Whats Driving the Bank Rush?

Indian corporates with dreams to own banks will have to deal with a more powerful RBI
Sugata Ghosh

It was like a bomb in the backyard, ticking away for years. Few feared it could explode, no one believed it had the potency to rattle everyone around. When it did, it caused red faces and weeks of bad press, exposing the ignorance about a high-risk business and the cavalier attitude of men who ran it. Most of Corporate Indias brush with financial services be it banking, nonbanking, brokerage and private equity have been either short-lived and bitter, or long and unpromising. Some quietly swallowed loss, quickly burying the scandal; few made real money out of it at least not in transactions which were above board. But the wonder world of finance continues to cast its spell on business houses. Today, they all want to own a bank that big missing piece they think can make all the difference. Whats in a bank? Its a business with stifling rules, a difficult regulator, hidden risks and cut-throat competition. Whats in it that excites some of the biggest names in India Inc? But, make no mistake: this is one business that can never fail. In all other businesses, you may either succeed or languish for years or fall by the wayside. But in banking, only the degree of success may differ. A few will emerge like HDFC Bank and Axis Bank, with high market capitalisation, robust earnings and solid brands; some like Bank of Rajasthan will flounder. But even banks that dont quite make it will find takers. The near insurmountable entry barriers will always command a scarcity premium, but buyers with dreams of owning a bank will be willing to pay. Unless there are blatant governance lapses like using depositors savings to ramp up stocks, cutting sweetheart deals with a rogue trader and passing off sticky, irrecoverable loans as standard ones promoters can extract a good deal while palming off the bank to new investors. But this certainly isnt the only reason behind the excitement that followed RBIs draft rules. There are business reasons. Like roads, ports, schools and healthcare, a bank is a utility which will generate a decent return. The speed with which you make money may be limited by regulations on capital, exposures, risks and tighter rules that follow every new shock in financial markets. But you have to screw it up big time to keep on losing money. A lot depends on how the manager who understands the business deals with promoters who often dont. The CEO, who can persuade top shareholders that quality of loans should not be compromised to fatten balance sheet and play the valuation game, will be the winner in 10 years from now. But sparing a few CEOs of banks, backed by large and, occasionally, faceless institutions, few could choose a pace they preferred. Many gave in to pressure, while some switched jobs. It is not easy to deal with promoters who have tasted the power that a bank wields another reason that will drive some to fish for a licence. The power to influence credit, the ability to leverage and the freedom to lend . 1,000 with less than . 100 of your own capital can be irresistible, even tempting. A successful banker will tell you that while these will thrill many business houses, there are large and untapped frontiers which can be the money-spinners a decade later.

There are unbanked areas, and banks have to crack that model of doing business there. Find your target market, define businesses, pick the right technology, take care of credit risks and make the right hire, said one of them. Few can deny, but how many will go for it? Till now, old and new-generation banks havent quite done that: all have tried to make money by snooping around for a niche market, jostling in crowded, overbanked towns to push home and auto loans, find corporate borrowers, ask them to direct their vendors and employees to open saving accounts, join a debt syndication deal, trade in bonds and currencies and make quick spreads through structured finance and fancy derivative transactions. Will the new kids, whoever they turn out to be, do something different? Theres something else that hasnt crossed the minds of corporates. Their relentless lobbying will slowly make RBI, already a formidable regulator, a more powerful entity. For arguments sake, if RBI decides to be a little less selective and instead becomes more generous in giving licences, it will end up controlling the lives of most large businesses houses. These corporate groups will have to deal with a super regulator who can sack CEOs, lower their salaries, supersede boards, put them under oath and undertake inspections may be to find out whether a bank borrower is also a vendor for a promoter group company. All that will happen later. For the next one year, governor Subbarao and his team can put up their feet and relax. The action will shift from Mumbai to Delhi as business house lobbyists spend more time trying to bring about changes in the Banking Regulation Act, which will make RBI more powerful and failing which no licence will be issued. For years, several RBI governors have pushed for it, with no success. Now, with the stroke of a pen, Mint Road has made sure that India Inc does the messy work that it couldnt.

