EVOLUTION OF INDIAN BANKING SYSTEM

A Minor Project Report

Submitted in partial fulfillment of the requirements for BBA(Banking&Insurance) semesterVI Programme of

G.G.S.Indraprastha University, Delhi

SUBMITTED BY

Jasmine kaur

BBA(Banking&Insurance)semesterVI

Enrol. No.: 074

Delhi College of Advanced Studies

Shanker Garden, Vikaspuri

New Delhi -110018

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 the coverage wider since 1969. In 1969a major

position of 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 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 banks offices magnitude and the 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 endeavor of this study to analyze the present state of various

banks keeping in view the primary data has been collected regarding the present state of loan

schemes in various banks by using a questionnaire.

I would take this opportunity to thank Mr. Joshi, Faculty, for being cooperative and helpful

guide.

A note of thanks is due to all those, too many to single out by names, which have helped in no

small measure by cooperating during by providing their valuable time, inputs and assistance.

Their support, guidance and motivation were very valuable and encouraging

.

DECLARATION

I hereby declare that the minor project report, entitled “Evolution of Indian

Banking System”, is based on my original study and has not been submitted

earlier for any degree or diploma of any institution/university.

The work of other author (s), wherever used, has been acknowledged at

appropriate place(s).

Place: Candidate’s signature

Name:

Date: Enrol. No.:

Countersigned

Name:

Supervisor

Delhi College of Advanced Studies

INTRODUCTION

We can identify three distinct phases in the history of Indian Banking.

1. Early phase from 1786 to 1969

2. Nationalization of Banks and up to 1991 prior to banking sector

Reforms

3. New phase of Indian Banking with the advent of Financial & Banking

Sector Reforms after 1991.

The advent of banking system of India started with the establishment of the first

joint stock bank, The General Bank of India in the year 1786. After this first bank,

Bank of Hindustan and Bengal Bank came to existence.

In the mid of 19th century, East India Company established three banks The Bank

of Bengal in 1809, The Bank of Bombay in 1840, and bank of Madras in 1843.

These banks were independent units and called Presidency banks. These three

banks were amalgamated in 1920 and a new bank, Imperial Bank of India was

established. All these institutions started as private shareholders banks and the

shareholders were mostly Europeans. The Allahabad Bank was established in

1865.

The next bank to be set up was the Punjab National Bank Ltd. which was

established with its headquarters at Lahore in 1894 for the first time exclusively by

Indians.

Most of the Indian commercial banks, however, owe their origin to the 20th

century. Bank of India, Central Bank of India, Bank of Baroda, the Canara Bank,

the Indian Bank, and the Bank of Mysore were established between 1906 and

1913.

The last major commercial bank to be set up in this phase was the United

Commercial Bank in 1943. Earlier the establishment of Reserve Bank of India in

1935 as the central bank of the country was an important step in the development

of commercial banking in India. The history of joint stock banking in this first

phase was characterized by slow growth and periodic failures. There were as many

as 1100 banks, mostly small banks, failed during the period from 1913 to 1948.

The Government of India concerned by the frequent bank failures in the country

causing miseries to innumerable small depositors and others enacted The Banking

Companies Act, 1949. The 1949?, as per amending Act of 1965 (Act No.23 of

1965).

Reserve Bank of India as the Central Banking Authority of the country was vested

with extensive powers for banking supervision.

Deficiencies of Indian Banking System before Nationalisation

Commercial banks, as they were privately owned, on regional or sectarian basis

resulted in development of banking on ethnic and provincial basis with parochial

outlook. These Institutions did not play their due role in the planned development

of the country. Deposit mobilisation was slow. Public had less confidence in the

banks on account of frequent bank failures. The savings bank facility provided by

the Postal department was viewed a comparatively safer field of investment of

savings by the public. Even the deficient savings thus mobilised by commercial

banks were not channeled for the development of the economy of the country.

Funds were largely given to traders, who hoarded agricultural produce after

harvest, creating anartificial scarcity, to make a good fortune in selling them at a

later period, when prices were soaring.

The Reserve Bank of India had to step in at these occasions to introduce selective

credit controls on several commodities to remedy this situation.

Initial Phase of Nationalisation

When the country attained independence Indian Banking was exclusively in the

private sector. In addition to the Imperial Bank, there were five big banks each

holding public deposits aggregating Rs.100 Crores and more, viz. the Central Bank

of India Ltd., the Punjab National Bank Ltd., the Bank of India Ltd., the Bank of

Baroda Ltd. and the United Commercial Bank Ltd. Rest of the banks were

exclusively regional in character holding deposits of less than Rs.50 Crores.

