ATTRACTIVE

Banks/Financial Institutions
India JULY 01, 2016
UPDATE
BSE-30: 27,000

Minor changes to trend levels. In FY2016, there was a rise in the gap (6% as
compared to 4% yoy) between retirement assets and liabilities of public banks.
Retirement costs contribute ~28% to overall staff costs and these costs were higher
than the contributions made to the scheme, indicating a possible timing mismatch in
some banks. Retirement schemes appear to be maturing based on our analysis, but
aggressive assumption does indicate that actuarial losses would remain high in the short
term.

Marginal increase in gap; could be due to timing issues QUICK NUMBERS

In FY2016 there was a marginal increase in the gap between pension assets and liabilities with
 Gap increased
a large share of this increase coming from a few banks, particularly Bank of Baroda. However,
between pension
we are not reading too much into this as there is a timing difference between contribution and
P&L charge. Exhibit 11 shows that the contribution to the scheme was 70% of the P&L impact assets and liabilities
as compared to ~1X earlier. This has kept operating expenses at elevated levels with retirement in FY2016
costs ~28% of the total staff costs for the bank (see Exhibit 6). Gratuity is of a lesser concern as
 Benefits paid and
overall costs are only 2-5% of reported staff costs (see Exhibit 7). We note that the gap has
actuarial losses
reduced in recent years primarily as the full impact of the re-opening of the second pension
scheme has been effected. The gap, which was quite significant in FY2011, has now been increased ~40% yoy
bridged at below 3.5% (see Exhibit 1).
 The share of
Actuarial losses jump sharply; assumptions have changed marginally defined
contribution is
We note two differences between the assumptions that banks (see Exhibit 8) have made rising sharply to 35-
between assets and liabilities. On the liabilities side, banks have marginally reduced their long
45% of active
term interest rate, which is positive, as it better reflects underlying liabilities. However, the
employees
decline is only marginal at ~10bps to 8.1%, but there was no change on the long term return
on assets yoy at 8.7% which is a bit disappointing as it is a fairly aggressive assumption.
However, we have noticed a lot of banks reporting sharp jumps in actuarial costs and increases
in actuarial losses as compared to their liabilities. This could be partly explained by costs on
account of long term life expectancy.

Employee mix changing positively leading to a decline in age and maturing retirement plans

Given the extent of disclosures and changes to many variables on defined benefit obligation,
we think this is very hard to prove with available data. However, we indirectly look at various
disclosures: (1) growth in benefits paid (~40% yoy) and (2) share of interest costs to current
service costs. At this point, we see strong signs of this showing a possible mature plan. In
FY2016 the share of benefits paid was at 9% of opening balances as compared to 5% in M.B. Mahesh, CFA
mb.mahesh@kotak.com
FY2012 (see Exhibit 11). Mumbai: +91-22-4336-0886

35-45% of employees in defined contribution; average staff costs have probably peaked Nischint Chawathe
nischint.chawathe@kotak.com
We maintain our outlook that the ratio of employees who are in defined benefit to total Mumbai: +91-22-4336-0887

employees is about 35-45% today as compared to less than 10% in FY2011 (see Exhibit 10) – a Abhijeet Sakhare
function of the new hiring under defined contribution. On the other hand, we think the ratio of abhijeet.sakhare@kotak.com
Mumbai: +91-22-4336-0889
active employees to those who have retired is likely to reverse in the next few years. Our
discussion with banks indicates that active employees in the defined benefit scheme have
declined to 55% levels from 65-70% levels in FY2011. This would also result in keeping the
average cost/employee closer to current levels. We do expect quite a few public banks to report
single digit growth in staff costs in the short term.

Kotak Institutional Equities Research

kotak.research@kotak.com
Mumbai: +91-22-4336-0000

For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
India Banks/Financial Institutions

Exhibit 1: Overall difference between assets and liabilities rose Exhibit 2: Contribution by employer remained high since
in FY2016 after a steady decline since FY2011 FY2010 primarily to meet the revised benefits offered
Status of retirement benefits, March fiscal year-ends, 2008-16 (` bn) Status of retirement benefits, March fiscal year-ends, 2008-16 (` bn)

400 250

320 200

240 150

160 100

80 50

- -
2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016
Notes: Notes:
a) Data for FY2008 does not include Dena Bank, Allahabad Bank a) Data for FY2008 does not include Dena Bank, Allahabad Bank
and Vijaya Bank. and Vijaya Bank.
b) Vijaya Bank, Andhra and Canara Bank reported pending b) Vijaya Bank, Andhra and Canara Bank reported pending
amortization is already as a part of fair value of planned assets amortization is already as a part of fair value of planned assets
resulting in lower shortfall than reported in the exhibit. resulting in lower shortfall than reported in the exhibit.

