Major changes await Indian banks

The remarkable growth story of the Indian banking market is appreciated globally now. Between 2000 and 2005, the total assets of the industry grew from $265 billion to $520 billion, profits grew from $1.7 billion to $5 billion.

Current projections suggest that in 2010, industry assets would exceed $1 trillion, with total profits pegged between $10-$12 billion.

This growth has been on the back of retail assets that have grown from $9 billion in 2000, to $66 billion today, and are projected to grow to a staggering $320 billion in 2010. The market share shifts that are likely to result are not as well appreciated; these share shifts need to inform banking policy much more.

The graphic captures a fairly dramatic shift in bank asset shares in the Indian market. The new private sector banks have stolen share not just from nationalised banks including the State Bank of India, but equally from foreign banks and old private banks.

Today, they collectively hold 13 per cent of the market. Should they maintain their 2000-05 growth rate, they will have about 28 per cent share of the market by 2010. The three top players would have grown at about the same speed as the much-celebrated IT industry in India.

The equity markets have also recognised and rewarded these players and currently have the highest price to earnings multiples amongst banks globally.

If we were to project future growth of private sector banks at the same pace as the past five years, ICICI Bank will overtake SBI as the largest bank in India. We have assumed only a 41 per cent CAGR for ICICI and not the 70 per cent rate it had grown at over the past five years.

At that growth, it would have a market share of over 18 per cent of the market. What is even more startling is that there would then be three private sector banks in the top six banks in India by asset size in 2010. Such a remarkable, largely organically-based market share shift would require policy attention from the powers that be.

If we look at the graphic in detail, the SBI share is down by three points to 20 per cent - despite its 9,000 branches, an established brand and pick of employees. The nationalised banks as a segment have lost four points though there have been a few notable exceptions - PNB and UCO.

But if we project this out, the outlook is dour - by current projections, in 2010, the overall segment may control less than 40 per cent of the market. On an average, each player will hold just two points of market share.

The two biggest foreign banks - Citi and Standard Chartered - and the foreign bank segment as a whole, have lagged the market in terms of growth. Indeed, with lower technology and factor costs, lower profit aspirations and easier distribution licensing, Indian private sector banks have taken share away from foreign banks, too.

The old private sector banks have also struggled and despite being available to foreign and domestic players, other than Vysya and Madura, have not even been acquired. Thus, the top-10 list in 2010 will have three private banks and bear little resemblance to the one in 2000.

There is a set of implications that such a transformation creates. What does one do with public sector banks? How does one treat the new private sector banks? How does one clean up the old private sector banks (our underbelly)? And what policy framework in 2009 would protect Indian interests?

RBI's stated policy currently would permit acquisitions of any Indian private sector bank after 2009. As per the policy in 2009, a determined foreign player could acquire any Indian private sector bank, the best assets in the market place.

Is this right? If we cannot consolidate our public sector banks (which appears mysteriously so), would it not be better to actually sell them rather than allow the new private sector banks to be bought in 2009? Further, given that we will be pressured to open up the banking sector, would it not be nice to clean up old private sector banks so that foreigners may want to buy them?

This requires us to change our policy paradigm. We need to change our bets. Remember that even in 2010 Indian players will remain minuscule by global standards. Citibank's current assets will be more than our entire sector in 2010; their current year profits of $25 billion would be more than double our projected profit pool in 2010.

Thus, our banks even at high P/Es will remain easy prey for foreign players. If we cannot consolidate and free our public sector banks, they will atrophy as today at a rate inversely correlated to the dynamism of some individual chairpersons.

Further, at a time when their balance sheets are clean, the avarice of the ruling party to reward political constituencies through them will also be high, further enfeebling them by 2010. Thus, maybe we should consider offering the smaller public sector banks (say, those with less than 2 per cent of share) to foreigners in 2009.

For the underbelly, should we not encourage the Sabres of the world to take over the old private sector banks? Let them attract risk-loving and confident Indian talent, whether working with foreign banks or public sector banks, to take the opportunity to get wealthy (through ESOPs).

Let them clean up the mess and provide the foreigners something that they would like to buy in 2009.

Given the strength of our private sector banks, the national policy should be formulated to support and bet on them like the Singapore government with DBS.

This, is if we believe that there is some merit in keeping the key parts of the sector under Indian incorporation and regulation.

We might then be pleasantly surprised by the creations of a few Indian regional winners - an ICICI with a global footprint so as to credibly challenge a CBA or a DBS. We need to remember that Asia is not idling; DBS is growing, as are the Chinese banks (even today the Bank of China has $500 billion in assets). We need to be thinking carefully and clearly about what we want our policy to achieve.