India Banking Overview

Financial Services Practice

Indian Banking:Towards Global Best Practices

Insights from industry benchmarking surveys

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Indian Banking:Towards Global Best Practices

Insights from industry benchmarking surveys

November, 2007

5

The Indian banking sector is rapidly globalising, making it important for Indian banks to ensure their

practices match those of the best banks in the world. This is the focus of this year’s Annual Bankers’

Conference, with the theme “Indian Banking: Towards Global Best Practices.”

To assess how leading banks in India are meeting global best practices, McKinsey & Company has

administered, on our behalf, five industry benchmarking surveys across selected banks. Building on

existing proprietary research across various industries internationally, McKinsey has achieved the

difficult task of defining, measuring and comparing the processes and practices of leading banks in

India with those of leading banks in other parts of the world. This report captures the findings and

conclusions of this research, and highlights what must be done to bring banking in India to world-class

levels.

The Bank of Baroda and the Indian Banks’ Association thank McKinsey & Company for devoting

time and resources to conducting the survey and putting together this report. We also thank all the

banks that have taken part in the benchmarking survey; their participation has made it a tremendous

success.

This is our first association with McKinsey & Company as Knowledge Partners. We hope to continue

this relationship in our future endeavours.

Dr. A. K. Khandelwal

Chairman & Managing Director

Bank of Baroda

H. N. Sinor

Chief Executive

Indian Banks’ Association

7

PrefaceIndia’s banking sector is growing rapidly and is expected to enjoy even greater growth opportunities

in the future. Several Indian banks are pursuing global strategies, as Indian companies globalise and

people of Indian origin increase their investment in India. At the same time, a large number of global

banks have stepped up their focus on India, keen to participate in the sector’s growth.

Today, the question often asked is: how competitive are Indian banks and how do the practices

at work in these banks compare against global best practices. To assess this, we at McKinsey &

Company, with support from the Indian Banks’ Association, profiled 14 leading banks in India, using

five proprietary surveys developed by our Banking and Securities, Organisation, Risk Management

and Business Technology practices and administered at banks across the world. This allowed us

to compare the performance and practices of Indian banks with those of global banks in a way we

believe has not been done before. The banks surveyed include: seven leading public sector banks,

four new private sector banks, and three large foreign banks with a significant presence in India.

The five surveys we administered are: the McKinsey Personal Financial Services Survey; Excellence in

Retail Banking Survey; IT Benchmarking Survey; Organisational Performance Profile Survey; and Asset

Liability Management Survey.

The surveys were detailed and consisted of two parts. The first entailed a qualitative assessment based

on a detailed performance grid to analyse the underlying practices at work (e.g., a self-assessment

grid to evaluate excellence in retail banking). The second involved detailed analyses of quantitative

data and financial performance (e.g., technology spends or retail banking data).The analysis focused

on unearthing underlying capabilities using our proprietary methodology in each of the survey areas.

All data was handled with utmost confidentiality. Findings and conclusions in the chapters that follow

reflect aggregate numbers with no attribution to any particular bank. During analysis, code names

were assigned to individual bank data to ensure confidentiality even within the working team.

Our findings uncover several interesting facts and trends that are likely to influence the evolution of

the sector in India. Five key highlights include:

(i) While on the surface most banks in India currently have similar levels of profitability, there are

dramatic differences in the underlying economics. The profitability of the wholesale banking

operations of attackers, i.e., new private and foreign banks, is much higher compared to incumbents,

i.e., public sector and old private banks that mainly rely on their valuable legacy retail franchises.

8

Our analysis shows that access to retail banking deposits is today the biggest driver of retail

banking profitability; in fact incumbent banks enjoy a staggering ROE (return on equity) of about

33 per cent on their retail banking portfolios. Attackers, on the other hand, are investing heavily in

building large-scale retail franchises.

(ii) Our research globally indicates that customer experience is the biggest driver of value. However, in

India customer experience and tailored offerings will be a big driver of bank profitability as young,

affluent customers are more demanding and discerning and are less credit-averse. Our survey reveals

that while attackers have revolutionalised levels of convenience and provide customers with superior

service levels, they also have more customers with “negative experiences”. Further, the research

shows that such customers fragment their wallet more than others leading to inferior economics.

(iii) The survey results show that Indian banks have historically had access to superior talent relative

to other global banks leading to superior organisation performance on average. However, it is well

known that incumbents suffer from a severe lack of specialist skills and new-age leaders. The

survey shows that the extent of the problem is acute and crippling for these banks. They need to

act urgently to attract, hire, develop and retain the best available talent to ensure sustained growth

in the long term. While attackers are doing better on this front, they will also have to deal with

severe talent shortage issues and will need to devise innovative strategies to continue to attract

talent and develop new leaders.

