global research on sbi

8/9/2019 Global Research on SBI

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Global Research - India Global Investment House

1State Bank of IndiaJanuary 2007

Investment Summary

State Bank of India (SBI) has history of more than 200 years of existence. SBI is the

largest commercial bank in India and accounts for approximately 18% of the total Indian

banking business and the group account for 25% of the total Indian banking business.

The central bank, Reserve Bank of India (RBI) is the largest shareholder in the bank with

59.7% stake followed by overseas investors including GDRs with 19.78% shareholding

as on September 06. RBIs stake in the bank is likely to be transferred to the Government

of India (GOI).

SBI has the largest distribution network in India spread across every nook and corner ofIndia. As on September 06, the bank has 14,061 branches which include 4,755 branches

of its associated banks. The bank also has the largest network of 5,624 ATMs.

Since the last five years the bank has showed continued growth in its core business. The

total asset size of the bank reported a CAGR of 9.4% during the period FY01-FY06 and

stood at Rs.4,938.69bn as of September 2006.

In H1FY07, the bank reported net interest income (NII) of Rs.182.14bn, representing

a growth of 2.74% over H1FY06 while the bank reported a net profit of Rs.19.8bn,

registering a decline of 18.67% during the same period.

Credit off take of the bank has been lower than the Indian banking industry during the

past few years. The total credit book of the bank grew at a CAGR of 18.2% over the last

five years and stood at Rs2,832.68bn at the end of September 2006. The industry growth

during the same period was around 28%.

The banks asset quality has improved over the past few years. Gross NPL to gross

loans stood at 3.57% as of Sep-end 2006 while net NPLs stood at 1.67%. The bank has

provided for 54.06% of its NPLs as on Sep-end 2006, which is below the industry average

of around 68%.

Reuters Code:

SBI.BOListing:Bombay Stock ExchangeNational Stock ExchangeLondon Stock ExchangeAhmedabad Stock ExchangeKolkata Stock ExchangeChennai Stock Exchange

Current Price:

Rs 1,223 (Jan 12, 2007)

State Bank of India

January 2007

HOLD


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2 State Bank of India January 2007

Total deposits of the bank grew at a CAGR of 9.4% over the last five years to reach

Rs3,800.5bn, with low cost deposits registering an impressive CAGR of 15.4% during

the same period. Contribution of low cost deposit to total deposit during the period too

has moved up sharply from 36.3% in FY01 to over 47.6% in FY06. However, currentand saving account (CASA) contribution in H1FY07 has declined to 43.65%, thereby

significantly increasing cost of funds and hence margin contraction. On a sequential

basis, margins of the bank declined by 8bps to 3.32%.

The capital adequacy ratio of the bank stood at 12.63% (Tier-I of 8.74% and Tier-II

of 3.89%) at the end of H1FY07. To augment its CAR to provide a stable platform for

further growth, the bank plans to raise upto Rs.100bn as subordinate debt during the next

few months. The bank also has a cushion to raise further Rs40bn in the form of Hybrid

Tier 1 capital.

SBI has been a net seller in the bond market and is using its excess investments to fund its

loan growth. As on September 2006, investment book size of the bank stood at Rs1,470bn

which declined from Rs1,650bn as of March 2006. Of the total book size, Rs1,020bn is

in Held To Maturity (HTM). Of the Available for Sale (AFS) book, the duration of the

portfolio of less than two years has been maintained, with mark-to market cushion up to

8.12%.

SBI is the market leader in the Indian banking space. At the CMP, stock trades at 14.5x

and 12.1x of its earnings for FY07E and FY08E respectively and 3.3x and 2.96x of its

adjusted book value.

We have valued SBI on a sum-of-the-parts methodology to capture the true value of

the associate banks and non-banking businesses. SBI has seven associate banks and

comprised a significant portion of the book value. Similarly, other businesses of the

bank are growing significantly faster than the core banking business and will make an

increasing part of the market value.

We initiate our coverage of SBI with a Hold rating and value the banks share at an

intrinsic value of Rs.1,209 based on the sum-of-the-parts valuation methodology. Though

the bank is the proxy for Indian economic growth, the current market price already

captures the future growth potential. Hence, we recommend a Hold on the stock with a

medium term perspective.


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Table 1: SBI at a glance

Price ( As on Jan 12 2007) Shares in Issue Market Cap 52 week price range

Rs.1,223 526.3mn Rs.643.6bn Rs.1,379/684

YearNet Interest

Income Rs. MnNet profit

Rs. mnEPSRs.

BVPSRs.

ROAE(%)

P/E(x)

P/BV(x)

2008 (E) 181,454 53,007 100.7 655.4 16.2 12.1 1.87

2007 (E) 160,784 44,367 84.3 586.0 15.2 14.5 2.09

2006 156,356 44,067 83.7 525.3 17.0 11.6 1.84

2005 139,446 43,045 81.8 457.4 19.4 8.0 1.44

Historical P/E & P/BV multiples pertain to respective year-end prices, while those for future years are based on

market price on the Bombay Stock Exchange as on Jan 12, 2007.

Source: SBI and Globals Estimate

Chart 1: Share Price movement vis--vis BSE Sensex and BSE Bankex

Source: Bombay Stock Exchange

0

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14000

16000

Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06

Index

0

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600

800

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1400

SBIshareprice(Rs)

SENSEX Bankex SBI


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State Bank of India

Background

State Bank of India is the largest and one of the oldest commercial bank in India, in existence

for more than 200 years. The bank provides a full range of corporate, commercial and retail

banking services in India. Indian central bank namely Reserve Bank of India (RBI) is the

major share holder of the bank with 59.7% stake. The bank is capitalized to the extent of

Rs.646bn with the public holding (other than promoters) at 40.3%.

SBI has the largest branch and ATM network spread across every corner of India. The

bank has a branch network of over 14,000 branches (including subsidiaries). Apart from

Indian network it also has a network of 73 overseas offices in 30 countries in all time zones,

correspondent relationship with 520 International banks in 123 countries. In recent past, SBI

has acquired banks in Mauritius, Kenya and Indonesia. The bank had total staff strength of198,774 as on 31st March, 2006. Of this, 29.51% are officers, 45.19% clerical staff and the

remaining 25.30% were sub-staff. The bank is listed on the Bombay Stock Exchange, National

Stock Exchange, Kolkata Stock Exchange, Chennai Stock Exchange and Ahmedabad Stock

Exchange while its GDRs are listed on the London Stock Exchange.

SBI group accounts for around 25% of the total business of the banking industry while it

accounts for 35% of the total foreign exchange in India. With this type of strong base, SBI

has displayed a continued performance in the last few years in scaling up its efficiency levels.

Net Interest Income of the bank has witnessed a CAGR of 13.3% during the last five years.

During the same period, net interest margin (NIM) of the bank has gone up from as low as

2.9% in FY02 to 3.40% in FY06 and currently is at 3.32%.

Management

The bank has 14 directors on the Board and is responsible for the management of the

banks business. The board in addition to monitoring corporate performance also carries out

functions such as approving the business plan, reviewing and approving the annual budgets

and borrowing limits and fixing exposure limits. Mr. O. P. Bhatt is the Chairman of the bank.

The five-year term of Mr. Bhatt will expire in March 2011. Prior to this appointment, Mr.

Bhatt was Managing Director at State Bank of Travancore. Mr. Bhatt has more than 30 years

of experience in the Indian banking industry and is seen as futuristic leader in his approach

towards technology and customer service. Mr. Bhatt has had the best of foreign exposure inSBI. We believe that the appointment of Mr. Bhatt would be a key to SBIs future growth

momentum. Mr. T S Bhattacharya is the Managing Director of the bank and known for his

vast experience in the banking industry. Recently, the senior management of the bank has

been broadened considerably. The positions of CFO and the head of treasury have been

segregated, and new heads for rural banking and for corporate development and new business

banking have been appointed. The managements thrust on growth of the bank in terms of

network and size would also ensure encouraging prospects in time to come.

SBI has a strong and

experienced management


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Shareholding & Liquidity

Reserve Bank of India is the largest shareholder in the bank with 59.7% stake followed by

overseas investors including GDRs with 19.78% stake as on September 06. Indian financial

institutions held 12.3% while Indian public held just 8.2% of the stock. RBI is the monetary

authority and having majority shareholding reflects conflict of interest. Now the government

is rectifying the above error by transferring RBIs holding to itself. Post this, SBI will have a

further headroom to dilute the GOIs stake from 59.7% to 51.0%, which will further improve

its CAR and Tier I ratio.

Chart 2: Shareholding Pattern of the Bank as on 30th September 2006

Source: SBI

As of Sep 2006, SBI has 526.3mn shares outstanding and going by the actual trading volume,

the stocks liquidity seems to have decreased in the past two years. In the first half of FY2007,

93mn shares exchanged hands. The daily share turnover during the year 2006 was 0.22%

down from 0.39% witnessed in 2005. But the sentiment in the stock market improved in the

first six months of the current fiscal with the bank clocking further gains. As of January 12,

2007 banks market capitalisation stood at Rs.643.6bn.

