f o r    m a n a g i n g    t o m o r r o w
FEB. 25, 2007
 Cover Story
 BT Special
 Back of the Book

Trading with ASEAN
In the recent Indo-ASEAN summit, ASEAN was, for the first time, on the defensive. India has agreed to bring down its negative list of imports to 490 items in the free trade agreement with the 10 ASEAN nations. But India’s step towards free trade was not matched by the ASEAN nations, as more than 1,000 items still figure in the negative list of the ASEAN. In 2005-06, India’s total trade with ASEAN was at $22 billion (Rs 99,000 crore), against just $7 billion (Rs 31,500 crore) in 2000-01.

Exchange Deal
Indian markets are on a roll. Global stock exchanges and financial institutions’ interest in the Indian stock exchanges goes to show the long-term growth potential of India Inc. The year has started on a positive note. The NYSE and three global financial institutions have each picked up a 5 per cent stake in the NSE. The deal will open exciting vistas in global co-operation for the NSE, and at the same time could improve the fortune of smaller exchanges in the country.
More Net Specials
Business Today,  February 11, 2007
Best Banks in 2010 A Look Ahead
With the economy surging and business going global, India's best banks will need not just world class size but new skills and operational efficiencies to remain competitive.
Sanjay Aggarwal (R), Head, Financial Services and Ravi Trivedy, Executive Director, Advisory Services, KPMG
Soothsayers in times gone by had a much easier task than those plying their art today. Even as late as, say, 1990, the world was round, slow moving and changes were easier to predict. At the start of 2007, the world has nearly become flat, the pace of change is dramatic and soothsaying requires great courage. In nature, the chaos theory states that the fluttering of a butterfly's wings in the Amazon basin can cause typhoons in the Indian Ocean. Much in the same manner, in today's inter-connected world, the hiring of one Indian software engineer in Bangalore can have a direct impact on the working of a production plant in the us, a sub-assembly plant in Brazil, a distribution hub in Korea or an end-consumer in Finland.

India's Rightful Place in the Global Economy - Marching Ahead

Unless there is an unpredictable global event which has an impact on the state of many nations, this pace of change is likely to continue. In India, the building up of infrastructure-massive power projects, many more kilometres of highways, rapidly increasing telecom, broadband and media penetration, continuing demand of connectivity-enabled back-office services, development of commercial and residential real estate, privatisation of transportation infrastructure-will fuel the next decade of growth. The good news does not stop here. The long-term strengths of the Indian corporate and SME sectors-innovative, hungry and not dependent on the Government or bureaucracy for their future-will sustain India's competitive growth through a combination of rising exports and greater efficiency. The rapidly expanding services sector, which now contributes over 50 per cent of India's GDP (up from roughly 20 per cent in the early 70's), will continue to impress, as it caters to the unfulfilled needs of a vast majority of Indians. The traditional agriculture sector will also aim for higher growth, driven by a slew of government policies, coupled with the economically viable models being implemented by private companies.

The broad-based consensus among political parties on economic policy will ensure that this growth continues irrespective of which coalition Government is in power. While everyone envisages a few hiccups along the way due to appeasement policies or the slowing down of certain initiatives due to coalition politics, the broad consensus is that we are too far down the path to make any dramatic U-turns. India has chosen globalisation over protectionism and this decision is unlikely to be reversed. Based on these projections, we have decided to only build on an optimistic scenario, rather than build alternate scenarios of flattening or stagnation of the growth engine.

Assessing the Risks

While we have decided to only take an optimistic scenario, it would be inappropriate to ignore potential risks. We need to recognise the predictable (trends based) major risks that the global and Indian economy must be able to overcome to sustain this growth rate. These risks, ranging from the impact of global warming, rising costs of combating terrorism, high oil prices, impact of demographics (and related healthcare/pensions costs)-could potentially derail some parts of the world economy. For India, additional risks such as galloping inflation due to an overheated economy, lack of speed in building up infrastructure, social unrest linked to the increasing gap between the 'haves' and 'have-nots', and the instability on our borders, could create blips, which would need adjustments to our monetary, social or foreign policies. However, in our optimistic scenario, we predict that the impact of these risks will be contained, and managed effectively by the government, and will not create major speed-bumps in the way of sustained growth.

