Banking-Mc Kinsey

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Wholesale banking in India:The next frontier

Akash Lal and

Naveen Tahilyani

Now is the time to spot opportunities and risks in the coming boom.

Wholesale banking in India is set for a period of sharp growth. Revenues from wholesale bankingactivities are likely to more than double overthe next ve years as infrastructure investment,expansion by Indian companies overseas,and further Indianization of multinational busi-

nesses, among other trends, drive new business.Foreign players and the countrys domestic banks,however, will nd themselves in a tough com-mercial environment and must overcome a rangeof challenges if they are to maintain, or assume,a leading position in the market.

Prospects for Indias wholesale banking marketare intriguing. Wholesale banking revenues,which in India account for close to 30 percent of

total banking revenues, are expected to more thandouble, from roughly $16 billion in scal2010 to between $35 billion and $40 billion by 2015 (Exhibit 1). McKinseys analysis showsthat returns on equity are typically in the range of 15 percent to 30 percent.

Corporate banking, including both lendingand fee businesses, accounts for the lions shareof the wholesale marketabout 85 percent.Revenues from this source are projected to grow at about 19 percent annually, reaching$30 billion by scal 2015.

Investment banking and markets, checked by the slowdown in the global economy, should

M A R C H 20 11

f i n a n c i a l s e r v i c e s p r a c t i c e


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2 Wholesale banking in India: The next frontier

bounce back. We estimate revenues will risefrom $1.8 billion in nancial year 2010 toreach $6 billion by nancial year 2015, an annualincrease of 27 percent. Equities (primary origination and secondary t rading) are expectedto account for close to 70 percent of this total,M&A for 20 percent to 25 percent, and debt capitalmarkets and private-equity syndication forbetween 5 percent and 10 percent. The recent rise

in equity markets and the subsequent pickup inM&A activity are already being felt.

This article will examine the trends underlying theexpected levels of growth, then address the key issues and priorities from the perspective of foreigninstitutions and their domestic counterparts.

Whats driving growth

Several trends will shape the evolution of Indias wholesale banking markets and create new

opportunities for foreign and domesticplayers alike:

An expected surge of infrastructure investment,creating demand for additional bankingproducts and services

The continuing globalization of Indiancompanies, bringing with it theneed for acquisition expertise, trade- nanceand treasury services, and cash- management skills

Growing interest in the India story,inspiring a host of inbound M&A dealsand increased fund allocation by global managers

Increasing sophistication of products andsolutions, driving higher margins

A continuing focus on midmarket companieswith new banking requirements

Regulatory change in bond and equity markets

Exhibit 1

Wholesale banking revenues, $ billion, %

Wholesale banking revenues in India are expected to grow quickly.

1Compound annual growth rate .2M&A includes domestic and cross-border M&A and private-equity syndication.3Estimated .

Investment banking 2

CAGR, 1 FY 200815, %

Foreign-currency creditsTrade nanceProject nanceCash managementForeign exchange and rates

Local credits(net interest income)

1722

1919

19

18

256

4

100% =

19

13

31

2010 3

12

12

9

16

13

15

3540

121113

32

2015 3

4


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3March 2011

Infrastructure investment

Investments in infrastructure totaling $240billion between 2007 and 2010 have already beenmade under Indias 11th Five-Year Plan, and itis projected that investments under the plan willreach $500 billion, or roughly 8 percent of GDP, by the end of 2011. Demand for core infra-structure will nevertheless likely outstripsupply in the future. To sustain Indias economic

growth, the Planning Commission thereforeenvisages that $1 tril lion (about 10 percent of GDP)will be spent on infrastructure during the 12thplan from 2012 to 2017 (Exhibit 2).

According to the Planning Commission, half of the investment during the 12th plan, or some$500 billion, is likely to come from the privatesector, implying a more than threefold increase in

private-sector investment over the 11th plan.Another $250 billion is likely to be raised by thepublic sector through external nancing. Meet- ing these investment needs could create annualwholesale banking revenues of $6 billion to$7 billion across lending, debt syndication, capitalraising, and secondary markets. But banksmust be willing to innovate, potentially becomingactive developers in addition to operating

through third parties, and they must also embracemore sophisticated products, such as projectnancing, through a mix of syndicated lending in

foreign currencies, nontraditional structured-trade- nance instruments, and securitization of cash ows.

Managing asset-liability mismatches will be a key challenge that will require institutions to

Exhibit 2

Spending plan for infrastructure during the 10th, 11th,and 12th plans, $ billion, FY 200607 prices

Infrastructure spending is a powerful source of growth.

1Projected investments .2Average for the 10th plan.

