Trends in Indian Banking Industry

Sustained demand for bank credit has characterised the Indian banking system in the past four years in consonance with the upturn in economic activity. Non-food credit extended by SCBs recorded an average annual growth of 26.1 per cent between 2002-03 and 2005-06, higher than that of 14.5 per cent recorded during the preceding four-year period (1998-99 to 2001-02).

The total advances of SCBs as on March 31, 2006 were Rs. 15,156,680 million, which translates into a growth of 31.98 per cent over the previous year. The sharp expansion in credit in recent years also reflects, in part, policy initiatives to improve flow of credit to sectors like agriculture. The agricultural credit provided by co-operative banks, commercial banks and RRBs increased by 44 per cent and reached Rs. 1,253,090 million during 2004-05, compared to Rs. 869,810 million during 2003-04. The ground level credit flow to agriculture and allied activities reached Rs.1,574,800 million during 2005-06. Similarly, demand for credit by industry has shown a recovery in the current cyclical upturn. Growth of credit to the industrial sector accelerated from 15.6 per cent during the 1990s to 18.5 per cent between 2002-03 and 2004-05.
Retail loans, which witnessed a growth of over 40.0 per cent in 2004-05 and again in 2005-06, have been the prime driver of the credit growth in recent years. Retail loans as a percentage of gross advances increased from 22.0 per cent in March 2004 to 25.5 per cent in March 2006. Of the components of retail credit, the growth in housing loans was 50.0 per cent in 2004-05 and 34.0 per cent in 2005-06. Banks direct exposure to commercial real estate also more than doubled in the last financial year.

The program of linking self-help groups (“SHGs”) with the banking system is an important component of the micro-finance programme in the country. As on March 31, 2006, as many as 1,996,488 (provisional) SHGs were linked to banks and the total credit to SHGs was Rs. 94,950 million. The Union Budget, 2006- 07 (the “Budget”) has proposed to enhance the annual target of credit linkage to 385,000 SHGs during the year. The Budget also announced a scheme providing short-term credit to farmers at 7 per cent per annum.

The Government shall provide a subsidy of 2 per cent on all crop loans extended by banks. Banks are permitted to use the services of SHGs, non-governmental organisations (“NGOs”), microfinance institutions (“MFIs”) and other civil society organisations (“CSOs”) and post offices as intermediaries in providing financial and banking services. The share of total retail credit in bank credit has increased from 6.4 per cent to 22.5 per cent between 1990 and 2006. The share of agriculture in total credit, which had declined from 15.9 per cent as on March 31, 1990 to 9.6 per cent as on March 31, 2001, has since recovered to 10.8 per cent as on March 31, 2005. The share of industry in total credit has continued to decline, falling to 38.8 per cent as on March 31, 2005 from a peak of 49.1 per cent as on March 31, 1999.

Asset Quality
The asset quality of SCBs improved during 2005-06, with gross and net NPA ratios reaching historical low levels of 3.5 per cent and 1.3 per cent, respectively, as on March 31, 2006. Robust economic activity and a better recovery climate have facilitated reduction in NPAs in recent years.

Investments
Investments by banks comprise two broad categories, namely, Government and other approved securities (SLR investments), and commercial paper, shares, bonds and debentures issued by the corporate sector and public sector undertakings (non-SLR investments). During 2005-06, investment of SCBs decreased by 0.2 per cent as against the increase of 8.1 per cent in the previous year. Deposits

Deposits of SCBs as on March 31, 2006 were Rs. 21,624,740 million, growing at a rate of 17.96 per cent in 2005-06 over 2004-05, compared to a growth of 17.45 per cent in 2004-05 over 2003-04.Non Deposit Resources

Banks have traditionally funded their lending operations with deposits. While deposits continue to be the main source of funding, the relative significance of non-deposit resources like borrowings, retained earnings and capital has increased.Income and profitability
The total income of SCBs declined from 8.21 per cent of their assets in 2004-05 to 8.03 per cent in 2005- 06, as both interest and non-interest income moderated during the year. Total expenditure (as a percentage of total assets), on the other hand, was unchanged from the previous year. As a result, earnings before provisions and taxes (as a percentage of total assets), during 2005-06 were lower than the previous year.

However, in view of lower provisions, profits after tax (as a percentage of total assets), at 0.88 per cent during 2005-06 was almost the same as during 2004-05 (0.89 per cent). Interest income, which is the major source of income, rose sharply by 18.59 per cent during 2005-06 compared to 9.8 per cent (including conversion impact) in 2004-05.

Capital Adequacy
The overall CRAR of SCBs at 12.4 per cent as on March 31, 2006 was less than the previous year’s level (12.8 per cent). The decline in CRAR during 2005-06 could be attributed to the higher rate of increase in total risk weighted assets compared to the expansion in capital during the year.

Technology
Technology is emerging as a key-driver of business in the banking and financial services industry. Banks are developing alternative channels of delivery such as ATMs, telebanking, remote access and Internet banking. Indian banks have been making significant investments in technology. In addition to the computerisation of their front-office operations, the banks have moved towards back-office centralisation.

