The document discusses key points from a banking conference in India regarding regulatory views on Basel III and opportunities for infrastructure and SME financing. Regulators are taking a conservative approach to Basel III implementation to ensure long-term stability. Additional capital requirements for Indian banks are estimated at ~INR5t by 2018, with financing state-owned banks being a challenge. Priority sector lending remains a focus, and structural changes are needed to better support SME and infrastructure financing opportunities.

1. 12 September 2012
Update
Financials
Regulators' views: Conservative approach on Basel III; focus on priority sector
Panelists' views: Structural changes required to capitalize on huge infra and SME financing opportunity
We attended FIBAC 2012, an annual Banking Conference organized by the Federation of Indian
Chambers of Commerce and Industry (FICCI) together with the Indian Banks' Association (IBA).
Key takeaways from Panel discussions and expert speak:
 Basel III - RBI maintaining stance of conservative regulator; willing to impose higher cost in
the near term for long term financial stability
 Huge capital requirement of INR5t by March 2018; financing state-owned banks a challenge
 Focused approach on priority sector lending; banks need to be efficient in intermediation
 SME and Infra financing - huge opportunity; structural changes required
Basel III - RBI maintaining conservative stance
The RBI's decision to adopt Basel III guidelines with
more conservative requirements indicates its
willingness to impose higher cost in the near term to
achieve long-term financial stability of the Indian
Banking system. The reason behind RBI's decision for
Indian banks' higher capital requirement under Basel
III v/s global peers is to address any judgmental errors
under standardized approach of Basel II (e.g. wrong
application of risk weights, mis-classification of asset
quality, etc). Also, the RBI does not want to dilute the
comfortable position that Indian banks have as far as
leverage is concerned and has prescribed Leverage
Ratio of 4.5% v/s the Basel Committee recommendation
of 3% during the parallel run. RBI will decide the final
leverage ratio post final prescription by Basel
Committee.
Huge capital requirement; financing state-owned
banks a challenge
Indian banks' current capital levels are comfortable at
the aggregate level even as per Basel III, though some
individual banks may need to raise capital.
Nevertheless, their capital requirements are expected
to increase, as growth accelerates, going forward. Based
on the RBI's quick estimates, the additional capital
requirement for the Indian banking system till FY18
would be ~INR5t (equity capital of INR1.75t + non-equity
capital of INR3.25t). As far as state-owned banks are
concerned, a lot will depend on how much the
government contributes. RBI estimates indicate that
state-owned banks may have to raise INR0.7t-1t from
the capital markets.
Focused approach on priority sector lending;
banks need to be efficient in intermediation
Providing timely and adequate credit to deserving but
underprivileged sections of the society remains a top
priority for the RBI. The declining share of agriculture
in GDP, and thus, lack of absorption capacity cannot be
accepted as a valid reason for prescribing lower targets,
as agriculture segment generates employment for
nearly two-third of India's population. The RBI has
largely maintained the targets and sub-targets within
priority sector loans (PSLs), as it did not want to distort
the allocation of credit by banks. On-lending to NBFCs/
HFCs is not classified as PSL - banks need to lend directly
(instead of relying on NBFCs/ HFCs), reduce
intermediation cost, and provide the benefit of lower
cost directly to customers.
SME and Infra financing - huge opportunity;
structural changes required
The panel discussions on lending to small and medium
enterprises (SMEs) and infrastructure financing mainly
revolved around the major issues/challenges that
banks face in lending to these segments, while
acknowledging the huge financing opportunity that
these segments offer, structural changes by the
government of India (led by strong political will) to
improve the investment climate and steps to improve
fund flows are the key requirements to boost the
Infrastructure segment. Greater cooperation from
financiers (e.g. increased support in documentation)
and awareness of special schemes launched by the
SIDBI (with government support) are some of the
suggestions to improve the flow of credit to SMEs.
Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com) + 91 22 3982 5415
Sohail Halai (Sohail.Halai@MotilalOswal.com) / Umang Shah (Umang.Shah@MotilalOswal.com)
Investors are advised to refer through disclosures made at the end of the Research Report.

