Saturday, July 12, 2008



This report analyzes Banking industry taking into perspective the growth of the Indian economy and the sustainability of this industry in the present scenario. The report also contains an assessment based on Porters analysis, PEST analysis, covering the relevant political, economic, social and technological factors that have implications for the development of the bank. Additionally, it evaluates the industry within the Michael Porter framework. The report goes on to describe the competitive landscape and provides a comparative financial study of the major players in the industry. It also captures the important trends and key issues and provides an outlook on the bank.


Porters model is, applied microeconomic principles to business strategy and analyzed the strategic requirements of industrial sectors, not just specific companies. The five forces are competitive factors which determine industry competition and include: suppliers, rivalry within an industry, substitute products, customers or buyers, and new entrants. Porters 5 forces model is shown in figure 1.1.

Figure 1.1 Porters 5 forces model

Although the strength of each force can vary from industry to industry, the forces, when considered together, determine long-term profitability within the specific industrial sector. The strength of each force is a separate function of the industry structure, which Porter defines as "the underlying economic and technical characteristics of an industry."

Collectively, the five forces affect prices, necessary investment for competitiveness, market share, potential profits, profit margins, and industry volume. The key to the success of an industry, and thus the key to the model, is analyzing the changing dynamics and continuous flux between and within the five forces. Porter's model depends on the concept of power within the relationships of the five forces.

Porters 5 force model can help us determine the factors involved and various market forces that influence the functioning of the Bank business model. It helps in understanding the level of competition the banking industry faces, competition is an important factor to determine the level of profits the banking industry can achieve. Understanding the model helps banking industry to gauge its market positions. Understanding the competitors in the market can help the banking industry to gauge its strengths and weakness, and better equip itself to face the ever changing trends in the market, to optimize its profitability.

Let’s now customize the above model to understand the forces surrounding Banking industry.

Figure 1.2 Porters 5 forces model for banking industry

1.1 Bargaining Power of Suppliers to Banking industry

The Bargaining Power of Suppliers is high as there is rise in investment avenues like Mutual Funds, Tax-free bonds, Equity market etc. Providers of funds could be more demanding. As quality of services provided with minimum time matters a lot.

The term 'suppliers' comprises all sources for inputs that are needed in order to provide goods or services. Supplier bargaining power is likely to be high when:

  • Interest rates play a major role in the functioning of the bank.

  • Valuations of Dollar, Euro and Rupee play a major role.

  • The economic out look of the country determining the future of lending and borrowing capability of the bank.

  • RBI( Reserve Bank Of India) is the supreme controller of the functioning of the bank.

  • The functioning of the bank is very sensitive to the fluctuations in the interest rates of the Federal Reserve Bank in the US.

  • Since the bank has offshore operations in many countries its interest rate policy and products are directly related to the law of the land and the economy of the country. Example: Switzerland, Japan.

The bank does not have direct influence on the prevailing conditions it should adapt to the market and economic conditions.

1.2 Bargaining Power of Customers for Banking industry

Bargaining power of customers is very high, as banks have also forayed into the long-term finance.

Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes. Customers bargaining power is likely to be high when:

  • They take large volumes of loans and deposit large sums of money; there is a concentration of buyers.

  • The consumers have a wide choice of banks and services to choose, which offer very attractive offers for the consumers.

  • Retail lending (especially mortgage financing) formed a significant portion of the portfolio for banking industry and they have customized their products to cater to the diverse demands.

  • With better penetration in the semi urban and rural areas the bank garnered a higher proportion of low cost deposits thereby economizing on the cost of funds.

Figure 1.3 Distribution of financial services provided by banking industry

This pie-chart in figure 1.3 clearly indicates the distribution of financial services provided by banking industry as on May 2007.

Apart from streamlining their processes through technology initiatives such as ATMs, telephone banking, online banking and web based products, banking industry also resorted to cross selling of financial products such as credit cards, mutual funds and insurance policies to augment their fee based income.

Banking industry’s Foray into Rural Markets

Banking with the poor is a challenging task as the natures of demand requires doorstep services, flexibility in timings, and timely availability of services, low value and high volume transactions and requires simple processes with minimum documentation. The nature of supply however involves high cost of service delivery, rigid, inflexible timings and procedures and high transaction costs for the customers. With these features on the supply side, traditional banking is not poised to meet the requirements of the demand side. The reach of the banking sector in the rural areas was as low as 15% in terms of credit potential, and 18% in terms of population with physical access to a bank branch.

