CAGR in Advances

174

 

Ranking based on CAGR in deposits

175

 

Ranking based on CAGR in Net Profit

176

Ranking based Qualitative Factors

177

 

Ranking based on business per branch

179

 

Ranking based on business per employee

180

 

Ranking based on Profit per employee

181

xiii

179   Ranking based on business per employee 180   Ranking based on Profit per employee

REPORT ON INDIAN BANKING SECTOR

Executive Summary

Indian Banking Sector is dominated by Public Sector Banks (PSBs) which accounted for 72.6% of total advances of all Scheduled Commercial Banks excluding RRBs (SCBs) on 31st March 2008. PSBs have rapidly expanded their foot prints after nationalisation of banks in India. Although there is a restrictive entry/expansion for private sector banks and foreign banks in India, these banks have increased their presence and business over last 5 years.

SCBs in India have shown an impressive growth in deposits mobilisation over the years (Total deposit grown at CAGR of 19.6% from FY03-FY08 and 17.6% from FY88 to FY08). Among the group of banks, private sector and foreign banks deposits have grown at a higher CAGR of 26.7% and 22.5%, respectively from FY03 to FY08. Deposit as a percentage to GDP has increased steadily from 8.7% in FY51 to 67.8% in FY08 mainly due to rapid expansion by PSBs, entry of private and foreign banks and growing education among people with respect to saving and banking operations.

Unlike their western counterparts which rely heavily on bulk deposits, banks in India rely on household sector savings as their primary source of deposits. Deposits from household sector constituted 57.4% of the total banking deposits in FY07 (Individual and HUF share in total deposits was 44.5%). This distinct feature of the Indian banks makes them less prone to financial crisis, as was seen in the western world in mid FY09.

Till FY06, the CASA ratios of banks have been increasing or have remained constant, till FY06. However, in FY07 and FY08, the CASA ratio for most of the bank groups has declined mainly due to increased focused on term deposits to fund the high credit growth. Growth in term deposits of SCBs was at 28.9% and 24.5% in FY07 and FY08 as compared to 17.7% and 20.6% growth in CASA deposits in the same period.

Banking sector has seen the tremendous growth in credit off take in last five years (CAGR in advances for SCBs was at 27.4% from FY03 to FY08). Sector recorded credit growth of 33.3% in FY05 which was highest in last 2 and half decades and credit growth in excess of 30% for three consecutive years from FY04 to FY07, which is best in the banking sector so far.

Industrial credit accounted for 38.8% of total bank credit followed by services at 24.4%, retail loans at 22.5% and agriculture & food credit at 14.2% in FY08. Within the industrial credit, infrastructure accounts for highest share at 23.2%. (9% total bank credit).

Unsecured bank credit as percentage to total credit was at 23.3% in FY08 which has increased from 10.9% in FY2000. Share of unsecured credit is highest for foreign banks at 52.8% of total credit.

Total lending to sensitive sector (real estate accounts for 87.4% of sensitive sector lending) has grown at a CAGR of 46.1% during FY05 to FY08. As against this, the CAGR in total advances was at 29.1%. Among the group of banks, PSBs have least exposure to sensitive sector lending at 17.1% of total advances, followed by old private sector banks at 18.9%, foreign banks at 26.5% and new private sector banks at 34.1%.

1

advances, followed by old private sector banks at 18.9%, foreign banks at 26.5% and new private

REPORT ON INDIAN BANKING SECTOR

Due to rapid growth in advances, proportion of interest on advances in total interest earned of the banks has increased to 71.4% in FY08 as compared to 48.2% in FY01. Proportion of interest on investment has declined. Increase in economic activity and robust primary and secondary markets have helped the banks to garner larger increase in their fee based incomes. CAGR in core fee income for SCBs over FY03 to FY08 was at 24.0% (private sector banks 34.6% and foreign banks 31%).

Operating cost as a percentage to total assets for SCBs has been declining over the years.

Operating cost was at 2.84% of total assets in FY01 which decreased to 1.98% of the total assets

in FY08. Staff cost constitute the major portion of the total operating cost of the bank. It

constituted 51.6% of total operating cost in FY08 as compared to 68.0% in FY01 for SCBs. Average business per unit of staff cost was highest for foreign banks at Rs183.3, followed by private banks at 151.8, nationalised banks at 140.4 and SBI and associates at 120.6.

Spread (Return on funds minus cost of the funds) for SCBs decreased from 3.3% in FY06 to

3.0% in FY08, in spite of rapid growth in the credit off take mainly due to higher interest offered

by banks on short-term deposits to attract high volume of deposits. The spread is lowest for PSBs

2.7%, followed by old private sector banks, new private sector banks and foreign banks at 2.9%,

3.2% and 4.8% respectively.