Banking - Keeping Pace or Driving New Growth?

The banking industry exemplifies the cutting edge of this rapid pace of change. The direct and consequential impact of Enron was felt by banks across the world. The Sarbanes-Oxley Act that emerged in the wake of Enron, has banks in China, India and other developing nations struggling to manage global accounting norms. Cross-border deals, global hedge funds, sub-second forex arbitrage and funding of multi-billion dollar global IPOs are the order of the day, with the most aggressive banks assessing and taking risks far beyond their operating borders or traditional banking roles.

To drive these massive changes, and to manage the potential risks, India needs a much stronger banking sector-bigger banks which are able to undertake greater risks, become globally active, raising and managing capital from around the world, while being highly efficient-to service all parts of the population through a low-cost model.

The 'Best Banks' in India, in 2010, will need to start creating and implementing strategies in 2007 to seize the future opportunities for expansion. These banks will tie their future valuations to the growth models they will envision and action during the next two years. In view of the threat imposed by the proposed opening up of the market to global competition, these banks will grow organically and through acquisitions-to a size and efficiency that will enable them to take on other global banks of significant size and scale.

The characteristics of the 'Best Banks in 2010' must be viewed in the context of global factors. As a part of this future gazing, we will also attempt to assess potential political, economic or social risks that might impact the performance of the banking sector in India. We will try to build two scenarios, which will evaluate the opportunities and threats that emerge, due to these risks.

Global Forecast Scenarios for 2010 and Potential Impacts on Banking

Most economists that study the patterns of the global economy are warning of a slowdown in the US economy over the next few years. While this is counter-balanced to a certain degree against the growth of the BRIC (Brazil, Russia, India and China) economies and an upturn in the Japanese economy, any slackness in the US economy generally triggers a global slowdown. The best global banks would have already hedged their business and profit models against such risks through rapid global expansion-more specifically into the BRIC economies. The rising incomes from operations in these economies will more than likely compensate for the slower growth in the US.

The larger universal banks will continue to thrive by spreading their risks and deployable capital across a portfolio of businesses, especially retail and investment banking. Organic growth for these banks will continue to take place through regional expansion, as permitted by regulatory authorities. Most will, however, seek to grow inorganically, through country-specific acquisitions, to rapidly acquire local presence through an existing set of customers, a reasonably sized business, and most importantly, local knowledge and capabilities. These banks will then leverage their global competencies to scale up operations and target the latent demand for value-added services, on a fee-based model.

The 'Best Banks' would also have built highly cost-effective operations structures through a combination of increased outsourcing of back-office operations to their own offshore captive units and reducing their it costs though a mix of lower cost solutions and long-term outsourcing deals. A set of specialist banks, with deep focus on specific segments or products, will also thrive-with new business models created out of loosely coupled alliances of "best-of-breed" value propositions.

The Elephant Gathers Momentum - India's Macro-economic Outlook for 2010

India is expected to witness 8.5 per cent to 9.5 per cent CAGR GDP growth for the decade leading up to 2010-led by the services sectors, with strong support from the manufacturing sector. With fiscal controls in place, the economy, while thriving, should not have over-heated.

FDI inflows are expected to continue to fuel growth in many sectors especially retail, financial services and all areas of infrastructure. This FDI influx will allow these sectors to scale to globally efficient levels, and given growing demand due to per capita under-penetration, should deliver massive returns to investors (as has been witnessed in the telecom business).

SME growth is likely to aid growth in the manufacturing sector. While the largest manufacturers may increasingly globalise through acquisitions and probably sacrifice short-term profitability, the huge SME base in India is expected to unleash itself through better credit or FDI inputs, technology up-gradation, better distribution and integration with global supply chains.

With renewed focus on agriculture through government policy, private sector interest in the agri supply-chain infrastructure and strengthening of agricultural credit, the sector is expected to show better results, thus enabling all round growth.

