Banking industry of India consists of foreign and domestic banks.

ABSTRACT

The main purpose of this thesis is to measure the market concentration of Indian banking industry after the implementation of the reforms in financial sector and also to measure the financial performance of the top five foreign banks that are operating in India. After the reforms were implemented the foreign banks are allowed to operate more freely compared with the pre-reform period. Herfindahl-Hirschman Index (HHI) method is used to measure the market concentration and accounting ratios like ROA, NIM and C/I are used to measure the financial performance.Since the entry of foreign banks in India after the reforms process, it is observed that the banking system of India is highly concentrated and the market share of public sector banks reduced from 90 % to 60%.At the same time there is increase in the market share of foreign and new private banks. In terms of ROA, NIM and C/I it is observed that the foreign banks are performing better when compared with the other banks that are present in India.

CHAPTER-1

Aims, Objectives and the Structure of the Dissertation

1.1 Introduction

The financial system of India is huge with different financial institutions and instruments. Banking industry of India consists of foreign and domestic banks. There is strict control on expansion of business for the foreign banks that are operating in India by the regulators before the reform process. After the reform process the foreign banks are allowed to expand without much control. Now there are 34 foreign banks that are operating in India. ‘The rise of Indian economy is one of the most important economic forces in the world. Since two decades the Indian economy is growing twice as fast as the rest of the world. India’s economy can surpass the Japan’s economy if the same trend continuous for another two decades’. (Morgan Stanley 2004)

Astrong banking sector is required to India to maintain rapid and consistent growth. Based on the observed results it is proved that the reason for financial crises that took place between 1980s and 1990s is because of weak banking sector. To create consistency in the financial system of India it is important to have efficiency in the banking sector. Banking system in India is strong and well developed. The visionaries and entrepreneurs of India have started most of the banks in India during the pre-independence to offer financial support to industrialists and traders of India. Banks in India have played a major role by lending finance to Indian industry thereby they helped in the growth and development of economy of India.

1.1.1 Development of Indian Banking System

Financial system of India is vast with different financial institutionsand instruments. Bery (1996) stated that banking industry in India includes domesticbanks and foreign banks. Calcutta is the place where banking in India started. Since 1858 there were foreign banks that were present in India and the first foreign bank was founded in Calcutta. Active trading port for the British Empire was Calcutta.

In 1786 the first bank was founded in India which is General Bank of India. After that the Bengal Bank and Bank of Hindustan were set up. The banks that were set up by the East India Company are Bengal Bank in 1809, in 1840 it was Bank of Bombay and in1843 it was Bank of Madras. All the three banks were called presidency banks which later merged to form private shareholders bank called Imperial Bank and most of the shareholders were European. The bank that was completely owned by the government of India is Allahabad Bank which was set up in 1865. Punjab National Bank was founded in 1894 and Bank of India, Central Bank of India, Bank of Baroda, Indian Bank and Bank of Mysore are some of the banks that were set up between 1906 and 1913. In 1935 Reserve Bank of India was established. Credit Lyonnais was the first foreign bank that was established in Calcutta in 1850s to carry out operations in Calcutta which was also an important trade port for British Empire. ABN Amro Bank, Citibank and Standard Chartered bank are other foreign banks that were setup later.

Many bank failures have been witnessed by India during American civil war and all this was becauseof few banks that were open to finance industriesand also to approximate trades in cotton. There is no supply of cotton to Lancashire by America at the time of warbecause of the huge exposureby banks in speculative trades in cottonthey could not carry on and lead to the failure of banks. There is loss of deposits and interest on deposits by the people. Public has lack of confidence in banks during this period and to make the banks efficient, the government of India initiated The Banking Companies Act 1949 and later on it is changed as Banking Regulation Act 1949. Reserve Bank of India acts as a Central Banking Authority whichhas taken strong powers for supervision of banking system in India. Imperial bank of India later on changed as State Bank of Indiathat operates as an official agent to Reserve Bank of India. It also carries out banking transactions for Union and state governments in the country.

1.1.2 Nationalisation of Banks

State bank of India is the first bank that got nationalised in 1955 while the other banks started to get nationalised later on in 1955. In the same period 14 other large banks got nationalised which resulted in rising of public sector banks share from 31% to 86%. The primary motive behind nationalising banks was to rapidly expand the branch network and secondly for channelling of credit in line with a five year priority plan. In order to achieve these targets, the banks which got nationalised were given their own targets of branch expansion and credit extension to specified groups at 33.33%. In the later years, six more banks got nationalised which increased the public sector bank share again to 92%. The second target was set in order to have a control over the banking sector, as the branch expansion should reach the poor people and also fund rising deficit. The target for priority sector lending was increased to 40% after the nationalisation of six other banks. However, there were inefficiencies in Indian banking system due to the newly introduced policies for promoting equal distribution of funds. The first phase of liberalisation took place in 1980’s to neutralize this effect. The policy changes that were introduced include preface of treasury bills, establishing money markets and finally deregulation of interest rates. The government took control over bank funds by increasing the statutory liquid ratio (SLR) to 38.5% from 25% and Cash Reserve Ratio (CRR) to 15% from 2% before 1991, which is a massive increase. Indian banking system had become an important part of the government’s spending policy by then. Along with all these, the government also took the control over the funds and interest rates on loans and deposits. There was a change in this mechanism during the early 1990’s due to the triggering of balance-of-payment crisis.

1.1.3 Banking Reforms in 1991

The Indian banking systems faced drastic problems in the late 1980’s along with the economy going down. Banking sector seemed to get very low in profit, inefficient and was not financially good. Though they saw a drastic increase in the deposits, they still were unprofitable. The return on equity was higher at the rate of 9.5% but the return on assets was very low at the rate of 0.15%. At this time Indian capital reserves were seen at 1.5% when compared with other Asian countries which were 4-6%, which was greater. The first phase of banking reforms took place under the chairmanship of M Narasinham during 1991. This committee was working on liberalisation of the banking sector. The committee worked on lessening the financial repression in the Indian banking sector by lowering the SLR and CRR rates. The committee also identified the major cause for the unprofitability as the priority sector lending and further recommended for cutting down the target to 10% from 40%. However, it was not implemented and the targets for domestic banks were 40% and foreign banks were 10% remained the same. The trouble of priority sector lending was then reduced by introducing the IT companies under them. The deregulation of interest rates was the primary component of the banking sector reforms that expected the growth in the financial savings and the financial system. Another important reform that took place in the banking industry is the liberalisation of the entry of foreign and private banks. Till the late 1990’s reforms had taken place, the Indian banking sector was uncompetitive. Due to this liberalisation seven private banks and twenty foreign banks were allowed to start their operations in India after 1994. By early 2004, the new banks that entered had collaborated and had combined share constituting 20% share of the total assets.

However, the elimination of entry barriers has brought a lot of benefits in the form of specialised skills, new technology, greater portfolio diversification and better risk management practice. Under the chairmanship of Narasimham, the committee strengthened the prudential norms and the supervisory framework.

After the reforms in the banking industry, the sector has tremendously grown and there seem to be a good competitive market in the current scenario. Hence, financial reforms have directly increased the financial performance of the banks over a period of years.

1.2 Aims and Objectives

To calculate thefinancial performance of foreign banks and their impact on the market concentrationin India is the key aim and objective of this paper. Utilisation of accounting ratios like ROA, ROE is used to calculate the financial performance and the method used to measure the market concentration is Herfindahl-Hirschman Index (HHI)

1.3 Motivation of Research

There is consistency in the economic growth of India after the 1991 banking reforms. Liberalising the foreign banks entry barrier and also the diversification is one of the major aspects of the banking reforms. Ever since the reform process is implementedthere are so many banks that started their operations in India and there were many banks that were waiting for the approval of Reserve Bank of India. There are not many papers that worked on measuring the financial performance of foreign banks and their market concentration in India. Taking into consideration these two features, have preferred to calculate the financial performance and their impact on market concentration in India.

1.4 Data and Methodology

For data and methodology the financial statements of thebanksthat are published in the particular banks websitesand also Reserve Bank of India website will be used to measure the financial performance of foreign banks and their market concentration in India. Market share of the banks is known with the financial statement which is used to measure the market concentration. Secondary data is used to collect data which is by books and online.

1.5 Structure Summary of the Dissertation

Dissertation structure is divided into five chapters .The first chapter of the dissertation is the brief introduction of the banking system of India that is followed by the aims and objectives of the research. Literature review where the theories of bankingandpast findings on the same topic are discussed in the second chapter. Data and methodology is in the third chapter. Data analysis where the results are taken and are compared with the performance of previous years in graphs where necessary is the fourth chapter. The last chapter of the dissertation is going to be brief summary of the findings, limitations of the paper, policy recommendation on the banking sector, research for the better growth and some suggestions of the research.

