Banking on rural India to achieve growth of 6-7 pc

New Delhi: Indian banking continues to transform at a rapid pace. The entry of private banks with high efficiency operating models, deployment of integrated technology platforms, new risk paradigms and above all, the emergence of highly demanding customer segments have all contributed to this transformation, says the ICC-KPMG Banking Report. The report released at the 5th ICC Banking Summit in Kolkata discusses key trends and opportunities for growth.
According to Ambarish Dasgupta, Head of Management Consulting, KPMG in India, “Over the past couple of years, the Indian banking sector has displayed a high level of resilience in the face of global uncertainty. We believe that for India to achieve the GDP growth rate of 6-7 percent, the banking sector will have to play a pivotal role. The banks will have to focus on emerging middle India, rural customers and MSME sector especially in the eastern and north—eastern states. This would require banks to adopt a flexible operating model and utilize big data for deeper customer insights. However, we foresee that a lack of leadership and easy availability of growth capital would be a challenge as the banks set out to fuel their growth aspirations.”
Four major trends that will dominate the Indian banking sector in the future:
--- Raising capital for public sector banks (PSBs) — Yes, it could be a problem in the future!
Assuming an annual credit growth rate from FY12-FY21 at 20 percent and the annual risk weighted asset growth rate at 22 percent, KPMG expects the Tier-I capital requirement for public sector banks for the same period to be in the range of INR 9,60,000 crore. The government’s intent to not dilute their stake leaves them with few options— The Government could consider creating a holding company (Holdco) and transfer its stake in the PSBs to this company. The Holdco can raise long term debt from domestic and international markets to infuse equity in the PSBs and act as an investment company for the Government of India. Another option for the government could be to consider diluting its stake in PSBs through issuance of Differential Voting Rights (DVR) such that the economic stake dilution is also kept to the minimum. The Government may also consider in the future on having a Golden share in each of the PSBs under which while the Government’s economic and voting stake may fall below 51 percent, it will always have the right to control the respective PSBs due to the possession of this Golden share.
--- M&A in PSBs will be a reality only when the government intervenes. 
Given the fact that over 70 percent of the market is dominated by PSBs, the Government of India and the RBI will have to drive consolidation amongst the large PSBs to create ‘large banks’ by mandating the merger of identified banks. This will be a significant departure from the previously stated non-interventionist policy of the finance ministry and the RBI, and as expected, will require great political will power and many levels of dispute resolution models.
--- Expect competition from foreign banks as they acquire ‘near national treatment’
The foreign banks operating in India with large networks would be keen to convert to WOS if they get national treatment in terms of opening branches in metros and tier-II cities and not just to expand branch network within the context of RBI regulations. When the major banks convert to WOS, they are likely to provide another level of competition to the domestic banks.
--- Closing the gap —financial inclusion will require innovative operating models
Technology-driven models such as mobile banking will inevitably change banks’ operating models and help banks in lowering their cost-income ratio.
Funding the aspirations of emerging modern India:
---- For the rising middle class, investment in banking products may not be the default choice for the middle class:  Banks would have to strive hard to attract deposits in the future as the rising segment opens up to other avenues for savings and investments such as mutual funds, insurance, real-estate and commodities.
---- Retail credit will bloom and not all banks will be able to manage the challenges: New risk assessment models that consider future cash flows, ownership of other financial products and behavioural data from alternate sources (such as track record of mobile bill payments etc.), shall be increasingly deployed by these banks to assess credit risk in real-time. Further, these banks shall also change their operating model to centralise credit decision and support it with innovative tools to analyse behavioural data at an individual and segment level. A major opportunity exists for retail lenders to develop and implement skills and tools that shall enable them to make credit pricing decisions at each individual’s level, rather than at a product level.
---- Gold loan business will continue to thrive in the future – banks will have to fight for their niches: Banks will have to identify the niche customer segments in the middle income class – those seeking higher value loans, small businesses that need capital for expansion – that they have the power and model to address. It is very likely that NBFCs will continue to dominate the market for customers seeking small ticket and high flexibility loans. This segment focus will enable banks to build a branch led operating model, where the speed of disbursement and flexibility of repayment terms will be of less importance when compared to size of loan and other bundled services
---- Will banks meet the emerging middle class needs? : The new middle class is likely to be fickle in its banking relationship – given the very low costs of, and multiple available options for, switching. The key to building and profiting from a long-term relationship with this segment will be the ability to build trust over a series of transactions.

