G.P on Portfolio Management With Respect To Banking Industry

8/7/2019 G.P on Portfolio Management With Respect To Banking Industry

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Portfolio Management With Respect To Banking Industry

RESEARCH METODOLOGY

1.1 Problem Definition

The main aim of this project is to find out the best

banking stock listed on BSE. There are basically two main

reasons behind choosing this project. First, the banking

industry is a very important part of Indian financial

system and this project gives us the opportunity to

analyze the banking industry in detail and to get the

knowledge of different aspects of the banking industry.

Secondly taking investment decisions is a crucial

characteristic of a financial manager. Investment

decisions also include investment in the stock market.Learning how to invest in the stock market helps not only

the financial manager but the individual investors also. In

addition to the above-mentioned opportunity, this project

also provides us an opportunity to learn the different

aspects of investment decisions related to stock market.

1.2 Sources of Data

The data collected in this project is all secondary data.

The data has been collected from various sites. The data

relating to the historical balance sheet and Profit and Loss

Account pertains to the Annual Reports of the respective

banks. The data of the monthly share prices of the banks

and sensex has been taken from the BSE website.

1.3 Objectives of the Project

To analyze Indian economy and to find out its

impact on banking industry. To study banking industry with respect to

different parameters such as structure of banking

industry, government regulations, emerging patterns

etc.

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To scrutinize fundamentally strong banks listed

on BSE.

To carry out qualitative and quantitative

analysis of selected banks.

To apply the stock valuation models such as

CAPM, MV/BV approach, Discounted and Cash flow

technique to find out the best banks stock to invest.

1.4 Scope of the Study

In this study twenty-four Indian banks are taken which

were listed as on January 1, 2003 on the Stock Exchange,

Mumbai. The P&L, balance sheets and cash flows have

been projected for the year 2002-03 and 2003-04. Thisproject gives us the investment opportunities for the next

one year. The projections are based on the information

available in the annual reports of the banks and through

market information. While projecting the financials of the

bank some basic assumptions have been made. Due to

time constraints and resource constraints we were not

able to include some banks, which were good on the basis

of selection criteria.

Limitations

This study is based on the secondary data only.

The data for some banks was not available so we

can not say the banks that we scrutinized are only

fundamentally strong banks.

The projections for different banks are based on

historical data only and we did not have the complete

information about the companys future plans. Time constraint. We have selected the banks on the

basis of some limited criteria only.

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INTRODUCTION TO BANKING INDUSTRY

Performance of banking industry is taken as barometer of

economy as a whole, due to banks wide spectrum of

exposure across industries. Unfortunately for India, the

banking sector has historically remained under the

impact of non-competitiveness, poor technology

integration, high NPAs and grossly under productivemanpower. In last few years, intense competition,

opening of economy, new entrants, new regulation and

standards has changed the macro-economic environment

for banks.

In ancient times, the Indian banking system existed

in the form of money lending. It was just over a century

ago that the country saw the evolution of proper banking.During the British Raj, some agency house carried on

banking business. But, they were closed down between

1929-32. Following serious financial trouble, three

presidency banks were merged into the imperial bank of

India in 1919, which later became State Bank of India.

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The first bank of limited liability merged by Indians was

Oudh Commercial founded in 1881. Subsequently, Punjab

National Bank was established in 1894. Also, the

swadeshi movement, which began in 1906, emerged the

formation of a number of commercial banks. In promoting

the banks and spreading the habit among savers leading

merchant communities in different parts of India have

played a major role. It helped them to promote trade with

neighboring countries like Burma, Malaysia and Sri Lanka,

besides their trading operations in India.

The banking system can be broadly classified as

organized and unorganized banking system. The

unorganized banking system comprises of moneylenders,indigenous bankers, lending pawnbrokers, landlords,

traders, etc. Whereas the organized banking system

comprises of Scheduled Banks and Non-Scheduled Banks

that are permitted by RBI to undertake banking business.

Scheduled banks are those banks that are included

in the second schedule of the RBI Act 1934, subject to

fulfilling certain conditions. The scheduled banks

comprising of Scheduled Commercial Banks andScheduled Co-operative Banks enjoy certain privileges

like approaching the RBI for financial assistance,

refinance etc and correspondingly, they have certain

obligations like maintaining certain cash reserves,

submission of returns as prescribed by the RBI etc.

As of March 2002, there are about 294 Scheduled

Commercial Banks and 67 Schedule Co-operative Banks.

Of the 294 Scheduled Commercial Banks, 196 areregional rural banks. These 294 Scheduled Commercial

Banks have an extensive branch network of 66,276

offices across the country, of which over 49% are in rural

areas, 22% in semi-urban areas, 16% in urban areas and

about 13% in metropolitan cities.

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Non-Scheduled Banks are those joint stock banks,

which are not included in the second Schedule of the RBI

Act 134, on account of the failure to comply with the

minimum requirements for being scheduled. There were

16 Non-Scheduled Commercial Banks in June 1969. As on

March 2002, there are 5 Non-Scheduled Commercial

Banks, which are local area banks. However there are

more then 2000 Non-Scheduled Co-operative Banks,

which are concentrated in few states like Maharashtra,

Gujarat, Karnataka, Andhra Pradesh and Tamil Nadu.

Further based on ownership, the Scheduled

Commercial Banks can further be classified as Public

Sector Banks, Private Sector Banks, Foreign Banks andRegional Rural Banks. Public Sector Banks are sub-

classified into the State Bank of India (erstwhile Imperial

Bank of India nationalized by central enactment in 1955)

and its 7 associates nationalized in 1959 and other

Nationalized Banks which were nationalized in two

phases; 14 banks were nationalized on July 19, 1969 and

6 others on April 15, 1980.

Also the Private Sector Banks can be classified as oldprivate sector banks and new private sector banks,

wherein the latter enjoy superior discounting in the

bourses. After RBI reopened the banking sector to private

players, about eight private sector banks were licensed in

1995, which brought with them latest technology,

customer-oriented service, innovative products and

aggressive marketing.

Despite increasing competition, public sector bankscontinue to dominate. This category currently accounts

for more than 81% of all deposits and over 79% of all

advances in the domestic banking industry. This scale of

operations bestows upon them a higher bargaining power

enabling them to play a dominant role in the liquidity and

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interest rate levels in the system. However, the scenario

in the future may undergo a change with the growth of

the new private sector banks. These banks are in a more

advantageous position because of their superior

technology-based operations, lower manpower and a

lower non-performing assets (NPA) level.

2.1 Reforms in Banking Sector

The financial sector reforms were undertaken early in the

reform cycle. The reforms in the financial sector were

initiated in a well structured, sequenced and phased

manner with cautious and proper sequencing; mutually

reinforcing measures; complimentarily between reformsin banking sector and changes in fiscal external and

monetary policies; developing financial infrastructure;

and developing financial markets.

The recommendations of the Narasimham

Committee-I in 1991 provided the blue print for the first

generation of reform of the financial sector. The period

1992-97 witnessed the laying of the foundations for

reforms in banking system. This period saw theimplementation of prudential norms pertaining to capital

adequacy, income recognition, asset classification and

provisioning, exposure norms, etc. The difficult task of

ushering in some of the structural changes accomplished

during this period provided the foundation for further

reforms. In fact, that India withstood the contagion in

1997 justify the stability of the banking system. While

these reforms were under way, cataclysmic changes were

taking place in the world economy, coinciding with themovement towards global integration of financial

services. Against such backdrop, the report of

Narasimham Committee-II in 1998 provided the roadmap

for the second generation reform process.

