Cover Story: The Best Banks and the Worst, Pg 2

The best banks' strategy: Trim expenditure on provisions and contingencies, thus narrowing the gap between operating profits and net profits.

Expenditure on provisions and contingencies grew by just 4.88 per cent, making it the slowest-growing component of bank expenditure in 1997-98. Three factors account for this deceleration, none of which is likely to be present in 1998-99. The first was a smaller tax-bite. Budget 97 slashed corporate tax rates from 40 to 30 per cent, lowering tax provisioning requirements. Budget 98, however, has maintained tax rates at these levels, limiting the possibility of further tax savings.

Second, lower maturity yields on government securities provided a bonanza for the banks. Not only did it shrink provisioning requirements for the year, it also allowed the banks which had not marked their full investment portfolios to market-- namely, the public sector banks--to write back provisions for depreciation in previous years to the P&I account. Successive monetary policies have hiked the proportion of the bank investment portfolio that is to be marked to market. The current proportion is 60 per cent, but several public sector banks seized the opportunity offered by lower yields to mark their entire investment portfolio to market. Some of the biggest beneficiaries: State Bank of India (total writebacks on account of excess depreciation: Rs 964 crore); Punjab National Bank (Rs 386 crore); Bank of Baroda (Rs 260 crore), and State Bank of Patiala (Rs 97 crore). However, these windfall gains are a one-time event. And with rising inflation exerting upward pressure on nominal interest rates, depreciation provisions are likely to balloon next year.

The third factor: Better recoveries from bad loans. Some of the public sector banks have worked out compromise arrangements with defaulting corporates, which at least provides for a partial recovery of dues. Central Bank of India (Rank: 71), for instance, has been able to reduce the ratio of NPAs-to-Net Advances from 14.40 per cent in 1996-97 to 12.21 per cent in 1997-98 largely because loan loss recoveries grew to Rs 385 crore. The foreign banks also gained--but from long overdue settlements from the Great Indian Securities Scam. An infusion of Rs 12.30 crore helped boost Standard Chartered Bank's rank from 36th to 25th. Even more dramatic was ANZ Grindlays' ascent to 4th place, fuelled, in part, by the Rs 506 crore that it received from the National Housing Bank following a special court ruling.

But the legal infrastructure for the recovery of non-performing loans still does not exist. The functioning of debt recovery tribunals has been hampered considerably by litigation in various high courts. Complains Bank of Baroda's Kannan: "Of the Rs 45,000-crore worth of gross NPAs, over Rs 12,000 crore is locked up in the courts." So, the only solution to the problem of high NPAs is ruthless provisioning. Till date, the banking system has provided for about Rs 20,000 crore, which means it is still stuck with net NPAs worth Rs 25,000 crore. Even that is an underestimate as it does not include advances covered by government guarantees, which have turned sticky. Nor does it include allowances for "evergreening"--the practice of extending fresh advances to defaulting corporates so that the prospective defaulter can make interest payments, thus enabling the asset to escape the non-performing loan tag. Warns K.R. Maheshwari, 60, Managing Director, IndusInd Bank: "npa levels are going to go up for all the banks." And so too will provisions.

The BT Assessment: Six years of provisioning and write-offs have helped enough to restore the health of the banks' balance-sheets. But as regulators tighten income-recognition and asset-classification norms still further, expenditure on provisions and contingencies will burgeon.

The best banks' strategy: Pare down operating expenses through organisational restructuring.

Certainly, the banks are making an all-out effort to rein in cost growth. Points out Harkirat Singh, 46, ceo, Deutsche Bank: "In a year of economic slowdown, aggressive asset expansion will lead to asset quality problems. Therefore, the focus has to be on improving efficiency." As a result of such belt-tightening measures, operating expenses accounted for 2.81 per cent of total assets in 1997-98--down slightly from the 2.91 per cent ratio achieved last year.

