Central bank chiefHasincumbentchanged theinstitution orhas itchangedhim?Page 3

Indian Banking & FinanceFT SPECIAL REPORT

www.ft.com/reports | @ftreportsMonday October 12 2015

Inside

Public sectorWhere does integrity liein a Kafkaesque world,asks author of radicalreform blueprintPage 2

CompetitionYou wait nearly adecade and suddenly 20new banks turn upPage 2

Financial inclusionGrand design to bringmoney to the massesbecomes realityPage 3

Outside interestForeigners fromSingapore to Britain lineup for slices of agrowing piePage 4

V iewed from afar, 2015should have marked thestart of a golden age ofIndian banking. The econ-omy is recovering after a

prolonged slowdown. Funding is badlyneeded for infrastructure projects, giv-inglendersabigopportunitytogrow.

Retail banks have ample room toexpand in a country where most peopleare yet to open current accounts. Mostprojections suggest India will becomethe world’s third-largest banking systemby assets over the next decade or so,trailingonlyChinaandtheUS.

There has also been plenty of recentregulatory reform. Raghuram Rajan,governor of the Reserve Bank of India,has been energetic, promising to bring anew wave of competition to a once-sleepy sector. Local bankers soundupbeatabouttheir long-termprospects.

“We’ve been through a tough periodbut the recovery will give opportunitiesto grow everywhere,” says ShikhaSharma, managing director of AxisBank,a largeprivatesector lender.

In the short term, Indian bankingseems less sure of itself, for two reasons.The first concerns bad loans: India’s fin-anciers are tarred by the term “lazybanking”, referring to government rulesthat force lenders to park sizeabledeposits into ultra-safe governmentbonds, leaving little room to deploy cap-ital in imaginative ways. Yet over thepast decade, many of these supposedlyidle lenders suddenly became hyperac-tive,withnear-disastrousresults.

In particular, state-backed banks,which control around three-quarters ofassets, lent recklessly. Loans to localindustrial groups funded big projects inareas such as property and power. Many

went wrong, hobbled by bureaucraticdelays and haphazard management.Today, official data show 11 per cent ofloans are stressed — one of the highestrates in Asia. Many analysts think thetruefigure ishigherstill.

Arundhati Bhattacharya, chair ofStateBankof India, thecountry’s largestlender, says everyone must share theblame. Bankers took unacceptablerisks. Tycoons were foolhardy. Politi-cians did little to help investmentprojects that became stuck. Fixing thiswill take time, as well as further regula-tory reforms. “Even under the best cir-cumstances, we will see a gradualbuild-up in projects,” Ms Bhattacharyasays. “We keep saying, no more ‘band

aid’ solutions. We need a cure and weneedtodoitproperly.”

India’s bad loan epidemic underlines asecond problem: the weak health of its27 state-backed banks more generally.Private sector lenders such as HDFCBank and Axis often win warm reviewsfrom analysts. But many state-ownedlenders are in poor shape, constrainedby complex regulations and weak bal-ance sheets. Finding capital is a particu-lar problem. India’s government, whichowns majority stakes in each bank,recently injected Rs700bn ($11bn) totide them over until 2017. Most analystssay far more will be needed to meetlooming Basel III lending rules, whichsharply increase the amount of capitalbanks must hold to protect against arepeatof theglobal financialcrisis.

Some remedial measures have beentaken. Mr Rajan has introduced reforms

continuedonpage2

Problem loansdemandmorethan ‘band-aid’solutionsProspects are good but red tape and shortage ofstate funds hamper progress, reports James Crabtree

‘Successive governments inIndia have failed to graspthe nettle of radical publicsector bank reform’

Losing its shine: 2015 should have marked start of a golden age — Fanatic Studio/Alamy

2 ★ FINANCIAL TIMES Monday 12 October 2015

Indian Banking & Finance

in areas ranging from capital adequacyrules to asset quality guidelines, in whatMs Sharma describes as “the biggest setof changes” for the sector in recent his-tory. The RBI has made potentially far-reaching changes elsewhere, includinghandingout licences tonearly twodozennew private sector banks, with thepromiseofmoretocome.

There are profound changes brewingelsewhere too, argues Rajiv Lall, manag-ing director of IDFC Bank. Smartphoneownership is rocketing, helping banksreach new customers, especially in ruralareas. Technology will create new mod-els of low-cost lending, suitable for thehundreds of millions of Indians whosave under their mattresses and borrowfrommoneylenders.

Yet prime minister Narendra Modimust first fix the structural problemshis government inherited last year —and in particular that of its strugglingstate lenders. In 2014, Mr Rajan com-missioned banker P Jayendra Nayak toexamine their condition. His analysismade for grim reading, while his solu-tions — including pushing the govern-ment to sell off its majority stakes —wereoftenradical.

More than a year later, Mr Nayak’sassessment of progress is not kind.Measures to recapitalise the banks arehalfhearted. Changes to bank govern-ance, such as appointing new leaders orindependentboards,havebeenpatchy.

“Successive governments in Indiahave demonstrated unwillingness tograsp the nettle of radical public sectorbankreform,”hewrites inthisreport.

India must grapple with two funda-mental challenges. The first relates tothe structure of the sector itself; India’spublic banks are losing market share tofaster-growing private lenders. Ratherthan sustaining a host of weak players,many think it would be wiser to build upfewer, stronger institutions, makingthem more akin to China’s powerfulstate banks. “There should be consoli-dation in the sector. There’s no doubtabout it,”MsBhattacharyasays.

