Cover Story: The Best Banks and the Worst

THE TOP TEN

I. Bank Of America
ii. IndusInd Bank
iii. Deutsche Bank
iv. ANZ Grindlays Bank
v. Citibank
vi. ABN-Amro Bank
vii. Siam Commercial Bank
viii. HDFC Bank
ix. Global Trust Bank
x. Corporation Bank

Take a bow, Mr Banker. In a year marked by crumbling currencies, market meltdowns, and the onset of a global economic slowdown, you--the bankers who head India's 100 scheduled commercial banks--succeeded in turning your industry into an unlikely haven of stability. Unlikely, because the Indian banks have consistently been rated by international agencies as amongst the most fragile in Asia. But, as the annual BT-KPMG rankings of the Best Banks in 1997-98 reveal, a fragile system has demonstrated a surprising resilience to turmoil--a resilience that defies global banking trends.

It may not last long. But it's real. And, ironically, it has materialised because India's Best Banks have, for long, been operating under conditions similar to those that assailed the world last year. So, while their global counterparts may have been forced to whip off their bowler hats and scratch their heads, the country's bankers simply went about their businesses, which was to embark on the next step in their attempts to cope with the changes unleashed by liberalisation and the need to be competitive.

Consider the backdrop to banking in India, circa 1997-98. Their appetite for funds lost under the onslaught of the slowdown, corporates refused to borrow--even as bank deposits swelled. Compelled to service those burgeoning liabilities, but unable to lend recklessly and allow their Non-Performing Assets (NPAs) to grow, bankers were forced to compete for the handful of safe bets there were among borrowers. Worse, the development financial institutions began muscling in on their turf. The response?

Wisely, the banks chose to use the opportunity to prepare for the future rather than scramble and skirmish for current business. Many of them refocused their activities, seeking clearly-defined identities in terms of services and customer segments. Most of them concentrated on cleaning up their books by paring down their npas. All of them looked inward, freezing costs, improving operational efficiencies, and boosting productivities. In the process, what they gained were just the qualities that enabled them to defy the global current. To be sure, these advantages cannot be gained over and over again. Nor did the fundamental flaws of India's banking system and the banks themselves disappear overnight. But as the sharp contrasts with international trends reveal, the country's bankers, obviously, did something right.

Arun Duggal

The Best Foreign Bank: Bank of America
CEO: Arun Duggal
Total Deposits: Rs 3,860.30 crore
Total Advances: Rs 3844.09 crore
Strategy: Portfolio Quality

The Global Banking Trend-I: An economic downturn combined with wild swings in exchange rates and asset prices usually presages a contraction in banking activity since bad debts pile up and lending activity shrinks.

The Indian Banking contrast-I: In 1997-98, agricultural production shrivelled by 3.70 per cent; export growth slumped to a mere 1.50 per cent; and industrial growth remained sluggish, further extending a protracted industrial slowdown. Rupee volatility spiked upwards as the currency depreciated by more than 12 per cent against the dollar. Yet, gross bank credit grew by 15.90 per cent, up from the 11.70 per cent expansion clocked in 1996-97. At the same time, the net npas consumed a smaller proportion of net advances, falling from 9.18 per cent to 8.69 per cent.

The Global Banking Trend-II: As banking crises erupt around the world with alarming alacrity, capital- and credit-flows dry up, intensifying an already-acute liquidity crunch.

The Indian Banking contrast-II: Bank vaults are brimming over with funds. Drooping capital markets ensured that the bulk of financial savings found its way into bank deposits. Aggregate deposit growth rates zoomed from an already-high 16.50 per cent in 1996-97 to 19.70 per cent in 1997-98, pumping an additional Rs 99,811 crore into bank coffers. In fact, bankers had to cope with the problems posed, not by a lack of funds, but by a lack of profitable deployment avenues for those funds. After all, an industrial slowdown combined with lacklustre capital markets also translates into lower absorption of credit by corporates.

The Global Banking Trend-III: A spreading economic slowdown exacts a heavy toll on bank profitability as income growth slows and provisions for NPAs mount.

