India's Leading BFSI Companies 2016

India's Leading BFSI Companies 2016

Global Banking Scenario

The global financial crisis of 2008 exposed the weakness in the global financial system. Since the crisis, tighter regulations on banks, both general and specific to their international operations, combined with a need to clean up balance sheets have induced banks to cut back their international lending. International banks, especially European banks have reduced their cross-border lending (direct lending to non-affiliated entities in other countries) and shifted their focus more on multinational banking with more local and locally funded operations.

During the global financial crisis, a number of banks in many countries either failed or received taxpayer-funded bailouts. Thus to prevent this type of global situation further in the future, a series of significant regulatory changes to the international banking sector were introduced. These regulatory changes are made to help manage systemic risk by strengthening capital, liquidity and leverage requirements for all banks.

As a part of regulatory change, Basel III, a framework which sets out global regulatory rules for bank capital and liquidity was developed and agreed by The Basel Committee on Banking Supervision. Subsequently, the phase-in of Basel III capital rules began in 2013. While these rules are being set internationally, the pace of domestic implementation of these is not consistent around the world but most likely these will come in place globally by 2019.

• Basel III Capital rules

Under this rule, the banks are required to hold capital equal to at least 10.5% of their total risk-weighted assets by 2019. The global systemically important banks (G-SIBs) and domestic systemically important banks (D-SIBs) are required to hold additional capital as failure of any from these set of banks can have a significant impact on global and domestic economies.

• Basel III Liquidity rules

These rules are set to ensure that banks have sufficient, high-quality liquid assets to withstand a period of economic stress. The Basel Committee has developed two minimum rules for liquidity which includes the Liquidity Coverage Ratio (LCR) having a 30-day horizon and the Net Stable Funding Ratio (NSFR) having a time horizon of one year. LCR requirements will be phased in between 2015 and 2019 while NSFR will be phased out by 2018.

Over 90% of the banks worldwide achieve capital ratio target of 7%

Banks worldwide went on an overdrive boosting their capital ratios, eventually outpacing the targets implied in the Basel III phase-in arrangements. As per the study conducted by Basel Committee on Banking Supervision, all the 97 banks in the large internationally active banks group (banks having Tier 1 capital of more than Euro 3 bn) displayed a Common Equity Tier 1 (CET1) ratio under Basel III above both the 4.5% minimum capital requirement and the 7% target ratio (the minimum capital requirement plus the capital conservation buffer). By June 30 2014, large internationally active banks, as a group, increased the average ratio of their CET1 capital to risk weighed assets (RWAs) to 10.8% from 9.5% as on June 30 2013. Of the 114 banks in the other banks group, 99% reported a CET1 ratio equal to or higher than 4.5%; while 93% also achieved the target of 7%. Other banks, as a group also reached the same average capital ratio levels of 11.2% as on Jun 31 2014 as compared to 9.1% as on June 31 2013.

The major growth driver for the steady improvements in the regulatory capital positions of both advanced economy and emerging market economies is the higher profits. Retained earnings were one of the major contributing factors for 45% increase in large internationally active banks’ CET1 capital between mid-2011 and mid-2014. Increased capital coupled with declining risk-weighted assets has helped the CET1 regulatory ratios increase from 7.1% to 10.8% over the same period.

Continued policy improvements and economic reforms coupled with greater efforts by the banks to strengthen their capital position have led to the improvement in capital adequacy levels in various economies. Banks in few of the advanced economies like UK, Canada and Germany exhibited decline in their capital adequacy levels. Most of the Emerging market and developing economies including India, China and Brazil with the exception of Russia exhibited increase in their capital adequacy levels.

Among the BRICS nation, the aggregate capital adequacy ratio of Russia decreased from 13.5% in 2013 to 12.5% in 2014 on account of increasing NPAs from 6% in 2013 to 6.7% in 2014. Other BRICS nations including India, China, Brazil and South Africa demonstrated increase in their capital adequacy ratio from 12.3%, 12.2%, 16.1% and 12.3% in 2013 to 12.5%, 12.4%, 16.7% and 12.5% in 2014 respectively.

