SAYING YES

Rana Kapoor, CEO, YES Bank: Ambitious plan Is it going to be yes or a no bank? That's the million dollar question that people are asking after the fiasco of another late-entry private bank, GTB, and the latest RBI guideline-limit foreign ownership to just 5 per cent in any Indian bank. Promoted by two Rabo India brass-Ashok Kapur (Chairman of Yes Bank) and Rana Kapoor (CEO of Yes Bank), the bank is also funded by Rabobank (20 per cent) and three other private institutional investors-CVC-Citigroup (New York), Asian Infrastructure Fund (Hong Kong) and ChrysCapital (San Francisco), who hold 25 per cent. With 90 professionals on board, it aims to have 8-10 branches by March 2005. It plans to focus on sunrise sectors such as telecommunications, infrastructure development and agribusiness, and given the UPA government's thrust on rural lending, it could well turn out to be a successful experiment.

There are just too many of them out there. Twenty-seven nationalised or public sector banks, 28 private sector banks-seven new, 21 old-36 foreign banks, more than a thousand urban and rural cooperative banks, 20 financial institutions and thousands of non-banking financial institutions (nbfcs). All chasing the same customers for business.

Just far too many of them. What business sense, for instance, does it make to have over 100 bank branches in Mumbai's business district of Nariman Point or four nationalised branches standing cheek by jowl on D.N. Road in South Mumbai, competing for the same slice of the retail business pie?

Very little, one could argue. Rationalisation is the only way out, and that can only happen through mergers and acquisitions, and takeovers of smaller ones by the bigger ones. And that, fortunately, has started to happen, though initially, for a completely different reason.

Quiet clearly, the first wave of consolidation in the Indian banking system had little to do in terms of achieving global size of funds, becoming internationally competitive or to have the best management practices. Most mergers have happened because of financial distress, such as the amalgamation of Benaras State Bank with Bank of Baroda in 2002, Nedungadi Bank's amalgamation with Punjab National Bank in 2003 or even the most recent, the amalgamation of the loss-making Global Trust Bank with the Oriental Bank of Commerce.

Clear signal

In these takeover cases, the aim of the regulatory authorities was more to send a clear signal to the depositors that their interests would be safeguarded at any cost, and to pre-empt any chance of contagion or a run on the system than to bring about a consolidation within the sector.

PLUM PICKINGS

S.S. Kohli, Chairman, PNB: Happy hunting The days of distress mergers may not be over yet. A major makeover seems to be on the cards in the sector. A new wave of consolidation in the banking sector is likely to be triggered off by the need for capital, achieving global economies of scale and the desire to be competitive in the domestic market. Moreover, with the Reserve Bank of India draft guideline stipulating that all private banks should have a minimum net worth of Rs 300 crore, this implies that old private sector banks with regional presence but little capacity to bring in fresh funds will be attractive takeover targets. And there are a host of smaller banks just ripe for the picking. These include Karnataka Bank, Laxmi Vilas Bank, Citi Union Bank, Dhanalaxmi Bank, Karur Vysya Bank and Bank of Punjab. The Federal Bank and South Indian Bank where ICICI Bank holds 20.44 per cent and 11.25 per cent equity stake as financial investment respectively, have also become attractive options if the RBI guidelines on diversified ownership become a policy.

The mood now is unabashedly in favour of consolidation. Says H.N. Sinor, CEO, Indian Banks Association (IBA): "The consolidation process may have started out of compulsion on account of distressed assets. Going ahead, we could see more market-driven mergers and amalgamations along the lines of that between Times Bank and HDFC Bank in 1999 or the acquisition of Bank of Madura by ICICI Bank." The other more recent merger on July 7, 2004, of IDBI Bank with the parent, IDBI, to become a major commercial bank is clearly a move to acquire both muscle and reach. As M. Damodaran, Chairman, IDBI Bank, explains: "We have started the process of growth. With the focus on development finance, IDBI cannot afford to stay at its current size.''

Damodaran could not have been more categorical. The merged entity, with an asset base of Rs 80,000 crore, will rank the seventh after State Bank of India, ICICI Bank, PNB, Canara Bank, bob and Bank of India, pushing HDFC Bank a notch lower in the process. In terms of total income, the merged entity would rank fourth, but the pecking order by the end of the year is anybody's guess, given Damodaran's declared intent of taking on the leader of the pack, the State Bank of India.

Clearly, cut-throat competition and the need to acquire more financial muscle to fund India's development activity are likely to spark the next powerful wave of consolidation in the banking sector over the next couple of years. Says K.V. Kamath, CEO, ICICI Bank: "Banks will have to play a key role in supporting and sustaining the economic momentum in the country. To do so, banks need to grow in size, probably double their balance sheets in the coming years.''

Agrees IBA's Sinor. "One way to obtain incremental capital is through consolidation.'' That, and the need to scale up operations, will entail some kind of consolidation among the smaller banks in the near future. While bigger players such as SBI, ICICI Bank and HDFC Bank, should have little difficulty in raising funds either in the domestic or overseas markets, given their healthy balance books, the smaller ones could face a problem.