Yet this begs a second question: whatto do with the rest? India’s is one of theworld’s most state-dominated bankingsystems. Many analysts think the gov-ernment lacks the funds to recapitalise

its banks properly. The most plausiblealternative, as suggested by Mr Nayak,is gradually to hand ownership to theprivate sector, by selling the govern-ment’sholdingsbelow50percent.

So far, this idea has received littlebacking. Changes to bank ownershipwould require controversial legalchanges. Even if Mr Modi wanted tointroduce them, he would be unlikely tofind enough support until after the nextelection in2019—assuminghewins.

Ultimately, however, inaction mayprove costly. India’s rapid growth meansit is likely to become one of the world’smost significant banking systems underalmost any scenario. But if the majorityof its lenders are to reach that stage ingood health, “band aid solutions” areunlikelytodothetrick.

continued frompage1

‘Band-aid’solutions notenough forproblem loans

Successivegovernments inIndiahavedemonstratedunwillingness tograspthenettleofradicalpublicsectorbankreform.Thesebanksownalittleovertwo-thirdsof theassetsof thecountry’sbankingsector,butearnaboutathirdof theprofits.This implies thatthereturnonassetsof theotherbanks—mainlythedomesticprivatesectorbanks—isover fourtimesthatof thepublicsectorbanks.

Suchsteepdifferentials inproductivitywouldnormally leadtorapidchanges inmarketstructure,butthegovernment’speriodicrecapitalisationof itsbankshasmadethechangemoregradual.

Inrecentyears,however, theextentofrecapitalisationneededfor thesebankshasrisensharply.Acontinuanceof thisapproachwillhaveonerousconsequences for thegovernment’sfiscalconsolidation,andthisrealisationhaspromptedthegovernmenttobudgetmuchsmallercapitalallocationsthanthebanksrequire.

Eachyearthegovernmentstrugglestoensurethat itsbanksmeetminimumcapitaladequacyrequirementswhileretainingmajoritystatecontrol.This is

likelytobea losingbattle,becauseof thesteeperosioninassetquality.

At theendof June, the impairedassetsof thesebanks,comprising loansreportedasnon-performingtogetherwith loansrestructured,was13.7percentofall loans.Thiscompareswith just3.7percent forprivatesectorbanks.

Regulatoryforbearance intherecognitionofnon-performing loans,togetherwithagentlersystemofprovisioningunder itsaccountingstandardscomparedwith internationalrules,enables thesebankstoreportalowerequityerosionandappearstrongerthantheyare.

Assetqualityandproductivityarethesymptoms,but themalaiseaffectingthesebanksarises fromgovernance.Therearebothexternalandinternalconstraints togoodgovernance,butuntil theexternalharness is looseneditisunlikelythatpoor internalgovernancecanbeeasily improved.Therearethree interlockingproblems.

First, theboardsof thesebanksareinadequatelyempowered.ThebanksweretakenoverbythegovernmentthroughtheBankNationalisationActsof1970and1980.Underwide-rangingregulatoryandgovernancepowers, thegovernmentcannotify“schemes”for itsbanksonanyaspectof itsbusinessoroperations. Intheprocess ithashomogenised itsbanks,erodingtheabilityofboardstocreatedifferentiationandcompetitiveness.

Second, theappointmentsprocess iscompromised.Directorsareairdropped

ontoboardswithoutanyconsultationwithbankchiefexecutives.

Withnotableexceptions,anopaqueselectionprocessdoesnotbringprofessionalsofgoodstandingontotheseboards.Theappointmentofchiefexecutivesandother full-timedirectorsisalso flawedintheabsenceofasearchprocess,andwithshort interviewsforselectionconductedbycivil servantsandregulators.

Third,andthis isadeepirony, thegovernmentsaddleswithdisadvantagestheverybanks intowhich ithasputcapital.TheReserveBankof India(RBI)regulatesallbanks,but thepublicsectorbankshave inthegovernmentasecondregulator.Thesebanksarealsothemainconduit forahostofgovernment-sponsoreddevelopment lendingprogrammes,whichtheprivatesector

banksgenerallystayoutof.Similarly,vigilanceandenforcement inprivatesectorbanks ishandled internally,butinpublicsectorbanks it isco-ordinatedbythegovernment’sCentralVigilanceCommission.

AnyloanaboveathresholdofRs10mwhichturnsbadisexaminedforproceduralviolations,andsuchaviolationcanleadtotheprosecutionof

managerswhoapprovedthe loan,irrespectiveofwhethertherehasbeenanypersonalbenefit to them.

Asstatisticianswouldsay, thisencouragesType1andType2errors(thedishonestgetawayandtheproceduralviolators,whomaybehonest,aretrapped). InthisKafkaesqueworld,perennialdoubtsexistaboutwhere integrityresides. Incontrast,proceduralviolationsarenotanissuewithprivatesectorbanks,aseachloanreflectsauniqueborrower-creditorrelationship,andsomeof themostinnovative lending,asnewsectorsgaintraction,requires thedesignofnovelmodels.

TheModigovernmenthasrecognisedthemalaise,but itsresponseshitherto,containedin itsrecentseven-pointIndradhanushpackage,havebeenveryinadequate.Theextensivebankgovernancepowersvested inthegovernmentneedtobetransferredtothebankboards,andtheregulatorypowerstoRBI.Aneatwayofdoingsowouldbetotransfergovernmentstakesinbanks,alongwithgovernancepowers, toaholdingcompany.