CHAPTER 2

Literature Review

2.1 Introduction

The developments of Indian banking system that took place in pre and post independence has been explained in the first chapter. The process of reform process which started in 1990s is also outlined. This chapter explains the economic growth in India since financial reform started in India. The financial system in India and banking reform steps that has supported the strong economic growth is also explained in this chapter. The past finding done on financial performance of banks and the impact on market concentration by foreign banks is followed in the next sectionand the last section is followed by the theories of banking.

2.2 Economic Growth in India

There is significant change in the growth of Indian economy after the financial reforms in India in 1991. India is the fourth largest economic power in terms of Purchasing Power Parity (PPP) and is expected to become third largest economy in terms of PPP by surpassing Japan. India is considered to be one of the few markets which offer high degree of growth and earnings potential in all areas of business. India was very muchsemi-socialist economy until the year 1991.Foreign investments was not welcomed and in establishing new business there were several structural and self-important impediments. The entrepreneurial talent is seen with the opening up of Indian economy in 1991 and in less than two decades India is identified as the next economic superpower of the world. Average annual growth of 7.6% during the tenth plan has been recorded and target of 9% growth for eleventh plan has been set. Service sector which contributes more than 50% of India’s Domestic Product (GDP) is one of the structural changes achieved by the Indian economy.

2.3 Overview of Indian Financial System

Financial system of India consists of insurance companies, capital markets, mutual funds, postal services; developmental financial institutions and banks .To support the growth of the economy financial system should be stable and efficient .So there is need for regular supervision. There are independent regulators for insurance companies, capital markets and banks in India. In the next section there is a brief introduction on these financial institutions and regulatory bodies.

2.3.1 Insurance Companies in India

The system by which the losses faced by few are spread over a large group uncovered to same risk is insurance. For the uncertainties of life insurance policies are considered to be safe heavens. These policies help as financial support to the individual apart from mitigating the risk.

There is long history for insurance companies in India which way back in 1818. Oriental Life Insurance Company was the first company which was established by Europeans in Calcutta. It was a British company and established to serve the needs of the European community. Bombay Mutual Life Assurance Society whichstarted its operation in 1871 was the first Indian insurance company. All life insurance companies were nationalised in 1956 and non-life insurance companies are no different. The first non-life insurance company was Triton Insurance Company started in Calcutta. Non-life insurance companies are nationalised in 1972.Four subsidiaries: the National Insurance, Oriental Insurance, United India Insurance and New India Assurance Company Ltd were formed with General Insurance Corporation of India (GIC) which is a holding company. For over three decades insurance industry is regulated by these companies.

After liberalisation the marketswere opened for private players to set up and provide insurance services. Four insurance companies from GIC were separated by the government to operate independently. New regulatory body called Insurance Regulatory and Development Authority (IRDA) has been set up by the government. Maximum of 26% of foreign equity stake is allowed by IRDA in domestic insurance, reinsurance companies and insurance broking firms.

IRDA specified solvency margin for insurance companies. As specified by IRDA; Required Solvency Margin (RSM)-1 is based on 20% of the higher of gross premiums multiplied by a factor specifies by IRDA and RSM-2 is based on 30% of the higher of gross net incurred claims multiplied by a factor. For non-life insurance and for rural business the statutory requirement in the first financial year is 2% of the gross premium income, 3% in the second year and 5% within the next three years.

2.3.2 Postal Services in India

Postal services in India is considered as the largest network in the world with over 155,000 post offices spread all over the country as on March 2001.Postal services play an important role in rural areas and 89% of the post offices are located in rural areas. Banking services are also provided in these areas. Different kinds of accounts like savings account, recurring deposit account, monthly income account and time deposit account are offered by the post offices. Apart from these services they also offer various types of savings and tax savings instruments like national savings certificate, public provident fund and so on.

2.3.3 Capital Markets in India

One of the important sources for companies to raise capital is the capital markets and this will provide opportunity for the company to be traded publicly. Further capital can be raised by selling the shares of ownership of the company in public markets. There is growth in the capital markets with the establishment of Bombay Stock Exchange in 1875 and Ahmadabad Exchange in 1894 and 22 other exchanges in differentparts of the country.

There are many difficult times that were seen in the Indian stock markets like wealth and expenditure tax imposed by the government in 1957,tax on bonus issue and dividend freeze in 1959 and 1962 china war which led to the increase of domestic prices and ban of commodity trading in 1966.There has been good time apart from the difficult times like participation of retail investors and multinational companies which operate in India were asked to reduce foreign shareholding to a certain percentage. The reforms that took place in 1990s were beneficial for the stock market to move northward directionand retail interest towards capital markets. By removing long term investment gains tax, implementing short term gains tax the reform process was carried. Since then there is steady growth in the market. Even though the Indian markets were notfully developed there have been scams like price manipulation. Securities and Exchange Board of India (SEBI) was set up 1992 to tackle such problems and to regulate and supervise the capital markets in India. Powers were obtained by the SEBI and operations were started in 2000. NSE was set up in 1984, online trading started in 1995, derivative trading in 2000.The major developments seen in the Indian capital markets are the prevention of insider trading act, introduction of fraudulent trade practice act, takeover code and corporate governance norms. With these developments Indian markets have been made safer and also attracted the foreign institutional investors.

2.3.4 Mutual Funds in India

A group of investor’s fund which is operated by a fund manager in order to purchase diversified portfolio of stocks and bonds is called a mutual fund. Mutual funds are considered as instruments of investing money and they protect the common investor who cannot compete and understand the stock market.

UTI which was set up in 1963 is the first mutual fund in India and was a joint initiative of Government of India and Reserve Bank of India (RBI).Before the non-mutual funds have entered, UTI is only institute operated for almost 30 years. It consists of Life Insurance Corporation (LIC), GIC and Indian mutual funds and public sector banks. Entry of private players in mutual fund industry started in the year 1993.According to the changing market environment the mutual fund regulations are revised from time to time. SEBI acts as a regulatory body for mutual funds in India. The formulation of policies for mutual funds is done by SEBI and it also regulates to protect the interest of the Indian investors.

2.3.5 Banking in India

Like many countries, in India too banks play a major role and are the common monetary area. Banks act as financial intermediaries in channelling funds from the savers to the borrowers who are in need of funds. This will help to use the resources in better way and leads to the economic growth of the country. Before 1990s Indian banking sector is considered to be highly concentrated and there is steady decrease after the banking sector reforms in 1991.Indian banking industry is dominated by the public sector banks because of their branch network and their ability to enter into rural areas. Public sector banks have accounts for nearly 90% of total deposits and advances in 1990-1991 but there has been decrease in the percentage share to 80% with the start of the reforms.

Concentration refers to the degree of control of economic activity by large firms. Usually the prices of the financial products are brought down by the competitive markets and it also increases the efficiency of the sector. Growth can be promoted by the concentrated markets by providing credit to the industries but it has impact when the customer is concerned and agency problem, high interest rates and banking costs is caused by the lack of competition.

`2.3.5. 1 Structure of Banking Sector of India

Banking sector of India consists of scheduled and non-scheduled banks and central bank acts as their regulatory body. The banks which do not satisfy the conditions required by the second scheduled of the banking regulation act of 1965 are considered as non-scheduled banks and the banks which satisfy the conditions as per the second scheduled banking act are considered as scheduled banks. The criteria laid down by the second scheduled banking act is :first, to have paid up capital and reserves of not less than RS 500000 and second, to satisfy the central bank that it affects are not affected in a way against the interest of the depositors. Classifications of scheduled banks are into scheduled commercial banks and scheduled cooperative banks. There is further classification of scheduled commercial banks which are into four categories and they are:

Public Sector Banks

History of the Indian banking system is over 200 years and there have been many transformations in the banking industry since independence. Public Sector banks dominate the banking in India. But the competition can be seen with the start of the banking reforms. There are 28 Public sector banks in India out of which 8 are State Bank of India (SBI) and its subsidiaries. List of public sector banks are mentioned in the appendix.

Private Sector Banks

Since the establishment of banking system in India there is public sector banking in India. IndusInd bankis the first public sector banking. The bank which has promoted a world class institute and also considered as the tenth largest development bank in India is IDBI. Housing Development Finance Corporation (HDFC) is the first private sector bank to get principal approval from the central bank of India. For the development of banking industry in India public sector banks have played a major role and also made Indian banks more efficient and customer friendly. There is a list of private sector banks in India given in the appendix.

Foreign banks

Banking industry in India has become more efficient and competitive with the entry of foreign banks. Latest banking technology and practices are brought to India by the foreign banks. Central bank of India controls and supervises the foreign banks. Until the banking reforms period foreign banks were restricted upon opening of new branches in India. There is a list of foreign banks in India given in the appendix.