Government first implemented the exercise of nationalisation of a significant part

of the Indian Banking system in the year 1955, when Imperial Bank of India was

Nationalised in that year. But the major process of nationalisation was carried out

on 19th July 1969, when the then Prime Minister of India, Mrs.Indira Gandhi

announced the nationalisation of 14 major commercial banks in the country. One

more phase of nationalisation was carried out in the year 1980, when seven more

banks were nationalised. This brought 80% of the banking segment in India under

Government ownership.

The Indian Economy is driven by strong fundamentals with GDP growth at 9.1%

for H1 FY07 – strongest growth in any six months since H1 FY04 and uptrend in

Industrial Cycle with Average Index of Industrial Production growth at 10.2%

being the strongest run in the past 11 years.

On political front, the Indian Government has signed nuclear deal with America

indicating India’s importance in the global context opening up many opportunities.

Along with this, Chinese President Hu is expected to visit India. This will improve

trade and other ties between two of the fastest growing economies.

In Capital Market, Strong foreign inflows with Portfolio flows of nearby USD

9.2bn took BSE Sensex to 14,000 + (50% higher) compared to FY 05-06. The

Indian corporate raised USD 6bn by issuing Initial public offer in India and abroad.

High Credit growth at 30%, it continued the trend of last 5 years where it has

averaged around 25% and lastly M&A activity which was at its peak with sectors

beyond IT and Pharma making global & domestic acquisitions.

The high growth sectors are Power where power ministry and local private

players announce 9 ultra mega projects (4,000 MW each) provides visibility

on power & infra front.

Retail - a Point of inflection with major Indian corporate announcing plans,

entry of world majors like Wal-Mart & foreign investment allowed in single

brand retail and Real Estate with major huge build-out plans and Special

Economic Zone policy of government is major driver of growth.

Banking in which Banks are allowed to raise hybrid capital which opens

new avenues for funding credit growth.

As such, the report focus on change factors in Banking Industry as this industry is

expected to have major impact on Indian Economy.

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 broadly be categorized as institutional and non-institutional.

The major institutional suppliers of credit in India are banks and non-bank

financial institutions (that is, development financial institutions or DFIs), other

financial institutions (FIs), and non-banking finance companies (NBFCs). The non-

institutional or unorganized sources of credit include indigenous bankers and

money-lenders. Information about the unorganized sector is limited and not readily

available.

An important feature of the credit market is its term structure:

(a) Short-term credit

(b) Medium-term credit

(c) Long-term credit.

While banks and NBFCs predominantly cater for short-term needs, FIs provide

mostly medium and long-term funds.

REVIEW OF LITERATURE

IA Bank ties up with SBI for money transfers

NEW JERSEY: Indus American Bank has tied up with State Bank of India to

offer money transfer services to India for its clients. Under the new money transfer

service, which will provide expanded services to Indus American Bank customers

can expect service at over 14,000 branch locations of State Bank of India within

India, and at over 14,000 additional RTGS participating banks.

Funds remitted from Indus American Bank would reach recipients typically within

24 hours. As the largest bank in India, State Bank of India offers excellent

exchange rates which are now available to Indus American Bank customers. India

is one of the biggest destinations for foreign remittances.

ICICI Bank allots equity shares

ICICI Bank allotted 17,800 equity shares of face value of Rs 10 each on Sep. 18,

2007 under the employees stock option sceme, 2000 (ESOS).ICICI Bank

(ICICIBANK) was promoted in 1994 by ICICI, an Indian development financial

institution. The two entities subsequently merged to become the largest

commercial bank in the private sector.

Shares of the company gained Rs 7.75, or 1.38%, to settle at Rs 569.9. The total

volume of shares traded was 173,655 at the BSE.(Tuesday)

HDFC Asset Management to launch debt fund

MUMBAI (Reuters) - HDFC Asset Management Co Ltd said on Tuesday that it

will launch a close-ended debt fund on Sept. 27.

The fund, HDFC FMP 18M September 2007, will be open for subscription till Oct.

8. It will invest at least 60 percent of the assets in debt and money market

instruments and the rest in government securities, the fund house said.

HDFC to cut interest rates

Economic Times, India - Sat Sep 22, 2007 12:14pm IST

Mortgage lender Housing Development Finance Corp is likely to cut its interest

rates next week, the Economic Times reported on Saturday.

"The cost of wholesale funding has come down and we are taking a look at passing

on the benefits to borrowers," HDFC Chairman Deepak Parekh was quoted as

saying.

The report also quoted HDFC Managing Director Keki Mistry as saying the

company was looking at a half percentage point cut and that the new rates would

be announced next week.

The last decade has seen many positive developments in the Indian banking sector.

The policy makers, 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. The sector now

compares favourably with banking sectors in the region on metrics like growth,

profitability and non-performing assets (NPAs). A few banks have established an

outstanding track record of innovation, growth and value creation. This is reflected

in their market valuation. However, improved regulations, innovation, growth and

value creation in the sector remain limited to a small part of it.