(iv) The Asset Liability Management Survey shows that treasury is a significant contributor to bank

earnings in India. The treasury divisions at Indian banks are integrated profit centres that manage

capital market businesses and credit and market risk. It is encouraging to see that several attackers

have leapfrogged on this front and are using sophisticated risk management techniques on par

with those implemented by global banks. However, risk management practices in public sector

banks are at a nascent stage and simply conform to regulatory and compliance measures.

(v) Indian banks, in particular attackers, have leveraged the nation’s IT skills to establish a competitive

advantage. IT has now become a distinctive capability that these banks can successfully export

to international markets as they globalise. Attackers with best-in-class IT capabilities are truly the

best in the world on account of three factors: the ability to avoid using legacy systems, superior

governance practices that often entail direct CEO involvement, and the India advantage. However,

most incumbents have made large investments in technologies such as core banking solutions,

but have not fully developed strategies to derive value from these investments, e.g., leverage

these investments to upgrade their levels of customer service.

We hope that these findings derived from a robust fact base will stimulate debate and facilitate

informed decision making in India’s banking sector as it aspires to become globally competitive and

continues to grow rapidly in both the domestic and international markets.

Joydeep Sengupta

Director

McKinsey & Company

Renny Thomas

Partner

McKinsey & Company

Banking in India: Towards global best practices

15

Banking in India: Towards global best practicesOver the last four years, India’s economy has been on a high growth trajectory, creating unprecedented

opportunities for its banking sector. Most banks have enjoyed high growth and their valuations have

appreciated significantly during this period. Looking ahead, the most pertinent issue is how well the

banking sector is positioned to cater to continued growth.

A holistic assessment of the banking sector is possible only by looking at the roles and actions of

banks, their core capabilities and their ability to meet systemic objectives, which include increasing

shareholder value, fostering financial inclusion, contributing to GDP growth, efficiently managing

intermediation cost, and effectively allocating capital and maintaining system stability (Exhibit 1).

Exhibit 1

Assessing the performance of the Indian banking sector

Source: McKinsey analysis

1. Return share-holder value

2. Foster financial inclusion

3. Contribute to GDP growth

4. Efficiently manage intermediation costs

5. Effectively allocate capital and maintain stability

Five key objectives

Policymakers

Stakeholders Enablers

Core capabilities• Organisation • Sales and

distribution• Credit and risk• IT and operations

Enabling regulatory environment

Banks

ILLUSTRATIVE

Exhibit 1

16

GLOBAL COMPARISONS INDICATE THAT INDIA’S BANKING SECTOR MEETS ITS OBJECTIVES BUT IS POLARISED

Our survey of 14 leading banks in India shows that banks have done remarkably well in increasing

shareholder value, allocating capital effectively, and contributing to GDP growth (Exhibit 2). However,

in comparison to international peers Indian banks could do more to foster financial inclusion and

manage intermediation costs. Our findings also highlight the clear divide between the performance

of incumbents, i.e., public sector and old private banks, and attackers, i.e., new private and foreign

banks, a reflection of the underlying shifts in the banking sector.

Increasing shareholder value: Indian banks have enjoyed high growth in underlying businesses over

the last three years. Loans have grown at over 30 per cent and deposits at about 18 per cent during

this time. Profitability remains robust at around 18 per cent (pre-tax return on equity), which compares

favourably to that of Asian peers. This up-tick in performance has been handsomely rewarded: banking

stocks have appreciated by over 35 per cent year-on-year from January 2000 to October 2007, outdoing

overall stock-market growth in India as well as that of banks in the region (Exhibit 3).

Fostering financial inclusion: Indian households are among the highest savers in the world, saving as

much as 32.4 per cent of their income. Household savings account for 69 per cent of India’s gross

national savings, significantly more than in most countries. But the financial system has only been

able to access 47 per cent of these savings (Exhibit 4), partly because of geographical fragmentation

that often results in limited reach.

Further, Indian urban centres account for almost 60 per cent of total savings deposits (as of March

2006), despite only 27 per cent of the population residing in 4,000 urban locations. This reaffirms two

widely held beliefs—the potential of customers in urban areas is high and more importantly, there is

need to foster financial inclusion to tap the remaining 73 per cent of customers fragmented across

650,000 villages in India.

Exhibit 2

Banks are doing well on 2 of the 5 objectives


Made significant progress

Need to make significant progress

Made progress

1. Return shareholder value

2. Foster financial inclusion

3. Contribute to GDP growth

4. Effectively manage intermediation costs

5. Effectively allocate capital and maintain stability

Performance on achieving these objectivesFive key objectives of the banking sector

Five key objectives

Policy makers


Corecapabilities


Banks

ILLUSTRATIVE

Exhibit 2

17

Exhibit 3

Indian banks have provided high returns to shareholders over the last few years

India achieved the highest growth in the region and has maintained high profitability . . .