Regional Rural banks

There are regional rural banks in India since the beginning of the banking system. Regional rural banks focus mainly on the agro sector. They progressed into all the areas of the country and also helped in the economic growth of the country. There are 30 Regional Rural Banks in India under State Bank of India which are called RRBs. The percentage of rural banks that are present in the remote areas is more than 90%. There are only few banks that operate in the rural areas for the development of the areas apart from the SBI and the banks are

National Bank for Agriculture and Development

Sindhanur Urban Souharda Cooperative Bank

Haryana State Cooperative Apex Bank Limited

Syndicate Bank

United Bank of India

2.3.5.2 Central Bank

The central bank of the Indian banking system is Reserve Bank of India (RBI). Most of the central banks are established in the twentieth century. On the basis of the recommendations of Hilton Young Commission Reserve Bank of India (RBI) was set up in the year 1935 in compliance with the provision of the RBI act 1934.Operations have been started by the RBI by taking over from the government. Till then Imperial Bank of India and the Controller of Currency has been performing the functions. Until 1947 RBI acted as central bank of Burma even though Burma was separated from India in 1937 and RBI also acted as Central Bank for Pakistan until the State bank of Pakistan started its operations. RBI which was initially set up as a shareholders bank was nationalised in 1949.

The basic functions of the RBI are explained in the preface of the RBI. They are

‘To regulate the issue of the bank notes and keeping of reserve with a view to securing monetary stability in India generally to operate the currency and credit system of the country to its advantage’.

Following are the main functions of RBI

First function of RBI: It is responsible for formulating, implementing and monitoring monetary policy functions in India to ensure price stability and maximum flow of credit to productive sector. Second function is supervisory and regulatory functions are performed for the Indian banking system. Guidelines of banking operations within which the country’s banking and financial system operates; to maintain confidence in the system, protect depositor’s interest and provide cost-effective banking services to the public is issued by the RBI. Third function is to enhance external trade and payment and promote orderly development and maintenance of foreign exchange market in India, foreign exchange operations in the country is maintained by the RBI. Fourth function is RBI issues currency in India and the last function is developmental functions to meet national objectives is performed by the RBI. Apart from these functions RBI also acts as a banker to the government and merchant banking function is performed by the RBI for the state and central government.

Banking accounts for all scheduled banks is maintained by the RBI.As on June 2010 domestic assets of RBI was RS 3,88,594.36 crores and RS 12,85,971.71 crores was total foreign exchange reserves. RBI net income has decreased to 27,166.12 crores as on Mar 2010 from 33,230.88 crores as on March 2009

2.4 Banking Reforms

To develop a clear and stable environment for banks and to overcome any crises banking reforms were initiated. Interest rates, pre-emption in the form of reserve requirements and allocation of credit to specific sectors are related to the reforms. One of the major parts of the reform process is deregulation of interest rates which has improved the efficiency to resource allocation. The banking reform process is gradual upon the institution of prudential regulation for the banking system.

As part of the reforms capital into public sector banks has been introduced by the government. With equity participation by the private investors there is increase in the capital base of these banks. There is decrease in the share of public sector banks to 75 percent in 2004 from 90 percent in 1991.There is improved accountability and efficiency because of the diversification of ownership.

Enhancing the efficiency and productivity through competition is one of the major objectives of the banking sector. There has been liberalisation in the guidelines forthe entry offoreign banks .Procedures for the establishment of new banks in the private sector have been implemented. There have been restrictions for setting up of new branches by the foreign banks that are operating in India tillthe reform process. To increase the competition in the banking sector there has been allowance up to 74 percent subject to guidelines issued from time to time on the foreign direct investment in private sector. This is one of the major steps in banking sector reforms.

The next step in the banking reforms is the consolidation. The providers of long term funds have been the Development Financial Institutions, while there is no clarity which is increasing over time between the finance providers of long term and short term funds. There isstudy of the difficulties thatare involved in the role and operationsof theDevelopment Financial Institutionsand one of the major initiatives towards the universal banking is the guidelines that are led by the RBI is the reverse merger of a large development financial institution with commercial bank subsidiary. In regard to the banking sector thereare Institutional and legal reforms that were carried out. To exercise good supervision there was establishment ofBoard of Financial Supervision (BFS) in 1994with specific members from the RBI board. There will be board meeting once in a month totake decisions and direction of supervision in definite cases. An integrated approach for the supervision of commercial banks, DFIs, non-banking finance companies, urban cooperative banks is also ensured. There are policies in regard to regulation and supervision and of all types of payment and settlements.

To enhance the transparencies and disclosure standards there are measures that have been carried out. There are certain matters that should be placed in the public domain like the fines that are imposed by the RBI on certain banksand alsodirections thatare issuedon certain mattersthat came up out of inspection.

The minimum capital to risk asset ratio (CRAR) is at 9 percent which is more than international standards norms. The regulatory frameworks and supervisory practices have approximately come togetherwith the best practices in the world.

There has been major impact on the overall efficiency andstability of the banking industry in India after implementation of the banking reforms. There is consistency in thenon-performing assets, return on assets and capital adequacy ratio. The need to review the manpower resources drawing strategies for the requirements and for reducing the operating cost and to increase profitability of banks is emphasized in the reform process.

2.5 Foreign Banks and Their Products and Services

Since 1958 foreign banks were present in India and Calcutta was the first place in India where foreign bank was established. The trading port for the British Empire was Calcutta. Credit Lyonnaiswas the first foreign bankto carry outthe operations of Calcutta port. At present there are 34 foreign banks that are operating in India. There was restriction for the foreign banksthat were operating in Indiatoset up branchesunlike the public sector banks. There were many new foreign banks that entered after the implementation of the banking reforms. Thereis strict control by the regulators on the merger of foreign banks with any private bank. The entry of some of the major foreign banks and the services offered by them to Indian customerswill be explained in the next paragraph.

The bank that enjoysa strong presence as a corporate bank in Indiais ABN AMRO along with wide range of global transaction services. Amro India Corporate Finance facilitates the investment banking services to the customers. Privatebankingservicesthat provides wide range of quality portfolio advisory service with a comprehensive business and carrying out platform complemented by personalised banking and customised serviceshas been launched by the bank. To deliver credit to the poor women in India especially in rural areasthe bank has launched microfinance programme through microfinance institutes.

In view that India is a major trading partner in UAE import trade Abu Dhabi Commercial bank started its business in India in the year 1980.Because of the initiation of technology, highly developed communications, refined transportation and better financial services there has been an improvement in the trade relations between the countries. Opening accounts, dematerialisation, transfer of securities, keeping track of securities, freeze or defreeze the account with respective to customer decision and there will be an option for the customer to pledge his/her securities as a collateral for personal needsare the different kinds of services that are offered by the bank to its customers.

The bank that has long traditionin private banking in India is BNP Paribas. Operations of BNP Paribas bank first started in Calcutta. There is efficient infrastructure forthe bankto provide services like corporate banking and private banking. Metro cash, rapid cash, quick cash are the different kinds of services that are offered by the bankand also customersget advises on planning their cash flows better by the BNPP forecast. Single account operation is enough removing the requirement to open collection accounts at different centres, cash management provides credit confirmation statement on the day of credit, structured MIS report for easier reconciliation, one point reference for all queries, customized MIS report to suit customer needs and also possibility of linkage with all ERP platform such as SAP, BAAN etc .All these are the main advantages for customers holding an accountin BNP Paribas.

Citi bank was set up in India in 1902.Lending actively to individualswas startedby the Citi bank and is considered as the largest consumer financier in the world. The principles that are followed by the bank while dealing with the customersareproviding superiorproducts and services to its customers, truth in lending, to consider lending to customer as a transaction but as a relationship and custodian of public funds, fast and transparent credit decisions. Customers who are holding online banking account can use the facilities like reward points can be redeemed, paying the bills through online, sending demand draft anywhere in India, facility toget statements through emails, mobile banking, registering for instant alerts and suggestions on security investment by Citi online. Shop n’ win points, securing thechild future, immediate cash facility up to three times of one’s salary are the facilities that can be enjoyed by the customers who are holding the holding Suvidah account. There is wide range offlexible and personalizedCiti bank cards that are availableand can be managed online. MTV Citibank card, Indian Oil Citibank car, Citibank silver international card, CRY card, WWF card, Times card and Citibank Cricket Visa card are some of the cards offered by the bank. Citibank direct account is considered as one of the best rates in the market.

