DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY
LUCKNOW

FINAL DRAFT
ECONOMICS
BANKING INDUSTRY IN INDIA
Submitted as a part of Project Work undertaken for the partial fulfilment of the B.A. LL.B. (Hons.) 5-Year Integrated
Course of RMLNLU-Lucknow

Under The Guidance of: Visiting Professor

(Economics)
Prof. (Dr.) Madhuri
Srivastava
Project by:
 Chandan Maheshwari III Semester, Batch 2012-
17
Roll. No. 46, Section-A
ACKNOWLEDGEMENTS
A debt of gratitude to Dr Madhuri Srivastava for giving me an opportunity to write a
project on such a burning topic, and guiding me regarding all what troubled me;
To librarians and officials of the Dr Madhu Limaye Library, for providing me with all
facilities that I required;
To Aditya Shankar, Anurag Bhaskar, Smriti, Amit Bandhu, Malik Fahd, Vishal Sharma,
Shashank Tyagi, Akanksha Singh; friends and colleagues who were an immense help in research,
completion and motivation for this project;
And to the best parents a child could hope for…Swati and Sanjeev Maheshwari, for
everything…
C.M.
5th Oct. 2013
Lucknow

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TABLE OF CONTENTS
ACKNOWLEDGEMENTS 1
PREFACE 3
INTRODUCTION 3
OBJECTIVES OF STUDY.............................................................................................................................3
CONCEPTUALISATION..............................................................................................................................4
FOCUS OF THE PROBLEM.........................................................................................................................4
LIMITATIONS OF STUDY...........................................................................................................................5
RESEARCH METHODOLOGY 5
RESEARCH DESIGN...................................................................................................................................6
SAMPLING: DESIGN AND PROCEDURE.....................................................................................................6
INDIAN ECONOMY: MACRO-ECONOMIC FACTORS AFFECTING INDIAN
BANKING 7
INDIAN BANKING INDUSTRY 7
NEED FOR BANKS.....................................................................................................................................7
INDIAN BANKING SECTOR EXPERIENCE...................................................................................................8
INDIAN FINANCIAL SECTOR ‘SWOT’ ANALYSIS.........................................................................................8
STRUCTURE OF THE BANKING SECTOR 9
CREDIT GROWTH...................................................................................................................................10
MICRO-FACTORS AFFECTING INDIAN BANKING INDUSTRY 10
VALUATION TOOLS 13
MAJOR FINDINGS 17
CONCLUSION 18
BIBLIOGRAPHY 19

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PREFACE
The introduction and application of the concept of customer services entered in a
welcoming way in India only after independence. The banking system in India has come a long
way during the last two centuries. Its growth was faster and coverage wider since 1969. In 1969,
a major portion of the banking sector was entrusted to the public sector. This process continued
and embraced few private banks in 1980.
The transfer of ownership of banks from the public to the private was aimed at entrusting
the banks with greater responsibilities for the economic development of India by taking banking
services to the masses and taking special care of the weaker section of the society and the
priority sector of the economy. Though the number of bank offices, magnitude and variety of
their operations has grown considerably during the period of near about three decades, but it
appears that the banking sector has entered into serious among customers.
For overcoming this problem, banking industry should seek introspection and adopt
refined management techniques. It has been an endeavour of this study to analyse the present
state of various banks keeping in view the data that has been collected regarding the present state
of loan schemes in various banks from various sources.

INTRODUCTION
In India, given the relatively underdeveloped capital market and with little internal
resources, firms and economic entities depend largely on financial intermediaries to meet their
fund requirements. In terms of supply of credit, financial intermediaries can be classified under
two heads, namely, institutional and non-institutional. The major institutional credit suppliers in
India are banks and non-bank financial institutions (e.g. development financial institutions, other
financial institutions and non-bank finance companies). The non-institutional or unorganized
sources of credit include indigenous bankers and money-lenders.
An important feature of credit market is its term structure—
1. Short-term credit,
2. Medium-term credit, and
3. Long-term credit.
While banks and non-bank finance companies provide prominently cater for short-term needs,
Finance Institutions provide mostly medium and long-term funds.

OBJECTIVES OF STUDY
 Today’s banking sector plays a dominant role regarding investment decision. It basically
tells about how these funds are effectively and efficiently utilized in order or maximize
profits.

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  To study the growth and performance of the banking industry.
 To find the policies which can be adopted to better the goodwill of the banking industry.
 To provide suggestions for better functioning of business.
 To study loan schemes of two-banking companies at their prime, SBI and ICICI.

CONCEPTUALISATION
The last decade has seen many positive developments in the last decade in the Indian
banking industry. The policy makers, which comprise the RBI, Ministry of Finance and related
government and financial sector regulatory entities have made several notable efforts to improve
regulation in this highly volatile sector. A few banks have established an outstanding track record
of innovation, growth and value creation. This is reflected in their market valuation. However,
only a few big firms in the industry show good performance records.
The cost of banking intermediation in India is higher and bank penetration is far lower
than in other markets. India should strengthen itself significantly if it has to support the vibrant
and modern economy which India aspires to be. While the onus for this change lies mainly with
bank managements, an enabling policy and regulatory framework will also be critical to their
success.
The failure to respond to changing market realities has stunted the development of the
financial sector in many developing countries. A weak banking structure has been unable to fuel
continued growth, which has harmed the long-term health of their economies. The researcher
emphasizes the need to act both decisively and quickly to build an enabling, rather than a
limiting banking sector in India.

