Credit Appraisal Process at Axis Bank
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INTRODUCTION TO BANKING SECTOR
A snapshot of the banking industry
The Reserve Bank of India (RBI), as the central bank of the country, closely monitors developments in the whole financial sector.
The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end March 2002, there were 296 Commercial banks operating in India. This included 27 Public Sector Banks (PSBs), 31 Private, 42 Foreign and 196 Regional Rural Banks. Also, there were 67 scheduled co-operative banks consisting of 51 scheduled urban cooperative banks and 16 scheduled state co-operative banks.
Scheduled commercial banks touched, on the deposit front, a growth of 14% as against 18% registered in the previous year. And on advances, the growth was 14.5% against 17.3% of the earlier year.
State Bank of India is still the largest bank in India with the market share of 20% ICICI and its two subsidiaries merged with ICICI Bank, leading creating the second largest bank in India with a balance sheet size of Rs. 1040bn.
Higher provisioning norms, tighter asset classification norms, dispensing with the concept of ‘past due’ for recognition of NPAs, lowering of ceiling on exposure to a single borrower and group exposure etc., are among the measures in order to improve the banking sector.
A minimum stipulated Capital Adequacy Ratio (CAR) was introduced to strengthen the ability of banks to absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposed to hike the CAR to 12% by 2004 based on the Basle Committee recommendations.
Reforms in the Banking sector
The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and resulted in a shift from Class banking to Mass banking. This in turn resulted in a significant growth in the geographical coverage of banks. Every bank has to earmark a minimum percentage of their Loan portfolio to sectors identified as “priority sectors”. The manufacturing sector also grew during the 1970s in protected environs and the banking sector was a critical source. The next wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since then the number scheduled commercial banks increased four-fold and the number of banks branches increased eight-fold.
Classification of Banks:
The Indian banking industry, which is governed by the Banking Regulation Act of India
1949 can be broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks comprise commercial banks and the co-operative banks. In Terms of ownership, commercial banks can be further grouped into nationalized banks, the State Bank of India and its group banks, regional rural banks and private sector banks (the old / new domestic and foreign). These banks have over 67,000 branches spread across the country. The Indian banking industry is a mix of the public sector, private sector and foreign banks. The private sector banks are again spilt into old banks and new banks.
GLOBAL AND LOCAL SCENARIO OF BANKING SECTOR
Indian Banking System: The Current State & Road Ahead
Recent time has witnessed the world economy develop serious difficulties in terms of lapse of banking & financial institutions and plunging demand. Prospects became very uncertain causing recession in major economies. However, amidst all this chaos India’s banking sector has been amongst the few to maintain resilience.
A progressively growing balance sheet, higher pace of credit expansion, expanding profitability and productivity akin to banks in developed markets, lower incidence of nonperforming assets and focus on financial inclusion have contributed to making Indian banking vibrant and strong. Indian banks have begun to revise their growth approach and re-evaluate the prospects on hand to keep the economy rolling. The way forward for the Indian banks is to innovate to take advantage of the new business opportunities and at the same time ensure continuous assessment of risks.
A rigorous evaluation of the health of commercial banks, recently undertaken by the Committee on Financial Sector Assessment (CFSA) also shows that the commercial banks are robust and versatile. The single-factor stress tests undertaken by the CFSA divulge that the banking system can endure considerable shocks arising from large possible changes in credit quality, interest rate and liquidity conditions. These stress tests for credit, market and liquidity risk show that Indian banks are by and large resilient.
General Banking Scenario
The pace of development for the Indian banking industry has been tremendous over the past decade. As the world reels from the global financial meltdown, India’s banking sector has been one of the very few to actually maintain resilience while continuing to provide growth opportunities, a feat unlikely to be matched by other developed markets around the world. FICCI conducted a survey on the Indian Banking Industry to assess the competitive advantage offered by the banking sector, as well as the policies and structures required to further stimulate the pace of growth.
The predicament of the banks in the developed countries owing to excessive leverage and lax regulatory system has time and again been compared with somewhat unscathed Indian Banking Sector. An attempt has been made to understand the general sentiment with regards to the performance, the challenges and the opportunities ahead for the Indian Banking Sector.
A majority of the respondents, almost 69% of them, felt that the Indian banking Industry was in a very good to excellent shape, with a further 25% feeling it was in good shape and only 6% of the respondents feeling that the performance of the industry was just average. In fact, an overwhelming majority (93.33%) of the respondents felt that the banking industry compared with the best of the sectors of the economy, including pharmaceuticals, infrastructure, etc.