Some Bitter Lessons from the Past

GLOBAL TRUST BANK From day one, there were whispers of sharp practices. But GTB still came across as a success story of a professional entrepreneur. Amid a mountain of sticky loans, insider trading allegations and an aborted merger, the bank was merged with PSU Oriental Bank of Commerce. SIKKIM BANK With its registered office in Gangtok and headquarters in Calcutta, it was a sleepy sill shop that few knew about. But it was a quiet, money laundering machine that fronted for a few Andhra and Tamil Nadu politicians. The major shareholder was a leading Calcutta-based stock broker whose good days came to an end after the 2001 payment crisis in Calcutta Stock Exchange. After RBI inspection revealed rampant evergreening, the bank was merged with Bank of Baroda. CENTURION BANK The private bank became a basket case after the promoters decided to merge their ailing finance company with the bank. It was a ploy to cut their losses by using the banks balance sheet. But after a while, the gaping holes in the non-bank finance firm were big enough to push the banks net worth into a negative territory. After a few years, a private equity fund stepped in to pick up a substantial stake in Centurion, and RBI approved a complex capital restructuring to keep it afloat.

BANK OF RAJASTHAN It was a governance issue of another kind. Investigations carried out by financial market regulators brought out the strange shareholding structure where small, inconspicuous individuals, living in Mumbai chawls were holding shares worth crores while fronting for large shareholders. UNITED WESTERN BANK RBI tried a different method to push through an amalgamation of this small, Maharashtra-based bank whose capital was eroded by bad loans with a bigger institution. The regulator decided to auction the bank and all interested lenders were asked to bid. ICICI, the biggest private bank, joined the race along with a few MNC banks. United Western was eventually handed over to IDBI Bank, which by then had changed its ownership from private sector to a stateowned bank NEDUNGADI BANK Kozhikode-based Nedungadi, the oldest private sector bank in Kerala, had surrendered its treasury operations to a Mumbai-based stock broker who had joined hands with a textile mill owner. The bank was amalgamated with Punjab National Bank in a typical shotgun wedding style that RBI has perfected to force-merge sick banks.

RBI WILL HAVE THE LAST WORD

Bank Window Opens for Cos with Stoppers

India Inc excited as draft norms will not be too difficult to meet for cos with strong credentials
OUR BUREAU MUMBAI

After years of intense lobbying, business houses wanting to set up banks are spotting a ray of hope. The Reserve Bank of India is slowly opening the doors for corporates to enter the highly-regulated industry, but with caution, conditions and caveats. In draft guidelines issued on Monday, the banking regulator laid down the broad rules of the game: finance companies can be converted into banks, and promoter groups with sound credentials and integrity and a 10-year record of successfully running their businesses can set up banks. Such banks should have a minimum paid-up capital of . 500 crore, run 25% of their branches in rural unbanked regions, list within two years, and be owned by a separate holding company that cannot borrow money to float the bank. Total foreign holding in the bank cannot cross 49% while the operating company must lower its stake to 20% by 10 years. Corporates may find it easy to meet most conditions, but the RBI has spelt out it will be very selective and have the last word. it may not be possible to issue licences to all the applicants meeting the eligibility criteria, said the draft note. A key pre-condition is changes in the Banking Regulation Act to empower the RBI to supersede bank boards and block purchase of 5% or more shares if the investor is not fit and proper. India Inc, nonetheless, is excited. Reiterating the Aditya Birla Groups strong intent to enter banking, Chairman Kumar Mangalam Birla said it was a forward step while Bajaj Finserve MD Sanjiv Bajaj said the guidelines were practical and Bajaj Auto and Bajaj Finserve are eligible. A senior Tata Group official said it was a positive move. Banking on New Rules The Hurdles No new licence till laws change to give RBI more power Negative feedback from other regulators can dash chances Comments from CBI, ED & other govt agencies can backfire The Race Tatas, Aditya Birla group, Bajaj, L&T, LIC Housing, M&M, Shriram group, Reliance, ADAG, PFC, IFCI, Religare, Srei may be interested Edelweiss with active broking biz