Source: Company, Kotak Institutional Equities Source: Company, Kotak Institutional Equities

FY2015 was the last year of ammortisation of the reopening of the second
pension option which began in FY2011
Public banks completed a key journey in FY2015 with respect to provisions for the second
pension option after starting this exercise in FY2011. With contribution to the pension fund
(see Exhibit 2) and benefits arising from rising interest rates, there has been a steady decline
in the gap between pension assets and liabilities, though we saw a gap opened in FY2016.
We are not reading too much into this gap currently based on our discussion with a few
banks where the divergence has been quite large.

We do think that the gap has significantly narrowed in recent years but believe there would
be some difference between the assets and liabilities each year. This occurs primarily due to
a mismatch between the ascertainment of liabilities which happens at the end of the
financial year and the contribution to meet that shortfall by the bank at the beginning of the
next financial year. We have probably now reached normalized levels of mismatches.

We have discussed our long term view on the movement of pension liability in subsequent
sections.

2 KOTAK INSTITUTIONAL EQUITIES RESEARCH

 Banks/Financial Institutions India

Exhibit 3: Shortfall between pension assets and liabilities at 6% in FY2016

PBO, FPA and shortfall between PBO and FPA, March fiscal year-ends, 2012-16 (%)

2012 2013 2014 2015 2016

Amm. Short- Amm. Short- Amm. Short- Amm. Short- Amm. Short-
PBO FPA Pending fall (%) PBO FPA Pending fall (%) PBO FPA Pending fall (%) PBOFPA Pending fall (%) PBO FPA Pending fall (%)
Allahabad 32 26 4 (5.6) 37 33 3 (3.4) 41 41 1 2.2 46 46 - (0.5) 52 52 - 0.1
Andhra 24 24 0.0 28 28 32 33 37 38 - 41 41 -
BoB 70 57 11 (2.8) 75 67 7 (1.5) 83 76 4 (3.2) 89 87 - (2.7) 119 90 - (24.4)
BoI 71 51 13 (10.4) 74 65 9 (0.2) 80 73 4 (4.2) 94 90 - (4.0) 111 105 - (5.1)
Canara 77 75 (3.4) 86 81 (5.9) 90 89 (1.5) 96 92 (4.5) 100 93 (6.4)
Dena 17 14 2 (2.3) 18 16 1 (0.8) 19 18 1 (4.2) 22 22 - 3.3 25 27 - 6.9
Indian 39 34 5 (0.0) 45 42 3 (0.0) 49 48 2 (0.0) 53 52 - (1.7) 56 55 - (1.8)
IOB 44 39 5 0.0 49 46 3 0.4 54 54 2 2.3 60 60 - 0.4 68 68 - (0.1)
OBC 29 21 5 (8.3) 33 27 3 (8.3) 38 34 2 (7.3) 43 43 - (0.7) 49 49 - (0.3)
PNB 117 102 17 1.9 136 124 11 (0.1) 152 148 7 1.7 182 174 - (4.6) 202 208 - 3.3
SBI (cons) 460 359 12 (19.4) 501 447 8 (9.3) 571 531 4 (6.2) 645 619 - (4.1) 732 668 - (8.7)
Union 53 40 0 (23.6) 60 48 0 (20.3) 67 61 0 (8.7) 82 79 - (4.3) 96 95 - (1.0)
UCO 33 30 3 0.3 39 37 2 0.1 47 45 1 (1.0) 53 52 - (2.5) 63 57 - (9.1)
Vijaya 19 19 - (1.7) 20 20 - (2.3) 21 22 - 5.3 24 23 - (2.5) 26 25 - (2.3)
Total 1,084 891 77 (10.7) 1,2001,080 51 (5.8) 1,345 1,273 27 (3.4) 1,528
1,477 - (3.4) 1,740 1,635 - (6.0)
Notes:
a) PBO- Projected benefit obligation, Fair value of planned assets
b) Vijaya Bank, Andhra and Canara Bank reported pending amortization is already as a part of FPA. Hence, not been included in amortization
pending
c) BoB has taken the provisions for the changes to the revised tables in FY2016 but transferred the amount only in FY2017 which has resulted in a
steep between assets and liabilities

Source: Company, Kotak Institutional Equities

Employer contribution stable in pension while gratuity saw decline in FY2016

As of FY2016 the total contribution to the fund by banks as compared to the costs reported
for retirement expenses reduced to 0.7X (see Exhibit 4) of the required contribution
expensed to the earnings statement. This is still higher than the contribution given prior to
the second pension option. The difference in contribution and expense charged could partly
be a timing issue for a few banks as the change in assumptions made on mortality tables for
a few banks may be fully visible in FY2017. We understand that certain banks had made
their contributions in 1QFY17 though the P&L reflects the cost of this transition.