Credit slower wage growth for the bulk of this decline. In 1997-98, the wage bill of the scheduled commercial banks rose by just 8.60 per cent due to a near freeze on the number of employees. Indeed, given the strong presence of labour unions and the practice of negotiating industry-wide wage-settlement packages, the heavily-overstaffed public sector banks will have to rely on the process of natural attrition to shrink their bloated workforce. So, future gains in labour productivity will continue to be slow and small.

And other operating expenses are only likely to rise as the process of computerising a sprawling branch network continues. The foreign banks score high on productivity parameters precisely because of large investments in technology. On an average, other operating expenses--which consist mainly of expenditure on capital equipment like computers and technology--account for 16.10 per cent of the total cost for the foreign banks as compared to 7.60 per cent for the public sector banks. Observes R.S. Hugar, 59, Chairman, Corporation Bank: "There must be constant technology upgradation to suit the fast-changing needs of an increasingly-competitive market."

The BT Assessment: Rationalising cost structures is, perhaps, the most effective response to shrinking spreads. But it is an on-going, long-term effort. Therefore, the immediate impact on bank bottomlines will be minimal.

The end of the era of bumper growth profits has already begun. To be sure, the benefits derived from 6 years of calibrated financial sector reforms enabled the Indian banks to resist the drag of both a domestic industrial slowdown and a global financial crisis. But not for long. Warns Bank of America's Duggal: "Banking activity mirrors economic activity. Therefore, if the banking system continues to expand faster than the economy, there will be problems of deteriorating asset quality, increasing market risk, and rising asset-liability mismatches." Those are risks that only the best banks will be able to conquer. More than individual acumen or strategic judgement, it is the systems--practices that cannot be deviated from--that a bank uses in a high-risk environment that will enable it to survive the coming contraction. Nothing else can the banks really bank on.

Indian Banking: Time for a Renewal

Indian bankers today have innumerable challenges: worrying levels of Non-Performing Assets (NPAs), stricter prudential norms, new and expanded risks, and questions like, "Do we need to be bigger? Stronger?" Those questions are hard to answer. Simultaneously, the banks face a task that is less tangible but no less difficult. In search of that elusive competitive edge, they must re-invent themselves. It's time for a renewal in Indian banking.

Indian banking today is in the grip of profound structural changes--deep, wrenching, but exciting. The big by-product of liberalisation is increased choice, not just for customers, but also for the banks. New businesses, new customers, and new products beckon, but bring increased risks and competition. How might that change banks? Look around the world.

The age of global mega-mergers in banking is here. Earlier this year, Citicorp and Travelers Group announced a merger that would create a giant with $700 billion in assets, followed by a $570-billion merger announcement from NationsBank Corp. and BankAmerica Corp.. On a much smaller scale, the same imperatives of lowering costs, increasing efficiency, and gaining clout will, eventually, drive mergers in Indian banking. Then there's competition. In many a market, non-banks have already eroded traditional bank franchises. Depositors, and corporate and retail borrowers all have other options today. In the US, for instance, the share of the commercial banks in household assets fell from 90 per cent in 1980 to 55 per cent at the end of 1997, while mutual funds raised their share from 10 per cent to 44 per cent. In the same period, the banks' share of business credit fell from about 50 to 35 per cent. Their share of consumer credit was an even smaller 28 per cent while the non-banks held the remaining 72 per cent. Indian bankers rightly expect that their monopoly in these areas will also decline.

Today, the banks have to compete with their peers as well as with other financial companies. But tomorrow, competitors might zoom in from completely unexpected industries, as deregulation and new technology blur old boundaries, rewriting the conventional definition of a bank. In New Zealand, for instance, the government has considered various deregulations; so, public utilities like telephone companies might hold interest-bearing balances for customers, who could use them to pay other merchants. With the rise of the Internet, players like Microsoft, with access to millions of households, are racing to position themselves as new intermediaries, selling everything from cars to mutual funds. By some estimates, on-line sales of financial services, including those by the banks, will grow from $1.20 billion in 1997 to $5 billion in 2001.

