Y V Reddy: Banking sector in global perspective
Inaugural address by Dr Y V Reddy, Governor of the Reserve Bank of India, at Bankers' Conference
2004, New Delhi, 10 November 2004.
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Distinguished guests, Ladies and Gentlemen,
It is indeed a pleasure and privilege to be amidst this august gathering of eminent bankers, experts
and policymakers. Over the years, the Conference has evolved as an important forum for structured
information sharing among not only delegates from the banking sector, but also experts from research
institutions, credit rating agencies, international institutions and other financial sector bodies. The
Bankers' Conference, 2004 is a great advancement over the previous years. The most notable feature
is that Respected President Dr. A.P.J. Abdul Kalam is addressing this gathering. In addition, we also
have here today, globally renowned policy makers amidst us who will give us the benefit of their views.
These include, Ms. Anne Krueger, First Managing Director of the IMF, a dear friend of mine, and a
distinguished Central Banker, Governor Caruana of Bank of Spain who is also Chairman of the Basel
Committee on Banking Supervision.
The subjects selected for the Conference are of great importance and we, in RBI, look forward to the
benefit of your deliberations. My inaugural address today will be brief and in the nature of a few
comments on the status of Indian banking industry and challenges ahead in a global perspective.
I. Status of Indian banking industry
It is useful to note some telling facts about the status of the Indian banking industry juxtaposed with
other countries, recognising the differences between the developed and the emerging economies.
First, the structure of the industry: In the world's top 1000 banks, there are many more large and
medium-sized domestic banks from the developed countries than from the emerging economies.
Illustratively, according to The Banker 2004, out of the top 1000 banks globally, over 200 are located
in USA, just above 100 in Japan, over 80 in Germany, over 40 in Spain and around 40 in the UK. Even
China has as many as 16 banks within the top 1000, out of which, as many as 14 are in the top 500.
India, on the other hand, had 20 banks within the top 1000 out of which only 6 were within the top
500 banks. This is perhaps reflective of differences in size of economies and of the financial sectors.
Second, the share of bank assets in the aggregate financial sector assets: In most emerging
markets, banking sector assets comprise well over 80 per cent of total financial sector assets, whereas
these figures are much lower in the developed economies. Furthermore, deposits as a share of total
bank liabilities have declined since 1990 in many developed countries, while in developing countries
public deposits continue to be dominant in banks. In India, the share of banking assets in total
financial sector assets is around 75 per cent, as of end-March 2004. There is, no doubt, merit in
recognising the importance of diversification in the institutional and instrument-specific aspects of
financial intermediation in the interests of wider choice, competition and stability. However, the
dominant role of banks in financial intermediation in emerging economies and particularly in India, will
continue in the medium-term; and the banks will continue to be "special" for a long time. In this regard,
it is useful to emphasise the dominance of banks in the developing countries in promoting non-bank
financial intermediaries and services including in development of debt-markets. Even where role of
banks is apparently diminishing in emerging markets, substantively, they continue to play a leading
role in non-banking financing activities, including the development of financial markets.
Third, internationalisation of banking operations: The foreign controlled banking assets, as a
proportion of total domestic banking assets, increased significantly in several European countries
(Austria, Ireland, Spain, Germany and Nordic countries), but increases have been fairly small in some
others (UK and Switzerland). Amongst the emerging economies, while there was marked increase of
foreign-controlled ownership in several Latin American economies, the increase has, at best, been
modest in the Asian economies. Available evidence seems to indicate some correlation between the
extent of liberalisation of capital account in the emerging markets and the share of assets controlled by
foreign banks. As per the evidence available, the foreign banks in India, which are present in the form
of branches, seem to enjoy greater freedom in their operations, including retail banking, in the country
on par with domestic banks, as compared with most of the other developing countries. Furthermore,
the profitability of their operations in India is considerably higher than that of the domestically-owned
banks and, in fact, is higher than the foreign banks' operations in most other developing countries.
India continues to grant branch licences more liberally than the commitments made to the WTO.
Fourth, the share of state-owned banks in total banking sector assets: Emerging economies, with
predominantly Government-owned banks, tend to have much higher state-ownership of banks
compared to their developed counterparts. While many emerging countries chose to privatise their
public sector banking industry after a process of absorption of the overhang problems by the
Government, we have encouraged state-run banks to diversify ownership by inducting private share
capital through public offerings rather than by strategic sales and still absorb the overhang problems.
