Commercial Bank Management

PGSEM and PGP December 09-February 2010

This course is focused on

Functional aspects of commercial banking
Liabilities management Credit management Capital adequacy management Investment management

Risk management
Liquidity risk management Interest rate risk management Credit risk management Operational risk management Risk capital allocation Indian Banking policy and the environment is the backdrop of the course

Scheme of Evaluation
Three quizzes (30%)- quiz dates-16th September, 30th September, 14th October Assignment-2 (25%) Final test (45%)

Banking Sector in India :An Overview

Evolution of Indian Banking

Post-Independence(1947-69): Monopoly, concentration of economic power Nationalization(1969): Social control, directed credit Financial sector reforms(1992): Competition, deregulation Consolidation(2001): Universal banking models, mergers etc Financial inclusion, Leveling the playing field (2008):

Indian Banking (1947-1970)

Government take over of RBI(January 1949) Enactment of Banking Regulation Act 1949 Committee on Rural Credit Survey(1951)The Committee recommended one strong integrated state partnered commercial banking institution to stimulate banking development in general and rural credit in particular. The Imperial Bank of India was taken over by the Government of India and called as State Bank of India in 1955 Nationalization of private banks in 1969 and 1980

Impact of Nationalization
(1970 to 1992) Substantial increase in banking business in terms of per capita branches, deposits, and deployment of credit. Penetration of banking activity to rural and semi-urban areas Excessive focus on quantitative achievement and social obligations, often at the expense of achieving profitability and efficiency Capital base was eroded Rise in quantum of bad Loans Poor customer service

Indian Commercial banks: At a glance

Jun-69 Number of Commercial Banks Number of Bank Offices in India Rural Semi-urban Urban Metropoliton Deposits (Rs in millions) Advances (Rs in million) Deposits of Public Sector Banks Advances of Public sector banks Percentage of Deposits of Public sector banks Percentage of Advances of Public sector banks NA 73 8262 1833 3342 1584 1503
46460 35990

Mar-80 75 32149 15105 8122 5178 4014

426528 270081

Mar-92 77 60570 35269 11356 8279 5666

2654629 1598078

Mar-07 82 73836 30560 16484 13840 12952

26969803 19812163

391841.9 248876.2

2358874 14401229

19941995.8 14401228.9

92% 92%

89% 90%

74% 73%

Financial Sector reforms: A beginning

Chakravarthy Committee Report (1985) and Vaghual Committee(1990) brought some changes in the financial markets. The innovative instruments like Treasury bills, CPs, CDs have become new avenues for banks. Entry of Banks into para banking services (late eighties); Merchant banking, Mutual Funds, Leasing, Factoring etc...

McKinnon-Shaw-Maxwell Fry Hypothesis

Excessive intervention in the financial system leads to financial repression and comes in the way of financial intermediation and its contribution to resource mobilization needs to be qualified

Bank Management: Three fundamental approaches

The accommodation principle: Banks should accommodate the legitimate credit demands of commerce, industry and agriculture The profit maximizing principle: The stock adjustment principle

Profit Maximizing Principle

Neo classical marginal principle Banks select asset portfolio by understanding costbenefit analysis so as to maximize the return, net of cost, from the entire portfolio. It is also risk-return approach This approach attempts to incorporate the element of uncertainty inherently associated with decision making process The asset choice modeling assumes greater importance

Stock Adjustment Principle

Banks have a desired level of each balance sheet item and they adjust the stocks of each of the variables so as to close the gap between actual and desired levels

Reforms in Banking Sector-post 1992

Competition Enhancing Measures Measures Enhancing Role of Market Forces Prudential Measures Institutional and Legal Measures Supervisory Measures Technology Related Measures

Implications of reforms on bank management

How do banks manage liabilities and funds? How to price deposits and minimise cost of funds? How to rate the loans? What are the risk-return characteristics of loans? How to price the loans? How to fix the exposure norms? How to estimate expected and unexpected losses on loans? How to manage market risks?

