'Yes, we need consolidation'

round table last month, the CEOs of big banks, an investment banker, a consultant and the chief executive of the Indian Banks' Association (IBA) met to discuss the topic "Consolidation in Indian Banking."

The participants were A K Purwar, chairman, State Bank of India; K V Kamath, CEO & managing director, ICICI Bank; Aditya Puri, managing director, HDFC Bank; A Christopher Low, CEO, Standard Chartered Bank; Leo Puri, principal, McKinsey & Company; Nimesh Kampani, chairman and managing director, J M Morgan Stanley and H N Sinor, chief executive, IBA.

The discussion was moderated by Tamal Bandyopadhyay, city editor, Business Standard.

Excerpts:

Moderator: Welcome to Business Standard's Fifth Annual Round Table. The topic of today's discussion "� consolidation among India's public sector banks "� was flagged off by Union Finance minister P Chidambaram at the Indian Banks' Association's annual general meeting in August. Do we actually need these mergers?

Sinor: I think this is really a time for consolidation. Let me talk about my personal experience. When I moved over from Union Bank to Central Bank, I realised that these two banks were more or less identical, having more or less the same kind of culture and processes.

In that case, do we really need two different entities? About eight years back, I had made some back-of-the-envelope calculations and found that a merger of the two could have saved almost Rs 400 crore.

In those days, technology usage had not kicked off. But today we find that a large number of banks have their own independent technology plans and each one is spending a large amount of money on it.

Instead, two or three banks coming together and spending the same amount of money can serve the purpose.

Aditya Puri: Fundamentally, a merger must have three or four objectives. There has to be increased market share, increased geography or reduction in expenses and, last but not the least, it has to be attractive to the shareholders.

Is consolidation necessary in the banking industry? Probably yes. If it is done carefully and with a clear objective in mind, it is worthwhile.

For nationalised banks, I think it will purely be a decision of the government. For other banks, commercial considerations will matter.

Christopher Low: If you look at the international context, size is increasingly the trend. As net interest margins get thinner, the need for more sophisticated products and low-cost technology will be felt.

If you look at the total banking market in India, excluding rural and cooperative banks, there are nearly 100 banks. Depending on the government's view on how quickly the public sector banks can have private shareholders of any reasonable influence, probably two or three in the public sector, two or three private banks and two or three foreign banks will emerge as big banks.

That will be the normal shape that you see in other international markets and a similar direction is coming from the prime minister and the finance minister. How quickly that happens is the challenge. But it will definitely happen and Standard Chartered wants to be a major player and be one of those three foreign banks that are left.

Leo Puri: From the point of view of the financial system, we need consolidation for three reasons. Financial stability is an issue. We should be quite clear that at the bottom end of the pyramid we do have weak banks that are a threat to the system. We need to address them.

As a shareholder, the government needs bank consolidation. Despite the big bull run we have had, on the whole banks in India are relatively poorly valued. Public sector banks are rated at a multiple of three to four times as opposed to eight or nine which could be typical for the private sector or 10 to 15 which is typical elsewhere.

Consolidation is needed for customers also. Intermediation costs in India remain high because there is relative inefficiency in the system. Whether it is the small and medium enterprise segment or the mass market retail segment or even the agricultural segment "� all are under-served. We have sub-scale banks that cannot invest and serve their customers.

I would also argue that you probably need consolidation for the sake of the employees in the banking system. We have a very large pool of unskilled labour in the banking system which employs a million people.

What I mean by "unskilled" is people that need to be retrained for modern banking. As part of consolidation, what has to happen is the retraining and re-skilling of the work force.

Nimesh Kampani: It's important that depositors' money is protected. The whole banking scenario is really fragmented. If you look at the world banking system, the five top banks control 75 to 95 per cent of the assets.

In India, the top five banks control 43 per cent of assets. So consolidation is a must as otherwise the shareholders will suffer as in the case of Global Trust Bank.

Mergers should not be forced. If you take all the worst banks and merge them with SBI or ICICI Bank, the shareholders of ICICI or SBI will suffer.

Kamath: The answer unequivocally is 'Yes, we need consolidation'.

The fifth largest bank in China probably is bigger than the top five Indian banks put together in terms of assets.It means that the ability of the Chinese banks to do business, whether domestically or globally, is significantly more than any one of our banks. I think it is in that context that the finance minister has been saying that we need to build scale.

You need engines of finance which can meet the growth aspirations. I think we need to come up with a structure wherein you have banks and other intermediaries which have the ability to marshal large amounts of cash and put on the table a large ticket sized item.