Global Expansion of Indian Banking
The idea of creating bigger banks to take on competition sounds attractive but one must realize even the biggest among Indian banks are small by global standards. The lack of global scale for Indian banks came into sharp focus during the recent financial crisis which saw several international banks reneging on their funding commitments to Indian companies, but local banks could not step into the breach because of balance sheet limitations.
In this light, 93.75% of all respondents to their survey are considering expanding their operations in the future. They further asked participants on the methods that they consider suitable to meet their expansion needs. They divide them into organic means of growth that comes out of an increase in the bank’s own business activity, and inorganic means that includes mergers or takeovers.
Scope for New Entrants
81.25% also felt that there was further scope for new entrants in the market, in spite of capital management and human resource constraints, as there continue to remain opportunities in unbanked areas. With only 30-35% of the population financially included, and the Indian banking industry unsaturated with CAGR of well above 20%, participants in their survey felt that the market definitely has scope to accommodate new players.
While there has been prior debate, they questioned banks on NBFCs and Industrial houses being established as banking institutions and find opinion to be marginally against the notion, with 35.71% in favour while 42.86% were against them being established as banks.
However, on further questioning, 57.14% of respondents feel that the above may be allowed but only if it is along with specific regulatory limitations. Banks felt that limitations regarding track record, ensuring adequate capitalization levels, a tiered license that enables new entrants to enter into specific areas of the business only after satisfactorily achieving set milestones for the prior stages, cap on promoter's holdings and wider public holding in addition to a common banking regulator on a level playing field are essential before they may set themselves up as banks.
Over the last three decades, there has been a remarkable increase in the size, spread and scope of activities of banks in India. The business profile of banks has transformed dramatically to include non-traditional activities like merchant banking, mutual funds,new financial services and products and the human resource development.
Their survey finds that within retail operations, banks rate product development and differentiation; innovation and customization; cost reduction; cross selling and technological up gradation as equally important to the growth of their retail operations. Additionally a few respondents also find pro-active financial inclusion, credit discipline and income growth of individuals and customer orientation to be significant factors for their retail growth.
There is, at the same time, an urgent need for Indian banks to move beyond retail banking, and further grow and expand their fee- based operations, which has globally remained one of the key drivers of growth and profitability. In fact, over 80% of banks in their survey have only up to 15% of their total incomes constituted by fee- based income; and barely 13% have 20-30% of their total income constituted by fee-based income.
Financial Inclusion and Expansion of Banking Services
Transition from class banking to mass banking and increased customer focus is drastically changing the landscape of Indian banking. Expansion of retail banking has a lot of potential as retail assets are just 22% of the total banking assets and contribution of retail loans to GDP stands merely at 6% in India vis-à-vis 15% in China and 24% in Thailand. All banks in their survey weigh Cost effective credit delivery mechanisms (100%) as most important to the promotion of financial inclusion. This was followed by factors such as identifying needs and developing relevant financial products (75%), demographic knowledge and strong local relations (62.5%) and ensuring productive use and adequate returns on credit employed (43.75%) in decreasing levels of importance. In fact, India has an expanding middle class of 250 to 300 million people in need of varied banking services. While 60% of our population has access to banks, only 15% of them have loan accounts and an overwhelming 70% of farmers have no access to formal sources of credit, reflective of immense potential for the banking system This is mirrored in the fact that while our survey finds no discernible shift in the lending pattern of banks across Tier 1, Tier 2 and Tier 3 cities over the last two years, 93% Indian Banking System: The Current State & Road Ahead Page | 20 participants still find rural markets to be to be a profitable avenue, with 53% of respondents finding it lucrative in spite of it being a difficult market. Cost of accessing markets has been the only sour note in the overall experience of our respondents in rural markets At the same time, more than 81.25% of our respondents have a strategy in place to tap rural markets, with the remainder as yet undecided on their plan of action. Tie ups with micro finance institutions (MFIs)/SHG and introduction of innovative and customized products are considered most important to approaching rural markets according to respondents, more so as compared to internet kiosks, post offices and supply chain management techniques
Credit Flow and Industry
India Inc is completely dependent on the Banking System for meeting its funding requirement. One of the major complaints from the industry has in fact been high lending rates in spite of massive cuts in policy rates by the RBI. We asked the banks what they felt were major factors responsible for rigid prime lending rates.
None of the banks in their survey considered the cap on bank deposit rates to be one of the causes of inflexible lending rates. Due to long-term maturity, the trend seems to be changing. However, there are other factors which have led to the stickiness of lending rates such as wariness of corporate credit risk (33.33%), competition from government small savings schemes (26.67%). Benchmarking of SME and export loans against PLR (20.00%) on the other hand, do not seem to have as significant an influence over lending rates according to banks.