The cost of banking intermediation in India is higher and bank penetration is far

lower than in other markets. India’s banking industry must strengthen itself

significantly if it has to support the modern and vibrant 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. In this “white paper”, we emphasize the need to act both

decisively and quickly to build an enabling, rather than a limiting, banking sector

in India.

INDIAN BANKING INDUSTRYIn 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 broadly be categorized as institutional and non-institutional.

The major institutional suppliers of credit in India are banks and non-bank

financial institutions (that is, development financial institutions or DFIs), other

financial institutions (FIs), and non-banking finance companies (NBFCs). The non-

institutional or unorganized sources of credit include indigenous bankers and

money-lenders. Information about the unorganized sector is limited and not readily

available.

An important feature of the credit market is its term structure:

(a) Short-term credit

(b) Medium-term credit

(c) Long-term credit.

While banks and NBFCs predominantly cater for short-term needs, FIs provide

mostly medium and long-term funds.

Need for Banks

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. 11.51 billion.

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

Role of Bank

Channel household savings

Service Provider

Risk Transformation

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 GoI 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 segment of the economy like agriculture and the small-scale industrial

sector. Bank failures and mergers resulted in a decline in number of banks from

648 (including 97 scheduled commercial banks or SCBs and 551 non-SCBs) in

1947 to 89 in 1969 (comprising 73 SCBs and 16 non-SCBs). The lop-sided pattern

of credit disbursal, and perhaps the spate of bank failures during the sixties, forced

the government to resort to nationalization of banks. In July 1969, the GoI

nationalized 14 scheduled commercial banks (SCBs), each having minimum

aggregate deposits of Rs. 500 million. State-control was considered as a necessary

catalyst for economic growth and ensuring an even distribution of banking

facilities. Subsequently, in 1980, the GoI nationalised another 6 banks2, each

having deposits of Rs. 2,000 million and above.

The nationalization of banks was the culmination of pressures to use the banks as

public instruments of development. The GoI 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 (NPAs), 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.

OBJECTIVES OF THE STUDY

Today’s banking sector play a dominant role regarding investment decision.

It basically tells about how these funds are effectively and efficiently utilized

in order to maximize profits.

To study the growth and performance of banking company.

To find out what are the policies that we have to be adopted to increase the

goodwill of the company.

To provide suggestions for better functioning of business.

To know about the various loan schemes of these two banking companies

i.e. ICICI & SBI.

To make a detailed study of various financial services provide by the

different banks.

To analyze customers view point regarding their banks.

To study effective and most popular bank among the customers regarding its

services.

To find out the rate of interest of banks and reaction of customers on it.

To make analysis on the economic benefits provided by various banks.

Suggest the investors whether to invest in shares of Banking Companies.

FOCUS OF THE PROBLEM

The research report concentrates on macro and micro factors affecting Banking

Industry, Evolution of Banking Industry and its current status. Various regulatory

and reform processes also affect banking industry. The report also throws a light

on them.

The report finally ends with valuation of major players in banking Industry and the

major 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 will have to be financially strong and

operationally efficient. Capital would be a key factor in building a successful

institution. The banking and finance system will improve competitiveness through

a process of consolidation, either through mergers and acquisitions through

strategic alliances. Technology would be the key to the competitiveness of banking

and finance system. Indian players will keep pace with global leaders in the use of

banking technology.

In such a scenario, on-line accessibility will be available to the customers from any

part of the globe; ‘Anywhere’ and ‘Anytime’ banking will be realized truly and

fully. In this context, the research paper approached “Indian Banking System” as

the shape of the banking sector will be the result of a strong interplay between the

decisions taken by policy makers and actions of bank managements.

2. Banking Evolution & Regulatory Framework

Financial Sector Reforms set in motion in 1991 have greatly changed the face of

Indian Banking. The banking industry has moved gradually from a regulated

environment to a deregulated market economy. The market developments kindled

by liberalization and globalization have resulted in changes in the intermediation

role of banks. The pace of transformation has been more significant in recent times

with technology acting as a catalyst.

While the banking system has done fairly well in adjusting to the new market

dynamics, greater challenges lie ahead. Financial sector would be opened up for

greater international competition under WTO. 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 policy makers, 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.

The sector now compares favorably with banking sectors in the region on metrics

like growth, profitability and non-performing assets (NPAs). A few banks have

established an outstanding track record of innovation, growth and value creation.

This is reflected in their market valuation. However, improved regulations,

innovation, growth and value creation in the sector remain limited to a small part

of it. The cost of banking intermediation in India is higher and bank penetration is

far lower than in other markets. India’s banking industry must strengthen itself

significantly, if it has to support the modern and vibrant economy which India

aspires to be, while the onus for this change lies mainly with bank managements,

and enabling policy and regulatory framework will also be critical to their success.