Net profit for SCBs increased at a CAGR of 20.2% from FY03 to FY08. Among the group of

banks, CAGR in profit of SBI and associates was lowest at 14.8% followed by nationalised banks

at 17.7%. CAGR in profit of foreign banks was highest at 29.5% and private banks at 26.7%. The

reason attributed to this could be the already established presence for PSBs and low base effect of private and foreign banks.

A significant improvement in recovering the NPAs combined with a sharp increase in gross

advances for SCBs led to a sharp decline in the ratio of gross NPAs to gross advances to 2.3% in

FY08 from 12.7% in FY2000. Net NPAs to Net advances declined to 1.0% in FY08 as compared

to 6.8% in FY2000. Excellent performance of high deposit and credit growth, all time low level

NPAs witnessed in the period between FY04 to FY08 which is the best in banking industry so far is difficult to repeat. The Indian economy is witnessing moderation in growth which will lead to slowing of credit offtake, moderate growth in deposits and increase in slippages.

Bank credit to grow at a CAGR of 17-19% from FY09 to FY11

CARE Research expects the credit offtake to slow down in next two years. Fresh credit demand will be hit by slower economic growth due to both recession in developed economies and sluggish domestic demand. We estimate growth in credit offtake to be around 15-17% for FY10 and 19- 21% for FY11 for SCBs.

Going forward, CARE Research feels that the growth in bank credit offtake would be fuelled by growth in lending to the infrastructure sector (share of infrastructure in total bank credit will increase from 9.0% in FY08 to 12% in FY11). Although slower economic growth will delay capex cycle and overall demand for credit by corporates, incremental offtake from them will remain high for banks due to lack of funds from non banking channels. We project flat to declining growth for personal loans and credit card outstandings and moderate growth in home loans (share of retail credit will decline from 22.5% in FY08 to 18% in FY11).

2

and moderate growth in home loans (share of retail credit will decline from 22.5% in FY08

REPORT ON INDIAN BANKING SECTOR

PSBs credit growth will be higher than industry average in FY10 mainly due to government push for cheap credit and their stronghold in lending to corporates where credit offtake will not see as big a dent as expected in retail credit. In our view, some of the private sector and foreign banks will focus more on restructuring their balance sheets and the loan portfolios which are presently highly skewed towards retail credit. We may see the balance sheet size of some such players remaining stagnant or marginally declining in FY10. Credit growth for PSBs will be around 18- 19% while private and foreign banks’ credit will grow at 12-14% and 6-8% respectively in FY10.

Deposits to grow at a CAGR of 18-20% from FY09 to FY11

Banks have since FY2000 seen the wide mismatch with credit growth surpassing deposit growth. However, we feel that deposit growth will be greater than or equal to credit growth in the next two years. Keeping in mind our projection of credit growth, we expect the deposit growth rate to hover around 18% to 20% in FY10 & FY11.

Incremental current account deposits will be lower in next two years as sluggish business coupled with shortage of funds compels corporates to curtail the idle funds kept in banking system. With slower economic growth the demand deposits will contribute only 7-8% as seen in 1992-93, 1997- 98, 2001-03. Saving deposits/ term deposit mobilization may be less affected due to relatively declining risk appetite of investors and alternative investment options like equity investments are turning less lucrative in the present scenario.

Fleet of deposits will continue in favour of PSBs as seen in H2FY09. Global financial crisis have put the expansion plan of foreign banks in India on a hold. Deposit growth for PSBs will be around 20-21% while private and foreign banks’ deposits will grow at 12-14% and 7-9% respectively in FY10.

Lower Treasury gains

We do not expect the treasury gains of FY02-FY05 (constituted around ~7-10% of total income) period to be repeated in the years to come. Most of the treasury gains were booked in Q3FY09 due to sharp fall in G-sec yield (declined from 9.5% in Jul’08 to 5.1% in Jan’08 i.e. in 6 months time). We expect the bond yields to remain firm due to higher borrowing by government in next two years. Also lesser excess investment in SLR portfolio will cap the treasury gains.

NIMs under pressure

Slower economic growth and its adverse effects on incremental credit demand have led banks to reduce loan yields ahead of deposit rates. Lagged effect of deposit rate cut is expected to trim the NIM in FY10. Spread between the Benchmark prime lending rate and deposits rate of more than one year maturity touched its historic low of 3.0% in Nov’08 and is currently hovering at around 3.5% which will also translate into lower NIMs for banks. We believe that the deposit rates offer little scope for further reduction. However, cut in policy rates (CRR and repo by 400bps and SLR by 100bps) have decreased the cost of the fund for the banks, which is positive for protecting the margins for the banks. Lagging effect will not be present in FY11 and the sector will see better NIMs as compared to FY10.

