N. S. Vageesh

Any increase in interest rate will not bite either the retail or the industrial borrower. So, in that sense, it is benign. The rise we see from the bottom, in absolute terms, is still low and will not impact the borrower. PROF. T. T. RAM MOHAN, IIM-A

Retail banking has been the buzzword for bankers in the past two years. But it is not the El Dorado that public sector banks think it is, says Professor T. T. Ram Mohan of IIM-Ahmedabad. He cautions banks about the pitfalls ahead, especially now, as the market is being explored further.

Prof Ram Mohan, a keen observer and commentator on the financial sector, teaches a few core courses in the finance area at IIM-A. He worked in consultancy and financial services before entering academics. He graduated in Metallurgical Engineering from IIT Bombay and then went to IIM-Calcutta for his MBA. He did his doctoral programme at the Stern School of Business in New York.

He spoke to Business Line on a range of current issues in banking, when he was in Chennai recently.

Excerpts from the interview:

You have suggested that there are huge hidden costs to retail banking expansion, which public sector banks have not taken into account. Can you please elaborate on that?

They are hidden in the sense they (the PSBs) do not have the capacity to monitor costs, customer-wise. They do not have what we call the customer profitability report — that is central to modern banks, which some private banks have. Many private banks are able to capture the entire range of transaction costs of their customer, whether he makes a phone call, goes to an ATM or branch.

Therefore, at any given point of time, they know if having the customer makes sense. They can go for aggressive pricing, knowing the fee income that may come from a particular customer. But public sector banks try to match them on loan pricing without knowing whether it makes commercial sense.

The Indian market is growing in volumes. But is it profitable for you? It is an assumption they make, that at the market rate for housing loan, it is profitable. There is no way of knowing it. Many problems show up with a lag. If a customer has not paid, you have to follow up. You need to send letters, make phone calls and incur legal costs that show up later. The point is does pricing take into account all these future costs? That is why you have to be wary.

The other thing is that with regard to documentation, verification, etc., banks have been lax. So some big non-performing assets (NPAs) on the housing front are starting to show up. More generally, once you have scratched the surface of the retail market, then, naturally, the NPAs are not going to be the same as the beginning. The whole thrust towards retail cannot be premised indefinitely on the expectation that NPAs will be 0.25 per cent or 0.5 per cent or 1 per cent. That is in the beginning, when the market is new. Once the best is over, you go to the next tier. I am not saying that we are there already. There are still good quality customers available. But what we have seen in the initial five years may not continue in the next five.

What should banks do in such a situation? Do they rein in retail credit?

It is happening in some way already. Starting this year, you will see more balanced growth in retail and wholesale books. ICICI Bank has said that on an incremental basis its retail exposure will be lower. One of the reasons may be that apart from the concerns on the retail book, corporate demand is looking up. International rates are also going up. The imbalance between wholesale and retail is getting corrected.

In a regime of falling interest rates, it may make sense to emphasise on retail growth. But now that interest rates are going up, there are serious asset-liability management issues, because your deposits are short-term, while the housing loans are of 10-15-year tenors. And, therefore, corrective processes are coming into play and the result would be a balanced growth between retail and wholesale.

You had hinted in an article, a couple of months back, that we might be entering a period of benign interest rates. We saw some increase recently. What is your opinion now?

The interest rate increase we are seeing is from an all-time low. The decline we saw earlier was very steep. Any increase, which takes place, will not bite either the retail or the industrial borrower. So, in that sense, it is benign. The interest rate cycle cannot be abolished. There will be increases and decreases. But the rise we see from the bottom, in absolute terms, is still low and will not impact the borrower.

Second, with regard to the international interest rate cycle, the question to ask is how far does it have to go. The IMF has said, in its World Economic Outlook, that it may be a year or two. That means we are close to the end of the interest rate cycle. So if we assume that over the next year, we still have these quarter-point increases, another 1-1.5 per cent increase over the next year, in the Indian context, you are seeing the peak.

So, there is no cause for concern...

No. And the overall liquidity position caused by massive foreign inflows is again an immutable reality. There may be some volatility in FII flows. But look at things in totality — the service exports, remittances, FII and FDI inflows. While there may be ups and downs with regard to FII flows, as far as FDI is concerned, the trend can only be upwards, because we are starting from an abysmal $2 billion a year. That is pathetic in relation to the capacity of the economy to absorb foreign investment. The liquidity position does not fundamentally change. That is what is conducive to benign interest rates, apart from international trends.

What is the optimum size for a PSB? You said that after a particular size, it is not profitable to grow. What is the size you have in mind?

Internationally, there have been some studies. Earlier, they talked of $10 billion, but the ground is constantly shifting. More recently, studies have put the figure for American banks at $20 billion. But it is a function of so many things — transaction costs, technology, product mix, interest rate environment, etc. It is not the same thing for banks here.

To say that Indian banks will reap economies of scale by growing bigger is only a presumption. No empirical studies have been done and it is not established that there are clear gains from scale economies. Some studies show, for any firm, there is scale economy up to a point, and then diseconomies set in. This is particularly true if you grow through mergers. This has to be very carefully thought through.

The Finance Minister, Mr P. Chidambaram, has been pushing through this idea of mergers among PSBs on the ground that bigger size is necessary to compete. What is your view?

My point is that this has to be based on studies on what constitutes optimum size in the Indian context. The second point I would like to make is that, in general, you go for mergers when you exhaust the opportunities for organic growth.

Every merger, in some sense, is a confession of failure. What the management is saying is that, "I can't grow on my own. The only way I can grow is joining with another guy." Now, what we are seeing in India is top line and bottomline growth of an unprecedented quality in the last several years, especially in PSBs. When the ability to grow on your own is there, why invite trouble by going for mergers? I say inviting trouble, because there are cultural issues that are significant. People issues are significant. For example, who is going to report to whom? Sorting this out takes one or two years. Are you going to expend energy on these kinds of issues? There are a host of HRD issues in the present environment that need to be addressed. Why not focus on that, especially when the market is growing?

The third point is that growing in scale to cope with foreign competition is a pipe-dream. That is because the largest bank in India, the State Bank of India, is not even tenth the size of the tenth largest bank in the world. And SBI is a giant here. Even if others merge, they are not going to have a credible size to take on foreign banks in the international arena. Is more size necessary for taking on competition in the home turf? That is there already. If any foreign bank has to have credible size here, you need Rs 75,000 crore of assets by 2009. That would require an investment of about $1.5 billion. That is not small even for leading international banks. When the total FDI is $3 billion, half of that for a single bank is not a joke.

The question that a foreign bank will have to ask is, what will this fetch in terms of branch network or brands. It will not fetch anything comparable to what the PSBs have. If they want to come in a big way, they may through acquisition of PSBs. That is when we will feel the heat. Every time a senior American official comes to India, he says we need to open up our banking sector. That does not mean they want to take some co-operative bank. Citibank or Bank of America is not interested in that. They are interested in the PSBs. We have the scale to be competitive in the Indian environment now. That is what we should be focussing on.

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