3. Internal Hindrances to Banking Industry

The research focuses on emphasizing the need of decisively and quickly to build

and enabling, rather than a limiting, banking sector in India. The major challenges

ahead for bank management are as follows:

First, cost management, a key to sustainability of bank profits as well as their

long-term viability.

Second, recovery management, which is a key to the stability of the banking

sector.

Third, technological intensity of banking, an area where India happens to be a

world leader in information technology, but its usage by our banking system is

somewhat muted. It is wise for Indian banks to exploit this globally state-of-art

expertise, domestically available, to their fullest advantage.

Fourth, risk management, Banks can, on their part, formulate ‘early warning

indicators’ suited to their own requirements, business profile and risk appetite

in order to better monitor and manage risks.

Fifth, governance because the quality of corporate governance in the banks

becomes critical as competition intensifies, banks strive to retain their client base,

and regulators move out of controls and micro-regulation.

LIMITATION OF THE STUDY

The scope of the study will be restricted to selected Banks.

Many of the respondents did not think hard enough while choosing the

specific point. This could have led to a biased view and thus affected the

analysis.

There may be other events during the Clean and Window Period which may

distort the results.

INDIAN ECONOMY-MACRO FACTORS AFFECTING INDIAN BANKING

Robust economic growth in FY07. GDP is increased by over 8% in FY07;

Agriculture, industry and services to grow at 1.7%, 10.5% and 10.7%

respectively

Rabi season experiences normal monsoon

IIP (Index of Industrial Production) growth dips in October 2006. The poor

performance of the manufacturing sector, which forms 80% of the IIP index

lead to a blip in its robust growth trend for the past 9 months. Both mining

and electricity grew faster than last year at 4% and 9.7% Vs – 0.1% and

7.7% respectively

WPI (Wholesale Price Index) rose to 5.43% for the week ending December

16; higher inflation in primary commodities remains. The inflation in the

coming weeks may remain high due to lower base effect.

CRR (Cash Reserve Ratio) hike of 50 bps to absorb Rs.135bn from the

system. The CRR rate hike of 50bps came as a surprise but it reflects that

RBI’s intention of controlling credit off-take and liquidity management by

raising repo and reverse repo rate could not achieve the desired results due to

which RBI used CRR rate hike – a new instrument to control liquidity

Exports growth back on track in November 2006. On the basis of the BoP, in

H1FY06 exports grew at 23%, imports at 25.3% resulting in the trade

balance of US$35bn. Net invisibles grew by 17.6% to US$23.5bn and

capital inflows (in the form of FDI, NRI deposits and ECB) at US$20.3bn (a

yoy growth of 49%) brought the balance of payment to US$8.6bn, (a yoy

growth of 33%).

Rupee appreciates further against dollar and yen but continues to depreciate

against Euro and pound on an YTD basis as on December 2006. In real

terms, from April 2006 to October 2006, the rupee appreciated by 1.8% vis-

à-vis a basket of six currencies.

The Indian Economy has seen major Macro changes in:

1. Gross Domestic Product:

The Indian Economy is driven by the strong fundamentals and uptrend in

industrial cycle. The Indian economy maintained a strong growth momentum

for the third successive year in 2005-06 with real GDP growth accelerating to

8.4% 2005-06. The services sector recorded double digit growth to contribute

nearly three-fourths of incremental GDP. A consistent increase in domestic

investment rate from 23.0% of GDP in 2001-02 to 30.1% in 2004-05 supported

a high credit growth witnessed during the past few years. The manufacturing

sector – the key growth driver for banking credit, clocked a healthy growth of

9.0% during FY06.

2. FDI Confidence Index:

Relaxation of foreign direct investment rules has expanded the mountain of

capital in every sector of Indian economy. The government is making efforts in

liberalizing the guidelines and norms for investment through FDI, making them

more NRI friendly. Mainly due to efforts taken by Indian Government, Indian

rank 2nd among all countries in the world on FDI Confidence Index.

Source: AT Kearney Report, 2005

3. Inflation:

Inflation remained largely benevolent due to investment driven nature of

growth and subsidized nature of oil prices as pass-on of international crude

price rise remained incomplete in India. WPI Inflation has risen to 5.45% for

the week ended November 18, 2006 after remaining in the range of 4.0-5.0%

earlier. RBI has repeatedly cautioned that maintaining inflation in the target

range may call for substantial monetary tightening should crude prices persist at

high level. The money supply has grown by 18.7% yoy till November 10, 2006

during the current fiscal, which poses a significant threat to RBI’s efforts of

containing inflation in the desired range of 5.0-5.5%.