* Growth data for China is from 2001-06Source: EIU; Central banks of various countries; DataStream; McKinsey analysis

Indian banking sector outperformed most banking indices with highest total returns to shareholders . . .

Assets growth

CAGR;FY04-06

Deposits growth

CAGR;FY04-06

Pre tax ROE

Per cent; FY06

18.8

16.1

18.2

9.1

Countries

India

Malaysia

China*

Thailand

18.1

14.5

7.2

17.2 17.9

16.3

15.1

9.1

Per cent, TRS CAGR; Jan 00-Oct 07

0

200

400

600

800

1,000

1,200

Dec-99 Jul-01 Feb-03 Sep-04 Apr-06 Oct-07

Indian market: 24.03

Indian banks: 36.76

Chinese banks: 17.57

UK banks: 9.34

Dow Jones Index: 4.54

FTSE all shares: 7.16

Indian banksIndian marketChinese banks

UK banksFTSE all shares Dow Jones Index

Exhibit 3

Exhibit 4

India's households are among the highest savers; however the financial sector attracts only 47% of total savings

162024

3744

55

69

India France China* Mexico Japan South Korea

United States

* MGI estimate based on 2005 GDP and estimates of flow-of-funds information** Number of ATMs in 2006

Source: Country National Accounts; IMF; McKinsey Global Institute; McKinsey analysis

32.4 18.0 50.4 21.2 26.4 32.8 12.9

Gross national savings ratesPer cent of nominal GDP; 2005

• Only 47% of the total saving is accessed by the financial services sector (2005)

• High geographic fragmentation has meant that banks have not been able to reach a large part of the population– About 34% of total bank branches are

in urban India– There are 19 ATMs per thousand

people in India as compared to 51 in China, 193 in Brazil, and 246 in Mexico**

Household savings as a share of gross national savings

Per cent; 2005

Exhibit 4

18

Contributing to GDP growth: The financial services sector contributes about 5 per cent to the nation’s

GDP. This is line with the ratios in most the developed and developing countries and reflects the ability

of the sector to create employment. Our work suggests that the financial services sector will create

3.6 million direct jobs by 2010. By 2020, this figure could double to over 7.4 million (Exhibit 5) with

the banking sector accounting for one-third of the total, and the insurance and asset management

industries for the remaining.

Managing intermediation costs: Intermediation costs continue to remain high in India as compared

to those in other markets. At 5.1 per cent (the difference between the average cost of lending and

the average cost of raising liabilities), it is also among the highest in the region. Part of the difference

is driven by the cost associated in meeting regulatory requirements. Banks are required to keep a

minimum statutory liquidity requirement (SLR) of 25 per cent and maintain lending to the priority

sector at 40 per cent of total lending. A large portion of funds are thus invested in these low-yielding

assets that contribute to higher intermediation costs on the core lending portfolio. Overall efficiency

is further constrained by low ticket sizes in general (Exhibit 6).

Allocating capital and managing system stability: Indian banks seem to have made significant

improvements in capital allocation. In 2003, 56 per cent of capital was allocated to sectors yielding

low returns, often less than cost of debt. In 2007, however, only 22 per cent of capital was allocated

to underperforming sectors. A much stronger economy accounts for some of the difference, but banks

deserve some credit for a dramatic reduction in non-performing loans between 2003–07 (Exhibit 7).

Exhibit 5

Healthy contribution to GDP and good employment prospects characterise the banking landscape

Source: EIU; RBI; WIM; Hewitt; McKinsey analysis

Indian banking sector’s contribution to GDP is healthy, almost at par with developed countries and better than most peers in the region …

2.5

2.6

4.8

5.1

5.3

6.5China

USA

India

UK

Malaysia

Thailand

Banking sector’s value-added to nominal GDP; per cent; 2006

• Financial services can employ as many as 3.6 million people by 2010 and 7.4 million people by 2020

. . . and has the potential to employ people in large numbers

Exhibit 5

19

Exhibit 6

Cost of intermediation in India remains high

Source: EIU; RBI; WIM; McKinsey analysis

High intermediation costs despite spurt in lending interest rates and deposit rates

Difference between lending rate and deposits, represented by spreadsPer cent; 2007

2.42.9

3.44.0

5.1

India Thailand China USA Singapore

Average lending rate ~13% and deposit rate at 8% in FY07

Driven by • Low overall

efficiency– Small ticket size

• Low operating efficiency

• Regulatory cost associated with– Statutory

requirements for CRR, SLR

– Priority sector lending

Exhibit 6

Exhibit 7

NPAs have reduced dramatically due to improved capital allocation aided by a booming economy

* ROIC = (PAT + (interest payment x (1-tax rate))/total capital employed** Cost of debt = Prime lending rate x (1–tax rate)