3

for the banks. Lagging effect will not be present in FY11 and the sector will see

REPORT ON INDIAN BANKING SECTOR

Gross NPAs to gross advances to touch 4.3% by FY11

We believe that gross NPA to gross advances to increase from 2.3% in FY08 to 4.25-4.50% by the end of FY11 and Net NPA to Net advances to increase from current 1% to 2.7-3.0% by the end of FY11. Lower proportion of lending to stressed sectors, comparatively lower corporate leverage, and better risk management will result into lower NPAs in current asset cycle as compared to past. (FY2000 gross NPA to gross advance were in excess of 15%)

Flat to marginal growth in net profit in FY10

Reduced NIMs and slower growth in advances as compared to last year will reduce the growth in Net interest income (NII). Lower treasury gains and lower core income due to slower economic activity will curtail growth in other income significantly. Higher provisioning for NPAs and increased wages due to revision for PSBs will have negative impact on profitability. CARE Research believes flat to marginally positive growth in net profit for banking industry in FY10 and moderate growth of 8-10% for FY11.

4

flat to marginally positive growth in net profit for banking industry in FY10 and moderate growth

REPORT ON INDIAN BANKING SECTOR

Chapter 1 History of banking sector in India

Origination of banking in India dates to the last decades of the 18th century with the General Bank of India, which started in 1786, and the Bank of Hindustan (both of which are now defunct.) The oldest bank in existence in India is the State Bank of India (SBI), the largest commercial bank in the country that traces its origins back to June 1806. The history of the banking sector can be better understood by dividing it into.

1. History of SBI and Associates

2. History of other banks in India (includes Nationalised Banks, Private Banks and Foreign Banks)

1.1 History of SBI and Associates

The oldest bank in existence in India is the SBI, which originated as the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal in 1809.

Bank of Bengal was one of the three presidency banks, the other two being the Bank of Bombay (established in 1840) and the Bank of Madras (established in 1843), all three of which were established under charters from the British East India Company.

For many years, the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1925 to form the Imperial Bank of India which started as private shareholders banks, mostly Europeans shareholders.

State Bank of India Act was established in 1955. Pursuant to the provisions of the State Bank of India Act (1955), the Reserve Bank of India (RBI), which is India's central bank, acquired a controlling interest (60%) in the Imperial Bank of India. On April 30, 1955 the Imperial Bank of India was renamed as the State Bank of India. In 2008, the Government took over the stake held by RBI.

In 1959, the Government passed the State Bank of India (Subsidiary Banks) Act, enabling the SBI to take over eight former State-associated banks as its subsidiaries.

1. State Bank of Indore

2. State Bank of Bikaner & Jaipur

3. State Bank of Hyderabad

4. State Bank of Mysore

5. State Bank of Patiala

6. State Bank of Travancore

7. State Bank of Saurashtra

Later on in September 2008, State Bank of Saurashtra was merged with the parent bank - SBI.

5

State Bank of Saurashtra Later on in September 2008, State Bank of Saurasht ra was merged

REPORT ON INDIAN BANKING SECTOR

1.2 History of other banks in India (includes Nationalised Banks, Private Banks and Foreign Banks)

We further divide history of other banks in India into following groups.

No

Year

Period

Characterised by

1 1840

 

to

Pre Independence

Small size, less regulated and bank failures

1947

2 1947

 

to

Post Independence to

Slower growth, private sector dominance and start of regulation

1969

Nationalisation

3 1969

 

to

Nationalisation to

Nationalised of banks by government, high regulation, secular growth in business and expansion & rising inefficiencies

1991

Liberalisation

4 1991

 

to

Liberalisation to current

De-regulation, entry of private and foreign banks and technological advancement

2008

date

1.2.1 Pre Independence (1840 to 1947)

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.

The second entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India.

The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to form banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India.

The period during the First World War (1914-1918) through the end of the Second World War (1939-1945), and two years thereafter until the independence of India were challenging for the Indian banking industry. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following table:

Year

No. of banks failed

1913

12

1914

42

1915

11

1916

13

1917

9

1918

7

6

Year No. of banks failed 1913 12 1914 42 1915 11 1916 13 1917 9 1918

1.2.2

Post Independence to Nationalisation (1947 to 1969)

REPORT ON INDIAN BANKING SECTOR

The Government of India (GOI) initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps taken to regulate banking include:

In 1948, the RBI, India's central banking authority, was nationalised, and it became an institution owned by the Government of India.

In 1949, the Banking Regulation Act was enacted which empowered the RBI "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors.

1.2.3 Nationalisation to liberalisation (1969 to 1991)

By the 1960s, the Indian banking industry had become an important tool to facilitate the development of the Indian economy. At the same time, it had emerged as a large employer, and a debate had been ensued about the possibility to nationalise the banking industry.