Retirement costs to total staff costs has increased to ~28% in FY2016 as compared to 22-23%
levels in the previous few years primarily on account of a few banks like Bank of India and
Bank of Baroda who changed their mortality tables but we note that this is still lower as
compared to the impact that was seen in FY2011 at 33% (see Exhibit 6). This is still higher
than 10-15% levels reported in FY2009-10. We see this declining hereon as FY2015 was the
final year of the ammortisation cost of the second pension option.

On the other hand, the impact of gratuity is lot lower. The cost to earnings has been less
than 5% in the past few years (see Exhibit 5 and 7). On an average the cost related to
gratuity is ~10-15% of the pension related costs. FY2016 saw it lower at 11%.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

India Banks/Financial Institutions

Exhibit 4: Contribution by employer to the pension fund has been rising to cover the shortfall
Charges to P&L and contribution of employer to the fund, March fiscal year-ends, 2008-16 (%)

Employer contribution (LHS) Expenses charged to P&L (LHS)

(Rs bn) (X)
Contribution to P&L charge (RHS)
250 3.0

200 2.4

150 1.8

100 1.2

50 0.6

- -
2008 2009 2010 2011 2012 2013 2014 2015 2016

Notes:
a) Data for FY2008 does not include Dena Bank, Allahabad Bank and Vijaya Bank.

Source: Company, Kotak Institutional Equities

Exhibit 5: Contribution by employer to the gratuity fund continued to decline in FY2016

Charges to P&L and contribution of employer to the gratuity fund, March fiscal year-ends, 2010-16 (%)

Employer contribution (LHS) Expenses charged to P&L (LHS)

(Rs bn) Contribution to P&L charge (RHS) (X)

45 3.0

36 2.4

27 1.8

18 1.2

9 0.6

- -
2010 2011 2012 2013 2014 2015 2016

Notes:
a) Data for FY2008 does not include Dena Bank, Allahabad Bank and Vijaya Bank.

Source: Company, Kotak Institutional Equities

4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

 Banks/Financial Institutions India

Exhibit 6: Pension benefits charged to P&L to total staff costs continues to remain high
Pension costs to total staff costs, March fiscal year-ends, 2011-16 (` bn)

2011 2012 2013 2014 2015 2016

Pension % of Pension % of Pension % of Pension % of Staff Pension % of Staff Pension % of
cost staff cost cost staff cost cost staff cost cost staff cost cost cost staff cost cost cost staff cost
Allahabad 19 123.8 6 31.3 5 25.1 3 15.3 23 4 16.8 21 7 31.4
Andhra 7 63.8 2 20.9 4 31.7 3 23.7 17 6 33.5 17 3 15.5
BoB 10 34.5 7 22.5 7 19.8 10 24.5 43 9 21.6 81 30 37.3
BoI 15 41.9 7 24.3 7 21.1 11 26.6 50 16 32.1 54 18 34.2
Canara 9 30.1 7 25.2 3 10.5 (1) (2.0) 43 7 15.5 44 7 16.3
Dena 2 28.7 2 21.4 2 19.0 2 24.8 11 2 20.4 14 4 28.1
Indian 11 78.5 5 30.7 8 38.1 5 25.6 17 5 26.9 20 4 20.4
IOB 1 3.5 5 23.0 4 16.5 4 15.3 26 5 19.6 34 8 24.8
OBC 4 41.0 2 17.6 3 20.0 3 19.1 16 3 16.8 20 3 16.9
PNB 13 29.6 14 30.5 20 35.3 20 30.2 73 33 45.1 64 16 25.3
SBI (cons) 35 18.0 40 19.4 35 14.9 63 22.0 297 47 15.9 310 83 26.7
Union 11 44.0 9 36.2 10 36.8 11 33.9 38 15 39.2 37 11 31.1
UCO 6 42.3 6 43.2 7 45.3 8 53.0 16 7 41.1 18 14 78.8
Vijaya 9 85.1 1 7.4 1 12.2 1 10.8 12 3 22.5 12 3 24.0
Total 152 32.9 114 23.6 116 21.3 144 22.7 683 161 23.6 748 213 28.5
Notes:
(a) Reported pension costs that is charged to the P&L is higher in FY2011 primarily due to one-off benefit provided to current and retired employees.
(b) We have includes the cost of retirement provisions for BoB as a part of staff costs though it is part of provisions as per financials