The largest bank that is operating in Taiwan is the China Trust Commercial Bank and was set up in many countries including India. Operations of the China Trust Commercial Bank startedin India in 1996 providingthe financial support to the increasing investments of Taiwanese businessman in India. Import services like issuing documentary credits or guarantees, providing loans against import bills, facilitating discount of import bills overseas, import bills for collection, foreign remittance relating to imports using swift or telex and also provide shipping guarantee or delivery orders are different kinds of services that are provided by the bank. Packing credit, export bills negotiations, export bills discounting, confirmations and advises relating to documentary credits and export bills for collection are the export services that are provided by the bank. Foreign inward remittance using swift/telex, foreign outward remittance using swift/telex, advanced remittance relating to imports are the remittance services that are provided by the bank to its customers. Foreign exchange forward contracts, trade information related Taiwan, forex advisory services, credit enquiries of oversees parties are some of the trade services offered.

Deutsche bank is one of the top banks in financial services and is one of the largest banks in Germany. EURO 1,906 billion assets are held by the bank till the first of quarter of 2010. The bank is present in 74 countries. The bank deals with corporate banking, securities, transaction banking, private wealth management and asset management. Private wealth management, DB real estate, DWS investments, Deutsche asset management and Scudder investments are some of the services that are offered byDeutsche bank. Equities, fixed income, foreign exchange, commodities, corporate finance, relationship management, asset finance and leasing, global cash management, global trade finance and trust and securities services are the products and services that are offered to institutional and corporate clients.

The largest bank in Hong Kong is Hongkong and Shanghai Banking Corporation (HSBC). There are branches of HSBC in major cities in India. There is broad range of private and personal banking products are offered by HSBC NRI in India and oversees. The latest technology is developed and implemented by HSBC group to make efficient and easy service of banking and other related services. There is self service banking with more than 150 and many off branch ATMs, 24 hours phone banking, access to centralised database for trade and corporate banking services, transactions between all branches in the country. Treasury dealing system and well developed card system that supports credit and debit cards, master cards, VISA for domestic and international etc.

The largest international banking group in India is the Standard Charted Bank. There is 2.4 million customers in retail banking and corporate customers over 1200. Consumer banking, personal loans, wealth management, mortgages are the main services that are offered by the Standard Charted Bank. Specialisation of bank in terms of cash management, trade, and finance treasury are the services offered for the wholesale banking. Standard Charted Bank is the first bank that issued global credit card in India, photo card, picture card and the bank was the first card issuer that has been awarded ISOcertificate. International debit card, sapnay credit card are some of the innovate products that were offered to the customers in India by the bank. An overdraft is issued against the security of car, smart credit, personal credit issued to the salaried employees.

Foreign exchange services, safety deposit t boxes, providing loans on currency accounts, services to meet customer needs, term deposits, letters of credit, letters of guarantee, collections, balance reporting, wire/swift transfers, metal trading, loans on precious metals, base metals, other currency accounts, retail finance services, investment banking, commercial banking, asset and wealth management and treasury and security service these are all the other services that are offered by the foreign banks.

Since there is strict control by the regulators over the foreign banks, there is no foreign bank that entered the country through merger and acquisition or by taking over the private banks.

The foreign banks that started business in India after 2009 are Royal Bank of Scotland, UBS, GE Capital, Credit Suisse, American Express bank, Societe Generale, JP Morgan Chase bank, Barclays. The bank that has joint venture in the Indian investment banking space is Merrill Lynch. Stakes are held by Goldman Sachs in Kotak Mahindra. GE capital made its presence in consumer finance by GE Capital India.

2.6 Theories of Banking
2.6.1 Financial Stability

The important aspect of any country is the financial stability which received a greater consideration in recent times. The complete functioning of financial markets and institutes in the country without any problems is referred to as financial stability. Due to the changing trends and developments in the financial system there has been pressure on the stability of the financial markets. Greater importance of financial stability is brought by the process of globalisation, implementation of advanced information technology, telecommunication technology and deregulation of the financial sector in emerging markets.

The existence of more complex products has been brought by the great deal of deregulation and liberalisation along with technological developments. Different kinds of risks are raised by the diversification of activities by the institutions. Financial sector compared to the real economy has been expanded at a higher pace with rapid growth especially in equity, debt and derivative markets. There are wide ranges of activities that are started by the financial institutions apart from the traditional banking activities like deposits and lending loans. Financial systems are more included nationally and internationally because of the increased degree of cross-industry and cross-broader integration and also new technological developments in the banking industry. Efficient allocation of economic resources geographically and over time is promoted by the financial stability in the system. Macro economic performance of the economy, monetary stability, regulation and supervision of banking and financial institutions and other risks that influence the financial markets are the various activities that are focused by the financial stability of an economy. To maintain the strong macroeconomic dynamics it is important to have efficient financial system in the country. Financial System Assessment Programme (FSAP) was introduced by the World Bank after the banking crises in 1990s to identify the strengths, risks and vulnerabilities of financial system in member countries and to ensure the development of financial sector. To assess agreement with the international standards and codes in the financial sector including Basel core principles of Banking Supervision is the key aspect of FSAP.

There is a disagreement that less concentrated financial markets face financial risks than the concentrated markets. In general market power is increased by the concentrated banking sector and also improves profit resulting in more stable market. Banking crises is faced by the less concentrated markets and is proved from the empirical results. Because of the intense competition between the banks there was failure of US banking system in 1980s.But there is an argument that banks have higher rents and higher charter value which have market power and have several chances of bankruptcy. Banks have lower charter value and have high risk taking behaviour in competitive market.

In Indian context, RBI act 1934 did not confirm openly that RBI is going to ensure the financial stability. To maintain price stability and to ensure that there is sufficient credit in the system to support growth are the objectives of the monetary policy in India. But recently the major issue in the monetary policy is financial stability due to the institutional atmosphere and integration of domestic financial markets with global markets. To understand and develop strong similarities between the macroeconomic performance and financial stability has become very important.

2.6.2 Technological Innovation in Indian Banks

Over the last two decades there has been major impact on the nature of banking and the manner in which banks and financial institutions are organised because of the importance and development of information technology and telecommunication technology. There is need for technological innovations in the banking sector as banks play an important role in providing finance and mobilising savings especially in emerging markets compared to the matured markets. Transactions costs will be lowered and revenues will be increased with the efficient use of technology in the banking industry. Banks will be benefited to cross market and existing products to customers because of the technology. There will be development of new financial products in the system because of the technological innovation. Bad credit risks can be identified with the technology and it also reduces adverse selection of moral hazard problems. If there is no efficient method of selecting the application for the lending process the balance sheets of the banks will be seriously affected that may expose the banks to external shocks and can lead to serious financial crises.

There will be speediness in financial account reporting and timeless of public disclosures through regulatory reports with the usage of technology in the banking sector. Overall improvements of financial transparency can be ensured by public disclosures. For administrative control like better risk management system technology can be helpful to improve systems that are disclosed in regulatory reports to supervisors and in annual reports to investor, which increases bank transparency and helps the banks to reduce their cost of capital (Basel Committee, 1998). Therefore technology in banking can be competitive edge and industrial survival.

There has been increased competition within the country and outside after the Indian economy opened to foreign banks. Technology was brought to the Indian banking system by thenew foreign banks that entered India. When compared to the public sector banks, the new private banksstarted to operate efficiently after adopting the technology from the foreign banks. There should be implementation of cost savingstrategies in the banking services by the public sector banksto have a better competition both the foreign and private banks. There is an allowance for the use of technology in operations and equipment after the agreement signed by the banks union with Indian Bank Association in 1997.After the securities scandal in 1992 there was also a regulatory pressure to adopt technology. There is productivity advantage for the foreign banks and private banks over the public sector banks because they have adopted the technology early in their banking activities. When public sector banks are compared with the private sector and foreign banks there is major difference of business and profit per employee and this is shown in the below table.

Table 2.1: Indian banks performance as per employee: 1997-2001(in lakhs)

Types Of Banks

1997

1998

1999

2000

2001

Business Per Employee

Foreign Banks

Private banks

Public Sector Banks

453

464

69

649

803

80

677

621

93

571

889

110

553

750

145

Profit Per Employee

Foreign Banks

Private Banks

Public Sector Banks

5.0

7.0

0.357.4

9.0

0.83.0

7.2

0.65

5.8

9.4

0.75

2.9

7.0

0.65

Source: Annual Accounts of Scheduled Commercial Banks

2.6.3 Economic Performance

Banks act as service sector as they contribute to the economic growth of the country not by producing real goods but by allocating funds to the industries .An efficient banking system will play an important role in the economic growth. Credit allocation efficiency and the product efficiency are the two variables that are used to explain the effect of competitive market and one with market power on economic growth. Banks contribute to the growth of the country by supporting capital accretion through the supply of credit. Besanko and Thakor (1992) have observedloan and deposit market for the banks in competitive market and one with market power using theoretical model. The study found that the loan rates are decreased and deposit rates are increased in competitive market when compared with one with market power. Guzman (2000) study found that monopoly in banking tends to decrease in capital accumulation as monopoly banking system will screen credit under conditions whereas banks in competitive market would not. This study used general-equilibrium model. The end result using the model is low deposit rates are offered by thebanks with market powerand charge high lending rates. The theory that market power is damaging to consumer and growth of the country have been proved by both the models. It is also observed that competitive markets have fewer prices when compared to the one with market power. When outputs are produced at minimum cost product efficiency is obtained. In traditional industrial organisation framework this is attained through perfect competition. There are no economies of scale is seen by the perfect competition. We can expect the perfectly competitive markets to maximise productive efficiency if there are no economies of scale. If there are no economies of scale large banks with market power tend to be the product effectiveness.

