KPMG CII Indian Banking

Indian Banking
Maneuvering
through Turbulence:
Emerging
strategies
Foreword CII
During the last two decades of

unshackling its chains, the elephant
that is Indian economy seldom came
across such challenges as it does
now. The twin tasks of reinvigorating
economic growth and reining in
inflation during the times of dwindling
rupee value, weak global demand
and persistent current account deficit
present a mesh of problems that need
immediate and coordinated actions on
the fiscal and monetary front.
Indias economic growth that sunk to
a decade low of 5 percent last year
continues to plague the economy. While
the performance of key sectors such
as manufacturing, farm and mining
are below par, the reforms process
that began last year failed to generate
enough momentum to restore the
growth figures.
Against this backdrop, the banking
sector has an important role to play in
stimulating economic growth. Banking,
arguably the fulcrum of our financial
system, is a sector that can really help in
deploying our national savings towards
infrastructure development. This will in
turn stimulate economic activity on one
hand, and help sustain a high growth
rate on the other.
The central bank has taken several

policy initiatives on compliance and
governance something that could
redefine the contours of the sector and
benefit the economy in the long run.
The volatile economic scenario has
forced banks to try various business
models either to increase their
bottomline or manage risks better.
Adoption of new technologies and
a constant pursuit of innovation to
improve products and services will be
crucial.
Sudhir Deoras
Chairman
CII Eastern Region
In this context, KPMG as our knowledge

partner for Banking Colloquium 2013 has
prepared a report. The study attempts
to capture the current scenario and
detail of the strategies being adopted
by banks, way forward to compliance
and governance, financial inclusion,
technology in banking, market risk
hedging and proposed new banks.
We hope the report will help the
industry understand the emerging
strategies needed to maneuver through
these times of turbulence.
The bigger the challenges, more is the

need for innovative ideas and strategies
by bankers to counter risks. Banks also
have a larger role to play in increasing
financial inclusion. Proposed licenses
for new banks raise hope for increased
penetration and enhanced credit
availability.
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
Foreword KPMG
Banks face challenges from many

sourcesIndian economy slow-down
is one of them. Few factors responsible
for GDP growth rate of 5 percent could
be an over-cautious monetary policy
that could not deliver on lowering the
inflation rate but contributed to increase
in the borrowing costs, governments
pending decisions on a few strategic
policies, high current account deficit and
oil prices. The sharp depreciation and
uncertainty of the rupee in recent times
has further aggravated the problems of
the Indian economy.
Slower economy leads to deteriorating
asset quality which is already causing
stress to the banking sector. The RBI
estimates that the gross NPA ratio of
banks may rise to 4.4 percent by March
2014 as compared to 3.42 percent in FY
13. NPA ratio was 2.94 percent in FY12.
In an uncertain environment, banks are
extremely concerned with liquidity risk
and concentration & correlation risks
and have to develop tools to calculate
economic capital that will integrate
credit and market risks. Currency
volatility is also giving few bankers
sleepless nights. Another challenge
facing the banking sector is that of
compliance and governance. Fit and
proper guidelines were issued by the
RBI for directors to ensure appropriate
officials at the helm. To reduce systemic
risk, regulators have also placed lot of
checks and balances in the sector.
From tapping new segments in the
SME sector to funding cross-country
aspirations as Indian corporates go
global, Indian banks are pursuing
multiple strategies for growth in an
uncertain environment.
The Public sector banks (PSBs) are

much ahead of the Private sector banks
in their overseas presence, constituting
over 90 percent of 171 overseas
branches as of March 31st,2013.
To meet these requirements and
challenges, industry players are
harnessing technology for creating
innovative and cost-efficient operating
models to sustain profitability and
viability. Discussions have been on
branchless banking but a branch avatar
will never go out of picture for lesstechnology savvy customers. Banks
are also deliberating on social media
initiatives to reach out to urban and
emerging class and SMAC (social,
mobile, analytics and cloud) on a whole
could bring a new perspective on
customer experience and on creating a
sustainable business.
Ambarish Dasgupta
Head - Management Consulting

KPMG in India
RBIs objective of increasing financial

penetration and credit availability
with reaching out to the bottom of
the pyramid has resulted in giving out
clear guidelines to the new banking
entrants(whenever they are on
board)open one in four branches in
rural unbanked areas! The successful
banking aspirants would have their
task cut out as they balance the
twin objective of reaching out to the
emerging India in the Tier 3 to 6 cities
while achieving financial inclusion.
This paper is an attempt to discuss the
opportunities and challenges that lie
ahead of the Indian banking industry.
Emerging strategies of
Banking sector
Contents
01
09
Governance and Compliance
Gearing up for the next level
Financial inclusion - Quest for
profitability
13
SMAC - Future of
technology
17
Merit in banking on
new licenses
21
19
Hedging the market risk
1 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies
Emerging
strategies of
Banking sector
Over the past couple of years,

the Indian banking sector has
displayed a high level of resilience in the face of high domestic inflation, rupee depreciation and fiscal uncertainty in
the US and Europe. This has
necessitated the banks in India
to concentrate much more on
operating efficiency, outsourcing and cost optimization now
than ever before. With deregulation of savings bank rate and
bleak global economy, the
banks are focusing on alternative sources of revenue, like
fee income, trade and vendor
financing, geographic expansion et al to maximize their
revenues. The Banking sector in India has adopted and
embraced technology to keep
pace with the international
development in the banking
industry and offer quality products to its clients. Technology
has enabled banks to conceive
and deliver products that are
more in line with the requirements of its clients on the
one hand and also more cost
efficient on the other. We have
captured few emerging trends
in the Banking space that are
gaining traction.
Focusing on the emerging India

Banks and regulators alike have woken up to the growing needs of emerging India.
While the credit disbursal of all SCBs has doubled from FY08 to FY12 to INR 48,215
bn1, the share of non metro regions in the incremental credit pie has increased from
30 percent in FY09 to 39 percent in FY12, indicating that the Non-metro regions are
increasingly gaining share.
The number of bank branches in urban and semi-urban2 areas has been growing at a
fast pace. Fifty eight percent of ~25,000 branches opened in last five years were in
urban and semi-urban regions.
Incremental credit disbursed by SCBs (INR bn)
Source: RBI - Statistical Tables relating to Banks in India FY 12
1
2

RBI - Statistical Tables relating to Banking FY 12

As per RBI definition - Rural: population less than 10,000; Semi-Urban: 10,000 and above and less than 1 lakh; Urban: 1 lakh and
above and less than 10 lakh; Metropolitan: 10 lakh and above
CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 2
Even the number of bank branches in urban and semi-urban areas has been growing
at a fast pace. The growing economic activity and increasing per capita income have
been crucial factors driving the credit growth in these regions. Fifty eight percent
~25,000 branches opened in last five years were in urban and semi-urban regions.
RBI is keen to improve the banking situation in rural areas and has mandated banks
to allocate at least 25 percent of new branches in unbanked rural centers. Further,
the increasing number of High Net worth Individuals (HNWIs) in the non metro
areas is leading to an increase in demand for better or more sophisticated services,
including Private banking and Wealth management; banks are not only focusing
on numbers in the emerging markets within the country but also on the quality of
services being delivered in these regions, based on type of clientele.
Population wise incremental branches in last 5 years
Source: RBI - Statistical Tables relating to Banks in India FY 12
Banks are constantly trying to increase their overseas

expansion to meet the growing trade demand
Country-wise branches of Indian Banks at
overseas centres as on March 31, 2013
Indian banks have been increasingly

growing their international presence
in the recent past. In part to cater
to the growing Indian diaspora in
foreign countries (estimated at ~ 20
mn persons) and in part to meet the
growing demands from cross border
trade and economic activity.
The Public sector banks (PSBs) are
much ahead of the Private sector
banks in their overseas presence,
constituting over 90 percent of 171
Others include:
Afganistan,
Australia,
Bahamas,
Bahrain,
Bangladesh,
Belgium,
Cambodia,
Cayman Islands,
Channel
Islands, France,
Germany, Israel,
Japan, Kenya,
Maldives, Qatar,
Saudia Arbia,
Seychelles,
South Africa,
South Korea,
Oman, Thailand,
Top Exports Markets (FY 2013, USD bn)
overseas branches as of March 31st,

