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I. Overview

The world is facing the worst economic crisis since the Great Depression in 1930s. Effects of the crisis have spread far and wide due to excessive debt, deflationary conditions, financial closures and unjustified money hoarding. The financial crisis turned unwieldy with the collapse of the US subprime mortgage segment in September 2008 and its turbulence has severely weakened global financial institutions and markets. The upheaval in the credit market and its consequent fall out has left large global banks in the midst of financial duress. Economic conditions worsened as growth decelerated and inflation rates toughened in advanced economies. The US economy, in particular, has been severely hit by the subprime mortgage fiasco.

The global credit crisis has had far reaching implications for the banking industry, which has been growing at a rapid pace till 2007. The industry witnessed record profits and higher profitability between 2002 and 2007 because of the greatest economic boom but losses from the US subprime mortgage loans escalated into widespread financial stress globally for the industry. Earlier on the US banks had a dominant role in the global banking industry but today, credit crisis looms large over them. Further, as banks have been trying to improve their loan-to-deposit ratio and BASEL II capital adequacy ratios, lending has been diminishing.

Despite the financial turmoil, many banks, both in India and globally, have reported creditable performances during the year. Banks from emerging economies have been particularly impressive. In fact, banks from BRIC countries feature among the Top 1000 banks of the world, according to The Banker, London Jul 2008 edition. The US subprime crisis and its aftermath continue to affect developed markets, but emerging economies, especially the BRIC countries, remain less affected. Banks from these countries and other emerging economies are slowly and steadily making their influence and strength felt.

According to The Banker, 119 banks from BRIC countries were among the Top 1000 — in 2003, only 61 banks figured in the ranking. China’s two biggest banks, ICBC and Bank of China, also figured in the Top 10 world banks; five years ago the same banks had the 16th and 15th ranks, respectively. Chinese banks have surely come a long way since 2003 when none of these banks featured even in the top 25 banks in terms of market capitalisation. In present times, however, China accounts for three out of the Top four banks in the world in terms of market capitalisation. The 184 Asian banks in the Top 1000 banks accounted for 19% of aggregate profits in 2008 as compared with 12% in the previous year. State Bank of India (SBI) features among the top Asian banks with its pre tax profits rising to almost 30.6% during FY08 to reach USD 3.44 bn. SBI’s assets grew by 26% to USD 256.9 bn while its Tier I capital touched USD 16.1 bn, registering a whopping growth of 48%. According to the Banker, India’s banks account for only 7% of the aggregate Tier I capital and aggregate assets of the Top 200 banks.

II. Global banking – Key developments

In Nov 2008, the International Monetary Fund (IMF) cut its forecast for global growth in 2009 by three-fourth percentage points to 2.2%. In Jan 2009, IMF further revised the global growth rates to 0.5% for 2009. Governments across countries, both developed and developing, are taking measures to control the crisis. Their focus has shifted though from revival of waning financial institutions to stimulating domestic demand.

According to IMF, growth in Asia is likely to slow down from 7.6% in 2007 to 4.9% in 2009. Despite strong fundamentals, substantial external reserves and robust corporate and banking sectors, the region has been affected mainly owing to close trade and financial integration with the rest of the world. In comparison to Asian countries, growth in advanced economies is projected to contract by 0.3% only in 2009. Even though emerging economies are not poised for a robust growth, IMF estimates them to account for 100% of world growth.

II. Indian banking sector overview

The Indian economy recorded more than 9.0% growth in FY08 driven by consumption and domestic investment. India’s integration with the world also has risen considerably over the years. Its merchandise exports plus imports as a proportion of GDP grew from 21.2% in FY98 to 34.7% in FY08. The ratio of gross current account and gross capital flows to GDP, which is an expanded measure of globalisation, increased from 46.8% in FY98 to 117.0% in FY08. Banking sector assets grew faster than the real economy, resulting in an increase in the assets to GDP ratio to 91.8% at end Mar 2008. The overall financial performance of SCBs during the fiscal was underpinned by hardening of lending and deposit rates. During the above period the RBI witnessed large variations in liquidity on account of varying degrees of cash balance of the Central Government as well as volatility in the flow of cash into the country. Growth in money supply decelerated marginally from 21.5% in FY07 to 20.8% during FY08. Credit growth during the year showed some deceleration mainly on account of lower growth in agriculture and allied activities and personal loans, whereas credit to the services sector showed a higher growth. The demand for bank credit was the highest for the industrial sectors and commercial real estate sector at 43% and 38% respectively. On the other hand, the growth in credit during FY09 (y-o-y upto Aug 1, 2008) resulted in the incremental non-food credit deposit ratio to 85.4%. In the foreign exchange market too, during FY09 (upto Dec 2, 2008) the Indian rupee generally depreciated and moved in the range of Rs 39.89-50.53 per USD. The rupee which depreciated beginning Apr 2008, reflected FII outflows, bearish stock market conditions, high inflation and higher crude oil prices.

IV a. International trade in banking services

In the context of negotiations for liberalising the financial services sector under the WTO as a part of General Agreement on Trade in Services (GATS), international trade in banking services has more prevalence. At present, there are 29 foreign banks operating in India that together reported a total asset base of Rs 2,780.1 bn, disbursed credit worth Rs 1,263.3 bn and received deposits amounting to Rs 1,508 bn. The RBI had conducted a survey Jan 2008 in order to collect disaggregated information on various banking services offered by overseas branches of Indian banks and branches of foreign banks in India. In the survey 25 foreign banks of the 29 banks operating in India participated. The survey revealed that the 25 respondent banks extended a total credit of Rs 1,245.1 bn and received deposits worth Rs 1,473.4 bn, indicating coverage of almost 99% and 98% respectively. These figures indicate the growing importance of foreign banking operations in the Indian banking industry.

