BFSI sector – An Overview of the Banking Industry
BFSI stands for the Banking, Financial Services, and Insurance sector. Fundamentally, it represents a major portion of the multi-billion dollar Indian economy comprising all Banking, Insurance, and Non-Banking Financial Institutions. The latter is known as the NBFCs. Also, the BFSI industry largely refers to financial service firms such as Broking, and Asset Management.
India, as a business destination, fosters all the positives for the BFSI sector to flourish at an appreciable pace. Inter-dependent factors of government policy, active public/private involvement, robust regulatory measures, and technological evolution have spurred the BFSI sector to register strong numbers in recent years.
Banking is one of the pillar components of the BFSI industry. It would not be wrong to call it an industry in and of itself, comprising of the following structure:
1. Central Bank
This bank is the highest in the pecking order of any national economy holding regulatory powers to supervise the functioning of the national (restricted to a country) banking industry. It authorizes the flow of currency, reducing or increasing the same to keep inflation in check. Only the Central Bank of a country has the power to print the paper currency of a nation. In India, the Reserve Bank of India is the designated Central Bank of the country.
2. Scheduled Commercial Banks
They are further classified into 3 categories:
- Public Sector Banks (PSB)
It refers to those banks wherein the government owns the majority stake i.e. greater than 50% and whose shares are listed on public exchanges. Effective from April 1st, 2020, the list of active public sector banks has been reduced from 27 to 12. This is the result of a few PSBs being merged under a single pre-existing bank. An example would be Vijaya Bank and Dena Bank being merged into the Bank of Baroda. State Bank of India, Bank of Baroda, and Bank of India are a few examples.
- Private Sector Banks
This refers to the banks where the majority stake/equity is controlled by private shareholders. The Indian economy houses 22 active Private Sector Banks as of writing. Examples include HDFC Bank, ICICI Bank, Axis Bank, etc.
- Foreign Banks
This refers to any bank that is headquartered outside India. Host-countries (in this case India) savor a dual benefit as foreign banks accelerate dealings in international transactions along with increasing the employment scope in the banking sector. As of writing, there are a total of 45 foreign banks in India. Examples include Citibank, Standard Chartered Bank, HSBC, etc.
3. Regional Rural Banks (RRB)
By definition, their incorporation is scheduled by the government of India, essentially making them government banks. Their primary objective is to serve the rural regions where they are chartered to be established, however, this is not to be confused with a statutory restriction to expand. RRBs may or may not have branches in urban district centers. E.g. Karnataka Vikas Grain Bank.
4. Cooperative Banks
Their objective is to promote social welfare, hence the schemes are targeted towards under-privileged or financially under-serviced sections of the society. Although they welcome business from all socio-economic sections, the incoming capital is utilized to grant loans to the working class such as agriculturists. They function on a no-profit no-loss basis and are further divided into the following types:
- State Co-operative Banks (SCBs) – It is the largest division of the Central Cooperative Bank operating at the state level. Their source of funds is loans, social capital, or overdrafts of the Reserve Bank of India.
- Primary Credit Society (PCS) – It refers to an institution with the ability to disburse loans at a smaller regional level, such as a village.
- District Central Co-operative Banks (DCCB) – These banks operate at a district level in India. They bridge the link between an SCB and PCS offering banking services to mainly the agricultural sector.
- Urban Co-operative Bank (UCB) – They have branches in the urban/semi—urban centers of India and cater to mainly small businesses.
5. Specialized Bank
Their banking assistance is limited to a particular industry. They are of three types:
- Export-Import Bank of India (EXIM Bank) – It assists the export and import sector of India.
- Small Industries Development Bank of India (SIDBI) – Businesses operating in small-scale industries can get loans on easy terms through SIDBI.
- National Bank of Agriculture and Rural Development (NABARD) – It provides financial help to the agricultural sector of India.
6. Development Banks
Such institutions are also referred to as development finance institutions or a development finance company. They provide capital assistance for economic development projects. Their objective is not to make a profit but promote social development and such banks may be set up by either the governments or charitable institutions. Examples of such banks in India include Industrial Finance Corporation of India (IFCI), and State Finance Corporations (SFC).
7. Small Finance Bank (SFB)
They target overlooked sections of the society by other banks such as micro industries, unorganized sectors, small or marginal farmers, etc.
8. Payments Bank
Except for issuing loans and credit cards to customers, Payments Bank accept restricted deposits from customers up to INR 1, 00, 000. Their portfolio of services includes issuing debit/ATM cards, current/savings account, and offer mobile banking and financial services to customers. Examples include Airtel Payments Bank, Jio Payments Bank, and Paytm Payments Bank.
10. Non-Banking Financial Institutions (NBFCs)
NBFCs are financial institutions offering a variety of banking services but they do not have a banking license. In a conventional sense, NBFCs are not allowed to accept demand deposits or funds otherwise stored in a savings account, from the public. Their scope of services could include offering loans, credit, underwriting, retirement plans, and merger proposals.
As per government-funded research, the Scheduled Commercial Banks comprise the largest share of the banking sector (76.1%), followed by the NBFCs (15.4%), Cooperative Banks (6.8%), and finally, Regional Rural Banks (1.7%). In the last 3 decades, in particular, the Indian Banking industry has come leaps and bounds to its present-day image of a global financial powerhouse. This introduction of forward-thinking steps to revitalize the economy can be traced to 1991- 1997 when the entry of new private sector banks infused competition in an otherwise dormant industry.
