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WorldJuly 2 2012

Reserve Bank of India confident that banks can grow to meet demand

The evolution of the Indian banking sector has been slow and steady thus far, but with 60% of its population still unbanked and $1000bn of investment planned for the development of its infrastructure, India's needs are fast outstripping the sector's capabilities. Deputy governor of Reserve Bank of India Anand Sinha is confident that the country's banks can rise to this challenge, but there are areas that he believes they must improve on first.
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India resists the Islamic finance influence

Millions of tourists visit India’s world-famous Taj Mahal every year. Built more than 350 years ago by the Mughal emperor Shah Jahan, in memory of his beloved wife Mumtaz Mahal, the Unesco World Heritage Site symbolises India, and its adjacent identical mosques provide a grand example of Islamic design and creativity.

In 1947, the partition of British India was instituted on the basis of religious demographics, with the creation of the sovereign states of India and Pakistan, both of which had significant Muslim populations. In the 21st century, the Muslim population of India has reached some 150 million, or 13.5% of the country's population, giving the country the third largest population of Muslims in the world, after Indonesia and Pakistan.

Does India therefore aspire to establish an Islamic finance sector in the same way that other countries, including neighbouring Pakistan, have done?

The answer is both clear and blunt. The Reserve Bank of India's deputy governor, Anand Sinha, is unequivocal in his response: “Our current banking system is not compatible with Islamic finance.” Bankers seem to share the RBI’s views, and are unanimous in responding that they see no possibility of Islamic finance developing in the future. While neighbouring Muslim states are seeing the attractions of Islamic finance, India has made its opposition to the alternative financial system abundantly clear.

India might have just one-third the number of banks in The Banker's Top 1000 World Banks listing as China, but Anand Sinha, deputy governor of the Reserve Bank of India (RBI), is bullish about the sector. “The banking system is bound to grow substantially,” he says, adding that India’s 77 main banks – comprising 27 public sector banks, 30 foreign banks, 10 new-generation private banks and 10 old-generation private banks – are strong and well managed but still need to improve in terms of technology and risk management.

Future prospects

As of the end of April 2012, India's banks have been fully compliant with Basel II and the RBI is accelerating the implementation of Basel III. But despite this, and a current capital adequacy ratio of 13.4%, Mr Sinha still has concerns about asset quality and the growing level of non-performing loans (NPLs) in India's banking sector. NPLs reached 2.95% at the end of 2011. However, in April 2012 this figure had almost bottomed out. Mr Sinha predicts that, at worst, about 20% of the restructured assets in the system can turn bad.

The performance of India's banks has remained steady in the past few years, despite the international global crisis, with return on equity at 13%. Mr Sinha is confident that India's low credit-to-gross domestic product ratio of 60% will grow in the next five to 10 years as banks expand. Domestic-driven manufacturing is one likely engine to this growth, with an estimated $1000bn to be spend on infrastructure alone between 2012 and 2017.

The deputy governor is also keen to improve financial inclusion and offer incentives to those banks focusing on getting some of the 60% of the unbanked population banked.

Catching up

Comparing India to China, Mr Sinha acknowledges that India’s banks should be larger and that the country needs banks that can finance its growing needs. While he acknowledges that consolidation has not taken off, he is keen to add that ”banks need to be bigger but develop as simpler structures and not become too complex”. He sees the country's banks becoming more sophisticated in the next five to 10 years, with many changing their business model.

Mr Sinha explains how the new generation of private banks in India have taken 10% market share from public sector banks in a trend that is likely to continue. In its latest report, RBI showed that nationalised banks accounted for 52.2% of aggregate deposits, while State Bank of India and its associates accounted for 21.8%.

The share of new private sector banks, old private sector banks, foreign banks and regional rural banks in aggregate deposits was 13.7%, 4.8%, 4.6% and 2.9%, respectively. While 51.6% of gross bank credit was accounted for by nationalised banks, 22.1% by State Bank of India and 13.8% by new private, foreign, old private and regional banks held 5.2%, 4.8% and 2.5%, respectively. 

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Read more about:  Asia-Pacific , India