Banking industry chose to pursue the unreached rural markets as part of its strategy of being a universal bank. However, instead of taking the conventional branch banking model for increasing its outreach, the Bank decided to work with models which would combine the strengths of intermediary forms of organization with the financial bandwidth of a banking institution.

1.3 Threat of New Entrants for banking industry

Licensing and Government and RBI requirements, investment in technology, skills required for financial management, distribution reach, good branch networks. The entry of foreign banks is posing a big challenge.

The competition in this industry will be the higher, if it is easier for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty, financial services, and deposit interest rates) at any time. There is always a latent pressure for reaction and adjustment for existing players in this industry. The threat of new entries will depend on the extent to which there are barriers to entry. These are typically:

  • Economies of scale (minimum size requirements for profitable operations)

  • High initial investments and fixed costs

  • Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets

  • Bank reputation and brand loyalty of customers

  • Protected intellectual property like patents, licenses, etc.

  • Scarcity of important resources, e.g. qualified expert financial experts and adequate staff

  • Good network of branches with ATM’s channels are controlled by existing players
  • Existing players have close customer relations, e.g. from long-term financial service contracts

  • Moderate switching costs for customers

  • Legislation and government action that control the banking sector

RBI's roadmap for the penetration of foreign banks and the acquisition of stake by the foreign entities in Indian private banks seems to be a step towards facilitating entry of foreign banks into India. The twin-phased roadmap also seems to be towards fulfilling the key objectives of competition, consolidation and convergence in the sector. Policy initiatives such as lifting the 10% cap on voting rights in private banks was another much awaited decision for facilitating foreign ownership in private banks. This initiative is expected to pick up momentum once the sector opens up for foreign competition post FY09, banking industry has high vested interested for such moves.

Given the low credit penetration and strong capex cycle, credit growth for banking industry is expected to remain robust despite the prospect of rise in interest rates, going forward. While better asset quality projects a positive outlook for the bank, margin pressures and capital crunch remain some of the prime concerns.

1.4 Threat of Substitutes for banking industry

Threat of substitutes is also high as there are large numbers of investment and borrowing avenues. NBFCs and small co-operative banks are also posing a major threat to the market share of the bank.

A threat from substitutes exists if there are alternative banking services available with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for the bank. This category also relates to complementary products. Similarly to the threat of new entrants, the threat of substitutes is determined by factors like:

  • Close customer relationships

  • Switching costs for customers

  • The relative price for performance of substitutes

  • Current trends

  • High returns during Bull market.

  • People are not very conservative and are risk takers.

Non-banking financial companies (NBFCs) are privately owned financial intermediates focusing mainly on leasing, hire purchase, car and consumer durable finance, investment banking and advisory services. NBFCs are able to earn higher returns due to their ability to manage high-risk assets. For instance auto financing is high yielding. Banking industry also faces strong competition from mutual funds and stock markets.

FIs are not required to maintain cash reserve ratio (CRR) and statutory liquid ratio (SLR). Priority sector lending norm of 40% (of total advances) is not applicable to them. While this is at their advantage, they do not have access to low cost demand deposits. As a result their cost of funds is always high, resulting in thinner interest spread.

Non-banking finance companies (NBFCs) and housing finance companies (HFCs) that were banned from accessing the overseas market for resources by the Finance Ministry a few years back will now be able to access low cost funds through the FCCB route. This will not only ease pressure on their fund mobilization but also exert heavy pressure on banking industry and will have to face a stiff competition.

Investors’ awareness of trading in the Indian capital markets is a serious threat to the Revenue generation of banking industry.

1.5 Competitive Rivalry between Existing Players for banking industry

There are numerous informal financing in the rural area. There is intense competition due to the large number of capital markets in India for investing.

