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Executive summary
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The Indian retail finance market has witnessed a sea change during the last few years.
Earlier, Indians were averse to the concept of availing credit to fund their purchases and
believed in the concept of saving and then spending. However, today, there are a variety
of consumer credit products being literally forced upon consumers by overzealous
lenders, who have realized the huge latent potential of the burgeoning Indian
consumers. This has gradually led to a shift in the psychology of Indian consumers, who
no longer consider credit as a social stigma and are more than willing to fulfill their
aspirations through the credit mechanism.
Until 10 years ago, mainly non-banking finance companies (NBFCs) and housing
finance companies (HFCs) catered to the nascent Indian retail finance market, while
commercial banks focused on corporate lending. Commercial banks, instead of lending
to retail consumers directly, would provide funds to NBFCs and HFCs, which, in turn,
would lend to retail consumers. The mid ‘90s saw several NBFCs mushrooming to
exploit the huge potential of this market. As competition intensified, many NBFCs, in
order to capture a share of this retail market pie, ignored the risks associated with the
retail lending business and landed up burning their fingers. Consequently, the late ‘90s
and early 2000 witnessed a number of NBFCs either shutting shop or curtailing their
operations.
This report focuses on the retail asset finance market, which comprises mainly loans for
housing, cars and utility vehicles (auto finance), commercial vehicles and two-wheelers.
The retail asset finance market has grown between 1998-99 and 2003-04 at an
annualized rate of 35 per cent (disbursements). The high growth rate between 1998-99
and 2003-04 can be attributed to the fact that 5 years ago, the retail finance market was
in its infancy, with few people availing credit to fund their purchases. Going forward,
CRIS INFAC expects the retail finance market to grow at an annual rate of 18 per cent,
from Rs 1,213 billion in 2003-04 to Rs 2,792 billion in 2008-09.
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The Indian consumer is fast changing his habits, borrowing money to buy the
products he wants, not content with buying what he can afford. The resultant consumer
boom is what market strategists explain as the key to the success of the Indian
consumer finance market.
Consumer finance today is a win-win system in which everyone stands to gain. For the
Indian consumer, it is an opportunity to upgrade his standard of living right now instead
of waiting for years for his savings to accumulate. For manufacturers, it stimulates
demand and lowers inventory. For middlemen, it's a sales boosting device. For players
of consumer finance, it's a means of profit generation.
The buy-now-pay-later culture is still fairly nascent in India, evolving through various
forms like consumer lending, consumer credit, consumer loans, friendly and family
borrowings, kitties, daily payment schemes etc.
The basic underpinning of consumer financing is that the consumers' present spending
habits tend to be geared to expectations of future income. They are losing their fear of
borrowing, riding surfboards of consumer finance.
Retail banking
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Retail banking is quite broad in nature - it refers to the dealing of commercial banks with
individual customers, both on liabilities and assets sides of the balance sheet. Fixed,
current / savings accounts on the liabilities side; and mortgages, loans (e.g., personal,
housing, auto, and educational) on the assets side, are the more important of the
products offered by banks. Related ancillary services include credit cards, or depository
services. Today’s retail banking sector is characterized by three basic characteristics:
2• Multiple channels of distribution (call centre, branch, Internet and kiosk); and
The typical products offered in the Indian retail banking segment are housing loans,
consumption loans for purchase of durables, auto loans, credit cards and educational
loans. The loans are marketed under attractive brand names to differentiate the
products offered by different banks. As the Report on Trend and Progress of India,
2003-04 has shown that the loan values of these retail lending typically range between
Rs.20, 000 to Rs.100 lakh. The loans are generally for duration of five to seven years
with housing loans granted for a longer duration of 15 years. Credit card is another
rapidly growing sub-segment of this product group.
In recent past retail lending has turned out to be a key profit driver for banks with retail
portfolio constituting 21.5 per cent of total outstanding advances as on March 2004. The
overall impairment of the retail loan portfolio worked out much less then the Gross NPA
ratio for the entire loan portfolio.
Within the retail segment, the housing loans had the least gross asset impairment. In
fact, retailing make ample business sense in the banking sector.