FOCUS OF THE PROBLEM

The project report concentrates on micro and macro factors affecting banking industry,
evolution of banking industry and its current status. Various regulatory and reform processes also
affects banking industry. The report also throws light on them.
The report will end with valuation of major players in the banking industry and
challenges faced by this industry.
1. Banking Challenges: It is expected that the Indian banking and finance system will be
globally competitive. For this, the market players need to be financially strong and
operationally efficient. Capital would be a key factor in building a successful institution.
Competitiveness can be improved through a process of consolidation, either through
mergers and acquisitions through strategic alliances. Technology will also be a key to
competitive build-up in the industry. Technology will be the defining criteria for the
progress of the finance and the banking industry.
2. Banking Evolution and Regulatory Framework: Financial Sector Reforms set in
motion in 1991 have greatly changed the face of Indian banking. The banking industry
has gradually moved from the regulated economy to the deregulated market economy.

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 The LPG policy have led to a drastic change in the intermediation role of banks. The pace
of change has been faster in recent times simply because of the emergence of new
technologies, and their rapid development serves as a further catalyst. The LPG-
challenges have been met quite well by the industry, but greater challenges of increased
competition due to WTO await our industry. Banks will have to gear up to meet stringent
prudential capital adequacy norms under Basel II. In addition to WTO and Basel II, the
Free Trade Agreements (FTAs) such as with Singapore, may have an impact on the shape
of the banking industry. Banks will also have to cope with challenges posed by
technological innovations in banking. Banks need to prepare for the changes. In this
context the need for drawing up a Road Map to the future assumes relevance. The last
decade has seen many positive developments in the Indian Banking Sector. The
policymakers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and
related government and financial sector regulatory entities, have made several notable
efforts to improve regulation in the sector.
3. Internal Hindrances to Banking Industry: The research focuses on emphasizing the
need of decisively and quickly to build an enabling rather than a limiting banking sector
in India. The major challenges for bank management are—
 Cost management, a key to sustainability of bank profits as well as their long-term
viability.
 Recovery management, a key to stability of banking sector.
 Technological intensity of banking, an area where India happens to be world
leader in IT, but its usage by our banks is somewhat muted. It’ll be wise for Indian
banks to exploit this global state of art expertise, domestically available to their
full advantage.
 Risk management, banks can formulate “early warning indicators” suited to their
own requirements, business profile and risk appetite in order to manage and
monitor risks better.
 Governance, because its quality becomes critical as competition intensifies, banks
strive to retain their client base and regulators move out of controls and micro-
regulation.

LIMITATIONS OF STUDY
 The scope of the study will be restricted to selected banks.
 The data taken into consideration might be biased or not based on thorough analysis, as
most of the data is taken from interviews of persons.
 The data used for research purposes might not be the latest available.

RESEARCH METHODOLOGY
Problem Definition: To determine and analyse the hidden potential in the banking sector
in India so as to suggest to the investors whether to invest in the shares of the banking
companies.

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 Objective: Discover insights into and develop an understanding of the various micro and
macro-economic factors that have bearing on the functioning of the banking sector.
Valuation: The project involves valuation of major Indian banks including ICICI, SBI
and HDFC. The methodology followed is target pricing which includes estimating growth rate
by regression on historical sales to forecast next year sales, earning and profit and loss account.
The earning per share is calculated which is multiplied to historical price-earning to forecast
intrinsic value of share.
Result: All shares are undervalued and expected to give positive risk adjusted returns to
investors. Since the intrinsic value is more than the current market price for all the companies,
the share can be recommended to conservative investors.

RESEARCH DESIGN
Exploratory research design because the problem required an in-depth study of all the
related variables.
Past information and forecasts: Past information has been collected in the form of
accounting statements (cash flow, income statement and balance sheet) including the sales
account for the past ten years. Forecast are done in relation to the future performance in terms of
sales for HDFC, ICICI and the State Bank. Other forecasts include EPS calculation and
comparison of future target price with current market price. Once the info was collected, the next
step was to search for resources (mentioned in the Bibliography) and constraints with respect to
the area of research.

SAMPLING: DESIGN AND PROCEDURE

Sampling technique: Convenient sampling as part of as part of non-probability sampling
by taking the three banks as major performers in the Indian banking sector and highlights of
sector’s overall performance.
Data collection: Secondary data has been used to carry out the study. To review the
literature available regarding the subject; various journals, magazines related research papers and
the internet have been used.

