Last week, in an interview with a television channel, ICICI Bank Ltd’s joint managing director and chief financial officer Chanda Kochhar said the bank is not looking at any of the sick financial intermediaries overseas for possible acquisition, even though there have been offers.
“Just because something comes cheap, you don’t necessarily have to buy it,” she said. “You need to see the quality of assets. There are many challenges and we don’t need to go for these challenges. We are happy to take those risks that we understand.” This is a rather dramatic statement from a bank that so far believed in the culture of high growth, high delivery and high performance.
Investors rushed to dump ICICI’s stock last week, fearing it has huge exposure to Lehman Brothers Holdings Inc., which filed for Chapter 11 bankruptcy in the US. In three trading days, ICICI Bank lost some 14% of its value. Since the beginning of the year, its market value has been eroded by more than 49% while the Sensex, India’s most-tracked equity index, has lost much less, about 31%, and Bankex, the banking industry index, 38%. Investors’ fears seemed misplaced as ICICI Bank’s exposure to Lehman is relatively minuscule, but that did not put a lid on rumours of bank directors selling their stocks and depositors withdrawing money.
ICICI Bank was created in 2002 after the 1955-born development financial institution ICICI was merged with its subsidiary, floated in 1994 when the Indian central bank gave licences to the first set of so-called new private banks.
The merger, which created India’s first universal bank, or a one-stop shop to meet all financial needs of consumers, was a compulsion for the group as the development financial institution lost its relevance in a liberalized economy and was fast crumbling under huge asset-liability mismatches. As the government was no longer doling out subsidized funds to such institutions, ICICI was borrowing short and lending long for projects. The rising interest rates and tight liquidity that hit the financial system in the mid-1990s also took its toll on the quality of assets. Along with growing asset-liability mismatches, the piling of stressed assets was also a big concern for K.V. Kamath, who took over as managing director and chief executive officer in May 1996, replacing Narayan Vaghul.
In the run-up to the creation of the universal bank, Kamath stitched a string of mergers to build the scale. First, SCICI Ltd, a shipping finance firm within the group, was merged with ICICI. This was followed by mergers of two non-banking finance firms with it, Anagram Finance Ltd and ITC Classic Ltd. Bank of Madura, a south-based old private bank with substantial exposure to farm loans, was also merged with ICICI. Recently, ICICI Bank acquired a Russian bank, Investitsionno-Kreditny Bank, with a small asset base, and an equally small domestic bank, Sangli Bank Ltd.
These mergers have helped ICICI build the scale to some extent, but not the infrastructure that a bank needs to support the scale. It employed thousands of agents to sell mortgages, car and consumer loans, aggressively tapping the rising disposable incomes in the world’s second fastest growing major economy, but these cannot garner deposits.
In the absence of retail deposits, the bank’s dependence on high-cost wholesale deposits has grown, bringing down its net interest margin or the spread between the cost of funds and its earnings on such funds. Its low net interest margin is partly compensated by ICICI Bank’s high fee income, about 40% of its total income, the highest among Indian banks and comparable with global banks. But to raise its fee income it has exposed itself to complicated, structured derivative products both in India and overseas.
The high-growth business model has also forced it to raise equity from the market frequently. This has a chain effect and the bank is always under pressure to keep the growth momentum as otherwise the return on its expanding equity shrinks. Between 2004 and 2007, its balance sheet has grown at more than 40% every year. It has also aggressively expanded its overseas presence in past few years, setting up shop in 18 countries and building $25 billion (Rs1.1 trillion) of assets, roughly one-fourth of its book.
This business model worked wonderfully in a booming economy but the scenario has changed. It cannot push growth overseas because of global risk aversion following the subprime crisis that is rocking the financial world. With rising interest rates and tightening liquidity, the loan growth on home turf is also slowing and the quality of assets is deteriorating. Higher non-performing assets, or NPAs, call for higher provisioning, and that affects profitability.
To be sure, ICICI Bank is well capitalized and it does not have any liquidity problem. But it needs to get rid of its obsession for growth in a slowing economy.
The business model needs to change from growth to consolidation. The share of retail assets of the bank in its overall asset base that was 65% a year ago has already come down to 52% and will shrink further. Similarly, its portfolio of high-cost wholesale deposits is also coming down with increasing focus on low-cost current and savings accounts. It has also got rid of its entire $700 million exposure to credit derivatives such as credit defaults swaps, credit-linked notes and collateralized debt obligations in its overseas books.
But the most important outcome of the mini crisis is ICICI Bank’s realization that it doesn’t need to embrace risks that it does not understand. For India’s largest private sector bank, it signifies a big cultural shift.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org.
Also Read Tamal Bandyopadhyay’s earlier columns