X-efficiency method is one of the major methods used for measuring product efficiency. It is observed that the competitive market is related with higher efficiency. Angelini, Cetorelli (2000) proved that after the 1993 reform process the banking system of Italy has become more competitive. Schure, Wagenvoort (1999) has proved that after 1993 banking reforms in the Italian banking sector there is improvement in the X-efficiency. It is proved that the competitive market is associated with higher X-efficiency in the US banking sector by Evanoff, Ors (2002)

It is clear from the studies that there is more efficiency in the less concentrated markets than the one with market power.

Sathye, M (2002) observed that the foreign banks in India to obtain whether their presence has made any change in the market concentration and therefore increased the competition. Sathye used regression variables that are derived from prior theories to measure the market concentration and found that there is no impact on market concentration in Indian banking system by the foreign banks.

Rivera (1993) found that there is major impact in Spanish banking because of the foreign banks by using the dummy variables to calculate the market concentration.

2.6.4 Globalisation

Globalisationrevolutionised the banking industry. New technology in the banking industry is brought by the globalisation. On the other hand there are issues like impact on bank performance, banks lending pattern, and bank capitalisation because of globalisation.

There are many studies that proved that there has been improved efficiency of domestic banks because of the entry of foreign banks as they are forced to reduce cost and also decrease the spread between the rates which they charge the lenders and pay rates to depositors. There is positive impact on the corporate governance of banks because of globalisation as the foreign banks does not breakthe lending limits much as they have the fear of getting trouble by the domestic regulators and this has been proved by the studies.

There is no clarity in the lending pattern because of the entry of foreign banks in the Indian banking industry. There are some studies which proved that the performance of foreign banks is good in the developing economies in consumer finance. When business is concerned the studies by the World Bank found that there was less credit provided to the small and medium sized business by the foreign banks in Latin America while Inter-American Development Bank (IDB) found no difference in lending pattern of both domestic and foreign banks. The Financial Authority should consider how foreign banks might affect the capital of banking system. It is not possible for the low capitalised banks to absorb losses and cannot close the business without causing losses to depositors and counterparties. In recapitalising the banking system foreign banks have played an important role. $ 8.8 billion have been brought in to the banking system by the foreign banks in Mexico which is equal to 42% of the entire system. To take over the country’s two largest financial institutions the government of Brazil has taken funds from the European banks and this step made Brazil to escape from the systemic banking crises in 1990and helped in decrease of fiscal pressure.

2.6.5 Corporate Governance

To ensure effective risk management and financial stability the concept of corporate governance has become very important to banks and financial institutions. Corporate governance has become important aspect in the financial system to observe the strength of the financial system and its ability to deal with the financial shocks. The health of the financial systemrelies on identifying the measure, monitoring and controlling the risks. The Reserve bank of India is the responsible body for corporate governance in India. Banks and financial institutions of India as a part of reform process have been given measures and guidelines to improve transparency and disclosure to control risk and asset liability management. Interaction with the participants has been strengthened at both formal and informal levels.

2.6.6 Consolidation

The best way to make the acquiring bank stronger is the bank merger. By bank mergersthe scope and scale of the banks can be achieved. Banks will be benefited by the mergers as it will help them to diversify their operations across different regions and it will also help to diversify the risks. Mergers will result in cost efficiency and also improve the competitive strength when they compete in the open market with other banks. There is an outlook that has been set up by the Indian banking industry to compete with both domestic and foreign banks. Sudesha Das an Indian economist mentioned that if the banks which are on top 10 merges into 3 or 4 banksthere would be lot of difference in the Indian banking sector. Some of the mergers have taken place in India after the financial sector reforms. In order to operate private banking, in 2005 India’s largest financial institution IDBI merged with IDBI bank. Consolidation in banking sector is aimed by the government of Indiaand in addition RBI is acting as a good support. This willhelp in further mergers in banking in India.

2.6.7 Privatisation

Over thelast two decades the privatisation in banking has swept the world. The government has to authenticate privatisation in regard topromoting efficiency,to increase the revenues for the state, reducing the intervention of the government in the economy and supporting wider share of ideas, to support wider share of ownership and to the growth of capital markets is also examined. To promote efficiency in the system is the most important objective. It is also examined that the public ownership is someway likely to be with lower efficiency.

There are many studies by the agency theories onthe superiority by the private sector over the public sector. There is lack of initiativesfor the managers in the public sector as there is poor monitoring. According to the property rights, there is increase in the inefficiency in the public sector because of the failure to allocate property rights. Ultimately managers are not worried about the bankruptcy in the public sector as they expect that they would be bailed out by government.

Public sector banks in India are large and well diversified. Privatisation usually takes place in India through disinvestment of equity. Transfer of control from government to anybody else is not considered as privatisation. Government holds stake in the public sector banks ranging from 1 to 40%.The stake in non-public sector decreased to 51%.Privatisation is relatively new in India and it is part of the economic reform process.

On the data taken from the 10 largest commercial banks in 92 countries, La Porta (2000) states that where there is greater state ownership of banks will see less development in the financial sector, lesser growth and lesser productivity. Borth (2001) found that where the ownership of the banks is greater it is likely to be associated with higher interest rate spreads, lower private credit, and activity on the stock exchange is less and lesser non-bank credit.

Hence, it is understood that when the ownership is greater it is likely to be non-competitive and competition from the banks and non-banks is reduced. When the ownership of the state is greater the bank licenses for the foreign banks will be rejected more and this is proved by Borth

2.7 Financial Indicators of Indian Banking Sector

To maintain the financial stability in the country it is very important to have good and financial soundness of banking and financial institutions. The pressure on the domestic banks and financial institutions is more because of the raise in globalisation of banking as the domestic banks have to forcefully meet the international standards in regard to financial soundness. As there are new private banks that entered the competition in the banking sector is increased and also the number of foreign banks increased. In July 2006 in a report that was submitted by the committee of Fuller Capital Accountant Convertibility examined that the banking system of India will be exposed to higher market volatility. Hence it is vital to support risk management capabilitiesby the banking system of India with higher efficiency in supervision and regulatory system. . Therefore, using different financial indicators there is an effort that is made to benchmark Indian banks with global benchmark in terms of different financial indicators

2.7.1 Capital Adequacy Ratio (CAR)

To estimate the soundness of a bank, capital is used as an indicator because it acts as a final buffer against the loss that is suffered by the banks. National regulatorsspecified the banks about the minimum amount of capital that they should maintain until the successful harmonisation by the Basel Accord 1988. To keep the banks out of difficulty regulatorstried to make sure that the minimum capital requirement is maintained by the banks and financial institutions. This w ill not only help the depositors but also the wider economy. It is observed that there is major impact on the economy of a country because of the failure ofone of banks. The impact of theIndian banking reformshas played an important role on the effectiveness and stability of the Indian banking system. There should be a structure designed by the regulators to make the customers inclined towards the public sector banks. To support the diversified risk profile of banks, the regulators should promote the banks to maintain Capital Adequacy ratio (CAR) more than the supposed requirement which is 8%. To determine the bank ratingthe Capital adequacy ratio acts as an important role. Banks in India are capitalised well as there are above the international norm which is 8%.Indian banks are placed better than the Asian countries and this is because the Basel norms are accepted by the RBI.

Below is the table of t he Capital Adequacy Ratio of Indian banks.

Table 2.2: Capital Adequacy Ratio in Indian Banks as of 2000-2006

Type of Banks

2000-2001

2001-2002

2002-2003

2003-2004

2004-2005

2005-2006

Nationalised Banks

10.20

10.90

12.20

13.10

13.20

12.27

State Bank Group

12.70

13.30

13.40

13.40

12.40

11.95

Old Private Banks

11.90

12.50

12.80

13.70

12.50

11.69

New Private Banks

11.50

12.30

11.30

10.20

12.10

12.60

Foreign Banks

12.60

12.90

15.20

15.00

14.00

13.02

Source: Trends and Progress of Banking in India, available at: www.rbi.org.in

2.7.2 Non-Performing Assets
2.7.2 Non-Performing Assets

The main reason for the banking crises in most of the countries is the high amount of non-performing loans (NPL). This has placed the government under pressure to reorganise the banking system as a reason of government face and fiscal cost. In general high amount of non-performing loans needs reorganising the banking system, loss of employment and output besides fiscal cost. Non-performing loans differ from one country to another. The factors that are responsible for NPL in Japan and Thailand is the real estate market failure, declining in business performance of state enterprises in China, there is problem in allocation of credit and control of interest rates in Korea, exchange rate is overvalued and bank directors who are allocating credit to companies lack financial discipline. Political motivated lending is the main reason for non-performing loans in Turkey.

