Financial Management of Banks, NBFCs and Insurance Companies in India

Academic Year 2010-11 Trimester V Lecture 1

1

Lecture I Part I

Books/Other material for study/reference

2

Books• Management of Banking and Financial Services,

Pearson Education-2nd Edition 2010 Authors: Padmalatha Suresh & Justin Paul• Management of Banking, Cengage Learning-6th

Edition 2006, Indian Reprint 2009 Authors: S Scott MacDonald & Timothy W Koch• Risk Management & Insurance, Tata McGraw-Hill

2004 Edition, 9th Reprint 2010 Authors: Scott E Harrington & Gregory R Niehaus

3

Other Important MaterialAvailable on respective Websites

• RBI Report on Trend and Progress of Banking in India for the Year ended 30th June 2009 dated 22nd October 2009

• IRDA’s Annual Report for 2008-09 dated 1st December 2009

• Latest Annual Reports of major Banks, NBFCs and Insurance Companies

• Coverage in newspapers and magazines relating to current issues facing the industry

4

Lecture I Part II

Some observations on the Indian Banking Industry

5

Banking Industry in India: 1999-2009• During the last decade, The number of banks has declined from 297 in 2000 to 171 in 2008,

mainly due to closure/merger of weak rural banks Number of branches rose from 65,412 in 2000 to 76,050 in 2008.

However, the break up shows greater focus of the banks in this regard on metro and urban areas, as under:

Rural branches went down from 32,734 to 31,076 Urban branches went up from 10,052 to 14,392 Metro branches went up from 8,219 to 12,908 All Banks’ aggregated Loan book rose from Rs 4 trillion to Rs 29.41

trillion in 2009, with percentage of bank loans to GDP, going up from 19% to around 52% as of now, and the credit deposit ratio going up from 53.3% in 2000 to 70.34% as of now

6

Major Banks in India: Performance during 1999-2009

• Among the private sector banks, assets of Axis Bank grew from Rs 66.69 billion to Rs 1.48 trillion, HDFC Bank from Rs 116.56 billion to Rs 1.83 trillion & ICICI Bank from Rs 120.73 billion to Rs 3.8 trillion. During the decade their net annual profits went up respectively from Rs 51 crore to Rs 1,815 crore, from Rs 120 crore to Rs 2,215 crore, and from Rs 105 crore to Rs 3,758 crore

• During the decade, the assets of SBI, PNB and BOB went up respectively from Rs 2.61 trillion to Rs 9.65 trillion, from Rs 0.54 trillion to Rs 2.74 trillion, and from Rs 0.58 trillion to Rs 2.27 trillion. Their profits went up respectively from Rs 2,056 crore to Rs 9,121 crore, from Rs 408 crore to Rs 3,091 crore, and from Rs 503 crore to Rs 2,227 crore

• The reduction in NPAs by the public sector banks has been truly remarkable. In 2000, 4 of them had double digit net NPAs which are now down to less than 1% in case of Indian Bank, Allahabad Bank and SBB&J, with Dena Bank also at just 1.09%

• The relative movements in case of NPAs of new generation private sector banks are not comparable, since having come up in the mid 90s, they were not carrying any baggage

• A few of the private sector banks either died or were merged during the past decade. Global Trust Bank was merged with Oriental Bank of Commerce; Centurion Bank first took over Bank of Punjab and then merged with HDFC Bank. The story goes on

7

CURRENT ISSUES AND FUTURE CHALLENGES IN INDIA

Lecture IPart III

8

Banking Industry in India – the road ahead M & As• With mergers and amalgamations we might see emergence of

3/4 banks, which are half or one third the size of SBI, depending on the initiatives of the government. The issue however continues to be politically sensitive

• FINANCIAL INCLUSION CHALLENGE• Only 40% of the Indian population has bank accounts, 13%

debit cards and 2% credit cards. Spread of banking at a faster pace in the rural areas, through branches, banking correspondents and mobile telephony, at a fast pace is likely. RBI has directed banks to come up with specific plans for covering rural India