On July 19, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi by whom 14 major commercial banks in the country were nationalised. The second phase of nationalisation of the Indian Banking Sector was carried out in 1980 with seven more banks being nationalised.

With the second dose of nationalisation, the GOI controlled around 91% of the banking business of India. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalised banks and resulted in the reduction of the number of nationalised banks from 20 to 19.

A number of questions were raised regarding the procedure adopted by the then government in suddenly going for the nationalisation of banks. There was no official report, which had gathered expert opinions and evidence on the need either for social control or for nationalisation of banks. The chiefs of private banks had not been consulted as to the need and implications of the proposed measure.

Arguments of government for nationalisation were as follows

Before the nationalisation, the privately-owned banks were operating on the criteria of profit maximisation and lesser emphasis was placed on the development of rural areas. Credit and deposits base was confined to large corporates and wealthy depositors.

The nationalised banking set-up would vigorously pursue expansion programmes to cover rural areas, smaller towns and lower income groups.

To pay special attention to inter-sectoral balances and balanced regional development.

To take away the stranglehold of the few industrial houses on credit and reduce their control over the community's resources.

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the stranglehold of the few industrial houses on credit and reduce their control over the community's

REPORT ON INDIAN BANKING SECTOR

Ensure stability in the functioning of the credit institutions and inspire more confidence among the depositors.

Encourage healthy competition between large and small industrial houses.

In summary, the following are the steps taken by the Government of India to regulate the banking institutions in the country:

1949: Enactment of Banking Regulation Act. 1955: Nationalisation of SBI. 1959: Nationalisation of SBI subsidiaries. 1961: Insurance cover extended to deposits. 1969: Nationalisation of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalisation of seven banks with deposits over Rs.200 crores.

1.2.4 Liberalisation to current date (1991 to 2008)

The policies of nationalisation and social reforms that were supposed to promote a more equal distribution of funds, also led to inefficiencies in the Indian banking system. To alleviate the negative effects, some reforms were enacted in the second half of the 1980s. The main policy changes were the introduction of Treasury Bills, the creation of money markets, and a partial deregulation of interest rates. Despite the reform attempts, the Indian banking sector had like the overall economy severe structural problems by the end of the 1980s. By international standards, the Indian banks were extremely unprofitable despite a rapid growth in deposits. In 1991, GOI liberalised the economy. The objective of banking sector reforms was in line with the overall goals of the 1991 economic reforms of opening the economy.

Narsimhan Rao government embarked on a policy of liberalisation by licensing a small number of private banks. These new banks came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, UTI Bank (now re-named as Axis Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalised the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks.

Interest rate liberalisation

1. The interest rate structure was too complex with both lending and deposit rates set by the RBI. The regulation of lending rate for loans in excess of rupees two lakhs, which accounted for over 90% of total advances, was abolished in October

1994.

2. Banks were allowed to decide and announce Prime Lending Rate (PLR), after taking into account the cost of the funds and transaction costs.

8

decide and announce Prime Lending Rate (PLR), after taking into account the cost of the funds

REPORT ON INDIAN BANKING SECTOR

3. From October 1995, regulations relating to fixing of rate of interest for term deposits with a maturity of more than two years were liberalised. The minimum maturity was subsequently lowered from two years to 15 days in 1998.

4. Since 2004, the RBI is only regulating and prescribing deposit rates for the savings deposits and deposits from Non resident Indians For all other deposits above 15 days, banks are free to set their own interest rates.

Privatisation

1. In the year 1994, Private sector banks were permitted to commence operations in India. Banks were allowed to raise the capital to meet the capital adequacy norms through capital market route, provided the government holding does not fall below 51%.

2. FDI/FII limits on investments in shares of private sector banks were raised to 51% in 2001.

3. In 2004, FDI/FII limits on investments in shares of private sector banks was further relaxed and increased to 74%, with no one FII holding more than 5% stake without the consent of RBI and FII limit in PSBs was capped at 20%.

4. Foreign banks with restriction on branch opening and operation were allowed to enter on selective basis in 2004. More liberal entry for foreign banks was proposed after April 2009.

Entry of foreign banks

RBI announced its policy decision on March 2004 for gradual entry of foreign banks in India in synchronised manner in two phases. In order to allow the Indian Banks sufficient time to prepare for global competition, initially the entry of foreign banks in first phase was more restrictive.

Phase 1 (March 2005 to March 2009)

1. Foreign banks were allowed to establish presence in India and were given an option to operate through branch presence or set up a 100% Wholly Owned Subsidiary (WOS).

