Focus shifts to retail banking

WITH SPREADS shrinking, Indian banks are following their global counterparts and focusing on increasing the share of their fee- based income. The ratio of non-interest income to total funds has already increased for some banks and the first quarter results of the current fiscal affirm this fact.

``Within the banking sector, increasing competition and growing risks remain important challenges,'' stated Mr. Janki Ballabh, Chairman, State Bank of India, in the latest annual report of the bank. According to him, competition for market share is increasing the pressure on profitability and forcing banks to trim costs, particularly transaction costs and improve efficiency. Mr. Ballabh added, ``As banks concentrate on consolidation to meet competition, the key driver in staying ahead of the competition is technology and how well banks use it to meet the needs of their customers. In today's sophisticated market, credit risk along with market risk and operational risk are the real challenges before banks.''

During April to mid-June, the increase in deposits was Rs. 45,389 crores against Rs. 27,125 crores during the same period in the previous year, that is, a rise of 19.3 per cent as against 16.3 per cent in the same period last year. The proportion of time deposits as compared to demand deposits was higher indicating spreads may shrink further. ``In 2001-02, the overall growth in deposits is expected to be lower at around 16 per cent, largely due to slower growth in money supply compared with that in 2000- 01, lower interest rates on deposits especially bulk deposits and reduction in dividend distribution taxes from 20 per cent to 10 per cent on mutual funds making mutual funds a more tax-efficient investment,'' said Mr. M. M. Joseph, Research Head of SBI Capital Markets.

As of mid-June, the growth in scheduled commercial banks' (SCBs) credit slowed down to 15.6 per cent on a year-on-year (YoY) basis from 23 per cent a year ago. This was the lowest growth recorded since September 1999 when the YoY increase in bank credit was 15 per cent. In absolute terms, total credit increased by Rs. 7,743 crores during April to mid-June 2001 against Rs. 10,965 crores during the corresponding period of the previous year. Credit growth during April-May remained around 16.5 per cent on a YoY basis.

The slowdown could be attributed to lack of credit off-take by the industrial sector even as food credit continued to surge. Because of the recession and industrial slowdown, most corporates appear to have postponed their expansion plans and have put on hold greenfield projects.

Moreover big corporates are bypassing banks and raising money through the debt market and commercial papers, which are cheaper than bank credit.

Therefore, banks are being forced to look at the mid-corporates. But, this is a risky strategy as the risk is concentrated and delinquency higher.

To compensate, most banks have devised strategies to go in for retail banking as a major thrust area.

``The risk here is distributed and there is a huge market to be tapped,'' said Mr. Joseph. Some of the banks which have been aggressive in this area are HDFC Bank, ICICI Bank, State Bank of India (SBI) and Corporation Bank.

In the fourth quarter of 2000-01, interest rates, especially on short tenure, declined due to a reduction in the Bank Rate and a cut in interest rates on contractual savings such as Public Provident Fund (PPF). In 2001-02, interest rates are expected to decline marginally due to a better liquidity position. Some of the major banks have reduced their prime lending rates (PLRs) and others are likely to follow suit. ``The spreads have been shrinking and banks are searching for other avenues to protect their bottomlines,'' said Mr. Joseph.

A comparison of old and new private sector banks indicates a clear difference in profitability. New private sector banks have shown higher ROA and a higher RONW as compared to old private sector banks. It is also interesting to see the performance of banks over the previous year.

The accompanying table shows the break up of total income. Other income has increased over a couple of years. This trend has been maintained in the first quarter of 2001-02. Non-interest income was 2.05 per cent for IndusInd Bank this year as compared to 1.48 per cent last year.

With spreads shrinking, Indian banks are following their global counterparts and focusing on increasing the share of their fee- based income. ``Fee-based income'' may increase marginally in future.

The ratio of non-interest income to total funds has increased for some banks. A rising ratio is expected in the future.

The increase in net sales of Corporation Bank is only 5 per cent while the rise in other income is 34 per cent. ICICI also raised its other income by 307 per cent as compared to a net sales increase of only 65 per cent.

The growth in the economy has been sluggish and banks can no longer afford to rely on big corporate customers. There is a shift in focus towards retail banking. Most banks are targeting the middle class and lower middle class segment. Huge non- performing assets (NPAs) are plaguing old private sector banks. The asset quality of banks is largely dependent on economic growth and makes it difficult for them to recover loans till the economy revives.

Some positive policy initiatives have been taken by the Government which will give an impetus to consolidation in the banking industry. The limit of foreign direct investment (FDI) in private sector banks has been raised to 49 per cent from 33 per cent. This will allow foreign banks to buy a strategic stake in private sector banks having the latest technology and better quality assets. This year, the banking industry has witnessed two big mergers. Times Bank merged with HDFC Bank and Bank of Madura with ICICI Bank. Banks could increase their revenue base and leverage on their distribution network by investing in the growing insurance sector. However, the inflows would be slow to begin with. There has also been a thrust on the housing sector.

Flexible financing with lower interest rates has resulted in brisk activity in the sector. SBI and other banks have launched voluntary retirement scheme (VRS), an effort to bring down operating cost. There is an increased focus towards auto loans, car loans, funding for infrastructure, and other fee-based services such as guarantees and commissions on drafts, gold banking, derivatives and the like.

``Overall, HDFC Bank, ICICI Bank and SBI have shown good performance and appeared to be geared to take on the challenges,'' said Mr. Joseph.

These banks are changing their strategy and shifting focus from big corporates to mid-corporates and also retail banking and housing finance. The Indian banking system is in the midst of a technological revolution with banks offering anywhere banking, 24/7 and also attempting to become a one stop financial shop offering all financial solutions.

It is believed that new private sector banks such as HDFC Bank and ICICI Bank have demonstrated their ability to improve other income, which was previously the forte of foreign banks due to good service.

This trend is expected to continue. Nationalised banks and old private sector banks will also follow suit and there is hardly any progress in this area. If old private sector banks have to survive they will have to compete on service.

Oommen A. Ninan

in Mumbai

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