Source: Company, Kotak Institutional Equities

Exhibit 7: Gratuity benefits charged to P&L is lot lower

Gratuity costs to total staff costs, March fiscal year-ends, 2011-16 (` bn)

2011 2012 2013 2014 2015 2016

% of % of % of % of % of % of
Gratuity staff cost Gratuity staff cost Gratuity staff cost Gratuity staff cost Gratuity staff cost Gratuity staff cost
Allahabad 2 13.7 2 8.8 1 3.1 1 4.4 1 3.3 1 4.9
Andhra 2 15.2 0 3.1 1 4.1 0 2.4 0 1.5 1 6.1
BoB 4 13.9 1 4.9 1 3.9 1 2.4 0 0.9 0 0.3
BoI 3 8.3 2 6.7 2 6.5 1 2.8 1 2.5 2 4.3
Canara 1 4.7 2 7.7 2 6.0 (1) (1.6) 3 6.5 1 2.3
Dena 0 0.5 1 7.7 0 6.1 0 0.6 0 2.3 1 5.1
Indian 1 7.1 1 5.9 1 7.4 2 9.6 0 2.4 1 4.5
IOB 2 9.7 1 3.7 2 8.4 0 1.9 0 0.3 2 4.5
OBC 2 15.7 0 2.5 1 4.8 1 3.0 0 2.3 1 2.7
PNB 5 10.2 3 6.4 2 3.8 2 2.4 1 1.1 4 5.7
SBI (cons) 20 10.3 14 7.0 10 4.4 5 1.7 7 2.5 9 2.8
Union 1 5.6 2 8.2 1 5.3 2 6.2 1 3.1 1 2.0
UCO 2 13.7 2 13.4 2 10.3 1 6.9 0 1.8 1 6.1
V ijaya 1 8.4 0 1.8 0 2.0 0 0.7 0 0.9 0 2.7
Total 45 9.9 32 6.6 27 4.9 15 2.4 16 2.4 24 3.2

Source: Company, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

India Banks/Financial Institutions

Assumptions could get better, but banks are taking some hit elsewhere
There has been a lot of discussion on this subject in the recent years. Assumptions continue
to remain a source of concern (see Exhibit 8) but note that there is very little that a bank can
possibly do to make changes on a few of them. Discount rates for capturing long term
liability costs and expected return on planned assets are linked to long-term benchmark
instruments.

An interesting observation is that in FY2016 there was a sharp rise in pension cost reflecting
higher actuarial losses. While one could attribute FY2015 with sharp decline in interest rates
the same cannot be used in FY2016. This has increased the pension obligations but we
believe that this could be due to differences arising out of age assumptions and actual age
of retired employees.

The importance of the interest rate assumptions: a few thoughts

An important point to note is that the impact of these high interest rate assumptions does
not have similar impact on the fair value of assets and defined benefit obligation. The peak
liability creation closes as the active employees (not all employees of the plan) start declining
and this is the scenario that we are seeing today (see Exhibit 10). However, the assets that
are created need to be in existence till the last member is active in the plan post his
retirement. Hence, the duration of the creation of liabilities (which is indirectly checked
through the change in current service cost) because of the change in active employees is lot
lower than the duration of the assets required to service all employees (which is indirectly
checked through the change in current service cost). We think this is important as we should
not look at the two having similar or double impact when interest rates decline.

We acknowledge that we have some shortcomings with respect to data availability with
respect to (1) age of employees in the plan including those who participated recently
(especially those who have retired) (2) total number of members who are currently part of
the plan (3) expected outstanding liability that needs to be created over a period to
understand the full contribution that needs to be provided by banks and importantly (4) the
mortality tables of LIC (1994-96) for valuing the actuarial liability assuming a superannuation
period of 60 years with some level of early retirement/disablement/attrition rate. Hence, we
look at proxies to understand these issues.

6 KOTAK INSTITUTIONAL EQUITIES RESEARCH

 Banks/Financial Institutions India

Exhibit 8: Change in assumptions was not material in FY2016

March fiscal year-ends, 2011-16 (%)

