Indian financial system is broadly classified in to two groups :
1. Organised sector
The financial system is also divided into users of financial services and providers. Financial institutions sell their services to households, business and government who are the users of financial services. The providers of financial services are:
Money and Capital markets
Informal financial enterprises
The organised financial system comprises the following subsystems:
The banking system
The co-operative system
Development banking system
The unorganised financial system comprises of money lenders, indigenous bankers, lending pawn brokers, landlords, traders, etc. There are also a host of financial companies, investment companies, chit funds, etc. in the unorganised sector. These are not regulated by the central bank or government in a systematic manner.
INDIAN BANKING SYSTEM
Banking system in India has its origin as early as the Vedic period. It is believed that the transition from the money lending to the bank must have occurred even before Manu, the great Hindu Jurist, who has devoted a section of his work to deposits and advances and laid down rules relating to rates of interest. The General Bank of India was the joint stock bank to be established in the year 1786. The others, which followed, were the bank of Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued till 1906 while the other two failed in the meantime. In the first half of the 19th century the east India company established three banks; the bank of Bengal in 1809, the bank of Bombay in 1840 and the bank of Madras in 1843. These three banks also known as Presidency banks were independent units and functioned well. These three banks were amalgamated in 1920 and a new bank, the Imperial bank of India was established on 27th January 1921. With the passing of the state bank of India act in 1955 newly constituted state bank of India. The Reserve bank which is Central bank was created in 1935 by passing Reserve bank of India act 1934. In the wake of Swadeshi Bank Movement, a number of banks with Indian Management were established in the country namely, Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda, the Central bank of India Ltd. On July 19, 1969, 14 major banks of the country were nationalised and in 15th April 1980 six more commercial private sector banks of the country were also taken over by the government. Today the commercial banking system in India may be distinguished into:
1. Public Sector Banks
State Bank of India and its associate banks called the State Bank group
20 nationalised banks
Regional Rural Banks mainly sponsored by public sector banks
Private Sector banks
Old generation private banks
New generation private banks
Foreign banks of India
Scheduled co-operative banks
Co-operative Sector Banks
The co-operative banking sector has been developed in the country to the supplement the village money lender. The co-operative banking sector in India is divided into 4 components.
State Co-operative banks
Central Co-operative banks
Primary Agriculture Credit Societies
Land Development banks
Urban Co-operative banks
Primary Agricultural Development banks
Primary Land Development banks
State Land Development banks
Development banks are those financial institutions which provide long term capital for industries and agriculture namely:
Industrial Finance Corporation of India (IFCI)
Industrial Development bank of India (IDBI)
Industrial Credit and Investment Corporation of India (ICICI)
Industrial Investment bank of India (IIBI)
Small Industries Development bank of India (SIDBI)
National bank for Agriculture and Rural Development (NABARD)
Export Import Bank of India
National Housing Bank
The money market is the market in which short term funds are borrowed and lend. The leading money market institutions are:
Discount and Finance House of India Limited (DFHI)
Securities Trading Corporation of India (STCI)
Until independence, the banking system was primarily associated with urban culture. In order to achieve the social and economic objectives of the country, the banks have to spread out into rural and UN-banked areas and make credit available to the large mass of the people in those areas. Therefore in 1950, the Imperial bank of India was asked to expand its offices in rural areas and it was brought under government control in July 1955 and renamed State Bank of India. In 1968 to supplement efforts of the State bank of India the government introduced social control over the banks. But this control is found wanting. In 19th July 1969 the government nationalised 14 major banks with deposits over 50 crores. On 15-4-1980, 6 more commercial private sector banks with deposits over 200 crores were nationalised.
In July 1993, New Bank of India was merged with Punjab National bank. Now, there are 27 banks in the public sector viz. State Bank of India and its 7 associates, 19 commercial banks exclusive of regional rural banks.
Allahabad bank Andhra bank
Bank of Baroda Bank of India
Bank of Maharashtra Canara bank
Dena bank Indian bank
India Overseas Bank Oriental Bank of Commerce
Punjab and Sind bank Punjab National bank
Syndicate bank Union bank of India
United bank of India UCO bank
Performance of PSU Banks in 2003
As per the report compiled by ICRA, the combined net profits of the 27 PSU banks increased by 48 percent to Rs 12,294 crores in the last fiscal. Net NPAs fell drastically from 5.8 to 4.5 percent. The capital base of PSU banks increased to Rs 14,175 crore by the end of last fiscal, from Rs 3,034 crore in 1990-91, with all the bank meeting the RBI stipulated 9.0 percent capital adequacy ratio by March 31, 2003.