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Some noteworthy developments in the banking sector are

as follows:

a) Interest rates have been deregulated, allowing

banks the freedom to determine deposit in lending

rates. Currently, on the deposit side, the interest rate

on saving deposit is administered; whereas, on the

lending side, while sub-PLR lending has been

permitted, the maximum spread in restricted to 4%

over the PLR of each bank and there is ceiling of PLR

on small loans up to Rs.2, 00,000.

b) The State Bank of India and other nationalized banks

enabled to access the capital market for debt and

equity.c) Prudential norms for income recognition,

classification of assets and provisioning of bad debts

for commercial banks, including RRBs and FIs

introduced. They are required to adopt uniform and

sound accounting practices in respect of these matters,

and the valuation of investments. Banks are required

to mark to market the securities held by them.

d) The Performance Obligations and Commitments

obtained by RBI from each bank; they provide for

essential quantifiable performance parameters which

lay emphasis on increased but low cost deposits,

quality lending, generation of more income and profits,

compliance with priority sectors and export lending

requirements, improvement in the quality of

investments, reduction in expenditure, and stepping up

of staff productivity. The PO&C are meant to ensure a

high level of portfolio quality so that problems such asheavy losses, low profits, and erosion of equity do not

recur.

e) Banks required to make their balance sheet fully

transparent and make full disclosures in keeping with

international accounts standard committee.

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f) Banks given greater freedom to open, shift, and

swap branches as also to open extension counters.

g) The perceived constraints on banks such as prior

credit authorization. Inventory and receivable norms,

obligatory consortium lending and curbs in respect of

project finance relaxed.

h) The budgetary support extended for recapitalisation

of weak public sector banks.

i) Banks set free to fix their own foreign exchange

open position limit subject to RBI approval.

j) Steps have been initiated to strengthen PSBs

through increasing their autonomy. Several banks

capital base has been written off and some havereturned capital to the government. It was recognized

that restoration of health of banking system required

both a stock solution (i.e. restoration of net worth)

and a flow solution (i.e. an improvement in future

profitability). Restoration of net worth was achieved

through capital infusions from the budget. Competition

has been infused by allowing new private sector banks

and more liberal entry of foreign banks.

k) A set of micro-prudential measure have been

stipulated to impart greater strength to the banking

system and also, ensure their safety and soundness

with the stated objective of moving towards

international best practices.

l) Measures have also been taken to broaden the

ownership base of PSBs; consequently, the private

shareholding in PSBs has gone up, ranging from 23 %

( Bank of India) to 43.7 %(State Bank of India).m) The banking system has also witnessed greater

levels of transparency and standards of disclosure.

n) As the banking system has liberalized and became

increasingly market oriented, the financial markets

have been concurrently developed, while the conduct

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of monetary policy has been tailored to take into

account the realities of the changing environment

(switch to indirect instruments).

This set of measures, coupled with many others, did

have their positive impact on the system. There has been

considerable improvement in the profitability of the

banking system measured in terms of operating and net

profits. What is equally important is the fact the

intermediation process has improved. The profile of asset

portfolio and also the extent of the net non-performing

loans as percentage of total assets have shown

improvement. During this period, the supervisory strategyhas undergone a change, moving from opacity to

transparency.

2.2 Main Elements of Emerging Banking in India

A quiet revolution has been brewing on the banking front

in the country. The entry of private players has set the

market buzzing with activity. At the center of all this

frenzy is the customer who is being wooed with a blitz ofattractive schemes, home & phone banking and plenty of

other innovative products.

a) Trendy Moves

One of the most prominent factors to come to the fore

in Indian banking is that a large number of banks are

gravitating towards the retail customer. There are

several reasons for this. The first being that overall

credit off take has been quite low. And second, banksfound that there were not enough profitable and

creditworthy corporate customers for their funds. As far

as the benefits to the bottom-line are concerned, it will

take some time to become significantly visible.

According to bankers high initial infrastructure cost

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would lead to a longer break-even period but once this

is through then the benefits would be high.

b) Earnings Pattern

It is important to consider the changing face of bank

profit and loss accounts. Traditionally, the main

earnings of banks have come from the core activity of

lending. This is reflected in the break-up of income

wherein interest/discount on advances/bills represents

a large part of income. With the normal credit off-take

of the bank on slower ground, many banks have

pumped an increasing amount into government

securities. Due to this, income on investments hasgone up significantly which is reflected in the

increasing investment deposit ratio. This has given

banks the required boost in tough times faced by the

economy.

The prevailing situation in the economy has led

to an increasing investor preference for bank deposits.

The fall in the equity markets resulted in investors

looking for low risk avenues to park their funds. With a

general fall in interest rates across the economy, the

rates on bank deposits too have fallen but the element

of safety associated with these deposits is proving to

be a comfort factor for lots of investors. At the same

time, the crisis faced by the cooperative sector

following the collapse of the Madhavpura Co-operative

Bank has led to a large number of depositors,

especially in the western states of the country, pullingout their deposits from the cooperative banks and

shifting to commercial banks.

c) Mergers

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In todays scenario lot of mergers are taking place in

banking sector and the banks are moving towards

universal banking. The examples of mergers are the

merger between HDFC and times bank, PNB and New

Bank of India, ICICI and ICICI bank etc. among these

the merger between ICICI and ICICI bank has resulted

into the second largest bank in the country after SBI. It

is one of the biggest events in recent financial history

and a prime example of the concept of universal

banking.

d) Banks Entry into Insurance

Different banks are given permission to set up lifeinsurance subsidiary or to enter into joint venture with

insurance company or for strategic investment or to

act as insurance agents. For example, SBI has been

permitted to set up a life insurance subsidiary on risk

participation basis with 74 % equity holding. J&K bank

ltd., and Vysya Bank Ltd., have been accorded

approval to contribute 25% and 45% respectively to

the equity of insurance joint ventures on risk

participation basis. PNB and Vijya bank were permitted

to make strategic investment to the extent of 15% and

8%, respectively, in the life and non-life insurance joint

venture. Citibank, American Express, Standard

Chartered Bank, HSBC, ABN-Amro, HDFC Bank and

Deutsche bank have been given permission to act as

corporate agents of insurance companies fro

distribution of insurance products of fee basis.

e) Lead Bank Schemes

Under this scheme, a given bank is entrusted with the

responsibility of locating growth centers, assessing

deposit potential, identifying functional and territorial

credit gaps, and evolving co-coordinated programmes

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of credit deployment is each district assigned to it, with

the help of other banks and credit agencies. The RBI

has allotted the districts, to nationalized banks and

each of these banks has been designated a lead bank

for the districts allotted to it. As at end of March 31,

2001, Lead Bank Scheme covered 576 districts in the

country.

f) Use of Information Technology

Economic integration within and across countries,

deregulation, advances in telecommunications, and the

growth of the internet and wireless communication

technologies are dramatically changing the structureand nature of financial services. The use of IT is much

more in private sector banks than in public sector

banks. The state-of-the-art call centers and internet

banking has helped them to reach customers even at

far-flung locations. An important initiative currently

being witnessed is that public sector banks are

concentrating on information technology initiatives in

order to combat their private sector counterparts who

have made substantial gains on this front. The public

sectors banks are now increasing their IT spend to

make up for the loss of the first mover advantage. SBI,

for example, has committed Rs. 500 crore for its IT

initiative over the next few years to implement

anytime, anywhere banking.

g) Priority Sector Lending

Priority sector lending is the lending to agriculture,small-scale industries, transport operators, etc. the

priority lending has been increased by all the three

types of banks that is by private sector, public sector or

foreign banks. In March 2001, the priority sector

advances of PSBs were 43% of the net bank credit, that

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overall interest rate structure in the financial system,

with different authorities setting different interest rate,

it might impinge upon the signaling mechanism of the

Bank Rate.