Table 2: Liquidity of SBIs stock

Mar-2004 Mar-2005 Mar-2006 H1 2007

Volume of shares traded (000) 502,840 457,731 295,303 92,528

Shares turnover Daily Averages (%) 0.39% 0.34% 0.22% 0.14%Value traded (Rs. mn) 264,155 243,817 244,999 79,550

No. of transactions 3,832,948 4,223,574 3,168,107 1,570,410

Market Capitalisation (Rs. mn) 84,530 176,718 243,443 375,765

Source: Bombay Stock Exchange

59.7% Reserve Bank of India

Mutual Funds / UTI

Financial Institutions / Banks

Overseas investors including FIIs/OCBs/NRIs

GDR Issue

Others

6.0%

6.3%

11.9%

7.9%

8.2%


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Key Areas of Operations

The business operations of SBI can be broadly classified into the key income generating areas

such as National Banking, International Banking, Corporate Banking, & Treasury operations.The functioning of some of the key divisions is enumerated below:

Chart 3: Key Business Areas of the Bank

Source: SBI, GlobalResearch

a) Corporate Banking

The corporate banking segment of the bank has total business of around Rs1,193bn. SBI has

created various Strategic Business Units (SBU) in order to streamline its operations. These

SBUs are as follows:

a.1) Corporate Accounts

This SBU is important for the bank as its loan portfolio constituted about 27.05% of the

banks commercial and institutional non-food credit and 12.85% of the total domestic credit

portfolio as on 31st March 2006.

Some of the products under corporate accounts SBU are as follows:

SBI-FAST, which is the cash management product offered by this SBU, had a turnover

of Rs.4,705.75bn as of 31st March 2006. This product is now a comprehensive cash

management solution, offering payments in addition to collections.

Vendor financing activity is being integrated with core banking through the internet

platform. This is identified as a focus area to capture the credit portfolio of vendors.

The foreign exchange business grew by around 55% y-o-y and reached Rs.1,747.70bn as

of 31st March 2006. This SBU now handles nearly 12% of the countrys visible trade andabout 43% of banks forex business.

a.2) Leasing

This SBU is not writing any leases since the past few years as unfavorable business climate

and availability of alternative funding options at cheaper cost. As at the end March 2006, the

disbursements and capitalization were zero and profit amounted to Rs.245.9mn.

a.3) Project Finance

This SBU focuses on funding core projects like power, telecom, roads, ports, airports, special

economic zones and others. During FY06, total sanctions for 18 projects involving a total

State Bank of

India

Corporate

Banking

National

Banking

International

Banking

Treasury

Operations

Associates &

Subsidiaries


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amount of Rs.42.11bn were in place as against 13 projects involving Rs.25.08bn in the

previous year. It also handles non-infrastructure projects with certain ceilings on minimum

project costs. During FY06 sanctions for 29 projects involving a total amount of Rs.55.80bn

were in place as against 27 projects involving Rs.51.63bn in the previous year.

As a whole, this SBU achieved total sanctions of Rs.238.86bn (fund based and non fund

based) including syndication amount of Rs.140.95bn during the period ended March 2006.

During FY06, this SBU entered into financing of aviation sector actively by sanctioning

loans for modernization of airports and acquisition of aircrafts.

a.4) Mid Corporate Group

The Mid Corporate Group (MCG) created in June 2004 has 7 MCG Regional Offices

controlling 28 large branches with high concentration of Mid Corporate (MC) business.

The entire Off-Site MC business of all branches at 31 identified centres has been brought

under the fold of MCG. The average processing time of credit proposals is about 15 days

and quicker decision making on credit proposals of the Mid Corporate units has resulted in

greater customer satisfaction.

As of March 2006, 21 MCG branches have been migrated to core banking platform. New

technology products like RTGS, CINB, Multi-City cheque facility and Core Power have been

introduced in all these branches. These technology products coupled with quick Turn Around

Time (TAT) have enabled Mid-Corporate Group to increase its business substantially and

generate higher income, both interest and fee based.

a.5) Stressed Assets Management

During FY06, the banking industry witnessed a major policy initiative by Reserve Bank

of India with the opening up of sale / purchase of non performing assets to banks, FIs and

non-banking finance companies (NBFCs). During FY06, the bank sold NPAs to the tune

of Rs.8.9bn against security receipts and Rs.11.41bn on cash basis to Asset Reconstruction

Company (ARCIL). The progress in enforcing the security interest has somewhat slowed

down due to the requirement of withdrawing suits pending before the tribunal prior to action

being initiated against the defaulting borrowers under the SARFAESI Act.

b) National Banking

The national banking group has 14 administrative circles encompassing a vast network of

9,177 branches, 4 sub-offices, 12 exchange bureaus, 104 satellite offices and 679 extension

counters, to reach out to customers, even in the remotest corners of the country. Out of

the total branches, 809 are specialized branches. This group consists of four business group

which are enumerated below:

b.1) Personal Banking SBU

This SBU is mainly responsible for retail business. During FY06, personal banking advances

increased from Rs.464.51bn to Rs.610.67bn, showing a growth of Rs.146.16bn at the rate of

31.47 % against a growth rate of 40.12% in the previous year.

On the home loan front, several new products were introduced, tailored to fit the needs of

specific customer segments, such as SBIMaxgain (minimize interest burden, earn on savings,


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at no extra cost), SBI NRI-Home Loans, SBI Freedom Home Loans (Loans given without

mortgage of property, but against alternate securities, instead), SBI Tribal Plus Home Loans.

The auto loans portfolio has shown a growth of Rs.17.74bn in absolute terms and 65% which

is considerably higher than last years growth, mainly due to implementation of well plannedstrategies.

b.2) Small & Medium Enterprises

The SME Business Unit implemented comprehensive strategies, revamped business processes

and with its focus on market dynamics and customer preferences, achieved commendable

business growth. The initiative was implemented by focusing on specific industry segments,

and concentrating on various players in the value chain. Debt restructuring mechanism for

units in SME sector has been devised to ensure restructuring of debt of all eligible Small and

Medium Enterprises (SMEs) on favourable terms.

Focused on the SME sector, projects under Uptech are taken up in location specific and

activity specific industry clusters. So far the bank has taken 28 projects for modernisation

under the Project Uptech covering industries like foundry, pumps, glass, auto components,

and knitwear, etc. The bank has also covered agro based industries like rice mills, sago and

starch and horticulture activities like Apple Orchards and grape farming under the scheme.

The deposits of the SME SBU increased to Rs.1,042.70bn as at the end of March 2006 from

Rs.890.60bn of previous year recording a growth of 17.08% during the year. SME advances

increased to Rs.456.53bn from Rs.328.30bn of previous year, recording a growth of 39.06 %.

The criteria laid down by the Government of India for growth in SME advances is 20%.

b.3) Agricultural Banking

This SBU is accountable for agricultural credit both traditional and new thrust areas like

contract farming, farmers financed through Agri Export Zones (AEZs) and value chain

financing. Increase in disbursements during FY06 was 83% against the Govt. of India target

of 30%. Agricultural advances grew from a level of Rs.205.26bn in FY05 to Rs.305.16bn as

at the end of March 06. As on November 2006, agriculture loans contribute 11% of the total

loan book.

b.4) Government Banking

With the establishment of the government business unit and the consequent focus on

marketing, business turnover of this segment has grown substantially over the years. Banks

business turnover from the government business segment during 2004-05 was Rs.8,843.81bn.

The turnover increased by 10.52 % to Rs.9,773.90bn during FY06.

c) International Banking

SBI has a network of 73 overseas offices in 30 countries in all time zones and correspondent

relationship with 520 international banks in 123 countries. The bank is keen to implement

core banking solution to its international branches also. During FY06, 25 foreign offices were

successfully switched over to Finacle software. SBI has installed ATMs at Male, Muscat

and Colombo Offices. In recent years, SBI acquired 76% shareholding in Giro Commercial

Bank Limited in Kenya and PT Indomonex Bank Ltd. in Indonesia. The bank incorporated a

company SBI Botswana Ltd. at Gaborone.


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d) Treasury

The bank manages an integrated treasury covering both domestic and foreign exchange

markets. In recent years, the treasury operation of the bank has become more active amidst

rising interest rate scenario, robust credit growth and liquidity constraints. The bank

diversified its operations more actively into alternative assets classes with a view to diversify

the portfolio and build alternative revenue streams in order to offset the losses in fixed income

portfolio.

