India’s state-owned banks compete with private firms

India: The State they’re in

Milking the finance ministry

IF A BANK’S success could be judged by its in-house dining, State Bank of India might be top of the list – by 1970s’ British standards.

On an executive-level floor whose decor also suggests the decade of Opec’s birth, Euromoney is munching on grey peas, mushy broccoli, and some cruelly battered fish.

Across the table sits Om Prakash Bhatt, chairman and managing director of State Bank of India. We are talking about the inauguration by finance minister Palaniappan Chidambaram of State Bank’s 10,000th branch. It happened this March in Puduvayal, a village in Tamil Nadu, in the finance minister’s parliamentary constituency.

"We are opening more than 1,000 branches a year. We are opening branches across the country in almost every district and almost every day," says Bhatt.

If one counts the 4,500 branches operated by the group’s subsidiary institutions that it is trying to merge into the parent, State Bank has about 14,500 branches in India. Worldwide, only Industrial and Commercial Bank of China (ICBC) has more.

State Bank is breaking other records. Its hiring of 22,000 people this year might be the biggest recruitment drive of any bank in the world, ever. A staggering 2.5 million people have applied for the jobs, according to Bhatt. State Bank already has almost 180,000 employees. The bank also plans to have a presence of some sort (through branches, ATMs, or biometric smartcard terminals installed in local stores) in 100,000 of India’s 650,000 villages, within two years.

Are things any different from the 1970s, when prime minister Indira Gandhi nationalized banks, and the Reserve Bank of India, the central bank, told them to open in almost every single village they possibly could?

Today, private Indian companies are buying assets around the world. But one news agency reports the finance minister urging his audience in Puduvayal to "remember Indira Gandhi whenever you take loans and repay them."

Public service ethic

Pay is the main reason India’s government banks could struggle further. State-owned Chinese banks, such as ICBC, now motivate staff with market-linked salaries. Ten years ago, their top executives received tiny salaries set by the government.

Top executives of State Bank and other public lenders in India are still in a similar position. They receive roughly the same amount as a newly recruited graduate at an Indian privately owned bank such as ICICI or Kotak. That means State Bank’s chairman earns about $1,000 a month.

Still, these government bankers do find some incentives.

"There is something called status that is much beyond money. A public-sector chairman has higher status than a private-sector chairman," says KR Kamath, executive director of government-owned Bank of India.

One non-salary benefit government-bank top brass enjoy is a chauffeur-driven car. It might not always be a luxury brand. State Bank’s chairman has a Toyota. Executives might also get membership of exclusive clubs. Their healthcare is paid for, and they get housed in legacy properties, often in desirable areas of town.

So there might be a faded glamour that comes with being one of these government-appointed, state bank executives: an old-fashioned, second-hand glory, perhaps ultimately rubbed off the ruling Congress Party’s president, Sonia Gandhi – the widow of the son of Indira Gandhi.

But the bad news for the public banks is that nowadays such status is not enough to attract the brightest graduates, who are more enticed by what gains more respect in the new India. Indeed, if such perks were given monetary value, most executives at the public banks would probably still earn less than one-third of the salaries of their private-sector equivalents.

Teaching old dogs new tricks

Today, India has only one bank in the world’s top 100 by assets: State Bank, which ranks about 80th. China, with a similar population, has four banks, all state-owned, in the top 30. Even after a decade of rapid growth, bank credit relative to GDP is still far lower in India than in other emerging markets.

The public-sector banks, which hold some 70% of deposits in India, have updated their technology over the past few years. Many of their branches, especially in poorer areas of the country, look fairly run-down and basic. But almost 85% of branches are now fully computerized. Furthermore, branches connected to a centralized operating system now cover 80% of public-sector banks’ business. This makes it easier for the state banks to divide their operations into product types rather than geographic regions.

State banks are trying to stop new private banks such as ICICI eating into their market share by copying their techniques: in other words, by using labour freed by technology to go out and sell their products. Certainly, advertisements for the state banks are being shown up and down the country. Some, however, say the technology at the state banks is under-used because of the bank’s legions of ageing employees, who are stuck in their ways.