j) Non-Performing Assets

Non-performing assets of the banks include sub-

standard assets, doubtful assets, and loss assets as per

the classification used by banks. Although the NPAs

have declined over the years, they were and are still at

a worrisome level. The route problem is that there is a

sizable overhang component arising from the weak

debt recovery processes, inadequate legal structure,weakness in underlying security, inadequate risk

management techniques, etc. the non-performing

loans can be categorized as loans to agricultural

sector, directed lending, loans to small enterprises and

loans to corporate sector. Many of the directed loans

are subsistence loans, where default rates are high and

recovery prospects not bright. As regards loan to

agricultural borrowers, legal impediments often prove

to be a challenging proposition for banks to recover

their dues. Loans to small enterprise become difficult

to recover due to inordinate judicial delays. Even if

court decrees can be obtained towards recovery, by

the time the charge of the assets is taken, its realizable

value is significantly diminished because of several

reasons including depreciation of the asset, lack of

borrowers cooperation, limited market value of the

asset, with the concomitant effect that such decreesare not executed. As regards corporate loans, suits

pending/referred to BIFR leave little headroom for

banks to affect recovery. Inadequate corporate

governance practices coupled with problems of fixation

of accountability leaves little maneuverability for banks

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of commission from the seller minus the risk and

interest factor, and administrative and advertising

expenses,. In addition banks earn by way of initial,

annual, add-on, and reissue fees from the prospective

cardholders. The volume of credit cards as a % of

population is 0.4 in India. The latest generation cards

available in India at present include ATM cards, Change

cards, Phone cards, Pre-paid Mobile SIM cards, and

Smart cards.

m) Consortium Approach

This approach requires that more than one bank would

finance a single borrower requiring large credit limit. It(a) enables banks to spread risk of lending, (b) break

the monopoly of big banks to have large accounts, (c)

enables banks to share experience and expertise, (d)

introduce uniformity in approaches to lending, (e)

enables banks to pool their resources, and (f) checked

multiple financing of the same account.

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PORTFOLIO MANAGEMENT

3.1 Introduction

In view of peculiar nature of stock exchange operations

most of the investors feel insecure in managing their

investment on the stock market because it is difficult for

an individual to identify companies that have growth

prospects conducive for investment. This is further

complicated by the volatile nature of the markets, which

demands constant reshuffling of portfolios to capitalize on

the growth opportunities.

Even if the investor is able to identify growth

oriented companies and their securities, the trading

practices are complicated, making it a difficult task for

investors to trade in all the exchanges and follow up post

trading formalities. That is why professional investment

advice through portfolio management services can help

the investor to make an intelligent and informed choice

between alternative investments opportunities without

the worry of post trading hassles.

3.2 Meaning of Portfolio Management

Portfolio management in common parlance refers to the

selection of securities and their continuous shifting in the

portfolio to optimize returns to suit the objectives of an

investor. This, however, requires financial expertise in

selecting the right mix of securities in changing g market

conditions to get the best out of the stock market. InIndia, as well as in a number of Western countries,

portfolio management service has assumed the role of a

specialized service now a days and a high number of

professional merchant bankers compete aggressively to

provide the best to high net worth clients, who have little

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time to manage their investments. The idea is catching

on with the boom in the capital market and an increasing

number of people are inclined to make profits out of their

hard-earned savings.

Portfolio management service is one of the

merchant banking activities recognized by Securities and

Exchange Board of India (SEBI). The portfolio

management service can be rendered either by the SEBI

authorized categories I & II merchant bankers or portfolio

mangers or discretionary portfolio manger as defined in

clauses (e) and (f) of Rule 2 of Securities and Exchange

Board of India Rules, 1993.

According to the definitions as contained in the

above clauses, a portfolio manger means any person who

pursuant to a contract or arrangement with a client,

advises or directs or undertakes on behalf of the client

(whether as a discretionary portfolio manager or

otherwise) the management or administration of a

portfolio of securities or the funds of the client, as the

case may be. A merchant banker acting as a portfolio

manager shall also be bound by the rules and regulationsas applicable to a portfolio manager.

Realizing the importance of portfolio management

services, the Securities and Exchange Board of India has

laid down certain guidelines for the proper and

professional conduct of portfolio management services.

As per guidelines, only recognized merchant bankers

registered with SEBI are authorized to offer the services.

Portfolio means the total holdings of securities belongingto any person.

3.3 Objectives of Portfolio Management

Security/safety of Principal: Security not only

involves keeping the principal sum intact but also

keeping intact its purchasing power.

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Stability of income so as to facilitate planning more

accurately and systematically the reinvestment or

consumption of income.

Capital growth that can be attained by reinvesting in

growth securities or through purchase of growth

securities.

Marketability i.e. the case with which a security can

be bought or sold. This is essential for providing

flexibility to investment portfolio.

Liquidity i.e. nearness to money. It is desirable for

the investor so as to take advantage of attractive

opportunities upcoming in the mkt.

Diversification: The basic objective of building aportfolio is to reduce the risk of loss of capital and/or

income by investing in various types of securities

and over a wide range of industries.

Favorable tax status: The effective yield an investor

gets from his investment depends on tax to which it

is subject. By minimizing the tax burden, yield can

be effectively improved.

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ECONOMIC ANALYSIS

It involves analyzing the major factors that affects the

national economy. These major factors are GDP, inflation,

interest rates, forex reserves, monitory policy, fiscal

policy, monsoon etc. it is important to predict the course

of national economy because economic activity affects

the corporate profits, investors attitudes and expectations

and ultimately stock prices. An outlook of sagging

economic growth can lead to lower corporate profits, a

prospect that can engender investors pessimism and

lower security prices. Some industries might be expectedto hold up better, and stock prices of companies in these

industries may not decline as much as in general. The key

point is that overall economic activity manifests itself in

the behavior of stock in general. We have adopted two

approaches for analyzing the economy. First is the

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indicator approach and another is using the major factors

of economy as mentioned above.

4.1 Indicator Approach

In this approach we have used two indexes named DSE-

ECRI Indian leading index and DSE-ECRI Indian coincident

index.

The DSE-ECRI Indian leading index, a precursor of

Indian economic recession and recoveries, rose to 181.1

in October 2002 from 172.3 in September 2002. Its

growth rate also jumped to 20.1% in Oct. from 11.5% a

month ago. This suggests that economic recovery is likely

to continue, at least for the near term. The leading index

has grown in double digits since May 2002 and has been

on the rise since the last quarter of 2001, which indicates

pick-up in economic activities.

Growth of economy can also be judged by the DSE-

ECRI Indian coincident index. It rose 6.5% in August, 2.8%

in September and 4.6% in October 2002. This confirms

the 5.7% GDP growth recorded in the July-September

quarter of fiscal year 2002-03.

4.2 Analyzing Economy using Different Parameters

Monsoon

The dependence of Indian economy on agricultureand monsoon is very high due to lack of infrastructure

facilities like irrigation network. It has lead to high

dependence on monsoon rains. Nearly 60% of

countrys gross cropped area under cultivation is

dependent on rains. Therefore poor monsoons are

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bound to affect the overall economy. The lack of

monsoon hits the small farmers harder as they do not

have any irrigation facilities. Lack of income in the

hand of small farmers hits consumption in the rural

area. The industries that may be hit in such scenarios

will be consumer non-durables, consumer durables,

cement and automobiles, particularly two wheelers.

