The respect and benefits that come with being a truly global bank are immense. From making the brand a trustworthy household name, to catapulting the executives to rockstar status, the lures of it are massive. But should the State Bank of India pursue this dream at the cost of profitability

Shakti Shankar Patra | @TheDollarBiz 

The year 2008 changed the way the global banking industry functioned. Massive deregulation and a very loose interest rate policy to tide over the twin crisis of the dot-com bust and 9/11 attacks meant that credit had been allowed to flow into the broader economy at a rate never before seen in human history. Consumer credit had soared, house prices skyrocketed and bankers had their hands full. But with interest rates near-zero, it was difficult for a bank to make a killing in the traditional way. So, what had followed was financial engineering of the most bizarre kind and, as always, the epicenter of this was US.

From mortgage-backed securities (MBSs) to credit default swaps (CDSs); from collateralised debt obligations (CDOs) to collateralised bond obligations (CBOs) – every penny lent was packaged and repackaged and speculated on. To ensure a steady flow of such products, multi-million dollar loans were given to even those who had the worst possible credit profile – some of these loans colloquially being called no income, no job, no asset (NINJA) loans. Rating agencies also saw this as an opportunity to make hay and gave AAA ratings to even the most risky debt. As long as the music played, the party continued. But when it stopped, banks had nowhere to hide.

While the bursting of the credit bubble mostly affected western banks, those in India were not entirely immune. Any kind of exposure to the US and European housing market was looked at with suspicion and the toughest of questions asked. What helped Indian banks tide over the storm unscathed though was their limited exposure to the western housing market, thanks to strict regulations of the Reserve Bank of India, which was admired all over the world for its role in curbing the animal instincts of Indian bankers.

With this backdrop and barely five years since the credit crisis, it must be surprising to many that Indian banks are actually looking outward to fuel growth. And the largest among them – State Bank of India – is at the forefront of this.

As old as the hills

In its current avatar, the State Bank of India is exactly 59 years old as it came into being on July 1, 1955, after the State Bank of India Act was passed by the Parliament. However, its origins can be traced back to 1806. That’s right; SBI is actually older than the country it is based in! Four years after the State Bank of India Act was passed, the Parliament passed the State Bank of India (Subsidiary Banks) Act in 1959, which made eight other banks its subsidiaries.

SBI also has a long history of acquiring other smaller banks – mostly in bailouts. The first bank that SBI rescued and acquired was the Bank of Behar in 1969, followed by the National Bank of Lahore, Krishnaram Baldeo Bank, Bank of Cochin, State Bank of Travancore and several others. A Fortune 500 company, SBI currently has consolidated assets worth Rs.23.95 lakh crores, 15,869 branches, 190 foreign offices, over 21.9 crore active customers, 43,515 ATMs across India, 1.77 crore Internet banking users, 95 lakh mobile banking users, and of course over 2.2 lakh employees.

Against the best

According a Capgemini report on the global banking industry, total assets of the world’s top 1,000 banks grew by 4.9% in 2012 whereas a The Dollar Business Intelligence Unit analysis reveals that the average of the same for SBI in FY2012, FY2013 and FY2014 stood at 12.52% – almost 8 percentage points higher. Similarly, in terms of Cost to Income ratios, while the same for North American and European banks in 2012 were 67.8% and 64.2% respectively, the three year average for SBI is 48.8% – again 15 to 19 percentage points lower. This basically means that not only are global banks (particularly those in Europe and North America) growing at a much slower rate than SBI, but are also incurring more for every penny worth of income as compared to the Indian behemoth. If these numbers are not enough to persuade the SBI management to stick to India and dissuade them from venturing out (unless it’s for an ego boost), then a look at the net interest margin for SBI’s own domestic and foreign operations should seal the deal.

According to SBI’s FY2014 Annual Report, the bank had a domestic net interest margin (NIM) of 3.49% while the same for its foreign offices was just 1.42% – more than 200 bps lower! So, why is SBI trying to expand its global footprint when domestic interest margins are higher and cost of operations are lower? That’s a billion dollar question.

Lure of foreign shores

In the traditional sense, banking is a monotonous business. A banker accepts deposits at X% and lends at Y%. The only way it makes a profit is in terms of the difference between Y and X. And when things go wrong, one bad loan can wipe all the gains made by virtue of the difference between Y and X. About 60-70 years back, the global banking community understood this. It just couldn’t live with the tiny profits it was making while the businesses it was lending to, were spinning out the big bucks. Hence, it started venturing out into areas – from raising money for businesses to downright speculation – which never made sense to the purists. While in the short run this meant great margins that made shareholders happy, in the long run it was a disaster waiting to happen. While post several such booms and busts, regulations in the West have been tightened and ‘pure banks’ are not allowed to speculate with depositors’ money there are always ways around such regulations that are brazenly exploited in the West. Is it this lure that is making India’s top bank look elsewhere?

The second home

While explaining the concept of risk free rate, a renowned professor once told his class, “There’s no investment that is risk free; the closest you have in India is deposits with SBI.” While the statement was made in jest, it conveys the respect that SBI is given in our country. And maybe the obligation that comes with this kind of respect has forced SBI to cater to the Indian community abroad and also the banking needs of the exporters and importers community.

While SBI has a presence in 36 countries, a close look at the entire list makes it clear that the focus has been on countries with a large expatriate Indian community, like Bahrain, Singapore, Mauritius, Canada, South Africa, and of course US. In fact, one of the main subsidiaries of SBI in the US is State Bank of India (California). Established in 1982, with nine branches in California and one in Washington D.C., SBIC primarily caters to the huge Indian community in Silicon Valley – something that becomes very clear by a single look at the bank’s website what with ‘Exchange Rates’ section talking only about remittances to India! One gets the same impression after visiting the website of State Bank of India, United States of America. With a slogan like ‘Your Best Link to India’, the bank has made it very clear that it essentially is for Indians in US or for those doing business in India – unlike the Citibanks and Deutsches of the world, who are in India, catering to Indians.

Epilogue

To be fair to SBI, the rate of growth of its foreign offices have slowed down in the last two years. After a 54% jump in the number of its foreign offices in FY2010, it has added just 17 new foreign offices in the last two years. So, maybe the realisation has sunk in. But a look at the balance sheet, raises eyebrows yet again. In the last five years (since FY2009), growth in the bank’s foreign offices assets has clearly outpaced that of its total assets. While the difference is not massive and a lower base in foreign offices could be one of the reasons for this, the question remains as to why would a bank accumulate more and more assets (which means more and more liabilities) if the return on those assets (RoA) is progressively lower?

As per the earlier mentioned Capgemini report, the RoA of Latin American banks, at 1.6%, was the highest in 2012, while the same for banks in Asia-Pacific region was at 1.1%. As compared to this, SBI’s average RoA for FY2012, FY2013 and FY2014 has been just 0.83%. This obviously means SBI is grossly underperforming its peers in emerging markets, despite witnessing a strong growth in total assets. While an anaemic domestic economy and rising NPAs were the main reasons for this, a calmer growth in foreign offices assets, would have reduced the overall asset size and improved its RoA.

If one takes into account the fact that RBI is now handing out new banking licenses (since the penetration of banks in India is very low), it makes even more sense for SBI to stop looking elsewhere and concentrate on the domestic economy. Of course, if alpha returns from foreign lands in the years to come, you’ll find us writing otherwise.