Banking in India, Past, Present and Future
Banking - Back in the day
In India, retail banking is still at a very nascent stage. In fact retail banking as we know it, i.e. a customer centric organisation based on personal banking facilities, has been around for less than 2 decades. The Congress government, led by Indira Gandhi in 1969 nationalised the 14 largest commercial banks in India and a further 8 were nationalised in 1980. India had been trending towards a socialist mixed economy since India achieved independence from Britain. For whatever reasons they had, the founding fathers of this country, in particular India’s first prime minister, Jawaharlal Nehru felt that the government knew better than its own people. The then and subsequent Congress led governments of India embarked on an ambitious regime of intervention, regulation and ultimately nationalisation. They devised a complex system of licenses granted by the government simply to do business known as the infamous “license Raj”. A system which was completely disastrous for the country’s economy, and from which it will never ever truly recover. Empowering bureaucrat’s rather than entrepreneurs, stifling innovation and instead rewarding inefficiency, resulting in widespread corruption.
The 4-6-4 Rule
As a result Indian Banks from 1969 onwards had little incentive to serve retail customers. The government effectively controlled credit delivery in the country because it felt it needed to play a larger role in this critical area of the economy. Whilst retail banking was being revolutionised in the rest of the world with innovative new products being designed and developed for the consumer, the sector stagnated in India with anemic growth and poorly served customers. In those days Indian bankers followed the 4-6-4 rule. Borrow at 4% lend at 6% and then be back home for 4 PM!
Crisis and Reform
In 1991, India experienced a serious financial crisis and was nearly bankrupted and with only 2 weeks worth of foreign exchange reserves left to pay for imports, the country almost defaulted on its sovereign debt. It became clear that the country had to be reformed if it wished to survive. The PV Narasimha Rao led government, along with then Finance Minister Manmohan Singh, who is now the current Prime Minister of India, set about the process of liberalising the country’s economy. Undertaking much needed reform, dismantling the paralysing system of the “license raj” and allowing foreign direct investment into domestic sectors of the economy.
Today’s landscape
One of the areas which obviously benefited was retail banking (reforms were also responsible for the IT boom). Banking had up to that point been a sleepy backwater for career civil servants who lived out their entire working lives without any interference from shareholders or accountability from their customers. Things started to change dramatically in 1991 when the Government of India licensed a handful of private banks, to operate relatively freely. Global Trust Bank, Axis Bank, ICICI Bank and HDFC were the first of a new generation of Indian banks hungry for business, looking carefully at western business models and aggressively marketing new products like credit cards and personal loans and later ATM’s and internet banking to their customers.
Opening India up to Competition
Global banking giants like HSBC, Citibank and even smaller regional Asian players Like Standard Chartered have in fact been present in the India for decades, HSBC for example has been operating in India since 1959; though with very few branches and simply to service trade financing requirements for its corporate customers. In the last decade though, the retail banking sector has been opened up to foreign players, though they have not been allowed to compete on a level playing field. Whilst Indian banks can grow as they like and open up branches as when and where they see fit, provided they receive the requisite RBI approval which is mostly a given. Foreign banks do not have the same privileges. Foreign banks like Citi and HSBC are allowed to open up a maximum of 12 new branches every year and don’t receive the necessary approvals to open even that many. In contrast HDFC, which currently has the second largest branch network in the country after ICICI Bank, plans to open up 250 new branches in the 2008 alone, eventually making it the largest branch network in the country. Foreign banks that operate wholly owned subsidiaries in the country have not been allowed to hold more than a 5% stake in domestic Indian banks either. So foreign players cannot increase their market share through acquisitions, though ING Groep NV holds a 43.9% stake in ING Vysya bank. ING is the only foreign financial institution to hold a sizeable stake in a domestic Indian bank and is allowed to do so because it does not operate a separate subsidiary in the country.
Multinational banks which have been eying the India growth story for the last decade have been keen to get their hands on substantial market share as the economy grows at over 8% annually and almost every single major retail banking group has either applied to the RBI for permission to start a subsidiary already, or has an India strategy in place. Domestic banks on the other hand have transformed, even government owned banks are waking up from a deep sleep and finding that in order to survive in this brave new world where customer is king they need to compete.