4. Gross Fiscal Deficit:

The gross fiscal deficit (GFD) to GDP ratio for 2005-06 was at 4.1 per cent as

against the budget estimate of 4.3 per cent. Fiscal and revenue deficit for April-

November 2006 widened to 72.8% of BE and 99.7% of BE Vs 74.7% of BE

and 91.5% of BE respectively in April-November 2005. The current levels are

much higher than the last month’s fiscal deficit of 58.6% of BE and revenue

deficit of79.4% of BE. The improvement in the GFD was facilitated by a

decline in capital outlay and the availability of disinvestment proceeds. The

revenue deficit, though lower in absolute terms, remained at budgeted level of

2.7 per cent of GDP in 2005-06.

Source: RBI, Ministry of commerce and Industry

5. Interest Rate:

The yield on dated government securities (G-Sec) has been moving up since the

beginning of FY05. The yield on 10 year paper began during Q1 to close the

quarter at 8.12%. During July 06, it continue to move up to 8.42% but reacted

sharply thereafter to once again come down to 7.4% at present as the market

participants believed that US Fed and other central banks worldwide would not

only pause rate hikes but soon get into rate the current fiscal at 7.50% but

moved up quite sharply cut mode.

Source: RBI

Real interest rate indicated by spread between inflation and 10 year benchmark

yield has trended in the range of 2-4%. The real interest rate in developed

economies is normally in the range of 2-3%. However, the marginal productivity

of capital being much higher in the developing economy like India. Due to this,

real interest should be higher than those prevailing in more matured economies.

6.Rising Oil prices and Exchange Rate:

World over, the central bankers led by US Federal Reserves embarked on

withdrawal of monetary accommodation through a series of rate hikes as the rising

oil and asset prices threatened the global economies with inflationary pressures.

The US Fed, which embarked on an aggressive rate hike campaign through 17

consecutive rate hikes of the magnitude of 25 bps, several economies including

Euro-zone and Japan hiked their key policy rates. In response to the same, RBI has

hiked the key policy Repo and Reverse Repo rates five times over the past two

years. This has led to a significant hardening of interest rates over the past 4-5

quarters, which has adversely impacted the cost of funds for banks.

7.Capital Market:

Financial markets in India and globally have seen little volatility over the last few

Years. There have been only two spikes in India – in April 2004 when the UPA

government came to power and in May 2006. In India, stock markets will be the

most impacted by negative news flows as other areas where shocks can be

absorbed such as the currency, interest rate and corporate bond markets are not free

or well developed. The Capital Market has seen balance sheet value being

unlocked through monetization of embedded assets, demergers, IPOs, etc. Indian

companies continue to build value in the balance sheet as newer opportunities

emerge through smart capex, inorganic growth and extracting value thru the

revenue statement.

RESEARCH METHODOLO

GY

RESEARCH METHODOLOGY

Problem Definition:

To determine and analyze the hidden potential in Banking sector in India so as to suggest the

investors whether to invest in shares of Banking Companies.

Objective:

Discover insights into and develop an understanding of the various Macro and Micro Economic

Factors that have bearing on the functioning of the Banking sector.

Evaluate the performance of some of the banks based on the past data and forecast the future

prospects.

Valuation :

The project involves valuation of major Indian Banks including ICICI Bank, SBI and HDFC

Bank. 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.

Then EPS is calculated which is multiplied to Historical P/E 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 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:

Collected the past information in the form of details of the various accounting statements

(Income Statement, Balance Sheet etc.), including the sales for the past 10 years (1997-2006).

Forecasts are done in relation to the future performance in terms of sales for HDFC Bank, ICICI

Bank, and SBI. Other forecasts include the EPS calculation and comparison of forecasted Future

Target Price with the Current Market Price.

Once the information was collected, the next step was to search for resources and constraints

with respect to the area of research.

Resources and Constraints:

Resources:

Various Publications like

AT Kearney Report, 2005

FICCI Survey on status of Indian Banking Industry – Progress and Agenda Ahead

Indian Banks Association, Various Years, Performance Highlights of Banks (Mumbai).

Reserve Bank of India, 2005, “Annual Policy Statement for the year 2005-06” (Mumbai).

Company Reports

Constraints:

Lack of time availability with the people involved in any manner with the research

especially when decisions were to be made quickly.

Difficulty in application of Statistical Tools.

Difficulty in making accurate forecasts because of presence of Economic impediments

like inflation, RBI policies etc.

SAMPLING: DESIGN AND PROCEDURE:

Sampling Technique:

“Convenience Sampling” as a part of Non-Probability sampling by taking the three banks as

the major performers in the Indian Banking Sector and highlighters of sector’s overall

performance.

Sample Size:

Sample Size was restricted to 3, including ICICI Bank, HDFC Bank and State Bank of India.

Executing the Sampling Process:

Through making a comparison among the various key figures of sales, profits and accounting

ratios deduced from accounting statements.