Banks are also implementing “Core Banking” or “Centralised Banking”, which provides connectivity between branches and helps offer a large number of value-added products, benefiting a larger number of customers. A number of banks have joined together in small clusters to share their ATM networks. There are currently five such ATM network clusters functioning in India. The total number of ATMs installed by the SCBs was 21,147 as on March 31, 2006.

As on April 13, 2007 RTGS connectivity was available in 28,776 branches against 24,425 as on October 23, 2006. The launch of the pilot project for Cheque Truncation System, which aims at enhancing efficiency in the retail cheque clearing sector, is expected to be implemented in December 2007.

The National Electronic Funds Transfer (“NEFT”) system for electronic transfer of funds, which was operationalised on November 1, 2005, is now available at 9,096 branches.

Recovery/Rehabilitation of Debts

Debt Recovery Tribunals (DRTs)
DRTs have been established under the Recovery of Debts due to Banks and Financial Institutions Act, 1993 for expeditious adjudication and recovery of debts that are owed to banks and financial institutions. Out of 71,399 cases for claims in a an amount of Rs. 1,112,930 million filed with DRTs by the banks, 36,803 cases for claims in a an amount of Rs. 427,920 million have been adjudicated as on March 31, 2006. The amount recovered as on March 31, 2006 through the adjudicated cases was Rs. 149,920 million.

SARFAESI Act
The SARFAESI Act passed in Parliament in 2002 gives powers of “seize and desist” to banks. Banks can give a notice in writing to the borrower requiring it to discharge its liabilities within 60 days, failing which the secured creditor may take possession of the assets constituting the security for the loan and exercise management rights in relation thereto. The SARFAESI Act also provides for the establishment of asset reconstruction companies regulated by the RBI to acquire assets from banks and financial institutions. The constitutionality of the SARFAESI Act was challenged in Mardia Chemicals Limited v. Union of India, AIR 2004 SC 2371. The Supreme Court upheld the validity of the SARFAESI Act, except Section 17(2), which it struck down on the ground that the requirement of making a deposit of 75 per cent of the amount claimed at the time of making a petition or an appeal to the DRT in order to challenge the measures taken by the creditor was unreasonable. In addition to the SARFAESI Act several states also have revenue recovery acts and lok adalats.Corporate Debt Restructuring (“CDR”)
In order to put in place an institutional mechanism for the restructuring of corporate debt, the RBI has devised a CDR system. The CDR system is a non-statutory, voluntary mechanism based on debtor-creditor and inter-creditor agreements. Multiple banking accounts with an exposure of Rs. 100 million and above may be referred to the CDR Forum.
The total membership of the CDR Forum, as on March 31, 2004 was 60, of which there were 14 FIs, 27 public sector banks and 19 private sector banks.

Consolidation
So far, consolidation has been limited to mergers of a few private banks or financially distressed banks. The Government has provided tax breaks aimed at promoting mergers and acquisitions. For instance, Section 72A and Section 72AA of the I.T. Act enable the acquiring entity, which could be a company, a corresponding new bank, a banking company or a specified bank to “carry forward and set-off accumulated losses and unabsorbed depreciation” of the acquired entity, subject to specified conditions being fulfilled. Public sector banks are also forming certain alliances for cooperation in various areas, e.g., sharing of ATMs, cross-selling products etc.

Performance Highlights of Public Sector Banks

Salient features of the operations of public sector banks based on a few important parameters are given below:

Total Assets – The total assets of the public sector banks increased from Rs. 17,739,810 million as on March 31, 2005 to Rs. 20,148,980 million as on March 31, 2006, a growth of 13.6 per cent which was lower than the growth of 20.5 per cent recorded in the previous year.

Deposits – The total deposits mobilized by public sector banks increased from Rs. 14,365,410 million as on March 31, 2005 to Rs. 16,224,810 million as on March 31, 2006, a growth of 12.9 per cent, which was lower than the previous year’s growth of 16.8 percent.

Investments – Investments of public sector banks decreased in 2006. In absolute terms, total investments declined from Rs. 6,862,130 million as on March 31, 2005 to Rs. 6,337,410 million as on March 31, 2006, a decline of 7.6 per cent compared to a growth of 9.6 per cent in the previous year.

Advances - The total advances of the public sector banks increased from Rs. 8,542,150 million as on March 31, 2005 to Rs. 11,061,280 million as on March 31, 2006, a growth of 29.5 per cent which was lower than a growth of 34.9 per cent in the previous year.

NPAs - During the year, both gross and net NPA were lower than that of the previous year. Gross NPA declined from Rs. 484,060 million as on March 31, 2005 to Rs. 421,060 million as on March 31, 2006, a decline of 13.0 per cent compared to the previous year’s decline of 8.1 per cent.

