Banking Industry Vision report 2010: Echoing the cost-control wisdom
Gist of the Report with assessment/comment
[Source: Article by Dharmalingam Venugopal economist, Indian Overseas Bank published in
Business Line, Internet Edition dated Friday, Jan 23, 2004 ]

YEARS ago when Mr T. A. Pai was asked for an explanation for the fast growth of banking in south Canara, he put it simply: In conventional economics, income minus expenditure is savings; in south Canara, income minus savings is expenditure. Echoing a similar wisdom, the Banking Industry Vision report 2010, released recently, urges banks to focus on cost saving to survive in future.

The report has been prepared for the Indian Banks' Association by a committee of experts headed by Mr S. C. Gupta, Chairman and Managing Director, Indian Overseas Bank.

In the sheltered days of banking, when customers could be freely charged, banks concerned themselves with only `revenue' which was equal to cost plus profit. Post-reforms, when the cost of services became nearly equal across banks and cost-control was key to higher profits, the focus of banks shifted to `profit', which was equal to revenue minus cost.

In the future, as domestic and international competition hots up, banks may have to shift their focus to `cost' which will be determined by revenue minus profit. In other words, cost-control in tandem with efficient use of resources and increase in productivity will determine the winners and laggards in the future, says the report.

The growth of banking in the coming years is likely to be more qualitative than quantitative, according to the report. Based on the projections made in the "India Vision 2020" prepared by the Planning Commission and the Draft 10th Plan, the report forecasts that the pace of expansion in the balance-sheets of banks is likely to decelerate.

The total assets of all scheduled commercial banks by end-March 2010 is estimated at Rs 40,90,000 crore. That will form about 65 per cent of GDP at current market prices as compared to 67 per cent in 2002-03.

Banks assets are expected to grow at an annual composite rate of growth of 13.4 per cent during the rest of the decade against 16.7 per cent between 1994-95 and 2002-03.

On the liability side, there is likely to be large additions to capital base and reserves. As the reliance on borrowed funds increases, the pace of deposit growth may slow down.

On the asset side, the pace of growth in both advances and investments is forecast to weaken.

On the growing influence of globalisation on the Indian banking industry, the report is of the opinion that the financial sector would be opened up for greater international competition under WTO. Opening up of the financial sector from 2005, under WTO, would see a number of global banks taking large stakes and control over banking entities in the country.

They are expected to bring with them capital, technology, and management skills which would increase the competitive spirit in the system leading to greater efficiency. Government policy to allow greater FDI in banking and the move to amend Banking regulations Act to remove the existing 10 per cent cap on voting rights of shareholders are pointer to these developments, says the report.

The pressure on banks to gear up to meet stringent prudential capital adequacy norms under Basel II and the various Free Trade Agreements that India is entering into with other countries, such as Singapore, will also impact on globalisation of Indian banking.

However, according to the report, the flow need not be one way. Some of the Indian banks may also emerge global players. As globalisation opens up opportunities for Indian corporate entities to expand their business overseas, banks in India wanting to increase their international presence could naturally be expected to follow these corporate entities and other trade flows out of India.

Alongside, the growing pressure on capital structure of banks is expected to trigger a phase of consolidation in the banking industry. In the past mergers were initiated by regulators to protect the interest of depositors of weak banks. In recent years, there have been a number of market-led mergers between private banks.

This process is expected to gain momentum in the coming years, says the report. Mergers between public sector banks or public sector banks and private banks could be the next logical development, the report adds. Consolidation could also take place through strategic alliances or partnerships covering specific areas of business such as credit cards, insurance etc.

The ability to gauge the risks and take appropriate position will be the key to successful banking in the emerging scenario. Risk-takers will survive, effective risk mangers will prosper and risk-averse are likely to perish, the report asserts.

In this context, the report makes a very pertinent recommendation that risk management has to trickle down from the corporate office to branches.

As audit and supervision shifts to a risk-based approach rather than transaction oriented, the risk awareness levels of line functionaries also will have to increase.

The report also talks of the need for banks to deal with issues relating to `reputational risk' to maintain a high degree of public confidence for raising capital and other resources

Technological developments would render flow of information and data faster leading to faster appraisal and decision-making. This would enable banks to make credit management more effective, besides leading to an appreciable reduction in transaction cost.

To reduce investment costs in technology, banks are likely to resort more and more to sharing facilities such as ATM networks, the report says. Banks and financial institutions will join together to share facilities in the areas of payment and settlement, back-office processing, date warehousing, and so on.

The advent of new technologies could see the emergence of new players doing financial intermediation. For example, according to the report, we could see utility service providers offering, say, bill payment services or supermarkets or retailers doing basic lending operations. The conventional definition of banking might undergo changes.

All these developments need not mean banks will give the go-by to social banking. Rather than being seen as directed lending such lending would be business driven, the report predicts. Rural market comprises 74 per cent of the population, 41 per cent of the middle-class, and 58 per cent of disposable income.

Consumer growth is taking place at a fast pace in 17,000-odd villages with a population of more than 5,000. Of these, more than 50 per cent are concentrated in just seven states. Small-scale industries would remain important for banks.

However, instead of the narrow definition of SSI based on the investment in fixed assets, the focus may shift to small and medium enterprises (SMEs) as a group. Changes could be expected in the delivery channel for small borrowers, agriculturists and unorganised sectors also.

The expected integration of various intermediaries in the financial system would require a strong regulatory framework, the report states. It would also require a number of legislative changes to enable the banking system to remain contemporary and competitive. Underscoring that there would be an increased need for self-regulation, the report states that development of best practices could evolve better through self-regulation rather than based on regulatory prescriptions.

For instance, to enlist the confidence of the global investors and international market players, the banks will have to adopt the best global practices of financial accounting and reporting. It is expected that banks would migrate to global accounting standards smoothly, although it would mean greater disclosure and tighter norms, the report adds.

Notwithstanding the limited time ahead, the expectations, suggestions and recommendations of the Banking Industry Vision report are well within the realm of realisation in part or whole. The first phase of banking reforms was born out of panic. The second phase can be implemented from a position of strength and confidence in a compressed time frame.