Method of Data Collection:

Secondary Data is collected to carry out the study. To review the literature available regarding

the subject; various journals, magazines, related research papers and Internet would be used

INDIAN ECONOMY-MACRO FACTORS

AFFECTING INDIAN BANKING

Major Changes in FY 2006-07

Robust economic growth in FY07. GDP is increased by over 8% in FY07; Agriculture,

industry and services to grow at 1.7%, 10.5% and 10.7% respectively

Rabi season experiences normal monsoon

IIP (Index of Industrial Production) growth dips in October 2006. The poor performance

of the manufacturing sector, which forms 80% of the IIP index lead to a blip in its robust

growth trend for the past 9 months. Both mining and electricity grew faster than last year

at 4% and 9.7% Vs – 0.1% and 7.7% respectively

WPI (Wholesale Price Index) rose to 5.43% for the week ending December 16; higher

inflation in primary commodities remains. The inflation in the coming weeks may remain

high due to lower base effect.

CRR (Cash Reserve Ratio) hike of 50 bps to absorb Rs.135bn from the system. The CRR

rate hike of 50bps came as a surprise but it reflects that RBI’s intention of controlling

credit off-take and liquidity management by raising repo and reverse repo rate could not

achieve the desired results due to which RBI used CRR rate hike – a new instrument to

control liquidity

Exports growth back on track in November 2006. On the basis of the BoP, in H1FY06

exports grew at 23%, imports at 25.3% resulting in the trade balance of US$35bn. Net

invisibles grew by 17.6% to US$23.5bn and capital inflows (in the form of FDI, NRI

deposits and ECB) at US$20.3bn (a yoy growth of 49%) brought the balance of payment

to US$8.6bn, (a yoy growth of 33%).

Rupee appreciates further against dollar and yen but continues to depreciate against Euro

and pound on an YTD basis as on December 2006. In real terms, from April 2006 to

October 2006, the rupee appreciated by 1.8% vis-à-vis a basket of six currencies.

The Indian Economy has seen major Macro changes in:

6. Gross Domestic Product:

The Indian Economy is driven by the strong fundamentals and uptrend in industrial cycle.

The Indian economy maintained a strong growth momentum for the third successive year in

2005-06 with real GDP growth accelerating to 8.4% 2005-06. The services sector recorded

double digit growth to contribute nearly three-fourths of incremental GDP. A consistent

increase in domestic investment rate from 23.0% of GDP in 2001-02 to 30.1% in 2004-05

supported a high credit growth witnessed during the past few years. The manufacturing

sector – the key growth driver for banking credit, clocked a healthy growth of 9.0% during

FY06.

In FY 06-07, services sector account for major 55% of India GDP followed by 25% in Industrial

sector and 20% in agriculture sector.

FY07 Vs Q2FY06, the growth rate in GDP components are as follows:

Agriculture: 1.7%

Industry: 10.5%

Service: 10.7

7. FDI Confidence Index:

Relaxation of foreign direct investment rules has expanded the mountain of capital in every

sector of Indian economy. The government is making efforts in liberalizing the guidelines

and norms for investment through FDI, making them more NRI friendly. Mainly due to

efforts taken by Indian Government, Indian rank 2nd among all countries in the world on FDI

Confidence Index.

Source: AT Kearney Report, 2005

8. Inflation:

Inflation remained largely benevolent due to investment driven nature of growth and

subsidized nature of oil prices as pass-on of international crude price rise remained

incomplete in India. WPI Inflation has risen to 5.45% for the week ended November 18,

2006 after remaining in the range of 4.0-5.0% earlier. RBI has repeatedly cautioned that

maintaining inflation in the target range may call for substantial monetary tightening should

crude prices persist at high level. The money supply has grown by 18.7% yoy till November

10, 2006 during the current fiscal, which poses a significant threat to RBI’s efforts of

containing inflation in the desired range of 5.0-5.5%.

9. Gross Fiscal Deficit:

The gross fiscal deficit (GFD) to GDP ratio for 2005-06 was at 4.1 per cent as against the

budget estimate of 4.3 per cent. Fiscal and revenue deficit for April-November 2006 widened

to 72.8% of BE and 99.7% of BE Vs 74.7% of BE and 91.5% of BE respectively in April-

November 2005. The current levels are much higher than the last month’s fiscal deficit of

58.6% of BE and revenue deficit of79.4% of BE. The improvement in the GFD was

facilitated by a decline in capital outlay and the availability of disinvestment proceeds. The

revenue deficit, though lower in absolute terms, remained at budgeted level of 2.7 per cent of

GDP in 2005-06.

Source: RBI, Ministry of commerce and Industry

10. Interest Rate:

The yield on dated government securities (G-Sec) has been moving up since the

beginning of FY05. The yield on 10 year paper began during Q1 to close the quarter at

8.12%. During July 06, it continue to move up to 8.42% but reacted sharply thereafter to

once again come down to 7.4% at present as the market participants believed that US Fed

and other central banks worldwide would not only pause rate hikes but soon get into rate the

current fiscal at 7.50% but moved up quite sharply cut mode.