2011 2012 2013 2014 2015 2016

Discount Return Salary Discount Return Salary Discount Return Salary Discount Return Salary Discount Return Salary Discount Return Salary
Allahabad 8.5 8.0 4.0 8.5 8.5 5.0 8.0 8.0 5.5 8.8 8.0 5.5 8.0 8.0 5.5 7.5 7.5 5.5
Andhra 8.4 8.5 3.0 8.4 8.5 3.0 8.1 9.0 4.0 9.1 9.0 5.0 7.8 9.0 5.0 8.1 9.0 5.0
BoB 8.5 8.0 4.0 8.8 8.0 4.0 8.3 8.0 6.0 8.5 8.7 6.0 8.0 8.0 6.0 8.0 8.0 6.0
BoI 8.5 8.0 4.0 9.0 8.0 4.0 8.0 8.0 5.0 9.3 8.4 6.0 8.0 8.6 5.5 8.1 8.9 5.5
Canara 8.5 8.0 4.0 8.7 8.0 4.0 8.3 8.0 4.0 9.3 9.2 5.5 8.0 9.2 5.5 8.0 9.3 5.5
Dena 8.5 8.5 4.0 8.5 8.5 5.0 8.0 8.0 5.5 8.8 9.0 5.0 8.0 9.0 5.0 8.0 9.0 5.0
Indian 8.5 9.0 8.6 9.0 8.4 9.0 9.3 9.0 5.5 8.0 8.0 6.0 8.0 9.0 6.0
IOB 8.5 9.1 3.0 8.5 8.5 3.0 8.5 9.0 4.0 8.8 9.0 5.0 8.8 9.0 5.0 7.8 9.0 5.0
OBC 8.5 8.1 6.0 8.5 8.5 6.0 8.5 9.1 5.5 9.0 9.0 5.3 8.8 9.0 5.3 8.5 8.9 5.0
PNB 8.5 8.6 5.0 8.8 8.6 5.0 8.5 8.6 5.0 9.1 8.6 5.5 8.0 8.6 5.5 8.2 8.6 5.8
SBI (cons) 8.4 7.9 4.4 8.7 8.1 4.4 8.4 8.3 4.6 9.2 9.0 5.0 8.2 8.7 5.0 8.1 8.2 5.0
Union 8.0 8.0 4.0 9.0 8.0 4.0 8.5 8.7 4.0 9.3 8.7 5.0 8.0 8.7 5.0 8.0 8.7 5.0
UCO 8.5 9.0 5.0 8.5 9.1 5.0 8.0 9.2 5.5 8.5 9.4 5.7 8.0 9.4 5.7 8.0 9.0 5.3
Vijaya 8.5 8.3 4.3 9.0 8.3 1.5 8.0 8.7 5.5 8.5 9.5 5.5 8.0 9.0 5.5 8.0 9.0 5.5
J&K Bank 8.0 8.0 3.0 8.5 8.0 3.5 8.0 8.0 3.5 9.0 8.0 5.0 8.0 8.0 5.0
Average 8.4 8.3 4.1 8.7 8.4 4.1 8.2 8.5 4.8 9.0 8.8 5.4 8.1 8.7 5.4 8.0 8.7 5.4
Notes:
a) Discount refers to discount rate of pension obligation, return refers to return on assets and salary pertains to escalation of staff costs
b) Allahabad Bank gave salary escalation at 7.5% for first 20 years and 5% thereafter for FY2009-10.
c) Indian Bank gave salary escalation at 2% basic and 7.5% DA for FY2010 and 1% basic, 4.7% DA for FY2011 and 1% basic and 3% DA in
FY2012

Source: Company, Kotak Institutional Equities

Greater impact from actuarial assumptions could reflect aggressive assumptions

FY2016 saw a sharp rise in actuarial losses despite the change in interest rates not being too
material. BoB, IOB, Union and UCO Bank have reported a sharp rise in PBO due to these
losses. Given the limited disclosures it is rather difficult to point out factors leading to
actuarial impact, but these losses could reflect the aggressive assumptions made by banks
and hence could potentially report higher actuarial losses for an extended period.

The reasons for this, as highlighted in the earlier section, could be due to various reasons.
However, one possible explanation is the difference between observed and assumed
variances in age of a pensioner post his retirement. This would remain a problem for some
time, but we are not perturbed as most of these plans are at a fair level of maturity given
the levels of retirement that we are seeing in this employee base.

Others reasons could include factoring in new actuarial tables (2006-08) as compared to
1994-96 tables or secondary impact caused due to marginal changes in salary on a yearly
basis such as promotions.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 7

 India Banks/Financial Institutions

Exhibit 9: Impact due to changes in actuarial assumptions was 10% of opening liabilities in FY2016 as compared to 8% in FY2015
Actuarial losses to opening liabilities, March fiscal-year ends, 2011-16 (` bn)