20133. Many of the private banks do not
have branches, but are present through
representative offices.
Non resident Indians (NRIs) deposits
aggregated USD 14.2 bn in the financial
year ended March 2013, a y-o-y increase
of 19 percent. The Indian Diaspora
worldwide is estimated to be ~20 mn
persons4 and is on a constant rise.
Top Imports Sources (FY 2013, USD bn)
Source: Reserve Bank of India
Source: Ministry of Commerce & Industry, Government of India
The total trade, export and import, have

clocked a 19 percent CAGR over the
last year, period ending FY 13. The top
trading partners are China, Middle East,
US, HK, Singapore et al. The Banks have
shown particular interest in opening
branches in these regions which have
a strong trade relationship with India.
Total trade with China has grown at
17 percent CAGR from FY10 to FY13
and this has enticed banking players to
open branches in China. For example,
Axis Bank recently got permission from
RBI to open a branch in China and ICICI
Bank is awaiting RBIs approval for the
same. ICICI Bank is looking for foreign
expansion by opening branches in
Australia, South Africa and Mauritius5.
PSBs are also aiming to expand their

presence abroad. SBI wants to explore
territories where Indian Banks havent
tread yet, like Latin America. Dena
Bank is also awaiting RBIs permission
to open branches in US, UK and Africa.
Overseas expansion in PSBs might
be constrained on account of the
limited capital headroom they have for
such ventures, and the Government
being hard pressed to find funds for
recapitalizing PSBs. Therefore, PSBs
might be very careful in their selection
of target markets compared to well
capitalized PBs.
3

4
RBI Country-wise branches of Indian Banks at Overseas

Centres as on March 31, 2013
Including Non Resident Indians and Person of Indian origin
Business Standard June, 2013; http://www.businessstandard.com/article/finance/icici-bank-for-more-branchexpansion-113062400758_1.html
Supply Chain Financing (SCF) is gaining traction in

India
SCF is rapidly gaining attention in international markets and is growing at a pace of
30 40 percent at major international banks according to a research6. Key elements
of SCF include factoring, invoice discounting/reverse factoring, purchase order/
invoice data management, bank assisted open account, open account payment,
export/seller finance and buyer side finance. All the products aiming at providing
better liquidity to the corporates and their entire value chain at lower financing
rates. Currently, the growth in this domain comes from US and western European
countries, but the future growth is expected to come from emerging economies
like India and China.
With various government policies supporting exporters in India, the export credit
is growing at a rapid rate (Three year CAGR at 14 percent and five year CAGR at 22
percent). A part of this is also supplier financing, which has been gaining popularity.
Outstanding advances of SCBs to exporters (INR bn)
Source: Monetary policy department, RBI (http://www.rbi.org.in/scripts/PublicationsView.aspx?id=14681)
Banks are increasingly focusing on increasing their business from SCF. This can be
witnessed in growing number of branches in Industrial units. The banks are holding
awareness campaigns and seminars to educate the corporate world of the benefits
of SCF. Certain players are focusing on developing expertise in particular sectors.
Factoring and reverse factoring have not gained much momentum in India and
still offers an untapped market. Factor products offer greater flexibility compared
to other instruments used for working capital finance. Although receivables enjoy
property rights and are transferable, a statutory framework for factoring was
introduced only in 2011 by way of the Factoring Regulation Bill.
In the context of serving our clients responsibly, value chain financing is an

integral part of our business strategy covering both, our corporate clients
as well as their vendor partners, who are largely SMEs. We have further
sharpened our focus on this format of supply-chain financing to meet priority
sector obligations, given that our distribution network limits direct access to
such borrowers.
Abhijit Sen CFO, Citibank
Demica Research, 2013
The Factoring bill essentially protects

micro and small businesses from
delayed payments for goods and
services by larger entities. Traditional
banks used to provide loans based on
the borrowers (i.e. the MSME players)
ability to service the loan. Factoring will
however evaluate the lending decision
based on the ultimate debtor (i.e. the
ultimate customer of the MSME). This
will greatly improve the liquidity and
working capital problems of MSME
players.
Indian factoring market in the last decade
Source: Factors Chain International
Comparison with major Asian Markets
Domestic
International
With favourable legislations, factoring

is gradually taking off in India. The
Indian market constitutes a mere one
percent of the worlds factoring market
and 0.5 percent of the working capital
requirement of Indian companies7 and is
constantly growing.
Source: Factors Chain International
http://www.indiafactoring.in/Admin/DocFile/161-1204201
2%20-%20financial%20express.pdf
As illustrated above, there is a huge gap between Indian factoring market and
the international counterparts and offers a great opportunity for Indian banks to
capture this gap. The factoring industry in India is dominated by PSBs and financial
institutions. SBI Global Factors is the market leader with 80 percent of the market
share. Other players include CanBank Factors, DBS, Axis Bank, HSBC and Standard
Chartered7.
Focus on improving operating efficiency

and outsourcing
Indian banks are now getting

to be somewhat mature users
of technology and are investing
significantly in good data mining
solutions to understand the
behavioral trends of customers
and offer intelligent cross sell
solutions to customers, primarily
to improve productivity. There is
also concurrently an increasing
trend towards outsourcing to retain
flexibility, manage scale more
efficiently and cut operating costs,
essentially to leverage on partners
strengths in specific areas
Jaideep Iyer Group President, Financial
Management, Yes Bank
With increasing competition,

emerging customer demands,
regulatory interventions, technologyled disruptions, higher shareholder
expectations, Indian banks are being
forced to constantly review and revisit
their operating models. The resulting
changes are making Indian banks
nimbler, more cost efficient, better
focused on customer services and
witnessing good returns through fee
based services and products.
Indian banks are constantly optimising
the use of technology as the change
agent, in order to improve operational
efficiency and enhance customer
experience. It is estimated that Indian
banking and securities companies will
spend INR 416 bn (USD 6.75 bn) on IT
products and services in 20138, which
will be 13 percent increase from INR
370 bn (USD 6.0 bn) spent in 2012.
Emergence of low cost channels like
internet banking, mobile banking, and
mobile ATMs have been successfully
implemented by many players and
have also found wider acceptance in
the customer base. This has led to
enhanced focus on digital banking and
self-service channel usage to reduce
the cost of operations. The number of
mobile banking transactions doubled to
5.6 mln in January 2013 from 2.8 mln
in January 20129. The value of these
transactions increased three-fold to
INR 625 Cr (USD 105.73 mln) during
the month from INR 191 Cr (USD 32.31
mln).
Banks have either centralised mid/
back office processes through a shared
services center or have outsourced
their technology requirements to a third
party. In addition to focus, this also gives
banks a huge cost advantage.
8
9
For example, Indian market has

witnessed an increasing number of
ATMs under outsourcing management.
By outsourcing their ATM management
to service providers like Fidelity National
Information Services (FIS), the bank
is able to focus on its core business
expansion and customer service
initiatives - allowing for more rapid
growth while ensuring its customers
have a high-quality, reliable ATM
service. FIS the market leader and
worlds largest provider of banking and
payments technology manages about
11000 ATMS across India.
Karnataka Bank is the latest to join
more than half of Indias top 30 banks
who rely on FIS. By outsourcing the
management of its ATM estate to FIS,
Karnataka Bank would be in a position
to release vital capital to redeploy on
core activities, increase operational
efficiencies, provide better service
to its customers and insulate itself
from technology obsolescence. The
announcement made by Karnataka Bank
in May 2013 underscores a growing
trend in India for banks to contract
non-differentiating services, such as
ATM driving, to expert providers such
as FIS. Banks benefit by redirecting
investments tied up in ATM equipment
and operations to more strategic areas,
thus deriving operational efficiencies.
In addition, banks can leverage the ATM
driving expertise of FIS to deliver a highquality and reliable ATM service to their
customers.
While transaction based banking
operations are being successfully
streamlined, Priority Sector Lending
and Financial Inclusion still remain a
challenge. The section on Financial
Inclusion in the report elaborates on
how to create a profitable model to
deliver rural credit.
Gartner Research- http://www.gartner.com/newsroom/id/2319115