Reorganisation of the treasury processes at domestic and global levels is also being

undertaken to leverage on the operational synergy between business units and network. The

reorganization seeks to enhance the efficiencies in use of manpower resources and increase

maneuverability of banks operations in the markets both domestic as well as international.

e) Associates & Subsidiaries

The State Bank Group with a network of 14,061 branches including 4,755 branches of its

seven Associate Banks dominates the banking industry in India. In addition to banking, the

Group, through its various subsidiaries, provides a whole range of financial services which

includes Life Insurance, Merchant Banking, Mutual Funds, Credit Card, Factoring, Security

trading and primary dealership in the Money Market.

e.1) Associates Banks:

SBI has seven associate banks namely

State Bank of Indore

State Bank of Travancore

State Bank of Bikaner and Jaipur

State Bank of Mysore

State Bank of Patiala

State Bank of Hyderabad

State Bank of Saurashtra

All associate banks have migrated to Core Banking (CBS) platform. Single window delivery

system has been introduced in all associate banks. SBIs seven associate banks are the first

amongst the public sector banks in India to get fully networked through CBS, providing

anytime-anywhere banking to its customers to facilitate a bouquet of innovative customer

offerings.

e.2) Non-Banking Subsidiaries/Joint Ventures

i) SBI Life:

SBI Life is the third largest private insure with the market share of 10.21% among the private

players and number one in terms of number of lives insured amongst private players (no. of

lives insured and policies is 25mn). In H1FY07 gross premium was Rs.7.68bn.

ii) SBI Capital Markets Limited (SBICAP)

SBI Caps forged ahead in issue management, project advisory and structured finance, sales


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and distribution. To capitalize on the emerging opportunities, SBI Caps has promoted four

wholly owned subsidiaries viz. SBICAP Securities Ltd. for undertaking stock broking

activities, SBICAPS Ventures Limited, SBICAP Trustee Company Limited for undertaking

venture capital business and SBI CAP (UK) LTD., for carrying on the Financial ServicesAuthority (FSA) regulated activities.

On the international front, the expertise of SBI Caps in the infrastructure and project advisory

has received international acclaim. In addition, the company has been placed 11th globally in

the Mandated Project Advisor league tables by Thompsons, and one of the projects handled

by the company has been selected as the Asia Pacific Infrastructure deal of the year for FY06.

SBI Caps booked gross income amounting to Rs.1.79bn in FY06 as against Rs.1.75bn in the

previous year, while PAT of the company was at Rs.906.2mn in FY06 as against Rs.881.2mn

in the last year.

iii) SBI DFHI LTD

SBI group holds 67.01% of the companys paid up capital, while other nationalized banks

hold 22.46%. All India financial institutions and private sector banks hold 5.84% and the

Asian Development Bank holds 4.69% as on March 31, 2006. For the year ended 31st March,

2006, the company has earned a PAT of Rs.24.4mn. Total secondary market turnover of the

company was Rs.285.39bn which amounted to a market share of 12.89% among all primary

dealers.

iv) SBI Cards & Payments Services Pvt. Ltd. (SBICSPL)

SBICSPL is ranked 2nd in industry with cards in force over 3mn as on September 06. During

FY06, the aggregate revenue generated by the SBICSPL was Rs.5.27bn while pre-tax profit

was Rs.558.6mn.

v) SBI Funds Management (P) Ltd. (SBIFMPL)

SBI Mutual Fund is the mutual funds arm of the bank. SBIFMPL reported a total inflow of

Rs.481.67bn in the various schemes during the year. The total assets under management

are Rs.132.49bn. The company reported a net profit of Rs.186.4mn as at the end of March,

2006.

f) Human Resources

The bank had total staff strength of 198,774 on the 31st March, 2006. Of this, 29.51% are

officers, 45.19% clerical staff and the remaining 25.30% were sub-staff. SBI had launched

VRS scheme for its employees in FY01 in which it has reduced it staff by approximately

5,000 and estimates natural retirement of another 5,000 employees in next 4-5 year.


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Strategy and New Developments

Though a public sector bank, it has set in motion a series of steps to transform itself into a

modern, technology enabled customer-centric, world-class banking organization, meetingbest global practices and standards in banking and service delivery. The bank has maintained

its record of profitability, while adjusting to the changing circumstances and interest rate

environment. Despite intense competition and pressure on spreads it has maintained and

improved its NIM. Major innovations and initiatives are in the arena of technology, banking

products and processes, service delivery channels and human resource to efficientlyserve bank

customers across the globe. The bank maintains its drive on the technology front to enhance

customer service, increase productivity, and manage risk better. After having computerized

all its branches, it has been moving swiftly to implement real time on-line banking.

As a part of its strategy to stay ahead of the competition, SBI had increased its benchmark

lending rates by 50 basis points to 11.5 percent; this lending rate increase is due to the risingcost of funds for banks, which are paying more for deposits as a way of encouraging investors

to save.

Growing international presence.

The bank continues to expand its global footprints with the number of foreign offices

having increased to 70 in 2005-06 from 54 in 2004-05. During the year FY06, SBI opened

representative offices in Angola and Turkey and additional branches were opened in

Bangladesh, Sri Lanka, U.K, and Canada. In tandem with the countrys growing trade and

business with China, its representative office in Shanghai was upgraded to a full branch. The

bank is also proceeding apace on international acquisitions. Following on from its successful

acquisition of Indian Ocean International Bank in Mauritius, the bank is acquiring a majoritystake in Giro Commercial Bank in Kenya and PT Bank IndoMonex in Indonesia. Together,

foreign offices and subsidiaries brought in a net profit of US$80 million, contributing a

steadily growing share to the overall profits of the bank. The foreign branches are on core

banking.

New thrust areas

Going forward, the bank identifies new thrust areas to sustain its growth momentum, and

these include:

Finally, waking up to intense competition in the domestic and international financial

sectors, SBI has begun firming up 15 new business initiatives with substantial profitpotential.

The bank has formed a new department to draw up a blueprint for these cutting-edge

segments in financial sector services Private equity, point of sale, cards business (gift

cards, payroll cards & other cards,) pension, general insurance, merchant acquisitions and

gold banking are a few areas SBI is looking at for developing its profile as a modern 21st

century bank. With the new initiative, SBI is determined to capture its lost market share.

On the private equity business, the bank not earmarked any amount, but it could be in a

range of Rs1bn-1.5bn.


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State Bank of India has applied for permission for banking operations in China, which, if

approved, would enable Chinese corporations to open their accounts with India's largest

banking network. The SBI Shanghai branch will also increase investment in China,

enhancing trade development between New Delhi and Beijing. SBI was expected to offerremittance services in China and might open new branches in South China and Beijing by

2008. SBI's Shanghai branch provides investment consultancy and acquisition financing,

and remittances directly to India, as well as foreign currency services for overseas

companies.

As per the new SBI Act the bank can raise funds from the market and lower the central

bank's holding to 51 percent. The new bill proposes to amend the SBI Act to allow the

minimum central bank holding in the bank to be lowered to 51 percent from 55 percent.

The bill seeks to allow SBI to raise funds through preference shares or private placements.

It will also be allowed to issue bonus shares, which it could not do under the existing act.

The voting rights of preference shareholders will be capped at 10 percent.

The bank could raise fresh equity in the fiscal year beginning in April 2007, after changes

are made in the law to dilute the central bank's stake. The bill also seeks to increase SBI's

authorised capital to Rs.50bn. The bank's paid-up capital was Rs.5.26bn as of Sep 06.

Indian banks have been raising capital to comply with Basel II prudential norms and meet

strong demand for loans in a fast growing economy.

SBI group has around 8,500 branches under CBS platform with 3,710 branches of SBI.

As a group SBI has 64% of it business and around 89mn accounts under CBS.


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Indian Banking Sector

Indian banking sector can be divided mainly into four broad categories namely public

sector banks, old private sector banks, new private sector banks, and foreign banks. Theother categories of banks include co-operative banks and regional rural banks. Since these

banks dont form a substantial chunk of the banking system, we will focus on the first four

categories. There were as many as 222 scheduled commercial banks in India as at the end of

Mar 2006.

Table 3: No. of banks in India

Mar-02 Mar-03 Mar-04 Mar-05 Mar-06

Number of Commercial Banks (a+b) 297 292 290 289 222

a. Scheduled Commercial Banks 293 288 286 285 218

- of which: Regional Rural Banks 196 196 196 196 133

b. Non-Scheduled Commercial Banks 4 4 4 4 4Source: Reserve Bank of India

Indian banking driven by structural factors

The Indian banking sector in recent years is driven mainly by structural factors such as

corporate capex cycle, retail loan boom, and infrastructure funding with low incremental

defaults. Robust macroeconomic performance continued to strengthen the financial

performance of scheduled commercial banks (SCBs) in recent years and this trend continued

in 2005-06 as well. The banking sector has been driven by vigorous credit growth during

recent years. The heartening factor was that the credit offtake was more broad-based with all

the sectors of the economy going for credit. Housing and retail segments were joined by the

demand for credit from agriculture and industry segment as well.

