Financial Analysis of Banking Industry in India

A Group Assignment for

Management Accounting

Submitted to
Professor Prakash Singh
Finance and Accounting Area
IIM Lucknow

Submitted by Group 5

Name
Abhinav Pandey
Abhishek Choudhry
Abhishek Dharam
Nigam Mehta
Sahil Garg
Shelly Arora

Roll No
IPMX09001
IPMX09002
IPMX09003
IPMX09035
IPMX09043
IPMX09049

May 17, 2016

Table of Contents

Contents
Table of Contents ............................................................................................................................................... 2
Introduction ....................................................................................................................................................... 3
Macro-economic factors affecting Banking Industry......................................................................................... 4
Industry characteristics ...................................................................................................................................... 5
Banking Industry in NEWS.................................................................................................................................. 7

Introduction
Choice of industry
Banks play a pivotal role in a countrys economy as suppliers of financial liquidity and credit services. The
products of the banking industry broadly include deposits, credit products and customized banking services.
Most of the banks offer the same kind of products with minor variations. The banks differentiate themselves
in terms of quality of services and the delivery channels used.
We selected this industry as the banks serve two customer segments the borrowers and the depositors.
Also, the banking scenario in our country is heavily regulated. Over the last couple of years, financial
inclusion and digital technology adoption have become the keywords for this industry. A lot of new players
are expected to join this industry after RBI gave banking licenses last year. We feel that it would be
interesting to learn about the growth and changes in the banking services. Accordingly, we have picked the
players: a largest state owned bank, a private sector bank and a government bank in distress.

Choice of players
1. State Bank of India
SBI was constituted through an Act of Parliament on 8 May 1955, after the Reserve Bank of India acquired
controlling stake in the Imperial Bank of India, which then came to be known as State Bank of India. As of
19th May 2015, the bank had a pan Indian coverage of 84,036 villages with more than 14000 branches. The
bank owns a network of 54,560 ATMs. It has an active customer base of over 27.32 crores.
We have selected SBI as it is the largest bank in the country in terms of Deposits, Advances, Profits,
Branches and Employees.

2. HDFC Bank Ltd

HDFC Bank was incorporated in August 1994. As of December 31, 2015, the Bank had a national network of
4,281 branches and 11,843 ATM's in 2,505 cities/towns.
We have selected HDFC Bank Ltd as a cursory look at the companys Annual statement showed that over
the past five years, it has reported a growth in Profit after Tax in the range of 20% - 33%. It would be
interesting to know how the bank has managed to achieve such results.
3. United Bank of India
United Bank of India Ltd., was incorporated in 1950. It is one of the 14 banks that were nationalized in 1969.
As of May 2015, the bank had 2000+ branches with more than 3.64 Crore customers.
We have selected United Bank of India as the companys performance in the FY 2013-14 was significantly
impacted by the bad loans. In fact in November 2013, the RBI banned the bank from lending amounts
exceeding Rs10 Crore to a single borrower after the banks bad loans piled up. Over a period of time, these
restrictions have been gradually lifted.

Macro-economic factors affecting Banking Industry

Macroeconomic factors reveal that an economic slowdown greatly impacts the financial stability of the banking
sector. A fall in the economic activity, represented by GDP growth rate and trade balance, adversely affects the
various business sectors and thus makes it difficult for them to service the loans taken by the business entities.
Similarly, a high inflation level prevalent in the country, captured by the wholesale price index, reduces the
disposable income of individuals and increases the input costs for business groups. This again leads to higher
chances of loan defaults. Higher government borrowing also reduces the money in the market available in the form
of loan to non-government entities. This also increases the interest rate which dissuades the general public from
availing loans.

GDP growth: It is expected that the financial sector profitability will increase during cyclical upswings, owing to the
fact that lending will increase during times of economic growth. This indicates a positive relationship between GDP
growth and profitability of banks.
TRB (Trade Balance) represents the ratio of Indias trade balance (total exports total imports) to the GDP. Higher
trade balance ratio signifies better performance by exporters of the country and hence could be negatively
correlated with NPA.
Wholesale Price Index Inflation represents the inflation of the country represented by the wholesale price index.
Higher level of inflation would reduce the disposable income of an individual/entity and would adversely impact
his/her loan repayment capability and hence would increase the NPA levels. The relationship between inflation and
profitability is substantial. Inflation accounts for economic uncertainty. The impact of inflation rate on the
profitability of the Banking Sector is negative.
FD (Fiscal Deficit) Increase in fiscal deficit would lead to increased borrowing by the government which is considered
as a safe asset with no chances of default. This would also reduce the money available for lending in the market and
increase the weighted average lending rate. This would impact the business of banks.
Capital Requirement RBI declares the Statutory Liquidity Ratio (SLR) which makes it mandatory for banks to invest in
government securities. Banks with surplus liquidity are also inclined to invest in these securities, over and above
their SLR, as they are considered a secured investment option without any chances of default.