Just as loss-making branches are almost never shut down, the civil servant employees of state banks are almost never laid off. "We don’t fire anybody," says one State Bank employee.

The result of this is an average age at many government lenders, including State Bank, of almost 50, compared with lower than 30 at ICICI. Private banks’ customers are younger, too. Profits per employee at the private banks are about three times as much as at the public-sector banks.

Nevertheless, the biggest and the best public banks are tapping new sources of income. State Bank of India, for example, posted profits up almost 50% last year, and that at a time when interest rate increases were bringing down profits from its government bond portfolio.

"We have lent more to retail, where the yields are higher. We are also focusing more on fee-based income," says Bhatt. "For example, we cross-sell far more of the mutual funds and life products of our financial services subsidiaries in our branch network. Fee income from cross-selling such products almost doubled last year, and we are hoping to double it again this year." SBI’s chairman encourages his employees to sell more of these products as far as he can with the 1% of net profit that state banks are allowed to spend on staff incentives. Trophies, holidays and gold coins are the new goodies awaiting his best performers.

International tie-ups

Other public banks are following State Bank’s example. Many of them already sell third-party products such as mutual funds and the unit-linked life insurance that is so popular in India. Now, though, more and more of India’s state banks are teaming up with foreign insurance and asset management firms to help the state banks design their own tailor-made products to distribute in their vast branch networks.

State Bank of India’s joint venture with French insurer Cardif, which it may list next year, is already more than five years old. Its joint venture with Société Générale Asset Management is three years old. However, it was only this July that the first board meeting took place for a new joint venture between Mumbai state lender Bank of Baroda and UniCredit’s asset management subsidiary Pioneer. The first board meeting for Bank of Baroda’s insurance joint venture with Britain’s Legal & General also took place in July.

Last year, Dutch asset manager Robeco teamed up with Bangalore-based state bank Canara to sell mutual funds that HSBC will help manage. HSBC also set up a life insurance joint venture with Canara Bank and Oriental Bank of Commerce, another Indian state-owned bank, last year.

Government-owned Union Bank of India will shortly sign an agreement to distribute mutual funds specifically designed for it by Belgium’s KBC, according to the bank’s executive director. Union Bank is also a minority partner in a life insurance joint venture with Bank of India and Dai Chi of Japan. RS Reddy, executive director of Union Bank, says it is hoped the first policy will be sold by the end of the year.

Punjab National Bank, which has 4,500 branches, will be looking for a joint-venture partner to design such products for it soon, according to the bank’s chairman.

One advantage of these joint ventures is that their employees can be paid much more than staff in the main bank. For the international firms, it can be a way to get around the restrictions the central bank places on accessing India’s massive retail market.

Branch expansion programmes were a hallmark of India’s public-sector banks after Indira Gandhi’s Bank Nationalization Act of 1969. Thanks to her government, and the central bankers that worked alongside it, some of the most undeveloped regions of India already have liberal sprinklings of bank branches.

The present finance minister has also expressed a wish for India to bring its overall number of bank branches to 100,000 from 70,000. Bringing credit to the poor, it seems, is a vote winner.

Last year, State Bank of India opened 1,000 branches, and it plans to open 2,000 this year. With their technology updated and fewer non-performing loans, state banks are ready to start expanding again. But what is the ultimate motive: social inclusion or profit?

Targets set by the central bank require Indian banks (both public and private) to allocate at least 40% of their loan books to priority sectors, including at least 18% to agriculture. Moreover, according to deputy governor Vittaldas Leeladhar, who handles the central bank’s responsibilities as the financial services regulator, branch licensing is done in such a way that 50% of new bank branches are established in areas where the proportion of bank branches to population is lower than the national average.