Stock and flow problem are the two aspects of Non-performing loans (NPL).Eliminating NPL of banks and increasing capital is dealt by stock problem. Quality of bank earnings to prevent future weakening ofbank balance sheet is dealt by flow problem. This need specialisation, better technology, cost saving and good credit assessment. Using asset management companies is the most general method used to resolve NPL problems, loan swaps and liability exchange are the other methods used to determine the NPL problem.

After the reform process NPL market of India has seen good development which is still continuing. Securities and reconstruction of financial assets and enforcement of security investment act were implemented in 2002. To improve the asset quality and capital adequacy ratio with regard to remove the bad loans has been allowed to the banks by this act.

Table below shows the comparison between percentage of non-performing assets and percentage of total assets.

Table 2.3: Percentage of Non-Performing Assets to Total Assets in Indian Banks

Type of Banks

2002-2003

2003-2004

2004-2005

2005-2006

2006-2007

Nationalised Banks

4.66

3.86

2.96

2.24

1.64

State Bank Group

3.48

2.91

2.49

1.81

1.57

Old Private Banks

4.34

3.64

3.15

2.51

1.85

New Private Banks

3.76

2.42

1.56

0.96

1.07

Foreign Banks

2.44

2.13

1.43

0.97

0.89

Source: Trends and Progress of Banking in India, available at: www.rbi.org.in

Table 2.4: Percentage of Non-Performing Assets to Total Advances in Indian Banks

Type of Banks

2002-2003

2003-2004

2004-2005

2005-2006

2006-2007

Nationalised Banks

9.72

8.21

5.82

3.81

2.69

State Bank Group

8.68

6.98

5.32

3.31

2.59

Old Private Banks

8.86

7.59

5.97

4.39

3.13

New Private Banks

7.64

4.99

3.59

1.74

1.93

Foreign Banks

5.25

4.62

2.85

1.95

1.77

Source: Trends and Progress of Banking in India, available at: www.rbi.org.in

In terms of non-performing assets public sector banks have maintained lot of ground after the financial sector reforms which can be observed by the above table. However foreign banks and some new private banks are positioned well in terms of non-performing assets.

2.7.3 Return on Assets (ROA)

The ratio of net profits to total assets is called Return on Assets of banks. One of the key indicators of profitability ofbanks is Return on Assets (ROA). Soundness of a banking system is indicated by higher ROA. It isobserved that the financial markets are placed stable even when there are unexpected shocks by higher ROA. There has been good improvement in ROA year after year by Indian banks.0.9-4.3 is the ROA in international standards. Improvement in ROA over the years is shown in the below table.

Table 2.5: ROA of Indian Banks

Type of Banks

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

Nationalised

0.33

0.69

0.98

1.19

0.89

0.81

0.85

State Bank

0.55

0.77

0.91

1.02

0.91

0.86

0.82

Old Private

0.59

1.08

1.17

1.20

0.33

0.58

0.70

New Private

0.81

0.44

0.90

0.83

1.05

0.97

0.91

Foreign

0.93

1.32

1.56

1.65

1.29

1.54

1.65

Source: Trends and Progress of Banking in India, available at: www.rbi.org.in

ROA of Indian banks shows substantial improvement. However, there should be improvement in ROA to meet the international standards which range between 0.9-4.3 by nationalised and state bank group.

2.8 Conclusion

The financial system in India is goodbut it is observed that the development of capital markets is required. From the theories of banking it is also proved that competitive markets are more efficient than one with market power. Indianbanks are well compared with global standards in terms of capital adequacy ratio, non-performing assets and return on assetsafter implementation of financial sector reforms. When compared to public sector banks foreign banks and private banks are performing in better way. Public sector banks should improve their return on assets. Competition in Indian market has been improved with the presence of foreign banks

Chapter 3

Data and Methodology

3.1 Introduction

The earlier chapter of the paper demonstrated the Indian financial system and the reforms that were undertaken which led to the growth of the Indian economy. There are many theories that led to the enhanced efficiency of Indian banking system but the very same can have detrimental effects if not supervised properly. The paper also discusses the effects of market concentration on the prices of the products and the productivity of the industry. After the liberalisation of Indian economy many foreign players have entered the country and the market share of the public sector banks fell down drastically from up 90% as many new private sector banks have come in. The new private banks also start using the technology brought in by the foreign entrants. It is thus vital to know how foreign players had an effect on the Indian market concentration. Also it is interesting to know the financial performance of the foreign banks since they implemented many technological innovations and even diversified their offerings to the customers.

The later part discusses the data and methodology used for calculating the financial performance of the foreign banks and their impact on the market concentration.

3.2 Methodology

Market concentration means the number firms present in the industry and their relevant market share. It is measured using Herfindahl-Hirschman Index (HHI) method. Here, we consider a sample of top five foreign banks operating in India to calculate the financial performance. For the purpose the study the following ratios are being used:

Return on Assets (ROA),
Net Interest Margin (NIM) and
Cost-income ratio (CIR).

Also Accounting ratios tool by bank managers, equity analysts and shareholders is used for comparing the performance of banks year over year. To measure the efficiency of banks Data Envelope Analysis (DEA) method can also be used.

Herfindahl-Hirschman Index (HHI) is the widely used method for measuring market concentration. Abbreviated as HHI, it is the sum of the squares of the market share of each firm operating in the market and is influenced by 2 factors:

1. The number of the firms present in the market and

2. Their size in the market.

HHI would be lower when: high number of firms in the market and

HHI would be higher when: low number of firms in the market and difference in their size. The formula used for measuring HHI is

Where

si is the market share of each firm

i is the market and

n is the number of firms.

But there are difficulties in using HHI method: and one of which is that one has to calculate the market share of each firm operating in the market. And also smaller firms hardly have an effect on the HHI number because larger firms have higher share. US Department of Justice (DOJ) divides the market into three different categories based on the HHI number.

A market is less concentrated if HHI < 1000, moderately concentrated if HHI range is 1000 – 1800 and highly concentrated if the HHI number is > 1800.

Accounting ratios are calculated the following way:

Return on Assets (ROA) – it is the measure of profitability of firm relative to its total assets. ROA also gives clear indication of how efficiently management is utilising the assets. The higher the ROA the better is the company since it indicates that the company is earning more on less investments and the formula for measuring it is

ROA = Net Income / Total Assets.

Net Interest Margin (NIM) – It is the difference between the interest incomes earned on loans and the interest they pay on deposits by banks to the total assets. It is very important to banks because 75% to 80% accounts for total revenues; any small change on the interest margin has huge impact on the profitability of the bank. Since, it is an integral part of efficiency ratio, any improvement in NIM can improve the efficiency ratio. The formula used for measuring NIM is

NIM= Income Interest – Interest Expenses / Total Assets

Cost-income ratio (CIR) – It is the cost-income ratio which is similar to net-interest margin. And the difference between them is that a bank should have higher NIM and lower CIR to operate efficiently and effectively. The cost/income ratio can be calculated using the formula

CIR = operating expenses / total income.

3.3 Rationale for Choosing This Method

Market concentration elucidates to what extent the top players in an industry control the market. The various methods used for measuring market concentration are:

Concentration Ratio method
Herfindahl-Hirschman Index (HHI) method
Bains measure
Learners measure
3.3.1 Concentration Ratio Method

Concentration Ratio is the percentage of total sales contributed by the top firms in the industry. There are various versions of concentration ratios available like CR4, CR8 and so on and so forth depending on the number of firms controlling the major market share. The CR4 is calculated by summing up the market share of the top four firms in the market and CR8 is calculated by summing up the market share of top eight firms in the industry. But this method has some limitations. There is no specific evidence available anywhere as to why we consider the market share of top four or top eight firms and this method does not give the clear picture of the true market structure. One can say we randomly choose concentration ratio method for measuring market concentration.

3.3.2 Bains Measure

According to Bain the degree of monopoly is calculated based on the super normal profits earned by a firm. The super normal profits are not competed in a market where there is no threat of entrance from new firms into the market. Whereas in a competitive market the super normal profits are competed because of more number of firms in the market, also there is a chance of entry of more number of firms. The biggest limitation of this method is that all super normal profits are not monopoly; there is a chance of windfall gains when the demand and cost conditions change.

