Innovations in Banking in next 5 years in

India
Innovation in Banking is going to be the key in FY 2010-2011 and beyond!

Innovation has always been an important area of focus for all industries, not just for
Banks. However, in view of the economic slowdown, it is common knowledge that banks
have been taking a very conservative approach over the last two years as many have been
consolidating their portfolio and innovating products had lost its importance and has
taken a back seat. We have not seen many innovative products designed for customers
during the consolidation phase, and rightly so, as the primary focus of Banks has been in
cleansing their portfolio and tightening credit extension apart from being extremely
guarded in getting only credit worthy customers in their books.

The scene in the Indian Banking industry is changing; the various global economies have
started showing signs of revival leaving behind them the worst recessionary phase and
moving towards growth. The Prime Minister of India, during the recent platinum jubilee
celebrations of Reserve Bank of India, has encouraged Banks to be more innovative.
Please recall the budgetary announcement by the Finance Minister on opening up the
Banking space by offering additional banking licenses to private players and NBFC’s. It
is expected that at least 5 more International Banking giants will set up operations in
India in the next 1-2 years, bringing with them superior technology. These are exciting
times for customers in India and challenging times for existing Banks, more so for the
Public Sector Banks.

The choice before the customer today is far wider both in the selection of banks as well
asproducts than ever before. The future growth is largely in retail banking. Innovating
products backed by superior service are vital to provide the cutting edge.

Here’s a quick look at some factors which may probably be the key drivers for
Innovation in Banking, keeping in mind customer expectations and behavior changes:

1. With intense competition between banks which is going to be more severe in the
coming years and with more private players waiting to step in, adopting new technology
has assumed added importance, especially for public sector banks. The key to success is
adopting state-of-the-art technology and continuously accelerating business processes.

2. Investment and innovation in technology will result in further advancement in credit

analytics systems that will help them assess customer behavior and enhance portfolio
profitability. Experience in matured markets has proven the value of credit bureaus in the
development of consumer credit. With the possibility of more credit bureau’s competing
with CIBIL looming large, further advancement and innovation to quickly assess
customer credit history will be a critical factor to provide convenience banking to
customers. The day is not far away where you call up your Bank for a loan, provide your
UID/PAN Number, your credit score verified, eligibility calculated and the processing is
completed almost instantaneously and the loan amount gets credited to your account
within 24 hours.

3. The 3G spectrum auction expected in mid 2010 across various circles to private
telecom providers in India will further open up immense migration possibilities to more
convenient channels. It may not be too long where the customer would access his bank
account using a secured application through his mobile phone. Needless to say, a secured
and fast internet banking platform will become a basic necessity.

4. RBI’s recent directive on payment of interest on daily balance maintained in the

savings account effective 1st April 2010 will result in higher outflow to Banks. This will
also result in the interest rates for short term deposits (7 - 90 days) undergoing an upward
revision as against the 2.5% - 3.5% being paid currently by banks on these deposits.
While most Banks seem to have enhanced their technology to comply with this interest
calculation methodology, this change however would result in an increased outflow of
around 20% in interest credits. Banks will find ways to innovate and encourage
customers to use their debit cards for purchases, bring the average daily balance down
and gain the differential between interchange spend and interest payouts. These strategies
of promoting debit card usage will also keeps the banking system going, interchange
revenues flowing in and ensuring that credit exposure by way of credit cards is
minimized.

5. Continuous innovation on the product offerings by Banks is paramount to ensure that

their products stand out from the crowd. A lot of effort and innovation from Banks is
required to make their product the preferred choice of the customer. This needs to be
backed by a powerful and customized loyalty program for customers to be continuously
encouraged to keep using their card. Service is an extremely vital cog in the wheel and
the Banks which make the investment to have superior service levels as their USP will
have a clear advantage. Investment in providing a chat interface as a service channel for
routine enquiries would be in line with times to come.

6. Ten years ago, a customer would have been happy to bank with those who provided
just a fixed deposit or a recurring deposit in addition to his savings account and a credit
card. Today, there is a need to spread the wealth around, diversify the savings into shares,
fixed de¬posits, mutual funds, pension products and insurance. Banks have a choice –
offer all these as part of their Convenience Banking to customers or lose him. This desire
and the compulsion to be the one-stop shop for the entire customer’s investment and
borrowing needs will ensure a lot of banks adopt this model increasingly.

7. Smart Cards embedded with microprocessors or memory chips will become tamper
proof and replace the existing plastic cards, offering customers a secure digital identity.
This will also provide convenience to customers; provide access to bank’s website and
individual accounts, accurate tracking of usage, spend analysis and manage long term
customer relationships through efficient, timely and valuable services to them.
8. Biometric ATM’s will replace the conventional ATM’s across the country, apart from
all banks investing in additional ATM’s. Banks can authenticate the identity of the
customer in three ways; most common being something the user knows (passwords or
personal identification numbers), something the user has (a security token etc) or
something the user is (a physical characteristic like fingerprint, palm geometry etc.,
called as biometric). With increasing threats on compromise of passwords and account
take over’s and misuse of cards, biometric form of authentication (which have withstood
the test of scrutiny coming out as the most secure form) for ATM and POS transactions
would be the way ahead. Statistics show that India’s ATM density is around 35 ATM’s
per million people which is abysmally low compared to the US’s ATM density of 1300.
This is an area of focus for many banks clearly, offering a branding and marketing
proposition for their investments apart from interchange revenues on usage.

9. Cheques will gradually be phased out and replaced by RTGS and NEFT and other
electronic forms of money transfers and payment mechanisms offering superior
turnaround times. Operational efficiency in processing electronic payment mechanisms
will undergo a radical change, with the beneficiary receiving the credit real time online.

10. The 2010 Census process which has begun is going to throw up interesting focus
areas for Banks. The demographics of our country, with 54% of the Indian population
being under 25 years of age and 60% within 40 years of age, will be a key driver to create
a large retail customer base. With increasing income levels and an annual GDP growth of
8.5-9% predicted for the next 2-3 years, this segment is a good target market to sell
insurance, mutual funds, credit cards etc.

With so much of talk about inclusive growth and focus on rural development, there is a
considerable gap between demand and supply for all financial services, especially in rural
segments. Almost 70% of the rural population does not have a bank account, 85% do not
have access to credit and less than 10% have any kind of insurance (life, health, crop
insurance etc). More importantly, still 60% of the rural poor borrow from moneylenders,
friends and other sources.

While banks have largely stayed away from lending to this segment leaving it to the
microfinance companies and institutions, the statistics suggest that non-performing loans
in the rural sector are similar to urban averaging between 1-2%. It would make enormous
business sense for banks and over the next few years, we would be seeing many banks
enter into micro finance which will, hopefully narrow the gap between banking services
provided in urban and rural India.

Here’s a look at some statistics on how the various segments within the Banking industry
today are placed in terms of financial strength to take on these challenges:

• SBI & Associates have been aggressive in their ability to attract capital, deposits and
investments and have been in the forefront in advances, followed by nationalized banks
and other scheduled banks. This also shows in their increase in income from interest and
other incomes. Foreign banks have been very cautious in their advances.
• Foreign Banks have a distinct advantage - their Business per employee is almost 100%
better than most banks in India and their profit per employee is 400% higher. Their cost
of funds (CoF) is also significantly lower by almost 25% compared to all banks and they
have performed well to get superior returns on assets. A superior CRAR, higher than the
overall industry average gives a lot of comfort but a significantly higher net NPA ratio at
1.80 is still a cause of concern.