Just to put it in context, the State Bank of India is three times the size of Bank of America. The State Bank is probably reaching 90 million to 100 million customers. Bank of America has 30 million customers. On that basis, I am saying that it is three times the size. But if you look at assets, Bank of America has more than a trillion dollars of assets. So it has the muscle. Its ability to cut costs is significantly higher because it is earning that much more.

In almost all such comparisons, the scale of assets for foreign banks is 10 times the size for a like-to-like operation. This is a challenge we will face as we go along. We can build the financial size but we are also going to increase the size in terms of the customer base. We already have challenges in terms of branch network, people and technology.

Therefore, while I entirely endorse the proposition that we have to go through consolidation, I would guess that there is simultaneously an issue of sequencing. If we don't do so, we probably will encounter more problems than solutions. The challenge of the branch network, the people and the technology "� all three will have to be sequenced as part of the process of consolidation.

AK Purwar: With our kind of size, we are able to bring down the per unit cost of technology and various other things. Unless consolidation happens in the banking industry, this kind of substantial cut in cost per unit of production cannot be achieved and efficiencies will never come.

Although SBI has 14,000 branches and 100 million customers, it's very small compared with Citibank which has a market capitalisation of $250 billion. Our market cap is $7-7.5 billion. Citi has a capital of $67 billion and we have 10 per cent of that. We need to grow a lot more not only domestically but on a global market plane.

Moderator: Should foreign banks be allowed to play a big role in the consolidation game?

Kampani: I am a firm believer that healthy competition is always welcome.

What I have understood is that the RBI is not saying 'no' to foreign banks but will check whether the bank is 'fit and proper'. We need a debate on that. But we need to check on reciprocity. If foreign banks want a bigger presence here, will Indian banks also get a similar facility to open their branches abroad?

Sinor: At the macro level, the issue is in a way settled in the sense that the government is quite clear that the 74 per cent foreign direct investment route is permitted in the banking sector. But ultimately it is the regulator which has to regulate the entities in the banking sector and naturally it would like to see that the 'fit and proper' criteria is met by those who would like to come into the system.

I have seen how Indian banks are treated, particularly in western countries. If we want to open a branch, there are so many restrictions "� what kind of route we need to take, a subsidiary or a branch route, and the regulation is very tight. I believe that foreign banks should get the same treatment here.

The RBI has come out with guidelines on private sector banking ownership and governance and it is trying to work out separate guidelines for foreign banks. The regulator won't stop foreign banks from coming in but will ensure that they meet certain requirements.

Leo Puri: We have typically talked of three broad models. At one extreme is the purely market driven model which is typically what happens post-crisis, where you have no option and let the market recapitalise the system.

That is what happened in Argentina with roughly about half the assets in the private banking system acquired by foreign banks.

At the other extreme, you have a totally protectionist model which says that we will try and shore up our domestic banks as best as we can, keep foreigners out and we will force them into local consolidation which is, say, what has happened in Malaysia and we follow a protectionist stance towards consolidation.

I think there is a very healthy model in the middle which we like to label as 'managed transition'. Economies such as Brazil and Spain have been through it, where fundamentally what you look to create is two or four national champions in the public and private sector which are the anchors of the system. You do actually have two or three foreign banks which start playing a major role and you fundamentally define the policy framework within which you are comfortable.

One of the problems that we have in India is that, unlike in many other countries, we somehow appear to be shy of publicly taking a direct stand on policy issues. Does the RBI want to have foreign banks? If so, to what extent does it wish to have them? In every other economy, whether it is dealing with oil and gas, or telecom or banking or airlines, people take a policy stand. Our policy makers should not have any hesitation about taking a stand because there are plenty of examples.

Australia has a four-pillar policy. Acquisition of the Australia-New Zealand Bank is banned as it is one of the pillars of its banking system. Canada has a similar system. Some people may argue it is a protectionist, anti-free-market. So be it. The fact is that the policy makers have a clear perspective. Players know the rules of the game.

I think what is more important is that a view be taken, and we should not be ashamed as a country to serve our national interest. We cannot afford to have the arbitrary, ad hoc and fuzzy environment in which we are currently operating.

Aditya Puri: If you are a player in this country, it is the right of the regulator and the country to define the framework that they want for the banking system. No country in the world allows absolute and free access to the banking system.