2. Financials | Update
Dr D Subbarao, Governor, RBI on Basel III
Additional capital requirement of ~INR5t for Indian banking system by Mar-18



Dr D Subbarao
Governor - RBI

Dr Subbarao addressed some of the major conceptual and implementation issues related
to Basel III. He explained that the RBI's decision to adopt the Basel III guidelines with more
conservative requirements indicates its willingness to impose higher cost in the near
term to achieve long-term financial stability of the Indian Banking system.
Indian banks' current capital levels are comfortable at an aggregate level even under
Basel III, though some individual banks may need to raise capital. The RBI's quick estimates
indicate additional capital requirement of ~INR5t (equity capital of INR1.75t + non-equity
capital of INR3.25t) for the Indian banking system by March 2018.
The reason for higher capital requirement for Indian banks under Basel III v/s global peers
is to address any judgmental errors like wrong application of risk weights, misclassification
of asset quality, etc under standardized approach of Basel II.
Also, the RBI does not want to dilute the comfortable position Indian Banks have as far as
leverage is concerned. It has prescribed Leverage Ratio of 4.5% for Indian banks v/s the
Basel Committee recommendation of 3% during the parallel run. The RBI will announce
the final Leverage Ratio once the Basel Committee issues its final prescription.
Charges against Basel II in light of global financial crisis only partly valid
Basel I had a 'one size fits all' approach, which was corrected with Basel II, which
introduced risk sensitive capital regulation. Factors that led to the global financial
crisis (GFC) under Basel II are:
 Risk-sensitive capital regulation made it pro-cyclical, leading to the vicious cycle
of deleveraging. In difficult times, Basel II imposed additional capital
requirements, which banks were unable to bring in, leading to deleveraging. To
an extent, Basel II also lacked changes in the definition and composition of
regulatory capital.
 Basel II lacked explicit regulation that governs leverage.
 Focus was exclusively on individual financial institutions and systemic risk arising
from interconnectedness was ignored.
Failure of the market risk
framework underlying
Basel II may have
supported the crisis, but
may not have caused it
Dr Subbarao mentioned that above mentioned charges against Basel II are only partly
valid, as Basel II, which became operational in June 2006, was still largely work in
progress when the crisis began unfolding in August 2007. Hence, it is possible that the
failure of the market risk framework underlying Basel II may have supported the
crisis, but may not have caused it.
Basel III an attempt to plug loopholes in Basel II
Basel III maintains the
core essence of Basel II
with higher emphasis on
core equity
12 September 2012
Basel III is prepared to plug the loopholes in Basel II and try to reflect the lessons
learned during the crisis. Basel III maintains the core essence of Basel II, which is the
link between the risk profiles and capital requirements of individual banks. Key
changes in Basel III v/s Basel II are:
(a) The quality and composition of capital has been enhanced, with more emphasis
on core equity capital.
(b) Introduction of capital conservation buffer to the tune of 2.5% to ensure that
banks are able to absorb losses without breaching the minimum capital
requirement.
2

3. Financials | Update
(c) Introduction of the countercyclical capital buffer of 0-2.5% of risk-weighted assets
(RWA), which could be imposed on banks during periods of excess credit growth.
(d) A provision for a higher capital surcharge on systemically important banks.
(e) Prescription of minimum Tier-I leverage ratio to avoid excess leverage in the
system due to risk sensitive approach of capital requirement.
(f) Measures to tackle potential short-term liquidity stress and longer-term structural
liquidity mismatches in banks' balance sheets.
Requirements under Basel III, globally
Globally contribution of
core Tier-I equity
has been raised from
2% to 4.5%
Capital Requirements under Basel II and III (%)
A = B+D Minimum Total Capital
B
Minimum Tier 1 Capital
C
of which, Minimum Common Equity Tier 1 Capital
D
Maximum Tier 2 Capital (within Total Capital)
E
Capital Conservation Buffer (CCB)
F = C+E Minimum Common Equity Tier 1 Capital + CCB
G = A+E Minimum Total Capital + CCB
Basel II
8.0
4.0
2.0
4.0
0.0
2.0
8.0
Basel III
(as on Jan 01, 2019)
8.0
6.0
4.5
2.0
2.5
7.0
10.5
Liquidity Standards
Ratio
Liquidity Coverage Ratio (LCR)
(to be introduced as on January 01, 2015)
Basel II
-
Net Stable Funding Ratio (NSFR)
(to be introduced as on January 01, 2018)
-
Basel III
Stock of high-quality liquid assets > 100%
Total net cash outflows over the next
30 calendar days
Available amount of stable funding > 100%
Required amount of stable funding
(g) Provisioning norms: The Basel Committee supports the proposal for adoption of
an "expected loss" based measure of provisioning, which captures actual losses
more transparently and is also less procyclical than the current "incurred loss"
approach, which would also make financial reporting more useful for all
stakeholders, including regulators and supervisors.
(h) The Basel Committee is also enhancing the disclosure norms for banks, making
them more transparent and more comparable.
Huge capital requirement; financing state-owned banks' capital
requirement an issue
Indian banks' current capital levels are comfortable at the aggregate level even under
Basel III, though some individual banks may need to raise capital. Nevertheless, their
capital requirements are expected to increase, as growth accelerates, going forward.
Based on the RBI's quick estimates, the additional capital requirement for the Indian
banking system would be ~INR5t (equity capital of INR1.75t + non-equity capital of
INR3.25t) by FY18. As far as state-owned banks are concerned, a lot will depend on
how much the government contributes. RBI estimates indicate that state-owned banks
may have to raise INR0.7t-1t from the capital markets.
12 September 2012
3

