Project On Finance

SECTOR OVERVIEW
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Introduction: Banking sector
The Indian Banking industry governed by the Banking Regulation Act

of India, 1949, falling into two broad classifications, non-scheduled
banks and scheduled banks. Within the commercial banks there are
nationalized banks, the State Bank of India and its group banks,
regional rural banks and private sector banks (the old/ new domestic
and foreign).
With the economic growth picking up pace and the investment cycle
on the way to recovery, the banking sector has witnessed a
transformation in its vital role of intermediating between the demand
and supply of funds. The revived credit off take (both from the food
and non food segments) and structural reforms have paved the way
for a change in the dynamics of the sector itself. Besides gearing up
for the compliance with Basel accord, the sector is also looking
forward to consolidation and investments on the FDI front.
Public sector banks have undergone much restructuring alongside

technology implementation. NPAs have been written off against
treasury gains in the last few years.
Retail lending (especially mortgage financing) has been grabbing a

major share of the market in the last 3 years. With better penetration
in the semi urban and rural areas the banks garnered a higher
proportion of low cost deposits thereby economizing on the cost of
funds.
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Apart from streamlining their processes through technology initiatives
such as ATMs, telephone banking, online banking and web based
products, banks have also resorted to cross selling of financial
products such as credit cards, mutual funds and insurance policies to
augment their fee based income.
RBI's soft interest rate policy has helped increase the liquidity in the
market, and banks have been liquidating their gilt portfolios partially
to free resources for lending. Credit off take is expected to be
reasonably good both on retail and corporate sides. Following the
advice of the government banks have increased lending to
agricultural sector, while ensuring good quality lending by informed
customer analysis.
Currently the banking sector in the country is strongly fragmented and

hence with further policy changes taking place in the sector,
consolidation is likely to take place at a faster rate. However this is
subject to the removal of the ceiling on voting rights will ensure that
private sector and foreign banks will be in a much better position to
carry out acquisitions in the banking sector. A hike in FDI capital
limits in the sector would further go a long way in the process of
consolidation. In terms of credit growth, going forward, India's core
sector is witnessing a revival of sorts. The manufacturing sector has
shown significant improvement in FY05. Hence as corporate growth
picks up lending too is likely to see an uptick. Retail credit off-take is
expected to remain strong going forward with the housing finance
industry, the main contributor to credit off-take from this segment,
expected to grow between 20%-25% in the next 3-4 years.
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Indian banks have to be encouraged to expand fast, both through
organic growth and through consolidation, in order to fuel the growth
of large firms and to strengthen their risk assessment systems, for
catering to the requirements of smaller firms. Various policy
measures are in process to help this transition along. However, when
we look at the global scenario, only 22 Indian banks figure in the list
of top 1000 banks and there are only 5 Indian banks in the list of top
500 banks. The biggest Indian bank, State Bank of India, has a
market capitalization of under US$ 10 billion compared to the market
capitalization of US$ 243 billion of Citigroup. Indian banking sector
has a long way to go before we can say that Indian banks are
relatively significant players. Having said that, there are sufficient
reasons to believe that the Indian Banking sector is poised for
tremendous growth and with proper policy framework in place, it
would be very soon, matching their global counterparts on most of the
relevant banking indicators/ parameters (except size for some time to
come).
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INDIAN BANKING
SYSTEM
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Indian Banking System:
For the past three decades India's banking system has several
outstanding achievements to its credit. The government's regular
policy for Indian bank since 1969 has paid rich dividends with the
nationalization of 14 major private banks of India. The first bank in
India, though conservative, was established in 1786. From 1786 till
today, the journey of Indian Banking System can be segregated into
three distinct phases. They are as mentioned below:
• Early phase from 1786 to 1969 of Indian Banks

• Nationalisation of Indian Banks and up to 1991 prior to Indian
banking sector Reforms.
• New phase of Indian Banking System with the advent of Indian
Financial & Banking Sector Reforms after 1991.
Phase I
During the first phase the growth was very slow and banks also
experienced periodic failures between 1913 and 1948. There were
approximately 1100 banks, mostly small. To streamline the
functioning and activities of commercial banks, the Government of
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India came up with The Banking Companies Act, 1949 which was
later changed to Banking Regulation Act 1949 as per amending Act
of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with
extensive powers for the supervision of banking in India as the
Central Banking Authority.
Phase II
The following are the steps taken by the Government of India to

Regulate Banking Institutions in the Country:
• 1949: Enactment of Banking Regulation Act.

• 1955: Nationalisation of State Bank of India.
• 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 200
crore.
Phase III
In 1991, under the chairmanship of M Narasimham, a committee was

set up by his name which worked for the liberalisation of banking
practices. The country is flooded with foreign banks and their ATM
stations. Efforts are being put to give a satisfactory service to
customers. Phone banking and net banking is introduced. The entire
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system became more convenient and swift. Time is given more
importance than money.
Current Scenario:
The Indian Banking industry has been undergoing rapid changes

reflecting a number of underlying changes. Liberalization and
deregulation witnessed in the Indian markets in the 1990s have
resulted in a spurt in banking activity in India. Significant advances in
communication have enabled banks to expand their reach, both in
terms of geography covered as well as new products introduced. With
increased competition in wholesale banking due to the entry of
foreign banks and new private sector banks, the sector has witnessed
a squeeze in margins. This has led to banks increasing their focus on
retail banking so as to obtain access to low cost funds and to expand
into relatively untapped, potential growth areas. Banks and financial
institutions are thus continuously exploring new avenues for
increasing their footprint and safeguarding their margins.
Competition from multinational banks and entry of new private sector

banks has rewritten the rules of the retail lending business in India.
Slow growth in corporate lending, pressure on corporate spreads due
to competition and concerns over asset quality have induced public
sector banks to follow the private sector banks in placing emphasis
on growth through expansion of retail portfolio.
The Indian retail lending market is relatively unexplored with the per-
capita usage of retail product offerings such as housing finance,
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credit cards, auto loans, consumer finance, etc. lower as compared to
Asian peers. Also the relative size of the Indian market, backed by
factors such as a growing population of bankable households, low
penetration rate for retail finance products and the increased
propensity of the urban populace to take credit, offers scope for
expansion.
In retail financing most of the players are trying to enter or

consolidate their housing finance segment, as housing loans market
is perhaps the least risky segment in the financial sector. Housing
finance companies (HFCs) generally target the retail borrower where
the nature of the loan ensures that defaults are few and far between.
The relatively small size of a housing loan also ensures the risk is
well spread out. Moreover pursuance to the government's policy to
provide shelter to a large number of people and concessions
provided in the Finance Act to boost housing and housing finance
activities indicates great future potential for this segment.
The industry is currently in a transition phase. On the one hand, the

PSBs, which are the mainstay of the Indian Banking system, are in
the process of shedding their flab in terms of excessive manpower,
excessive non Performing Assets (NPA’s) and excessive
governmental equity, while on the other hand the private sector banks
are consolidating themselves through mergers and acquisitions.
Public Sector banks that imbibe new concepts in banking, turn tech
savvy, leaner and meaner post VRS and obtain more autonomy by
keeping governmental stake to the minimum can succeed in
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effectively taking on the private sector banks by virtue of their sheer
size. Weaker PSU banks are unlikely to survive in the long run.
Consequently, they are likely to be either acquired by stronger
players or will be forced to look out for other strategies to infuse
greater capital. The private players however cannot match the PSBs
great reach, great size and access to low cost deposits. Therefore
one of the means for them to combat the PSBs has been through the
merger and acquisition (M&A) route. Over the last two years, the
industry has witnessed several such instances. For instance, HDFC
Bank’s merger with Times Bank; ICICI Bank’s acquisition of ITC
Classic, Anagram Finance and Bank of Madura. Centurion Bank,
Indusland Bank, Bank of Punjab, Vysya Bank are said to be on the
lookout. The UTI bank- Global Trust Bank merger however opened a
Pandora’s box and brought about the realization that all was not well
in the functioning of many of the private sector banks.
In the near term, the low interest rate scenario is likely to affect the
spreads of majors. This is likely to result in a greater focus on better
asset-liability management procedures. Consequently, only banks
that strive hard to increase their share of fee-based revenues are
likely to do better in the future.
Commercial banking structure
The commercial banking structure in India consists of:
• Scheduled Commercial Banks in India

• Unscheduled Banks in India
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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.
"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".
As on September 2005, there were about 269 commercial banks. Of

the 269 commercial banks, 265 were scheduled commercial banks
and 4 were non scheduled commercial banks. As on September
2005, there were 68,246 offices in India out of which around 46.74%
were in rural areas, 22.62% were in semi-urban areas, 17% in urban
areas and 13.64% in metropolitan cities.
Growth of Indian Banking Sector
Banks 2001-02 2002-03 2003-04 2004-05
Public Sector 968749 1079167 1229463 1435853
Private Sector 169439 207173 252336 312645
Foreign 64511 69110 79141 86505
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Deposits
1600000
1400000
1200000
crores
1000000
800000
600000
400000
200000
0
2001-02 2002-03 2003-04 2004-05
yr
Public Sector Private Sector Foreign
Banks 2001-02 2002-03 2003-04 2004-05
Public Sector 117253 128464 137587 144344
Private Sector 20817 31846 31814 32463
Foreign 12960 11999 12819 13034
Net Income
160000
140000
120000
100000
crores
80000
60000
40000
20000
0
2001-02 2002-03 2003-04 2004-05
yr
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Banks 2001-02 2002-03 2003-04 2004-05
Public Sector 480680 548436 633036 854671
Private Sector 118430 138949 161083 220337
Foreign 48632 52018 59822 75318
Advances
1000000
800000
600000
crore
400000
200000
0
2001-02 2002-03 2003-04 2004-05
yr
Banks 2001-02 2002-03 2003-04 2004-05
Public Sector 8302 12296 16547 15477
Private Sector 1779 2958 4162 3564
Foreign 1492 1817 2110 1982
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C
Net Profit
20000
15000
crore
10000
5000
0
2001-02 2002-03 2003-04 2004-05
yr
Banks 2001-02 2002-03 2003-04 2004-05
Public Sector 1.92 2.15 2.47 3.06
Private Sector 3.97 4.44 5.1 5.77
Foreign 8.18 10.34 9.81 9.4
14
Business / Employee
12
10
8
crore
6
4
2
0
2001-02 2002-03 2003-04 2004-05
yr
Financial and Banking Sector Reforms
The Banking System:
Almost 80% of the business is still controlled by Public Sector Banks

(PSBs). PSBs are still dominating the commercial banking system.
Shares of the leading PSBs are already listed on the stock
exchanges.
The RBI has given licenses to new private sector banks as part of the
liberalisation process. The RBI has also been granting licenses to
industrial houses.
Many banks are successfully running in the retail and consumer

segments but are yet to deliver services to industrial finance, retail
trade, small business and agricultural finance.
The PSBs will play an important role in the industry due to its number
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of branches and foreign banks facing the constraint of limited number
of branches.
Deregulation of Banking System:
Prudential norms were introduced for income recognition, asset

classification, provisioning for delinquent loans and for capital
adequacy. In order to reach the stipulated capital adequacy norms,
substantial capital were provided by the Government to PSBs.
Government pre-emption of banks' resources through statutory

liquidity ratio (SLR) and cash reserve ratio (CRR) brought down in
steps.
Interest rates on the deposits and lending sides almost entirely were
deregulated.
New private sector banks allowed promoting and encouraging
competition.
PSBs were encouraged to approach the public for raising resources.
Recovery of debts due to banks and the Financial Institutions Act,

1993 was passed, and special recovery tribunals set up to facilitate
quicker recovery of loan arrears.
Bank lending norms liberalised and a loan system to ensure better
control over credit introduced.
Banks asked to set up asset liability management (ALM) systems.

