The Hindu Business Line : Banking towards best practices

Public sector banks in the country are still riding their core strengths, though all this could change once services are further liberalised as per WTO norms. To stay competitive, they will then have to adopt new products and rigorous credit norms that foreign and private sector banks are fostering.

G. Srinivasan

The slow but steady entry of private banks and a limited number of foreign banks in the country in recent years has put the spotlight squarely on the performance of 21 public sector banks, including State Bank of India (SBI), 19 nationalised banks and Industrial Development Bank of India (IDBI).

No doubt, most of the nationalised banks have been doing their best to set up as many automatic teller machines (ATMs) as HDFC Bank, ICICI Bank and Axis Bank have done in far corners of the country in a serious bid to customer needs.

But private and foreign banks have gradually augmented their presence since the 1990s, when their combined share of total assets was less than 10 per cent, to more than 29 per cent today, with an independent research and rating agency estimating that public sector banks have been losing, on average, one per cent of market share a year over a 15-year span.

Given the statutory and other provisions of public sector banks, requiring that the Government should not hold, at any time, less than 55 per cent of the equity capital of SBI and 51 per cent in nationalised banks, the ability of these banks to raise capital for growth without curtailing the government shareholding is severely circumscribed.

Is there any way public sector banks can address the key competitive challenges from private and foreign banks, without altering their character?

A principal constraint for many public sector banks is their ability to modernise by upgrading technological platforms and capabilities through branch computerisation and implementation of core banking solutions.

Public sector banks are also constrained by an archaic human resources structure and an inflexible and often inefficient labour force that is not amenable to any rationalisation move. This has also thwarted their ability to attract talent and compete on equal terms with counterparts in private and foreign banks.

The latest ‘Banking System Outlook’ by rating agency Moody’s Investors Service provides an overview of what ails the banking industry when it states that “computerisation of the huge number of public sector bank branches, networking and carrying out vital business process re-engineering (BPR) are the main issues to be tackled”.

Tackling challenges

It suggests Indian banks need to focus on stepping up fee-based income, as this would be key to improving their quality of earnings and maintaining profitability. This is all the more important in the backdrop of the advent of “anytime, anywhere” banking amenities which have gradually but perceptibly pared down the fees charged by banks for money transfers.

This is further compounded by the several banks’ offer to customers of many of their new technology-related services at no extra fee. Moody’s estimates that in fiscal 2006-07, fees and commissions accounted for just 8.8 per cent of the Indian commercial banks’ total income, while for foreign banks in India this figure was almost double, at 15.2 per cent.

Looking ahead, Moody’s prescription for Indian banks is to offer value-added services in foreign exchange, cash management, bancassurance and mutual funds sales, as well as offering investment banking and advisory functions in a serious bid to ramp up fee-based income.

Distinctive products

Public sector banks in the country ought to take a leaf out of the book of private sector and foreign banks which, despite limited branch networks, can still “attract quality banking business by offering distinctive products and services, including off-balance-sheet funding and hedging instruments, to more sophisticated clientele”.

Presumably because their more flexible nature and sophisticated infrastructure permits them to be more competitive, domestic public sector banks need to shed their strait-jacket approach and acquire some market-savvy characteristics, a pre-requisite for facing competition effectively.

For this purpose, the government, as the majority owner, should come forward to provide some functional autonomy to the boards of these banks if it is unable to shed its equity in the face of strident opposition from entrenched bank employees who do not want to stir out of their cocoons of safety and tenure security till retirement.

Even as different banks are at various stages of honing their risk management techniques, with private sector and foreign banks in the vanguard, it is only recently that some public sector banks have appointed and adopted the concept of a Chief Risk Officer (CRO) overseeing credit, market and operational risks and being independent from routine line management.

This is an area where public sector banks need to act with tact and fast, especially when innovative financing mechanisms have been proliferating that disperse risk to unknown entities, as has been disastrously borne out by the US sub-prime crisis.

Greater autonomy

Moody’s also welcomes a recent decision by the Ministry of Finance to provide a higher degree of autonomy to public sector banks without having to resort to bureaucratic and time-consuming government approval. Public sector banks will now have the option and flexibility to close or merge unviable branches, open overseas offices, set up subsidiaries and take up new businesses as part of their overall strategic direction.

They will also have the elbow room to accord higher remuneration to a ‘specialised cadre’, subject to an overall ceiling for establishment expenditure. How soon these decisions will be translated into action at the individual bank level will largely determine the relative competitive strengths of the Indian banking system in the days to come.

No doubt, Indian banks’ strong deposit franchises are their core competence, bolstering their financial profiles and ratings, as preliminary figures suggest growth of around 22 per cent in customer deposits for all commercial banks in fiscal 2007-08. The public sector banks continue to straddle the country’s banking arena with their core strength of deposits intact, despite the visible inroads by private banks and foreign banks and the gradual opening up of the financial sector to foreign competition. But once the ongoing talks on services trade liberalisation under the WTO umbrella are sealed, they have to get their act together.

The PSBs will eventually have to adopt new products, rigorous credit norms and sophisticated management information systems (MIS) that foreign and private sector banks are fostering, not only to survive but to succeed and lead in the changing financial world.

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