The credit demand was not entirely financed by the customer deposits as the growth of deposits

slowed down marginally in 2005-06. In order to meet the increased demand for credit, banks

increased their dependence to non-deposit resources. In addition to this, number of banks

curtailed their fresh investment in Government securities to finance the credit demand. The

strong credit offtake was primarily responsible for the improved net interest income of many

banks. In fact, the strong credit demand was able to more than offset the impact of sharp

decline in non-interest income. Profitability of public sector and new private sector banks

improved, despite hardening of sovereign yields.

Asset quality of SCBs has been improving since the past three years as reflected in the declinein gross non-performing assets in absolute terms. This is despite the fact that, RBI has asked

banks to switch over to the 90-day delinquency norm with effect from March 2004. With the

sharp increase in risk-weighted assets, many banks shored up their capital by way of new

issues.

Public sector banks dominate the Indian banking system though their market share is

dwindling

The public sector banks (PSBs) account for a major share of all the banking indicators like

assets, deposits, advances etc. However, the private sector banks, especially new private

banks like ICICI Bank, HDFC Bank and UTI Bank etc. are giving tough competition to their

Robust macroeconomic

performance strengthen

the financial performance

of commercial banks in

recent years


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government owned peers. Public sector banks which comprise State Bank of India group and

other nationalised banks are continuously losing their market share in bank deposits since the

opening up of the banking sector to their private counterparts. According to latest Reserve

Bank of India (RBI) figures, private banks and foreign banks have gained during the year.The data indicates that SBI groups market share in deposits dipped to 23.4% in FY06 from

24.2% in the previous year. The share of nationalised banks, as a group, accounted for 48.4%,

down from 49.8% in the previous year. The share of foreign banks, regional rural banks and

private banks aggregate deposits were 5.3% and 19.4%, respectively, as against 4.45% and

18.1%, respectively, in the previous year.

As regards loans extended by commercial banks, there has been no significant change in the

market share of various bank groups. The share of nationalised banks was 47.5% in FY06

as against 47.4% in the previous year. The share of the SBI group was stable at 23.1%. The

share of private banks was 20.2% (20.1%). However, foreign banks recorded a marginal dip

in their share in bank credit to 6.5% as against 6.7% in the previous year.

Robust growth in assets

The asset size of 43 private sector banks, for which the data is available, rose by a healthy

37.7% during 2005-06 as compared to 23.2% in 2004-05. Loans and advances constituted

53.5% of the total assets in 2005-06 as compared to 51.3% during the previous year. On

the back of robust economic growth and industrial recovery, loans and advances witnessed

strong growth while investments surged by 30.8% in FY06. On the liabilities side, total

deposits constitute around 69.7% of the total liabilities of the private sector banks in 2005-

06. Deposits grew by 41.6% in 2005-06. In keeping with the Basel II requirements, capital

and reserves and surplus showed vigorous growth. The increased capital also underscores the

growing importance of non-deposit resources of SCBs.

Table 4: Consolidated Balance Sheet of 43 Private Sector Banks (Rs. bn)

Year FY03 FY04 FY05 FY06

Sources of Funds

Capital 46.45 47.63 74.95 92.89

Reserves Total 219.39 261.70 369.16 525.04

Deposits 2,128.37 2,719.87 3,352.40 4,746.44

Borrowings 566.30 531.65 655.93 794.83

Other Liabilities & Provisions 376.61 475.32 519.46 688.44

Total Liabilities 3,337.11 4,036.16 4,971.90 6,847.65

Application of funds

Cash & Balances with RBI 164.85 234.34 245.18 277.59Balances with Banks & money at Call 124.77 154.81 201.07 323.79

Investments 1,201.90 1,426.68 1,580.23 2,066.44

Advances 1,534.66 1,863.76 2,552.38 3,667.89

Fixed Assets 79.29 80.08 81.96 91.22

Other Assets 231.65 276.49 311.08 420.72

Total Assets 3,337.11 4,036.16 4,971.90 6,847.65

Source: Capitaline.com

Business growth of all scheduled commercial banks

During the last financial year ( up to March 31, 2006) incremental gross bank credit increased

by 36% as compared to a growth of 31.9% (net of conversion) in the same period of the


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previous year. The year on year growth of gross bank credit as on 31st March 2006 was

29.9% as against 26.9% (net of conversion) on the corresponding date of last year.

Non food credit up to FY06 registered a growth of 37.3% as compared to 32.8% duringthe same period last year. The year on year growth rate of non food credit was 30.8% as

compared with 27.7% on the corresponding date of last year.

Table 5: Business growth of Indian banking sector

Outstanding as on (Rs.bn) % Variations

Items 18-Mar-05 31-Mar-06

1. Bank Credit 11,004.3 14,964.7 36.0%

Food Credit 411.2 417.9 1.6%

Non Food Credit 10,593.1 14,546.9 37.3%

2. Aggregate deposit 17,002.0 20,876.7 22.8%Demand Deposit 2,480.3 3,472.5 40.0%

Time Deposit 14,521.7 17,404.2 19.8%

3. Investments in Govt. and

other approved securities7,391.5 7,275.8 -1.6%

Government Securities 7,189.8 7,046.9 -2.0%

Other approved securities 201.7 228.8 13.4%

Source: Monthly economy report Mar06 (Ministry of Finance)

Retail loan boom

Retail credit to GDP continues to remain low compared to other regional emerging markets.The target population is small, however growing at a fast pace. We expect the retail credit

market to grow from Rs.750bn in Mar 03 to Rs 3464bn by Mar 08.

Table 6: Share of retail loan as percentage of GDP (%)

Name of the Country Retail loan/GDP

Singapore 48.0

Malaysia 52.0

Taiwan 52.0

Hong Kong 60.0

India 8.0

Source: Federation of Indian Chambers of Commerce and Industry

Indias population is young with over 50% of the population under the age of 25 and 80%

under the age 45. Growing urbanization, rising disposable income of the middle-income

group comprising 23% of the population is leading to a shift in consumption patterns and

fuelling retail loan boom. With savings rate at 28% (of which 90% is from households), and

low leverage of individual balance sheets, we expect retail loan boom to continue with low

incremental defaults.


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Private sector banks having higher operating cost

Foreign banks in India have one of the highest operating expenses to total assets ratio in

India at 2.7% during the first quarter of FY07. Foreign banks were followed by new private

sector banks with the operating expenses to total assets ratio of 2.6%. The reason behind the

higher operating expenses for the foreign banks and new private sector banks is their heavy

investment in technology as compared to the government owned banks. The operating cost

for public sector banks took a breather in FY06, on the back of the base effect of higher staff

costs in FY05 (staff cost account for over 65-70% of the total operating expenses).

Table 7: Scheduled Commercial Banks Operating Exp/Total Assets

( Per cent) 2005-06 2006-07

Item/ Bank Group Q1 Q2 Q3 Q4 Q1

Operating Expenses/ Total Assets*

Scheduled Commercial Banks 2.2 2.3 2.4 1.7 2.3

Public Sector Banks 2.1 2.3 2.4 1.7 2.2

Old Private Sector Banks 2.3 2.2 2.3 1.5 2.1

New Private Sector Banks 2.4 2.4 2.1 1.6 2.6

Foreign Banks 2.8 2.7 3.5 2.0 2.7

* Operating expenses annualised to ensure comparability between quarters.

Source: RBI

Operating costs are not likely to take a breather for private sector banks as the banks are

aggressively increasing their delivery channels and investing heavily in technology. The new

formats include specialised offices where banks extend low-ticket credit and raise low cost

deposits. High volume growth is likely on the back of higher operating costs. However, we do

not expect any rise in operating cost to income ratio, despite the rapid increase in infrastructure

as we believe that the income is also expected to go up sharply going forward.

NIM improved for efficient players

Scheduled commercial banks in India have a net interest margin of around 3% during the first

quarter of FY07. Foreign banks in India have one of the highest net interest margins to total

assets ratio of 4% followed by public sector banks and old private sector banks. We believe

that net interest margins had come under pressure due to competition, a better regulatory

environment and lower risk charge for default on loans. We believe that net interest income

growth will be robust due to growth in volumes of credit-offtake.

Table 8: Scheduled Commercial Banks - Net Interest Income/Total Assets

(Per cent) 2005-06 2006-07


Net Interest Income/Total Assets*





Foreign Banks 3.8 3.7 3.6 2.8 4.2

*NII annualised to ensure comparability between quarters.

Source: RBI


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Net profit remains flat

Total income of SCBs declined from 8.21% of their assets in 2004-05 to 8.03% in 2005-06,

as both interest and non-interest income moderated during the year. Total expenditure (as

% to total assets), on the other hand, was unchanged from the previous year. As a result,

earnings before provisions and taxes, as % to total assets, during 2005-06 were lower than

the previous year. However, in view of lower provisions, profits after tax, as % to total assets,

at 0.88% during 2005-06 were almost the same as during 2004-05 (0.89%). As many as 45

banks (out of the total of 85 banks) recorded an increase in the profits ratio during the year.