While new generation private sector banks have been able to create a niche in this
regard, the public sector banks have not lagged behind. Leveraging their vast branch
network and outreach, public sector banks have aggressively forayed to garner a larger
slice of the retail pie. By international standards, however, there is still much scope for
retail banking in India. After all, retail loans constitute less than seven per cent of GDP in
India vis-à-vis about 35 per cent for other Asian economies - South Korea (55 per cent),
Taiwan (52 per cent), Malaysia (33 per cent) and Thailand (18 per cent). As retail
banking in India is still growing from modest base, there is a likelihood that the growth
numbers seem to get somewhat exaggerated. One, thus, has to exercise caution is
interpreting the growth of retail banking in India.
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The table below indicates Market size and CAGR of main product of retail banking in
India. We can observe that Auto loans and Home loan are biggest contributor of growth
in retail banking in India.
higher middle class with rising Disposable Income, changing life style,
aspiration and willingness to spend more for luxuries
Scope for subsential development of funds which offer better return trade
off and well diversify credit portfolio
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The banking Industry, prior to late 1990s, mainly focused on lending to ‘productive’
sectors and areas like consumer finance were not catered to. NBFCs essentially filled
this gap and thus had a dominant presence in this segment. But post 2000, on the back
of lower credit offtake from corporate sector, banks started exploring other safer
investment avenue for parking their funds and this in turn led to the retail finance
explosion in the economy. The equation today has turned in favor of banks, currently
commanding a 30-80% market share of core retail segments and the share is increasing
day by day.
Tax Breaks:
The recent budgets provided for various tax and fiscal incentives for deploying funds in
the housing sector. The Reserve Bank of India (RBI) had also directed commercial
banks to allocate at least 3 per cent of their incremental deposits in fiscal 2002 to
housing loans. At the same time the policy of the Reserve Bank of India regarding the
inclusion of Mortgage backed securities as a part of priority sector lending for banks and
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reducing the risk-weight on home loans from 100 per cent to 50 per cent made the
sector more attractive for the banks.
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Others growth Drivers
Economic prosperity and the consequent increase in purchasing power has given
a fillip to a consumer boom. Note that during the 10 years after 1992, India's
economy grew at an average rate of 6.8 percent and continues to grow at the
almost the same rate – not many countries in the world match this performance.
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Treasury income of the banks, which had strengthened the bottom lines of banks
for the past few years, has been on the decline during the last two years. In such
a scenario, retail business provides a good vehicle of profit maximisation.
Decline in interest rates have also contributed to the growth of retail credit by
generating the demand for such credit.
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Comprehensives range of financial products in retail banking
Deposit products
Credit cards
Auto finance
Personal Loans
Debit cards
While usage of cards by customers of banks in India has been in vogue since the mid-
1980s, it is only since the early 1990s that the market had witnessed a quantum jump.
The total number of cards issued by 42 banks and outstanding, increased from 2.69
crore as on end December 2003 to 4.33 crore as on end December 2004. The actual
usage too has registered increases both in terms of volume and value. Almost all the
categories of banks issue credit cards. Credit cards have found greater acceptance in
terms of usage in the major cities of the country, with the four major metropolitan cities
accounting for the bulk of the transactions.
In view of this ever increasing role of credit cards a Working Group was set up for
regulatory mechanism for cards. The terms of reference of the Working Group were
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fairly broad and the Group was to look into the type of regulatory measures that are to
be introduced for plastic cards (credit, debit and smart cards) for encouraging their
growth in a safe, secure and efficient manner, as also to take care of the best customer
practices and grievances redressal mechanism for the card users. The Reserve Bank
has been receiving a number of complaints regarding various undesirable practices by
credit card issuing institutions and their agents. Some of them are:
Unsolicited calls to members of the public by card issuing banks/ direct selling
agents pressurizing them to apply for credit card.
Sending credit cards to persons who have not applied for them / activating
unsolicited cards without the approval of the recipient.
In view of its backward and forward linkages with other sectors of the economy, housing
finance in developing countries is seen as a social good. In India, growth of housing
finance segment has accelerated in recent years. Several supporting policy measures
(like tax benefits) and the supervisory incentives instituted had played a major role in
this market.