Source: Government of India Planning Commission

201

10th plan

Spending as% of GDP

11th plan 12th plan

67

2008

80

2009

89

2010

102117

138158

180204

231

2011 1 2012 1 2013 1 2014 1 2015 1 2016 1 2017 1

5.0 2 6.4 7.2 7.5 7.9 8.4 9.0 9.5 9.9 10.3 10.7

+15%


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broaden the sources of funds for projects beyondbank nancing. Services such as bond place-ments and credit enhancement should provideadditional sources of revenue as the corporatebond market deepens and the regulatory frame-work for introducing longer-term sources of funds (for example, insurance and pension funds)is put in place.

Globalization of Indian corporatesClose to 60 percent of Indian companies expectto increase their share of overseas businessover the next ve years, according to McKinseysglobalization survey. 1 This development,which will take the form of greater exports,increased international operations, andexpanded sourcing, will create three types of opportunities for wholesale banking players:

Acquisitions. Outbound acquisitions by

Indian companies in the rst seven months of 2010 amounted to $22 billion, signi cantly higher than the $8 billion recorded in 2009; italso exceeded the total in 2007, before thecrisis. This acquisition spree looks set to continue, as global targets become cheaperand competition from international nancialsponsors, such as private-equity and leveraged-buyout rms, diminishes.

Trade nance and treasury. As Indian

companies expand trade with other countries,the need for services such as letters of credit, export insurance, structured foreign-exchange solutions, and receivables

nancing increases.

Cash management. Companies with globaloperations have to manage cash ows at a globallevel and therefore require more complex andsophisticated solutions.

Indianization of the capital markets

Inbound M&A deals amounted to a healthy $80 billion between 2006 and 2010, a trend we

expect to continue as multinational corpo-rations increasingly respond to the India storyand take advantage of easier foreign-direct-investment regulations. The new wave willprovide fresh deal-structuring, treasury, andtrade- nance opportunities. Foreign banksare aggressively leveraging global relationships tosupport international clients as they crafttheir Indian entry plans, but domestic playerscan use their domestic balance sheets towin a share of the action.

Simultaneously, global institutional investorsare increasing their allocations to emergingmarkets, including India. Our conversations withsome of these large players suggest thatthe allocation to emerging markets could rise to18 percent to 25 percent from 10 percent to12 percent. As of January 2010, long-only fundsamong foreign institutional investors ( FII s)had invested around $81 billion in India, or about

1 Survey conducted with morethan 50 top managementexecutives representing lead-ing Indian corporatesacross sectors.


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25 percent of their major emerging-market ows.More FII s are registering in India, 2 while severaltop global private-equity and venture-capital

rms have established of ces in the country. Forseveral of these players, India is among thetop three or four global destinations outside theirhome market where they have an on-the-ground presence.

The enhanced interest in India is likely tostimulate primary and secondary equities marketsin the coming years.

Increased product sophistication

Trade nance accounts for about 12 percentof corporate banking revenues and will likely continue at these levels. But while demandfor traditional, low-return products (for example,letters of credit, bank guarantees) will grow,demand for more sophisticated, bundled foreign-exchange and derivative structures will grow even faster. Leading players, we believe, will continue to pursue areas such as factoring, supply chain nance, and structured trade nance. Supply

chain nance and factoring are already signi -cant markets in their own right, with totalrevenues projected to exceed $1.4 billion by 2012.

Structured trade nance, par ticularly export-backed commodity nancing, is growing at 20percent to 25 percent per annum.

Given that the share of Indian imports on openaccounts is just 15 percent to 20 percent,in comparison with an average of 50 percent to60 percent in the rest of Asia, companieswill likely look to banks to provide an integratedworking-capital solution. Banks, for theirpart, are moving to create integrated sales forces

as well as technology platforms that straddlethe two products.

Midcorporate enthusiasm

With intense competition and therefore lowermargins from servicing large corporate customersin the future, the midmarket will remaina critical area of wholesale activity. The typicalcorporate banking return on equity for serv-ing midsize corporations in India, for example, is

2The number of registered FII sin India increased from 996 in2007 to 1,319 in 2008.


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about one-and-a-half times that of the large-company segment.

Midmarket companies already represent a thirdof the overall wholesale banking market.But as their ambitions grow, these businesses willdemand more sophisticated instruments,such as capital market products and derivatives,not just traditional products, such as lending

and trade nance. Midcorporates will also featuremore in private-equity deals in India, whichcurrently average around $38 million. 3 Thesesmall deals constituted about 25 percentof the $6.5 billion of private-equity syndicationvolumes in 2009. Commercial banks witha signi cant midcorporate franchise have theopportunity to create a private-equity syndication franchise.