RBI guidelines issued for risk management systems in banks
encompassing credit, market and operational risks.
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A credit information bureau being established to identify bad risks.
Derivative products such as forward rate agreements (FRAs) and

interest rate swaps (IRSs) introduced.
Porters Five Force Model: An analysis of Indian Banking

System.
SUPPLIER POWER -High

During periods of tight liquidity.
Trade unions in public sector banks can be anti

reforms.
Depositors may invest elsewhere if interest rates

fall.
There are large numbers of banks and rise in

investment avenues like Mutual Funds, Tax-free
bonds, Equity market etc.
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THREAT OF SUBSTITUTES: High
BARRIERS TO ENTRY There are public sector banks, private sector and
Licensing requirement. foreign banks along with non banking finance
companies competing in similar business lines.
Investment in technology
In the lending side of the business,
and branch network.
banks are seeing competition rise
Banks are fearful of being squeezed out of
the payments business, especially since it from unconventional companies
is a good source of fee-based revenue.
e.g. car companies are offering
Another trend that poses a threat is
companies offering other financial 0% financing, why would anyone
services. What would it take for an
insurance company to start offering want to get a car loan from the bank and pay 5-10%
mortgage and loan service? interest?
BUYER POWER DEGREE OF RIVALRY: High

There is intense competition due to the large
High switching costs number of players in the market.
For good creditworthy borrowers bargaining
power is high due to the availability of large There are 296 Commercial banks operating in
number of banks. India.
It is high due to high competition and Banks attempt to lure clients away from competitor
growing avenues of raising funds like banks by offering lower financing, preferred rates,
Commercial Papers etc. and investment services.
The banking sector is in a race to see who can

offer the better and faster services, but this also
causes banks to experience a lower ROA.
They then have an incentive to take- on high risk

projects.
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BENCHMARKING-
INDIAN BANKING
INUSTRY
Benchmarking the Indian Banking Industry:
In an increasingly integrated world, disruptions anywhere may have

repercussions for the banking system. Weak and unsound financial
system may also find it difficult to compete in the global marketplace.
It is, therefore, important from the financial stability perspective that
banks are sound by international standards. Significant strengthening
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of prudential supervision coupled with wide-ranging measures
undertaken by the Government and the Reserve Bank has
significantly improved the health of the banking sector. After initiation
of reforms in the early 1990s, financial performance, especially of
PSBs, has improved markedly. Several balance sheet and profitability

indicators suggest that the Indian banking sector now compares well
with the global benchmarks.
Funding Volatility Ratio
The funding volatility ratio (FVR), an important aspect of banks’

balance sheet, measures the extent to which banks rely on volatile
liabilities to finance their assets. The smaller the ratio, the better the
bank’s liquidity profile. Accordingly, it is preferable to have FVR=0
(whereby volatile liabilities are either exactly or more than fully
covered by liquid assets).
Bank group 2002-03 2003-04 2004-05
Public Sector -0.25 -0.23 -0.19
Private Sector -0.27 -0.23 -0.15
Foreign Banks -0.25 -0.18 -0.11
Scheduled Commercial -0.25 -0.25 -0.17
Global range for 1998: [-0.71 to 0.11]
Return on Assets
Bank group 2004 2005
Public Sector 1.1 0.9
Private Sector 0.9 0.8
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Foreign Banks 1.7 1.3
Scheduled Commercial 1.1 0.9
Emerging Markets
Argentina -0.3 1
Brazil 1.8
Mexico 1.5 2
Korea 0.9
Developed Markets
South Africa 1.2 1.3
US 1.4
UK 0.6 0.8
Japan 0.1 0.3
Canada 0.8 0.8
Australia 1.1 1.2
Global range for 2004: [-1.2 to 6.2]
The return on total assets (RoA) of banks, defined as the ratio of net
profit to total assets, is one of the most widely employed measure of
profitability. A bank performing on sound commercial lines is
expected to exhibit a healthy RoA. Globally, the RoA of the banking
sector for 2004 ranged between -1.2 per cent and 6.2 per cent .The
RoA of SCBs in India for 2004-05 was 0.9 per cent. The ratio was
highest for foreign banks, followed by new private sector banks. The
RoA of public sector banks was close to the industry level within the
country and the international benchmark.
Net Interest Margin:
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The net interest margin (NIM) of a bank reflects the efficiency of its
intermediation process, a lower margin being indicative of higher
efficiency. Most countries in developed and even several emerging
economies have NIM of around 2 per cent of total assets. Globally,
net interest margin for the banking sector generally varies markedly.
In the Indian context, among bank-groups, NIM of new private sector
banks was the lowest in 2004-05, while it was slightly higher for old
private sector banks. The ratio in the case of public sector banks was
close to 3 per cent. Foreign banks had the highest NIM.
Bank group 2002-03 2003-04 2004-05
Public Sector 2.9 2.9 3
Private Sector 1.9 2.2 2.3
Foreign Banks 3.4 3.6 3.3
Scheduled Commercial 2.8 2.9 2.9
Global range: [1.2 to 11.6] Average over the period 1995-99.
Non-Performing Loans (NPLs) Ratio:
A common measure of banks’ asset quality is the ratio of gross non-

performing advances to gross advances. Banks with adequate credit
risk management practices are expected to have lower non-
performing loans. Globally, non-performing loan ratio varies widely
from a low of 0.3 per cent to 3.0 per cent in developed economies to
over 10.0 per cent in several Latin American economies. Consequent
upon several measures undertaken, as
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part of financial sector reforms, non-performing loans ratio of Indian
banks declined steadily over the years. The ratio of NPLs to total
loans of SCBs, which was at a high of 15.7 per cent at end-March
1997, declined steadily to 5.2 per cent by end-March 2005 banks
exhibit wide variations in the provisioning to NPLs ratio from less than
10 per cent to over 200 per cent. However, emerging markets with a
high quantum of NPL tend to have higher provisions. The
provisioning to NPLs ratio by Indian banks was around 60 per cent at
end-March 2005, which was within the global range.
Private Sector
Old Pvt. Sector 7.6 6
New Pvt. Sector 5 3.6
Foreign Banks 4.6 2.8
Emerging Markets
Argentina 18.6 17.1
Brazil 3.9
Mexico 2.5 2.4
Korea 1.7
Developed Markets
US 1.1 0.8
UK 2.5 2.2
Japan 5.2 2.9
Canada 1.2 0.7
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Australia 0.4 0.3
Global range for 2004: [0.3 to 30.0]
Capital Adequacy Ratio:
The capital to risk weighted assets ratio (CRAR) is the most widely
employed measure of
soundness of a bank. The CRAR of the bank reflects its ability to

withstand shocks in the event of adverse developments. The global
range for capital adequacy ratio lies between 8.8 per cent and 37.1
per cent. In the Indian context, banks have improved their capital
adequacy ratio. The overall capital adequacy ratio of SCBs at end-
March 2005 was 12.8 per cent as against the regulatory requirement
of 9 per cent, which itself is higher than the Basel norm of 8 per cent.
The capital adequacy ratio was broadly comparable with the global
range. Most banks, including the systematically important, satisfy the
regulatory capital adequacy requirements. The CRAR of 78 banks out
of 88 was above 10 per cent. Only two banks had capital adequacy
ratio below the regulatory minimum. However, their share in total
banking sector assets was less than 0.5 per cent.
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Private Sector
Old Pvt. Sector 13.7 12.5
New Pvt. Sector 10.2 11.8
Foreign Banks 15 14.1
Emerging Markets
Argentina 11.2 11.6
Brazil 18.2
Mexico 14.1 13.7
Korea 11.3
Developed Markets
US 13 13.2
UK 12.4 12.3
Japan 11.1 11.6
Canada 13.4 13.3
Australia 10.1 10.5
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Global range for 2004: [8.8 to 37.1]
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Global Competitiveness
of Indian Banks
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Indian banks fare well against global peers: Some performance
indicators
But there's an interesting twist to the story. Despite being small in

terms of capital base and assets, Indian banks are way ahead of their
global counterparts when it comes to return on assets, a parameter
which denotes efficiency. Except for Bank of America and Citigroup,
not too many of the global giants can match Indian banks in terms of
ROA. Last year, Bank of America's ROA was 1.91 per cent, while that
of Citigroup's was 1.63 per cent. Andhra Bank's ROA was not far
behind at 1.59 per cent. In fact, its ROA was the highest among all
Asian banks. Among other Indian banks, Oriental Bank of
Commerce's ROA was 1.41 per cent, HDFC Bank's 1.29 per cent,
ICICI Bank and Allahabad Bank's 1.20 per cent, Punjab National
Bank's 1.12 per cent and Canara
Bank's 1.01 per cent. Last year, SBI's ROA was 0.94 per cent.
Among the top four Chinese banks only China Construction Bank had
an ROA of 1.29 per cent. The other three bank's ROA varied between
0.05 and 0.81 per cent. Among the top 10 global giants, JP Morgan
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Chase, Credit Agricole, Mitsubishi Tokyo, Mizo Financial and BNP
Paribas had an ROA of less than 1 per cent.
Vital Statistics (Source: Mckinsey RBI Report)
Another indicator of the banking industry's health and efficiency is its

non-performing assets. On this count too, Indian banks are way
ahead of their Chinese counterparts and on par with the global giants.
So obviously, a group of efficient Indian bankers is spending its time
and energy in running tiny banks. On this count alone, they should
start thinking of consolidation. If the industry pushes for mergers
among regional players, then five of the public sector banks in the
western region - Bank of India, Bank of Baroda, Union Bank, Bank of
Maharashtra and Dena Bank - will collectively own assets worth $76
billion and capital $3.9 billion. On this basis, the merged entity could
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be Asia's 21st largest bank. Globally, it will be ranked 138. It may not
be easy to merge all regional banks because of practical issues such
as duplication of branches and common customers, banks should
begin drafting a blue print for consolidation if they want to build scale
and compete with the so-called predators when the sector opens up
in 2009. The gross
NPA to advances ratio for the sector declined from 16% in FY97 to
5% in FY05. Although this was above the range of 0.3% to 3% for the
developed economies, it was well below the average of 10% for
several Latin American economies. In fact, Indian banks fare much
better in this respect than their Chinese counterparts (having average
NPA levels of 15% to 20%). Actually, the Indian banking sector
compares well with the global benchmarks, thanks to prudential
supervision and the measures undertaken by the Reserve Bank of
India and the
Government. In its report on Trends and Progresses of Banking in

India 2004-05, the RBI has compared the Indian scheduled
commercial banks (SCBs) to banks in other countries on various
financial and soundness indicators. These parameters include
funding volatility ratio, return on assets, net interest margin, cost-
income ratio, non - performing loans ratio and capital adequacy ratio.
The return on total assets (ROA) of banks, defined as ratio of net

profit to total assets, was 0.9 per cent for SCBs in India in 2004-05,
as compared to the global ROA of between -1.2 per cent and 6.2 per
cent, said the RBI in its report. The ROA was the highest for foreign
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banks at 1.3 per cent, followed by new private sector banks at 1.1 per
cent. For public sector banks, it was 0.9 per cent. ROA is one of the
most widely employed measures of profitability. With regard to
funding volatility ratio (FVR), which measures the extent to which
banks rely on volatile liabilities to finance their assets, the ratio for
various bank groups was in the range of -0.11 to - 0.23 per cent. This
compares favorably with the global range, which was in the range of
-0.71 and 0.11 per cent, the ratio being primarily negative for most
countries. Most countries in developed and even several emerging
economies have net interest margin (NIM) of around 2 per cent of
total assets. In India, the NIM for scheduled commercial banks was
2.9 per cent in 2004-05, with the new private banks having the lowest
NIM in 2004-05, at 2.2 per cent. The cost-income ratio CIR for Indian
banks was 0.5 per cent, with the global range being 0.46 to 0.68 per
cent. The ratio of non-performing loans (NPL) to total assets vary
from 0.3 per cent to 3 per cent in developed economies to over 10
per cent in several Latin America economies, said the report. In the
case of Indian banks, the NPL has declined to 5.2 percent by end-
March 2005. Provisioning to NPLs ratio was 60.3 per cent for Indian
banks, which was within the global range. Globally, the provisioning
ratio varies from less than 10 per cent to over 200 per cent. Indian
banks have improved their capital adequacy ratio (CAR) or the capital
to risk weighted assets ratio. The global range for CAR lies between
8.8 per cent and 37.1 per cent. For Indian banks, it is 12.8 per cent,
which is higher than the regulatory requirement of 9 per cent. Globally
the capital to assets ratio varies between 2.7 per cent and 20.2 per
cent. For Indian banks it is 6.3 per cent.
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Consolidation in Banking Industry
With 27 public sector banks, 31 private banks and 29 foreign banks, a

consolidation exercise in the banking industry cannot be kept in cold
storage. Due to diversified operations and varying credit profiles of
banks, merger and consolidation would serve as a risk mitigation or
risk sharing mechanism, besides increasing the potential for growth.
Owing to greater scale and size, consolidation can help save
intermediation cost and improve efficiency
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Cost comparison within Indian Banking Industry
Avenues need to be explored for raising capital to meet international