The Indian Banking contrast-III: Certainly, income growth has slowed. A 175 to 200 basis points decline in the Prime Lending Rates charged by the scheduled commercial banks over the year has squeezed interest spreads from 3.46 per cent of the total assets in 1996-97 to 2.96 per cent in 1997-98. Yet, although the growth of the largest component of banking income is decelerating, profits continued to surge. The operating profits of the scheduled commercial banks rose to over Rs 14,500 crore in 1997-98--from Rs 12,339 crore in 1996-97--while net profits shot up to Rs 6,500 crore from Rs 4,578.02 crore in the same period, a jump of over 41 per cent. Much of this rise was fuelled by a decline in provisioning expenditure from 1.16 per cent of total assets in 1996-97 to 1.03 per cent this year.

Against this backdrop emerged the year's winners. Ever since its introduction in 1994, the BT Banks' Scoreboard has faithfully tracked the competitive repositioning among the banks as they jostled for survival in an increasingly-deregulated marketspace. It has charted the rapid rise through the ranks of the new private sector banks; it has reflected the fluctuating fortunes of various foreign banks; and it has traced the tumble of the weak public sector banks. Amidst the tumult unleashed by financial sector liberalisation, no single bank has managed to retain its pole position--until now. For the second year in a row, Bank of America remains India's best bank--even as its US parent makes provisions for a staggering $1.40 billion loss in the third quarter of this year. In fact, the identities of the top 3 banks remained unchanged, displaying a remarkable degree of stability in a year of global financial upheaval. Thus, IndusInd Bank and Deutsche Bank retained their No. 2 and No. 3 positions, respectively.

But can the Best Banks, as well as those further down the ranks, continue to weather the gathering financial storm rolling around the globe? Even though it lauds the "impressive performance" of the banking sector, the Mid-Term Review of the Monetary & Credit Policy for 1998-99 keeps re-emphasising the need to further tighten prudential norms. Markets too have remained wary. Over the last 6 months, banking stocks have shed over 50 per cent of their market capitalisation in spite of a healthy profits growth. BT assessed the strategies employed by the banks to boost their bottomlines in order to determine whether today's Best Banks will remain so tomorrow.

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The Best Private Bank: Indusind Bank
MD: K R Maheshwari
Total Deposits: Rs 4273.34 crore
Total Advances: Rs 2450.83 crore
Strategy: Grow Retail Business

With interest rates falling, non-interest income was, unsurprisingly, the fastest-growing component of the banks' total income. Other income grew by 24.41 per cent, more than twice the 10.11 per cent expansion logged by interest income. Confirms Manoch Dangkomen, 35, coo, Siam Commercial Bank (Rank: 7): "In 1997-98, we tried to reduce the fund-base, and focused on non-interest income, as a result of which profitability increased." But there is a catch to such a strategy. Fee-based income activities, like the more traditional sources of fund-based income activities such as lending, also depend heavily on the business cycle. In an economic slowdown, demand for investment banking, brokerage, and other corporate advisory services is bound to drop. So what accounted for the spurt in other income?

First, larger profits on exchange-rate transactions. The gyrations in the foreign exchange markets provided the savvy banks with a host of arbitrage opportunities. Indeed, even though trade-flows were slowing, gross inter-bank turnover in the foreign exchange market rocketed by 39.40 per cent. The biggest gainers from these frenzied trading activities were the foreign banks. Much of the 55.14 per cent growth in other income that propelled ANZ Grindlays up the scoreboard from 27th to 4th position was driven by profits from its currency-trading operations.

The second factor: Windfall gains on the sale of securities. Ironically, when the Reserve Bank of India (RBI) sought to clamp down on such arbitrage opportunities through a series of liquidity-tightening measures in November, 1997, and again in January, 1998, the banks were forced to offload substantial portions of their investment portfolio. But as interest rates had fallen over the year, the value of that portfolio had swelled, allowing the banks to book phenomenally-large gains. Sample some of the returns generated: Bank of America's income from sale of investments grew by 238.70 per cent, Dena Bank's by 782.70 per cent, and Karur Vysya Bank's by 1,073.80 per cent.

The third contributor: Niche capital market opportunities. True, the slump in both the primary and secondary markets has severely curbed investment banking operations. But the innovative banks can still identify profitable pockets of activity. Both IndusInd Bank (Rank: 2) and HDFC Bank (Rank: 8) have built up sizeable depository and custodial services businesses, which enabled them to cash in on the rising trade in dematerialised shares.