Should foreign banks be allowed? Yes, they should be allowed but within a clearly defined framework. Should they come here? Should they have multiple entities? Should they be incorporated? What are the reciprocal issues? You try and open a branch in the US and you will see that the open economy is actually the most shut economy on earth. So we don't need to be apologetic.

Kamath: Each country has its own policy. China has, at one end of the spectrum, a policy on how they allow you to enter. You enter through a representative office and after a few years you get a branch may be and thereafter you grow in terms of branches and so on. It is a long drawn out process, well stated.

So is the case in the US. No bank will be allowed, at least from this part of the world, entry with a number of branches on day one.

Purwar: In some sectors like insurance and mutual funds, we have a lot of foreign participation, and foreign institutions have come and added value to the industry. If we have to come up to global standards, we have to see to it that the best global players are allowed to come in and upgrade the system in the best manner.

Aditya Puri: How many foreign banks are willing to take the organic route of putting seeds here and letting them grow and waiting that time? I have my doubts.

Low: Standard Chartered has been here longer than anybody around this table. We started in 1853 under a different name, of course. So there was a long term commitment to sow and grow, as many of you know.

The existing banking system in India is already world class and foreign banks can add value in terms of bringing in FDI and, related to that, giving the international investor the confidence that India has changed and is moving very fast.

Moderator: Let's focus on the roadblocks to consolidation.

For instance, if you look at the Indian banking sector, there is no uniformity on the technology front. Then, there is the issue of HRD ...

Leo Puri: I think that is the core issue. You have got to have a value creating path and objective when you set about this process.

There is a range of costs "� people and non-people and recovery related that you can improve. Secondly, it presumes that you can improve revenue synergy which in India is largely a case about building good distribution and pushing products. The third is that there is a series of treasury and funding related synergies that you can capture if you go about this in the right way.

Through these three levers, you will certainly find value on the revenue and the treasury funding lever almost from day one. You will have to pick your way through the cost drivers and understand what can you do today with the branches, the people, the recoveries and the technology. I believe there is already value today which can be captured without too much resistance.

Kampani: Another very important aspect is the re-training of the staff because in the public sector many inefficiencies exist. You don't have an exit policy in the labour laws which is a problem.

If you look at statistics outside of India, the mergers and acquisitions which have taken place in the US on an average in the last five years, 40 per cent of the cost of the target bank was reduced by the merger process. If you look at Asia and Europe, the cost reduction is about 37 per cent. When two people are coming together, the valuation for the shareholders has to go up, the customer should benefit, the depositor must feel much safer and the employees should be fully secured.

Sinor: The employees of public sector banks are ageing. Almost 35 to 40 per cent will be natural attrition of people by 2008-2009. That would mean that there are a larger number of people prepared to take VRS in case it is offered and the cost also would be much lower than if the employees were younger. So there is a positive side to the rationalisation of staff.

Talking of legal aspects, we have got a lot of issues around our present legislation on the banking system. We are governed by various Acts.

One set of banks is governed by the Bank Nationalisation Act; the State Bank is governed by the State Bank of India Act, private banks are governed by the Companies Act and Banking Regulation Act. Sometimes there are overriding provisions.

We need to do some kind of harmonisation. One suggestion that keeps coming up regularly is the corporatisation of most of the public sector banks. If we do this, by and large, the issue can be resolved.

Kampani: If the nationalised banks merge today, they do not get certain tax benefits because they are not corporates.

Low: A condition for win-win consolidation is the mindset. If the mindset is not right, not just at the senior management level but throughout the organisation, it will not be successful.

Aditya Puri: There is a total misconception that India is well banked. Our loan assets are a very small percentage of the GDP. We don't have profitability because it is split among so many people and you don't have multiple products from the same bank.

The market opportunity is phenomenal and the decision makers are the powers that be. And the faster they decide, the better it will be for everybody.

Kampani: Total loans as a percentage of GDP in India is 28.6 per cent, of which business loans are 23.2 per cent, the retail loans are only 5.4 per cent. Out of this, housing loans are only 2.7 per cent of GDP and non-housing are 2.7 per cent.

If you look at Australia, loans are 114 per cent of GDP, for Hong Kong 138 per cent of GDP, for Taiwan 149 per cent of GDP, Singapore 102 per cent of GDP and Malaysia 136 per cent of GDP. That is why we are under-banked.

Kamath: Rather than calling it under-banked, I think we are under-served.

Because if you look at per branch population, we are as good as the US. So I don't think we are under-banked, we are under-served. This is where the opportunity is in terms of bringing new products and services to the people.