2. Foreign banks were allowed to open 12 branches a year (the limit was in line with World Trade Organisation (WTO) commitment). Branch licensing procedure was kept same as applicable for private banks. More liberal branch opening policy was adopted in under-banked areas.

3. The limit of 12 branches a year was raised to 20 branches for foreign banks in March 2006.

4. Acquisition of shares in Indian banks by foreign banks was permitted for banks which are identified by RBI for restructuring.

9

of shares in Indian banks by foreign banks was permitted for banks which are identified by

REPORT ON INDIAN BANKING SECTOR

Phase 2 (April 2009 onwards)

1. Branch expansion: - After reviewing the experience of the first phase, RBI has proposed to remove the restriction on branch expansion and limited excess to Indian market and treating them on par with domestic banks to the extent appropriate.

2. Listing of foreign banks: - After completion of the proposed year of operation in India, WOS of foreign banks will be allowed to list and dilute the stake in the manner that at least of 26% of the paid-up capital remains with the resident Indian.

3. Mergers and acquisitions: - After a review is made with regard to the extent of penetration of foreign investment in Indian banks and functioning of foreign banks, foreign banks may be permitted, subject to regulatory approvals and such conditions as may be prescribed, to enter into merger and acquisition transactions with any private sector bank in India, subject to the overall investment limit of 74 per cent.

No. of banks in India have declined over the past 10 years

As depicted in the following graph, the number of SCBs has been declining over the years from around 300 banks in FY2000 to 165 banks as on date. Several small regional rural banks have been merged with their parent banks or have closed down.

Fig 1.1 – No. of Scheduled Commercial Banks in India

325 275 225 175 125 75 No. of reporting SCBs Apr-00 Oct-00 Apr-01 Oct-01 Apr-02
325
275
225
175
125
75
No. of reporting SCBs
Apr-00
Oct-00
Apr-01
Oct-01
Apr-02
Oct-02
Apr-03
Oct-03
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08

Source: RBI and CARE Research

10

Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Source: RBI and CARE Research

REPORT ON INDIAN BANKING SECTOR

1.3 Various Banking Groups

Fig 1.2 – Classification of banks into various groups

Banks in India Scheduled Commercial Banks Unscheduled Commercial Banks Public Sector Private Sector Foreign
Banks in India
Scheduled Commercial Banks
Unscheduled Commercial
Banks
Public Sector
Private Sector
Foreign
Regional
Banks
Banks
Banks
Rural Banks
State Bank of India
and Associates
Nationalised Banks

Source: CARE Research

The commercial banking structure in India consists of:

Scheduled Commercial Banks in India

Unscheduled Banks in India

Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act. The scheduled commercial banks in India comprise of SBI and its associates, nationalised banks, foreign banks, private sector banks, co-operative banks and regional rural banks.

Non-scheduled bank in India means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank. SCBs in India can be divided into five groups. SBI and its associates Nationalised banks Private sector banks Foreign banks.

Regional Rural Banks (RRBs)

We have done the analysis of first four banking groups and excluded RRBs in our report.

11

Regional Rural Banks (RRBs) We have done the analysis of first four ba nking groups and

REPORT ON INDIAN BANKING SECTOR

Table 1.1 – List of banks under various banking groups SBI and Associates

1. SBI

5. State Bank of Mysore

2. State Bank of Bikaner and Jaipur

6. State Bank of Patiala

3. State Bank of Hyderabad

7. State Bank of Travancore

4. State Bank of Indore

 

Nationalised Banks

1. Allahabad Bank

11.

Indian Bank

2. Andhra Bank

12.

Indian Overseas Bank

3. Bank of Baroda

13.

Oriental Bank of Commerce

4. Bank of India

14.

Punjab National Bank

5. Bank of Maharashtra

15.

Punjab & Sind Bank

6. Canara Bank

16.

Syndicate Bank

7. Central Bank of India

17.

Union Bank of India

8. Corporation Bank

18.

United Bank of India

9. Dena Bank

19.

UCO Bank

10. IDBI Bank Ltd.

20.

Vijaya Bank

Private Sector Banks

1. Axis Bank

12.

Jammu & Kashmir Bank

2. Bank Of Rajasthan

13.

Karnataka Bank

3. Catholic Syrian Bank

14.

Karur Vysya Bank

4. City Union Bank

15.

Kotak Mahindra Bank

5. Development Credit Bank

16.

Lakshmi Vilas Bank

6. Dhanalakshmi Bank

17.

Nainital Bank

7. Federal Bank

18.

Ratnakar Bank

8. HDFC Bank

19.

SBI Commercial & International Bank

9. ICICI Bank

20.

South Indian Bank

10. IndusInd Bank

21.

Tamilnad Mercantile Bank

11. ING Vysya Bank

22.