Reserve Bank of India
Changing dynamics
of fee based income
portfolio
Fee income has gained significant
focus as a source of revenue in the past
decade. With the rising pressure on
cost of funds, it is imperative for banks
to look at other avenues to boost their
income. The fee income in FY 13 for
67 banks in our sample set10 was INR
64,418 Cr; clocking a three year CAGR
of 12 percent and five year CAGR of 15
percent.
PSBs have constituted a large part
(60 percent) of this basket since the
beginning, owing to their reach and size.
Pressure on fee based income

However, in recent times with the
overall pressure on the economy and
changing regulations, the fee based
incomes of banks have come under
pressure. Banks earned lower corporate
banking fees due to slowdown in project
finance. Also, with The Reserve Bank of
Indias (RBI) recent measures to tighten
liquidity and curb volatility in foreign
exchange rates have led to a rise in
bond yields leading to a drop in treasury
incomes for banks. On the retail side,
fee income earned by banks on account
of sale of gold coins has dried up with
the government banning sale of gold
coins by banks. These factors have
necessitated banks to revamp their fee
based product portfolio.
Emerging trends
Banks looking to increase fee-based
income are shifting focus to selling
life insurance and general insurance
policies (through bancassurance tie ups
or as insurance brokers). Indian bank
recently partnered with United India
Insurance and launched a web portal
for its Arogya Raksha group mediclaim
insurance policies. Moving forward,
the bank is in talks with a life insurance
company for a similar tie-up in the life
insurance space. The bank expects a
30 percent11 growth in income from
insurance this fiscal. Some of the other
recent bancassurance tie-ups include
PNB with Metlife and Axis Bank with
Fee Income (INR Cr)
Source: KPMG-Business Today Best Banks December 2012
Max Life insurance. With the increasing

trends in insurance penetration on both
life and general insurance side, banks
identify this as one of the key drivers of
fee income growth.
Retail fee income is another area where
banks have increased focus to augment
their growth. Retail fee income of banks
typically comprises commissions they
earn from sale of third-party products,
like insurance and mutual funds,
transaction charges on savings and
current accounts, processing fees on

consumer loans and credit cards, and
fees from foreign exchange transactions
and remittances.
Private sector banks are specifically
focusing on income on foreign exchange
transactions and remittances. Axis
Bank, the third largest private sector
lender in the country, reported close to
43 percent rise in retail fee income in
FY13.
10 The sample set comprises of 26 PSBs, 18 PBs, and 23 Foreign banks

11 http://articles.timesofindia.indiatimes.com/2013-06-14/india-business/39975382_1_fee-income-fee-based-income-fy-13
Governance and
Compliance
Gearing up for
the next level
The banking sector is crucial for

an economy since it channelises
savings into investments. It
provides credit to the productive
sectors and finances the
needs of the real economy. For
emerging economies, banks are
more important since they are
important drivers of financial
inclusion and economic growth.
Banks by nature are highly
leveraged and interconnected.
Hence, poor governance or
failure in banks can trigger
bigger crisis and threaten
stability of the economy.
Banks in India are well
regulated with The Reserve
Bank of India adopting a
forward looking yet cautious
approach. In the 1990s, the
tone of banking regulation
shifted from prescriptive to
prudential, shifting the onus
from regulations to corporate
governance. Various guidelines
were issued over the years to
improve corporate governance
in banks. To get competent
directors on board, the RBI
issued fit and proper criteria
for directors which said that
private banks should carry out
due diligence to determine the
suitability of the person for
appointment as a director based
on qualification, expertise, track
record and integrity.
In 2005, the Ganguly Committee recommended separation of Chairman and MD

roles. The recommendation was implemented in private banks. The RBI also issued
guidelines on ownership and governance in private banks to ensure that ownership
and control of banks are well diversified and thus not detrimental to depositors
interest. Moreover, any acquisition of shares in private sector banks resulting in
a shareholding of 5 percent or more of the paid up capital requires the RBIs prior
approval. Banks are also mandated to have committees on audit, nominations and
remuneration, fraud monitoring, and customer services. All these provisions put the
corporate governance framework adopted by Indian banks on par with international
standards.
Although improving regulatory landscape is a welcome move, regulation in isolation
is not enough. It is a necessary but not a sufficient condition for good governance.
Regulation can complement governance, not replace it. Good governance has to be
institutionalized by individual banks for it to be effective. While broadly Indian banks
have good governance standards, there is room for improvement.
In the sections below, we take a brief look at the important issues in governance
and compliance in Indian banks and how they can be addressed.
Governance in Indian banks

The financial crisis of 2008 brought inadequate governance in banks and other
financial institutions in sharp focus. Experts argue that simplistic assumptions
and lack of rigorous questioning by bank boards led to the crisis. Banks boards,
management, and employees faced conflict of interest routinely in their jobs. When
faced with a conflicting situation, compensation structures in the financial sector,
which should have ideally pushed the decision makers towards the better choice,
instead encouraged excessive risk taking.
Once the crisis started in one area of the financial sector, it spread to other
areas quickly due to blurred boundaries between banking, insurance and asset
management businesses. Although Indian banks came out of the crisis relatively
unscathed, they (particularly the public sector banks) face peculiar governance
challenges in the form of government control.
Governments control over public

sector banks
The Indian banking sector is characterised by the dominance of PSBs which
account for approximately 70 percent of
the industry1. The government through
its agencies owns majority stakes
in these banks and exerts influence
through its monetary policy and directives.
In the context of PSBs, it is difficult to
adhere to public ownership and yet give
near total autonomy to their boards
as compared to private sector banks
where the board has autonomy and all
shareholders are treated at par.
Bank Subsidiary Model needs to be
reassessed
Another governance related issue in
Indian banks is the corporate structure
they follow. Currently in India, the bank
subsidiary model is popular. Under this
model, non-banking activities such
as insurance, asset management etc
are done in separately constituted
subsidiaries of the bank. This model
has its own set of problems and
disadvantages. E.g. firstly, losses of
subsidiaries could substantially damage
the financial health of the bank and
risk the safety of deposits. Secondly,
since the bank will be responsible for
equity infusion in the subsidiaries and
their management, having several
subsidiaries could stretch the banks
finances and other resources. Thirdly,
the proportion of foreign holding
in holding banking company is not
taken into account for the purpose of
calculating the cap of foreign holding in
subsidiaries. And finally, the subsidiary
model could lead to excessive leverage
by the downstream affiliates.
The Shyamala Gopinath Working
Group appointed by the Reserve Bank
recommended that the financial holding
company model should be preferred for
the financial sector in India.
Reserve Bank of India
RBI Press Release RBI discloses the names of applicants

for new bank licences in the private sector, Jul 2013
Revising the compensation structure

