“Indian banks: Tremendous opportunities but even bigger challenges”

February 2011

(Part 1 of 4) Conversation with MV Nair, CEO, Union Bank of India, on – rise in alternative banking transactions as cost of IT is low – overseas expansion to support Indian corporations – legacy of largest nationalized retail bank in India

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Here is the transcript of the video.

1. Emphasis is on retail customers

Emmanuel Daniel (ED): I’m speaking today with Mr. MV Nair, the chairman of Union Bank of India. Mr. Nair, you’ve been chairman of the bank now since 2006, and the Indian state-owned banks have a reputation for being solidly well run, conservative, risk averse and so on. Is it possible to maintain that kind of approach to banking today?

MV Nair (MVN): I think you’re right that it’s a very well run bank. But I would not agree regarding risk aversion. If you look at the type of engagements we have, be it in the space of financial inclusion, be it financing education, be it financing small enterprise, it is a highly risky space, but the banking practices we are developing over the time are closer to the customer and support enterprise, but monitoring them, has picked up some good strength. We’ll continue to do that for a simple reason. If we look at the evolution of banking, post 1992, when reform started, there were quite a few complications but they all strengthened the public sector banks. Public sector banks strengthened their technologies and capabilities, strengthened human operation capabilities and today most of the numbers are very good numbers. While then it was fair, quite a few of the public sector banks vanished from the scene because of the competition.

ED: How would you characterize the franchise of Union Bank? Do you have a certain customer pool, a kind of customer category that you’re very good at?

MVN: Yes. I think we are very good with retail customers, and we are very good with small and medium customers. The bank has got a national character. We have about 3,000 branches across the country. We have to be in all the different spaces. We are very good in dealing with retail customers. That’s where we have been developing our capability for the future.

ED: And given the fact that there are a number of state-owned banks, or state-owned enterprises, if I were to look at your loan book, are there specific sectors you’re very strong in, or you’re most exposed to?

MVN: If you were looking at the loan book, it would be a reflection of the banking sector in the country, as a side though, we have a market share of 18.5%. It looks small, but then it is the fifth largest national bank in the country, so naturally we have to cater to agriculture, to small and medium enterprise, large corporations. All the major large corporations have a relationship with the bank. So you can’t do without some of these spaces.

If you were to ask me where exactly Union Bank is focusing, it is in the retail space. The reason behind that is, the way the Indian economy is evolving, especially given this demographic profile, we are clearly seeing a huge opportunity coming up in the next generation of customers. So we are preparing, or at least trying to be better prepared, to cater to their needs. That’s how the bank is evolving, but as a bank, or should I say, government-owned bank in the country, we have to be in all these spaces.

ED: The government almost has this policy where they take career bankers at the very end of their career, almost, to become chairmen of banks. And the tenure used to be shorter, about three years. And now it’s about five years. Does this policy by which chairmen are appointed, in itself, maintain the conservative character of state banks, the unwillingness to take risks and so on? Bearing in mind, of course, that you have overseen the development of this bank, you’ve invested in technology and so on, do you see that character changing the way in which chairmen are selected, and the mandate that’s given to you?

MVN: Actually, it’s definitely changing. You look at large-sized state banks, who have got about 25% market share, the last four of chairmen of the State Bank of India had between four to five years’ tenure, which is not in the past, it’s just very changing. And then you have to pass through a particular phase right now where a large number of senior colleagues are retiring. It’s a very interesting phase the banks are passing through. So it is quite challenging for the government to choose a chairman or managing director. But then they are clearly focusing on having at least four to five years’ tenure for the chairmen. That’s why you’ll find the larger national banks—Punjab National Bank, the chairman has about five years’ tenure. Union Bank, we have five years’ tenure. At Bank of Baroda, the chairman has got four, five years tenure.

2. Banks and citizens to benefit from growth in India

ED: I want to capture the essence of how you, as a chairman of a domestic bank, view the economy of India, and the impact that foreign influence is having on the economy of India? How would you read how India’s developing today?