Source: RBI; CMIE-Prowess; McKinsey analysis

Sector ROIC* (2003)

Economic growth underpins the return on capital employed across industries…

. . . while non performing loans have declined in the banking sector over the last few years

4.7

14.4

Sector ROIC* (2007)

Total capital employed (2003)

56%

Total capital employed (2007)

22%

44%

NetNPA

GrossNPA78%

Cost of debt** = 7.46

Costof debt** =

9.55

8.1

16.5

Example industries• Paper and paper

products• Steel• Textiles• Hotels and tourism

Example industries• Drugs• Auto• Food and beverage• Petroleum

Example industries• Textiles• Plastic• Rubber• Health services• Inorganic chemicals

Example industries• Paint• Cement• Auto• Drug• Food and beverage

ROIC < cost of debt

ROIC > cost of debt

ESTIMATES

NPAs as a percentage to advances

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2003 04 05 06 2007

Exhibit 7

20

Underlying shifts in the banking sector reveal a clear divide

India’s banking sector is marked by a clear divide between incumbents and attackers covered in

the survey. Another characteristic feature is that, though attackers have been appropriating share,

incumbents have enjoyed better returns in segments such as retail banking.

Between 2000 and 2007, attackers have increased assets from 12 to 26 per cent, profits from 21 to

32 per cent, and market capitalisation from 37 to 49 per cent. They have been rewarded with a higher

than average P/E (price-to-earnings) ratio of 27, compared to 7 for incumbents, and a price-to-book

ratio of 3 compared to 1.0 for incumbents (Exhibit 8). There are good reasons for this trend. Attacker

banks exhibit far higher capabilities—often matching world standards. Our proprietary Excellence in

Retail Banking Survey (covered in chapter 3) reveals the vast differences in capabilities (Exhibit 9).

The picture is more mixed when it comes to returns. While the overall profitability of attackers and

incumbents is similar, at 15 per cent and 14 per cent respectively, there is a striking underlying

difference. Incumbents earn a whopping 33 per cent return on equity in their retail businesses

compared to an average of 16 per cent for attackers. Nevertheless, incumbents earn just a 9 per cent

return on equity on the rest of their business compared to 15 per cent for attackers (Exhibit 10).

While profitability varies widely within the two groups of banks, retail profitability largely depends on

the stage at which banks are investing in building a franchise. The fact that, incumbents enjoy a return

on equity of around 33 per cent (capital allocated using Basel I norm) reinforces that retail banking

adds more value once the franchise is built. Incumbents continue to profit from large deposit bases,

thanks to their legacy distribution networks and franchises. Meanwhile attackers continue to invest

heavily in building a retail franchise and realise a relatively lower return on equity. However, attackers

that have already invested ahead of the competition have begun to reap the benefits of a large

franchise compared to players with smaller franchises.

Exhibit 8

Beneath the surface, significant shifts are taking place in the banking landscape

Share of assets Share of profitsShare of market cap** P/BV P/E

21

79

7,306

2000

32

68

31,230

2007

12

88

1,133

2000

26

74

3,384

2007

37

63

36,356

51

2000*

49

298,849

2007*

Rs crore; per centRs 000 crore; per cent

* As of 29 March 2007; market cap for banks not listed in FY00 imputed using a price to book value of peers** Foreign banks not included in market cap analysis as they are not listed

Source: CMIE-Prowess; DataStream; Bloomberg; annual reports; McKinsey analysis

3

1 7

27

Times; 2007 Times; 2007

Incumbents –old private and public sector banks

Attacker –new private and foreign banks

Rs crore; per cent

Exhibit 8

21

Exhibit 9

Distribution efficiency

Marketing and sales

Processing and IT

Credit policy and skills

* Ranked on a scale of 0-4, 0 being the lowest and 4 being the highestSource: McKinsey & Company Proprietary Excellence in Retail Banking survey of leading banks in India

Corporate leadership

Capabilities contrast dramatically – attackers demonstrate global capabilities while incumbents lag behindRankings*; 2007

2 3 4

Incumbents

Top 10 global banks

Attackers

Indiaaverage

Asian max

ERB EXAMPLE

Exhibit 9

Exhibit 10

Per cent; 2007***

Share of capital employed Share of profits

Post tax – return on equity**

Legacy of branch networks and retail deposits of incumbents are levelling the playing field

* Rest of bank includes all activities other than retail, like SME, wholesale, treasury, after adjusting for excess capital** Return on equity using regulatory capital requirement of 9%; Asset income includes capital benefit and deposit income includes third

party distribution income*** Data for banks from our excellence in retail banking survey database

Source:Annual reports; RBI; McKinsey analysis for top Indian banks in our Excellence in Retail Banking survey

3763

50

50

3367

40

60

32

68

47

53

Attackers

Incumbents

15

14Overall

Retail

Rest of bank* 8

16

33

15

65

38

Split of retail revenue from deposits

ESTIMATES

Exhibit 10

22

Incumbents earn as much as 65 per cent of their retail revenue pool from deposits, as opposed to

attackers, who earn 38 per cent from it. Retail deposits are a huge driver of profit and could be seen

as a separate profit centre, not only a source of funds for the lending. But the incumbents can’t rest

easy. A large part of the rest of the business—wholesale banking and treasury—is rapidly globalising

and is an area where attackers have begun to dominate.