to improve governance
After the 2008 financial crisis,
compensation structure in banks came
under sharp focus and criticism. Now it
is widely acknowledged that aggressive
and irrational incentives and excessive
risk taking by bank executives fuelled
the crisis. The compensation structure
at times encouraged compromising
long-term interests for short-term gains.
To check excessive risk-taking behavior,
the RBI issued guidelines which
aligned compensation structures with
prudent risk taking and instituted a
claw back mechanism. However, as
of now there is no consensus on what
is a good compensation structure for
non-executive directors. Currently
non-executive directors are paid sitting
fees. There is a school of thought that
believes that non-executive directors
should be paid a regular or a fixed
contractual remuneration. Although this
is a good idea, it is difficult to implement
in practice. Firstly, non-executive
directors typically serve for shorter
periods and have term limits. Secondly,
in banks the results of risks taken
manifest after a long gap. And finally
since non-executive directors serve
on several committees comprising of
many directors, it is difficult to apportion
responsibility on them individually.
Hence, aligning non-executive directors
compensation structure with outcomes
of corporate governance is still a grey
area.
Separating the roles of Chairman
and Managing Director
In 2005 the Ganguly Committee
appointed by the RBI recommended
that the posts of the chairman of the
board and the CEO of the bank should
be bifurcated. The committee argued
that this will bring about more focus
and vision and necessary thrust to the
functioning of the top management
of the bank and also provide effective
checks and balances. The committees
recommendations were implemented in

private sector banks in 2007. However,
the finance ministry did not favor the
proposal and hence it was not adopted
in public sector banks except in SBI and
associates.
Allowing corporates into the banking
space
The RBI has received 26 applications
for new banking licences2. However,
there is a lot of debate on whether
large corporates should be allowed to
start a bank. International experience
in this regard has been mixed. While
corporates can bring in professional
management experience and capital,
many experts fear that they will use the
bank as a private pool of readily available
funds.
However, to avoid this, the RBI has built
in several safeguards in the new banking
licence guideline. To keep non-serious
players at bay, the guideline says that
the applicant entity/group should have
a past record of sound credentials and
integrity, should be financially sound
and have a successful track record of 10
years. It also underlines the importance
of diversified ownership. It says that
a Non-Operative Financial Holding
Companies (NOFHC) should set up new
banks. The NOFHC should retain their
equity capital in the bank at a minimum
of 40 percent for fuveyears after which
they should reduce to 15 percent within
12 years. The guideline also has criteria
on financial inclusion.
The above provisions clearly show that
the regulator wants new banks to have
good governance standards. Failing to
meet the aforementioned conditions
could have serious repercussions for
new banks.
Importance of
compliance at banks
Compliance for banks is given a lot of
importance as they are the engines of
a countrys economy and, therefore,
also more regulated. In fact, post the
financial crisis regulatory supervision
of banks has increased noticeably,
underscoring the increasing importance
of regulatory compliance for banks.
Evolution of banking regulations and
enforcement
In 2010, Basel Committee on
Banking Supervision (BCBS) issued
comprehensive Basel III guidelines to
improve the banking sectors ability to
absorb shocks arising from financial
and economic stress. The guidelines
recommend more stringent capital
and liquidity requirements apart from
suggesting enhancements to Basel
II and market risk frameworks. In the
same year the US introduced DoddFrank Act to enhance financial stability,
orderly liquidation and other host of
measures to ensure measures directed
at hedge funds, insurance companies
and banks.
Similarly, in India, RBI has been
issuing a host of directives to improve
governance and compliance at Indian
banks in the last two years. Specifically,
the regulator has issued key directives
aimed at enhancing corporate
governance at NBFCs, enhancing
know your customer (KYC)/anti-money
laundering (AML) norms, tightening
regulatory oversight at foreign banks by
making CEOs of such banks responsible
for compliance, structuring the credit
approval process by recommending a
board-level credit committee, etc. The
new guidelines for issuance of banking
licenses are also indicative of this trend.
RBI is also strengthening its
enforcement efforts. Its recent orders
penalising 19 commercial banks for
mis-selling derivative products to clients
and 3-4 banks for violation of KYC/
AML norms is indicative of this trend.
Additionally, RBI recently constituted a
High-Level Steering Committee which
recommends the regulator to transition
to a risk-based supervision (RBS)
approach, which entails determining
the intensity of supervision based
on a banks risk profile. This would

necessitate banks to strengthen their
governance, risk management and
compliance frameworks.
Banking communitys response to
this evolution
Often, companies tend to respond to
more regulations, increased scrutiny and
instances of wrong doing with another
checklist or another layer of control or
redundant procedures. This may or may
not address the issue permanently.
More importantly, this spontaneous
reaction could create multiplicity in
rules, increased compliance costs,
unwanted bureaucracy and delayed
decisions.
The spontaneous reaction is to a
certain extent because organisations
view compliance as a mere cost of
doing business and as an impediment
to their operations. This could be
counterproductive and often lead to
misdirected compliance and control.
This in turn could lead to overlapping
and inconsistent rules and regulations
that are difficult to comprehend or
requirements that without a clear
purpose or intention and remain merely
on paper.
In fact, banks stand to gain more if
they leverage compliance as a value
driver and comply with laws of the
land in sprit. This comes from a good
understanding of the consequences of
non-compliance on the bank and on
the industry/economy as a whole at all
levels of the organization.
Rigorous: Adopting a zero-
tolerance approach to noncompliance involves making

efforts to curtail all sorts of noncompliance and not just material
ones. Any non-compliance in
regards to regulations is viewed
seriously, regardless of the extent
of the regulators supervision, and
corrective actions are implemented
in a timely manner to curtail any such
future instances of non-compliance.
Co-operative: Making the process
co-operative involves leveraging

the synergy of compliance
initiatives across the organisations
and avoiding any duplication of
efforts. This reduces the cost,
complications and inconsistencies
in regulatory compliance for banks.
One of the ways to achieve this
is by establishing an empowered,
independent compliance
function.
Pervasive: Introducing a pervasive
approach involves making

compliance with regulations or the
banks internal rules everyones
responsibility. The banks employee
performance system accords as
much importance to compliance
KPIs as given to business KPIs.
It also involves timely training
and communication to educate
employees on the intent behind
regulations and the banks internal
rules.
Compliance as a value driver

In order to leverage it as a value-driver,
banks should adopt a compliance
framework that is proactive, rigorous,
co-operative and pervasive.
Proactive: Addressing compliance
proactively involves a two-pronged
strategy of assessing compliance
risks, including upcoming ones,
and inducing appropriate changes
in policies, processes and controls
to address these risks. It involves
implementing best practices by
complying with the spirit of the
regulations than merely the letter
of it.
Conclusion
Indian banking sector is at an
inflexion point. To meet the demands
of Indias huge potential, heavy
infrastructure spending, and the
governments ambitious financial
inclusion plan the banking sector will
have to gear up for unprecedented
challenges. To prepare for
the upcoming challenges, the
government formed a commission
with a task of overhauling the
regulatory landscape of financial
sector. The commission Financial
Sector Legislative Reforms
Commission drafted a code called
the Indian Financial Code (IFC).
The IFC has called for a unified
regulator for the financial services
sector which will regulate insurance,
capital market, pension funds and
commodities derivatives market.
It has recommended that the RBI
should continue to exist outside
the unified regulator although
with modified functions of setting
monetary policy, regulating banks
and payment systems.
To what extent the RBIs functions

will be modified is not known yet.
However, one of the most important
challenges the sector is likely to
face is the challenge of governance
and compliance. Achieving optimal
growth, balancing stakeholder
expectations and complying with
regulations is likely to be a tight
rope walk for the sector. However,
with support from the RBI and
the government, it is likely to be a
rewarding experience.
Financial
inclusion - Quest
for profitability
Financial exclusion has been

