India's Banks Gear Up for the Global Market

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India's banking industry these days finds itself on a treadmill where it has to keep pace with the country's rapid growth by servicing a customer base with global options.

A report by the consulting firm McKinsey & Co. finds that while Indian banks fare well by global standards on a few counts, including increasing shareholder value, they will have to do much more to stay competitive. India Knowledge@Wharton spoke with experts at Wharton, McKinsey and the Indian School of Business about how India's banks can deal with the challenges they face.

McKinsey, with support from the Indian Banks Association, tracked 14 leading Indian banks and their customers in five surveys. These covered their performance in personal financial services, retail banking, IT benchmarks, organizational performance and asset liability management. The institutions included seven public sector banks, four from the private sector and three foreign organizations.

India's banks have had "unprecedented opportunities" in the last four years of India's rapid growth, lifting their valuations , according to the McKinsey report. It is now time to look at how well they are positioned for continued growth, the report adds. Joydeep Sengupta, director at McKinsey and leader of the firm's financial services practice in India and Southeast Asia, who co-authored the report with McKinsey partner Renny Thomas, says their effort is the first of its kind to benchmark Indian banks' performance on a global scale.

How They Fare

India's banking industry fared better than its Asian peers on two out of five objectives that McKinsey identified. They scored high marks in increasing shareholder value and allocating capital efficiently, the report finds. They also compare favorably on a third parameter -- contributing to India's GDP (gross domestic product ) -- on a global scale, the report adds.

Indian banks, however, don't look as good in fostering "financial inclusion"; banks in other countries do a better job of tapping household savings, the McKinsey report says. Also, they could do a better job of managing intermediation costs more efficiently, read as the spread between the interest rate on loans advanced and that paid for deposits.

Indian banks have a lot of ground to cover in participating in the country's GDP, says Rajesh Chakrabarti, professor of finance at the Indian School of Business in Hyderabad. "Bank credit accounts for about 40% of GDP in India, but it far exceeds the GDP in other Asian countries like Hong Kong, China, Taiwan, Singapore and Malaysia," he says.

Indian banks achieved the highest pretax returns on investment across Asia at 17.9% in 2006, compared with those in Malaysia (16.3%), China (15.1%) and Thailand (9.1%), the report says. That performance helped Indian banks post the highest returns to shareholders as measured by stock market banking indices , it adds.

Between January 2000 and October 2007, Indian banks delivered returns to shareholders of 36.76% (compounded annual growth rate ), compared with 24.03% for the entire Indian stock market. In the same period, Chinese banks achieved returns to shareholders of 17.57%, while British banks managed only 9.34%.

All those ranked better than the 7.16% by all shares on the FTSE (Financial Times Stock Exchange) index and 4.54% on the Dow Jones Industrial Average (DJI Quote), as tracked by the McKinsey report.

Chakrabarti says foreign banks operating in India have been the most profitable , and he attributes that to their ability to attract corporate current accounts, on which they pay zero interest; savings accounts pay interest rates of 3.5%, while longer-term deposits attract rates of up to 9%, the peak rate being that for senior citizens. "The current deposits keep their overall interest rates low and margins high," Chakrabarti notes.