4. Financials | Update
Additional common equity requirements of Indian banks under Basel III (INR b)
Public Sector
Private Sector
Common Equity Requirements of Indian Banks under Basel III
Banks
Banks
Total
Additional Equity Capital Requirements under Basel III
1,400-1,500
200-250 1,600-1,750
Additional Equity Capital Requirements under Basel II
650-700
20-25
670-725
Net Equity Capital Requirements under Basel III (A-B)
750-800
180-225
930-1,025
Of Additional Equity Capital Requirements under Basel III
for Public Sector Banks (A)
Government Share (if present shareholding pattern is maintained)
880-910
Government Share (if shareholding is brought down to 51%)
660-690
Market Share (if the Government’s shareholding pattern
520-590
is maintained at present level)
Note: Assumptions used for calculating capital requirement till 31 March 2018: (1) risk weighted assets of individual banks
will increase by 20% per annum, and (2) internal accruals will be of the order of 1% of risk weighted assets.
Additional
A
B
C
D
RoE likely to be impacted; reducing intermediation cost the key
Improving operating
efficiency and reducing
intermediation cost a
must to negate the
impact of higher cost of
capital
Dr Subbarao mentioned that the profitability (RoE) of Indian banks is likely to remain
under pressure in the short term, once Basel III is implemented, mainly due to higher
cost of equity capital - Basel III lays higher emphasis on core equity capital and leverage
gets constrained. However, the expected benefits arising out of a more stable and
stronger banking system will largely offset the negative impact of lower RoE, in the
medium to long term. Moreover, the Governor pointed out that with NIM remaining
high at ~3% levels, there is scope for banks to improve operating efficiency and reduce
cost of financial intermediation. This would help to achieve better returns, negating
the impact of higher cost of capital.
Rationale for adopting Basel III considering less complex financial system
in India
As India integrates with the rest of the world (Indian banks are going abroad and
foreign banks are coming to India), we cannot afford to have a regulatory deviation
from global standards.
 The 'perception' of a lower standard regulatory regime will put Indian banks at a
disadvantage in global competition, especially because the implementation of
Basel III is subject to a 'peer group' review, whose findings will be in the public
domain.
 Deviation from Basel III will also hurt Indian banks in actual practice, as Basel III
provides for improved risk management systems.

Rationale for higher capital requirement, leverage ratio and early
implementation
Higher capital requirement: To address any judgmental error in capital adequacy,
wrong application of standardized risk weights, misclassification of asset quality, etc.
Moreover, Indian banks have not been subjected to Pillar-2 capital requirement under
Basel II, and hence, higher capital requirements would address any potential concerns
related to undercapitalization of risky exposures.
12 September 2012
4