an area of concern and casts
shadows over the long-term
sustainable growth of the
Indian economy. Though
the country has had a large
unorganized sector (consisting
of money lenders, chit funds,
etc.) providing the financial
services for a long time, the
reach of the organized sector
(banks, NBFCs, MFIs, NGOs,
etc.) remained limited. The
unregulated unorganised
sector players, with their
strong focus on earning
profits, did little to bring in the
financially excluded people in
the mainstream.
The central bank prescribes the
following four basic financial
services to be provided to any
individual to count her
as financially included.
Access to basic savings
account
Availability of affordable
credit
Access to remittance
services
Opportunity to buy
insurance and investment
products.
Data released by the World Bank depicts that on an average Indians over the age
of 15 years remain considerably under-banked as compared to their global peers.
While almost half the global population above 15 years has an account at a formal
institution, the figure is only 35 percent in India. The scenario is even worse in case
of female population. Looking at the same metric for the bottom 40 percent of the
population by income, 41 percent population globally has an account as compared
with 27 percent in case of India.
Financial inclusion status for population above 15 years: global comparison (in %)
Source: India Commercial Banking Report - New Permits To Boost Competition In Underbanked Economy, ISI Emerging Markets,
accessed on 26 August 2013
Even the extent of financial exclusion in India is

widespread as reflected in the following facts.1
Highest number of households (145 million)
excluded from banking
50 percent of the population does not have
bank account
Only 34 percent of the population engaged
in formal banking
Only 17 percent of population has any credit
exposure especially in remote villages
Out of 600,000 villages, only 30,000 (5
percent of total villages) have commercial
bank branch
Only 10 percent have life insurance cover
while just 9.6 percent have any non-life
insurance.
The policy makers have adopted a multipronged approach to address the issue of
financial exclusion. Key elements of the
strategy include:
Evolving regulatory guidelines with
development perspective
Deepening banking reach and coverage
Introduction of Innovative products
Encouraging use of technology
Financial literacy and financial inclusionsynced approach.
There has been an intense debate on the
appropriate model for FI. RBI has favored
bank-led model instead of the technologyled model which has been successful in
many other countries. The model allows the
country to leverage existing branch base for a
planned, structured and sustained FI process.
It also reduces the risk given the low literacy
levels (and even lower financial literacy) of
the potential set of customers leaving them
vulnerable to players either not regulated at all
or not regulated by the RBI.
Till date, India has had a limited success in
achieving FI with the model. However, given
the Indian scenario, the model facilitates a
consistent and planned move towards the goal
of FI while maintaining the financial stability.
Challenges in reaching out to the under-banked

Infrastructure: Both physical and digital connectivity are essential for institution
to provide financial services through a mix of channels depending on the cost

and type of services offered. To illustrate, the widespread use of the kiosk
banking has been inhibited by poor connectivity in the hinterland.
In terms of credit, lack of credit history and limited collateral poses a
challenge: Credit bureaus have not expanded their reach much to the rural
areas; hence banks are hesitant to hand out loans to the under-banked with
limited documentation in terms of proof of income. Also, asset ownership is
limited and generally restricted to farm land with no clear documentation.
Varied profile of consumers: Banking needs vary according to the customer
profiles and due to diversity in population, it becomes difficult for bankers to

understand this segment.
Global FI models and relevance for India

Many of the scalable and successful experiences globally have been led by telecom
companies with the banks playing a secondary role.
M-Pesa in Kenya: Parallel banking ecosystem managed by telecom companies,
allowing the consumers to make majority of mobile banking payments, transfers

and transactions on their mobile phones. It is a cost effective and adaptable
system which has brought many people into the formal banking system and
has grown rapidly with client base of around 10 million, roughly 40 percent of
Kenyas adult population.
USAID MABS in Philippines: Microenterprise Access to Banking Services
(MABS) assists network of partner rural banks in the development and

introduction of innovative products, including mobile financial services. Its a
successful model that has more than 90 MABS-supported rural banks managing
around 250,000 microloan borrowers and 1.5 million micro-savings accounts.
These banks have also registered more than 250,000 mobile phone banking
clients and have processed more than USD250 million in mobile banking
transactions. This model could be used to provide training and technical
assistance to rural banks in India which could give a boost to innovative product
launches in the rural segment.
MTN Mobile Money in South Africa: Mobile operator MTN and Standard
Bank, through their joint venture MTN Banking, launched a mobile banking
product MTN MobileMoney. Every MTN SIM card has an embedded banking
application and only MTN subscribers can open MobileMoney accounts. Under
MTN MobileMoney, 1.6 million people are registered users with over USD90
million transacted every month. Although Indian banks have started teaming
up with mobile operators for providing banking services to unbanked people,
banking regulations do not permit a lead role for telecom companies in India.
Our experience shows that the goal of financial inclusion is better served
through mainstream banking institutions as only they have the ability to
offer the suite of products required to bring in effective/meaningful financial
inclusion.
The development of the habit of banking would lead to an increase in savings
and investment improve the efficiency of allocation of capital and increase the
ability of monetary authorities to stabilise the economy in times of crisis.
Deepali-Pant Joshi ED, Reserve Bank of India
1

Financial Inclusion and Financial Literacy Indian Way,

Dr. KC Chakrabarty, RBI
Way forward
A meaningful FI could be achieved only
through a collaborative effort of all the
stakeholders involved. Policymakers
could help provide a facilitating policy
framework, infrastructure support and
enabling environment whereas service
providers should experiment with
different models to serve the unbanked.
Further, there has to be collaboration
among service providers with financial
institutions partnering with telecom,
technology, and consumer product
providers to create an enabling
environment.
Government and regulators
initiatives
RBI has already made it very clear
that the new banks, that will be given
licenses, have to open one in four
branches in rural areas. Premises of
allowing new banks in the sector is to
reach out to the bottom of pyramid.
Improve Financial Literacy: The
GoI and RBI should put in place a

country-wide strategy to provide
financial education using standard
literacy material both as part of the
school curriculum and as a part of
the kit to educate adults.
Aadhaar card: The nation-wide
initiative to provide a unique

identifier to every Indian, could be
integrated with the service delivery
mechanism. It could help address
the main issue of complying with the
know your customer (KYC) norms
that banks perceive to be probably
the biggest hurdle in expanding
their reach. Successful integration
of Aadhaar with banks database
would also allow banks to have a
360 degree view of their customers
to better manage risk and cross sell
more services.
Bankers initiatives
Simplicity is the key: Due to
financial ignorance, developing
simple easy to understand product
for the rural population is the key to
success.
Microfinance sector has been quite

successful (As a sector we reach
around 2.5 crore women in India) to
take financial products to poor and
excluded but fallacy is that we are not
considered an important channel of
financial inclusion as a very important
financial service i.e. acceptance of
credit is beyond purview of MFIs.
There is no reason to undervalue
the potential of this channel, before
looking to some other industry for
solution.
Chandra Shekhar Ghosh Chairman & MD,
Bandhan Financial Services Pvt. Ltd.
Leverage technology to develop
innovative operating models: As

discussed above, technology-based
initiatives are leading examples for
success in FI. BC channels and other
low cost delivery models such as
mobile banking would help bankers
reach out to the bottom of pyramid.
SMAC - Future of
technology
Traditionally banks have

