Branching out

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India’s central bank wants to introduce innovation and competition through new banks so as to breathe life into the country’s financial sector. It is a scheme that has worked before, but, as the economy stumbles, the regulator is not making it easy for potential lenders.

Much of India’s modern private banking sector, including four of the current five most active lenders, has its roots in earlier rounds of licences the Reserve Bank of India granted in 1993 and 2003. This year’s process attracted 26 new applicants before the July 1 deadline.

Results are expected in January, but it is still unclear what exactly the winners will be winning. The opportunities appear very different than when incumbents, such as Yes Bank, ICICI Bank and Axis Bank, won licences.

Indian dealmakers are looking to the May general election as a key inflection point in the country’s return to economic stability, if not strength. Yet, whichever way the post-election markets pan out, the conditions in the banking market will remain challenging. New banks have a lot to contend with.

Previous private sector licensees were able to grow rapidly in targeting large urban areas. This time, however, the regulator is requiring newly licensed banks to focus on rural areas. Banking penetration is low in rural India, but accessing clients there costs more money and time than it does in cities, according to analysts.

“It is important to realise that the challenges are different now,” said Saswata Guha, director at Fitch Ratings in Mumbai. “The guidelines are far more stringent. It seems clear that the regulator means business.”

Previous banking applicants did not have it all their own way. Most of the 10 new banks set up in 1993, for example, have been merged into other institutions or have been rebranded. Most applicants in 2003 did not even have a chance because, of about 100 applications, RBI awarded only two permits.

The RBI will be at least as strict this time, analysts say, with demands on profitability, capital adequacy and growth for the new banks. Those prerequisites alone limited the number of new banks that applied.

“A candidate needs the capital wherewithal to comply with rules and, also, to have a certain standing in the space,” Guha said. “All of this means only serious contenders can apply. Looking at the 26 names, only a few could probably comply with the requirements, maybe five or six.”

Serious capital

New banks are required to open one in four branches in rural areas and meet statutory reserve requirements. Lenders must place 4% of deposits with the RBI and hold 23% in government bonds from the start. Banks are also obliged to maintain up to 40% of their net bank credit as loans to priority sectors, such as agriculture, education and housing.

Still, the interest of the 26 hopefuls suggests a belief in India’s long-term prospects, despite current political and regulatory gridlock.

Only around half of all Indian households currently have access to banking services and, as the economy grows, so will demand for more sophisticated and expensive services.

The world’s second-most populous country still has solid longer-term growth prospects. The IMF projects GDP growth of 5.68% this year, 6.23% in 2014 and 6.63% in 2015. That will represent the type of economic rebound that banks thrive on. The Indian economy grew only 3.99% in 2012, a significant drop from 7.75% in 2011 and 11.23% in 2010.

For these predictions to come true, however, India’s policymakers have their work cut out for them.

“There is a broad consensus that a lot has to be done quickly to improve India’s economy,” said Geeta Chugh, credit analyst at S&P, based in Mumbai. “We forecast 5.5% GDP growth this fiscal year, although there is a high downside risk that growth could slow to 4.5%. We are more optimistic about next year with growth expectations of 5.5% (downside scenario) to 6.5% (base-case scenario).”

None of this means that new banks will have it easy. The sector requires innovation, capital and tenacity. Analysts say that successful banks are going to have to look well beyond the current economic conditions in India to be successful.

“I’m sure it’s not going to be very easy, because the implications of doing anything in India is that it’s not going to be easy,” said a source at an institution that had applied for a licence. “The macro picture is important, but we are more concerned about our next deal, and how and where we’re going to do it.”

The RBI has attracted a wide range of banking hopefuls, including conglomerates like Aditya Birla Nuvo and Tata Sons, finance firms like Reliance Capital, IDFC and Shriram Capital, and Department of Posts. The diversity of interests these applicants represent reflect the breadth of ideas needed to advance the country’s banking sector.

“The regulator and the Indian banking sector are looking for financial innovation,” Fitch’s Guha said. “When ICICI and Axis came into the system, we saw a lot of innovation. Having new banks could breathe some life into the system, in the form of ideas and capital.”

“If you look at the guidelines, only the biggest and most patient and thorough banks are going to get licences. My sense is that it would take three to five years for the banks to break even.”

However, even in the most optimistic scenario, new banks will take a long time to adapt to market conditions and develop strong footholds.

“The gestation period for a successful bank should be very long,” Guha said. “So, only the serious banks should be applying. If you look at the guidelines, only the biggest and most patient and thorough banks are going to get licences. My sense is that it would take three to five years for the banks to break even.”

Foreign competition

The Indian banking market has proven difficult for some local and foreign institutions. Swiss bank UBS decided to surrender its licence in June and close its banking unit, including fixed-income and foreign-exchange and credit-service operations. That followed similar recent moves from investment banking rivals Morgan Stanley and Goldman Sachs in the past year.

Yet, these global banks can still compete for investment banking businesses, such as M&A, ECM and DCM. These lines fall under merchant banking licences that the Securities and Exchange Board of India regulates.

Some of those markets have been particularly active lately.

“One area that we continue to look at is cross-border M&A and related business,” said Ravi Shankar, managing director, investment banking, India, at UBS. “We are spending a lot of time with Indian companies that continue to look at opportunities to expand abroad and international companies that have made or want to make acquisitions in India.”

UBS, Standard Chartered and Credit Suisse, three foreign firms, are advisers to Videocon Industries on its US$2.5bn sale of a gas asset in Mozambique to ONGC Videsh and Oil India.

One of the more closely watched deals to come out of India this year is Apollo Tyres’ purchase of US-based Cooper Tire & Rubber for US$2.5bn in cash. India’s Apollo enlisted foreign banks for the trade. Morgan Stanley and Deutsche Bank were advisers. The two advisers, Standard Chartered and Goldman Sachs ,are, meanwhile, providing the financing.

The prospects for similar types of transactions continue to attract foreign banks to India, even if they do not have traditional banking licences.

The Indian equity market is still a priority for some foreign banks, even if volumes have been low this year. Foreign institutions still dominate the equity league table, according to Thomson Reuters data, accounting for seven of the 10 most active banks for equity placements. Citigroup, Goldman Sachs and Morgan Stanley are in the top five, for instance, with a combined 31% of the market through September 5.

“You can’t have all the cylinders firing all the time. While there is always some action in each of our product lines in India, depending on the environment, some products do better than the others. This year we have seen good M&A deal flows, while overall ECM transactions have been subdued given the economic conditions”, said Sunil Sanghai, managing director, head of banking, India, at HSBC.

“Given the demographics and the growing consumption story, most of the global investors I speak to are still bullish on the long-term story on India”, Sanghai said.

The syndicated loan and rupee bond markets, on the other hand, are the domain of local banks. State Bank of India has a 74.2% share of new loans signed this year, according to Thomson Reuters figures, with ICICI Bank, Axis Bank, Yes Bank and IDBI completing the top five. Meanwhile, the top-five rupee bond underwriters are Axis, Trust Group, Yes Bank, ICICI and HSBC.

“The basic allure of India as a BRIC nation has not gone away,” Shankar at UBS said. “Fundamentally, there is nothing wrong with India, but there is a lack of confidence in the government’s policy making. A new government can help improve things.”