Introduction

The Indian banking system consists of 26 public sector banks, 25 private sector
banks, 43 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks
and 93,550 rural cooperative banks, in addition to cooperative credit institutions.
Among these institutions, public-sector banks control nearly 80 percent of the
market.
The Indian Banking industry is currently worth Rs. 92 trillion.
An IBA-FICCI-BCG report has predicted that Indias gross domestic product (GDP)
growth will make the Indian banking industry the third largest in the world by
2025.
According to the report, the domestic banking industry is set for an exponential
growth in the coming years with its assets size poised to touch USD 28,500
billion by the turn of the 2025.
Global rating agency Moody's has upgraded its outlook for the Indian banking
system to stable from negative based on its assessment of five drivers including
improvement in operating environment and stable asset risk and capital
scenario.

Notable trends in Banking Sector

Improved risk management practices
Indian banks are increasingly focusing on adopting integrated approach to risk
management
Banks have already embraced the international banking supervision accord of
Basel II.; According to RBI, majority of the banks already meet capital
requirements of Basel III, which has a deadline of 31 March 2019
Most of the banks have put in place the framework for asset-liability match,
credit and derivatives risk management

Diversification of revenue stream

Banks are laying emphasis on diversifying the source of revenue stream to
protect themselves from interest rate cycle and its impact on interest income
Focusing on increasing fee and fund based income by launching plethora of new
asset management, wealth management and treasury products
Technological innovations
Indian banks, including public sector banks are aggressively improving their
technology infrastructure to enhance customer experience and gain competitive
advantage

Internet and mobile banking is gaining rapid foothold

Customer Relationship Management (CRM) and data warehousing will drive the
next wave of technology in banks
Indian banks are rapidly focusing on SMAC (Social, Mobile, Analytics and Cloud)
techniques to reach new customers
Banks are using technology at various levels such as, back-office processing,
convergence of delivery channels, IT-enabled business process reengineering as
well as communication with customers
Indian banks currently devote around 15 per cent of total spending on
technology
Technology has allowed banks to increase their scale rapidly and manage
increased business and transactions volume with lesser man power and reduced
costs (at the operational level)
Digital analytics is providing deeper insights into customer needs and enabling
banks to offer highly targeted products and services; this is likely to pick up pace
in the coming years
New channel-integration technologies are enabling a more seamless end-to-end
experience for banking customers
Many banks, including HDFC, ICICI and AXIS are exploring the option to launch
contact-less credit and debit cards in the market shortly. The cards, which use
near field communication (NFC) mechanism, will allow customers to transact
without having to insert or swipe.
Banks protect margins by promoting usage of efficient technologies like mobile
and internet banking
Overseas expansion
Although at a nascent stage, private and public banks are gradually expanding
operations overseas
Internationally, banks target India-based customers and investors, settled abroad

Focus on financial inclusion

RBI has emphasised the need to focus on spreading the reach of banking
services to the un-banked population of India
Indian banks are expanding their branch network in the rural areas to capture
the new business opportunity

Derivatives and risk management products

The increasingly dynamic business scenario and financial sophistication has

increased the need for customised exotic financial products
Banks are developing Innovative financial products and advanced risk
management methods to capture the market share

Consolidation
With entry of foreign banks competition in the Indian banking sector has
intensified
Banks are increasingly looking at consolidation to derive greater benefits such
as enhanced synergy, cost take-outs from economies of scale, organisational
efficiency, and diversification of risks

Growth Drivers
Favourable demographics and rising income levels
Standard & Poors estimates that credit growth in Indias banking sector would
improve to 11-13 per cent in FY17
Policy support
Simplification of KYC norms, introduction of no-frills accounts and Kisan Credit
Cards to increase rural banking penetration.
The central bank granted in-principle approval to 11 payments banks and 10
small finance banks in FY 2015-16 to increase banking penetration.

Infrastructure Financing
Banking sector is expected to finance part of the USD1 trillion infrastructure
investments in the coming years , opening a huge opportunity for the sector

Employment Opportunities in BSFI Industry

BSFI workforce requirement between 2008 and 2022 is expected to be about 4.2
million and sector may create up to 20 lakh new jobs in the next 5-10 years.
Apart from the on-rolls employment there is significant contractual employment
across all the above segments through various financial positions such as Direct
Selling Agents (DSAs), Insurance agents, Mutual Fund Advisors, etc.

Challenges in BFSI

The major challenge faced by the Indian Banking and Financial sector is that the
level of financial exclusion in India is alarming and there is an urgent need to find
a plausible solution to the same.

Financial inclusion has solely been the responsibility of public banks up until now,
but by using inclusive growth as one of the criteria for new licences (new banks
have to open 25 per cent of their branches in rural areas); the RBI is making the
new private sector banks responsible as well.

The banking and insurance industry is challenged by competitive pressures,

changes in customer loyalty, stringent regulatory environment and entry of new
players, all of which are pressuring the organizations to adopt new business
models, streamline operations and improve processes.