Table 9: Scheduled Commercial Banks - Net Profit/Total Assets

(Per cent) 2005-06 2006-07


Net Profit/Total Assets*


Public Sector Banks 0.8 0.9 1.0 0.6 0.7Old Private Sector Banks 0.7 0.6 0.8 0.3 0.8


Foreign Banks 1.7 1.9 1.0 1.5 2.4

*Net profit annualised to ensure comparability between quarters.

Source: RBI

Improving asset quality..

The SARFAESI Act, brought into force in mid-2002, empowered the banks to sidestep the

courts and dispose of the defaulters properties given as securities to recover the dues after

giving due notice. Though the act sent the defaulters scurrying in panic, its progress has

been plagued by one hurdle or the other. According to a CRISIL study, about 36% of theoutstanding NPAs are outside the jurisdiction of the act on account of the exemptions provided

by it. Agricultural loans and loans below Rs1.1mn are outside its purview. The study further

says that banks can apply the act only to one-third of the gross outstanding NPAs. Public

sector banks have sent notices to 28,866 entities for recovering Rs101.7bn under the act.

While these recoveries may seem insignificant in comparison to the overall level of NPAs

in the banking system, the substantial amounts recovered in such a short time from long

pending sticky loans is indeed commendable. There is now a growing consensus among the

bankers and borrowers alike that more stringent debt recovery measures will follow in the

future. This augurs well for the NPA problem of the banks; more importantly, it will have a

healthy deterrent action on fresh slippage also.

Asset quality of scheduled commercial banks improved further during the year, with gross

and net NPA ratios reaching historical low levels of 3.5% and 1.3%, respectively, at end-

March 2006. Robust economic activity and better recovery climate have facilitated reduction

in non-performing assets in recent years. Only five banks had net NPAs in excess of five per

cent of their net advances. Financial institutions, scheduled urban co-operative banks and

Non Banking Finance Companies also recorded an improvement in their asset quality during

2005-06, with net NPA ratios reaching 1.3%, 3% and 1%, respectively, of their net advances

at the end of March 2006.


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Table 10: Scheduled Commercial Banks - Gross NPAs to Gross Advances

(Per cent) 2005-06 2006-07


Gross NPAs to Gross AdvancesScheduled Commercial Banks 5.1 4.7 4.1 3.5 3.4




Foreign Banks 3.0 2.5 2.4 2.1 1.9

Net NPAs to Net Advances





Foreign Banks 0.9 0.7 0.7 0.8 0.7

Source: RBI

Credit Information Bureau ...

With the launch of Credit Information Bureau (India) Limited (CIBIL) in 2000 asset quality

of banks is likely to improve further. CIBILs aim is to fulfill the need of credit granting

institutions for comprehensive credit information by collecting, collating and disseminating

credit information pertaining to both commercial and consumer borrowers, to a closed user

group of Members. The database compiled by CIBIL would contain the credit history of

borrowers including details such as the name of the company or partnership, full address,

registration number, names of directors or partners, credit facilities availed, amount

outstanding against each facility, among other information.

CIBIL had launched its consumer bureau, catering to individual borrowers and has amassed

55 million records so far. Around 90% of the lenders in the financial system are now using

the database of Cibil. Recently, CIBIL has launched its commercial bureau for catering to

non-individuals viz. corporate, small and medium enterprises (SMEs) and other types of

business entities earlier this month.

Sufficient capital to sustain growth

At end-March 2006, scheduled commercial banks were well placed in respect of capital

requirements, notwithstanding a modest decline in the aggregated capital ratios during the

year. The decline in CRAR during 2005-06 could be attributed to the higher rate of increase

in total risk weighted assets vis--vis the expansion in capital during the year. Higher growth

in risk weighted assets, in turn, reflected higher growth in the advances portfolio of banks

as compared to investments in government securities, increase in risk weights for personal

loans, real estate and capital market exposure and application of capital charge for market

risk for investments held under the available for sale category from March 2006. Although

the overall CRAR declined, the core capital ( i.e., Tier I) ratio of the banks increased from

8.4% cent at end-March 2005 to 9.3% at end-March 2006 reflecting increased access by

banks to primary capital market as also transfer of investment fluctuation reserve from Tier

II to Tier I capital. The increase in Tier I ratio would provide more headroom to banks in

raising capital funds through Tier II, especially in the context of implementation of Basel


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II norms from March 2007. Only three scheduled commercial banks, of which one is under

moratorium, could not meet the prescribed CRAR requirements at end March 2006.

Table 11: Scheduled Commercial Banks - CRAR(Per cent) 2005-06 2006-07






Foreign Banks 13.4 13.2 13.3 13.0 12.3

Source: RBI

Agriculture lending faltering despite growth potential

Agriculture lending has emerged as one of the fastest growing loan segments for commercialbanks. But despite a huge growth potential, most banks are still below the level of 18% of

total loans stipulated by the government. As per the priority sector norms in India, banks

have to lend 40% of net bank credit to priority sector which includes among other, agriculture

loan, small scale industry loans and home loans upto Rs1mn. Of this banks have to lend 18%

to agriculture.

Market major SBI has managed to reach just 14.3% of the stipulated 18% during FY06.

Among other major commercial banks, ICICI Bank has managed to achieve a target of 16.8%,

while Union Bank of India and Bank of Baroda recorded 16% and 14.6%, respectively.

Bank of India is the only entity among large lenders to cross the 18% target at 19.3%. The

government wants the banks to double their agri-loan portfolio over the next three years.

Basel-II norms some breather for banks

In its mid-term review of Annual Policy for FY07, RBI pushed back the deadline for

implementation of Basel II norms. While foreign banks in India and Indian banks operating

abroad are to meet Basel-II norms by March 31, 2008, all other scheduled commercial banks

will have to adhere to these guidelines pertaining to risk provisioning by March 31, 2009.

This will provide banks some more time to put in place appropriate systems so as to ensure

full compliance of Basel II.

Credit cycle likely to sustain

Low real rates and a sharp rise in bank credit have been at the heart of Indias growth storyover the past three years. Nominal bank credit growth has accelerated from the bottom of

10.7% in September 2003 to 30.5% currently. The current credit cycle is the longest credit

cycle India has witnessed since the early 1970s. Commercial credit to GDP has increased to

47% as at end-June 2006 from 35% in January 2003. Though it is still lower as compared to

East Asia and Pacific nations with the credit to GDP ratio of around 105%. Credit outstanding

has increased by almost US$190bn to US$380bn over the past three years.


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Table 12: Growth Markets- Key Sovereign Indicators (%)

Country Broad Money/GDP Private Credit/GDP

Turkey 49.8 25.4

Russia 35.2 27.1Brazil 27.9 32.7

China 163.5 123.5

India 69.4 47.0

US 64.1 82.7

Source: Fitch Sovereign data comparator

The most important point here is the rising interest rates. Even though there is sharp rise in

real interest rates, credit growth would not be impacted due to higher demand from every

sector like corporate, retail and agriculture. With the banks increasing its deposits rates there

will be a relatively higher time deposit growth in the banking system, which will ensure easy

flow of credit to the corporate sector.

RBI has been concerned about the strong credit growth in the retail and real estate sectors.

Over the past three years, only 44% of the incremental credit disbursed flowed to the

industrial and agriculture sectors. In a bid to slow this aggressive credit growth in sectors

other than industry and agriculture, RBI has initiated number of restraining measures which

include increasing risk weightage for commercial real estate-related loans to 150% from

100%, for housing to 75% from 50% and for consumer loans (unsecured credit and credit

cards) to 125% from 100%. RBI has also increased the mandatory standard loan provisioning

in specific sectors (personal loans, capital market-related loans, residential loans greater than

Rs2mn and commercial real estate loans) to 1% from 0.4%.

On a year-on-year basis, non-food credit of SCBs exhibited a growth of Rs.3,761.05bn

(30.5%) as on October 13, 2006 on top of an increase of Rs.2,979.03bn (31.8%) a year ago.

Provisional information available from select SCBs for June 2006 indicates that within the

services sector which currently absorbs about 49% of non-food bank credit, retail lending

rose by 47% on a year-on-year basis with growth in housing loans being 54.3%. As a result,

the share of retail credit in total bank credit increased marginally from 26.8% in June 2005

to 27.3% in June 2006. Loans to commercial real estate almost doubled during the period,

increasing their share in total bank credit from 1.4% to 2.0%. The year-on-year growth in

credit to industry was of the order of 26.6% by June 2006; however, its share in total bank

credit fell from 43.2% in June 2005 to 37.8% in June 2006. Substantial increases were

observed in credit flow to industries like infrastructure (28.3%), metals (38.0%), textiles(32.2%), engineering (23.0%), vehicles (33.0%), gems and jewellery (46.3%), food processing

(25.8%) and construction (59.7%). Shares of bank credit to infrastructure, metals and textile

industries in total credit to industry increased from 19.8%, 11.1% and 10.8%, respectively, in

June 2005 to 20.1%, 12.1% and 11.3%, respectively, in June 2006. The year-on-year growth

in bank credit to agriculture was of the order of 37% by June 2006. The share of agriculture

in total bank credit rose marginally from 13.1% in March 2006 to 13.4% in June 2006.

