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T. B. Kapali

One of the most prominent developments in Indian banking in the recent past has been the rapid growth of the retail loan portfolios of private sector commercial banks.

The growth posted by some of the private sector banks has been such (a near doubling of retail credit in around two years which shows an annual rate of growth of around 35 per cent) as to overshadow the more modest attainments on this front by other b anks — particularly the public sector banks. It has also created the perception that overall economic conditions have so changed that a major shift in business strategy (such as the dominant focus on retail banking as against wholesale banking) is quite inevitable and the future lies only in retail banking expansion.

So we see public sector banks announcing significant retail initiatives which ultimately do not take off as envisaged.

ICICI Bank, for example, which has a total loan base of around Rs 2,00,000 crore as of March 2007 has 65 per cent or Rs 1,30,000 crore of this under the retail category — comprising housing loans, credit card receivables, auto loans, personal loans and small business loans. The proportion of retail loans is not much lower in the case of HDFC Bank also. The bank’s retail loans have grown by around 35 per cent on average in the past few years and accounted for as much as 57 per cent (Rs 28,000 crore) of its total loans of Rs 49,000 crore as of March 2007. And both the banks have reiterated that retail banking will continue to be a key area of strategic emphasis for them in the ensuing period.

The retail credit growth of nationalised banks does pale in comparison with that of the private bank majors. Retail credit increased only from 10 per cent of nationalised banks’ total credit in March 2000 to around 15 per cent of total credit in March 2007. In absolute terms, the group of 20 nationalised banks had around Rs 1,35,000 crore of retail loans in March 2007. The State Bank group had a higher proportion of its total loans under the retail category – around 25 per cent in March 2007 and this share was slightly more than double (10 per cent) of what the group had under this category in March 2000. (The public sector banks — comprising the State Bank group and the nationalised banks — account for around 60 per cent of total banking business.)

For the banking sector as a whole, retail credit now forms around 25 per cent of the total credit. Total bank credit as of June 2007 is Rs 19,00,000 crore. This means that just two banks, ICICI Bank and HDFC Bank, now account for close to one-third of the total retail credit portfolio of the entire banking sector. And the way these two banks are going about expanding their retail business — investing heavily in expanding their physical branch network, continued emphasis on alternative delivery channels such as ATMs/Internet, the technology initiatives they are undertaking to sustain the retail business as a high volume, commodity-style business, all indicate that they could well account for a much higher share of the total retail business in the ensuing period.

Whichever way one looks at it, it is clear that a great retail-credit push is happening — driven by a handful of private sector banks, while the public sector banks, as a category, do not seem to be in the race, either by choice or by design. Private sector banks seem to be operating a business strategy which is profoundly different from that followed by the public sector banks.

What are the main features of this strategy of retail credit expansion? What drives or what has contributed to the surge in retail credit? Is it sustainable or is the recent emphasis on retail transitory? Are public sector banks missing out or are they becoming late starters in an operating environment in which the dominant opportunities are in the retail space? What could be the pitfalls or disadvantages in a situation where just a handful of banks account for a major chunk of the total exposures in a particular business segment? Will it dilute the risk diversification benefits which the retail business by its very nature provides?

The second half of the 1990s was a period marked by increased emphasis on (then) new concepts such as ATMs/Internet/on-line banking as alternative delivery channels.

The past few years, though, have seen a clear revival of the brick-and-mortar concept with the expansion of the physical branch network, one of the major features of the retail push. It is the costs being incurred in the creation of the retail infrastructure — not only the physical branch network but the concomitant infrastructure which has to go with a branch — which suggests that this retail push is here to stay and is not transitory.

Banks such as ICICI or HDFC possibly see the physical branch network as a critical requirement in their endeavour to increase the share of retail funding also in their overall funding patterns. In other words, while credit growth on the retail side is now working well as a business strategy, the effort now is to expand the overall retail banking franchise itself — comprising liabilities as well as assets.

The macroeconomic picture also suggests that retail credit business, which at present accounts for a quarter of the total credit business, will significantly rise as a proportion of the total lending business.

Cross-country studies clearly point to such an outcome with increasing urbanisation, rising income levels and further development of the financial markets which will provide alternative means of financing for the other major claimant of bank finance (the commercial/corporate sector), all indicating that the demand for retail finance will continue to be very strong well into the future.

The perceived stability of the income stream from the retail business is probably the most important driver of the push into retail.

From a strategic point of view, this stability is expected to offset the inherent volatility of revenues/profits from other lines of business, such as financial markets trading/corporate and commercial banking.

Indeed, a study of the earnings profile/balance-sheet structure of banks such as ICICI or HDFC over the past few years does show the stability which has been imparted to the overall revenue stream by the retail business.

This stability basically arises from the widely dispersed nature of the retail assets portfolio. This means that banks are able to significantly diversify away specific-borrower risk and, at the aggregate level, are exposed to the overall systematic or macroeconomic risk only.

The efforts to make retail banking a high volume and commodity-style business can be better understood in this backdrop. Technology plays a big part here in enabling the conduct of the retail business as a high volume game.

The retail credit explosion — particularly among the private sector banks — is well established. But what prevents this phenomenon from being labelled a retail banking expansion is the fact that the growth so far has been restricted to the asset side only for the private sector banks.

The differences between the new private banks and public sector banks with respect to the funding profile/retail asset profile stand out. For public sector banks, retail deposits (meaning deposits of individuals) account for as much as 65 per cent of their overall deposit base but retail assets form only around 25 per cent of their total credit. For the private banks, retail deposits are much lower at around 35-40 per cent of the total deposit base but retail assets dominate their overall asset portfolios.

Significant implications flow from this diversity in funding/asset profiles. For private sector banks, it is imperative to increase the retail share in their funding to sustain and improve the profitability of their retail asset business. For the public sector banks, the high share of retail deposits points to the opportunities ahead.

For public sector banks, a major shift in business strategy to focus on retail may be optimal for the long term from a returns/risk point of view — provided they can create and improve the infrastructure in terms of technology, people, processes and pricing.

The business marketing model, for instance, where direct marketing agents have been employed in a systematic manner to source retail assets, has been a notable success with private banks registering quantum growth in their retail portfolios in the past few years.

A similar model is yet to be tried out generally by public sector banks, though one has noticed a couple of banks beginning to employ such concepts. The funding base, in terms of the higher proportion of retail deposits, is also much more stable for public sector banks giving them a natural advantage on the pricing front.

If the processes and the technology can be harnessed, retail banking could provide an ideal combination of higher margin businesses (such as credit cards, personal loans) as well as a fair degree of risk diversification on the entire portfolio.

Overall, the evolving economic environment does point to retail accounting for a much higher proportion of the balance sheets of financial intermediaries. The private sector banks seem to be well prepared for this scenario.

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