Basel II norms. According to a FICCI survey, a majority of banks face
an incremental capital requirement of 1-2% or more (Exhibit 2). It is
estimated that the banking system will need an additional capital
infusion of around USD 9 million by March 2010. Experts in the Indian
Banking industry have long been contemplating on the consolidation
leading to 6-7 major players in the market. What India needs is a
roadmap for managed consolidation. Banks need to find ways for
voluntary mergers so that the shareholder value is maximized for
both the entities. Government is also planning to kick-off
consolidation in the sector by lining up a series of merger and
acquisition proposals for the public sector banks.
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Globalization of Operations
Of the many Asia Pacific countries, China, Taiwan, South Korea and
India will continue to influence the development of the Asian markets.
India has a huge potential to become major growth market for
traditional banking, investment banking and securities growth given
its rapidly growing economy and banking industry. According to
Moody’s Investor Services data, Indian lenders have posted highest
ROE of 20.38% (system average of 3 years) by Indonesia (20.19%)
and New Zealand (18.83%). As a result, leading international and
regional banks are interested to establish their presence in India.
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Whereas 29 foreign banks have 255 branches in India (Source: RBI’s
annual report), Indian banks have managed to open only 110
branches abroad. This clearly indicates a one sided flow which needs
to be changed for Indian banking sector to have a visibility in the
global markets. Another issue is that of uniform regulation, which
implies convergence of regulation for Indian and foreign banks in the
commonly exploited affairs. However, as banks compete for
globalization, it might get difficult to propagate social sector and
government policy signals through them. An indication of the same
can be seen from a shrinking size of bank credit from 17.3% of net
bank credit in 1999-2000 to 7% in 2003-04. Given that in 2009 the
banking sector will be completely opened up, domestic banks may be
35
in a weak position if mergers and consolidations do not conclude
effectively.
36
BUDGET IMPACTS
37
Budget & Banking Sector:
Budget Measures:
• Autonomy to RBI to implement reforms in banking sector.

• Amendment of the Banking Regulation Act.
• Allow banking companies to issue preference shares to boost their
Tier-I capital.
• Introduce provisions to enable the consolidated supervision of
banks and their subsidiaries by RBI.
• Increase bank lending to agricultural sector by 30% and PSU
banks to increase number of agricultural borrowers by 5 m.
• Remove the lower and upper bounds to the statutory liquidity ratio
(SLR) and removal of the limits on the cash reserve ratio (CRR) to
provide flexibility to RBI to prescribe prudential norms
• Enable RBI to lend or borrow securities by way of repo, reverse
repo or otherwise.
• 0.1% banking transaction tax to be imposed on cash withdrawals
above Rs. 10,000 on a single day.
• Removal of benefits available to depositors (Section 80-L)
Budget Impact:
• Higher autonomy to RBI will enable the apex bank to vary the CRR
and SLR limits as per the liquidity requirements of banks (in
consonance with the credit growth) and this in turn, will facilitate
more flexible conduct of monetary policy. Also, enabling RBI to
lend or borrow securities by way of repo or reverse repo will
enhance trading of government securities.
38
• The proposal to amend the Banking Regulation Act does not
specify the intended modifications to be brought in the act.
However, the same may consider the enhancement of FDI limits
and higher voting rights cap.
• Allowing banking companies to issue preference shares will
enable them to infuse more Tier I capital and thereby help them
comply with Basel requirements
• Mandation on PSU banks to hike their agricultural lending may
resurface the problem of NPAs for these banks.
• Banks are also likely to be the beneficiaries of higher infrastructure
lending by way of routing their funds through the 'Infrastructure
financing SPV' for eligible and appraised projects. While this would
provide an impetus to core advances of banks, the quality of such
advances is likely to be better. In this light, there is relatively less
NPA risk.
• The 0.1% banking transaction tax will discourage cash
transactions.
• The removal of benefits to individuals with respect to Section 80-L
i.e. deduction to a limit on interest on bank deposits could impact
deposit growth.
Key Positives:
• Guidelines on bank mergers: The RBI's guideline on bank

mergers cleared the persisting ambiguity regarding the route that
banks need to follow for their inorganic growth.
• Liberalisation of ECB norms: The government also liberalised
ECB norms to permit financial sector entities engaged in
39
infrastructure funding to raise ECBs. This enabled banks and
financial institutions, which were earlier not permitted to raise such
funds, explore this route for raising cheaper funds in the overseas
markets.
• Restriction of voting rights: In another move to narrow down the
impact of foreign entities on management of domestic banks, the
government in its new norms for ADR/GDR issues has specified
that the voting rights of ADR/GDR holders will be restricted to 10%
(which is as per RBI norms).
• Credit classification: To accelerate the initiatives for credit
efficiency of banking entities post Basel II (FY07 onwards), the RBI
has suggested that banks will need to classify loans above Rs. 50
m as 'non-retail exposure' and exercise credit rating on the same
through their internal rating mechanism.
• Ceiling on dividends: The RBI has raised the ceiling on the
dividends that commercial banks are permitted to pay to 40% of a
bank's net profits, from the earlier 33.3%. The caveat, however, is
that banks can now pay dividends if their NPAs are less than 7%
of their total advances and they have had a capital adequacy ratio
(CAR) of at least 9% for three consecutive years. As not meeting
any of the said guidelines makes a bank ineligible for dividend
payment, it ensure that bank sustain a healthy asset book in the
longer term.
• Hybrid capital: In an attempt to relieve banks of their capital
crunch, the RBI has allowed them to raise perpetual bonds and
other hybrid capital securities to shore up their capital.
Significantly, FII and NRI investment limits in these securities have
40
been fixed at 49%, compared to 20% foreign equity holding
allowed in PSU banks.
Key Negatives:
• Increase in risk weightage: The National Housing Bank (NHB)

has further tightened norms for housing finance companies (HFC)
in the wake of the risk foreseen due to high asset prices. The NHB
has increased the risk weightage for loans to the commercial real
estate sector from 100% to 125%. Also, investments in mortgage-
backed-securities (MBS) will attract risk weightage of 125%. The
decision comes close on the heels of the NHB increasing the risk
weightage on home loans from 50% to 75%. This will lead to
contraction in CAR.
• Refusal to dilute stake in PSU banks: The government has
refused to dilute its stake in PSU banks below 51% thus choking
the headroom available to these banks for raining equity capital.
• Higher provision for standard assets: The RBI has increased
the provisioning requirement on standard assets from 0.25% to
0.4%, thus increasing the provisioning liability for banks.
• Interest rate dampener: The interest rate movement in the short
term is likely to be with an upward bias as is evident from the RBI's
dual 25 basis points rise in repo and reverse repo rates. A
corresponding rise in deposit rates, not commensurate with rise in
yields, may pressurise the margins.
• Impediments in Sectoral reforms: Opposition from Left and
resultant cautious approach from the North Block in terms of
41
approving merger of PSU banks may hamper their growth
prospects in the medium term (NIMs) for the sector
Sector Outlook:
The budget has been a mixed one for the banking sector. While there
is increased flexibility, the move to boost agriculture advances is
likely to have a much larger impact on PSU majors. While we expect
the credit growth to remain robust (though slower than 21% in the
recent past), not all banks will be able to reap the benefits from such
sector trends. Enhanced lending to agriculture and priority sectors
(including infrastructure lending) will require banks to exercise more
caution on the NPA front. Amendments to Banking Regulation Act
may however, fulfill the key objectives of competition, consolidation
and convergence as highlighted in the budget speech.
42
Credit Policy &
Regulatory Policy
43
Credit Policy 2006-07
The Annual Policy Statement 2006-07 surprised the market by not

changing any of the interest rates. It is a masterly summary of money,
bond and forex markets as well as the risk profile of the economy and
the banking system. In the annual policy unveiled on 18 April 2006,
the RBI governor, Yaga Venugopal Reddy, cautiously sought to
maintain the growth momentum by keeping the policy rates and
reserve ratios stable. The central bank has however indicated the
possibility of rate hikes later in the event of an upturn in inflation due
to pass-through of international oil prices. The policy concentrated
more on quality of credit off take.
Mr. Reddy expressed his concern over loan bubble and has
packaged the measures in a way that are politically acceptable.
Reserve Bank of India has called for a slowdown in lending to
sensitive sectors such as real estate and capital markets. RBI wants
to ensure that banks have the necessary cushion to absorb a
possible correction in the real estate market.
Monetary & Credit creation
44
Money supply (M3) increased by 20.4 % (Rs.4, 58,456 crores) in
2005-06 as compared with 12.1 % (Rs.2, 42,260 crores), net of
conversion, in the previous year. The year-on-year increase in non-
food bank credit during 2005-06 (over April 1, 2005) was 30.8 %
(Rs.3, 42,493 crores) on top of 27.5 % (Rs.2, 21,602 crores), net of
conversion, a year ago. Substantial increases were observed in credit
flow to industries like food processing, iron and steel, cotton textiles,
vehicles, chemicals, gems and jewellery and construction. credit
growth outpaced deposit growth by a substantial margin. The
aggregate deposits of SCBs increased by 22.8 % (Rs.3, 87,471
crores) during 2005-06 as against an increase of 12.8 % (Rs.1,
92,269 crores), net of conversion, in the previous year.
The expansion in M3 is projected to be around 15% for 2006-07.

While this indicative projection is consistent with the projected GDP
growth and inflation. The growth in aggregate deposits is projected to
be around Rs.3, 30,000 crores in 2006-07. Non-food bank credit
including investments in bonds/debentures/shares of public sector
undertakings and private corporate sector and commercial paper
(CP) is expected to increase by around 20 % from a growth of above
30 % presently.
Liquidity Position
RBI in its annual policy kept key policy rates unchanged this would
keep the liquidity condition in the market conducive for the growth of
the industry. Liquidity as reflected in outstanding under the Liquidity
Adjustment Facility (LAF), the Market Stabilization Scheme (MSS)
45
and surplus cash balances of the Central Government taken together
increased marginally from an average of Rs.1, 14,192 crores in
March 2005 to Rs.1, 15,258 crores in October 2005. The IMD
redemption at end-December, 2005 accounted for about Rs.32, 000
crores of this decline of Rs.40, 924 crores. During the year, the
financial markets shifted from surplus mode to deficit in terms of LAF.
On a net basis, the average daily LAF reverse repo absorption was
Rs.22, 481 crores and Rs.25, 409 crores in the first and the second
quarters, respectively, but declined to Rs.7, 825 crores in the third
quarter, and finally shifted into average daily repo injection of Rs.11,
686 crores during the last quarter. Pressures on market liquidity
warranted appropriate monetary operations to avoid wide fluctuations
in market rates and to ensure reasonable stability in financial markets
consistent with the monetary policy stance. The outstanding balances
under MSS increased from Rs.65, 481 crores at end-March 2005 to a
peak of Rs.80, 585 crores in early September and thereafter declined
by Rs.51, 585 crores to Rs.29, 000 crores by end-March 2006
reflecting the unwinding of MSS balances. During January-March
2006, Rs.17, 578 crores was released through unwinding of MSS
securities.
Financial markets remained generally stable during 2005-06 although

interest rates firmed up in all segments and the uncollateralized
overnight call market experienced persistent tightness during the last
quarter of the year. A noteworthy and desirable development during
the year was the substantial shift of money market activity from the
uncollateralized call money segment to the collateralized market repo
46
and collateralized borrowing and lending obligations (CBLO) markets.
The share of the uncollateralized call market in the total overnight
market transactions declined from 48.5% in April 2005 to 26.7% in
March2006.
The call money rate moved up from an average of 5.12% in October

