The Indian Banking Industry:
Consolidation, Technology and Customer Focus

Pritesh Y. Chothani
Ritesh Sud
Rachna Srivastava
PGDBM 2006 Student
IMT, Ghaziabad

The Indian Banking Industry

India has a long history of both public and private banking. Modern banking in India began in the 18th century, with the founding of the English Agency House in Calcutta and Bombay. In the first half of the 19th century, three Presidency banks were founded. After the 1860 introduction of limited liability, private banks began to appear, and foreign banks entered the market. The beginning of the 20th century saw the introduction of joint stock banks. In 1935, the presidency banks were merged together to form the Imperial Bank of India, which was subsequently renamed the State Bank of India. Also that year, India's central bank, the Reserve Bank of India (RBI), began operation. Following independence, the RBI was given broad regulatory authority over commercial banks in India. In 1959, the State Bank of India acquired the state-owned banks of eight former princely states. Thus, by July 1969, approximately 31 percent of scheduled bank branches throughout India were government controlled, as part of the State Bank of India.

The post-war development strategy was in many ways a socialist one, and the Indian government felt that banks in private hands did not lend enough to those who needed it most. In July 1969, the government nationalized all banks whose nationwide deposits were greater than Rs. 500 million, resulting in the nationalization of 54 percent more of the branches in India, and bringing the total number of branches under government control to 84 percent.

After nationalization, the breadth and scope of the Indian banking sector expanded at a rate perhaps unmatched by any other country. Indian banking has been remarkably successful at achieving mass participation. Between the time of the 1969 nationalizations and the present, over 58,000 bank branches were opened in India; these new branches, as of March 2003, had mobilized over 9 trillion Rupees in deposits, which represent the overwhelming majority of deposits in Indian banks. This rapid expansion is attributable to a policy, which required banks to open four branches in unbanked locations for every branch opened in banked locations.

Between 1969 and 1980, the number of private branches grew more quickly than public banks, and on April 1, 1980, they accounted for approximately 17.5 percent of bank branches in India.

In April of 1980, the government undertook a second round of nationalization, placing under government control the six private banks whose nationwide deposits were above Rs. 2 billion, or a further 8 percent of bank branches, leaving approximately 10 percent of bank branches in private hands. The share of private bank branches stayed fairly constant between 1980 to 2000.

Nationalized banks remained corporate entities, retaining most of their staff, with the exception of the board of directors, who were replaced by appointees of the central government.

Since 1980, has been no further nationalization, and indeed the trend appears to be reversing itself, as nationalized banks are issuing shares to the public, in what amounts to a step towards privatization. The considerable accomplishments of the Indian banking sector notwithstanding, advocates for privatization argue that privatization will lead to several substantial improvements.

Recently, the Indian banking sector has witnessed the introduction of several "new private banks," either newly founded, or created by previously extant financial institutions. The new private banks have grown quickly in the past few years, and one has grown to be the second largest bank in India. India has also seen the entry of over two dozen foreign banks since the commencement of financial reforms. While we believe both of these types of banks deserve study, our focus here is on the older private sector, and nationalized banks, since they represent the overwhelming majority of banking activity in India.


"Consolidation alone will give banks the muscle, size and scale to act like world-class banks. We have to think global and act local and seek new markets, new classes of borrowers. It is heartening to note that the Indian Banks' Association is working out a strategy for consolidation among banks," P. Chidambaram

Late last year, Finance Minister P. Chidambaram met the heads of a few state-owned banks in Jaipur, Rajasthan. At the meeting, the Bank Chairmen were asked to express their views on consolidation in Indian banking. They were chary about discussing the matter but most believed that state-owned banks would be acquiring other banks and wouldn't be acquired should bank mergers and acquisitions (M&A) become the order of the day.

Within days of Chidambaram's clarion call for consolidation, public sector bank CEOs began furiously discussing which bank would gobble up which other bank.