To hedge against the us economy's slowdown, India's trade is likely to increase with China, Western Europe and south-east Asia/Japan. The slowdown is potentially a double-edged sword-while a rising rupee against the dollar might impact our exports, a slowdown in the us economy may result in other benefits such a larger push to outsource jobs to India and increase in the inflow of investment funds.

The demographic landscape (with roughly 50 per cent of Indians below 25 years of age) is expected to present new opportunities and challenges. This group has been characterised as better earning, with a propensity for higher spending and less focused on saving. While this trend would augur well for all sectors of industry, it would further necessitate a review of fiscal policies and strategies for managing the balance between credit off-take and deposit growth.

Although 2009 will be the year for parliamentary elections, all sides of the political spectrum will be expected to promise to continue with the economic reforms programme.

Indian Banking 2010 - Systemic Strengthening through Consolidation and De-control

The banking industry will most likely see dramatic changes between 2007 and 2009. The Government, with a plan to spend over $350 billion on infrastructure, will need to prevail on the RBI to open the doors to allow global banks entry, partly to help in funding this growth and partly to strengthen the system. Capital account convertibility, integrated pan-India payment systems, and synergies with the growth in capital markets and insurance, would be among the many expected systemic changes that would fundamentally re-shape the dynamics of the banking industry.

Consolidation is expected to take place among the public sector banks, resulting in the formation of six or seven large banks. These consolidated banks would shore up their balance sheets and would be better positioned to allocate risk capital under the Basel II capital adequacy norms. This consolidation would further improve the risk profile of the banking industry and the Indian economy, by substantially reducing the threats of weak bank failures and better corporate governance. These larger banks would be better positioned to undertake larger risks and would be able to ensure higher shareholder returns, subject to them re-vitalising their human resource management models and efficiently managing merger-linked issues. If this does not happen, the consolidation exercise and post-merger value creation is expected to remain a major risk.

It is highly unlikely that any of these consolidated banks will enter the league of the Top 50 global banks in terms of asset base by 2010, but the leaders would have charted out aggressive acquisition-led growth paths to gain a meaningful size. Until then, the Indian corporate world, as well as large infrastructure builders would have to continue to raise funds through lead global banks or overseas consortiums. The leading Indian banks are expected to continue to go global by opening up additional overseas branches that allow them to be a part of these consortiums.

To improve competitiveness in relation to global banks, the Government would need to dilute its stake to below majority shareholding in public sector banks. This would ideally be achieved through a combination of sale of large stakes to the Indian private sector and/or global banks, and through public sell-offs. While RBI policies are expected to ensure that all banks comply with socialistic banking and priority sector norms, these banks would be able to freely define new growth strategies-capital deployment, global branch expansion, new product introduction to enhance fee-based income and stronger control over risks.

The RBI might allow large corporate houses with a proven track record of good governance to convert their Non-Banking Financial Companies (NBFCs) into banks. These banks could bring in major global banks as strategic partners (much like the earlier developments in the insurance industry) and further strengthen the sector.

Additional strictures and tighter control of the regulatory framework are expected to fortify the system by reducing the number of weak cooperative banks and small NBFCs. These small players would most likely be forced to merge with stronger private, foreign and public sector banks, as compliance with capital adequacy norms is expected to be a severe challenge. While market forces are likely to ensure that the shareholders of these banks get a fair deal, customers would have to be managed carefully during the transition.

Banks with better control over their risk assessment are likely to aggressively expand their portfolios by buying distressed assets from the public sector and smaller/weaker banks. These assets would probably be available at deep discounts-but would hold a good promise of returns, driven by better management of the recovery process and availability of better structured offerings.

The combination of consolidation and entry of more private and foreign banks would ideally result in far greater penetration of financial services in India-with banks taking competitive positions by product, market or customer segments. Large universal banks would thrive, driven by size, diversity in their product portfolios, enhanced capacity to underwrite larger risks and pan-India service networks. Niche or focussed banks would need to build value propositions for specific customer segments, driven by high-quality skills and deep understanding of customer needs.

Together these banks could create a stronger ecosystem, which would be extremely critical to sustain a strong foundation for the India growth story.