Income - The total interest income of public sector banks increased from Rs. 1,203,650 million during 2004-05 to Rs. 1,376,140 million in 2005-06, a growth of 14.3 per cent compared to the previous year’s growth of 9.9 percent.

Expenditure – The total expenditure (excluding provisions and contingencies) increased from Rs. 1,058,060 million to Rs. 1,218,040 million, a growth of 15.1 per cent compared to 7.6 per cent in the previous year. Interest expenditure increased from Rs. 687,640 million during 2004-05 to Rs. 802,720 million during 2005-06, a growth of 16.7 per cent which was higher than the previous year’s growth of 4.6 per cent.Profit – In absolute terms the total operating profit increased from Rs. 385,150 million during 2004-05 to Rs. 388,960 million during 2005-06. Growth in operating profit of the banks increased marginally from a decline of 1.9 per cent during 2004-05 to a growth of 0.99 per cent during 2005-06.Recent Policy Developments
In its Annual Policy Statement 2007-08, the RBI introduced the following key measures:

> The fixed repo rate under the Liquidity Adjustment Facility was increased from 7.0 per cent to 7.75 per cent.
> Currently, the interest rate ceiling on FCNR (B) deposits of all maturities has been fixed at LIBOR/SWAP rates for the corresponding maturities minus 25 basis points for the respective foreign currencies. In view of the prevailing monetary conditions, RBI proposed to reduce, with immediate effect, the interest rate ceiling on FCNR (B) deposits by 50 basis points, i.e., to Libor minus 75 basis points.
> Currently, the interest rate ceiling on Non-Resident (External) Rupee Account (“NR(E)RA)”) for one to three years maturity should not exceed 50 basis points above LIBOR/SWAP rates for U.S. dollar of corresponding maturity. In view of the prevailing monetary conditions, RBI proposed to reduce, with immediate effect, the interest rate ceiling on NR(E)RA deposits by 50 basis points, i.e., to LIBOR/SWAP rates.
> The Reserve Bank has taken several initiatives to provide a more conducive environment for the conduct of foreign exchange business to provide prompt and efficient customer service by progressively liberalising foreign exchange related transactions, removing restrictions, simplifying procedures and by rationalization of overseas investments.
> The prudential limit on credit and non-credit facilities extended by banks to Indian joint ventures /wholly owned subsidiaries incorporate outside India was enhanced from 10 per cent to 20 per cent of unimpaired capital funds (Tier I and Tier II capital) of the bank with a view to facilitating the expansion of Indian corporates’ business abroad.

• Structural and developmental measures for deepening and widening the government securities market were adopted.
• To improve the credit delivery mechanism and make available basic banking services to the wider sections of society and to ensure development of the rural-agrarian economy by improving credit flow to agriculture and other segments of priority sector, strengthening of the rural financial infrastructure and promoting financial inclusion, financial literacy and credit counselling.
• Further, amalgamation and merger of RRBs was implemented reducing the total number of RRBs from 196 to 96.
• The pilot project for cheque truncation, which aims at enhancing efficiency in the retail cheque clearing sector, is expected to be implemented in December 2007.
• The proposed National Settlement System (“NSS”) which aims at settling clearing positions of various clearing houses centrally, is expected to be introduced during 2007-2008.
• As part of financial inclusion, the State Level/Union Territory Bankers’ Committee (SLBC/ UTLBC) of convenor banks in all States/Union Territories were advised to undertake an evaluation of the progress made in the selected districts in each State / Union Territory where these scheme were implemented for achieving 100 per cent financial inclusion by providing “no frills” accounts and general purpose credit cards.
• The RBI waived processing fees on banks for both electronic clearing services (“ECS”) and electronic fund transfers (“EFT”) transactions as well as for the RTGS and the NEFT transactions up to March 31, 2007 with a view to promoting electronic transactions. The RBI would continue with the waiver of processing fees to banks in order to further promote electronic transactions system, until the retail operations are taken over by the National Payments Corporation of India (NPCI). Accordingly, processing fees for transactions relating to RTGS, ECS, EFT and NEFT has been waived up to March 31, 2008.• As part of the gradual process of financial sector liberalisation in India, it is proposed to introduce credit derivatives in a calibrated manner to permit banks and primary dealers to begin transacting in single-entity credit default swaps (CDS).• Other measures which are proposed to be implemented during 2007-08 include: mandating all inter-bank transactions for settlement only through the RTGS mode; review of the norms relating to membership of the Indian Financial Network to facilitate larger participation in electronic payment based message transfers; effecting the settlements arrived at by the Clearing Corporation of India Limited. (CCIL) and the major stock exchanges National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) as RTGS batch settlements; implementation of the National Settlement System (NSS) for processing the clearing settlements of the major clearing houses as RTGS batch settlement; implementation of the National Electronic Funds Transfer (NEFT) for greater coverage and reach for the common man; gradual upward revision of the per-transaction limit for customer based transactions to a level of Rs.100 million; and migration of Government based payment and receipt transactions to electronic means.

Source: RHP of Central Bank of India