Consolidation in the banking industry is crucial from various aspects. The factors inducing consolidation include technological progress, excess retention capacity, emerging opportunities and deregulation of various functional and product restrictions. A strong banking system is critical for sound economic growth so it is natural to improve the comprehensiveness and quality of the banking system to bring efficiency in the performance of the real sectors. The past one decade has seen the transformation of the banking industry throughout the world from a highly protected and regulated industry to a competitive and deregulated one. Especially, globalization coupled with technological development has shrunk the boundaries by which financial services and products are being provided to the customers residing at any part of the globe. Further, due to innovations and improvements in service delivery channels, the trend of global banking has now been marked by twin phenomena of consolidation and convergence. The trend towards consolidation has been driven by the need to attain meaningful balance sheet size and market share in the face of intensified competition, whereas the trend towards convergence is driven across the industry to provide most of the financial services such as banking, insurance, investment, cash management etc. to the customers under one roof.

In this scenario, if banks are to be made more effective, efficient and comparable with their counterparts functioning abroad, they would need to be more capitalized, automated and technology oriented, even while strengthening their internal operations and systems. Similarly, in order to make them comparable with their competitors from abroad with regard to the size of their capital and asset base, it would be necessary

Bank Consolidation assumes significance from the point of view of making Indian banking strong and sound apart from its growth and development to become sustainable.


* As competition heats up, many banks having bigger size, will command more in the market. A bigger bank would have more staff strength, greater geographical reach, more financial resources, more delegated power and less operational and transactional costs due to economies of scale. A bigger financial conglomeration can easily withstand external assaults more effectively.

* Mergers and acquisitions can help banks with complimentary expertise to boost up their combined talents as well as on presenting a vastly improved performance. For instance, a foreign bank with proven merit in treasury operations when merged with a bank with investible surpluses could generate substantial profits.

* The geographical and regional spread would get widened when banks with different strongholds merge. Based on the principles of synergy, the business volume and geographical reach of consolidated entity automatically increases by many folds.

* Similarly, the market image and brand name of the consolidated entity will always likely to get a boost in comparison to the individual banks. This will lead to a better market image, which in turn translates to better performance expectations by the investors and the analysts, thus finally leading to better valuations in the market. We know, that better market valuations mean better shareholder returns leading to an even better market image. Thus, a reinforcing vicious cycle would set in.

* The larger size, greater geographical penetration and enhanced market image and other synergic factors would inevitably increase the bargaining power of the new bank. In a competitive world where the battle is fierce, a better bargaining power position is always an invaluable asset.

* The business in near future is unlikely to remain localized but bound to go global. In view of the saturating environment at domestic front, banks will have to venture overseas without any hesitation. Initial foray into overseas markets are always made through strategic alliances and joint ventures. A merged entity with bigger market size, greater geographical spread, sound financial position, good image, greater resistance etc. would necessarily be successful in the overseas. All these virtues also help in acquiring tenders and bids.

* The consolidated entity can serve the end user i.e. the customer in a better way through providing single window service by offering a variety of services like conventional banking, merchant banking, mutual funds, insurance etc. under one umbrella leading to innovation and origin of new hybrid products and services like bancassurance.

Risk Associated with Consolidation:

There are several risks associated with consolidation and few of them are as follows:

* When two banks merge into one then there is an inevitable increase in the size of the organization. Big size may not always be better. The size may get too widely and go beyond the control of the management. The increased size may become a drug rather than an asset.

* Consolidation does not lead to instant results and there is an incubation period before the results arrive. Mergers and acquisitions are sometimes followed by losses and tough intervening periods before the eventual profits pour in. Patience, forbearance and resilience are required in ample measure to make any merger a success story. All may not be up to the plan, which explains why there are high rate of failures in mergers.

* Consolidation mainly comes due to the decision taken at the top. It is a top-heavy decision and willingness of the rank and file of both entities may not be forthcoming. This leads to problems of industrial relations, deprivation, depression and demotivation among the employees. Such a work force can never churn out good results. Therefore, personal management at the highest order with humane touch alone can pave the way.

* The structure, systems and the procedures followed in two banks may be vastly different, for example, a PSU bank or an old generation bank and that of a technologically superior foreign bank. The erstwhile structures, systems and procedures may not be conducive in the new milieu. A thorough overhauling and systems analysis has to be done to assimilate both the organizations. This is a time consuming process and requires lot of cautions approaches to reduce the frictions.

* There is a problem of valuation associated with all mergers. The shareholder of existing entities has to be given new shares. Till now a foolproof valuation system for transfer and compensation is yet to emerge.