5. Financials | Update
The RBI's prescription for Indian banks under Basel III is more stringent than global peers
RBI has prescribed
stringent core Tier I ratio
of 5.5% (v/s 4.5% by Basel
committee) and leverage
ratio of 4.5% (v/s 3% by
Basel committee) during
parallel run till
March 2018
Minimum Regulatory Capital Prescriptions
(as % of risk weighted assets)
Basel III
RBI Prescription
(as on Jan 01, Current Basel III (as on
2019) Basel II
Mar 31, 2018)
A = B+D Minimum Total Capital
8.0
9.0
9.0
B
Minimum Tier 1 Capital
6.0
6.0
7.0
C
of which, Minimum Common Equity Tier 1 Capital
4.5
3.6
5.5
D
Maximum Tier 2 Capital (within Total Capital)
2.0
3.0
2.0
E
Capital Conservation Buffer (CCB)
2.5
2.5
F = C+E Minimum Common Equity Tier 1 Capital + CCB
7.0
3.6
8.0
G = A+E Minimum Total Capital + CCB
10.5
11.5
H
Leverage Ratio (ratio to total assets)
3.0
4.5
Overall capital ratio requirement
Despite the RBI's
stringent prescription
towards capital
requirement, overall
capital ratio remains low
as compared with some
other Asian economies
Indian banks are already
at 4.5% leverage ratio at
the aggregate level it is
prudent not to dilute this
'comfortable' position
Country
Basel III
India
Philippines
Singapore
China
South Africa
Min. Common Equity Ratio
(incl. Capital Conservation Buffer)
7.0
8.0
8.5
9.0
7.5
9.0
Min. Total Capital Ratio (%)
10.5
11.5
12.5
12.5
10.5
12.5
Higher leverage ratio: The RBI has prescribed leverage ratio of 4.5% (22x tier-I capital)
v/s the Basel Committee recommendation of 3% (33x tier-I capital). Indian banks are
already at 4.5% leverage at the aggregate level and the RBI believes it is prudent not
to dilute this 'comfortable' position during the parallel run to Basel III. The RBI will
finalize the ratio after the Basel Committee comes out with the final leverage ratio.
Early implementation: The RBI has agreed to start the implementation as per the
internationally agreed date of 1 January 2013. However, the end date has been
advanced from the internationally agreed 31 December 2018 by nine months to 31
March 2018, as 31 March 2019 would have overshoot the Basel III prescription by three
months and would have attracted adverse notice.
Key challenges in implementation of Basel III
One of the major challenges of Basel III is to identify the inflexion point in an
economic cycle, which should trigger the release of the counter-cyclical buffer.
 The RBI strongly believes that there is need for building capacity within the banks,
and also within the RBI, to efficiently implement Basel III.

12 September 2012
5

6. Financials | Update
Dr K C Chakrabarty, Deputy Governor, RBI on PSL Guidelines
Focused approach on priority sector; banks should improve intermediation



Dr K C Chakrabarty
Deputy Governor - RBI


Dr Chakrabarty used the platform of FIBAC 2012 to clarify the RBI's thought process on
the revised priority sector guidelines and allay some of the apprehensions raised by
bankers.
Providing timely and adequate credit to deserving but underprivileged sections of the
society remains a top priority for the RBI, and this is at the core of the new priority sector
guidelines.
The declining share of agriculture in GDP, and thus, lack of absorption capacity cannot be
accepted as a valid reason for prescribing lower targets, as agriculture generates livelihood
for almost two-third of India's population. Moreover, this sector does not have recourse
to other sources; the inherent weakness in the cooperative structure restricts its ability
to cater to this segment.
The RBI has largely maintained the targets and sub-targets within priority sector loans
(PSLs), as it did not want to distort the allocation of credit by banks.
On-lending to NBFCs/HFCs is not classified as PSL - banks need to lend directly (instead of
relying on NBFCs/ HFCs), reduce intermediation cost, and provide the benefit of lower
cost directly to customers.
Basic philosophy for framing new priority sector guidelines
Banks to undertake
priority sector lending
(PSL) as part of their
normal business
operations and it should
not be viewed by them as
CSR activity
The RBI expects banks to
lend directly to
beneficiaries instead of
routing loans through
intermediaries
Priority sectors are those sectors of the economy, which though viable and
creditworthy, may not get timely and adequate credit in the absence of this special
dispensation. Sectors that are able to get timely and adequate credit should not
qualify for priority sector status. The focus of the guidelines is on direct agricultural
lending to individuals, self help groups (SHGs) and joint liability groups (JLGs).
 The RBI expects banks to undertake priority sector lending (PSL) as part of their
normal business operations and it should not be viewed by them as CSR activity.
The RBI has made an important facilitation in this regard - the pricing of all credit
has been made free.
 The RBI expects banks to lend directly to beneficiaries instead of routing loans
through intermediaries. This will ensure better risk management and reduce
transaction costs for such loans.
 The RBI wants banks to create innovative structures, products and processes - they
should be willing to take risks and innovate.