Regulatory change

In most developed markets, corporate bondsrepresent a signi cant part of overall wholesalebanking revenues. In India, however, thecorporate bond and securitization markets arenascent, with total revenues of approximately $30 million in 2010, 4 compared with total equity capital market ( ECM) revenues of about$390 million. Several regulatory issues haveaffected the growth of the market, notably the substantial disclosure requirements, limits onpension funds and insurance companies,

restrictions on upfront pro t booking of gainsfrom securitization, and the introductionof a rupee-for-rupee capital requirement for both

rst- and second-loss credit enhancements.

Bond issues in the future will increase asliquidity tightens and banks face capital pressurefollowing the implementation of Basel II;however, for the market to really take off, moreregulatory easing will be required. For example,companies can create a credit-enhancementproduct for bonds, reduce haircuts on corporatebond repos to create a viable repo market,simplify bond-listing requirements, and reduce

stamp duty on corporate bonds f rom 0.375 percentto 0.250 percent per annum across all states.

As for equities, the Indian bourses must increasedomestic retail and foreign investor partici-pation. A raft of regulations focused on corporateoversight, enhanced investor protection, andconvenient participation is expected. For example,the Securities and Exchange Board of Indiarecently issued several important guidelines onbook building, disclosure norms, and Indian

depositary receipts rights.

Imperatives for success

While corporate lending and trade nanceaccount for about 80 percent of the revenues of Indian banks, particularly public-sector ones,foreign banks derive 60 percent to 70 percent of their business from treasury, capital markets,and investment banking. Foreign players, forexample, hold a 60 percent to 75 percent share of ECM s, M&A s, and derivatives. Public-sector

banks, on the other hand, dominate balance-sheet-heavy segments such as corporatelending and plain-vanilla trade nance (lettersof credit, bank guarantees).

Several regulatory issues have affectedthe growth of the market.

3 Asian Venture Capital Journal .4 Includes revenues only

from primary origination of bonds; does not includerevenues from private place-ment of debt.


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These starting positions are by no means xed,and the picture is changing rapidly, especially post- crisis, as Indian banks focus more of theirenergies on fee income to drive wholesale pro t- ability. That said, foreign and domestic bankswill need to set different priorities to deal with thechallenges ahead.

An agenda for foreign banks

We see three key priorities for foreign banks:reaching out to the midmarket, overcoming theirlack of domestic balance-sheet muscle, andleveraging synergies in corporate and invest-ment banking.

Improve distr ibution to reach midcorporatesand small and midsize enterprises ( SME s). About 45 percent of foreign banks branchesare concentrated in metro areas and Tier 1 citiesbecause of restrictions on the number of

bank branches they can open. Foreign banksthus struggle to serve midcorporates andSME s outside these cities. As a result, foreignbanks have focused on large corporates.However, faced with growing competition andmargin erosion in their large-corporatebusiness, foreign banks must develop cost-effective ways to serve pro table midcorporateand SME segments. For example, they could offer products such as supply chain nance,which will enable them to target SME s and

midcorporates that are suppliers or distributorsfor their large corporates.

Overcome rupee balance-sheet disadvantage.Foreign banks in India are limited by the sizeof their rupee balance sheets. As Indian banksstart exing their muscle and demandinga higher share of non-fund-based business(exploiting their lending relationships),foreign banks must nd ways to overcome this

disadvantage, perhaps by offering clientsunique structuring, lines of credit, and offshore products.

Leverage synergies across corporate andinvestment banking. Foreign players havecreated high-cost, siloed units in corporate andinvestment banking. Only by moving fromproduct-centric to client-centric models will

they be able to capture a higher share of business in areas such as infrastructure andtrade nance. While domestic players leveragetheir corporate banking capabilities andrelationships to make inroads in investmentbanking, foreign players can use theirsuperior investment-banking capabilities andrelationships to make greater headway in corporate banking.

Priorities for local institutions

Domestic banks have ve priorities:

Enhance capabilities to play in the non-fund-based business. Thanks to their widespreadbranch networks and retail customer franchises,Indian banks (part icularly public-sector banks)have been able to deploy a large deposit base intheir lending. However, they have not beenable to build on their strong lending relationshipsto expand into non-fund-based businesses(such as transaction banking, foreign exchange,

treasury, and capital markets). That meansdeveloping new capabilities, including customer- coverage and account-planning processes,product design and structuring, and risk manage-ment, to provide a full suite of competitiveproducts and to deepen client relationships.

Build offshore business models. Wholesaleproducts will become more global as Indiancompanies expand their international


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