Tales from the Road: India

3 June 2019


Everywhere you go in Mumbai there are signs saying: ‘Mumbai is upgrading’… the same could be said of India as a whole.

India’s banks are full of potential. Not only are their growth prospects underpinned by a whole host of structural drivers, but relatively new developments, such as bankruptcy regulations and the rapid adoption of technology are opening the door to further possibilities. Paul Sloane, emerging markets portfolio manager, reports back from Mumbai on why he is even more positive on the investment opportunities in Indian financials.

India is Upgrading

Everywhere you go in Mumbai there are signs saying: ‘Mumbai is upgrading’. The slogan is a reference to the significant development work taking place on the city’s metro, but the same could be said of India as a whole – and in particular its banking industry

It's been a period of pain, but Indian financials are now emerging from a phase of elevated bad corporate debts and investors are re-examining the prospects for those companies with less well-funded business models. However, it was clear to me ahead of my trip that the raw materials are already in place for an extended period of high growth. My meetings with industry leaders and smaller disrupters left me confident on the future investment potential.

Structural reasons to invest

Indian financial services are something of an outlier within emerging market countries, with low levels of household debt, housing loan penetration and insurance penetration. These factors are critical building blocks supporting the growth opportunity for the country’s financial groups.


Meanwhile, financial inclusion in India has soared in recent years, with the share of adults owning a bank account rising from 35% in 2011, to 80% in 2017*. Financial inclusion and credit scoring for the entire population has been made much easier by the presence of Aadhaar, a strategic policy tool for social and financial inclusion implemented by the Unique Identification Authority of India (UIDAI). Aadhaar provides residents of India with a unique identifying number based on demographic and biometric information and is the world's largest biometric ID system. To illustrate the extent to which this is easing the process, new customers living in locations with no physical banks – or even an ATM – can have a 10-page credit report available without a lengthy delay. This is a phenomenal way for banks to access rural India.

Another positive factor is the increased likelihood of a further material shift in market share over time from public to private-sector banks. The latter still control a large part of the market but remain poorly capitalised, poorly funded and poorly run compared with their private-sector peers.

Financial institution account ownership rate India 2011-2017

Source: Statista, World Bank, Gates Foundation, Global Findex Database.

Game-changing new developments

What makes the current environment particularly exciting for me are the relatively new developments aimed at mitigating some of the risks which have dogged the industry.

The most important of these is the Insolvency and Bankruptcy Code (IBC) which was passed in 2016 and was a frequent discussion point throughout my company meetings. Its target is improving the country’s track record on bad loan resolution, by shifting the balance of power in bankruptcy cases from the business owners to the creditors.

The IBC has the potential to make a big difference in the thorny area of large corporate insolvencies. Under the new law, ‘promoters’ (an individual or group in charge of a firm) can no longer simply game the system in an attempt to retain ownership of assets. While some of the businesses I spoke to in India were cautious on how effective the IBC will be, others welcomed it, believing it is already encouraging better promoter behaviour. What was clear though, was that for businesses there is a big difference between the old process, where bankruptcy proceedings can face lengthy court delays and this newer faster-acting mechanism.

Other measures have also been brought in to reduce common issues for banks – for example to assist early recognition of corporate non-performing loans. Banks in India now routinely share monthly data on potentially delinquent corporate loans, using this data to strengthen early warning systems. HDFC Bank (held in the strategy) is an example of a bank with an excellent history of credit risk management.


One reason for this is its historic proactivity around the first instances of missed payments, which is designed to identify and cure potential non-performing loans before they occur. System-wide behaviours which mirror this approach can be seen as a real positive.

Making the digital leap is essential

One of the most significant developments in India is the arrival of new technology. In many areas it is leapfrogging other countries, not least in the rapid adoption of universal payment systems, such as UPI (United Payments Interface). The technological advances being made are undoubtedly helped by strong backing from central government – which looks likely to continue.

Many private banks would certainly appear to be on the front foot in terms of fully embracing the digital opportunities and new ways of working, including new partnerships, but companies are having to invest materially and wisely to ensure they are not left behind.

