The Hindu Business Line : Consolidation, reforms will dominate banks' agenda

"Banks in India encountered many challenges and opportunities amidst strong and sustained economic growth," observes Mr Ashvin Parekh, Partner, National Leader, Global Financial Services, Ernst & Young. Here are his answers to a few questions from Business Line.

Lot of action on the deal street?

Yes, the hunger of Indian banks for acquisition increased significantly in 2006. It was evident in the fact that there were 17 contenders to acquire United Western Bank, a loss-making bank. ICICI Bank acquired Sangli Bank recently.

What have been the reasons for heightened interest in mergers and acquisitions?

Consolidation among banks is being fuelled by two prominent factors. The larger banks are looking at acquisition as a means to rapidly expand their reach and enhance regional presence.

On the other hand, smaller banks, feeling the pinch of capital adequacy requirements, are looking at consolidation as a way to address the problem.

The government, which is keen to see a few large world-class banks with international presence, is not averse to consolidation.

How has been the approach of the RBI during the year?

In the face of inflationary pressures and burgeoning credit to real estate, capital markets and consumer sectors, the Reserve Bank of India adopted a cautious approach. It increased repo rate, reverse repo rate, CRR (cash reserve ratio) and capital provisioning requirements for the real estate sector. These measures are a clear signal of hardening interest rates in the economy.

The year was good for foreign banks, wasn't it?

In response to the clamour of foreign banks for a level-playing field vis-à-vis Indian banks, the RBI came out with the roadmap for the liberalisation of the banking sector.

As per the roadmap, foreign banks will be able to freely expand their branch network as well as acquire Indian banks after March 2009.

Meanwhile, existing foreign banks may convert their branches into wholly owned subsidiaries (WOS) and new foreign banks can enter via WOS route.

It is a wake-up call for Indian banks to set their house in order and increase their efficiency and productivity so as to efficiently compete with foreign banks.

Basel got pushed further. Does the postponement augur well for Indian banking?

The deadline for compliance with Basel II norms has been extended to March 31, 2008 for foreign banks operating in India and Indian banks having presence outside India, and March 31, 2009 for all other scheduled commercial banks.

While the principal reason cited for the extension was non-preparedness of banks, this has diluted the seriousness of banks to comply with the norms.

Did the year see any significant developments in fund raising?

The RBI permitted banks to raise capital by issuing hybrid debt instruments, such as innovative perpetual debt instruments and upper tier II bonds, in foreign currency without its prior approval. This has helped banks raise additional capital at a lower cost.

Year 2007. What is the outlook for Indian banking?

Looking ahead, 2007 promises to be even more challenging. Interest rates are expected to harden further and cost of funds for banks is set to increase.

Competition for deposits is going to intensify, as banks will focus on increasing their deposit base to feed the rapidly growing credit off take. Net interest margins are expected to come under pressure forcing banks to explore new avenues of increasing fee-based income and improving operational efficiencies.

Specific strategies for banks?

Microfinance and agri-finance will be seen as profitable ventures rather than just regulatory obligations. Technology will become a key enabler for banks to increase their reach and enhance service quality in a cost-effective manner.

Disposal of non-performing loans (NPLs) will also be a key focus area for banks in their attempt to clean up their balance sheets and meet prudential norms. Quest for consolidation is expected to strengthen further as banks will increasingly seek to adopt the inorganic route to gain scale.

How will the coming quarters pan out?

The first two quarters of 2007 will witness good growth, tighter liquidity, particularly around March and hardening up of interest rates.

The last two quarters may witness a sentiment of consolidation and perhaps, therefore, require a closer look at the quality of assets and the portfolio performance.

Consolidation, reforms and compliance will dominate the boardroom's agenda.

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