FinTech tipping point

Antony Jenkins, former CEO of Barclays, has predicted that banks are
facing their own 'Uber moment' due to the rapid growth of financial
technologies (Fintech).
In the developed economies, physical branches are being left obsolete by
popular new FinTech start-ups. It is predicted that developed market banks could
cut branch numbers by as much as 50% over the next 10 years.
In China, top FinTech companies (such as Alipay or Tencent) often have as many,
if not more, clients than the top banks.

Low Banking Penetration

The real annual disposable household income in rural India is forecasted to grow
at CAGR of 3.6 per cent over the next 15 years
Despite healthy growth over the past few years, the Indian banking sector is
relatively underpenetrated.
Loans-to-GDP ratio is low (62 per cent) relative to many of its emerging markets
peers as well as developed economies such as the US and UK
Limited banking penetration in India is also evident from low branch per 100,000
adults ratio
Branch per 100,000 adults in India stands at 747 compared to 1,065 for Brazil
and 2,063 for Malaysia
Of the 600,000 village habitations in India only 5 per cent have a commercial
bank branch
Only 40 per cent of the adult population has bank accounts

Debit card holders constitute only 13 per cent of the population and only 2 per
cent have a credit card
51.4 per cent of nearly 89.3 million farm households do not have access to any
credit either from institutional or non-institutional sources
Agriculture requires timely credit to enable smooth functioning. However, only
one-eighth of farm households avail bank credit

Asset Quality Concerns

Gross Non-Performing Assets (GNPAs) and Net Non-Performing Assets (NNPAs) for
the Indian banking system as a whole stood at 4.45% and 2.36% of total
advances respectively as per RBI data.
According to industry estimates, gross NPAs for Indian banks are expected to rise
to 5.9% of total advances for FY16 compared to 4.4% in the previous fiscal year.
On a standalone basis, the impaired asset ratios do not appear as alarming but
when one considers the total Stressed Assets Ratio (Gross NPA + Restructured
Loans to Gross Advances) for the Indian banking system, which stands at 10.9%;
the situation is distressing.
State owned public sector banks account for the bulk of impaired assets in Indian
banking system.

Problems of Public Sector Banks

Public sector banks (PSBs) accounted for 72.1% of the total banking sector
assets. However, in terms of profits, the share of private banks surpassed
that of PSBs. In FY15, PSBs had a share of 42.1% in overall profits.
Indias banking sector performance over the past five years since the 2008-2009
Global Financial Crisis (GFC) reflects a contrasting picture depending upon bank
ownership. On the one hand, private sector Indian banks and foreign banks have
exhibited profitability improvements, better asset quality trends, lower credit
costs and healthy capital levels. On the other hand, state owned public banks
(PSU Banks) have been facing declining earnings growth, narrowing profit
margins, significant deterioration in asset quality and elevated credit costs
Weakness in Indias banking sector is highly skewed, with bulk of the
restructured loans (nearly 80%) sitting with small state owned banks.
Return of Assets (ROA)a measure of bank profitability On this parameter,
public sector banks reported a marginal decline in RoA from 0.5% to 0.46%. On
the other hand, private sector banks saw their RoA improve from 1.65% to 1.68%
during 2015-16.
Credit costs of public sector banks have been in the elevated range of 1.1% to
1.2% while for the private banks they are lower, between 0.5% to 0.8%.

Net new NPL formation rate (as % of total loans) for Indias public sector banks
has jumped two fold from 1.0% in FY10 (Fiscal year ending March 2010) to 2.0%
in FY15.
Data compiled by the finance ministry show public sector banks' combined
market capitalisation is only 36 per cent of the banking sector's total market cap
even though they control 77 per cent of the loan market while their average
price-to-book value (P/BV) is 0.67. In contrast, private sector lenders' market cap
is 74 per cent with average P/BV at 2.35.
Capital Adequacy Woes
PSBs continued to report the lowest CAR that stood below 12% whereas private
banks recorded a CAR of around 16% as at 31st March 2015.
Banks need capital for two reasons: one, to support the credit need of the
borrowers, and, two, to make good the erosion in capital as they need to set
aside money to take care of bad assets.
The decision of the government to capitalise public sector banks based on their
efficiency could go a long way in ending the muscle power that the state-run
banks enjoy, if the government sticks to the strategy of selective infusion of
capital.
Global rating agency, Fitch, is of the view that the governments ability to
provide substantial financial support to the banking system in a potential crisis is
limited given the already high government debt burden.

Government Initiatives
Bankruptcy code
The law will ensure time-bound settlement of insolvency, enable faster
turnaround of businesses and create a data base of serial defaulters-all critical in
resolving India's bad debt problem, which has crippled bank lending.

