Analysis of the Banking Sector in

India
Contents
 Introduction
 Evolution of the banking sector in India
 Structure of the Market
 Major Players
 Market Share
 Regulatory changes
 Concentration
 Nature and Extent of competition
 Competitive Analysis
 Conclusion
Introduction
Indian economy is world’s fastest growing economy with GDP growth of more than 7% per year.
Banking sector plays a vital role in growth of India by supporting economic development through
efficient Financial services. Banks consider retail banking as their core banking function and retail
customers are considered as their core customers. Core banking includes activities like savings
account, loans, mortgages and payments.

Evolution of Indian Banking Sector

Core banking activities such as money lending and borrowing can be traced back to 2000 – 1400
BC. Kautilya’s Arthashastra which dates to the 4th Century BC is one of the oldest written evidence
containing terms such as creditors, lenders and lending rates.

During this period and for the times to follow, there was a lack formal, organized and connected
banking system. It was only during the 18th Century that commercial banking was introduced in
India with the establishment of Bank of Calcutta in 1806. Later, two more Presidency banks were
set up namely the Bank of Madras and the Bank of Bombay.

The three banks amalgamated in 1921 to form the Imperial Bank of India which was a formal
Commercial bank and played a role of banker to the banks and a banker to the government.

Later in 1935, a central bank for the country was established namely, the “Reserve Bank of
India” which took Central banking functions from Imperial Bank of India and subsequently
The State Bank of India formed in 1955 took over the other functions of the Imperial Bank of
India.

After independence, numerous steps were taken towards reinforcing the trade, commerce
and economics and making Banking the financial backbone of the country, namely:

1. The Banking Regulation Act, 1949

2. The State Financial Corporation Act, 1951
3. The Reserve Bank of India (Amendment) Act, 1953

The banking sector went through major changes and developments during 1967-1991. The
major development was nationalization of 14 banks in 1969 and 6more banks in 1980.

After this period, the entry of private players such as ICICI and HDFC has intensified
competition. Also, this period marks a tremendous change in terms of technological
advancement in banking sector.
Structure of the Market

Major Players

27 Public sector banks

22 Private sector banks 44 Foreign banks SBI PNB

56 Rural regional banks
1589 Urban cooperative banks 93550 Rural cooperative banks
Canara Bank of
Bank Baroda

Major Public
Sector Banks

HDFC ICICI HSBC Citibank

Kotak Standard
Axis Bank Barclays
Mahindra Chartered

Major Private Major Foreign

Sector Banks Banks
Market Share

Public Sector Banks

SBI PNB
Others SBI Bank of Baroda Canara Bank Bank of India
34% 37% Others

Bank of India
6% PNB
Canara Bank 8%
7% Bank of Baroda
8%

Private Sector Banks

Others 22% HDFC 26%

HDFC ICICI
Axis Bank Yes Bank
Kotak Mahindra

Kotak Mahindra 6%
Others

Yes Bank
8%
ICICI
21%
Axis Bank
17%

Regulatory Changes

 With the clearance of Banking Regulation(amendment), RBI was empowered to deal

with NPA in banking sector
 Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 bill has been passed
and is expected to strengthen banking sector
 Recapitalization bonds worth 80000 crore was approved
 RBI has mandated the KYC standard and made Aadhar linkage compulsory to bank
accounts (though subject to final decision by supreme court) and demanded banks
to forward a comprehensive policy framework to avoid money laundering activities.
Concentration

With the structural and regulatory changes

initiated by Reserve Bank of India in the past
couple of decades, especially pertaining to
branch licensing and foreign banks’ entry, the
Banking Industry has witnessed a decrease in
the market share of state-controlled banks
because of the entry of private and foreign
banks in Indian market.

The concentration ratio of top 5 banks CR(5)

and that of top 10 banks CR(10) based on their
asset represents the market share of top 5 or 10
banks relative to the industry. CR(5) and CR(10)
can be seen decreasing throughout the last few
years which means that there is a decrease in
market shares of the top 5 or 10 banks and an
increase in market share of smaller and newer
banks.

Nature and Extent of Competition

Indian banking sector is a highly profitable one owing to the large difference between the
lending rate and deposit rate. RBI, on several occasions, has said that this spread needs to
be narrowed down for the economy to grow by double digits. However, the banks are
reluctant to deviate from the existing highly profitable model.

With Indian economy growing at a rapid rate, the demand for credit is expected to grow and
so is the interest income for banks. Thus, the banks are opposed to any change in the status
quo because it is allowing them to make supernormal profits in the highly regulated banking
sector.

Indian banks are heavily capitalizing on entry barriers set by RBI, moreover they also favour
regulation over savings bank rate which is quite low. With a savings rate of around 4% and
lending rate of around 11%, the banks manage to reap off huge amount of profit from the
“Net Interest Margin”. Any kind of deregulation in the savings rate would attract
competition and would bring the savings rate up and hence then banks will have to lose on
higher profit margins.

With above mentioned facts, the Indian Banking sector can be considered as moving
towards an Oligopoly market from a competitive market.

Competitive Analysis

Competition in banking sector is essentially regarded as a positive phenomenon, as it is

considered to make banks more efficient and customer centric. Also, it endorses financial
innovation and pushes banks to invest in diverse portfolios thus setting up a stage for niche
sectors to grow within an economy.

Some of the key determinants of Competition in any sector include entry-exit barriers and
regulations from a central governing body. Indian Banking industry is known to have one of
the highest entry barriers in the form of minimum regulatory requirements, branch licensing
and restriction to the entry of foreign firms and it is one of the most highly regulated
sectors.

Classical theory and structure Conduct Performance (SCP) hypothesis states that an increase
in concentration ratio of the top banks means a decrease in the competitive conduct and
vice-versa.

In recent times, the Indian banking industry has seen a reduction in market concentration of
top few banks which, according to the classical theory, would mean that the market has
become more competitive. However, the Indian banking sector has also seen a reduction in
competition because of the entry barriers, over regulation and consolidation exercises.

CONCLUSION

The banking business works on charging higher lending rates to the borrowers and giving
lower interest rates to the depositors. The gap between these rates, Net Interest Margin, is
more than what the consumers would like. The banks, however, don’t feel obliged to reduce
this gap and pass on the benefits to the consumers as the banks do not fear any competition
from new entrants as there are huge entry barriers which make it an oligopoly. The market
players have a mutual understanding to regulate their services for their best interests. This
can be seen by instances when the lowering of the Policy/ Repo rate by the RBI doesn’t
reflect quickly on the lending rates/ MCLR of the banks. However, an increase in repo rate
by the RBI is quickly passed on to the consumer. There is also disparity of services
offered to existing customers and those to the new customers. For instance, while the
interest rate goes down, banks woo new customers with lower rates, but refuse to give the
benefit to existing customers. Also, banks mostly offer fixed rate for deposits and floating
rates for loans. The RBI should look into the rationale of banks in fixing their lending rates
and suggest corrective regulations so as to pass on the benefits to the consumers.

References

 https://www.ibef.org/industry/banking-india.aspx
 https://www.rbi.org.in/