2005 to 6.58% in Mar06. The overnight CBLO and market repo rates
also rose from 5.01% and 4.98%, respectively, in October 2005 to
6.22% and 6.17% in March 2006.
In the Government securities market, the primary market yields of 91-

day and 364-day Treasury Bills (T-Bills) increased from 5.12% and
5.60 % at end-April 2005 to 6.11% and 6.42%, respectively, at end-
March 2006. The 182-day T-Bill yield moved up from 5.29% to 6.61
% during this period. The yield on Government securities with 1-year
residual maturity in the secondary market increased from 5.77 % as
at end-April 2005 to 6.52 % at end-March 2006 but subsequently
declined to 6.29 % as on April 13, 2006. The yield on Government
securities with 10-year residual maturity increased from 7.35 % at
end-April 2005 to 7.52 % at end-March 2006 and further to 7.55 % as
on April 13.Consequently, the yield spread between 10-year and 1-
year Government securities came down from 158 basis points in April
2005 to 100 basis points in March 2006 but increased to 126 basis
points on April 13, 2006.
Monetary Measures and Regulatory Policies
Bank Rate
47
Bank Rate is the rate at which RBI allows finance to commercial
banks. Any change in bank rate is a signal to the banks to revise
deposit rates as well as Prime Lending Rate (PLR). In Annual
Monetary Policy for the year 2006-07, RBI has decided to maintain
Bank rate at its present level of 6%.
Reverse Repo rate
The reverse repo rate is the rate at which banks park their short-term
excess liquidity with the RBI. In its Annual Credit Policy for FY07 the
Reserve Bank of India has decided to keep reverse repo rate
unchanged at 5.5% under its liquidity adjustment facility (LAF) due to
tight liquidity conditions. The spread between the reverse repo rate
and the repo rate has also been kept same at 100 basis points.
Accordingly, the fixed repo rate under LAF will also be kept
unchanged at 6.50%
Cash Reserve Ratio
Banks are required to maintain certain %age of demand and time

liabilities in the form of cash reserves or by way of current account
with the Reserve Bank of India (RBI), this is known as Cash reserve
ratio, the objective of it is to ensure the safety and liquidity of the
deposits with the banks. Reserve bank of India has decided to keep
CRR at 5%. While the Reserve Bank continues to pursue its medium-
term objective of reducing the CRR to the statutory minimum level of
3.0%, on a review of the current liquidity situation, it is felt desirable to
keep the present level of CRR at 5.0% unchanged.
48
Interest Rate Policy
The interest rate on savings bank deposits is regulated by the RBI,

has also been kept unchanged at prescribed rate of 3.5% per annum.
Currently RBI considers it appropriate to maintain the status quo
while it recognizes that deregulation of this interest rate is essential
for product innovation and price discovery in the long run.
• RBI has increased Interest rates on non-resident (external) rupee

deposits for one to three years maturity by 25 basis points to 1%
above LIBOR/SWAP rates for US dollar of corresponding maturity
with immediate effect. This has made NRE Rupee Deposits more
attractive for the investors. This will help in bringing more foreign
inflows to the country.
RBI has increased the export credit interest rate by 25 basis points to
LIBOR plus 1% with immediate effect. Going forward, foreign
currency, pre-shipment and post-shipment credit will become dearer
for the exporters.
49
BASEL II - NORMS
50
BASEL- II:
The New Basel Capital Accord, often referred to as the Basel II

Accord or simply Basel II, was approved by the Basel Committee on
Banking Supervision of Bank for International Settlements in June
2004 and suggests that banks and supervisors implement it by
beginning 2007, providing a transition time of 30 months. It is
estimated that the Accord would be implemented in over 100
countries, including India. Basel II takes a three-pillar approach to
regulatory capital measurement and capital standards: Pillar 1
(minimum capital requirements); Pillar 2 (supervisory oversight); and
Pillar 3 (market discipline and disclosures).
Basel II Accord:
51
Pillar 1 Specifies new standards for minimum capital
requirements, along with the methodology for assigning
risk weights on the basis of credit risk and market risk; also
specifies capital requirement for operational risk.
Pillar 2 Enlarges the role of banking supervisors and gives power
to them to review the banks’ risk management systems.
Pillar 3 Defines the standards and requirements for higher
disclosure by banks on capital adequacy, asset quality and
other risk management processes.
Approach of the Reserve Bank of India to Basel II Accord
The Reserve Bank of India (RBI) has asked banks to move in the
direction of implementing the Basel II norms, and in the process
identify the areas that need strengthening. The RBI aims to reach the
global best standards in a phased manner, taking a consultative
approach rather than a directive one. The RBI has set up a steering
committee to suggest migration methodology to Basel II. Based on
recommendations of the Steering Committee, in February 2005, RBI
has proposed the “Draft Guidelines for Implementing New Capital
Adequacy Framework” covering the capital adequacy guidelines of
the Basel II accord. RBI expects banks to adopt the Standardised
Approach
for the measurement of Credit Risk and the Basic Indicator Approach
for the assessment of Operational Risk. Over time, when adequate
risk management skills have developed,
52
some banks may be allowed to migrate to the Internal Ratings Based
approach for credit risk measurement.
Standardised approach as suggested by RBI may not

significantly alter Credit Risk measurement for Indian banks
In the Standardised approach proposed by Basel II Accord, credit risk

is measured on the basis of the risk ratings assigned by external
credit assessment institutions. This approach is different from the one
under Basel I in the sense that the earlier norms had a “one size fits
all” approach, i.e. 100% risk weight for all corporate exposures. Thus,
the risk weighted corporate assets measured using the standardised
approach of Basel II would get lower risk weights as compared with
100% risk weights under Basel II.
Basel II gives a free hand to national regulators (in India’s case, the
RBI) to specify different risk weights for retail exposures, in case they
think that to be more appropriate. To facilitate a move towards Basel
II, the RBI has also come out with an indicative mapping of domestic
corporate long term loans and bond credit ratings against corporate
ratings by international agencies. Going by this mapping, the impact
of the lower risk weights assigned to higher rated corporates would
not be significant for the loans & advances portfolio of banks, as
these portfolios mainly have unrated entities, which under the new
draft guidelines continue to have a risk weight of 100%. However,
given the investments into higher rated corporates in the bonds and
debentures portfolio, the risk weighted corporate assets measured
using the standardised approach may get marginally lower risk
53
weights as compared with the 100% risk weights assigned under
Basel I.
For retail exposures—which banks in India are increasing focusing on

for asset growth—RBI has proposed a lower 75% risk weights (in line
with the Basel II norms) against the currently applicable risk weights
of 125% and 100% for personal/credit card loans, and other retail
loans respectively.
For mortgage loans secured by residential property and occupied by

the borrower, Basel II specifies a risk weight of 35%, which is
significantly lower than the RBI’s draft prescription of 75% (if margins
are 25% or more) and 100% (if margins <25%). Given mortgage loan
portfolio collateralised on residential property and the current credit
guidelines of majority of banks giving housing loans with 20%
margins, we estimate that the risk weight applicable would be 100%.
The risk weights would decline over time to
75% for residential mortgage loans, as the mortgage loan is repaid

and (if) the market price of property appreciates.
Most of the banks have a large short-term portfolio in cash credit,

overdraft and working capital demand loans, which are currently
unrated, and carry a risk weight of 100%. Similarly, in the investment
portfolio the banks have short-term investments in commercial
papers, which also currently carry 100% risk weight. The RBI’s draft
capital adequacy guidelines also provide for lower risk weights for
short tem exposures. We can expect the banks to marginally benefit
from these short term credit risk weight guidelines, given the small
54
investments in commercial papers. The banks can drive maximum
benefit from these proposed short-term credit risk weights, in case
they were to get short-term ratings for the short-term exposure such
as cash credit, overdraft and short term working capital demand
loans.
An Illustration
A typical bank portfolio has an exposure to retail loans, mortgage

loans, personal/credit card loans, corporate loans, cash credit,
working capital demand loans, corporate bonds and commercial
papers. For illustration, we have considered a bank with exposures to
these loans segments and applied the current and new risk weights
(under Basel II). Typically, a bank’s corporate loan portfolio including
cash credit and working capital demand loans has mostly unrated
exposures.
Share Current Risk Current Risk Risk Basel II

Weight Weighted Basel II Weighted
Assets Weights Assets
Personal/cr 2.00% 125% 2.50% 75% 1.50%
edit card
loans
Mortgage 12.00% 75% 9.00% 100% 12.00%
Other retail 8.00% 100% 8.00% 75% 6.00%
loans
Corporate 28.00% 100% 28.00% 100.90% 28.25%
Loans
55
Cash 40% 100% 40% 100% 40%
Credit &
Demand
Loans
Corporate 9% 100% 9.09% 72.70% 6.54%
Bonds
Corporate 1.00% 100% 1.00% 20.60% 0.21%
CPs
Total 100% 97.50% 94.50%
As the preceding table shows, the risk weights under Basel II are
marginally lower at 94.50% vis-à-vis the 97.50% under Basel I. Thus,
implementation of Basel II would result in a marginally lower credit
risk weights and a marginal release in regulatory capital needed for
credit risk. As a result, we expect for most banks, Basel II would
result in reduction in regulatory credit risk weights. However, if the
banks were to significantly increase their retail exposures or get
external ratings for the short-term exposures (cash credit, overdraft
and working capital demand loans), the credit risk weights could
decline significantly.
Operational Risk Capital allocation would be a drag on capital

for Indian banks
Basel II has indicated three methodologies for measuring operational

risk: Basic Indicator Approach; Standardised Approach; and
Advanced Measurement Approach (AMA). The RBI has clarified that
56
banks in India would follow the Basic Indicator Approach to begin
with. Subsequently, only banks that are able to demonstrate better
risk management systems would be asked to migrate to the
Standardised Approach and AMA.
The Basic Indicator Approach to measuring operational risk links the

capital charge for operational risk to a single parameter, that is, the
bank’s gross annual revenue. The Basic Indicator approach specifies
that banks should hold capital charge for operational risk equal to the
average of the 15% of annual positive gross income over the past
three years, excluding any year when the gross income was negative.
Gross income is defined as net interest income and non-interest
income, grossed up for any provisions, unpaid interests and operating
expenses (such as fees paid for outsourced services). It should only
exclude treasury gains/losses from banking book and other
extraordinary and irregular income (such as income from insurance).
All Scheduled Commercial Banks in India:
Interest Interest Net Non Annual Capital

Expense Interest Interest Gross Required
Income
Income Income Income
2001-02 1,269,69 875,157 394,535 240,562 635,097 95,265
2
2002-03 1,407,42 935,963 471,462 316,025 787,488 118,123
5
2003-04 1,440,28 875,668 564,615 397,389 962,004 144,301
4
57
The Indian banks would need additional capital to the extent of Rs.
110 billion to meet the capital charge requirement for operational risk
under Basel II. Given the asset growth
witnessed in the past and the expected growth trends, the capital
charge requirement for operational risk would grow 15-20% annually
over the next three years, which implies that the banks would need to
raise Rs. 180-200 billion over the medium term.
India Banking 2010

58
Towards a High-
performing Sector
India Banking 2010
The last decade has seen many positive developments in the Indian
banking sector. The
policy makers, which comprise the Reserve Bank of India (RBI),