SuchaBankInvestmentCompany(BIC)would inturntransfer thesepowers tobankboards inaphasedmanner,as itgainsconfidencethateachboardhasbeenwellconstituted.Tosucceed,aBICwouldneedinitialempowermentandlegally-entrenchedindependence.Clearly,onlyagovernmentwhichhasthepoliticalresolvetotransformandstrengthenits

bankswillembarkonsuchatrajectory.Thisrequires legislation;until then,

theboardappointmentprocesscouldbecleanedup.Thegovernment ismovingtoconstituteaBankBoardsBureau(BBB)tohandleappointments,butbyannouncingthat theFinanceMinistryandRBIofficerswillbepartof theBBB,thechange ismerelyoneof form.Professionalisingtheselectionprocessforappointmentsmeansbringing inthosewhounderstandbanking,andpreferablykeepingothersout.

Finally, there isaneedforone lawunderwhichallbanksareregulated,irrespectiveofownership,andthisrequires therepealof theBankNationalisationActs. If there is tobestatecapitalismwithinbanking,levellingthefield for itsownbankswouldgivethegovernmentabargain:boardempowerment improves,better-paidmanagershelpbring inspecialistskillsandthebanksbeginthe journeytowardsgreatercompetitiveness.

Theradical restructuringofpublicsectorbanksrequires thegovernmenttoexpendpoliticalcapital, for thereareseveralconstituenciesopposedtosuchreform.Fitfulandincrementalimprovementsareunlikelytocurethemalaiseor improveassetqualityandproductivity.

There isalsothesilentconstituency,thetaxpayer, inwhose interests thebanksneedtoberun.Andonthedistanthorizon, there is theunformedandapproachinghazeof financialdestabilisation.

‘In this Kafkaesque world where does integrity lie?’OPINION

P JayendraNayak

A sclerotic banking system is one of theareas most ripe for change in the tech-nologicalupheavalgrippingIndia.

The ability to bank through mobilephones is at the heart of an attempt tobring banking services to the country’spoorest people, as well as change thenatureof Indianbankinggenerally.

Explosive growth is being prophesied.The share of mobile as a channel for

payments in India may rise from lessthan 1 per cent currently to more than10 per cent in seven years, while thevalue of mobile banking transactionsmight rise 200 per cent to $3.5tn,according to Bank of America MerrillLynch(BAML).

“The next wave — from branch to cus-tomers’ pockets — is the big leap now.And that’s where new players are com-ing in,” says Sanjay Swamy, head ofPrime Venture Partners, a Bangalore-basedtechnology investor.Fast-growingfintech payment companies such asPaytm, MobiKwik, Citrus Pay, Ezetapand CCAvenue “are looking at what thebanks are doing and seeing if they canunbundlethebanks’products”.

The big question for incumbents,

such as State Bank of India, is whethernewcomers are going to slowly eat olderbanks’ lunch,orcomplementthem.Oneof themainchallenges“woulddefinitelybe the digital vision” admits ArundhatiBhattacharya, chair of SBI. “Banks arealso finding a lot of competition fromcompanies that are not banks,” she says,adding that if SBI wants to stay relevant,that is something itneedstoworkon.

Central bank chief Raghuram Rajanhas made his position clear: “With morethan900mmobilephones, thepotentialfor mobile banking as a delivery chan-nel for financial services is a big oppor-tunity in India,” he said in a speech lastyear. Analysts are cautiously optimisticthat such rhetoric will be followed upand that experiments will be allowed in

the market. “All regulators have a chal-lenge — they are here to protect, not dis-rupt. But the market disrupts, and it isgoing to push the regulator along,” saysMohandasPai,an investorbased inBan-galore.

How the banks will respond isunclear. Banks which concentrate on a“digital edge” will “gain disproportion-ate market share over the next 5-7years”, according to BAML. It points toprivate banks such as HDFC Bank andAxis as best positioned, alongside thelikes of state-owned SBI, thanks to theirdominance in payment transactionsandmobilebanking.

There is somewhatpredictablescepti-cism among fintech investors about thewider banking system’s ability to adapt.

“Banks are safe platforms,” said MrSwamy. “Innovation kind of goesagainstwhat theyweresetuptodo.”

Incumbents must either find a way toinnovate internally, or team up withstart-ups. One solution would be to givethe latter access to established banks’platforms in a mutually beneficial rela-tionship — like a banking version of theAppleappstore, saysMrSwamy.

The danger, particularly for the statebanks, is that through inaction they willsee theprofitablebitsof theirbusinessescannibalised over the longer term. “Therelationship between banks and theircustomers is changing,” says Mr Pai,adding that new entrants “are trying tocapture the younger people. That is thelonger-termthreat for thebanks.”

Mobile banking threatens to hack into giants’ profitsTechnology

Start-ups mobilise to takeadvantage of the nation’s900m handheld devices,reports David Keohane

Y ou wait nearly a decade for anew bank to open in Indiaand then more than 20 turnupatonce.

The first arrived inAugust, with the launch of BandhanBank, a former microfinance group tar-geting poorer customers, and the coun-try’s first new lender since 2004. IDFCBank, a new full-service retail and com-mercialbank,launchedearlythismonth.

Elsewhere, the Reserve Bank of Indiahas over recent months handed outlicences to 11 new payments banks, aform of stripped-down institution thatwill mostly target poorer customersover mobile phones, and 10 smallfinance banks, another experimentallender focusedonmicro-enterprises.

A handful of minor foreign bankshave also applied to set up domesticsubsidiaries. This follows a regulatorydeal which allows them to compete withdomestic players on roughly equalterms — for example, by being allowedto open more branches — but at the costof having to meet stricter regulations inareassuchas financial inclusion.