Industry characteristics
Major Players
The following are the top 5 banks in the country, going by market capitalization:
1) HDFC Bank
2) State Bank of India
3) ICICI Bank Limited
4) Axis Bank
5) Kotak Mahindra Bank

Market Share

Source: www.Jagoinvestor.com

Generic Business Model & Cost Structure

The basic function of bank is to accept deposits for the purpose of lending. But the amount of money that banks can
lend is directly affected by the various reserve requirements set by the Central Bank. Banks in India also have to
adhere to other requirements such as Priority Sector lending and mandatory opening certain percentage of branches
in unbanked rural centers. Banks by the very nature of their business are highly leveraged and thus are required to
fulfill rules of Capital Requirement (based on regulatory guidelines). In India as per the RBI, implementation of Basel
III will be completed in a phased manner by 31 March 2018.
The major challenge faced by Indian Bank is the stress in asset quality. The asset quality problem can be ascribed to
various causes like Environmental factors, Corporate Imprudence, Corporate Misdemeanors and Banks failings.
Once the advance is classified as NPA, it is accompanied by provisioning, which ensures the bank sets aside a buffer
to absorb likely losses. The stressed asset has moved up to 14.5 % as at the end of Dec 2015.
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Two major sources of revenue for the bank are Interest income and Fee revenue & Commission. Banks make money
from the interest rate differential and charge fee income for various allied services such as locker. The also get
commissions for activities like insurance and credit cards. The major cost of the bank is Interest Expenses and
Channel Costs.

Issues and Concerns of the Industry

The following are the major concerns for most of the players in the current scenario:
a) Non-Performing Assets
b) Reduced profits:
c) Corruption
d) Monetary Transmission

Analysis of Michael Porter's Five Forces

Threat of New Entrants: Low
Stringent regulations and high initial investment make the entry of new players difficult. Although a
relaxation in RBI norms and Government policies have allowed a number of foreign and private players to
enter the market, it is still not possible for anyone to start up a bank. Low product differentiation also acts
as a deterrent to new entries as grabbing a market share becomes difficult.
Bargaining Power of Suppliers: Low
Capital and Human resources are the two major supplies needed by a bank. The major source of capital for
Indian banks is household deposits. Low risk aptitude of the depositors, few alternatives for investments
and RBI regulations for deciding the interest rates significantly reduces the bargaining power of the
depositors (suppliers).
With an increase in unemployment rates and decrease in number of jobs in the field of engineering, a major
chunk of youth aspires for jobs in banking industry. According to a news report, State Bank of India received
17 Lakh applications for its 1500 vacancies in 2013. Hence there is no dearth of human capital in banking
which further reduces the buying power of suppliers.
Bargaining Power of Buyers: Moderate
The customer base of Indian banks constitutes majorly of retail customers and Corporates seeking relatively
bigger loans. The switching cost from one bank to another for a household customer is significant while for
a corporate it is negligible. Hence Household customers have no or negligible impact on the price, the rate
of interest, of the product whereas large corporate accounts can bargain with banks to some extent.
Availability of Substitutes: Moderate
Non-banking financial services company can provide services or investment options similar to a bank. But
for a risk-averse investor, there are very few options available for investment in Indian markets.
On the lending side of the business, banks face competition from traditional money lenders who operate
without collaterals and focus on uneducated customers.
Competition: High
The banking industry has been around for significant time and hence is highly competitive. Banks have
reached about everyone who needs banking services in the urban areas. Hence banks attempt to lure
clients away from competitor banks by offering lower rates and faster services. Consolidation and mergers
of banks industry is likely in near future and this adds to the pressure to outperform on smaller banks.
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Banking Industry in NEWS