Housing credit has increased substantially over last few years, but from a very low base.
During the period 1993-2004, outstanding housing loans by scheduled commercial
banks and housing finance companies grew at a trend rate of 23 per cent. The share of
housing loans in total non-food credit of scheduled commercial banks has increased
from about 3 per cent in 1992-93 to about 7 per cent in 2003-04. Recent data reveal that
non-priority sector housing loans outstanding as on February 18, 2005 were around Rs.
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74 thousand crore, which is, however, only 8.0 per cent of the gross bank credit. As
already pointed out, direct housing loans up to Rs. 15 lakh irrespective of the location
now qualify as priority sector lending; housing loans are understood to form a large
component of such lending. In addition, housing credit is also being provided by housing
finance companies, which in turn are also receiving some bank finance.
Thus, from miniscule amounts, the exposure of the banking sector to housing loans has
gone up. Unlike many other countries, asset impairment on account of housing finance
constitutes a very small portion. However, with growing competition in the housing
finance market, there has been a growing concern over its likely impact on the asset
quality. While no immediate financial stability concerns exist, there is a need to put in
place appropriate risk management systems, strengthen internal control procedures and
also improve regulatory oversight in this area. Banks also need to monitor their
exposure and the credit quality. In a fiercely competitive market, there may be some
temptation to slacken the loan scrutiny procedures and this needs to be severely
checked.
Having delineated the broad contours of retail banking in India let me now come to its
opportunities and challenges.
Housing finance holds the key for sustained long-term growth due to low penetration levels
Among the major asset finance markets, housing finance has the lowest penetration
levels; also, housing finance has the highest potential demand among all retail finance
markets. The ticket size in housing finance is relatively higher than the ticket size in
other segments like auto finance and two-wheeler finance; hence, an increase in the
penetration of housing finance will have a sizeable impact on the growth of the retail
asset finance market.
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Penetration levels - units financed in 2003-04
Currently, over 90 per cent of the borrowers availing housing finance are salaried
employees and the balance are self-employed professionals like doctors, chartered
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accountant, architects, etc. However, financiers have been sceptical in lending to the
self-employed business class due to the difficulty in accessing their credit worthiness.
There is a huge potential demand for housing finance from this segment, and CRIS
INFAC believes that if the lenders are able to specifically design products to address the
non-salaried borrowers, the growth in housing finance will be much higher than CRIS
INFAC's estimates based on the current product offerings. Currently, CRIS INFAC
expects the housing finance market to record an annual growth rate of 18.8 per cent till
2008-09 to reach Rs 1,347 billion from Rs 569 billion in 2003-04.
Socio-demographic changes:
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Decline in interest rates
Fiscal incentives
Regulatory issues
• Supply-side regulations
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Customers' borrowing ability has increased substantially
Consumers generally look at the EMI obligation at the time of availing a loan. During the
last 5 years, customers' borrowing ability has increased substantially, due to declining
interest rates and increasing loan tenures. The housing finance market has witnessed
the highest rise, of about 50 per cent, in the borrowing ability between 1998-99 and
2003-04 considering only the above two factors.
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Auto finance
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Two-wheeler finance
The key growth drivers for the auto finance market are
Changing consumer mindset towards availing finance, leading to a higher number
of the vehicles sold being financed
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Market Share
NBFCs, HDFC Bank,
13.80% 8.90% ICICI Bank,
29.20%
Other PSU
banks, 6.10%
Standard
ABN Amro Chartered
Bank, 2.80% Citigroup , Bank, 11.00%
State Bank of 8.10%
India, 5.30%
ICICI Bank Standard Chartered Bank
Citigroup State Bank of India
ABN Amro Bank Other PSU & private banks
NBFCs HDFC Bank
The key drivers to achieve a 7.0 per cent CAGR in financing Commercial Vehicles
till 2008-09 are:
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Increase in penetration by organised players in used vehicle finance and
refinance.