Ratio of bank regulatory capital to risk weighted assets (%)

Return on Assets remain stable in most of the economies

The Return on Assets (RoA), an indicator of banking system’s profitability showed a mixed trend across the economies. Among advanced economies, few economies like the US and UK displayed deterioration in RoA while other economies like Australia, Canada and Japan demonstrated a stable to modest growth in their RoA. Among the Euro Zone, economies like Greece, Portugal and Slovenia has reported negative return on assets due to impact on profitability driven by weak economic activities.

Amongst the BRICS countries, all economies except Russia have shown stable RoA in 2014. Russia has reported sharp decline in RoA in 2014 as compared to 2013 due to increase in NPA (increased from 6% in 2013 to 6.7% in 2014) and reduction in profitability.

NPAs on the rise in Euro zone

With the economy bouncing back after the crisis in few advanced countries, the asset quality of advanced economies like the US, UK has improved over the period of last four years. However, banks in the Euro Zone remain burdened by the large and growing stock of non-performing assets (NPAs), which are largely the outcome of corporate debt overhang and the economic slowdown. Asset quality continued to deteriorate in the euro area as a whole in 2014 with total non-performing loans standing at more than €900 billion.

Furthermore, the stock of non-performing loans in the euro area is unevenly distributed, with about two-thirds located in six euro area countries viz Cyprus, Greece, Ireland, Italy, Portugal and Slovenia. By the end of 2014, these six euro area countries witnessed the soaring of their NPAs-to-total loans ratio to very high levels, even to the extent of 10% or more. The situation was the worst in Cyprus with over 45% of its loans marked as NPAs followed by Greece, with almost one-thirds (34.3%) of its total loans marked as NPAs. Ireland (18.7%), Slovenia (11.7%), Cyprus (16.6%), Italy (17.3%) and Portugal (11.2%) also witnessed NPAs levels of more than 10%.

On the other hand, banks in the US and UK made steady progress in managing their NPAs. The US banking sector posted steady declines in the aggregate NPA ratio, which fell to 2% by 2014 from 4.4% in 2010. The UK’s banking sector also posted declines in the aggregate NPA ratio from 4% in 2010 to 2.7% in 2014.

Among the BRICS nation, the aggregate NPA ratio of South Africa banking decreased from 3.6% in 2013 to 3.3% in 2014 and Brazil’s NPA ratio remained at the same level at 2.9%. Other BRICS nations including India, China and Russia demonstrated increase in their NPAs with their NPA ratio increasing from 4%, 1% and 6% in 2013 to 4.3%, 1.1% and 6.7% in 2014 respectively.

Ratio of Non-Performing Loans to Total Loans (%)

The Way Forward

In advanced economies, to support the economic growth and to bring inflation to the target level, accommodative monetary policy needs to be continued. The countries where fiscal position is in control should increase the investment in infrastructure and the countries with high public debt should balance between fiscal management and improving the economic activity.

The Euro zone is recovering but the recovery is turning out to be weaker than expected. The investments are still well below pre-crisis levels and high unemployment, large debt burdens; higher real interest rates in stressed economies, weak banks and contracting credit are continuously posing obstacles to the resurgence of domestic demand. The Euro Zone also requires the repairing of bank balance sheets with implementation of a mechanism which can facilitate credit flowing across the borders and reducing financial fragmentation.

In emerging market and developing, budget deficits and public debt levels are generally lower than in developed economies. As commodity prices are expected to remain weak, government revenues of the countries whose GDP is dependent on commodities is likely to remain subdued. Despite comparatively low public debt levels, a more cautious attitude towards sovereign borrowing should be adopted by many developing countries. Higher benchmark interest rates, volatile exchange rate and any change in appetite of investor to invest in emerging markets may hamper the ability of developing countries to refinance.

Indian Banking industry

Overview on Indian Banking Industry

The Indian banking industry plays a key role in the economic development and growth of the country and is the most dominant segment of the financial sector. The Indian banking sector comprises of different types of institutions catering to the diverse banking needs of different sectors of the economy. Banks operational in India can be broadly classified as commercial and co-operative banks. Commercial banks constitute the largest segment of the banking system.