Ministry of Finance and related government and financial sector
regulatory entities, have made several notable efforts to improve
regulation in the sector. The sector now compares favourably with
banking sectors in the region on metrics like growth, profitability and
non-performing assets (NPAs). A few banks have established an
59
outstanding track record of innovation, growth and value creation.
This is reflected in their market valuation. However, improved
regulations, innovation, growth and value creation in the sector
remain limited to a small part of it. The cost of banking intermediation
in India is higher and bank penetration is far lower than in other
markets. India’s banking industry must strengthen itself significantly if
it has to support the modern and vibrant economy which India aspires
to be. While the onus for this change lies mainly with bank
managements, an enabling policy and regulatory framework will also
be critical to their success. The failure to respond to changing market
realities has stunted the development of the financial sector in many
developing countries. A weak banking structure has been unable to
fuel continued growth, which has harmed the long-term health of their
economies. In this “white paper”, we emphasise the need to act both
decisively and quickly to build an enabling, rather than a limiting,
banking sector in India.
OPPORTUNITIES AND CHALLENGES FOR PLAYERS
The bar for what it means to be a successful player in the sector has
been raised. Four challenges must be addressed before success can
be achieved. First, the market is seeing discontinuous growth driven
by new products and services that include pportunities in credit cards,
consumer finance and wealth management on the retail side, and in
fee-based income and investment banking on the wholesale banking
side. These require new skills in sales & marketing, credit and
60
operations. Second, banks will no longer enjoy windfall treasury gains
that the decade-long secular decline in interest rates provided. This
will expose the weaker banks. Third, with increased interest in India,
competition from foreign banks will only intensify. Fourth, given the
demographic shifts resulting from changes in age profile and
household income, consumers will increasingly demand enhanced
institutional capabilities and service levels from banks.
ONE OF THREE SCENARIOS WILL PLAY OUT BY 2010
The interplay between policy and regulatory interventions and

management strategies will determine the performance of Indian
banking over the next few years. Legislative actions will shape the
regulatory stance through six key elements: industry structure and
sector consolidation; freedom to deploy capital; regulatory coverage;
corporate governance; labour reforms and human capital
development; and support for creating
Through these scenarios, we paint a picture of the events and

outcomes that will be the consequence of the actions of policy
makers and bank managements. These actions will have dramatically
different outcomes; the costs of inaction or insufficient action will be
high. Specifically, at one extreme, the sector could account for over
7.7 per cent of GDP with over Rs.. 7,500 billion in market cap, while
at the other it could account for just 3.3 per cent of GDP with a
market cap of Rs. 2,400 billion. Banking sector intermediation,
as measured by total loans as a percentage of GDP, could grow

marginally from its current levels of ~30 per cent to ~45 per cent or
61
grow significantly to over 100 per cent of GDP. In all of this, the
sector could generate employment to the tune of 1.5 million
compared to 0.9 million today. Availability of capital would be a key
factor — the banking sector will require as much as Rs. 600 billion
(US$ 14 billion) in capital to fund growth in
advances, non-performing loan (NPL) write offs and investments in IT

and human capital upgradation to reach the high-performing
scenario. Three scenarios can be defined to characterize these
outcomes:
High performance:
In this scenario, policy makers intervene only to the extent required to

ensure system stability and protection of consumer interests, leaving
managements free to drive far-reaching changes. Changes in
regulations and bank capabilities reduce intermediation
costs leading to increased growth, innovation and productivity.

Banking becomes an
even greater driver of GDP growth and employment and large

sections of the population gain access to quality banking products.
Management is able to overhaul bank organizational structures, focus
on industry consolidation and transform the banks into industry
shapers.In this scenario we witness consolidation within public sector
banks (PSBs) and within private sector banks. Foreign banks begin to
be active in M&A, buying out some old private and newer private
banks. Some M&A activity also begins to take place between private
and public sector banks. As a result, foreign and new private banks
62
grow at rates of 50 per cent, while PSB improve their growth rate to
15 per cent. The share of the private sector banks (including through
mergers with PSBs) increases to 35per cent and that of foreign banks
increases to 20 per cent of total sector assets. The share of banking
sector value add in GDP increases to over 7.7 per cent, from current
levels of 2.5 per cent. Funding this dramatic growth will require as
much as Rs. 600 billion in capital over the next few years.
Evolution:
Policy makers adopt a pro-market stance but are cautious in

liberalising the
industry. As a result of this, some constraints still exist. Processes to

create highly efficient organisations have been initiated but most
banks are still not best-in-class operators.Thus, while the sector
emerges as an important driver of the economy and wealth in 2010, it
has still not come of age in comparison to developed markets.
Significant changes are still required in policy and regulation and in
capability-building measures, especially by public sector and old
private sector banks. In this scenario, M&A activity is driven primarily
by new private banks, which take over some
old private banks and also merge among themselves. As a result,

growth of these banks increases to 35 per cent. Foreign banks also
grow faster at 30 per cent due to a relaxation of some regulations.
The share of private sector banks increases to 30 per cent of total
sector assets, from current levels of 18 per cent, while that of foreign
63
banks increases to over 12 per cent of total assets. The share of
banking sector value add to GDP increases to over 4.7 per cent.
Stagnation:
In this scenario, policy makers intervene to set restrictive conditions

and management is unable to execute the changes needed to
enhance returns to shareholders and provide quality products and
services to customers. As a result, growth and productivity levels are
low and the banking sector is unable to support a fast-growing
economy. This scenario sees limited consolidation in the sector and
most banks remain sub-scale. New private sector banks continue on
their growth path of 25 per cent. There is a slowdown in PSB and old
private sector bank growth. The share of foreign banks remains at 7
per cent of total assets. Banking sector value add, meanwhile, is only
3.3 per cent of GDP.
64
FINANCIAL ANALYSIS OF
BANKS
• STATE BANK OF INDIA

• BANK OF BARODA
• ICICI BANK
• HDFC BANK
STATE BANK OF INDIA
Company Background :
65
State Bank of India (SBI) is the largest commercial bank in India in
terms of profits, assets, deposits, branches and employees. It was
established in June 02, 1806. It is also the oldest bank in India. The
bank has a network of over 13600 branches in India and 54
overseas offices in 28 countries. At present, 1,300 branches have

been put on the core banking solution. It has the largest customer
base in the country serving 90 million customers. The bank has
seven associate banks, one fully owned bank and six non-banking
subsidiaries. SBI has nearly 1/5th market share in deposits and
advances and along with the seven associates, enjoys a market
share of around 1/4th. The bank created separate SBUs to focus
marketing efforts in areas such as Personal Banking, Agricultural
sector, SMEs and Government business. As on 30\09\05, Promoters
of the Bank hold
59.73%, followed by institutional investors 24.13%, other investors

9.69% and general public holds the remaining 6.46% stake in the
Bank.
Key Highlights
• Tata Consultancy Services (TCS) and SBI have formed a joint

venture called C-Edge Technologies Ltd. • SBI's credit offtake is
growing at 30% and the bank has experienced a better credit pick
up in corporate, agricultural and services sectors as compared to
last year.
• The Bank has got permission from the Saudi government to open
a branch in the Jeddah. Further it will enter Pakistan as well.
66
• The Bank plans to implement the CBS at 80% of its 9000
branches, by September 2006.
• The Bank has decided to foray into the pension and general
insurance sectors.
• The Bank has appointed a world-class global consultant to take
care of Basel II compliance norms.
• The Bank will foray into international bond trading through its
foreign offices.
• The Bank has decided to raise Rs.3300 Crores in the form of debt
from both domestic and international market.
• The bank has acquired 76% of the paid-up capital along with
management control of a small Indonesian bank PT Bank
IndoMonex. Earlier this year, SBI had bought a 51% stake in
Mauritius-based Indian Ocean International Bank and 76% stake
in closely held Giro Commercial Bank of Kenya.
• SBI proposes to double its global assets from the current level of
USD13 billion to USD26 billion over the next few years.
BUSINESSES
ORISSA BUSINESS
The Bank is laying emphasis on rural, agricultural and large industry

sector in Orissa to expand its business. The Bank proposes to double
its business in Orissa over next three years. At present the combined
business of the bank stood at Rs. 16000 Crores. The bank now holds
36% of the market share in all banking transactions in the state and
intends to increase it to 40% by end of the year.
67
BENGAL CIRCLE
The Banks, Bengal Circle, has set a target of Rs.650 Crores of home
loans for the current fiscal as compared to Rs.400 Crores in 2004-05.
It hopes to sanction loans worth about Rs.150 Crores in the present
fair. Total loans sanctioned under personal banking accounted for
nearly 40 per cent of the total advances of the bank in Bengal Circle.
SME
The SME Rating Agency of India Ltd (SMERA) has signed a MoU
with SBI for rating the SME clients of the bank. Under the agreement,
SBI would encourage its SME clients to be rated by SMERA. The
banks would process quickly applications for financial assistance by
SME's that have opted for rating. The companies that have been
rated could also expect concession in interest rates and lesser
collaterals. The financial performance, operating efficiency and
payment history would be some of the issues that would be
considered d for rating. Further the Bank has signed a MoU with
SIDBI for co-financing small and medium enterprises in Andhra
Pradesh, Tamil Nadu, Uttar Pradesh, Jammu & Kashmir, Jharkhand,
Delhi and Bihar.
SSI's
The Bank and Crisil have signed a MoU under which the latter will
assign ratings to small-scale industries (SSI's) that are borrowers of
SBI. These ratings will be carried out under the NSIC-Crisil
68
performance and credit rating scheme for SSI's. Crisil will also be
offering a discount in its standard fee for this scheme. The rating will
be an additional input for SBI to determine interest rates, margins and
collateral requirements for SSI borrowers.
PENSION, GENERAL INSURANCE SECTORS
The bank may venture into the pension sector either through a joint
venture or independently. It has decided to foray into the pension
and general insurance sectors. The bank would look at the general
insurance sector only after they have made a foray into the pension
sector.
Cautions
• The government ownership of PSU banks increases the risk of delay

in the further structural reforms.
• The issues with the staff in certain circles with regard to
implementation of core banking solution and shifting of forex office
could affect the business, as these are important growth areas for
the Bank.
• Increasing competition in Retail banking from private players like
ICICI and HDFC Bank will put pressure on the margins thus
reducing profitability.
• The Bank's government business may take a marginal hit in 2005-06,
after the Reserve Bank of India changed the agency commission
69
norm on government business payable to banks to volume of
transaction from value of transaction.
Ratios Definition
Interest paid on deposit/interest
Interest Expense/ Interest Income (%) earned on advances
Fee based income/ (total income
Fee Based Income/ Total Income(%) earned - interest expended)
Total employee cost / (total
Employee Cost / Operating Cost (%) operating cost - depreciation)
Total Interest exp / Avg. interest bearing Total interest on deposits / Average
funds (%) of quarterly interest bearing funds
(Interest Income - Interest
Interest spread (%) Expenses) / (Total Assets - NPA)
Fund Based Income / Funds employed Income generated by investments /
(%) (total liabilities - other provisions)
Net profit / (total liabilities - other
Net Profit / Funds Employed (%) provisions)
PAT / Networth (%) Profit after Tax / Networth
Tax / PBT (%) Tax / (Net Profit + tax)
(Paid up Capital + Reserves &
Networth / Total Liabilities (x) surplus) / Total Liabilities
Investment Deposit Ratio (x) Investments / Deposits
Credit Deposit Ratio (x) Credit / Deposits
Net non performing assets / total
NPA advances
CAR (Tier I capital + Tier II capital) / Risk
70
weighted average.
Income Statement
31-Mar-06 31-Mar-05 31-Mar-04 Assets 3
Months 12 12 12 Net Own Assets 2
Interest Income 357949.3 324280.02 304604.91 Net Lease Assets(after 1
Lease Adj A/c)
Other Income 73886.9 71199.04 76126.67 Investment 1
Operating Income 431836.2 395479.06 380731.58 Advances 2
Interest Expenses 201592.9 184833.76 192741.76 Cash & Money at call 4
Employee Expenses 81230.4 69073.48 64476.93 Other Current Assets 2
OPBDT 82747.71 77350.48 43793.45 Balance Sheet Total(BT) 4
OPBT 71413.71 69828.37 36810 Liabilities
Tax 24994.8 24477 0 Equity Share Capital 5
Pat 44066.7 43045.17 36810 Reserves 2
Dividend 7516.23 6578.74 5789.29 Deposits 3
Borrowings 3
Other Cash liab/prov. 5
Balance Sheet Total(BT) 4
71
State bank of India :
Ratios
31-Mar-06 31-Mar-05 31-Mar-04
Non Performing Assets(NPA) % 1.87 2.65 3.48
Capital Adequacy Ratio(CAR) % 11.88 12.45 13.53
Share Statistics
EPS (Rs.) 83.73 81.79 69.94
CFPS (Rs.) 96.08 83.21
Book Value (Rs.) 541 457.39 384.41
DPS (Rs.) 16.72 12.5 11
P/E ratio 11.57 8 8.66
Ratio Analysis
Interest Expense/ Interest Income (%) 56.31 57 63.28
Fee Based Income/ Total Income(%) 17.35 16.83 16.6
Employee Cost / Operating Cost (%) 73.87 74.1 75.44
Total Interest exp / Avg. interest bearing