CORE CAPABILITIES OF BANKS IN INDIA: ACTIONS NEEDED ON MULTIPLE DIMENSIONS

In view of the sharp divide in Indian banking, it is imperative to assess attackers’ and incumbents’

core capabilities. Our survey reveals several areas in which banks belonging to both categories display

scope for improvement (Exhibit 11).

Organisation: Imperative need to strengthen leadership and talent

An assessment of the organisational capabilities of banks in India using McKinsey’s proprietary

Organisational Performance Profile Survey indicates that Indian banks on average have benefited

from superior organisation performance relative to banks in other markets given their historic access

to superior talent. However, today, incumbents need to strengthen their organisations on several

dimensions. At present, the low motivation and skills are of particular concern, and if not addressed

could prove “crippling” for these organisations (Exhibit 12).

A challenge both types of banks face is people development, although it is a particularly acute one

for incumbents. Close to 80 per cent of responses from incumbents indicate that recruitment, people

development, and retention require urgent attention (Exhibit 13).

Exhibit 11

Real capability levels of incumbents and attackers differ significantly


ILLUSTRATIVE

Sales and distribution2

Organisation1

Credit and risk3

Information technology and operation4

Incumbents Attackers

Low levelof capability

High levelof capability

Five key objectives1. Return shareholder

value 2. Foster financial

inclusion3. Contribute to GDP

growth4. Effectively manage

intermediation costs5. Effectively allocate

capital and maintain stability

Four key capabilities

Policy makers


Corecapabilities


Banks

Exhibit 11

23

Exhibit 12

Incumbents (7)n = 586 Direction

61%

ExternalOrientation75%

Accounta-bility68%

Capability82%

Leadership74%

Direction81%

ExternalOrientation81%

Innovation72%

Accounta-bility83%

Capability83%

Motivation82%

Leadership81%

Attackers (7)n = 438

Environ-ment and values60%

Environ-ment and values74%

Distinctive (85%+)Superior (70-85%)Common (50-69%)Not effective (0-49%)

Attackers display superior organisation and performance attributes, incumbents fall short on a few

Source: McKinsey & Company Proprietary Organisation Performance Profile survey of leading banks in India (n = 1,024)

Per cent responding strongly agree or agree; 2007

Coordina-tion and control73%

Motivation57%

Innovation53%

Coordina-tion and control76%

-20%

-7%

-14%

-15% -3%

-1% -25%

-19%-6%

(Incumbents – Attackers)

Exhibit 12

Exhibit 13

Talent and people development will be the biggest challenge for Indian banks, particularly for the incumbents

The company continually refreshes its talent pool by recruiting top performers from outside the company to fill key roles

1

The company proactively identifies and mines the best external sources of top candidates

2

The company attracts highly talented people3

The company extends financial incentives to motivate employees at all levels

4

15

22

26

13

62

69

51

54

Organisation performance parameter Performance level

Source:McKinsey & Company Proprietary Organisation Performance Profile survey of leading banks in India (n = 1,024)

Per cent responding strongly agree or agree; 2007 Incumbents

Attackers

Exhibit 13

24

Sales and distribution: Driven by innovation

Attackers have innovated considerably in the area of sales and distribution. They rank higher than the

best global banks in effective multi-channel management and the development of future channels, and

also score high on the aggressive use of remote channels, to the extent that their branch interactions

are lower by a third compared to incumbents. Attacker banks could use innovative and efficient alternate

channel management capabilities to gain a competitive advantage as they globalise (Exhibit 14).

On average, attackers score higher than incumbents on customer service. But customers also report

more negative experiences with these banks than with incumbents. This shows that as customers

become more discerning, their expectations rise. Attackers in India must enhance customer service

to dissuade these customers from fragmenting their wallet by increasing the numbers of banking

relationships. Our survey shows that customers reporting positive experiences with banks have

relationships with 2.4 financial institutions; while those reporting negative experiences on average

have relationships with 2.7 financial institutions (Exhibit 15). Further, the emergence of newer customer

segments, such as affluent and young professionals, will drive demand for superior banking services.

