Nature and extent of diversification in Indian banking sector.
Arora, Sangeeta ; Sidhu, Shubpreet Kaur
[ILLUSTRATION OMITTED]
Introduction
Diversification in the banking sector has emerged from a host of
considerations. Elimination of the unevenness of the geographical reach,
stimulation of product process innovation, diversification of risk etc.
are some such considerations. The term "Diversification" is
characterized by the concept of multi dimensionality. As per Ansoff
(1957,1958) diversification commonly refers to "entering new market
with new products". According to Rumelt (1974) diversification
strategy as a firms "commitment to diversity per se, together with
the strengths, skills or purpose that span this diversity, shown by the
way in which business activities are related to one another'.
(Rumelt 1974: 29). Banks adopt diversification move as a part of growth
strategy. They may go for expansion via diversifying geographically
or/and via product market diversification. i.e., by adding new products
and business lines. Broadly, banking industry may adopt diversification
route in the following forms;-
1) Vertical or horizontal integration to create diversified
financial group
2) Alliance diversification via joint ventures, tie-ups etc.
Before discussing the nature of diversification in banks, a brief
discussion is given on the underlying relationship between the three
important segments of financial markets. i.e., commercial banks,
insurance and investment business. This relationship provides a base for
diversification of banking activities and integrating these three
different businesses. Investment and insurance business generally
finance a growing volume of assets and do not have adequate capital
base. In such situations commercial banks can provide a substantial
capital base. Also, commercial bank's branch wide network can
provide scope to investment and insurance business for the distribution
of their financial products like mutual funds, debentures, policies etc.
Moreover, as in the present scenario when the proportion of bank credit
in corporate debt is declining. The banks are increasingly turning
turned to new, non-traditional financial activities as a way of
maintaining their position as financial intermediaries . Integration of
all the three business in the form of diversified financial group can
play a compensatory role. But inspite of this significant relationship
these three businesses require varying business skills and operational
skills. There is also a difference in attitude towards risk. Commercial
banks avoid risk, insurance business aims to cover risk while investment
banks specialize in risk management. Moreover, these three business have
different approach towards customers. Therefore, these factors have to
be kept in consideration, while integrating and diversifying the banking
operations.
Rationale Behind Diversification
During the second half of the 1990s many Indian banks have indeed
adopted universal banking structures (in different forms and degrees) as
a strategic response to increased competition in both domestic as well
as global market. Bank s pursue diversification move for variety of
reasons which may both be proactive and defensive. Disintermediation in
commercial banking in combination with new capital adequacy rules and
narrowing interest margins led to an increased pressure on the banks
profitability. In response, commercial banks are diversifying by moving
towards generating income from nontraditional sources like fee and fund
based services. Beside this, Diversification in the banking sector has
emerged from a host of considerations. Diversification helps a bank in
eliminating the unevenness of geographical reach, product-process
innovation, exploit economies of scale and scope, reap benefit of
advanced technology, diversify risk along with mobilization of
additional capital. Diversification has opened the door for commercial
banks to earn fee income from investment banking, merchant banking,
insurance agency, securities brokerage, and other nontraditional
financial services. Ali- Yrkko (2002), classifies the banks' motive
to diversify as synergy (or economic) motive, managerial motive, value
maximization motive, increased market power motive, capital strength and
risk diversification motives etc. Determinants of diversification can be
categorized into two categories. External determinants such as Economies
of Scale and Scope, Dynamics of bank Competition, Global presence of
Financial Conglomerates and Disintermediation in banking activities.
While the internal determinants include risk reduction motive, decline
in interest margin, cost of production, low cost of capital, technology
upgradation etc.
In this paper an attempt is made to study the nature and extent of
diversification in Indian banking sector. The paper has been structured
as follows. In the beginning, a brief introduction and rationale for
diversification in banks is given. Section I deals with research
methodology .In Section II, nature and extent of diversification in
banks is studied. Degree of diversification is empirically measured in
section III. This is followed by results and implications for the
banking sector.
Section I
The objective of this paper is to analyze the
1) Nature and Extent of Diversification in the Indian Banking
Sector
2) To Measure the Degree of Diversification in Indian Banks.