Declining contribution to GDP no reason to prune agricultural lending targets
There is an argument that the share of agriculture in India's GDP is very low and there
is not enough absorption capacity for agricultural credit. Hence, the target for direct
agricultural lending is on the higher side. However, the RBI believes that the declining
share of agriculture in GDP cannot be accepted as a valid reason for prescribing lower
targets, as agriculture generates livelihood for almost two-third of India's population.
It is also critical for ensuring food security and poverty alleviation. Moreover, this
sector does not have recourse to other sources of finance such as equity, commercial
paper, etc. The inherent weakness in the cooperative structure restricts its ability to
cater to this segment.
12 September 2012
6

7. Financials | Update
The contribution of Agriculture to India's GDP has declined steadily (%)
Even though share of
agriculture in GDP has
decline it still employees
almost 2/3rd of India's
population
Source: RBI
Only about 46.3% of
Small and Marginal
farmers have access to
credit
According to the 'Situation Assessment Survey of Farmers' conducted as a part of the
59th round of National Sample Survey (January-December 2003), the estimated
number of rural households in India was 147.9m, of which 60.4% were farmer
households. Of these, 74.97m households were small and marginal farmer households
(SFMFHs). Of the 74.97m SFMFHs, only about 46.3%, i.e. 34.7m farmer households
had access to credit. The most important source of credit for farmers, in terms of
percentage of outstanding loan amount, was banks (36%), followed by money lenders
(26%). This indicates that a vast majority of farmers are still deprived of credit from
formal financial institutions. Dependence on usurious moneylenders continues to
afflict the rural poor.
PSL target for foreign banks with more than 20 branches increased to 40%
Based on the Nair Committee recommendations, in the revised priority sector
guidelines, the RBI has adopted a graded approach in fixing priority sector targets for
foreign banks. Smaller banks with less than 20 branches have a target of 32% and
those with 20 or more branches have been mandated to attain a target of 40% within
five years.
Eliminate the regulatory
arbitrage by prescribing
targets similar to Indian
banks
12 September 2012
Rationale: Several foreign banks with large presence in India have shown keen interest
in actively participating in the India growth story. The RBI wishes to eliminate the
regulatory arbitrage by prescribing targets similar to Indian banks. Moreover, the RBI
also strongly believes that foreign banks are likely to play an important role in bringing
innovation, expertise and alternate delivery models, which will provide credit in a
cost effective manner to agriculture and rural areas. Hence, the RBI wants to encourage
foreign banks to open branches in rural areas and take steps to promote financial
inclusion.
7

8. Financials | Update
Important changes in new PSL guidelines and rationale for the same
Linking the pricing to the
base rate ensures greater
transparency in pricing
and ease of monitoring
Direct lending improves
credit monitoring and
reduces transaction costs
Change: According to the revised guidelines, banks will be allowed to continue
classifying their investments in securitised assets and outright purchases, where the
underlying assets qualify for PSL status, under respective categories of PSL. However,
the pricing for the ultimate beneficiary has been capped at base rate plus 8%.
Rationale: Linking the pricing to the base rate ensures greater transparency in pricing
and ease of monitoring. The ceiling on pricing, in contrast to the general freedom
given to the banks in pricing loans, is because a free market still does not exist for the
poor, and hence, pricing is prone to distortions.
Change: In the final revised guidelines, bank loans to NBFCs (other than MFIs including
NBFC-MFIs) for on-lending remain ineligible for classification under PSL. However,
loans through MFIs (including NBFC-MFIs), which adhere to the criteria prescribed by
the RBI, have been given PSL status.
Rationale: The RBI wants banks to lend directly to achieve priority sector targets and
not go through any intermediaries, as direct lending improves credit monitoring and
reduces transaction costs. However, it has allowed PSL status for MFI on-lending, as
credit is going to the most vulnerable sections of the society and low income groups
of the population.
Change: Banks' on-lending to HFCs will also not be classified as PSL.
Rational: As on-lending to NBFCs is not considered as PSL, there is no logic to treat
bank loans to HFCs for on-lending, as PSL. Further, being financial intermediaries,
banks need to lend directly instead of relying on NBFCs/HFCs.
Change: In the earlier guidelines, housing loans up to INR2.5m were categorized as
PSL irrespective of the location. However, as per the revised guidelines, loans up to
INR2.5m for housing in metro centers with population above 1m and INR1.5m at other
centers would be treated as PSL.
Rationale: This measure is expected to fine tune the disbursal of need-based housing
loans in all centers.
Change: Bank financing of agriculture through non-financial intermediaries such as
primary agricultural credit societies (PACS), farmers' service societies (FSS) and largesize adivasi multi-purpose societies (LAMPS) ceded to or managed or controlled by
such banks, has also been treated as direct agricultural lending v/s indirect earlier.
Rationale: This dispensation would facilitate direct agricultural finance by banks that
do not have wide presence in rural areas, and which would otherwise have struggled
to meet the targets.
Change: Additional services are included with a rider of credit exposure fixed at
INR10m.
Rationale: While the services sector is contributing around 67% of our economy,
services and personal loans received only 23.6% and 18.4%, respectively of bank credit.
There is a mass of people residing in the interiors that is willing to provide security to
obtain credit, but is not getting the credit. Providing loans to these segments,
particularly for productive purposes, will help in tackling the problem of retail inflation.
12 September 2012
8