Take all these together, and the resultwill be “far greater competition” forexisting players, says Arundhati Bhatta-charya, chair of State Bank of India, thecountry’s largest lenderbyassets.

“Suddenly,asectorgetsnearly30newentities. I don’t think it has happened inany sector anywhere. I’m not sure ifsomething like this has happened any-where intheworld,”shesays.

Whether this plethora of upstarts willbring fundamental changes is open todebate. Some opinion holds that thenewcomers will start small and, beyondIDFC Bank, most are likely to stay thatway. Many may struggle to develop adecentbusinessmodel, too.

The last time India issued licences tonew banks in the mid-1990s, a numberran into financial trouble and had to beboughtoutbyincumbents.

Some of the new entrants are also notquite as new as they might at firstappear — notably the payments banks,many of which involve tie-ups with tra-ditional institutions. SBI, for instance, issetting up such a bank as part of a dealwith the telecoms arms of RelianceIndustries,abigconglomerate.

However in theory, some paymentsbanks could grow quickly, especiallythose backed by global telecoms playerssuch as Britain’s Vodafone and India’sBharti Airtel. These will hope to mimicthe success of services such as Voda-fone’s M-Pesa mobile money system,which has done well in a handful ofother emerging economies, including

Kenya. If such a model can be made towork in India, it could allow the newbanks to eat away at revenues nowearnedbymoreestablishedrivals.

The incumbents are taking solace inthe fact that the business model forthese new banks remains unclear, whileIndia’s onerous financial regulationsmay make it tough for mobile compa-nies tocompeteeffectively.

A strategy focusing largely on low-value financial transfers will come withthin margins, while the new lenders cantake only small deposits, and are notallowedto lendorofferothermorecom-plexservices.

“There is no secret . . . to setting up anew bank,” says Paresh Sukthankar,deputy managing director of HDFCBank, India’s second-largest private sec-tor lender by assets. “There is nothingthat a payment bank can do which weare not already doing. But there are lotsof things which we can do which a pay-mentbankcannot.”

More interesting, perhaps, is whetherthis early flurry of niche entrants mightbecome a precursor to a second phase,in which the central bank hands outmore licences for universal banks inthe mould of the new IDFC Bank —and potentially, run by India’s mostestablished corporate names.

Raghuram Rajan, the RBI chief, haspledged to begin an “on tap” regime forlicences, moving from a system in whichahandfularedoledoutevery10yearsorsotoone inwhichanyinstitutionsmeet-ing the regulator’s conditions wouldautomaticallygainapproval.

Many of India’s largest conglomerateswant to take advantage of this. Some,such as the Tata and Mahindra groups,bid for licences when Mr Rajan firstannounced plans for a new round ofthem last year — only to withdraw theirbids in the face of strict rules set downby the central bank to counter concernsthat the conglomerates might face con-flicts of interests; for instance, by usingtheir banking arms to lend to othercompanieswithin thesamegroup.

Similar rules are likely to continue toblock some of India’s big corporatenames, such as billionaire AnilAmbani’s Reliance group, from winningcoveted licences.

A more likely scenario is that finan-cial services groups with simplerstructures and no attachment to com-plex business — known as non-bankfinancial companies — will be able toupgrade to full bank status.

Either way, while Mr Rajan’s tapmight not produce a flood, at least atrickleofnewbanks isstill likely.

Newly-licensedupstarts carrypotential seedsof revolution

New banksNewcomers are expected to fostermore competition, reports James Crabtree

Speaking out:State Bank ofIndia chairArundhatiBhattacharyaShailesh Andrade/Reuters

The nextphase ofreform is tomove to an‘on tap’systemofregulatoryapproval

Rs700bnThe sumploughedinto India’s statebanks to tide themover until 2017

11%Percentage of allIndian bank loansacross the boardthat are ‘stressed’

ContributorsJames CrabtreeMumbai correspondent

Amy KazminSouth Asia correspondent

David KeohaneFT Alphaville India correspondent

Laura NoonanInvestment banking correspondent

P Jayendra NayakChaired the 2014 Committee to ReviewGovernance of Boards of Banks in India

Leyla BoultonCommissioning editor

Christina MaddenSub-editor

Steven BirdDesigner

Andy MearsPicture editor

For advertising details, contact:Srinivas Iyer +91 98-20-132670srinivas.iyer@publicitas.com, or yourusual FT representative.All editorial content in this report isproduced by the FT. Our advertisers haveno influence over or prior sight of thearticles.

Domestic credit (2004 $tn)

0

10

Performance and prospects

20

30

40

50China

2004 10 20 30 40 50

The rise of the Asian giants

Sources: RBI; PricewaterhouseCoopers baseline scenario projections

USIndia

Germany

JapanUK

2007 onwards are projections

India’s banks

Private banks

State banks

Per cent

0

2

4

6

Mar2011

Mar12

Mar13

Mar14

Sep14

Mar15

Non-performing assets Restructured assets

024

68

101214

Mar2011

Mar12

Mar13

Mar14

Sep14

Mar15

P Jayendra Nayak:‘Incrementalimprovements willnot cure themalaise or improveproductivity’

Monday 12 October 2015 ★ FINANCIAL TIMES 3

Centralbankers tendtobeviewedascautioustechnocrats, fondofcarefulphrasingandaversetodramaticaction.

Butas thedrivingforcebehindrecentmovestoshakeupIndianbankingRaghuramRajan,governorof theReserveBankof India, showsfewsignsofcircumspection.

