Interesting times for financial services

The last year was eventful for the financial services industry; 2017 is expected to surpass that.

Over the years we have seen new sectors gaining prominence, be it microfinance, gold finance or small finance banks. Insurance, and in particular general insurance, is the new sector in focus. Over the last 2-3 years, the life insurance space has seen consolidation, IPOs, exit of domestic/foreign JV partners and more. As the gap between the top 5-7 players and the rest increases, we will see further consolidation.

General insurance companies are expected to follow a similar path. We are already seeing the initial signs of such JV restructuring with increasing interest from private equity players. Typically, in any new sector, the leaders tap the public markets and create a benchmark. In life insurance, we saw HDFC Life and ICICI Prudential Life taking that path. In the general insurance sector, the Government has already taken the lead to list five PSU general insurance companies, with GIC Re and New India Assurance likely to hit the public markets in FY18. Private players are not far behind.

An interesting characteristic in the current scenario is the strong investor conviction across diversified segments of financial services, unlike in the past when investors largely focused on the lending businesses. In addition to life and general insurance, there is a high level of interest in asset management and stock exchanges. The BSE has already listed with a strong investor response in the IPO. UTI AMC is likely to tap the capital markets and, like any emerging sector, we may see asset management leaders choosing to go public.

NBFCs are going through an interesting phase post demonetisation. Good monsoons in 2016 triggered expectations of high growth and improved asset quality. Demonetisation has, however, been a dampener leading to lower disbursements and uncertainty on recoveries. We will have to wait for 2-3 months to understand the true impact. More importantly, some of these lending institutions may have to change their lending models as the business models of their customers undergo a change. For example, some NBFCs based their lending model on providing credit considering a customer’s formal and informal income, which is expected to change post demonetisation. GST and lower tax rates as announced in the Budget for MSMEs may further incentivise business through formal channels. This not only impacts the credit appraisal systems at NBFCs, it could also lead to new competition from banks. It will be worthwhile to see how these NBFCs maintain their standing by creating an alternate niche.

Small Finance Banks (SFBs) are the new competition to the old private sector banks, PSBs, NBFCs and cooperative banks. SFBs could make some of these entities redundant by focusing on technology, efficiency, thought leadership in financial inclusion and product innovation. Some of the larger SFBs could potentially become universal banks and even suitors for some of the old private sector banks and/or microfinance institutions (MFIs). Many SFBs and new licensees of universal banks may get listed in the next couple of years considering the RBI requirements for listing.

We have already seen significant interest from strategic players in the microfinance segment. MFIs have been acquired by players such as IDFC and IIFL, among others. Some of the smaller MFIs could be the target of mid-sized banks as that would ensure a commercially viable model to tap the lower end of the population and increase the reach in semi-urban and rural geographies.

Finally, we expect PSBs to refocus their efforts on asset quality. They are already showing an improving trajectory in GNPA numbers and strong treasury gains in the next couple of quarters will help matters further. Additionally, many PSBs may tap the capital markets, preferably through a rights issue, to strengthen their balance sheets and clean up stressed assets. Some of the old private sector banks such as Karnataka Bank and South Indian Bank are already raising funds through rights issues. A cleaned up balance sheet has better receptivity from new investors who are eager to invest for growth capital rather than for cleansing balance sheets.

Add to this, the rapid strides in digital transformation and 2017 will prove to be a fascinating year for the financial services industry.

The writer is head of Financial Services Practice, Kotak Investment Banking. The views are personal

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