Banks need innovation in their distribution channels to cater to changing customer preferences, as well as improve productivity and cost-efficiency, said a new report by McKinsey & Company.
The report, ‘Reimagining Banking in India: Gearing up to meet the new environment’, said banking in India had made strong progress across many metrics such as improving access to banking products and services, maintaining stability in the sector and creating value for shareholders.
Access to banking
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Total loans (as percentage of gross domestic product, or GDP) extended to all segments increased 103 per cent, from 0.29 per cent in 2003 to 0.59 per cent in 2013, the report said, adding penetration of loan products among people (measured as percentage of those with access to at least one loan product) increased 140 per cent. “However, despite the presence of nearly 90 scheduled commercial banks in India, the extent of access is still low, with about 35 per cent of India’s population financially excluded, and only 28 per cent of total bank retail credit being channelled to rural and semi-urban areas, which constitute 87 per cent of the population,” the report said.
Decline in banking outcomes
While the banking system remained well-capitalised, the report said there was a significant increase in risk levels, owing to rising non-profitable assets. It added value creation had reduced through the last three years---valuations had seen reduction and there was a consequent decline in shareholder returns. Total returns to shareholders (three-year compounded annual growth rate, or CAGR) fell from 16 per cent in 2010 to 12 per cent in 2013.
McKinsey said the Indian banking sector’s growth had slowed through the last three years, though the decline had not been as steep as that seen in the overall economy. “The credit and deposit growth (three-year CAGR) in the banking sector has fallen three and five absolute per cent points, respectively---credit growth fell from 22 per cent in 2010 to 19 per cent in 2013, while deposit growth fell from 21 per cent in 2010 to 16 per cent in 2013.”
Macroeconomic and external factors
McKinsey said several discontinuities across the macroeconomic situation, customer behaviour shifts, technology disruptions, regulatory changes, wage inflation and the fight for talent were reshaping Indian banking. The report said real GDP growth had fallen from an average of 8.1 per cent (between 2004 and 2011) to less than five per cent in the fourth quarter of 2013. This was attributed to the declining savings rate, the shift from financial to physical savings, declining investment rates (as percentage of GDP) and impact of global capital flows driving volatility.
Policies were further limiting commercial lending, McKinsey said. This includes directed lending policies such as statutory liquidity ratio and priority sector lending, which limit availability of funds for commercial lending. Further, it was reflected implementation of Basel-III norms was likely to lead to a capital crunch.
Lack of innovation
McKinsey said innovation in the Indian banking sector in the last three-four years was less than in 2002-2007, across customer propositions, low-cost models (especially distribution) and risk management capabilities. Consequently, the report added, cost efficiencies remained unchanged (about 70 per cent for all banks) through the last decade. This indicated low innovation in productivity and efficiency improvement.
Lack of innovation had also created a situation in which public sector banks were under-performing their private peers.
Other issues discussed in the report included high fragmentation, which led to low cost-efficiency and low value-creation, high government ownership, leading to high capital strain on the government, and low ownership of banking assets by foreign banks in India.
The future
With the banking sector potentially on the verge of moving from value-delivering to under-delivering, the report said by 2020, the sector could evolve in three different directions---return on the value-delivering path; move into a profitable, but under-delivering zone; or move through a crisis-like situation.
To become a “bank of the future”, the report said banking players should innovate in three aspects---customer insights and proposition, distribution and risk architecture. On distribution, McKinsey said banks should leverage digital banking to cater to high-value customers. The report also called for profitably serving small and medium businesses and capturing the rural and mass market by leveraging technology and analytics.
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