As per a report compiled by ICRA, the combined net profits of the 27 PSU banks increased by 48 percent to Rs 12,294 crore in the last fiscal. The net profits has increased 92.5 percent in 2001-02. Thus, the net profit of PSU banks increased 2.8 times during the last two financial years. Of the total State Bank of India and its associates contributed Rs 4,510 crore or 36.7 percent of the pie, while the share of 19 nationalised banks was at 73.3 percent at Rs 7,784 crore.
SBI topped the list posting a net profit of Rs 3,105 crore. SBI was followed by Canara Bank with the net profit of Rs 1,019 crore, Bank of India (Rs 851 crore), Punjab National Bank (Rs 842 crores) and the Bank of Baroda (Rs 773 crores). Net NPAs fell drastically from 5.8 to 4.5 percent. Gross NPAs came down to less than 10 percent from 11.1 percent. The PSU banks were able to reduce their gross NPAs to 9.2 percent at about Rs 54,134 crore while net NPAs came down to Rs 4.5 percent Rs 24,974 crore. Three of eight SBI and associate banks had a net NPA exceeding 10 percent in 1996-97 but the number reduced to NIL in 2002-03. The number of PSU banks having NPAs in excess of 10 percent also declined from seven at the end of 1996-97 to three at the end of last fiscal.
For PSU banks, gross NPAs banks increased to Rs 14,175 crore by the end of last fiscal, from Rs 3,034 crore in 1990-91, with all the banks meeting the RBI stipulated 9.0 percent capital adequacy ratio by March 31, 2003. The main reason for improvement in CAR was the Rs 22,500 crore recapitalisation in 19 PSU banks during the last decade. In 2002-03, Canara Bank, PNB, Union Bank and Allahabad Bank raised nearly Rs 937 crore.
As per ICRA report, the combined income of the PSU banks inched up 9.6 percent to Rs 1,28,464 crore last fiscal. The trend in declining interest rates in the economy resulted in a mere 1.0 percent increase in interest expenses to Rs 69,853 crore. NPAs and taxes resulted in a 30.3 percent rise in provisions to Rs 17,420 crore.
Role of Banks
Banks in India have traditionally offered mass banking products. Most common deposit products being Savings Bank, Current Account, Term deposit Account and lending products being credit and term loans. Due to Reserve Bank of India guidelines, Banks have had little to do besides accepting deposits at rates fixed by Reserve Bank of India and lend amount arrived by the formula stipulated by the Reserve Bank of India at rates prescribed by the latter. PLR (Prime Lending Rate) was the bench mark for interest on the lending products. But PLR itself was, more often than not, dedicated by RBI. Further, remittance products were limited to issuance of drafts, telegraphic transfers, bankers cheque and internal transfer of funds.
In view of several developments in the 1990s, the entire banking products structure has undergone a major change. As part of the economic reforms, banking industry has been deregulated and made competitive. New players have added to the competition. IT revolution has made it possible to provide ease and flexibility in operations to customers. Rapid strides in information technology have, in fact, redefined the role and the structure of banking in India. Further, due to exposure to global trends after information explosion led by internet, customers- both individuals and corporates- are now demanding better services with more products from their banks. Financial market has turned in to the buyers market. Banks are also changing with time and are trying to become one-stop financial supermarkets. Market focus in shifting from masses banking products to class banking with introduction of value added and customised products.
A few foreign & private sector banks have already introduced customised banking products like Investment Advisory Services, SGL 2 accounts, Photo credit-cards, cash management services, Investment products and Tax advisory Services. A few banks have gone into market mutual fund schemes. Eventually, the bank plans to market bonds and debentures, when allowed. Insurance peddling by banks will be reality soon. The recent credit policy of RBI announced on 24-4-2000 has further facilitated the entry of banks in this sector. Banks also offer advisory services termed as ‘private banking’ to “high relationship value” clients. Products like debit cards, flexi deposits, ATM cards, personal loans including consumer loans, housing loans and vehicle loans have been introduced by a number of banks. Public Sector banks like SBI have also started focusing on this area. SBI has opened more than 100 new branches called personal banking branches (PBB). The PBBs will also market SBIs entire spectrum of loan products: housing loans, car loans, personal loans, consumer durable loans, education loans, loans against share, financing against gold.
Major Player and Market Shares
Housing finance can be raised from banks, housing finance companies. HDFC dominates the housing finance sector with 45% market share, followed by HUDCO by 21% and LIC housing with 16% share. Other major players include SBI homes promoted by SBI and CanFin homes promoted by Canara Bank- Gujarat Rural Housing Corporation promoted by HDFC.