Credit to GDP ratio much lower

The credit to GDP ratio was slightly above 40% by end-March 2006. However, despite the

steady increase over the years, the credit to GDP ratio in India is much lower than several

Credit to GDP ratio in

India was slightly above

40 % by end-March 2006


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advanced and emerging market economies. For example, it is around 150% in China and

in Thailand its just above 90%. This suggests that financial deepening is still low in India

as compared to the other emerging countries and is expected to improve further with the

development of the financial sector. Thus, India offers tremendous potential in the long-termas its credit to GDP ratio is likely to improve further.

Foreign banks eager to enter Indian market

India offers tremendous opportunities for banks in India. This is the reason why a number

of foreign banks are eager to set up shop in India. However, the government is moving

cautiously in opening up the market to foreign banks. The government has set up a roadmap

for the foreign banks to tread on. The roadmap has two phases. During the first phase

between March 05 and March 09, foreign banks may establish a presence by setting up a

wholly-owned subsidiary or conversion of existing branches into a wholly-owned subsidiary.

The second phase is to commence in April 09 after consultation with all stakeholders in

the banking sector. The review is expected to examine issues such as dilution of stake and

permitting mergers/acquisitions of private sector banks in India by a foreign bank.

A large number of foreign banks are queuing up to enter India despite a regulatory iron

curtain that is restricting entry. This is regardless of the fact that most foreign banks

seems to be unhappy with the Reserve Bank of Indias roadmap for liberalisation of entry

norms for foreign banks proposed in February 05. Foreign banks wants the government

to relax regulations such as priority sector lending, ownership rules and statutory liquidity

requirements, branch licensing, single borrower limits etc.

Foreign banks have targeted India for a variety of reasons. They are impressed by the pace of

reforms, huge market, interest of foreign institutional investors and the countrys changing

image. This is evident from the levels of investment and expansion plans for the country.

Union Bank of Switzerland (UBS) and Australia-based Macquarie Bank are some of the

banks which are interested in India.

Banks investment valuation set to change

Banks method of evaluating their investments in their listed subsidiaries or in joint venture

companies may now undergo a drastic change. Banks typically classify these investments

under the held-to-maturity (HTM) category. The Reserve Bank of India (RBI) released a

set of revised draft guidelines which suggest that banks should evaluate these investments

based on the extent of impairment in these companies. The extent of impairment could be

detected either through the market prices or through the current rating of the security. In case

of unrated securities, RBI suggests that banks may consider the market price in conjunction

with the age of the security. The proposed regulation requires banks to set aside funds for a

fall in the market value of their equity investments even if there is no intent to sell them.

Besides, investments in perpetual preference shares, units of open-ended mutual fund schemes

and securities with a put option cannot be classified as HTM reserves. As per revised draft

guidelines on classification and valuation of investments, banks should transfer

scripts from the held-for-trade to the available-for-sale (AFS) category either at the acquisition

cost or the book value or market value on the date of transfer, whichever is the least. These

guidelines are expected to come into force from April 1, 07. The book value of the individual


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securities would undergo a change with a corresponding debit to the profit and loss account.

Earlier, banks were asked to provide for depreciation and hence this change was reflected in

the banks net profit figures. However, these guidelines would impact the banks operating

profit. The guidelines also aim at providing banks boards room to fix the internal limits forholdings in the HTM category. This indirectly implies that RBIs stipulation, which makes

it mandatory for all banks to maintain at least 25% of their net demand and time liabilities as

reserves under the SLR portfolio.

Through these proposed set of guidelines, RBI has attempted to give a clear definition of

securities which are eligible for classification under the HTM bucket. It states that only

securities with fixed or determinable payments having a fixed maturity that a bank intends

to hold and has the ability to hold till the term of maturity may be classified under the HTM

category. These proposed norms prevent a bank from classifying any security as HTM, if it

has sold or reclassified, more than 5 % of the HTM before maturity at the end of the previous

financial year.

Performance of listed banks

Strong growth in Indian economy assisted banks to increase their asset base. Comparison in

asset base indicates that the private sector banks are in better position than the public sector

banks in terms of asset growth. In the private banking space ICICI Bank, HDFC Bank & UTI

Bank showed strong growth in their asset base whereas in the public sector bank Allahabad

Bank, Canara Bank and Bank of Baroda lead the sector. State Bank of India which has the

largest asset base in the country recorded a modest growth of 7.4%.

Table 13: Assets of Some of the Listed Commercial Banks (Rs.bn)

Bank Mar-05 Mar-06 % Change H1 FY07Private Sector Banks

ICICI Bank 1,676.59 2,513.89 49.94% 2,823.73

HDFC Bank 514.3 735.06 42.92% 896.0*

UTI Bank 377.44 497.31 31.76% 649.7*

J&K Bank 244.23 264.49 8.30% 223.11

Karur Vysya Bank 78.84 90.07 14.24% NA

Federal Bank 151.25 168.52 11.42% 310.0

Kotak Bank 65.18 101.75 56.11% 135.22

Yes Bank 1.28 4.16 225.00% 62.82

Public Sector Banks

State Bank of India 4,598.82 4,938.68 7.39% 4,938.69

Bank of Baroda 94.66 113.39 19.79% 1,265.56

Bank of India 949.78 1,122.74 18.21% 1,232.57

IDBI Ltd 814.3 886.33 8.85% 932.35

Corporation Bank 339.23 405.06 19.41% 462.85

Source: Respective banks and Global Research *9M FY07

Since the past few years, customer deposits of banks recorded strong growth. Private sector

banks reported excellent performance as compared to their government owned peers.

However, some of the public sector banks are giving tough competition to their private sector

peers. In the private banking space, ICICI Bank was the leader in customer deposit growth

as its deposit grew by 65.4% followed by HDFC Bank (53.5%) and Kotak Bank (52.7%). In


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the public sector banking space, IDBI Bank reported stellar performance as its deposits grew

by 72% followed by Corporation Bank with growth rate of 20.7%. SBI, which is the largest

bank in India, reported a growth of just 3.5%.

Table 14: Customer Deposits of Some of the Listed Commercial Banks (Rs.bn)

Bank Mar-05 Mar-06 % Change H1 FY07

Private Sector Banks

ICICI Bank 998.19 1,650.83 65.38% 1894.99

HDFC Bank 363.543 557.96 53.48% 667.49*

UTI Bank 317.12 401.11 26.49% 509.20*

J&K Bank 216.45 234.85 8.50% NA

Karur Vysya Bank 66.72 75.76 13.55% 81.07^

Federal Bank 134.76 151.92 12.73% 182.88

Kotak Bank 43.00 65.66 52.71% NA

Yes Bank 6.63 29.1 338.91% 43.30

Public Sector Banks

State Bank of India 3,670.48 3,800.46 3.54% 3,926.15

Bank of Baroda 81.33 93.66 15.16% 1,076.82

Bank of India 788.21 939.32 19.17% 1,032.94

IDBI Ltd 151.02 260 72.16% 309.53

Corporation Bank 272.33 328.76 20.72% NA

Source: Banks and Global Research

Note: ^ June 06, * December 06 , NA Not available

Federal Bank reported a sharp jump of 150% in its earnings at the end of FY06 over FY05.

Other major banks which reported strong growth in net profits include and IDBI (45%). In

the public sector domain Bank of India reported a growth of 106.3% followed by IDBI Bank

with 82.3% growth. Laggards included IndusInd Bank, whose net profit declined by 82.3%,

followed by Bank of Maharashtra (-71%) and Vijaya Bank (-66.7%).


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Table 17: Non Performing Assets of some of the banks (September 2006)

Gross NPA Net NPA

% of

Advances

% of

AdvancesBanks ( Rs.bn) (Rs.bn)

ICICI Bank 37.01 2.20 15.45 0.90

Corporation Bank 6.16 2.16 1.34 0.48

Bank of India 22.19 2.96 7.89 1.07

Bank of Baroda 24.88 3.44 5.44 0.79

UTI Bank 4.72 1.20 2.67 0.68

IDBI Ltd 13.32 2.31 7.359 1.29

Source: CMIE

Consolidation is slowly in process

There are many small and medium size banks across India; some of these are regional havingstrong network in their region. RBI is very actively tracking performance of these banks

and taking strict action if the performance of regional banks is poor. In 2006, RBI put to

following banks under moratorium.