Nowtwoyears intoathree-yearterm,MrRajanhasmovedquicklyto fashionwhathedescribesasa“remaking”ofIndianbanking.

Sincehisappointment inSeptember2013, licenceshavebeenissuedforanewgenerationofprivate lenders;foreignbankshavebeenpushedtosetupIndiansubsidiaries;government-backedlendershavebeenchivviedtopatchuptheirbalancesheets.

Drawingonanacademicbackgroundinfinance,MrRajan’sapproachhasfocusedonenhancingcompetition—ushering innewentrantsandeasingrulesonestablishedprivate-sectorplayers—aspartofwiderplanstoendIndia’s imageasahometosleepy,unimaginative financial institutions.

Forstrugglingstate-backedbanks,whichcontrolabout three-quartersoflendingandhavedonemuchtocontributetothat image, thetaskhasbeenmoreremedial—not least intighteningregulationstostoparepeatofthereckless lendingexhibitedduringIndia’smid-2000seconomicboom.

MrRajanwonadmirers fromthestartofhis tenure,helpedalongbyastellarrésumé—academicsuperstar,governmentadviser inNewDelhi,andIMFchiefeconomist.

Itwas inthe latterrole thathewascredited in2005withpredictingelementsof thecomingglobalfinancialcrisis.

Followinghisarrivalat the

centralbankinthemidstofacurrencycrisis, theRBIbroughtstability totherupeethroughaninvestmentschemethatattracted$34bnfromwealthyIndians livingabroad.

“Hewonalotofcredit for thoseearlymonthswhenthingswere inarealmess,andhehelpedputthemright,”saysRanaKapoor,chiefexecutiveofYesBank,amidsizeprivatesector lender.

Otheradmirerspoint toMrRajan’sfocusonprices,andinparticularanewtarget tobring inflationdownto just4percentby2018,withinplusorminus2percentagepoints.

Thataim,agreedbyprimeministerNarendraModiearlythisyear,wouldsee inflationfall farbelowthe level thatIndianshavetraditionallyendured. Itwouldalsohelpthewiderbankingsectorbylowering inflationexpectationsamongconsumers, thusincreasingtheoddsthat theywouldputtheirmoneyintosavingsschemes.

“FormalisingIndianinflation—movingfromamuddledmonetarypolicyregimetoaclearone—isagreatstep,”saysPranjulBhandari,aneconomistatHSBC.

Criticsare fewer,but tendtobesplitintotwocamps.ThefirstgroupaccusesMrRajanofexcessiveanti-inflationaryzeal,achargewhichunitesbusinesstitanswithpoliticians inNewDelhi.ArunJaitley, financeminister,madethispoint lastmonth,arguingthat“commonsensesaystheratesshouldcomedown”nowthat inflation is“undercontrol”.

ThesecondlineofcriticismpaintsMrRajanasmoving inbroadlytheright

directionbutdoingsotooslowly,perhaps for fearofruffling feathersatthecentralbankoramonghispaymasters inNewDelhi.

For instance, Indiahas launchednearlytwodozennewbanksonhiswatch—butonlyone isabig, full-service lender.

Despitemuchtoughtalk, theRBIhasstruggledtomakeprogress inaddressingtheunderlyingcausesofIndia’sbadloansproblem.

“Hehasbeensomewhatdisappointinginhowfarandhowfasthehaspushed,”saystheheadofoneMumbai-basedfinancial institution,whoaskednot tobenamed.“Hehasn’tchangedtheRBI.Maybeithaschangedhim.”

Eveninprivate, suchcriticismremainsrare—butMrRajan’sultimatereputationascentralbankchiefwill stilldependonthemanner inwhichhefinisheshis terminoffice,andwhetherhewinsasecond.

Onecrucial testwill lie inhisability toeffect India’snewanti-inflationregime,includingthe launchofanewBritish-stylemonetarypolicycommittee.Centralbankgovernors tendtobejudgedontheirrecord incurbinginflation.Sofar,MrRajanhasbeenfortunate,enjoyingthebenefitsofaglobalslumpincommodities.Buthemustnowhitorexceedhisowntargetsinthefaceofatrickyglobaleconomicenvironment,whichwillbenoeasytask.

Ensuringthesuccessful launchof thevariousnewbanksposesafurtherchallenge,as isdeliveringonapromiseto launchan“ontap”regimefornewlicences,potentiallybringingmanymoreplayers intothesector.Morealsoneedstobedonetohelpbanksridthemselvesofnon-performingassets.

Finally, there is thequestionofhisownfutureplans;MrRajan’s tenure

isupnextyear.Typically, India’scentralbankgovernorsservetwoterms,

but the incumbenthaskeptquietaboutwhathe

wants todonext.Withoutasecondstintinthegovernorship,hisambitionsto

remakeIndia’sbankingsectorwillbelefthalf-finished.

Central banker wins credit forreform of monetary policyProfile

Admirers praise RaghuramRajan’s focus on fightinginflation but critics say heneeds to move faster on badloans, says James Crabtree

RBI chief: RaghuramRajan—Abhijit Bhatlekar/Mint viaGetty Images

Indian Banking & Finance

J analakshmi Financial Services,a Bangalore-based micro-lender, has been making smallloans to working-class womenin India’s urban slums and set-

tlements formorethanadecade.Today, it has a portfolio of nearly

$800m in loans to about 3m borrowersin165Indiancities.

But now, Janalakshmi is preparing toleap into the world of fully-fledgedbanking — albeit at the bottom end ofIndia’s financial sector.

