[sbinews] The churn in Indian banking (Businessworld)

  • From: rajendra.pai@xxxxxxxxx
  • To: sbinews@xxxxxxxxxxxxx
  • Date: Mon, 01 Dec 2003 11:39:14 +0500 (IST)

The churn in Indian banking 
The sector will soon see the first signs of a churn and consolidation. 
 The author is chief economist, Confederation of Indian Industry 
As a watcher of India's banking sector, I am looking forward to the next three 
years. These may be famous last words, but I do believe that we will see the 
onset of a process of churning, mergers, acquisitions and consolidation - the 
stuff that occurred in the manufacturing industries between 1997 and 2002, but 
which, by and large, had left banking untouched. Let me first share with you 
the logic, and then the possible scenario.

Notwithstanding the Reserve Bank of India's periodic pronouncements of its 
'bias towards a soft interest rate regime', it would be foolhardy to believe 
that interest rates will continue moving southward. They can't. For one, the 
trend rate of WPI inflation is running at over 4.5% with signs of it creeping 
up to 5%; and one can't expect the short end of the yield curve to have 
negative real interest rates. Also, with impending elections, it is unlikely 
that the government will reduce administered interest rates. 

Moreover, with the manufacturing boom set to continue, we should be looking at 
the beginnings of an investment cycle. Many companies that built capacities in 
the first half of the 1990s are seeing their surplus capacity squeezed out by 
growth in demand. To be sure, productivity improvement can raise output without 
large increases in investment. Nevertheless, I expect more than 150 listed 
companies to plan, on an average, something like Rs 250 crore of investment per 
firm over the next three quarters - or Rs 37,500 crore of additional funds 
requirement. If we add to this the capital needed for infrastructure projects, 
we could be looking at a hefty growth in investment demand. In such a milieu, I 
don't expect interest rates to soften. Indeed, they may even marginally harden 
by June-July 2004. 

For banks, it means the good old days of booking mark-to-market profits on 
highly over-weighted treasury operations are over. On an average, public sector 
banks are carrying 16 percentage points more of government securities than 
warranted by the statutory requirements. The 600 basis points fall in interest 
rates over the last three years created windfall book profits to treasury. 
These not only covered the negative (at best, nominally positive) carry on 
G-secs, but also hid the poor performance in lending. This cream will be a 
thing of the past. 

Therefore, the balance-sheets and profit and loss accounts of many of our 
public sector banks are going to look worse than before. If we add to this the 
costs of even a gradual introduction of income recognition and capital adequacy 
norms proposed by Basle II, then the financials will look far worse. These 
factors will create more sensible, operationally determined valuation of our 
banks, and also force the pace for mergers and consolidation. 

I see three types of mergers and acquisitions on the horizon. First, where the 
more aggressive foreign banks such as Citibank, ABN-AMRO, and even Standard 
Chartered will seek to buy attractively valued smaller Indian private banks - 
either because these have niche customers, or unchallenged businesses, or a 
strong, localised geographical presence. Second, some of the newer Indian 
private sector banks - especially ICICI Bank and, to a lesser extent, HDFC Bank 
- which will also seek such private sector targets. Third, which may be the 
slowest off the block, is mergers between some of the public sector banks - if 
not entire banks, then well defined parts of operations. It may be slower in 
coming because public sector banks will have to get government approvals and 
also bear the costs of Parliamentary oversight. 

If you noticed, I haven't mentioned a fourth trend - that of foreign banks 
acquiring sizable stakes or business interests in public sector banks. No 
doubt, it will happen one day. But somehow, the realist in me doesn't think 
that the political stage is yet set for a public sector bank, however small, 
being taken over by the gora paltan. That will be the next stage of reforms 
and, hopefully, I will write a column on it three years from now.  

Email From "rajendra.pai@xxxxxxxxx" was security checked by 3.90  version of 
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