"We should reach rural areas. We should liberate people from [informal] moneylenders," Leeladhar tells Euromoney. "You are not opening a branch just for getting profits. In underbanked areas, it may take some time for the business to come," He adds: "In a rural area you cannot expect a new branch to be profitable within one year."

Still, when asked about Bank of Baroda’s branch expansion programme, Satish Gupta, the bank’s joint executive director, says: "It is a commercial consideration." Similarly, State Bank’s Bhatt says: "This is about positioning the bank for a more profitable future." Overall, the 1,000 branches State Bank opened last year have already been profitable, he says.

Part of the explanation of banks’ motivations – at least as far as public-sector branch expansions are concerned – might be that India’s banking industry has reached a point at which banks will choose to go to rural areas, as banks are doing elsewhere in the developing world, because those areas offer the best growth opportunities. With the availability of low-cost ATMs and biometric smartcard readers that can be used in village stores, even the foreign banks (which do not have any priority-sector obligations to agriculture) are looking to the Indian countryside with more interest. But will the banks want to go to the most needy rural areas, or the ones that present the best business opportunities?

Money for nothing

In the early part of this decade, half a decade after new privately owned banks were allowed to open, most public sector banks floated minority stakes on the stock market. So not only do they have to compete with more aggressive private-sector banks, they must deal with two types of stakeholders with different objectives: the government, whose main aim is to get re-elected; and private shareholders, whose main concern is financial return.

One example of a possible conflict of interest here is perhaps the $15 billion farm-loan-waiver programme the finance minister announced in his budget this February – a policy some think was instigated by Sonia Gandhi. In reaction to a wave of suicides by indebted farmers, the government said it would write off debts owed by farmers who have less than five acres of land. Partial write-offs were also promised to farmers with bigger plots.

"Clearly, the budget proposal is a populist move in a pre-election year by the finance minister," says research from Mumbai-based investment firm Edelweiss.

Public-sector banks are central to this policy because they are responsible for almost all of the loans to farmers (38% of public-sector bank branches are in rural areas compared with just 5% of branches of the new private banks). The banks have been promised complete monetary compensation for the loans written off. But there are worries that the write-offs will make it more difficult for banks to collect loan repayments from small farmers in the future. "Farmers might expect a loan waiver every five years," says Vishal Goyal, an analyst at Edelweiss.

Such concerns, according to Aditya Narain, head of research in India for Citi, have been reflected in the stock market, where the publicly owned banks have been particularly badly affected by this year’s correction.

The central bank has proposed setting up a working group to investigate the credit culture of the banks, and to suggest steps to improve this if it is found to have deteriorated. But borrowers whose loans were overdue will still get a clean slate, which could undermine previous campaigns to make it clear to villagers that timely repayments result in bigger loans in the future.

Unhealthier than they look

Vittaldas Leeladhar might well have a soft spot for the public-sector banks. The deputy governor ran a number of state banks before joining the Reserve Bank of India. Most recently, he was the chairman of Union Bank.

"The public-sector banks are doing a good job," he says.

To illustrate the health of the public-sector banks, Leeladhar points out that their non-performing loans constitute only about 1% of their loan books, whereas 10 years ago they were almost 10%. The Indian banking system as a whole has an average capital adequacy ratio of more than 13%, against a central bank minimum of 9% and a Basle II minimum of 8%, he points out.

Asked how state banks have been able to clean their loan book so dramatically, Leeladhar mentions the low interest rates that prevailed in the past few years, which boosted profits from the bank’s relatively large government bond portfolios. He also mentions their higher fee income and says that legislation at the beginning of the decade made it easier for banks to recover bad loans.

With interest rates rising over the past two years, public-sector banks have had to use some of the Investment Fluctuation Reserves that the central bank insists they build up during periods of low interest rates. Higher inflation this year at the same time as a stock market correction would seem to signal that the state banks might have to cope with even smaller treasury profits – especially as mark-to-market rules are being more stringently imposed.

Leeladhar says: "They still have capabilities of absorbing shocks." But whatever may happen in the future, capital adequacy and non-performing loan ratios certainly look much worse at the Chinese state banks than at those in India.

