What are the core competencies of banks as opposed to other financial intermediaries? Basically, it consists of their efficient provision of liquidity and safety for depositors, 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 squeezed interest rate margins. Leading banks have, thus, been 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.
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Technology has led to the introduction of many innovations including web-enabled solutions, further reducing costs and improving service delivery.
For investors in bank stocks, the most important theme to keep in mind is the 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 a slowing down of critical and timely decision-making is a clear concern.
Poor service stemming from a bureaucratic ethos whittles down brand equity and can cause large-scale customer attrition. Policy loans to wealth destroyers can only translate into increasing bad loans and its attendant higher provisioning. In this case, an economy mired in stagnation and facing the onslaught of savage foreign competition will not be of much help either.
Another critical failure of public sector banks is their rudderless roaming in 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 without commensurate investment in human capital. Overstaffing will remain despite periodical voluntary retirement schemes.
This has led to a labor cost legacy that public sector banks now wear like a crown of thorns. The high cost-to-income ratios, when compared with new private sector entrants, promises to bleed them.
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 than a merciful death, will remain a perennial 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, while high, may prove inadequate. Here's why: India does not have proper bankruptcy and foreclosure norms.
Our courts are not known for their speed in dispensing cases. Second, non-performing loans recognition norms have hitherto been lax. More aggressive norms will need additional provisioning.
The recent nod given by the Reserve Bank of India to allow the entry of two new private banks and the large investments that public sector banks are making to grow in the retail segment will lead to even more competitive conditions leading to further erosion in their margins.
The creation of universal banks will further erode profitability because the fee-based income market has largely been the domain of banks and not of 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 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 share price bands for a year and risk-reward ratios throw up some interesting numbers. SBI share's projected price band is Rs 200-400, Corporation Bank projected price band is Rs 75-175 and HDFC Bank's is Rs 200-500. IDBI Bank shares look cheap. The bank has its strategy right but is dependent on IDBI's moves to rule out a merger.
Once that issue is cleared up, it can increase its resources without issuing equity at the current dilutive market price. UTI Bank has its strategy right, its growth engines are in place and the stock looks cheap.
(Chetan Parikh is a Director of www.capitalideasonline.com and owns shares of HDFC Bank and IDBI Bank)