Banking Industry Outlook and Expectations for 2011

The Indian banking sector has been an integral part of the overall economy growing with and supporting the growth of other sectors. The sector has withstood the global financial turmoil with little disruption and continued to grow at a healthy pace.

Banking Industry Outlook and Expectations for 2011 from Dun & Bradstreet are as follows:

Regulatory thrust on financial inclusion to widen the reach of the banking sector:
The RBI has been actively encouraging financial inclusion. There are around 72,315 villages, with a population of over 2000 (as per the 2001 census), that are yet unbanked and which need to be brought under the banking net. Only around 40% of the Indian population is currently connected to the banking system. The RBI has issued a directive to public sector banks to ensure that all these villages with population above 2000 be brought under the formal banking net by 2012 resulting in an addition of around 145 million customers into the banking network.

Mobile technology to drive the next leg of the banking sector growth; would also support financial inclusion:
Technology has played a key role in the Indian banking sector. As per the FY10 RBI release, around 90% of the public sector branches have been updated with core banking software, while around 97.8% of the public sector banks branches have been fully computerized. 

Consolidation the way forward for the banking sectors; would help banks finance larger transactions:
The Indian banking sector has witnessed consolidation over the past couple of years. As per RBI data there have around 25 mergers in the banking sector in the last two decades. Some of the key mergers which have taken place in the last couple of years have been Global Trust Bank with Oriental Bank of Commerce, Bank of Punjab with Centurion Bank, further Lord Krishna Bank with Centurion Bank of Punjab and then eventually with HDFC Bank, The Sangli Bank  with ICICI Bank and the latest one being Bank of Rajasthan with ICICI Bank.

Having a minimum capital of more than Rs. 10 billion is one of the options that RBI is contemplating as the minimum capital requirement to obtain a new bank license. Given that around eight domestic banks still have a net worth lower than Rs.10 billion, in FY10, there is further scope for consolidation. Also, this would help banks in meeting capital adequacy requirements and financing large transactions and investments made by the Indian corporate sector.

Credit growth to continue on upward trajectory:
The banking sector business has grown at a CAGR of around 23% between FY05 to FY10. On account of lower capital expenditure by the industry, coupled with the apprehension of the banking sector to issue credit the sector witnessed a slightly modest growth in FY10 y-o-y of around 16.7 %. However, the same has witnessed a pickup in the current financial year, with a growth of around 20% y-o-y as of October 2010. With the overall economy expected to grow at around 8.8% for FY11, and services and industry expected to grow at a faster pace of around 10.3% and 9.5% respectively, bank credit is expected to continue at a healthy pace.

Take-out financing expected to be in revival mode on the back of infrastructure growth:
Take-out financing is a method of providing finance for longer duration projects (say of 15 years) by banks by sanctioning medium term loans (say 5-7 years). It is an understanding that the loan will be taken out of books of the financing bank within a pre-fixed period, by another institution thus preventing any possible asset-liability mismatch as most of the liabilities of the banks are in the form of deposits which have tenure of less than 5 years. As per FY09 RBI data on maturity pattern of deposits, only around 7.4% of the total deposit amounts for SCBs were for more than 5 year maturity. After taking out the loans from the banks, the institution could off-load them to another bank or keep it. Although the take out financing as a concept has witnessed teething issues, the revival of the same is expected given the RBI allowing take out financing via ECBs.

Investments in commercial papers to rise given the shift to the base rate system:
The Indian Banking sector moved to the base rate system from July 2010 as against the incumbent PLR (Prime Lending Rate) system. The base rate is calculated as the cost of deposits and cost of keeping aside cash to meet CRR and SLR requirements. With no bank allowed to lend below the base rate, the NBFCs and corporations with better ratings, which until the introduction of the base rate could negotiate and borrow below PLR from the banks, could now move to issuing commercial papers for their short term capital requirements for tenures ranging from 15 days to 365 days. Since the interest rates on commercial papers are linked to the yield on the one-year government bond, they would turn out to be cheaper than banks loans for better rated companies. The banks can then invest in these commercial papers