With limited differentiation on the product side, the pricing power of banks, especially large banks, could continue to diminish, according to India Ratings and Research (Ind-Ra). Similar pressure can be witnessed on the liability side, it added.
The credit rating agency observed that with deposit yields being largely comparable, the key differences lie in the rates offered for different tenors.
"Once the economy settles, the credit costs are also likely to stabilise. In that environment, operating costs could play a major differentiator among public sector banks (PSBs) and private sector banks and, to some extent, within those groups," said Jindal Haria, Director, Ind-Ra.
Indian banks spent Rs 2.76 lakh crore in FY19 on running their operations of which about 50 per cent was non-employee related. Ind-Ra, in a study, observed that both PSBs and private banks generally show divergent trends on many expense items under the head of non-employee operating costs.
However, some banks in both groups standout with exhibiting lower linearity between these costs and business growth.
Banks’ operating expenses increased over FY15-FY19
The total operating expenses of the banking system increased to 1.88 per cent of average assets in FY19 from 1.73 per cent in FY15. "This seems counter-intuitive as the pace of technological adoption would have driven one to think that the cost would have declined over the years," the agency noted in the study.
Public sector banks (PSBs) have seen a decline in their branches and ATMs over FY18-FY19 with over 5 per cent annual ATM count decline and 2 per cent annual decline in branches.
The study showed that the employee costs of the banking system declined marginally to 0.93 per cent of average assets in FY19 from 0.96 per cent in FY15 while non-employee operating costs increased to 0.95 per cent of average assets from 0.77 per cent.
The State Bank of India (SBI), Punjab National Bank and Union Bank fare better on this count compared to other PSBs.
Amongst private banks, Axis Bank, HDFC Bank, Kotak Mahindra Bank and Federal Bank have seen a decline in non-employee operating costs as a percentage of assets while ICICI Bank and IndusInd Bank have seen a marginal increase, the study said.
Ind-Ra observed that the banks that are doing better on this metric, in all probability, see economies of scale, benefits of the digital technology adoption and lower growth in per unit operating cost and as a consequence, better returns.
Private Banks get more Value for their money
The study said despite increasing the number of branches by 37 per cent over FY15-FY19, private banks spent 31 per cent of their non-employee operating costs on physical infrastructure, while PSBs spent 45 per cent with 1.2 per cent growth in the number of branches over the same period.
The unit cost of physical infrastructure is actually lower for PSBs at Rs 37 lakh per annum against Rs 68 lakh for private banks.
During the period FY15-FY19, the rental cost of unit infrastructure for private banks was about 58 per cent higher than that of PSBs while the growth in the rental cost for a unit infrastructure was 11 per cent for private banks and 26 per cent for PSBs.
Private Banks spend more on attracting customers
According to Ind-Ra, in FY19, private banks spent 8 per cent of non-operating employee costs on advertising, sales and promotion, direct marketing and communication while PSBs spent 3 per cent on the similar activities.
In fact, PSBs’ expenditure on these heads declined from 6 per cent in FY15 while that for the private banks declined from 9 per cent. This impact again magnifies as private banks’ non-employee operating costs are at 1.4 per cent of average assets while it is 0.75 per cent for PSBs, the study said.
Audit and legal expenses inverse for PSBs and Private Banks
Surprisingly, private banks spent cumulatively Rs 70 crore on auditor’s fees and expenses in FY19 while PSBs spent Rs 980 crore which, on the face of it, is disproportionate given that private sector banks constitute only 32 per cent of total banking assets, the agency said.
"Considering the asset quality of PSBs is weaker than that of private banks, it is surprising that the PSBs spend 1 per cent of their non-employee operating expenses on legal aspects while private banks spend 2 per cent. This may imply that private banks are expending more on efforts to recover their assets," the agency noted.
PSBs’ have to realign their strategy
Contrary to popular belief, private sector banks are spending more on physical infrastructure, marketing and legal expenses that relate to building catchments for business and recovering loans.
PSBs play an important role in implementing financial inclusion policies of the government and hence some of the infrastructure (that they are required to set up) may be a drag on the profitability, the agency said.
However, spending on systems and processes, marketing, on-boarding customers to use digital channels and reducing reliance on branches, etc may be charged to the profit and loss account but practically are investments that will result in lower costs in the medium-to-long term, it added.
Reducing branch sizes systematically, tightening rental agreements will also give some benefits to PSBs from the operating costs point of view.
The agency said, "A young banking customer, if he or she goes to branches at all, may give importance to the look and feel of the branches and customer service; these renovation and maintenance expenses play a role in attracting the customers.
"As the 10 PSBs amalgamate into four, it provides these banks a holistic opportunity to rework their non-employee operating cost framework," it added.