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How They FareIndia'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
Better Capital AllocationIndian banks have improved capital allocation dramatically during the past four years, and this is evident in the decline of their gross non-performing assets (NPAs) as a proportion of total loans -- from 9% in 2003 to about 3%, the report finds. Indian banks could achieve that with a lot of help from a booming economy, but they deserve credit also for making better lending choices, McKinsey says. For instance, Indian banks reduced their exposure to industries where they were losing money, such as paper, steel, textiles, hotels and tourism, from 56% in 2003 to 22% in 2007. They achieved this by increasing their exposure to borrowers that brought positive returns, including paints, cement, automobiles and pharmaceuticals, from 44% to 78% in the last four years, the report says. The intermediation cost -- or the
Incumbents vs. AttackersThe McKinsey surveys also revealed fundamental shifts occurring in the composition of Indian banks, with newly emergent private banks -- McKinsey calls them "attackers" -- rapidly stacking up gains over the older, incumbent banks, with improved customer service, better
On the measure of "credit and risk best practices," Indian banks fare well against their global peers, although incumbent banks fall short, the report says. This measure covers banks' performance on credit
underwriting , rating , risk-based pricing, credit portfolio management and credit monitoring. On a scale of 0 to 4, McKinsey gives Indian attacker banks the top score of 3.3, while the top global banks average 3.2 and Asian banks average 3.1. India's incumbent banks manage a score of just 2.8 on that scale of credit and risk best practices. "On the whole, they lack advanced early warning systems and use only basic funds transfer pricing methodologies to conform to regulatory and compliance measures," the report says. McKinsey's surveys also reveal that Indian banks have done better than their global peers in organizational performance, "given their historic access to superior talent." The report also puts Indian banks ahead of their Asian counterparts in "distribution efficiency," while both share equal scores in "marketing and sales." Asian banks and the top 10 global banks do better than their Indian counterparts in corporate leadership, IT capabilities and credit skills. However, the Indian attacker banks are ahead of the incumbents on all fronts, including what McKinsey calls " corporate leadership ." a reference to the country's established IT skill base ." Sengupta says that while incumbent banks have been relatively slower to embrace IT and other technology, they will still derive advantages on that front. "In an ironic way, they are able to leapfrog as they have been later adopters of technology," he says. On customer satisfaction, which McKinsey rates as "the biggest driver of value," the report says the attacker banks have "revolutionized levels of convenience and provide customers with superior service." At the same time, the attacker firms also have "more customers with negative experiences" than the incumbents. "Customer experience and tailored offerings will be a big driver of bank profitability, as young, affluent customers are more demanding and discerning and are less credit-averse." "That is scary for the incumbent banks," says Chakrabarti. He adds that while the incumbent banks fare as well as the attacker banks on profitability measures, they are unable to win over the younger, upper middle class group of customers that is commonly referred to as the "mass affluent." India's mass affluent class is heading towards private banks and foreign banks, driven mainly by customer service needs, he notes. "That is where your cheap deposits will come from, and those are the people who will use your banking services and to whom you can sell your insurance products and other fee-based services," says Chakrabarti. "That is the customer service the incumbent banks want to hold on to, to maintain your profitability."
Technology and PerformanceIn using technology to shore up their performance, the best banks in India (including five leading private and foreign banks operating in the country) "are among the most efficient in the world," the McKinsey report says. In one specific measure of IT spending per 1,000 accounts, the "best Indian banks" spent an average $10.2 in 2007, while European banks averaged $76, the firm notes. The Indian attacker banks with "best-in-class" IT capabilities "are truly the best in the world," McKinsey adds, identifying three factors driving this trend: "the ability to avoid using legacy systems, superior governance practices that often entail direct CEO involvement and the India advantage
Allen says that "the big banks across the world seem to have a problem with customer satisfaction," and he raises some fundamental issues here. "If you make a mistake like bouncing a check, the bank charges you a high
penalty price; that may get people upset with them," he says. "On the other hand, they provide a lot of services for free, such as when you use your own bank's ATM or when they process the checks you write. If they charge you for those services, it may get people even more upset." It isn't easy to determine what drives customer satisfaction while banks try to stay both competitive and profitable, says Allen. "They have to make money somehow, and it is interesting the way they do it. The question is whether the way they do it is actually the best. Maybe the way they do it -- subsidize a lot of services and make it up somewhere else -- is the best way." According to Sengupta, McKinsey's research reveals that the corporate customers of Indian banks tend to be less forgiving about inferior customer service than individuals. "For the corporate customer, the ability to access funding overseas at a relatively cheaper rate very quickly and conveniently is a big dimension, besides access to innovative products and best-in-class risk-management systems," he says. However, the leading Indian banks are able to meet those requirements for the top-tier corporations, he adds. "The challenge Indian banks face is in the next tier -- the slightly smaller corporations -- for whom they need to provide the same level of service and range of products." Although Indian banks look good in select areas vs. their global peers, they are relatively small, says Sengupta. But India's economic growth and the banking industry's efforts to meet global standards will change that picture dramatically in a decade, he notes. "Five years ago, no Indian bank had a market capitalization of more than $5 billion or $6 billion. Today, you have at least two banks (the State Bank of India (no ADR ) and ICICI Bank ( IBN)) with market caps of $30 billion to $40 billion. Roll the clock forward 10 years, and you can easily see that crossing $100 billion to $150 billion, and at least two or three truly global banks emerging from India." ICICI Bank, Housing Development Finance Corp. (no ADR) and HDFC Bank (HDB) are the current top bank/financial sector holdings in Blackstone's (BX) India Fund (IFN) and Barclays' (BCS) iPath MSCI India Index ETN (INP).