The housing finance industry, encompassing banks and housing finance companies (HFCs), have exhibited a 36 percent growth between April and December 2002 despite the high repayment levels experienced by some HFCs. While banks have not faced significant prepayments in this period, credit rating information services of India (crisil) estimates the prepayment levels of HFCs outstanding loans to be about 12-14 percent. Were it not for these prepayments, the industry’s outstanding assets would have grown at a higher 43%.
The competitive landscape in the sector has changed with banks laying a greater thrust on housing finance resulting intense competition. Banks have an inherent advantage in retail finance, especially in housing loans, because of their lower cost of funds, existing retail relationships in liability products and large branch network. Major banks have overtaken HFCs in the April-December 2002 period, as a result of which they have a higher market share maintain its high growth rates in future given that the key growth drivers, the governments thrust on the housing sector in terms of fiscal incentives for individual housing loans coupled with the demand supply gap in housing, would remain strong.
Housing Finance: Building in Strength
HOUSING FINANCE Companies (HFCs) are building up fast and strong. While most financial sector entities continue to be troubled by poor quality assets, the HFCs are growing fast, and there is unlikely to be declined in the quality of assets.
To get an overview of the industry status, consider the growth in disbursements of HDFC and LIC housing finance which account for about 75% of all housing loans. Their disbursements recorded a compound annual growth rate of 28% over the last two years, reflecting the demand for housing loans.
The buoyancy in the industry comes on the heels of a mix of favourable set of factors. A study of these factors would give an indication of the prospectus for the industry.
Among the most important reasons for sound base on which a HFC rests is the unique nature of the end-product for which a HFC performs the task of financial intermediation. Housing may be characterised as a basic for which there is a perennial demand.
….and Factors Leading to its Affordability
A critical factor in determining the demand for a housing loan is the ability of a borrower to afford one. This may be loosely described as the ability of a borrower to comfortably repay the installments on the borrowed amount.
At the moment, the ability of a typical borrower to afford a housing loan is higher than it was in the last two decades. HDFC, the market leader in housing finance, sys that the cost of a house, when expressed as a multiple of a borrowers annual income, has come down about 12 times the annual income in the early 1980s to just four times now.
As a consequence of the general rise in income outstripping the rise in the cost of housing, the potential market size for HFCs have grown enormously, while simultaneously reducing the risk attached to a housing loan.
Low interest and fiscal benefits
Two other factors contributed to ‘affordability’. Interest rates are at their lowest. Following the Reserve Bank of India’s decision to reduce the bank rate by one percentage point to 7% in April, the HFCs took the cue and reduced the interest rate on the housing loans in the 12.75-13.5% range, a level reached after a series of interest rates cuts iver the last two years.
The level of construction activity plays a critical growth in the growth of the economy because of its strong linkage to others sectors. It is believed that housing has a direct impact on 32 upstream and 76 downstream industries, including cement and steel. In some parts of the world, ‘housing starts’ are critical macroeconomic indicators.
In this backdrop, the previous two union budgets provided significant fiscal benefits for the housing sector, in the form of substantive deductions in the tax liability of individuals who take a loan to purchase a dwelling unit.
From the industry has come a series of innovations in the terms of housing loan products. Driven in the part by the increasing competition, the HFCs are tailoring the loan products to meet a variety of differing needs of borrowers. For instance, HDFC has introduced housing loans which come with a floating rate of interest. Besides tailoring the products, housing loans also come with additional benefits, such as an insurance cover.
The Unfolding Scenario
Low interest rate, positive legal amendments and fiscal benefits have all combined to make the market for housing loans one of the safest segments in financial intermediation.
In this upbeat situation. The areas of concern for the HFCs tend to get little attention. While the problem areas may certainly be lower than the other segments of financial intermediation, about 300 HFCs do have to face up to concerns that are common to the other areas.
The chief concern for the HFCs is the increasing competition. According to one section of the industry, about 300 HFCs are operating of which only a few are registered with the NHB. Registration allows an HFC to seek refinance from the NHB.
Over the last year, the market has witnessed the entry of new players of significant size. Primarily, the advent of ICICI, a financial institution which would not be operating under the same constrains as other HFCs in terms of prudential guidelines. Among the other entities in the housing loan market are non-banking finance companies-promoted entities and banks which seem to have targeted the market with renewed vigour.
Low Margin Business…….
Following the gradual breakdown of the compartments that separate the different aspects of financial intermediation, the entire sector has seen a relentless squeeze a of the spread. The same trend is responsible for the declining spread in the housing loan market. The trend in spreads is best captured by the declining spread of HDFC, the most important HFC today. HDFCs spread on loans over the cost of borrowing declined from 2.06% per annum in 1997-98 to 1.83% in 1998-99.