9. Financials | Update
Credit flow to the services sector has improved, but needs to improve further (%)
and personal loans
Providing loans to retail
and services segment, for
productive purposes, will
help in tackling the
problem of retail
inflation
Source: RBI
Change: As per the revised guidelines, investments made by banks in securitized
assets originated by NBFCs, where the underlying assets were loans against gold
jewelry, and purchase/ assignment of gold loan portfolio from NBFCs, do not qualify
for PSL status.
Rationale: Such pool of loan assets against gold jewelry is generally extended by
NBFCs without proper credit appraisal and without verification of end use of funds.
Some special scrutiny by the RBI has confirmed this aspect, and hence, they do not
qualify for PSL status.
Other changes
Credit to institutions for agriculture purpose is treated as indirect financing now
 Credit to food and agro processing industries is treated as MSE loans, now

12 September 2012
9

10. Financials | Update
Panel discussion on Infrastructure Financing
Huge long-term opportunity, though major challenges exist



The panel discussion mainly revolved around the major issues/challenges currently faced
by the Indian Power/Infrastructure sector and plausible options to resolve the same.
While the opportunity size in the Infrastructure sector remains huge, structural changes
(led by strong political will) are required to make the sector attractive once again.
Reviving the investment cycle is crucial for a country like India, which starves for
infrastructure development.
Panelists





Mr Santosh B Nayar, DMD & Group Executive (Corporate Banking), State Bank of
India
Mr N G Yao Loong, ED, Financial Markets Strategy Department, Monetary Authority
of Singapore
Mr Vikram Limaye, Deputy MD, IDFC
Mr K V Srinivasan, CEO, Reliance Commercial Finance
Mr A Subbarao, Group CFO, GMR Group
India's Infrastructure sector could offer USD1t opportunity
Funding requirement of
12th Plan more than
double of 11th Plan
Despite huge investments in the Infrastructure sector over the past few years, India
remains starved of basic infrastructure across the length and breadth of the country.
Initial estimates indicate funding requirement of ~USD1t for the 12th plan, more than
double of what was envisaged for the 11th plan. The opportunity remains huge across
segments such as Power, Roads, Telecom, Railways, Ports, etc.
Power: Per capita power consumption, 2010 (kWh)
Funding requirement for infrastructure in 12th plan (USD b)
Source: BCG Presentation at FIBAC 2012
12 September 2012
10

11. Financials | Update
Projected infrastructure investment in 12th plan (USD b)
Power and roads will
continue to be a key
focus area even in 12th
plan
Source: BCG Presentation at FIBAC 2012
Sources of funds during the first three years of 11th plan
Source: BCG Presentation at FIBAC 2012
However, there are major challenges ahead, which could impede growth
Apart from the contagion
effect of the global
macroeconomic
slowdown, a number of
issues faced by India's
Power/Infrastructure
sector are self-inflicted
12 September 2012
While the Indian Infrastructure sector offers huge growth opportunity, the sector is
currently reeling under several pressures, led by multiple macro and regulatory
factors. Apart from the contagion effect of the global macroeconomic slowdown, a
number of issues faced by India's Power/Infrastructure sector are self-inflicted. These
can be resolved provided there is political will.
Recent events like the failure of the power grid, concerns relating to fuel supply for
power developers, delay in environment clearances for power plants, and government
inaction / policy logjam raise serious concerns about the political will to sort out
issues of national importance and are hampering the investment cycle, which is critical
for the infrastructure development of the country.
11