been the pioneers in
harnessing new technology
trends. The applicability of
Moores law in the areas of
telecommunication, internet
and mobility were significant
enablers for banks in achieving
two extremely important
business objectives
revenue enhancement with
cost efficiencies. In existing
times, the financial services
industry is keenly exploring
the transformation potential
of the new generation of
technologies available
like Social media, Mobile,
Analytics and Cloud (SMAC).
The increased commoditization
of service offerings from banks
has placed incessant demand
on them to adopt variable cost
structures, increase revenue,
improve products and services,
expand market share and
achieve nonlinear revenue
growth.
The Indian banking industry
has to its credit a number
of innovations, many of
them driven by technology
investments.
The Indian Capital Markets sector moved to a T+2 settlement cycle, long before
many developed economies. Similarly the introduction of NEFT and RTGS were
watershed moments in Indias payment landscape which enabled a significant
shift to electronic payment forms at a lower cost. The Pan India UID program when
linked to financial transactions is expected to significantly plug the current leakages
in Government welfare schemes.
In the current environment, the key focus areas of bank are lowering cost of
funds, faster rollout of products achieving financial inclusion and priority sector
lending targets in a profitable manner, compliance with various national and global
regulatory norms and increased customer satisfaction.
Social media
Social media can be used as an effective tool to interact with the customers
regarding queries and complaints. Once the queries or complaints have been
posted on the social media page, the financial institution representative can address
it in a timely fashion. If the activity requires any exchange of sensitive information,
the financial institution may contact the customer directly using a secured channel
of communication. Hence, social media can be efficiently used as the first level of
query resolution and as this is a non core activity which is moved away from the
branch and other delivery channels, it leads to cost savings for the firm.
Social media, being multidirectional, allows customers to convey sentiments
regarding the firm. Therefore, it would be prudent for financial institutions to
have presence on social media to gauge the attitude of the customers. In case of
public airing negative sentiments, the financial institution can act swiftly thereby
containing the issue.
The fundamental use that a social network can serve a financial institution is
brand awareness. Financial institutions can engage the users of social media in
different ways such as by displaying special offers and discounts, asking questions
or conducting polls, displaying industry related news and opinions, etc. Engaging
the social media users effectively can result in increase in brand awareness at a
significantly lower investment compared to mainstream media.
However social media is considered to be unchartered territory under the
apprehension that it is still evolving and it would be prudent to engage only after it
has reached a mature stage.
Mobility
In a land where almost a billion people
own mobile phones, cash is still king
and large swathes of the population
have no formal bank account, mobile
payments are quickly becoming a critical
part of Indias economy. Mobile phone
penetration is booming and while
levels have not quite reached that of
some Asian or European countries few
people in either the cities or the furthest
reaches of the countryside are without
some level of access to a mobile phone.
Banks, on the other hand, are few and
far in between; in fact, it is estimated
that only about a quarter of all Indians
have a bank account, while more than
60 percent own a mobile phone. Faced
with these dynamics, it does not take
long to realize that mobile payments will
ultimately bring transformation to not
only the payments industry, but society
at large.
One of the most promising signs of
Indias leadership in mobile payments
comes from the high level of
cooperation within the industry itself.
On both the banking and the telecoms
sides, we are seeing players come
together and put aside their competitive
differences in order to develop common
standards and approaches to mobile
payments. All stakeholders - banks,
telecoms operators, technology
providers, regulators and government
organizations - have created the Mobile
Payments Forum of India (MPFI), and
are collaborating to address the market
needs.
As a result, India has witnessed the
ascendency of two initiatives that,
together, are accelerating growth of
the mobile payments market. Interbank
Mobile Payment Service (IMPS) - a
platform developed by National Payment
Corporation of India is already adopted
by more than fifty of Indias banks to
offer instant payment and remittance
services using SMS, WAP, and a range
of mobile apps.
Cloud
The advent of cloud computing has
resulted in the dismantling of traditional
cost structures. It enables organizations
to shift from a CAPEX heavy model to a
variable cost model. Software licenses,
servers, networking equipments,

storage devices are typically considered
to be the key CAPEX components. In
a cloud model, the bank pays for what
it needs when it needs it. Cloud also
allows a bank to scale its business
operations.
Using cloud services, it is easier
to collaborate with partners and
customers, which can lead to
improvements in productivity and
increased innovation. Cloud-based
platforms can bring together disparate
groups of people who can collaborate
and share resources, information and
processes.
The ability to respond to rapidly
changing customer needs is a key
competitive differentiator. Like
companies in other industries, banks are
continuously seeking ways to improve
their agility and adjust to market
demands. By enabling businesses
to rapidly adjust processes, products
and services to meet the changing
needs of the market, cloud computing
can facilitate rapid prototyping and
innovation, which helps speed time to
market.
However the adoption of cloud in banks
has not achieved the scale that was
originally envisaged. Security and Data
Privacy concerns are attributed as some
of the key reasons for this. Additionally
banks are also concerned by risks of
provider performance and downtime.
The tax implications of using cloud
services are also one area that some
banks seek clarity on.
Analytics
The role of analytics has evolved from
being a simple support function to that
of a key business differentiator.
Analytics today can be effectively
deployed at every stage of the
consumer lifecycle. The Know your
customer (KYC) activity in the customer
onboarding process is increasingly
dependent on analytics tools to identify
the right set of customers. Anti-money
laundering (AML) monitoring is another
aspect where complex algorithms are
used to identify reportable transactions.
Similarly consumer spend analysis can
assist banks in identifying cross sell and
up sell opportunities. Loan originators
and servicers can differentiate

themselves in the marketplace with
superior underwriting techniques and
sophisticated models that can predict
potentially non performing portfolios
with a high degree of accuracy.
Analytics also is playing a significant role
in optimal product pricing.
The banking industry is replete with
examples of retail banking service
providers that have harnessed the
capabilities of analytics. As the banking
industry gets more complex, analytics
is forecasted to have a even more
significant play.
Way forward
The collective usage of SMAC has
a multiplier effect on the benefits
delivered. These tools can be applied
at different stages of any typical
banking process. For example, the
data generated by users social media
postings can be coupled with locationbased data from their mobile devices,
which can, in turn, be analysed in
real time on a virtual cloud platform.
The explosion of data and analytics
technology allows banks to store,
manipulate, and analyse greater
volumes of data and extract meaningful
insights about customers preferences.
This comprehensive view of the
customer can be used to effectively
engage existing and potential
customers through tailored marketing
strategies. Services and products can
be presented based on customers
preferences. Individualised sales and
marketing strategies can help banks
target different customers for easy
mobile deposits, mortgage loans, small
business loans, and so on.
Ultimately, this granular, 360-degree
customer view made possible through
SMAC technologies can improve the
loyalty of existing customers, help
banks engage these customers in new
services, and increase the market share
for banks by attracting new customers.
Hedging the
market risk
Banks have long faced the risk

of losses from undesirable
market movements. This
signifies that institutions
should have the best possible
approaches to understand,
model and manage market
risk and to estimate capital
reserves they need to provide
as buffer against their market
exposures. As Indian banks
moves towards the Value at
Risk (VaR) based approach
to capture trading book risks,
this chapter captures some
of the challenges banks need
to focus on before the banks
migrate to the new regime.
The trading book supervisory regime introduced in 1996, requires financial

institutions to measure risks resulting from the transactions held in their trading
book and to cover market risks by regulatory capital. Market risk includes: interest
rate risk, equity position risk, settlement and counterparty risk and foreign exchange
risk. This regime offers firms the use of either a standardised approach or an
internal models approach to calculate the capital requirements associated with the
trading book. Most of the internationally active banks favour the internal models
approach, built on the Value at Risk (VaR) methodology. Both the general risk, arising
from general market movements, and the specific risk, related to changes in the
credit quality of issuers, to be covered by adequate capital.
During the 2008 financial crisis it became evident that many banks had built up
materially undercapitalised trading book exposures. The revisions introduced under
Basel 2.5 aimed to reduce cyclicality of the market risk framework and to increase
the overall levels of market risk capital held by banks, particularly for those areas
exposed to credit risk. It introduced measures through incremental risk charge
(IRC). However, regulators are still of the view that the market holds inappropriate
levels of capital with regards to the Trading Book. The Basel III requires banks to
carry out Credit Valuation Adjustment (CVA) capital charge to protect themselves
against the potential mark to market losses associated with deterioration in the
creditworthiness of the counterparty, if the deals are done in OTC market.
Complete assessment of risks in trading book