* Further, there is also a problem of brand projection. This becomes more complicated when existing brands themselves have a good appeal. Question arises whether the earlier brands should continue to be projected or should they be submerged in favour of a new comprehensive identity. Goodwill is often towards a brand and its sub-merger is usually not taken kindly.


To get a perspective on the recent developments lets look first at what's happened between 1969, when the first set of 14 private banks was nationalised, and now. During these years, the banking landscape changed dramatically. In 1969, India had 89 commercial banks. By March 2004, this number had climbed to 290. In 1969, there were 73 scheduled commercial banks (SCBs). Now, there are 90 of them, excluding the 196 regional rural banks (RRBs). The total number of branches during the three-and-a-half decades jumped over eight-fold, from 8,262 to 69,071. The growth has been phenomenal in rural India where the number of branches zoomed from 1,833 to 32,227. In contrast, the number of branches in the metropolitan cities grew at a slower pace, from 1,503 to 9,750. The total deposits of all scheduled commercial banks shot up by almost 332 times and their advances soared 240.50 times.

Yet, nobody denies that India is under-serviced. A country of 1.1 billion people has only about 250 million account holders. But if one excludes those with multiple accounts, especially in metropolitan and urban bank branches, the number would drastically come down. Despite lazy banking (a term Reserve Bank of India deputy governor Rakesh Mohan coined for commercial bankers who prefer to invest money only in zero risk government securities), the industry has been growing by 15-17 per cent annually, versus the 1-2 per cent growth rate of European banks.

So enormous opportunities exist. India's financial sector is going to boom in a growing economy where millions of people will join the workforce and need bank accounts. Banks will, therefore, need to plan for all this and learn basic survival skills. Globalisation in the context of financial markets does not mean only acquiring the ability to protect their turfs when foreign banks invade India but also going abroad and competing in other markets. One useful prerequisite for that is size.

In terms of size and scale, the big Indian banks are pygmies. The combined assets of the five largest Indian banks the State Bank of India, ICICI Bank, Punjab National Bank, Canara Bank and Bank of India on March 31, 2003 were less than the assets of the largest Chinese bank, China Construction Bank, which is roughly 7.4 times the size of the State Bank of India. The Banker's list of the top 1000 banks of the world (July 2004) has 20 Indian banks. Only six of them come in the top 500 group. The State Bank is positioned 82nd, ICICI Bank 268th, Punjab National Bank 313th, Canara Bank 405th, Bank of Baroda 425th and Bank of India 474th. Even in the Asian context, only one Indian bank State Bank of India figures in the top 25 banks based on Tier I capital, even though Indian banks offer the highest average return on capital among Asian peers. No wonder the focus is on scale.

The net NPAs of Indian banks have dropped substantially over the last few years not on account of any dramatic improvement in the quality of assets or better credit appraisal and monitoring but because of huge provisioning. So in a rising interest rate scenario, banks will face a double whammy. In the absence of high treasury income, their profitability will be hit and they will not be able to make large provisions to bring down their net NPAs further. If they want to continue to make large provisions for NPAs, their profitability will be squeezed even more. So, the soft underbelly of the Indian banking system may once again be exposed as interest rates rise. By pushing consolidation and merging some of the weak banks with stronger ones the government is trying to create a situation where it does not need to dole out public money to bail out banks.


Mr. Purwar of SBI in a Round Table Conference by Business Standard said, "The State Bank group is a group of nine. We can merge this group into one, or we can continue to have the present position with the difference that the technological platform of the entire group will be one. Business processes across the group will be the same. So what will happen is, although there will be nine faces of the bank, a virtual merger will be in place.

Seven to 10 years down the line, there could be six to seven public sector banks and a couple of private sector banks and certainly some foreign banks. In this scenario, I foresee the State Bank group continuing to have anything between 22 and 26 per cent market share. I don't foresee SBI's leadership being under threat. "

" whether there is a merger or not, 80 per cent of the assets in the system will be basically in the hands of a few banks. That is what is happening globally also and we can't duck that.

You also need a push from somewhere, a nod from somewhere, to get the big guys to move. Also, we now need to set a timeframe for consolidation so that people start working towards it. In terms of the number of players, I guess it is going to be 80:20 and within that you will have in the public sector a handful five or six players that will be the leaders. And it is not unreasonable to assume that there will be three or four private banks and three or four foreign banks.", Mr. Kamath of ICICI Bank at the same Round Table.