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INDIAN ECONOMY: MACRO-ECONOMIC FACTORS
AFFECTING INDIAN BANKING
Major changes—
1. Robust economic growth; 1.7% in agriculture, 10.7% in industry and 10.7% in services.
2. Rabi season experiences normal monsoon.
3. Index of industrial production growth has dipped. The poor performance of the
manufacturing sector, which forms 80% of the IIP has led to a blip in the robust growth
trend. Mining and electricity have grown faster than last year.
4. Wholesale price index rose to 5.43; higher inflation in primary industries remains. It may
remain high due to lower base effect.
5. Cash reserve ratio hike of 50bps to absorb 135b from the system. This shows RBI’s intent
of regulating credit take-off in the economy.
6. Exports growth coming back on track.
7. Rupee is down, but appreciating at a slow pace.
8. Indian economy maintains a strong growth momentum with real GDP. The manufacturing
sector—the key growth driver for banking credit—continues its uphill journey.
9. Relaxation of FDI rules has expanded the mountain of capital in all sectors. India ranks
second in FDI Confidence Index (after China).
10. The gross fiscal deficit is also showing positive trends.
11. The interest rates have been changed, due to the reform measures taken by the new RBI
Governor, Mr. Raghuram Rajan. The interest rates should be higher in economies like
India because of the larger marginal productivity of capital.
12. Increasing crude oil prices also affect the banking sector.
13. Capital markets are lesser volatile than they used to be.

INDIAN BANKING INDUSTRY

In India, given the relatively under-developed capital market and with little internal
resources, firms and economic entities rely on financial intermediaries to meet their fund
requirements. In terms of supply of credit, financial intermediaries can be broadly classified as
institutional and non-institutional. The major institutional suppliers of credit in India are banks
and non-banking financial institutions (development financial institutions). The non-institutional
sources include indigenous bankers and money-lenders.

NEED FOR BANKS

There are three roles the banks play—
1. Channel household savings.
2. Risk transformation.
3. Service provider.

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INDIAN BANKING SECTOR EXPERIENCE
India inherited a weak financial system after independence in 1947. At end-1947, there
were 625 commercial banks in India, with an asset base of Rs. 11.51b. Commercial banks
mobilized household savings through demand and term deposits, and disbursed credit primarily
to large corporations. Following Independence, the development of rural India was given the
highest priority. The commercial banks of the country including the IBI had till then confined
their operations to the urban sector and were not equipped to respond to the emergent needs of
economic regeneration of the rural areas. In order to serve the economy in general and the rural
sector in particular, the All India Rural Credit Survey Committee recommended the creation of a
state-partnered and state-sponsored bank by taking over the IBI, and integrating with it, the
former state-owned or state-associate banks. Accordingly, an act was passed in Parliament in
May 1955, and the State Bank of India (SBI) was constituted on July 1, 1955. More than a
quarter of the resources of the Indian banking system thus passed under the direct control of the
State. Subsequently in 1959, the State Bank of India (Subsidiary Bank) Act was passed (SBI
Act), enabling the SBI to take over 8 former State-associate banks as its subsidiaries (later named
Associates).The Government of India also felt the need to bring about wider diffusion of banking
facilities and to change the uneven distribution of bank lending. The proportion of credit going to
industry and trade increased from a high 83% in 1951 to 90% in 1968. This increase was at the
expense of some crucial segments of the economy like agriculture and small-scale industrial
sector. Bank failures and mergers resulted in a decline in number of banks. The lop-sided pattern
of credit disbursal and perhaps the spate of bank failures during the 1960s forced the government
to resort to nationalization of banks. In July 1969, the Government nationalized 14 banks, each
having minimum deposit of 500m. State control was considered as a necessary catalyst for
economic growth and ensuring an even distribution of banking facilities. Subsequently, more
banks were nationalized.
The nationalization of banks was the culmination of pressures to use the banks as public
instruments of development. The Government of India imposed `social control’ on banks.
However, by the 1980s, it was generally perceived that the operational efficiency of banks was
declining. Banks were characterized by low profitability, high and growing non-performing
assets, and low capital base. Average returns on assets were only around 0.15% in the second half
of the 1980s and capital aggregated an estimated 1.5% of assets. Poor internal controls and the
lack of proper disclosure norms led to many problems being kept under cover. The quality of
customer service did not keep pace with the increasing expectations. In 1991, a fresh era in
Indian banking began with the introduction of banking sector reforms as part of the overall
economic liberalization in India.

INDIAN FINANCIAL SECTOR ‘SWOT’ ANALYSIS

Strengths:
1. Proven asset quality resilience in past downturns.
2. Proven management teams, track records.
3. Stable industry dynamics.
4. Well-established regulatory framework.

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 5. Stable and low non-preforming loans formation rate.
Weaknesses:
1. Continued crowding out effect from government budget deficit, combined with
accelerating private sector credit demands.
2. Ownership restrictions.
3. Constraints on state-owned banks’ micro-reforms, including HR, staff-cut, branch-cut
constraints.
Opportunities:
1. Improving secular GDP growth prospects.
2. Establishments of Special Economic Zones likely to promote further industrialization.
3. Years of catch-up economics—low per-capita income, educated workforce.
4. Rapid financial deepening—loan growth as multiple of nominal-GDP growth.
5. Rising consumer spending, consumer credit business.
6. Rising corporate capital expenditure, investments.
7. Mergers and acquisitions optionality.
Threats:
1. “Running on empty” in terms of liquidity.
2. Tightening in global equity may trickle down to India.
3. Potentially hawkish RBI stance on inflation/monetary policy.
4. Potential rise in long bond/yields, market to market risk for banks.
5. Potential for valuation pullback, should earnings delivery disappoint expectations.