(Source: Economic Times and The Financial Express)
(1) UPI will make Paytm, ICICI Banks Pockets, HDFC Banks Chillr redundant: Centrum
The on-going push by the Reserve Bank of India to revolutionise banking through the Unified Payments Interface
(UPI) will leave mobile wallets redundant, as mobile banking has jumped over threefold in February from the
year-ago period, according to a report.
The report, by city-based Centrum Broking, stated that mobile wallet services like SBIs Buddy, ICICI Banks
Pockets, HDFC Banks Chillr and standalone operator Paytm will be redundant with the massive adoption of the
UPI.
(2) First small finance bank starts operations
Punjab-headquartered Capital Local Area Bank launched the country's first small finance bank on Sunday, seven
months after the Reserve Bank of India gave its in-principle approval for this new type of banks.
Capital Small Finance Bank Ltd commenced operations with 10 branches. "We have approval for 27 branches for
this year," Managing Director Sarvjit Singh Samra said. "The bank will focus on neighboring states for branch
expansion in the initial years."
(3) State run banks, led by SBI, decide to freeze lending to Punjab government
Beleaguered state run lenders, grappling with mounting bad loans, decided on Monday to freeze lending to the
Punjab government. More than 30 bankers, led by State Bank of India, also decided to ask the central
government to make good any losses the lenders may suffer because of the mismatch between the value of food
grain in Punjab granaries and the loans provided to buy them.
After an over two-hour-long meeting, the bankers unanimously decided that they will not lend to Punjab unless
the issue of missing food grain is resolved. The move could throw Punjab's economy into a tailspin as the new
procurement season has just begun and the state is among the biggest buyers of food grain. Punjab Chief
Minister Parkash Singh Badal met Prime Minister Narendra Modi on Monday to discuss the issue.
(4) Singapore's DBS offers 7% rate on digital bank accounts
Singapore's DBS Bank aims to be a disruptor in India even as it awaits the RBI's nod to upgrade its branch to a
subsidiary which will have unrestricted access to the country. The bank is offering digital bank accounts with zero
balance requirements, 7% interest rate on savings and unlimited access to ATMs. These accounts can be opened
by anyone with a smartphone, an Aadhaar card and a PAN card.
(5) Kotak Mahindra announces rise in earnings, becomes 2nd most valued private bank
At a time when most Indian banks profitability has been marred by high levels of bad loans and provisions, Kotak
Mahindra Bank's earnings reflect the rise of yet another superior class bank despite the challenging times.
The private lender which recently toppled ICICI Bank to emerge as India's 2nd most valued private bank reported
a 32% rise in its net profit for the quarter ended March 2016. Its net profit stood at Rs 695.78 crore as compared
with Rs 527.14 crore a year ago.
(6) FCNR maturities may force banks to delay interest rate cuts.
The Reserve Bank of India may face serious challenge from the softer interest rate regime when it comes to
managing cash or liquidity in the system as significant fund flows could create a vacuum between September and
November this year.
According an SBI report, an estimated Rs 99,000 crore could go out of the system towards the maturity of a
special deposits scheme known as foreign currency nonresident (Banks) introduced three years ago to check the
7

rupee's free fall against the dollar.

(7) Banks now sell more insurance policies than individual agents
In the last few years, the life insurance industry has seen high attrition of individual agents largely due to low
remuneration. At the same time, the contribution of bank channels in selling life insurance policies has gone up.
According to the annual report of the Insurance and Regulatory Development Authority of India (IRDA), corporate
banks had a share of 47.37% of individual new business premium in 2014-15, while the share of private insurers
in 2012-13 was 43.08%. On the other hand, individual agents who had share of 39.68% of individual new business
premium in 2012-13 came down to 35.73% in 2014-15 for private insurance players.
(8) Uniform definition for non-performing assets on the cards
At a time when Indian banks are battling the bad loan menace, global banking regulators body BIS has proposed
a uniform definition for non-performing assets and forbearance to ensure consistency in disclosures.
The Switzerland-based BIS said definition of non-performing exposures introduces criteria for categorising loans
and debt securities that are centred on delinquency status (90 days past due) or the unlikeliness of repayment.
Besides, it seeks to clarify the consideration of collateral in categorising assets as non-performing, apart from
mooting clear rules with respect to upgrading of an exposure from non-performing to performing asset.
(9) Banks may face problem with shrinking deposits and rising loans
Indian banks are facing a peculiar problem - that deposits growth is at a five decade low, and loans growth is
beginning to turn after a five years of continuous fall - probably limiting the fall in borrowing costs as banks may
be forced to deposit rates if demand for loans accelerate. Banks are reducing the proportion of their government
bond holdings to the total deposits as they begin to lend more than previous years, data from the Reserve Bank
of India shows. The so called credit- to-deposit ratio has surged to 77.6%, in March'16, from 76.5% a year earlier
indicating that banks are lending a bigger portion of the every Rs.100 taken as deposit.
If the current trend continues, then even government borrowings could get costlier. As banks reduce the
proportion of purchase of government bonds, yields on them could climb and consequently push up costs for
even corporates.
(10) Majority of Public sector Banks reported loss due to high NPA provisioning.
Five of the six public sector banks that declared their results on Friday reported quarterly losses as nonperforming assets (NPAs) continued to pile on after the Reserve Bank of India's ( RBI ) asset quality review (AQR).
Bank of Baroda, Central Bank of India, Allahabad bank, UCO Bank and Dena Bank reported a loss for the second
consecutive quarter.
Union Bank of India was the only exception reporting a small net profit in the quarter ended March 2016, though
down 78% from a year ago.