may lose out; IDFC & IndiaBulls said they are not interested in banking THE RULES Paid-up cap of Rs 500 crore, listing within 2 years No foreign entity/NRI can hold over 5% shares Biz groups will have to float a holding co to own bank & other financial services like insurance, broking etc Some Time before RBI Issues Licence Even though the financial services business has been a pitfall for several corporate houses in the last two decades, most have harboured hopes of promoting banks. Its a high-risk business and you have to be paranoid to run it, said Uday Kotak, whose group had received a banking licence in the last round (2003-04). But like others, he too was enthused on Monday: I hope this bodes well for the government as it plans to move on the reform path. The RBI, which has had to deal with shady promoters holding benami shares, brokers taking over treasury of small private and co-operative banks, and flamboyant promoters cutting funny deals with diamond merchants to borrow money for the bank, is understandably paranoid. Under the current norms, promoters will have to declare their source of funds and no single entity or group, other than the operating company, shall have direct or indirect shareholding in excess of 10%. The draft guidelines reflect the RBIs learnings from bank failures. For instance, restricting exposures to suppliers and customers of industrial houses where it is a promoter is really seen as a form of connected lending and selfdealing, said H Jayesh, founder partner at law firm JurisCorp. While corporates will now pressurise the government to amend the BR Act, it will be some time before the RBI issues the first licence. According to Ashvin Parekh, partner, Ernst & Young, It may be 2-3 years before we see a new bank becoming operational. Diversified ownership and exercise of regulatory control are essential conditions...There have been instances in the past where promoter shareholding was not pared according to plans. Some aspirants like Religare were confident they would be able to fulfil the RBIs criteria. Religare Enterprises Limited (REL) is already regulated by the RBI. Besides, they have also separated ownership and management, and today majority of Religare Enterprises board members are independent of the promoter group and the promoters themselves do not participate at the REL board level, said a Religare spokesperson. Anil Ambanis Reliance Capital said it was looking forward to the release of the final guidelines while N Sivaraman, president, L&T Finance Holdings, said two years is too short a period for a new bank to get listed. Considering the time a new bank would require to create a base and brand to raise money, a fiveyear period would have been better, he said. Among the eligibility conditions outlined by it, the RBI will collect feedback from other regulators as well as agencies like CBI and Enforcement Directorate while deciding on an application. Conditions like these have created a widely shared perception that the central bank may not be in a hurry to grant licences till some of the ongoing investigations are over. While the RBI will have a lot of discretion, it has framed the guidelines with an open mindthere may not be

any hidden lever, said Saurabh Tripathi, partner & director at The Boston Consulting Group.

Banking
Last Updated: July 2011 Indian Banking Sector: Overview The Indian banking sector comprises 26 state sector banks, besides a number of private as well as co-operative sector players. The banking sector in India has made significant progress in the last five years the growth is well reflected through parameters including profitability, annual credit growth, and decline in non-performing assets (NPAs). In the last decade, the sector witnessed many positive developments, as policy makers which comprise the Reserve Bank of India (RBI), Ministry of Finance and associated government and financial sector regulatory entities, made several distinguished efforts to improve regulation. Worth noting is the fact that Indias banking sector has been one of the very few ones that have actually been able to maintain resilience without much impacting the growth process. Growth in the sector has been favoured by factors including low defaulter ratio,strong economic growth, central banks regular intervention and pre-emptive adjustment of monetary policy. India has the potential to become the third largest banking sector by 2050 after China and US, according to a PricewaterhouseCoopers (PwC) report titled Banking In 2050. The report states that India has particularly strong long-term growth potential. Indian Banking Sector Key Drivers The banking sector in India is expected to have another good year during 2011, with growth being propelled by factors such as good economic growth, favourable demographics and low penetration, according to a report titled Indian banks are likely to ride an economic growth wave, by research firm Standard & Poors.

The countrys economy grew by 8.5 per cent in the last fiscal and the government expects the growth impetus to continue this year as well More than 50 per cent of Indias population is under the age of 30 years, which is a major target group for banks Penetration of banking services in the country remains low. The government has set targets to provide banking facilities to all areas with a population of over 2,000 by March, 2012.

Indian Banking Sector Key Statistics The banking sector in India is well capitalised, with capital ratios being above the global average. The average tier-1 Capital Adequacy Ratio (CAR) of the Indian banking industry is

above 10 per cent compared to the Basel III norm of 8.5 per cent including the contingency buffer. Moreover, the Reserve Bank of India, in its Financial Stability Report (FSR) has also asserted that the sector remains well capitalised with both core capital adequacy and leverage ratios at comfortable level. Efficient internal capital generation, fairly active capital markets, and strong support from the government ensured good capitalisation for most banks. The overall CAR reached 14 per cent as on March 31, 2011. High levels of public deposits also ensured a comfortable liquidity profile The total assets size of the banking industry rose by more than five times between March 2000 and March 2010 - from US$ 250 billion to more than US$ 1.3 trillion - a Compound Annual Growth Rate (CAGR) of 18 per cent compared to the average GDP growth of 7.2 per cent during the same period. During the last five years, while the annual rate of credit growth was 23 per cent, profitability was maintained at around 15 per cent. While the Indian banking sector is characterised by the presence of a large number of players, top 10 banks accounted for a significant 57 per cent share of the total credit as on March 31, 2011. Nationalised banks accounted for 52.2 per cent of the aggregate deposits, with State Bank of India (SBI) and its Associates accounting for 22.1 per cent. The share of new private sector banks, foreign banks, old private sector banks, and regional rural banks in aggregate deposits was 13.3 per cent, 4.8 per cent, 4.6 per cent and 3.0 per cent, respectively, according to RBIs Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks, December 2010. With respect to gross bank credit, nationalised banks had the highest share of 51.6 per cent in the total bank credit. They were followed by SBI and its associates at 22.7 per cent and new private sector banks at 13.7 per cent. Foreign banks, old private sector banks and regional rural banks had comparatively lower shares in the total bank credit at 5.1 per cent, 4.5 per cent and 2.5 per cent, respectively. India's foreign exchange reserves were US$ 314.6 billion as on July 8, 2011, according to the data in the weekly statistical supplement (WSS) released by RBI. Indian bank loans increased by 19.9 per cent year-on- year (y-o-y) as of July 1, 2011, according to the central bank's WSS. Deposits rose by 18.4 per cent from a year earlier. Indian Banking Trends& Developments The last three decades have demonstrated a significant increase in the size, spread and scope of activities of banks in India. The business profile of banks has changed significantly to include non-traditional activities such as merchant banking, new financial services, mutual funds, etc. The evolution from class banking to mass banking and rising customer focus is immensely changing the landscape of Indian banking.