Research Methodology and Data Source
The purpose of the first part of this research paper is to study
the pattern of diversification followed by banks in India and to analyze
the extent to which they are diversified in respect of their operation
and location. For this, it is required to differentiate between
diversified banks from non-diversified banks. In the present study,
those banks will be included in the definition of diversified banks,
which have at least one insurance subsidiary or investment institution
or both. These may be in the form of a subsidiary, joint venture or in
any other mode such as alliance distribution etc. Second objective of
the study is to measure the degree of diversification in banks. The
degree of diversification is a measure of the diversity status of the
bank and gives an indication how diversified a bank is. The entropy
index prescribed by (Jacquemin and Berry, 1979) will be used to measure
the degree of diversification. The present study will be focused to
Indian banking sector only and analysis will be restricted to all the
public and private sector banks excluding foreign sector and regional
rural sector banks. Foreign sector banks are excluded from the study
because most of these banks are well diversified. Moreover they have a
minor presence in India in the form of a representative office or a
branch office. For instance, Bank of America has a maximum of only 13
branches operating in India.
Database of Banks
Data used for the paper is secondary in nature. Data is collected
from several sources which include database provided by Reserve Bank of
India, Indian Bankers Association, Prowess and Capitaline
software's. The data on bank-specific variables have been extracted
from the statistical tables relating to banks in India, an annual
publication of the Reserve Bank of India (RBI), which provides bank-wise
information on balance sheet as well as profit and loss indicators.
Section II
Banking sector practices a wide range of organization structures to
expand their business. To study the Nature and Extent of Diversification
in Banks , the approach developed by Ramanujam and Varadarajan(1987)
will be used. In their study, the authors have used a two dimensional,
categorical measure of firm diversity that builds on the work of Berry
(1971) and Wood (1971). Wood (1971) has defined two patterns of
diversification i.e., NSD (Narrow Spectrum Diversification) and BSD
(Broad Spectrum Diversification). These two types of categorizations
will be used with little variation along with a third category that is
AD (Alliance Diversification). This is a common diversification strategy
used in service sector. For the purpose, following definitions will be
used to study nature and extent of diversification in Indian banking
sector.
* BSD(unrelated product diversification)--Broad Spectrum
Diversification refers to expansion other than vertical integration into
a different four-digit business. i.e., into a different non-banking
business like merchant banking, factoring etc.
* NSD(related product diversification)--Narrow Spectrum
Diversification refers to expansion through vertical integration into
similar banking business through banking subsidiaries.
* AD- Alliance Diversification refers to expansion of banking and
non banking through tie-ups, joint ventures.
* BSD (Broad Spectrum Diversification) and UB (Unrelated Business)
* NSD (Narrow Spectrum Diversification) and RB (Related Business)
* AD (Alliance Diversification)
Figure 1 shows the nature of diversification in Indian banking
sector. In respect of public sector banks in India, out of a total of 21
banks, 12 banks are diversified and 9 banks are non diversified as on
31st March 2008. This includes IDBI ltd (other public sector bank) which
is a well diversified bank. State Bank of India, has adopted both BSD
(Broad spectrum diversification) move and NSD (Narrow spectrum
diversification) move along with AD(Alliance diversification). It has
six banking subsidiaries and four non banking subsidiaries along with
many foreign subsidiaries. SBI has entered a number of new businesses
with strategic tie ups - Pension Funds, General Insurance, Custodial
Services, Private Equity, Mobile Banking, Point of Sale, Mergers and
Acquisition, Advisory Services, Structured Products etc. Bank of Baroda
is another bank which has adopted all the three moves for
diversification. In NSD, it has one associate bank i.e., Nanital Bank
and several subsidiaries dealing with banking and non banking business.
It has diversified into areas of merchant banking, housing finance,
credit cards and mutual funds as a move to become a one stop financial
supermarket. Banks like Canara bank, Central Bank of India, Corporation
Bank, Allahbad bank have diversified through BSD move. Canara Bank has
been scaling up its market position to emerge as a major 'Financial
Conglomerate' with nine subsidiaries/sponsored institutions/joint
ventures in India and abroad. While Allahbad bank Instituted AllBank
Finance Ltd., a wholly owned subsidiary for Merchant Banking. Andhra
Bank , Canara Bank, Indian Bank and Punjab and Sind Bank have started
diversification move through AD .i.e., Alliance Diversification. Andhra
Bank entered MoU with Bank of Baroda and Legal and General Group of UK
to form a joint venture life insurance company.