Last month the microlender — whichwas previously required to ensure that85 per cent of its portfolio consisted ofloans of less than Rs100,000 ($1,530) —received approval in principle from theReserveBankof Indiatotransformitselfinto a small finance bank, a new type ofentitybeingcreatedbytheRBI.

Small finance banks will be allowedto extend larger and longer-termloans than microlenders, on the con-dition that half of their portfolios con-sist of loans less than Rs2.5m — andthat 75 per cent of lending is in prior-ity sectors, such as lending to smalland medium-sized enterprises.

Along with extended loan terms, thenew institutions will be able to offerother financial services, including bankaccounts, taking deposits, facilitatingpaymentsandtransferringmoney.

“Customers need a savings solution,because they save and borrow at thesame time,” says VS Radhakrishnan,chief executive of Janalakshmi.

“We should be in a position to offer

our customers exactly the same aswhat you and I get.”

The transformation of eight micro-lenders and two other institutions intosmall finance banks is part of a widerpush in India to shake up the lower endof the financial markets and providehigh-quality, well regulated financialservices to a clientele — includingmicro-enterprises and informal sectorworkers—longshunnedbymainstreamcommercialbanks.

In August the RBI also issued licencesto 11 companies, including telephonegroups such as Vodafone and Airtel, andtech enterprises such as Paytm, tolaunch another type of business, calledpaymentsbanks.

The payments banks are expected toreach customers largely through mobilephones;manyof themwillpiggybackonexistingtelecomsinfrastructure.

They will be permitted to take depos-its of up to Rs100,000 and make trans-fers, too. They will not be permitted tolend, however, and will rely instead ontransactionfees tomaketheirmoney.

Together, these new categories ofbankareexpectedtohaveatransforma-tive effect on India’s financial landscape— providing regulated alternatives tothe usurious informal moneylenders,dubious deposit-taking schemes andindependent couriers that have tradi-tionally been the mainstays of financialservicesat the lowerendof thecountry’seconomy.

“There is a whole new architectureemerging,” says Alok Prasad, former

chief executive of the MicrofinanceInstitutes Network.

“We are putting in the plumbing offinancial inclusion. It’s like this biggranddesignunfolding.”

For decades, New Delhi and the cen-tral bank in Mumbai have looked topublic-sector banks to meet thedemand for credit and other financialservices for the poorest — albeit withoutmuchsuccess.

Despite prodding from successiveNew Delhi governments, mainstreambanks have shunned potential custom-ers they considered too risky. Instead,they have focused on influential corpo-rate borrowers and India’s growing pro-fessional and middle classes. They havealso been reluctant to offer bankaccounts to small savers, given hightransactioncostsandlowbalances.

Only about 35 per cent of India’salmost 1.3bn people have access to bankaccounts, compared with a global aver-age of 50 per cent, according to a 2011WorldBankstudy.

At the same time, stodgy RBI ruleshave prevented the uptake of servicessuch as Vodafone’s M-Pesa and othermobile functions, which have proven sopopular inKenyaandelsewhere.

It is little surprise that this radicalshake-up of the financial landscape istaking place under the watch ofRaghuramRajan, theRBIgovernor.

In 2008, while still lecturing at theUniversity of Chicago’s Booth School ofBusiness, Mr Rajan chaired a govern-mental committee that considered howtoreformIndia’s financial sector.

In his report, “A Hundred SmallSteps”,MrRajanarguedthat therewasa“moral and economic imperative” tobring new dynamism to India’s ineffi-cient, under-developed financial indus-try. In particular, those at the bottom ofIndia’s economic pyramid neededaccess todecent financial services.

Mr Rajan has found a kindred spirit inNarendra Modi, the prime minister wholast year gave his support to a campaignthat has seen mainstream public and

private-sector commercial banks open112maccounts forpoor families.

At the end of September, accountsopened through the prime minister’s JanDhan Yojana (or People’s Wealthscheme)hadatotalbalanceofRs243bn.

Mr Modi’s government is also creatinga new Mudra Bank (Mudra stands forMicro Units Development & RefinanceAgency) to which it has pledgedRs200bninfunds.

Mudra’s mandate is to provide refi-nancing for microlenders and otherfinancial institutions — including thenew small finance banks — for loans ofless thanRs1mtomicro-enterprises.

“You are looking at pretty transfor-mational stuff in the banking land-scape,” says Mr Prasad, who sits on theMudra board. “We are creating a paral-lel set of banking institutions whosecore competencies are focused on thelowerendof themarket.

“In two or three years, the way finan-cial inclusion will look will be dramati-callybetter thaninthepast.”

Grand design tobringmoney tothemassesbecomes realityInclusionGovernmentwidens access to financewithplanof a ‘hundred small steps’,writesAmyKazmin

Better coverage:once-shunnedclients to benefit—Prashanth Vishwanathen

‘Themoralimperativeis to helpthose at thebottomofIndia’seconomicpyramid’

4 ★ FINANCIAL TIMES Monday 12 October 2015

Indian Banking & Finance

T he Royal Bank of Scotland(RBS) has joined a long lineof international banksretrenching from India.However, Standard Char-

tered and HSBC both insist that theiroperations in Asia’s third-largest coun-tryareonaverydifferentpath.

“India is a priority market for theHSBC group and we look forward to par-ticipating in the Indian growth story,”says Stuart Milne, who has been chiefexecutive of 32,000-strong HSBC Indiasince2012.