However, financiers may face the following challenges in the coming years:
High exposure to small fleet operators and first-time buyers, who would be the
first to be negatively affected in the expected downturn
Hike in fuel prices without comparable change in freight rate to negatively affect
the profitability of truck operators, (their credit worthiness may be hit)
The key growth drivers for the two-wheeler finance market are:
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• Increased interest among the female population for ungeared two-
wheelers
Currently, the organised retail finance market is catered to by NBFCs, HFCs and banks,
with each of them vying for a share of the retail finance pie. While NBFCs and HFCs
have the advantage of having years of experience in understanding the needs of the
retail customer, banks (which have been late entrants) have the advantage of lower cost
of funds. Due to the stiff competition in this market, CRIS INFAC expects a structural
change within this industry, resulting in only the most efficient players surviving this
competition.
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Present industry structure
The retail finance industry in India has two broad categories of players - Banks (private,
public, foreign and others) and non-banking companies (NBFCs/HFCs). These players
can further be segmented based on the combination of two parameters - a) their cost of
funds and operations and b) their loan-origination skills (appraisal and collection
systems) as depicted in the graph below.
Quadrant I: This group includes those lenders who have the advantage of low cost of
funds and the benefit of efficient loan origination and servicing skills. Typically, new
private sector banks, foreign banks and large HFCs and NBFCs would fall into this
quadrant; for example, ICICI Bank, Citibank, HDFC Ltd, LICHF Sundaram Finance,
Kotak Primus, Cholamandalam Investment and Finance Ltd, etc.
Quadrant II: Lenders who have the advantage of low cost of funds, but do not have
appropriate systems, fall in this quadrant. Most public sector banks can be classified in
this quadrant.
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Quadrant III: This quadrant includes the most inefficient players in the housing finance
market. These players have the disadvantage of high cost of funds and lack efficient
systems. Banks do not fall into this category; however, small localised NBFCs/HFCs
with inefficient systems and high cost would fall in this quadrant.
Quadrant IV: This quadrant includes lenders who have established efficient systems to
originate and service loans, but have a high cost of funds; for instance, smaller HFCs
like Gruh Finance, Dewan Housing Finance, and NBFCs like Sriram Transport Finance,
Magma Leasing, etc.
As the competition in the housing finance market intensifies, CRIS INFAC expects a
change in the role of the various players in the market.
Quadrant II: Some Quadrant II players will graduate to Quadrant I by improving their
own systems (loan origination and servicing), while others will acquire Quadrant IV
players, thereby graduating to Quadrant I. The remaining players of Quadrant II will
maintain their presence in the market by becoming indirect lenders and leveraging their
low cost of funds in either purchasing portfolios or investing in mortgage/asset-backed
securities.
Quadrant III players: On account of their high cost and inefficient systems, these
players will be left out of the market. But they can leverage their investment in
distribution networks and convert themselves into direct selling agents (DSAs) for large
players.
Quadrant IV players: Players who do not merge with stronger players from Quadrant I
or II will have to reduce their cost of funds by either selling their portfolio or securitising
it. This will transform these players into originators for larger players. However, in
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securitisation, these players will have to take the first loss in case of defaults; also, they
will continue to have a riskier profile.
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Opportunities and challenges of retail banking in India
Retail banking has immense opportunities in a growing economy like India. As the
growth story gets unfolded in India, retail banking is going to emerge a major driver. A.
T. Kearney, a global management consulting firm, recently identified India as the
"second most attractive retail destination" of 30 emergent markets.
The rise of the Indian middle class is an important contributory factor in this regard. The
percentage of middle to high income Indian households is expected to continue rising.
The younger population not only wields increasing purchasing power, but as far as
acquiring personal debt is concerned, they are perhaps more comfortable than previous
generations. Improving consumer purchasing power, coupled with more liberal attitudes
toward personal debt, is contributing to India's retail banking segment.