Over the past several years, monsoons have been

uniformly good leading to high consumption of some

goods in rural areas. One of the biggest beneficiaries of

better rural income was the automobile industry, which

saw an unprecedented jump in sales year after year. In

the current financial year the monsoon was bad andthere was drought in 14 states. According to the CSO

data, the overall agriculture growth for April-September

in 2002-03 has slipped to 2.5% in comparison to the

3.3% in the similar period in 2001-02. In particular, the

second quarter June-September, has shown zero

growth. There are estimates that the output of various

kharif crops would be significantly lower than the

previous year. Rice production is estimated to fall by16%, that of coarse cereals by 27.5% and pulses by

16.9%. Even the production of commercial crops such

as cotton and sugarcane is due to decline significantly.

At the same time, the CSO has calculated that not

withstanding this dip, the overall agriculture sector

would register a zero growth, and particularly as part of

counter measures against drought, the government

was able to affect a higher output of horticulture and

livestock products.

Historically, a severe drought caused a major

economic crisis. When rainfall become below normal,

by say 15% or more, growth rate of both GDP from

agriculture and aggregate GDP declined and in

extreme cases both become negative. The incidence of

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unemployment and underemployment increase,

essentially in the rural areas. Inflation rate shot up to

double-digits. The food imports necessitated by the fall

in domestic production led to foreign exchange crisis.

Finally, the burden of drought relief, borne mainly by

the government of India, increases the fiscal deficit.

The drought, therefore, became the most important

factor behind the economic crisis in 1965-66, 1966-67,

1972-73, 1974-75 and 1979-80. Even in this year also

the rainfall was well below the normal. But at this time

we had 60 million tones of food grains and above 60

billion $ of foreign exchange which have saved us from

the severe drought impact.

GDP

National Income Accounts measures the value of

production in an economy, and how that produce is

disposed off by all the agents of that economy. Though

there are several components and categories in which

this output is measured are the GDP at market price,

and GDP at factor cost. There is the broadest maser of

output in the economy what the GDP measure is value

added. There are two ways in which GDP measured.

One way is to do so by measuring it at the production

stage and the other is to measure it as the sum total of

consumptions. Both should yield the some result. In

India, central statistical organization measures output

from the production side, broadly dividing it into three

sectors: agriculture, industry and services.

On 31st December 2002 the Central Statistic

Organization released latest data of actual economic

performance. This data covers the period April to

September, constituting the first half of 2002-03.

According to this, the overall economic growth, in

terms of GDP has shown 5.9% growth for the period. In

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the first quarter, for the period April- Jun the GDP

showed 6% growth. More significant, in the 2nd quarter,

July September, despite drought in many part of the

country, it slipped only marginally to 5.8. The first half

of the previous fiscal year 2001-2002 had witnessed

4.4 % growth. The July-September period of 2001-2002

had witnessed 5.3% growth.

The data for agricultural growth is given in the

previous topic. On the other hand, the service sector

has shown 7.5% growth in the first half of 2002-03.

This sector had shown 5.5% growth in the first half of

the previous financial year.

PARTICULARS

April-

September

2002-

03

2001-

02

A Agriculture Sector 2.5 3.3

B Service Sector 7.5 5.5

a) Financing, insurance, 8.9 7.6

Real estate & busi.

Services

b

)

Trade, hotels,

communication 8 2.4

C Industrial Sector 5.1 2.1

a

)Capital Goods 8.9 6.8

b

) Basic Engineering Goods 4.8 2.1

c

) Non-durable goods 14.8 2.8

d Consumer Durables -6.5

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)

The industrial growth for the April-September

period in the current fiscal was 5.1%. The same period

for the previous financial year, 2001-02 witnessed

industrial growth at just 2.1%. The industrial sector has

demonstrated a fairly broad based recovery this year.

Thus the lower agriculture growth has been offset by

higher industrial production. Thus the overall economic

performance is very attractive for the first half of the

current financial year. Therefore we can say that the

country has acquired the capability to consistently

witness much higher growth rate. The higher GDPindicates that the economy is on a strong footing and

the 8% growth premise for the tenth plan period (2002-

07) is very much achievable.

Even the import of capital good has increased

which itself give an indication about the expansion of

manufacturing industry. If we see growth of consumer

non-durable goods for this period, it is even more

striking. It is 14.8% while it was 2.8% in the April-September period last year. According to experts, this

indicates a massive pick-up in consumer spending and

demand. Growth rates for various sectors have given

below.

GDP At Constant

Factor Cost

1990-91 5.60%

1991-92 1.30%

1998-99 6.50%

1999-00 6.10%

2000-01 4%

2001-02 5.40%

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In 2001-02 gross and net domestic savings at

current prices grew by 11.8% and 13.3% respectively

to increase their share in GDP at market prices. Gross

(net) domestic savings, as a proportion of GDP (NNP) at

market prices, improved to 24(16) % in 2001-02, from

23.4% (15.4) in 2000-01. The household sector was the

best performer with the increase in its gross savings

exceeding the total savings in its gross domestic

savings. Households increased the share of financial

savings in their total savings from 48% in 2000-01 to

49.8% in 2001-02. Private corporate savings increased

roughly at half the rate of increase of householdsavings. This shows better prospects for retail banking.

The higher industrial growth indicates that it

will be beneficial for the bank industry, as the

corporates loans demand will shoot up. During the last

year the agricultural growth was almost nil. Due to the

priority sector lending norms this may affect the NPA

levels of banking sector.

Interest Rates

Interest rates have different meanings for different

people. For the man on the street it could mean the

rate of interest he earns on his deposits or the rate he

pays on his housing loans. For corporate it could mean

the rate of interest it pays for borrowing money from

banks and for bank traders it would mean the yields on

gilts.

During 2002-03, financial market in India

have been generally stable, liquidity has been

adequate and the interest rate environment favorable

to promote investments. Accordingly, there has been a

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fall in interest rates all across the financial system and

maturity tenors. Banks have reduced their deposits and

lending rates. The maximum interest on banks fixed

deposits which used to be a high as 13-14% before 4-5

years ago has been consistently reduced to 6-6.5%.

Similarly, the lending rates of banks (PLR) reduced

from as high as 18-19% to 11-12% as of now. The

interest rate on government security has also fallen

significantly. The yield on 10-year benchmark

government paper reduced from 14% in March 1996 to

10.36% in March 2001. In 2001-02 it dropped by

whopping 300 basis points to 7.36% as on March 31,

2002. In the current financial year, the same has fallenby around 100 basis points so far to 6.38% as of now.

Even large corporate could access market directly and

rise funds cheaply. The major drivers to the softening

of interest rate during the current year is comfortable

liquidity propelled by strong forex flows & CRR cuts by

75 basis points, appreciating rupees, slow credit off

take, low inflation and falling global interest rates.

The RBI announced a cut in the bank rate in themidterm review of monetary policy. Classical economic

theory says that lower the interest rate, the better it is.

In a low interest rate regime many good things happen.

Demand for consumer goods like autos get a boost.

These goods are mostly bought under installment

purchase schemes and if interest rates are lowered,

more people can afford them. The stock market too

gets a boost. People shift their funds from fixed

deposits in banks to buy shares. Corporates on theother hand reduce interest cost and invest such

savings in crediting new capacities. Most importantly,

the government can then cut taxes. The governments

outgo on interest payments of its market borrowings

reduces, and this allows it to reduce taxes.

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In other words, interest rates should go down

as much as possible. If the above argument is true, the

Japanese economy should have been booming. But it is

not the case. If we take the case of India, vast

majorities of our people have burnt their fingers in the

stock market, in buying real estates where prices have

gone down significantly. Even if we see the trend

during the 9th plan period, there is a shift in the

composition of financial assets of the household sector

from deposits and shares and debentures to long term

and less risky instruments. The decline in the share of

deposits is probable due to the falling interest rates

compared to other long-term instruments whereimpact was partly cushioned by favorable tax

treatment. Thus not only the interest rates but the

perceived riskiness can also affect the investment

patterns in the economy.