STRUCTURE OF THE BANKING SECTOR

The banking sector in India functions under the umbrella of RBI—the regulatory central
bank. The Reserve Bank of India Act was passed in 1934 and it was constituted in 1935. The
Banking Regulations Act was passed in 1949. This Act brought the RBI under government
control. Under the Act, the RBI received wide-ranging powers in regards to establishments of
new banks, mergers and amalgamation of banks, opening and closing of branches of banks,
maintaining certain standards of banking business, inspection of banks etc. The Act also vested
licencing powers and the authority to conduct inspections with the RBI.
Banks in India can be broadly classified as regional rural banks, scheduled commercial
banks and co-operative banks. This project consists research regarding the SCBs only.
The SCBs can be classified as under:
1. Public sector banks (SBI, its associates and nationalized banks);
2. Private sector banks (old and new); and
3. Foreign banks.

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In terms of asset size, among foreign banks – Citibank, HSBC and Standard Chartered Bank are
leaders with asset base of Rs.45437Cr, Rs.37473Cr and Rs.48412Cr. Among private sector
banks, ICICI Bank is the leader with asset base of Rs.251389Cr followed by HDFC Bank of size
Rs.73506Cr and UTI Bank of size Rs.49731Cr. In terms of asset size, public sector banks have
highest base compared to private and foreign banks. SBI and associated have asset base of
Rs.691872Cr while other banks such as BOB, BOI, Canara Bank and PNB have each more than
Rs.100000Cr.

CREDIT GROWTH
The bank lending has expanded in a number of emerging market economies, especially in
Asia and Latin America, in recent years. Bank credit to the private sector, in real terms, was
rising at a rate between 10 and 40 percent in a number of countries. The reasons have been strong
growth, excess liquidity in banking systems reflecting easier global and domestic monetary
conditions, and substantial bank restructuring. The recent surge in bank lending has been
associated with the changes in the asset side of the balance sheet of banks.
First, credit to the business sector—historically the most important component of bank
assets—has been weak, while the share of the household sector has increased sharply in many
countries. Second, bank investments in government securities has increased sharply. As a result,
commercial banks continue to hold a very large part of their domestic assets in form of
government securities—a process which seems to have begun in the mid-1990s.

MICRO-FACTORS AFFECTING INDIAN BANKING

INDUSTRY
Loan Demand: Over the past three years, Indian banking industry has seen sustained
strength in credit growth, which is not just a function of economic buoyancy, but also the broad
basing of loan demand.
This has recently been articulated by the central bank too:
“A contextual analysis of the co-movement between macro-economic performance and
bank credit in the current phase of business cycle suggests that factors other than demand may
also be at work; financial deepening from a low base; structural shift in supply’s elasticity;
rising efficiency of credit markets; and competitive pressures augmenting the overall supply of
credit.”
(Reserve Bank of India, Monetary Policy Review, October 2006)
The slowdown of the mid-1990s hit the banks very hard because corporate, which
accounted for a lion’s share of bank-credit, went into a less profitable and hence a financial
restructuring mode. There was no retail credit then, banks did not focus on small and medium
enterprises and farm lending was done grudgingly, under compulsion. Along with the
diversification of the pie that keeps the tempo of demand intact, after a long time industry has

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also started demanding higher levels of credit. Until recently, growth in industrial credit was
almost wholly driven by infrastructure. Then the participation has widened perceptibly.
If a substantial portion of loan growth gets driven by the banking system taking away
market shares from informal sectors – this is clearly happening to farm credit, SMEs and to a
limited extent non-mortgage retail – interest rate considerations influencing demand will be
relatively low. SMEs and the rural folk have accessed credit from other sources at exorbitant
interest rates, and hence banks’ rates going by 200-300bps is not so meaningful. That explains
the apparent lack of correlation between rates that have been rising and loan demand.
Rising funding costs with soft lending rates irrational:
Plenty of historical evidence of return of pricing power to banks: Concerns
are often expressed about banks’ ability to increase lending rates in face of competition and
government pressure. The reality is that banks, which led the mortgage price war, have increased
mortgage rate by 200-300bps from the bottom, and is yet to see significant resistance. That PSU
banks raised prime lending rates twice in. competition from overseas borrowings is a serious
factor only with AAA companies, and banks have reduced exposure to them considerably during
the last 3-4 years. Government stand is understandably against higher interest rates. However, it
is unlikely that the government will be able to influence the course of interest-rates single-
handedly.
Inflexibility of deposit growth a myth: With 100-200bps increase in the card
rates of deposits, banks have managed to move the deposit growth rates from 16% to 20%, on a
larger base. In the last 5 years, household financial savings have moved out of equities and long
term products to bank deposits in percentage terms. The point to note here is that component of
cash has marginally risen—that’s the real incremental opportunity as more cash from chests
moves into bank deposits first before potentially going to other avenues. The coming period is
expected to be one of “margin pressure.” This is because as the last interest rate cycle showed,
deposit costs increase first, and followed by lending rates. The fourth quarter Q4 is usually a
period of tight liquidity, and the RBI could be increasing CRR or SLR requirements to further
tighten the liquidity. Also banks will be cautious about the actual implementation of the lending
rates increases and may do it in a graduated fashion so as not to invite outright resistance or overt
attention from the government. HDFC, PNB, SBI and few others have nevertheless already made
a beginning by increasing their prime lending rates after the CRR hike by the RBI. However the
fight for deposits has intensified and it is possible that in Q4 banks could be increasing their
exposure to high-cost wholesale deposits, taken at higher than card rates.
Banks’ increased risk appetite good for loan yields: The banks’ lending risk
appetite has increased significantly in the last 5 years—banks veering more towards lending at
increasing spreads rather than investing in risk-free bonds. Accordingly banks are willing to take
higher risks which is good for overall asset yields.
Investment spreads may increase in the future: As long duration bonds at high
interest rates have been coming up for maturity and getting re-priced at lower interest rates,
yields on investments have been constantly falling in the last two years.