The combination of the above factors promises substantial growth in the retail sector,
which at present is in the nascent stage. Due to bundling of services and delivery
channels, the areas of potential conflicts of interest tend to increase in universal banks
and financial conglomerates. Some of the key policy issues relevant to the retail banking
sector are: financial inclusion, responsible lending, access to finance, long-term savings,
financial capability, consumer protection, regulation and financial crime prevention. The
strong growth in disbursements will lead to a 37% growth in outstanding retail loans to
$130bn in FY2007. This would represent 33-35% of bank credit and 18% of GDP in that
year. Mortgages would comprise 62% of the market.
In India, the ratio of consumer financing to GDP in India is 2.6 per cent, while in
developed countries this ratio is normally 40-50 per cent and in South East countries it is
7-10 per cent. India has a very youthful demography, with more than 50 per cent of the
population below 25 years as long as there are no external shocks and internal
meltdown. If handled properly, the number of rural middle income households could
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grow exponentially and provide the next big boost to consumer spending and market
growth. The rural market already accounts for over one-third of consumer sales, and
most of the really Big Ideas of the future such as healthcare, energy, housing,
transportation and education — revolves around the rural economy.
Challenges for the industry
Rising indebtedness could turn out to be a cause for concern in the future. India's
position, of course, is not comparable to that of the developed world where
household debt as a proportion of disposable income is much higher. Such a
scenario creates high uncertainty.
Information technology poses both opportunities and challenges. Even with ATM
machines and Internet Banking, many consumers still prefer the personal touch of
their neighborhood branch bank. Technology has made it possible to deliver
services throughout the branch bank network, providing instant updates to
checking accounts and rapid movement of money for stock transfers. However,
this dependency on the network has brought IT department’s additional
responsibilities and challenges in managing, maintaining and optimizing the
performance of retail banking networks.
KYC Issues and money laundering risks in retail banking is yet another important
issue. Retail lending is often regarded as a low risk area for money laundering
because of the perception of the sums involved. However, competition for clients
may also lead to KYC procedures being waived in the bid for new business.
Banks must also consider seriously the type of identification documents they will
accept and other processes to be completed. The Reserve Bank has issued
details guidelines on application of KYC norms in November 2004.
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Risk in Retail Banking
Success Formula
Cross selling
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Strong brand products and recovery Management
Basel II
By the year 2006, Indian banks are required to adhere to the international standard of
capital adequacy norms under the new capital accord of Basel II. The RBI has already
taken steps to implement two major components of the second pillar of Basel II i.e., risk
based supervision and prompt corrective action (PCA). The PCA framework has already
been put into operation on an experimental basis by the Reserve bank. A pilot- run of
risk- based supervision has been introduced in October 2003.
The implementation of Basel II norms will have two implications on the banking
system.
First is the ability of the banks to measure the risks they bear. Although banks are now
having adequate risk management practices in place, the existing system may not be
able to support the banks in meeting the stringent norms. This calls for additional
investment in information technology and information sharing systems.
Second is the challenge of meeting the adequacy norms by providing more capital
towards reserves. Banks have to look out for funds to back the identified risks and then
earn income to service the additional capital requirement. If the banks are not able to
meet the reserve criteria, then the ability of the banks to lend further will be limited. This
can have a negative impact on their income.
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the commercial and cooperative banks have to become the member of RTGS. Currently
3000 out of total of around 67000 branches would be able to provide RTGS facility and
since majority of these branches belong to PSU Banks and which haven’t networked
their branches this will mean loss of business to them. If the commercial and co-
operative banks do not become members, then the settlement risk cannot be totally
eliminated.
Future of retail Banking
For the Banks to compete & succeed in retail banking market new initiative &
innovations, new strategies, new delivery mechanism and ability to cross sell products
are imperative. At the same time banks should align themselves with customer &
become more and more customer centric with proper emphasis on relationship
management.
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Conclusion
While retail banking offers phenomenal opportunities for growth, the challenges are
equally daunting. How far the retail banking is able to lead growth of the banking
industry in future would depend upon the capacity building of the banks to meet the
challenges and make use of the opportunities profitably. However, the kind of
technology used and the efficiency of operations would provide the much needed
competitive edge for success in retail banking business. Furthermore, in all these
customers’ interest is of paramount importance. The banking sector in India is
demonstrating this and I do hope they would continue to chart in this traded path.
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