• Banks are being compelled to reach out to rural India, but they are increasingly appreciating the business opportunity in financial inclusion, as urban consumers suffer from loan fatigue and corporations find other ways of raising money

9

NEW CHALLENGES• The global financial crisis of 2007 has thrown up new

challenges for the financial system• The key contributory factors for the crisis were:– Lower interest rates inducing higher risk taking, and leading

to an asset price bubble– Changing structure of the financial sector and rapid pace of

innovation over the last two decades, and the failure of risk management to match up to the new demands

– Failure to adequately regulate highly leveraged financial institutions

• The very foundation that a sound financial system requires – TRUST, crumbled. Consequently, Banks that had liquidity hoarded it, and the banks who did not have it, faced doomsday

10

FINANCIAL REGULATION

• There are two vital objectives of financial regulation– Mitigation of systemic risk– Consumer protection

• Financial regulation typically uses tools such as – Prudential regulation– Specialized tools such as deposit insurance– Regulation of payment and settlement systems– Regulation of business entities

11

FINANCIAL STABILITY – THE OVERARCHING AGENDA OF FINANCIAL REGULATION FOR THE FUTURE

• Financial stability has to be an explicit objective of regulation

• International co-operation key to resolving systemic crises in the new world

• India’s financial sector reasonably insulated from crisis of 2007

• ‘Financial stability’ has now been made explicit objective of RBI monetary policy

12

The New Focus on Financial Stability across the World

• For a fairly long time the main focus of the regulators used to be on Inflation and Growth

• One major outcome of the G 20 deliberations post the crisis is the establishment of a new ‘Financial Stability Board’ that includes all large countries of the world, to be operated by the IMF, with a strengthened mandate

13

Financial Stability and Development CouncilDiffering views of RBI & MOF

• The Reserve Bank of India had shown a red flag to the finance ministry on the proposed Financial Stability and Development Council.

• In a letter written to the ministry in July 2010, the central bank had said that the proposed FSDC should not try to be a super regulator but rather confine itself to financial literacy and inclusion.

• The latest letter was in response to a discussion paper from the finance ministry on FSDC. In this, RBI has also made a case for being designated the 'systemic regulator', a role it says that it has already been performing.

• RBI feels that the responsibility for financial stability and macro-prudential regulation of the financial sector should 'vest explicitly' with RBI.

• The bank has cited four international practices -- the US Federal Reserve, Bank of England, European Central Bank and Bank of France -- who have the final say in their country/region over issues concerning financial stability.

14

Challenges before regulators in the world– How do we define ‘financial stability’?– Who takes the responsibility of ensuring financial

stability?– Where does ‘risk management’ amount to

‘conservativeness’?– What are the reforms required to create an efficient

and effective regulatory architecture to ensure financial stability?

– How do we resolve the constant tension between fiscal and monetary policies? Think about the need to keep rates low because of large government borrowing programmes.

15

COMMERCIAL BANKING SYSTEM IN INDIA - AS OF 2009

• Public sector banks [27]• Private sector banks [22]• Foreign banks [32]• Regional rural banks [84] [Figures in brackets show number of

institutions]

16

Alternative Organisations for Financial Conglomerates

• Universal Bank Model – All financial operations are conducted within a single corporate entity

• Operating Subsidiary Model – Operations are conducted as subsidiaries of a financial institution

• Holding Company Model – Financial operations are carried out by distinct entities such as banks, mutual funds, insurance companies, NBFC, HFC, etc.

