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SONALI SINHA, ASSOCIATE DIRECTOR, ERNST & YOUNG.

Incomes have risen and so have lending rates. This has affected the borrower’s repayment capacity and today many banks are ‘less’ inclined to dole out consumer loans as quickly as they did earlier. Are banks facing the heat? “Customer leverage has also gone up in both the retail and corporate segments, and there is increasing vulnerability to further rises in interest rates given the inflationary situation and the pressure on margins,” says < em style="b">Ms Sonali Sinha, Associate Director, Transaction Advisory Services, Ernst & Young.

While terming it India’s own sub-prime would be going overboard, the fact remains that Indian banks like all other financial institutions are also vulnerable. When Business Line asked Ms Sinha about the outlook for the Indian banking sector in the current context, she seemed to believe that banks are better capitalised now and, hence, have a greater ability to absorb credit losses. She also shares over the email her opinion on the financial sector, especially banks, insurance companies, non-banking financial companies (NBFCs) and mutual funds. Read on…

Excerpts from the interaction:

What is the outlook for the banking sector in India given the current global scenario?

Overall, Indian banks will continue to benefit from the growth opportunities in the economy given their dominant status as financial intermediaries. However, the greater share of consumer lending, including unsecured loans, provided by the private sector banks has resulted in increasing stress on the banks’ asset quality and profitability.

Gross non-performing assets (NPAs), which had been declining consistently since the late 1990s, have started to pick up again. The rising interest rates have affected the borrowers’ repayment capacity, especially in the consumer loans. Customer leverage has also gone up in both the retail and corporate segments and there is increasing vulnerability to further rises in interest rates given the inflationary situation and the pressure on margins.

Is there a silver lining?

Yes. On the positive side, the banks are better capitalised now and hence have a greater ability to absorb credit losses. Banks have been raising capital in both the domestic and international markets and the reported capital adequacy ratio was comfortable at 12.36 per cent for March 2007. Notably, the private sector banks have had greater flexibility to raise capital compared to the public sector banks, given the minimum government holding prescribed at 51 per cent for nationalised banks.

The sub-prime crisis, which has impacted a limited number of banks that had some exposure to such assets, has had a larger impact on the banking system in terms of the resultant widening of the credit spreads and hampering the plans of banks to issue hybrid Tier I and Tier II capital in the international markets. In such a scenario, the ability to raise capital to support growth would emerge as a key differentiator.

Are Indian banks poised for a consolidation?

The need for fresh equity will persist as the loan growth rate is expected to continue to outstrip the internal capital generation ratio by a fairly wide margin. The introduction of the Basel II norms would also result in additional capital charges for operational risk, which may get balanced to some extent by possibly lower charges for credit risk under the standardised approach.

Given the lull in the equity market, we might see more of preferential allotment of equity to private equity and institutional investors. Another trend which is evident is the process of consolidation, especially the voluntary mergers among private sector banks. However, consolidation among public sector banks is yet to take off given the concerns on integration issues.

Do you foresee increased M&A activity as an outcome of the proposed relaxation in 2009 for foreign banks?

As per the roadmap for presence of foreign banks in India issued by the RBI on February 28, 2005, foreign banks were to be allowed, on a case to case basis, to acquire controlling stake in a phased manner in a weak private sector bank in the first phase (till March 2009). They could also open a wholly-owned subsidiary which would be treated at par with the branch operations of foreign banks operating in India.

In the second phase starting from April 2009, it was proposed that there would be further liberalisation based on a review of the experience in the first phase. The roadmap envisaged that in this phase, foreign banks may be allowed to acquire stakes in any private sector bank within the FDI limit, subject to approval. However, given the rather limited liberalisation in the first phase itself, we do not expect major liberalisation during 2009.

Let’s talk about the mutual fund industry. Where do you see it going?

The Indian mutual fund industry has grown at a rapid pace over the last few years buoyed by the bullish equity markets, higher profitability of corporates fuelling the growth in liquid and debt schemes, assets under management (AUM), and higher retail penetration.

Fuelled by the investment, retirement, and insurance needs of the increasingly affluent Indian consumers, the sector has grown at a rate of more than 40 per cent annually for the past four years during March 2004-08. The asset management industry is anticipated to account for around 40 per cent of the GDP by 2014, up from the existing 10 per cent levels.

Why is the Indian asset management industry attracting so many eyeballs, especially from foreign players?

The asset management industry is expected to maintain its growth trajectory backed by the introduction of new products such as real estate funds, reliance on new and innovative distribution channels, and tapping of new investors. The attractiveness of this sector can be judged by the number of new players, both domestic and international, looking to enter the market.

A large number of global asset management players have already entered the market through joint ventures or on their own. However, the market is very competitive. High churn rates and the low fees resulting from strong competition have made it hard to turn a profit. Building a strong brand and an efficient distribution system are the key to building sustainable franchises over the longer term.

This is the main driver for several of the large banks and brokerage players to explore entry into this business as a joint venture with foreign partners. Some of the recent transactions such as the Canara Robeco deal and the Stanchart IDFC deal have shown that the transaction multiples are inching up.

What is the overall view of transaction activity in the financial services market?

To quickly summarise across various segments, we expect the consolidation process to continue in the banking sector along with a fair amount of fund-raising activity. The mutual fund and insurance sectors will see more of greenfield joint ventures. M&A activity will continue in the NBFC sector as more and more foreign players enter the market; and on the brokerage side we expect to see some consolidation.

Overall, the attractiveness of the financial services sector will remain high as it is a proxy for economic growth.

D. MURALI

KUMAR SHANKAR ROY

More Stories on : Interview | Credit Market | Account Speak | Non-Performing Assets

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