2011 2012 2013 2014 2015 2016

% of % of % of % of % of % of
PBO Loss PBO PBO Loss PBO PBO Loss PBO PBO Loss PBO PBO Loss PBO PBO Loss PBO
Allahabad 7 15 211.6 26 (0) (0.9) 32 (1) (4.3) 37 (2) (5.8) 41 (2) (4.6) 46 0 0.6
Andhra 9 2 27.6 21 1 4.2 24 1 4.9 28 1 3.4 32 1 4.3 37 2 4.2
BoB 29 (1) (2.5) 67 0 0.1 70 (8) (10.7) 75 (4) (5.8) 83 (4) (5.0) 89 20 22.2
BoI 22 19 87.0 69 (1) (1.6) 71 (8) (10.6) 74 (2) (3.0) 80 6 7.4 94 9 9.9
Canara 34 20 59.0 72 3 4.3 77 6 7.7 86 2 2.6 90 3 3.0 96 (2) (2.6)
Dena 9 7 82.2 17 0 1.3 17 (1) (5.8) 18 (0) (0.3) 19 1 5.2 22 2 10.5
Indian 19 6 31.2 36 (1) (1.5) 39 5 13.8 45 3 5.8 49 3 6.2 53 4 7.2
IOB 20 18 88.4 39 4 10.4 44 4 9.3 49 5 9.6 54 6 10.5 60 9 15.1
OBC 9 15 167.3 25 1 4.5 29 2 6.2 33 2 5.7 38 1 3.8 44 2 5.0
PNB 47 (3) (6.0) 106 (7) (6.8) 117 11 9.4 136 8 5.8 152 21 13.9 182 13 6.9
SBI (cons) 269 19 7.0 419 6 1.5 460 14 3.1 501 47 9.4 569 51 8.9 645 69 10.7
Union 14 4 27.0 48 2 4.4 53 4 6.8 60 4 6.2 67 12 17.6 82 13 15.7
UCO 14 17 123.7 31 1 2.3 33 5 14.8 39 4 10.9 47 3 5.8 53 9 16.2
Vijaya 7 1 18.5 18 0 1.7 19 (2) (10.0) 20 (1) (4.4) 21 1 2.9 24 1 4.7
Total 508 139 27.5 991 9 1.0 1,084 33 3.0 1,200 65 5.5 1,343 102 7.6 1,529 150 9.8
Notes:
(A) FY2011 saw a higher impact due to recognition implementation of the second pension option from “past service cost” while the largest impact
was taken due to the implementation of the wage settlement of the previous cycle.
(B) BoB and BoI have moved their mortality tables to 2006-08 in FY2016 leading to a rise in actuarial losses while SBI completed this exercise in
FY2014
(C) Some banks have not explicitly mentioned the impact of the second pension option in FY2011 and could have been a part under actuarial
gains/loss in FY2011. Hence, FY2011 may not be a correct year to understand the long term changes.

Source: Company, Kotak Institutional Equities

35-45% of active employees are already under defined contribution

We think that PSU Banks are probably moving far rapidly to defined contribution plans than
our initial expectation. Note that PSU Banks moved to defined contribution (employees
contribute 10% of basic pay and dearness allowance with a matching contribution from
banks) from August 01, 2010.

The exhibit below shows that that the ratio of employees who are currently part of defined
benefit plan and active have fallen to ~55% levels as compared to ~90% in FY2011. On the
other side, the important ratio to track would be the split of employees in the plan between
active/retired and the outstanding liabilities assumed by the bank for these employees.
Discussion with various banks indicate that this ratio which was probably closer to 65-70%
in FY2011 has dropped to ~55% in FY2014 and the probability is high that we would see
this declining to 45-50% or lower by FY2016 for most public banks. This is important to
track as this would help us understand the “current service cost” movement under defined
benefit obligation. As this ratio (share of active to retired employees in the plan) declines the
pace of increase in the current service costs declines as well which then gives us an
indication that the plan is closer to maturity.

8 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Banks/Financial Institutions India

Exhibit 10: ~45% of employees are now outside the defined benefit scheme
Number of active members in the defined benefit to overall active employees, March fiscal year-ends, 2010-16

2010 2011 2012 2013 2014 2015 2016

Bank of India
No of members (#) 15,085 36,950 34,498 31,932 29,254 26,268
Outstanding employ ees (#) 39,676 39,785 41,890 42,146 43,143 45,613 45,713
% of members to employ ees 38.0 92.9 82.4 75.8 67.8 57.6 -
Union Bank of India
No of members (#) 14,497 27,856 26,345 24,739 23,163 21,337 19,670
Outstanding employ ees (#) 29,419 29,462 30,838 31,798 33,806 35,514 35,473
% of members to employ ees 49.3 94.5 85.4 77.8 68.5 60.1 55.5
Notes:
(A) Data post FY2010 includes active members who opted for the second pension option scheme

Source: Company, Kotak Institutional Equities

The other way to track this ratio would be to look at the movement in various other
reported items. This is not as reliable as what was described previously but we do keep track
of the following: (1) increase in current service cost (2) relative contribution of interest costs
as compared to current service cost and (3) benefits paid. The former two are heavily
influenced by the discount rate and salary escalation assumptions but the third is a bit more
reliable. The exhibit below shows that the trend in benefits paid to opening balances is
steadily rising. The third has a key drawback as it is not necessary that the opening balance
factors in the full cost of the liabilities that needs to be paid. Given the limited data, we do
think that the third option does offer a better alternative. Note that many banks adjust the
difference in expected cost and actual costs under actuarial losses. Hence the one-time cost
taken by SBI in FY2014 could possibly be taken across a period by all public banks.