(Current model used in India is the ‘Operating Subsidiary Model)

17

CO-OPERATIVE CREDIT INSTITUTIONS• URBAN CO-OPERATIVE BANKS [1721]– Scheduled UCB [53]– Non scheduled UCB [1668]

• RURAL CO-OPERATIVE CREDIT INSTITUTIONS [96061]– Short term [95344]• State co-operative banks• District central co-operative banks• Primary agriculture credit societies

– Long term [717]• SCARDB – State Co-op and Rural Development Bank• PCARDB – Primary Co-op and Agriculure Rural

Development Bank18

Committee on Financial Sector Assessment (CFSA)

• According to CFSA, dual regulatory control of RBI and NABARD, is the single most important regulatory and supervisory weakness in the co-operative banking sector

• Further, directors are appointed on political affiliation• CFSA’s report points out that the sector is plagued by:1. Low resource base2. Inadequate business diversification and recoveries3. High level of accumulated losses4. Weak MIS and poor controls

19

EVOLUTION OF INDIAN BANKING The period can be divided in 4 phases, as under:– Pre 1947: no entry norms, several banks failed as they were

either too small to stand global pressures or mismanaged– 1947-1967: Banking Companies Act (now called Banking

Regulation Act) enacted, SBI expanded in rural areas, nexus between big industrial houses and banks resulted in no credit being extended to agricultural or SSI sectors

– 1967-1991-92: tightening of social controls, directed lending introduced, asset quality suffered, banks low on profitability

– 1991-92: financial sector reforms, prudential norms in accordance with international best practices, improved profitability, greater risk aversion also leading to low credit, particularly to agricultural sector

20

NON BANKING FINANCE COMPANIES: 2009

• Deposit taking – NBFC-D [336]• Non deposit taking – NBFC- ND [12402] - There are a few

very important companies classified in this category under the sub-category, NBFC-ND-SI, which are systemically important, have asset size of over Rs 100 crores and are the fastest growing category in the NBFCs space

• Residuary NBFC – RNBFC [2] Total – (12740)

21

Some other Classifications: Finance Companies• There are 43 Housing finance companies.

These are regulated by NHB• NBFCs are also classified on the basis of “Asset

Type” as ‘Asset Finance Companies’, ‘Loan Companies’ and ‘Investment Companies’

• Mortgage Guarantee Company (Reserve Bank) Guidelines, 2008' notified on 15th February 2008 now allows mortgage guarantee company to commence the business of providing mortgage guarantee in India

22

Lecture IPart IV

Group Presentations Guidelines to follow

ANDList of Topics for Group projects/presentations

23

Topics: Indian Banks, NBFCs and Insurance Companies • You will cover all the entities in the group i.e. each bank,

finance company, and insurance company, separately as well as present the group position on a consolidated basis

• ICICI Bank• Housing Development Finance Corporation Limited• Life Insurance Corporation of India• Bajaj Finserv Limited• SBI• Punjab National Bank• Reliance Capital Limited• Bank of India• Kotak Mahindra Bank

24

What aspects will you focus on?• Look at the position/developments over a period of 10 years, at

least 5 years• Cover the following aspects, at the minimum (think about what

you learnt in the first year in the course “Financial Analysis”)1. Strategy2. Performance3. Financial Strength – Capital Adequacy4. Diversifications5. M & As6. NPAs7. Technological Upgradation8. Corporate Communication9. Customer Service10.Market Position 25

Guidelines for presentations• Make a oral 5 minutes presentation (1 person only from each

group) in the next class on Monday, the 27th of September, 2010 to talk about what exactly you will cover in your group presentations later. This will be like presenting your project synopsis

• As regards the final group presentations, one group will present in each session. This will be an exhaustive presentation

• The final examination may include questions from the better presentations

• Class participation marks will be given on the basis of contribution made by the remaining students in regard discussions on the company being discussed

• Presentation time of each group will be 45 minutes, including Q&A time

• All group members to present some slides• Commencement of presentations on 11th October 2010• All PPTs to reach me in advance, by 5.30 pm on 8th October 2010• Delay will attract a penalty

An important point• As the companies/banks in the list should be

among the recruiters later during the academic year, every one in the group should actively participate in the group-work and do a first rate job. Free-riders beware!

• For the same reason, be very attentive in the classes, particularly during the presentations, and make these as meaningful as possible. Add value for the whole class by your interventions; you need to go beyond asking questions

27