Emerging Trends
Deposit banking to financial services Balance sheet exposures to off-balance sheet exposures Capital adequacy to capital efficiency Physical distribution to virtual distribution Fragmentation to consolidation Data to information to knowledge

INDIAN COMMERCIAL BANKING:INSTITUTIONAL SET UP Reserve Bank of India

Commercial Banks

Coperative banks (2805)

Public Sector

Private Sector

SBI and Associates Nationalised Banks (8) (19+1)

RRBs (193)

Domestic banks

Foreign banks (31)

Old Banks New Banks (19) (8)

LABs (4)

Scheduled Commercial Banks

A bank which is included under second schedule of the RBI Act. Under Section 42(6) of the Act, the RBI may include any bank after satisfying minimum criteria. The minimum criteria is Banks whose deposits are more than Rs. 150 Cr, they are all Scheduled Banks

Institutional Structure of Commercial Banks in India

96

29 25 20

STATE BANK OF INDIA & ITS ASSOCIATES

NATIONALISED BANKS

PRIVATE BANKS

FOREIGN BANKS

REGIONAL RURAL BANKS

Advances of Various Banking Groups as on 31 March 2007

Foreign Banks 9%

SBI group 13%

Private Banks 26%

Nationalised Banks 52%

Deposits of various banking Groups as on 31st March 2007

Foreign Banks 6% Private Banks 20%

SBI group 24%

Nationalised Banks 50%

Banking Sector: Emerging Trends

Forces of change
Competition Deregulation and reregulation Technology Globalisation Global Regulation: Basel-II

Foreign banks entry time-table

ROADMAP

PRIOR TO MARCH 2005 2005-2009 AFTER 2009 Branches or Full national treatment, including IPO, Structure of foreign bank Branches only wholly-owned subject to 26% of paid-in capital being presence in India subsidiaries held by resident Indians 74% for banks Aggregate FDI limit in private 49% identified as 74% banks distressed by RBI Proposed amendment to allow voting rights to reflect 10% Foreign voting rights limit ownership level Branching limit per year 12 >12 subject to RBI approval

Unchanged 5% foreign investment limit in private banks by individual foreign banks 10% foreign investment limit in private banks by FIIs or individual corporate entities

Competition from Non-Banks

In US, GE and Ford emerged as the largest financial services companies In UK, Sainsbury, Marks & Spencer and Tesco are taking deposits and making loans Fixed costs of entering into various markets has come down due to technology Australian retail giant Woolworths is launching its credit card in calendar year 2008. After that, the company would consider offering other financial services including home loans or insurance to its customers.

Year

Retailer

Product

Provider

Brand Promoted in Store

Jun-96 Oct-96

Tesco Sainsbury

Instant Access Savings Account Instant Access Savings Account Credit Cards

Natwest Bank of Scotland

Tesco Sainsbury

Dec-96 Feb-97

Safeway Tesco

Deposit Account Instant Access Savings Account

Abbey National RBS

Abbey National Tesco

Mar-97

Morrisons

Savings Account
Credit Card Travel Insurance, Foreign Currency Mortgages Insurance Instant Access Account Home Insurance Home Insurance Pet Care Insurance

Midland

Midland

Jul-97
Jul-97 Sep-97 Jan-98 Jan-98 Mar-98 Jun-98

Tesco
Sainsbury Asda Safeway Sainsbury Tesco Sainsbury

RBS, Direct lane

Bank of Scotland Lloyds-Tsb Abbey National Royal and Sun Alliance Direct Line Royal and Sun Alliance

Tesco
Sainsbury Lloyds-Tsb Abbey National Royal and Sun Alliance Tesco Royal and Sun Alliance

Source: Andrew Alexander and Jane Pollard, Banks, Grocers and the changing retailing of financial services in Britain, JRCS, 2000

Competition from Non-Banks

Controlling communication networks and gate ways are emerging as brokers directing the customers The loyalty of customer is increasingly broker oriented rather than ultimate producer of the product The possession of brand name is inspiring confidence