In case of Private sector banks, old private sector banks are not
diversified at all, while most of the new generation private sector
banks are highly diversified. HDFC Bank, ICICI Bank, Indusind Bank,
Kotak Mahindra Bank and ING Vysya Bank are categorized as banks that
have followed BSD (Broad spectrum Diversification) and AD (Alliance
Diversification) to expand their banking and non banking products and
services. HDFC Bank's target market ranges from large, blue-chip
manufacturing companies in the Indian corporate to small and mid-sized
corporate and agri-based businesses. The bank provides a wide range of
commercial and transactional banking services, including working capital
finance, trade services, transactional services, cash management, etc.
ICICI Bank is India's second-largest bank in India. ICICI Bank
offers a wide range of banking products and financial services to
corporate and retail customers through a variety of delivery channels
and through its specialized subsidiaries and affiliates in the areas of
investment banking, life and non-life insurance, venture capital and
asset management. Most of these banks are diversifying through Broad
Spectrum diversification, either through their own non-banking
subsidiaries such as securities houses or insurance companies or have
become heavily involved in product sales such as bancassurance or mutual
funds etc. In private sector banks, UTI Bank and Yes bank are not
diversified and are dealing in single banking business only.
Section III
Measurement of Degree of Diversification
To measure the degree of diversification numerous methods like
Entropy measure(Jacquemin and Berry, 1979) Concentric Index, and
Herfindhal Index have been used in the litreature of strategic and
financial management. However , entropy measure "quantified as a
continuous one" has remained widely used as a measures for
diversification. The entropy measure is attractive, it is argued,
because it takes into account "two elements of diversification: (i)
the number of segments in which a firm operates, and (ii) the relative
importance of each of the segments in the total sales" reviewed
(Palepu, 1985). The entropy measure of a firm's diversification is
defined as "a weighted average of a firm's diversification
within sectors" (Jacquemin and Berry, 1979, p. 362), "a
weighted average of the shares of the segments" (Palepu, 1985, p.
252). The weight is assumed to be the logarithm of the inverse of the
proportion of total business in each segment (Chatterjee and Blocher,
1992). The higher this index, the more diversified the bank is.
Enropy measure = [n.summation over (i=1)] [P.sub.i] where [Pi] is
the proportion of total operations within segment I,n is number of
segments in which the bank operates.
In the table below, diversification index for banking groups namely
SBI (State Bank of India and associates), NBs (National banks) and Pvt
banks(New Generation Private Bank)* operating in India is computed for
the time period between 1994 to 2007.This time period is selected
because most banks have started diversification moves after the
implementation of economic and financial sector reforms of 1991. From
these respective groups income of those banks which are not
diversified(as shown in table 1) is excluded as they operate in single
banking business. For computing Pi i.e, proportion of 'income from
diversified operation and services', Income from other sources i.e,
income from other than interest income is computed. Income from other
sources consist of commission, exchange and brokerage, net profit (loss)
on sale of land, building and other assets, net profit (loss) on
exchange transaction, miscellaneous income, net profit (loss) on sale of
investments, net profit (loss) on revaluation of investments, is taken.
By using the entropy index of Jacqueimin and Berry (1979),
diversification index of banking sector operating in India is computed.
As shown in the table 1, in the year 1994-1995, diversification
level is highest in SBI (0.529) followed by National banks (.4099). It
the least i.e, (0.223) in private sector banks. This was the period when
new generation private sector banks were being setup . By 1995-96, a
total of nine private sector banks were in operation. Over this period,
index of private banks have increased continuously indicating that these
banks started to rely more on diversified source of income that is on
"other income". Diversification index of state bank of India,
over the time period of 1994 to 2006 remained the highest with six
banking subsidiaries and a number of non banking subsidiaries and joint
ventures. In the year 2007, the diversification index of private banks
rose to 0.516 which is even higher then SBI group followed by national
banks. In respect of national banks, a mixed trend is seen in their
diversification index.