According to the expertise the outlook on

interest rate appear to be optimistic with both the RBI

and finance ministry insisting on softer interest rates

regime to stimulate investment and revive demand inthe economy. If the U.S Federal Reserve adapts

tightening bias, it can affect the interest here.

Industrial recovery leading to credit pick up can also

affect the interest rates. Any strain on fiscal position

and the exchange rate may also put pressure on it. The

policy announcement in the budget and annual

monetary and credit policy announcement will chart

the direction of interest rate going forward. The lower

interest rates can contribute to the greater competitivestrength of the Indian industry through cost reduction.

The interest rate continues to be below rate ofgrowth of GDP, this is a sign of fiscal sustainabilityeven though the ratio of debt to GDP keeps rising.

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Inflation

Inflation rates for different years are as follow.

INFLATION

RATES

1998-99 6%

1999-00 3.30%

2000-01 7.10%

2001-02 3.60%

In simple terms inflation is the rise in prices. During

2001-02 the inflation rate declined in terms of

Wholesale Price Index. The 52-week average inflationrate declined from 7% at the beginning of 2001-02 to

4.7% for the week ended January 2002.

The inflation rate is declining in these days. It

has remained in range of 4%. ETIG computed the

implied rate of inflation in the national account

statistics. The exercise reveals that the implicit

inflation rate in 2002-03 was just 2.3% down from 3.4%

in the previous year. The implicit inflation rate innational account is considered to be the widest

measure of inflation in the economy, since unlike the

wholesale price index, it also incorporate the effect of

price rise in services. As the inflation rate is at nominal

level currently, so we can say that the savings will

increase which indicates good signal for banks.

Forex reserve

FOREIGN DIRECT

INVESTMENT

1998-99 13339.84

1999-00 16867.79

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2000-01 19341.73

2001-02 19265.1

It comprised mainly of foreign currency assets, gold

and SDRS with RBI. The FER held by the RBI have

crossed the market of 70 $ billion. Higher foreign

reserves maintain confidence in the external value of

the rupee. It assures economy agents that RBI has

necessary resources to prevent the rupee from

depreciating widely. In turn, this prevents any panic

buying of imports or sudden liquidation of portfolio

investment by foreigners. The rising reserves offer us

an unusual opportunity to complete our tradeliberalization program at rapid pace. Further

liberalization will stimulate imports and create the

necessary demand for dollars. This could help in the

contingencies such as war.

Fiscal Deficit

The fiscal deficit, as a proportion of GDP, has gone up

from 4.1% in 1996-97 to 5.9% in 2001-02 for the

central government and from 9.6% in 1999-00 to 9.9%in 2001-02 for the general government (i.e.

consolidated centre and states).

The governments failure to rein in fiscal deficit

has emerged as a major impediment threatening the

economy, nullifying benefits arising out of low inflation,

soft interest regime, high foreign exchange reserve

and upturn in the performance of manufacturing

sector. Inability to meet revenue growth targets andlack of adequate control over expenditure, particularly

plan expenditure, as led to a situation where only

drastic steps could contain the deficit from going out of

hand. The situation has only worsened due to

uncertainty over disinvestments, which was expected

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more than Rs. 1,09,000 crores. Many PSUs whom the

government had lent at higher interest rates are

returning the money to the respective central

government departments and accessing much cheaper

money from the market. Finance minister Mr. Jaswant

Singh has also began the process of asking department

to return capex budget unspent. From the defense

ministry alone about Rs. 3000 crores could be

returned. All the above heads aggregated could save

the centre about Rs. 20,000 crore as against the

budgeted figure. This could take care of the expected

revenue shortfall of Rs. 12,000 crore as well as the

shortfall in disinvestments receipts of Rs. 6000 crores.

Monetary and credit policy

Monetary and credit policy of RBI determines the

supply of money in the economy and the rate of

interest and availability of credit. It also contains an

economic overview and presents future forecasts.

Monetary and credit policy has stance of a soft

interest rate bias and efficient liquidity management. It

has also maintained the RBIs focus on improving the

regulatory and risk management framework for banks.

In the mid term review in October 02, RBI reduce the

bank rate to 6.25%, CRR to 4.75% and reduce repo

rate by 25 basis point to 5.75%. Reduction in bank rate

and repo rate reinforces the RBIs soft interest rate

policy.

The policy appears to aim at maintaining a

stable, low interest rate scenario while takingmeasures to make the banking system more efficient,

in order to crate a platform for growth.

INDUSTRY ANALYSIS

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When an economy grows, it is very unlikely that all

industries in the economy would grow at the same rate.

So it is necessary to examine industry specific factors, in

addition to economy-wide factors. An appraisal of

particular industrys prospects is essential, since the basic

profitability of any company depends upon the economic

prospects of the industry to which it belongs.

5.1 Structure of Banking Industry

The banking system can be broadly classified as

organized and unorganized banking system. The

unorganized banking system comprises of moneylenders,

indigenous bankers, lending pawnbrokers, landlords,traders, etc. Whereas the organized banking system

comprises of Scheduled Banks and Non-Scheduled Banks

that are permitted by RBI to undertake banking business.

As of March 2002, there are about 294 Scheduled

Commercial Banks and 67 Schedule Co-operative Banks.

Of the 294 Scheduled Commercial Banks, 196 are

regional rural banks. These 294 Scheduled Commercial

Banks have an extensive branch network of 66,276offices across the country, of which over 49% are in rural

areas, 22% in semi-

There were 16 Non-Scheduled Commercial Banks in

June urban areas, 16% in urban areas and about 13% in

metropolitan cities. 1969. As on March 2002, there are 5

Non-Scheduled Commercial Banks which are local area

banks. However there are more then 2000 Non-Scheduled

Co-operative Banks which are concentrated in few stateslike Maharashtra, Gujarat, Karnataka, Andhra Pradesh and

Tamil Nadu.

Further based on ownership, the Scheduled

Commercial Banks can further be classified as Public

Sector Banks, Private Sector Banks, Foreign Banks and

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Regional Rural Banks. Public Sector Banks are sub-

classified into the State Bank of India (erstwhile Imperial

Bank of India nationalized by central enactment in 1955)

and its 7 associates nationalized in 1959 and other

Nationalised Banks which were nationalized in two

phases; 14 banks were nationalised on July 19, 1969 and

6 others on April 15, 1980.

Also the Private Sector Banks can be classified as old

private sector banks and new private sector banks,

wherein the latter enjoy superior discounting in the

bourses. After RBI reopened the banking sector to private

players, about eight private sector banks were licensed in1995, which brought with them latest technology,

customer-oriented service, innovative products and

aggressive marketing.

Despite increasing competition, public sector banks

continue to dominate. This category currently accounts

for more than 81% of all deposits and over 79% of all

advances in the domestic banking industry. This scale of

operations bestows upon them a higher bargaining powerenabling them to play a dominant role in the liquidity and

interest rate levels in the system. However, the scenario

in the future may undergo a change with the growth of

the new private sector banks. These banks are in a more

advantageous position because of their superior

technology-based operations, lower manpower and a

lower non-performing assets (NPA) level.

Among all the commercial banks, SBI is the largest

bank, whereas ICICI Bank is the largest private sector

bank.

5.2 Cost Dynamics

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Banking, everywhere in the world, is a highly regulated

industry. The banking industry is the repository of

savings of a nation contributed by millions of people.

