The Hindu Business Line : ‘Outward orientation is the need of the hour’

The Indian Banks’ Association is a voluntary body of 150 banks that functions as a platform for addressing issues concerning the banking industry. Every year, the association conducts its annual conference in association with a host bank. Mr M.B.N. Rao, Chairman and Managing Director of Canara Bank, is the current Chairman of the association. He addresses some of the key challenges that face the banking industry on the eve of this conference.

What are the challenges facing the banking industry on the eve of the migration to Basel II guidelines beginning from March?

Basel-II provides a new approach to risk management practices. It necessitates revamping the entire risk management processes and procedures and adopting new system and procedure.

The important challenges confronting the banking system could be identified and isolated as under:

Internal assessment of risk, valuation of collaterals and aligning the risk processes with market valuation requires up-gradation of human resources and strengthening of MIS.

Board of Directors and Senior Management should assess the risk appetite of the bank and frame suitable risk management policies and processes.

Creating awareness of risks at transaction level/grass root level. Operationalisation of risk policies and processes, institutionalising risk management is the biggest challenge. Bank wide risk management culture must be developed.

Manpower skill set — providing trained and skilled human capital to establish and manage risk management system. Retention of trained personnel is also a challenge.

Technological upgradation. Identification and implementation of suitablesoftware solutions, particularly to adopt advanced approaches of risk management. Scope for "Black-Box" approach while adopting the software solutions.

Historical data build up- Superior MIS supported by high-quality data amenable to detailed technical analysis. An integrated information system which require a lot of historical data to provide foundation for forecasting and building up models in respect of various activities.

Market risk together with the new system of assessment of credit risk and operational risk calls for more provision of capital, optimum utilisation and management of capital, access to capital sources.

Risk sensitivity will be enhanced with the adoption of Basel-II guidelines and further expansion of asset size would be constrained by the availability of capital.

Risk rating of borrowers through external credit rating agencies (ECAIs) to claim capital leverage. Rating penetration is low.

Unworthy/less creditworthy borrowers may remain unrated. Best rated clients may demand better rates which may put on pressure on the margins.

Adoption of risk based pricing. Establishment of risk-reward concepts.

Need to take a comprehensive view of operational risk management. Creating loss data base, evolving risk matrix etc.

Evolving efficient stress testing framework. validation of internalmodels.

Understanding and implementing high standards of corporate governance.

Appropriateness of disclosures and its validation and frequency.

Though implementation of Basel-II would be a challenge for the Indian banks, it provides an opportunity to leverage capital base, improve the risk management practices and enhance the bottomlines by moving from capital adequacy to capital efficiency. Canara Bank has already commenced a parallel run of the new capital adequacy framework under Basel II norm and is inreadiness to make a smooth switchover within the RBI prescribed timeframe.

Do Indian banks, especially the large banks, see opportunities in the global sub-prime meltdown and probably another crisis in the event of an international CDS meltdown?

India is largely insulated from the sub-prime lending crisis.

The financial institutions and investors have, however, been considering the sub-prime crisis as an opportunity to make money by purchasing assets/equities at lower prices.

Many companies, including mutual funds, insurance companies, investment banking, NBFCs etc., in fact purchased assets/equities at very low prices.

While there are opportunities for profit in the sub-prime crisis, it is very difficult to know whether prices of such equities/assets have reached the minimum level, when the market for such equities/assets would revive and the cost of holding equities/assets in the banks’ balance sheet.

Indian banks have stringent regulations for such type of venture and compared to the risk associated with such opportunity, the profit would be meagre and the contagion effect of such risk would have stringent impact on the bank’s balance sheet.

Does such a situation allow domestic banks to make more aggressive forays into the international markets (organic and inorganic) currently dominated by western banks?

It is gratifying to note that Indian companies are gradually acquiring their rightful place in the sun.

But Indian banks’ presence abroad has been limited despite large opportunities available in the wake of globalisation.

The outward orientation, which helped Indian manufacturing companies to emerge world class and size, especially in the post-reforms period, needs to be replicated in the Indian banking sector, particularly with many Indian companies taking recourse to M&As outside.

Indian banking presence in the international markets has so far been confined to only serving domestic trade and non-resident customers. Is there an opportunity for Indian banks to become big players in niche areas such as project finance, where they have acquired considerable experience during the last decade in the domestic markets?

Indian economy and its banking structure have seen moving to its second stage of growth trajectory since last few years.

It is after introduction of financial reforms that truly helped Indian banking sector to experience new growth dimension.

There is an urgent need to sustain this growth trajectory and probably scale up to its next phase of growth to match up to world class and size.

With good dividends being reaped from the competition, Indian banking sector is set to witness growing process of convergence and consolidation.

As Indian companies are growing large with overseas acquisitions, Indian banks are next in the line.

This is well evidenced from the recent spate of overseas expansion plan of many Indian banks. Indian banks are following this trend in encashing opportunities in the emerging economies and also in OECD countries.

Over the last decade, there has been a tremendous increase in inflow of private and public investments to infrastructure sectors and project funding by Indian banks.

The banks in India have been adopting international financial models and practices in funding the PPP projects structured through SPV routes.

In this process, Indian banks have gained substantial experience in evaluating projects and financing techniques of international standards.

Of late, banks are also entering into the area of Foreign Currency Debt Syndication and participating extensively in the opverseas debt raising programmes. India being one of the fastest developing economies attracting huge FDI, many global banks are interested in lending to projects in India and China, primarily owing to better spreads.

This gives opportunities to Indian banks to enter into international debt syndications. We have to look forward to working towards better visibility of our competencies to corporate world abroad so as to instill confidence in them.

This will provide Indian banks the much needed fee-based income. The development of Mumbai as an international financial centre would also be helpful in raising the bar.

What would be the human resource issues challenging the banking sector, especially in this fast changing environment?

Human resource issues challenging the banking sector include recruitment, compensation, evaluation and management (of performance), promotions, managing relations and planning.

It is not bricks or mortar or even fancy interior decoration that makes an institution. But it is the quality of persons who work for it.

This is why, it is necessary for the long-term objective of the individual and the institution to be in harmony, to be insync for sustained growth of both the individual and the institution.

Clearly the issue of human resources management (HRM) has immense contextual significance because of the overarching context of the rapid growth of the Indian economy and the emergence of the banking and financial services sector as a key growth driver.

While different organisations can adopt varying HR practices, a basic requirement is the pursuit of what has sometimes been called as the “Glocalisation” strategy, i.e., pursuing global benchmarks without ever being oblivious of local realities.

Is there a possibility that the focus would change from just net interest margins to a much broader ratio-return on assets. (This ratio is barely 1 per cent for banks as against 5 per cent for global banks)?

The net-interest margins and return on assets are the two widely used yardsticks for measuring profitability. High level of intermediation cost coupled with low technology absorption have been some of the key factors behind low return on assets for Indian banks vis-À-vis their global counterparts.

In the changing banking scenario, wherein most of the banks in India are scaling up their tech-spending and are moving towards implementing core banking solution in full steam and placing other tech-enabled delivery channels, such as Internet and mobile banking, ATMs,etc., there is a manifest need to focus on a much more broader ratio- return on assets.

This requires a paradigm shift from plain vanilla lending to diversified lending to commerce and industry, accent on cross-selling: fee-income, wealth management, bancassurance, mutual funds, capital market,structured products, credit/debit cards, launching of innovative products and enhanced role of fee based income and product innovations and process re-engineering to meet customer requirements, reduce cost, improve efficiency to enhance the return on assets in conformity with global benchmarks.