We believe that banks should be able to manage this liability as they are still in a phase of
strong growth in balance sheet (over 10-12% CAGR in the medium term) giving adequate
cushion for higher-than-expected contribution while the defined benefit plan witnesses a
steady decline of members.

Exhibit 11: Contribution of interest costs are nearly double of current service costs
March fiscal year-ends, 2010-16 (₹ bn)

2010 2011 2012 2013 2014 2015 2016

Opening balance 465 528 1,034 1,132 1,255 1,405 1,604
Current serv ice costs 20 34 47 59 59 71 79
% of opening balance 4.3 6.4 4.5 5.2 4.7 5.0 4.9
Interest costs 37 43 87 96 106 114 120
% of opening balance 7.9 8.2 8.5 8.5 8.4 8.1 7.5
Discount rate assumption (%) 8.0 8.5 8.6 8.3 9.1 8.0 8.0
Benefits paid 30 42 51 70 86 101 139
% of opening balance 6.6 7.9 5.0 6.2 6.8 7.2 8.7

Source: Company, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH 9

India Banks/Financial Institutions

Possibility of employee costs peaking for public banks is high, in our view
We think that the average cost/employee is unlikely to see further increase from current
levels. The exhibit below shows that the staff costs per active employee has increased by 7%
yoy for public banks in FY2016 while it has increased by 4% for private banks. The
consistent rise of staff costs has created a sharp divergence where it appears that the
average cost/employee is 33% higher for public banks. This could be partly true as the
average age of employees is far higher at over 40 years as compared to ~30 years for private
banks. However, we think this is an incorrect analysis as ~25-30% of the reported costs
pertain to retirement benefits where we think the contribution is closer to peak levels. This
does not mean that a reversal is immediate but the probability is very high that we could see
this ratio at closer to current levels for public banks and probably start declining in a few
years from now.

Exhibit 12: Employee costs increased 7% yoy in FY2016 and >33% higher than private banks
Average cost/employee, March fiscal year-ends, 2010-16 (`)

2010 2011 2012 2013 2014 2015 2016

Public banks
Allahabad 488,400 737,890 841,640 884,780 952,780 945,570 1,026,340
Andhra 577,350 777,890 787,710 813,980 784,640 911,650 1,011,790
BoB 620,300 738,370 726,230 808,990 929,140 893,560 1,290,290
BoI 575,230 874,750 747,700 745,040 935,910 1,123,490 1,173,210
Canara 501,590 675,490 694,090 765,860 805,410 834,160 823,400
Dena 501,360 672,140 709,180 743,680 834,860 839,140 1,060,900
Indian 613,020 688,350 782,230 1,052,660 1,008,210 877,370 983,710
IOB 662,070 661,070 783,810 808,090 814,750 859,360 902,660
OBC 647,230 655,770 780,110 850,400 872,150 823,880 988,650
PNB 542,180 783,010 792,880 904,920 1,010,680 1,106,770 952,830
Union 463,610 883,030 822,310 879,690 1,008,400 1,092,190 990,730
SBI 628,010 718,830 774,340 828,380 999,460 1,081,490 1,193,130
UCO 450,240 639,780 599,080 589,670 635,980 659,400 688,930
V ijay a 599,500 879,410 636,410 694,460 818,000 835,330 963,290
Total 580,610 738,760 760,330 822,190 935,280 990,230 1,063,170
Growth (%) 17.1 27.2 2.9 8.1 13.8 5.9 7.4
Priv ate banks
Axis Bank 594,270 671,410 715,170 682,660 647,740 735,960 731,010
HDF C Bank 437,810 527,830 558,970 586,850 609,050 650,080 688,860
ICICI Bank 509,040 574,670 610,050 647,040 628,500 678,150 704,790
IndusInd Bank 603,190 617,630 592,830 633,830 597,440 564,940 586,090
Yes Bank 900,570 1,040,740 992,890 1,035,120 991,530 999,250 1,004,880
Total 506,070 587,110 620,280 644,210 638,070 685,580 710,180
Growth (%) (2.8) 16.0 5.6 3.9 (1.0) 7.4 3.6
(% difference - public
and private) 12.8 20.5 18.4 21.6 31.8 30.8 33.2

Source: Company, Kotak Institutional Equities

We base our decline argument on the mix of employees that we are seeing in these banks.
The average age of employees in public banks has started to reverse. For example, the
average age of employees in PNB has declined to 43 years as compared to 50 years in
FY2010. In UCO Bank, 34% of employees are less than 30 years and 54% are less than 45
years while in FY2010 less than 80% of the employees were below 45 years. With more
retirement coming through in the next few years, we see the average cost is likely to decline
and not increase any further.