funds (%) 4.2 5.15 6.05
Interest spread (%) 3.43 2.68 2.21
Fund Based Income / Funds employed (%) 8.72 8.65 9.78
Net Profit / Funds Employed (%) 1 1.05 1.04
PAT / Networth (%) 15.94 17.88 18.19
Tax / PBT (%) 36.19 36.25 0
Networth / Total Liabilities (x) 0.06 0.05 0.05
Investment Deposit Ratio (x) 0.43 0.54 0.58
Credit Deposit Ratio (x) 0.68 0.55 0.5
Profits per employee (Rs. Lakhs) 2.16 2.07 1.76
72
Business per employee (Rs. crore) 2.9 2.43 2.1
Return on Assets (%) 0.892274083 0.936003 0.902615
Return on Equity (%) 15.94073322 17.88174 18.1946
state Bank of India:
Operating Ratios
70
60 Interest Expense/ Interest
Income (%)
50
Fee Based Income/ Total
40 Income(%)
30 Interst spread (%)
20
Fund Based Income / Funds
10 employed (%)
0
2004 2005 2006
The Fee based income has seen a steady growth over the period.
The Fee based income is higher than the PSBs but less than the
private players like the ICICI and HDFC. The interest expense has
been declining and is in tune with the industry standard. The interest
spread has a growth higher than the peers.
73
Other Financial Ratios
16
14 Non Performing
12 Assets(NPA) %
10 Capital Adequacy
Ratio(CAR) %
8
Investment Deposit
6 Ratio (x)
4 Credit Deposit Ratio
2 (x)
0
2004 2005 2006
The bank has very high NPA despite of decline in last three years. It
is more than the current industry average. The CAR has declined
over the year and the Basel II norms will pose a problem in coming
years. The other ratios are quite similar to the industry standard.
Efficiency Ratios
3.5
3
2.5
Profits per employee
2 (Rs. Lakhs)
1.5 Business per
employee (Rs. crore)
1
0.5
0
2004 2005 2006
74
The banks efficiency ratios are seen increasing over the period. This
is a result of the restructuring steps taken by the Central Government.
Still it is very low as compared to the competitors.
Bank of Baroda:
Sir Sayajirao Gaekwad III established Bank of Baroda in 1908 and

after the nationalisation of the bank, the Government of India is a
major shareholder in the bank and holds 66.22 per cent in the bank.
The bank has a wide branch network of 2679 branches including 38
overseas branches. The bank was the first bank to venture outside
India and now has presence in 16 countries including US, UK, UAE,
Hong kong, Mauritius etc.
The Bank has established its presence in all the major areas of
banking including housing finance, credit cards, asset management
and capital market through its various subsidiaries. This diversified
presence is helping the bank move towards the concept of Universal
Banking.
The bank has taken various IT initiatives. It has launched OmniBoB

that provides banking services through Phone and over PC. To
improve upon its operating efficiencies, the bank has appointed
Gartner Group as consultants.
In July 2002, Benares State Bank was merged with BOB and the
financials include Benares Bank's results.
75
Income Statement
31-Mar-06 31-Mar-05 31-Mar-04
Months 12 12 12 Assets
Interest Income 71000.04 64314.18 61470.69 Net Own Assets
Net Lease Assets(after Lease Adj

Other Income 11916.85 13048.28 17190.06 A/c)
Interest Expenses 38750.87 34521.46 35754.82 Advances
Employee Expenses 15237.87 13810.52 12525.22 Cash & Money at call
OPBDT 12257.31 7587.17 10425.66 Other Current Assets
OPBT 11146 6768.4 9669.96 Balance Sheet Total(BT)
Tax 2876.4 0 0
Pat 8269.6 6768.4 9669.96 Liabilities
Dividend 2076.77 1669.56 1906.2 Equity Share Capital
Reserves
Deposits
Borrowings
Other Cash liab/prov.
76
Balance Sheet Total(BT)
Ratios
31-Mar-06 31-Mar-05 31-Mar-04
Share Statistics
EPS (Rs.) 22.53 23.08 32.97
CFPS (Rs.) 25.56 25.87 35.55
Book Value (Rs.) 213.74 191.9 174.96
DPS (Rs.) 5.66 5.69 6.5
P/E ratio 10.23 9.43 7.36
Ratio Analysis
Interest Expense/ Interest Income (%) 54.58 53.68 58.17
Fee Based Income/ Total Income(%) 8.17 8 8.03
Total Interest exp / Avg. interest bearing

funds (%) 4.27 4.4 5.08
Fund Based Income / Funds employed (%) 7.29 8.13 9.31
Net Profit / Funds Employed (%) 0.78 0.76 1.22
PAT / Networth (%) 10.54 12.03 18.85
77
Tax / PBT (%) 25.81 0 0
Return on Assets (%) 0.73 0.71 1.14
Return on Equity (%) 10.54 12.03 18.85
Bank of Baroda:
Operating Ratios
70
60 Interest Expense/
Interest Income (%)
50
Fee Based Income/
40 Total Income(%)
30 Interst spread (%)
20
Fund Based Income /
10 Funds employed (%)
0
2004 2005 2006
78
The Operating performance of Bank of Baroda is quite stagnant in
last three years. They have good Interest Spread ratio which is quite
consistent but they lack in Fee based income. This is a section where
private bankers have done exceptionally well then the PSBs. Even
the Fund based income as compared to the Funds employed has
been declining over the period so this is also affecting the operating
performance of the bank.
16
14 Non Performing
12 Assets(NPA) %
10 Capital Adequacy
Ratio(CAR) %
8
Investment Deposit Ratio
6 (x)
4 Credit Deposit Ratio (x)
2
0
2004 2005 2006
The NPA ratio has been steadily declining which shows the
increasing efficiency of the bank. CAR is also as per the industry
standard and they are in better position to apply Basel II norms. The
investment deposit ratio has declined over the years that show the
avoidance of risky ventures by the bank that leads to increase in
credit deposit ratio.
79
Efficiency Ratios
4
3.5
3
2.5 Profits per employee
(Rs. Lakhs)
2
Business per
1.5 employee (Rs. crore)
1
0.5
0
2004 2005 2006
The above ratios show that the efficiency of the bank has increased
but in comparison to private sector banks this growth is nominal.
ICICI BANK
ICICI Bank Ltd. (ICICI) promoted in 1994 as a wholly owned

subsidiary of ICICI Limited, was given a universal banking status after
a reverse merger with ICICI Ltd. in 2001. In 1999, ICICI became the
first Indian company and the first bank or financial institution from
non-Japan Asia to be listed on the NYSE. ICICI is India's second-
largest bank with a 30% market share, 562 branches and 2000 rural
Internet franchisees for distribution of its financial products. ICICI
offers banking products and financial services to corporate and retail
customers through channels, subsidiaries and affiliates in the areas
80
of investment banking, life and non-life insurance, venture capital,
asset management and information technology. ICICI has a
subsidiary in UK and Canada along with representative offices in
China and Dubai. As on 30/09/05, Institutional Investors hold 62.63%
stake, followed by other investors with 31.51% and general public
holds the remaining 5.85% stake in the bank.
Key Highlights
• The Bank is planning to raise Rs 7,000 Crs additional equity through

a combination of American Depository Shares (ADS) and domestic
public issues, with a greenshoe option of 15 per cent.
• The bank expects the assets under management under its Private
banking portfolio to double to Rs.50000 Crs in the next six months.
The bank plans to expand its private banking operations to 250 cities
by the end of 2005-06.
• The bank has recorded healthy growth in Microfinance, with assets
growing to Rs 880 Crs as on September 2005 from Rs 20 Crs in
March 2002. It also plans to increase the number of Microfinance
Institutions in its lending portfolio from 50 to 200 in the next 2-3 years.
• The bank has tied up with Bharti televentures to launch credit card on
the mobile phone. Also it may offer a loan card, by around diwali this
year.
• ICICI Bank along with Software giants Infosys Technologies and
Wipro are the three Indian companies that figure in the list of 50
fabulous Asian firms compiled by Forbes magazine.
• ICICI has securitised a part of commercial vehicles loan receivables,
aggregating to Rs 21.44 Crs. Rating agency Icra has assigned
81
conditional highest credit quality ratings 'LAAA' (SO) to the
contributions under the szzzecuritisation issue.
• The Bank plans to embark on a two-pronged strategy of rapid
penetration into the rural market, unlocking the power of technology,
while laying special thrust on overseas expansion.
• ICICI Bank has signed a MoU with eSeva to provide Internet-based
payment solution for registered members of eSeva in Hyderabad.
• Pantaloon retail has tied up with the Bank to launch a co-branded
credit card. Apart from this Globus Stores Pvt Ltd, is negotiating with
ICICI Bank for a co-branded card.
• In a move to give a boost to the Small & Medium Enterprises (SME)
sector, ICICI Bank has decided to tie up with UK-based private equity
fund Avigo for SME sector. ICICI Bank would primarily provide
database on Indian SME's in the proposed alliance.
BUSINESSES
Microfinance
The bank has clocked a healthy growth in microfinance, with asset

size growing to Rs 880 Crs as on September 2005 from Rs 20 Crs in
March 2002. ICICI Bank is focusing on the securitisation model to
expand its microfinance portfolio, working on issuance of bonds
against the securitised microfinance assets. The bank plans to
increase the number of microfinance institutions in its lending portfolio
to 200 in the next 2-3 years. The bank currently is working with 50
micro finance institutions, majorly concentrated in the southern
states.
82
Private Banking
The banks private banking portfolio has grown 270 per cent to Rs
25,000 from Rs 9,000 Crs in April 2004. Further, it expects the assets
under management (Private banking portfolio) to double to Rs 50,000
Crs in the next six months. The bank plans to expand its private
banking operations to 250 cities by the end of 2005-06. ICICI had
launched its private banking services in August 2002 in 30 branches
located in 20 cities. The services are now offered in 400 branches
across 200 cities. Nearly 50 per cent of the portfolio under private
banking is in equities.
Rural Banking
Rural banking is the new area of focus through micro finance, rural
Internet kiosks and low cost ATMs. The Bank sees the rural market
as the next big opportunity. In a bid to search for more innovative
products for its rural clientele, the Bank has undertaken five pilot
projects to roll out rural-friendly biometric smart cards. The success of
these pilot projects will influence the bank's decision to introduce
smart cards. On conventional rural models adopted by domestic
banks, like contract farming and supply chains have not been
successful formulae to tap the critical mass in rural areas. At present,
the Bank has a rural exposure of Rs 5,500 Crs, of which microfinance
constitutes Rs 1,000 Crs, covering 12 lakh customers. This is growing
by 70-80 per cent every year.
SME- Sector
83
The Bank has decided to tie up with UK-based private equity fund
Avigo for SME sector. Under the agreement Avigo would take equity
stake in the SME's. The Bank would primarily provide database on
Indian SME's in the proposed alliance. It is, however, not clear,
whether the bank would take a debt position in the tie-up. The tie-up
is expected to have a positive impact on the bank's fee-based
income.
BPO business
ICICI Bank is considering options of a complete sale of its 60 percent

stake in ICICI Onesource if the offers it receives are attractive
enough.
Cautions
• Intense competition from Foreign and large Indian players in the

market.
Rising interest rate scenario will have adverse impact on the treasury
income of the bank.ICICI Bank :
Income Statement
Months 31-Mar-06 31-Mar-05 31-Mar-04 3
Interest Income 12 12 12 Assets
84
Other Income 137844.96 94098.94 88940.41 Net Own Assets
Net Lease Assets(after

Operating Income (OI) 50366.22 34162.35 30649.23 Lease Adj A/c)
Interest Expenses 188211.18 128261.29 119589.63 Investment 7
Employee Expenses 95974.48 65708.88 70152.49 Advances 14
OPBDT 10822.93 7374.12 5460.57 Cash & Money at call 1
OPBT 37173.99 31145.66 24416.62 Other Current Assets 1
Tax 30936.08 25242.03 19022.21 Balance Sheet Total(BT) 25
Pat 6882.18 1764.93 2719.95
Dividend 25400.75 20052.02 16371.06 Liabilities
7593.33 6329.61 5440.59 Equity Share Capital
Reserves 2
Deposits 16
Borrowings 3
Balance Sheet Total(BT) 25
ICICI Bank :
Ratios
31-Mar-06 31-Mar-05 31-Mar-04
Non Performing Assets(NPA) % 0.72 2 2.21

