Dear Reader,
Setting up a banking operation in India is tough and that is an understatement. One of the heavily regulated sectors, banks are put to test more often by the economy they service rather than the regulator that breathes down their every move. It is a tough sector to break even and generate profits, but tougher to not make mistakes as the long history of India’s lenders bungling every decade shows.
Indeed, from the rot in private sector banking that resulted in nationalisation in the late 1960s to the toxic loan crisis in 2015, banks have been engulfed in the flames of their bad risk assessments periodically. Besides these, there are always small fires that the regulator steps in to put out like the one two years ago where unsecured retail lending threatened to disrupt asset quality.
Why would any foreign investor in their right mind get involved in this sector?
Simply because there is no other sector that has generated lip-smacking returns regularly than banks. Here is a little perspective. The Nifty Bank index is up 13.72 percent so far this fiscal year while the broader Nifty has gained 9.04 percent. The banking index has consistently outperformed the broader market for decades now and is somewhat of a driver for the rest of the market gains. The banking sector’s profits, especially that of the private sector banks, have risen exponentially.
Today the sector has the capital, the heft, and the regulatory blessing to grow fast. Banks’ brothers in arm are the fintech companies that have revolutionised the payments system and reduced the cost of banking to some extent. Together, the growth and profits from a bubbling retail lending market is too hard to ignore for foreign investors.
But the old way of setting up a branch here is no longer viable. It is obvious that the cost of starting banks from scratch in India is steep. Established foreign banks such as Citigroup and Standard Chartered Bank have made no headway in the market despite being around for decades. In fact, most foreign banks are essentially boutique services compared with the established local private sector banks. It is a challenge to scale up in profits and market share here.
This explains why Emirates NBD took the route to invest 60 percent into local RBL Bank for a consideration of $3 billion, the largest deal of this kind for the Indian banking industry. This is the new trick by foreign investors to finally get access to India’s retail lending market, as Sundeep Khanna explained in his piece earlier this week. This follows Japan’s Sumitomo Mitsui Banking Corporation’s purchase of 20 percent stake in Yes Bank in May this year. Both these transactions are driven by the potential of the business rather than a rescue move as the DBS acquisition of Laxmi Vilas Bank was. Dinesh Unnikrishnan pointed out the differences in this piece here and also the fact that the banking industry is no longer viewed as just a high-yield investment but more a platform to expand geographically.
Will this fresh blood help India’s banks to avoid historic mishaps and serve the economy in terms of funding?
The answer to that is not a clear yes. Granted, Emirates NBD and others bring in a critical component of growth into banks: capital. They also bring in an outsider’s perspective and expertise and perhaps a new and better way to banking. But it would be foolhardy to believe that accidents in the banking industry can be avoided.
Recall that RBL Bank was mired in governance concerns just four years ago and Yes Bank had to be brought from the precipice of collapse because of governance lapses. Foreign investment that brings in expertise and oversight cannot substitute the eye of the local regulator.
India’s credit market is not riskier than many other jurisdictions, but it is a treacherous one. Productivity of existing banks at the branch level is not appealing enough as our Chart of the Day points out. Competition is tough. Emirates NBD or any other foreign investor looking to invest must be wary of their capital firing up exuberance in lending, something that Indian banks have fallen prey to many times.
In return, foreign investors can get a slice of India’s credit fuelled consumption at a time when households have tasted quick and easy services and other wealth products and are primed to adopt newer financial pathways.
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Aparna Iyer
Moneycontrol Pro
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