A reason to smile: United Western Bank depositors have got a bailout from IDBI

"To say that the banking industry is undergoing transition or change is an understatement. The pressures of competition are so high that changes now are not limited to interest rates or the margins only. They go much beyond that-to the extent of even redefining the role of banking and the very way of performing it."

This prophetic proclamation made a couple of years ago is of none other than Satish Kashinath Marathe, Chairman & CEO, United Western Bank (UWB). In early September, the ailing UWB was shut down by the Reserve Bank of India, and last fortnight the apex bank decreed that the Satara-headquartered bank would be merged into public sector bank, IDBI. Marathe, a law graduate and a former treasurer of the BJP's Akhil Bhartiya Vidyarthi Parishad, probably didn't envision that it would be UWB that would undergo the "transition" and become a victim of "the pressures of competition". After all, Marathe appeared to have big plans for his bank, which are evident in his concluding observations in the same speech. "UWB is reaching out to customers in their homes, offices and even shops through various delivery channels like ATMs, internet banking, debit cards, kiosks and so on. The bank believes that there is no substitute for personal relationship banking. It's the face behind the technology that will always symbolise the bank."

One would have been tempted to have faith in Marathe's dream for UWB, only if he hadn't quietly exited in July. By then, UWB's net worth had turned negative, and losses piled up to Rs 200 crore-plus. Marathe, who might have well read the writing on the wall, was lucky he could bail out in time. But the bank, its depositors and investors weren't. UWB might be the latest in a string of banks that has gone belly up, but the pattern is such that few CEOs acknowledge the extent of the rot that has set in-until the 11th-and-a-half hour. The question reverberating in corridors of the Rs 36,10,500-crore banking industry today is: After UWB, who? Call it a paradox or a quirk of fate: Even as the financial services sector is witnessing explosive growth in retail as well as in lending to small & medium enterprises (SMEs), with credit growth of 32 per cent comfortably outpacing deposit growth, the universe of old private sector banks (or OPSBS as they are known) is teetering on the brink. Early this year, it was the turn of Ganesh Bank of Kurndwad to be placed under RBI moratorium-the bank was eventually merged into Federal Bank.

"There are compelling reasons for old private sector banks to proactively look for mergers," says Rana Kapoor, Managing Director & CEO of the three-year-old, new-generation private sector bank, yes Bank Ltd. One OPSB that did agree with that line of thinking is the 66-year-old Lord Krishna Bank (LKB), which last month joined hands with Rana Talwar's Centurion Bank as the Kochi-based bank realised the danger in going it alone despite showing a strong turnaround in 2005-06. LKB took the merger decision as its capital adequacy ratio was flirting around the RBI-mandated 9 per cent and its net worth of Rs 164 crore was woefully short of RBI's stipulation.

"There are compelling reasons for old private sector banks to proactively look for mergers" Rana Kapoor Managing Director & CEO, YES Bank

The OPSB Landscape

But such distress and consequent consolidation in the recent past may be just the tip of the sinking OPSB iceberg. A clutch of banks belonging to the old brigade is struggling to come to terms with RBI-set benchmarks on parameters like net non-performing assets (NPAs), profitability, net worth and efficiency (see The RBI's Signposts). Competition from newer and smarter rivals on the block, an inability to mobilise low cost deposits, an inadequate capital base and a high incidence of NPAs are all contributing to the dark clouds hovering over the OPSB landscape. Just one broad indicator: Over half-a-dozen of the OPSBs have net worths that are less than the RBI-stipulated Rs 300 crore. Now take a peek into some individual cases: In 2004-05 (the latest year for which financials are available), Sangli Bank showed a loss of Rs 31 crore, and its net worth was just a sixth of what RBI has mandated. Then consider another Maharashtra-based bank, the Kolhapur-headquartered Ratnakar Bank: Net profit for 2005-06 was a paltry Rs 1 crore, and net worth stood at Rs 54 crore. And at least another three-Catholic Syrian Bank (CSB), Dhanalakshmi Bank and Nainital Bank-are in danger of being cleaned out in the medium term as their net worths are woefully below the apex bank's prescription. "Given the regional presence they have, it's difficult for OPSBs to prosper," says B. Sambamurthy, CEO, Corporation Bank, which was one of the many unsuccessful bidders for UWB.