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 Non-performing loans: concerns overstated:
Loan growth NPL: The asset price deflation (real estate prices) may hurt banks’
asset quality by blowing it out of proportion.
Residential mortgages: It is very unlikely that near term that there can be a
large-scale increase in delinquencies on loans taken on the first house (typically self-occupied);
unless there is a household income problem, it doesn’t matter to the borrower whether the price
of the house he is staying is in is rising or falling. Even then, with an average loan-to-value of
75%, a 25% fall is theoretically not possible. LTV ratios had gone up to more risky levels at the
peak of the mortgage boom. Problems can arise more frequently for loans taken for the second
house, typically for investment/speculation. Banks have been reluctant to disclose the exact
volume of second houses financed. Most banks claim that it is in the range of 2-5% of
incremental mortgage lending. There is a possibility that some individuals have been hiding from
banks the fact that they already have one more loan, but this is becoming increasingly difficult
with a credit bureau now in full swing. Even if the assumption that 10% of the outstanding
mortgages are for the second house and all of that goes bad, it will mean 1% of the banking
system’s loans go bad. Commercial real estate: According to figures disclosed by the RBI itself,
real estate loans constituted 2.0% of gross non-food credit of banks as of end-June. Even if it has
been growing at high percentage rates is not material as the base was very low. In any case, by
increasing standard assets provisioning on these loans to 100bps from 25bps, risk weights from
100% to 150% and instructing banks not to lend unless the developer has “all the permissions.”
One stark example of this is the largest bank SBI itself. In the mid-1990s, SBI’s portfolio was
distributed between large corporate, farm credit and trade, with little coming from others. The
September portfolio looks dramatically different.
SBI’s loan portfolio now quite diversified: SBI’s credit goes majorly to personal
credit (23%) and mid-corporates (25%). International ops, farm credit (10%) and big corporates
and small-businesses (11%) account for the remaining large share.
Cost of borrowings has risen, but so has income: The apparent disconnect
between interest rates rising now for two years and lending not losing steam can be explained by
I) rising incomes in case of individuals, thereby imparting increased thrust to retail lending, and
II) improved corporate profitability through better pricing power. While there are several studies
illustrating the household income growth in India, according to National Council for Applied
Economic Research, an explosive growth is underway in the percentage of households earning
Rs91, 000-1,000,000 per annum, the most prominent individual borrowers for banks. The
corporate pricing power story is less known because of the media harping on high competition
and margin compression. While these issues cannot be summarily dismissed, it is a fact that
manufactured product inflation has been rising. Even the RBI has recently commented on the
increased ability of manufacturers to pass on cost increases. And with a considerably de-
leveraged corporate India compared with the early/mid 1990s, these levels of increases in interest
costs have been easily absorbed by companies.
Technology: The trend in banking is changing from computerization of branches to
laying a common platform by having a core banking solution in all the branches. At the same

12
time, Indian banks are looking at internet banking which promises to grow into an alternate self-
service channel. As the mind-set of the Indian customer undergoes a change, Indian banks need
to encompass the extension of all the services that are required and dictated by customers. In
future, banks will need to focus on value-differentiating services by keeping in-house their
competitive advantages while partnering with others who complement its services. The
emergence of peer-to-peer money transmission mechanisms (such as Western Union Money
Transfer) poses a challenge to current role of bankers and emphasizes the role of robust payment
systems like RTGS in maintaining and promoting financial stability.
Areas of improvement: The few challenges that await banks in adopting
technology are—
1. Indian banks still don’t have the robust systems required for efficient functioning of
online banking. RBI has provided guidelines relating to security and other issues and
hopefully, online banking will see a surge in the usage from current 1%to at least 10% in
the next couple of years.
2. Banks need to explore newer channels such as SMS, WAP and 3G mobile telephony
applications to facilitate online access to customers.
3. Banks, in a drive to carry on with tremendous expansion in terms of customer base, needs
to have employees who are well informed about products and services and are
comfortable with technology which requires extensive training.
Potential pitfalls: Banks should not get overwhelmed by the concept of
automation and online banking. The banks need to realize that they need to maintain different
delivery for different generations. Banks still need to maintain brick-and-mortar locations that
people feel comfortable with.

VALUATION TOOLS
ICICI Bank:
Business—ICICI Bank was promoted in 1994 by ICICI Ltd., an Indian
development financial institution. The two entities subsequently merged to become the largest
commercial bank in the private sector. A new generation bank, ICICI Bank started with all the
latest technologies to hit the Indian banking industry in the second half of the nineties. All its
branches are fully computerized with the state-of-the-art technology and systems, networked
through VSAT technology. The bank is connected to the SWIFT International network. In 2005,
it expanded its network to 562 branches and 1,910 ATMs. It continued to expand its electronic
channels, namely internet banking, mobile banking, call centres and ATMs, and migrate
customer transaction volumes to these channels. Over 70% of customer induced transactions take
place through these electronic channels. It has acquired a small Russian banking entity,
Investitsionno-Kreditny Bank (IKB), which will help boost its corporate business and deposit
franchise overseas. The bank has also built several strategic alliances with banks like Wells Fargo
in USA, Lloyds TSB in UK and DBS in Singapore.