3.3.3 Learner’s Measure

According to Learner, larger the difference between the price and marginal cost, greater is the monopoly power. That is the ability of a seller to sell a product much above its marginal cost. In a competitive market the seller does not have monopoly power. The monopoly power depends on the elasticity of demand of the products in the market. The income effect which measures the monopoly power can be positive or negative.

3.3.4 Herfindahl-Hirschman Index (HHI)

As already said in this chapter, HHI is the sum of the squares of the market share of every firm in the market. Usually, HHI is considered to be the best method for measuring market concentration. It gives the picture of entire market structure. The only limitation is that one has to calculate the market share of every firm in the market to get the value of concentration.

Market concentration plays a prominent role in a merger case. According to Competitive Authority a merger can raise the competitive concerns if the number of HHI is increased more than 100 points in a moderately concentrated market and 50 point in a highly concentrated market.

All the above methods have either one or two drawbacks but HHI method can overcome the drawbacks by calculating the market share of each firm. It also gives distinct picture of the entire market structure. Hence we choose HHI method for calculating market concentration.

3.4 Data Collection

The paper will make use of the secondary data which includes Annual Reports of banks for the period of 2002-2006 for calculating the market shares of each bank and for calculating accounting ratios like ROA, NIM and cost-income ratio which are obtained from the website of central bank and also collected from bank scope data base where the results of banks around the world can be found. The data used is absolutely reliable as it accepts the general accounting principles and also meets the regulatory norms and requirements of the Reserve Bank of India.

3.5 Data Analytical Tool

At the end of all calculations the results would be interpreted in a graphical representation which would give a clear picture of year over year financial performance of foreign banks. The result of market concentration gives the picture of how the market is concentrated- high, moderate or low. The results are graphically shown which indicate to a clear picture of how the market is concentrated year over year.

3.6 Conclusion

This chapter suggests that how the market concentration and financial performance of foreign banks are measured. The result expected would be like there is improvement in performance of foreign banks when they are compared every year and also there is gradual decrease in the market concentration because of the entry of foreign banks and the private banks that have adopted the technology after the banking reforms were implemented in their banking services.

CHAPTER-4

Data Analysis and Result

4.1 Introduction

The present chapter tries to find the financial performance of foreign banks and their market concentration in India based on the observed results. In order to do that there is explanation in the earlier chapter on the methods that are going to be used and from the annual reports that are published by the RBI for the period between 2003 and 2007 the data is collected and is used. To measure the financial performance of foreign banks, accounting ratios are used and the most accepted method HHI index is used to measure the market concentration.

In the following section there will be discussion on the performance of foreign banks and also to find out whether there is any impact on the market concentration by the foreign banks as the performance of foreign and private has been better and also private banks performance is better after they implemented the technology in their banking which is adopted from the foreign banks.

4.2 Data Analysis

In this research, the data are gathered from Reserve Bank of India (RBI) website annual reports. On using HHI method to measure the market concentration, the person is suppose to be aware of every single bank’s market share value to derive the precise results. The collected data consist of ag98gregate revenues of the commercial and individual banks which have operations existing in India. Therefore, on utilizing the available data, the researcher will be able to calculate the market share value of every single in India by applying the formula given below.

Market share of each bank = Individual Bank Revenues / Total Revenues

Therefore, the market share of each bank can be derived calculated through HHI method. Based on the HHI score, the market can considered as concentrated, moderately concentrated or low concentrated. The slab rate of HHI score is as mentioned below:

Less than 1000 = low concentrated;

1000 to 1800 = moderately concentrated; and

If Above 1800 = highly concentrated.

The authorization of merging or rejection on merger case is actually based HH scores. The market share value of all the banks is listed in appendix.

In the row, the next entity is performance of foreign banks. To pursue the performance calculation, five foreign banks listed as top five banks are picked and worked out using accounting ratios such as ROA, C/I and NIM. The data used to calculate performance are collected from annual reports published in Reserve Bank of India website. From the obtained data, it will be possible to get the results of C /I, NIM and ROA. However, the data does not contain total asset value of the bank, yet net income of each bank and return on assets is been found. By using these variables, total assets of banks, which will support in finding NIM of each bank.

On the other side, the measurement of scheduled commercial banks is calculated through India Budget and published on websites as well. On reviewing the data, it is found that profitability of scheduled commercial banks has decreased eventually over years.

This proves that there is decrease in the profitability of scheduled commercial banks over the years.

The performance of Banks measured by Deepak Katri and Nitin Kumar have used profitability ratio RAO and after applied regression value and derived that public sector banks are quite not well as private and foreign banks.

4.3 Interpretation of Results
4.3.1 Market Concentration

It is believed based on the empirical results that the banking industry in India is not much concentrated and competitive. The key factor that plays an important role in any sector is the market concentration. The sector is said to be less competitive and have higher profits when there is higher market concentration and in similar method it is indicated that the sector is more competitive and have less profits when the market concentration is lower.

After the financial reforms the banking system of India has witnessed a great competition and there is entry of new foreign banks in India .Besides this technology is adopted by the new private banks from the foreign banks. It is assumed that 90% of the market share was held by the public sector banks of India before carrying out the reform process. At present the market share has come down 70%, 66%, 67%, 63% and 62% for years 2003-2007 respectively. There is substantial increase in the share of foreign and private banks.

The level of market concentration in Indian banking sector from the year 2003-2007 is shown below

Table 4.1: Level of Market Concentration in Indian Banking System

Year

2003

2004

2005

2006

2007

Market Concentration

636

594

601

586

511

Source: Based on the data published by RBI and authors own calculation.

Figure 4.1: Level of Market Concentration in Indian Banking System

For the period between 2003 and 2007 the HHI score ranged between 500 and 600.Except for the year 2005 it is observed that HHI score increased year after year. Based on these figures it is clear thatthe banking system in India has become more competitive. It is general phenomenon that when the HHI value is below 1000 it is said as less competitive. Market has become more competitive from few years.

4.3.2 Financial Performance for Top Five Foreign Banks Operating in India

On basis of NIM, ROA and C/I the foreign banks performance is calculated. For the period between 2003 -2007 the performance is calculated. Performance of foreign banks is given in the following table.

4.3.2.1 Return on Assets

Table 4.2: Return on Assets for Top Five Foreign Banks Operating in India

20032004200520062007
Standard Chartered Bank2.921.741.972.493.06
HSBC0.800.781.271.581.82
Deutsche Bank2.923.170.721.041.23
Citi Bank1.171.401.00.951.02
ABN Amro Bank1.561.841.271.031.37

Source: Based on the data published by RBI and authors own calculation.

Return on Assets is the ratio of net profits to its assets. Using the assets for better profitability by the management is indicated by ROA.As the company earns more on less investment it is better for a company to have higher ROA.

Performance of top five foreign banks in terms of ROA is shown in the above table. There is no consistent increase in ROA by the three banks when they are compared every year but they have shown good ROAapart from HSBC and Standard Chartered Banks which showed consistency. Increase in the net interest income is the reason for increase of ROA for HSBC and Standard Chartered bank.

4.3.2.2 Net Interest Margin

Table 4.3: Net Interest Margin for Top Five Foreign Banks in India

20032004200520062007
Standard Chartered Bank2.961.842.552.693.13
HSBC1.020.841.311.702.17
Deutsche Bank1.300.460.280.751.49
Citi Bank1.281.541.231.241.26
ABN Amro Bank1.942.301.651.271.66

Source: Based on the data published by RBI and authors own calculation.

Foreign banks have better NIM which can be noticed from the above table. In the years 2004 and 2005 NIM is decreased for Deutsche Bank and the reason is that more than the interest income there is increase in other incomes which is important to observe. Nevertheless good net interest margin is maintained by the foreign banks.

4.3.2.3 Cost to Income Ratio

Since lower cost to income ratio gives more profit the cost to income ratio is also considered as efficiency measure. For the efficient operation of banks there should be high net interest margin and low cost to income ratio.

20032004200520062007
Standard Chartered Bank2024292926
HSBC3129313234
Deutsche Bank2419344046
Citi Bank3132393732
ABN Amro Bank3341423832

Source: Based on the data published by RBI and authors own calculation.

Figure 4.4: Percentage of C/I for Top Five Foreign Banks in India

19-46 is the range of cost income ratio for the top five foreign banks that are operating in India. Apart from the ABN Amro bank cost to income ratio is steadily increasedyear after year .In the year 2004there is lowest cost to income ratio and highest cost to income ratio in the year 2007.

4.4 Conclusion

Banking system in India is highly concentrated and even there is increase in level of concentration over the year which is confirmed by the above calculations. Based on ROA, NIM and C/I it is observedthat the .performance of foreign banks is betterwhen they are compared every year. The level of other income earned by the foreign banks is decreasing year after year which is an important observation done while doing the dissertation. In ter2ms of ROA, NIM and C/I it is seen that there is consistent improvement for foreign banks. Because of the increase in competition in the banking sector there is huge pressure on NIM. Banking industry is likely to be more concentrated as there is entry of foreign banks in Indian market.