Share Statistics
EPS (Rs.) 28.54 27.21 26.56
85
CFPS (Rs.) 35.55 35.23 35.31
Book Value (Rs.) 249.54 170.33 129.96
DPS (Rs.) 8.53 8.59 8.83
P/E ratio 20.64 14.49 11.16
Ratio Analysis
Interest Expense/ Interest Income
(%) 69.62 69.83 78.88
Total Interest exp / Avg. interest
bearing funds (%) 5.7 5.66 7.74
Fund Based Income / Funds
employed (%) 6.8 7.26 10.19
PAT / Networth (%) 11.44 15.98 20.44
Tax / PBT (%) 21.32 8.09 14.25
Profits per employee (Rs. Lakhs) 10 11 12
86
Return on Equity (%) 11.44 15.98 20.44
ICICI Bank:
Op eratin g R atio s
90
80 Interes t E x pens e/ Interes t
70 Inc om e (% )
60 F ee B as ed Inc om e/ Total
50 Inc om e(% )
40 Inters t s pread (% )
30
20 F und B as ed Inc om e / F unds
10 em ploy ed (% )
0
2004 2005 2006
Fee based income of the bank is the highest in the industry and has
been continuously growing which shows the banks impetus on
increasing the services provided. The interest expense to interest
income ratio is decreasing but is still much higher than the PSBs. The
Fund based income has seen a decline over the period. The interest
spread has been steadily increasing but still low indicating high
interest expenditure.
87
16
14 Non Performing
12 Assets(NPA) %
10 Capital Adequacy
Ratio(CAR) %
8
Investment Deposit
6 Ratio (x)
4 Credit Deposit Ratio
2 (x)
0
2004 2005 2006
The Investment deposit ratio and Credit deposit ratio are quite high
well above the industry standard. It is due utilization of banks capital
and borrowings to give credit and investment. This shows the
aggression of bank. The NPA has declined over the years and they
have also improved their CAR steadily. The CAR includes the
borrowings which is a factor for such a high ratio.
88
Efficiency Ratios
14
12
10
8 (Rs. Lakhs)
6 Business per
4
2
0
2004 2005 2006
The efficiency ratios are seen declining over the period but is still
above the competitors. The bank is having the highest profit per
employee of the 4 banks.
HDFC BANK
The Housing Development Finance Corporation Limited (HDFC)

established HDFC BANK LIMITED. HDFC bank was incorporated in
August 1994, when the sector was liberalized. At present, HDFC
bank has a network of 467 branches spread over 211 cities across
the country. They were among the first to offer wireless application
protocol services to customers. The bank's ATM network increased
from 910 to 1147 as on Mar 2005. It is recognized as a leading
89
provider of cash management and transactional banking solutions to
corporate customers, mutual funds, stock exchange members and
banks. The bank offers wide range of banking services and its key
business areas include Wholesale Banking, Retail Banking &
Treasury operations. As on 30/09/2005, Promoters hold 22.08%
stake, followed by Institutional Investors 39.01%, other investors
26.61% and General Public holds the remaining 12.31% stake in the
bank.
Key Highlights
• HDFC securities Ltd. has become the subsidiary company of the

Bank.
• For the niche segment the Bank along with MasterCard International
has launched a new credit card called the Titanium Card.
• As of June 2005, the number of debit cards issued by the bank
crossed 3.1 million while credit cards issued touched the 1.5 million
mark.
• The Bank has achieved complete Straight Thru Processing (STP) by
integrating all 470 branches to the Real Time Gross Settlement
System (RTGS) network.
• The Bank has been awarded The Asian Banker Excellence in Retail
Banking Risk Management Award in India for 2004 in recognition of
its risk management abilities.
90
• The Bank raised USD100 million, denominated in Japanese yen,
through equivalent one-year loan facility.
• Budget 2005-06 has allowed the banks to raise capital by way of
Preference Shares. This will help them meet the Basel II
requirements. Also, decrease in corporate tax will boost the profits.
However, tax @ 0.10% on cash withdrawal above Rs.25, 000/- and
withdrawal of Section 80L will have a negative impact. Overall,
Budget 2005-06 will have a positive impact.
• The bank declared a dividend of 45% (i.e. Rs.4.50 per share) to the
shareholders of the Bank.
• The bank currently has no plans to merge with its parent HDFC Ltd.
• The bank plans to disburse over Rs.1000 Crs for financing
agricultural commodities in 2005-06.
BUSINESSES
Housing Loan Market
• The Bank made a back-door entry into home loans by offering loans
against property in the previous financial year. The bank in the recent
past bought back around Rs.200 Crs worth of home loans from
HDFC. According to the arrangement between Bank and its parent,
home loans sold by HDFC Bank are booked and serviced by HDFC
91
and 70 percent of these loans are sold back to HDFC Bank. The
home loan portfolio, which is around Rs 200 Crores, is expected to
grow to Rs 600 Crores in the current fiscal. The average interest rate
on the portfolio is in the range of 7.50 to 8 percent. The home loan
market is competitive and the size of the pie is growing everyday. The
bank offers the home loan product to its customers and also targets
the open market through its distribution channels. The bank expects
the incremental growth in housing loan business to contribute to its
bottom-line by next fiscal. The bank's retail business is expected to
grow by 30 to 40 percent by the end of this fiscal.
International
• HDFC Bank is planning to expand its overseas operations in

Southeast Asia, Europe and the US. It aims to consolidate its
overseas operations through local bank alliances and alternative
channels instead of opening a full- fledged branch in line with the
bank's strategy. The aim of such expansion is to tap NRI business
and therefore it is primarily targeting such countries that have a
sizeable Indian population. The bank has a representative office in
Dubai and tie - ups in Saudi Arabia, Qatar and Kuwait.
Micro-financing
92
• The Bank is hoping to increase funding to micro-finance
institutions to Rs.250 Crs this year compared to Rs.75 Crs during
2005.
Cautions
• Consolidation in state owned bank might create business threat for

the bank.
• Upward moving interest rate may hamper company's performance.
• Capital adequacy of the bank is around the 11.9%, which compared
to other larger banks is below par.
• Recently Top Executives of the bank are turning in their resignations.
HDFC Bank :
Income Statement
31-Mar-06 31-Mar-05 31-Mar-04 31-M
Months 12 12 12 Assets
93
Interest Income 44753.4 30934.9 25489.3 Net Own Assets
Net Lease
Assets(after Lease
Other Income 12136.4 6373.6 4909.4 Adj A/c)
Operating
Income 56889.8 37308.5 30398.7 Investment 28
Interest
Expenses 19295 13155.6 12110.5 Advances 35
Employee
Expenses 4868.2 2766.7 2040.9 Cash & Money at call
OPBDT 14324 11236.6 6352.2 Other Current Assets 2
Balance Sheet
OPBT 12538.1 9795.9 5095 Total(BT) 73
Tax 3830.3 3140.3 0
Pat 8707.8 6655.6 5095 Liabilities
Dividend 1722.3 1400.7 1000.5 Equity Share Capital
Reserves 4
Deposits 55
Borrowings 4
Balance Sheet
Total(BT) 73
HDFC Bank :
94
Ratios
31-Mar-06 31-Mar-05 31-Mar-04

Share Statistics
EPS (Rs.) 27.81 21.48 17.89
CFPS (Rs.) 33.51 26.13 22.3
Book Value (Rs.) 169.24 145.86 94.52
DPS (Rs.) 5.5 4.52 3.51
P/E ratio 27.84 25.37 21.17
Ratio Analysis
Interest Expense/ Interest Income (%) 43.11 42.53 47.51
Total Interest exp / Avg. interest
bearing funds (%) 3.78 3.54 4.24
Fund Based Income / Funds employed
(%) 6.92 6.57 7.47
PAT / Networth (%) 16.43 14.73 18.93
Tax / PBT (%) 30.55 32.06 0
95
Return on Equity (%) 16.43 14.73 18.93
HDFC Bank:
The HDFC bank has seen a steep growth in the Fee based income
which forms a major portion of their income. But there has been a
drop in the Fund based income as compared to the funds employed.
This drop is compensated by the Fee based income. The Interest
expenses as compared to the interest income are also decreasing
indicating better operating performance. The interest spread is
consistently growing and is better than most of the peers.
96
O p eratin g R atio s
50
45 Interes t E x pens e/ Interes t
40 Inc om e (% )
35
F ee B as ed Inc om e/ Total
30
Inc om e(% )
25
20 Inters t s pread (% )
15
10 F und B as ed Inc om e / F unds
5 em ploy ed (% )
0
2004 2005 2006
97
14
12 Non Performing
Assets(NPA) %
10
Capital Adequacy
8 Ratio(CAR) %
6 Investment Deposit
Ratio (x)
4
Credit Deposit Ratio
2 (x)
0
2004 2005 2006
The NPA ratio of the bank is the lowest in the industry. They have got
the best banking practices in the industry. Their investment deposit
and Credit deposit ratio are in tune with the industry. They have
maintained a healthy CAR.
98
Efficiency Ratios
10
9
8
7
6
(Rs. Lakhs)
5
4 Business per
3
2
1
0
2004 2005 2006
Though the efficiency ratios have been declining for the past three
years, it is still well above the rest.
99
100
INTERBANK
COMPARISON
101
INTER BANK COMPARISON:
1. EPS:
EPS
100
80
60
40
20
0
2004 2005 2006
Bank of Baroda HDFC Bank Ltd. ICICI Bank Ltd. SBI
The EPS of the SBI is the highest of the four banks which indicates a
higher earning for the shareholders as compared to the shareholders
of the other banks. The EPS for ICICI bank and HDFC bank has
grown steadily and are also good earnings. The EPS Bank of Baroda
has dropped over the years in consideration but still is maintaining
healthy EPS.
102
2. Operating Income:
Operating Income
500000
400000
crores
300000
200000
100000
0
2004 2005 2006
The operating income for all the banks has grown steeply in the last
year because of the growth of the economy. SBI has the highest
operating income of the four but ICICI has been fast in catching up.
HDFC and Bank of Baroda have shown steady growth in their
operating income in this period. The above graph depicts the
difference between the no.1 and no.2 in the banking industry.
3. Profit after Tax:
103
Profit After Tax
50000
40000
crores
30000
20000
10000
0
2004 2005 2006
The profit after tax for SBI is the highest but ICICI shown highest
growth rate of. Even HDFC has grown more than the PSBs. There
has been a net decrease in the profit after tax of Bank of Baroda
which is because of drop in operating income in year 2005.
104
4. Return on Assets:
Return on Assets
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
2004 2005 2006
The return on total assets (RoA) of banks, defined as the ratio of net
profit to total assets, is one of the most widely employed measure of
profitability. A bank performing on sound commercial lines is
expected to exhibit a healthy RoA. The RoA of the banks are in
tandem with the industry standards. ICICI bank has a declining RoA
while SBI is having a constant RoA.
105
5. P/E ratio:
P/E ratio
30
25
20
15
10
5
0
2004 2005 2006
Bank of Baroda HDFC Bank Ltd. ICICI Bank Ltd. SBI Bankex Nifty
The P/E ratio of the all the banks are growing constantly which shows
the current market trend.
6. Interest Expense/ Interest Income (%):
106
Interest Expense/ Interst Income (%)
100
80
60
40
20
0
2004 2005 2006
The interest expense to interest expense ratio for HDFC bank is the
lowest indicating better operational practices. The ICICI bank has the
highest interest expense to interest income ratio which is decreasing
but it is indicative of their aggressive policy in the credit
disbursement. The Bank of Baroda and SBI are having a steadily
decreasing ratio but have some catching to do to match HDFC bank.
7. Fee Based Income / Total Income (%):
Fee Based Income / Total Income (%)
35
30
25
20
15
10
5
0
2004 2005 2006
107
Interest rate fluctuations play a huge role in the profitability of a bank.
Banks are, therefore, trying to get away from this dependency by
generating more revenue on fee-based services. Firms with higher
fee-based revenue will typically earn a higher return on assets than
competitors. ICICI bank has the highest fee based income which has
shown a growth trend over the observed period thus indicating an
increase in the number of services offered. The SBI and Bank of
Baroda like the other PSBs lack in the fee based income as
compared to the private sector and the foreign banks.
8. Interest Spread (%):
108
Interest Spread (%)
0
2004 2005 2006
One key figure for evaluating management is the Interest spread as it