Impact of Technology

The 6 Cs

Traditional Model

Internet Enabled

Cross Sell
Connectivity Channels

Product driven Value driven

Stand alone Few Connected Multiple High-across products and banks Outside Industry

Consolidation Low Within Competition Industry

Convenience 24 x 7x 365 (Source: Sanjiv Singhal (2003) Internet Banking: The Second Wave, p 43)

Short time window

The PC will be the information highway. The mobile phone

will be the transaction highway

-Kees Van Rossum, Executive Vice President, Retail Banking, Post bank

Country
Finland Germany

Bank
Leonia/Various Deutsche Direkt Hypo Vereinsbank

Mobile Operator
Sonera Mannesmann T-mobil Viag Interkom

LBBW
Italy Banca Intesa Banco di Roma/Fineco Japan Norway Spain Sweden England Sakura Bank Den Norske Bank BBVA Swed Bank Lloyd's Natwest

MobilCom
Omnitel Telcom Italia NTT DoCoMo Telenor Telefonica Moviles Telenor BT-Celinet Orange

Leverage on Technology
Operational efficiency Customer Management Product Management Distribution

Consolidation

Mergers and Acquisitions: Driving factors

Economies of Scale Overcapacity High cost distribution and transaction infrastructures such as branch networks and IT platforms that lend themselves to rationalization Economies of Scope Universal Banks Barriers in product innovation leads to innovation on distribution side Capital adequacy requirements

Potential Industry Structure

Few

Many
Small Medium Large

Size

Financial Inclusion
Financial inclusion is delivery of banking services at an affordable cost to the vast sections of disadvantaged and low income groups. As banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of the public policy.

Financial Inclusion
The Financial Inclusion Task Force in UK has identified three priority areas for the purpose of financial inclusion access to banking access to affordable credit access to free face-to-face money advice UK has established a Financial Inclusion Fund to promote financial inclusion and assigned responsibility to banks and credit unions in removing financial exclusion. Basic no frills accounts have been introduced.

Financial Inclusion: Initiatives of UK

Credit unions have been established, accompanied by tighter regulations to ensure greater protection for investors. Post Office Card Account (POCA) has been created for those who are unable or unwilling to access a basic bank account. The concept of a Savings Gateway has been piloted. This offers those on low-income employment, 1 from the State for every 1 they invest, up to a maximum of 25 per month. Community Finance Learning Initiatives (CFLIs) were also introduced with a view to promoting basic financial literacy among housing association tenants.

Indicator of banking growth

Opportunity

Benchmarking of Indian Banking Sector Country 1 India Emerging and Developing Economies Brazil Mexico Russia China United Arab Emirates South Africa Return on Assets 2 1.0* Gross NPL to Gross Advances 3 2.3* CRAR 4 13.0* Provisions to Capital to NPL Assets 5 6 52.6* 6.4**

1.1 1.2 0.5* 1* 2.2* 1

4.3 3.8 7.6 1.8 2.5* 5.1

18.5 15.2 18.5 12.0* 16.2 13.5

157.3 143.7 90.8 134.3 101.5* _

9.2 9.1 13.6* 5.4 10.6* 7.9*

Advanced Economies USA UK Japan France Germany Italy Canada Korea

* Data pertains to 2008. ** data pertains to 2007 ^ Data pertains to 2006 Note: Data pertains to 2009.

0.2 -0.5 0.2 0.4** 0.3** 0.3* 1.3 0.5*

3.8 1.6 1.7 2.8** 2.7** 5.5 0.9 1.5

13.5 12.9* 13.4 10.2** 12.9** 10.8* 10.3 12.9

66.5 54.6^ 25.5 51.3** 56.7* 46.1* 29.8 125.3

10.1 4.4* 3.6* 4.2* 4.5* 6.6* 5.8 9.5

Ratio of Deposit Accounts to Adult Population

All India Average (based on 2001 Census) Kerala Bihar Nagaland 59% 89% 33% 21%

Haryana, Chandigarh and Delhi

UK (British Bankers Association Survey1992)

84%
94%