Source: RBI

Real interest rate indicated by spread between inflation and 10 year benchmark yield has trended

in the range of 2-4%. The real interest rate in developed economies is normally in the range of 2-

3%. However, the marginal productivity of capital being much higher in the developing

economy like India. Due to this, real interest should be higher than those prevailing in more

matured economies.

11. Rising Oil prices and Exchange Rate:

World over, the central bankers led by US Federal Reserves embarked on withdrawal of

monetary accommodation through a series of rate hikes as the rising oil and asset prices

threatened the global economies with inflationary pressures. The US Fed, which embarked

on an aggressive rate hike campaign through 17 consecutive rate hikes of the magnitude of

25 bps, several economies including Euro-zone and Japan hiked their key policy rates. In

response to the same, RBI has hiked the key policy Repo and Reverse Repo rates five times

over the past two years. This has led to a significant hardening of interest rates over the past

4-5 quarters, which has adversely impacted the cost of funds for banks.

12. Capital Market:

Financial markets in India and globally have seen little volatility over the last few Years.

There have been only two spikes in India – in April 2004 when the UPA government came to

power and in May 2006. In India, stock markets will be the most impacted by negative news

flows as other areas where shocks can be absorbed such as the currency, interest rate and

corporate bond markets are not free or well developed. The Capital Market has seen balance

sheet value being unlocked through monetization of embedded assets, demergers, IPOs, etc.

Indian companies continue to build value in the balance sheet as newer opportunities emerge

through smart capex, inorganic growth and extracting value thru the revenue statement.

INDIAN FINANCIAL SERVICES SECTOR

SWOT ANALYSIS

Strengths:

Proven asset quality resilience in past downturns

Proven management teams, track record

Stable industry dynamics

Well-established regulatory framework

Stable/low NPL formation rates

Weaknesses:

Continued crowding out effect from govt budget deficit, combined with accelerating

private sector credit demands

Ownership restrictions

Constraints on state-owned banks' micro reforms, including HR, staff cut, branch cut

constraints

Opportunities:

Improving secular GDP growth prospects

Establishment of special economic zones likely to promote further industrialization

Years, if not decades, of catch-up economics— low per capita income, educated

workforce

Rapid financial deepening, i.e. loan growth as multiple of nominal GDP growth

Rising consumer spending, consumer credit business

Rising corporate capex, investments

M&A optionality

Threats:

"Running on empty" in terms of liquidity

Tightening in global liquidity may trickle down to India

Potentially hawkish RBI stance on inflation/monetary policy

Potential rise in long bond \ yields, MTM risk for banks

Potential for valuation pullback, should earnings delivery disappoint expectations

STRUCTURE OF THE BANKING SECTOR

The banking sector in India functions under the umbrella of the RBI—the regulatory, central

bank. The Reserve Bank of India Act was passed in 1934 and the RBI was constituted in 1935 as

the apex bank. 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

establishment of new banks, mergers and amalgamations of banks, opening and closing of

branches of banks, maintaining certain standards of banking business, inspection of banks, etc.

The Act also vested licensing powers and the authority to conduct inspections with the RBI.

Banks in India can broadly be classified as regional rural banks or RRBs, scheduled commercial

banks or SCBs, and co-operative banks. The scope of the report includes the SCBs only3.

The SCBs for the purpose of this comment can be classified into the following three categories:

Public sector banks or PSBs (SBI & its associates, and nationalized banks);

Private sector banks (old and new); and

Foreign banks

SBI & Associates Nationalised Banks Private Banks Foreign Banks

8

20

29 30

No. of Banks in India for FY 05-06

Category of Banks

Source: IBA

SBI & Associates Nationalised Banks Private Banks Foreign Banks

198

1327

565

201

Asset Size of Banks for FY 05-06 ('000 crores)

Category of Banks

Source : IBA

In terms of asset size, among Foreign banks – Citibank, HSBC and Standard Chartered bank are

leaders with asset base of Rs.45437 cr, Rs.37473 cr and Rs.48412 cr. Resp. in FY 05-06. Among

private sector banks, ICICI Bank is the leader with asset base of Rs.251389 cr followed by

HDFC Bank of size Rs.73506 cr and UTI Bank of size Rs.49731 cr. In terms of asset size,

public sector banks have highest base compared to private and foreign banks. SBI & Associated

have asset base of Rs.691872 cr while other banks such as BOB, BOI, Canara Bank and PNB

Bank have each more than Rs.100000 cr.