ICICI Bank Managing Director & CEO K.V. Kamath (right) and Indiabulls Director Gagan Banga were among the 17 unsuccessful bidders for the ailing UWB

There are, it appears, bankers who don't quite agree with this doomsday projection. Why else would Dhanalakshmi Bank go about doling out chunky dividends to shareholders? The Kerala-based bank duly earned RBI's snub-just days after the UWB moratorium-and it was forced to lower its dividend from 7 per cent to 5.25 per cent for 2005-06. The 79-year-old bank's capital adequacy is lower than LKB's (which merged with Centurion Bank of Punjab). Yet another bank that's putting up a brave front is the precariously-perched Ratnakar Bank. Says Chairman & CEO Subhash G. Kutte: "We have taken a decision this week to induct a strategic investor or raise the capital through a rights issue." That may provide a temporary lifeline, but with a net worth of one-sixth of the RBI-stipulated requirement and a capital adequacy barely over 9 per cent, it won't be easy finding investors willing to put their money in the bank.

"We are selling ourselves on the future. Some people will buy our story and some not" Gautam Vir Managing Director & CEO, Development Credit Bank

RBI Diktat

Another bank that's come under close RBI scrutiny is the 70-year-old Development Credit Bank (DCB), which was converted into a private sector bank in the mid-90s from a cooperative bank. The apex bank has directed its promoter to reduce its stake to 10 per cent or below within one year of listing or by March 31, 2007. The promoter, Aga Khan Fund for Economic Development, currently owns over 50 per cent of the bank. DCB has yet to tap the capital market. But with losses of a little under Rs 200 crore piled up over the past three years, investors wouldn't exactly be queuing up for subscription forms. Says Gautam Vir, Managing Director & CEO, DCB: "We don't have a track record. We only had a problematic track record. We are selling ourselves on the future. Some people will buy our story and some not." "As a small bank it's more difficult to raise capital than a bigger bank, but as you get bigger it would become easier," he adds.

HOW IDBI CAME IN FROM THE COLD

In IDBI's fold: Customers at a UWB branch The development financial institution turned bank was probably the last in the list of 17 suitors for the now-defunct United Western Bank (UWB), which included a couple of foreign banks, a handful of public sector banks, a couple of new private sector banks, a curious combination of a housing finance major and a state financial institution, and for good measure a broking firm. But 10 days after the Reserve Bank of India slapped a moratorium on UWB, IDBI Bank Ltd stole the show by offering a 30 per cent premium, at Rs 28 per share, to the shareholders of the Satara-headquartered bank. But it might have not been shareholder interest that convinced the mandarins on Mint Street about the viability of IDBI Bank as a suitor for UWB. What worked in IDBI Bank's favour is its categorical move to take care of UWB's depositors (UWB's deposit base stands at Rs 6,480 crore) without relying on any support from the Deposit Insurance and Credit Guarantee Corporation. Then, the bank did not ask for any regulatory forbearance in terms of relaxation in statutory liquidity ratio, cash reserve ratio, priority sector lending and non-performing assets (NPAs). "Some acquirers did ask for more time to reduce UWB's levels of NPAs," reveals a banking industry source. UWB had net NPAs of 5.66 per cent in 2005-06 as against the generally accepted limit of 3 per cent. RBI also looked at the 'synergy factor' on the branches front, and examined the extent of overlap that existed between UWB's branches and those of its prospective acquirers. IDBI Bank has 195 branches across the country, with just 41 in Maharashtra, so the extent of overlap would be minimal in its case. UBW has 230 branches, almost all of them in Maharashtra. "Also, there was no issue of a culture mismatch as both the banks are based in Maharashtra," adds the source. What might have clinched the matter for IDBI Bank was its willingness to take care of all employees of the loss-making bank; many of the other bidders weren't as generous, considering UWB had a loss per employee of Rs 3.48 lakh. Clearly, going by the RBI rule book, the highest bidder doesn't always get the crown. IDBI Bank for its part may feel a strain on the capital adequacy and NPAs front. According to rating agency CRISIL, the payout of Rs 150 crore will result in a slight decline in IDBI Bank's capital adequacy ratio. "The bank's asset quality is also expected to decline marginally following the addition of UWB's portfolio, which has a weaker asset quality," says CRISIL. UWB's gross NPAs as on March 31, 2006 were at 11.5 per cent compared to 2 per cent for IDBI Bank. "The effectiveness of the integration of UWB's employee base with that of IDBI Ltd will be a key monitorable, going forward," observes CRISIL.