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 ICICI has entered into strategic alliance with Prudential Plc. of UK for its mutual fund
business. The duo has been fairly aggressive through their companies, Prudential ICICI Asset
Management Company Limited and Prudential ICICI Trust Limited. The bank is also keen to
offer its services to the Indian agricultural sector. Over 2,000 Internet kiosks and 70 agro-desks
have been established in locations with large agricultural markets.
Developments—ICICI Bank launched `Mutual Fund Sweep Account` - an
automatic sweeping facility which allows current account holders to park their short-term
surpluses into liquid mutual funds and earn higher returns. Initially, ICICI Bank current account
customers will have the facility to invest their account surpluses in the liquid fund schemes of
Prudential ICICI Asset Management Company and GIC Mutual Fund.
The bank is in the process of the reverse merger of ICICI with ICICI Bank. The merger of
two wholly-owned subsidiaries of ICICI, ICICI Personal Financial Services Limited and ICICI
Capital Services Limited, with ICICI Bank is also underway. ICRA has assigned an A1+ rating,
indicating highest safety in the short-term, to the Rs 500Cr certificates of deposit (CD)
programme of ICICI Bank Ltd (IBL). The rating agency said in its report that the rating takes
into consideration IBL`s strategic importance to its parent ICICI, IBL`s comfortable profitability
and capital adequacy, good control on asset quality. ICICI Bank has tied up with MasterCard
International to launch ICICI Bank MasterCard credit cards. At present ICICI Bank’s credit card
base stands at around 5, 50,000, while for debit cards it is Rs 4,50,000. ICICI Bank is the largest
card issuer in the market. The bank is adding credit and debit cards at the rate of Rs 1lakh per
month. The bank had launched the credit card business 2 years back, while the debit card
business is relatively new.
ICICI Bank is India's second-largest bank with total assets of Rs 3,562.28b (US$ 77
billion) at December 31, 2009 and profit after tax Rs 30.19b (US$ 648.8 million) for the nine
months ended December 31, 2009. The Bank has a network of 1,646 branches and about 4,883
ATMs in India and presence in 18 countries. ICICI Bank offers a wide range of banking products
and financial services to corporate and retail customers through a variety of delivery channels
and through its specialised subsidiaries and affiliates in the areas of investment banking, life and
non-life insurance, venture capital and asset management. The Bank currently has subsidiaries in
the United Kingdom, Russia and Canada, branches in United States, Singapore, Bahrain, Hong
Kong, Sri Lanka, Qatar and Dubai International Finance Centre and representative offices in
United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. Our
UK subsidiary has established branches in Belgium and Germany. ICICI Bank's equity shares are
listed in India on Bombay Stock Exchange and the National Stock Exchange of India Limited
and its American Depositary Receipts (ADRs) are listed on the New York Stock Exchange
(NYSE).
HDFC Bank:
HDFC Bank Ltd was set up in 1994 by India’s leading housing finance company
Housing Development Finance Corporation (HDFC). The bank offers a wide range of services
which can be classified into three categories namely, treasury, wholesale banking and retail
banking services. The bank has a distribution network of 535 (in 228 cities) and 1,323 ATMs and

14
a customer base of 9.6 million as of March 2006. Under wholesale banking, it provides working
capital finance, trade services, transactional services and cash management. Treasury function
includes foreign exchange & derivatives, money market securities and equities. Retail loan
products are auto loans, personal loans and loans for two-wheelers. It also provides depository
participant services for retail customers. It was the first Indian bank which launched an
international debit card. With products including the Kisan Gold Card, rural supply chain
initiatives and commodity finance covering the entire agriculture financing cycle, the bank’s
agriculture lending increased by over 60% during the year. The proportion of NPA`s to total
advances increased to 0.4 per cent from 0.3 per cent last year. This marginal increase is because
of the changing mix of loans as HDFC Bank has a high share of auto loans. The bank’s focus on
semi-urban and under banked markets continued with more than half of its retail loans being
given in non-metro markets. The bank’s total capital adequacy ratio (CAR) as on March 31, 2006
stood at 11.41%. The authorized capital of HDFC Bank is Rs.450Cr. The paid-up capital
isRs.311.9Cr. The HDFC Group holds 22.1% of the bank's equity and about 19.4% of the equity
is held by the ADS Depository (in respect of the bank's American Depository Shares (ADS)
Issue). Roughly 31.3% of the equity is held by Foreign Institutional Investors (FIIs) and the bank
has about 190,000 shareholders. The shares are listed on the Stock Exchange, Mumbai and the
National Stock Exchange. The bank's American Depository Shares are listed on the New York
Stock Exchange (NYSE) under the symbol "HDB".
Technology— HDFC Bank operates in a highly automated environment in terms
of information technology and communication systems. All the bank's branches have online
connectivity, which enables the bank to offer speedy funds transfer facilities to its customers.
Multi-branch access is also provided to retail customers through the branch network and
Automated Teller Machines (ATMs).The Bank has made substantial efforts and investments in
acquiring the best technology available internationally, to build the infrastructure for a world
class bank. The Bank's business is supported by scalable and robust systems which ensure that
our clients always get the finest services we offer. The Bank has prioritised its engagement in
technology and the internet as one of its key goals and has already made significant progress in
web-enabling its core businesses. In each of its businesses, the Bank has succeeded in leveraging
its market position, expertise and technology to create a competitive advantage and build market
share.
Business—HDFC Bank offers a wide range of commercial and transactional
banking services and treasury products to wholesale and retail customers. The bank has three key
business segments:
1. Wholesale Banking Services: The Bank's target market ranges from large, blue-chip
manufacturing companies in the Indian corporate to small & mid-sized corporates and
agro-based businesses. For these customers, the Bank provides a wide range of
commercial and transactional banking services, including working capital finance, trade
services, transactional services, cash management, etc. The bank is also a leading
provider of structured solutions, which combine cash management services with vendor
and distributor finance for facilitating superior supply chain management for its corporate
customers. Based on its superior product delivery / service levels and strong customer