The Customer is Always Right
What does this all mean for the consumer? It should mean better service for a start, and this has largely been the case. Prior to reform, just making a withdrawal from the bank required a day off from work in order to stand in a queue. Now one can simply visit an ATM or transact via the internet. It should be mentioned that service levels are not always up to standard however, and if you do indeed have a problem, it can be time consuming and rather frustrating in India compared to the rest of the world. The second implication of increased competition is that there are a whole host of products available to consumers that were not available previously. Mortgages offered by private lenders have facilitated the property boom in this country, credit cards have helped stoke a retail boom, personal loans and overdrafts have all allowed individuals to aspire to a standard of living that was simply not attainable in the past.
No Pain No Gain
There is no gain without pain however, especially in the area of unsecured lending more commonly known as credit cards or overdrafts. In their rush to grab market share, banks especially the foreign ones which are not allowed to compete on a level playing field with their domestic rivals have been less than prudent in who they have issued their cards too. Growth in consumer lending has started off from a low base, from almost zero in fact and there has been torrid growth in loan portfolios, double digit every year for the last decade. In order to sustain such growth, banks have compromised on credit quality; customers themselves are not always the most well informed either. In a country where there is almost no personal debt and no real history of it, individuals who have been making bad decisions, either don’t understand the implications of defaulting or simply don’t care. This has led to a high level of delinquencies especially for the foreign retail banks that have been the most aggressive in trying to capture market share, because they simply don’t have the branch network to compete with domestic rivals. This has resulted in high levels of interest rates for everyone as banks try to compensate. And this is the basis of the industry lobby’s complaint before the Supreme Court of India in fact. Though the lobby claims the reason for excessive penal rates of interest is their high costs, what they really face is a poor quality portfolio which has a higher than average default ratio mainly due to poor or even predatory lending practices.
The Lesson of Subprime
Regulation and protection has had its benefits too, it has not all been bad. Because Indian banks are heavily regulated in terms of the types of assets they can invest in, domestic Indian banks have largely been insulated from the credit contagion that is sweeping the globe and the US in particular. ICICI Bank, India’s largest private sector bank for example, has had to write down less than US$250 million dollars so far. Most of which was exposure to a derivative contract it had with a client, that was related to the value of a subprime asset rather than holding subprime assets on its balance sheet itself. Compared to the nearly US$500 billion that has been written down so far globally, that amount is little more than a sneeze and they seem to be the only Indian financial institution with any serious exposure. In this instance being a little less evolved has been to India’s advantage. The Indian financial system can look to the west as it becomes more sophisticated and avoid some of the mistakes that have caused global financial giants to teeter on the edge of insolvency and force venerable investment banks like Lehman Brothers and Merrill Lynch to either declare bankruptcy or sell themselves to someone else and lose their independence.
Indian Banking - The Future
Ultimately the Indian financial services industry has come a long way, Indian consumers can avail themselves to nearly any product that is conceivable now. The banks themselves need to evaluate customers better, despite their thirst for market share, so that they can remain healthy and interest rates can be kept lower for everyone. Customers need to be better educated about what it is they are getting into. The government needs to regulate further so that consumer are better protected, have all the information available and are able to make educated well informed decisions. And everybody not just the banks, but we as individuals, need to look and be able to learn not just from our own mistakes from the mistakes of the others as well.
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3 Responses to “Banking in India, Past, Present and Future”
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Nice article!
Very good and comprehensive article. It was 6 and not 8 banks nationalised in 1980. Indian banking system experienced several ups and downs for various reasons. If politics and economy was not faring well; banking - public or private obviously was not productive or profitable too. But they have always supported the Govt policies thanks to not so independent RBI (Central Bank).
Post reforms era, thanks to technology, legal and accounting changes and several other radical measures, they proved to be efficient. Public Sector Banks withstood all types of onslaughts including competing with Private - old and new - as also foreign banks. Today, there is a perfect level playing field even though certain policies like appointment of CMDs / CEOs and Directors on the Board still vests with RBI / GOI. CAR, CRR, SLR, Priority Sector and other obligations still are in force.
Indian Financial System has also witnessed 3-4 major scams even after 1991 and witnessed the meltdown in 1998, Stock Market crashes and now the Sub-prime crisis. Banking system in India is very robust and is poised to grow faster in the years to come and face stiff challenges.
Thank you very much for the correction. Much obliged. I am not entirely sure that foreign banks would agree there is a level playing field in India I am sure they would dearly love to be able to set up more than 12 branches a years. But I would agree that a lot of government owned banks seem to have held there own during what can only really be described as a remarkable transformation for the industry.