Credit and risk management: Long way to match global standards

Overall, banks in India seem to be managing risk well. But, once again, attackers perform better than

incumbents on this front. This suggests that incumbents risk market disfavour, reflected by the higher

chance of adverse portfolio selection (Exhibit 16). Incumbents will need to strengthen credit risk

management, particularly their funding and liquidity practices. Our survey showed that, on the whole,

they lack advanced early warning systems and use only basic funds transfer pricing methodologies to

conform to regulatory and compliance measures (Exhibit 17).

Exhibit 14

Attackers compare favourably against global peers on distribution efficiency*

Attackers in India have pioneered global standards of innovation in distribution

3.2

3.6

Branch capacitymanagement

3.43.3

Effective use of direct channel

3.1

2.6

Multi-channelmanagement

3.3

3.1

Development of future channel

* Scale of 0-4, 0 being the lowest and 4 being the highestSource: McKinsey & Company Proprietary Excellence in Retail Banking survey and Personal Financial Services survey

3.8

4.2

1.9

0.9

0.4

0.9

34.057.0

Branch

55.039.0

ATM

Telephone

Mobile

Top 10 global banks

Attackers have a higher usage of alternate channels, whereas incumbents continue to leverage their branch network

Per cent using a particular channel

Internet

Incumbents

Attackers

Exhibit 14

25

Exhibit 15

8471

6170

6875

IncumbentsAttackers

While existing service levels are perceived as high, increasing customer demands will put pressure on banks

The waiting time at the branch office is reasonable

Problems areresolved by the first person I speak with

The company delivers on its promises

“Have you had any negative experience with your bank in the past 2 years?”

Negative experience leads to use of more financial institutions

1

2

3

New emerging segments likely to drive need for superior services• Affluent customers• Young professionals

2.4

2.7

People with positive momentsof truth

People with negative moments of truth

Average numbers of financial institutions used

8

12

IncumbentsAttackers

Source:McKinsey & Company Proprietary Personal Financial Services survey

Per cent responding strongly agree or agree; 2007

Exhibit 15

Exhibit 16

Attackers

Incumbent

Indian banks compare favourably against global credit and risk best practices

. . . However, incumbents lag behind significantly*

3.2

2.3

3.4

2.6

3.1

2.1

3.3

2

Credit underwriting, rating and scoring

* On a scale of 0-4, 0 being the lowest and 4 being the highest Source: McKinsey & Company Proprietary Excellence in Retail Banking survey of leading banks in India

Risk-based pricing

Credit portfolio management

Credit monitoring workout

3.13.2

Top 10 global banks

Asian max

2.8

Incum-bents

3.3

Attackers

Attackers exercise best-in-class credit skills and policy* . . .

Exhibit 16

26

Exhibit 18

On technology the best banks in India are among the most efficient in the world

US$ 000s; 2007

* Accounts include only deposit accounts** Sample set of best banks in India includes 5 leading private and foreign banks

Source: McKinsey & Company Proprietary IT Benchmarking survey of leading banks in India; McKinsey analysis

ESTIMATES

IT spend/ banking FTE

2.4

6.2

21.2

9.1

Network spend/ access point

7.0

11.9

11.7

n/a

Desktop + helpdesk spend/ desktop

1.5

0.4

0.5

1.0

IT spend/1,000 accounts*

10.2

15.9

n/a

76

Best Indian banks**

Sampleaverage

India

European bank average

Exhibit 18

Exhibit 17

33

67

0

63

12

25

88

8

4

Overall funding and liquidity practices will need strengthening

Incumbents lack advanced early warning systems and contingency plans . . .

17

33

38

50

33

42

Formal contingency plan

Formal contingency plan including escalation process with increased severity of stress

. . . and significantly lag behind attackers in the use of advanced FTP methodology

Single rate (one rate applies to all)

Matched-term funding rates

Multiple rates (different rates apply to different B/S items)

Source: McKinsey & Company Proprietary Asset Liability Management survey of leading banks in India

Percentage of respondents; 2007

Top 10 global banks

Incumbents

Attackers

Exhibit 17

27

IT and operations: Opportunity to leverage competitive capabilities globally

In technology, select private and foreign banks in India are among the best in the world, spending

less than US$11 per account on IT systems and services, compared to an average spend of

US$76 per account in European banks. This has been achieved by avoiding legacy systems, using

distributed computing, and benefiting from India’s lower cost talent pool. While there are still areas

for improvement, Indian banks can export these capabilities (low-cost technology platform) as they

globalise (Exhibit 18).

Our methodology

109

Our methodologyMcKinsey & Company, with support from the Indian Banks’ Association, profiled 14 leading banks in

India, using five proprietary surveys to assess how well their capabilities meet global best practices.

The five surveys we administered are: the McKinsey Personal Financial Services Survey; Excellence in

Retail Banking Survey; Organisational Performance Profile Survey; Asset Liability Management Survey;

and IT Benchmarking Survey. Our survey findings were compared with the results of the corresponding

five surveys administered across global banks. The comparisons allowed us to determine how Indian

banks perform vis-à-vis global counterparts. Below, we describe each of the surveys and the methodology

that we followed.