Payments and banking transactions through mobile phones in India are likely to reach US$350 billion by 2015, according to global management consulting firm, The Boston Consulting Group (BCG). This, in turn, will provide banks, telecom operators, device makers and service providers an opportunity to earn fee income of US$4.5 billion With an objective of increasing the financial inclusion, the SBI has opened 21 new branches, besides, 101 new Automatic Teller Machines (ATMs) and 400 green channel counters. Around 350,000 villages spanning the entire India would have access to financial services offered by banks in the next two financial years, according to a plan given by banks to the RBI. RBI has directed banks to ensure that 223,473 villages have access to basic financial services by March 2012 Three local banks have partnered with a global financial technology firm - Polaris Software with its headquarters in India - to establish a joint venture IT company in Bangladesh. The company would start with providing software solutions to these three banks before selling customised services to other banks, non-bank financial institutions and insurance companies

Indian Banking Key Investments

Standard Chartered Private Equity (SCPE) said that it has invested US$ 56 million in Ravi Jaipuria-promoted Varun Beverages International (VBIL), buying a "significant minority" stake in the bottling firm. The funds would be used to fast-track VBIL's growth in its beverages business in India and in foreign countries South Indian Bank has signed a service agreement with TimesofMoney, an e-payments service provider to offer remittance solutions to Non Resident Indians (NRIs) in selected countries. The service would enable NRIs to get a strong transaction platform along with better pricing and safety, besides speedy money transfer

Government Initiatives The policy makers for the banking sector, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. These changes include:

Strengthening prudential norms Developing the payments system and, Integrating regulations between commercial and co-operative banks To support capitalisation, the government has infused Rs 23,200 crore (US$ 5.2 billion) into state-owned banks during the last three fiscals The RBI has said that for each branch that is proposed to be opened in Tier 3 to Tier 6 centres of under-banked districts of under-banked States, a bank will get the authorisation to open a branch in a Tier 1 or Tier 2 centre. This incentive to banks comes on the back of the continuing need to open more branches in these States in order to ensure more uniform spatial distribution With financial inclusion being a key program for RBI and the government, the central bank has decided to give private banks a push to go rural. The RBI has, in its circular,

said that banks should open at least 25 per cent of the branches under the annual branch expansion plan in un-banked rural centres. Indian Banking - Road Ahead The Indian banking story is running in parallel with Indias growth story. With economic growth of India expected to average at double-digit for the current decade, the banking sector is also poised for growth as the factors contributing to the growth of GDP would act as catalysts for the banking sector as well in retail, corporate as well as rural banking. By 2017, the average consumption in rural India will be the same as of urban India in 2005, according to a McKinsey study. As a result, Indias labour force will grow at a higher rate than population growth and therefore, the ratio of working age population to total population will be on the rise, and it will be more urban, rich and educated. This will result in a higher flow of savings to the banking system. Consumer credit is expected to drive future growth of the sector. Further, Indias mortgage loan and wealth management business will grow 10 times by 2020, according to the estimates put by Boston Consulting Group (BCG). An under penetrated market, both in terms of number of accounts and number of borrowers, the banking segment in India holds huge potential for the future. (Exchange rate used: INR 1 = US$ 0.02253, as on July 22, 2011) References: RBI documents, weekly statistical supplement by RBI, RBIs Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks, December 2010, Press Releases, McKinsey report on Indian Banking, Report by Thomas White on Indian Banking