Yes Bank

12

South Indian Bank 10. IndusInd Bank 21. Tamilnad Mercantile Bank 11. ING Vysya Bank 22. Yes

REPORT ON INDIAN BANKING SECTOR

Foreign Banks

1. ABN AMRO Bank

15. DBS Bank

2. Abu Dhabi Commercial Bank

16. Deutsche Bank

3. Antwerp Diamond Bank

17. HSBC

4. Arab Bangladesh Bank

18. JP Morgan Chase Bank

5. Bank Of America

19. Krung Thai Bank

6. Bank Of Bahrain & Kuwait

20. Mashreq Bank

7. Bank Of Ceylon

21. Mizuho Corporate Bank

8. Bank Of Nova Scotia

22. Oman International Bank

9. Bank Of Tokyo-Mitsubishi-UFI

23. Shinhan Bank

10. Barclays Bank

24. Societe Generale

11. BNP Paribas

25. Sonali Bank

12. Calyon Bank

26. Standard Chartered Bank

13. Chinatrust Commercial Bank

27. State Bank of Mauritius

14. Citibank

 

Source: RBI and CARE Research

Fig 1.3 – No. of offices of commercial banks(both scheduled and non-scheduled including RRBs) over
Fig 1.3 – No. of offices of commercial banks(both scheduled and non-scheduled
including RRBs) over the years
80000
5.0
4.5
75000
4.0
3.5
70000
3.0
65000
2.5
2.0
60000
1.5
1.0
55000
0.5
50000
0.0
No. of Offices
Growth % (y-o-y)
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
Percent

Source: RBI and CARE Research

The number of offices (branches plus administrative offices) for all SCBs increased from 64,184 in FY1995 to 77,773 in FY2008. The number of offices for SCBs increased at a higher pace between FY06 and FY08. The branch network increased by 10% between FY06 to FY08 in three years as compared to 10.6% from FY1995 to FY2005 (i.e. 10 years).

13

increased by 10% between FY06 to FY08 in three years as compared to 10.6% from FY1995

REPORT ON INDIAN BANKING SECTOR

1.4 Regional Distribution of Branches

Fig 1.4 – Regional distribution of branches for SCBs as on March 31, 2008

distribution of branches for SCBs as on March 31, 2008 Source: RBI and CARE Research On

Source: RBI and CARE Research

On an overall basis, the branches of the SCBs in India are fairly distributed. The state-owned banks have to adhere to social objective set by the government. Since nationalisation, PSBs have increased their presence in rural and semi-urban areas.

Private and foreign banks started operating post 1994. Since the main driver for these banks was profit maximisation and due to restriction on opening of branches, their branch network is being concentrated in metro and urban regions.

14

and due to restriction on openi ng of branches, their branch network is being concentrated in

REPORT ON INDIAN BANKING SECTOR

Fig 1.5 – Distribution of branches among regions for various bank groups

of branches among regions for various bank groups Source: RBI and CARE Research As depicted in

Source: RBI and CARE Research

As depicted in above graphs, there is a noticeable difference between rural and semi-urban presence of PSBs, private & foreign banks. SBI and associates and nationalised banks have around 34% of the branches situated in rural area as compared to 12.5% and 0% for private and foreign banks.

15

have around 34% of the branches situated in rural area as compared to 12.5% and 0%

REPORT ON INDIAN BANKING SECTOR

Chapter 2 Role of Reserve Bank of India

Established in 1935, under the Reserve bank of India Act, 1934, RBI is the central bank of the country. RBI was nationalised in the year 1949. Functions of the RBI can be divided into two.

Monetary functions also known as the central banking functions of the RBI are related to control and regulation of money and credit, i.e., issue of currency, control of bank credit, control of foreign exchange operations, banker to the Government and to the money market. Monetary functions of the RBI are significant as they control and regulate the volume of money and credit in the country.

Non-monetary functions includes supervision of banks operating India, promotion of sound banking

2.1 RBI monetary and credit policy

GOI uses various tools for development of economy. Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy. Fiscal policy is decided by the GOI through annual budget by the Finance Ministry. Monetary policy is a subject matter of RBI.

Monetary Policy

The RBI is responsible for formulating and implementing Monetary Policy which is essentially a stabilisation policy. It is not intended to influence the long-term growth potential of the economy, but aims at ironing out the fluctuations in the economy also referred to as business cycles. This is done to minimise fluctuations and ensure a sustainable mix of growth and inflation in the economy.

The RBI regulates the supply of money and the cost and availability of credit in the economy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. The Monetary Policy aims to maintain price stability, full employment and economic growth.

Historically, the Monetary Policy is announced twice a year - a slack season policy (April- September) and a busy season policy (October-March) in accordance with the agricultural cycles. These cycles also coincide with the halves of the financial year.