In addition to the increase in default risk, the growing presence in trading book,
of corporate bonds and structured products, which are generally less liquid, has
resulted in an escalation of certain types of risk. The latter, which include liquidity
risk, concentration risk and correlation risk, are not fully addressed in current
regulations on market risk.
Liquidity risk
The liquidity of a financial instrument
plays a key role in determining the
holding period for a bank of such an
instrument and therefore in assessing
the regulatory capital requirement to
which it is subject. In general, credit risk
in the trading book is subject to lower
regulatory capital requirements than
in the banking book. The difference
in capital can be mainly attributed to
the different time horizons on which
the risks are assessed: one year for
credit risk (corresponding to a horizon
for estimating the probability of default
of the issuer) and ten days for market
risk (corresponding to a horizon for the
closing out or hedging of positions).
The preferential treatment granted to
the trading book can be ascribed to
the fact that the positions are held for
short-term sale and they can be easily
unwound or hedged on the market.
However, in practice, this is often not
the case. Many of the instruments held
by the bank in trading book may not be
very liquid. The market liquidity also
varies according to economic cycles.
Nevertheless, the assumption that
positions can be closed out or hedged
within ten days, which is currently
used as a basis for calculating capital
requirements using Value at Risk
(VaR) models, may prove inappropriate
for the increasingly frequent case of
illiquid positions. The inclusion of such
positions in the trading book therefore
generally results in insufficient capital
requirements.
Concentration and Correlation risks
Concentration risk is another risk, which
is not captured appropriately by the
institutions. Indeed, most corporate
bonds include the same names in
their reference portfolio, giving rise to
concentration risk on an entity and/or a
sector associated with their widespread
use in institutions active credit portfolio
management.
Economic capital and

stress testing
To overcome some of the challenges,
one of the solutions the leadings banks
have been considering is to developing
tools for calculating economic capital,
which will integrate credit and market
risks and their different components.
Economic capital for all types of risk
is generally calculated at the one-year
horizon with a confidence interval
determined by the bank on the basis of
the probability of default corresponding
to its current or targeted rating. While
the main tool for measuring economic
capital associated with market risk
often remains a VaR calculation based
on a 10-day holding period, some
regulators have devised complementary
approaches using stress testing and/or
scaling up the VaR to reflect a horizon
for closing out or hedging positions
assumed to exceed ten days.
Furthermore, although modeling credit
risk correlations is not as yet common
practice, progress is being made in this
area. Some models now incorporate
contagion effects, which allow banks
using them to capture the impact on
credit risk from declines in overall
market liquidity, the failure of large firms
or adverse industry-level developments.
Such approaches make it possible to
better take into account extreme or tail
risks as well as liquidity risk.
Banking supervisors, in addition to the
increase in the current VaR multiplier
and/or considering stress scenarios,
will enhance the review and the
assessment of the methods developed
by banks to calculate and monitor their
economic capital modeling.
Going forward
The Basel Committee is also
considering replacing Value at risk
(VaR) measurement by expected
shortfall (ES). ES is a method of
measuring the riskiness of a position by
considering both the size and likelihood
of losses. ES has advantages over VaR
as it captures tail risks.
The current volatility in Currency
Market is clear demonstration of
how abruptly market conditions and
volatility can change. In fact far from
extreme events, the high volatility has
become almost a part of the normal
market conditions. Being concerned
about the situation, RBI in a draft circular
last month, has put the onus to banks
on measuring the effect of volatility
to its corporate clients. Based on the
impact on the earnings of its clients,
banks have to enhance the provisioning
requirements and in high volatile
cases (where earnings are affected
by over 70 percent) the risk weights
to corresponding client increases by
25 percent. With the current volatility,
decline in asset qualities and new
capital norms (Basel III), many banks
are looking to raise fresh capital. The
banks also need to strengthen the
Oversight Board to review the trading
book positions and take appropriate
actions swiftly to save the interest
of the institution. To aid the process,
strong technology platform along with
appropriate analytics are essential prerequites.
But if the cost of doing business
remains high the business could simply
be switched into unregulated or more
lightly regulated institutions such as
hedge funds. Perhaps the pendulum
is shifting too far to the side of
conservatism and will make traditional
banking difficult and bring about newer
models of delivery of financial products
in the global economy.
Another, correlated risk, which needs

to be captured, is correlation between
different risk types (credit, interest,
currency, equity risks). An increase in
trading in such instruments, mispriced
in relation to the real risks incurred,
would constitute structural risks.
Merit in
banking on new
licenses
Banking turf is set to change.

The RBI had set the ball rolling
when they opened the stage
with the intention to hand
out licenses to new entrants.
Undoubtedly, the official
reason was to bring a large
number of hitherto unbanked
and under-banked population
in the formal financial system,
but how many aspirants will
be allowed to get into the ring
is RBIs prerogative. In 1993,
when the RBI licensed some
private banks, it received 113
applications but only 10 banks
got the license1.
Till now, `financial inclusion
was the responsibility of
public sector banks but by
using inclusive growth as
the base for licenses, RBI has
made private sector banks
equally responsible in social
objectives. As one can see
from the table, currently,
public sector banks have more
branches than any other bank
group in the rural and semiurban areas.
No. of branches of Scheduled Commercial Banks as on 31st March, 2013

Bank Group
Rural
Semiurban
Urban
Metropolitan
Total
Public Sector
23286
18854
14649
13632
70421
Private Sector
1937
5128
3722
3797
14584
Foreign Banks
65
249
331
Regional Rural
Banks
12722
3228
891
166
17007
Total
37953
27219
19327
17844
102343
Source: Department of Financial Services, June 2013
One can argue, whether new banks are required in the Indian banking sector. If we
look at statistics, India being one of the top 10 economies of the world and with
relatively lower domestic credit to GDP percentage provides great opportunity for
the banking sector to grow. Indian Banking is expected to become 5th largest by
the year 2020 and 3rd largest by the year 2025. Banking credit is likely to grow at ~17
percent CAGR in the medium term leading to increased credit penetration.
A large portion of rural populations still remains unbanked. Any new banking
aspirant should create a business plan which will provide banking facilities
and services for the bottom of the pyramid.
This is a difficult task, so only those who are able to understand this specific
market should establish rural branches, lest their portfolio may become suboptimal and operations saddled with high cost.
Hemant Kanoria CMD, SREI Infrastructure Finance Ltd.
Indias Aspiring Banks Line up for Licenses, January 17,

2013 in India Knowledge@Wharton
Banking credit is expected to grow at CAGR ~17% in the medium term (INR Bn)
Source: RBI, KPMG in India analysis
Significant head-room for growth

Domestic credit to GDP (% 2011)
Source: World Bank report 2012
In fact, rural and semi-urban areas

are still under-penetrated with
banking services and with increasing
consumption they provide great
opportunity for banking services to grow
in these areas.
As per Census 2011, 58.7 percent
households are availing banking
services in the country2. There are
102,343 branches of Scheduled
Commercial Banks (SCBs) in the
country, out of which 37,953 (37
percent) bank branches are in the rural
areas and 27,219 (26 percent) in semiurban areas, constituting 63 percent of
the total numbers of branches in semiurban and rural areas of the country.
However, a significant proportion of the
households, especially in rural areas,
are still outside the formal fold of the
banking system. New banks would help
in inclusive growth.
Department of Financial Service, June 2013
The average ROA for private sector excludes Ratnakar