……….But Low Risks Too
the special nature of housing finance makes it one the least risky areas in financial intermediation. The NPAs, defined as the outstanding loans on which installments remain unpaid for more than six months, of the HFCs are among the lowest in the financial sector. HDFC, for instance, recorded only 0.90% of NPAs in relation to its total portfolio in 1999-2000. LIC housing finance, on the other hand, registered a higher level of NPAs; it was around 4% of the total portfolio in 1998-99.
Like the new-generation private sector banks, the HFCs are typically going to have a superior quality of assets vis-à-vis other entities in the financial sector. This, in turn, means the business will be characterised by low risk. With spreads declining, the business of giving housing loans is going to be characterised by both low risk and low returns.
ROLE OF BANKS
In this milieu, some banks seem to have made an aggressive bid to attract customers. With the advantage banks may have in terms of low cost of funds, they are generally in a position to price a product at a lower level compared to the others in the financial sector.
It is debatable, however, if banks can sustain their aggressive foray in to the market for housing loans because banks typically have a higher degree of operating cost of funds.
With the interest rates among the top HFCs tending to converge, and borrowers generally willing to be neutral among the HFCs there is a difference of only about 25 basis points, the quality of service is what lends the competitive edge to an HFC.
Service, the key
Last year when ICICI made a foray into the market for retail housing loans, quality and value-added service was the thrust area rather than interest rate. ICICI capitalised on the absence of ‘door delivery’ for housing loans, and a quickly built a reputation by going to the potential borrower rather than waiting for him to come to them.
With the quality of service gaining importance, market leaders, such as HDFC, and new entrants, such as ICICI, are likely to do well as their track record suggests that quality of service is a strong point. Other HFCs that score on this count are the ones linked to some of the top-rung NBFCs. The ability to reach and quickly cater to the customer, traditionally out of the ambit of the banking and financial institutions, is the fort of the NBFCs. The same quality may see them gaining a significant chunk of market share.
The absence of prompt and easy service may let down banks. The ones in a powerful position to shake up the market, such as nationalised banks with a wide network, do not have reputation for service. Banks are believed to insist on a higher level of documentation -–a deterrent for a potential customer.
With housing finance emerging as a low risk, low margin business with service providing a competitive edge, it may difficult to dislodge existing market leaders such as HDFC and LIC housing finance which have considerable experience. For equity market followers, HDFC remains the best long-term investment because of its responsive service and ability to contain risk in the business.
The HFCs as a standalone business are likely to become increasingly rare. With the barriers between different areas in the financial sector breaking down, the industry is likely to be characterised by entities that seek to provide a variety of loans under one umbrella. Thus, the market has seen the entry of ICICI, Sundaram Home Finance and HDFC planning ventures in other segments of the financial sector.
The outcome of the trend towards providing different services by capitalising on a common database and brand name may lead to stiff competition and significant product innovation. But for now, among the HFCs, HDFC remains on top and presents the soundest equity investment in the sector.
View from the other side
The market for housing loans is not as simple as it appears at first sight.
Housing finance companies (HFCs) officials point to quite a few quirks in the market that make for a challenging environment. Typically, housing loans are disbursed for 15 years. But when it comes to repayment, the situation takes an interesting turn. According to HFC officials, quite a few loans are repaid by the end of the eight or ninth year. They attribute the large-scale prepayment to psychological factors including the average Indians discomfort with outstanding debt.
Given the experience the HFC have had with prepayment, officials of ones—that are two into the first and second year of operations—say they have actually factored in the prepayment for all their 15 and 20 year loan disbursements.
Another interesting factor about the Indian housing finance market is that individuals usually for about 40% of the cost of the house out their savings. In other words, the loan to value ratio is only about 60%. This, in turn, may have a significant bearing on the relatively low NPA levels of the industry.
The loan to value ratio has a bearing on the areas of the finance too. NBFCs that finance commercial vehicles claim that the cost incurred by the borrower to add value to a commercial vehicle serves as a deterrent to the likelihood of a willful default because if the NBFC repossess the vehicle, the borrowers funds too get locked up.
This may not be the only reason for the low NPAs in the housing finance market. The unique nature of the product itself makes the likelihood of default dim.
One of the leading HFCs claimed that an internal study revealed that the maximum number of defaults came from the category of the borrowers who borrowed less than Rs 1 lakh towards a housing loan.
Another interesting claim from the same HFC is that the highest number delinquencies, when studied according to the profession of the borrower, shows that the worst offenders are lawyers, teachers, politicians and journalists.
