COMMERCIAL BANKING (COBK)

The Financial Crisis and Indian Banks:

Survival of the fittest

Aakanksha Thete

15F101

Antony Attokaran

15F110

Rajgopal B

15F140

Sachin Kulkarni

15F142

R Swetha

15F156

Rejath Johny

15F240

Group COBK 1-5

TERM 4, 2016
T A PAI MANAGEMENT INSTITUTE, MANIPAL

Summary
In the era post-independence, Indian banking sector comprised private and foreign
banks. The nationalization of banks mainly took place in 1969 during the Indira
Gandhi regime. Till the 90s, banks were subject to strict regulations like limits on
asset allocation, interest rate ceilings and entry into new markets. 50% of the banks
assets were preserved as cash, deposits and government securities. It was during
1991 that financial reforms came in to effect and regulations on banks were a bit
toned down.
The year 2008, saw financial crisis hit all over the world owing to the subprime
mortgage crisis in the USA. Observation of the Herfindhal index showed that the
power of the public banks in the markets kept on reducing till 2008. But the
noticeable point was, even though the market power of public banks increased
during 2008-09, the increase was not pronounced.
Although many of the analysts and industry experts were of the view that Indian
banks were mostly insulated from the financial crisis of 2008, it was not rightly so.
Experts had the above viewpoints because of the high stake holding of public entities
and conservative managements in the public banks. It can be seen that even the
largest private sector bank, ICICI suffered a 10% loss in deposits. These deposits
were moved from private banks to public banks and the shift was very pronounced. It
can be seen that public banks did not experience much slowdown in deposit growth
and indeed SBI, which is the largest public sector bank in India experienced a rapid
growth in deposit growth rate.
Many factors which led to the problem were considered. The major ones were
sources of funding for the bank, credit growth prior to crisis, bank health measured
by realized profitability, size of bank and capital backing by the government. It was
found that huge capital reallocation towards SBI could not be explained by these
factors alone. It was suspected that depositors were more confident with SBI.
To have a clear understanding of the issue, regression analysis was used
considering critical factors affecting the working of banks. The banks were bundled
together as public and private banks separately. To check the effect on a single bank,
that bank was added or removed accordingly from the bundle and therefore from the
regression process. The factors tested were:

Deposit growth

Asset growth
Credit growth
ROA
Capital
Effect of explicit guarantees by government

The control factors used in the process were:

Bank profitability - ROA

Asset quality provisions and capital ratios
Funding sources
Asset size using log of assets

The derived results of the process are as follows:

Private banks experienced slower deposit growth than public banks
The impact of crisis on deposit growth of public banks was slightly positive
There was a very high positive impact on SBI in terms of deposit growth
HDFC bank had high deposit growth at 10% level when compared to other
private banks
ICICI had slower deposit growth compared to other private banks
The deposit growth rate of HDFC was nowhere near as compared to that of
SBI
Other banks that were included in the experiment were foreign banks. The share of
assets of foreign banks is comparatively smaller and their business models are
different. The bundles of public banks and private banks were compared with the
bundle of foreign banks. It came out that the foreign banks faced a similar asset
reallocation crisis from them which was comparable to the private banks.
The extension of study reveals that private banks experienced slowdown in retail
deposits and not in term deposits, which points to the corporates shifting their current
accounts to public banks. Also during the crisis SBI had gained in both types of the
deposits. The study reveals that the interest rate was negatively correlated with
deposit growth. The study based on the characteristics of the banks showed that the
depositors discriminated between the healthier and weaker banks. The deposit
growth for the larger banks with higher provisioning was found to be slower. This
reveals that depositors considered banks with higher provisions as weaker. The
depositors had shown much confidence in the SBI than other stronger private banks.
From these findings, it can be concluded that trust in safety of deposits at SBI is due
to the broader implication of the public ownership and rooted with the bank
characteristics. Credit growth, return on asset does not differ across the banks and
largest hit on capital during the crisis was on public banks other than SBI.