This force describes the intensity of competition between existing players and banking industry in financial markets. High competitive pressure results in pressure on prices and margins and thus on profitability for every finance organization in the segment. Competition between existing players is likely to be high when

  • There are many players of about the same size

  • Players have similar strategies

  • There is not much differentiation between players and their products, hence, there is much price competition

  • Low market growth rates (growth of a finance organization / individual is possible only at the expense of a competitor)

  • Barriers for exit are high (e.g. expensive and highly specialized service oriented approach)

  • Less paper work in case of rural / local financers

India’s capital markets have experienced sweeping changes since the beginning of the last decade. Its market infrastructure has advanced while corporate governance has progressed faster than in many other emerging market economies. Its Regulatory framework institutions like SEBI, Sock exchanges play a major role in India’s capital market.

An enabling environment is coming in place and there is an overriding increase in the domestic investors’ knowledge regarding the merits and risks of capital market investing. Professional financial services not only execute trades for their clients but also provide them critical and timely investment advice.

A person who had invested 10k every month from 1996 to 2006 in mutual funds have reaped an amazing returns of around one crore rupees. By timing the market properly based on technical or fundamental analysis, the returns are very huge compared to what one gets from investing in fixed deposits or other schemes in the banks.

Rural people have easier access to local financers rather than banks. Getting loans from informal financers is easier with hardly any paper work than undergoing a formal process in the banks. Illiteracy still has its strong hold on the minds of rural people and they feel that bank is not for poor illiterates like them.

Informal financers are very proactive in their restructuring initiatives be it in implementation or pursuing people. The rate of inflation draws the urban mass closer to the capital markets.

Many financial institutions such as SBI, HDFC, HSBC, ICICI Banks will spend the rest of this decade positioning themselves to meet the demand for long-term savings products and for life-cycle wealth management services.

Bringing intensive awareness in the rural people about the services provided by the banks and by eradicating illiteracy, banking industry can become a great success in the rural areas of the country. Having its branches even in the remote areas of the country is a necessity to overcome the challenges of the informal financial organizations or individuals.

By offering effective life-cycle wealth management services and by predicting changes in consumer preferences through the cycle banking industry can be very successful, at least in developed markets. Branding, product mix, customer service and performance metrics must all support the goal of building a long-lasting and multi-faceted relationship with the customer.


The “radical and ongoing changes occurring in society create an uncertain environment and have an impact on the function of the whole organization”. A PEST analysis is merely a framework that categorizes environmental influences as political, economic, social and technological forces. The analysis examines the impact of each of these factors (and their interplay with each other) on the business. The results can then be used to take advantage of opportunities and to make contingency plans for threats when preparing business and strategic plans.

PEST analysis is a useful strategic tool for understanding market growth or decline, business position, potential and direction for operations. The headings of PEST are a framework for reviewing a situation, and can in addition to Porter’s Five Forces models, be applied by companies to review a strategic directions, including marketing proposition. The use of PEST analysis can be seen effective for business and strategic planning, marketing planning, business and product development and research reports. PEST also ensures that company’s performance is aligned positively with the powerful forces of change that are affecting business environment. PEST is useful when a company decides to enter its business operations into new markets and new countries. The use of PEST, in this case, helps to break free of unconscious assumptions, and help to effectively adapt to the realities of the new environment.

PEST model is depicted in figure 2.1.

Figure 2.1 PEST Model

PEST Analysis for Banking industry

Political Factors

Focus on Regulations

High Capital Adequacy Ratio (CAR) for Implementation of Basel II

Economic Factors

Growing Economy

Low Interest Rates

Social Factors

Loyalty Factor

Increased Penetration of Cards

Increased Usage of Online Banking

Technological Factors

IT Services

Mobile Banking

Banking industry must build a high-performance culture centered around the customer. Staff incentives linked to customer satisfaction and service levels will become more prevalent. Timely and insightful metrics on customer attitudes will become a greater priority. Banking industry has to think about the customer experience first and their internal processes second if it has to stay ahead and to stave off its rivals.

Security will be a significant differentiator for financial institutions. The reputation and operational risks from breaches in security are growing, and franchises and brands can suffer immense damage from unauthorized release of data, or leaks from their own or an outsourced database.

Rising competitive pressures will force Banking industry to differentiate itself more aggressively, whether through its product mix, market focus, or branding proposition. Restructuring will focus on entrenching existing areas of strength, not developing entirely new ones.

Cost-efficiency will remain key factor. Expect a further acceleration in the outsourcing of non-core functions and greater emphasis on performance improvement as the bank will seek to increase the efficiency of back-office processes.

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