Breaking into Broking At 2 pm on Wednesday, 6 October 2010, Anand Dorairaj, partner at the private equity firm New Silk

Route (NSR) met Amitabh Chaturvedi, CEO and MD of Dhanlaxmi Bank, and Bipin Kabra, its chief financial officer (CFO) over coffee to discuss a possible stake sale in broking firm Destimoney. The offer was turned down. In April 2010, the bank had tied up with Destimoney to provide an online trading platform to its customers, but did not feel the need to acquire stake in the broking firm. But a lot can happen over a cup of coffee. After two meetings over 16 days, on 22 October, the Kerala-based bank paid Rs 13 crore to acquire 15 per cent in Destimoney, valuing the broking outfit at Rs 86-87 crore, much lower than the Rs 200 crore that New Silk Route had paid to buy the company from UK-based Dawnay Day and Alok Vajpeyi in August 2008. Vivek (Sett, partner at NSR) and Anand (Dorairaj) knew we were interested in getting into the capital market business, says Kabra. It seemed to be a great strategic fit with our banking operations. Dhanlaxmi Bank will be a strategic investor in Destimoney but over time, says Kabra, the bank will acquire a majority stake. NSR plans to divest another 36 per cent to three or four financial investors. Cut to Axis Bank, which, in November 2010, bought Enam Securities for Rs 2,067 crore, acquiring Enams investment banking business. These two instances beg the question: why are banks getting into the capital markets business? Customers who invest in capital markets maintain three or four times the balance they would in a normal savings account, explains Kabra. It increases the current and savings bank account (CASA) deposit base. So the banks get greater access to cheap capital, and bigger net interest margin or NIM, the difference between the interest rate paid on deposits and that charged on loans. Also, customer needs are expanding; so if a bank offers more services, it will be able to retain more loyal customers. There was a lacuna in our product offering and we wanted to fill that gap, says Shailendra Bhandari, MD and CEO, ING Vysya Bank. We didnt have the bandwidth, so we roped in a partner. Angel Broking will provide online broking services to ING Vysya. The bank expects its CASA to grow 25 per cent as a result. Axis Bank and Dhanlaxmi Bank are just two instances of what may become a trend; the entire banking industry is gearing up to get a piece of the capital markets business. There is not much left in traditional banking, so they are willing to get into hitherto uncharted territory, says C. Jayaram, executive director at Kotak Mahindra Bank (KMB). However, banking and broking are
Prof T. Mathew Assistant Professor SFIMAR

independent businesses. CASA benefits are not enough to get into broking; you have to believe that broking makes sense. Jayaram should know. His was the first brokering and financial services company to get a banking licence from the Reserve Bank of India in 2003. For 2009-10 (FY10), the capital market business for KMB accounted for nearly 22 per cent of the overall consolidated profit. In comparison, the profit contribution from capital markets for other major banks (ICICI Bank, HDFC Bank, State Bank of India, etc.) is in the 1.3-2.6 per cent range.

Apart from the total balance sheet size, even in absolute terms, KMBs profit from capital business is Rs 284 crore nearly double that of big daddy SBIs Rs 150 crore in FY10. Some seem to have realised this, like Axis Bank, which has a strong small and medium enterprise (SME) clientele, besides itself being a large player in the debt markets. The Enam acquisition positions Axis well in taking its client to the equity capital market. Even before the Enam deal, Axis had tasked Macquarie Capital with finding a suitable partner. Apart from more services and access to funds, banks also see capital markets as a business opportunity, says Sachin Sondhi, senior director at Deloitte India, a global consultancy firm. They recognise that building capability organically is harder. Therefore, they are venturing into tie-ups or going for acquisition, he says.

Prof T. Mathew Assistant Professor SFIMAR

But capital requirement norms have restricted many banks from making acquisitions of this kind. Instead, it is the smaller banks such as Saraswat Co-operative Bank and Development Credit Bank that are tying up with brokerages; both these banks are trying to work out an exclusive tie-up with India Infoline to provide online trading for their customers. Looking into the risk-reward profile, banks prefer not to tinker too much with their portfolio and are instead looking at ways to offer online broking services as better Internet connectivity has propelled demand. More importantly, payments and market settlements are electronic. As on end-December 2010, online trading turnover as a percentage of the total market turnover is 16 per cent compared to 3 per cent in FY04

