What are the core competencies of banks as opposed to other financial intermediaries? Basically their efficient provision of liquidity and safety to depositors, the monitoring of loans and purveying payment services like credit cards.
Globally, in the age of "equitisation" this is under threat. Financial innovation, the declining costs of securitisation and the increasing knowledge and experience of market participants has caused securities issuance to displace bank lending as the major source of capital for large corporations. Furthermore technological progress has brought down costs and have squeezed interest rate margins. Leading banks have been thus de-emphasising lending and relying increasingly on fee based income. Deregulation is causing financial intermediaries to blur divides, cross-sell products and become customer - centric rather than product- centric. Technology has led to the introduction of many innovations including web- enabled solutions further reducing costs and improving service delivery.
The broadest theme that investors in banking stock should be looking at is a continuing squeeze on loan margins and increasing income from fees and services. Balance sheet size will decline in importance over time.
Public sector banks are ill suited to function in such an environment. Top management playing musical chairs is a reality that cannot be wished away. In a difficult and rapidly changing economic environment, such slowing down of critical and timely decision making is a clear concern. Poor service stemming from a bureaucratic ethos whittles brand equity and can cause large scale customer attrition. Policy loans to wealth destroyers can only translate into increasing NPLs with the attendant provisioning. An economy in the throes of stagnation and facing the onslaught of savage foreign competition cannot help.
Another critical failure of public sector banks is their rudderless roaming in the technology backwaters. In the age of networks, they stand out as docile dinosaurs. Far from being customer- centric, they cannot be even product-centric. Talk of aggressive computerisation will be difficult to translate into practice in the absence of a communserate investment in human capital. Overstaffing does not help. And will remain despite periodical voluntary retirement schemes.
This has led to a labor cost legacy that the public sector banks wear like a crown of thorns. The high cost-to-income ratios in relation to the newer private sector entrants promises to bleed then. A similar legacy of far flung branches, serving anything but a business purpose, subsumed to the needs of politics rather than economics, doomed forever to a subsidised existence rather then a merciful death will remain a perennial commercial curse. It is hard to see any value creating changes here, at least in the foreseeable future.
Asset quality, notwithstanding the recently announced arrival of India’s first asset reconstruction company, remains suspect. Loan-loss coverage ratios, whilst high, may prove inadequate. Here’s why 1). India does not have proper bankruptcy and foreclosure norms. Our courts are not known for their speed in dispensing cases. 2) NPL recognition norms have hitherto been lax. More aggressive norms will need additional provisioning.
The recent nod by RBI to allow the entry of two new private banks and the large investments that the public sector banks are making for growth in the retail segment in creating highly competitive conditions for fee based services leading to erosion in their margins. The creation of universal banks will further erode profitability because the fee based income market has been largely the domain of banks and not the financial institutions. For instance, non-banks do not earn any forex fees at all which is exclusively a banking activity. Investments in technology platforms offer the greatest scope for superior service and hence customer acquisition. A global theme, the unbundling of manufacturing and distribution of financial products, is also being played out in this segment- some banks are using their branch networks to sell insurance and mutual fund products.
Projected price bands for a year and risk reward ratios throw up some interesting numbers. SBI’s projected price band is Rs.200-400, Corporation Bank’s projected price band is Rs.75-175 and HDFC Bank’s Rs.200-500. IDBI Bank is cheap, has its strategy right but is dependent on IDBI’s moves to rule out a merger. It can only then increase its resources without issuing equity at the current dilutive market price. UTI Bank has its strategy right, growth engines in place and is cheap.
(The columnist owns shares of HDFC Bank and IDBI Bank)
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