Debt Recovery Measures

The government has introduced a number of debt recovery measures such as
Joint Lender's Forum, Structured Debt Restructuring (SDR), 5/25 refinancing
scheme for extension of tenure in case of infra loans, and Ujwal Discom
Assurance Yojana (UDAY) scheme for salvaging loans taken by debt-ridden and
loss-making SEBs.
Deposit Mobilisation
Under Pradhan Mantri Jan Dhan Yojna (PMJDY), 217 million accounts have been
opened and 174.6 million RuPay debit cards have been issued. These new
accounts have mustered deposits worth almost Rs 37,000crore (US$ 5.53 billion).

Capital Infusion

Government has decided to infuse Rs.22,900 crore (Rs 229.15 billion) capital in
public sector banks (PSBs) in this fiscal.
However, this amount of infusion is inadequate.
Fitch has said losses at public-sector banks in the second half of the fiscal year
ending March 2016 were double the government's capital injection in FY16, and
had eroded the equivalent of nearly 15 per cent of the capital as at the end of
FY15.
Rating agency ICRA has estimated that the tier-I capital required by PSBs would
be in the region of Rs 40,000 crore to Rs 50,000 crore , which is higher than that
announced by the government this year.

Tapping external capital

The problem is these banks are unlikely to gain access to the capital markets for
equity capital.
Listed PSBs, except State Bank of India and Bank of Baroda, are now trading at a
significant discount to their book value, severely limiting their ability to attract
external capital.

Banking Sector Reforms

On 14 August 2015, the Government launched a seven pronged plan
Indradhanush for revamping PSBs. These seven elements include: Appointments of Bank
MDs and Chairman , Bank Board of Bureau, Capitalisation, De-stressing,
Empowerment, Framework
of Accountability and Governance Reforms

RBI Initiatives
Asset quality review: The asset quality review (AQR), which was started by
the Reserve Bank of India (RBI) back in February this year, was to ensure
banks were taking proactive steps to clean up their balance sheets, which
will help them in the long run.
Under the scheme, banks have been advised to clean up their balance
sheets and declare certain accounts as non-performing assets (NPAs),
which are at present not marked as such.
Following the asset quality review, banks have reported a near 70 per cent
surge in non-performing assets over the past six months.

Gross NPAs of banks and institutions have shot up by Rs 2,41,000 crore in

December and March quarters, mostly due to aggressive provisioning
undertaken by the PSU banks at the behest of RBI
Sustainable structuring of stressed assets: The Reserve Bank of India's
scheme for sustainable structuring of stressed assets (S4A) is yet another
tool provided to the banks to tackle the growing challenge of stressed
assets emanating from loans given to large companies turning bad.
S4A envisages the determination of a sustainable debt level for stressed
borrowers, and bifurcation of outstanding debt into sustainable debt and
equity/quasi-equity instruments, which are expected to provide upside to
lenders when the borrower turns around.
CRILC :RBI has created a large loan database (CRILC) that included all
loans over Rs. 5 crore, which are shared with all the banks. The CRILC data
included the status of each loan - reflecting whether it was performing,
already an NPA or going towards NPA. That database allows banks to
identify early warning signs of distress in a borrower such as habitual late
payments to a segment of lenders.
Suggestions for improving the efficiency of public sector banks:
Power sector reforms are crucial to ease asset quality burden of
PSU banks
PSU banks need to focus on retain loans which constitute roughly
30% to 60% of the loan books of private sector Indian banks as compared
to 10% to 20% for their public sector counterparts. Retain loans have
lower default rates since 2010.
Focus on margins to offset sluggish loan growth
Against the backdrop of sluggish loan growth, Indias private sector banks
have focused on improving profitability and improvements in Current
Account Savings Account Ratio (CASA), which resulted in better margins,
higher ROAs and higher earnings performance. In contrast, public sector
banks focused more on growing their loan book through greater reliance
on bulk funding which led to margin erosion and hampered profitability.
As the Banking Boards Bureau is only an interim measure, the government
must fast-track the setting up of a non-operative holding company for all
banks to minimise its role in managing the affairs of PSBs.
The government must address some of the fundamental issues and infuse
right skills and expertise in these banks. In their absence, capital infusion
alone is a band-aid solution to the problems.

Structural Changes Suggested by McKinsey

McKinsey has suggested a three-tier banking structure.
On top will be large banks, which can happen through consolidation of
some of the public sector banks.
The second is state-linked banks
The McKinsey report also talked about policy banks, which will implement
the government's policy decisions such as directed lending, which is
currently being done by public sector banks. If these banks are freed from
the burden of directed lending, their efficiency will improve. One step in
this direction has already been taken with the setting up of the Micro Units
Development Refinance Agency (MUDRA) Bank.
PJ Nayak committee recommendations set up to review
governance structure in banks
The government should cut its shareholding below 51 per cent; set up an
omnibus bank investment company, which will be the holding company
for all public sector banks; and constitute a bank board bureau which will
appoint board members as well as chief executives