MVN: It’s a country which is being rebuilt. The activity a reflection of the country, there’s a huge amount of activity taking place—airports are being built in small centres. I went to Bangalore a month back, which is where my career was built, but there has been a gap of about one and half years—a new airport, you find ports being built, roads being built, a whole amount of investment taking place in infrastructure, a huge amount of migration to urban cities. Now, we have a focus on education, a focus on so many things. So what you’re really seeing is a country being rebuilt. So if you have good governance, the country’s economy will grow at about 10%.

If you have some handicaps, then you have 1 or 2% less but on a medium term basis, 20, 30 years, the growth is certain. In such a situation, the banking sector which is a reflection of the economy, the key challenge is to create capacity. And that is where the foreign flows are important. It’s an opportunity which any foreign investor should look at. There are issues—with the government, with approvals—but then there are huge amounts of opportunities. A lot is being sorted out. But the fact of the matter is, for someone who is looking at the country, for someone who would like to invest in the country, it is the best time to begin.

ED: That’s for the foreign investor coming in. But how much of this development is the average man on the street in India benefitting from? Education levels still remain low—healthcare, mortality rate, there’s a lot of work to be done on that front—and it seems that the corporate world in India is speaking one language, and the social world is speaking another language today. Do you think that the corporate world’s progress is sustainable if some of the social indicators are not dealt with?

MVN: Let me put it slightly differently. In the last two years, the government has been focusing on an inclusive growth agenda. The inclusive growth agenda encompasses a large number of those who were not touched by growth opportunities in the past. 37% of government allocation is going to the social sector. In effect, it is social security in a slightly different form. If you go to a developed country, you’ll find if you are unemployed, you’ll get social security benefits. Well here, it is a hundred days worth of work that is being given. Which is actually social security. You are actually given employment by way of social security benefits.

Look at the major initiatives: a right to education, a right to information, a right to employment… Now, these are path-breaking initiatives which will take a reasonable amount of time to have impact. But I, as a banker, when I see a village today, I see migration decrease  because there are a hundred days of employment for you in a village. On the education side, it’s debatable. There’s a huge amount of emphasis to educate the people, so as I said, it’s a country in the making, a country being rebuilt. But the intent is very clear, to reach out to all those who have not been reached in the past. That is the reason I said 10% growth is bound to happen because all of this is contributing to the growth process.

ED: How do you view what needs to be done in the agricultural sector in India? Traditional bank lending effectively meant that you write off a lot of that loan which was sort of like a state directed lending policy. In fact, a lot of foreign analysts don’t appreciate that element of state-owned banks in India. What do you think needs to change in agriculture sector?

MVN: Actually, a lot of things need to change. Land holdings are small. We don’t have good post-harvest capacity, so from the farm to the plate, 50% of the produce gets wasted. Quite a lot of things have to happen. As a matter of a fact, not only banks, but policymakers at all levels are focusing on it and we need to get that right. All of us realize that. In the past we have focused more on subsidy-based lending to agriculture but today it is very clear. We need to create warehouses, godowns, and markets. A lot of action is taking place on that basis. But as I said, in most of these areas it is unfinished work, but the intent to work on this is very much there.

3. Possible benefits from foreign banks and the impact of the Internet

ED: Are you afraid of foreign banks?

MVN: Not at all. I mean there is clearly an Indian banking structure if you look at it. There are 70% with public banks. About 20% of the private banks in which there are two categories, old private sector banks, and new private sector banks. Then you have foreign banks, regional rural banks, and corporate banks. Foreign banks, when they operate, they bring in the best of the products globally available, which is good for us because we learn from them. The private sector banks bring competition, technology capabilities and new practices. And we have picked up on this. So it is good to have this type of structure because it brings the best of all the banks.

ED: How do you read the government’s recent moves and desire to get the foreign banks to incorporate in India?