Conclusion
To conclude, the study reveals that out of a total sample of 48
banks operating in India consisting of public and private sector banks,
18 banks are diversified while majority of banks i.e, 30 banks are not
diversified. But it is significant to mention that the non diversified
banks hold very less proportion in term of market and asset size
signifying that the bigger banks have gone in for diversification. The
trend towards diversification in banks is found higher in respect of
public sector banks as12 public sector banks are diversified while out
of private sector banks, only new generation banks are diversified. SBI
has emerged as one of the well diversified bank by venturing into number
of banking and non banking business through subsidiaries, joint ventures
and tie-ups. In second part, degree of diversification in banks is
measured by using entropy index of diversification. Diversification
index of State Bank of India has remained highest over the time period
of 1994 to 2006. While private sector banks have started diversification
move in 1994-1995 with their emergence. On an average as per entropy
measure they have become more diversified from the year 2000 onwards
with index at 0.403 and reaching upto as high as 0.516 in 2007. The
diversification index of National Banks shows a fluctuating trend. This
shows that even though only new generation private sector banks have
diversified but their degree of diversification is higher than national
banks.
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Table--I
Measure of Diversification in Indian Banks (Entropy measure)
Year SBI N B Pvt. Bank
1994 0.529644 0.4099 0.223
1995 0.526056 0.4151 0.281
1996 0.53017 0.3286 0.408
1997 0.529484 0.3274 0.436
1998 0.521502 0.3275 0.383
1999 0.528029 0.3280 0.359
2000 0.522042 0.3294 0.403
2001 0.524283 0.3296 0.372
2002 0.499872 0.3221 0.443
2003 0.501679 0.4256 0.487
2004 0.512042 0.3231 0.457
2005 0.512246 0.3542 0.458
2006 0.509631 0.4301 0.487
2007 0.464591 0.3286 0.516
Figure--I
Measure of Diversification in Indian Banks (Entropy measure)
S. BANKS DIVERSIFIED NON DIVERSIFIED
No. BANKS BANKS
BSD NSD AD
I Public Sector Banks
1. State Bank of India ***** **** ****
and Associates UB RB RB & UB
2. Allahbad bank ****
UB
3. Andhra Bank ****
RB
4. Bank of Baroda **** **** ****
UB RB RB
5. Bank of India **** ****
UB RB & UB
6. Bank of Maharastra ****
ND
7. Canara Bank **** ****
UB RB & UB
8. Central Bank of India ****
UB
9. Corporation bank ****
UB
10. Dena Bank ****
ND
11. Indian Bank **** ****
UB UB
12. Indian Overseas Bank ****
ND
13. Oriental bank of ****
Commerce N D
14. Punjab & Sind Bank ****
UB
15. Punjab National bank ****
UB
16. Syndicate Bank ****
ND
17. Uco Bank ****
ND
18. Union Bank of India ****
ND
19. United Bank of India ****
ND
20. Vijaya Bank ****
ND
II Other Public Sector Bank
21. Idbi Ltd. ****
UB
III Private Sector Banks
22. Bharat Overseas ****
Bank ND
23. City Union Bank Ltd ****
ND
24. Development ****
Credit Bank ND
25. Karnataka Bank ****
ND
26. Lord Krishna Bank ****
ND
27. Nainital Bank ****
ND
28. SBI Commercial & ****
International Bank RB
29. Tamilnad ****
Mercantile Bank ND
30. The Bank of ****
Rajasthan Ltd. ND
31. The Catholic Syrian ****
Bank Ltd. ND
32. The Dhanlaxmi ****
Bank Ltd. ND
33. The Federal Bank Ltd ****
ND
34. The Ganesh Bank ****
of Kurundwad Ltd ND
35. The Jammu & ****
Kashmir Bank Ltd. ND
36. The Karur Vysya ****
Bank Ltd ND
37. The Laxmi Vilas ****
Bank Ltd ND
38. The Ratnakar ****
Bank Ltd ND
39. The Sangli Bank Ltd ****
ND
40. The South Indiian ****
Bank Ltd ND
41. The United Western ****
Bank Ltd ND
42. Hdfc Bank Ltd **** ****
UB UB
43. Icici Bank Ltd **** ****
UB UB
44. Indusind Bank Ltd **** ****
UB UB
45. Kotak Mahindra **** ****
Bank Ltd UB UB
46. Uti Bank Ltd ****
ND
47. Yes Bank Ltd. ****
ND
48. Ing Vysya Bank Ltd. **** ****
UB UB
Total No. of Banks 14 3 13 30
