InFocus | India
A robust banking culture
The health of the banking industry is important to India's programme of economic reform. In this respect, much has been achieved. Non-performing loans have been cleaned up and deposits and loans are both growing quickly.
- Financial Times
- Published: 00:00 August 14, 2006
- Reserve Bank of India headquartersin Mumbai.
- Image Credit: Gulf News file
Standard Chartered first opened for business in Kolkata in 1858 and, in keeping with its long history, the emerging markets specialist remains the largest foreign bank in India almost 150 years later.
Yet when compared with the overall size of the Indian economy, Standard Chartered remains a small operator. The bank, which became the market leader in 2000 after it bought the Indian operations of ANZ, has 81 branches in India.
While this represents about one-third of all the branches controlled by foreign banks, it is dwarfed by the domestic banks which, between them, have about 40,000 branches.
For most large western banks, India represents something of a conundrum. On paper it is a large and growing market, with a banking system that is in reasonably healthy shape when compared with China.
Yet while western banks have been busily taking minority stakes in Chinese banks in an attempt to establish a foothold in the country, the Indian market has proved more difficult and harder to unlock.
This is partly a reflection of necessity. While Chinese banks are eager for western technology and credibility as they attempt to shrug off a legacy of communist control and raise capital, Indian banks do not need as much foreign help.
As a result, the Reserve Bank of India has restricted external investment in the country's banks - except those deemed to be in financial difficulty - and have also placed strict limits on the number of branches foreign banks can open.
Indian rules require a bank to obtain a new licence for every branch it wants to open. As part of an agreement with the World Trade Organisation, between 15 and 20 new branch licences are being handed out to foreign banks each year.
This slow pace has proved frustrating for banks eager to tap into the growing demand for financial services among India's emerging middle class. Meanwhile, restrictions on foreign ownership have forced banks such as HSBC, the world's third-largest financial services group, to shrink their shareholdings in local banks.
These restrictions are expected to stay in place until 2009 when India has pledged to open up its banking system. Yet bank executives are still unclear whether they will then be free to take full control of Indian lenders.
The health of the banking industry is important to India's programme of economic reform. In this respect, much has been achieved. Non-performing loans have been cleaned up and deposits and loans are both growing quickly.
"We are at a stage where there is robustness in the banking system, there are strong risk management practices, and technology has reduced costs," says Gunit Chadha, chief executive of Deutsche Bank in India.
"The pace of innovation will increase, even while the central bank simultaneously would like to build a more inclusive banking culture that allows the common man on the street to benefit from banking services."
However, Indian banks remain fragmented, inefficient, and largely under state control: about three-quarters of the country's banking assets are in state hands. These banks are also bad at recycling capital in the economy.
According to the RBI, only 72 per cent of deposits are subsequently lent out. Poor people in rural areas still have limited access to banks and often have to rely on moneylenders for loans. What is more, some observers say the benefits of recent reforms still have to be proved.
"The last five years have seen the state-owned banks improve the balance sheets considerably — though this was done at a time when interest rates were coming down," says Neeraj Swaroop, chief executive of Standard Chartered in India. "The real test is going to be now. How improved are they in their ability to manage in a rising interest rate environment?"
In the absence of significant growth opportunities in retail banking, most western banks are concentrating on wholesale financial services: helping to finance growing companies in India and facilitating trade with the rest of the world. However, in this respect, there is also pressure for reform.
India's currency is not convertible, limiting the scope for the introduction of a broader range of investment banking products, while some regulations continue to limit banks' ability to securitise loans or structure derivatives.
Observers point out that changes in this area could benefit the underlying economy by freeing up companies' access to capital. "It's important that innovation comes in the credit markets and in corporate debt. These issues are equally, if not more, important than the branch licensing issue, which is often over-debated," says Deutsche Bank's Chadha.
Foreign banks are also increasingly building up their private banking businesses, targeting wealthy Indians in large cities such as Mumbai. This remains a relatively small business when compared with the wealth of so-called non-resident Indians, who account for a growing proportion of private banking accounts in financial centres such as London.
The main challenge for foreign banks in India, however, is to be patient. While the prospect of establishing a base in such a large developing country is mouthwatering, the Indian authorities are likely to be cautious about opening up the market until the domestic banks have undergone further reform.
In the meantime, bank executives must attempt to build up their local brands in preparation for changes which will not come for at least another three years. As McKinsey, the consultancy, wrote in a report published last year: "Maintaining a fundamentally long-term value-creation mindset will be (the foreign banks') greatest challenge."
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