MVN: I was just having this discussion with one my foreign bank colleagues here because he was asking the same question. If a large global bank has to be locally incorporated, what are the pluses and minuses? A minus is that it gets a lower rating, whereas the bank is better rated globally. A minus is they have to raise funds at a local cost which is high. Otherwise globally they can raise funds at a low cost. I made a point to my friend here that if you are looking at India for the next 30 years there are huge opportunities in India as a country. If that is what it is, it is advisable to look at a bank within the country. You have an opportunity. Today, if the offer is made for the foreign bank to come in, and get incorporated locally, or an Indian corporation to start a bank, the Indian corporation will jump on it. t is the same opportunity coming to a foreign bank. The India corporate will jump on it and pick it up because it’s a good opportunity. It’s the way you look at it. But otherwise, for the regulator, it makes sense to have control of the banks operating, and all the regulators across the globe are preferring this model.

ED: Your balance sheet grew very much on its net interest margin rather than on fee-based business. Does that make you even more of a traditional bank, and do you have any ideas of increasing the fee-based component?

MVN: Yes, that’s a very good question. If you look at the last four years, our core fee income grew at a CAGR of 46%, and this year it will end up at about 8%. So after four years of exponential growth, it’s getting balanced out because there are one or two corrections that have taken place in terms of fee structure during this year. Going forward, the capability to grow with fee income is intact. There’s one year of correction, which is expected after exponential growth of 46% during this year. And we expect to grow at 25% consistently for the next few years. Coming to the net interest margin, it’s true that this year it’s been very good, but then we intend to maintain that at about 3.1 to 3.2% consistently year after year.

ED: What happens when the regulator finally starts to deregulate interest rates and deregulate the domestic money market?

MVN: The questions mark is if the regulator deregulates the savings bank interest rate, then what will happen? That is the question. It’s not that the bankers are not comfortable in deregulating the savings bank rate, but the issue is that this is a country where, if you go to the rural market, those 55 to 60% are the people who should be adequately compensated by the interest rate in saving account. In case the rate gets deregulated it may so happen that my charges on most of these transactions will get added because banks will make money. In case the interest rate goes up, my fee may go up, but today their basic accounts, are not charged. So a bank will find its balance. But the concern that we have is that rural consumers are not that well educated, and that they should not lose out when the interest rate actually comes down. If it goes up, it may go up, if it comes down, it can come down 1%, whereas they now get 3.5%. Otherwise banks will be able to pass on up-and-down interest rates.

ED: How international does Union Bank have to be? Or even you have to be, as chairman of Union Bank?

MVN: It is very much a part. The often-asked question is, when you have such a large market, where should you have global aspirations? How we look at it is that Indian corporations are truly going global and they need banking facilities and if we don’t follow them, some of the business that will normally come to us will be missing so that is the reason we opened our Hong Kong branch first, two years back. That bank branch is doing very well. We have approval to open up a subsidiary in UK, and we will also be opening one branch in Sydney, so we are slowly, not aggressively, opening, but we are just following our own clients. And this is a must. While India is as a country growing, we will be following our corporations globally.

ED: And on the technology front, what is the Internet doing to your bank?

MVN: Oh, it’s fantastic. I’m extremely happy the way that technology has helped us. When you compare India versus other countries, the technology cost in India is almost only 10% of the cost in many other countries and we are able to pass on that benefit to the customers very fast. What really surprised me is that in 2008 we tracked transactions taking place in alternative channels, and it was just 6%. In just three years, today, it is 47% of transactions and it is growing exponentially. I think it’s phenomenal. And the ability to pass on this benefit in the future is going to be fantastic.

ED: Is there any goal ambition to create market share in any one of your key products?

MVN: We have a very clear focus strategy. How we look at it is that there are three segments of customers, looking at the next ten years. One is our existing customers. If we look at the industry, we have 350 million customers as a whole. The next generation of customers, popularly known as Gen Y customers, who are today below the age of 15, are expected to be 350 million in number, an equal number to those today. Another segment coming up is new bankable customers who are unbanked today. Union Bank is well prepared in all three segments. With the unbanked customers, we are ahead of the curve. Our intention is to get 7% market share in unbanked customers, as against our present 3.5% share. The products are in place, the strategy is in place, technology capabilities are in place. I think we should be able to do it.

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