Trends in the Banking Industry for the past 3 years

Key Factors that impacted the performance of the banking industry

Credit and deposit growth continued to remain sluggish

The growth in aggregate deposits moderated to 11.4% in FY15 from 14.1% in FY14 due to lower deposit mobilization as well as base effect i.e. high accretion to NRI deposits owing to fresh foreign currency non-resident account (banks) (FCNR (B)) deposits mobilized under the swap scheme during Sep to Nov 2013 to tide over the external financing requirements. Further, during FY15, banks reduced deposit rates on various maturities which impacted the growth of aggregate deposits.

Similarly, growth of overall bank credit also decelerated in FY15. The increase in nonperforming assets (NPAs) and corporate debt restructuring emerged to be major concerns for the economy during 2015. The corporate sector’s preference for raising finances through issuance of commercial papers (CP) and external commercial borrowings (ECBs) also seemed to have impacted the credit off-take growth. Consequently, growth in credit off-take of all SCBs decelerated to nearly 9.5% in FY15 from 13.9% in FY14. Increase in risk aversion due to deterioration in asset quality and availability of alternative sources of funds resulted in moderation in credit off-take.

Trends in Credit-off take and Deposits Growth (y-o-y)

CRAR (Basel III) for all SCBs stood at a comfortable level of 13% during FY15

The RBI implemented the Basel-III capital regulation to enhance SCBs’ ability to absorb shocks from financial and economic stress. The RBI extended the end date for full implementation to Mar 31, 2019. The regulatory requirement for capital to risk-weighted assets ratio (CRAR) Basel III stood at 9% for FY15.

The CRAR of SCBs though met the regulatory requirement, declined marginally to 12.9% in Mar 2015 from 13.02% in Mar 2014. Public sector banks (PSBs) recorded the lowest CRAR among all bank-groups. Moving ahead the banking industry, especially PSBs will require substantial capital to meet regulatory requirements with respect to additional capital buffers.

Asset quality of all SCBs continued to deteriorate

Deteriorating asset quality has emerged to be a major concern for the domestic banking industry. The gross nonperforming advances (GNPAs) of all SCBs as a percentage of gross advances grew to 4.6% in Mar 2015 from 4.1% in Mar 2014. The net non-performing advances (NNPAs) as a percentage of the total net advances for all SCBs grew from 2.2% as on Mar 2014 to 2.5% as on Mar 2015.

GNPA ratio (%)

Continued pressure on profitability of SCBs eased during FY15

Net Interest Income (NII) recorded decelerated growth of 9.3% in FY15 as compared to 11.7% in FY14. The share of NII to total operating income (TOI) of all SCBs dropped to 69.5% in FY15 from 71.1% in FY14.

Trends in net profit growth y-o-y

Net profit growth which was showing a downward trend since FY11 improved significantly in FY15. Net profit recorded significant growth of 11.4% during FY15 compared to a decline of 14.1% during FY14. Some significant factors attributing to this growth included the impact of base effect, increase in treasury gains and write back of excess provisions held in investment portfolio.

Focus on Financial Inclusion to continue to improve banking accessibility in rural areas

The RBI has advised domestic banks to adopt a structured approach to financial inclusion (FI) through preparation of board approved FIPs. The first phase of FIPs was implemented over 2010-13. Banks were advised to prepare fresh threeyear FIPs for 2013-16 with the focus on enhancing the volume of transactions in the large number of accounts opened. The launch of the FIP has aided in growth of banking outlets in villages, grant of credit and deployment of ATMs in rural areas.

Several policies have been implemented to promote financial inclusion such as the launch of the ‘Pradhan Mantri Jan Dhan Yojana’ (PMJDY) in Aug 2014 and the ‘RuPay Card’ - a ‘payment’ solution. The Yojana envisions universal access to banking facilities with at least one basic banking account for every household, financial literacy, access to credit and insurance. PMJDY’s benefits include a RuPay debit card, 1 lakh accident insurance cover and an additional 30,000 life insurance cover. It is a platform for Direct Benefits Transfer (DBT) which will help plug leakages in subsidies.

As on Jan 2015, 123.1 mn bank accounts have been opened under PMJDY, of which 73.6 mn are in rural areas and 49.5 mn in urban areas. Under the PMJDY, 67.5% of the accounts as on Jan 2015 are with zero balance. The total number of banking outlets, opening of BSBDAs and small credits have grown significantly during FY15 due to PMJDY.