Thus a bank basically acts as an intermediary between

savers and borrowers. Hence, costs to a bank are the

interest cost paid to savers and the establishment cost. A

bank's margin arises out of the difference in interest paid

to depositors and charged to borrowers. The funds raised

from savers are deployed in three ways - loans and

advances to industry and agriculture, investment in

government securities, investment in private sector

equity, debentures, commercial papers, etc.

A bank's sources of revenue are interest from loansand advances, income from government securities and

dividend/interest from private sector equity investments

and debt instruments.

Apart from this, a bank also earns non-fund-based

income, also called as fee-based income for the various

services rendered by it as a banker or in the course of

banking activities. It includes treasury and forex

operations, income from trading in shares, guaranteecommission, etc.

The employee cost is about 9% of the normal

banking income of private sector banks, while it is over

16% in public sector banks. Recently, the over-staffed

public sector banks have rolled out a VRS package for

their employees.

Unlike in past where the bankers had practically

forgotten the significance and importance of profits in thelife and operations of a bank. They perceived that rules of

the game have changed. Instead of deposits and priority

sector lending, which were the yardstick for measuring

the banks performance hitherto, it will now to be the

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profits. Innovative and unconventional methods of profits

are being learnt and devised.

With the economy engulfed in recession, many of

the bank advances to core industries like steel, textileshave ended up as NPAs affecting the profitability, liquidity

of banks and in some case their very financial viability.

With prudential norms getting stringer, of late, banks

incur substantial costs on account of reversal of income

booked earlier in respect of non-performing assets, and

the provisions to be made thereof.

Further with the deregulation of interest rate

structure, pricing of loan and deposit products will be

determined by market forces as well as assets-liability

profile of specific banks. This versatile instrument of

interest rate can be very usefully employed to meet

different or changing objectives of a bank from time to

time.

5.3 Structural Changes

Banks have started accessing Tier - II capital like

preference shares and its deployment pattern has alsochanged, with new avenues like bonds, debentures etc.

When funds are accessed as deposits, SLR (Statutory

Liquidity Ratio) and CRR (Cash Reserve Ratio) needs to be

maintained but if it is accessed as Tier II capital, it not

only improves the bank's capital adequacy but the bank

is also absolved of SLR and CRR requirements on such

Tier II funds. Likewise, when lending, a bank needs to

ensure priority sector lending does not fall below 40 % ofthe total lending, while deployment through debentures

and other instruments is devoid of these restrictions.

Even corporates prefer to access funds through such

instruments, because, depending on their financial

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strength, coupon rates gets finer, thereby reducing their

cost of funds.

5.4 Current Scenario

Changing Face of Banking Industry

Since its inceptions, banking has continually evolved

but perhaps the pace of change has never been as

rapid as in the current time. New thinking is emerging

and focus has now changed in the banking industry.

Nowadays, the banks do not rely on the lending as one

of their main products. In todays competitive

environment number of banks is increasing and the

number of bankable corporates is reducing. The growthin number of banks has been fuelled by the emergence

of several private sector banks while the bankability of

more and more corporates is reducing owing to the

continued recession in most industries.

The stiff competition has reduced margins for

the banks. The banks are now trying to increase the

flow of transactions through their consumers which

provides fee based income a comparative lower risk. The competition also makes relationship banking

essential. Relationship helps the banks to sell standard

products which are not very different from one bank to

another as well as it also helps to understand the

clients need in time and working out structured

customized solutions. Several new products have been

evolved in this area during the last few years. This area

is witnessing growth at higher margin.The other focus area for the baking industry is

channel finance. In this concept the bank use the

credit-worthiness of the major corporates and provide

funding to the channel partner viz. suppliers and

dealers at spreads better than what the corporate

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offers but lower than what the channel partners get on

their own strength. Pure lending has also given way to

trade financing with structures to mitigate risk and

improve pricing. The service levels and the turnaround

times have also improved due to the increased

competition. This is mainly because of centralization of

processing and investment in technology. Banks are

now moving towards, providing Internet banking to

customers, which cannot only be used for inquiry but

also for transaction initiation.

Hence, banking is changing and the times are

exciting for all the corporates as well as the

professional bankers.

Non-Performing Assets

The issue of NPA Management is the biggest challenge

before the banking sector. The higher competition has

led the banks to accumulate poor quality of assets.

The quantum of NPA is the true indicator of quality of

assets. NPAs are a serious strain on the profitability as

banks cannot book income in such accounts and theyare required to charge the funding cost and provision

requirement to their profits.

The total non-performing loans for the financial

sector were estimated at Rs. 110,000 crores. Banks

alone have about Rs. 70,900 crore worth of NPAs, were

estimated at approximately 10.4% of their gross

advances. The level of gross NPAs of all groups of

banks for the last three years is shown in the followingtable.

TABLE : NPAs (Rs.

in Cr)

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Bank Group

Gross NPAs*

200

0 2001 2002

Public Sector

Banks

5303

3

5477

3 56507

14%

12.40

%

11.10

%

Private Sector

Banks 4761 6039 11672

8.20

%

8.40

% 9.70%

Foreign Banks 2614 3071 2726

7%6.80

% 5.40%

Total

6040

8

6388

3 70905

12.7

%

11.4

% 10.4%

*% figures are gross NPAs as % of gross

advances

Source: Professional Banker, March2003

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Chart 1 : Gross NPAs as % of total advances

0

2

4

6

8

10

12

Public Sector Private

Sector

Foreign

Banks

Public Sector

Private Sector

Foreign Banks

Chart 2 : Gross NPAs (Rs. in Billion)

27.26

116.72

565.07

Public Sector

Private Sector

Foreign Banks

However after passing of the Securitization and

Reconstruction of Financial Assets and Enforcement of

Security Interest Act 2002, the banks will be able to

reduce their NPA levels drastically. The reduction of the

NPA levels will increase the bottom-line of the banks.

And also the budget on Gilt-buyback will affect

positively on banks balance sheet. If the government

buyback the securities, banks will be able to show

stronger balance sheet from the next financial year by

providing for NPAs at the same time they can get rid of

investment, which though paying a higher return

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cannot be off-loaded for an expected gain, simply

because the securities are illiquid and coupon rates on

such bonds are completely out of sync with prevailing

market yields. Thus, banks have ample opportunity to

reduce their NPAs.

Spreads

The magnitude of spread measures the intrinsic profit

earning power of the banks. Spread is defined here

simply as the difference between the ratio of interest

earned to total assets and the ratio of interest

expended to total assets, which is the formula used by

the RBI in estimating a banks spread. By definition,higher the spread the greater is the banks efficiency

and vice versa. According a recent study by RBI the

average spread of 97 scheduled commercial banks

both, Indian and Foreign, declined by 0.65% points

during the last 5 years from 3.22% in 1996-97 to

2.57% in 2001-02.During this period the interest rates

were falling at regular intervals. The fall in interest

rates affected both interest earnings and interest

expenditure of banks but its impact was higher on theearning side.

Thus there is a steady decline in commercial

banks spread in recent years and this indicates a

decline in profit earning capacity.

Technological Shift

After entry of Private Sector Bank into the banking

sector, the Public Sector Banks have loosened theirclients, who switched their loyalties on discovering the

joys of convenient banking. One of the biggest changes

that the Private sector has brought about is in the

application of modern technology like Internet banking

and just around the corner ATMs. This has benefited

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both the banks and the customers and a lot of private

banks actually have more ATMs than physical

branches. And this has led many banks to invest

heavily on the technological aspects. Private sector

banks spend on technology goes in hand with their

expansion while Public Sector and medium sized

private banks focus on automating their urban

branches and networking them.