Ganesh Bank of Kurundwad (on the border of Maharashtra and Karnataka) will be merged

with Federal Bank, a Kerala-based private bank.

United Western Bank will be merged with IDBI

Many banks are coming forward to take over these banks to extend their network and mobilize

more low cost fund. In case of UWB, players like Canara Bank, ICICI Bank, Citibank,Standard Chartered Bank, and a consortium of HDFC and the State Industrial Investment

Corporation of Maharashtra had shown their interest in the bank. This shows that there is

atleast a desire of consolidation amongst the industry players.

RBI hikes CRR by 50bps to control overheating

RBI has recently announced a 50 basis points hike in cash reserve ratio. This step by RBI

preserved to curb overheating of the economy, check inflationary expectations and suck out

excess liquidity from the system. This would absorb Rs135bn from the system and this could

put a pressure on the cost of funds as money supply would be constrained. This move could

also force banks to reduce their credit exposure. Interest rates may also be impacted as a

result. This hike to be undertaken in two stages, in first step, the CRR will be raised from thepresent 5% to 5.25% effective from the fortnight beginning December 23, 2006. The second

25-basis point hike will be effective from the fortnight beginning January 6, 2007.


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Financial Performance - FY06

SBI is the largest commercial bank in India. SBI as a group handles more than one fourth

business of the Indian banking industry. During the last five years, SBIs total balance sheetsize grew at a CAGR of 9.4% and stood at Rs4,938bn at the end of FY06. The bank has

wide distribution network with more then 14,000 branches and 5,600 plus ATMs. Currently

the bank is focusing on its network and trying to mobilize more low cost deposits. We

have analysed the performance of SBI based on various key parameters, which have been

enumerated below:

Analysis of Income Statement

Net interest income growing steadily

As mentioned earlier, SBI has reported a steady performance since the past few years.

Interest income of the bank grew at a CAGR of 6.5% during the period 2001-2006 and stoodat Rs.357.95bn at the end of Mar 31, 2006. During the same period, interest expense rose by

a modest CAGR of 2.6% due to restructuring of its liabilities. This resulted in a CAGR of

13.3% in net interest income. The bank continued this growth momentum in 2006 to register

an impressive year-on-year improvement in financial performance. For the financial year

ended Mar 31, 2006 interest income of the bank grew by 10.4% over the previous year to

Rs.357.95bn while interest expense rose by 9.1% to Rs.201.6bn. The overall result was that

the net interest income of the bank jumped by 12.1% to Rs.156.36bn. The increase in net

interest income was primarily driven by the strong balance sheet growth and increase in the

share of demand deposits in total deposits during the year.

Table 18: Historical Net Interest Income of the Bank(Rs. Mn) FY01 FY02 FY03 FY04 FY05 FY06 CAGR

Interest Income 261,386 298,101 310,870 304,605 324,280 357,949 6.5%

Interest Expense 177,560 207,288 211,095 192,742 184,834 201,593 2.6%

Net Interest Income 83,826 90,812 99,776 111,863 139,446 156,356 13.3%

Source: SBI, GlobalResearch Analysis

Another major contributor to the growth of net interest income was the rapid growth in

low cost deposits, which helped the bank in containing its cost of funds. During 2005-06,

low cost deposits grew by 19.3% on a year-on-year basis, which helped contain the cost of

funds. In addition, the redemption of India Millenium Deposit and Resurgent India Bonds

has also helped the bank to lower its cost of funds. Another positive factor is that the interestexpense to interest income ratio declined consistently from 69.5% in 2002 to 56.3% in 2006.

We believe that the bank would sustain this ratio and can marginally improve on it mainly

because of its resource mobilization power and cost control measures.

Net Interest income of the

bank grew at a CAGR of

13.3% during the last five

years.

During 2005-06, demand

deposits grew by 19.3%

on a y-o-y basis.


30/49



Chart 5: Interest Income and Interest Expense trends for the Bank

Source: SBI, Global Research Analysis

Non-interest income - leading from the front

Historically, it has been the non-interest income that gave a fillip to the earnings of the bank.

The non interest income of the bank increased at a CAGR of 13.7% over the last five years. In

2006 non-interest income (excluding sale of investment) made further headway as it improved

by a stupendous 27.26% to reach Rs.73.9bn. The key contributor to strong growth in non-

interest income has been other income. Other income contributed 14% in 2002 and 25.0%

in 2006 to total non-interest income. The fees and commission income, which constituted

around 54% of the total non interest income, recorded a growth of 12.7% in 2006 and stood

at Rs.39.96bn. Going forward, we believe that the bank with its domestic expansion plan will

give much needed thrust to its efforts to enhance fees and commission income. Income from

foreign exchange transactions also recorded impressive gain of 80.8% to Rs.9.55bn. Forex

income contributed 12.92% to the total non-interest income of the bank.

Table 19: Trend in Non-Interest Income

Rs. Mn FY01 FY02 FY03 FY04 FY05 FY06 CAGR

Commission, exchange & b rokerage 26,324 28,165 29,774 31,207 35,447 39,962 8.7%

Sale of investments 3,419 3,516 16,946 30,735 17,753 5,872 11.4%

Exchange transactions 3,036 4,076 4,636 5,030 5,282 9,548 25.8%

Other Income 6,052 5,987 13,189 9,152 12,717 18,506 25.0%

Total non-interest income 38,830 41,745 64,544 76,125 71,199 73,887 13.7%


Income from investments also formed a part of the non-interest income of the bank in the

past, though it has always been volatile. During 2005-06, there has been a significant decline

in profits from trading in investments to Rs.5.9bn compared to Rs.17.75bn in the previous

year.

Provision for loan assets

The bank continues to provide aggressively against loan assets and has also created a floating

provision. For the year ended Mar 06, the bank has made total provisions of Rs186.3bn

(against Rs.165.96 in the previous year), which includes loan-loss provisions, provisions for

standard assets and floating provisions. Pursuant to the change in provisioning requirement

Non interest income of

the bank increased at a

CAGR of 13.7% over the

last five years.

-

50 , 000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

F Y 0 1 F Y 0 2 F Y 0 3 F Y 0 4 F Y 0 5 F Y 0 6

(RsMn)

I n t e r e s t I n c o m e I n t e r e s t E x p e n s e


31/49



for standard assets from 0.25% to 0.4% as notified by RBI, the bank has made an additional

provision during 2005-06. The bank has provided Rs.38.92bn towards provision for

depreciation on investments in India, including amortisation of premium on Held to Maturity

category as against Rs.23.27bn in 2004-05 and Rs.4.05bn towards standard assets as againstRs.1.15bn in 2004-05. Including this amount, the total provision held on standard assets

amounts to Rs.9.13bn.

Operating expenses

Operating expenses of the bank grew in line with the growth in business. The total operating

expenses grew at a CAGR of 7.2% in the last five years. For the year ended Mar-06, operating

expenses rose by 16.4% over the previous year and stood at Rs.117.3bn. Employee expenses,

which always contributed substantial chunk of the total operating expenses, grew by 17.6%

in FY2006 to Rs.81.2bn. During the year there was decline in the operational efficiency as

the cost to total operating income after provision improved from 60.7% in FY05 to 62.9%

in FY06.

Table 20: Break up of Operating Expenditures

Particulars FY01 FY02 FY03 FY04 FY05 FY06 CAGR 01-06

Employee expenses 60,116 51,528 56,887 64,477 69,073 81,230 6.2%

Depreciation on banks property 4,019 4,250 4,937 6,983 7,522 7,291 12.7%

Other operating expense 18,853 16,332 17,654 20,993 24,146 28,729 8.8%

Total Operating Expenses 82,988 72,109 79,478 92,453 100,742 117,251 7.2%

Source: SBI, Global Research Analysis

Impressive Earnings Growth

Overall, the bank reported a strong performance in the past five years with its net profitability

of the bank recording a CAGR of impressive 22.4%. The year 2006 also turned out to be

profitable for the bank with the bank reporting a net profit of Rs.44.1bn, a rise of just 2.4%

over FY2005. The improved earnings have also led to the improvement in the earning per

share of the bank, which rose from Rs.30.5 in FY2001 to Rs.83.7 in FY06. Manpower

productivity has also risen over the years as profit per employee increased steadily from

Rs.0.2mn in FY05 to Rs.0.22mn in FY06. During the same period the business per employee

has been also increased to Rs29.9mn.

Table 21: Profitability Indicators

Rs. Mn FY02 FY03 FY04 FY05 FY06Net Profit (Rs. mn) 24,316 31,050 36,810 43,045 44,067

EPS (Rs.) 46.2 59.0 69.9 81.79 83.73

RoAA (%) 0.73% 0.86% 0.94% 0.99% 0.92%

RoAE (%) 17.0% 19.2% 19.7% 19.4% 17.0%


Despite the improved earnings over the years, some of the banks profitability indicators like

Return on Average Assets (RoAA) and Return on Average Equity (RoAE) seem to have

deteriorated. This is primarily due to sharp rise in assets for expansion purpose. The return on

average assets declined from 0.94% in FY04 to 0.92% in FY06, while the return on average

Operating expenses

grew at a CAGR of 7.2%

during the last five years.