MSME sector:
---- Small Industries Development Bank of India (SIDBI) has estimated the overall debt finance demand of the MSME sector at INR 32,50,000 crore. 22 percent of this amount is the debt financed through the formal sector, in which banks have the largest share (approximately 85 percent). Most of this debt flows to the registered enterprises. The risk perception attached to unregistered or unorganized enterprises due to a lack of transparent financial data, limited immovable collateral and lack of credit assessment skills of some sub-segments and the preference for ‘less hassled’, informal financing, reduces addressable demand considerably. 
--- While challenges for financing this sector continue, Reserve Bank of India (RBI) is creating an impetus for banks to finance.
---- Banks will need to develop multiple operating models and go-to-market strategies for the MSME market
Infrastructure financing: 
--- Policy inaction, reluctance of promoters to invest additional equity, and specific issues like lack of reliable fuel supply or issues in land acquisition have increased risk in the largest infrastructure sectors i.e. power and roads.
--- Significant private sector investments are required for bridging infrastructure investments gap and meeting revised targets by the Planning Commission. Considering the 70:30 debt to equity ratio, the overall debt requirements (disbursement potential) is expected to be INR ~14.3 lakh cr.
Rural opportunity is large and growing: 
--- Rural India constitutes 69 percent of the total population and drives about half the GDP of the country, a ratio which has mostly remained unchanged over the past ten years. However, it has been observed that its per capita GDP has grown faster than its urban counterparts, growing at ~ 6.2 percent since 2001 as against 4.7 percent for urban India, signaling higher productivity growth. The proportion of the rural households earning an income of INR 90,000 and above has increased to 37 percent in 2011 as compared to ~18 percent in 2001 with maximum growth being seen in the higher income brackets.
· Despite the growth in rural areas, access to banking services is still constrained. Various challenges are:  lack of adequate credit information, High operational costs and complexity, diverse profile, and limited collateral.
· Technology enabled solutions can go a long way in developing low cost and efficient delivery channels for rural India. There are several technologies which have already come up in the market – low cost ATMs, point-of-sale terminals, mobile-based technologies etc. and are being experimented with. Mobile- based technologies are likely to lead the way as mobile consolidates its position as an ubiquitous connectivity device. Banks need to work extensively towards customer education and awareness.
Innovative and cost-effective operating models:
Based on the firm’s business strategy and changing market dynamics, a bank’s target operating model should encompass the following guiding principles:
· Operation and technology should be highly automated, low cost, robust and scalable.
· Operations and technology should be extendable to other parts of the business.
· Redesigned business operating models should separate generic products from higher margin products in order to leverage scale and cost efficiency for generic products and to focus on revenue and margin for complex products.
· Combining functions (as in factory and or utility models) and costs across multiple products/ services and territories can eliminate products/ service and geographic silos.
· A joint venture or consortia structure that combines in-house capabilities, processes and functions with other processing leading capabilities, scale, and/or cost structures can deliver big benefits—but is not easy to achieve.
Public sector banks-Challenged for growth capital:
· The government, which owns 70 percent of the banking system, alone, will have to pump in around INR 415,955 crs till FY211 to retain its shareholding in the public sector banks at the current level to meet the norms. The implementation of new Basel-III norms will affect the investor returns. They have to look at a longer horizon, where a stable financial system will ensure a better and less volatile return. With the new capital norms coming into effect, sectors like retail will be attractive as these require less capital.
Addressing the leadership vacuum in the PSBs:
· The Indian public sector banking group is currently set to face a major talent pipeline challenge with over 80 percent of senior management personnel in the industry due to retire in the coming 5 years, there is a shortage of skilled managers to replace the middle management personnel who will be moving into these senior management roles; thereby creating a leadership vacuum in the middle.
· Public sector banks (PSBs) are set to face a ‘retirement decade’ soon- Over 1.8 lakh personnel from the baby boomer generation, who are currently in senior and middle management roles in PSBs, are due to retire in the coming 5-10 years. Due to a decade long hiring freeze in the 1990s and high resistance to hiring talent laterally, many PSBs do not have a strong enough talent pipeline to replace the personnel who will be moving out of these roles.
· To define a long term talent management strategy, banks will need to look at their talent management model and critically reassess and redefine it. In our opinion, plan will have to be devised at each step of the talent cycle using either one or more of four key strategic design elements- restore, grow, develop and strengthen.