12. Financials | Update
The panelists raised some of the key issues impacting the growth of the sector and
considered suggestions that could put the sector back on track. They are:
Delays in obtaining clearances
One of the major concerns today is delays in environmental and other procedural
clearances, which have delayed several infrastructure projects.
Either state government
should be accountable or
central government
should centralize the
clearance process
Suggested solution: The state should be made accountable for providing timely
clearances (land acquisition, environmental, etc) that are required for any project.
Alternatively, the government should centralize the clearance process and set a
timeline within which all clearances should be provided.
Meeting the huge investment need for infrastructure development could
be a challenge
The 12th plan envisages funding requirement to the tune of ~USD1t. However the
uncertainty surrounding the Infrastructure sector and government inaction could lead
to challenges in meeting this humongous funding requirement. Moreover, with
bankers and other financial institutions becoming more risk averse, new alternative
channels for funding this requirement need to be developed.
Suggested solution: (a) Further easing of ECB norms to allow higher inflow of foreign
capital, (b) Deepening of domestic bond market, (c) Channelizing long-term insurance
and pension funds into the sector, and (d) Allowing more tax-free instruments and
creating an organized retail bond market to channelize household savings into longterm productive sectors rather than into gold purchases.
Shortage of skilled labor
Another major issue faced by developers is the shortage of skilled labour. As a result,
construction work at many sites is undertaken without the supervision of any engineer.
This leads to deterioration in the quality of construction and thereby projects
developed are of inferior quality.
Suggested solution: The boom in the IT and services sector has led to shortage of
engineers in this field. The panelists suggested that the government needs to take
appropriate steps to promote vocational studies and also needs to create awareness
about career opportunities associated with this field.
Conclusion: While a host of issues impacting the Infrastructure sector were raised
and plausible resolutions were discussed, the course ahead for the Indian
infrastructure sector will be contingent on reform measures by the government.
Financiers and infrastructure developers on the panel unanimously agreed that
the government needs to take some serious steps to revive the sector; otherwise,
there could be serious implications on the macroeconomic growth of the country.
12 September 2012
12

13. Financials | Update
Panel discussion on SME Financing
Banks reluctant to lend due to high risk perception; huge opportunity



The panel discussion revolved around the need to increase bank lending to SMEs, as the
segment is an important contributor to the GDP and a major employer. Though the
opportunity is huge, banks (especially private banks) are reluctant to lend to SMEs due to
higher risk perception.
Corporate governance is a key issue that needs to be resolved. Greater cooperation from
financiers (increased support in documentation) coupled with awareness about special
schemes launched by SIDBI (with support from the government) could help increase
flows to this segment.
While delinquency may be high in the SME segment, risk-adjusted margins (given higher
yield on loans) are higher than in the large corporate segment. This coupled with tapping
of huge cross-selling opportunities could make this segment highly profitable.
Panelists






Mr M Narendra, CMD, Indian Overseas Bank
Mr N K Maini, DMD, SIDBI
Mr M K Nag, CGM-SME, State Bank of India
Mr Arun Thukral, MD, CIBIL
Mr Pranav Chawda, MD and Head - SME, Citi
Mr Sachin Nigam, Senior Director, SME Ratings, CRISIL
Private sector banks reluctant to lend to SMEs; NBFCs grabbing market share
Availability of funds is one of the challenges for SMEs. In the last three years,
bank loans to the SME/mid-corporate segment have grown at a CAGR of just ~13%,
as compared to 18% CAGR in overall loans and 25%+ CAGR in the large corporate
segment.
 While the share of state-owned banks in overall loans is ~75%, it is 90%+ in case of
SME financing, which indicates higher reluctance of private banks in lending to
this segment.
 NBFCs have sensed the opportunity in the segment, and their share in incremental
SME financing has increased to 20-30% in the last five years. However, pent-up
demand for funds still remains high and there exists an opportunity for banks to
accelerate growth in this segment.