The RBI as per the world-wide practice has shifted to market-based instruments for monetary management from non-market-based instruments like interest rate control. The RBI can influence the cost of funds and availability of credit in the economy by altering the repo/reverse repo rates, changing the reserve requirements and engaging in open market operations.

16

by altering the re po/reverse repo rates, changing the reserve requirements and engaging in open market

REPORT ON INDIAN BANKING SECTOR

2.2 Developments in FY09 and Role of RBI

The RBI’s role in monetary development and price stability can be well understood by the developments which happened in FY09. We divide the developments in financial markets in FY09 into two.

From April 2008 to September 2008

Up to the mid of FY09, India continued its dream run of high economic growth. Due to sustained inflow of foreign capital in India and high commodities and oil prices, inflation rate touched record highs of 12.91% in August 2008. The RBI reacted to this by increasing the Cash Reserve Ratio (CRR) by 150 bps from 7.5% to 9.0% and increase in repo rate by 125 bps from 7.75% to 9.0% up to the end of September 2008. This enabled the bank to suck out excess liquidity in the system, thereby containing inflation.

From September 2008 to March 2009

Near collapse of the world’s financial system and global recession made its impact felt on the domestic economy in last two quarters of FY09. The domestic economy slowed down considerably in later half of the FY09. Movement in inflation was southward due to world-wide slowdown and correction in commodities prices. In order to check the domestic slowdown RBI, aided by declining inflation, slashed the CRR, SLR and repo rates sharply by 400 bps, 100 bps and 400 bps, respectively over a period of 6 months from Aug’08 to Jan’09.

Fig 2.1 – Changes in policy rate in FY09 to check inflation

14 13 12 High inflation: 11 CRR, repo increased 10 by 150 and 125 bps
14
13
12
High inflation:
11
CRR, repo increased
10
by 150 and 125 bps
9
to suck the liquidity
8
7
6
5
4
Lower inflation and ease in
liquidity: CRR, repo and SLR
reduced by 400, 350 and 100
3
bps to check growth
2
1
-
Inflation Rate (%)
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09

Source: RBI and CARE Research

17

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 Source: RBI and CARE Research

REPORT ON INDIAN BANKING SECTOR

2.3 Liquidity Adjustment Facility (LAF)

LAF is used by RBI for managing the day-to-day liquidity in the banking system. LAF operations are carried out twice in a day. LAF is carried out with the help of two key rates viz Repo rate and Reverse repo rate. The term repo stands for repurchase agreement. Repo rate is the rate that RBI charges the banks when they borrow from it or the rate at which RBI lends to the banks. Repo operations increase liquidity in the system. Reverse repo rate is the rate that RBI offers the banks for parking their funds with it or the rate at which RBI borrows from the banks. Reverse repo operations suck out liquidity from the system.

Fig 2.2 – Trend in repo and reverse repo rates over the years

9.5 8.5 7.5 6.5 5.5 4.5 3.5 2.5 Repo rate Reverse Repo Percent Mar-01 Sep-01
9.5
8.5
7.5
6.5
5.5
4.5
3.5
2.5
Repo rate
Reverse Repo
Percent
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09

Source: RBI and CARE Research

RBI uses the LAF to inject or absorb the liquidity into the banking system. Increasing repo rate from 7.75% in May 2008 to 9.0% in September 2008 was done to increase the cost of credit and to tighten the liquidity in the system due to increasing inflation. However, falling inflation and fear of economic slowdown prompted RBI to reduce the repo and reverse repo rates to bring down the cost of the credit. Yearly trend since FY01 shows that, repo and reverse repo rates are either increasing or decreasing in the given financial year, with the exception of FY09. High inflation due to over-heating of the economy in the first half resulted in RBI increasing the rates. Global financial crisis in mid FY09 and fear of slowdown supported the rate reduction.

18

in RBI increasing the rates. Global financial crisis in mid FY09 and fear of slowdown supported

REPORT ON INDIAN BANKING SECTOR

Fig 2.3 – Spread between Repo and Reverse repo rates

3.5 3.0 2.5 2.0 1.5 1.0 0.5 - Spread (%) Mar-01 Sep-01 Mar-02 Sep-02 Mar-03
3.5
3.0
2.5
2.0
1.5
1.0
0.5
-
Spread (%)
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09

Source: RBI and CARE Research

The spread between the repo and reverse repo also signals RBI’s intention of cheaper/costlier credit. Deceasing spread from July 2003 till September 2006 suggests the cheaper credit policy from RBI to push economic growth. The spread was at it lowest level of 1.0% from April 2005 to September 2006. The increasing spread from May 2008 to September 2008 suggests the tightening of credit due to higher inflation and overheating of the economy. However from September 2008 onwards, the RBI has adopted cheaper credit policy and thereby has reduced the spread between the repo and reverse repo from 3.0% in September 2008 to 1.5% in February 2009.