Fragmented Topography

And there are any number of banks in India's fragmented topography (see The Possible Targets), who could find the going tough in the next couple of years. These include Karnataka Bank, Laxmi Vilas Bank, Dhanalaxmi Bank and Karur Vysya Bank. This is borne out by the recent DSP Merrill Lynch report, which shows that nearly 80 banks have a marketshare of less than 2 per cent and that the number two player has a marketshare of just 6 per cent.

SIZE MATTERS

M. Damodaran, Chairman, IDBI Bank: Will the UTI magic rub off? Can you name four or five banks that are likely to emerge as global players? The answers seems obvious enough since it will be the bigger banks in public and private sector that are likely to head the list. Hence banks will necessarily have to have deep pockets, strong brand name and a fine balance between risks and returns. As of today, the banks that look set to emerge as global players are the State Bank of India, ICICI Bank, HDFC Bank and the newly merged entity of IDBI and IDBI Bank. As K.V. Kamath, CEO, ICICI Bank, points out: "Indian banks will need to embark on a quick build up of skill sets, gain in size and substantially upgrade their technological make-up to be able to face competition here and in the global space.''

Then, there are the old private sector banks, most of whom have capital bases ranging between Rs 75 crore and Rs 150 crore, have fragmented widespread ownership, and are too small from an acquisition perspective and unlikely to add value to the acquirer. The only way out for these banks is to become bigger players with enough capital to build up their asset portfolios and thereafter catch the attention of the acquirer.

Not many of the smaller private banks may turn out to be as lucky as their public sector counterparts-the government has pumped more than Rs 21,400 crore into at least 10 of them over the last 12 years-or even the Centurian Bank which got a new life after it was taken over by Bank of Muscat and Sabre Capital last year.

Adds Deepak Gupta, CEO, Kotak Bank: "There is likely to be a lot of play in this direction among the smaller banks following the net interest income model (where banks are dependent on income from spreads between lending and borrowing) or the treasury model.'' Chiefly because both these models are capital intensive and require economies of scale to be sustainable in the long run. The smaller players in this segment are likely to come under pressure and get marginalised because of difficulty in raising cheap deposits and because of their high-risk assets.

Forget global aspirations, even meeting prudential norms or servicing bigger clients will require deep pockets, larger capital and tightening risk management practices. And all that will need huge infusions of capital. As ICICI Bank's Kamath explains: "Indian banks will need to embark on a quick build-up of competencies, gain in size substantially, and upgrade their technological make-up to be able to face competition here and in the global space.''

Even servicing mega corporates could become difficult. For instance, how many banks can hope to finance a hypothetical Rs 1,44,245-crore mega Indian oil major formed out of the merger of ONGC, BPCL, HPCL and GAIL (India). Hence Anando Bhaumik, Vice President, Fitch Rating, observes: "Bankers will need to keep pace with corporates and therefore have to gain in size." Niall Booker, CEO, HSBC in India, too remains pessimistic about these banks' ability to raise funds and fund the country's developmental needs. "With rising interest rates and flat yield curves, public sector banks' ability to generate adequate profit will be impacted. The shortfall, however, can be made good by foreign investment."

THE GREAT CHURN

Rana Talwar, Chairman, Sabre Capital: Playing the saviour The distress amalgamation of the global trust bank with the Oriental Bank of Commerce is a pointer to the increasingly shaky functioning of the banking system in the country. Another distressed entity, the loss-making Centurian Bank, got a new lease of life in 2003, when it was saved by fresh infusion of funds by Bank of Muscat and Sabre Capital. The past 11 years have seen a host of mergers and amalgamations in the banking sector. While mergers such as that of Times Bank with HDFC Bank have been strategy-driven, the same could not be said of others. Whatever the reasons, such mergers have worked wonder for these banks' institutional health. ICICI Bank has already emerged as the country's second largest bank after SBI after its merger with ICICI. Going by past history, the next likely candidates may well be small players like UTI Bank and Bank of Punjab. Want to bet?

Big Dampener

The current RBI draft guidelines, however, could act as a big dampener. If guidelines become a policy, dispersed ownership and limits on inter-bank investment by private and foreign players to 5 per cent could force HSBC to reduce its financial investment in UTI Bank from 14.7 per cent. Several other private banks may have to similarly reduce their stakes in the bank. It could also prevent foreign banks such as ABN Amro, Deutsche Bank or Citibank from making bid for banks with regional presence, and go in for organic growth.

And as far as the public sector banks are concerned, they will continue to remain outside the ambit of M&As. The reasons are simple. While government-owned banks can take over private and foreign ones, the opposite is not true. The combined ceiling of 20 per cent-both in terms of FDI and FII holdings-means that this important financial segment will remain outside the purview of M&A activities.

However, that is no reason why mergers between government banks cannot happen. Industry watchers believe that it makes eminent sense to merge SBI with its subsidiaries or have a merger among two or three mid-tier public sector banks such as PNB, BOB, BOI, Canara Bank and Corporation Bank.

And if the whispers in the North Block are to be believed, the government could well be working on the lines recommended by Narasimham Committee Report of 1991. In all likelihood, that would result in the emergence of three-to-four large banks (including SBI) having a global presence, eight to 10 national banks and a few region specific local banks. Even the IBA has set up a committee to look at various issues and iron out legal and hr hassles in consolidation.

While consolidation may not end all the woes of the small and weak banks, it will at least help them to adjust to the realities of the global markets. Going ahead, big may mean beautiful for the banking sector.