CHAPTER 5

CONCLUSION

5.1 Introduction

The earlier chapters of this paper have thoroughly elucidated about the banking system in India pre and post independence. It also spoke of the financial system in India. Pre-liberalisation, public sector banks had a market share of 90% and they were literally dominating the Indian banking industry as there were restrictions on the private banks. Post liberalisation, the market share of the public sector banks drastically fell down because there were relaxed rules with respect to the entry of the foreign players into the Indian market. Infact they were allowed to operate more freely. Foreign players used innovative technology and new entrant private players also adopted this technology. The use of technology leads to faster and quicker growth of the new private sector banks. The banks became more efficient in terms of revenues generated per employee and profit earned per employee and this is shown in table 2.1. They have proved to have better ROA and non-performing assets when compared to public sector banks.

The next section deals with the findings of the research, followed by policy recommendations, limitations of this research, suggestion for further research that is not covered and finally the conclusion of the research.

5.2 Summary Findings

The study is predominantly done for two purposes. Firstly, to know the performance of foreign banks in terms of return on assets, net-interest margin and cost to income ratio after the introduction of financial reforms. Secondly, to know and understand how foreign banks had an impact on market concentration. For undertaking the research secondary data is used and the data is collected from the central bank website. There are various methods available for the study. To find out the performance of foreign banks, top five foreign banks operating in India were taken and accounting ratios like ROA, NIM and C/I are calculated to know their performance. Calculation of market concentration is done by using one of the most popular method HHI index. Market share of each and every bank operating in India for the period 2003-2007 is calculated because to use HHI method one should know the market share of each and every firm operating so that the result would be accurate and justified.

After the execution of financial reforms in 1991 the Indian banking industry’s concentration has increased after 1991.The market share of public sector banks drastically fell from 90% to 70%, 66%, 67%, 63% and 62% for the period 2003-2007 respectively. It is because after the execution of reforms many new foreign players and new private players have entered the India and foreign players were allowed to operate more freely and they have been allowed for branch networking which was a distant dream prior 1991. This led to increased revenues and greater market share. Even private players that entered the country have grown faster and quickly. Though there is decrease in market share of public sector banks they still dominate the Indian banking industry because of their huge size and quick penetration into small cities and towns and more surprisingly into rural areas.

It is essential to know how foreign players are performing post liberalisation era. The numbers have proved that they have better ROA as compared to previous years because there was tremendous growth in advances and they also earned more on other income which helped them to be better placed. The NIM of the banks have moved up exceptionally well up the ladder except for Deutsche bank since they have high percentage of other income than interest income. But as time passed by it also showed improved performance in terms of NIM by reducing its percentage of other income when compared to interest income. The C/I is increasing for foreign banks as compared to earlier years because of increase in competition which has put pressure on the margins and increase in operating expenses. Because of high competition in the industry banks were under pressure to maintain low lending rate though the CRR and SLR have gone up in 2006 and 2007 due to higher inflation which is above central bank range.

5.3 Policy Recommendation

History (and theories) has proved that competition in industry increases efficiency. Indian banking sector is highly competitive but public sector banks have to go a long way in implementation of latest technology in their banking services and should provide different kinds of financial products. Government of India has more than 70% stake in almost every public sector bank and even 100% stake in certain banks. A divestment plan by government will do good to these banks. Like, banks will be able to operate more freely and survive in highly competitive environment. There are also restrictions that foreign banks cannot acquire any local private bank unless it is weak. If the restriction is not put by the government small banks operating in India can be merged by the big banks so that further help for the improving efficiency of Indian banking sector can be achieved.

5.4 Limitations of This Thesis

There are certain drawbacks of this study like it does not measure the efficiency of Indian banking industry and how it impacts the profitability of the industry. The financial performances of foreign banks with other groups of banks operating in India were not compared by this study. A slight change in figures from the data collected from central banks when compared to the data released by the individual banks is observed. Another drawback is that the figures can be manipulated by the banks for enhanced look than they actually are and this could affect the accuracy of the study.

5.5 Suggestion for Further Research

People interested in doing research on Indian banking sector can find out the efficiency of the sector and calculate its impact on the profitability. The performance of foreign banks vis-a-vis other groups operating in India using accounting ratios can be further pursued in research.

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Appendix

Nationalized Banks2002-20032003-20042004-20052005-20062006-2007

Allahabad Bank1.71.82.01.91.9
Andhra Bank1.61.51.61.31.3
Bank of Baroda4.24.24.23.73.7
Bank of India4.34.13.93.73.8
Bank of Maharastra1.41.41.41.10.9
Canara Bank4.74.95.54.54.6
Central Bank of India3.23.23.32.62.4
Corporation Bank1.51.41.51.41.4
Dena Bank1.21.21.00.90.9
IDBI– –1.63.02.6
Indian Bank1.71.81.71.71.8
Indian Overseas Bank2.32.42.42.02.2
Oriental Bank of Commerce2.22.12.12.02.0
Punjab & Sind Bank0.91.30.70.61.0
Punjab National Bank5.05.25.24.04.5
Syndicate Bank1.92.02.22.02.4
Vijaya Bank1.11.31.21.11.1

SBI & its Associates

State Bank of Bikaner & Jaipur1.01.11.30.51.0
State of Hyderabad1.41.51.41.01.0
State Bank of India21.020.020.019.616
State Bank of Indore0.70.70.60.70.7
State Bank of Mysore0.70.70.80.70.7
State Bank of Patiala1.21.31.21.21.2
State Bank of Saurashtra0.60.60.60.50.5
State Bank of Travancore1.01.21.21.21.0

List of Banks and their individual Market Share (2003-2007)

Private Banks2002-20032003-20042004-20052005-20062006-2007

Bank of Rajasthan0.30.30.30.20.3
Catholic Syrian Bank0.20.20.21.81.6
Centurion Bank of Punjab0.20.20.20.40.6
City Union Bank0.10.10.10.10.1
Development Credit Bank0.20.20.20.10.1
Dhanalakshmi Bank0.10.10.10.10.1
Federal Bank0.70.80.70.70.7
HDFC Bank1.41.61.92.52.6
ICICI Bank7.26.56.68.310.4
ING Vysya Bank0.70.60.50.60.5
Jammu & Kashmir Bank0.90.90.50.80.7
Karnataka Bank0.60.90.50.50.5
Karur Vysya Bank0.60.90.50.50.5
Kotak Mahindra Bank0.20.30.40.70.9
Lakshmi Vilas Bank0.20.10.10.10.1
Lord Krishna Bank0.10.10.10.10.07
Nainital Bank0.040.040.040.040.04
Ratnakar Bank0.040.040.030.030.03
Sangli Bank0.090.080.090.040.04
SBI Comm. & Int Bank0.030.030.010.020.01
South Indian Bank0.040.040.040.030.03
Tamilnadu Mercantile Bank0.30.30.30.20.2
UTI Bank1.01.11.21.02.0
Yes Bank––0.020.010.02
Indus Ind Bank0.50.70.70.60.
Foreign Banks2002-20032003-20042004-20052005-20062006-2007

ABN Amro Bank0.50.50.60.91.0
Abu Dhabi Bank0.10.080.090.050.04
Amerian Express Bank0.30.20.20.20.2
Antwerp Diamond Bank0.0070.010.010.010.01
Arab Bangladesh Bank0.0040.0040.0040.0030.003
Bank of International Indonesia0.0020.0020.0020.0020.003
Bank of America0.20.10.10.20.2
Bank of Baharain & Kuwait0.040.020.010.010.01
Bank of Ceylon0.0080.0070.0070.0060.007
Bank of Nova Scotia0.10.090.10.10.1
Bank of Tokyo0.070.080.070.050.06
Mitsubishi UFJ0.070.080.070.050.06
Barclays Bank0.070.070.080.10.1
BNP Paribas0.10.10.10.10.1
Calyon Bank0.050.020.070.10.1
Chinatrust Commercial Bank0.0080.0070.0050.0040.004
Citi Bank1.51.61.61.82.0
DBS Bank0.020.010.020.060.1
Deutsche Bank0.40.50.40.50.6
HSBC Bank1.11.21.21.41.7
JP Morgan Chase Bank0.030.030.060.10.2
Krung Thai Bank0.0020.0010.0020.0020.002
Mashreq Bank0.030.010.010.010.005
Mizuho Corporate Bank0.010.010.010.010.02
Oman International Bank0.020.010.010.0070.006
Shinhan Bank0.010.0070.0090.0090.01
Societe General0.020.020.020.050.07
Sonali Bank0.0020.0020.0030.0020.005
Standard chartered Bank1.51.81.51.92.0
State Bank of Mauritius0.020.030.020.020.02

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