The future is clearly online, says Jayaram of KMB. In the next 5-7 years, I see 50 per cent of the total volumes coming from online trading. Another nudge towards equity broking is the less than stellar returns on products like life insurance plans and mutual funds. Also, the lines between cross-selling financial products of brokerages and banks are slowly blurring. Firms such as Indiabulls Financial Services, India Infoline and Edelweiss Capital

Prof T. Mathew Assistant Professor SFIMAR

are aggressively building a strong credit business, one that was hitherto predominantly done by banks. Today, banks are inclined to go out on their own. For instance, Bank of Baroda recently parted ways with India Infoline and is all set to launch its own online trading platform. Axis Bank, too, has launched Axis Direct; earlier they had a tieup with Geojit Financial Services. While SBI has had a tie-up with Motilal Oswal Securities for the past three years, it has asked the broking firm to stop tapping its client base for online trading. Motilal Oswal has registered 50,000 SBI clients for online trading on its own platform. The fundamental premise of going on its own is that the bank is able to retain customers and grow its footprint with them, says Sondhi of Deloitte. Revenues apart, current regulations do not allow brokers to share broking income with the bank. Instead, it is treated as marketing expenses and shared with the bank. The brokerage fee is the largest pie in broking, and the brokerage firm gets it. The other piece is made up of the demat and the banking accounts, both of which are with the bank. The revenue share is 60:40 in favour of the broking firm. As one senior banker points out, the banks want a clean balance sheet and are, therefore, testing the waters before they venture out solo. In some ways, banks are in a situation similar to that of US firms Charles Schwab and Merrill Lynch (the latter does not exist today) in the mid- to late-1990s. When equity trading took off in the US, Merrill Lynch considered the biggest broking firm then did not create its own online trading platform for a long time; the power of their broking was strong enough. Schwab, primarily a discount broking house, went the other way and started live online trading in 1996, and acquired 2 million online accounts by 1998, forcing Merrill Lynch to build its own online trading capabilities. Deloittes Sondhi was a part of the team that had assisted Merrill Lynch then. The big shift was felt after a while. Online trading became so intrinsic to the client relationship (that) Merrill felt it was better to build and keep it in-house, and not lose the advantage to a third party, he says. Sondhi feels that as Indian banks develop experience around investment products, they will start to either buy out or build-up or strengthen their own platforms. Many are doing so already, in addition to partnering with trading houses. Some people feel it is partly a matter of retaining assets and not losing customers. Bank customers are becoming savvy and their disposable incomes are rising, but banks do not see any increase in their share of the growing wallet, as customers pull money from bank accounts and into mutual funds or insurance. Now, banks want to leverage their customer relationship and translate it into commercial returns by offering a broader set of products.
Prof T. Mathew Assistant Professor SFIMAR

But when you integrate and broaden the portfolio offering, you naturally increase the level of risk; the exposure is through multiple products and businesses. So risk management and capital management will have to be calibrated in accordance with how those businesses mature, and that is where banks might fall short. The risk that a banking enterprise is willing to take has to be seen differently. The level of competence and discipline in managing risk and capital for businesses that have diverse needs also has to grow in line, says Sondhi. If you dont do that, you could have excessive risk in a certain part of the business that can bring down the entire enterprise similar to what happened in the West. KMBs Jayaram concurs. The challenge for banks that consider starting their own standalone brokerages will have to be carefully studied, he says. It is a good business which, in some sense, does not require high capital. But you require strong technology, processes, systems and, most importantly, strong risk management. Besides, it is no more a highmargin business. The new Basel III norms will require banks to provide sufficient balances in the form of capital adequacy and reserve, which will restrict banks from expanding, but will provide the much needed protection. Whether banks offer products in-house or through a separate subsidiary, they will have to run each business with its own independent risk and business profiles. The enterprise value will depend on how well they cross-fertilise each business in a way that benefits customers. Today we are in an evolution phase, which has already taken place in other markets. So, we are far from the challenges that the West has had. As advanced as markets in India may appear, from a regulatory and development perspective, capital markets are still at a nascent stage. Capital markets are growing at a torrid rate; but all talk of banking consolidation in the way that the US and European markets experienced it, is a distant reality. Banks see online broking as an opportunity, and are trying to make the most of its economic value. At the same time, they might, however, want to consider the inherent risks as well. After all, they cannot afford to go broke.

Prof T. Mathew Assistant Professor SFIMAR