For instance, United Bank of India has

announced its intention to spent Rs.150 crores on

technology while Vysya Bank plans to spent Rs.60

crore on the same. The State Bank of India is going to

spent Rs.500 crore over a 3 years period. Even thesmaller banks like Bharat Overseas Bank and City

Union Bank are also planning to spend on the IT

aspect. The World Bank has also announced an

automation fund for Indian banks under which Indian

Bank, Dena Bank and Bank of Baroda will receive

around $25 million to spend solely on IT. The number

of fully computerized branches has increased from

5514 in Sep. 2000 to 11578 in March 2002. Therefore,it is very important for any bank to spend on IT to

survive in the industry.

Banking sector scenario in government security

Bank has been warned that they cannot continue to

invest heavily in low holding government securities to

make up the commercial credit. The government is

concerned that banks could take body below once

interest rate start hardening. The concerned wise inthe economy survey comes a month after financial

ministry circulated report that said that only 10 of the

42 major banks in the country are hedged, in the since

of starting to gain or loss less than 25% of equity

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capital in the event of a 320 basis point interest rate

stock.

Pointing out that bank are not passing on the

full benefit of the reduction in landing cost toborrowers, the survey said that cuts in interest rate

and increase in forex inflows have fail to result in any

appreciable increase in credit flow to the commercial

sector.

The survey highlights that banks investment in

government securities rose by a record 35%to 85738

crore during the current fiscal up to January 10,2003

from Rs 63,082 crore in the corresponding period lastyear and this was despite the fact there has been

sharp fall in yields on government securities. Banks

investment in G-Secs now amounts to 37.8% of banks

net demand and time liabilities as compared to the

statutory stipulation of 25%. As against this, bank

credit to the commercial sector rose only 9.7% till

January 10 this fiscal, compared to 11% in the year-ago

period.

Lending Rate Cuts Not Matched by Cut In

Interest on Deposit

Alarms bells are ringing big time. This time over banks

lending below the primary lending rates. Though sub-

PLR lending by the commercial Banks has been

growing, the survey point out, taking up almost over

one third of the total lending pie, the rate cuts, havent

keep pace with the deposit rate snips. While the bankrate cut of 75 basis point from 7% in march 2001 to 6

point 25% in January 10/2003, has been matched by a

cut in PLR by the bank from a band of 11%-12% in

march 30, 2001 to a band of 10.75% to 11.5% in

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January 10/2003,the fall in deposit rate have been

sharper in comparing to the cut in the PLR.

The rates fill from a band of 8.5% to 10% in

March 30/2001 to band of 5.5% to 6.5% in January

10/2003. Indeed, if anything the stats only point to the

in efficiency of the banking sector. The interest spread

the difference between interest charge to the borrower

and interest paid to the deposit, increase by 6.8% in

2001-2002.

A higher spread means higher cost of

intermediation. But the ratio of interest spread to the

total assets has declining from 2.9% into 2000-2001 to

2.6% in 2001-2002, meaning that the yields on assetshave come down or that the repressing is thinner.

Sharp Raise in Provisioning by private banks

Private sector banks saw a share rise in provisions and

contingencies during 02-03, while this declined for

foreign banks, said the economy survey for 02-03.

Provision for entire banking sector rose by 36.6% to Rs

18242 crore, from Rs 13,353 crore in previous years.

While provisioning for new private sector bank

grew by 83.3%, for old generation private rose

by55.3% and public sector bank by 41% provision for

foreign banks declined by 6.7%. Provision for new

private banks rose to Rs 1337 crore, from Rs 730 crore.

For old generation private sector banks, it grew to Rs

1512 crore, from Rs 974 crore

Deposit the leap in provisions; the numbers of

private sector banks are much smaller than public

sector and foreign banks. Even though there has been

declined in percentage terms for foreign banks, the

provision for 01-02 was Rs2021 crore, compared to Rs

13372 crore, from Rs 9485 crore. In case of SBI group,

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it rose by almost 50% to Rs5270 crore from Rs 3518

crore. The increase in provisioning reflects provisioning

for NPAs by banks to meet prudential requirements

said the economy survey. During 01-02 the proportion

of NPAs to net advances was the highest for public

sector banks at 5.8%, closely followed by private sector

banks (5.7%)

5.5 GOVERNMENT POLICY

Securitisation Bill

An ordinance on Securitisation and Reconstruction of

Financial Assets and Enforcement of Security Interest

was promulgated on 24th June 2002. The same has

been passed by the Parliament in Nov. 2002. The

ordinance will help banks and financial institutions

improve their financial position in three ways. Firstly it

will help banks and FIs turn their assets into securities,

which could be traded in the market in smaller

bundles. This would bring immediate liquidity, which

can be lent, instead of waiting for loans to be realized.

The new law will also help them in setting up assetreconstruction companies to recover their bad assets.

And finally, it will help in the enforcement of security

interest (i.e. right to the security in case of default by

the client). This ordinance creates a right environment

for faster recovery of dues and gives hope that the

huge the burden (now estimated at over Rs 1,100

billion) of NPAs on Indian financial sector will be

reduced to a more reasonable level. It also offers scope

for Public Sector Banks to clean up their balance sheets

faster.

Using this law, banks may make lesser

provisions for NPAs and recoveries may in fact result in

some write backs thereby adding to the bottomline

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directly. No doubt this Act is a good thing to have

happen, but in reality it is not magic wand against the

mounted NPAs because of several reasons which are

explained below. In the case of ARCs, while they would

be in a position to make a concentrated efforts at

recovery after buying out the problem assets, the issue

of valuation of these assets and the role of the valuer

yet to be clear. Besides secured assets would also

include both tangible and intangible assets. Intangible

could be things like software, brands, goodwill, and the

like, valuation for which could be crucial. There is also

the issue of the banks paying insurance and providing

security to the assets. All these being highly manpowerintensive, banks are finding themselves inadequate in

dealing with this aspect. Besides, 75 percents of the

lenders in the value will have to agree to the decision

to attach the properties. Though banks may well go

and attach properties under the Act, selling them

would pose another problem since it is difficult to find

buyers. Another cause for confusion remains: banks

having to go to more than one forum for recourse. Most

public sector banks have already find cases for

majority of their NPAs with the debt recovery tribunals,

which they say have proved a rather defensive mode

of recovery. With the new Act some banks are now

wondering how to balance the two fora.

In conclusion, having got a powerful tool in

hands, banks will now have to learn how best to use it

to their advantage. On this Act, a lot of work remains to

be done, with clear policies and guidelines requiredbefore the banks can truly reap its benefits.

RBI Regulation

The Reserve Bank of India (RBI) in its recent credit

policy declared on 29th Oct. 2002 has decided to

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reduce the bank rate; cash reserve ratio (CRR) and the

repo-rate by 25 basis points (bps) each. The bank rate

has been reduced from 6.5% to 6.25%. Likewise, the

repo-rate under RBI's liquidity adjustment facility (LAF)

has been reduced from 5.75% to 5.5%. CRR has been

reducing from 5% to 4.75%. However this will be

effective from the fortnight beginning 16th Nov. 2002.

RBI has also asked bank to maintain a minimum of

80% of the required CRR on a daily basis with effect

from the fortnight beginning 16th Nov. 2002. As per

industry estimate, the CRR reduction would infuse

further liquidity of around Rs 3,000 crore into the inter-

bank market.While fiscal policies are the domain of the

government, the monetary policy is the domain of RBI.

It has taken various measures to adjust the money

supply in the economy in accordance with the internal

and external business environment prevailing. Banks,

which control sizeable flows of money of the nation,

are accordingly advised/ directed by RBI.