indicates the net income which the bank earns from its core business
of lending. The interest expenses are their main costs (similar to
manufacturing cost for companies) and interest income is their main
revenue source. Most banks will have interest spread in the 2-5%
range; this might appear low, but even a .01% change from the
previous year means big changes in profits. Thus HDFC has the best
interest spread but even SBI and Bank of Baroda are maintaining a
healthy interest spread. ICICI bank has interest spread well below the
industry standards. This is because of the high interest expense
incurred by the ICICI bank.
109
9. Investment Deposit Ratio:
Investment Deposit Ratio
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
2004 2005 2006
The investment-deposit ratio shows banks investments in statutory

liquidity ratio (SLR) instruments (plus other eligible papers) as a
percentage of deposits. According to current regulations, banks have
to maintain a minimum SLR level of 25% of net demand and time
liabilities (i.e. deposits). From the above graph we can say that the
banks are reducing the investment deposit ratio. This suggests that
banks are either selling their holdings of government paper to raise
resources for lending, or investing proportionately less than their
growth in deposits. The investment-deposit ratio has come down not
merely because banks are selling their SLR investments but because
110
they have stopped provisioning for more. A general reducing trend
has been observed in all the banks and all the banks have similar
ratios.
10. Credit Deposit Ratio:
Credit Deposit Ratio
0.8
0.6
0.4
0.2
0
2004 2005 2006
The declining investment-deposit ratio has meant that the credit-

deposit ratio has gone up. The credit demand has been robust over
the years and the banks are lending more than investing in the
government paper. The banks are routing cash to higher return
customers. The ICICI bank has the highest credit deposit ratio which
111
indicates a very aggressive lending policy. But many other banks also
have 100% credit deposit ratio which means they are lending all the
money obtained from deposits.
11. NPA (%):
NPA (%)
4
3.5
3
2.5
2
1.5
1
0.5
0
2004 2005 2006
The HDFC has the lowest NPA of the all the four banks while SBI has
the highest of the four. HDFC bank has been able to maintain the
NPA ratio stable over these years which show the superior quality of
assets. While the other banks have been successful in reducing the
NPA but still SBI has a very considerable amount of non performing
assets in its portfolio. Bank of Baroda and ICICI bank have been able
to bring the NPA to less than 1% which shows better asset
management practices.
12. CAR (%):
112
CAR
16
14
12
10
8
6
4
2
0
31-Mar-04 31-Mar-05 31-Mar-06
A bank's capital, or equity, is the margin by which creditors are

covered if the bank had to liquidate assets. A good measure of a
bank's health is its capital/asset ratio, which, by law, is required to be
above a prescribed minimum which currently is 8%. A ratio below the
minimum indicates that the bank is not adequately capitalized to
expand its operations. The ratio ensures that the bank do not expand
their business without having adequate capital. All the banks are
maintaining a healthy CAR.
113
CONCLUSION
114
CONCLUSION
The Indian banking sector has continued to grow rapidly after 1991.
Last year, its growth was 21% and likely to grow in future too. Though
a robust growth could be seen in future, this sector might not perform
well compare to last year. With credit growth of 30%, deposit growth
of 30% and inflation touching 5.5%, the government is eager to
reduce the money supply from the economy. It won’t be surprising for
anybody if RBI increases lending rate (repo rate) or CRR or both in
coming times. One good thing about this sector is that it has great
opportunity in agricultural sector but the banks have to keep in check
the NPAs over there. The opening of banking sector in 2009 will
definitely make the market full of foreign player but it will also give
opportunity to the Indian banks to start their overseas business.
Implementation of Basel II is likely to improve the risk management

systems of banks as the banks aim for adequate capitalization to
meet the underlying credit risks and strengthen the overall financial
115
system of the country. In India, over the short term, commercial
banks may need to augment their regulatory capitalization levels in
order to comply with Basel II. However, over the long term, they
would derive benefits from improved operational and credit risk
management practices. Problems will be more for the nationalized
bank as they have to keep 51% of the total equity in the name of
government and cannot dilute the stake of government below 51%.
Among the four banks, I found HDFC bank as the no. 1 bank. It has
lowest NPA among all and its growth rate is also good. ICICI is also
growing at a good rate but their NPA is worry for them. Private Banks
have an edge over the public bank and they are more efficient. It
could be easily seen by the profit and business per employee.
Another problem with the public sector bank is compliance of Basel II
norms. SBI has big problem with the lowest CAR and also their
inability to raise capital by issuing equity as they are quite close to
55%, which they have to maintain. The no. of branches of public
sector gives an edge over the private players and a small
improvement in their business can get them a big profit. In short I
could say that all the four banks are good to invest for long term and
if economy is growing at 8% then banking sector will definitely grow in
future
116
117
Suggestions & Recommendations
118
NEED TO CREATE A MARKET-DRIVEN BANKING SECTOR WITH
ADEQUATE FOCUS ON SOCIAL DEVELOPMENT
The term “policy makers” used in this document, as mentioned

earlier, refers to the Ministry of Finance and the RBI and includes the
other relevant government and regulatory entities for the banking
sector. We believe a co-ordinated effort between the various entities
is required to enable positive action. This will spur on the
performance
of the sector. The policy makers need to make co-ordinated efforts on

six fronts:
Help shape a superior industry structure in a phased manner through

“managed consolidation” and by enabling capital availability. This
would create 3-4 global sized banks controlling 35-45 per cent of the
market in India; 6-8 national banks controlling 20-25 per cent of the
market; 4-6 foreign banks with 15-20 per cent share in the market,
and the rest being specialist players (geographical or
product/segment focused). Focus strongly on “social development” by
moving away from universal directed norms to
119
an explicit incentive-driven framework by introducing credit
guarantees and market subsidies to encourage leading public sector,
private and foreign players to leverage technology to innovate and
profitably provide banking services to lower income and rural
markets. Create a unified regulator, distinct from the central bank of
the country, in a phased manner to overcome supervisory difficulties
and reduce compliance costs.
Improve corporate governance primarily by increasing board

independence and accountability. Accelerate the creation of world
class supporting infrastructure (e.g., payments, asset reconstruction
companies (ARCs), credit bureaus, back-office utilities) to help the
banking sector focus on core activities. Enable labour reforms,
focusing on enriching human capital, to help public sector and old
private banks become competitive.
NEED FOR DECISIVE ACTION BY BANK MANAGEMENTS
Management imperatives will differ by bank. However, there will be

common themes across classes of banks:
PSBs need to fundamentally strengthen institutional skill levels

especially in sales and marketing, service operations, risk
management and the overall organizational performance ethic. The
last, i.e., strengthening human capital will be the single biggest
challenge. Old private sector banks also have the need to
120
fundamentally strengthen skill levels. However, even more imperative
is their need to examine their participation in the Indian banking
sector and their ability to remain independent in the light of the
discontinuities in the sector. New private banks could reach the next
level of their growth in the Indian banking sector by continuing to
innovate and develop differentiated business models to profitably
serve segments like the rural/low income and affluent/ HNI segments;
actively adopting acquisitions as a means to grow and reaching the
next level of performance in their service platforms. Attracting,
developing and retaining more leadership capacity would be key to
achieving this and would pose the biggest challenge. Foreign banks
committed to making a play in India will need to adopt alternative
approaches to win the “race for the customer” and build a value-
creating customer franchise in advance of regulations potentially
opening up post 2009. At the same time, they should stay in the
game for potential acquisition opportunities as and when they appear
in the near term. Maintaining a fundamentally long-term value-
creation mindset will be their greatest challenge.
The extent to which Indian policy makers and bank managements

develop and execute such a clear and complementary agenda to
tackle emerging discontinuities will lay the foundations for a high-
performing sector in 2010.
121
122
REFERENCES
• www.rbiindia.com
• www.myiris.com
• www.indiabulls.com
• www.iba.com
• www.ibs.com
• www.sharekhan.com
• www.nseindia.com
• www.hdfcsecurites.com
• www.equitymaster.com
• www.icici.com
• www.hdfcbank.com
• www.investopedia.com
• Financial Management – Khan & Jain
• Financial Management – I.M. Pandey
• Financial Institutions & Markets – L. M. Bhole
123
Bibliography
• “Banking Sector in Global Perspective” - Inaugural address by

Dr Y V Reddy, Governor
RBI, at Banker’s Conference, New Delhi, 10 November 2004.
• FICCI Survey on the status of the Indian Banking Industry -

Progress and Agenda Ahead
“Financial Reforms and Monetary Policy: The Indian Experience”,
Paper presented by Rakesh Mohan at Stanford, June 2, 2006
• Henry Engler and James Essinger, The Future of Banking.

London: Pearson Education Ltd., 2000.
124
• “Indian Banking 2010: Towards a high performing sector”,
McKinsey & Co, 2005
• “Mergers & Acquisitions in the Indian Banking Sector”,

McKinsey & Co., 2004
• Stuart Barnett and Others edit., Top Ten Issues Global Banking
Industry Outlook 2003. New York:Deloitte Touche Tohmatsu,
2003.
• The Banker, Top 1000 World Banks. London: Financial Times

Business Ltd., July 2004.
• Tab Bowers, Greg Gibb and Jeffrey Wong, Banking in Asia,

Singapore: John Wiley & Sons Asia Pte Ltd.,2003.
125

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SECTOR OVERVIEW

The Indian Banking industry governed by the Banking Regulation Act

Public sector banks have undergone much restructuring alongside

Retail lending (especially mortgage financing) has been grabbing a

Currently the banking sector in the country is strongly fragmented and

• Early phase from 1786 to 1969 of Indian Banks

The following are the steps taken by the Government of India to

• 1949: Enactment of Banking Regulation Act.

In 1991, under the chairmanship of M Narasimham, a committee was

The Indian Banking industry has been undergoing rapid changes

Competition from multinational banks and entry of new private sector

In retail financing most of the players are trying to enter or

The industry is currently in a transition phase. On the one hand, the

Commercial banking structure

The commercial banking structure in India consists of:

• Scheduled Commercial Banks in India

"Non-scheduled bank in India" means a banking company as

As on September 2005, there were about 269 commercial banks. Of

Growth of Indian Banking Sector

Banks 2001-02 2002-03 2003-04 2004-05

Public Sector 968749 1079167 1229463 1435853

Private Sector 169439 207173 252336 312645

Foreign 64511 69110 79141 86505

Public Sector Private Sector Foreign

Banks 2001-02 2002-03 2003-04 2004-05

Public Sector 117253 128464 137587 144344

Private Sector 20817 31846 31814 32463

Foreign 12960 11999 12819 13034

Public Sector Private Sector Foreign

Public Sector 480680 548436 633036 854671

Private Sector 118430 138949 161083 220337

Foreign 48632 52018 59822 75318

Public Sector Private Sector Foreign

Banks 2001-02 2002-03 2003-04 2004-05

Public Sector 8302 12296 16547 15477

Private Sector 1779 2958 4162 3564

Foreign 1492 1817 2110 1982

Public Sector Private Sector Foreign

Banks 2001-02 2002-03 2003-04 2004-05

Public Sector 1.92 2.15 2.47 3.06

Private Sector 3.97 4.44 5.1 5.77

Foreign 8.18 10.34 9.81 9.4

Public Sector Private Sector Foreign

Financial and Banking Sector Reforms

The Banking System:

Almost 80% of the business is still controlled by Public Sector Banks

Many banks are successfully running in the retail and consumer

Deregulation of Banking System:

Prudential norms were introduced for income recognition, asset

Government pre-emption of banks' resources through statutory

PSBs were encouraged to approach the public for raising resources.

Recovery of debts due to banks and the Financial Institutions Act,

Banks asked to set up asset liability management (ALM) systems.

Derivative products such as forward rate agreements (FRAs) and

Porters Five Force Model: An analysis of Indian Banking

SUPPLIER POWER -High

Trade unions in public sector banks can be anti

Depositors may invest elsewhere if interest rates

There are large numbers of banks and rise in

BUYER POWER DEGREE OF RIVALRY: High

The banking sector is in a race to see who can

They then have an incentive to take- on high risk