The process has helped reduce the burden on the Government, enhance transparency, encourage
market discipline and improve efficiency as reflected in stock market valuation, promote efficient new
private sector banks, while drastically reducing the share of the wholly government owned public
sector banks in a rapidly growing industry. Our successful reform of public sector banks is a good
example of a dynamic mix of public and private ownership in banks.
A noteworthy feature of banking reforms in India is the growth of newly licensed private sector banks,
some of which have attained globally best standards in terms of technology, services and
sophistication. In many respects related to performance, these domestically promoted banks have
surpassed branches of foreign banks in India, and could be a role model for other banks.
II. Challenges ahead
Let me highlight some thoughts on certain areas which have a key bearing on the ability of Indian
banks to remain competitive and enhance soundness. Needless to state, these are more in the nature
of random thoughts, rather than any structured thinking, and are meant to invite discussion.
First, cost management. Cost containment is a key to sustainability of bank profits as well as their
long-term viability. To highlight this point, let me, take recourse to some figures. In 2003, operating
costs of banks as a proportion of total average assets1 in the UK were 2.12 per cent, for those in
Switzerland they were 2.03 per cent, and less than 2 per cent in major European economies like
Sweden, Austria, Germany and France. In India, however, in 2003, operating costs as proportion of
total assets of scheduled commercial banks stood at 2.24 per cent. The tasks ahead are thus clear
and within reach.
Second, recovery management. This is a key to the stability of the banking sector. There should be
no hesitation in stating that Indian banks have done a remarkable job in containment of
non-performing loans (NPL) considering the overhang issues and overall difficult environment. Let me
add that for 2004, the net NPL ratio for the Indian scheduled commercial banks at 2.9 per cent is
ample testimony to the impressive efforts being made by our banking system. In fact, recovery
management is also linked to the banks' interest margins. We must recognise that cost and recovery
management supported by enabling legal framework hold the key to future health and competitiveness
of the Indian banks. No doubt, improving recovery-management in India is an area requiring
expeditious and effective actions in legal, institutional and judicial processes.
Third, technological intensity of banking: This is one area where perhaps India needs to do
significant 'catching up', notwithstanding the rapid strides made over the last few years, though data
on this score are difficult to come by. Some available figures indicate that in late 1999, the percentage
of customers using online banking was less than 1 per cent in India, compared with anywhere
between 6-30 per cent in developed economies like US, UK, Germany, Finland and Sweden. Even in
Latin America, these figures are much higher than for India. While admittedly the numbers for India are
likely to be much higher at present than these figures suggest, so would be the case for these other
economies as well. The issue, therefore, remains what has been the extent of 'catching up' by India on
this score? In fact, this seems somewhat intriguing: India happens to be a world leader in information
technology, but its usage by our banking system is somewhat muted. It is wise for Indian banks to
exploit this globally state-of-art expertise, domestically available, to their fullest advantage.
Fourth, risk management. Banking in modern economies is all about risk management. The
successful negotiation and implementation of Basel II Accord is likely to lead to an even sharper focus
on the risk measurement and risk management at the institutional level. Thankfully, the Basel
Committee has, through its various publications, provided useful guidelines on managing the various
facets of risk. The institution of sound risk management practices would be an important pillar for
staying ahead of the competition. Banks can, on their part, formulate 'early warning indicators' suited
to their own requirements, business profile and risk appetite in order to better monitor and manage
risks.
Fifth, governance. The recent irregularities involving accounting firms in the US have amply
demonstrated the importance of good corporate governance practices. The quality of corporate
governance in the banks becomes critical as competition intensifies, banks strive to retain their client
base, and regulators move out of controls and micro-regulation. As already mentioned, banks are
special in emerging markets since they take a leading role in development of other financial
intermediaries and of financial markets, apart from having a large recourse to public deposits. No
doubt, there is nothing like an 'optimal' level of governance for one to be satisfied with. The objective
should be to continuously strive for excellence. The RBI has, on its part, made significant efforts to
improve governance practices in banks, drawing upon international best practices. It is heartening to
note that corporate governance presently finds explicit mention in the annual reports of several banks.
The improved corporate governance practice would also provide an opportunity to accord greater
freedom to the banks' boards and move away from micro regulation to macro management. Banks in
India are custodians of depositors' monies, monies of the millions of depositors who are seeking safe
avenues for their hard earned savings, and hence, banks must accept and perform an effective
fiduciary role. In this light, improvement in policy-framework, regulatory regime, market-perceptions,
and indeed, popular sentiments relating to governance in banks need to be on the top of the agenda
to serve our society's needs and realities while being in harmony with the global perspective.
Thank you.