IV b. Growth in reserve money

During FY08, reserve money was higher than last year’s level and grew by 30.9% as compared with 23.7% in the previous year. Reserve money is the sum total of banks’ deposits with the RBI, currency in circulation in the market and other deposits. During FY08, reserve money limits fluctuated as bankers’ deposits with the RBI wavered owing to hikes in the CRR. These deposits increased by 66.5% in FY08 as compared with 45.6% in the previous fiscal and as on Mar 31, 2008, the total outstanding reserve was Rs 928,417 mn.

IV c. Currency management

During FY08, value and volume of banknotes in circulation rose by 17.2% and 11.0% each as compared with 17.6% and 5.2% a year ago. The shift towards higher denomination bank notes, particularly Rs 1,000 and Rs 500 notes, caused the growth in volume of banknotes to be lower than their value. While the volume of Rs 500 banknotes rose by 16.7% during FY08 as compared with 23.6% a year ago, the volume of Rs 1,000 banknotes grew by 50.7% in FY08 as against 45.7% in the previous year. The circulation of Rs 10 denomination bank notes increased by 30.4% because the RBI infused fresh bank notes to improve their quality. The volume of banknotes in the denominations of Rs 2 and Rs 5 grew by 23.2%, and volumes of Rs 20, Rs 50 and Rs 100 bank notes decreased marginally in FY08 as compared with FY07. The total value and volume of coins increased by 13.3% and 5.7% during FY08 as compared with 11.2% and 6.5% in the previous year.

IV d. Performance of scheduled commercial banks (SCB)

SCBs continued to perform robustly during FY08 owing to an encouraging macroeconomic environment. Even though SCBs’ credit growth was moderate, because of RBI’s policy initiatives, their deposit growth was impressive; but fall in term deposits made the growth tad lower than previous year’s growth. Owing to strong deposit growth and moderate credit growth, SCBs’ credit deposit ratio declined.

IV e. No-frills account for greater financial inclusion

Banks have provided greater financial inclusion to large sections of the population by making available basic banking services. No-frills accounts, one such initiative taken by banks, especially public sector banks, have increased considerably in the last few years. A no-frill account typically has the facility of zero or very low balance and limited transaction facilities. During FY07, the number of such accounts in the public sector banks rose more than 16 times on a y-o-y basis and almost doubled in FY08. Private banks’ no-frills account increased more than four times in FY07 and their growth almost doubled in the subsequent fiscal. Foreign banks also reported a significant rise in the number of no-frills accounts opened. The number of no-frills accounts with foreign banks went up from 231 in FY06 to 5,919 in FY07 and further increased more than four times to 33,115 in FY08.

IV f. Dominant role of information technology in banking

Information technology has been the single-largest force that has facilitated successful transformation of transactions and analytical processes of banking business. The operational landscape of the Indian financial sector has changed — paper and electronic modes of payment have converged and operational efficiency and flexibility have improved — with the adoption of IT-intensive processes.

In addition, it has also enabled innovative delivery channels like introducing advanced technology in retail banking operations. For instance, the retail electronic funds transfer system that comprises electronic clearing services (ECS), electronic funds transfer (EFT) and national electronic funds transfer (NEFT) systems is possible due to IT enabled systems. EFT usage has increased more than five times during FY08 over the previous year, reflecting its prominence across retail electronic funds transfer systems. Electronic banking services have resulted in a sea change in the manner in which customers interact with banks, having a positive impact on customer experience as well as bringing operational and cost benefits to the banks.

The value per transaction of ECS credit went up from Rs 7,310.48 in FY06 to Rs 99,817.78 in FY08. Value per transaction from ECS debit did not undergo any significant change between FY06 and FY08 and grew from Rs 3,611.44 in FY06 to Rs 3,849.67 in FY08.

Transaction value through credit cards also did not report any substantial change. Value per credit card transaction went up from Rs 2,170.98 in FY06 to Rs 2,539.76 in FY08. Transaction value per debit card at Rs 1,290.77 in FY07 and Rs 1,417.91 in FY08 was lower than that of credit cards during this period.

IV g. Mergers and acquisitions

Mergers and acquisitions in the banking sector fall under the purview of the Banking Regulation Act. Banks opt for mergers and acquisitions to offset decline in profitability. During FY08, the Indian banking industry witnessed many amalgamations and mergers. Some such amalgamations were: Sangli Bank and ICICI Bank with effect from Apr 19, 2007; Lord Krishna Bank and Centurion Bank of Punjab with effect from Aug 29, 2007 and American Express Bank and Standard Chartered Bank from Mar 5, 2008. Two banks changed their names during FY08; Arab Bangladesh Bank changed its name to AB Bank while IDBI Ltd changed its name to IDBI Bank Ltd.

As on May 1, 2008, the number of regional rural banks (RRBs) declined from 196 to 88, because 154 RRBs merged into 45 RRBs. Usually, government policy governs mergers and acquisitions of RRBs. Since Sep 2005 many RRBs were merged pursuant to recommendations of the committee on the flow of credit to agriculture and related activities. The committee had recommended the restructuring of RRBs in order to improve the operational viability of RRBs while taking advantage of the economies of scale. The structural consolidation of RRBs has resulted in the formation of new RRBs that were financially stronger and bigger in terms of business volume and reach.