It's not all gloom and doom for the banks, though. Those forces offer as many opportunities as threats. The banks themselves are using technology to reach out to customers in new ways, including deregulation, to offer new products and services. In all that, individual initiative rather than an ability to blindly follow the manual will be the key. Because, to succeed, or even survive, the banks must anticipate change, recognise opportunities, and manage risks.

There is already early evidence of that in India. Look at bank results for 1997-98, and it is the diversity of performance that will strike you, especially at the public sector banks. When they began their clean-up in 1992, it was also a chance to start over, because they could openly declare loan losses, and the government gave them fresh capital and the breathing space to recover. Some used that wisely, and one group of banks has moved ahead, with healthy balance-sheets and bright futures. But others have not profited from the new start, and still lag behind with high NPAs and a worrying weakness in competitiveness. So, there is a clear differentiation between the banks already. This gap is set to widen, especially since the government has begun divesting its stake in some public sector banks. The effect is mainly psychological because the government's stake is still well above 51 per cent. Nevertheless, these banks are suddenly speaking the new language of shareholder value, profitability, and commercial considerations.

What does true renewal entail? To prosper, the banks need focused managements to map a clear direction, and trained and committed staff to get there. For instance, take Citibank worldwide. While it always had a retail presence, the bank's global consumer banking thrust is only 2 decades old. Achieving its present success meant a big overhaul, from the top management that wrote the strategy to the last phone banker who linked the bank to the customer. At the other end of the spectrum, take Bangladesh's Grameen Bank, everybody's favourite development banking success story. It has an impeccable record of lending to sectors that other banks dismiss as unviable, yet ensuring enviably-high recovery rates. It is the bank's employees, criss-crossing the countryside, who have implemented its blueprint for sustainable small credit.

Renewal has 4 main planks. First, the banks must chalk out a strategic direction, driven by understanding and anticipating customer-needs. The banks must be clear where they want to be, both in markets and in customers' minds. Do they want to be in wholesale or retail? Should they aim for high-end customers or go for the mass market? Are there businesses where they can't compete effectively? Would an alliance, even with a competitor, offer better value to the consumer? If strategy provides a destination and a roadmap, operations provide a roadworthy vehicle. To attract and retain customers, the banks need to optimise their networks, speed up decision-making, cut down on bureaucratic layers, and sharpen response times. The banks have a real opportunity to reap benefits by rebuilding their business processes. For instance, the process of appraising borrowers and disbursing credit can be cut from months to days. The fuel for strategic and operational changes will come from infotech, which is a great enabler. Infotech can do more than ensure greater efficiency. It can also help the banks change the way they do business. For instance, data warehousing and mining can help a bank understand who its most profitable customers are, and then adopt different marketing strategies for them. Infotech can also help the banks to understand and manage risks.

But none of that will be effective without the fourth leg of the renewal platform: people and change-management. The Herculean challenge is to translate a vision into a language that 1.30 million employees can understand, and then equip them with new skills. The banks will have to galvanise the mass of their employees, communicate tirelessly with them, and invest in training. The banking industry has a huge network of training institutes, but courses and trainers are often outdated or inappropriate. Converting these institutes into true factories of change would give the banks a big edge. Cynics might say that bank employees don't want change. But that would be a short-sighted view. For example, when Bank of Maharashtra was striving to erase its losses, the bank's employees deferred their own monetary benefits to help bring the bank back to health. And when the public sector banks went public in a poor capital market, their employees rallied round to ensure substantial retail collections.

Finally, a somewhat-nostalgic reminder: there is no dearth of initiative in the banking industry. After nationalisation, bankers accompanied and often led the push for development, going out into uncharted territory to establish branches in every backwater of the country. Perhaps it is time for Indian banking to rediscover some of that spirit, in a new interpretation for our times.

The author is MD (Consulting), KPMG Peat Marwick