The Best Banks in India in 2010 - Strategically Focussed to be the Best

The "Best Banks in India in 2010" will not be the best by chance nor will their position be guaranteed by size or P-E (Price-Earnings) multiples on the stock markets. The "Best Banks in India in 2010" will have reached leadership positions by demonstrating resilience, flexibility and focussed strategic intent, as measured by key performance indicators.

These indicators would eventually add up to the three elements that make up shareholder value-return on equity, growth and brand value.

Underlying these three results would be a slew of metrics that would measure both market facing and internal strengths. While banks would still be measured by quantitative assessments, parameters such as brand value would also be assessed. KPMG has developed a "Value Assessment Framework for Banks" which defines the end business results, the underlying drivers and some examples of metrics which will be used to measure results.

KPMG has also developed a view on the performance that is likely to be demonstrated by the 'Best Banks' across a few key metrics.

Revenue Growth vs Cost-to-Income ratio

Revenue growth and the impact on a bank's cost-to-income ratio is one of the critical ratios that will matter. Banks that grow with a fiscally responsible strategy will be rewarded more than banks that grow tactically or with a short-term opportunistic vision. The next few years will most likely see banks struggling to control this ratio. It is expected that costs related to growth initiatives such as increase in global operations, deeper retail lending penetration and post-merger integration efforts, will escalate at a faster pace than the initial income flow from these initiatives.

Revenue Growth vs Operating Profit Growth

The Best Banks will strategically manage both the challenges of high revenue growth and increased operating profits. The challenge, in the Indian context, will be to demonstrate this growth in a time of rapidly changing scenarios. With the likely easing of capital deployment norms, better quality asset portfolios through managed risk and securitisation, and the expectation of higher revenues in a booming economy, the Best Banks would ideally be in a position to increase their operating profits.

Cost-to-Income ratios vs Return on Assets

The best global banks are constantly focussed on ensuring that they get the best returns on their assets-however, many banks do this at a very high cost. In 2010, as today, the market is expected to value higher those banks that manage to get best ROA at low cost-to-income ratios.

Cost/Asset vs Revenue/Asset

Banks that are unable to manage their costs for creating assets will always be undervalued, even if the revenue generated by these assets is higher. The 'Best Banks' of the future will manage this through better fiscal management and innovation of the asset creation process.

Productivity and Efficiency

These standard measures of revenue per channel and employee will be essential to understand internal efficiencies and optimised operating models. For large Indian banks, these measures would also reflect the results of any organisational transformation effort. The Best Banks would be constantly striving to improve these parameters through better customer segmentation, optimised delivery for each segment and aggressive selling programmes.

Return to Shareholders

The ultimate test for India's Best Banks would be the return they provide to shareholders-either as they dilute original promoter stakes to global entrants or as the valuation received at the time of consolidation. In the past, superior market valuation was seen as the outcome of good business operations and the resulting profitability. In today's times and very likely in the future, strategies would need to be specifically developed and implemented to create greater market value.


The "Best Banks in India in 2010" are not going to achieve this position by chance. Given the backdrop of the opportunities and challenges thrown up by India's growth and other global mega-trends, these banks will surely develop and execute strategies that will allow them to be globally competitive.

While these banks may not end up being the biggest or the most profitable in 2010, they would most certainly demonstrate leadership in profitable growth. They are expected to grow at par with their global counterparts by successfully broadening their local and global reach, managing deeper and innovative penetration into their target segments and by making local and overseas acquisitions.

These banks are expected to strategically focus on managing the diversification of their portfolios to hedge their risks, while continuously optimising their capital deployment to ensure the right balance between risk, return, compliance, long-term potential, short-term opportunities and obligation to society. The likely CXO level focus on developing a highly productive and efficient workforce, supported by best-in-class technology and optimised operating models, is also expected to differentiate the 'Best Banks' from the rest.

Finally, to ensure that all their stakeholders benefit from this value creation, the Best Banks are expected to continue their efforts towards improving transparency and accuracy in reporting, and compliance and operational diligence in their operations, as foundations of good corporate governance.

As a result, these banks will be seen not only as strong financial pillars of the country, but also as strong brands with deep intrinsic value, which would ultimately be reflected in the global acceptance of their market valuation.