Fig 2.4 – Large LAF injection during Jul to Oct’08 and subsequent absorption from Dec’08 to Mar’09s

Average daily 1200000 absorption of Rs. 56594 cr in Apr'09 700000 200000 -300000 -800000 -1300000
Average daily
1200000
absorption of Rs.
56594 cr in Apr'09
700000
200000
-300000
-800000
-1300000
Average daily
infusion of Rs.
42791cr in Sept'08
Rs cr
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09

Source: RBI and CARE Research

19

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 Source: RBI and CARE Research

REPORT ON INDIAN BANKING SECTOR

The bankruptcy/sell out/ restructuring of some of the world’s largest financial institutions brought pressures on the domestic money and foreign exchange markets, in conjunction with temporary local factors such as advance tax outflows. In order to alleviate these pressures, the RBI initiated a series of measures. The average daily net outstanding liquidity injection under LAF was Rs.42,591 crore during September 2008 as compared with Rs.22,560 crore in the previous month. Liquidity conditions eased from November 2008. The LAF shifted from net injection mode to net absorption mode. The average daily net outstanding liquidity absorption under LAF was Rs.22,294 crore during December 2008. Lesser avenues of lending due to economic downturn had made banks to park excess funds with RBI under reverse repo. Daily abruption under reverse repo crossed Rs. 1,00,000 crore in April 2009. RBI has been discouraging reverse repo in order to compel the banks to lend more. RBI has cancelled the secondary liquidity adjustment facility (evening reverse repo auctions) effective from May 2009 and reduced the reverse repo rate to 3.75%.

2.4 Cash Reserve Ratio (CRR)

All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the CRR which can also be effectively used to manage liquidity, inflation and cost of credit in the banking system by RBI. Higher CRR will increase the cost of the fund with the bank and in turn will make the credit costlier for borrower and vice-versa.

Fig 2.5 – Changes in CRR for Macro economic objective

9 CRR at record high of 8.5 8 9.0%, last seen in Mar'00 to check
9
CRR at record high of
8.5
8
9.0%, last seen in
Mar'00 to check
soaring inflation.
7.5
7
6.5
sharp cut in CRR (400
bps in 5 months) to
6
address liquidty crunch
5.5
5
4.5
4
percent
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09

Source: RBI and CARE Research

20

Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Source: RBI and CARE Research

REPORT ON INDIAN BANKING SECTOR

Chapter 3 Deposits

3.1 Sources of Funds for Banks

Deposits are traditionally the main source of funding for banks. As shown below, deposits as a percentage to total resources of the SCBs were at 76.7% as at 31st March 2008.

Fig 3.1 – Break-up of total resources of SCBs as on 31 st March 2008

Break-up of total resources of SCBs as on 31 st March 2008 Source: RBI and CARE

Source: RBI and CARE Research

However, reliance on deposits as a primary source of funds has decreased over the years for SCBs. Within the categories of banks, PSBs have higher proportion of deposits in their total resources as compared to private and foreign banks. The reliance on deposits as resources by Foreign banks was the least at 52.5% as on 31 st March 2008, whereas, deposits as a percentage to total resources of Nationalised banks and SBI and associate banks were high at 79.9% and 76.5%, respectively on the same date.

Fig 3.2 – Deposits as a Percentage of total resources for various bank groups

90 85 80 75 70 65 60 55 50 FY01 FY02 FY03 FY04 FY05 FY06
90
85
80
75
70
65
60
55
50
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
Percent

SBI and Associates50 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 Percent SCBs Source: RBI and CARE Research

SCBsFY04 FY05 FY06 FY07 FY08 Percent SBI and Associates Source: RBI and CARE Research Nationalised Banks

Source: RBI and CARE Research

Nationalised BanksFY06 FY07 FY08 Percent SBI and Associates SCBs Source: RBI and CARE Research Foreign Banks Private

Foreign BanksFY06 FY07 FY08 Percent SBI and Associates SCBs Source: RBI and CARE Research Nationalised Banks Private

Percent SBI and Associates SCBs Source: RBI and CARE Research Nationalised Banks Foreign Banks Private Sector

Private Sector Banks

21

Percent SBI and Associates SCBs Source: RBI and CARE Research Nationalised Banks Foreign Banks Private Sector

REPORT ON INDIAN BANKING SECTOR

Fig 3.3 – Total deposits and y-o-y growth in deposits of SCBs

3,500,000 26 24.6 24 3,000,000 22 23.1 2,500,000 17.8 20 16.6 2,000,000 17.2 16.2 18
3,500,000