10 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Banks/Financial Institutions India

Exhibit 13: Average age of employees has declined to 43 years in FY2015

Average age across different levels for PNB, March fiscal year-ends, 2010-15 (%)

2010 2011 2012 2013 2014 2015

Officer 50.2 50.4 50.1 49.5 49.1 48.2
Clerical 49.8 49.6 44.9 44.7 43.0 41.1
Sub-staff 46.9 45.9 44.5 42.4 40.5 38.8
Total 49.3 49.0 46.8 46.0 44.7 43.1

Source: Company, Kotak Institutional Equities

Exhibit 14: UCO Bank has seen a fairly sharp decline in average age in the past two years
Share of employees across various age buckets for UCO Bank, March fiscal year-ends, 2010-15 (%)

2010 2011 2012 2013 2014 2015

Less than 30 years 7.7 7.3 11.2 23.4 28.5 33.5
30 years -45 years 8.9 11.0 11.5 13.7 16.7 20.3
45 years -55 years 61.1 47.8 40.9 29.7 23.1 16.9
>55 years 22.3 34.0 36.5 33.2 31.7 29.3

Source: Company, Kotak Institutional Equities

Exhibit 15: The average age has been broadly stable for the past few years at 29-30
Break-up of employees by age for Axis Bank, March fiscal year-ends, 2010-15 (%)

2010 2011 2012 2013 2014 2015

Below 30 66.0 70.9 69.0 67.9 64.2 51.6
30-40 years 29.0 24.9 27.0 28.1 31.7 42.2
40 - 50 years 4.0 3.5 3.0 3.3 3.5 5.2
50 - 60 years 1.0 0.7 1.0 0.7 0.7 1.0
Average age (years) 29 29 29 29 30

Source: Company, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH 11

Disclosures

"I, M.B. Mahesh, hereby certify that all of the views expressed in this report accurately reflect my personal views about the
subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be,
directly or indirectly, related to the specific recommendations or views expressed in this report."

Kotak Institutional Equities Research coverage universe

Distribution of ratings/investment banking relationships
Percentage of companies covered by Kotak Institutional
70%
Equities, within the specified category.

60%
Percentage of companies within each category for
which Kotak Institutional Equities and or its affiliates has
50%
provided investment banking services within the
previous 12 months.
40% * The above categories are defined as follows: Buy = We
34.4%
30.6% expect this stock to deliver more than 15% returns over
30% the next 12 months; Add = We expect this stock to
deliver 5-15% returns over the next 12 months; Reduce
19.4% = We expect this stock to deliver -5-+5% returns over
20% 15.6% the next 12 months; Sell = We expect this stock to deliver
less than -5% returns over the next 12 months. Our
10% target prices are also on a 12-month horizon basis.
5.0%
3.3% These ratings are used illustratively to comply with
1.1% 0.6%
applicable regulations. As of 31/03/2016 Kotak
0%
Institutional Equities Investment Research had
BUY ADD REDUCE SELL
investment ratings on 180 equity securities.

Source: Kotak Institutional Equities As of March 31, 2016

Ratings and other definitions/identifiers

Definitions of rating

BUY. We expect this stock to deliver more than 15% returns over the next 12 months.

ADD. We expect this stock to deliver 5-15% returns over the next 12 months.

REDUCE. We expect this stock to deliver -5-+5% returns over the next 12 months.

SELL. We expect this stock to deliver <-5% returns over the next 12 months.

Our target prices are also on a 12-month horizon basis.

Other definitions

Coverage view. The coverage view represents each analyst’s overall fundamental outlook on the Sector. The coverage view will consist of one of the following
designations: Attractive, Neutral, Cautious.

Other ratings/identifiers

NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s)
and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction
involving this company and in certain other circumstances.

CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.

NC = Not Covered. Kotak Securities does not cover this company.

RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient
fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock
and should not be relied upon.

NA = Not Available or Not Applicable. The information is not available for display or is not applicable.

NM = Not Meaningful. The information is not meaningful and is therefore excluded.

12 KOTAK INSTITUTIONAL EQUITIES RESEARCH

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