15
 orientation, the Bank has made significant inroads into the banking consortia of a number
of leading Indian corporates including multinationals, companies from the domestic
business houses and prime public sector companies. It is recognised as a leading provider
of cash management and transactional banking solutions to corporate customers, mutual
funds, stock exchange members and banks.
2. Retail Banking Services: The objective of the Retail Bank is to provide its target market
customers a full range of financial products and banking services, giving the customer a
one-stop window for all his/her banking requirements. The products are backed by world-
class service and delivered to customers through the growing branch network, as well as
through alternative delivery channels like ATMs, Phone Banking, Net Banking and
Mobile Banking. The HDFC Bank Preferred program for high net worth individuals, the
HDFC Bank Plus and the Investment Advisory Services programs have been designed
keeping in mind needs of customers who seek distinct financial solutions, information
and advice on various investment avenues. The Bank also has a wide array of retail loan
products including Auto Loans, Loans against marketable securities, Personal Loans and
Loans for Two-wheelers. It is also a leading provider of Depository Participant (DP)
services for retail customers, providing customers the facility to hold their investments in
electronic form. HDFC Bank was the first bank in India to launch an International Debit
Card in association with VISA (VISA Electron) and issues the MasterCard Maestro debit
card as well. The Bank launched its credit card business in late 2001. By March 2009, the
bank had a total card base (debit and credit cards) of over 13 million. The Bank is also
one of the leading players in the “merchant acquiring” business with over 70,000 Point-
of-sale (POS) terminals for debit / credit cards acceptance at merchant establishments.
The Bank is well positioned as a leader in various net based B2C opportunities including
a wide range of internet banking services for Fixed Deposits, Loans, Bill Payments, etc.
3. Treasury: Within this business, the bank has three main product areas - Foreign Exchange
and Derivatives, Local Currency Money Market & Debt Securities, and Equities. With
the liberalisation of the financial markets in India, corporates need more sophisticated
risk management information, advice and product structures. These and fine pricing on
various treasury products are provided through the bank's Treasury team. To comply with
statutory reserve requirements, the bank is required to hold 25% of its deposits in
government securities. The Treasury business is responsible for managing the returns and
market risk on this investment portfolio.
Management—Mr CM Vasudeva took over as the bank’s Chairman in 2010. The
Managing Director, Mr Aditya Puri, has been a professional banker for over 25 years, and before
joining HDFC Bank in 1994 was heading Citibank's operations in Malaysia. The Bank's Board of
Directors is composed of eminent individuals with a wealth of experience in public policy,
administration, industry and commercial banking. Senior executives representing HDFC are also
on the Board. Senior banking professionals with substantial experience in India and abroad head
various businesses and functions and report to the Managing Director. Given the professional
expertise of the management team and the overall focus on recruiting and retaining the best
talent in the industry, the bank believes that its people are a significant competitive strength.
SBI Bank:
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 State Bank of India is the largest bank in India. It is also, measured by the number
of branch offices and employees, the largest bank in the world. Established in 1806 as Bank of
Bengal, it remains the oldest commercial bank in the Indian Subcontinent and also the most
successful one providing various domestic, international and NRI products and services, through
its vast network in India and overseas. With an asset base of $126 billion and its reach, it is a
regional banking behemoth. The bank was nationalized in 1955 with the Reserve Bank of India
having a 60% stake. It has laid emphasis on reducing the huge manpower through Golden
handshake schemes and computerizing its operations. State Bank of India has often acted as
guarantor to the Indian Government, most notably during Chandra Shekhar's tenure as Prime
Minister of India. With more than 9400 branches and a further 4000+ associate bank branches,
the SBI has extensive coverage. State Bank of India has electronically networked most of its
metropolitan, urban and semi-urban branches under Core Banking System. The bank has the
largest ATM network in the country having more than 5600 in number. The State Bank of India
has had steady growth over its history, though it was marred by the Harshad Mehta scam in
1992. Following its arch-rival ICICI Bank, the bank has started Core banking process by which
more than 4400+ branched have been completed so far. In recent years, the bank has sought to
expand its overseas operations by buying foreign banks. It is the only Indian bank to feature in
the top 100 world banks in the Fortune Global 500 rating and various other rankings. According
to the Forbes 2000 listing it tops all Indian companies.
According to PM Network, State Bank of India launched a project in 2002 to network
more than 14,000 domestic and 70 foreign offices and branches. The first and the second phases
of the project have already been completed and the third phase is still in progress. As of
December 2006, over 10,000 branches have been covered. The new infrastructure serves as the
bank's backbone, carrying all applications, such as the IP telephone network, ATM network,
Internet banking and internal e-mail. The new infrastructure has enabled the bank to further grow
its ATM network with plans to add another 3,000 by the end of 2008 raising the total number to
8,600.