PERSONAL FINANCIAL SERVICES

The proprietary McKinsey Personal Financial Services Survey is one of the largest customer surveys in

Asia. It is administered across 12 Asian markets and captures customer data from multiple customer

segments, e.g., affluent and mass affluent.

To assess consumer needs, attitudes and behaviours in personal financial services (PFS), McKinsey’s

Asia-Pacific PFS 2007 survey profiled over 13,000 customers across 12 Asian countries in 2007. The

survey collected quantitative data through 60-minute, face-to-face interviews with customers, who were

asked over 150 questions. It spanned all key customer segments and product markets. In India, the

survey covered over 5,300 customers from urban and rural segments. The India survey also offered a

basis for comparison with the results from 36,000 profiles available through four such surveys carried

out in India by McKinsey since 1998.

EXCELLENCE IN RETAIL BANKING

Excellence in Retail Banking (ERB) is a McKinsey approach for assessing the linkages between strategy,

capability and performance in retail banking. The overall performance of banks is assessed along

five dimensions: corporate leadership and performance, marketing and sales, distribution efficiency,

processing efficiency, and credit policy and skills (Exhibit 1).

The survey consisted of two stages. In the first stage participants ranked themselves on a scale of

zero to four across 32 competencies reflecting the five dimensions of excellence (zero being the lowest

and four the highest score). During the second stage, participating banks provided information on their

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retail deposits, loans, fee income, operating costs (across branches, other channels, back offices and

other areas) and credit losses. To assess true profitability and return on equity, we transfer priced

revenues both on the deposit and loans side based on market clearing rates, and attributed costs

and provisions based on data collected from the banks. In addition, we attributed capital using Basel

I norms.

Using this proprietary ERB methodology, we assessed retail banking practices, operating efficiency,

growth and profitability. We then compared the findings with those of over 100 leading banks across

the world surveyed earlier.

For the purposes of analysis, we grouped the 14 banks according to the inherent growth of the franchise

(measured by annual growth in total retail deposits plus retail loans over three years) and overall

profitability (measured by the cost-income ratio).

ORGANISATIONAL PERFORMANCE PROFILE

This proprietary survey evaluates the effectiveness of an organisation in achieving its vision and

aspirations. The Organisation Performance Profile (OPP) Survey has covered over 100,000 participants

from over 400 global organisations so far. The resulting database of over 100,000 respondents was

cleaned, normalised (to address language and cultural barriers) and tested using rigorous methodologies

to validate the soundness of the outcomes. All standard tests on the integrity and robustness of our

data (e.g., Cronbach’s alpha) were run. An exhaustive set of OPP frameworks was tested and refined

using data from these surveys and data available on the financial performance of these organisations.

The results of these tests have confirmed the reliability and validity of the survey tool.

The Organisation Performance Profile Survey was administered with over 1,000 senior managers at the

participating banks. Their responses were then compared with responses in our global database.

Exhibit 1

Excellence in Retail Banking

Superiorcredit policyand skills

Corporateleadership for performance

Highly

developed

marketing

and sales

competence

Differentiatedand efficient distribution

Highly efficient processesand IT

Source: McKinsey & Company Proprietary Excellence in Retail Banking framework

Defining the excellence in retail banking methodology

Exhibit 1

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The survey examines three drivers of organisational performance: alignment, execution and renewal.

Alignment indicates a shared understanding of where an organisation is headed, what its purpose and

strategy is, and how supportive its internal environment is, including culture and interactions, to help

employees achieve its overall vision and aspirations. Strong alignment is one of the key attributes of

an effective organisation.

Alignment is assessed by measuring responses to statements related to the following attributes of an

organisation:

Direction: People understand and are aligned with the company’s vision or strategy and how it is to be

achieved.

Leadership: Leaders at all levels inspire employees and shape their actions to achieve better

performance.

Environment and values: The quality of employee interaction (e.g., culture, workspace design) fosters

a shared understanding of core values. This is usually achieved by sufficient collaboration and

transparency, and process-driven efficiency and consistency.

Execution was assessed through responses to statements about outcomes and supporting

practices:

Accountability: Reporting relationships and the performance assessment process ensure that people

are accountable for results.

Capability: Internal skills and talent are sufficient to support the company’s strategy and to create a

competitive edge.

Coordination and control: Business performance and risk are measured and reported.

Motivation: Employees are inspired to perform and encouraged to stay with the company.

Renewal is a key attribute of an organisation’s performance and is revealed by how the organisation

understands, interacts, responds and adapts to its situation and external environment. The survey

gathers responses on how organisations are performing on each of these attributes:

External orientation: Constant two-way interaction takes place between the organisation and customers,

suppliers, partners, or other external groups that help create value.