The study conducted on the Indian banks after the crisis showed that the superior
performance of the public sector banks did not last during 2011 and 2012. The public
sector banks and SBI in particular experienced slower deposit growth during the
period. The banks that received capital injection had slower credit growth. SBI and
other public sector banks faced lower returns and higher provisioning after the crisis.
The study concludes that the reallocation of deposits was predominantly towards the
largest and best known public banks which in case State bank of India, rather than
the public sector banks as a whole. There was no sign of superior stability or returns
for the public sector banks during the crisis period. Thus the article comes to a
plausible conclusion that shift of deposits during the crisis was due to the implicit
guarantee enjoyed by the oldest and best known public sector bank, State bank of
India. The banks were forced to hold more capital and maintain more liquidity to
reassure depositors in order to maintain the stability of their operations. The implicit
guarantee for the larger public sector banks is a moral hazard as it would restrict
them from improving their efficiency and encouraging excessive risk taking. This
leads to the suggestion that the implicit guarantees to SBI and Public-sector banks
should be scaled back by either preventing them from becoming too big or by setting
up more effective mechanisms for the orderly resolution insolvent institutions.

Critique
The analysis carried out in the paper is robust and captures all the relevant
information or data concerned with understanding the flight in deposits in India
during the crunch of 2008. Deposit growth, asset growth, credit growth, return on
assets, bank profitability, asset quality, funding sources, bank characteristics and
size are important aspects to be considered to understand the issue. Regression
analysis, arguably is one of the best tool to correlate the relationships between
seemingly unrelated variables. Most of the variables considered are of quantitative
type and not much importance is given to qualitative aspects of the study. Following
are some of the suggestions if deemed right, can make the outcome better.
Limitations and omissions
The study fails to capture the consumer behaviour attached to the Indian banking
system

SBI is analogous to the Indian commercial banks with 20% market share in
deposits and loans. With more than 14000 branches, SBI is omnipresent in
every nook and corner of the country, operating in the worlds largest
centralised core banking system. As of 2014-15, it had assets of 20.480
trillion (US$300 billion) People perceive SBI to be safe and too big to default
or fail. In times of uncertainties or the financial crisis, SBI arguably assumes
priority to other public and private banks for safer deposits. A common person
who can be considered as financially illiterate doesnt understand the nitty

gritty issues of a crisis, balance sheet variables, asset growth or credit growth
of the bank. With all the turbulence in the market, an investor would
understandably deposit in SBI with the implicit backing by the government
which owns a 60% stake
The study fails to understand or doesnt consider the consumer
behaviour attached to banking with SBI. Regression analysis considers
several variable of bank size, credit growth, asset growth, but a deeper
understanding of consumer behaviour would have presented more convincing
results

Results stated post research do not single out concrete reasons for the flight
of deposits from private and public sector banks in India following the onset of
the global financial crisis. The results are rather probabilistic
The study is country specific and cannot be generalized.
The focus is mainly on domestic banks in this paper
For arriving at conclusions, the author has used bank annual data (common in
the literature), but higher frequency data would have perhaps allowed
researchers to tell richer stories and come to a more conclusive results
Since the study captures two years of post-crisis data, perhaps it does not
capture the complete fallout of the financial crisis

Suggestions
The study was conducted only for the financial crisis of 2008 and aftermath. The
authors could reach towards a plausible reason of expectation of an implicit
guarantee for the oldest and best known public-sector institution as the reason for
reallocation of deposits towards State Bank of India. Conducting the study on
multiple financial crisis to find if similar behavior were observed could strengthen the
conclusion put forward by the study.

Future Outlook
SBI has proposed merger of its 5 associate banks and Bhartiya Mahila Bank to form
a single large entity by March 2017. This would make SBI too big to fail and flight of
deposit to SBI would be much more aggravated in the next financial crisis,
challenging the existence of the private banks during the crisis period. If the merger
happens, the only way out for the private banks (like ICICI, HDFC, Axis etc.) would
be to merge among themselves to form a large entity to reduce the impact. But, as
study concludes, the implicit guarantee as the main factor for the reallocation of
deposits is likely to reoccur as happened during the crisis. The repercussion of 2008
crisis on Indian economy is considered to be less when compared to others major
economies but still it has affected the public confidence in the Indian banking sector.
Hence, it is necessary to set up mechanisms for the orderly resolution of insolvent
institutions in order to avoid impact on Indian Banks during financial crisis affecting
Indian economy.

Private sector banks purely depend on public deposits from their customer base.
Hence, to attract more deposits from the public, private sector banks normally offer
higher interest rates. There is an inherent risk of default and liquidity issues for such
banks. Moreover, with BASEL III mandating adequate capital requirements, it would
be difficult for private banks to operate. With no backing from the government
(implicitly or explicitly), depositors would be wary of depositing in private bank. Also,
with majority of the studies suggesting PSUs to be healthier and robust, there will
definitely be flight of deposits to PSUs from private banks in light of any financial
crisis in future.