In FY06, he bank reported

net profit of Rs.44.1bn, a

rise of 2.1% over FY2005.


32/49



equity down from 19.7% in FY04 to 17.0% in FY06.

Maintained efficiency

SBI has displayed a steady performance in the last few years in scaling up its efficiencylevels. Net Interest Income (NII) of the bank has witnessed a CAGR of 13.3% in the last five

years. The net interest margin (NIM) of the bank has gone up from as low as 2.9% in FY01 to

3.4% in FY06. Spread of the bank has also increased from 1.7% in FY02 to 3% in FY06.

Chart 6: Rising NII & NIM


Higher Dividend

The bank has recommended a higher dividend rate of 140% on equity shares, compared to

the 125% dividend declared for the previous year. With the increase in earnings in future, the

bank is expected to distribute handsome dividends to shareholders.

Analysis of Balance Sheet

Assets growing strongly

The asset profile of SBI is spread over a wide array of asset categories similar to the other

commercial banks in India. This has enabled the bank to minimise its risk exposure, yet

achieve the expected returns. Due to the banks nature of operations, loan portfolio accounted

for a substantial portion of the banks assets and it formed 52.98% of the total assets in FY06.

Investments portfolio also accounted for the major portion of the banks assets. In 2006,

investments portfolio accounted for 32.9% of the total assets. The total assets of the bank

grew at a CAGR of 9.4% in the last five years and stood at Rs.4,938.7bn at the end of FY06

representing an increase of 7.4% over FY2005.

Credit book of the bank

grew at a CAGR of 18.2%

over the last 5 years.

Net NPL to net loans

stood at 1.87% in 2006.

-

20,000

40,00060,000

80,000

100,000

120,000

140,000

160,000

180,000

FY01 FY02 FY03 FY04 FY05 FY06

NII(Rsmn)

2.5%

2.7%

2.9%

3.1%

3.3%

3.5%

NIM(

%)

NII NIM


33/49



Chart 7: Break up of Assets

Source: SBI, Global Research

Due to stiff competition prevailing in the industry total credit book of the bank grew at a CAGR

of 18.2% over the last five years. The asset growth in FY06 was mainly fuelled by 29.3%

growth in gross loans and advances to customers and banks and stood at Rs.2,616.4bn.

Project finance achieved total sanctions of Rs.238.86bn (fund based and non fund based)

including syndication amount of Rs.140.95bn during the period ended March 2006 while mid

corporate credit has increased by 42% to Rs194.3bn.

The aggregate advances (excluding food and inter-bank advances) of the national banking

group which includes personal , SME, agricultural and government banking increased from

Rs.980.50bn in FY05 to Rs.1,337.81bn in FY06 registering a growth of 36.44% during the

year. This is on account of an impressive growth of 39.72 % under agriculture and 31.49%

growth in personal segment. Housing loans portfolio registered an increase of 28.11%

growth.

Personal banking advances increased from Rs.464.51bn in the previous year to Rs.610.67bn

in FY06, showing a growth of Rs.146.16bn at the rate of 31.47 % against a growth rate of

40.12% in the previous year. The SME advances increased to Rs.456.53bn in FY06 from

Rs.328.30bn in the previous year, recording a growth of 39.06 %. The criteria laid down by

the government for growth in SME advances is 20%. Agricultural advances grew from a

level of Rs. 205.26bn in March 05 to Rs.305.16bn as at the end of March 06. Growth during

the year was Rs.99.90bn and the y-o-y growth rate works out to 49%.

NPL is declining though provisions have also declined

Asset quality of SBI has been improving since the past few years despite sharp rise in asset

size. The ratio of gross NPAs to gross loans have come down from 11.95% in March 2002

to 3.88% in March 2006. With continuous cleaning of the balance sheet, net NPAs have now

come down to 1.87%. The bank has provided for about 53% of its non-performing loans in

2006. The bank continued to improve its asset quality, as a result of which net NPLs, as a

52.98%

32.91%

9.02%4.53%0.56%

Cash and Balances with RBI, banks and money at short and call notice

Net Investment

Loanes & AdvancesNet Fixed Assets

Other Assets


34/49



percentage of net customer assets, declined substantially from 2.65% as on 31st March 2005

to 1.87% as on 31st March 2006. The bank is looking forward to clean its balance sheet and

write off some of its old problem loans.

Gross NPL in absolute terms has declined from Rs 124.56bn in 2005 to Rs103.76bn in 2006.

During the same period, coverage has declined from 57% in 2004 to 53% in 2006. In case of

economic slowdown, SBIs asset quality is likely to take a hit as the bank has grown its asset

coupled with an increase in gross NPLs. This coupled with low coverage ratio, is likely to

affect bottom line in case of an economic slowdown.

Table 22: Asset Quality of SBI

Mar-04 Mar-05 Mar-06

Gross NPLs/Gross Loans 7.83% 6.10% 3.96%

Net NPLs/Net Loans 3.45% 2.64% 1.88%

Loan Loss Reserves/Gross Loans 4.0% 3.0% 1.8%Loan Loss Reserves/NPLs* 57% 57% 53%

Source: SBI, GlobalResearch (*as per Annual Report)

Investment Portfolio

The investment portfolio constituted around 32.91% of the total asset size of the bank at

the end of FY06. The banks investments declined by 17.54% from Rs.1,971bn in FY05

to Rs.1,625bn in FY06. A major portion of the investment was in the domestic market in

government and other approved securities. The overall domestic investment portfolio has,

however, shrunk from Rs.1,954bn in FY05 to Rs.1,593bn in FY06 as the bank redeemed

some of its investment to divert funds to boost loans and advances portfolio. During the year,

the bank further de-risked the investment portfolio to manage interest rate risk through acombination of measures such as shifting securities amounting to Rs.297.88bn from AFS to

HTM, use of derivatives, reducing the modified duration, etc.

The government is planning to bring an ordinance to empower the RBI to fix the level of

banks SLR. A cut in SLR rate at this point would infuse future liquidity into the system.

Thought the law allows RBI to lower the banks SLR requirements below exciting 25%, we

believe that the central bank unlikely to take such steps, as concerns over excess liquidity in

the system and claiming inflation persist.

Funding Structure

Historically, around 5-6% of the balance sheet was funded by shareholders equity with therest coming from customers and inter-bank deposits. The bank has been able to expand its

deposit base by rapid expansion in semi-urban and rural areas of the country and by way of

introducing number of innovative products.


35/49



Chart 8: Break up of liabilities


Growing low cost deposits lead to lower cost of funds

The deposit growth for SBI has been satisfactory, especially the term deposit category. Total

deposits grew at a CAGR of 9.4% over the period 2002-06 to reach Rs3,800bn, with low cost

deposits registering a CAGR of over 15.4% during the same period. Contribution of low cost

deposit to total deposit during the period too has moved up from just 36.48% in FY02 to over

47.55% in FY06. As mentioned earlier, the redemption of India Millennium Deposit and RBI

bonds has also helped the bank to lower the cost of deposits.

As at the end of March 2006, the share of the banks deposits in total resources was at 75.9%,

with outstanding deposits at Rs.3,800bn, reflecting a growth of 19.3% over the previous year.

Out of this, savings bank deposits, an important part of low cost deposits, grew by 18.8%.

Chart 9: Movement of Deposit Growth


On the back of robust low cost deposit growth, cost of funds for SBI has seen a substantial

reduction. With growing reach through larger branch and ATM network, we opine that the

low cost deposits would continue to be on current levels to maintain the cost of funds. This,

according to us, would play a critical role to maintain Net Interest Margins (NIMs) at current

levels in time to come.

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

FY02 FY03 FY04 FY05 FY06

(Rs.bn)

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Demand Deposits Savings Depos it Term Deposits CASA (%)

59.7% Deposits

Borrowings

Subordinated Debt

Other Libilities and Provisions

Total Shareholders Equity

6.0%

6.3%

11.9%

7.9%

8.2%


36/49



Borrowings and subordinated debt

Borrowing from RBI and other banks and financial institutions constituted around 9.5% of

the total liabilities and shareholders equity of the bank while subordinated debt comprised

around 1.8% of the same. In FY06, borrowings of the bank increased by 59.7% to Rs.1,993bn.

Subordinated debt outstanding at the end of FY06 stood at Rs.86.7bn and is a long-term

unsecured non-convertible debt which qualifies as Tier II risk based capital.

Capital Adequacy Ratio remains on lower side

Despite a subsequent strong growth in assets, the Capital Adequacy Ratio (CAR) at the

end of the year was at 11.88%, above the benchmark requirement

global research on sbi

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