Progress on financial inclusion by banks

Banks recorded maximum addition of ATMs and offices in rural areas for inclusive growth in FY15

Banks are increasingly adding branches and ATMs in rural areas to tap these markets and for inclusive growth. Total number of ATMs in India has grown to 181,252 as on Mar 2015 from 74,505 as on Mar 2011. As on Mar 2015, ATMs of all SCBs in rural and semi urban areas accounted for 44% share of the total ATMs in the country compared to 41.6% as on Mar 2014. In addition of all the ATMs that were opened in FY15, around 39% were in rural areas and 24% in semiurban areas.

Total number of bank offices in India has grown to 125,863 as on Mar 2015 from 89,110 as on Mar 2011. Offices in rural areas formed the largest share of 38% in FY15 along with the highest addition in the branch network during FY15, both in absolute and percentage terms in rural areas.

Penetration of electronic payment modes is on the rise

The RBI enacted Payment and Settlement Systems Act 2007 (PSS Act) to provide sound legal basis for the regulation and supervision of payment systems in India. To make the PSS Act more effective, amendments to provide finality to the determination of the payment obligations and settlement instructions between a central counter party (the system provider) and system participants in the event of insolvency, dissolution, or winding up of a central counter party have been added. The Payment and Settlement Systems (Amendment) Bill 2014 has been passed by the Lok Sabha in the winter Session of 2014 and was passed by the Rajya Sabha in Apr 2015.

The RBI to promote electronic payments in the country has continued its efforts in making the payment systems safe, efficient, interoperable, authorised, accessible, inclusive and compliant with international standards. Various initiatives for infrastructure enhancements have been undertaken including implementation of Trade Receivables and Discounting System and the Bharat Bill Payment System.

The continued trend of greater acceptance in electronic payments over paper cheques was also seen during FY15. Nearly 90% of the total settlement volumes have been carried out through retail electronic modes as on Aug 2014. Transactions through RTGS have grown 14.4% and 2.7%, in volume and value terms respectively in FY15. Retail electronic segment saw growth of 52.25% in volume and 36.59% in value during FY15. NEFT volumes and values rose 40.3% and 36.58% respectively, during FY15. Debit card usage has registered a growth of 16.36% in volume whereas credit card witnessed growth of 20.97% in FY15.

Distribution of settlement systems (Percentage share in total by value)

In volume terms, the no. of transactions handled through RTGS has increased to 92.78 mn during FY15 from 81.1 mn in FY14. In value terms, RTGS transactions have increased from 905 tn in FY14 to 929 tn in FY15. Under the retail electronic payments the volume handled grew from 1,108.32 mn during FY14 to 1,687 mn during FY15. Similarly, in value terms also, it has increased to 65 tn from 48 tn.

Further, the use of internet, social media and smart phones for banking has been on the rise on account of growing internet and mobile penetration. During FY15, mobile banking services executed 172 mn transactions valued at 1,035 bn, registering y-o-y growth of 82% in volume and 362% in value. Despite the high mobile density in the country, there exists immense potential for leveraging the mobile technology to offer banking services.

Distribution of settlement systems (Percentage share in total by volume)

The Road Ahead

Economic growth, infrastructure investments, financial inclusion, favourable demography & rising income levels (which will lead to increased demand for banking services), rapid urbanisation, policy support, technological innovation and digitisation are expected to drive growth in the banking sector.

Digitisation is a focus area for the Government and leveraging various digital technologies such as SMAC (Social, Mobile, Analytics and Cloud) capabilities will facilitate banks in reaching out to new customers, enhancing customer experience, gaining insights into customer behaviour and improving revenue generation & operational efficiency. Growing internet, mobile banking and technology led distribution models is expected to widen reach, reduce costs, protect margins and promote growth for banks.

Further, some of the key reform measures such as licensing of payment and small bank, change in the norms of recapitalization of PSBs etc. taken towards improvement in corporate governance and financial inclusion are expected to positively impact the banking industry.

With government initiatives like PMJDY and the MUDRA Bank, as well as increased adoption of technology, new processes such as direct benefits transfers, enhanced inclusive growth is expected. A vast un-banked population offers potential for growth and scope for innovation in delivery models. To bring rural population under the banking ambit, the Government of India and RBI have prioritized financial inclusion. SCBs are expanding their branch network to tap rural areas for further business opportunities. Rural banking is expected to grow further moving ahead.