Ananth Narayan, head of StandardChartered’s markets for India, is simi-larly effusive about the nation’s status asan “extremely key market” and seesopportunities in retail and corporatelending in an economy set to grow bymorethan7percent thisyear.

US banking giant Citi also remainscommittedto India.But for themajorityof western banks, the market’s chal-lenges — of being a tiny player in a terri-tory so far from home — outweigh thebenefits. Foreign banks, whose collec-tive market share is just over 6 per cent,have traditionally been blocked frommaking acquisitions and have facedsevere restrictions on the number ofbranchestheycanopen.

A recent change in regulations allowsforeigners to create Indian subsidiaries,freeing them from restrictions on acqui-sitions and branches while imposingnew ones such as quotas allocating 8 percent of their net credit to small farmers.The public sector Indian banks areutterly dominant with a market share ofabout 70 per cent, so internationalbanks can never hope to achieve pricingpower.

In the pre-crisis era of booming eco-nomic growth and free, easy globalfinancial regulation, foreign banks wereprepared to try their luck in Indiadespite unfavourable odds. The post-crisisworld isanotherstory.

“Western banks are inhibited becauseof their own challenges at home with

their regulators,” says Shinjini Kumar,executivedirectorwithPwCIndia.

“They don’t have the bandwidth to bein a country where revenues are notsubstantial; but the compliance over-heads by way of implementing homestandards and country standards can befairlysignificant.”

RBS’s late-September sale of itsIndian private bank to a companybackedbyits localmanagerwasaclassiccase. RBS, which is more than 80 percent owned by the UK taxpayer as aresult of its bailout following the 2008financial crisis, could not justify contin-uingtoownthebusiness.

“We’ve seen some [foreign banks]back right off,” says Ms Kumar. Theirspots have been filled by banks from theMiddle East, Australia and SoutheastAsia, or by local players. “We haven’tseen a single western bank come in, andwe’reunlikelyto,”sheadds.

Ms Kumar says some foreign bankshave found sweet spots by concentrat-ing on a narrow segment of the market.Citi India’s chief executive, Pramit Jha-veri, has focused the bank on “profita-ble niches” such as credit cards, wealthmanagement and mortgages to service

wealthy Indians. Korean and Japanesebanks have done well looking after cli-ents from their home markets, whileDeutsche Bank has a strong corporatebanking arm. The “churn” among for-eign banks has been particularly high inretail banking, says Ms Kumar. Barclaysand RBS are among those which tried tobreak into retail lending but pulledback.

HSBC’s Mr Milne admits that wagesare increasing faster than the consumerprice index, which is up 3.7 per cent inthe year to August. “This means thatcompanies need to get more efficientover time,” he says. Bad loans across theIndian banking sector rose to 4.45 percent in March 2015, up from 4.1 per centa year earlier, creating further head-aches for banks — although Mr Milnesaysthepace isnowslowing.

The Asian Development Bankrecently cut its annual growth estimatesfor the Indian economy to 7.4 per centfrom 7.8 per cent. Foreign banks can livewiththat.“Indiastandsoutasanoasisofgrowth at a time [of] global economicslowdown,”saysMrNarayan.

The European Commission expectsthe EU’s economy to grow by 1.8 per

cent thisyear,and2.1percent in2016.Given their advantageous starting

point, domestic banks appear bestplaced to take advantage of India’s supe-rior growth. Yet HSBC insists that for-eignbankswillnotbe leftout.

“As the pie expands, there are biggerpieces of the pie to be had by all,” saysMr Milne. While Indian banks, giventheir reach across the country, will cer-tainly grow rapidly, he says, “banks likeHSBC can also leverage the opportuni-tiesbyplayingtotheirstrengths.”

Those strengths, he adds, include anability to support clients across theAmericas, Europe and the Asia-Pacificregion. Foreign banks have less to fearthan their Indian rivals from the newBasel III global capital requirements,which come into force in 2018. Indianbanks need tens of billions of dollars inextra capital to meet the new rules — ifthey do not get it, their capacity to lendwillbeconstrained.

Mr Narayan says his bank, which has100 branches in 42 Indian cities, plansto increase its customer base amongcash-rich businesses in sectors with thehighestgrowthpotential.

“Ontheretail side, it’savastuntappedmarket,” he adds. “For a population of1.3bn people, only 200m have bankaccounts.”

He is cautious, however, aboutwhether the new licensing regime willmakearealdifference for foreignbanks.“We will have to be guided by what theregulator dictates,” he says. “There arepositives . . . but there are some prettyonerousrequirements.”

Singapore’s SBM Bank (Mauritius)and DBS Bank are among applicants toset up subsidiaries. Those familiar withStandard Chartered’s position have saidthe bank is likely to set up a subsidiarywithinthenext threeyears.

“We feel that the regulatoryrisks . . . are a bit overstated,” says MrMilne. “Some people may not be happywith the pace of change or execution,but thedirectionhasalwaysbeenclear.”

Hopefulminoritystays in ‘prioritymarket’Foreign banksTemptedbystronggrowth,players fromUKtoSingaporeprepare foropportunity toopensubsidiaries, saysLauraNoonan

On the international stage, the country’sbankingsystemremains far less impres-sive than some other sectors operatingoutsideIndia.

Total Indian bank assets of Rs110tn($1.7tn) as of March 2015 representbarely one per cent of global bankingassets and a fraction of China’s $29.5tn

banking assets — the emerging marketthat India issooftencomparedwith.

Yet not long ago, a more grandiosefuturewasenvisioned.

When the Indian economy was lastgrowing quickly, just before and afterthe financial crisis of 2008, optimismabounded.