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 per cent in a number of countries by 2005 (BIS, 2006). Several factors

have contributed to the significant rise in bank lending in emerging economies such as 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 important changes on the asset side of

banks balance sheet. First, credit to the business sector - historically the most important

component of banks assets – has been weak, while the share of the household sector has

increased sharply in several countries. Second, banks investments in Government securities

increased sharply until 2004-05. As a result, commercial banks continue to hold a very large part

of their domestic assets in the form of Government securities - a process that seems to have

begun in the mid-1990s

MICRO

FACTORS

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 macroeconomic performance and bank

credit in the current phase of the business cycle suggests that factors other than demand may

also be at work: financial deepening from a low base; structural shifts in supply elasticity’s;

rising efficiency of credit markets; and competitive pressures augmenting the overall supply of

credit.” (Reserve Bank of India, Monetary Policy Review, October 2006).

Loan growth sustained for very long

Source: RBI

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 also started demanding higher

levels of credit. In the five years prior to FY05, growth in industrial credit was almost wholly

driven by infrastructure. There is a perceptibly wider participation from other segments during

FY05 and FY06.

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 the 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 rate from 15-16% to 19- 20%, on a larger base. In the last five 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 (currency) 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 Q4FY07 is expected to be a period of margin pressure. This is because as the last interest-

rate cycle showed, deposit costs increase first, and followed by lending rates. Q4 is also 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

rate increases and may do it in a graduated fashion so as not to invite outright resistance or overt

attention from the government. HDFC Bank, PNB, SBI and a few others have nevertheless

already made a beginning by increasing their prime lending rates after the cash reserve ratio hike

by the RBI. However, the fight for deposits has intensified and it is possible that in Q4FY07

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 over the last five 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 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 continuously falling over the last

few years.

Non – Performing Loans (NPLs): concerns overstated:

Loan growth-NPL

The asset price deflation (read real estate prices) may hurting banks’ asset quality has been

blown out of proportion.

Residential mortgages:

It is very unlikely in near term that there can be a large-scale increase in delinquencies on loans

taken for the first house (typically self-occupied); unless there is a household income problem, it

does not matter to the borrower whether the price of the house he is staying 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 2006. 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

Sep’06 portfolio looks dramatically different.

SBI’s loan portfolio now quite diversified

Source: Company data,

Cost of borrowing has risen, but so have incomes:

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 pa, 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 time, Indian banks are looking

at internet banking which promises to grow into an alternate self-service channel. As the mindset

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-Houser 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:

Few challenges associated with technology adoption by banks are:

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.

Banks need to explore newer channels such as SMS, WAP and 3G mobile

telephony applications to facilitate online access to customers.

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 centers 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.

ICICI has entered into strategic alliance with Prudential plc. of UK for its mutual find

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 agri-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

500 crore 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 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 1,00,000 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. 3,562.28 billion (US$ 77

billion) at December 31, 2009 and profit after tax Rs. 30.19 billion (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 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.450 crore (Rs.4.5 billion). The paid-up capital is

Rs.311.9 crore (Rs.3.1 billion). 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:

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 agri-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 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.

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, NetBanking 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.

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. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr. Capoor was

a Deputy Governor of the Reserve Bank of India. 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 :

State Bank of India (SBI) 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(CBS). The bank has the largest ATM network in the country having more than

5600 in number [1]. 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.

Group companies

SBI Capital Markets Ltd

SBI Mutual Fund (A Trust)

SBI Factors and Commercial Services Ltd

SBI DFHI Ltd

SBI Cards and Payment Services Pvt Ltd

SBI Life Insurance Co. Ltd - Bancassurance (Life Insurance)

SBI Funds Management Pvt Ltd

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 FINDINGS

Major Macro – Economic Factors include Gross Domestic Product – which has grown by over

8% in 2005-06, FDI Confidence Index – where India stands II in the world, Inflation – which has

slow 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 relax as oil prices have fallen beside Indian Rupee has

strengthen 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

Bank 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.691872 cr. Bank group-wise, new private sector banks

grew at the highest rate during 2005-06 (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 2006 from 75.3 per cent at end-March 2005,

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 in 2005-06 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 in 2005-06. 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 2004

to 25.5 per cent in March 2006.

ICICI Bank is the leading market player with change in loans market share in FY02-06 of over

5% and change in deposits market share in FY 02-06 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: Some of Micro-Economic factors

identified in the report are:

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 and

100% in real estate sector).

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

Non – Performing Loans (NPLs) - The Total bank loans stood at Rs 15,231.7bn, of which

housing loans are Rs. 1719.2bn. However, the Industry’s share of total credit has dropped

to 40%

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

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.

BIBLIOGRAPHY

BIBLIOGRAPHY

Company Reports

Government of India, 1998, Report of the Committee on Banking Sector Reforms

Government of India, 1991, Report of the Committee on the Financial System

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

Reserve Bank of India, 2008, “Annual Policy Statement for the year 2007-08” (Mumbai).

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).