While the share of stateowned banks in overall
loans is ~75%, it is 90%+
in case of SME financing
BCG survey: Most SMEs dissatisfied with speed of credit and pricing
Growth in SMEs / mid-corporate segment
% of respondents satisfied
Large
Medium
Small
Source: BCG Presentation at FIBAC 2012, RBI
12 September 2012
13

14. Financials | Update
Risks higher in SME segment, but risk-adjusted margins superior
Lack of proper
documentation,
corporate governance,
lower risk management
capabilities,
concentration risk etc are
some of the
disinclination for SME
lending
Reluctance to lend / risk of default is higher in the SME segment due to (1) Lack of
proper information in terms of historical income and balance sheet statements, (2)
Issues related to corporate governance, (3) Lower risk management capabilities
(volatility in forex, raw material prices, etc), and (4) Higher dependence on health of
large corporate segment (e.g. elongation of working capital cycle could impact cash
flows and increase risk of default).
While all panelists agreed that the risk of defaults in is higher in the SME segment,
some panelists pointed out that the risk is already embedded in the yields on loans
and that the risk-adjusted margins are higher in the SME segment than in the large
corporate segment. Further, there is a huge opportunity to cross-sell, which would
make the business proposition attractive.
SBI's perspective on SME lending
SBI has reported higher stress in the mid-corporate and SME segments in the last 5-6
quarters, with GNPA increasing to 9.3% (3.5% in FY11) and 7.2% (5.3% in FY11),
respectively as at June 2012. It has initiated various steps to mitigate risk and increase
fund flows to the sector.
Higher stress visible in SME and mid-corporate segment
As a consequence growth has moderated and the
contribution as a % of portfolio has been coming down
(as a % of loans)
GNPA (%)
Source: Company, MOSL
Steps initiated by SBI to mitigate risk
CGTMSME scheme,
channel financing etc are
some of the initiatives
taken by SBIN
12 September 2012
1. SBI has made it mandatory to register loans (without taking collateral) below
INR10m under CGTMSME scheme (retail trade and some other loans are, however,
not covered under it), which provides insurance at a nominal rate of one percent.
2. In channel financing, SBI has entered into agreements with many large industrial
houses and dealers, under which if a dealer defaults, the industrial house would
cancel the dealership. This has deterred dealers from defaulting on their loan
payments.
14

15. Financials | Update
SBI is channelizing efforts to increase delivery
Specialized SME
branches, dedicated
relationship manager etc
are the steps taken by
SBIN to improve flow of
credit to SME
In last two years, SBI has revamped its delivery channels by identifying 600
branches as specialized SME branches to increase focus on the SME segment and
achieve better risk management.
 It has mapped its existing branches to SME clusters to offer prompt and better
service. It has also deputed 500 relationship managers (RMs) for mid-corporate
accounts (credit limit of INR10m and above) and 300 RMs for SME accounts (to
increase further) to increase focus on this segment. The steps taken have resulted
in increased credit flow, which would be visible in future quarters.

Steps taken by SIDBI to increase fund flow to SME segment
With the support of the government, SIDBI has launched a scheme called
'CGTMSME' under which it guarantees the insurer (fee of 1% of outstanding loans),
to make good the loss incurred by the lender up to 75-85% of the loan facility in
case the borrower fails to discharge its liabilities.
 Till now, SIDBI has registered 0.85m accounts with value of INR420b. However,
SIDBI is of the view that there is lack of awareness/utilization of the benefits of
such schemes. Greater awareness/utilization within banks could further improve
growth in the SME segment.
 SIDBI has introduced risk-based capital, where it infuses equity/quasi-equity into
companies to promote them.
 The government has allocated INR50b in the last budget. Given the challenges in
the economic environment, it has also proposed to utilize INR10b of these funds
for the turnaround of companies that are just about to fall sick.

Conclusion: All the panelists unanimously agreed that SME segment would remain
an integral part of the Indian economy and financial assistance by banks would
help them prosper, and in turn, support domestic growth. However, risk associated
with the segment will continue to be a hindrance. To increase flow of funds into
this segment there is a need for collaboration between SME (increased
transparency, proper documentation, better risk management) and the financers
(greater role in advisory and financial management). Financing constraints may
prevail in the near and medium term, but increased awareness of new schemes
launched by SIDBI (e.g. SBIN took the benefit of CGTMSME scheme) and support by
the government (announcement of some policy measures) could partially ease the
situation.
12 September 2012
15

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