The Union Budget 2002 has furthered bankingreforms and facilitated improvement in the margins of

the sector. The finance minister announced that a new

law will be enacted to improve foreclosure and

enforcement of securities and also enable

securitization of long term loans. It also promised that

Asset Reconstruction Company would be formed by

June'02.

On direct taxes front, the Union Budget 2002increased the provision for bad and doubtful debts

from 5% hitherto to 7.5% of their total income w.e.f.

accounting year 2002-03. Further, the optional

deduction of their NPAs categorized as loss or doubtful

debts has also been increased from 5% to 10%.

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The Budget 2002 also provided an option to

foreign banks to either operate as branches of their

parent banks or to set up subsidiaries. Such

subsidiaries will however, have to adhere to all banking

regulations, including priority sector lending norms that

are applicable to other domestic banks.

The Deposit Insurance Credit and Guarantee

Corporation (DICGC) will be converted into the Bank

Deposits Insurance Corporation (BDIC) to make it an

effective institution for dealing with depositor's risks

and for dealing with distressed banks.

In Feb'02, RBI permitted FDI in private sectorbanks up to 49%. Likewise, FDI and portfolio

investment in nationalized banks, SBI and its associate

banks are subject to overall statutory limits of 20%. FDI

in private sector banks will be under the automatic

route for shares acquired through IPOs, private

placements, ADRs/GDRs and acquisition oif shares

from existing share holders. However, FIPB approval is

required, followed by in principle approval from

Exchange Control Department of RBI, if the existingshares of a bank are to be transferred from residents to

non-residents.

In Mar'02, the government clarified that the

portfolio investment by foreign institutional investors in

the private sector banks would be outside the FDI limitof 49%. Hence, FII investments in private sector banks

can go upto 49% subject to approval of the respective

bank's board and its shareholders. Nevertheless, the

maximum voting rights for a shareholder continues to

be capped at 10% of the total voting rights of the bank.

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The central bank has been selective in

approving establishment of new banks. In Jan'01, the

RBI directive was that the promoter's shareholding in

private sector banks should not exceed 40% and if they

so exceed, have to be disinvested after completion of

one year of banking operations. However, in June '02,

RBI had enhanced the maximum limit of promoter's

stake in private banks to 49%.

Recent RBI directives, which enables banks to

lend below prime lending rate (PLR) to premium

clients, is likely to lead to churning of creamy clients

amongst leading banks. SBI, Punjab National Bank,

Corporation Bank and Bank of India have startedoffering loans priced about 100 basis points less than

their respective PLRs to select corporates.

RBI had formulated Prompt Correction Action

(PCA) in August 2000, wherein trigger points are

identified, for taking corrective actions, to prevent a

bank from liquidating. The parameters identified are

slippage of capital adequacy ratio (CAR) below 9%,

surge of NPAs above 10% and fall in return on assetsbelow 0.25%.

Recently, the Income Tax Department has held

that NPA provisioning as per RBI rules will not be

allowed as a deduction, but only the actual amount

written off will be allowed. This will increase the income

tax liability of old public and private sector banks

substantially, as they have to pay tax on NPAs

provided in the books, to the extent not written off.Public sector banking is at the crossroads. The

government has already announced its intention to

reduce its share in the capital of the banks to around

33%, while retaining their public sector character. The

impact of this move, for which legislation is with the

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Parliament, will go much beyond the financial impact.

Banks will have to change their operating style and

take into account the aspirations of the larger group of

shareholders.

RBI has directed the banks that their capital

market exposure should be restricted to 5% of

advances and 20% of their networth, whichever is less.

While about 5 banks exceeded the 5% advance limit,

nearly 25 banks have violated the limit of 20% of

networth norm. Nevertheless, RBI is likely to take a

case by case approach and give time to bring down the

exposures of these banks to the limit fixed.

5.6 Critical Success Factors

Asset liability management, effective monitoring of loans,

recovery of NPAs, reducing cost of deposits, controlling

establishment costs are critical success factors. Ensuring

capital adequacy, exposure norms and other prudential

norms in line with RBI guidelines are also critical.

Wresting blue chip accounts, expanding depositor base

and leveraging them for fee-based income are alsoessential for growth and development.

Technology has already brought about revolutionary

changes. Services like Internet Banking, Mobile Banking,

Anywhere and Anytime Banking will not be added

features but promise to be a standardised banking

environment in the next few years. While on one hand it

has the potential to reduce the transaction costs, the

initial capital requirements will be heavy. Banks, whichhave a legacy of a large workforce, will have to find ways

to offset these technology costs by reduction in staff

costs, if any meaningful reduction in transaction costs has

to be achieved.

5.7 Mergers and Acquisitions

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The RBI on 14th November 2002 notified the draft

scheme for amalgamation of Nedungadi Bank (NBL) with

PNB and the bank merged in the first week of February

2003. Dutch financial giant ING's has proposed to hike its

stake in Vysya Bank by another 29% to 49%. In June

2002, the union government approved the amalgamation

of Benaras State Bank (BSB) with Bank of Baroda. The

former had total staff strength of 1400 and around 105

branches across the country. According to BOB, the

amalgamation of BSB is likely to be completed in two

months from the date of receipt of Centers approval.

ICICI Bank has become the second largest bank in

India (next only to State Bank of India), with the mergerof its parent ICICI with itself wef March 2002. In Oct.

2001, LIC has picked up additional 15.28% stake in

Corporation bank, thereby increasing its stake in the

latter to 27%. The latest increase in stake comes on

account of picking up 2.4 crore shares in Corporation

Bank @ Rs 196 per share aggregating Rs 459.42 crore.

In November 1999, HDFC Bank merged Times Bank

with itself, starting off M&A activity in new private sectorbanks. Standard Chartered Bank became one of the

world's leading emerging markets bank with the

acquisition of ANZ Grindlays Bank and Chase Consumer

Banking.

Merger, Acquisitions and Alliances can emerge as a

route to survival. The weaker banks would need to merge

entirely or sell some of their networks to other banks. In

this direction RBI directed PNB to takeover NedungadiBank. Next from the regulators list is Centurion Bank

which is likely to be taken over by Andhra Bank.

5.8 Outlook of Indian Banking Industry

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The banking scenario in the country has been undergoing

a qualitative shift towards internationalism. Global best

practices are finding greater acceptance and systemic

deficiencies, which are a legacy of the past, are being

addressed. The future, therefore, seems to be exciting,

but only for those who can withstand the stress and strain

that the reforms bring along.

The new Capital Accord, on which deliberations are

going on, will bring about changes in the CARs to provide

for newer risks. It is expected that banks will have to

improve their capital structure to meet these enhanced

requirements, or else restrict their ambition for asset

growth. The changes may call for conservation of capitalresources and, for some banks; it may need a fresh

infusion of funds.

The gross NPAs will go up in March 2004 when the

NPA recognition shift 180 days over due to 90 days.

Recoveries are however expected to improve with the

passing of new securitisation and reconstruction of

financial assets and enforcement of security interest bill,

2002. Bankers will have to focus on cleaning theirbalance sheet and bring down their net NPAs to around

1% in the next 2-3 years, which may virtually impossible

for weaker banks. Overall the outlook of the banking

industry is looking optimistic. This will have a positive

impact on the share prices of the banks.

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Table : 1 Bank of Baroda

DATE KEY FINANCIALS Rs. In Million

Industry : Banking Mar.2001 Mar.2002 Q.Sept.(U) '02

BSE Index : 3390.12 Operating Income 57573.4 59555.4 15477.2

P/E Ratio 3.8 Other income 7062.8 9931.7 3602.5

52 WK h/l : 78/35 Total Income 64636.2 69487.1 19079.7

Face

G.P on Portfolio Management With Respect To Banking Industry

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