Broadly, there is a consensus among the Banks Chairmen that consolidation is inevitable and that the government must create an enabling situation where the leaders are encouraged to take the lead. Eight to ten big banks will dominate the industry over the next five years or so.


The role of IT has become so integrated and pervasive with banking that it is impossible to think about banking processes without an effective IT system in place. Today, the failure of IT systems could render a bank dysfunctional. A number of banks such as State Bank of India, Oriental Bank of Commerce, Canara bank, Bank of Maharastra, Indian Overseas Bank have floated tenders to scale up their disaster recovery and business continuity systems.

Technology has become central to banking. It has moved from being just a business enabler to being a business driver. Technology in banking has evolved substantially from the days of back office automation to today's online, centralized and integrated solutions.

Ten years ago, most of the advanced banks had branch automation software with 'online' passbook printing facilities. At the branch level, banks were moving away from product-specific counters and trying any-counter service for all products. Most of the time, the biggest incentive for using technology was to improve internal housekeeping by virtue of automating interest applications, accruals, standing orders and processes. Many banks took the lead in branch computerization, but this competitive advantage was not significant since it did not have significant impact on customer service. Also, banks could really not use the infrastructure for introducing new products and services.

Then came the second wave of technology change in banking, when banks realized that they needed to move to centralized core banking solutions for offering services such as anywhere banking. This was a significant change from the Indian perspective, since centralized core banking solutions required banks to invest huge amounts of money towards building infrastructure. Once this infrastructure was in place, banks started venturing into newer opportunities in the area of ATMs, debit cards and Internet banking, which in turn raised the expectations from core banking solutions.

Core banking applications help integrate the enterprise to existing in-house applications to offer a single customer view. These applications provide automation across multiple delivery channels.

Banks are reinventing themselves as marketing agencies by selling products like bancassurance, RBI bonds, credit cards, etc. Core banking applications are able to support this.


Managing customers is one of the main issues that banks face in today's hyper competitive environment. If the service levels are not up to customer expectations, in all likelihood the customer might take his business elsewhere. This is where Customer Relationship Management (CRM) practices (most important) and software (on the technology side) play an important role.

Banks, who have absorbed CRM systems have been able to achieve transparency in customer interface and have made sure that customers receive offers which match with their needs. No easy task this! Consequently this has resulted in greater income for the bank as CRM 'satisfies customers and immediately builds loyalty'. Appropriate deployment of CRM systems also attracts newer customers, which can only be beneficial for any financial institution in the face of harsh competition.

Another advantage of CRM is that employees are no longer burdened with the task of identifying opportunities by manually reviewing reports by studying client trends. Cross sell processes can be launched automatically by connecting transactions to CRM. This empowers the bank and simultaneously provides information to employees.

Customers are always undergoing life-changing experiences like marriage, birth of a child, investing in a new house or opening new accounts. The magic of technology lies in gathering this knowledge and transforming them into means and ways of strengthening relationships with customers. Technology helps change the vision of the banks along with important changes in the lives of their customers.

Mobile banking service is another luxury, which customers can enjoy today. Technology has enabled customers to access information through the phone instead of physically traveling to bank locations for the slightest of queries. Phones and advanced web phones have made it possible for customers to get details of balances, accounts and other transactions without traveling.

Services such as money transfers and personal payments online and through the phone are already available. Technologies such as Internet banking and mobile banking have certainly simplified our lives. The best part is that these transactions (online and mobile) can be done in complete confidentiality and within a secured network, thus, protecting the customer/user from any fraudulent practices.

Customers are enjoying technology in every sense in their financial relationships with banks. For example: Account aggregation is an existing technology in the arena of online banking. Moreover features such as chip, PIN, TIN are armed with the potential of dealing with multiple applications and that too on one card.

In this day and age, customers enjoy complete luxury in terms of customized technical solutions and banks use the same to cement long term, mutually beneficial relationships.

Pritesh Y. Chothani
Ritesh Sud
Rachna Srivastava
PGDBM 2006 Student
IMT, Ghaziabad

Source : E-mail November 2, 2005




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