When an economy starts slipping, banks are usually the first to feel the heat. Good companies cut back on borrowings because they are investing less in new projects, deposits increase because edgy consumers put off purchases, and the difference between interest paid on deposits and interest received on loans begins to dangerously narrow. Unless, of course, the bank can rein in its own costs. And last year was as tough as they come. (In case you are wondering what explains the fat profits of the banks, let it be told that the profits came more from treasury operations rather than core operations.) Interest rates have fallen from 7 per cent in September 2001 to 6.25 per cent currently, corporate credit offtake went up only by 11.3 per cent to Rs 7,56,300, and every bank (its development institution parent included) wants to go retail.

So what does this year's BT-KPMG Best Banks survey throw up? A deepening of the trend that the survey has painted since it was first launched in 1993. And that is, the rapid rise of private sector banks, struggle among the public sector banks, and fluctuations in the fortunes of foreign private banks. But a mere comparison with the 2000 rankings (no survey was done in 2001) is unlikely to detail the changes in the industry landscape. For one, this year's survey is based on a vastly different, and improved, methodology. There are six broad parameters on which the banks have been scored, and the weightages are biased towards operations, asset and earnings quality-for obvious reasons. In our last survey, we had ranked banks with just one branch separately. This year, that has been done in the case of banks with five or less branches.

Surprisingly though-on second thoughts, not so surprisingly-the universe of the top 10 banks has not changed dramatically. We still have the foreign banks like ABN-Amro, Citibank, and Standard Chartered hogging the top slots, and savvy Indian banks like the private sector's HDFC Bank and the public sector's Corporation Bank jostling for the honours. But let not that fool you.

This year's stricter methodology is making the competition more intense. For instance, previous survey's number one bank, Bank of America, ranks number four on a separate listing of banks with five or less branches. The number two, Citibank, is this year's number four, and gainers include HDFC Bank, which has vaulted from #7 to #2, and ABN-Amro, which moves two notches up right to the top of the list.

You'll find the reasons behind the changing fortunes of the banks to be the same. It boils down to three things: retail thrust, systems and processes for monitoring asset quality, and innovation. Says Aditya Puri, CEO, HDFC Bank: "Growth is not an issue for us, but we are not going blindly for volumes." In fact, it is on asset quality, and that alone, that the future of Indian banks will hinge. And for the public sector banks, the future looks ominous on that count. Take a look at the top 10. What do you see? Just three are public sector banks, although this group accounts for 75 per cent of the industry's asset base of Rs 15,35,513.13 crore. The culprit? Years of mismanagement and inefficiency, which have made them too corpulent to respond swiftly to changing market needs.

Will things change? Certainly, at least at some banks. The State Bank of India (and some other group banks, besides Corporation Bank) seems determined to change things for the better. As SBI's new chairman A.K. Purwar is quoted elsewhere in the issue, he wants to woo the consumers with new product launches, innovations, and faster credit delivery. At Corporation Bank, technology and managerial talent are being combined to give the bank its edge. "A performance-oriented culture is the key to success," says the bank's Chairman and Managing Director, K. Cherian Varghese.

At some others, especially the bottom trawlers, changes will be hard to effect. A big reason: non-performing assets. The stack of this sticky asset has been growing year after year, and especially at public sector banks that have lax appraisal and control systems. The gross non-performing assets for scheduled commercial banks stood at Rs 70,904 crore as on March 31, 2002, compared to Rs 63,741 crore at the end of the previous year. While the NPAs of public sector banks increased marginally during the year despite recoveries, the more efficient foreign banks managed to keep their NPAs under check. Says P.T. Kuppuswamy, Chairman, The Karur Vysya Bank (#9): "Building up low-cost deposit base, high-quality assets, and managing impaired assets are going to be the key challenges for any bank."

Fortunately for the banks, a silver lining is beginning to emerge. The ratio of net NPAs to net advances has fallen from 7.6 per cent to 5.5 per cent in 2002, according to a central bank report.

The reduction has happened partly because the banks, having made higher profits on sale of investments and treasury profits, quickly made higher provisions, thereby cleaning up their balance sheets to some extent. However, as a Fitch Ratings report on Indian banks points out, "gross NPAs will go up further in March 2004, when the NPA recognition norm shifts from 180 days overdue to 90 days". Recoveries, however, are expected to improve with the passing of the new Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest bill, 2002. Says Ashvin Parekh, Executive Director, Deloitte, Haskins & Sells: "Bankers will have to focus on cleaning their balance sheets and bring down their net NPAs to around 1 per cent in the next two to three years."

That may be virtually impossible for weaker banks like Dena, whose non-performing assets as a percentage of net advances stands at a staggering 16 per cent. Also, the weaker banks either do not have the wherewithal to invest in technology or have not started doing so. But technology-like online banking and automated teller machines-will be a crucial differentiator in the retail market.

Mergers, acquisitions and alliances would then emerge as a route to survival. Points out a Fitch ratings report: ''The weaker banks would need to merge entirely or sell some of their network to stronger banks.''

Already, the RBI has directed Punjab National Bank to take over Nedungadi Bank. Next on the regulator's list is Centurion Bank, which could likely be married to Andhra Bank. If the economy doesn't pick up soon enough, the mergers and acquisitions may happen sooner than you expect.

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