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Over the last decade, Indian banks have enjoyed bumper returns as total industry assets grew from $290 billion in 2001 to over $1,600 billion in 2011. Indian banks did better than their emerging Asia counterparts, with ten of them among Asia’s top 30 value creator banks in the past decade. In the next ten years, banking revenues in India will likely climb further from $56 billion in 2010 to $250 billion by 2020 — contributing to more than 12% of Asia’s total banking revenue growth.
Consequently, four or five Indian banks could potentially enter the global top 20 by market capitalisation by 2020.
However, the speed and pace of the next decade’s growth is contingent upon how adeptly Indian banks can navigate major environmental disruptions, which are already determining the industry’s state of play in Asia.
An uncertain macro-economic environment caused by slow developed markets and exacerbated by local market uncertainties, has led to a higher level of loan losses and slowed growth. Concurrently, changing global and local financial regulations, such as Basel III, will further pressure Indian banks.
Also critical are the discontinuities created by changing consumer behaviour and rapidly evolving technologies. Our research shows that consumer loyalty in India has dropped by 40% since 2007, giving rise to an increasing number of banking relationships per customer and increasingly fragmented wallets across banks. Thanks to new technologies giving rise to alternate banking channels, financial institutions should therefore be prepared to compete for their consumers with new rivals who use disruptive new technologies such as wireless broadband, big data and cloud.
Unaddressed, these discontinuities could are likely to push down the average return on equity (RoE) for banks in India by 4 percentage points for existing players.
Naturally, this has implications for the future strategy of banks. McKinsey research on 300 banks in Asia showed that historically the best predictor of a bank’s returns is the average RoE of the home market it comes from—and only 14 of the 300 banks analysed significantly outperformed their country’s median RoE.
Given the emerging discontinuities, India’s banks must think beyond simply relying on revenue growth momentum. Banks that have spent the past five years prioritising growth by setting up more branches and acquiring new customers will have to differentiate themselves by building one or more of three transformative capabilities: Next generation risk management skills to profitably target underserved segments such as SMEs and mass market; innovative multi-channel distribution infrastructure to increase share of primary banking relationships, and privileged customer insights for a more granular approach to growth.
Next generation risk management capabilities will transform the way banks grow a critical but underserved part of the Indian financial services landscape: SMEs, self-employed individuals, and the mass market. Currently, banks have not completely understood these segments, and through-cycle returns particularly on lending—vary widely among banks.
However, our analysis of the past decade’s top performing banks in Asia showed that several had superior risk management capabilities, and had sustainably and successfully lent to SMEs, achieving higher margins and better growth. The capabilities need to be end to end– from prospecting, to underwriting, to monitoring early warning systems, to collections – to earn superior returns. New mechanisms could offer opportunities for differentiated capabilities through several changes, for instance, incentivising sales staff based on collections, not disbursals; innovative collateral-based lending; using qualitative credit assessments to underwrite; developing effective early warning systems; and fully utilising internal and external data to underwrite and monitor credit risk.
Seamless multi-channel distribution will soon be essential to serve customers who increasingly move between online and offline channels in their consumer decision journey. Today, the most-searched financial services brands online in India are seeing the fastest revenue growth offline, proving that building a brand online has real power in an online-offline world. By 2015, India’s current online user base of 122 million is likely to touch 350 million, of which 70 million digital high-value consumers will drive a revenue pool of $60 billion to 70 billion by 2020. Capturing this opportunity here and now is critical, because online consumer behaviour is changing faster than financial institutions are responding.
Privileged consumer insights can be used to develop a granular approach to access local markets and customer segments. These insights are a much greater driver of growth and economics than currently perceived by most banks. For example, the McKinsey Cityscope demographics database shows that 80% of emerging Asia’s and India’s growth will come from middle-weight cities, some of which contain more affluent people than larger cities. For instance, Ahmedabad has a much higher per capita income than Delhi, Bangalore, Chennai or Kolkata with a higher proportion of digital high-value customers than any other city in India. Similarly, micro-market insights can reveal pronounced differences – for example, 7 of 35 micro-markets in Mumbai will account for 40% of potential new CASA deposits over the next 5 years, while others will see a de-growth in the same period.
Banks must pick where they invest against developing these three transformative capabilities. The discontinuities will pressure average industry returns and level the playing field for attackers who will use new technologies to compete with established financial institutions. However, those Indian banks that lead in the list of the world’s top 20 banks will have innovated successfully for even greater returns, potentially widening the gap between the top performers and the rest of the industry for another decade after.
The above will be deliberated upon by the eminent speakers at the BANCON 2012 which is hosted by Bank of Maharashtra jointly with Indian Banks’ Association, scheduled for 24th & 25th November 20012 at Pune, Maharashtra.
Renny Thomas is a partner at McKinsey & Company, and leads McKinsey’s Financial Services practice in India