And yet this is part of the problem: the public-sector banks that dominate financial intermediation in India are good at collecting cheap deposits from their branch networks and then lending the money out to the government by buying treasury bills. They are less good at lending to relatively risky borrowers. Borrowers from the state banks have to contend with corruption, exacting paperwork demands and bank managers with powerful bank- and government-based monitoring commissions breathing down their necks. This means that most loans are still obtained from the usurious hands of informal moneylenders – loans that will still have to be paid, despite the government’s farm-loan-waiver scheme.

Mission unaccomplished

Ranjana Kumar, the central vigilance commissioner for banking, describes her position as being similar in seniority to a supreme court judge. She tells Euromoney that there is less corruption in the banking system than five years ago, in part because of investments in technology and risk management.

But it would seem such improvements, combined with the monitoring and investigatory powers of the Central Vigilance Commission, are still insufficient to stop public-sector bank officials demanding bribes to supplement their meagre wages. In a survey of poor households released this summer by corruption watchdog Transparency International, 42% of respondents felt that staff in banking services indulge in corrupt practices or remain absent from their desks during office hours. Procedural delays were among the main causes of inconvenience cited by householders.

Such luxuries as time, collateral and even money for bribes are things many Indians cannot afford. And, according to Raghuram Rajan, who submitted a government-commissioned report earlier this year on financial-sector reform, the inability of many rural Indians to access credit from state banks undermines those banks’ raison d’être.

"The argument offered when these banks were nationalized was that they weren’t offering credit to the needy sectors of society: the poor, the small and medium-sized enterprises, and so on," the former chief economist at the IMF and now professor of finance at the University of Chicago says. "But because of bureaucratization and their very large size, it is very hard for these banks to make the kind of loans that the very poor need. If, for example, a man in a village needs money for medicine for a sick child, he won’t get the money from a state-owned bank. He would need proof, some collateral, something to pledge, none of which he will be able to get fast enough. So what does he do? He goes to the moneylender." Government banks, government problems

State Bank of India is basically a branch of India’s notoriously sprawling civil service, a bit like the railways. Can anything be done to make State Bank and other Indian government banks more nimble?

Rajan puts forward a number of ideas in his report. He suggests experimental privatization of small underperforming banks. He also suggests that the government should own the banks through holding companies to free them from the added oversight (for example on pay and from the Central Vigilance Commission) that comes with being a public body.

These suggestions, according to Duvvuri Subbarao, the government’s finance secretary, were made bearing in mind the political difficulties of divestment. Indeed, far from a green light having been given to privatization, even minor financial reforms by the present government have been stalled by the support the Congress Party’s coalition received from the Left Front to help build a majority. The Left Front withdrew its support for the coalition this summer because of its aversion to an India-US nuclear energy deal.

But the six months or so before the next election will probably not be enough to make any of the changes the public banks might need. Reform would need to be made through a new parliament, where the Left Front might also wield power. Even if the Left Front loses a lot of seats, it is far from certain that the main parties will make changes in ownership.

Leeladhar says the central bank has not yet looked into facilitating a carbon trading-style market in fulfilled priority sector obligations, something Rajan suggests would enable individual banks to focus on what they do best. When asked about another of the report’s proposals, Leeladhar says: "The report may say anything."

But is this, I ask him, the danger: that this report, like others before it, simply gets ignored?

"It is not fair to say that reports are being produced and nothing is happening. The Narasimham Committee reports changed the face of banking in India," he says.

It was indeed in part thanks to the Narasimham Committee that new private banks such as ICICI were allowed in the mid-1990s, subsequently becoming big players. But Leeladhar does not mention that the Narasimham Committee, more than a decade ago, also suggested that the government reduce ownership in public banks below 50% (while maintaining its control). Public banks today still contend with a 51% minimum government ownership. State Bank has to be 55% publicly owned.

In that respect, India’s public banks are in much the same position as they were three decades ago.