The banks we met were keen to demonstrate they are rising to the challenge. State Bank of India (not held in the strategy) for example, highlighted that it has the ex-CEO of IT services company Infosys on its board as part of its technology transition project. However, the most impressive banks I met were those which are showing real leadership in the field.

One example is ICICI Bank (not held), where the company’s approach is pitched at three levels. Its first tier is using technology to run the bank more efficiently, using 600 in-house and 1,500 long-term outsourced technicians. The second tier is about transforming the bank’s operations, working with partners on an open-architecture basis including Indian digital wallet company Paytm and US giant Google. The third tier is a full-scale ‘reimagining’ for the bank. It has a 25-member team dedicated to exploring the opportunities for stake building in fintech and backing smaller start-up projects, which could fundamentally change its business model in the future

Meanwhile, HDFC Bank, is using its data warehousing and analytics to develop a better understanding of its customers. It wants to lend more to its best customers. Its push into cross-selling has involved incremental retail lending to its top one third of its customers (15 million out of 45 million) and although much of the lending is unsecured in nature the sophisticated use of data is designed to risk manage the portfolio effectively. In many respects HDFC Bank has been focusing on data and technology long before it became an ever-present theme in global bank analysis and discourse.

Tactical reasons to be positive

During my visit, India was gearing up for its elections, and these results may act as a tactical or short-term driver of the market and Indian financial stocks. However, even on a medium-term basis (one to two years) there is a reasonably clear path on corporate credit, as many banks emerge from a period of elevated loan losses.

After a healthy quantum of loss recognition, it looks like the system will naturally repair over the coming years although this is likely to result in a big improvement in the reported profits of some weaker banks (which is not typically a trend we would look to capitalise directly on).

The technological advances being made are undoubtedly helped by strong backing from central government – which looks likely to continue.

From a short-term credit cycle perspective, we appear to be in a healthy phase. Interestingly, we have also seen new CEOs arrive at three of the largest six private banks with mandates to enhance risk assessment to prevent future credit cycles being severe.

Stock picking matters in Indian banks

The last year has served as a healthy reminder of the difference between growth and sustainable growth and has demonstrated that stock picking in this area is really important. Stress in the non-bank sector (especially in the housing and real estate lending sectors) has meant that any business model without strong funding or without the advantage of a strong parent have been heavily scrutinised.

The initial trigger for this stress may have been rising interest rates but even with this threat fading, investors have reassessed the safety of less-conservative lenders, many of which were positively viewed by investors up until this phase.

We have seen one high-profile insolvency in the financial sector, plus an about turn from another large mortgage lender (which conceded it has to convert to bank status to better secure funding for its business model). At some point, this level of stress could rise to where it triggers a fresh wave of loan losses for the whole financial system. For now, the main impact of tight liquidity has been to drive market-share gains, more deposits and better loan pricing for the strong banking franchises.

Sustainable growth is the key

The latest research from my company meetings in India has reinforced some of the really positive aspects to the country's financials from an investment point of view.

The latest research from my company meetings in India has reinforced some of the really positive aspects to the country's financials from an investment point of view.

To use a running analogy, with such growth potential, Indian financial companies need to be cautious of ‘running too hard’, being too aggressive in their attempt to advance forward. In the environment we see developing over the next few years, companies which take appropriate risk in lending and funding will see the benefit for both their own businesses and their shareholders. Our research is centred on those which are focused, not just on growth, but sustainable growth.

Technology is a critical input into any sustainability judgement and the strategy already has exposure, through HDFC Bank, to one of the world’s highest-growth, most technologically sophisticated and most risk-aware large banks. We are confident in its ability to continue to outpace the already exciting system growth on offer in India. Following our most recent trip to Mumbai, we are looking closely at several peers to judge which other business models share its sustainable growth potential.

Important information

This information is issued and approved by Martin Currie Investment Management Limited (‘MCIM’). It does not constitute investment advice.

Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
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