I would think the major challenge is technology. Several banks are halfway through technology implementation. Even when platforms talk to each other, there are challenges, but when platforms don't talk to each other, platforms are not scaled up.

I want to touch on intermediation cost for a minute. My view is, and I can back it up by analysis, that intermediation cost is not high per se.

If you look at the number of customers, the number of transactions that the Indian banking system does, I dare say that our intermediation cost is probably one fourth of what it is anywhere in the world.

The problem is the other way round. Your income is low. If you translate your intermediation cost to income, it appears high. The average customer relationship in India is one-tenth of that in the West.

But there is another googly there. You break that down further, you are one-tenth, yours is one, they are ten. You have an 80 : 20 rule, or a 70:30 rule. 70 per cent of your customers are one-tenth of that. They are one hundred the size of the international customer and you expect the Indian banks to make money despite that low relationship! That is the challenge.

Kampani: It is exactly the same situation as in the capital market. The National Stock Exchange is the third largest in the world in terms of the number of trades, but if you look at the value, it is very low. That is because the level of income of people is not very high.

Leo Puri: For consolidation to be effective, it needs to be led by the leader. It cannot be led from the bottom up as a process of the weak consolidating with the weak. The leaders have the least incentive currently in India to lead consolidation. They are the most shy grooms I have ever seen. You may line up any swayamvar, they are not eager to put their garlands around anybody here. Without that we cannot have consolidation.

Moderator: How do you visualise the Indian banking sector over the next five years?

Sinor: I clearly see that consolidation will take place in the next two to five years. About 70 per cent of the public sector banks will consolidate.

I think this will also have a fallout on small private banks.

Moderator: How many public sector banks will survive in the next 5 years?

Sinor: About seven.

Low: I see the number dropping to three or four, depending on the government's appetite to open up, another three to four private banks and three to four big foreign players. Standard Chartered will be one of those three or four foreign banks.

Kampani: The niche players will continue. I see only a dozen big players.

I see about six to seven banks having a market share of about 70 per cent.

Leo Puri: There are very clearly two scenarios. One is a scenario where nothing happens. The reason nothing will happen is because the actual pressure on the public sector banks at the end of the day, given the moral hazards, the sovereign guarantee and so on that they carry, is not yet enough.

So, unless you have real pain in the system, the internal incentives to do anything remain, unfortunately, too low. So we are relying on government intervention to cause things to happen.

In a scenario where the leaders will lead, we will have half a dozen players, some mix of foreign, private andpublic.

Aditya Puri: It's quite likely that nothing will happen. But in that 'nothing will happen', the consumer will drive change and because of that, even if nothing was to happen, five or seven efficient banks will be having 70 per cent of the market share. That is one scenario.

The second scenario is that leaders can lead provided they have an enabling environment to lead.

Kamath: I endorse everything Aditya said. The first point that he made is that whether there is a merger or not, 80 per cent of the assets in the system will be basically in the hands of a few banks.

That is what is happening globally also and we can't duck that.

You also need a push from somewhere, a nod from somewhere, to get the big guys to move. Also, we now need to set a timeframe for consolidation so that people start working towards it.

In terms of the number of players, I guess it is going to be 80:20 and within that you will have in the public sector a handful "� five or six players that will be the leaders.

And it is not unreasonable to assume that there will be three or four private banks and three or four foreign banks.

Moderator: Purwar, are you going to merge your seven associate banks with SBI to show the way to the industry?

Purwar: The State Bank group is a group of nine. We can merge this group into one, or we can continue to have the present position with the difference that the technological platform of the entire group will be one.

Business processes across the group will be the same. So what will happen is, although there will be nine faces of the bank, a virtual merger will be in place.

Seven to 10 years down the line, there could be six to seven public sector banks and a couple of private sector banks and certainly some foreign banks.

In this scenario, I foresee the State Bank group continuing to have anything between 22 and 26 per cent market share. I don't foresee SBI's leadership being under threat.

Moderator: Are you willing to take over other banks?

Purwar: We are absolutely open, if the right candidates are there. We are open to the acquisition of any public sector or any other bank.

Moderator: Broadly, there is a consensus among our panelists that consolidation is inevitable and that the government must create an enabling situation where the leaders are encouraged to take the lead.

Eight to ten big banks will dominate the industry over the next five years or so. Foreign banks should be allowed to play a role in this consolidation game and the regulator must set the rules for them in a transparent manner without delay.

Thank you, all.