NEW-GEN BANKS: SO FAR, SO GOOD

The old private sector bank (OPSB) brigade may be grappling with its own set of headaches, but the new-generation, well-capitalised and professionally-run private sector banks may have a different kind of problem on their hands-a problem of plenty so to speak. The portfolio of most of these banks is heavily slanted towards retail. For instance, Rana Talwar's Centurion Bank has over 70 per cent of its advances locked in retail. And Kotak Bank has an 87 per cent bias towards retail (see New Lot, New Focus). Says Gautam Vir, Managing Director & CEO, Development Credit Bank: "Concentration of a portfolio in unsecured assets is risky, but if the retail assets are secured there is no cause for alarm." In fact, banks in the past got severely hit because of corporate default rather than retail. But sceptics argue that retail lending has just taken off and a blowout is imminent over the longer term. Rana Kapoor, Managing Director & CEO, YES Bank, which has 70 per cent of its portfolio in corporate banking, says: "We are a new bank. We would eventually look for a balanced portfolio of corporate, SME (small & medium enterprise) and retail." The threat to retail comes from hardening of interest rates and any reversal of economic buoyancy that the Indian economy has seen in the last three years. Krishnan Sitaraman, Head (Financial Sector Ratings), CRISIL, however, says there is no cause for concern if lending is done in a prudent way. The soft belly of the new generation private sector was exposed in 2004-05 when interest rates started inching upwards, resulting in treasury losses to banks. The recent demat scam in the capital market also exposed biggies like HDFC Bank, when the regulators found rampant violations of know-your-client norms. Experts point out that the pressure on these banks could come from stringent capital adequacy norms post Basel-II, and steadily increasing non-performing assets (NPAs) in the retail segment. Yet, when compared with the OSPB bunch, the new-gen cluster appears better placed.

To be sure, each OPSB is struggling to cope with its own set of problems. The 83-year-old Nainital Bank does have a profitable track record, but its capital adequacy is on the decline, dropping from 14.85 per cent in 2004-05 to 13.88 per cent last year. The net worth of Rs 112 crore is also much below the RBI-set limit. Meantime, down south, CSB is reeling under bottom line pressure, with net profits crashing from Rs 37 crore four years ago to Rs 6 crore in 2005-06. And in all these years, the capital adequacy of CSB never crossed the 11.50 per cent-mark. A clear case for consolidation, you would be tempted to venture. Not according to N.R. Achan, Chairman & CEO, CSB, who insists that the bank will continue to maintain its independent identity. "We believe inducting resources (via a merger) alone will not ensure survival. The final survivors would be banks with good corporate governance. In this crowded marketplace, both giants as well as regional banks can co-exist focussing on their niche areas," believes Achan. But the going will be tough. And Achan admits as much. "Maintaining profitability in the long run in a scenario of reduced margins, more stringent capital requirements and tough competition will be a challenge," he shrugs. Adds R.M. Nayak, Chairman & CEO, Lakshmi Vilas Bank (LVB), which had a net profit of Rs 3 crore and a capital adequacy ratio of 10.79 per cent last year: "Efficiency rather than size or type is the determining factor in the continued profitable growth of any bank in the country."

RBI Governor Y.V. Reddy is forcing old private sector banks to meet benchmarks on net NPAs, profitability, net worth and efficiency

It's not as if all OPSBs are staring down the barrel. A number of them, like Karnataka Bank, Tamilnad Mercantile Bank, City Union Bank, South India Bank, ING Vysya Bank and SBI Commercial & International Bank, have done well to withstand the competition and are turning out healthy profits (see ...But Some Healthy Old Private Sector Banks...). And they made sound acquisition targets too. "What we have seen so far is merger of bank in distress or smaller banks tying the knot with bigger banks. We are yet to see merger of two big banks to leverage business synergies," says Krishnan Sitaraman, Head (Financial Sector Ratings), CRISIL Ltd. Of course, banks like UWB and the other troubled OPSBs will come cheaper, and all their problems notwithstanding they bring a lot to the table. Sangli Bank, for instance, is headquartered in the wealthy sugar heartland of Maharashtra, and has a total of 186 branches. CSB has all of 320 branches. In comparison, a new private bank like Kotak Mahindra has just 65 branches nationwide. It's anybody's guess what happens to the IPSB club as interest rates fluctuate more wildly and more often than before, as the rupee slowly but surely moves towards full convertibility, as more and more one-stop financial services powerhouses establish themselves, and once Basel II norms come into play. Yet, the OPSBs, to their credit, are not all dross, and judicious consolidation can result in a win-win scenario for the acquirer as well as the acquired.