Kotak Mahindra Bank Ltd, the smallest among India’s new private banks by assets, seems to be following a unique business model built on the legacy of a lease finance and bill discounting firm that got approval to convert itself into a bank in 2003. It has been financing tractors, agriculture, commodities, commercial vehicles and construction equipment—something which it used do in its earlier avatar as a non-banking financial company (NBFC). Not too many banks in India fund such businesses.
Among other new private banks, IndusInd Bank Ltd has an exposure to commercial vehicle financing but that’s because of the merger of a group NBFC with itself. The erstwhile Centurion Bank Ltd (with which Bank of Punjab Ltd was merged, and subsequently, the merged entity was taken over by another new private bank, HDFC Bank Ltd) had exposure to some of these businesses as the lender had its origin in an NBFC, but instead of adding to its strength such assets actually dragged the bank down as bulk of them turned bad. Margin on such loans is relatively higher and risk is not too much as they are backed by assets.
What makes the Kotak Mahindra Bank model unique is not its exposure to such businesses, but its strategy of borrowing from India and lending to Bharat. Essentially this means 323-odd branches of the bank, most of which are located in urban centres, mobilize money from urban India and deploy in rural India. This is the reverse of what most Indian banks have been doing. Rural India traditionally is a reservoir of deposits and the money raised there is lent to urban consumers who borrow to buy homes and cars and finance their children’s education, holidays and investment in stock markets. The cost of such money is relatively low because rural folks normally do not keep their money in term deposits, which pay higher interest rates than savings deposits.
State Bank of India (SBI), the nation’s largest lender, mobilizes bulk of its deposits from rural and semi-urban India with its huge branch network. A relatively smaller bank such as Allahabad Bank, which has Rs 1.51 trillion in assets, also depends on its branch network in Uttar Pradesh and Bihar—India’s large hinterland—to raise cheap money. Foreign banks operating in India also indirectly depend on rural money. They do not have too many branches in rural and semi-urban India, but money raised from such pockets are available in the inter-bank market where traditionally cash-surplus domestic banks are lenders and foreign banks borrowers.
Kotak is happy borrowing from India and lending to Bharat as this makes business sense. Its net interest margin, or the difference between cost of borrowing and interest earned on loans, is 5.6%, the highest in the industry. Indeed, the operating cost is higher for handling such loans as they are small in size, but if a bank has the appropriate risk mitigation system in place, one can make good profit as the impact of one big-ticket loan going bad is much higher on a bank’s balance sheet than thousands of small borrowers delaying payments on account of a crop failure once in a while. Creation of such assets will be more challenging and exciting for the banking community as urbanization is gaining momentum, particularly in coastal India.
Census 2011 shows one in three Indians now lives in an urban habitat. The urbanization trend will throw new challenges to those Indian banks which want to take larger exposure to retail loans, but have not been able to do so. Take the case of Kolkata-based banks such as UCO Bank and Allahabad Bank. Allahabad Bank’s retail exposure is just about 14% of its loan book and that of UCO is even lower. Aren’t the consumers of West Bengal buying homes and cars? They are but when it comes to financing such assets, other banks which have presence in West Bengal are beating the local banks hollow. Incidentally, both UCO and Allahabad are not confined to the eastern state alone, they have presence across India (unlike United Bank of India, the third Kolkata-headquartered which is more region-focused). This means, they are not equipped to lend to the retail segment.
Technology is one area where these banks are lacking. Another area is possibly culture. For instance, the average age of UCO Bank employees is more than 50. At that age not too many employees are excited about the use of technology and neither are they in a position to appreciate the loan demand from young consumers. Many urban salaried employees now buy their first car in their 20s and home in their 30s. With an average age of employees over 50, a bank cannot woo such customers.
Cost of money for borrowers, both individuals as well as corporations, are going up with banks raising their loan rates. Even before the announcement of the quarterly monetary policy—slated next week—most banks have raised their loan rates and a few even their deposit rates, reacting to the last policy rate hike of the central bank in June.
Between January and now, SBI has raised its loan rate by 150 basis points (bps) and HDFC Bank by 175 bps. One basis point is one-hundredth of a percentage point. This makes clear that transmission of the monetary policy has become relatively faster. This has happened because of two reasons—by making the repo rate, or the rate at which the Reserve Bank of India lends to banks, its policy rate and keeping the financial system continuously in a cash-deficit position to make the repo rate effective. Is another round of rate hike round the corner? More on this next week.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Your comments are welcome at firstname.lastname@example.org