Innovation: A flow of ideas and change ensures that the organisation can sustain itself, survive and

grow over time.

The survey measures how organisations are doing on several aspects of organisational performance by

capturing two distinct but related elements of performance: outcomes and practices (Exhibit 2). It is

made up of two parts. In the first, respondents are asked to rank their company’s effectiveness on nine

predefined outcomes of organisational performance. In the second, respondents’ views are probed on

actions or practices that can be used to achieve each outcome.

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ASSET LIABILITY MANAGEMENT

The Asset Liability Management (ALM) Survey is based on McKinsey’s proprietary methodology to

assess banks across six key parameters—strategy and philosophy, organisation policy and governance,

structural market risk and capital, fund transfer pricing, funding and liquidity management, and systems

(Exhibit 3).

Exhibit 2

Defining the methodology used to assess the organisation’s performance profile

Direction

Coordinationand control

Account-ability

Externalorientation

Innovation

Capability Motivation

Environmentand values

Leadership

Organisation performance profile Performance culture comprises of9 outcomes, grouped into 3 clusters

Alignment

Where is the organisation headed, what is its purpose and strategy, and how supportive is its internal environment?

Execution

How does the organisationexecute against its strategy and deliver its services?

Renewal

How does the organisationunderstand, interact, respond, and adapt to its internal and external environment?

Source: McKinsey & Company Proprietary Organisation Performance Profile framework

Exhibit 2

Exhibit 4

Asset liability management best practices fall into 6 key areas

ALM best practices

Source:McKinsey & Company Proprietary Asset Liability Management Survey framework

1. Strategy and philosophy

6. Systems

2. Organisation, policy and

governance

5. Funding and

liquidity management

3. Structural market risk and capital management

4. Funds Transfer

Pricing(FTP)

Exhibit 3

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Strategy and philosophy: A bank’s risk management practices are guided by its risk strategy and

philosophy. We considered a bank’s ALM philosophy (e.g., profit versus cost centre), risk appetite,

integration with enterprise risk management and business strategy, and hedging strategy and policy.

Organisation, policy and governance: To achieve best-in-class ALM practices, banks must have a basic

organisational structure and responsibilities (risk group, treasury, ALCO) in place. Such arrangements

are necessary to establish risk policies and limit structures, to assess performance management and

incentives, and to review and audit procedures.

Market risk and capital management: Managing market risk is one of the most important functions

of ALM. Risk management techniques to manage different of types risks and processes—interest

rate risk and foreign exchange risk, hedging approaches and choice of instruments, and reporting and

monitoring—are assessed in this part.

Funds Transfer Pricing: As part of this parameter, we looked at the FTP methodology, FTP processes

and reporting, and monitoring of the FTP system.

Funding and liquidity management: This is the second most important function of ALM and it

encompasses funding and liquidity management processes, and balance sheet optimisation and yield

management.

Systems: Well-managed risk processes require suitably designed IT infrastructure. The system

architecture needs to facilitate risk measurement and control. Front- and back-end support is required

for the effective execution of risk processes.

Similar benchmarking initiatives were undertaken over the last few years across many financial

institutions worldwide—this allows for further comparisons across the stated parameters. The results

from the survey were benchmarked against those of our Global Treasury and ALM Survey conducted

across 30 leading institutions worldwide in late 2006.

IT BENCHMARKING

The IT benchmarking survey is based on McKinsey’s proprietary methodology to assess a bank’s overall

IT capability. It measures IT performance in banks along the following four dimensions (Exhibit 4):

Spend allocation: Total spends on technology are analysed by category, activity, and frequency (whether

recurring or one-time) to ascertain how much is invested and spent, in which areas, and for what

return.

Value creation: The survey assesses alignment of IT systems with corporate objectives to determine if

the right sets of activities are chosen to create business value from investments.

Solutions: The survey assesses whether the chosen solutions provide utility with minimal complexity.

Delivery: The survey probes for strong governance and management processes, development of in-

house talent and the right sourcing to determine how well the change and steady-state solutions are

being managed, measured, and delivered.

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Exhibit 5

The IT benchmark measures how technology enables business performance along 4 dimensions

• Current value creation• IT alignment with corporate

objectives

• IT spend effectiveness and intensity

• IT spend allocation

IT valuecreation

IT delivery

ITsp

end

Businessperformance

ITso

lutions

• IT governance• IT management processes• IT talent management• Sourcing• Productivity

• Application complexity management • Infrastructure complexity management• Cross-border consolidation for regional

banks

How does IT add value to the business and to what extent?

How effective are the chosen solutions?

How well are the change and steady-state solutions managed, measured, and delivered?

How much should be invested and spent, for what return and in which areas?

Source: McKinsey & Company Proprietary IT Benchmarking framework

Exhibit 4

India Banking Overview

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