The implications of the amendments to the provisions on foreclosure evoked slightly varied response from the industry. while one entity felt that the amendment may change the business model, other entities felt that the amendment was unlikely to have a significant impact on appraisal.
As for changes to the business model, it was felt that if the dwelling unit could be repossessed within a definitive time-frame, property value would play a bigger role in appraisal. The credit-worthiness of the borrower per se may not be that important.
The contrasting opinion was that creditworthiness of the borrower would continue to be of paramount importance. The amendment may only help securitisation. One trend that seems to be emerging is that the HFCs will fall over one another to introduce innovations in an attempt to attract customers. This is one market where the customer is definitely the king.
Case Study: STATE BANK OF INDIA
The state bank of India has crossed its targeted lending in housing finance for the year. Housing finance constitutes the major plank of the state banks new thrust into retail banking and represents about 40% of the banks retail assets. Housing finance forms of a major chunk of SBIs personal loans portfolio. For this financial year the bank had targeted disbursements of Rs 7,000 crore through its personal loans, of which housing finance alone is expected to contribute upto Rs 4,500 crore.
State bank had identified retail finance, along with infrastructure finance, as key areas to sustain growth in the backdrop of a slowing economy. The bank has recently revamped the entire housing loan procedure following major relaxation’s permitted by the Reserve Bank of India in April, 1998. With the new procedures in place, SBI is now placed on an even keel vis-a-vis housing finance companies.
State Bank has identified 500 branches across the country to specifically push housing loans. Housing loans have been assigned as the core business focus of these branches.
State bank is heavily banking on the completion of its 100 branch personnel banking network to give the big push to its retail products.
The bank is in the process of putting up a network of over hundred new branches exclusively dealing with personal banking products and with a distinct brand identity of a posh new generation bank. These branches meant to counter the growing aggression by foreign and new private sector banks will offer only personal banking services and not deal in corporate and business accounts. SBI plans to use these branches as an outlet for all its personal banking products. The idea is to make an account holder in these branches satisfy all his personal finance needs at the branch itself. At present, these products include SBIs housing loans, consumer finance scheme, educational loans, car loans, personal loans scheme, depository participant services, and advances against shares, debentures and PSU bonds. SBI has already opened about 15 of these branches in various metros.
HFCs may lose out to PSU banks
The recent years have seen more and more banks enter into housing finance. As the cost of the funds for banks has traditionally been low, they stand a good chance of weaning away business from the two established players. The fact that banks such as SBI that have a large network of branches that can be used to service consumer of housing finance at virtually no additional costs also goes in their favour. In order to gain prominence in the business, SBI merely needs to ensure a quick response to customer needs.
Social Responsibility for Nationalised Banks
The deficit in housing is continuously increasing despite all the hype created in this sector. To meet the scarcity and to help people who cannot afford to have their homes, the Government comes up with special housing schemes from time to time. One notable example is Pradhanmantri griha vikas pariyojana launched by the honourable Prime Minister, Mr. Atal Bihari Vajpayee. Nationalised banks have very significant role to play for such social welfare schemes.
What to expect…….
Year 2004 is unlikely to be significantly different. Tax benefits have played a major role in popularising home loans. Recommendations to curtail tax benefits have been rejected in the past, also no surprise elements are likely to find place in the forthcoming budget considering that general elections are scheduled to be held in late 2004. The rate-cut wars which commenced in 2003 are likely to continue into 2004 as well; however their intensity might taper off.
One disturbing feature in the entire scenario is the emergence of herd mentality. Consumers across board lured by falling rates have opted for home loans with floating rate. The notion that interest rates will continue to southwards has become increasingly prevalent.
While only a soothsayer may be able to predict how interest rates will move, circumstances seem to suggest that an upward hike in interest rates is a possibility which should not be ignored. Fixed rate loans would make a lot of sense if such situation arises. More importantly consumers need to select loans based on their profiles. Opting for floating rate loans simply because everyone does is so poor move. If you are in your mid-forties and have a low risks appetite, fixed rate loans should be the right choice, since the liability is defined and three are no unpleasant surprises. Conversely for some one in his thirties with a greater risk appetite and a view on interest rates, a floating rate fund makes perfect sense.
Give and take a few inches 2004 could be another favourable year for consumers. However from the consumers perspective it becomes critical that they make informed choices i.e. select the right options and understand implications of their loan agreements.
Banking industry in India is undergoing a rapid metamorphosis. Their role of traditional banker has been replaced with financial services provider for the clients. Most of the PSU and private sector banks in our country have already started looking at their portfolio of services offered and what they should do in the future for remaining competitive in the industry. as public sector banks are likely to undergo major consolidation, suddenly for many Indian banks things have changed.