There was a sense that Indian bankswere ready to compete more aggres-sively on a global level and becomeinternationallysignificant.

“During the last round of liquidity, alot of Indian companies went outbound,particularly the large infrastructure andcommodity companies,” says ShinjiniKumar, an executive director at PwC in

India — and the banks followed. WhileIndian bank branches abroad onlyincreased from 138 in 2009 to 178 in2014, according to the Reserve Bank ofIndia, Indian banks looked to deal fund-ingastheirpassport toglobalgrowth.

“It’s not that a large number ofbranches got opened,” said Ms Kumar.“Banks just got better opportunities todo business. It was their own companiessettingup,sotheycouldservethem.”

Confident big Indian companies suchas Tata Steel — which bought Anglo-Dutch steelmaker Corus in 2007 for$13.1bn—ledIndia’sbanksabroad.

“But that market cooled off as corpo-rationsstartedtohavetroubleathome,”

says Ms Kumar, who points out thatevery Indian bank abroad had beenchasing its clients from home.

Now Indian corporations and banksare struggling with bad loans and TataSteel followed up a $1.6bn writedown onCorus in 2013 with a $785m charge inMaythisyear.

Where Indian banks still do thriveabroad, often via subsidiaries, it ismostly to service India’s diaspora, par-ticularly their world-beating level ofremittances at about $70.4bn in2014,accordingtotheWorldBank.

The medium-term expectation, how-ever, is that Indian corporates will healtheir balance sheets and seek to strike

large international deals once more.Indian banks will follow, say analysts,and look to the rest of world as a sourceofrenewed growth.

“Intheeventofbusinessgrowingsub-stantially, we would hope to expand,”says Parthasarathi Mukherjee, head ofinternational business at Axis, India’sthird-largestprivatesectorbank.

“Our experience says that our coremarket is India — our expertise is here,there’s a better return on capital here. Itfrankly doesn’t really make sense tolookelsewhere,”saysMrMukherjee.

“The rest of the world is looking atIndia as an opportunity . . . It would beridiculous forusnot todothesame.”

Domestic players follow themoney with diaspora and corporatesGlobal expansion

Lenders are looking forgrowth abroad withoutmissing opportunities athome, reports David Keohane

Work inprogress: Citisays it isfocusing onprofitableniches

‘As the pieexpands,there arebiggerand biggerpieces of thepie to behad by all’

Shinjini Kumar: corporate troublesdamp bankers’ foreign ambitions

Singapore’s DBS doubled its profitsduring the financial crisis by goinginto Asian markets that westernbanks were deserting. Now chiefexecutive Piyush Gupta has set hissights on his homeland — India.

His is one of only three banks toapply for the new foreignsubsidiary licences offered by theReserve Bank of India. This wouldallow DBS to increase its branchnetwork from 12 to 80 branches.

Singapore’s biggest bank hasalso embarked on a new digitalpush and is hoping to woo millionsof customers to a new, online-onlyIndian “digibank”.

But patience will be required forthe transformation of DBS, from bitplayer to serious contender in theworld’s tenth-largest economy.

“We don’t have approvals yet [forthe new licence],” says Mr Gupta,whose experience includes headingCiti’s southeast Asia businessbefore he took over at DBS in 2010.

“RBI told us it focused on thepayments bank and small banklicences. It put all the (foreign)applications on the shelf.”

Eleven of those paymentslicences were granted in August.“We’re quite hopeful that they willnow start to focus on (foreignbank) approvals,” says Mr Gupta.

It will take another year for DBSto convert its existing legal entity.Only then will the bank be free toembark on a small-businesslending strategy that will allow itsIndian bank, with a loan book of4bn Singaporean dollars ($2.8bn),to keep pace with growth in otherbig Asian markets.

“You probably need a network of60 to 80 branches in these bigcountries to be where the SMEsare,” says Mr Gupta.

“In China and Indonesia, I havebranching privileges, I’m at roughly35-40 branches today. Over thenext five or six years we’ll get to60-80. But in India, we don’t havebranching privileges . . . so that’swhy we need the subsidiary.”

Mr Gupta wants to use the newlicence to open branches in 10 to 15leading Indian cities in the next fiveyears.

Some of that will depend on themacroeconomic environment, heargues, and in a difficult economicclimate, “then you don’t really putyour foot into SME [lending]”because small and mediumenterprise is the most vulnerable toadverse economic forces.

DBS has already experienced thevagaries of Indian SME lending. Inits 2013-14 financial year, more than10 per cent of its loan book wasnon-performing, though that fell to4.15 per cent in its 2014-15 financialyear.

As a subsidiary, DBS would haveless flexibility in where it lends,because it would be affected bystate quotas for loans to certainsectors.

Mr Gupta says that the quotaswould still apply “once you get to20 branches . . . whether yousubsidiarise or not”. Yet asubsidiary that lends to SMEs has“better opportunity to addressthose quotas in a more meaningfulway”.

The online push is simpler:“Our thing is to test over the nexttwo years whether we can get tomillions of customers in Indiapurely online,” Mr Gupta adds.

“Can I integrate into largeecosystems of online partners andget the customer reach? Thatremains to be seen.”

Laura Noonan

Case study: digitalendeavour of DBS

* Estimate based on a linear projectionSource: Committee to Review Governance of Boards of Banks in India, RBI, 2014

Market share of banks in India (%)

0

20

40

60

80

100

2000 2013 2025*

Private sector Public sector Foreign

Foreign vs local‘Wewill testwhetherwecanget tomillions ofcustomerspurely online’