Bringing Banking Up to Standard
With such diverse banking institutions in the county, the banks themselves have been forced to define a clear and progressive working mode. This includes well-defined channels for customer acquisition, a workflow to divert the incoming streams of capital, and monitoring the overall efficiency of the process. A banks’ working model consists of the following key steps:
1. Fund Mobilization
Banks raise capital (money) by inviting people to deposit money safely in the savings account. Their universal selling point (USP) lies in offering higher and better interest rates to consumers for doing so. Also, banks offer schemes to institutions for depositing funds. This huge chunk of money, both from retail and institutional customers is utilized to issue bonds in the market that public/private investors could purchase due to the value of their dividend earning potential over time.
This stage comprises detailed research to allocate the capital raised in the previous step. Research Analysts finalize a viable portfolio through which to use this capital to offer loans, credit, etc. and design various other financial instruments with strategic pricing.
This is arguable the most crucial stage where the banks establish physical (or online) touchpoints with their customers. Naturally, that commences by setting up branches in localities with the target consumer. The branches are then clustered under a Regional Offices and Processing Centres.
- Compliance Risk Management
The government has set up authorities, such as the Reserve Bank of India, to maintain oversight and ensure the smooth functioning of the banks in line with regulatory measures. Managing money requires high-stakes governance and risk management. This risk is in turn associated with and classified into credit risk, market risk, and operational risk.
- Service/Product Delivery
This is one of the key components that contribute to a bank’s profit books. A bank has to continuously add more and more retail customers opting for a savings account. To accelerate this account creation, a bank may offer higher interest rates to customers, and top it off with customer servicing for user retention.
4. Performance Monitoring
One of the prime aims of a bank remains initiating as many operating units (branches) as possible to acquire and serve the widest audience possible. Similarly, it is also a bank responsibility, that if it lends out loans via schemes or credit cards, that the same is recovered ethically and timely.
The industry has seen an increase in newly opened branches as India steps up efforts to bring the largely rural regions of the country to grips with banking. As the unexplored financial potential of the rural masses surfaces, there is a trend that suggests higher cross-product upselling across all banks.
The Ballooning Banking Reach in India
The top states in India, with the highest number of bank branches, are urban. Metropolitan areas with maximum development index. In the northern part, the locations include cities like New Delhi, Gurugram, Lucknow, and Kanpur. Similarly, in Southern India, the locations include Kochi, Coimbatore, Bengaluru, Hyderabad, Mumbai, Pune, and Nagpur.
Studies suggest the top 5 cities have reached their saturation point in terms of banking opportunities. Therefore, the effect would now seep out to the peripheral semi-urban and subsequently to the rural regions of the country. Unsurprisingly, that makes Tier I and Tier II cities the low hanging fruit the banking industry would go after. This effect is also being driven by the penetration of technology with cheaper smartphones that have led to the broadening of the average financial know-how of a citizen in such areas.
Government directives are gravitating in the same direction, with the Reserve Bank of India mandating in the past all domestic scheduled commercial banks to open a minimum percentage of new branches in semi-urban and rural areas.
Rising Trends in the Banking Industry
As pointed in the last section, technology has played an influential role in furthering the cause and effect of banking on the Indian masses. In addition to that, the industry owes its current shape and size to developing trends like growing customer centricity, from the banks towards customers. This has allowed wider competition and more options for people to choose from. Alternative Channels such as Point of Sale (PoS) terminals have digitally transformed the industry to make services mobile-friendly. As per a stat, in 2020, such channels will account for an estimated 87% of the transaction volume. Government Regulations are supporting the innovation in the industry the effect of which is visible in the following trends:
a. Digitization & Digitalization
The advent of services like internet-enabled banking, Real Time Gross Settlement, National Electronic Funds Transfer, and Immediate Payment Service (IMPS) have driven the cost of operations down. They are aiding front-lines to make fewer human errors than before and adding to the profit margins of the banks.
b. Online Mobile Banking
Mobile banking apps have taken banking to a whole new level and reduced the dependence on retail banking outlets. At the moment, an individual with a smartphone and an internet connection can easily monitor account balance, perform fund transfer, and make payments without visiting the branch. In the not so distant future, we can easily see the Internet of Things (IoT) and voice-enabled functions making banking seamless. Real-life use cases of the same have already made it to our homes with television, cars, and other appliances becoming voice-friendly.
c. Unified Payment Interface (UPI)
Staying put with technology, a Unified Payment Interface app is a payment system that allows immediate inter-bank fund transfer with a few clicks on your smartphone. It was engineered by the National Payments Corporation of India with the ruling oversight of the Reserve Bank of India. As far as inter-bank payment systems go, it doesn’t get any better than this. Introduced in the year 2016, the service is available 24/7, 365 days. As of writing, more than 50 banks support fund transfer through UPI.
This immutable technology has served ample proof to show how far it can go in securing records and preserving the history of data. The tech has crossed over from blog-hype on to ground realities and wherein the NITI Aayog is tasked with creating IndianChain to speed up transactions and reducing the risk of fraud.
e. Digital-Only Banks
In other words Payment banks. This is a new category of banking introduced by the Reserve Bank of India. Payment banks have the legal capacity to offer the majority of facilities that conventional banks do, except for issuing loans and credit cards. Each retail customer can deposit up to Rs. 100, 000 in the payments bank. Eleven entities have been accredited the license to operate as a payments bank by the RBI. Of these 11, 6 are active at the time of writing.
In FY 19, the Indian economy grew at 6.8%. Figures suggest that the economy could grow in 2019 - 20 at a pace of 5% and approximately 5.8% in 2021. With the rising disposable income of the masses, the banking sector as a whole would continue to expand at a double-digit CAGR from 2019 – 2024.