Bank and City Union. Source: Capitaline
Lets assume that licenses have been

handed out and new entrants are in a
competitive space, face-to-face with
strong opponents that have been in
the industry for eons. What will they
do differently to succeed? The answer
will definitely depend on the motive
behind the banking application but can
they survive by just being another bank?
Each one of them has to differentiate,
make a mark and establish a brand
amongst hordes of other brands to
ensure success. They have to manage
the lending risk to ensure their success.
Past experiences show that not all
banks that got licenses have survived
the grit and determination to scale
businesses.
hovering over the Indian economy

will move away and it will move to 7-9
percent growth orbit in the next 10
years. In the process of growth, banking
sector will also benefit and grow further.
Apart from the fact that the
opportunities are in galore in the banking
sector (current and future), the ROA for
private banks was 1.31 percent for FY13
as compared to 0.73 percent for PSBs
in the same period.3 The average net
NPAs to net advances for public sector
banks as on FY13 was 1.99 percent as
compared to 0.84 percent for private
sector banks.4
The banking sector has had rough years

since Lehman in 2008 but there is still
lot of scope for new entrants in the
private sector. What has attracted the
new entrants to this sector? Economists
are positive that the dark clouds
4

D Subbarao speech on Banking structure in India on 13th

August, 2013
Success of new banks would depend

on:
Sectoral expertise/ knowledge
The new players have to make their
mark on customers who already are
banking with other eminent players.
What will set them apart? What
will ensure success for new banks?
Sectoral expertise/ knowledge based
on products (asset-based finance,
commodity-based finance), on industry
(engineering, infrastructure, telecom,
media, technology etc), nature of
their work (transporters, distributors,
exporters, importers etc) or on
geography (North, South, East or West)
will definitely put them ahead of the
race and help them attain consumers
trust.
In case of retail, asset-backed lending
applicants who have an edge with their
customer base, loan book and sectoral
knowledge would be ahead in the race
as opposed to other applicants who
have to start from scratch. The transition
from an NBFC to a bank will depend
on strong management as they would
be moving in new businesses with
uncharted risk areas.
Customer segmentation is the key
Opening the market 10 years after
the last round of bank licenses means
that the current banks are already
entrenched in consumers mind and
wallets. Customer service is no longer
a virtue. New banks are expected to
wow the customer with their services.
However, Identifying the gaps whether
in an urban or rural area in terms of
high-end innovative products, need,
pricing or business models would put
the new banks on the road to success.
New banks have to analyse the gaps
in between the saturated markets
MSME, only women-led businesses,
wholesale banking, traders, totally
under-banked markets with unorganized
professions or corporate banking and
use different operating models to reach
out to their customers. They have to
use different customer segmentation
techniques to think differently in terms
of products and offer innovative needbased products to the customers at a
low cost.
Rural branches as the final frontier
Conclusion
Along with the above requirements,

RBI requires new banks to open
one in four branches in rural areas.
However, various challenges inherent
in rural finance have led to inadequate
access to financial services for the
rural population. How the new banks
maneuver around the high risk and
operational cost would be of great
interest to the stakeholders. Rural
economy is largely a cash economy,
which adds to the complexity and risk
of operations. New banks with strong
rural strategies, cost-effective operating
models, branches in tier-5 to 6 cities,
strong alliances with MFIs and BCs with
proper governance control and local
market knowledge would spell success
in the rural areas.
Operating in the niche area profitably

and creating a viable business would be
the key concern for all new bankers as
they have to adhere to all the statutory
reserve requirements that may affect
their credit availability:
Learning from the past to secure

future!
The RBI is cautious about the new
banks as they are concerned about
depositors money; therefore, they will
review all the banking licenses from a
fit and proper angle. There is no doubt
about the fact that governance and
strong risk management processes will
get priority when the RBI is deciding on
licenses. Post license, new banks have
to adhere to strong risk management
processes to ensure that there are
no lapses in the regulatory norms and
they are not the reason for triggering
systemic risk in the banking system.
SLR (Statutory liquidity ratio)
currently at 23 percent
CRR (cash reserve ratio) norms
currently at 4 percent
Banks have to be Basel-III
compliant.
Banks have to lend 40 percent of
their advances to the priority sector

Dynamic Provisioning.
The new governor, Mr. Raghuram

Rajan, has indicated that the bank
licenses would be handed out before or
within January 2014. How new banks
would change the enviornment would
be of interest to all stakeholders.
About CII
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conducive to the development of India, partnering industry, Government, and civil society,
through advisory and consultative processes.
CII is a non-government, not-for-profit, industry-led and industry-managed organization,
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CII charts change by working closely with Government on policy issues, interfacing with
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Extending its agenda beyond business, CII assists industry to identify and execute
corporate citizenship programmes. Partnerships with civil society organizations carry
forward corporate initiatives for integrated and inclusive development across diverse
domains including affirmative action, healthcare, education, livelihood, diversity
management, skill development, empowerment of women, and water, to name a few.
The CII Theme for 2013-14 is Accelerating Economic Growth through Innovation,
Transformation, Inclusion and Governance. Towards this, CII advocacy will accord top
priority to stepping up the growth trajectory of the nation, while retaining a strong focus
on accountability, transparency and measurement in the corporate and social eco-system,
building a knowledge economy, and broad-basing development to help deliver the fruits of
progress to all.
With 63 offices, including 10 Centres of Excellence, in India, and 7 overseas offices
in Australia, China, Egypt, France, Singapore, UK, and USA, as well as institutional
partnerships with 224 counterpart organizations in 90 countries, CII serves as a reference
point for Indian industry and the international business community.
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Thank you!
We would like to acknowledge the
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the development of this paper.
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Indian Banking

During the last two decades of

The central bank has taken several

In this context, KPMG as our knowledge

The bigger the challenges, more is the

Banks face challenges from many

The Public sector banks (PSBs) are

Head - Management Consulting

RBIs objective of increasing financial

1 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies

Over the past couple of years,

Focusing on the emerging India

Incremental credit disbursed by SCBs (INR bn)

Source: RBI - Statistical Tables relating to Banks in India FY 12

RBI - Statistical Tables relating to Banking FY 12

CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 2

Source: RBI - Statistical Tables relating to Banks in India FY 12

3 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies

Banks are constantly trying to increase their overseas

Indian banks have been increasingly

Top Exports Markets (FY 2013, USD bn)

overseas branches as of March 31st,

Top Imports Sources (FY 2013, USD bn)

Source: Reserve Bank of India

Source: Ministry of Commerce & Industry, Government of India

The total trade, export and import, have

PSBs are also aiming to expand their

RBI Country-wise branches of Indian Banks at Overseas

Business Standard June, 2013; http://www.businessstandard.com/article/finance/icici-bank-for-more-branchexpansion-113062400758_1.html

CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 4

Supply Chain Financing (SCF) is gaining traction in

Source: Monetary policy department, RBI (http://www.rbi.org.in/scripts/PublicationsView.aspx?id=14681)

In the context of serving our clients responsibly, value chain financing is an

Demica Research, 2013

5 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies

CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 6

The Factoring bill essentially protects

Indian factoring market in the last decade

Source: Factors Chain International

Comparison with major Asian Markets

With favourable legislations, factoring

Source: Factors Chain International

7 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies

Focus on improving operating efficiency

Indian banks are now getting

With increasing competition,

For example, Indian market has

Gartner Research- http://www.gartner.com/newsroom/id/2319115

CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies | 8

Pressure on fee based income

Fee Income (INR Cr)

Source: KPMG-Business Today Best Banks December 2012

Max Life insurance. With the increasing

current accounts, processing fees on

10 The sample set comprises of 26 PSBs, 18 PBs, and 23 Foreign banks

9 | CII-KPMG Indian Banking Maneuvering through Turbulence: Emerging strategies

The banking sector is crucial for

In 2005, the Ganguly Committee recommended separation of Chairman and MD

Governance in Indian banks