The BT Assessment: A rising share of fee income in total bank income is a natural consequence of the process of financial disintermediation. However, a strategy that relies solely on non-interest income growth to buoy profits is a risky bet since other income tends to be a highly-volatile component of earnings. Any way, value-added (read: fee-based) activities will always complement, and not substitute, the core business of intermediation (read: lending).

The best banks' strategy: Increase volumes to compensate for declining interest rate spreads.

The simplest way to soak up excess liquidity is to pump up investment and advances growth even though the returns on both have fallen. Agrees K. Kannan, 58, Chairman, Bank of Baroda (Rank: 30): "Profitability growth in the face of declining margins can be sustained only through increasing volumes." On an average, the banks earned 11.76 per cent on their advances while investments fetched them 11.72 per cent. Although these rates are similar, investments continued to expand at a faster clip, growing by 21.60 per cent as compared to 17.90 per cent for advances.

Surely, investments do have certain inherent advantages. Unlike advances, they are marketable instruments. Which means that a variety of strategic trading options, such as altering the maturity-mix or riding the yield-curve, can be utilised to enhance returns. For instance, aggressive secondary market operations enabled Jammu & Kashmir Bank--which has vaulted up the scoreboard from 43rd to 22nd spot--to generate a 15 per cent yield on its government securities portfolio. Marketability also means liquidity and, hence, a lower risk weight. Government and other approved securities carry a zero-risk tag--which not only skews the risk-return trade-off in their favour, but also minimises the capital contribution required to meet capital adequacy norms.

However, with the RBI's mid-term review requiring the banks to assign a 2.50 per cent market weight to government and other approved securities, expect the banks to increasingly channel investment funds into corporate securities. In fact, the switch is already taking place. Incremental investments in market instruments issued by the corporate sector shot up nearly three-fold from Rs 4,370 crore in 1996-97 to Rs 13,653 crore in 1997-98. Typically, the bulk of these investment-flows is too large, especially by a-grade corporates since they have the most to gain by accessing capital markets directly. True, a high-grade investment profile reduces the risk attached to such portfolios for the banks, but it also leaves the same banks with a riskier subset of borrowers: small and mid-size firms.

And the onus of assessing the credit risk now rests squarely with the banks. With the abolition of the maximum permissible bank finance system of working capital credit and the dismantling of consortium lending arrangements, rigid industry-wide credit norms specified by the regulator can no longer substitute for the individual judgement of the bank. The banks have to know their borrowers. Take the country's best public sector bank, Corporation Bank (Rank: 10), which has leveraged long-standing relationships with small and mid-size corporates to notch up a 42.70 per cent growth in advances. Even more impressive was the fact that volumes growth was not achieved at the expense of asset quality: the ratio of NPAs-to-Advances declined from 3.63 per cent in 1996-97 to 2.93 per cent in 1997-98.

The quantity and quality of corporate lending will, ultimately, depend on the business cycle. Faced with a protracted industrial slowdown, the banks are diversifying into other fund-based activities--notably, retail banking. Says M.S. Verma, 60, Chairman, State Bank of India (Rank: 23): "We are striving to diversify our portfolio by expanding retail activities, including the Gold Accumulation scheme for individuals." One caveat, however: diversification attempts into retail businesses such as mortgages, automobile finance, and personal loans must be backed by a strong branch and infotech network.

Infrastructure finance represents another major diversification opportunity. Concurs Arun Duggal, 52, CEO, Bank of America: "One of the main thrust areas of our bank will be providing finance for power, telecom, and petroleum projects." Indeed, the funds requirement is huge, adding up to Rs 5,40,210 crore over the next 5 years. So, the banks will not have to confront problems posed by a lack of fund-deployment opportunities. But they will have to deal with the problems posed by an asset-liability mismatch. Infrastructure projects take years to generate a steady stream of returns whereas the banks have to pay interest to their depositors every month.

The BT Assessment: A diversified earnings stream, combined with economies of scale, will smoothen out the impact of business cycles on profits. But the banks also need to retain a strategic focus in the midst of all this expansion. Only then will they be able to evolve the management skills and risk-assessment techniques necessary to minimise asset quality problems.