MAJOR FINDINGS
Major Macro – Economic Factors include Gross Domestic Product – which has grown by
over 8%, FDI Confidence Index – where India stands II in the world, Inflation – which has
slowed down due to falling crude prices, Gross Fiscal Deficit Interest Rate – the UPA
government is confident to achieve the budgeted targets, Rising Oil prices & Exchange Rate –
Indian government and oil companies are relaxed as oil prices have fallen beside Indian Rupee
has weakened against USD, EURO and Yen and Capital Market – the year is booming for market
with FII and mutual fund are pumping money increasing BSE Sensex returns over 50%. In June
2006, Indian Banking System is spread through 66000 branches with an asset base of about $270
billion. There are 87 Scheduled Commercial Banks operating in India including 8 Banks of SBI
& Associates, 20 Nationalized Banks, 29 Private Banks and 30 Foreign Banks. In terms of asset
size, public sector banks have highest base compared to private and foreign banks. SBI &
Associated have asset base of Rs.691872Cr. Bank group-wise, new private sector banks grew at

17
the highest rate (43.2 per cent), followed by foreign banks (31.2 per cent), public sector banks
(13.6 per cent) and old private sector banks (12.2 per cent). As a result, the relative significance
of PSBs declined significantly with their share in total assets of SCBs declining to 72.3 per cent
at end-March from 75.3 per cent at end-March, while that of new private sector banks increasing
to 15.1 per cent from 12.5 per cent. Credit to the priority sector increased by 33.7 per cent as
against 40.3 per cent in the previous year. The agriculture and housing sectors were the major
beneficiaries, which together accounted for more than two-third of incremental priority sector
lending. Credit to small scale industries also accelerated. Retail loans, which witnessed a growth
of over 40.0 per cent in 2004-05 and again in 2005-06, have been the prime driver of the credit
growth in recent years. Retail loans as a percentage of gross advances increased from 22.0 per
cent in March to 25.5 per cent in March 2010.
ICICI Bank is the leading market player with change in loans market share of over 5%
and change in deposits market share is nearby 2.5%. HDFC Bank and UTI Bank are also in high
growth phase. The laggards are SBI Bank, Bank of Baroda Bank, Bank of India and Punjab
National Bank.
Micro-Economic Factors affecting Banking Industry:
1. Loan Demand in which the Indian Banking Industry has seen sustained strength in credit
growth (a 30% increase in Oct 2006, of which 58% growth has seen in service sector
and100% in real estate sector).
2. Rising funding costs with soft lending rates – Deposits has seen a growth of 22% of which
household savings contribute to 43%, credit spread increase to 3.3% and Yield on
government bonds reduced to 7.75% due to rising interest cost.
3. Non – Performing Loans (NPLs) - The Total bank loans stood at Rs 15,231.7b, of which
housing loans are Rs 1719.2b. However, the Industry’s share of total credit has dropped to
40%.
4. Technology - Indian banks still don’t have the robust systems required for efficient
functioning of online banking and Banks need to explore newer channels such as SMS, WAP
and 3G mobile telephony applications to facilitate online access to customers.

CONCLUSION
The project involves valuation of major Indian Banks including ICICI Bank, SBI and
HDFC Bank. The methodology followed is Target Pricing, which including estimating growth
rate by regression on historical sales to forecast next year sales, earning and Profit and Loss
account. Then EPS is calculated which is multiplied to Historical P/E to forecast intrinsic value
of share. All shares are undervalued and expected to give positive risk adjusted returns to
investors. Since the intrinsic value is more than current market price for all the companies, the
share can be recommended to conservative investors.

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BIBLIOGRAPHY
 AT Kearney Report, 2005.
 Company Reports.
o HDFC Bank
o ICICI Bank
o SBI Bank
 FICCI Survey on Status of Indian Banking Industry—Progress and Agenda Ahead.
 Government of India, 1991, Report of the Committee on Banking Financial System.
 Government of India, 1998, Report of the Committee on Banking Sector Reforms.
 IMF Working Paper—Competition in Indian Banking, by A Prasad and Saibal Ghosh.
 Indian Banks Association, Various Years, Performance Highlights of Banks (Mumbai).
 Indian Banking Association.
 Ministry of Commerce and Industry.
 Project on Indian Banking System, http://www.scribd.com/doc/28128042/Project-on-
Indian-Banking-System.
 Reserve Bank of India (a), Various Years, Report on Trend and Progress of Banking in
India (Mumbai).
 Reserve Bank of India (b), Various Years, Statistical Tables relating to Banks in India
(Mumbai).
 Reserve Bank of India, 2008, “Annual Policy Statement for the Year 2007-08” (Mumbai).
 Reserve Bank of India, 2010, “Annual Policy Statement for the Year 2010-11” (Mumbai).

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