In my earlier article, “Global Scale in Banking: How many Indian Banks in the Top 50?“, I made an observation about the lack of global scale in Indian Banking. To understand why Indian Banks have not yet achieved global scale I reached out to Mr. Narayan Ramachandran, an expert in banking and finance. This article begins with some of my analysis followed by the interview with Mr. Narayan Ramachandran.

Mr. Narayan Ramachandran is an investor and entrepreneur with a focus on social businesses. Till recently, he was the Country Head of Morgan Stanley in India leading all of the group’s businesses. Prior to these roles, Narayan was the Head and lead portfolio manager of Morgan Stanley’s Global Emerging Markets and Global Asset Allocation teams, managing over $25 billion in assets. He joined Morgan Stanley in 1996 and has 20 years of investment experience. Before joining the firm, he was a managing director at Rogers Casey (now CRA Rogers Casey). In addition, Narayan was director of research at Rogers Casey and president of its investment advisory subsidiary. He began his career at Goldman Sachs. He received a B.Tech in chemical engineering from the Indian Institute of Technology Bombay and an M.B.A. from the University of Michigan. Narayan holds the Chartered Financial Analyst designation. Narayan has a keen interest in using market based solutions for poverty alleviation in areas such as microfinance, social venture capital, micro-insurance and affordable housing.

Here is some analysis that I have done to set the context for this interview:

I plotted a graph of all the 13 countries with banks in the top 50 along with India and Brazil which are the only two countries in the top 10 countries by GDP without a representation in the list of top 50 banks. The graph compares the GDP of the country and the median asset size of the banks of that country in the top 50.

The graph below has a coefficient of correlation equal to 0.55. This suggests that the relation between the two axes is moderately strong. If the same graph were to be plotted without India and Brazil, the coefficient of correlation would turn out to be 0.7, which would imply a stronger relation. Therefore what seems quite obvious from this is that India and Brazil are anomalies because despite their significant GDPs, they don’t have any large global banks.

Bank Graph

I present the interview with Mr. Narayan Ramachandran below:

Question:

Why are Indian banks so small compared to banks in other countries despite the relatively significant size of the Indian economy?

Answer:

As a country’s economy grows, the overall assets in the banking sector of the country will grow. But that does not mean that there needs to be some very large banks (top 50 by asset size, for instance) even when the banking sector grows with the economy. Some banks in these countries happen to naturally grow to be very large for organic/ market reasons. But that is not a criterion of the strength of the banking system in a country.

Also, in India the stock markets have played an important role in providing capital. This has provided several companies with an alternate means of financing – equity financing. This has given several companies a choice between equity from the public stock markets and loans from banks.  Over the past few years the corporate debt market has been growing stronger in India. This provides companies with yet another solution to acquire financing – debt financing from the bond market.

In India there are around 57 million enterprises of which approximately only 1.7 million have any sort of documentation at all. As a result banks are unable to provide loans to a vast majority of these entities. Also, Indian banks have a negligible international footprint, which is often a major source of growing assets in formal banks. However, as the Indian economy grows it is likely we will see our banks expanding into other countries.

We have also seen some consolidation of public sector banks in our country. But even with that, we don’t yet have a bank that is large enough to be significant in the global scheme of things.

Question:

You mentioned that the GDP size is directly proportional to the size of banks. However, banks in several European countries with smaller economies than ours are very large. What is the reason for this?

Answer:

There are broadly three categories of countries:

  1. India, China, Brazil, Indonesia, Saudi Arabia, Nigeria etc.
  2. Germany, France, and UK etc.
  3. Singapore, Switzerland, Bahrain, UAE etc.

The first category of countries is large emerging markets and independent sovereign states. The second category of countries is that of nations belonging to a union such as the EU. The banks in these countries benefit from the fact that the EU is of a continental scale. The third category of countries includes nations whose banks mainly serve clients from other countries. These banks therefore are not truly representative of their countries’ economies.

The answer to this question lies in the fact that many small countries housing large banks fall into either the second or third categories. It is hence better to compare the countries of the first category between themselves. 

Question:

Is it a problem for India that we don’t have global scale banks? What are some of the implications of having very large banks?

Answer:

The health of a bank is reflected in its ability to grow without generating Non-Performing Assets (NPAs). This is captured in its Return on Equity (ROE). As long as our banks in India are doing well on this parameter, the sector is in good shape. The asset size of any single bank is not relevant, except if a bank is unable to meet the borrowing needs of its client companies. In India, with well functioning equity markets, debt markets, and bank loans, the size of any single bank has not been a bottleneck for the growth of Indian companies.

What is more important is to ensure that there are more categories of banks serving different categories of customers – large banks serving large customers, and small banks serving customers with smaller needs.

Question:

Between PSU banks and private sector banks, which one is more poised to grow to a larger size over the next few years?

Answer:

Let me give you an example. In the airline industry, the top three private players have about two-thirds of the market share. Air India, which was once a dominant player, is now in the 4th place with about 13% of the market. Similarly in the banking sector, private banks are slowly capturing greater market share compared to PSU banks. Therefore, as the banking sector in India continues to evolve in the coming years it is likely we will see private sector banks growing larger.

Question:

How will the banking sector in India evolve over the next few years?

Answer:

With growth in GDP, our banks will definitely witness growth. Also, as more and more Indian companies grow their international presence, our banks too will follow.

Indian banks will also grow faster than banks in more developed countries. One of the reasons for this is that there are an incredible number of ways of new and sophisticated means of acquiring financing that are being developed in western countries. These include, special purpose vehicles, junk bonds etc. In India however such products have not yet become popular, and therefore bank loans will continue to be an important source of financing, at least in the foreseeable future.