Monday, December 19, 2011


Intensified competition
Currently the rural market is mainly dominated by NBFCs and other unorganized sources of funding. Also PSU banks are better positioned than the private sector banks in rural Indian. Going forward one will see things changing as greater thrust from the authorities will see the share of the NBFCs and unsecured institutions diminish. Currently some of the major NBFC players enjoy strong entry barriers in niche segments such as 2ND hand CV financing, equipment finance, gold loans, etc. This is mainly so as it takes years of experience to understand this client segment and their characteristics. Banks while initially reluctant to dabble with this segment have had time to develop their expertise and will soon start foraying into NBFC dominated areas. Within the banking segment itself there will be intensified competition. The RBI is likely to dole out fresh bank licenses very soon and one could see an influx of new banks as they seek to ensure greater financial participation and inclusion.

Greater emphasis on service and technology
In this era of intense competition banks will have to position themselves differently. While there is only so much one can alter in the banking business model, the key differentiators will be service quality and technology. PSU banks which were previously believed to shirk service have stepped up their game in recent years. The importance of technology while quite obvious in any industry could prove to be a huge differentiator. Mobile banking is expected to be a huge opportunity in the years to come. According to the Boston Consulting Group, payment and banking transactions through mobile phones could reach $350 billion by 2015. While the prospect of this happening is quite far away there could also come a day where one could have a branch-less banking system.

Fee based income
At the start of the previous decade Indian banks had a very limited fee based income component. While this has changed over the years, it is still far from the global average. Now in this long term structural era of rising interest rates where banks struggle to boost their NIMs one will see the banks focusing a lot more on their fee based activities. New generation banks are well stocked to provide these services (card services, guarantees, Investment banking, escrow, letter of credit, advisory services, etc.) but PSUs haven’t resorted to this in a big way. Going forward one is likely to see more impetus on the fee based income services.

Questionable if sizeable treasury gains can be made
Treasury yields have been low for the last decade or so, infact globally it has been low for over three decades. Now with the rapid rise in commodities, inflation has remained stubbornly high, thereby resulting in bond holders demanding a greater yield to hold onto bonds. This consequently makes bond investments less than appealing (inverse relationships of bond prices and yields) and it is questionable if treasury income will therefore be as high as it was in the previous decade, particularly for those banks who stick to HTM (Held to Maturity) as opposed to MTM (Mark to market).

To sum up..
Banks who manage and allocate capital well, have robust capital and liquidity buffers, possesses exceptional risk management, alternative fee based services have wide spreads, emphasize on service quality and seek to position themselves in a niche, differentiated manner in the eyes of the customer will prosper.

Near term outlook for banks
While inflation is expected to stay above the RBI’s comfort level there has been a decline or easing off of non food inflation. Besides the high base effect of the previous year will see the inflation number trend down in the months ahead. Commodity prices are a wild card and much could depend on liquidity driven initiatives taken by the West. On the other hand, the RBI has already tightened rates considerably and credit demand has certainly fallen off. Corporates are now resorting to borrowing from the overseas markets where rates are much lower. Thus weighing both sides of the coin it is fair to say that perhaps the rate cycle may be coming to an end.

Non food Credit outlook for the year as portended by the RBI is 18% while deposit outlook is pegged at 17%. Credit quality issues could crop up in this high interest rate regime so one is expecting to see a provisioning boost up. In the previous quarter results, one could see a clear deterioration in asset quality for most banks. Restructured assets as well are expected to rise.


The Indian growth story- Are banks good proxies to capture this growth?

‘The Indian growth story’ a popular phrase in investor circles may appear to be increasingly trite for the skeptics off late, but if one were to actually look at the larger picture and assuage the near term fears there is genuine merit in those four words. GDP which serves as the moniker for growth may have taken some sort of beating over the last few quarters and the year end FY12 expected figure leaves much to be desired. But if one were to widen the time period there is no doubt that the country is extremely well set to figure in the upper echelons of the growth table. Experts expect GDP to be anything between 7.4% to 7.8% for the current year but the long term median is expected to be 8-9%+. According to a report by PWC, India is poised to become the 2nd biggest economy in the world by 2050, with GDP in PPP terms expected to be $43180 billion, second only to China. Growth is expected to be more balanced and inclusive (though that is not the case currently) with services, industry and agriculture all expected to play crucial roles. Banks are fitting proxies in this attractive growth story for a whole host of reasons, none more important than the fact that they serve as intermediaries between savings and investment. According to McKinsey, based on how effectively banks capitalize on India’s growth potential, the banks could account for as much as 7.7% of the country’s GDP or 2.3% of the country’s GDP. Currently the figure stands at 2.5%. In a separate report PWC shows that from 2000-2010 while the Indian banking industry grew from $250 billion to more than $1.3 trillion at a CAGR of 18% compared to the average GDP growth of 7.2% for the same time period.

To read the full report: BANKING SECTOR